Investment Company Act - Section 7(a)
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
Our Ref. No. 2014312113
Your letter dated March 20, 2014 requests our assurance that we would not recommend enforcement action to the Securities and Exchange Commission (“Commission”) under section 7(a) of the Investment Company Act of 1940 (“1940 Act”) against insurance company separate accounts (“Separate Accounts”) that offer and sell group annuity contracts (“Contracts”), as part of a generic stable value investment option managed by Invesco Advisers, Inc. (“Invesco Advisers”), if the sponsors of plans organized under section 403(b) of the Internal Revenue Code of 1986 (“Code”) invest in such Separate Accounts.
You state the following:
Invesco Advisers is an investment adviser registered under the Investment Advisers Act of 1940. It provides discretionary advisory and asset management services to a variety of clients, including sponsors of 403(b) plans. In particular, Invesco Advisers would manage the 403(b) plan assets of 403(b) plan participants that designate assets to a generic stable value investment option (the “Invesco Option”). The targeted market for the Invesco Option will be 403(b) plans sponsored primarily by large institutions, such as universities and hospitals (“403(b) Plans”). The 403(b) Plans will offer their participants (“Participants”) multiple investment options, including the Invesco Option.
Under the Invesco Option, Invesco Advisers will allocate the 403(b) Plan assets it advises among certain investments, such as Contracts offered and sold by Separate Accounts. The Contracts will be privately offered in reliance on section 4(a)(2) of the Securities Act of 1933 or Regulation D thereunder. The Contracts offer employees a bundled investment and insurance product. Invesco Advisers will negotiate the features of each Contract with each issuing insurance company, including the terms of any insurance protection or wrapper.
Assets deposited into a Separate Account generally are managed by an asset manager unaffiliated with Invesco Advisers. The Separate Accounts essentially serve as building blocks to help achieve the Invesco Option’s investment objective, and a Participant generally would not know that s/he is investing in any particular Separate Account. Other investments of the Invesco Option will likely include a money market fund that is an investment company registered under the 1940 Act.
A 403(b) Plan is a tax-deferred retirement plan for employees of public schools, employees of certain tax-exempt organizations and certain ministers. Many 403(b) Plans and their sponsors are not subject to the Employee Retirement Securities Act of 1974 (“ERISA”), including the ERISA fiduciary standard. In addition, the vast majority of 403(b) Plans are not funded through trusts with trustees that either make investment decisions on behalf of the trust or select a menu of investment options for Participants. Instead, the employer that sponsors the 403(b) Plan, or a committee appointed by the sponsoring employer, serves as the 403(b) Plan’s fiduciary and designs the 403(b) Plan’s investment menu (e.g., a menu that could include the Invesco Option). Participants direct the investment of their 403(b) Plan balances in one or more of such investment options, and, if the Invesco Option was selected, the 403(b) Plan sponsor would invest the proceeds in one or more Separate Accounts.
You represent that each 403(b) Plan sponsor will be subject to the Prudent Man fiduciary standard of ERISA (as defined below) when selecting investment options and managers available under a 403(b) Plan through which assets would be invested in a Separate Account, including the Invesco Option and its manager, Invesco Advisers. In particular, the Prudent Man fiduciary standard requires a fiduciary to discharge its duties with respect to a plan solely in the interest of the participants and beneficiaries and “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims” (“Prudent Man fiduciary standard”). Accordingly, either the 403(b) Plans will indicate that their sponsors are subject to the Prudent Man fiduciary standard or the 403(b) Plan sponsors will contractually agree to be subject to the Prudent Man fiduciary standard. To the extent that Invesco Advisers manages 403(b) Plan assets that are subject to ERISA, you represent that it will comply with the provisions of ERISA and the rules and interpretations thereunder.
You also represent that a Participant’s investment discretion will be limited to allocating his or her account among the investment options available in the 403(b) Plan, including the ability to choose the Invesco Option. No representation will be made to Participants that any specific portion of their contributions to or account balances in the 403(b) Plan, or any specific portion of the Invesco Option, will be invested in any particular Separate Account. The Participants would generally not know that they are investing in a Separate Account. If the 403(b) Plan delivers any information to its Participants that mentions an investment in a particular Separate Account, it will be accompanied by a disclaimer to the effect that no assurances can be given that the Invesco Option will continue to invest its assets, or the same portion of its assets, in the Separate Account.
