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Summary of CommentsOn Proposed Amendments to Rule 17a-8
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| Professional and Trade Associations | |
| 1. American Bar Association, Section of Business Law, Committee on Federal Regulation of Securities, Subcommittee on Investment Companies and Investment Advisers | ABA Subcommittee |
| 2. Investment Company Institute | ICI |
| Investment Companies, Investment Advisers and Banks | |
| 3. Federated Investors, Inc. | Federated |
| 4. Fidelity Management & Research Co. | Fidelity |
| 5. Fleet National Bank and Fleet Investment Advisers, Inc. | Fleet |
| Law Firms | |
| 6. Davis, Polk & Wardwell | Davis Polk |
| 7. Hale & Dorr | Hale & Dorr |
| Other Commenters | |
| 8. Students at Florida International University | FIU Students |
On November 8, 2001, the Securities and Exchange Commission (the "Commission") issued a release ("Proposing Release") proposing amendments to rule 17a-8 under the Investment Company Act of 1940 (the "Investment Company Act" or "Act").1 Rule 17a-8 permits affiliated registered investment companies and series or portfolios of registered investment companies ("funds") to merge without first obtaining an exemptive order from the Commission. Currently, rule 17a-8 permits such a merger only when the participating funds are affiliated solely because they have a common investment adviser, common directors, and/or common officers. The proposed amendments would expand the availability of the rule to include the merger of funds that are affiliated for other reasons, such as when the funds have common large shareholders. The amendments also would permit a fund and an affiliated bank common trust fund or collective trust fund to merge under the rule. Furthermore, funds would have to comply with certain new conditions to avail themselves of the relief offered under rule 17a-8.
The Commission received seven comment letters and one telephone comment.2 The following discussion summarizes the commenters' general views and specific remarks on matters discussed in the Proposing Release. The Division of Investment Management prepared this summary.
All eight commenters expressed general support for the proposed changes to rule 17a-8. The ABA Subcommittee stated that it
commends the Commission and its staff for developing this important proposal to expand the Exemptive Rule. The expanded Exemptive Rule should significantly reduce the number of exemptive orders processed by the Commission and the associated costs to the industry. It also should allow funds to complete beneficial business transactions in a more timely manner.
As described in more detail below, each commenter also offered suggestions about one or more aspects of the proposed amendments.
Relief under rule 17a-8 is conditioned on a determination by the board of directors (including a majority of independent directors) of each participating fund that the merger is in the best interests of the fund, and will not dilute the interests of shareholders. The proposed amendments would add to rule 17a-8 a number of factors for the board to consider, if relevant, in making the determination that the merger is in the best interests of the fund.
Four commenters addressed the proposed inclusion of factors in the rule; all objected to the proposal.3 Three commenters stated that the factors are likely to become outdated.4 Federated and the ICI stated that including the factors is redundant with general state law requirements for boards of directors, and the ABA Subcommittee argued that specifying factors for a board to consider is unprecedented in Commission rules.5 Davis Polk and Federated complained that the factors were too vague.6 Three commenters argued that specifying factors for boards to consider is inconsistent with the Commission's recent approach of adopting rule amendments to enhance the independence of directors and encourage boards to engage in careful deliberations.7
Davis Polk and the ICI recommended that the factors be addressed in the adopting release for the rule 17a-8 amendments, rather than in the rule itself. Federated preferred that the factors not be discussed at all in the adopting release. All three commenters preferred that, if the release discusses the factors, it treat them as examples rather than as standards of board review, to avoid limiting the range of board discussions or necessitating further rulemaking if the importance of certain factors changes in the future.
Rule 17a-8 currently does not include a condition requiring shareholders of an acquired fund to vote on the merger. The proposed amendments would require a shareholder vote by each fund that would not survive the merger.
The ABA Subcommittee generally supported the shareholder vote condition,8 but it and four other commenters favored limiting the provision.9 Another commenter (Federated) generally opposed the condition as unnecessary, and expressed concern that requiring a shareholder vote would displace state law.
