[Federal Register Volume 79, Number 98 (Wednesday, May 21, 2014)]
[Notices]
[Pages 29226-29230]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-11684]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72173; File No. 811-02815]


Copley Fund, Inc.; Notice of Application

May 15, 2014.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice of an application for exemptive relief.

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Summary of Application: Applicant requests an order exempting it from 
rule 22c-1 under the Investment Company Act of 1940 (``Company Act'') 
and rule 4-01(a)(1) of Regulation S-X.

Applicant: Copley Fund, Inc. (``Copley'' or ``Fund'').

Filing Date: The application (together with the exhibits, the 
``Application'') was filed on September 4, 2013.

Hearing or Notification of Hearing: Interested persons may request a 
hearing by writing to the Commission's Secretary and serving applicant 
with a copy of the request, personally or by mail. Hearing requests 
should be received by the Commission by 5:30 p.m. on June 9, 2014, and 
should be accompanied by proof of service on the applicant, in the form 
of an affidavit or, for lawyers, a certificate of service. Hearing 
requests should state the nature of the writer's interest, the reason 
for the request, and the issues contested. Persons who wish to be 
notified of a hearing may request notification by writing to the 
Commission's Secretary. Absent a request for a hearing that is granted 
by the Commission, the Commission intends to issue an order under the 
Company Act denying the Application.

ADDRESSES: Secretary, Securities and Exchange Commission, 100 F Street 
NE., Washington, DC 20549-1090; Applicant, 5348 Vegas Drive, Suite 391, 
Las Vegas, Nevada 89108.

FOR FURTHER INFORMATION CONTACT: David Joire, Senior Counsel, or Nadya 
Roytblat, Assistant Chief Counsel, at (202) 551-6825, Division of 
Investment Management, Chief Counsel's Office.

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained via the 
Commission's Web site at http://www.sec.gov/rules/other.shtml or by 
calling (202) 551-8090.

I. Background

A. The Applicant

    1. Copley is a Nevada corporation registered under the Company Act 
as an open-end management investment company (``open-end fund'') that 
issues redeemable securities.\1\ Copley has been operating since 1978 
and invests primarily in U.S. equity securities. The Application states 
that Copley's ``stated investment objective is the generation and 
accumulation of dividend income'' and ``[i]ts secondary objective is 
`long-term capital appreciation.''' The Application also states that 
``[k]ey to the Fund's investment objective is its strategy, contrary to 
most other [open-end] funds, of not distributing dividends and capital 
gains to shareholders but rather accumulating them within the Fund.''
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    \1\ Section 4(3) of the Company Act defines a ``management 
company'' as any investment company other than a face-amount 
certificate company or a unit investment trust. Section 5(a)(1) of 
the Company Act defines an ``open-end company'' as a management 
company which is offering for sale or has outstanding any redeemable 
security of which it is the issuer. Section 2(a)(32) of the Company 
Act defines ``redeemable security'' to mean any security, other than 
short term paper, under the terms of which the holder, upon 
presentation to the issuer or to a person designated by the issuer, 
is entitled (whether absolutely or only out of surplus) to receive 
approximately his proportionate share of the issuer's current net 
assets, or the cash equivalent thereof.

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[[Page 29227]]

B. Copley's Status Under the Internal Revenue Code (``Code'')

    2. Virtually all open-end funds take advantage of special 
provisions in the Code, known as Subchapter M, that enable them to 
avoid a layer of tax at the corporate, i.e., fund, level.\2\ Under 
Subchapter M, an open-end fund that elects status as a ``regulated 
investment company'' (``RIC'') and meets certain requirements, one of 
which is to distribute at least 90% of investment company taxable 
income, in any taxable year, does not pay federal taxes at the fund 
level.\3\
    3. Copley has never availed itself of RIC status under the Code, so 
that, according to the Application, its shareholders ``are able to 
defer dividend and capital gains taxes [at the shareholder level] until 
redemption.'' Copley instead has elected to be treated as a ``C 
Corporation'' under the Code and thus is subject to federal taxation at 
the fund level.\4\ A shareholder of Copley, therefore, is subject to 
two layers of tax--once (indirectly) at the fund level and again 
(directly) at the shareholder level.\5\ Copley has significant 
unrealized gains in its portfolio and a federal income tax liability 
(``federal income tax liability'') would arise if those gains were 
realized by the Fund (i.e., if Copley were to sell any of its portfolio 
securities that had appreciated in value since the Fund acquired them).
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    \2\ See sections 851-855 and 860 of the Code.
    \3\ Id.
    \4\ See section 11 of the Code.
    \5\ A shareholder of a RIC and a shareholder of an open-end fund 
that is a C Corporation pay taxes at the shareholder level on any 
distributions from the fund and on any capital gains on the fund 
shares that they redeem. The Application states that Copley does not 
make any distributions to its shareholders.
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II. The Application

