Investment Company Act of 1940 — Section 17(j) and Rule 17j-1
Investment Advisers Act of 1940 — Section 204A and Rule 204A-1

WilmerHale, LLP
July 28, 2010

Your letter dated July 28, 2010 requests our assurance that we would not recommend enforcement action to the Securities and Exchange Commission (the "Commission") under Section 204A of the Investment Advisers Act of 1940 (the "Advisers Act") or Rule 204A-1 thereunder against a federally registered investment adviser (the "Adviser") if the Adviser's code of ethics does not include certain qualified tuition programs established pursuant to Section 529 of the Internal Revenue Code of 1986, as discussed below ("529 Plans") as reportable securities with respect to its access person's transactions and holdings in the 529 Plans. The type of 529 Plans as to which no-action relief is requested are those for which the Adviser or a control affiliate does not manage, distribute, market or underwrite the 529 Plan or the investments and strategies underlying the 529 Plan that is a college savings plan. You also request our assurance that we would not recommend enforcement action to the Commission under Section 204 of the Advisers Act, or Rule 204-2(a)(13) thereunder, against the Adviser if it does not make and keep records related to its access persons' transactions and holdings in those 529 Plans.

Facts

You state the following: 529 Plans are established and maintained by states, state agencies, and other state entities (each a "State Entity") to help families save money for higher education expenses.¹ A State Entity may sell the interests in a 529 Plan directly or may enlist the services of one or more broker-dealers to market and distribute the interests.² The interests are sold through the use of an "official statement" of the issuer which describes all of the material terms of the 529 Plan, such as the investment strategies offered, investments underlying these strategies, the administrative and other fees charged by the 529 Plan and its service providers, and the sales charges, if any, paid by the account owner. The official statement also discloses any scheduled variations in the sales charges, which typically are similar to those used in distributing mutual funds. In addition, the State Entity may enlist the services of one or more investment advisers to manage the underlying assets. When a 529 Plan meets the requirements of Section 529 of the Internal Revenue Code of 1986 (the "Internal Revenue Code"), the earnings and withdrawals are not subject to federal income taxes.³

You state that there are two general types of 529 Plans: prepaid college tuition plans and college savings plans. Prepaid college tuition plans allow an individual (the "account owner") to lock in the current tuition rate of a particular university or university system by purchasing tuition units or credits. Tuition credits entitle a designated beneficiary to a waiver or payment of higher education expenses at the applicable university — essentially locking in future tuition at current rates. The amounts contributed by each account owner are pooled into a single fund which is separately invested with a board of directors or trustees overseeing the management of the fund. You represent that the account owner does not participate in decisions regarding how the fund is invested. The benefit that an account owner receives (credit toward a designated portion of tuition) is not impacted by the investment performance of the underlying fund. The account owner may cancel the contract at any time and receive a refund.

You state that college savings plans allow the account owner to create an account for a designated beneficiary to which anyone may contribute, the principal and the earnings of which may only be used for that beneficiary's higher education expenses. Although college savings plans vary, they typically permit the account owner to select one or more investment strategies. An account owner of a 529 Plan that is a college savings plan may only select an investment strategy from among the strategies designed exclusively by the 529 Plan administrator or investment adviser. You represent that the investments underlying the investment strategies of a 529 Plan that is a college savings plan are mutual funds, guaranteed investment contracts, and separately managed investment portfolios (collectively, "investments"). You state that the account owner has the right to redeem his or her interest in a college savings 529 Plan. However, under the federal tax laws, if an account owner withdraws money (or redeems an interest) for expenses other than qualified education expenses, the earnings will be subject to a ten percent penalty and state and federal income taxes.

You represent that the extent to which an account owner may direct the underlying investments is strictly limited by Section 529 of the Internal Revenue Code and the regulations thereunder.⁴ You represent that an account owner may change investment strategies no more than once per year or when the designated beneficiary of a 529 Plan is changed,⁵ and may not change the mix of investments underlying his or her chosen strategy at all. In the case of 529 Plans which offer age-based strategies, the underlying assets are automatically allocated and re-allocated among investments in a manner intended to correspond to the age of the designated beneficiary. You represent that with respect to a 529 Plan that is a college savings plan, the underlying investment is not a "reportable fund" as defined under Rule 204A-1 under the Advisers Act⁶ and the Adviser or a control affiliate does not manage, distribute, market or underwrite the 529 Plan or the investments and strategies underlying the 529 Plan that is a college savings plan.

