Davis Polk & Wardwell

 

January 18, 2002

Re:   Proposed Amendments to Rule 17a-8 - File No. S7-21-01

Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, DC 20549-0609

Dear Mr. Katz:

We appreciate this opportunity to comment on the proposed amendments to Rule 17a-8 (collectively, the "Proposed Rule") under the Investment Company Act of 1940, as amended ("1940 Act") which the Securities and Exchange Commission (the "Commission") proposed November 8, 2001, pursuant to Release No. IC-25259 (the "Release"). The Proposed Rule would: (a) extend the benefits of Rule 17a-8 to cover mergers between funds affiliated for reasons other than common officers, directors and advisers, and (b) permit unregistered common and collective trust investment funds to merge with registered affiliates if certain conditions are met.

We fully support the Commission's goal to expand the scope of permissible mergers of affiliated investment companies. We agree that it would be more efficient in most instances to permit mergers between affiliated funds without requiring that they obtain an exemptive order. However, in our opinion, several alterations to the proposal would allow greater procedural efficiency while remaining consistent with the goal of protecting investors. Therefore, we request that the Commission consider the following issues prior to final adoption: (a) eliminating shareholder voting requirements for funds affiliated by reason of common officers, directors or advisers; (b) exempting mergers with any private fund, not merely with common and collective trust funds; and (c) specifying the factors for Board consideration in the adopting release rather than in the Rule itself.

A. Shareholder Voting

The Proposed Rule would require that mergers be approved by a majority of the outstanding voting securities of any fund that would not survive the merger. The Release points out that Section 1(b)(6) of the 1940 Act expresses Congress' expectation that a shareholder vote take place for such merger, and typically (though not always) applicants seeking exemptive orders for affiliated mergers have represented to the SEC that they would obtain shareholder approval by the acquired fund before consummation of the merger. Yet, changes in state laws have eviscerated the shareholder voting requirements in many cases.1

We believe that this shareholder voting requirement is unnecessary for the category of affiliated mergers that has been exempt since the original Rule was amended in 1980. Under the current Rule, mergers between funds affiliated by nature of common investment advisers, directors and/or officers are permitted without an exemptive order so long as the board of directors of each investment company, including a majority of the independent directors, concludes that the merger is in the best interests of the fund, and that the merger does not dilute the interests of existing fund shareholders. Thus, the Proposed Rules, although purportedly intended to "expand" the original exemption, would actually have the opposite effect in situations involving these mergers. The Proposed Rule would increase the procedural conditions for such mergers by mandating a shareholder vote.

We are not aware of any problems arising under the Rule as currently applied and believe there are reasons not to change the Rule on this issue. Fund directors are already subject to rigid standards of fiduciary duty under state and federal law requiring them to act in the best interests of the fund and its shareholders, and we believe they are most competent to continue making the decisions on such mergers under the originally enumerated conditions. Additionally, directors have both the resources and the ability to retain outside professional advice to assist them in their determinations. Reliance on the independent directors would be consistent with the direction taken by the Commission over the past few years to reaffirm and strengthen the role of independent directors as a "cornerstone" protection of shareholders' interests.2Last, we believe that there is ample evidence of the difficulty and expense faced by funds in obtaining quorums and requisite votes for shareholder meetings. Therefore, adding a shareholder vote requirement in the context of this class of affiliated mergers would only serve to add additional costs without materially advancing the protection of shareholder interests.

B. Enumeration of the Factors to be Considered by Directors

The rule proposes to include a number of factors that directors must consider, if relevant, in determining whether a merger is in the best interests of a fund (Proposed Rule 17a-8(a)(2)(ii)), including: (i) direct or indirect federal income tax consequences of the merger to fund shareholders; (ii) fees or expenses that will be borne directly or indirectly by the fund in connection with the merger; (iii) the effects of the merger on annual fund operating expenses and shareholder fees and services; and (iv) changes in investment objectives, resolutions and policies after the merger. The list is not intended to be exhaustive nor determinative. Fund directors or advisors must still consider other factors pursuant to their fiduciary obligations. The proposing release requires comment as to whether the factors should be discussed in the adopting release or the rule.

We believe that this list of factors should be contained in the Adopting Release, not the Rule itself. As a practical matter, it is impossible to enumerate an exhaustive list of factors for consideration ex ante. As a result, the proposed factors are sufficiently vague so as to better serve decision makers as a guide than a set rule. Inclusion of any such list in the actual Rule would risk creating an erroneous impression that they are inviolate factors and thereby limit the range of considerations directors review. It would also necessitate periodic rule amendments as other considerations are recognized over time. Furthermore, since the directors would not be relieved of their duties by following only the enumerated factors, any real benefit them to including them in the Rule is diminished.

C. Private Mergers

When the Commission (originally) proposed Rule 17a-8, they deferred consideration of whether transactions involving unregistered entities should be eligible for relief under the Rule. The Proposed Rule would now exempt mergers of funds with bank common trust funds or bank collective trust funds. We agree with this proposal but would urge the Commission to extend it further to permit all unregistered funds to merge with registered funds (provided that the registered fund survived). We see no sufficient reason to limit the exemption to one group of private funds. The considerations distinguishing registered funds from unregistered funds are the same for all private funds, and therefore the safeguards against mispricing of assets that have been proposed are sufficient for unregistered funds generally, not merely common trust funds. To the extent that any unregistered fund can abide by the additional procedures as those proposed for common trust funds or bank collective funds, the exemption should similarly apply.

We hope that the Commission will find these comments helpful and we would be pleased to discuss these comments with members of the Staff at their convenience. Please feel free to contact me at (212) 450-4684 or Andrew Moss at 212-450-4228 if the staff would like to discuss any of these points in greater detail.

 

Very truly yours,

Nora M. Jordan

 


1 See Del. Code Ann.tit. 12, §3806(a) (2000) which allows Business Trusts to take any action without shareholder approval.
2 See Release Nos 33-7932; 34-43786; IL-29816; File No S7-23-99, Role of Independent Directors of Investment Companies.