[Federal Register Volume 67, Number 89 (Wednesday, May 8, 2002)]
[Proposed Rules]
[Pages 31081-31096]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-11228]



  Federal Register / Vol. 67, No. 89 / Wednesday, May 8, 2002 / 
Proposed Rules  

[[Page 31081]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-25557, File No. S7-13-02]
RIN 3235-AI28


Transactions of Investment Companies With Portfolio and 
Subadvisory Affiliates

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing amendments to rules under the Investment Company Act of 1940 
to expand the current exemptions for investment companies (``funds'') 
to engage in transactions with ``portfolio affiliates''--companies that 
are affiliated with the fund solely as a result of the fund (or an 
affiliated fund) controlling them or owning more than five percent of 
their voting securities. The Commission is also proposing one new rule 
and several rule amendments to permit funds to engage in transactions 
with subadvisers of affiliated funds. The proposals respond to the 
growth of investment companies and changes in the organization of 
funds; they are designed to permit transactions between funds and 
certain affiliated persons under circumstances where it is unlikely 
that the affiliate would be in a position to take advantage of the 
fund.

DATES: Comments must be received on or before July 19, 2002.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW, Washington, DC 20549-0609. Comments also may be submitted 
electronically to the following e-mail address: [email protected]. 
All comment letters should refer to File No. S7-13-02; this file number 
should be included on the subject line if E-mail is used. Comment 
letters will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW, Washington, 
DC 20549. Electronically submitted comment letters also will be posted 
on the Commission's Internet Web site (http://www.sec.gov.) \1\
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    \1\ We do not edit personal, identifying information, such as 
names or E-mail addresses, from electronic submissions. Submit only 
information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: William C. Middlebrooks, Jr., 
Attorney, or Martha B. Peterson, Special Counsel, at (202) 942-0690, 
Office of Regulatory Policy, Division of Investment Management, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
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DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today 
is requesting public comment on proposed rule 17a-10 [17 CFR 270.17a-
10] and proposed amendments to rules 10f-3 [17 CFR 270.10f-3], 12d3-1 
[17 CFR 270.12d3-1], 17a-6 [17 CFR 270.17a-6], 17d-1 [17 CFR 270.17d-
1], and 17e-1 [17 CFR 270.17e-1] under the Investment Company Act of 
1940 [15 U.S.C. 80a] (``Investment Company Act'' or ``Act''). \2\
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    \2\ Unless otherwise noted, when we refer to rules 10f-3, 12d3-
1, 17a-6, 17d-1, or 17e-1, or any paragraph of those rules, we are 
referring to the following sections of the Code of Federal 
Regulations in which each of these rules is published: 17 CFR 
270.10f-3, 17 CFR 270.12d3-1, 17 CFR 270.17a-6, 17 CFR 270.17d-1, or 
17 CFR 270.17e-1 respectively.
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Table of Contents

I. Discussion
    A. Portfolio Affiliates
    1. Second-tier Affiliates
    2. Financial Interests
    3. Percentage Limits on Investment in Joint Enterprise
    B. Subadviser Affiliates
    1. Principal Transactions with Subadvisers: Section 17(a)
    2. Transactions With Subadvisers as Brokers: Section 17(e)
    3. Purchases During Primary Offering Underwritten by 
Subadvisers: Section 10(f)
    4. Ownership of Securities Issued by Subadvisers: Section 
12(d)(3)
II. General Request for Comment
III. Cost-Benefit Analysis
    A. Benefits
    1. In General
    2. Portfolio Affiliates
    3. Subadvisory Affiliates
    B. Costs
    1. Portfolio Affiliates
    2. Subadvisory Affiliates
    C. Request for Comment
IV. Consideration of Promotion of Efficiency, Competition, and 
Capital Formation
V. Paperwork Reduction Act
    A. Portfolio Affiliates
    B. Subadviser Affiliates
    C. Request for Comments
VI. Summary of Initial Regulatory Flexibility Analysis
VII. Statutory Authority Text of Proposed Rules

I. Discussion

    The Investment Company Act restricts a wide range of transactions 
and arrangements involving investment companies (``funds'') \3\ and 
their affiliated persons. These restrictions lie at the heart of the 
Act, and are designed to prevent affiliated persons from managing the 
fund's assets for their own benefit, rather than for the benefit of the 
fund's shareholders.\4\ Affiliated persons of a fund include (i) its 
investment adviser and any subadvisers, (ii) companies the fund 
controls or five percent (or more) of whose securities are held by the 
fund (``portfolio affiliates''), (iii) persons who control the fund, 
and (iv) persons who are under common control with the fund.\5\ Many of 
the restrictions on transactions and arrangements with fund affiliates 
apply not only to affiliated persons of the fund (``first-tier'' 
affiliates), but also to affiliated persons of those persons (``second-
tier'' affiliates).\6\
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    \3\ We use the term ``fund'' throughout this release to refer to 
registered investment companies, series of registered investment 
companies that are series companies, and business development 
companies, which are unregistered investment companies.
    \4\ See Investment Trusts and Investment Companies: Hearings on 
S. 3580 Before a Subcomm. of the Senate Comm. On Banking and 
Currency, 76th Cong., 3d Sess. 37 (1940) (Statement of Commissioner 
Healy).
    \5\ The Act defines an ``affiliated person'' of another person 
as (A) any person directly or indirectly owning, controlling, or 
holding with power to vote, five percent or more of the outstanding 
voting securities of such other person; (B) any person five percent 
or more of whose outstanding voting securities are directly or 
indirectly owned, controlled, or held with power to vote by such 
other person; (C) any person directly or indirectly controlling, 
controlled by, or under common control with such other person; (D) 
any officer, director, partner, copartner, or employee of such other 
person; (E) if such other person is a fund, any investment adviser 
of the fund or any member of its advisory board; and (F) if such 
other person is an unincorporated fund, not having a board of 
directors, the depositor of the fund. 15 U.S.C. 80a-2(a)(3). The 
term ``control'' means the power to exercise a controlling influence 
over the management or policies of a company, unless such power is 
solely the result of an official position with such company. Any 
person who owns beneficially, either directly or through one or more 
controlled companies, more than 25 percent of the voting securities 
of a company is presumed to control such company. 15 U.S.C. 80a-
2(a)(9).
    \6\ A fund's investment adviser is, for example, a first-tier 
affiliate of the fund. A company that owns five percent of the 
voting securities of the fund's investment adviser is a second-tier 
affiliate of the fund. The prohibitions of the Act extend to second-
tier affiliates to make those prohibitions more difficult to 
circumvent. See Investment Trusts and Investment Companies: Hearings 
on S. 3580 Before a Subcomm. of the Senate Comm. On Banking and 
Currency, 76th Cong., 3d Sess. 261 (1940) (Statement of David 
Schenker).
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    Provisions of the Act and our rules restricting transactions or 
arrangements with affiliated persons include:
     Section 17(a), which prohibits affiliated persons of a 
fund from borrowing money or other property from, or selling or buying 
securities or other property to or from the fund, or any company that 
the fund controls;\7\
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    \7\ 15 U.S.C. 80a-17(a). The prohibition in section 17(a) also 
extends to promoters and principal underwriters for the fund and 
persons affiliated with the promoters and principal underwriters. 
Section 17(a) was recently amended to make it unlawful for a first-
or second-tier affiliate to lend money or other property to a fund, 
or a company controlled by a fund, in contravention of such rules, 
regulations, or orders as the Commission, after consultation with 
and taking into consideration the views of the Federal banking 
agencies (as defined in section 3 of the Federal Deposit Insurance 
Act [12 U.S.C. 1813]), issues consistent with the protection of 
investors. 15 U.S.C. 80a-17(a)(4) (effective May 12, 2001). The 
Commission has not yet issued any rules or orders under this 
section. Section 17(a) applies to transactions between, among 
others, a fund and its portfolio affiliates. SEC v. General Time, 
407 F.2d 65, 68 (2d Cir. 1968); Talley Industries, Inc., Investment 
Company Act Release No. 5953 (Jan. 9, 1970).

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[[Page 31082]]

     Section 17(d), and rule 17d-1 thereunder, which prohibit 
affiliated persons of a fund from participating with the fund in any 
joint enterprise or other joint arrangement or profit-sharing plan;\8\
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    \8\ Section 17(d) of the Act makes it unlawful for first- and 
second-tier affiliates of a fund, the fund's principal underwriters, 
and affiliated persons of the fund's principal underwriters, acting 
as principal, to effect any transaction in which the fund or a 
company controlled by the fund is a joint or a joint and several 
participant ``in contravention of such rules and regulations as the 
Commission may prescribe for the purpose of limiting or preventing 
participation by such registered or controlled company on a basis 
different from or less advantageous than that of such other 
participant.'' 15 U.S.C. 80a-17(d). Rule 17d-1(a) prohibits first- 
and second-tier affiliates of a fund, the fund's principal 
underwriter, and affiliated persons of the fund's principal 
underwriter, acting as principal, from participating in or effecting 
any transaction in connection with any joint enterprise or other 
joint arrangement or profit-sharing plan in which any such fund or 
company controlled by a fund is a participant ``unless an 
application regarding such joint enterprise, arrangement or profit-
sharing plan has been filed with the Commission and has been 
granted.'' Section 17(d) and rule 17d-1 apply to joint transactions 
of funds and, among others, their portfolio affiliates. SEC v. 
Talley Industries, 399 F2d 396, 402 (2d Cir. 1968).
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     Section 10(f), which prohibits a fund from purchasing 
securities in a primary offering if certain affiliated persons of the 
fund are members of the underwriting or selling syndicate;\9\
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    \9\ 15 U.S.C. 80a-10(f).
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     Section 17(e), which limits the remuneration that 
affiliated persons of a fund may receive in transactions involving the 
fund, and companies that the fund controls; and\10\
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    \10\ Section 17(e)(1) of the Act prohibits an affiliated person 
acting as agent from accepting any compensation from any source 
(other than a regular salary or wage from a fund) for the purchase 
or sale of property to or for the fund, or companies controlled by 
the fund, except in the course of the person's business as an 
underwriter or broker. Section 17(e)(2) of the Act limits the 
remuneration that a person may receive when acting in reliance on 
section 17(e)(1)'s exemption for the brokerage business. 15 U.S.C. 
80a-17(e).
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     Section 12(d)(3) and rule 12d3-1, which together prohibit 
a fund from acquiring securities issued by, among others, its own 
investment adviser.\11\
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    \11\ Section 12(d)(3) of the Act generally prohibits any fund, 
and any company or companies controlled by a fund, from purchasing 
or acquiring any security issued by or any other interest in the 
business of any person who is a broker, a dealer, is engaged in the 
business of underwriting, or is either an investment adviser of an 
investment company or an investment adviser registered under the 
Investment Advisers Act of 1940. 15 U.S.C. 80a-12(d)(3), referring 
to 15 U.S.C. 80b. Rule 12d3-1 provides an exemption from this 
general prohibition, but the exemption does not extend to the 
acquisition of a general partnership interest or a security issued 
by the acquiring company's investment adviser, promoter, or 
principal underwriter, or any affiliated person of such investment 
adviser, promoter, or principal underwriter. See rule 12d3-1(c).
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    Since 1940, the number of persons who are either first-tier or 
second-tier affiliates of a fund has grown markedly for a number of 
reasons. First, as funds have grown larger, they are more likely to own 
positions in excess of five percent of the voting securities of an 
issuer, creating ``portfolio affiliates.'' \12\ Second, many funds 
today use subadvisers to help manage fund assets, making each 
subadviser an affiliate of the fund and persons affiliated with each 
subadviser second-tier affiliates of the fund.\13\ Third, most funds 
are today organized into complexes under the common control of an 
adviser (or other person), making each fund an affiliated person of all 
of the other funds in the complex.\14\ When multiple funds with 
subadvisers and portfolio affiliates are under common control, the 
number of potential first- and second-tier affiliated persons can be 
quite large.\15\
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    \12\ Average assets per fund grew from $346 million in 1990 to 
$852 million in 2000. Investment Company Institute, Mutual Fund Fact 
Book 63 (2001) (``ICI Fact Book''). Schedule 13D and 13G Reports [17 
CFR 240.13d-101 and 13d-102] (reporting ownership of more than five 
percent of the voting stock of a security traded on an exchange) by 
funds grew during the same period from 510 (reporting ownership by 
approximately 65 funds in 450 issuers) to 1,378 (reporting ownership 
by 190 funds in 875 issuers).
    \13\ Of the approximately 9,700 portfolios of open-end and 
closed-end investment companies reporting information on Form N-SAR 
[17 CFR 274.101] during the first six months of 2001, approximately 
1,900 reported using at least one subadviser, and 520 reported using 
two or more subadvisers.
    \14\ In 2000 there were 431 fund complexes. ICI Fact Book, supra 
note 12, at 63. Funds in a fund complex are under the common control 
of an investment adviser or other person when the adviser or other 
person exercises a controlling influence over the management or 
policies of the funds. 15 U.S.C. 80a-2(a)(9). See supra note 5. Not 
all advisers control the funds they advise. The determination of 
whether a fund is under the control of its adviser, officers, or 
directors depends on the relevant facts and circumstances. See 
Investment Company Mergers, Investment Company Act Release No. 25259 
(Nov. 8, 2001) [66 FR 57602 (Nov. 15, 2001)] at n.11. Throughout 
this release we presume that the funds in a fund complex are under 
common control as funds that are not affiliated persons will not 
require and thus will not rely on most of the proposed exemptions. 
The exception is the exemption for transactions restricted by 
section 10(f) of the Act, which we describe in section I.B.3.
    \15\ For example, in a fund complex with five funds controlled 
by a single investment adviser, if each fund has one subadviser and 
one portfolio affiliate, then every fund would have seven first-tier 
affiliates (one adviser, one subadviser, one portfolio affiliate, 
and four affiliated funds) and eight second-tier affiliates (four 
subadvisers of affiliated funds and four portfolio affiliates of 
affiliated funds).
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    The growth in the number of first-tier and second-tier affiliates 
of funds has resulted in an increasing number of persons with whom 
funds may not enter into transactions or arrangements under the Act. 
Many of these affiliated persons, however, have neither the ability nor 
the incentive to take advantage of the fund.\16\ Accordingly, we have 
issued a number of exemptive orders permitting transactions when we 
have determined that the exemption is in the public interest, and 
consistent with the protection of investors and the purposes of the 
Act.\17\
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    \16\ For example, in a fund complex where multiple funds are 
under common control but are managed by different subadvisers, each 
subadviser is a first-tier affiliate of any fund that it advises, 
and a second-tier affiliate of all of the other funds. The 
restrictions on affiliate transactions apply to dealings between a 
fund and the subadvisers that are its second-tier affiliates even if 
the fund's own subadviser is a business competitor of the second-
tier affiliate subadvisers.
    \17\ These orders have been issued pursuant to our authority 
under sections 6(c), 10(f), and 17(b) of the Act. 15 U.S.C. 80a-
6(c), 80a-10(f), and 80a-17(b). See, e.g., CDC IXIS Asset Management 
Advisers, L.P., Investment Company Act Release Nos. 25061 (July 12, 
2001) [66 FR 37497 (July 18, 2001)] (notice) and 25103 (Aug. 8, 
2001) (order); Frank Russell Investment Co., Investment Company Act 
Release Nos. 24820 (Jan. 3, 2001) [66 FR 2031 (Jan. 10, 2001)] 
(notice) and 24847 (Jan. 30, 2001) (order); SEI Investments 
Management Corporation, Investment Company Act Release Nos. 24430 
(Apr. 28, 2000) [65 FR 26246 (May 5, 2000)] (notice) and 24463 (May 
23, 2000) (order); North American Security Trust, Investment Company 
Act Release Nos. 18860 (Jul. 22, 1992) [57 FR 33540 (Jul. 29, 1992)] 
(notice) and 18899 (Aug. 18, 1992) (order); State Street Bank and 
Trust Co., Investment Company Act Release Nos. 19784 (Oct. 13, 1993) 
[58 FR 53983 (Oct. 19, 1993)] (notice) and 19844 (Nov. 9, 1993) 
(order).
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    We are today proposing one new rule and revisions to several 
current rules that would codify the terms of many of these orders.\18\ 
The proposed rule and rule amendments are designed to permit funds to 
engage in transactions and arrangements with affiliated persons that 
are not likely to raise the concerns that the Act was intended to 
address.\19\
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    \18\ We are also taking this opportunity to redraft in plain 
English the rules that permit funds to enter into transactions and 
arrangements with their portfolio affiliates.
    \19\ Today's proposal responds, in part, to a rulemaking 
petition submitted by the Investment Company Institute to the 
Commission in December 1998 (``ICI Petition''). A copy of that 
petition is available in the Commission's Public Reference Room, 450 
5th Street, NW, Washington, DC (File No. S7-13-02). In November 2000 
we proposed to amend rule 10f-3 to expand the exemption provided by 
the rule to permit a fund to purchase government securities in a 
syndicated offering. See Exemption for the Acquisition of Securities 
During the Existence of an Underwriting or Selling Syndicate, 
Investment Company Act Release No. 24775 (Nov. 29, 2000) [65 FR 
76189 (Dec. 6, 2000)]. We are reproposing certain aspects of the 
rule 10f-3 proposal in this Release, and are adopting other aspects 
of that proposal in a companion release that we are issuing today. 
See Exemption for the Acquisition of Securities During the Existence 
of an Underwriting or Selling Syndicate, Investment Company Act 
Release No. 25560 (April 30, 2002).

