November 27, 2001
Securities and Exchange Commission
450 5th Street NW
Washington, DC 20549-0609
Re: File No. S7-21-01
To Whom It May Concern:
We are a group of Florida International University students currently enrolled in the course titled Business and Society for the Fall 2001 term. Our group's intention for submitting the comments for the proposed rule in action is to add value to its purpose. We hope that our research will provide important information that will protect the obvious stakeholders, the investors in this case, affected by this action. But most importantly we hope that our contributions help implement the proposed rule and that it is finalized and adhered to. The following includes our extensive research for the proposed rule titled "Investment Company Mergers".
The Agency involved requested support is the Securities and Exchange Commission. The U.S. Securities Exchange Commission (SEC) primary mission is to its protect investors and maintain the integrity of the securities markets. The Commission is proposing amendments to the rule under the Investment Company Act of 1940 that permits mergers and other business combinations between certain affiliated investment companies. The proposed amendments would expand the types of business combinations exempted by the rule, codifying the relief provided in Commission exempt orders. The amendments also would make the rule, for the first time, available for mergers between registered investment companies and certain unregistered entities. The proposed amendments are designed to reduce the burdens on investment companies by eliminating the need to obtain Commission approval while protecting investors in these companies.
Due to market fluctuations in the free market economy there have been suggestions on amendments to revisions on the Investment Company Act of 1940. By decentralizing the power in the government agency and just allowing the government to be a mere regulator, it is proposing to reanalyze the foundations of a what a free market economy is or should be.
Although we agree with most of the clauses of the proposed rule, there was however one significant discrepancy. The revision allowing the fiduciary to seek voting instructions from the beneficiaries of the investment was in contradiction of the proposal of introducing independent evaluators to the transactions. Our comments below to this specific issue are further discussed in its own independent clause.
After carefully analyzing the most significant aspects of the proposed rule, those of which we felt were most noteworthy are strongly emphasized in the final revision found in this context.
Revision: Expansion of the rule 17a-8 to permit mergers between affiliated funds regardless of the nature of their affiliation and whether the proposed conditions of the relief under the expanded rule are sufficient to protect investors, or whether any of the conditions are unnecessary to protect investors.
We are in favor of the rule. Our reaction is that greater transparency and ease in merger situations is beneficial to its constituents. In this case, the investors, as outlined in the paragraph entitled "benefits" would be greatly benefited, not only by their capacity to now participate in funds they were not in before, but also by reduced costs. In my mind, if a merger makes sense from a business perspective (i.e., in this case if the funds are complementary in some form or fashion) there should be as few legal and regulatory constraints as possible. Expanding the rule would do that. The one thing one has to be careful of is preventing situations where fraud could take place. Rules are still needed to prevent that.
Revision: Debate on the requirement that merger be approved by the outstanding voting securities of any fund that will as well as the outstanding voting securities of any fund that will not survive the merger. Voting exemptions.
We feel that while the merger has not yet been enacted, the voting rights of the company (whether the surviving or non-surviving company) still remain, and thus still part of the board. Until a certified copy of the authorizing resolution adopted by the board is submitted, members of both participating parties still have a say in the matter (voting securities). The plan should not be contrary to the public interest. Even in instances where the merger is between two entities who share the same major stockholder, there still should require a `majority vote' amongst the shareholders of the company, with an approval rate of 51 percent or more, in accordance to state and federal laws.
Revision: Provision's consistency with state laws where some funds are organized.
We feel that if both entities are properly represented during the trance of a business merger, then there is a more clear and concise discussion leading to an unbiased and fair decision reached. In this manner, the implementation of the conversion would be more soothing in operation and ethically acceptable, not only to the company holding the name, but also the company merging into another company name.
This approach will also be in accordance with State Laws. One example is Title XXXVIII, Banks And Banking, Chapter 655: Financial Institutions Generally, s.s. 655.411, 2:
(a) The board of directors must approve a plan of conversion by a vote of a majority of all the directors. The plan must include a statement of:
The competitive impact of such change, including any effect on the availability of particular financial services in the market area, is served by the financial entity.
Any merger between two entities should be required a `majority vote' amongst the shareholders of the company, with an approval rate of 51 percent or more, in accordance to state and federal laws, and should look for the best resolution while having all involved parties in mind.
Revision: Deferral of Provision to State Law.
