|David E. Scott
|Telephone (860) 355-4700
November 18, 2003
Via Electronic Delivery
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
RE: Release Nos. 33-8297; IC-26198; File No. S7-18-03
Dear Mr. Katz,
We appreciate the opportunity to comment on the proposed rules ("Proposed Rules") under the Investment Company Act of 1940 (the "Act") that address the ability of an investment company to acquire shares of another investment company. The IMRC Group is a regulatory advisory practice providing compliance support and related services to investment advisers and investment company complexes, including some that would be directly affected by the Proposed Rules. In particular, we are grateful for the opportunity to comment on the Proposed Rules as they relate to allowing open-end and closed-end funds, including business development companies, greater flexibility in purchasing shares of registered money market funds pursuant to cash sweep arrangements.
Rule 12d1-1: Investments in Money Market Funds
Affiliated Money Market Funds
We support the Commission's proposal to provide exemptive relief from Section 17 of the Act with respect to purchases of affiliated money market fund shares. We agree with the premise that a fund's purchase and redemption of money market fund shares at the net asset value would provide little opportunity for insider self-dealing or overreaching. We also concur with the observations contained in the proposing release that there is little value to obtaining a control position in a money market fund, and money market funds do not control valuable brokerage commissions that can be directed to affiliates.
With respect the opportunity for layering of advisory fees and distribution expenses, we believe that a number of controls and disincentives currently exist to limit or prevent layering activities, including the following:
Unaffiliated Money Market Funds
We support the expansion of relief to funds that do not share the same adviser and we share the belief set forth in the proposing release that no greater risks exist for investments in money market funds that do not share the same adviser than investments in money market funds with a common adviser. We also respectfully request, for the reasons noted below, that the Commission provide exemptive relief from the provisions of Section 17 for funds that wish to participate in cash sweep arrangements that invest in the money market fund shares of other fund complexes.
It is a somewhat common practice, in our view, for funds of smaller complexes, and for funds with specific cash management needs, to invest in the money market funds of other fund complexes, within the limitations currently set forth by Section 12(d)(1) of the Act. This is particularly relevant for smaller fund complexes that do not manage internal money market funds and for state-specific municipal bond funds, which: (i) may not have corresponding state-specific money market funds available within their respective fund complexes; (ii) are typically unable to take advantage of other short-term cash management alternatives, such as repurchase agreements, due to tax and investment guideline considerations; and (iii) are often competing for limited market supplies of suitable investment securities.
We believe that, in the absence of exemptive relief from Section 17 of the Act, certain funds may face substantial operational challenges in fully utilizing the relief anticipated in the Proposed Rules. The cash sweep investments of a particular fund ("acquiring fund") may fluctuate substantially on a daily basis due to shareholder, investment, and operational activities. Similarly, a money market fund receiving cash sweep investments ("acquired fund") may also experience significant daily fluctuations in its shares outstanding. As a result, an acquiring fund's percentage ownership of an acquired fund may vary substantially from one day to the next and, consequently, the status of the two funds as "affiliated persons" may change frequently, possibly even daily in some instances. Under these circumstances, monitoring for, and ensuring, compliance with Section 17 restrictions and prohibitions would present significant operational difficulties which may preclude some funds from realizing the benefits of the relief provided in the Proposed Rules.
The operational difficulties noted above are particularly relevant in relation to Section 17(e) and Rule 17e-1 thereunder. A number of cash sweep programs invest in money market funds that are either offered by, or affiliated with, broker-dealers. Further, because the full scope of an acquired fund's broker-dealer affiliations may not be readily apparent, the investment adviser and/or administrator for an acquiring fund would be required, in many instances, to continuously seek updated information pertaining to affiliated broker-dealers from the respective service providers of each acquired fund and to coordinate this information with appropriate portfolio management and trading personnel on an ongoing basis. Additionally, compliance processes and controls would also be necessary to ensure ongoing trading and reporting compliance. These challenges would be further compounded for fund complexes that may require different cash sweep programs to accommodate varied fund types, such as municipal securities funds, treasury and government securities funds, and others, which would necessitate continuous information updates and coordination for multiple acquired funds and compliance monitoring and reporting for multiple and/or unique affiliations for each acquiring fund.
Given the potential operational challenges associated with application of Section 17 in these circumstances, including the inherent opportunities for errors and omissions, we believe that application of Section 17 may deter some funds from realizing the full benefits of the relief set forth in the Proposed Rules. Further, given that investments in money market funds provide little opportunity for self-dealing or over-reaching, we believe that exemptive relief from Section 17 would be appropriate and in the best interests of affected funds and their shareholders.
Closed-End Funds of Funds
Closed-end funds, including business development companies, would, in our view, derive significant benefit from an enhanced allowance to use cash sweep vehicles that invest in money market fund shares. While closed-end funds and business development companies generally do not experience the same levels of daily cash fluctuations typically experienced by many open-end funds, they must still maintain appropriate liquid cash balances for investment and operational purposes. Further, many closed-end funds have limited life cycles and often hold significant cash positions during their early stages, as they seek appropriate investments for fund assets, and during their late stages, as investments come to term.