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[[Page 31083]]

A. Portfolio Affiliates

    Rules 17a-6 and 17d-1(d)(5) permit a fund and its portfolio 
affiliates to engage in principal transactions and enter into joint 
arrangements that would otherwise be prohibited by section 17(a), or by 
section 17(d) and rule 17d-1(a). Under the rules, a fund may enter into 
a principal transaction or a joint arrangement with a portfolio 
affiliate, or an affiliated person of a portfolio affiliate, as long as 
certain other affiliated persons of the fund (e.g., the fund's adviser, 
persons controlling the fund, and persons under common control with the 
fund) (``Prohibited Participants'') are not parties to the transaction 
and do not have a financial interest in a party to the transaction.\20\
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    \20\ The rules were designed to exempt transactions and 
arrangements from the prohibitions of section 17 when neither the 
parties to the transaction, nor any person with a financial interest 
in a party to the transaction, has the potential to overreach the 
investment company. See Investment Company Act Release No. 10698 
(May 17, 1979) [44 FR 29908 (May 23, 1979)].
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1. Second-Tier Affiliates
    Rules 17a-6 and 17d-1(d)(5) give broad exemptions that permit 
transactions and arrangements involving a fund and its own portfolio 
affiliates, but do not extend to identical transactions or arrangements 
involving portfolio affiliates of funds under common control with the 
fund. As a result, a fund may be able to enter into a transaction or 
arrangement with its own portfolio affiliate (a first-tier affiliate), 
but not with a portfolio affiliate of another fund in the same complex 
(a second-tier affiliate).\21\
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    \21\ Thus, for example, under current rule 17a-6 a fund whose 
first-tier portfolio affiliate merges with another company in which 
the fund invests may receive shares of the acquiring company (in 
exchange for its shares of the acquired company) in connection with 
the merger. However, the rule does not permit an identical 
transaction in which the acquiring company is an affiliated person 
of another fund in the fund complex. See Longleaf Partners Funds 
Trust, SEC Staff No-Action Letter (Apr. 9, 2001).
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    Fund complexes and series companies were relatively uncommon when 
we amended rules 17a-6 (in 1964) \22\ and 17d-1(d)(5) (in 1974) \23\ to 
permit funds to engage in principal transactions and joint arrangements 
with their portfolio affiliates.\24\ Transactions and arrangements 
between a fund and its second-tier portfolio affiliates do not appear 
to raise concerns that are different from those raised by transactions 
and arrangements between a fund and its first-tier portfolio 
affiliates. Therefore, we are proposing to amend rules 17a-6 and 17d-1 
to permit a fund to engage in principal transactions or enter into 
joint arrangements with its second-tier portfolio affiliates under the 
same conditions as with first-tier portfolio affiliates.\25\
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    \22\ We adopted rule 17a-6 in 1961 to provide small business 
investment companies licensed by the United States Small Business 
Administration with an exemption from section 17(a)(1) and section 
17(a)(3) for certain transactions with their portfolio affiliates. 
Investment Company Act Release No. 3361 (Nov. 17, 1961) [26 FR 11238 
(Nov. 29, 1961)]. We amended the rule in 1964 to exempt from section 
17(a) additional persons and transactions, including transactions 
involving all other types of investment companies and their 
portfolio affiliates that were ``non-public'' companies, and again 
in 1979 to extend the rule to transactions with portfolio affiliates 
that are public companies. Investment Company Act Release Nos. 3968 
(Apr. 29, 1964) [29 FR 6152 (May 9, 1964)] and 10828 (Aug. 13, 1979) 
[44 FR 48657 (Aug. 20, 1979)].
    \23\ We amended rule 17d-1 in 1974 to permit joint transactions 
under conditions similar to those imposed by rule 17a-6. Adoption of 
Amendment to Rule 17d-1 Under the Investment Company Act of 1940 
Exempting Certain Joint Transactions Involving Registered Investment 
Companies, Including SBIC Stock Option Plans, From the Application 
Requirements of the Rule, Investment Company Act Release No. 8542 
(Oct. 15, 1974) [39 FR 37971 (Oct. 25, 1974)].
    \24\ In 1958 there were only five ``multi-fund'' open-end 
investment companies (series companies) and 29 ``multi-company 
groups'' (fund complexes). Wharton School of Finance and Commerce, A 
Study of Mutual Funds, H.R. Rep. No. 2274, 87th Cong., 2d Sess. 6, 
42 (1962). As recently as 1980 few management investment companies 
were organized as series companies and there were only 120 fund 
complexes. ICI Fund Fact Book, supra note 12, at 63; Securities and 
Exchange Commission Annual Report for 1980, 48th Annual Report. In 
2000, approximately 1,400 management investment companies were 
organized as series companies (with 7,000 portfolios) and there were 
approximately 430 fund complexes. ICI Fund Fact Book, supra note 12, 
at 63; Reports on Form N-SAR [17 CFR 274.101].
    \25\ Proposed rules 17a-6(a) and 17d-1(d)(5).
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    We request comment on our proposal to expand the exemptive relief 
provided in rules 17a-6 and 17d-1(d)(5). Do arrangements and 
transactions with second-tier portfolio affiliates raise investor 
protection issues not present in arrangements and transactions with 
first-tier portfolio affiliates? If so, should exemptive relief for 
transactions and arrangements involving second-tier portfolio 
affiliates be subject to any additional conditions?
2. Financial Interests
    As discussed above, our exemptions for transactions or arrangements 
with portfolio affiliates are unavailable if certain other affiliated 
persons have a ``financial interest'' in a party to the transaction 
(other than the fund).\26\ Our rules do not explain what constitutes a 
``financial interest'' in a party. Instead, the rules provide a list of 
interests that are deemed not to be ``financial interests.''\27\
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    \26\ Rules 17a-6(a)(5)(ii) and 17d-1(d)(5)(i).
    \27\ Rules 17a-6(b)(1) and 17d-1(d)(5)(iii).
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    We are concerned that the rules, as currently drafted, do not (and 
cannot) anticipate every remote or minor interest in a party to a 
transaction, and thus they may prohibit many transactions with 
portfolio affiliates even though the affiliated person's financial 
interest is unlikely to present an incentive for overreaching the fund. 
We are therefore proposing to amend rules 17a-6 and 17d-1(d)(5) to 
provide that, in addition to the interests currently deemed not to be 
``financial interests,'' the term ``financial interest'' does not 
include any interest that the fund's board of directors, including a 
majority of the directors who are not interested persons of the fund, 
finds to be not material.\28\
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    \28\ Proposed rules 17a-6(b)(1)(i)(H) and 17d-1(d)(5)(ii)(A)(8). 
Our proposed amendments would also require that the directors record 
the basis for their finding in the minutes of the board's meeting. 
Id.
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    We are also proposing to amend our rules to make them consistent 
with one another with regard to the time period for which a Prohibited 
Participant's financial interest will result in loss of the rules' 
exemption.\29\ Under the proposed amendments, the exemptions under both 
rules 17a-6 and 17d-1(d)(5) will be available unless a Prohibited 
Participant (i) has a financial interest in a party at the time of the 
fund's participation in the transaction or arrangement, (ii) had a 
financial interest in a party within the six months preceding the 
fund's participation, or (iii) will obtain a financial interest in a 
party pursuant to an arrangement in existence at the time of the fund's 
participation.\30\
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    \29\ Rule 17a-6 is not available if a Prohibited Participant 
``has, or within six months prior to the transaction had * * * or 
pursuant to an arrangement will acquire'' a financial interest in a 
party to the transaction. Rule 17a-6(a)(ii). Rule 17d-1(d)(5) is not 
available if a Prohibited Participant ``is, was or proposes to be'' 
a participant in the joint enterprise through a financial interest 
in a person ``who is, was or will be'' a participant in the joint 
enterprise. Rule 17d-1(d)(5)(i).
    \30\ Proposed rules 17a-6(b)(1)(ii) and 17d-1(d)(5)(ii)(B). Rule 
17d-1(d)(6) includes references to the Prohibited Participants 
identified in current rule 17d-1(d)(5)(i) and to the definition of 
``financial interest'' in current rule 17d-1(d)(5)(iii). We are 
proposing to amend rule 17d-1(d)(6) to conform these references to 
rule 17d-1(d)(5) as proposed to be amended.

