[Federal Register Volume 67, Number 142 (Wednesday, July 24, 2002)]
[Rules and Regulations]
[Pages 48512-48518]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-18699]



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Part II





Securities and Exchange Commission





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17 CFR Part 270



Investment Company Mergers; Final Rule

  Federal Register/Vol. 67, No. 142/Wednesday, July 24, 2002/Rules and 
Regulations  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-25666; File No. S7-21-01]
RIN 3235-AH81


Investment Company Mergers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting amendments to the rule under the Investment Company Act of 
1940 that permits mergers and other business combinations between 
certain affiliated investment companies. The amendments expand the 
types of business combinations permitted by the rule and make the rule 
available for mergers between registered investment companies and 
certain unregistered entities. The amendments are designed to reduce 
burdens on investment companies by eliminating the need to obtain 
Commission approval for mergers that present little risk of 
overreaching.

DATES: Effective Date: July 26, 2002.
    Compliance Date: October 25, 2002. Section II of this document 
contains more information on transition prior to the compliance date.

FOR FURTHER INFORMATION CONTACT: Robert S. Kim, Attorney, at (202) 942-
7961, or Martha B. Peterson, Special Counsel, at (202) 942-0690, Office 
of Regulatory Policy, Division of Investment Management, Securities and 
Exchange Commission, 450 5th Street, NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Commission today is adopting amendments 
to rule 17a-8 [17 CFR 270.17a-8] under the Investment Company Act of 
1940 [15 U.S.C. 80a] (``Investment Company Act'' or ``Act'').

Table of Contents

Executive Summary

I. Discussion
    A. Mergers between Registered Investment Companies
    B. Mergers of Registered Investment Companies and Certain 
Unregistered Entities
II. Effective Date
III. Cost-Benefit Analysis
    A. Benefits
    B. Costs
IV. Effects on Efficiency, Competition, and Capital Formation
V. Paperwork Reduction Act
VI. Summary of Final Regulatory Flexibility Analysis
VII. Statutory Authority

Text of Rule

Executive Summary

    The Commission is adopting amendments to rule 17a-8 under the 
Investment Company Act, the rule that permits mergers of registered 
investment companies (``funds'') with certain of their affiliated 
persons.\1\ The amendments expand the availability of the rule in two 
ways: first, the rule permits funds to merge with other affiliated 
funds without regard to the reason for their affiliation; and second, 
the rule permits funds to merge with unregistered bank common trust 
funds, bank collective trust funds, and unregistered insurance company 
separate accounts. The amendments subject the exemption to certain 
additional conditions designed to protect investors.
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    \1\Unless otherwise noted, when we refer to rule 17a-8 or any 
paragraph of that rule, we are referring to 17 CFR 270.17a-8, the 
section of the Code of Federal Regulations in which the rule is 
published, as amended by this release.
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I. Discussion

    Section 17 of the Investment Company Act prohibits certain 
transactions between funds\2\ and their affiliated persons\3\ unless 
the Commission issues an order after finding that (i) the terms of the 
proposed transaction are reasonable and fair and do not involve 
overreaching on the part of any person concerned, (ii) the proposed 
transaction is consistent with the policy of each fund, and (iii) the 
proposed transaction is consistent with the general purposes of the 
Act.\4\ This section operates to prohibit mergers\5\ of investment 
companies that are affiliated persons of each other, which typically 
include funds that are in the same fund complex.\6\ Since 1980, our 
rule 17a-8 has permitted mergers of funds that are affiliated solely 
because they have common investment advisers, officers and/or 
directors.\7\ We have considered other fund mergers on a case-by-case 
basis, and since 1980 we have issued more than 150 orders granting 
exemptions for fund mergers that did not qualify for relief under rule 
17a-8.\8\
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    \2\We use the term ``fund'' throughout this release to refer to 
registered investment companies and series of registered investment 
companies that are series companies.
    \3\The Act describes an ``affiliated person'' of another person 
as (A) any person directly or indirectly owning, controlling, or 
holding with power to vote, 5 percent or more of the outstanding 
voting securities of such other person; (B) any person 5 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 an investment company, any 
investment adviser thereof or any member of an advisory board 
thereof; and (F) if such other person is an unincorporated 
investment company not having a board of directors, the depositor 
thereof. 15 U.S.C. 80a-2(a)(3). Unless otherwise noted, in this 
release, we will use the term ``affiliate'' to include affiliated 
persons of the fund and affiliated persons of those affiliated 
persons. Section 17(a) also reaches transactions with a promoter of 
or a principal underwriter for a fund and affiliated persons of such 
promoter or principal underwriter. For purposes of this release, the 
term ``affiliates'' includes these persons as well.
    \4\15 U.S.C. 80a-17(a)-(b).
    \5\We use the term ``merger'' in rule 17a-8 and this release to 
refer to a merger, consolidation, or purchase or sale of 
substantially all of an entity's assets. Rule 17a-8(b)(1). A fund 
merger typically occurs in one of three ways, each of which involves 
the purchase or sale of fund assets: (i) One fund purchases the 
portfolio assets of the other; (ii) one fund purchases all 
securities issued by the other; or (iii) securities issued by one 
fund are exchanged for all or substantially all of the portfolio 
assets of the other fund.
    \6\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). 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. Throughout this release we presume 
that the funds in a fund complex are under common control, because 
funds that are not affiliated would not need relief under rule 17a-
8.
    \7\See Mergers and Consolidations Involving Registered 
Investment Companies, Investment Company Act Release No. 11053 (Feb. 
19, 1980) [45 FR 12408 (Feb. 26, 1980)].
    \8\Typically a single order provides an exemption for multiple 
funds. The 16 orders we issued in 2001 provided exemptions for 120 
mergers involving approximately 220 funds.
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    In November 2001, we proposed to codify the terms of our exemptive 
orders and expand the availability of rule 17a-8 to permit affiliated 
mergers regardless of the reasons for the funds' affiliation, and to 
permit funds to merge with unregistered bank common and collective 
trust funds.\9\ We received eight comments on the proposed amendments 
to rule 17a-8.\10\ Commenters supported the proposed broadening of the 
rule, but suggested changes. Today we are adopting the amendments to 
rule 17a-8, with several changes that respond to issues raised by 
commenters. The amended rule, which we describe below, will permit most 
mergers of registered investment