    4. The Application concerns the provision that Copley should make 
for its federal income tax liability for purposes of (i) calculating 
the current net asset value on which the price of Copley's redeemable 
securities must be based under rule 22c-1 under the Company Act, and 
(ii) preparing Copley's financial statements filed with the Commission 
as required by the Company Act. Copley currently makes a provision for 
federal income taxes for both purposes in the full amount of federal 
income tax that would be due if the full amount of Copley's existing 
unrealized gains were realized. Copley's current provision for federal 
income taxes is consistent with generally accepted accounting 
principles (``GAAP'').\6\
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    \6\ Specifically, Financial Accounting Standards Board 
(``FASB'') Accounting Standards Codification Topic 740, Income Taxes 
(``ASC 740'') indicates that financial statements should reflect 
deferred tax liabilities and assets for the future tax consequences 
of events that have been recognized in an entity's financial 
statements or tax returns. FASB ASC 740-10-10-1(b). ASC 740 
incorporates an assumption that the assets and liabilities of an 
entity will be recovered and settled at their carrying amounts for 
financial statement reporting purposes, which may be different from 
their carrying amounts for income tax purposes. Differences between 
book and tax carrying amounts that are caused by differences in the 
timing of recognition of transactions or events for financial 
reporting versus income tax purposes are referred to as temporary 
differences. See FASB ASC 740-10-25-20. ASC 740 provides examples of 
such differences. Revenues or gains that are taxable after they are 
recognized as income for financial reporting purposes are included 
as an example of a temporary difference. See FASB ASC 740-10-25-
20(a). Unrealized gains on investments, which are taxable after they 
are recognized in the financial statements (i.e., they are generally 
taxable only when the investments are sold), represent a temporary 
difference on which a deferred tax liability must be recognized; the 
recognized deferred tax liability is calculated by multiplying the 
temporary difference (i.e., the unrealized gains) by the expected 
tax rate at the expected time of reversal. See generally FASB ASC 
740-10-10-3 (indicating that the objective is to measure a deferred 
tax liability using the enacted tax rate expected to apply to 
taxable income in the periods in which the deferred tax liability is 
expected to be settled).
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    5. The Application requests an exemption from rule 22c-1 under the 
Company Act and rule 4-0l(a)(l) of Regulation S-X so that Copley could 
estimate a provision for federal income tax liability for both purposes 
using one of two formulas developed by Copley and described in the 
Application (together, the ``Proposed Method'').\7\ The Proposed Method 
would result in a provision for Copley's federal income tax liability 
that is less than the full amount of federal income tax that would be 
due if the full amount of Copley's existing unrealized gains were 
realized,\8\ and thus is inconsistent with GAAP. In support of its 
request for exemptions, the Application argues that ``the entire 
[federal income tax liability] would be due only in the unlikely event 
the entire portfolio were liquidated.'' The Application further argues 
that the ``use of the full liquidation value method has produced a 
skewed and unreasonable result--Copley's per share [net asset value] 
does not reflect the realistic value of the Fund,'' and that using the 
Proposed Method would ``fairly and accurately [reflect] a realistic tax 
liability.''
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    \7\ One of the formulas would be based on a quarterly 
calculation of Copley's historical portfolio turnover rate over the 
past five or ten years. The alternative formula would be based on 
the highest daily redemptions of Fund shares during the previous 
five years.
    \8\ The Application includes an extensive discussion of Copley's 
use, for a period of time prior to 2007, of a methodology similar to 
the Proposed Method, as well as Copley's subsequent discussions with 
the staff of the Commission's Division of Enforcement, resulting in 
Copley changing its methodology to make a provision for federal 
income tax liability in the full amount of federal income tax that 
would be due if the full amount of Copley's existing unrealized 
gains were realized. The Application also discusses a letter from 
the staff of the Commission's Division of Investment Management to 
Copley's counsel, dated April 5, 2013, available at http://www.sec.gov/divisions/investment/noaction/2013/copley-fund-040513-22c1.pdf, in which the staff rejected Copley's request for assurance 
that it would not recommend enforcement action to the Commission if 
Copley were to make a provision for federal income tax liability 
according to the Proposed Method.
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III. Legal Analysis