Three commenters recommended limiting the shareholder vote condition to mergers that have an important effect on a shareholder's investment:
Davis Polk opposed requiring a shareholder vote for mergers of funds that are currently covered by rule 17a-8, i.e., funds affiliated solely because of common advisers, directors and/or officers. Hale and Dorr recommended that certain mergers involving master-feeder funds be permitted to proceed without a shareholder vote.14
The Commission requested comment in the Proposing Release on whether, in the absence of a shareholder vote, shareholders would receive sufficient advance notice of the change in their investment through a merger. The ICI recommended that rule 17a-8 require advance notice to shareholders (e.g., 45 or 60 days) of mergers for which a shareholder vote is not solicited. Federated supported a notice requirement in lieu of any shareholder vote requirement. 15 It pointed to the shareholder notice requirement in rule 35d-1(c) as a model.16
When the Commission adopted rule 17a-8 in 1980, it designed the rule to be limited to affiliated mergers in which fund affiliates would not have both the ability and the pecuniary incentive to affect the terms of the merger. In furtherance of this objective, the proposed amendments would require that if an owner of more than five percent of the shares ("owner affiliate") of the fund holding the vote is another merging fund, or an investment adviser, principal underwriter, or owner affiliate of another merging fund ("related shareholder"), the related shareholder must vote its shares in the same proportion as non-related shareholders. The proposed amendments would except from this echo voting condition securities voted in accordance with instructions received from the beneficial owner of those securities, or from a person appointed to provide guidance on the voting of securities by a fiduciary of a plan under the Employee Retirement Income Security Act (ERISA).
The ABA Subcommittee and Fleet generally supported the proposed echo voting condition. The ABA Subcommittee, however, expressed concern that the condition was too restrictive for owner affiliates that are not otherwise affiliated with any of the merging funds.17
Three commenters objected to the echo voting condition as conflicting with a shareholder's right to vote, and unnecessary given the investor protection measures already provided in rule 17a-8.18 Two of these commenters, Federated and the ICI, also opposed echo voting as conflicting with the fiduciary duties of fiduciary shareholders such as bank trustees.19 The ICI also questioned the logistics of obtaining the related shareholder's vote, and noted that funds would have to seek exemptive relief if a related shareholder refused to vote its shares as directed. Fidelity recommended that rule 17a-8 be revised to permit the legal owner to use any objective method in voting on behalf of beneficial owners. Fidelity also recommended limiting the echo voting condition to circumstances in which the owner affiliate is in a control relationship with the adviser, principal underwriter, or promoter of the acquiring fund.20
The ABA Subcommittee and Fleet recommended an exception in the echo voting condition to permit related shareholders to vote their shares in accordance with the instructions of an independent third party fiduciary, regardless of whether the account is an ERISA account. The ABA Subcommittee also recommended creating an exception to accommodate instances in which other laws or regulations impose obligations or restrictions that conflict with the echo voting condition.21
Currently, relief under rule 17a-8 is available only for mergers of funds, i.e., registered investment companies. The proposed amendments would expand the rule to permit mergers between funds and unregistered common or collective trust funds, as long as the surviving entity is a fund.
The ICI and Davis Polk recommended that the rule be expanded to permit mergers of funds with any type of unregistered entity, as long as such mergers satisfy the rule's conditions. The ICI particularly favored the inclusion of insurance company separate accounts, which it characterized as "analogous to bank collective trust funds" in operation and structure.
The Commission expressed concern in the Proposing Release that the assets of unregistered entities may be mispriced for purposes of a merger, because unregistered entities may not calculate net asset value on a daily basis or in accordance with well-established procedures as funds do. Therefore, the proposed amendments would require the board of directors of any fund that merges with an unregistered entity to approve procedures for the valuation of the unregistered entity's assets. These procedures, among other things, must provide for the preparation of a report by an independent evaluator that sets forth the current fair market value (as of the date of the merger) of each asset that will be transferred by the unregistered entity to the fund.
Three commenters opposed the independent evaluator condition.22 They recommended relying instead on the acquiring fund's standard pricing procedures to value assets obtained from an unregistered entity. Federated and the ICI appeared to assume that a board would be required to accept the valuation opinion of the independent evaluator. They characterized the condition as problematic because the valuation procedures of the acquiring fund and independent evaluator are likely to differ, which might lead to pricing inconsistencies and the need to readjust asset values after the merger. Federated stated that the consequences also could include dilution of ownership and the creation of artificial tax gains or losses. Federated and the ABA Subcommittee also objected to the cost of engaging an independent evaluator.
The Proposing Release stated that, if the proposed amendments are adopted, all affiliated mergers must proceed either (i) in compliance with amended rule 17a-8 or (ii) pursuant to an exemptive order under section 17(b).23 The ABA Subcommittee recommended allowing mergers to proceed under rule 17a-7, in reliance on staff no-action letters, if the conditions of rule 17a-7 (other than the "cash only" requirement) are met.24 It argued that those conditions adequately protect investor interests.
The proposed amendments included a provision that would prohibit funds from relying on rule 17a-8 to effect a merger that is part of a plan or scheme to evade the affiliated transaction prohibitions of section 17(a) of the Act. Three commenters objected to this proposed anti-evasion provision as redundant with section 48(a) of the Act.25 The ABA Subcommittee noted that the anti-evasion provision and section 48(a) use different language, and suggested that, if the Commission adopts the provision, it clarify whether the provision is intended to differ from the standard of section 48(a).
