Investment Company Institute
February 19, 2003
Mr. Jonathan G. Katz
Re: Issuer Purchases of Equity Securities (File No. S7-50-02)
Dear Mr. Katz:
The Investment Company Institute1 appreciates the opportunity to comment on the Securities and Exchange Commission's proposal to amend Rule 10b-18 under the Securities Exchange Act of 1934, the rule that provides issuers with a "safe harbor" from liability for manipulation when they repurchase their common stock in the market in accordance with the rule's manner, timing, price, and volume conditions.2
The Institute supports the Commission's proposal. The proposed amendments to Rule 10b-18 would continue to permit repurchases by issuers of their securities under conditions that are unlikely to create manipulative effects on the issuer's security price. In addition, requiring issuers to provide disclosure with respect to proposed and actual repurchases would make information that can be relevant in making investment decisions available to the market.
Our specific comments on the Commission's proposal primarily focus on its application to investment companies as issuers. Closed-end investment companies currently rely on Rule 10b-18 to engage in repurchases of their securities (often when their shares are selling below their net asset value). While we generally support the Commission's proposal, we have significant concerns regarding the Commission's proposed treatment of block purchases. Accordingly, we recommend that the Commission continue to exclude block purchases from Rule 10b-18's volume limitations for closed-end funds. Alternatively, the Institute recommends that closed-end funds be permitted to purchase up to a daily aggregate amount of 10,000 shares. Finally, we recommend that the Commission gather and analyze data on the effect of eliminating the block exception for all issuers before determining to eliminate Rule 10b-18's exception for block purchases. Our comments are discussed in greater detail below.
I. Timing of Purchases
Rule 10b-18(b)(2) currently excludes from the safe harbor issuer repurchases during the last 30 minutes before the scheduled close of trading. This limitation applies regardless of the security's liquidity or daily trading volume. The Commission has proposed to modify Rule 10b-18 so that issuers of more liquid securities (i.e., those having an average daily trading volume ("ADTV") value of $1 million or more and a public float value of $150 million or more) could purchase their securities up to 10 minutes before the scheduled close of trading. The Proposing Release states that the 30-minute requirement may be unnecessarily long to prevent issuers of highly liquid securities from influencing market prices near the close of trading and requests comment on the proposed ten-minute requirement.3
The Institute supports permitting issuers of highly liquid securities to repurchase their securities up to ten minutes before the close of trading. We believe that the proposed ten minute standard (together with the other requirements of Rule 10b-18) would adequately protect against an issuer affecting the closing price of its securities. In addition, we believe it is important to continue to provide issuers with such a bright-line standard to determine their eligibility for the safe harbor.
II. Volume of Purchases
A. Closed-End Funds
Rule 10b-18(b)(4) currently permits an issuer to make daily purchases in an amount up to 25 percent of the ADTV in its shares. This volume limitation does not include an issuer's block purchases. Moreover, an issuer's block purchases are not included in determining a security's ADTV. The Commission has proposed eliminating the exception for block purchases so that, to qualify for the safe harbor, issuers would be required to include block purchases in the 25 percent volume limitation and in the security's ADTV. The Proposing Release requests comment on whether the Commission should retain the current block transaction exception, but raise the amount of shares constituting a block (e.g., use the New York Stock Exchange's definition). 4
Closed-end funds frequently utilize block purchases when repurchasing their shares because they typically result in lower commissions and better prices than market orders. Block purchases also allow closed-end funds to more selectively respond to a given buying opportunity (rather than being required to effect many smaller purchases over the course of a greater number of trading sessions to implement the fund's repurchase program). In all of these respects, closed-end funds are similar to other public companies.
We are concerned that including block purchases in Rule 10b-18 volume limitations would significantly limit the ability of closed-end funds to repurchase their securities. This appears to be at odds with the general premise of the proposal to relax the conditions of the safe harbor and to increase the number of shares that may be repurchased. In fact, by including block purchases in Rule 10b-18's volume limitations, the Commission would effectively be prohibiting issuers with ADTVs of less than 20,000 shares from making block purchases based on Rule 10b-18's current definition of "block" and issuers with ADTVs of less than 40,000 shares if the Commission decides to adopt the NYSE's definition of "block."
The Commission appears to recognize that making block purchases subject to Rule 10b-18's volume limitations would restrict the ability of issuers with less frequently traded securities to make repurchases. 5 Indeed, as applied to the universe of listed closed-end equity funds, the effect is dramatic and severe. Based on a survey conducted by the Institute, the median ADTV for such funds was 15,750 shares per fund for the year 2002. 6 As a result, under the proposal, more than half of these funds would be limited to repurchasing approximately 3900 shares or less per day. Moreover, the majority (56%) of the closed-end funds surveyed have an ADTV of less than 20,000 shares and 75% have an ADTV of less than 40,000 shares. As a result, under the proposal, a predominant portion of listed closed-end equity funds would be precluded from repurchasing shares in blocks, however defined.