[[Page 48513]]

companies to proceed without the need for exemptive relief.
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    \9\Investment Company Mergers, Investment Company Act Release 
No. 25259 (Nov. 8, 2001) [66 FR 57602 (Nov. 15, 2001)] (``Proposing 
Release'').
    \10\The comment letters and a summary of comments prepared by 
our staff are available for public inspection and copying in the 
Commission's Public Reference Room, 450 5th Street, NW, Washington, 
DC (File No. S7-21-01). The comment summary is also available on the 
Commission's Internet Web site (http://www.sec.gov/rules/extra/s72101commsumm.htm).
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A. Mergers Between Registered Investment Companies

    The Commission is adopting, as proposed, an amendment to rule 17a-8 
to permit affiliated fund mergers regardless of the reasons for the 
funds' affiliation.\11\ The rule will continue to require that each 
fund's board (including a majority of disinterested directors) 
determine that the merger is in the best interests of the fund and will 
not dilute the interests of shareholders.\12\ These are critical 
determinations boards must carefully consider, particularly when the 
merger involves significant conflicts of interest.\13\ Directors must 
request and evaluate any information reasonably necessary to their 
determinations, and consider and give appropriate weight to all 
pertinent factors in making their findings under the rule, and in 
fulfilling the overall duty of care they owe to the fund's 
shareholders.\14\ In making their determinations, boards should 
consider, if relevant, the following factors, among others\15\--
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    \11\Rule 17a-8(a).
    \12\Rule 17a-8(a)(2)(i). We are not adopting a proposal to 
prohibit funds from relying on rule 17a-8 to effect mergers that are 
part of a plan or scheme to evade the prohibitions of section 17(a) 
of the Act; section 48(a) of the Act already makes such activity 
unlawful. 15 U.S.C. 80a-47(a).
    \13\In January 2001, we amended rule 17a-8 to include conditions 
related to independent directors of a merging fund. Under those 
amendments, relief is conditioned on (i) a majority of the board of 
directors of each fund relying on the rule being independent 
directors, (ii) the independent directors of any fund relying on the 
rule selecting and nominating any other independent directors, and 
(iii) any legal counsel for the independent directors of the fund 
relying on the rule being an independent legal counsel. See rule 
17a-8(a)(4). See also Role of Independent Directors of Investment 
Companies, Investment Company Act Release No. 24816 (Jan. 2, 2001) 
[66 FR 3734 (Jan. 16, 2001)].
    \14\Rule 17a-8(a)(2)(ii).
    \15\In the proposal, we identified these factors in the text of 
the rule itself. See proposed rule 17a-8(a)(2)(ii). Consistent with 
our judgment to continue to rely on the exercise of judgment by the 
directors (including the disinterested directors), and because these 
factors only represent examples of factors that may be relevant, we 
have decided not to include the factors in the rule text. Instead, 
we have included a note in the rule to refer readers to this 
release. As such, the factors do not represent legal requirements. 
While it is true that the directors may not have to consider all of 
these factors, it is equally true that consideration of these 
factors may not suffice if the directors have not considered other 
relevant factors. In all cases, the directors must make their own 
determination as to what factors are relevant to making their 
findings under the rule.
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     Any fees or expenses that will be borne directly or 
indirectly by the fund in connection with the merger;\16\
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    \16\Directors should consider in particular whether the fund's 
payment of fees and expenses that would otherwise be paid by the 
fund's investment adviser raises questions under section 15(a)(1) 
[15 U.S.C. 80a-15(a)(1)] (advisory contract must precisely describe 
all compensation to be paid under the contract) and section 36(b) 
[15 U.S.C. 80a-35(b)] (investment adviser has fiduciary duty with 
respect to the receipt of compensation for services, or of payments 
of a material nature, paid by the fund or its shareholders). In 
addition, if the fund merger follows a merger of the fund's 
investment adviser, then the fund's payment of fees and expenses 
might constitute compensation to the investment adviser and raise 
questions regarding the availability of section 15(f) [15 U.S.C. 
80a-15(f)] (creating a safe harbor under which investment advisers 
may receive a benefit in connection with a sale of securities of, or 
a sale of any other interest in, an investment adviser that results 
in an assignment of an investment advisory contract, if certain 
conditions are met).
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     Any effect of the merger on annual fund operating expenses 
and shareholder fees and services;
     Any change in the fund's investment objectives, 
restrictions, and policies that will result from the merger; and
     Any direct or indirect federal income tax consequences of 
the merger to fund shareholders.
    We do not intend the list of factors to be exhaustive, and none of 
the factors would necessarily be determinative. Consideration of these 
specific factors does not relieve a board of the obligation to consider 
other relevant factors.\17\
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    \17\See supra note 15.
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    We are also adopting an amendment that requires the acquired fund, 
in a merger relying on rule 17a-8, to have the merger approved by its 
shareholders in certain circumstances.\18\ In the Proposing Release we 
expressed concern that funds were increasingly organized (or 
reorganized) under state laws that did not require shareholder approval 
of mergers, which could deny shareholders a voice in an important 
change in their investment.\19\ Most commenters supported requiring 
acquired companies to obtain shareholder approval, but in light of the 
costs of proxy solicitations, urged us to limit the requirement. One 
commenter recommended that we require shareholder approval only when 
the merger would result in a change that, in a context other than a 
merger, would require a shareholder vote under the Investment Company 
Act. We believe such an approach has merit because it would preserve 
important values embodied in the Investment Company Act while reducing 
the need for a fund to incur the expense of soliciting proxies when the 
merger may not raise significant issues for shareholders.
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    \18\In some cases rule 17a-8 may permit a merger to occur 
without shareholder approval, but state law or the fund's 
organizational documents may require shareholder approval. Nothing 
in rule 17a-8 relieves a fund of its obligations in this regard 
under state law or its organizational documents. We also proposed, 
but are not adopting, an amendment that would have required certain 
shareholders to ``echo vote'' their securities. Commenters pointed 
out that echo voting would be costly and complex, and that seeking 
instructions from beneficial owners could be contrary to the terms 
of underlying legal arrangements. Advisers (and their affiliated 
persons) that are also fund shareholders should carefully consider 
their fiduciary responsibilities to the fund when deciding how to 
cast their votes. We understand that it is a common practice for 
advisers with conflicting obligations to vote their shares in a 
manner similar to that which we proposed.
    \19\Proposing Release, supra note 9, at text accompanying nn.37-
41.
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    Under rule 17a-8, as we are today amending it, reliance on the rule 
requires the acquired fund to obtain the approval of a majority of its 
shareholders\20\ in circumstances that we have derived from various 
provisions of the Act and our rules that specify when a fund must 
obtain the approval of its shareholders.\21\ Under the rule as amended 
a majority of the shareholders of the acquired fund must approve the 
merger if--
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    \20\The amended rule requires a ``vote of a majority of the 
outstanding voting securities,'' as described in section 2(a)(42) of 
the Act. Rule 17a-8(a)(3). We have added this provision in response 
to a comment that shareholder votes required under rule 17a-8 be 
subject to the Act's requirements for majority approval. Cf. 
Proposing Release, supra note 9, at n.41.
    \21\We have not included the identical requirements because the 
application of such requirements in the context of a merger would 
not work, or might require a shareholder vote in all circumstances.
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     Any policy of the acquired fund that under section 13 of 
the Act could not be changed without a vote of a majority of its 
outstanding voting securities is materially different from a policy of 
the acquiring fund;\22\
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    \22\Rule 17a-8(a)(3)(i). Under section 13 of the Act no fund 
may, unless authorized by the vote of a majority of its outstanding 
voting securities: (1) change between being an open- and closed-end 
investment company or from being a diversified to a nondiversified 
company; (2) borrow money, issue senior securities, underwrite 
securities issued by other persons, purchase or sell real estate or 
commodities, or make loans to other persons, except in accordance 
with the recitals of policies contained in the fund's registration 
statement; (3) deviate from any investment policy that is changeable 
only by shareholder vote or any policy that is ``fundamental'' under 
section 8(b)(3) of the Act; or (4) change the nature of its business 
so as to cease to be an investment company. 15 U.S.C. 80a-13(a)(3).
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     The acquiring fund's advisory contract is materially 
different from that of the acquired fund, except for the identity of 
the funds as parties to the contract;\23\
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    \23\Rule 17a-8(a)(3)(ii). See 15 U.S.C. 80a-15 (requiring 
shareholder approval of advisory contracts). We interpret section 
15(a) to require shareholder approval of only material changes to an 
advisory contract, and thus have drafted the rule in a manner that 
reflects that interpretation. If, after the merger, the advisory 
fees payable by the acquiring fund will be greater than the advisory 
fees of the acquired fund, we would consider the increase in the 
advisory fee to be a material change requiring shareholder approval.