A. Rules 22c-1 and 2a-4 Under the Company Act

    6. As an open-end fund, Copley issues redeemable securities under 
the terms of which all of the holders, upon presentation to Copley or 
to a person designated by Copley, are entitled to receive approximately 
their proportionate share of Copley's current net assets or the cash 
equivalent thereof.\9\ Rule 22c-1 under the Company Act states, in 
relevant part, that no registered investment company issuing any 
redeemable security shall sell, redeem, or repurchase any such security 
except at a price based on the ``current net asset value'' of such 
security which is next computed after receipt of a tender of such 
security for redemption or of an order to purchase or sell such 
security. Rule 2a-4 under the Company Act defines the term ``current 
net asset value'' for use in computing periodically the price of a 
fund's shares to mean one determined substantially in accordance with 
the provisions of the rule. Rule 2a-4(a)(4) provides, in relevant part, 
that in determining the current net asset value, ``[a]ppropriate 
provision shall be made for Federal income taxes if required [by the 
open-end fund].'' An open-end fund that has elected RIC status under 
the Code generally would not need to make a ``provision . . . for 
Federal income taxes'' under rule 2a-4(a)(4), because it would not be 
subject to federal taxation at the fund level.\10\ In contrast, Copley, 
which has chosen to be a C Corporation and thus is subject to federal 
taxation at the fund level, must make an ``appropriate provision . . . 
for Federal

[[Page 29228]]

income taxes'' in computing its current net asset value under rule 2a-4 
for purposes of complying with rule 22c-1 under the Company Act. The 
Commission is aware of several other existing open-end funds that have 
chosen to be C Corporations and to which this provision of rule 2a-
4(a)(4) is relevant; none of these funds has requested an exemption 
relating to this provision.
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    \9\ See supra note 1 (definition of ``redeemable security'').
    \10\ An open-end fund that has elected RIC status under the Code 
may be subject to a 4% excise tax on undistributed income to the 
extent that the open-end fund does not satisfy certain distribution 
requirements for a calendar year. See Code Section 4982 ``Excise Tax 
on Undistributed Income of Regulated Investment Companies.''
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    7. Under rule 22c-1, an open-end fund may sell and redeem its 
redeemable securities only at a price based on its current net asset 
value, which equals the value of the fund's total assets minus the 
amount of the fund's total liabilities. Under rule 2a-4, an open-end 
fund generally must value its assets at their market value, in the case 
of securities for which market quotations are readily available, or at 
fair value, as determined in good faith by the fund's board of 
directors, in the case of other securities and assets.\11\ When 
calculating its current net asset value for purposes of rule 22c-1, an 
open-end fund: (i) adds up the current values of all of its assets 
(using their market values or fair values, as appropriate), which 
reflect any unrealized gains; and (ii) subtracts all of its 
liabilities, which include an appropriate provision for federal income 
taxes on any unrealized gains. If the open-end fund understates a 
liability, among other consequences, the calculated current net asset 
value will be overstated, as will the price at which the fund's 
redeemable securities are sold and redeemed. As a result, investors 
purchasing the fund's shares will pay too much for them, redeeming 
shareholders will receive too much for their shares, and the net asset 
value of shares held by the remaining shareholders may be reduced 
correspondingly when the full amount of the liability must be paid. 
This outcome would be counter to one of the primary principles 
underlying the Company Act, which is that sales and redemptions of 
redeemable securities should be effected at prices that are fair, and 
which do not result in dilution of shareholder interests or other harm 
to shareholders.\12\
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    \11\ See also section 2(a)(41) of the Company Act defining the 
term ``value.''
    \12\ See Investment Trusts and Investment Companies: Hearings on 
S.3580 Before a Subcommittee of the Senate Committee on Banking and 
Currency, 76th Cong., 3d Sess. 136-38 (1940) (hearings that preceded 
the enactment of the Company Act). In addition, all funds must 
accurately calculate their net asset values to ensure the accuracy 
of their payment of asset-based fees, such as investment advisory 
fees, as well as the accuracy of their reported performance. 
Statement Regarding ``Restricted Securities,'' Investment Company 
Act Release No. 5847 (Oct. 21, 1969).
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B. Rule 4-01(a)(1) of Regulation S-X