1 Investment Company Mergers, Investment Company Act Release No. 25259 (November 8, 2001), 66 Fed. Reg. 57602 (November 15, 2001).
2 We received comment letters from the ABA Subcommittee, the ICI, Federated, Fidelity, Fleet, and Davis Polk. An attorney at Hale & Dorr provided comments by telephone and agreed to follow up with written comments, but has not yet sent a letter. We received a seventh comment letter from the FIU Students, who expressed general support for the proposal.
3 ABA Subcommittee, Davis Polk, Federated, ICI.
4 ABA Subcommittee, Davis Polk, Federated. The ABA Subcommittee noted that the factors included in the 1979 and 1980 rule 12b-1 releases became outdated soon afterwards.
5 But see rule 17g-1(d)-(e) [17 CFR 270.17g-1(d)-(e)] (specifying factors for a board to consider when approving the form and amount of the bond against larceny and embezzlement covering officers and employees, and whether a premium may be paid for any joint insured bond or any amendment thereto).
6 Federated expressed particular concern about the vagueness of the factor concerning "change in services to be provided to shareholders."
7 ABA Subcommittee, Federated, ICI. The ABA Subcommittee argued that specifying the factors would unnecessarily complicate board deliberations. Federated and the ICI argued that including the factors in the rule might serve to limit board discussions to the factors listed, and dissuade board consideration of other important factors.
8 The ABA Subcommittee noted, however, that some of its members were concerned that the requirement would overrule state law.
9 ABA Subcommittee, Davis Polk, Fidelity, Hale and Dorr, ICI.
10 The ABA Subcommittee cited fund conversions to or from the master-feeder structure, and mergers that solely change a fund's domicile, as examples of mergers that would not materially affect shareholders. The ABA Subcommittee also expressed concern that the shareholder vote requirement could encourage a board or adviser in close cases to liquidate a fund (which does not require a shareholder vote), or to merge the fund with an unaffiliated fund, although such mergers are uncommon occurrences.
11 In response to a request for comment, the ICI recommended against requiring an acquiring fund to hold a shareholder vote.
12 Fidelity also stated that the vote requirement should be governed by the calculation of "majority" vote in section 2(a)(42) of the Act.
13 Fidelity also recommended that in situations in which the rule does not require a shareholder vote, the fund's directors should be able to require a shareholder vote.
14 Hale and Dorr stated that under existing rule 17a-8, mergers involving master-feeder funds that are effected solely for the purpose of shifting the investment management function to the master level, and in which the acquired fund actually remains in existence, are permitted to proceed without a shareholder vote.
15 Federated also supported requiring funds to disclose in their prospectus whether they can be acquired without a shareholder vote.
16 Rule 35d-1 under the Investment Company Act requires a fund that uses a name suggesting investment in certain investments, industries, countries or geographic regions either to adopt a fundamental policy to invest (under normal circumstances) at least 80 percent of its assets in the manner suggested by its name, or to adopt a policy to provide the fund's shareholders with at least 60 days notice of any change in the investment policy. The notice must be in plain English and include a statement alerting investors to the importance of the notice. See rule 35d-1(c) [17 CFR 270.35d-1(c)].
17 The ABA Subcommittee suggested three alternative revisions to the echo voting condition: (i) do not require echo voting by affiliates that are affiliated solely because of ownership of fund shares; (ii) permit those owner affiliates to engage an independent fiduciary to evaluate and vote on a merger; or (iii) do not require echo voting by owner affiliates unless they own more than 25 percent of the fund's shares (which, under the Act, means that the affiliate is presumed to control the fund).
18 Federated, Fidelity, ICI.
19 The ABA Subcommittee noted that even ERISA trustees could face conflicting legal duties because they may not be permitted to appoint another person to vote plan shares.
20 Fidelity also recommended that for purposes of calculating the extent of ownership, shares should be excluded that otherwise are subject to echo voting or that would fall within the exceptions to echo voting in the rule.
21 The ABA Subcommittee also recommended (i) permitting owner affiliates who are merely record owners to vote their shares either in accordance with instructions received from the beneficial owners or in the same proportion as other beneficial owners, and (ii) clarification of the definition of "ownership."
22 ABA Subcommittee, Federated, ICI.
23 See Proposing Release, supra note 1, at n.54 and accompanying text.
24 Rule 17a-7 under the Investment Company Act [17 CFR 270.17a-7] generally permits purchase and sale transactions of readily marketable securities between a fund and certain of its affiliates if a number of conditions are met.
25 ABA Subcommittee, Fidelity, ICI.
http://www.sec.gov/rules/extra/s72101commsumm.htm
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