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[[Page 31084]]

    We request comment on our proposed amendments regarding the 
financial interests of Prohibited Participants. Should Prohibited 
Participants be permitted to have an interest in parties to the 
transaction or arrangement if the interest is not material? Should the 
rules provide a standard against which directors should determine 
whether an interest is not material? \31\ If so, what should the 
standard be?
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    \31\ Compare rule 15a-4(b)(2)(v) [17 CFR 270.15a-4(b)(2)(v)] 
(board of directors must find differences between interim advisory 
contract and previous contract to be immaterial) with rule 0-
1(a)(6)(i)(A) [17 CFR 270.0-1(a)(6)(i)(A)] (majority of 
disinterested directors must reasonably determine in the exercise of 
their judgment that any representation of the fund's investment 
adviser, principal underwriter, administrator, or any of their 
control persons, since the beginning of the fund's last two 
completed fiscal years, is or was sufficiently limited that it is 
unlikely to adversely affect the professional judgment of person 
providing legal representation to the disinterested directors).
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3. Percentage Limits on Investment in Joint Enterprise
    A fund, or a company that a fund controls, may commit no more than 
five percent of its assets to a joint enterprise with a portfolio 
affiliate.\32\ When we amended rule 17d-1 to permit funds to engage in 
joint enterprises with portfolio affiliates, we were concerned that a 
fund that committed a significant percentage of its assets to a joint 
enterprise could be susceptible to disadvantage or unfair 
treatment.\33\ As a result, we decided to continue to review those 
transactions by considering exemptive relief on a case-by-case basis. 
There is no comparable limitation for principal transactions with 
portfolio affiliates, however, and it is not clear that the limit 
continues to serve a useful purpose. We therefore are proposing to 
amend rule 17d-1(d)(5) to eliminate the rule's percentage limit.\34\ We 
request comment on this amendment. Is there any specific harm that 
could result from elimination of the limit?
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    \32\ Rule 17d-1(d)(5)(ii) (In a joint enterprise, other than a 
merger of portfolio affiliates, neither a fund nor a company that a 
fund controls may commit in excess of five percent of its assets, 
except that a fund which is licensed by the Small Business 
Administration (SBA) under the Small Business Investment Act of 1958 
may not commit more than 20 percent of its paid-in capital and 
surplus.)
    \33\ See Notice of Proposal to Amend Rule 17d-1 Under the 
Investment Company Act of 1940 to Exempt Certain Joint Transactions 
Involving Registered Investment Companies, Including SBIC Stock 
Option Plans, From the Application Requirements of the Rule, 
Investment Company Act Release No. 8273 (Mar. 14, 1974) [39 FR 11312 
(Oct. 25, 1974)].
    \34\ A fund licensed by the Small Business Administration under 
the Small Business Investment Act of 1958 would, however, still be 
subject to all SBA regulations regarding the percentage of its paid-
in capital and surplus it could commit to a joint enterprise. See 13 
CFR 107.740.
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B. Subadviser Affiliates

    As we discussed above, funds today are typically organized, 
operated, and controlled by an investment adviser that advises a number 
of other funds in a fund complex. That adviser may be assisted by one 
or more subadvisers, which may provide general advisory assistance or 
may manage a discrete portion of the fund's portfolio and have no 
responsibilities with respect to the rest of the fund.\35\ Each 
subadviser is a first-tier affiliate of any fund it advises and a 
second-tier affiliate of each fund in the fund complex that it does not 
advise.\36\ Section 17(a) of the Act prohibits the common adviser (a 
first-tier affiliate) and each fund's own subadviser (a first-tier 
affiliate), as well as each subadviser of the other funds (second-tier 
affiliates) from entering into principal transactions with the 
fund.\37\ Section 17(e) restricts the remuneration the common adviser, 
each fund's own subadviser, and the subadvisers of the other funds may 
receive in transactions involving the fund and companies that the fund 
controls.\38\ Section 10(f) prohibits each fund from purchasing 
securities in any primary offering in which the underwriting or selling 
syndicate includes the common adviser, the fund's own subadviser, or 
any person with which these advisers are affiliated.\39\ Section 
12(d)(3) and rule 12d3-1 prohibit each fund from acquiring securities 
issued by the common adviser or its own subadvisers.\40\
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    \35\ See Benjamin J. Haskin, Hiring and Oversight of Sub-
Advisers, 5 The Investment Lawyer 8, 11 (1998) (describing 
subadvisory arrangements generally).
    \36\ A subadviser is an ``investment adviser'' for purposes of 
the Act, which defines a fund's ``investment adviser'' as a person 
(other than a bona fide officer, director, trustee, member of an 
advisory board, or employee of the fund) who regularly furnishes 
advice to the fund with respect to the desirability of investing in, 
purchasing, or selling securities or other property, or is empowered 
to determine what securities or other property are to be purchased 
or sold by the fund. 15 U.S.C. 80a-2(a)(20). The investment adviser 
may act pursuant to a contract with a fund [15 U.S.C. 80a-
2(a)(20)(A)] or pursuant to a contract with an investment adviser 
that has contracted with the fund. 15 U.S.C. 80a-2(a)(20)(B).
    \37\ The section also prohibits principal transactions between 
the fund and affiliates of the common adviser (second-tier 
affiliates) and affiliates of the fund's own subadviser (second-tier 
affiliates).
    \38\ The prohibition in section 17(e) also extends to affiliates 
of the common adviser and the fund's subadviser.
    \39\ A fund therefore is prohibited from purchasing securities 
in an offering in which a participant in the underwriting or selling 
syndicate is under common control with the fund's adviser.
    \40\ A fund is also prohibited from acquiring securities issued 
by an affiliated person of the common adviser or an affiliated 
person of the fund's subadviser if the affiliated person is a 
broker, dealer, investment adviser, or engaged in the business of 
underwriting.
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    Ordinarily a subadviser has little power to overreach those funds, 
or portions of a fund, with which it is affiliated but which it does 
not advise. We have, therefore, issued a number of orders exempting 
subadvisers and funds from sections 17(a), 17(e), 10(f), and 12(d)(3) 
in order to permit subadvisers to engage in transactions with 
affiliated funds when they are not in a position to influence the 
fund's decision to participate in the transaction.\41\ Today we are 
proposing to codify these orders in one new rule and three rule 
amendments. The new rule and amendments will permit these transactions 
and arrangements to go forward without the expense and delay of 
obtaining an exemptive order from the Commission.
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    \41\ See, e.g., CDC IXIS Management Advisers, L.P. et al., 
Investment Company Act Release Nos. 25061 (July 12, 2001) [66 FR 
37497 (July 18, 2001)] (notice) and 25103 (Aug. 8, 2001) (order); 
AMR Investment Services Trust, et al., Investment Company Act 
Release Nos. 23773 (Apr. 7, 1999) [64 FR 18454 (Apr. 14, 1999)] 
(notice) and 23823 (May 4, 1999) (order); North American Security 
Trust, Investment Company Act Release Nos. 18860 (Jul. 22, 1992) [57 
FR 33540 (July 29, 1992)] (notice) and 18899 (Aug. 18, 1992) 
(order); State Street Bank and Trust Co., Investment Company Act 
Release Nos. 19784 (Oct. 13, 1993) [58 FR 53983 (Oct. 19, 1993)] 
(notice) and 19844 (Nov. 9, 1993) (order).
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1. Principal Transactions With Subadvisers: Section 17(a)
    Section 17(a) of the Act prohibits a subadviser that is a first-or 
second-tier affiliate of a fund from borrowing money or other property 
from, or selling or buying securities or other property to or from the 
fund, or any company that the fund controls.\42\ We are proposing a new 
rule 17a-10 that would permit a subadviser of a fund to enter into 
transactions with (i) funds the subadviser does not advise but which 
are affiliated persons of a fund it does advise (e.g., other funds in 
the fund complex), and (ii) funds the subadviser does advise, but with 
respect to portions of the subadvised fund for which the subadviser 
does not provide investment advice.\43\ The proposed exemption

[[Page 31085]]

would be subject to conditions, discussed below, designed to limit its 
availability to circumstances in which the subadviser is unable to 
influence the management of the fund, or portion of the fund, that 
participates in the transaction (``participating fund'' or 
``participating portion'').
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    \42\ See supra note and accompanying text.
    \43\ This second category of relief would thus be available only 
when a fund has one or more subadvisers that are responsible for 
managing a discrete portion of the fund's assets. The rule would 
permit the adviser of one portion of the fund to direct that portion 
to engage in a principal transaction with the subadviser of another 
portion of the fund's assets. See discussion below.
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    First, the rule would require that the subadvisory relationship be 
the sole reason why section 17(a) prohibits the transaction (e.g., that 
the subadviser not be an affiliated person of the participating fund's 
investment advisers, officers, directors, promoters, or 
underwriters).\44\ Second, the rule would require the participating 
subadviser and any subadviser of the participating fund or portion to 
be prohibited by their advisory contracts from consulting with each 
other concerning securities transactions of the participating fund or 
portion.\45\ These conditions, which have been conditions of our 
exemptive orders permitting subadvisers to engage in principal 
transactions with funds with which they are affiliated, are designed to 
limit the rule's exemption to those transactions in which the 
subadviser has no incentive or ability to influence the investment 
decisions made on behalf of the fund or portion of the fund that 
participates in the transaction.
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    \44\ Proposed rule 17a-10(a)(1).
    \45\ Proposed rule 17a-10(a)(2). We are not proposing to extend 
this condition to the fund's principal adviser, although subadvisers 
and their affiliated persons would be permitted to rely on the rule 
to enter into transactions and arrangements with a fund or portion 
of a fund with respect to which the principal adviser alone provides 
investment advice. We are concerned that in the context of the 
relationship between a principal adviser and a subadviser the 
condition could be interpreted in a manner inconsistent with the 
principal adviser's duty to oversee the conduct of subadvisers. 
Nonetheless, the principal adviser remains a fiduciary of the fund 
and may not collaborate with fund subadvisers for the purpose of 
overreaching the fund.
---------------------------------------------------------------------------

    We are not proposing to prohibit subadvisers and principal advisers 
from consulting with each other, although subadvisers and their 
affiliated persons would be able to enter into affiliated transactions 
and arrangements with a fund (or a portion of a fund) that the 
principal adviser advises. Application of such a condition could 
interfere with the principal adviser's duty to supervise the 
performance of the subadviser.\46\ Nevertheless, the principal adviser, 
as a fiduciary to the fund, could not lawfully collaborate with 
subadvisers for the purpose of overreaching the fund. We request 
comment whether, in light of our decision not to impose a communication 
barrier, we should not permit subadvisers and their affiliates from 
entering into transactions with funds or portions of funds advised by a 
principal adviser.
---------------------------------------------------------------------------

    \46\ See Western Asset Management Co. and Legg Mason Fund 
Adviser, Inc., Investment Advisers Act Release No. 1980 (Sept. 28, 
2001).
---------------------------------------------------------------------------

    We request comment in general on our proposal to permit funds to 
engage in principal transactions with subadvisers (and their affiliated 
persons) that are affiliated with the fund, but which are not in a 
position to influence the fund's conduct. Are the proposed conditions 
sufficient to protect the fund from overreaching or self-dealing by 
subadvisers? Are any of the proposed conditions unnecessary? Should the 
proposed exemption be subject to additional conditions, such as 
conditions that would prevent a subadviser from influencing the 
principal adviser to coordinate the actions of the other subadvisers? 
Is this likely?
2. Transactions With Subadvisers as Brokers: Section 17(e)
    Section 17(e)(2) of the Act generally limits the remuneration that 
a first- or second-tier affiliate of a fund may receive for effecting 
purchases and sales of securities on a securities exchange on behalf of 
the fund, or a company the fund controls, to the ``usual and customary 
broker's commission.''\47\ The limits of section 17(e)(2) apply to 
purchases and sales made on behalf of a fund by the fund's subadviser 
(a first-tier affiliate), affiliates of the subadviser (second-tier 
affiliates), and subadvisers of funds under common control with the 
fund (second-tier affiliates).
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    \47\ Section 17(e)(2) limits the remuneration that any 
affiliated broker of a fund may receive in connection with a 
securities transaction to (A) the usual and customary broker's 
commission for transactions effected on an exchange, (B) two percent 
of the sales price for secondary distribution, and (C) one percent 
of the purchase or sale price for other purchases or sales.
---------------------------------------------------------------------------

    Rule 17e-1 describes the circumstances in which remuneration 
received by an affiliated person of a fund qualifies as the ``usual and 
customary broker's commission.'' The rule, among other things, requires 
that the fund's board of directors review transactions to determine 
that they comply with procedures adopted by the board to ensure that 
the remuneration received by the affiliated person does not exceed the 
usual and customary broker's commission (``review requirement'').\48\ 
In addition, the fund must maintain a record of the transactions 
(``recordkeeping requirement'').\49\ The review and recordkeeping 
requirements of rule 17e-1 were designed to permit fund directors and 
our examinations staff to monitor the reasonableness and fairness of 
remuneration received by affiliated persons of the fund.\50\ We are 
proposing to amend rule 17e-1 to permit an affiliated subadviser of a 
fund to receive remuneration for service as a broker without complying 
with these conditions, in circumstances in which the subadviser has 
very limited ability to influence decisions regarding the purchase and 
sale of fund securities.\51\ Under our proposal, funds would not have 
to comply with rule 17e-1's review and recordkeeping requirements in 
circumstances, and subject to conditions, identical to those in which a 
subadviser could engage in a principal transaction with an affiliated 
fund under proposed rule 17a-10.\52\
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    \48\ Rule 17e-1(a) and (b). The rule also requires that a 
majority of the directors of the fund not be ``interested persons'' 
of the fund, that those directors select and nominate any other 
disinterested directors, and any person who acts as legal counsel 
for the disinterested directors be an independent legal counsel. 
Rule 17e-1(c). Section 2(a)(19) identifies persons who are 
``interested persons'' of a fund. 15 U.S.C. 80a-2(a)(19).
    \49\ Rule 17e-1(d).
    \50\ Agency Transactions by Affiliated Persons on a Securities 
Exchange, Investment Company Act Release No. 10605 (Feb. 27, 1979) 
[44 FR 12202 (Mar. 6, 1979)] at n.10 and accompanying text.
    \51\ Funds are required to retain certain records of brokerage 
orders by or on behalf of the fund. See rule 31a-1(b)(5) [17 CFR 
270.31a-1(b)(5)]. Our proposal is not intended to affect these or 
other recordkeeping requirements not included within rule 17e-1.
    \52\ Proposed rules 17e-1(b)(3) and (d)(2). See supra Section 
I.B.1 (discussing conditions in proposed rule 17a-10).
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    The proposed amendments would relieve funds and subadvisers from 
the review and recordkeeping requirements when the relationship between 
the subadviser and fund is sufficiently remote to make it unlikely that 
the subadviser could directly or indirectly cause the fund to pay an 
unreasonable or unfair commission.\53\ We request commenters to address 
our proposal to exempt brokerage transactions between funds and certain 
affiliated subadvisers from rule 17e-1's review and recordkeeping 
requirements.
---------------------------------------------------------------------------