If this provision became part of the government through a federal law, the states would recognize in unison the sovereignty of a central authority while retaining certain residual powers of government (e.g. state laws). For that reason, if the provision, or proposed rule rather, were deferred to a state law it would raise issues amongst certain states (depending on the business movement in a given region). For example, a parent company could subsidize a company in Ohio (where this law is allotted), and merge with an unregistered entity while practicing in Virginia where this provision has not been passed. Clearly, it would bring about financial issues, as well as marginal and boundary questions as to where the company should be attributed to; should it then follow laws from where the parent company is based from, or should it abide by the state laws it currently operates? If there is such a discrepancy, then it brings about issues of inequality amongst the company, and the rest is just a domino effect. It is better, to be uniform in issues dealing with our economy, and thus releases a financial burden from the state and into the hands of the federal government, as a whole nation.
Revision: State laws anticipating issues raised by mergers or affiliated funds.
Florida State Laws have addressed issues that may, and would, be raised when dealing with mergers and/or affiliated funds. Title XXXVIII, Banks And Banking, Chapter 655: Financial Institutions Generally, s.s. 655.411 addresses fully all aspects of this topic and listing very detailed issues such as financing, voting, creditors, and management to mention a few. The state has already executed a thorough task at the state level to address such concerns, and abiding by the federal laws of mergers. For this reason, the proposed rule hence is better fit if adopted as a federal rule.
Revision: Sufficiency of approval by independent directors to protect investors in these funds.
Though it is an ideal scenario when an independent entity evaluates the situation and reports back a fair and disinterested opinion (or in this case, an approval), it should not be sufficient. We believe this because we realize the importance of freedom in the economy, the need for the government to be the spectator and the regulator, and not necessarily the key-player. Who else would want the company's achievement than those who will profit? In which case, the stockholders, investors, shareholders, employees, and/or those directors in charge of negotiating a business merger would be adequate participles. We believe that when one's own assets are at stake, one tends to act in the best interest of the assets. For this reason, as previously mentioned, it is necessary that the government (e.g. Securities and Exchange Commission) monitor and regulate the erroneous behavior that a company may participate in. In this matter, the entire operation is part of the free market economy, as well as part of the federal business process.
Revision: Absence of a shareholder vote, and timeframe for advance notice of changes in their investment through a merger.
As stated in The Investment Company Act of 1940, Section 57: Changes in Investment Policy,
No business development company shall, unless authorized by the vote of a majority of its outstanding voting securities or partnership interests, change the nature of its business so as to cease to be, or to withdraw its election as, a business development company.
By law, shareholders are entitled to receive sufficient advance notice of any changes with respects to their merger investment. However, what is considered enough time, and by whom? There should a designated time frame for such an event.
We choose to support Florida State Laws, in Title XXXVIII, Banks And Banking, Chapter 655: Financial Institutions Generally, s.s. 655.411, stating:
4. The schedule for termination of any nonconforming activities and disposition of any nonconforming assets and liabilities is reasonably prompt, and the plan for such termination and disposition does not include any unsafe or unsound practice.
*If the department disapproves the plan, it shall state its objections and give an opportunity to the parties to amend the plan to overcome such objections. The department may deny an application by any financial entity, which is subject to a cease, and desist order or other supervisory restriction or order imposed by any state or federal supervisory authority, insurer, or guarantor.
(f) The plan shall not take effect until the department has received notice that the commitment for insurance of accounts has been given by the insurer. Upon receipt of such notice, the department shall issue a new charter to the financial entity authorizing it to transact business pursuant to applicable law.
The procedures are clear in that an absent shareholder vote is required by law to notify the participating parties of the current situation (whether it is to terminate the negotiations, or alter the terms). Also, the communication has to reach participating parties without delay.
Revision: Some fund advisers have represented in applications for exemptive relief in connection with fund mergers that they will echo vote shares held in their name.
We believe that this is something that should be done, due to that fact that a shareholder should vote its shares in the same proportion as non-related shareholders. Taking in consideration that the General Rules and Regulations promulgated under the Securities Exchange Act of 1934, Rule 14d-10 states that all security holders not only should be treated equally and fair, but their voting power be relative to all other participating parties. It is only fair that everyone is represented equally despite of neither the merging company nor the title in the respective entity.
Revision: Often an investment adviser holds shares in a fiduciary capacity for the beneficial owners of the shares. In such a case, the fiduciary would be permitted to seek voting instructions from the beneficial owners. The proposed rule would not prevent a fiduciary or other related shareholder from advising the beneficial owners how the shares should be voted, after disclosing the nature of its affiliation with the other merging fund.
The problem that we see in this is that if the fiduciary is allowed to be advised by the beneficial owners, then they run the risk of being arbitrarily advised, while not necessarily in the state holders or the merging company's best interest. As an example, let's assume that a the bigger of the two merging companies has instructed the fiduciary representative to act in such a way that it would double the profits of the bigger company and yet reduce the entering personnel by half of the value. By doing so the bigger company has advised the fiduciary to act in an economically successful strategy, but by doing this it has impaired the entering company to greater heights.