    8. Under the Company Act, Copley is required to file with the 
Commission a registration statement and annual reports, which must 
contain Copley's financial statements.\13\ The form and content of and 
requirements for the financial statements filed pursuant to the Company 
Act are set forth in Regulation S-X. Rule 4-0l(a)(l) of Regulation S-X 
states, in relevant part, that ``[f]inancial statements filed with the 
Commission which are not prepared in accordance with [GAAP] will be 
presumed to be misleading or inaccurate, despite footnote or other 
disclosures, unless the Commission has otherwise provided.'' \14\
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    \13\ Sections 8(b) and 30 of the Company Act require the filing 
of registration statements and annual reports, respectively.
    \14\ Rule 4-01 of Regulation S-X is made applicable to 
investment companies registered under the Company Act by rule 6-03 
of Regulation S-X.
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C. Section 6(c) of the Company Act

    9. Although the Application requests an exemption from rule 22c-1 
under the Company Act and rule 4-01(a)(1) of Regulation S-X pursuant to 
section 36(a) of the Exchange Act, the Commission is considering the 
requested exemptions under section 6(c) of the Company Act because the 
provisions of rule 22c-1 under the Company Act and rule 4-01(a)(1) of 
Regulation S-X are made applicable to Copley by the requirements of the 
Company Act and the rules thereunder. Section 6(c) of the Company Act 
provides, in relevant part, that the ``Commission, . . . by order upon 
application, may conditionally or unconditionally exempt any person . . 
. from any provision or provisions of [the Company Act] . . . or of any 
rule or regulation thereunder, if and to the extent that such exemption 
is necessary or appropriate in the public interest and consistent with 
the protection of investors and the purposes fairly intended by the 
policy and provisions of [the Company Act].''

IV. The Commission's Preliminary Views

A. Rule 22c-1 Under the Company Act

    10. Rule 22c-1 under the Company Act, as described above, prohibits 
Copley from selling or redeeming its redeemable securities at a price 
other than one based on the ``current net asset value,'' as defined in 
rule 2a-4 under the Company Act. Copley seeks to sell and redeem its 
redeemable securities at a price that reflects Copley's provision, in 
accordance with the Proposed Method, for less than its full federal 
income tax liability that would arise if the unrealized gains in 
Copley's portfolio were realized by the Fund. If the Proposed Method 
results in an ``appropriate provision . . . for Federal income taxes'' 
under rule 2a-4(a)(4), then the price of Copley's redeemable securities 
would be based on the ``current net asset value'' as defined in rule 
2a-4(a)(4) and Copley would not need an exemption from rule 22c-1. On 
the other hand, if the Proposed Method does not make an ``appropriate 
provision . . . for Federal income taxes'' under rule 2a-4(a)(4), the 
price of Copley's redeemable securities would not be based on the 
``current net asset value'' as defined in rule 2a-4 and would cause 
Copley to violate rule 22c-1, unless the Commission issues an order 
exempting Copley from rule 22c-1. Because the Commission, for the 
reasons discussed below, preliminarily believes that the Proposed 
Method would not result in an ``appropriate provision . . . for Federal 
income taxes'' under rule 2a-4(a)(4), the Commission preliminarily 
believes that Copley, in order to avoid violating rule 22c-1, would 
need an exemption from rule 22c-1 to be able to sell and redeem its 
shares at a price that is not based on the ``current net asset value,'' 
as defined in rule 2a-4.
    11. Copley seeks an exemption from rule 22c-1 to be able to 
determine the price at which its redeemable securities may be purchased 
or redeemed based on a net asset value that would reflect less than the 
full amount of the federal income tax liability that would arise if all 
of the Fund's existing unrealized gains were realized, calculated based 
on the Proposed Method (``Proposed Method NAV'').\15\ The Application's 
justification for the use of the Proposed Method is that it would 
``provide its current and future investors with a more fair and 
accurate presentation of its [net