    \53\ Fund directors may, however, wish to continue to review 
these transactions as a matter of good business practice.
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3. Purchases During Primary Offering Underwritten by Subadvisers: 
Section 10(f)
    Section 10(f) of the Act prohibits a fund from purchasing any 
security during an underwriting or selling syndicate if the fund has 
certain affiliated relationships with a principal underwriter for the 
security.\54\ The

[[Page 31086]]

section protects fund shareholders by preventing an affiliated 
underwriter from placing or ``dumping'' unmarketable securities with 
the fund.\55\ Rule 10f-3 provides an exemption from the prohibition in 
section 10(f) if certain conditions are satisfied.\56\ One of the key 
conditions is that a fund relying on the rule, together with any other 
fund advised by the fund's adviser, purchase no more than 25 percent of 
the offering (``percentage limit'').\57\ The purpose of the percentage 
limit is to provide an indication that a significant portion of the 
offering is being purchased by persons acting independently of the 
adviser. The existence of these purchasers suggests that the price of 
the securities is based on market forces and demonstrates that the 
securities are not being ``dumped.''\58\
---------------------------------------------------------------------------

    \54\ Section 10(f), in relevant part, prohibits a registered 
investment company from knowingly purchasing or otherwise acquiring, 
during the existence of any underwriting or selling syndicate, any 
security (except a security of which the company is the issuer) a 
principal underwriter of which is an officer, director, member of an 
advisory board, investment adviser, or employee of the company, or 
any person of which any of the foregoing are affiliated persons.
    \55\ See Investment Trusts and Investment Companies: Hearings on 
S. 3580 Before a Subcomm. of the Senate Comm. On Banking and 
Currency, 76th Cong., 3d Sess. 35 (1940) (Statement of Commissioner 
Healy); Exemption for the Acquisition of Securities During the 
Existence of an Underwriting or Selling Syndicate, Investment 
Company Act Release No. 24775, supra note 19, at n.4 and 
accompanying text; Exemption for the Acquisition of Securities 
During the Existence of an Underwriting or Selling Syndicate, 
Investment Company Act Release No. 22775 (July 31, 1997) [62 FR 
42401 (Aug. 7, 1997)] at n.1 and accompanying text.
    \56\ Rule 10f-3 permits a fund to purchase securities in a 
transaction that otherwise would violate section 10(f) if, among 
other things: (i) The securities either are registered under the 
Securities Act of 1933 [15 U.S.C. 77a-aa], are part of an issue of 
government securities, are municipal securities with certain credit 
ratings, or are offered in certain foreign or private institutional 
offerings; (ii) the offering involves a ``firm commitment'' 
underwriting; (iii) the fund (together with other funds advised by 
the same investment adviser) purchases no more than 25 percent of 
the offering; (iv) the fund purchases the securities from a member 
of the syndicate other than its affiliated underwriter; (v) the 
fund's directors have approved procedures for purchases under the 
rule and regularly review the purchases to determine whether they 
have complied with the procedures. See rule 10f-3(b).
    \57\ Rule 10f-3(b)(7).
    \58\ See Exemption for the Acquisition of Securities During the 
Existence of an Underwriting or Selling Syndicate, Investment 
Company Act Release No. 24775, supra note 19, at n.22 and 
accompanying text.
---------------------------------------------------------------------------

    When a fund has multiple subadvisers, section 10(f) can limit 
significantly the fund's ability to purchase securities in a primary 
offering.\59\ A fund is subject to the prohibition in section 10(f) if 
any of its subadvisers participate in the underwriting or selling 
syndicate (or are affiliated persons of participants), whether or not 
the subadviser that recommends the purchase is participating. Moreover, 
in order for a fund to rely on the exemption in rule 10f-3, the 
aggregate purchases by all of the funds advised by each of the fund's 
subadvisers (as well as all of the funds advised by the fund's 
principal adviser) must comply with the rule's percentage limit.
---------------------------------------------------------------------------

    \59\ A fund may have multiple subadvisers because more than one 
subadviser has been retained to provide investment advice with 
respect to various portions of the fund. A fund may also have 
multiple subadvisers because the fund is one of several portfolios 
of a series company, and different subadvisers provide investment 
advice with respect to the assets of the different portfolios.
---------------------------------------------------------------------------

    We have issued a number of exemptive orders to permit funds to 
purchase securities during an underwriting or selling syndicate in 
which one of its subadvisers is a participant,\60\ when the adviser 
recommending the purchase is not a participant in the syndicate.\61\ 
These orders also permit a fund to purchase securities in reliance on 
rule 10f-3 without aggregating purchases by portions of the fund 
advised by advisers that are not participants in the syndicate. We 
concluded that, in these circumstances, an exemption from section 10(f) 
is consistent with the protection of investors because a subadviser 
that participates in an underwriting or selling syndicate has little 
opportunity to ``dump'' securities into funds or portions of a fund's 
portfolio that the subadviser does not advise. Moreover, we concluded 
that purchases recommended by an adviser that is not a participant in 
the underwriting (and not influenced by participants in the 
underwriting) should be considered purchases independent of the adviser 
participating in the underwriting. Today we are proposing amendments to 
rule 10f-3 to codify many of the terms of these orders.
---------------------------------------------------------------------------

    \60\ Unless otherwise noted, we will refer to a subadviser that 
is a principal underwriter, or an affiliated person of a principal 
underwriter of a security, as a ``participant'' in the underwriting 
or selling syndicate.
    \61\ See, e.g., CDC IXIS Asset Management Advisers, L.P., 
Investment Company Act Release Nos. 25061(July 12, 2001) [66 FR 
37497 (July 18, 2001)] (notice) and 25103 (Aug. 8, 2001) (order); AB 
Funds Trust, et al., Investment Company Act Release Nos. 24999 (June 
7, 2001) [66 FR 31953 (June 13, 2001)] (notice) and 25054 (June 29, 
2001) (order).
---------------------------------------------------------------------------

    The proposed amendments to rule 10f-3 would deem each of the series 
of a series company and the ``managed portions'' \62\ of a fund 
portfolio (``series'' or ``portion'') to be separate registered 
investment companies for purposes of section 10(f) and rule 10f-3.\63\ 
The amendments would exempt a purchase of securities by an investment 
company from the prohibition in section 10(f), if the purchase would 
not be prohibited if each series or portion were separately 
registered.\64\ The proposed amendments are designed to exempt funds 
from the prohibition in section 10(f) when that prohibition is 
triggered by the participation in an underwriting or selling syndicate 
of a person who is not in a position to influence the fund's investment 
decisions.\65\
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    \62\ A portion of a fund's portfolio would be a ``managed 
portion'' if it is a discrete portion of the portfolio for which a 
subadviser is responsible for providing investment advice, and the 
subadviser (i) does not provide investment advice with respect to 
any other portion of the fund's portfolio, (ii) is prohibited by its 
advisory contract from consulting with any other investment adviser 
of the investment company that is a principal underwriter or 
affiliated person of a principal underwriter concerning securities 
transactions of the fund, and (iii) is not an affiliated person of 
any other investment adviser, or any promoter, underwriter, officer, 
director, member of an advisory board, or employee of the investment 
company. Proposed rule 10f-3(a)(6).
    \63\ Proposed rule 10f-3(b).
    \64\ Id.
    \65\ The proposed amendments to rule 10f-3 would effectively 
permit a fund that is a series in a series company to purchase 
securities during an underwriting or selling syndicate in which an 
officer, director, member of an advisory board, investment adviser, 
or employee of a series other than the purchasing series is (or is 
an affiliated person of) a participant. The proposed amendments 
would also permit a fund to purchase securities during a syndicate 
in which an investment adviser of the fund is (or is an affiliated 
person of) a participant, if the investment adviser does not provide 
investment advice (or have the opportunity to influence investment 
decisions) for the portion of the fund's assets for which the 
securities are purchased.
---------------------------------------------------------------------------

    We are proposing additional amendments to rule 10f-3 that would 
revise the way funds are required to aggregate purchases to determine 
compliance with the percentage limits of rule 10f-3. Currently, a fund 
is required to aggregate all of its purchases with those of any other 
fund advised by its investment adviser.\66\ As a result, a fund that is 
a series must aggregate purchases by all of the other series if the 
fund's subadviser participates in the underwriting, but the fund need 
not aggregate purchases made by, for example, a hedge fund advised by 
the participating subadviser.
---------------------------------------------------------------------------

    \66\ Rule 10f-3(b)(7).
---------------------------------------------------------------------------

    The rule appears to be both too broad (in that in requires 
aggregation of purchases that are not influenced by participants in the 
underwriting) and too narrow (in that it does not require aggregation 
of purchases by accounts controlled by the adviser participating in the 
underwriting). Therefore, we are proposing to amend rule 10f-3 to 
require the aggregation of purchases by funds that are advised, and 
accounts

[[Page 31087]]

that are controlled, by an investment adviser that is a participant in 
the underwriting or selling syndicate.\67\ If multiple investment 
advisers provide investment advice to a fund (e.g., a principal adviser 
and one or more subadvisers) but only one of those advisers is a 
participant in the underwriting or selling syndicate, rule 10f-3's 
percentage limit would apply only to purchases by the funds and 
accounts of the participating investment adviser.\68\ We request 
comment on our proposal to amend rule 10f-3.
---------------------------------------------------------------------------

    \67\ Proposed rule 10f-3(c)(7).
    \68\ Id. If more than one investment adviser of a fund is a 
participant in the underwriting or selling syndicate then the 
percentage limit would apply independently with respect to each such 
investment adviser. Proposed rule 10f-3(c)(7)(iii). The percentage 
limit would not apply at all if a fund is prohibited from purchasing 
a security because a person other than the fund's investment adviser 
(e.g., an officer, director, or employee of the fund) is a 
participant in the underwriting or selling syndicate. Proposed rule 
10f-3(c)(7)(ii).
---------------------------------------------------------------------------

    As discussed above, the proposed percentage limit would encompass 
purchases by the accounts controlled by a fund's investment adviser, as 
well as the funds advised by the adviser. We initially proposed this 
amendment in 2000 because we were concerned that rule 10f-3's 
percentage limit may not provide reliable evidence of a market for the 
security if most or all of the offering is purchased by fund and non-
fund clients of an adviser participating in the underwriting or selling 
syndicate.\69\ While several commenters objected to the proposal, none 
addressed the policy concerns behind the proposal.\70\ We are re-
proposing the amendment today in light of the other changes we are 
proposing to the rule. We request comment on rule 10f-3's percentage 
limit under these circumstances. Do the other changes we are proposing 
to rule 10f-3 warrant further changes in the rule?
---------------------------------------------------------------------------

    \69\ See Exemption for the Acquisition of Securities During the 
Existence of an Underwriting or Selling Syndicate, supra note.
    \70\ Several commenters opposed the proposed amendment on the 
grounds that it could limit funds' access to primary offerings.
---------------------------------------------------------------------------

4. Ownership of Securities Issued by Subadvisers: Section 12(d)(3)
    Section 12(d)(3) of the Act generally prohibits funds, and 
companies controlled by funds, from purchasing securities issued by a 
registered investment adviser, broker, dealer, or underwriter 
(``securities-related businesses'').\71\ Rule 12d3-1 permits a fund to 
invest up to five percent of its assets in securities of an issuer 
deriving more than fifteen percent of its gross revenues from 
securities-related businesses,\72\ but a fund may not rely on rule 
12d3-1 to acquire securities of its own investment adviser or any 
affiliated person of its own investment adviser.\73\ Thus, a fund may 
not acquire securities issued by any of its subadvisers, or their 
affiliated persons.\74\
---------------------------------------------------------------------------

    \71\ With minor exceptions, section 12(d)(3) prohibits a fund 
from purchasing or otherwise acquiring ``any security issued by or 
any other interest in the business of any person who is a broker, a 
dealer, is engaged in the business of underwriting, or is [an] 
investment adviser.''
    \72\ Paragraph (a) of rule 12d3-1 permits a fund to acquire any 
security issued by any person that, in its most recent fiscal year, 
derived 15 percent or less of its gross revenues from securities-
related activities unless the fund would control such person after 
the acquisition. Paragraph (b)(3) of rule 12d3-1 permits a fund to 
invest up to five percent of the value of its total assets in the 
securities of an issuer that derives more than 15 percent of its 
gross revenues from securities-related activities. Rule 12d3-1(d)(1) 
defines ``securities related activities'' as a person's activities 
as a broker, a dealer, an underwriter, an investment adviser 
registered under the Investment Advisers Act of 1940 [15 U.S.C. 
80b], or an investment adviser to a registered investment company.
    \73\ Rule 12d3-1(c) provides that the rule does not exempt the 
acquisition of a security issued by the acquiring company's 
investment adviser, promoter, or principal underwriter, or any 
affiliated person of such investment adviser, promoter, or principal 
underwriter. Rule 12d3-1(d)(8) provides that any class or series of 
an investment company that issues two or more classes or series of 
preferred or special stock, each of which is preferred over all 
other classes or series with respect to assets specifically 
allocated to that class or series, shall be treated as if it is a 
registered investment company. Accordingly, a fund that is a series 
of a series company may rely on rule 12d3-1 to purchase securities 
issued by subadvisers (and persons affiliated with those 
subadvisers) of the other series of the series company.
    \74\ Congress adopted section 12(d)(3) for two purposes: (i) To 
limit the exposure of funds to the entrepreneurial risks peculiar to 
investing in securities-related businesses and (ii) to prevent 
potential conflicts of interest and certain reciprocal practices. 
See Investment Trusts and Investment Companies, Hearings on S. 3580 
before a Subcomm. Of the Comm. On Banking and Currency, 76th Cong., 
3d Sess. 243 (1940). In 1940 most securities-related businesses were 
organized as privately held general partnerships. If a securities-
related business failed, the fund, as a general partner, could have 
been held accountable for the partnership's liabilities. Rule 12d3-1 
preserves these purposes: rule 12d3-1(c) effectively precludes a 
fund from acquiring, regardless of the source of its revenues, a 
general partnership interest in a broker, dealer, investment 
adviser, or underwriter. Today, however, virtually all securities 
firms are organized as corporations and not as general partnerships.
---------------------------------------------------------------------------

