TO: File S7-47-02
FROM: Karen Goldstein
SUBJECT: Proposed Rule 3a-8 - Certain Research and Development Companies


May 9, 2003

On March 10, 2003, Nadya Roytblat, Janet Grossnickle and Karen Goldstein of the SEC's Division of Investment Management ("Staff") telephoned Matt Chambers and John Nagel of Wilmer, Cutler & Pickering, counsel to the Biotechnology Industry Organization ("BIO Counsel"), to request clarification of three issues raised in BIO's January 9, 2003, comment letter ("BIO's Comment Letter") on proposed rule 3a-8 under the Investment Company Act of 1940 ("Act"). Proposed rule 3a-8 would provide a nonexclusive safe harbor from the definition of investment company under the Act for certain research and development companies (R&D companies"). The following summarizes the issues discussed during the call.

The first issue discussed was the recommendation in BIO's Comment Letter to replace the term "revenues from investments" with "net income" from investments in paragraph (a)(2) of the proposed rule. The Staff noted to BIO Counsel that rule 3a-1 under the Act uses the term "net income after taxes." We understood BIO Counsel's response to be that there would not be a significant difference between applying a "net income after taxes" test and a "net income" test, but that using the former may create additional complexity since financial statements created using generally accepted accounting principles ("GAAP") would not contain that information.

The second issue discussed was the concern expressed in BIO's Comment Letter about the requirement in paragraph (a)(4) of the proposed rule that an R&D company determine its compliance with the proposed rule's asset limitations "immediately after the acquisition" of an "other investment," as defined in the proposed rule. We understood BIO Counsel's explanation to be that the phrase "immediately after the acquisition" could be interpreted to require an R&D company currently seeking to rely on the rule to have met the rule's asset limitation requirements at each time it had previously acquired an other investment; so that a company would need to "look back" and check for compliance at the time of each previous acquisition, even an acquisition made years prior to any decision to rely on the rule. The Staff explained that, as noted in the Commission release proposing rule 3a-8, the proposed rule intended to allow an R&D company to continue to rely on the rule if an other investment increased in value so long as the company did not acquire additional other investments. The Staff asked whether BIO's concerns could be addressed by clarifying that an R&D company had to be in compliance with the asset limitations when initially relying on the rule and, subsequently, following each acquisition of an other investment. We understood BIO Counsel's response to be that it would difficult to evaluate such a clarification without seeing the actual clarifying statement.1

The final issue discussed was comments in BIO's Comment Letter concerning the definition in proposed rule 3a-8(b)(4) of a "collaborative research and development arrangement" as an arrangement that "calls for the issuer to conduct joint research and development activities with one or more parties." BIO's Comment Letter recommended that the word "joint" be deleted from the definition because it could be read to require collaborating companies to have equivalent roles in conducting research and development and thus preclude certain common arrangements, such as a joint steering committee or research conducted sequentially by two companies. The Staff asked whether any other types of collaborative arrangements might be precluded by the word "joint." We understood BIO Counsel's response to be that these examples were the two most common arrangements and that a clarification with respect to joint steering committees and sequential research would address the concern.

1 On March 12, 2003, the Staff faxed to BIO's Counsel draft rule language (attached) designed to address the issue discussed in the March 10, 2003, telephone call concerning the application of the proposed rule's asset limitations. Later on March 12, 2003, the Staff spoke by telephone with BIO's Counsel to explain that the faxed draft language provided an R&D company with a "reset button" that would eliminate the need to look at past acquisitions of other investments when determining compliance with the rule at a particular point in time. BIO's Counsel said that they would review the language and get back to the Staff. On March 13, 2003, BIO's Counsel telephoned to say that they would be sending alternative language via e-mail. On March 17, 2003, BIO's Counsel clarified via e-mail and voicemail that the language they sent on March 13, 2003 was just an alternative to the Staff's draft language and that BIO continued to recommend the approach discussed in BIO's Comment Letter.