Similar to our views with respect to open-end funds, we believe that investments in money market funds by closed-end funds, including business development companies, pursuant to cash sweep arrangements, provide little risk of the abuse that section 12(d)(1) was designed to prevent. Also, we believe that significant controls and disincentives exist to prevent significant layering of fund assets, including: (i) investment guidelines and limitations as set forth by fund offering documents, which generally specify the levels and types of investments sought by their respective funds; (ii) the risk of underperformance, including the limitation of asset growth and potential losses of associated compensation; and (iii) oversight by boards of directors, trustees, or others serving similar functions, which have fiduciary obligations to ensure that these funds are not overcharged for services provided.
Because business development companies operate under unique regulatory schemes, additional exemptive relief and other guidance may be necessary to allow business development companies to fully utilize the relief set forth in the Proposed Rules. Specifically, we respectfully request that the Commission consider exemptive relief from Section 57 of the Act similar to that which is under consideration for the prohibitions and restrictions set forth by Section 17. We also ask that the Commission consider providing clarifying guidance as to whether investments in money market fund shares pursuant to cash sweep arrangements would be considered "cash items" as set forth in Section 55(a)(6) of the Act.
We support, as currently proposed, the elimination of most of the conditions set forth in the Commission's previous exemptive orders as well as the proposed requirements with respect to sales loads. Most funds enter into cash sweep arrangements for the purpose of ensuring ready access to suitable, highly liquid short-term investments that require minimum routine intervention by portfolio management personnel, thereby allowing relevant investment professionals to focus on their primary investment objectives. We believe, consequently, that barriers to, or restrictions placed upon, purchases and redemptions of money market shares pursuant to cash sweep arrangements may serve to undermine their underlying purpose and primary benefits.
As noted in the proposing release, money market funds are generally designed to accommodate cash fluctuations. Accordingly, we respectfully request that the Commission exclude mandatory purchase and sale restrictions upon money market fund trades conducted pursuant to cash sweep arrangements. We also ask, however, that the Commission allow money market funds to maintain all maximum number of options in managing cash flows, including the option to limit the percentage of fund assets that may be redeemed by another fund complex during the same business day, predicated upon pre-disclosure of this option in fund registration and other offering documents.
We also support allowing money market funds receiving cash sweep investments to, in turn, engage in cash sweep arrangements to aid in relieving operational difficulties associated with managing substantial cash inflows and outflows. In our support of this option, however, we acknowledge that certain risks may exist in allowing an acquired money market fund itself to have cash sweep arrangements that may not be as relevant for other types of funds. Because most funds are required to invest specified percentages of their assets in primary investment categories that often do not include money market funds and other short-term investments, these funds are generally limited, under normal circumstances, in the asset levels that may be invested in money market fund shares. Short-term securities, however, are themselves the primary investments of a money market fund, and many money market fund registration and/or offering documents allow for the purchase of other investment companies to the extent permitted by the Act. Consequently, many money market funds are currently limited in purchasing other money market funds primarily by the provisions of Section 12(d)(1) of the Act. We must also note that the performance disincentives associated with investing in money market funds, referenced in other parts of this letter as they pertain to other types of funds, may be less apparent for acquiring money market funds.
As noted above, we believe that mandated percentage limitations placed upon the use of cash sweep arrangements, including their use by acquiring money market funds, would work counter to their very purpose and primary benefits. The Commission may wish to consider, however, whether additional disclosures and/or reporting may be necessary in instances where an acquiring money market fund, that is not offered as a fund of funds, makes significant and routine use (for example, which may be defined as an average investment greater than 25% of average net assets over the course of a fiscal year, or by some other measure as the Commission deems appropriate) of other money market funds. Such disclosures and reporting might include additional footnotes and/or other disclosures in fund registration documents and, with particular respect to the purchase of money market funds by other money market funds in the same fund complex, a continued requirement for directors to make findings that investors are not paying multiple advisory fees for the same services.
We support proposed Rule 12d1-2 which, as noted in the proposing release, would permit an affiliated fund of funds to invest in affiliated or unaffiliated money market funds, in reliance on proposed rule 12d1-1, and would allow affiliated funds of funds the same opportunities as any other fund to invest in a cash sweep arrangement that will provide the greatest benefit to the acquiring fund. As with our views pertaining to investments in money market funds pursuant to cash sweep arrangements, we believe that the ability to make such investments is consistent with the best interests of funds and their shareholders and provides little opportunity for self-dealing or overreaching. Consequently, we also ask that the Commission provide exemptive relief from Section 17 similar to that which we have requested for other types of funds in order to allow affiliated funds of funds to fully benefit from the relief envisioned in the Proposed Rules.
The IMRC Group supports the Commission's efforts to allow greater flexibility in the use of money market funds pursuant to cash sweep arrangements. We also respectfully request that the Commission adopt provisions to extend exemptive relief under Sections 17 and 57 of the Act to allow all open-end and closed-end funds, including business development companies, to fully utilize the relief that would be provided by the Proposed Rules. We share the belief that investments in money market funds provide little opportunity for insider self-dealing or over-reaching and, consequently, believe that exemptive relief from Sections 17 and 57 would be appropriate and serve the best interests of affected funds and their shareholders.
We also generally support, but have not provided comments on, other provisions contained in the proposing release as they pertain to allowing greater flexibility in purchasing other investment companies and in providing appropriate disclosure of expenses to fund shareholders. We have not received sufficient input to date to provide consolidated comments pertaining to other areas, but would like to retain the option to do so, prior to the comment period closing date, should additional information become available.
Thank you for the opportunity to comment. If you have any questions regarding this letter, please do not hesitate to contact me at (860) 355-4700 or firstname.lastname@example.org.
David E. Scott