Revision: For purposes of echo voting, the votes of securities that are voted pursuant to either of these exceptions would be treated as votes of securities held by shareholders who are not related in calculating the proportional voting of securities.
In principle we have no problem with this, though we are concerned with potential pitfalls in this implementation. With this we mean that we feel that maybe some of the other shareholders might oppose to this. On the other hand this is very beneficial for everyone due to the fact that keeping the votes on security gives a better sense of security.
Revision: Include mergers with common and collective trust funds.
We feel that since there are a growing number of these transactions, particularly mergers involving bank common trust funds and collective trust funds and bank collective trust funds, this would be beneficial to the merging company since it would greatly reduce time. The merging company would not have to wait to become a registered `investment company'. This amendment would allow the merging company to spend more time evaluating its net asset value and would be able to spend time and money seeking an independent evaluator.
"Merging funds that are not registered as an investment company are usually not substantial enough to pull their own weight, thus, possibly in this situation to save themselves. They would need all they help they can get." Professor Donald Roomes, College of Business at FIU
Revision: Require directors of a fund merging with an unregistered entity to approve procedures for the valuation of the assets of the unregistered entity and on the use of an independent evaluator to value the assets of the unregistered entities.
We believe that this appears to be a very reasonable idea since the valuation of assets and business opportunities is often complex. There would be no personal interests involved that would affect the process of evaluating the assets if there were an independent evaluator assigned of the unregistered entity. Independent evaluating companies are used because they are often unbiased about the actual company they evaluate since there are no personal interests involved. They are licensed and run the risk of losing their validity if they abuse their power. A fair and reasonable evaluation would most likely be attained with the direct intervention of an independent evaluator.
There are many valuation services that help prevent and preclude these types of abuses that occur in connection with fund merger transactions. For example, the Battle Group, strongly believes in offering an independent perspective on valuation to protect the soundness and reliability of each of its clients.
Revision: The independent evaluator's report would be included in the records of the merger that the surviving fund would be required to maintain.
We believe that the surviving company should absorb the responsibility of maintaining the independent evaluator's report. Since the funds would belong to the surviving company it appears to be the convenient solution for maintaining a sound and reliable valuation.
We support our opinion based on the findings in the Investment Company Act of 1940 under Section 30 -- Accounts and Records, as it states the following:
(a) Every registered investment company, and every underwriter, broker, dealer, or investment adviser which is a majority-owned subsidiary of such a company, shall maintain and preserve for such period for the basis of financial statements.
(b) Any registered investment company, shall maintain and preserve for such period or periods records for such person's transactions with such registered company.
Revision: To amend Rule 17a-8 to include transactions originally excluded.
Rule 17a-8 was designed to facilitate mergers between affiliated funds that will generate benefits for each participating fund and its shareholders. However, this rule prohibits mergers with non-affiliated members to have direct transactions that would benefit both parties. The proposition is to make the rule's exemptive relief available only for mergers that are not part of a plan or scheme to evade the affiliated transaction. The proposition is deemed necessary in light of the investors and those who would benefit from the transaction with non-affiliated members, as long as the transaction does not become a barrier for any affiliated members' transactions. This provision would bring attention that the assets of the investors will be handled in the best interest of the investors in a perhaps more beneficial way since there will be a more broader choice of how to manage the investment/ assets of those investors. Therefore creating more certainty for the investors in their confidence of those advisors who are managing their assets. As long as these transactions with non-affiliated members are in the sole intent of benefiting the investors these transactions should be deemed as necessary and should not be prohibited. The rule should have clear specifications on what would be considered as an obstruction to those affiliated members and their transactions and how to deal with such members or non-members that do not abide by acting in a beneficial but legal manner while engaging in their transactions.
Revision: The nature and magnitude of the benefits afforded by the rule to funds, their investment advisers, their shareholders.
As far as "nature and magnitude of the benefits":
1. Funds - huge benefits. Less costs and more room for expansion in size and potential returns. Question is, can one prevent "hostile" situations where one fund forces the other to merge through whatever means possible. This rule must be specific enough to prevent that.
2. Advisors - The only real, immediately tangible, benefit we see to advisors is again reduced costs. The question is, who really bears those costs? If it is the shareholders (as one would expect) then the real benefits are afforded to the investors, not the advisors. Advisors could also personally benefit from having the increased opportunity to expand their own personal curriculum and experience, thus creating better opportunities for themselves.
3. Shareholders - These are the ones that really benefit. Like in a real life merger, shareholder value could easily be created thorough this kind of transaction. If we take it as a given that the merger makes sense for business purposes (i.e., expands investing horizon, increases potential returns, has complementary goals, reduces overhead, thus creating synergies, etc...), then the increased availability of these would amount to enhanced benefits to the ultimate customer, the shareholder.
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