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     After the merger, directors of the acquired fund who are 
not interested persons of the acquired fund and who were elected by its 
shareholders will not comprise a majority of the directors of the 
acquiring fund who are not interested persons of the acquiring 
fund;\24\ or
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    \24\Rule 17a-8(a)(3)(iii). In other words, a shareholder vote is 
not required if, after the merger, a majority of the disinterested 
directors of the acquiring company will be comprised of persons who 
were elected disinterested directors of the acquired company.
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     After the merger, the acquiring fund will be authorized to 
pay charges under a plan that provides for use of fund assets for 
distribution (``rule 12b-1 plan'') that are greater than charges 
authorized to be paid by the acquired fund under such a plan.\25\
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    \25\Rule 17a-8(a)(3)(iv). See rule 12b-1 under the Investment 
Company Act [17 CFR 270.12b-1] (describing circumstances in which an 
open-end management investment company may bear expenses associated 
with the distribution of its shares).
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    We are also adopting, as proposed, a requirement that each 
investment company that survives the merger preserve written records 
that document the merger and its terms.\26\ The records must include, 
among other things, the minute books setting forth the determinations 
of the funds' boards and the bases for those determinations, any 
supporting documents provided to the directors in connection with the 
merger, and documentation of the prices at which securities were 
transferred in the merger.\27\ The recordkeeping requirement ensures 
that we have adequate information to assess the merging funds' 
compliance with the rule's conditions.
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    \26\Rule 17a-8(a)(5) (requiring the company to keep these 
records for six years after the merger and, for the first two years, 
in an easily accessible place).
    \27\Rule 17a-8(a)(2)(iv). The merger records also must include 
any report of an independent evaluator necessary for compliance with 
rule 17a-8(a)(2)(iii). See infra Section I.B.
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B. Mergers of Registered Investment Companies and Certain Unregistered 
Entities