    We have issued several orders exempting funds from the prohibition 
in section 12(d)(3) to permit them to use rule 12d3-1 to purchase 
securities issued by fund subadvisers when the subadviser was not in a 
position to influence the decision by the fund to purchase the 
securities.\75\ We are today proposing to amend rule 12d3-1 to codify 
these orders and permit a fund to acquire securities issued by one of 
its subadvisers (or an affiliated person of one of its subadvisers) 
subject to the same conditions as the other rules we are proposing that 
would permit transactions with subadvisers and which we discuss 
above.\76\ The rule would be available only to a subadviser that 
provides investment advice with respect to a discrete portion of the 
fund's portfolio, and that is not an affiliated person of the adviser 
causing the fund to purchase the securities.\77\ We request comment on 
our proposal to amend rule 12d3-1.
---------------------------------------------------------------------------

    \75\ See, e.g., CDC IXIS Asset Management Advisers, L.P., 
Investment Company Act Release Nos. 25061 (July 12, 2001) [66 FR 
37497 (July 18, 2001)] (notice) and 25103 (Aug. 8, 2001) (order).
    \76\ Proposed rule 12d3-1(c)(3). See sections I.B.1. and I.B.3. 
of this Release (discussing proposed new rule 17a-10 and proposed 
amendments to rule 10f-3).
    \77\ Proposed rule 12d3-1(c)(3)(i) and (ii). The ownership 
limits in rule 12d3-1(a) and (b) would continue to apply to the fund 
as a whole.
---------------------------------------------------------------------------

II. General Request for Comment

    We request comment on the proposed rules and proposed rule 
amendments that are the subject of this Release, suggestions for 
additional provisions or changes to the rules, and comments on other 
matters that might have an effect on the proposals contained in this 
Release. We encourage commenters to provide data to support their 
views.

III. Cost-Benefit Analysis

    We are sensitive to the costs and benefits that result from our 
rules. The Act and our rules restrict the ability of a first-or second-
tier affiliate of a fund to engage in various types of transactions 
involving the fund, and companies that the fund controls, without first 
obtaining an exemptive order from the Commission. The proposed rule and 
amendments would expand the circumstances under which portfolio 
companies and subadvisers that are affiliated persons of funds may 
engage in otherwise prohibited transactions with those funds without 
first obtaining an exemptive order. We have identified certain costs 
and benefits, which are discussed below, which may result from the 
proposed rule and rule amendments. As the proposed rule and rule 
amendments are exemptive, rather than prescriptive, funds and their 
affiliated persons are not required to rely on them. Therefore, we 
assume that funds will only rely on the provisions of the proposed rule 
and rule amendments if the anticipated benefits from such actions would 
exceed the anticipated costs. We request comment on the costs and 
benefits of the proposed rule and amendments. We encourage commenters 
to identify, discuss, analyze, and supply relevant data regarding these 
or any additional costs and benefits.

[[Page 31088]]

A. Benefits

1. In General
    We anticipate that funds, their shareholders, and their advisers 
and other affiliated persons would benefit from the proposed rule and 
amendments. As discussed earlier, the number of persons that are 
affiliated persons of funds has increased markedly since 1940.\78\ As a 
result, there is an increasing number of persons with which funds may 
not enter into transactions under the Act, but which have neither the 
ability nor an incentive to take advantage of the funds. The Act 
authorizes us to issue orders providing exemptive relief from the 
restrictions on affiliate transactions, but the process for obtaining 
such an exemption imposes direct and indirect costs on funds. The 
proposed rules and amendments each will benefit funds, their 
shareholders, and their affiliated persons by eliminating these direct 
and indirect costs.
---------------------------------------------------------------------------

    \78\ Supra notes 12-14.
---------------------------------------------------------------------------

    The most direct cost of the application process is the cost of 
filing the application itself. From 1996 to 2001, we received twenty-
one applications for exemptions from sections 17(a), 17(d), 17(e), 
10(f), and 12(d)(3) that involved transactions of funds with portfolio 
and subadvisory affiliates. Based on discussions with industry 
representatives, our staff estimates the average cost of filing an 
application to be approximately $20,000 when the application involves 
relatively simple issues, and up to $80,000 for applications involving 
complex, novel issues. Thus, we estimate the cost of filing 
applications for these exemptions since 1996 to be between $420,000 to 
$1,680,000. Funds also commonly incur the cost of filing one or more 
amendments after the initial application. One benefit of our proposal 
would be elimination of these direct costs.
    The application process also produces indirect costs, as funds 
forego beneficial transactions rather than undertake to obtain an 
exemptive order. Funds may forgo transactions either because the 
anticipated benefit of the transaction does not exceed the cost of 
obtaining an exemptive order, or because the transaction is time-
sensitive, and it is not feasible for a fund to obtain an exemptive 
order quickly enough to be able to enter into the transaction. For 
applications since 1996, the time between the filing of an application 
and the granting of an exemptive order has ranged from four months for 
a relatively straightforward application that added parties to an 
earlier exemptive order,\79\ to 17 months for a more complicated 
application requiring several amendments.\80\ Encouraging beneficial 
transactions by eliminating these potentially significant costs and 
delays would be a further benefit of our proposal.
---------------------------------------------------------------------------

    \79\ See Mercury Asset Management International Ltd., Investment 
Company Act Release Nos. 23867 (June 9, 1999) [64 FR 32073 (June 15, 
1999)] (notice) (application was originally filed Mar. 3, 1999) and 
23887 (July 1, 1999) (order).
    \80\ See Frank Russell Investment Company et al., Investment 
Company Act Release Nos. 24820 (January 3, 2001) [66 FR 2031 (Jan. 
10, 2001)] (notice) (application was originally filed Aug. 21, 1999) 
and 24847 (Jan. 30, 2001) (order).
---------------------------------------------------------------------------

    Furthermore, eliminating direct and indirect costs of the 
application process may reduce factors that discriminate against 
smaller funds and smaller transactions. The direct cost and delay 
imposed by the application process may discourage smaller funds from 
applying for exemptions to a greater extent than larger funds, since a 
larger fund may be more willing to pay direct costs and wait for 
approval of exemptions. Funds of any size may have a disincentive to 
enter into smaller transactions if the cost of obtaining an exemptive 
order represents a greater proportion of the expected benefits of a 
smaller transaction than a larger one. Elimination of these factors 
would reduce ways in which currently there may be a disproportionate 
adverse effect on smaller funds and a distortion of investment 
decisions of funds away from smaller transactions.
2. Portfolio Affiliates
    The proposed amendments to rules 17a-6 and 17d-1(d)(5) regarding 
transactions and joint arrangements with second-tier portfolio 
affiliates may expand the range of possible partners with which funds 
may enter into transactions and joint arrangements. Funds, second-tier 
portfolio affiliates, and their shareholders each may benefit from the 
transactions and arrangements made possible by the proposed amendments. 
It may not be possible to quantify this benefit, since it varies on a 
case-by-case basis depending on the characteristics of individual 
transactions and joint arrangements and on the extent to which funds 
involved in such transactions have second-tier portfolio affiliates. 
Moreover, any benefits would have to be measured against the benefits 
of alternative transactions or joint arrangements that may have been 
entered into. We request comment on the nature and potential magnitude 
of this benefit.
    Amending rules 17a-6 and 17d-1(d)(5), to provide that the term 
``financial interest'' does not include interests that the fund's board 
of directors finds to be not material, may expand the range of possible 
partners for transactions and joint arrangements with funds by making 
the rules' exemptions more widely available.\81\ So too may the 
proposed removal of rule 17d-1(d)(5)'s condition limiting a fund to 
committing no more than five percent of its assets in any given joint 
enterprise.\82\ These amendments may, thus, expand the scope of the 
exemptions for transactions or joint arrangements with both first- and 
second-tier portfolio affiliates, to the additional benefit of funds, 
their portfolio affiliates, and their shareholders. We request comment 
on the nature and potential magnitude of this benefit.
---------------------------------------------------------------------------

    \81\ Expansion of the exemption in this manner may also impose 
costs by eliminating what has been a ``bright line'' prohibition and 
expanding the opportunities for harmful transactions. Commenters 
addressing the benefits of the rule's expansion should also address 
the potential costs.
    \82\ Rule 17d-1(d)(5)(ii).
---------------------------------------------------------------------------

3. Subadvisory Affiliates

Principal Transactions

    Proposed rule 17a-10 may benefit subadvisers, affiliated funds of a 
subadvised fund, and portions of the subadvised fund for which the 
subadviser does not provide investment advice by broadening investments 
options available to those persons. The restrictions that the Act 
currently places on transactions with affiliated persons limit the 
potential trading partners available to buyers and sellers. By allowing 
a subadviser of a fund to enter into principal transactions with (i) 
affiliated funds of the subadvised fund and (ii) those portions of the 
subadvised fund for which the subadviser does not provide investment 
advice, proposed rule 17a-10 would allow each party to enter into 
transactions with a wider range of funds. By broadening the markets 
available to both buyers and sellers, proposed rule 17a-10 may permit 
sellers to obtain more favorable pricing, and make a wider range of 
investment options available to buyers. It may not be possible to 
quantify this benefit, as it depends on the characteristics of 
individual transactions and on the extent to which funds involved in 
such transactions have subadvisory affiliates. We request comment on 
the nature and potential magnitude of this benefit.

Brokerage Transactions

    Proposed rule 17e-1 would, under certain circumstances, permit 
subadvisers and their affiliated persons

[[Page 31089]]

to receive remuneration when acting as broker for an affiliated fund, 
without complying with all of the rule's conditions. The rule requires, 
among other things, that fund directors review the transaction, and 
that funds maintain records of the transaction. Proposed rule 17e-1 
would exempt funds from these requirements in circumstances identical 
to those in which proposed rule 17a-10 would permit a subadviser or its 
affiliates to engage in a principal transaction with an affiliated 
fund.\83\ Our staff estimates that boards of directors of funds that 
employ affiliated brokers currently spend approximately 12.5 meeting 
hours per year per fund conducting the required review. Our staff 
further estimates that a fund that uses in-house counsel to assist fund 
directors in reviewing these transactions incurs a cost of $775 per 
year for counsel, based on an hourly cost for in-house counsel of $62 
per hour. Funds incur the additional incremental cost of maintaining 
records of the transaction. The proposed amendments to rule 17e-1 may 
benefit funds and their shareholders by allowing funds to avoid these 
tasks and expenses.
---------------------------------------------------------------------------

    \83\ Despite the proposed removal of some aspects of board 
review required by rule 17e-1, it may be prudent for fund directors 
to continue to oversee and review the proposed exempted transactions 
as a matter of course. We would not, however, view any such 
additional oversight as a cost attributable to the proposed 
amendments to rule 17e-1.
---------------------------------------------------------------------------

Purchases During Primary Offerings Underwritten by Affiliated 
Subadvisers

    The proposed amendments to rule 10f-3 may benefit funds by 
broadening their investment options. The Act prohibits a series of a 
series company from purchasing securities during an underwriting or 
selling syndicate of which an adviser to any of the series is a member. 
By providing that, for purposes of section 10(f) and rule 10f-3, a 
series of a series company is a separate investment company, the 
proposed amendments to rule 10f-3 could broaden (i) the investment 
opportunities available to such funds and (ii) the range of possible 
purchasers when a subadviser participates in an underwriting syndicate. 
Funds, fund shareholders, and subadvisers all may benefit from the 
proposed rule. As with proposed rule 17a-10, it may not be possible to 
quantify this benefit. We request comment on the nature and potential 
magnitude of this benefit.
    The Act also does not distinguish between a fund with multiple 
subadvisers that manage discrete portions of its portfolio, and a fund 
whose subadvisers manage the portfolio in its entirety. The proposed 
amendments to rule 10f-3 that would deem separately managed portions of 
a fund's portfolio to be separate investment companies for purposes of 
section 10(f) and rule 10f-3 may increase the investment opportunities 
of a fund with multiple subadvisers that manage discrete portions of 
its portfolio. Quantifying the potential magnitude of this benefit may 
not be possible. We request comment on the nature and potential 
magnitude of this benefit.
    The proposed amendments to rule 10f-3 regarding the rule's 
percentage limits also may broaden the investment options available to 
funds. The Act currently does not distinguish between purchases by 
funds or portions of funds that are recommended by a subadviser that is 
(or is an affiliated person of ) a participant in the underwriting or 
selling syndicate and purchases by funds or portions of funds for which 
other subadvisers provide investment advice. By providing that the 
percentage limit of rule 10f-3 applies only to purchases by funds, 
portions of funds, and accounts for which participants provide 
investment advice, the proposed amendments to rule 10f-3 may increase 
the investment opportunities of a fund with multiple subadvisers that 
manage discrete portions of its portfolio. It may not be possible to 
quantify the potential magnitude of this benefit. We request comment on 
the nature and potential magnitude of this benefit.
4. Ownership of Securities Issued by Subadvisers
    The proposed amendments to rule 12d3-1 may also benefit funds by 
broadening their investment options. The restrictions that the Act and 
rule 12d3-1 currently place on purchases by a fund of securities of its 
own investment adviser or any affiliated person of its own investment 
adviser may significantly limit the options available to a fund among 
securities issued by securities-related businesses, if the fund is 
advised by multiple investment advisers. Amending rule 12d3-1 to permit 
a fund to acquire securities issued by one of its subadvisers, or an 
affiliated person of one of its subadvisers, when the subadviser is not 
in a position to influence the decision by the fund to purchase the 
securities, may increase the investment opportunities of these funds. 
Quantifying the potential magnitude of this benefit also may not be 
possible. We request comment on the nature and potential magnitude of 
this benefit.