The Institute does not believe that the Commission should amend Rule 10b-18 to have this effect. We believe that closed-end funds should continue to be permitted to implement their repurchase programs under Rule 10b-18 by effecting block purchases. We further note that we are unaware of any abusive practices or manipulation attributable to closed-end funds repurchasing their shares. Accordingly, the Institute recommends that the Commission continue to exclude block purchases from Rule 10b-18's volume limitations for closed-end funds.7
As an alternative, the Institute recommends that closed-end funds be permitted to purchase up to a daily aggregate amount of 10,000 shares. This would enable closed-end funds to make a limited number of block purchases while also responding to the Commission's concern that the block exception essentially allows issuers to avoid any volume limitation by effecting their Rule 10b-18 purchases in block size.8
B. Other Issuers
Our concerns with respect to the calculation of the volume limitation would also appear to apply to other public companies with limited ADTVs. Our survey of the trading volumes of closed-end funds demonstrates the profound effect that the proposed change would have on their repurchases, and we have no reason to believe that the effects on such other public companies would be any different. As a result, the Institute believes that the Commission should gather and analyze data on the effect of eliminating the block exception for all issuers before determining to eliminate Rule 10b-18's exception for block purchases.
III. Rule 10b-18 Alternative Conditions
The Commission has proposed amending Rule 10b-18's volume limitations in the case of severe market declines from 25% to 100% of the ADTV for that security. The Proposing Release explains that the proposed volume modification would permit issuers to purchase more securities within the safe harbor in the trading session immediately following a market-wide trading suspension, or circuit breaker.9 The Institute supports the proposed change. Permitting issuers additional flexibility with respect to repurchases in the trading session following a market-wide trading suspension or circuit breaker in order to facilitate liquidity is reasonable and appropriate.
Closed-end funds are the only type of issuer currently required to provide disclosure with respect to repurchases of securities.10 The Commission has proposed requiring that all issuers, including closed-end funds, provide disclosure with respect to repurchases of common stock in both open market and private transactions. Closed-end funds would be required to provide this disclosure on Form N-CSR.11 The Proposing Release explains that the Commission is not proposing to eliminate or change any of the disclosure called for by Form N-23C-1 or Form N-SAR because of its belief that additional information regarding repurchase offers by closed-end funds would be useful to investors and requests comment on whether proposed Form N-CSR is the appropriate location for additional disclosure regarding repurchases.12 Comment is also requested on whether the Commission should no longer require disclosure about repurchases on Form N-23C-1 or Form N-SAR.
The Institute believes that it is unnecessary and inappropriate to require closed-end funds to provide information about repurchases on three different forms -- Form N-SAR, Form N-23C-1, and Form N-CSR. We, therefore, recommend that the Commission eliminate Form N-23C-1 (and make related changes to Rule 23c-1) and no longer require closed-end funds to provide disclosure regarding repurchases on Form N-SAR. Under our recommended approach, closed-end funds would be required to provide on Form N-CSR the same information regarding repurchases as that required of all other public companies.
The Proposing Release also requests comment on how frequently closed-end funds should be required to disclose information regarding repurchases of equity securities and whether closed-end funds should be required to make quarterly disclosure of repurchases just as is proposed for other public companies.13 The Institute believes that semi-annual disclosure on Form N-CSR will adequately inform the market with respect to the repurchase activity of closed-end funds. Consequently, we see no reason to require more frequent disclosure.
* * * * *
The Institute appreciates your consideration of our views on these issues. If you have any questions regarding our comments or would like additional information, you can contact me at (202) 218-3563.
cc: Paul F. Roye, Director
Annette L. Nazareth, Director
Percentiles of Average Daily Trading Volume for Closed-End Equity Funds
This table reflects data gathered for 100 closed-end equity funds. Averages are daily averages for each of the 100 funds for all trading days in 2002.*
* Note: As of September 2002, the Institute had 527 closed-end investment company members. Of these, 118 were equity funds. We have identified trading volumes for each trading day of 2002 for 100 of these closed-end equity funds. We found partial trading data for an additional 3 closed-end equity funds, and no trading data for the remaining 15 closed-end equity funds.
The aggregate net assets of the 118 closed-end equity funds totaled $30.3 billion, while assets of the 100 funds for which we have provided trading volumes amounted to $24.5 billion, or about 81 percent of the assets of the closed-end equity funds. The trading volumes provided above include block purchases by funds of their own shares.