Investment Company Act of 1940 — Sections 34(b), 35(d) and Rules 2a-7 and 35d-1
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
IM Ref. No. 20091131449
In your letter, dated July 27, 2009, you request our assurance that we would not recommend enforcement action to the U.S. Securities and Exchange Commission (“Commission”) under Sections 34(b) or 35(d) of the Investment Company Act of 1940 (“Act”) or Rule 22c-1 thereunder against any registered open-end investment company that relies on Rule 2a-7 under the Act (“Money Market Fund”) if such Fund treats Student Loan Short-Term Notes, as described in your letter, issued by Straight-A Funding, LLC ("Issuer"), as government securities for purposes of compliance with the diversification requirements under Rule 2a-7(c)(4)(i). You also request our assurance that we would not recommend enforcement action to the Commission under Section 35(d) of the Act or Rule 35d-1 thereunder if a Money Market Fund whose name suggests that the Fund focuses its investments in government securities (“Government Money Market Fund”) treats the Student Loan Short-Term Notes as government securities for purposes of complying with Rule 35d-1(a)(2)(i).
You state that the Issuer was established pursuant to a financing program (“Straight-A-Program”) designed by Citigroup Global Markets Inc., Morgan Stanley & Co. Incorporated and an advisory group of lenders to encourage lenders to provide students and parents with access to certain student loans (“Eligible Loans”) made under the Federal Family Education Loan Program (“FFELP”). You state that the FFELP loan market was impaired by the recent turmoil in the capital markets and that new funding for FFELP lenders through the asset-backed securities market has diminished. You state that, to address this concern, the U.S. Department of Education (“Department”), the U.S. Department of the Treasury and the Office of Management and Budget announced a new program, called the “ABCP Conduit Program,” to attract more private sector capital to the student loan market.1 You state that, although the Department could approve multiple issuers under the ABCP Conduit Program, the Straight-A-Program is intended to serve the entire FFELP program and be the first, and most likely only, program to be approved by the Department under the ABCP Conduit Program.
You state that generally each FFELP lender participating in the Straight-A-Program sells Eligible Loans to a newly formed special purpose vehicle ("SPV") that is wholly owned by that lender. You state that each SPV pledges its Eligible Loans to the Issuer to secure an asset-backed note (“Funding Note”) that the SPV sells to the Issuer.2 You state that the Funding Notes are entitled to the cash flows collected in connection with the Eligible Loans owned by the SPV.
You state that the Issuer finances the purchase of the Funding Notes by issuing Student Loan Short-Term Notes (“Issuer Notes”) in private placements.3 You state that Issuer Notes have initially been issued with expected maturities of up to 90 days and legal final maturities on the third business day following the expected maturity date (“Series-1 Issuer Notes”). In addition, you state that another series of Issuer Notes may later be issued with expected maturities of up to 90 days, but unlike Series-1 Issuer Notes, have legal final maturities on the seventh business day following the expected maturity date (“Series-2 Issuer Notes”).
You state that it is anticipated that each maturing Issuer Note will be repaid with proceeds of new Issuer Notes issued on their respective expected maturity dates (i.e., by “rolling” the Issuer Notes) and any collections received on the Funding Notes. You state that, if the Issuer cannot roll Issuer Notes or repay the maturing Issuer Notes from collections, the maturing Issuer Notes will be paid on the legal final maturity date, using funds advanced by the Federal Financing Bank (the “FFB”), an instrumentality of the U.S government acting under the supervision of the Secretary of the Treasury, pursuant to a Liquidity Loan Agreement that has been entered into between the FFB and the Issuer.4
You state that, under the Liquidity Loan Agreement, the FFB is obligated to provide financing to the Issuer upon request by the Issuer’s manager ("Manager"), whose responsibilities include managing the issuance of the Issuer Notes.5 You explain that, in the event that the Issuer is unable to roll the Issuer Notes on the day the Issuer Notes mature, a loan request will be delivered to the FFB by the Manager that will specify the borrowing date on which the FFB will be required to provide financing to the Issuer. You state that the borrowing date will be either the third or the seventh business day following the date on which the request is made, depending on whether the maturing Issuer Notes are Series-1 Issuer Notes or Series-2 Issuer Notes. You state that the FFB requires such advance notification because it is unable to provide funding for this Program on the same day that the funding request is made.6
You state that the FFB’s obligation to make loans to the Issuer is subject to two conditions. First, you explain that all loan requests to the FFB must stay within certain daily, weekly and aggregate funding limits. You explain that the FFB, upon a minimum of three business days’ notice, will fund any loan request not exceeding $3 billion on any single day or $10 billion during any single calendar week. In addition, the FFB will fund up to $5 billion on any single day or $15 billion during any single calendar week upon seven business days’ notice.7 You state that, under the terms of the Liquidity Loan Agreement, the FFB will not provide financing once the Issuer exceeds these limits or has more than a total of $60 billion in loans outstanding at any point in time. You state that the Issuer's Manager has policies and procedures in place intended to ensure that the FFB’s liquidity limits will not be breached.8
You also state that the FFB will not provide funding if the Issuer is in bankruptcy. You state that to address the bankruptcy concern, the organizational documents and agreements establishing the Straight-A Program require that: (i) the Issuer not be permitted to engage in business activities other than those relating to the Straight-A Program; (ii) the Issuer’s only borrowings be the Issuer Notes and any funds obtained from the FFB’s liquidity facility;9 and (iii) all Straight-A Program participants agree contractually not to place the Issuer in bankruptcy under any circumstances.
