Jorden Burt LLP
1025 Thomas Jefferson Street, N.W.
Suite 400 East
Washington, D.C. 20007-5208
Telephone (202) 965-8100
Facsimile (202) 965-8104
Joan E. Boros, Esquire
Writer's Direct Dial:
February 6, 2004
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609
RE: File No. S7-27-03
Proposed Amendments to Rules Governing Pricing of Mutual Fund Shares
Dear Mr. Katz:
Jorden Burt LLP, on behalf of its client the Jackson National Life Insurance Company (the "Company"), the Company's various separate accounts and the separate accounts of its affiliated life insurance company (together, the "Companies") that issue variable annuity contracts and variable life insurance policies, respectfully submits this comment letter regarding the Commission's proposed amendments to the rules governing pricing of mutual fund shares described in Release No. IC-26288 (Dec. 11, 2003) (the "Release"). As such, the Companies are the sponsors of insurance company separate accounts that are registered with the Commission as unit investment trusts ("UITs") pursuant to the Investment Company Act of 1940, as amended (the "1940 Act").
The Companies, on behalf of their separate account UITs, generally support the Commission's efforts to implement appropriate regulations to prevent unlawful late trading in fund shares, including the proposed amendments to Rule 22c-1 under the 1940 Act ("Rule 22c-1") as described in the Release. However, we note specifically the Commission's request in the Release for comments on other exceptions from the forward pricing amendments that should be considered. We wish to address the "conduit fund" exception as described in the Release and urge the Commission to extend application of that exception to or otherwise include a similar exception for "fund of funds" that are offered as investment options for separate accounts.
The Commission has proposed certain amendments to Rule 22c-1 to eliminate late trading through fund intermediaries, including a requirement that all purchase, exchange and redemption orders be received by the fund, a single transfer agent designated by the fund and required by written contract to receive order information and maintain a record of the date and time it receives the information, or a registered clearing agency (e.g., Fund/SERV) no later than the time at which the fund prices its securities (e.g., 4 p.m. EST), in order to obtain the same day's price (the "4:00 p.m. Hard Close").
The Commission has also proposed two exceptions to the proposed 4:00 p.m. Hard Close, including an exception for conduit funds. The Commission defines conduit funds in the Release as funds that rely on Section 12(d)(1)(E) under the 1940 Act, including certain insurance company separate accounts, and their divisions referred to as "sub-accounts" that invest in specified underlying mutual funds to fund variable contracts. The separate account acts as a conduit between the variable contract owners and the underlying fund because, as owner of the shares of the underlying funds that correspond to the designated sub-accounts, the separate account executes transactions in the underlying fund shares consistent with the variable contract owners' allocations and transfers of contract value among the various sub-accounts of the separate account. The separate account assets and individual contract owner contract values are allocated to underlying mutual funds such that the unit value of sub-accounts of the separate accounts are calculated based on the NAVs of those underlying funds. Section 12(d)(1)(E) excepts registered UITs, such as the Companies' separate accounts, from the "anti-pyramiding" provisions of Section 12(d)(1) that significantly restrict the ability of a registered investment company to invest in securities of other investment companies, provided certain requirements are met.
The relevant text of Section 12(d)(1)(E) that excepts registered UIT separate accounts from the anti-pyramiding restrictions of Section 12(d)(1) and that allows for them to invest in mutual funds requires that:
. . . (ii) [the security that is acquired by the investment company] is the only investment security held by such investment company (or such securities are the only investment securities held by such investment company, if such investment company is a registered [UIT] that issues two or more classes or series of securities, each of which provides for the accumulation of shares of a different investment company); . . . (emphasis added)
Thus, Section 12(d)(1)(E) only excepts securities purchased or acquired by an investment company the portfolio of which consists only of such security (or such securities are the only securities held by a registered UIT that issues two or more classes or series of securities, each of which provides for the accumulation of shares of a different investment company), assuming the other requirements of Section 12(d)(1)(E) are also met.