You state that participants in 529 Plans generally purchase interests in a trust or other financial instrument created by a State Entity. You state that interests in 529 Plans that are college savings plans are "municipal fund securities" and technically fall within the definition of "reportable securities" under Rule 204A-1 under the Advisers Act because the issuers, as state agencies or instrumentalities, are not subject to the Investment Company Act of 1940 (the "1940 Act").⁷ You state that you believe interests in 529 Plans that are prepaid college tuition plans may not be securities at all, and investment advisers are uncertain as to whether they should treat such interests as "reportable securities."⁸ Accordingly, you believe that an Adviser's code of ethics must require that interests in either type of 529 Plan be included in each access person's personal securities holdings and transaction reports, and that the Adviser must maintain records of the transaction and holdings reports that are related to 529 Plans in accordance with the record keeping requirements of Rule 204-2 under the Advisers Act. You argue, however, that the 529 Plans described in your letter present little opportunity for the type of improper trading that the access person reports are designed to identify.⁹ Therefore, you request that we would not recommend enforcement action under Section 204A of the Advisers Act if the Adviser does not treat the 529 Plans described in your letter as "reportable securities" for purposes of Rule 204A-1 under the Advisers Act.

Analysis

Section 204A of the Advisers Act, together with Rule 204A-1 thereunder, requires any registered investment adviser to establish, maintain and enforce a written code of ethics that, among other things, requires the reporting of securities transactions by the investment adviser's access persons.¹⁰ Specifically, Rule 204A-1(b) provides, as pertinent here, that the code of ethics must require that access persons submit to the investment adviser's chief compliance officer, or another person who is designated in the code of ethics, reports of the access persons' transactions in and holdings of "reportable securities," as defined in Rule 204A-1(e)(10) under the Advisers Act. Section 204 of the Advisers Act and Rule 204-2 thereunder govern the recordkeeping obligations of registered investment advisers. Rule 204-2(a)(13) requires an investment adviser to make and keep true, accurate and current records of the holdings and transaction reports that are required by Rule 204A-1 under the Advisers Act. Together, Rule 204A-1's reporting requirements and Rule 204-2(a)(13)'s recordkeeping requirements aid investment advisers and the Commission's examination staff in identifying conflict of interest situations involving access persons' personal securities transactions that could harm the interests of clients.¹¹ Those conflict of interest situations involve instances in which an access person's personal securities transactions benefit from a client's securities transactions, often to the client's detriment.

You acknowledge that 529 Plans that are college savings plans are reportable securities such that the Adviser's access persons must report their transactions in and holdings of 529 Plans in accordance with the Adviser's code of ethics, which it adopted in conformity with Rule 204A-1 under the Advisers Act. You state that the Adviser also acknowledges that Rule 204-2 under the Advisers Act requires it to maintain records of the transaction and holdings reports that are related to 529 Plans in accordance with the record keeping requirements of Rule 204-2 under the Advisers Act.

You represent that the interests in each type of 529 Plan (i.e., prepaid college tuition plans and college savings plans) are not traded on a secondary market.¹² You also represent that an account holder of a 529 Plan that is a college savings plan does not have the ability to change investment strategies more than once per year or when the designated beneficiary of a 529 Plan is changed and may not change the mix of investments underlying his or her chosen strategy at all. You also argue that an account holder of a 529 Plan that is a prepaid tuition plan has even less of an opportunity to control the investment of their contributions, because the account owner enters into a contract to lock in future tuition at current rates, and does not participate in investment decisions regarding his or her contributions. Consequently, you believe that the protections afforded to advisory clients through Rule 204A-1 under the Advisers Act are not necessary for an access person's investment in the 529 Plans described in your letter.

Conclusion

We agree that investments in the 529 Plans described in your letter appear to present little opportunity for the type of improper trading in either interests of these 529 Plans, or interests held indirectly in investments underlying these 529 Plans, that access person reports are designed to uncover. Based upon the facts and representations contained in your letter, we would not recommend enforcement action to the Commission under Section 204A of the Advisers Act, or Rule 204A-1 thereunder, against the Adviser if its code of ethics does not include the 529 Plans described in your letter as reportable securities with respect to its access persons' transactions and holdings in these 529 Plans.¹³ In addition, we would not recommend enforcement action to the Commission under Section 204 of the Advisers Act, or Rule 204-2(a)(13) thereunder, against the Adviser if the Adviser does not make and keep records related to its access persons' transactions and holdings in 529 Plans.

You have not requested our views on how 529 Plans described in your letter would be treated under Rule 17j-1 under the 1940 Act, which requires access persons of investment advisers to registered investment companies to report their personal transactions and holdings in "covered securities," as defined in the rule. The reporting requirements of Rule 204A-1 under the Advisers Act are modeled largely on those required by Rule 17j-1 under the 1940 Act.¹⁴ Thus, the relief that we provide in this letter with respect to the treatment of the 529 Plans under rule 204A-1 under the Advisers Act is applicable under Rule 17j-1 under the 1940 Act. Accordingly, for the reasons set forth in this letter, we would not recommend enforcement action to the Commission under Section 17(j) of the 1940 Act, or Rule 17j-1 thereunder, against the Adviser if its code of ethics adopted pursuant to Rule 17j-1 does not include the interests in 529 Plans described herein as "covered securities" as defined in the rule,¹⁵ with respect to certain of its access persons' transactions and holdings in these 529 Plans.