    We are expanding the exemption provided by rule 17a-8 to permit 
funds to merge with affiliated persons that are bank common trust 
funds,\28\ bank collective trust funds,\29\ and unregistered insurance 
company separate accounts,\30\ provided that the survivor is a 
registered investment company.\31\ We did not propose to permit mergers 
with unregistered insurance company separate accounts. One commenter 
pointed out, and we agree, that the issues raised by mergers with that 
type of account are similar to the issues raised by mergers with bank 
common and collective trust funds.
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    \28\Generally, common trust funds and similar funds are exempt 
from registration under section 3(c)(3) of the Act [15 U.S.C. 80a-
3(c)(3)]. See Proposing Release, supra note 9, at n.48.
    \29\Collective trust funds are exempt from registration under 
section 3(c)(11) of the Act [15 U.S.C. 80a-3(c)(11)]. See Proposing 
Release, supra note 9, at n.49.
    \30\Separate accounts are described in section 2(a)(37) of the 
Act [15 U.S.C. 80a-2(a)(37)].
    \31\Rule 17a-8(a)(1). As we discussed in the Proposing Release, 
the staff has written no-action letters in the past under section 
17(a) and rule 17a-7 to funds seeking to merge with unregistered 
entities. Proposing Release, supra note 9, at n.54. Parties to 
mergers that occur on or after the compliance date of the amendments 
to rule 17a-8 should not rely on the guidance in those letters. 
Parties to such mergers must either (i) comply with rule 17a-8 or 
another applicable rule or (ii) obtain an exemptive order from the 
Commission under section 17(b). A merger that is conducted in 
reliance on rule 17a-7 must comply with all of the conditions of 
that rule, including the requirement that the transaction be for no 
consideration other than cash payment against prompt delivery of a 
security for which market quotations are readily available. See 17 
CFR 270.17a-7(a).
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    We are also adopting a requirement that the board of directors of a 
fund that merges with an unregistered trust fund or account, in making 
its determination that the interests of the fund's shareholders will 
not be diluted as a result of the merger, approve procedures for the 
valuation of the securities (or other assets) that the unregistered 
entity will convey to the fund.\32\ These procedures must provide for 
the preparation of a report by an independent evaluator\33\ that sets 
forth the fair market value of any such assets for which market 
quotations are not readily available.\34\ The independent evaluator's 
report must be included in the records of the merger.\35\
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    \32\Rule 17a-8(a)(2)(iii).
    \33\An ``independent evaluator'' is a person having expertise in 
the valuation of securities and other financial assets who is not an 
interested person of the unregistered entity or any of its 
affiliated persons, other than the fund. Rule 17a-8(b)(3).
    \34\Rule 17a-8(a)(2)(iii). This provision requires the directors 
to obtain a report from an independent evaluator valuing those 
securities for which the directors will have to determine fair value 
for purposes of computing the net asset value of the fund's shares 
subsequent to the merger. See 17 CFR 270.2a-4(a). A number of 
commenters incorrectly assumed that our proposal would require the 
fund to accept the opinion of the independent evaluator and 
expressed a concern that the rule might require the fund to accept 
valuations for the purpose of the merger that it would not 
subsequently use, which would require a readjustment of values. The 
rule amendment essentially requires the board to receive a ``second 
opinion'' from an independent evaluator, which the board can use 
when considering the asset valuations that may have been prepared by 
a person that has an interest in the transaction. Although a board 
is free under the rule to reject the opinion, it should use caution 
in accepting a valuation by a person that has an interest in the 
merger when that person's valuation is materially different from 
that of the independent evaluator. The proposed amendments would 
have required that the independent evaluator's report include 
valuations for all securities to be conveyed to the acquiring fund. 
The rule amendments that we are adopting limit this requirement to 
securities for which market quotations are not readily available. 
Commenters expressed concern about the cost to funds of obtaining 
reports from independent evaluators, and we do not believe that it 
is necessary to require reports that value securities for which 
market quotations are readily available.
    \35\Rule 17a-8(a)(5).
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II. Effective Date

    The amendments to rule 17a-8 will be effective on July 26, 2002. 
The Administrative Procedure Act generally provides that a substantive 
rule may become effective no less than 30 days after publication in the 
Federal Register.\36\ Nevertheless, we may establish an effective date 
that is less than 30 days after publication for rule amendments that 
grant or recognize an exemption or relieve a restriction.\37\ Today's 
amendments meet these criteria, because the amendments exempt certain 
fund mergers from the prohibition in section 17(a).
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    \36\5 U.S.C. 553(d).
    \37\5 U.S.C. 553(d)(1).
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    Persons entering into mergers that occur on or after October 25, 
2002 (``compliance date'') must comply with the conditions in rule 17a-
8 as amended in order to rely on the exemption in the rule. Persons 
entering into mergers that occur between July 26, 2002 and the 
compliance date may rely on either rule 17a-8 as amended, or rule 17a-8 
as it existed prior to today's amendments.

III. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules. 
The amendments to rule 17a-8 are designed to reduce costs incurred by 
funds and advisers by eliminating the need for Commission approval of 
certain fund mergers. The amendments also supplement existing 
conditions of the rule, in order to ensure continued protection of fund 
shareholders in connection with mergers of funds and their affiliates. 
The Commission has identified certain costs, which are discussed below, 
that may result from the rule amendments. The rule amendments are 
exemptive, rather than prescriptive, and funds are not required to rely 
on them. Therefore, we assume that funds will rely on the rule 
amendments only if the anticipated benefit from doing so exceeds the 
anticipated cost. We did not receive any data regarding the costs and 
benefits of the rule amendments from commenters.

[[Page 48515]]