You state that Invesco Advisers would like to offer the Invesco Option to 403(b) Plan sponsors, which would require the 403(b) Plan sponsors to purchase the Contracts on behalf of the Participants that are invested in the Separate Account. Invesco Advisers are concerned, however, that Participants will not be able to invest in the Separate Account because they generally will not be “qualified purchasers” under section 2(a)(51) of the 1940 Act. You ask us to conclude, analogous to our position in H.E.B. Investment and Retirement Plan (“H.E.B.”), discussed below, that a fund relying on the exclusion from the definition of investment company in section 3(c)(7) of the 1940 Act (i.e., a Separate Account) in which the Invesco Option invests may treat the 403(b) Plan, and is not required to treat each Participant, as a qualified purchaser for section 3(c)(7) purposes, if the 403(b) Plan sponsor is subject to the Prudent Man fiduciary standard of ERISA when selecting investment options and managers available under a 403(b) Plan through which assets would be invested in a Separate Account, such as the Invesco Option.
Section 7(a) of the 1940 Act prohibits an investment company organized or otherwise created under the laws of the United States or of a state and having a board of directors from, among other things, offering or selling any security (or engaging in certain other activities) by use of the mails or any means or instrumentality of interstate commerce unless the company is registered under the 1940 Act. Section 3(c)(7) of the 1940 Act excludes from the definition of investment company any issuer whose outstanding securities are owned exclusively by persons who, at the time of acquisition of the securities, are qualified purchasers, and which is not making and does not propose to make a public offering of its securities.
Section 2(a)(51)(A)(iv) of the 1940 Act defines “qualified purchaser” to include “any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $25,000,000 in investments.” You represent that any 403(b) Plan investing in the Separate Accounts will meet the definition of “qualified purchaser”, as defined in section 2(a)(51)(iv) because the 403(b) Plan will own and invest on a discretionary basis not less than $25 million in investments and will be acting for its own account. You state that most of the Participants will not meet the “qualified purchaser” definition.
You argue that the proposed arrangement is structured and operated in a manner substantially similar to H.E.B. In that letter, we provided no-action assurances under section 7(a) of the 1940 Act to 3(c)(7) funds if a 401(k) plan subject to ERISA invested in 3(c)(7) funds. In particular, the 401(k) plan participants were not qualified purchasers, but the 401(k) plan’s trustees were subject to the fiduciary provisions of ERISA. These no-action assurances to H.E.B. were provided under conditions designed to ensure that (1) plan participants are not permitted to decide whether or how much to invest in particular investment alternatives, and (2) the decision to invest in a 3(c)(7) fund is made by the plan trustee or other plan fiduciary that makes investment decisions for the plan.
You contend that your proposed arrangement is consistent with our prior no-action assurances. In particular, each Participant’s investment discretion will be limited to allocating his or her account among a number of investment options, including the Invesco Option. In addition, the decision to invest the assets of the Invesco Option in a Separate Account relying on section 3(c)(7)’s exclusion from the definition of investment company is the sole responsibility of the 403(b) Plan sponsor, without direction from or consultation with any Participant other than the 403(b) Plan sponsors acting in their capacity as 403(b) Plan sponsors. You acknowledge that many 403(b) Plans are not subject to ERISA, and thus the 403(b) Plan sponsors are not required to be fiduciaries by operation of ERISA. You represent that either each such 403(b) Plan sponsor will indicate that it is subject to the Prudent Man fiduciary standard or the 403(b) Plan sponsor will contractually agree to be subject to the Prudent Man fiduciary standard. You believe that these representations, together with certain others, are consistent with Congress’s recognition that financially sophisticated investors are in a position to appreciate the risks associated with certain investment pools and do not need the protections of the 1940 Act.
Consistent with our no-action assurances/position in H.E.B. and our previous positions, we believe that a participant-directed plan, including a 403(b) Plan, that offers its Participants generic investment options that, in turn, may invest a portion of their assets in a 3(c)(7) fund such as a Separate Account, could be treated as a qualified purchaser in certain circumstances. In particular, the 403(b) Plan sponsor that is subject to the Prudent Man fiduciary standard makes the decision to include the Invesco Option (which in turn invests a portion of its assets in a Separate Account) as an investment option under the 403(b) Plan. This approach, consistent with the Commission’s approach in the context of a defined benefit plan, ensures that the person or persons making the investment decision would be in a position to appreciate the risks of investing in the Separate Account. We believe it is appropriate to apply a similar approach here.