Please note that our positions are with respect to enforcement action only, and do not express any legal conclusions on the issues presented. Because our positions are based upon the facts and representations contained in your letter, different facts or representations might require a different conclusion.

Endnotes

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¹ You state that in limited circumstances, certain educational institutions also may establish and maintain 529 Plans under Section 529(b)(1) of the Internal Revenue Code of 1986.

² You state that when enlisted in such capacity, the broker-dealer's activities are governed by the Municipal Securities Rulemaking Board, which has adopted standards governing a broker-dealer's activities. These standards include fair practice, disclosure requirements, suitability requirements, and professional qualification requirements.

³ See Section 529(b)(3) of the Internal Revenue Code and Internal Revenue Service Publication 970.

⁴ Section 529(b)(4) of the Internal Revenue Code provides that "any contributor to, or designated beneficiary under, such program may not directly or indirectly direct the investment of any contributions to the program (or any earnings thereon.)"

⁵ See I.R.S. Notice of Proposed Rulemaking, 2001-55, 2001-2 C.B. 299 (the "Notice"). You represent that the Internal Revenue Service and Treasury Department confirmed that account owners and 529 Plan administrators may rely on the guidance provided in the Notice pending issuance of final regulations under Section 529. To date, no final regulations have been issued. See Comment Request for Regulation Project, 75 Fed. Reg. 38872-01 (July 6, 2010). In January 2009, the IRS amended its earlier guidance and adopted a special rule, allowing account owners to change investment strategies twice in calendar year 2009. I.R.S. Notice 2009-1, 2009-2 I.R.B. That flexibility has not been extended beyond 2009.

⁶ Rule 204A-1(e)(9) defines a "reportable fund" as any fund for which the investment adviser serves as investment adviser as defined in Section 2(a)(20) of the Investment Company Act of 1940 or any fund whose investment adviser or principal underwriter controls the adviser, is controlled by the adviser, or is under common control of the adviser.

⁷ Rule 204A-1(e)(10) under the Advisers Act defines a "reportable security" broadly to include all securities as defined in Section 202(a)(18) of the Advisers Act, except that it does not include: a) direct obligations of the Government of the United States; b) bankers' acceptances, bank certificates of deposit, commercial paper and high quality short-term debt instruments, including repurchase agreements; c) shares issued by money market funds; d) shares issued by open-end funds other than reportable funds; and e) shares issued by unit investment trusts that are invested exclusively in one or more open-end funds, none of which is a reportable fund.

⁸ You have not asked, and we express no view, regarding whether an interest in a prepaid college tuition plan is a security.

⁹ You state that the Staff has granted assurances that it would not recommend enforcement action in other cases where it was unlikely that scalping or any other improper trading would occur. See e.g., M&G Investment Management Ltd., SEC Staff No-Action Letter (Mar. 1, 2007) and Manufacturers Adviser Corp., SEC Staff No-Action Letter (Sept. 10, 2002).

¹⁰ Rule 204A-1(e)(1) under the Advisers Act defines access persons to include any supervised person of an investment adviser who has access to non-public information regarding a client's securities transactions or holdings, or who is involved in making securities recommendations to clients, or who has access to such recommendations that are non-public.

¹¹ See Investment Adviser Codes of Ethics, Investment Advisers Act Release No. 2209, n.28 (Jan. 20, 2004) ("[o]ur proposal to have codes of ethics require initial and annual holdings reports would facilitate an adviser's assessment of whether an individual's personal securities holdings present a conflict of interest"); Investment Adviser Codes of Ethics, Investment Advisers Act Release No. 2256 (July 2, 2004) ("Adopting Release") ("[r]eviewing these reports will allow advisers as well as the Commission's examination staff to identify improper trades or patterns of trading by access persons").

¹² Compare letters cited in note 9 supra (providing similar relief when the investment is not traded in the secondary market) with National Compliance Services, Inc., SEC Staff No-Action Letter (Nov. 30, 2005) (declining to provide relief for an investment that is traded in the secondary market).

¹³ You do not ask, and we express no view, regarding an Adviser's compliance with Section 204A of the Advisers Act or Rule 204A-1 thereunder in a situation where the Adviser or a control affiliate manages, distributes, markets or underwrites the 529 Plan or the investments (including a fund that is defined as a reportable fund under Rule 204A-1) and strategies underlying the 529 Plan that is a college savings plan.

¹⁴ See Adopting Release at section II.C.

¹⁵ Rule 17j-1 under the 1940 Act defines a "covered security" as a security as defined in Section 2(a)(36) of the 1940 Act, except that it does not include: (i) direct obligations of the Government of the United States; (ii) bankers' acceptances, bank certificates of deposit, commercial paper and high quality short-term debt instruments, including repurchase agreements; and (iii) shares issued by open-end registered investment companies.

Incoming Letter

The Incoming Letter is in Acrobat format.

http://www.sec.gov/divisions/investment/noaction/2010/wilmerhale072810.htm