B. Costs

    The Commission anticipates that funds, their shareholders, and 
their advisers and other affiliated persons may incur certain costs 
from the proposed new rule and amendments. These persons may incur 
certain direct costs of complying with the proposed new rule and 
amendments. The exemptions in the proposed new rule and amendments also 
may encourage shifts in market behavior that would create direct and 
indirect costs for certain entities. Furthermore, the exemptions may 
allow funds to proceed with disadvantageous transactions that existing 
restrictions would have prevented.
1. Portfolio Affiliates
    The proposed amendments to rules 17a-6 and 17d-1(d)(5) would exempt 
currently prohibited transactions from the restrictions of sections 
17(a) and 17(d) and rule 17d-1. We do not anticipate that there will be 
any costs associated with the rule amendments, other than a cost 
associated with the proposed provision that a fund's board of directors 
may find that an interest is not material and hence not a ``financial 
interest.'' As a fund may only avail itself of the benefit of this 
aspect of the proposal if the fund directors make certain findings, and 
record the basis for those findings in their minutes, the benefit of 
the proposal is offset to some extent by the cost to the fund of the 
board fulfilling its obligations. Based on discussions with industry 
representatives, our staff estimates that reviewing the materiality of 
a Prohibited Participant's interest in a party to the transaction and 
recording the basis for those findings would require approximately 11.2 
hours and $1,140 per meeting, in addition to the discussions that occur 
during the board meeting. This cost may partially offset the benefits 
of the exemption, including the direct benefit of allowing a fund to 
forego the cost of applying for exemptive relief from the restrictions 
of section 17(a) and rule 17d-1. We assume that if the cost of holding 
such a meeting exceeds the benefit to the fund, the fund will either 
forgo the opportunity to engage in the transaction or require the 
Prohibited Participant to divest itself of its interest.
2. Subadvisory Affiliates
    In complying with the requirements of proposed rule 17a-10 and the 
proposed amendments to rules 10f-3, 12d3-1, and 17e-1 and availing 
themselves of their benefits, a fund and its advisers and subadvisers 
may incur

[[Page 31090]]

direct costs that would partially offset those benefits. In order for a 
fund to rely on the exemptions in the proposed rule and amendments, the 
fund's advisory contracts must include certain provisions, which they 
may not currently include. Since such contracts generally are subject 
to renewal at regular intervals, additional administrative cost may not 
be required to add such provisions. If adopted, we would not view the 
required changes to subadviser contracts to be material and, as a 
result, funds would not have to obtain shareholder approval of the 
change. Based on discussions with industry representatives, the staff 
estimates that drafting and executing revised subadvisory contracts 
would require approximately 6 hours. Assuming that all funds that are 
advised by subadvisers modify their advisory contracts in order that 
they and their affiliated funds may rely on the proposed exemptions, 
the proposed rule and rule amendments would create an estimated initial 
one-time cost of approximately $836,000.
    Proposed rule 17e-1 may result in increased costs to funds as a 
result of higher brokerage commissions. By exempting the commissions 
paid to certain affiliated subadvisers from the requirement for 
scrutiny by the board of directors, proposed rule 17e-1 may allow a 
rise in brokerage commissions, at the expense of the fund and its 
shareholders. Whether this increased cost would occur depends on the 
extent to which the scrutiny currently required of boards of directors 
has resulted in findings that commissions to be paid by funds are 
excessive. We request comment on the frequency of boards of directors 
making such findings, and the magnitude of the effect of such findings 
on brokerage commissions.
    The proposed amendments to rule 10f-3 may encourage division of 
funds into discrete parts managed by multiple subadvisers. A fund that 
is advised by subadvisers that participate, or are affiliated with 
persons that participate, in underwriting syndicates may have an 
incentive to reorganize in order to take advantage of the opportunity 
to have a part of the fund purchase securities during the syndicate. 
Likewise, a fund that is advised by a subadviser that participates in 
underwriting syndicates may have an incentive to reorganize in order to 
comply with the percentage limit of rule 10f-3 and take advantage of 
the opportunity to purchase securities in reliance on that rule's 
exemption. Such a development would benefit subadvisers, but the use of 
additional subadvisers could also result in increased costs to funds 
and their shareholders.

C. Request for Comment

    We request comment on the potential costs and benefits identified 
in the proposal and any other costs or benefits that may result from 
the proposed rules and amendments. We request comments on the 
anticipated costs and benefits of the proposed new rule 17a-10 and the 
proposed amendments to rules 10f-3, 17a-6, 17d-1(d)(5), 17e-1, and 
12d3-1 as compared with the costs and benefits of the Act without 
proposed rule 17a-10 and of rules 10f-3, 17a-6, 17d-1, 17e-1, and 12d3-
1 in their current forms. For purposes of the Small Business Regulatory 
Enforcement Fairness Act of 1996,\84\ the Commission also requests 
information regarding the proposed impact of the proposed rule on the 
economy on an annual basis. Commenters are requested to provide data to 
support their views.
---------------------------------------------------------------------------

    \84\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

IV. Consideration of Promotion of Efficiency, Competition, and 
Capital Formation

    Section 2(c) of the Investment Company Act requires the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider whether the action will promote efficiency, competition, 
and capital formation.\85\
---------------------------------------------------------------------------

    \85\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

Portfolio Affiliates

    The proposed amendments to rules 17a-6 and 17d-1(d)(5) would expand 
the circumstances under which funds, and companies they control, could 
enter into principal transactions and joint arrangements with portfolio 
affiliates without first obtaining an exemptive order from the 
Commission. The proposed amendments would permit funds and their 
controlled companies to engage in otherwise prohibited transactions 
with: (i) A wider array of first-tier portfolio affiliates than the 
rules currently permit; and (ii) certain second-tier portfolio 
affiliates.\86\ We anticipate that the proposed amendments will promote 
efficiency and competition. The Act's restrictions on transactions 
involving funds and their affiliated persons respond to market failures 
that can occur when an affiliated person, in a position to influence 
the management of a fund, causes the fund to behave in a manner that 
benefits the affiliated person, rather than the shareholders of the 
fund. The proposed amendments to rules 17a-6 and 17d-1(d)(5) would 
permit market forces to operate to allocate resources in circumstances 
where market failure is unlikely because the affiliated person is not 
in a position to influence fund management. The proposed amendments to 
rules 17a-6 and 17d-1(d)(5) are unrelated to, and we believe will have 
no effect on, capital formation.
---------------------------------------------------------------------------

    \86\ An additional proposed change to rule 17d-1(d)(5) would 
remove existing limitations regarding the percentage of a fund's 
assets that the fund could commit to a joint enterprise. If adopted, 
this amendment would bring rule 17d-1(d)(5) into line with rule 17a-
6, which has no such limitations. Rule 17d-1(d)(5)(ii).
---------------------------------------------------------------------------

Subadvisory Affiliates

    The proposed amendments to rules 17e-1, 10f-3, and 12d3-1 and 
proposed new rule 17a-10 would permit funds, and companies controlled 
by funds, to engage in transactions with subadvisers that are 
affiliated persons of the fund, but which are not in a position to 
influence the fund's decision to participate in the transaction. The 
proposed rule and amendments would permit, in limited circumstances, 
funds, and companies controlled by funds, to: (i) Engage in principal 
transactions with such subadvisers, (ii) purchase securities during a 
primary offering in which such subadvisers participate (or are 
affiliated with persons that participate) in the underwriting or 
selling syndicate, and (iii) purchase securities issued by such 
subadvisers. The proposed amendments to rule 17e-1 would permit, in 
limited circumstances, an affiliated subadviser acting as broker to 
receive remuneration without complying with certain conditions of the 
rule. As in the case of the proposed amendments to rules 17a-6 and 17d-
1(d)(5), we anticipate that the proposed rules and rule amendments will 
promote efficiency and competition by permitting market forces to 
operate in circumstances where there is limited chance of market 
failure. We also believe that the proposed amendments to rule 10f-3 may 
enhance capital formation by enabling funds to purchase securities 
during primary offerings, when they would otherwise be prohibited from 
doing so without a Commission exemptive order.
    The proposed rule and amendments may, however, adversely affect 
competition by promoting increased concentration of the market for 
subadvisory services. Proposed rule 17a-10 may reduce or eliminate any 
incentive to select subadvisers specifically because they are not 
affiliated with a large number of funds, which may encourage funds to 
shift subadvisory business toward certain

[[Page 31091]]

particularly successful subadvisers. The proposed amendments to rule 
10f-3 may remove an incentive to select subadvisers that are not either 
major participants or affiliated with major participants in the 
underwriting business. By removing disincentives against market 
concentration, these proposed rules may have the effect of encouraging 
the market for subadvisory services to concentrate in a smaller set of 
subadvisers.
    The Commission requests comments on whether the proposed rule 
amendments, if adopted, would promote efficiency, competition, and 
capital formation. Will the proposed amendments materially affect the 
number of transactions involving funds, their controlled companies, and 
affiliated persons of funds? Will any costs that result from the 
proposed amendments affect efficiency, competition, or capital 
formation? We will consider any comments in satisfying our 
responsibilities under section 2(c) of the Investment Company Act. We 
request commenters to provide empirical data and other factual support 
for their views to the extent possible.

V. Paperwork Reduction Act

    Certain provisions of proposed rule 17a-10 and the proposed 
amendments to rules 10f-3, 12d3-1, 17a-6, 17d-1, and 17e-1 contain 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 [44 U.S.C. 3501-3520] (``PRA''). The 
Commission is submitting the proposed collections of information to the 
Office of Management and Budget (``OMB'') for review in accordance with 
44 U.S.C. 3507(d) and 5 CFR 1320.11. The titles for the collections of 
information are: (i) ``Rule 10f-3 under the Investment Company Act of 
1940, Exemption for the acquisition of securities during the existence 
of an underwriting or selling syndicate'; (ii) ``Rule 12d3-1 under the 
Investment Company Act of 1940, Exemption of acquisitions of securities 
issued by persons engaged in securities related businesses'; (iii) 
``Rule 17a-6 under the Investment Company Act of 1940, Exemption for 
transactions with portfolio affiliates'; (iv) ``Rule 17a-10 under the 
Investment Company Act of 1940, Exemption for transactions with certain 
subadvisory affiliates'; (v) ``Rule 17d-1 under the Investment Company 
Act of 1940, Applications regarding joint enterprises or arrangements 
and certain profit-sharing plans'; and (vi) ``Rule 17e-1 under the 
Investment Company Act of 1940, Brokerage transactions on a securities 
exchange''. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.\87\
---------------------------------------------------------------------------

    \87\ Rule 10f-3 (OMB Control No. 3235-0226) was adopted pursuant 
to authority set forth in sections 10(f), 31(a), and 38(a) of the 
Investment Company Act [15 U.S.C. 80a-10(f), 80a-30(a), and 80a-
37(a)]. Rule 12d3-1 was adopted pursuant to authority set forth in 
sections 6(c) and 38(a) of the Act. [15 U.S.C. 80a-6(c)]. Rule 17a-6 
was adopted pursuant to authority set forth in sections 6(c), 17(b), 
31(a), and 38(a) of the Act [15 U.S.C. 80a-17(b)]. Rule 17d-1 was 
adopted pursuant to authority set forth in sections 6(c), 17(d), and 
38(a). Rule 17e-1 (OMB Control No. 3235-0217) was adopted pursuant 
to authority set forth in sections 6(c), 31(a), and 38(a) of the 
Act.
---------------------------------------------------------------------------

A. Portfolio Affiliates

Rules 17a-6 and 17d-1
    Under rules 17a-6 and 17d-1, a fund or company controlled by a fund 
may enter into principal and joint transactions with a portfolio 
affiliate, or an affiliated person of a portfolio affiliate, as long as 
certain other Prohibited Participants are not parties to the 
transaction and do not have a financial interest in a party to the 
transaction. Rules 17a-6 and 17d-1 include a list of interests that are 
not ``financial interests'' for purposes of the rule.\88\ We are 
proposing to amend that list to provide that ``financial interest'' 
does not include an interest that the fund's board of directors finds 
to be not material, provided that the directors record the basis for 
that finding in the minutes of their meeting.\89\ This aspect of the 
proposed amendments would create a paperwork burden.
---------------------------------------------------------------------------

    \88\ See supra note 26.
    \89\ Proposed rules 17a-6(b)(1)(H) and 17d-1(d)(8). Collection 
of this information is necessary to obtain the benefit of the 
exemption in the proposed rule amendments.
---------------------------------------------------------------------------

    Based on public filings with the Commission, the Commission's staff 
estimates that 200 registered investment companies are affiliated 
persons of 900 issuers as a result of the investment company's 
ownership or control of the issuer's voting securities, and that there 
are approximately 1,400 such affiliate relationships.\90\ The staff 
estimates that annually there will be a total of 1,400 principal 
transactions under rule 17a-6 \91\ and 1,400 joint arrangements under 
rule 17d-1(d)(5),\92\ and that for each rule approximately 420 
transactions or arrangements will result in a paperwork burden.\93\
---------------------------------------------------------------------------