Under the current interpretation of Section 12(d)(1)(E), each sub-account of a separate account is treated as a separate investment company or as a different class or series of securities issued by a single UIT. As such, in order to rely on Section 12(d)(1)(E), each individual sub-account of the registered UIT separate account must invest all its assets in a single underlying mutual fund, provided the other requirements of Section 12(d)(1)(E) are satisfied. Accordingly, registered insurance company separate accounts that rely on Section 12(d)(1)(E) have "one-on-one" arrangements with the respective underlying funds where a separate account organized into sub-accounts invests in a single designated underlying fund or portfolio of an underlying fund organized in series form.
The Commission's conduit fund exception, as proposed in the Release, would except only those "one-on-one" two-tier separate account-fund arrangements that rely on Section 12(d)(1)(E) from the proposed 4:00 p.m. Hard Close.
B. The Conduit Fund Exception Should Include Affiliated Fund of Funds
As discussed above, the conduit fund exception only contemplates those arrangements whereby an investment company invests substantially all its assets in one fund, including insurance company sub-accounts that each are required to invest in only one underlying mutual fund. The Release does not contemplate funds ("Top Tier Fund(s)") that invest in underlying affiliated funds ("Second Tier Fund(s)") that serve as investment options for separate accounts, but that in essence still act as conduit funds. These affiliated fund of funds arrangements do not fit within the exemption of Section 12(d)(1)(E) because the assets of the Top Tier Funds are invested in more than one underlying Second Tier affiliated fund (e.g., a "one-on-five" arrangement where the fund of funds invests in five underlying affiliated funds). Affiliated fund of funds rely on Section 12(d)(1)(G).
Section 12(d)(1)(G) exempts an open-end fund or UIT (the "acquiring company") from the Section 12(d)(1) anti-pyramiding restrictions where it acquires securities of another open-end fund or UIT (the "acquired company"), provided that:
- the acquired company and the acquiring company are part of the same group of investment companies (i.e., these investment companies hold themselves out to investors as "related" companies for purposes of investment and investor services);
- the acquiring company holds only securities of other registered open-end investment companies and registered UITs that are part of the same group of investment companies, Government securities, and short-term paper;
- either (i) the acquiring company does not pay any distribution-related charges with respect to the acquired shares or the acquiring company does not charge sales loads or distribution-related fees itself, or (ii) sales loads and distribution-related charges with respect to acquiring fund shares and acquired fund shares, when aggregated, are not excessive under applicable SEC or NASD rules; and
- the acquired company may not itself invest in other open-end funds or UITs in reliance on Section 12(d)(1)(F) or (G).
Accordingly, Section 12(d)(1)(G) allows an open-end fund to invest any amount of its own assets in one or more other registered funds or UITs in the same group of investment companies, provided the other requirements of Section 12(d)(1)(G) are met. These "affiliated funds of funds" are limited to investing in government securities, and short-term paper in addition to funds in the same fund group. The exemption also limits sales loads and distribution charges on fund shares, and requires that the acquired fund have a policy that it cannot acquire other fund shares in reliance on section 12(d)(1)(F) or 12(d)(1)(G).
In contrast, Section 12(d)(1)(F) under the 1940 Act permits registered investment companies to take small positions in an unlimited number of other funds (an "unaffiliated fund of funds") (i.e., not in the same group of investment companies). A registered investment company (and its affiliated persons) relying on the exception provided in Section 12(d)(1)(F) from the anti-pyramiding restrictions may acquire no more than 3% of the acquired company's securities; cannot charge a sales load greater than 1.5%; is restricted in its ability to redeem shares of the acquired company; and is unable to use its voting power to influence the outcome of shareholder votes held by the acquired company.
1. Pricing Rationale for Conduit Fund Exception
The Commission, in proposing the conduit fund exception, emphasized the necessity of granting such an exception from the 4:00 p.m. Hard Close for conduit funds because they "invest all their assets in another fund and therefore must calculate their NAV on the basis of the other fund's NAV." Thus the current exception permits an insurance company separate account or sub-account that invests in one underlying fund ("12(d)(1)(E) Account") to receive a transaction order before the 4:00 p.m. Hard Close and transmit the order to the underlying fund after 4:00 p.m. yet still receive the same-day's NAV because the separate account cannot calculate the value of its units (and thus the purchase or redemption price of the order) until its underlying fund calculates its NAV, after 4:00 p.m. As the Commission states in the Release, "the exception would permit a conduit fund, such as a 'master-feeder' fund or an insurance company separate account, to submit its orders based on the NAV established by the other fund on the same day."