[[Page 29229]]

asset value]'' because ``the entire [federal tax liability] would be 
due only in the unlikely event the entire portfolio were liquidated.''
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    \15\ The Application provides an example of the difference in 
the net asset value per share resulting from the use of the Proposed 
Method, as opposed to making a provision for the full federal income 
tax liability that would arise if all of the Fund's existing 
unrealized gains were realized. The Application points out that, 
following Copley's discussions with the staff of the Commission's 
Division of Enforcement in 2007, Copley changed its methodology to 
provide for the full federal income tax liability in the net asset 
value per share of its redeemable securities. The Application states 
that, whereas Copley's net asset value per share on February 28, 
2007, reflecting the use of a methodology similar to the Proposed 
Method, was stated in its annual report as being $54.67, ``the 
Restated Annual Report . . . reflect[ed] a per share [net] asset 
value for that same date (February 28, 2007) of $42.54.'' The $12.13 
reduction in the net asset value per share was a change of 22%.
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    12. As an open-end fund under the Company Act, Copley must stand 
ready to redeem its redeemable securities daily. Although Copley has 
been operating for several decades and the Application states that 
``the highest daily redemption in the history of the Fund since 
inception was . . . approximately 1.6% of the total outstanding shares 
on the date of the redemption,'' Copley cannot control or fully 
anticipate the level and amounts of shareholder redemptions and the 
resulting need to sell its portfolio investments to satisfy the 
redemption requests. However unlikely it may seem to Copley that it may 
need to liquidate its entire portfolio to meet redemption requests, 
that is a possibility that Copley may not rule out under the Company 
Act.\16\ That is because all of the holders of Copley's redeemable 
securities are entitled, under the terms of their securities, upon 
presentation to Copley or to a person designated by Copley, to receive 
approximately their proportionate share of Copley's current net assets 
or the cash equivalent thereof.\17\
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    \16\ Redemptions necessitating liquidation of a substantial 
amount of an open-end fund portfolio, while infrequent, have in fact 
been experienced by several open-end funds. See, e.g., L. Jones, 
``From Difficult to Disaster: Redemptions' Impact on Funds,'' 
Morningstar (Feb. 7, 2008), available at http://news.morningstar.com/articlenet/article.aspx?id=227989.
    \17\ See supra note 1 (definition of ``redeemable security'').
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    13. If Copley were to experience a high level of redemptions 
necessitating liquidation of a large portion of its portfolio with 
significant unrealized gains, Copley's pricing of its redeemable 
securities based on the Proposed Method NAV could result in the 
redeeming shareholders receiving a price for their shares that reflects 
more than their pro-rata share of the net asset value of the Fund, 
while the price of the shares held by the remaining shareholders would 
reflect less than their pro-rata share of the net asset value of the 
Fund. Copley's use of the Proposed Method could produce this disparate 
result because only the net asset value per share of the shares held by 
the remaining, non-redeeming shareholders would reflect the full actual 
federal income tax expense incurred as a result of the liquidation of 
the portfolio, even though the same amount of federal income tax 
liability existed, but was not provided for, when the other 
shareholders redeemed at a price based on a higher net asset value per 
share.
    14. For example, consider the following illustrative fact pattern 
of an open-end fund that is a C Corporation (``Fund A'') that records a 
2.8% federal income tax liability in accordance with Copley's Proposed 
Method but is required to pay federal income taxes at a rate of 
35%.\18\ As of the close of business on March 30, 2014, Fund A has 
total assets comprised of investments valued at $1,400,000, which 
reflects $400,000 in unrealized gains,\19\ and total liabilities 
comprised of a federal income tax liability on unrealized gains of 
$11,200.\20\ Fund A has 100,000 redeemable securities outstanding. As 
of the close of business on March 30, 2014, Fund A's net asset value 
and net asset value per share (NAV/share) are $1,388,800 \21\ and 
$13.888,\22\ respectively. On March 31, 2014, Fund A has no profit or 
loss for the day \23\ and shareholders unexpectedly request redemption 
of 60,000 shares, which entitles these shareholders to redeem at the 
March 31, 2014 closing NAV/share of $13.888.\24\ On April 1, 2014, in 
order to raise cash to satisfy the March 31, 2014 shareholder 
redemption requests of $833,280,\25\ Fund A sells investments of 
$834,000 with a cost basis of $534,000, resulting in realized gains of 
$300,000.\26\ Since Fund A realized $300,000 in gains, Fund A would 
have a federal income tax liability of $105,000.\27\ However, since 
Fund A's net asset value only reflected a $11,200 federal income tax 
liability as of March 31, 2014, Fund A has to record an additional 
$93,800 \28\ of a federal income tax expense and corresponding federal 
income tax liability on April 1, 2014. On April 1, 2014, Fund A has no 
other profit or loss \29\ besides recording the federal income tax 
expense and corresponding current federal income tax liability of 
$93,800 and an additional federal income tax expense and corresponding 
federal income tax liability of $2,800.\30\ At the close of business on 
April 1, 2014, Fund A has a net asset value of $458,920 \31\ and 
redeemable securities outstanding of 40,000,\32\ resulting in an NAV/
share of $11.473.\33\ Therefore, the redeeming shareholders received an 
NAV/share of $13.888 on March 31 while the NAV/share of the remaining 
shareholders was reduced to reflect the federal income tax accrual on 
gains realized by Fund A from selling portfolio securities with 
unrealized gains to pay the redeeming shareholders and thus their 
shares have an NAV/share of $11.473 on April 1, 2014. Although the same 
realized gains ($300,000) had been fully reflected in the net asset 
value on March 31 as unrealized gains, only 2.8% of the full 35% 
federal income tax liability on those unrealized gains had been 
reflected in the net asset value on that day, and the remaining 
shareholders were harmed solely as a result of Fund A's use of the 
Proposed Method.\34\ If Fund A reflected the full 35% federal income 
tax liability in its net asset value prior to receiving the shareholder 
redemption requests on March 31, 2014,

