Investment Company Act of 1940
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
Our Ref. No. 200612271435
Your letter dated December 27, 2006 requests our assurance that we would not recommend enforcement action to the Securities and Exchange Commission (the "Commission") against GuideStone Financial Resources of the Southern Baptist Convention ("GuideStone Financial"), GuideStone Capital Management ("GuideStone Management"), and the Real Estate Securities Fund and the Global Bond Fund (collectively, the "Unregistered Funds) under section 17(a)(1) of the Investment Company Act of 1940 (the "1940 Act") if, under the circumstances described below and without obtaining an order from the Commission under the 1940 Act, the Unregistered Funds sell portfolio securities to affiliated, newly created series of the Guidestone Funds (the "Trust") in exchange for shares of the newly created series (the "New Series").
You state the following: GuideStone Financial is a non-profit, non-stock corporation whose sole member is the Southern Baptist Convention. GuideStone Financial sponsors, maintains and/or administers various employee benefit plans for employees of churches and organizations controlled by, or associated with the Southern Baptist Convention. GuideStone Financial invests most of the employee benefit plan assets in series of the Trust, a registered open-end investment company, managed by GuideStone Management (a controlled affiliate of GuideStone Financial).1 GuideStone Financial also invests some of the employee benefit plan assets in certain investment pools, including the Unregistered Funds, that are exempt from registration as investment companies pursuant to section 3(c)(14) of the 1940 Act.2 The Unregistered Funds are managed by one or more sub-advisers who are responsible for the selection of the securities in which the Unregistered Funds invest and are otherwise unaffiliated with the Unregistered Funds, GuideStone Financial or GuideStone Management.
GuideStone Financial intends to engage in transactions by which all of the assets of each Unregistered Fund will be transferred to a corresponding New Series in exchange for shares of a New Series, whereupon the Unregistered Fund will distribute the shares of the corresponding New Series pro rata to its holders and terminate (a "Transaction"). You explain that each Transaction essentially entails a merger (as defined in rule 17a-8 under the 1940 Act) of an Unregistered Fund with a corresponding New Series whereby the New Series will be the surviving company.
Each New Series has the same investment objectives, investment policies and portfolio managers as its corresponding Unregistered Fund. GuideStone Financial believes that the plan participants would best be served through the use of the New Series, which will offer plan participants the added protections of the 1940 Act. The Transactions would allow the Unregistered Funds to sell portfolio securities to the New Series in exchange for shares of the New Series without the need to incur the costs of liquidating and reducing those investments to cash in order to purchase New Series shares.3
You represent that the Transactions will be effected consistent with the following representations (the "Representations"):
Section 17(a)(1) of the 1940 Act, in relevant part, prohibits any affiliated person of a registered investment company (a "first-tier affiliate"), or any affiliated person of such person (a "second-tier affiliate"), acting as principal, from knowingly selling any security or other property to the registered investment company.8 Section 17(a) was designed to prevent self-dealing and other forms of overreaching of a registered investment company by its affiliates.9 In particular, the section protects investors by prohibiting "a purchase or sale transaction when a party to the transaction has both the ability and the pecuniary incentive to influence the actions of the investment company."10
Section 17(a)(1) may be interpreted to prohibit the Transactions because the Unregistered Funds would act as principals in the Transactions, and because the Unregistered Funds and the New Series may be deemed to be affiliates of each other.11 The Transactions raise the concerns underlying section 17(a)(1) of the 1940 Act because GuideStone Financial and its affiliates may use their influence to cause the New Series to accept unwanted portfolio securities, and to issue its shares to the Unregistered Fund in exchange for consideration (i.e., portfolio securities) that is of lesser value than the shares issued.12
You state that the Unregistered Funds cannot rely on rule 17a-8 under the 1940 Act, which exempts mergers between registered investment companies, and between registered investment companies and certain affiliated entities (namely, bank common and collective trust funds and insurance company separate accounts, collectively the "Specified Entities"). You acknowledge that the Unregistered Funds are not Specified Entities. The Commission has addressed on a case-by-case basis through the exemptive process the mergers of registered investment companies with non-Specified Entities, and has imposed conditions to those mergers that address the possibility of overreaching by the non-Specified Entities.13 Those conditions require compliance with all of the requirements of rule 17a-8 under the 1940 Act (other than with respect to Specified Entities). In addition, the conditions require compliance with the requirements of rule 17a-7 under the 1940 Act (except for rule 17a-7(a)'s requirement that the merger be for cash payment).14
You contend that the Transactions would not raise the concerns underlying the prohibitions of section 17(a) of the 1940 Act if they are conducted pursuant to the Representations because they are consistent with the conditions in the orders and address the concerns underlying section 17(a). For instance, the Representations require scrutiny of the in-kind consideration to ensure that it is appropriate, in type and amount, for investment by each New Series in light of its investment objectives and policies. In addition, the Unregistered Funds and New Series would comply with all of the conditions of rule 17a-8 under the 1940 Act which, among other things, require an independent evaluator to value the assets to be transferred for which market quotations are not readily available.
On the basis of the facts and representations set forth in your letter, we would not recommend enforcement action to the Commission against GuideStone Financial, GuideStone Management or the Unregistered Funds under section 17(a)(1) of the 1940 Act if the Unregistered Funds sell portfolio securities to the New Series without obtaining an order from the Commission under the 1940 Act in the manner described in your letter. 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. Specifically, our position is limited to mergers of a non-Specified Entity and a newly created registered investment company without shareholders, other than the investment adviser or its affiliates.15
Sara P. Crovitz
Our position in this letter is not limited to Non-Specified Entities that, like the Unregistered Funds, are not registered with the Commission as investment companies in reliance on the exclusion from the definition of investment company in section 3(c)(14) of the 1940 Act.
We note that, in the context of amendments to rule 17a-8 under the 1940 Act, the Commission stated that mergers between registered investment companies and affiliated entities that are not Specified Entities must either comply with rule 17a-7 or rule 17a-8 or the parties must seek exemptive relief. See the 2002 Release at fn. 31 and accompanying text. The Unregistered Funds, the New Series, GuideStone Financial and GuideStone Management, however, represent that they generally will comply with the requirements of both rule 17a-7 and 17a-8 under the 1940 Act, except as explained above, and will also comply with the Representations which enhance the requirements of the rules. See Representations 2, 3, 6, 7, and 8. In addition, you note that the Unregistered Funds propose to transfer assets into newly created investment companies that do not have any other shareholders. Thus, the potential for overreaching the shareholders of a registered investment company (i.e., the New Series) is significantly diminished.
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