You state that each SPV may pledge Eligible Loans to the Issuer until July 1, 2010. You state that the Straight-A Program is scheduled to terminate on January 19, 2014, and that no Issuer Note will have a legal maturity date later than the last business day prior to that date. You state that it is hoped that the capital markets will stabilize prior to that time to enable the Eligible Loans to be refinanced outside of the Straight-A Program in a manner that will provide sufficient proceeds to repay all of the outstanding Issuer Notes. You state that, in the event that this does not occur, all outstanding Issuer Notes will be repaid through collection on the Funding Notes and payments made from the Department or the FFB. Consequently, you state that regardless of whether Eligible Loans are refinanced, investors in the Issuer Notes will be repaid as of the Notes’ legal final maturity date.
You assert that the FFB's obligations under the Liquidity Loan Agreement make the Issuer Notes equivalent to U.S. government securities for purposes of the extent to which a Money Market Fund may invest in the Issuer Notes (i) under the diversification requirements of Rule 2a-7(c)(4)(i) under the Act, and (ii) pursuant to Rule 35d-1(a)(2)(i) under the Act.
Rule 2a-7 provides exemptions from Sections 2(a)(41), 34(b) and 35(d) of the Act and Rules 2a-4 and 22c-1 thereunder necessary to permit Money Market Funds to use the amortized cost method of valuation, subject to a number of requirements. Rule 2a-7(c)(4)(i) generally requires a Money Market Fund to be diversified with respect to issuers of securities acquired by the Money Market Fund in order to limit the Money Market Fund’s exposure to credit risk associated with any single issuer.10 Rule 2a-7(c)(4)(i), in relevant part, specifically excludes government securities from the diversification requirement because such securities are presumed to present little, if any, credit risk.11 Rule 2a-7(a)(14) defines government securities by reference to Section 2(a)(16) of the Act which, in turn, defines a government security to mean, in relevant part, “any security issued or guaranteed as to principal or interest by the United States, or by a person controlled or supervised by and acting as an instrumentality of the Government of the United States pursuant to authority granted by the Congress or the United States."
You state that the FFB is an instrumentality of the government of the United States and that FFB's obligation under the Liquidity Loan Agreement acts as the practical equivalent of a guarantee of the payment of principal and interest on the Issuer Notes. You assert that the credit risk associated with the Issuer Notes are equivalent to that associated with traditional U.S. government securities. With respect to the FFB’s obligation under the Liquidity Loan Agreement being conditioned on the Issuer not being in bankruptcy and staying within the specified funding limits, you assert that failure to satisfy either condition would be extremely remote due to the structure of the Issuer and controls over its activities.12
Section 35(d) of the Act prohibits a registered investment company ("fund") from using a name that the Commission finds by rule to be materially deceptive or misleading. Rule 35d-1 addresses certain fund names that are likely to mislead investors about a fund's investment emphasis. Rule 35d-1(a)(2)(i), in relevant part, states that a materially deceptive name includes a name suggesting that the fund focuses its investments in a particular type of investments unless the fund has adopted a policy to invest, under normal circumstances, at least 80% of the value of its assets in the particular type of investments suggested by the fund’s name ("80% policy"). The use of the words “federal” or “government” or other words suggesting investment in U.S. government securities in a fund’s name would not be misleading for purposes of Section 35(d) of the Act if the fund invests at least 80% of the value of its assets in government securities, as defined in Section 2(a)(16) of the Act, and otherwise complies with Rule 35d-1.13
You argue that, in light of the FFB's obligation under the Liquidity Loan Agreement and the Department's support behind the Straight-A Program, the credit and other investment risks, as well as the liquidity characteristics, of the Issuer Notes are equivalent to those associated with traditional U.S. government securities.14 Accordingly, you argue that a Government Money Market Fund that treats the Issuer Notes as government securities for purposes of its 80% policy would not be misleading its investors or otherwise investing its assets in a manner inconsistent with its name.
