Biotechnology Industry Organization
January 30, 2003
Jonathan G. Katz
Re: Proposed Rule: Certain Research and Development Companies;
Dear Mr. Katz:
We are writing on behalf of the Biotechnology Industry Organization ("BIO")1 to address two comments of the Investment Company Institute ("ICI") on proposed Rule 3a-8 under the Investment Company Act of 1940.2 This letter supplements the BIO comment letter submitted on January 9th.
First, in commenting on the Commission's proposal to require that a "substantial percentage" of the expenses of companies relying on Rule 3a-8 consist of research and development expenses,3 the ICI recommends that the Commission adopt a bright-line standard for determining what constitutes a "substantial percentage." While the Commission's proposal leaves the phrase undefined, "to allow R&D companies to take into account fluctuations in the composition of their expenses over time,"4 the ICI recommends an objective standard, "such as a requirement that an issuer's research and development expenses be a majority of the issuer's total expenses over the relevant period." The ICI suggests that such a standard would "protect against misuse of the safe harbor" by "companies that are primarily engaged in the investment business."
BIO believes that a strict numerical standard, particularly a more than 50 percent requirement, would be unnecessarily restrictive. Although biotechnology companies typically spend voraciously on research and development, there are legitimate reasons for substantial fluctuations in the proportionate size of their research and development budgets that have no relation to any investor protection concern under the Investment Company Act. For example:
The potential for abuse of the safe harbor by companies engaged in an investment business is addressed thoroughly by the Commission's proposed "substantial percentage" approach in combination with the Rule's other safeguards. In particular, the Rule would require a company to have minimal investment management, custody, and research expenses, and to have investment income that is no more than twice research and development expenses. It is hard to fathom how a company that is really engaged in an investment business could have minimal investment-related expenses, limited investment income, and substantial research and development expenses. In addition, the Commission's proposed "substantial percentage" approach is exceptionally conservative in that an increase in numerous types of bona fide operating expenses that are in no way indicative of an investment business (such as manufacturing, marketing, and administrative overhead) could render a company unable to rely on the Rule.
In the event that the Commission decides to proceed with an objective standard as suggested by the ICI, BIO submits that a 30 percent requirement would be more than adequate to protect against abuse of the safe harbor. BIO further submits that, as the ICI concedes, allowance for "nonrecurring items or unusual fluctuations in recurring items" would be necessary to ensure an appropriate level of flexibility.
Second, the ICI recommends that the Commission consider "specific requirements related to credit quality, maturity and liquidity" for capital preservation investments, citing as an example Rule 2a-7, which governs the investment portfolios of money market funds. BIO believes that such requirements are unnecessary and would introduce undue complexity into the Rule. Rule 2a-7 has specific requirements for credit quality and maturity because money market funds hold themselves out to the public as having stable net asset values; research and development companies, of course, do no such thing. Moreover, for ten years research and development companies have been operating under the standard set by the Commission in the ICOS order.5 In the ICOS order, the Commission specifically addressed capital preservation investments using a standard similar to that proposed in Rule 3a-8. We are not aware of a single instance in which the standard has been abused.
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In light of the potentially life-saving research and development that Rule 3a-8 would facilitate, and the absence of any opposition to the proposed rule, BIO urges the Commission to act as soon as practicable to adopt it.
BIO commends the thoughtful and creative efforts of the Commission and its staff in proposing Rule 3a-8 and also appreciates the opportunity to offer these comments. If you have any questions, please call Matt Chambers at (202) 663-6591 or John Nagel at (202) 663-6134.
cc: Chairman Harvey L. Pitt