A. Benefits

    We anticipate that funds, their shareholders, and their advisers 
and other affiliates will benefit from the expansion of the rule to 
include mergers of affiliated funds, regardless of the nature of the 
affiliation, and mergers with common or collective trust funds and 
unregistered insurance company separate accounts. More merging funds 
will be able to rely on the rule and therefore will not have to obtain 
exemptive relief, which can be costly to merging funds, their 
shareholders, and their affiliates.\38\ Thus, the amendments will 
remove an obstacle to mergers of affiliated funds and can thereby 
reduce the costs of affiliated mergers. Investment advisers also can 
benefit from the greater ease with which mergers can be effected under 
the amended rule because they often bear all or a portion of the costs 
of obtaining exemptive relief.\39\
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    \38\In calendar year 2000, exemptive orders were issued for over 
30% of affiliated fund mergers. We believe that these mergers would 
have been able to proceed under amended rule 17a-8. As set forth in 
Section V below, we anticipate that there will be approximately 400 
affiliated fund mergers annually. Thus, assuming that 30% of these 
would have had to proceed under an exemptive order, annually 
approximately 120 mergers for which individualized exemptive relief 
would have been necessary will now be able to proceed under the 
rule. The Commission staff estimates, based on conversations with 
persons who have prepared exemptive applications for merger-related 
relief under section 17(b), that it costs an average of $36,000 to 
obtain an exemptive order permitting mergers of multiple portfolios 
of one or more affiliated registered investment companies. As 
discussed below, some funds may incur costs in complying with the 
rule's conditions that they otherwise would not have incurred. See 
infra Section III.B.
    \39\The costs of a fund merger may be borne totally or in part 
by the investment adviser to one or both of the merging funds or may 
be borne by one or both of the merging funds. The allocation of 
costs of the merger is a product of negotiation between the boards 
of the merging funds and their investment adviser(s).
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    The Commission staff anticipates that eliminating the need for 
merging funds to obtain individualized exemptive relief would not cause 
a significant increase in the number of mergers. However, to the extent 
that the number of mergers increases, mergers give shareholders of 
small or poorly performing funds an opportunity to shift their assets 
to a better performing fund without negative tax consequences.\40\ In 
addition, investment advisers can realize economies of scale through 
fund mergers, which spread the costs of management, some of which are 
fixed, across a larger pool of assets. Shareholders may benefit from 
these economies of scale in the form of lower fees and expenses.\41\
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    \40\Liquidations are generally taxable events for fund 
shareholders, whereas fund mergers can be structured to be non-
taxable.
    \41\See Narayanan Jayaraman, et al., An Analysis of the 
Determinants and Shareholder Wealth Effects of Mutual Fund Mergers, 
57 J.FIN. 1521 (2002) (finding that target shareholders benefit from 
improved performance and lower expense ratios).
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    We believe that the amendments, in addition to reducing costs faced 
by funds in connection with mergers, also may enhance the protections 
afforded by the rule to fund shareholders. We believe that the 
provision conditioning relief on the directors requesting and 
evaluating such information as may reasonably be necessary to determine 
whether the merger is in the best interests of the fund and will not 
dilute the interests of the fund's existing shareholders will encourage 
director scrutiny of fund mergers. Conditioning the rule's relief in 
certain circumstances on approval of the merger by a majority of the 
outstanding voting securities of an acquired fund can benefit fund 
shareholders by giving them an opportunity to assess the merger in 
light of their own financial circumstances. Submitting the merger to a 
vote, we believe, may improve its terms since the fund managers must 
persuade investors to approve them. Finally, we believe that the 
amended rule's recordkeeping requirements will ensure that our 
examinations staff will be able to assess merging funds' compliance 
with the rule.

B. Costs

    Merging funds that choose to rely on rule 17a-8, and their 
advisers, will incur certain costs in complying with the rule's 
conditions. The supplemental conditions included in the amendments, 
together with the increased numbers of merging funds likely to rely on 
the rule, may result in an increase in the aggregate annual cost of 
compliance with rule 17a-8.
    The amendments would eliminate the expenses of filing an exemptive 
application for certain merging funds.\42\ Unlike the expense of 
complying with rule 17a-8, however, the cost of an exemptive 
application may be shared by a number of merging funds. Therefore, 
there may be certain increased compliance costs under the amended rule 
for these merging funds.\43\ In addition, some merging funds that would 
have been able to comply with rule 17a-8 prior to the amendments may 
face higher costs under the amendments.\44\ Finally, funds merging with 
eligible unregistered funds will be able to avoid the expense of filing 
an exemptive application, but some funds may incur greater costs under 
the rule than they would have incurred otherwise, such as higher 
valuation costs because of the required independent evaluator's report.
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    \42\See supra note and accompanying text.
    \43\Except in rare circumstances, it is unlikely that funds will 
experience significantly higher costs in conducting a merger under 
the amended rule. See infra notes 46-47 and accompanying text 
(discussing costs associated with conducting a shareholder vote).
    \44\These increased costs may be attributable to the amended 
rule's requirements regarding board determinations, shareholder 
voting provisions, and/or recordkeeping requirements.
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    The rule is intended to ensure that boards thoroughly review merger 
transactions and their terms. Even in the absence of the amended rule, 
fund boards would meet to consider the merger; as a result, the 
incremental costs attributable to the board determination requirements 
of rule 17a-8 are likely to be minimal.
    In conjunction with the expansion of the rule to unregistered 
entities, the amendments require that fund boards establish procedures 
for valuing the assets held by any eligible unregistered funds 
participating in the merger. If the unregistered entity will convey 
assets to the fund for which market quotations are not readily 
available, then the valuation procedures must include the preparation 
of a report by an independent evaluator. The staff estimates that this 
requirement will impose an aggregate annual cost of approximately 
$195,000.\45\
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    \45\The staff estimates, based on a review of fund filings, that 
there will be approximately 13 mergers each year involving common or 
collective trust funds or unregistered separate accounts. The staff 
also estimates, based on discussions with professionals who have 
prepared similar valuation reports, that the preparation of an 
independent evaluator's report in these instances would cost 
approximately $15,000. This cost could, however, be considerably 
higher depending on the number and characteristics of the securities 
that are being valued.
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    We believe that there will be few additional shareholder votes 
annually as a result of the requirement in rule 17a-8 that shareholders 
of the acquired fund approve certain fund mergers.\46\ Currently, in 
most (if not all) cases acquired funds obtain approval of their 
shareholders before engaging in mergers that materially alter the 
investment held by fund shareholders. The staff estimates that the cost 
of obtaining

[[Page 48516]]

shareholder approval for a fund merger is approximately $75,000.\47\
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    \46\For purposes of our Paperwork Reduction Act analysis, we 
assumed that twenty funds each year will be affected. See infra 
Section V. Our staff rarely sees fund mergers in which there is no 
shareholder vote. Many funds are required by state law or the fund's 
organizational documents to conduct a shareholder vote in the event 
of a merger. Even funds that are not required to obtain shareholder 
approval may do so in order to maintain good relations with their 
shareholders.
    \47\This estimate, which is based on conversations with 
representatives of funds and service providers, includes the legal, 
mailing, printing, solicitation, and tabulation costs associated 
with a shareholder vote. For the estimated twenty affected funds, 
the annual aggregate cost of holding a shareholder vote (at a cost 
of $75,000 per fund) would be approximately $1,500,000. However, the 
cost of holding a shareholder vote would be offset by an affected 
fund avoiding the cost of sending shareholders an information 
statement. See 15 U.S.C. 78n(c) (providing that prior to any meeting 
of its shareholders with respect to which proxies are not solicited, 
an investment company must, in accordance with Commission rules, 
file with the Commission and transmit to all shareholders of record 
information substantially equivalent to the information which would 
be required to be transmitted if a solicitation were made). Our 
staff estimates, based on discussions with industry participants, 
that the cost of preparing and delivering an information statement 
is $30,000. Thus, we estimate that there will be an aggregate cost 
savings of $600,000 resulting in a net annual aggregate cost of 
holding a shareholder vote of approximately $900,000.
---------------------------------------------------------------------------