Based on the facts and representations in your letter, and in particular the unique circumstances and purposes behind the Straight-A Program, and without necessarily agreeing with your legal analysis, we would not recommend enforcement action to the Commission under (i) Sections 34(b) or 35(d) of the Act or Rule 22c-1 thereunder against any Money Market Fund if such Fund treats the Issuer Notes as government securities for purposes of compliance with the diversification requirements under Rule 2a-7(c)(4)(i), or (ii) Section 35(d) of the Act or Rule 35d-1 thereunder against any Government Money Market Fund if such Fund treats the Issuer Notes as government securities for purposes of complying with Rule 35d-1(a)(2)(i).
Because our positions are based on the facts and representations in your letter, you should note that any different facts or representations may require different conclusions. This response represents our view on enforcement action only, and does not express any legal conclusions on the issues presented.
Rochelle Kauffman Plesset
1 Department of Education, Department of the Treasury, Office of Management and Budget, Federal Family Education Loan Program (FFELP), 74 Fed. Reg. 2518 (Jan. 15, 2009).
2 You state that some FFELP lenders that are state agencies or charitable institutions are permitted to sell Funding Notes secured by Eligible Loans directly to the Issuer without an intermediate SPV.
3 You state that the Issuer is relying on the exclusion from the definition of investment company in Section 3(c)(1) of the Act, although it is possible that the Issuer may in the future adopt program changes to comply with Rule 3a-7 under the Act.
4 You state that the FFB will be repaid either from the proceeds that the Issuer receives from issuing new Issuer Notes or from selling pools of Eligible Loans to the Department pursuant to a forward purchase commitment agreement (“Put Agreement”). You state that, subject to the Put Agreement, the Department agrees to purchase the Eligible Loans to support the issuance of the Issuer Notes.
5 You explain that the Issuer’s operations, including funding decisions, are managed by a Manager, currently BMO Capital Markets Corp., pursuant to a management agreement. You also state that certain custodial and other services are provided to the Issuer by an Administrator, currently Bank of New York Mellon. You state that the Department had veto power over the selection of these entities as service providers, and in the event that there is a change in these service providers, the Department has approval rights with respect to the selection of their replacements. You also state that the Issuer has an advisory board drawn from participating FFELP lenders. You explain that, although the advisory board neither manages nor governs the Straight-A Program, it has certain oversight and veto rights with respect to the operation of the Program.
6 You state that, while the FFB will be the Issuer’s primary liquidity facility, the operational documents provide the Issuer with the flexibility to obtain additional liquidity facilities from highly rated private sector banks to bridge the expected maturity dates and legal final maturity dates of the Series-2 Issuer Notes. You explain that, because private sector facilities generally are able to fund on the same day on which a loan request is received, obtaining funds from such a facility would allow investors holding maturing Series-2 Issuer Notes to be paid sooner than the Notes’ legal final maturity date. You state that any private sector liquidity will not replace the FFB’s obligation with respect to the Issuer Notes. You explain that, while funds obtained from a private sector liquidity facility would be used to pay the Issuer Notes, funds obtained from the FFB would be used to repay the private sector facility (unless during the FFB’s seven-day notice period the Issuer is able to issue additional Issuer Notes and use the proceeds to repay the private sector facility). You state that the Straight-A Program does not currently intend to obtain liquidity from a private sector facility and that it is unlikely that the Program will ever obtain liquidity from such a facility.
7 You explain that the Series-2 Issuer Notes were added to the Straight-A-Program to enable the Issuer to exceed the $3 billion and the $10 billion limits to the extent permitted with a seven-day funding notice.
8 You also state that, in the extremely remote circumstance of the conditions for FFB's payment obligation not being met, the Department, subject to the Put Agreement, will purchase the Eligible Loans from the Issuer, which will provide the proceeds to repay the holders of the Issuer Notes.
9 As noted previously, the Issuer also has the flexibility to obtain liquidity from a private sector facility in a limited manner. See supra note 6.
10 See Revisions to Rules Regulating Money Market Funds, Investment Company Act Release No. 17589 (July 17, 1990) (“the ability of a fund to maintain a stable net asset value under rule 2a-7 may be impaired to the extent it invests heavily in one or more institutions that subsequently experience credit problems or default on their securities.”).
11 See Technical Revisions to the Rules and Forms Regulating Money Market Funds, Investment Company Act Release No. 22921 (Dec. 2, 1997).
12 See also supra note 8.
13 See SEC Staff Letter to the Investment Company Institute (Oct. 17, 2003).
14 You recognize that an investment by a Money Market Fund or Government Money Market Fund in the Issuer Notes would have to be consistent with the investment objectives and policies, as stated in any such Fund’s registration statement.
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