[[Page 29230]]

the redeeming shareholders would have redeemed at an NAV/share of 
$12.600 \35\ and the remaining shareholders would have held shares with 
an NAV/share of $12.600 \36\ (which is $1.127, or approximately 9.8%, 
higher than $11.473, their resulting NAV/share when applying the 
Proposed Method) on April 1, 2014. This result would have been fair and 
equitable to all of Fund A's shareholders.
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    \18\ In this example, under the Proposed Method, in lieu of 
recording the full federal income tax liability of 35% of unrealized 
gains, Fund A records a federal income tax liability of 2.8% of 
unrealized gains (which represents 8% times 35%, where 8% is based 
on highest daily redemptions of Fund A's shares during the previous 
five years).
    \19\ Valuation of $1,400,000 reflects $1,000,000 cost and 
$400,000 of unrealized gains.
    \20\ $11,200 federal income tax liability on unrealized gains 
equals $400,000 unrealized gains times 2.8% recorded federal income 
tax liability.
    \21\ $1,388,800 net asset value equals $1,400,000 total assets 
minus $11,200 total liabilities.
    \22\ $13.888 NAV/share equals $1,388,800 net asset value divided 
by 100,000 shares outstanding.
    \23\ Generally, an open-end fund would have daily profit or 
loss. However, because this is a simplified example presented solely 
for illustrative purposes, we assume that Fund A had no profit or 
loss on March 31, 2014.
    \24\ Because Fund A recorded no profit or loss on March 31, 
2014, the NAV/share as of the close of business on March 31, 2014 is 
the same as the NAV/share as of the close of business on March 30, 
2014.
    \25\ $833,280 redemption requests equal 60,000 shares redeemed 
times 13.888 NAV/share.
    \26\ For purposes of this simplified example, we assume that all 
transactions are recorded on trade date.
    \27\ $105,000 federal income tax liability equals $300,000 
realized gains times 35% federal income tax rate.
    \28\ $93,800 additional tax expense equals $105,000 federal 
income tax liability minus $11,200 federal income tax liability on 
unrealized gains already reflected in the net asset value.
    \29\ See generally supra note 23.
    \30\ Subsequent to the sale of investments to meet redemptions, 
Fund A has investments valued at $566,000 ($1,400,000 value of 
investments prior to sale minus $834,000 investments sold), with a 
cost basis of $466,000 ($1,000,000 cost of investments prior to sale 
minus $534,000 cost of investments sold) and unrealized gains of 
$100,000 ($566,000 value of investments minus $466,000 cost of 
investments). Therefore, Fund A, in accordance with the Proposed 
Method, records an additional federal income tax liability of $2,800 
(2.8% times $100,000 unrealized gains).
    \31\ $458,920 net asset value equals $1,388,800 net asset value 
prior to redemption minus $833,280 redemptions minus $93,800 
additional current federal income tax liability recorded minus 
$2,800 additional federal income tax liability recorded.
    \32\ 40,000 redeemable securities outstanding equals 100,000 
redeemable securities outstanding prior to redemption minus 60,000 
shares redeemed.
    \33\ $11.473 NAV/share equals $458,920 net asset value divided 
by 40,000 redeemable securities outstanding.
    \34\ If there had been any investors who purchased Fund shares 
on March 31 at the NAV/share of $13.888, they also would have been 
harmed by Fund A's use of the Proposed Method because they would 
have overpaid for their shares.
    \35\ $12.600 NAV/share on March 31, 2014 equals $1,260,000 net 
asset value divided by 100,000 shares outstanding, where $1,260,000 
net asset value equals $1,400,000 value of investments (inclusive of 
an unrealized gain of $400,000) minus federal income tax liability 
of $140,000 (where $140,000 equals $400,000 unrealized gains times 
35%).
    \36\ Shareholders would have redeemed 60,000 shares at the March 
31, 2014 NAV/share of $12.600 representing redemptions of $756,000. 
To satisfy redemptions, assume for illustrative purposes that Fund A 
would have sold the same $834,000 of investments with a cost basis 
of $534,000 resulting in a realized gain of $300,000. Fund A would 
owe $105,000 of federal income taxes ($300,000 realized gain times 
35%), however, under this fact pattern, Fund A already recorded a 
federal income tax liability in excess of $105,000 (i.e., Fund A 
recorded a federal income tax liability of $140,000), and therefore, 
Fund A would not need to record an additional federal income tax 
expense and corresponding federal income tax liability. Fund A's net 