Accordingly, based on the facts and representations set forth in your letter, we would not recommend enforcement action to the Commission under section 7(a) of the 1940 Act against the Separate Accounts that offer and sell Contracts, as part of the Invesco Option, if the 403(b) Plan sponsors invest in such Separate Accounts. In particular, we rely upon the following representations:
Because our position is based on all of the facts and representations made in your letter, you should note that any different facts or circumstances might require a different conclusion.
 Before allocating 403(b) Plan assets to a Separate Account, Invesco Advisers will consult with the 403(b) Plan sponsor and recommend Separate Accounts in which the Invesco Option would invest. Ultimately, the decision to invest the assets of the Invesco Option in a Separate Account is the sole responsibility of the 403(b) Plan sponsor, without direction from or consultation with any Participant other than the 403(b) Plan sponsor acting in its capacity as a 403(b) Plan sponsor.
 You state that the purchase of mutual fund shares will require the creation of a custodial arrangement pursuant to section 403(b)(7) of the Code.
 See generally section 403(b)(1)(A) of the Code; Field Assistance Bulletin No. 2007-02 issued by the Department of Labor’s Employee Benefits Security Administration (July 24, 2007) (“2007-02 Bulletin”). Under a 403(b) plan, employers may purchase for their eligible employees annuity contracts or establish custodial accounts invested only in mutual funds for the purpose of providing retirement income. See sections 403(b)(1)(A) and 403(b)(7) of the Code; 2007-02 Bulletin (indicating that “[a]lthough not subject to the qualification requirements of section 401 of the Code, some of the requirements that apply to qualified plans also apply, with modifications, to 403(b) plans.”).
 The ERISA fiduciary standard generally requires that a fiduciary discharge his or her duties with respect to a plan solely in the interest of the participants and beneficiaries and (1) for the exclusive purpose of “providing benefits to participants and their beneficiaries” and “defraying reasonable expenses of administering the plan,” (2) “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims,” (3) “by diversifying the investment of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so,” and (4) “in accordance with the documents and instruments governing the plan ….” See section 404(a)(1) of ERISA.
 Section 404(a)(1)(B) of ERISA.
 The selection of investment options by these 403(b) Plan sponsors also may be subject to state law fiduciary standards. In addition, Invesco Advisers serves in a fiduciary capacity with respect to the 403(b) Plan assets that it allocates to the various Contracts pursuant to its advisory agreement with the applicable 403(b) Plan sponsor.
 See H.E.B. Investment and Retirement Plan, H.E. Butt Grocery Company, SEC Staff No-Action Letter (May 18, 2001).
 The exclusion provided by section 3(c)(7) reflects Congress’ recognition that financially sophisticated investors are in a position to appreciate the risks associated with certain investment pools and do not need the protection of the 1940 Act. S. Rep. No. 293, 104th Cong., 2d Sess. 10 (1996) (“Generally, these investors can evaluate on their own behalf matters such as the level of a fund’s management fees, governance provisions, transactions with affiliates, investment risk, leverage, and redemption rights.”).
 Section 2(a)(51)(A) of the 1940 Act also generally defines “qualified purchaser” to include: (1) any natural person who owns not less than $5 million in investments; (2) certain family-owned companies that own not less than $5 million in investments; and (3) any trust that does not meet the definition of family-owned company in section 2(a)(51)(A)(ii) and that was not formed for the specific purpose of acquiring the securities offered by the Section 3(c)(7) Fund, and the trustees and settlors of which are qualified purchasers.
 See H.E.B. Investment and Retirement Plan, supra note 7.
 See Standish, Ayer & Wood, Inc. Stable Value Group Trust, SEC Staff No-Action Letter (Dec. 28, 1995) (regarding a participant-directed plan that invested a portion of its assets in a section 3(c)(1) fund) and The PanAgora Group Trust, SEC Staff No-Action Letter (Apr. 29, 1994) (for purposes of the one hundred-person limit of section 3(c)(1) of the 1940 Act, a partnership will constitute only one beneficial owner (provided that the attribution provision of section 3(c)(1)(A) does not apply) when the partnership is managed as a common investment vehicle, rather than as a device for facilitating individual investment decisions). See also Cornish & Carey Commercial, Inc., SEC Staff No-Action Letter (June 26, 1996) (under certain circumstances, the partners of a partnership that invests in a 3(c)(1) fund may be the beneficial owners of the securities that are held by the partnership because the partnership’s assets are the property of its partners).
 Among other things, rule 2a51-3 under the 1940 Act provides that a company shall not be deemed to be a qualified purchaser under section 2(a)(51)(A)(iv) of the 1940 Act if the company was formed for the specific purpose of acquiring the securities offered by a 3(c)(7) fund.
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