The Release and conduit fund exception do not contemplate other conduit fund-type arrangements where the NAV of the conduit fund is based on the NAV of the underlying fund aside from 12(d)(1)(E) Accounts and master-feeder funds. The funds described in this letter that invest in other affiliated funds that are offered to affiliated separate accounts ("12(d)(1)(G) Funds") also fit within the Commission's definition of "conduit funds" in that the 12(d)(1)(G) Fund may invest substantially all of its assets in other affiliated funds and therefore calculates its NAV based on the NAVs of the several affiliated funds in which it might invest. Because the NAVs of the underlying funds are not available until after 4:00 p.m., Top Tier 12(d)(1)(G) Funds should be permitted to submit their fund orders to the Second Tier underlying funds based on the NAV established by the underlying funds, e.g., after 4:00 p.m.
The Company understands from counsel's informal communications with Commission staff that the staff was under the impression that insurers with proprietary fund of funds did not seek to have the pricing of contract owner interests based on the net asset values of the Second Tier Funds on the same day as the owner's transaction in UIT interests. The Commission staff had assumed that the Top Tier Funds did not submit their orders to the Second Tier Funds in which they invest until the day after the separate account received the orders from variable contract owners, and thus may not have considered that this situation needed to be covered by the conduit fund exception. In fact, the Company's underlying proprietary funds of funds process and submit their fund orders to their respective underlying funds (e.g., after 4:00 p.m. when the same-day NAVs of the underlying funds are available) on the same day that the separate account receives its orders from the contract owners in order to get the same-day's price for the contract owner. As such, because 12(d)(1)(G) Funds can only calculate their NAV after 4:00 p.m., when the NAVs of the underlying funds in which they invest become available, they should be excepted from the proposed 4:00 p.m. Hard Close.
2. "Fund of Funds" are Regulated by the Commission
Another reason the Commission offered in the Release for excepting conduit funds from the proposed 4:00 p.m. Hard Close is that these conduit funds (i.e., insurance company separate accounts, feeder funds) are registered investment companies and are subject to regulation and oversight by the Commission. The recent late trading investigations have sparked a flurry of allegations against fund intermediaries (many of which are not regulated by the Commission), claiming that they obscured or misrepresented to the mutual fund the time that they received a purchase or redemption order, "blending" legitimate pre-4:00 p.m. orders with late orders. The Top-Tier 12(d)(1)(G) Funds, as investment companies registered under the 1940 Act, are subject to regulation and oversight by the Commission and thus would remain under the Commission's oversight if they were excepted from the proposed 4:00 p.m. Hard Close.
3. Not Extending the Conduit Fund Exception Produces Anomalous Results and Does Not Provide Contract Owners with the Most Current Prices
The Second Tier Funds are also available for direct investment by the separate accounts and their sub-accounts. As such, they are eligible to rely on the relief granted by the conduit fund exception in that 12(d)(1)(E) structure, but with no potential for abuse, would be prohibited from relying on it under the 12(d)(1)(G) structure. This limitation would produce an anomalous and confusing result, in addition to not providing variable contract owners with the most current prices of their UIT-related contract values.
* * *
In conclusion, we respectfully request that the Commission extend the conduit fund exception to include funds that rely on Section 12(d)(1)(G) under the 1940 Act or to otherwise include an exception for such affiliated fund of funds from the 4:00 p.m. Hard Close requirement. We thank the Commission in advance for its consideration of the foregoing comments and again express the appreciation of the Companies for the opportunity to present these comments. We would be pleased to discuss these or related matters with the members of the Commission or the Commission's staff should you require additional information.
Very truly yours,
JORDEN BURT LLP
Mr. Paul F. Roye, Director
Division of Investment Management
Securities and Exchange Commission
Ms. Susan Nash, Associate Director
Disclosure and Insurance Product Regulation
Division of Investment Management
Securities and Exchange Commission
Susan S. Rhee, Esq.
Jackson National Life Insurance Company