asset value after sale of investments and redemption of 60,000 
shares would be $504,000 ($1,260,000 net asset value before 
redemption minus $756,000 redemption) and Fund A's resulting NAV/
share would be $12.600 ($504,000 net asset value divided by 40,000 
shares outstanding).
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    15. The Commission therefore preliminarily believes that the 
Proposed Method would not result in an ``appropriate provision . . . 
for Federal income taxes'' as required by rule 2a-4(a)(4) under the 
Company Act. In the Commission's preliminary view, in order to make an 
``appropriate provision . . . for Federal income taxes'' under rule 2a-
4(a)(4), Copley must make a provision for the full federal income tax 
liability that would arise if all of the Fund's existing unrealized 
gains were realized. Making such a provision would result in purchases 
and redemptions of Copley's redeemable securities being effected, under 
rule 22c-1 under the Company Act, at a price based on a net asset value 
that reflects a fair and equitable treatment of all of Copley's 
shareholders. In contrast, the exemption from rule 22c-1 requested in 
the application to provide for less than the full federal income tax 
liability, could result in, among other things, redemptions of Copley's 
redeemable securities at prices based on a potentially significantly 
higher net asset value per share for some shareholders while the net 
asset value of shares held by the remaining shareholders may be reduced 
correspondingly when the full federal income tax liability is accrued, 
producing an unfair and inequitable result among Copley's shareholders.
    16. The Application discusses Copley's ``willingness to convert to 
RIC status in the event unforeseen circumstances caused [unrealized] 
gains to be realized that consumed the entire amount of accumulated 
deferred income taxes it has recognized'' as a way for the Fund to 
avoid having to pay more in federal income taxes than the amount 
provided for under the Proposed Method. Copley's suggested potential 
conversion to RIC status, however, does not change our analysis. In 
order to successfully convert to a RIC at a point in time, Copley would 
be required to comply with the Code's RIC requirements at all times 
during the taxable year, which may not be possible if Copley 
encountered the ``unforeseen circumstances'' mid-year or late-year.\37\ 
Moreover, despite converting to a RIC, Copley still would be subject to 
federal income tax on the unrealized gains on securities which existed 
prior to conversion to the extent the securities are sold within ten 
years after the conversion.\38\ Because Copley, as an open-end fund 
that has issued redeemable securities, cannot fully predict whether 
securities may need to be sold to meet redemption requests in the ten 
years after conversion to a RIC, Copley's contingent intent to convert 
to a RIC does not eliminate Copley's potential federal income tax 
liability.\39\
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    \37\ See section 851 of the Code.
    \38\ See Treas. Reg. section 1.337(d)-7.
    \39\ The Application discusses certain real estate investment 
trusts (``REITs''), which under the Code also may avoid a layer of 
tax at the corporate level if they elect ``REIT status'' and meet 
certain requirements, as examples of public companies that have 
converted from C Corporations and elected REIT status and, by doing 
so, avoided incurring a federal income tax liability. The 
Application states that ``[Copley is] aware of at least two 
entities--Weyerhaeuser and American Tower Corp.--that converted from 
C Corporations into [REITs] and, in doing so, have exercised 
discretion with respect to accounting for deferred tax 
liabilities.'' Among other differences, the REITs discussed in the 
Application are not open-end funds, do not issue redeemable 
securities and therefore do not face the associated potential need 
to sell portfolio assets to satisfy redemption requests.
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    17. Based on the foregoing, the Commission's preliminary view is 
that an exemption from rule 22c-1 under the Company Act is not 
necessary or appropriate in the public interest and is not consistent 
with the protection of investors and the purposes fairly intended by 
the policy and provisions of the Company Act. Accordingly, absent a 
request for a hearing that is granted by the Commission, the Commission 
intends to deny Copley's request for an exemption from rule 22c-1 under 
the Company Act.