    \90\ See supra note 12. For purposes of this analysis, the staff 
estimates that investment companies will enter into one principal 
transaction and one joint arrangement each year with each of their 
portfolio affiliates, and that in thirty percent of those 
transactions and arrangements a Prohibited Participant will have a 
financial interest in a party to the transaction that the board of 
directors of the affected investment company will consider for 
purposes of determining whether that financial interest is material.
    \91\ 1,400 affiliate relationships  x  1 principal transaction 
per year = 1,400 transactions under rule 17a-6.
    \92\ 1,400 affiliate relationships  x  1 joint arrangement per 
year = 1,400 joint arrangements under rule 17d-1(d)(5). In addition 
to expanding fund business opportunities by allowing funds to 
transact with a wider range of portfolio affiliates, we are also 
proposing to eliminate the limit imposed by rule 17d-1(d)(5) on the 
percentage of assets a fund can commit to any given joint 
enterprise. Rule 17d-1(d)(5)(ii). The staff does not anticipate that 
allowing funds to increase the size of their commitment to a joint 
transaction will result in an increase in the expected number of 
such transactions.
    \93\ 1,400 transactions or arrangements  x  .30 (percentage of 
transactions or arrangements in which a Prohibited Participant is 
assumed to have a financial interest) = 420.
---------------------------------------------------------------------------

    The Commission staff estimates that compliance with the proposed 
amendments would impose a burden of .2 hours for each transaction for 
which there is a paperwork burden.\94\ Therefore we estimate 84 burden 
hours to be associated with the proposed amendments to rule 17a-6 
annually and 84 burden hours to be associated with the proposed 
amendments to rule 17d-1 annually.
---------------------------------------------------------------------------

    \94\ The staff estimates the hourly burden to comply with the 
board of director's obligation to make a finding as to the 
materiality of a prohibited person's financial interest in a 
transaction to be 11 hours. The staff estimates that funds will 
spend .2 hours complying with the requirement that the basis for the 
board's findings be recorded in the minutes of its meeting.
---------------------------------------------------------------------------

B. Subadviser Affiliates

    The Commission staff estimates that 1,900 portfolios of 
approximately 800 investment companies use the services of one or more 
subadvisers.\95\ Based on discussions with industry representatives, 
the Commission staff estimates that it will require approximately 6 
hours to draft and execute revised subadvisory contracts (5 staff 
attorney hours, 1 supervisory attorney), in order for funds and 
subadvisers to be able to rely on the exemptions in proposed rule 17a-
10 and the proposed amendments to rule 10f-3, 17e-1, and 12d3-1.\96\ 
Assuming that all funds that are advised by subadvisers modify their 
advisory contracts in order that they and their affiliated funds may 
rely on the proposed exemptions, the proposed rule and rule amendments 
would create an estimated initial one-time burden of approximately 
11,400 burden hours.

[[Page 31092]]

The total estimated first year cost of these burden hours is 
$836,000.\97\
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    \95\ See supra note 13.
    \96\ The fund's advisory contracts must include these conditions 
in order for the fund to obtain the benefit of the exemptions in the 
proposed rule and rule amendments.
    \97\ (5 hours  x $62 = $310) + (1 hour  x $130 = $130) = $440. 
(5 attorney hours, 1 deputy general counsel hour). $440  x 1,900 
funds=$ 836,000.

                                       Estimated One Time Burden Hours and Cost of Subadvisory Rule and Amendments
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                            Cost per
        Number of funds modifying contracts          Staff attorney    Supervisory      Total burden    Cost per staff    supervisory     Total cost of
                                                         hours        attorney hours       hours        attorney hour    attorney hour     burden hours
--------------------------------------------------------------------------------------------------------------------------------------------------------
1,900.............................................               5                1           11,400              $62             $130         $836,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Proposed rule 17a-10 and the proposed amendments to rules 10f-3, 
12d3-1, and 17e-1 would require virtually identical modifications to 
fund advisory contracts. The Commission staff assumes that funds will 
rely equally on the exemptions in all of these rules, and therefore the 
burden hours associated with the required contract modifications should 
be apportioned equally among the four rules. Therefore the estimated 
one-time burden hours associated with rules 17a-10, 10f-3, 12d3-1, and 
17e-1 are 2,850 hours for each rule (11,400 total burden hours for all 
of the rules/four rules), and the estimated one-time cost of these 
burden hours is $209,000 for each rule ($836,000/four rules).\98\
---------------------------------------------------------------------------

    \98\ The proposed amendments to rule 17e-1 will also, as 
discussed below, decrease the burden hours associated with that 
rule.
---------------------------------------------------------------------------

    The staff estimates that a total of 60 funds will enter into 
subadvisory agreements each year after the first year in which the 
proposed rule and rule amendments are adopted.\99\ Assuming that each 
of these funds enters into a contract that permits it and its 
affiliated funds to rely on the exemptions in proposed rule 17a-10, and 
the proposed amendments to rules 10f-3, 12d3-1, and 17e-1, an estimated 
360 burden hours (90 hours per rule) will be associated with these 
rules annually, with an associated cost of $26,400 ($6,600 per 
rule).\100\
---------------------------------------------------------------------------

    \99\ Based on an analysis of investment company filings, the 
staff estimates that approximately 250 funds are created annually. 
Assuming that the number of these funds that will use the services 
of subadvisers is proportionate to the number of funds that 
currently use the services of subadvisers, then approximately 50 new 
funds will enter into subadvisory agreements each year. The 
Commission staff estimates, based on an analysis of investment 
company filings, that an additional 10 funds, currently in 
existence, will employ the services of subadvisers for the first 
time each year.
    \100\ 6 hours  x  60 funds=360 total hours. $440  x  60 funds= 
$26,400.
---------------------------------------------------------------------------

Rule 17e-1
    Based on an analysis of investment company filings, the staff 
estimates that approximately 293 investment companies use at least one 
affiliated broker and that each of these investment companies spends an 
estimated 12.5 hours per year (at a cost of $775 per year) complying 
with rule 17e-1's requirements that (i) the fund retain records of 
transactions entered into pursuant to the rule (``recordkeeping 
requirement''), and (ii) the fund's directors review those transactions 
quarterly (``review requirement'').\101\ Based on conversations with 
representatives of investment companies, the staff estimates that the 
proposed amendments to rule 17e-1 would exempt approximately 40 percent 
of transactions that occur under rule 17e-1 from the rule's 
recordkeeping and review requirements. The Commission staff estimates, 
therefore, that the proposed amendments to rule 17e-1 would, in this 
respect, decrease the rule's information collection burden to 2,200 
hours \102\ and $136,422 per year.\103\
---------------------------------------------------------------------------

    \101\ In calculating the total annual cost of complying with 
amended rule 17e-1, the Commission staff assumes that the entire 
burden would be attributable to professionals with an average hourly 
wage rate of $62 per hour.
    \102\ 293 transactions  x  12.5 hours = 3,663 hours if adopted; 
60% of the 293 transactions (or 176 transactions) would proceed 
under rule 17e-1. 176 transactions (60% of the 293 transactions 
anticipated to be impacted by rule)  x  12.5 hours = 2,200 hours.
    \103\ 3,663 hours  x  $62 = $227,106; 2,200 hours  x  $62 = 
$136,422.

               Estimated Reduction in Burden Hours and Cost of Rule 17E-1 (Effect of Exemption From Review and Recordkeeping Requirements)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             Number of
                                                                           funds subject   Burden hours    Total burden    Cost per hour
                                                             Number of          to              of           hours of           of         Total cost of
                                                           funds relying   recordkeeping   recordkeeping   recordkeeping   recordkeeping   burden hours
                                                           on rule 17e-1    and review      and review      and review      and review
                                                                           requirements    requirements    requirements    requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
Current Rule............................................             293             293            12.5           3,663             $62        $227,106
As proposed to be amended...............................             293             176            12.5           2,200              62         136,422
--------------------------------------------------------------------------------------------------------------------------------------------------------

    This reduction will be offset to some extent by the increase in 
estimated burden hours described above with respect to the required 
modifications of the funds' investment advisory contract. Therefore 
rule 17e-1, as proposed to be amended, would impose an estimated burden 
of 5,050 hours ($345,400) in the first year after the amendments are 
adopted, and an estimated burden of 2,290 hours ($143,000) in 
subsequent years.

C. Request for Comments

    We request comments on the accuracy of our estimates. Pursuant to 
44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) 
Evaluate whether the proposed collections of information are necessary 
for the proper performance of the functions of the agency, including 
whether the information will have practical utility; (ii) evaluate the 
accuracy of the Commission's estimate of the burden of the proposed 
collections of information; (iii) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (iv) evaluate whether there are ways to minimize the 
burden of the collections of information on those who are to

[[Page 31093]]

respond, including through the use of automated collection techniques 
or other forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements of the proposed rules and rule amendments should direct 
them to the Office of Management and Budget, Attention Desk Officer of 
the Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10202, New Executive Office Building, 
Washington, DC 20503, and should send a copy to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-13-02. OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication of this Release; therefore a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release. Requests 
for materials submitted to OMB by the Commission with regard to these 
collections of information should be in writing, refer to File No. S7-
13-02, and be submitted to the Securities and Exchange Commission, 
Records Management, Office of Filings and Information Services, 450 
Fifth Street, NW., Washington, DC 20549.

VI. Summary of Initial Regulatory Flexibility Analysis

    We have prepared an Initial Regulatory Flexibility Analysis 
(``IRFA'') in accordance with 5 U.S.C. 603 regarding the proposed rule 
17a-10 and the proposed amendments to rules 10f-3, 12d3-1, 17a-6, 17d-
1, and 17e-1 under the Investment Company Act. The following summarizes 
the IRFA.
    The IRFA summarizes the background of the proposed amendments. The 
IRFA also discusses the reasons for the proposed amendments and the 
objectives of, and legal basis for, the amendments. Those items are 
discussed above in the Release.
    The IRFA discusses the effect of the proposed amendments on small 
entities. For purposes of the Regulatory Flexibility Act, a fund is a 
small entity if the fund, together with other funds in the same group 
of related funds, has net assets of $50 million or less as of the end 
of its most recent fiscal year.\104\ An investment adviser is a small 
entity if it (i) manages less than $25 million in assets, (ii) has 
total assets of less than $5 million on the last day of its most recent 
fiscal year, and (iii) does not control, is not controlled by, and is 
not under common control with another investment adviser that manages 
$25 million or more in assets, or any person (other than a natural 
person) that had total assets of $5 million or more on the last day of 
the most recent fiscal year.\105\ A portfolio company (i.e., a company 
in which a fund invests) is a small entity if its total assets on the 
last day of its most recent fiscal year were $5 million or less.\106\ 
The staff estimates, based upon Commission filings, that there are 
approximately 3,650 active registered management investment companies, 
of which approximately 200 are small entities, and may rely on the rule 
if they satisfy its conditions. The staff further estimates that there 
are approximately 7,560 registered investment advisers, of which 
approximately 430 are small entities.\107\
---------------------------------------------------------------------------

    \104\ 17 CFR 270.0-10.
    \105\ 17 CFR 275.0-7.
    \106\ 17 CFR 240.0-10.
    \107\ We estimate that 875 issuers are portfolio affiliates of 
funds. See supra note 12. We are unable to estimate the number of 
these issuers that are small entities.
---------------------------------------------------------------------------

    The IRFA states that proposed amendments to rules 17a-6 and 17d-1 
would impose recordkeeping requirements on funds that engage in 
principal transactions or joint arrangements in reliance on the rule, 
when a Prohibited Participant has an interest in a party to the 
transaction or arrangement that is not material, in that the board of 
directors of the fund would be required to record in the minutes of its 
meetings the basis for the board's finding that the Prohibited 
Participant's interest is not material. The IRFA further explains that 
the exemptions in proposed rule 17a-10 and the proposed amendments to 
rules 10f-3, 12d3-1, and 17e-1 would be conditioned on the funds' 
advisory contracts including certain provisions.
    The IRFA explains that we have not identified any federal rules 
that duplicate or conflict with the proposed rule and rule amendments. 
The IRFA states that the Regulatory Flexibility Act directs the 
Commission to consider significant alternatives that would accomplish 
the stated objectives, while minimizing any significant economic impact 
on small entities. The overall impact of the amendments would be to 
decrease the burdens on all entities, including small entities, because 
the burdens under the proposed amendments should be more than offset by 
the elimination of existing requirements. Therefore, the potential 
impact of the amendments on small entities should not be significant. 
For these reasons, alternatives to the proposed amendments and proposed 
new rule are unlikely to minimize any impact that the proposed 
amendments may have on small entities.\108\
---------------------------------------------------------------------------

    \108\ Alternatives in this category would include: (i) 
Establishing different compliance or reporting standards that take 
into account the resources available to small entities; (ii) 
clarifying, consolidating or simplifying the compliance requirements 
for small entities; (iii) using performance rather than design 
standards; and (iv) exempting small entities from coverage of all or 
part of the rule.
---------------------------------------------------------------------------

    We encourage comment with respect to any aspect of the IRFA. We 
specifically request comment on the number of small entities that would 
be affected by the proposed rule amendments, and the likely impact of 
the proposal on small entities. Commenters are asked to describe the 
nature of any impact and provide empirical data supporting the extent 
of the impact. These comments will be considered in connection with the 
adoption of the rule amendments, and will be placed in the same public 
file as comments on the proposed amendments themselves. A copy of the 
IRFA may be obtained by contacting William C. Middlebrooks, Jr., 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0506.

VII. Statutory Authority

    The Commission is proposing amendments to rules 10f-3, 12d3-1, 17a-
6, 17d-1, and 17e-1 and new rule 17a-10 under the Investment Company 
Act pursuant to authority set forth in sections 6(c), 10(f), 17(b), 
17(d), 31(a), and 38(a) of the Investment Company Act.