    We believe that the incremental costs associated with the 
recordkeeping requirements in amended rule 17a-8 will not be 
significant. We believe that most funds already retain the types of 
records that are required by the amended rule as a matter of good 
business practice. Prior to the amendments, the rule required that the 
directors' findings and their bases be recorded in the minute books of 
the fund. The amended rule retains this requirement at what we 
anticipate will continue to be a minimal cost.\48\ The amended rule 
also requires the acquiring fund to retain written records describing 
the merger and its terms. The six-year retention period is consistent 
with the retention period applicable to similar fund records.\49\ We 
believe, therefore, that the recordkeeping requirement is unlikely to 
impose significant additional costs on funds.
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    \48\For purposes of the Paperwork Reduction Act analysis, the 
staff estimates that personnel of each fund will spend approximately 
.75 hours (.25 hours of professional time and .5 hours of clerical 
time) to satisfy the amended rule's recordkeeping requirements in 
connection with a merger. See infra Section V.
    \49\See rule 31a-2 [17 CFR 270.31a-2].
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IV. Effects on 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 consistent with the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation.\50\ None of the 
commenters addressed these issues.
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    \50\15 U.S.C. 80a-2(c). We are adopting the amendments to rule 
17a-8 pursuant to the authority in section 6(c) and 38(a) of the 
Act. As rules that we adopt under section 6(c) must be ``necessary 
or appropriate in the public interest,'' the requirements of section 
2(c) apply to the rule amendments.
---------------------------------------------------------------------------

    Today's amendments to rule 17a-8 are intended to make the rule 
available for more affiliated fund mergers, thereby eliminating the 
need for specific exemptive relief in most cases.\51\
---------------------------------------------------------------------------

    \51\See supra Section III.
---------------------------------------------------------------------------

    The rule amendments will expedite many mergers that, prior to the 
amendments, could proceed only if we issued an exemptive order. These 
mergers will now be less costly to the merging funds, their 
shareholders, and their affiliates. It is possible that reducing the 
cost of mergers will induce more funds to combine, thereby increasing 
industry concentration. We do not, however, believe that the cost of 
obtaining a Commission exemptive order is a significant factor in 
funds' decisions to enter into mergers, and we do not anticipate that 
the rule amendments will significantly increase or decrease the number 
of mergers that occur annually; therefore, the amendments will not have 
a significant direct effect on efficiency, competition, or capital 
formation.\52\
---------------------------------------------------------------------------

    \52\See supra Section III.A. for a discussion of the cost 
savings.
---------------------------------------------------------------------------

    The amendments may have certain secondary effects on efficiency and 
competition. By eliminating disparities in the costs incurred by 
affiliated funds that would have been able to merge under the rule 
prior to the amendments, versus those that would have merged through an 
exemptive order, the amendments may have a positive effect on 
competition. On the other hand, because (as discussed above) a small 
number of funds that would have been able to merge under the rule prior 
to the amendments may incur higher costs under the amended rule, the 
amendments may have a negative effect on efficiency. However, we do not 
anticipate that either effect will be significant.

V. Paperwork Reduction Act

    As explained in the Proposing Release, the amendments to rule 17a-8 
expand the rule's scope and add new conditions to the rule, some of 
which constitute new ``collection of information'' requirements within 
the meaning of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-
3520). We submitted these proposals 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 title for the collection of information is ``Rule 17a-
8 under the Investment Company Act of 1940 [17 CFR 270.17a-8], 
``Mergers of Certain Affiliated Investment Companies.'' 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. The OMB control number for amended rule 17a-8 is 3235-0235.
    As discussed above, today we are adopting amendments to rule 17a-8 
that are substantially similar to amendments that we proposed in 
November 2001. None of the commenters addressed the Paperwork Reduction 
Act burden associated with these amendments.
    The staff believes that the amendments will increase the annual 
hour burden associated with the rule, which is currently estimated to 
be 120 hours, and introduce an annual cost burden associated with the 
rule for purposes of the Paperwork Reduction Act. Because rule 17a-8 is 
an exemptive rule, funds may choose whether to rely on it. Therefore, 
any information provided under rule 17a-8 would be provided 
voluntarily. The amendments do not require that information be provided 
to the Commission, and thus this release does not address the 
confidentiality of responses under the amendments to rule 17a-8.
    We anticipate that most if not all funds that engage in mergers 
with affiliated funds will rely on rule 17a-8. Assuming that there will 
be approximately 400 mergers between affiliated funds or fund 
portfolios annually, we estimate that approximately 800 registered 
investment companies, or, in many cases, portfolios or series thereof, 
would be subject to the rule's information collection requirements 
annually.\53\ The Commission staff estimates that merging funds would 
spend annually an aggregate of 600 hours--200 hours of professional 
time and 400 hours of clerical time--recording the relevant 
determinations of the boards of directors and preserving written 
records of the mergers and their terms.\54\ The

[[Page 48517]]

amendments would require that written records describing the merger 
transaction and terms be maintained for six years after the merger, the 
first two in an easily accessible place.
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    \53\The staff estimate of approximately 400 mergers annually is 
higher than the approximately 279 mergers predicted for calendar 
year 2002 by a simple linear projection of merger data from 1993 
through 2000. The staff believes, based on an evaluation of the 
number of mergers in recent years and current industry conditions, 
that 279 is an underestimate of the number of mergers that are 
likely to occur annually.
    \54\The staff estimates, based on estimates made by the staff in 
1999 in connection with the application for an extension of OMB's 
approval for the rule 17a-8 paperwork collection burden, that the 
proposed amendments would cause each of the approximately 800 
participating portfolios or series of registered investment 
companies to incur an annual burden of .75 hours (.25 hours of 
professional time and .5 hours of clerical time) to record board 
resolutions documenting the board's findings and to preserve records 
of the merger transaction.
---------------------------------------------------------------------------