B. Rule 4-01(a)(1) of Regulation S-X

    18. The Commission's preliminary view that, in order to make an 
``appropriate provision . . . for Federal income taxes'' under rule 2a-
4(a)(4) under the Company Act, Copley must make a provision for the 
full federal income tax liability that would arise if all of the Fund's 
existing unrealized gains were realized, also is consistent with GAAP. 
The Application, however, requests an ``exemption'' from rule 4-
01(a)(1) of Regulation S-X for Copley to use a non-GAAP methodology in 
recording its federal income tax liability in its financial 
statements.\40\ If Copley were to use two different methodologies in 
calculating its net asset value--a GAAP-consistent methodology for 
purposes of pricing Copley's redeemable securities for purchases and 
redemptions under rules 2a-4 and 22c-1 under the Company Act, and a 
non-GAAP methodology in its financial statements--in the Commission's 
preliminary view, the result may be unnecessarily confusing to 
investors and contrary to the policy behind the Company Act's 
disclosure requirements. Accordingly, absent a request for a hearing 
that is granted by the Commission, the Commission intends to deny 
Copley's request for an exemption from rule 4-01(a)(1) of Regulation S-
X as not necessary or appropriate in the public interest and as not 
consistent with the protection of investors and the purposes fairly 
intended by the policy and provisions of the Company Act.
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    \40\ The Application does not state how Copley would present the 
amount of its federal income tax liability in its financial 
statements if the Commission granted the requested exemption. The 
Commission assumes that Copley would present the amount according to 
its Proposed Method in lieu of presenting the amount determined in 
accordance with GAAP.

    By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-11684 Filed 5-20-14; 8:45 am]
BILLING CODE 8011-01-P