Investment Advisers Act of 1940 - Section 17(a)(2)
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
Our Ref. No. 2006330942
Your letter dated May 19, 2006 requests our assurance that we would not recommend enforcement action to the Commission under Section 17(a)(2) of the Investment Company Act of 1940 (the "Investment Company Act") against Citigroup Global Markets Inc. ("CGMI") if, under the circumstances described below and without obtaining an order from the Commission under the Investment Company Act, CGMI receives from a Trust (as defined below), as redemption proceeds, securities deposited in the portfolio of the Trust (the "Securities").
You state that CGMI is a broker dealer and serves as the sponsor (the "Sponsor") to numerous series of unit investment trusts that are registered under the Investment Company Act (each series, an individual "Trust"). The Sponsor is also a promoter and a principal underwriter for each Trust. The Bank of New York serves as the trustee (the "Trustee") to each Trust and also would act as evaluator (the "Evaluator") with respect to any Trust that would propose to make in kind redemptions to the Sponsor. Each unit of a Trust (a "Unit") represents a fractional undivided interest in the Securities, and such Securities are held by the Trustee for the benefit of Unit holders (the "Holders").
You explain that, when a Holder wishes to redeem Units, the Holder tenders the Units to the Sponsor, which may purchase the tendered Units with its own money.1 The Sponsor becomes the owner of the Units and acts as principal when its tenders the Units to the Trust for redemption. You further state that, upon a request for an in kind redemption by the Sponsor, the Trust would distribute to the Sponsor its proportionate share of every Security in the Trust's portfolio. The in kind redemption would be effected based upon the price per Unit computed by the Trustee as of the 4:00 p.m., Eastern time (or earlier close of the New York Stock Exchange) next following the tender of any Units for redemption. The Evaluator would value the Securities to be distributed in the in kind redemption in the same manner as they are valued for purposes of computing the distributing Trust's net asset value.
You state that the Holders (including the non redeeming Holders) may prefer in kind redemptions over cash redemptions. You note that the transaction costs that are associated with the sale of Securities to obtain cash to meet a redemption request are borne by all Holders, including those that do not redeem. An in kind redemption would not cause a Trust to incur these transaction costs. You are concerned, however, that section 17(a)(2) of the Investment Company Act prohibits the in kind redemptions by the Sponsor.
Section 17(a)(2) prohibits, in relevant part, any promoter of or principal underwriter for a registered investment company, acting as principal, from knowingly purchasing securities or other property from the investment company (except securities of which the seller is the issuer). An in kind redemption involving a promoter2 or principal underwriter3 may be deemed to be a "purchase" of securities or other property from a registered investment company, such as a UIT, by a promoter or principal underwriter that section 17(a)(2) of the Investment Company Act prohibits.4
You state that the Sponsor is a promoter and a principal underwriter for the Trusts and acknowledge that an in kind redemption involving the Sponsor would be prohibited by section 17(a)(2) of the Investment Company Act. For a variety of reasons, however, you argue that section 17(a)(2) should not prohibit these in kind redemptions. You contend that we recognized in the Signature Letter that there are potential benefits to in kind redemptions and that certain in kind redemptions involving affiliated persons of open end investment companies could be effected fairly and not implicate the concerns underlying section 17(a). UITs, like open end investment companies, issue redeemable securities, the holders of which could also benefit by in kind redemptions, as explained earlier.5
In your incoming letter, you make a similar set of representations (as outlined below) to those made in the Signature Letter, which are tailored to in kind redemptions by the sponsor of a UIT. You contend, in essence, that an in kind redemption by the Sponsor of a Trust would not implicate the concerns underlying Section 17(a)(2) if it were effected according to these representations. We agree. We would not recommend enforcement action to the Commission under Section 17(a)(2) of the Investment Company Act against the Sponsor if, under the circumstances described in this letter and without obtaining an order from the Commission under the Investment Company Act, the Sponsor receives from a Trust, as redemption proceeds, Securities, provided that:
1. The in kind redemption is effected at approximately the redeeming Holder's (i.e., the Sponsor's) proportionate share of the distributing Trust's current net asset value, and thus does not result in the dilution of the interests of the remaining Holders of the Trust;6
2. The distributed Securities are valued in the same manner as they are valued for purposes of computing the distributing Trust's net asset value.7
3. The in kind redemption is consistent with the distributing Trust's redemption policies and undertakings, as set forth in the Trust's prospectus;
4. Neither the Sponsor, nor any other party with the ability and the pecuniary incentive to influence the in kind redemption, selects, or influences the selection of, the distributed securities;
5. Upon an in kind redemption by the Sponsor, the Trust distributes to the Sponsor its proportionate share of every Security in the Trust's portfolio.
6. The in kind redemption does not favor the Sponsor to the detriment of any other Holder;8
7. The Trustee to each Trust monitors each in kind redemption on a quarterly basis for compliance with (1) through (6) above;9 and
8. The distributing Trust maintains and preserves for a period of not less than six years from the end of the fiscal year in which the in-kind redemption occurs, the first two years in an easily accessible place, records for each in kind redemption setting forth a description of the composition of the Trust's portfolio (including each asset's value) immediately prior to the distribution, a description of each security distributed in kind, the terms of the in-kind redemption, the information or materials upon which the asset valuations were made, and a description of the composition of the Trust's investment portfolio (including each asset's value) one month after the in kind redemption.10
This response expresses our views on enforcement action only and does not express any legal conclusions on the issues presented. Because our position is based on the facts and representations in your letter, you should note that any different facts or representations may require a different conclusion.
John L. Sullivan
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