    We also anticipate that most if not all funds that engage in 
mergers with eligible unregistered funds will rely on rule 17a-8. Our 
staff estimates that approximately 13 merging funds would be covered by 
this provision in the first year following the adoption of this 
rule.\55\ Our staff further estimates, based on discussions with 
professionals who have prepared similar valuation reports, that an 
independent evaluator's report would cost approximately $15,000 and 
that, in the aggregate, the annual burden associated with this aspect 
of the rule will be approximately $195,000.\56\
---------------------------------------------------------------------------

    \55\This estimate is based on a review of fund filings. It is 
greater than the estimate in the Proposing Release because the 
amendments to rule 17a-8 in the Proposing Release did not include 
unregistered insurance company separate accounts as eligible 
unregistered funds. See supra Section I.B.
    \56\See supra note 45, which sets forth the basis for this 
estimate. This estimate is greater than the estimate in the 
Proposing Release because of the increase in the estimate of the 
number of merging funds that will rely on rule 17a-8. See supra note 
55.
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    There is a cost associated with obtaining the approval of the 
acquired fund's outstanding voting securities. The staff estimates that 
shareholder approval will be sought by approximately twenty funds each 
year that would not otherwise have conducted a shareholder vote.\57\ 
Funds or their advisers incur legal, mailing, printing, solicitation, 
and tabulation costs in connection with a shareholder vote. We 
estimate, based on discussions with representatives of funds and 
service providers, that the total cost to an acquired fund of obtaining 
shareholder approval for a fund merger is approximately $75,000. Thus, 
we anticipate that the total annual cost associated with this provision 
will be approximately $1,500,000. However, since a fund conducting a 
shareholder vote will not be required to send an information statement, 
the cost of the shareholder vote provision will be offset by the 
avoided cost of sending information statements. We estimate, based on 
discussions with fund representatives, that each information statement 
would cost $30,000 to prepare and deliver. Thus, we anticipate that a 
total of approximately $600,000 of costs will be avoided annually, and 
the net cost of the shareholder vote provision will be approximately 
$900,000.\58\
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    \57\Many funds are required by state law or their organizational 
documents to conduct a shareholder vote in the event of a merger. 
Moreover, even funds that are not required to obtain shareholder 
approval may do so in order to maintain good relations with their 
shareholders.
    \58\This figure is less than the estimate in the Proposing 
Release because the figure in the Proposing Release did not take 
into account the avoided cost of sending information statements. See 
Proposing Release, supra note, at text accompanying n.95.
---------------------------------------------------------------------------

    The Commission staff estimates that the paperwork burden arising 
from the proposed amendments reflects an increase in the paperwork 
burden associated with rule 17a-8 of 480 hours and an increase in the 
annual cost burden of approximately $1,095,000.\59\
---------------------------------------------------------------------------

    \59\This figure is the total of the estimated $195,000 annual 
cost associated with valuing the securities of eligible unregistered 
funds and the $900,000 annual net cost associated with obtaining 
shareholder approval. It differs from the figure of $3,650,000 in 
the Proposing Release because of (i) an increase of $45,000 in the 
estimated annual cost associated with valuing the securities of 
eligible unregistered funds, (ii) a decrease of $600,000 in the 
estimated annual cost associated with obtaining shareholder 
approval, and (iii) the elimination of the proposed echo voting 
provision and its accompanying cost, estimated at $2,000,000. See 
supra note 18 for a discussion of the proposed echo voting 
requirement.
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VI. Summary of Final Regulatory Flexibility Analysis

    The Commission has prepared a Final Regulatory Flexibility Analysis 
(``FRFA'') in accordance with 5 U.S.C. 604 regarding the amendments to 
rule 17a-8 under the Investment Company Act. A summary of the Initial 
Regulatory Flexibility Analysis (``IRFA''), which was prepared in 
accordance with 5 U.S.C. 603, was published in the Proposing Release. 
The following is a summary of the FRFA.

A. Need for and Objectives of the Rule Amendments

    The FRFA summarizes the background of the amendments. The FRFA also 
discusses the reasons for the amendments and the objectives of, and 
legal basis for, the amendments. Those items are discussed above in 
this release.

B. Significant Issues Raised by Public Comment

    The Commission received no comments on the IRFA.

C. Small Entities Subject to the Rule

    The FRFA discusses the effect of the amendments on small entities. 
A small business or small organization (collectively, ``small entity'') 
for purposes of the Regulatory Flexibility Act is a fund that, together 
with other funds in the same group of related investment companies, has 
net assets of $50 million or less as of the end of its most recent 
fiscal year.\60\ Of approximately 3,650 active funds, approximately 190 
are small entities. A fund that is a small entity, like other funds, 
will be affected by the amendments only if it seeks to merge with an 
affiliated fund, bank common trust fund, bank collective trust fund, or 
unregistered insurance company separate account.
---------------------------------------------------------------------------

    \60\Rule 0-10 [17 CFR 270.0-10].
---------------------------------------------------------------------------

    The FRFA states that the rule amendments should not have a 
substantial impact on small entities. Like other funds, a small entity 
will be affected by rule 17a-8 only if it enters into a merger with an 
affiliated person in reliance on the rule.