List of Subjects

17 CFR Part 270

    Investment companies; reporting and recordkeeping requirements; 
securities.

Text of Proposed Rules

    For reasons set forth in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is proposed to be amended as follows:

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. The authority citation for part 270 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 
unless otherwise noted;
* * * * *
    2. Section 270.10f-3 is amended by:
    a. Redesignating paragraph (b) as paragraph (c);
    b. Adding paragraphs (a)(6), (a)(7), (a)(8), and new paragraph (b);
    c. Revising the paragraph heading in newly redesignated paragraph 
(c); and

[[Page 31094]]

    d. Revising newly redesignated paragraph (c)(7) to read as follows:


Sec. 270.10f-3  Exemption for the acquisition of securities during the 
existence of an underwriting or selling syndicate.

    (a) * * *
    (6) Managed Portion of a portfolio of a registered investment 
company means a discrete portion of a portfolio of a registered 
investment company for which a Subadviser is responsible for providing 
investment advice, provided that:
    (i) The Subadviser is not an affiliated person of any investment 
adviser, promoter, underwriter, officer, director, member of an 
advisory board, or employee of the registered investment company; and
    (ii) The Subadviser's advisory contract:
    (A) Prohibits it from consulting with any subadviser of the 
investment company that is a principal underwriter or an affiliated 
person of a principal underwriter concerning securities transactions of 
the investment company; and
    (B) Limits its responsibility in providing advice to providing 
advice with respect to such portion.
    (7) Series of a Series Company means any class or series of a 
registered investment company that issues two or more classes or series 
of preferred or special stock, each of which is preferred over all 
other classes or series with respect to assets specifically allocated 
to that class or series.
    (8) Subadviser means an investment adviser as defined in section 
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
    (b) Exemption for purchases by Series Companies and Investment 
Companies with Managed Portions. For purposes of this section and 
section 10(f) of the Act (15 U.S.C. 80a-10(f)), each Series of a Series 
Company, and each Managed Portion of a portfolio of a registered 
investment company, is deemed to be a separate investment company. 
Therefore, a purchase or acquisition of a security by a registered 
investment company is exempt from the prohibitions of section 10(f) of 
the Act if section 10(f) of the Act would not prohibit such purchase if 
each Series and each Managed Portion of the company were a separately 
registered investment company.
    (c) Exemption for other purchases. * * *
    (7) Percentage limit. (i) Generally. The amount of securities of 
any class of such issue to be purchased by the investment company, 
aggregated with purchases by any other investment company advised by 
the investment company's investment adviser, and purchases by any other 
account over which such adviser has discretionary authority or 
otherwise exercises control, does not exceed the following limits:
    (A) If purchased in an offering other than an Eligible Rule 144A 
Offering, 25 percent of the principal amount of the offering of such 
class; or
    (B) If purchased in an Eligible Rule 144A Offering, 25 percent of 
the total of:
    (1) The principal amount of the offering of such class sold by 
underwriters or members of the selling syndicate to qualified 
institutional buyers, as defined in Sec. 230.144A(a)(1) of this 
chapter; plus
    (2) The principal amount of the offering of such class in any 
concurrent public offering.
    (ii) Exemption from percentage limit. The requirement in paragraph 
(c)(7)(i) of this section applies only if the investment adviser of the 
investment company is, or is an affiliated person of, a principal 
underwriter of the security; and
    (iii) Separate aggregation. The requirement in paragraph (c)(7)(i) 
of this section applies independently with respect to each investment 
adviser of the investment company that is, or is an affiliated person 
of, a principal underwriter of the security.
* * * * *
    3. Section 270.12d3-1 is amended by revising paragraph (c) and 
adding paragraph (d)(9) before the Note:


Sec. 270.12d3-1  Exemption of acquisitions of securities issued by 
persons engaged in securities related businesses.

* * * * *
    (c) Notwithstanding paragraphs (a) and (b) of this section, this 
section does not exempt the acquisition of:
    (1) A general partnership interest; or
    (2) A security issued by the acquiring company's promoter, 
principal underwriter, or any affiliated person of such promoter, or 
principal underwriter; or
    (3) A security issued by the acquiring company's investment 
adviser, or an affiliated person of the acquiring company's investment 
adviser, other than a security issued by a Subadviser or an affiliated 
person of a Subadviser of the acquiring company provided that:
    (i) Prohibited relationships. The Subadviser that is (or whose 
affiliated person is) the issuer is not, and is not an affiliated 
person of, an investment adviser responsible for providing advice with 
respect to the portion of the acquiring company that is acquiring the 
securities, or of any promoter, underwriter, officer, director, member 
of an advisory board, or employee of the acquiring company;
    (ii) Advisory contract. The advisory contracts of the Subadviser 
that is (or whose affiliated person is) the issuer, and any Subadviser 
that is advising the portion of the acquiring company that is 
purchasing the securities:
    (A) Prohibit them from consulting with each other concerning 
securities transactions for the acquiring company, other than for 
purposes of complying with the conditions of paragraphs (a) and (b) of 
this section; and
    (B) Limit their responsibility in providing advice to providing 
advice with respect to a discrete portion of the acquiring company's 
portfolio.
    (d) * * *
    (9) Subadviser means an investment adviser as defined in section 
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
* * * * *
    4. Section 270.17a-6 is revised to read as follows:


Sec. 270.17a-6  Exemption for transactions with portfolio affiliates.

    (a) Exemption for transactions with portfolio affiliates. A 
transaction to which a Fund, or a company controlled by a Fund, and a 
Portfolio Affiliate of the Fund are parties is exempt from the 
provisions of section 17(a) of the Act (15 U.S.C. 80a-17(a)), provided 
that none of the following persons is a party to the transaction, or 
has a direct or indirect Financial Interest in a party to the 
transaction other than the Fund:
    (1) An officer, director, employee, investment adviser, member of 
an advisory board, depositor, promoter of or principal underwriter for 
the Fund;
    (2) A person directly or indirectly controlling the Fund;
    (3) A person directly or indirectly owning, controlling or holding 
with power to vote five percent or more of the outstanding voting 
securities of the Fund;
    (4) A person directly or indirectly under common control with the 
Fund, other than:
    (i) A Portfolio Affiliate of the Fund; or
    (ii) A Fund whose sole interest in the transaction is an interest 
in a Portfolio Affiliate of the Fund; or
    (5) An affiliated person of any of the persons mentioned in 
paragraphs (a)(1)-(4) of this section, other than the Fund or a 
Portfolio Affiliate of the Fund.
    (b) Definitions.
    (1) Financial Interest.
    (i) The term Financial Interest as used in this section does not 
include:
    (A) Any interest through ownership of securities issued by the 
Fund;
    (B) Any interest of a wholly-owned subsidiary of a Fund;

[[Page 31095]]

    (C) Usual and ordinary fees for services as a director;
    (D) An interest of a non-executive employee;
    (E) An interest of an insurance company arising from a loan or 
policy made or issued by it in the ordinary course of business to a 
natural person;
    (F) An interest of a bank arising from a loan or account made or 
maintained by it in the ordinary course of business to or with a 
natural person, unless it arises from a loan to a person who is an 
officer, director or executive of a company which is a party to the 
transaction, or from a loan to a person who directly or indirectly 
owns, controls, or holds with power to vote, five percent or more of 
the outstanding voting securities of a company which is a party to the 
transaction;
    (G) An interest acquired in a transaction described in paragraph 
(d)(3) of Sec. 270.17d-1; or
    (H) Any other interest that the board of directors of the Fund, 
including a majority of the directors who are not interested persons of 
the Fund, finds to be not material, provided that the directors record 
the basis for that finding in the minutes of their meeting.
    (ii) A person has a Financial Interest in any party in which it has 
a Financial Interest, in which it had a Financial Interest within six 
months prior to the transaction, or in which it will acquire a 
Financial Interest pursuant to an arrangement in existence at the time 
of the transaction.
    (2) Fund means a registered investment company or separate series 
of a registered investment company.
    (3) Portfolio Affiliate of a Fund means a person that is an 
affiliated person (or an affiliated person of an affiliated person) of 
a Fund solely because the Fund, a Fund under common control with the 
Fund, or both:
    (i) Controls such person (or an affiliated person of such person); 
or
    (ii) Owns, controls, or holds with power to vote five percent or 
more of the outstanding voting securities of such person (or an 
affiliated person of such person).
    5. Section 270.17a-10 is added to read as follows:


Sec. 270.17a-10  Exemption for transactions with certain subadvisory 
affiliates.

    (a) Generally. A person that is prohibited by section 17(a) of the 
Act (15 U.S.C. 80a-17(a)) from entering into a transaction with a Fund 
solely because such person is, or is an affiliated person of, a 
Subadviser of the Fund, or a Subadviser of a Fund that is under common 
control with the Fund, may nonetheless enter into such transaction, if:
    (1) Prohibited relationship. The person is not, and is not an 
affiliated person of, an investment adviser responsible for providing 
advice with respect to the portion of the Fund for which the 
transaction is entered into, or of any promoter, underwriter, officer, 
director, member of an advisory board, or employee of the Fund.
    (2) Advisory contract. The advisory contracts of the Subadviser 
that is (or whose affiliated person is) entering into the transaction, 
and any Subadviser that is advising the fund (or portion of the fund) 
entering into the transaction:
    (i) Prohibit them from consulting with each other concerning 
securities transactions for the Fund; and
    (ii) If both such Subadvisers are responsible for providing 
investment advice to the Fund, limit their responsibility in providing 
advice with respect to a discrete portion of the Fund's portfolio.
    (b) Definitions.
    (1) Fund means a registered investment company and includes a 
separate series of a registered investment company.
    (2) Subadviser means an investment adviser as defined in section 
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
    6. Section 270.17d-1 is amended by revising paragraphs (d)(5) and 
(d)(6) to read as follows:


Sec. 270.17d-1  Applications regarding joint enterprises or 
arrangements and certain profit-sharing plans.

* * * * *
    (d) * * *
    (5) Any joint enterprise or other joint arrangement or profit-
sharing plan (``joint enterprise'') in which a registered investment 
company or a company controlled by such a company, is a participant, 
and in which a Portfolio Affiliate (as defined in Sec. 270.17a-6(b)(3)) 
of such registered investment company is also a participant, provided 
that:
    (i) None of the persons identified in Sec. 270.17a-6(a) is a 
participant in the joint enterprise, or has a direct or indirect 
Financial Interest in a participant in the joint enterprise (other than 
the registered investment company);
    (ii) Financial Interest.
    (A) The term Financial Interest as used in this section does not 
include:
    (1) Any interest through ownership of securities issued by the 
registered investment company;
    (2) Any interest of a wholly-owned subsidiary of the registered 
investment company;
    (3) Usual and ordinary fees for services as a director;
    (4) An interest of a non-executive employee;
    (5) An interest of an insurance company arising from a loan or 
policy made or issued by it in the ordinary course of business to a 
natural person;
    (6) An interest of a bank arising from a loan to a person who is an 
officer, director, or executive of a company which is a participant in 
the joint transaction or from a loan to a person who directly or 
indirectly owns, controls, or holds with power to vote, five percent or 
more of the outstanding voting securities of a company which is a 
participant in the joint transaction;
    (7) An interest acquired in a transaction described in paragraph 
(d)(3) of this section; or
    (8) Any other interest that the board of directors of the 
investment company, including a majority of the directors who are not 
interested persons of the investment company, finds to be not material, 
provided that the directors record the basis for that finding in the 
minutes of their meeting.
    (B) A person has a Financial Interest in any party in which it has 
a Financial Interest, in which it had a Financial Interest within six 
months prior to the investment company's participation in the 
enterprise, or in which it will acquire a Financial Interest pursuant 
to an arrangement in existence at the time of the investment company's 
participation in the enterprise.
    (6) The receipt of securities and/or cash by an investment company 
or a controlled company thereof and an affiliated person of such 
investment company or an affiliated person of such person pursuant to a 
plan of reorganization: Provided, That no person identified in 
Sec. 270.17a-6(a)(1) or any company in which such a person has a direct 
or indirect Financial Interest (as defined in paragraph (d)(5)(iii) of 
this section):
* * * * *
    7. Section 270.17e-1 is amended by revising paragraphs (b)(3) and 
(d) to read as follows:


Sec. 270.17e-1  Brokerage transactions on a securities exchange.

* * * * *
    (b) * * *
    (3) Determines no less frequently than quarterly that all 
transactions effected pursuant to this section during the preceding 
quarter (other than transactions in which the person acting as broker 
is a person permitted to enter into a transaction with the investment 
company by Sec. 270.17a-10) were effected in compliance with such 
procedures;
* * * * *
    (d) The investment company:

[[Page 31096]]

    (1) Shall maintain and preserve permanently in an easily accessible 
place a copy of the procedures (and any modification thereto) described 
in paragraph (b)(1) of this section; and
    (2) Shall maintain and preserve for a period not less than six 
years from the end of the fiscal year in which any transactions 
occurred, the first two years in an easily accessible place, a record 
of each such transaction (other than any transaction in which the 
person acting as broker is a person permitted to enter into a 
transaction with the investment company by Sec. 270.17a-10) setting 
forth the amount and source of the commission, fee or other 
remuneration received or to be received, the identity of the person 
acting as broker, the terms of the transaction, and the information or 
materials upon which the findings described in paragraph (b)(3) of this 
section were made.

    Dated: April 30, 2002.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 02-11228 Filed 5-7-02; 8:45 am]
BILLING CODE 8010-01-P