D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    As amended, the rule conditions relief on the board making the best 
interests and non-dilution determinations and on those determinations 
and the bases therefor being recorded in the minute books of each 
registered company. The rule requires that fund directors request and 
evaluate such information as may reasonably be necessary to their 
determinations, considering and giving appropriate weight to all 
pertinent factors. As a basis for the non-dilution finding, the board 
of directors of a fund that merges with an unregistered entity must 
approve procedures for the valuation of the securities (or other 
assets) that the unregistered entity will convey to the fund. These 
procedures must provide for the preparation of a report by an 
independent evaluator that sets forth the fair market value of any such 
assets for which market quotations are not readily available. The FRFA 
describes the provision in the rule related to shareholder voting. 
Finally, the FRFA describes the requirement that any surviving fund 
maintain records relating to the merger transaction for six years, the 
first two in an easily accessible place, following the merger.
    The FRFA explains that the amendments could benefit funds, 
including small entities, by expanding the availability of the rule to 
include mergers that are currently outside the scope of the rule. Funds 
that currently would have to incur the expense associated with filing 
applications for exemptive relief could rely on the rule.

E. Agency Action To Minimize Effect on Small Entities

    The FRFA explains that the Commission has considered significant 
alternatives to the amendments that would accomplish the stated 
objective, while minimizing any significant

[[Page 48518]]

adverse impact on small entities. The Commission believes that no 
alternative could carry out these objectives as effectively as the 
amendments.

VII. Statutory Authority

    The Commission is adopting amendments to rule 17a-8 pursuant to the 
authority set forth in sections 6(c) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-6(c), 80a-37(a)].

List of Subjects in 17 CFR Part 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Rule

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is 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 270.17a-8 is revised to read as follows:


Sec. 270.17a-8  Mergers of affiliated companies.

    (a) Exemption of affiliated mergers. A Merger of a registered 
investment company (or a series thereof) and one or more other 
registered investment companies (or series thereof) or Eligible 
Unregistered Funds is exempt from sections 17(a)(1) and (2) of the Act 
(15 U.S.C. 80a-17(a)(1)-(2)) if:
    (1) Surviving company. The Surviving Company is a registered 
investment company (or a series thereof).
    (2) Board determinations. As to any registered investment company 
(or series thereof) participating in the Merger (``Merging Company''):
    (i) The board of directors, including a majority of the directors 
who are not interested persons of the Merging Company or of any other 
company or series participating in the Merger, determines that:
    (A) Participation in the Merger is in the best interests of the 
Merging Company; and
    (B) The interests of the Merging Company's existing shareholders 
will not be diluted as a result of the Merger.

    Note to paragraph (a)(2)(i): For a discussion of factors that 
may be relevant to the determinations in paragraph (a)(2)(i) of this 
section, see Investment Company Act Release No. 25666, July 18, 
2002.

    (ii) The directors have requested and evaluated such information as 
may reasonably be necessary to their determinations in paragraph 
(a)(2)(i) of this section, and have considered and given appropriate 
weight to all pertinent factors.
    (iii) The directors, in making the determination in paragraph 
(a)(2)(i)(B) of this section, have approved procedures for the 
valuation of assets to be conveyed by each Eligible Unregistered Fund 
participating in the Merger. The approved procedures provide for the 
preparation of a report by an Independent Evaluator, to be considered 
in assessing the value of any securities (or other assets) for which 
market quotations are not readily available, that sets forth the fair 
value of each such asset as of the date of the Merger.
    (iv) The determinations required in paragraph (a)(2)(i) of this 
section and the bases thereof, including the factors considered by the 
directors pursuant to paragraph (a)(2)(ii) of this section, are 
recorded fully in the minute books of the Merging Company.
    (3) Shareholder approval. Participation in the Merger is approved 
by the vote of a majority of the outstanding voting securities (as 
provided in section 2(a)(42) of the Act (15 U.S.C. 80a-2(a)(42))) of 
any Merging Company that is not a Surviving Company, unless--
    (i) No policy of the Merging Company that under section 13 of the 
Act (15 U.S.C. 80a-13) could not be changed without a vote of a 
majority of its outstanding voting securities, is materially different 
from a policy of the Surviving Company;
    (ii) No advisory contract between the Merging Company and any 
investment adviser thereof is materially different from an advisory 
contract between the Surviving Company and any investment adviser 
thereof, except for the identity of the investment companies as a party 
to the contract;
    (iii) Directors of the Merging Company who are not interested 
persons of the Merging Company and who were elected by its 
shareholders, will comprise a majority of the directors of the 
Surviving Company who are not interested persons of the Surviving 
Company; and
    (iv) Any distribution fees (as a percentage of the fund's average 
net assets) authorized to be paid by the Surviving Company pursuant to 
a plan adopted in accordance with Sec. 270.12b-1 are no greater than 
the distribution fees (as a percentage of the fund's average net 
assets) authorized to be paid by the Merging Company pursuant to such a 
plan.
    (4) Board composition; independent directors. (i) A majority of the 
directors are not interested persons of the Merging Company and those 
directors select and nominate any other disinterested directors.
    (ii) Any person who acts as legal counsel for the disinterested 
directors is an independent legal counsel.
    (5) Merger records. Any Surviving Company preserves written records 
that describe the Merger and its terms for six years after the Merger 
(and for the first two years in an easily accessible place).
    (b) Definitions. For purposes of this section:
    (1) Merger means the merger, consolidation, or purchase or sale of 
substantially all of the assets between a registered investment company 
(or a series thereof) and another company;
    (2) Eligible Unregistered Fund means:
    (i) A collective trust fund, as described in section 3(c)(11) of 
the Act (15 U.S.C. 80a-3(c)(11));
    (ii) A common trust fund or similar fund, as described in section 
3(c)(3) of the Act (15 U.S.C. 80a-3(c)(3)); or
    (iii) A separate account, as described in section 2(a)(37) of the 
Act (15 U.S.C. 80a-2(a)(37)), that is neither registered under section 
8 of the Act, nor required to be so registered;
    (3) Independent Evaluator means a person who has expertise in the 
valuation of securities and other financial assets and who is not an 
interested person, as defined in section 2(a)(19) of the Act (15 U.S.C. 
80a-2(a)(19)), of the Eligible Unregistered Fund or any affiliate 
thereof except the Merging Company; and
    (4) Surviving Company means a company in which shareholders of a 
Merging Company will obtain an interest as a result of a Merger.

    Dated: July 18, 2002.
    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-18699 Filed 7-23-02; 8:45 am]
BILLING CODE 8010-01-P