Securities and Exchange Commission — Merrilllyncham042897
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Our Ref. No. 96-242
REPONSE OF TH OFFCE OF CHI COUNSEL
DMSION OF INESTMEN MANAGEMEN
Merr Lynch Asset Management
File No. 801-11583
Your letter of Januar 30, 1997 requests our assurace that we would not recommend
enforcement action to the Commission under section 10(t) or 17(e)(2) of the Investment
Company Act of 1940 (the "Investment Company Act"), or section 206(3) of the Investment
Advisers Act of 1940 (the "Advisers Act"), if a registered investment company (each a
"Fund") advised now or in the future by Merr Lynch Asset Management, L.P.
("MLAM"), Fund Asset Management, L.P. ("FAM"), or any investment advisory or
investment management afilate of or successor to MLAM or FAM, purchases newly issued
securities in trsactions in which Merr Lynch, Pierce, Fenner & Smith Incorporated
("Merr Lynch") acts as placement agent.
Facts
Merr Lynch, a registered broker-deaer, is a wholly owned subsidia of Merr
Lynch & Co., Inc. ("ML & Co"). MLAM and FAM (together, the "Advisers"), bbtli
registered investment advisers, also are wholly owned by ML & Co. Because Merr Lynch
and the Advisers are under the common control of ML & Co., ML & Co. and each Adviser
are afilated persons of each other. Because the Advisers are afilated persons of the Funds
they manage, Merr Lynch is
an affilated person of an afilated person of each Fund.
1
You represent that, despite theft afiltion, Merr Lynch and the Advisers are
separte entities and operate independently of each other. In parcula, you reresent that
Merr Lynch and the Advisers operate as independent profit centers, have separte offcers,
diectors and employees, maita separte books and records, and are separtely capitaed.
You represent that al investment decisions with respect to each Fund are made solely
by one or more portolio managers who are officers or authori agents of the Fund, and
who are employed solely by one of the Advisers. Portolio managers purchase securities for
their respective Funds that are consistent with that Fund's investment objectives, based solely
on the investment merits and price of the security. You represent that a major determinant
of these managers' compensation is the performance of the Funds they manage, and
that in no instace is their compensation afected by the amount- of business the Funds
conduct with Merr Lynch.
You state that portolio managers, on behal of the Funds, often purchase new issues
of securities placed directly by the issuer. In these transactions ("dit placement agency
! 1
. i The definition of "affiliated person" is set forth in section 2(a)(3) of the Investment
Company Act.
-,
-2
trasactions"), the issuer often uses a placement agent to perform services that faciltate the
sale of the securities. You explai that in diect placement agency trasactions, the
placement agent, acting solely as agent for the issuer, agrees only to use its best efforts and
incurs no liabilty if it fais to place the securities. The placement agent typicaly acts alone,
rather than as par of a group formed specifcaly to sell the securities. In those trasactions
in which there is more than one placement agent involved, the agents do not have joint
responsibilty for, or a joint interest in, the outcome of the distribution.
You state that Merr Lynch frequently acts as placement agent in diect placement
agency trasactions, and that the extent of Merr Lynch's parcipation in these trasactions
has made it increasingly necssar for the Funds to be able to purchase seèurities in
trasactions in which Merr Lynch acts as placement agent. Your request for relief covers
trsactions in which a Fund may purchase securities in diect placement agency trsactions
agent, provided that trasactions in securities other
in which Merr Lynch acts as placement
than money market instrments (which are the subject of cert exemptive orders_.gted to
the ,Funds)2 are conducted in accordace with the following procedures adopted by each
Fund's board of diectors, including by a majority of the Fund's diectors who are not
interested persons of the Fund ("disinterested diectors"), prior to commencement of the
trasactions.
3
1. Pror to each trasaction, ML or FAM wil obta such inormation as it
deems necessar to determine that the trasaction is in the best interests of the Fund. If
firs other than Merr Lynch are also actig as placement agent, ML or FAM wil
solicit a quote as to the security's price from at least ane other fir, and that quote wil be
documented on the trade ticket. In each such instace, MLAM or FAM must determe that
the terms of the purchase from Merr Lynch are at least as favorable as those obtaed from
the other fir before proceeg with the trasaction. If no fir other than Merr Lynch is
actig as placement agent, ML or F AM wil purchase the securities through Merr
Lynch only if Merr Lynch reresents that the net price to be paid by the Fund for the
2y ou represent that trsactions in money market instrments wil comply with the terms of
the relevant exemptive order, as it may be amended from time to tie, regardless of whether
such trasactions may techncay be considered to be pricipal or agency trasactions. See
CMA Tax-Exempt
Fund
etal., Investment
Company Act
ReI. No. 15475, Dec. 11, 1986 (notice
of application) and Investment Company Act ReI. No. 15520, Jan. 5, 1987 (order); Merr
Lynch Ready Assets Trust et al., Investment Company Act ReI. No. 18693, May 6, 1992 (notice
of application) and Investment Company Act ReI. No. 18748, June 2, 1992 (order).
3 As par of these procedures, Fund portfolio managers and Merr Lynch traders involved
in diect placement agency trsactions with Merr Lynch wil be specifcaly traed with
respect to these procedures, and must be approved by the relevant Fund, Adviser, or Merr
Lynch, respectively, to conduct these trasactions.
'e
-3
securities wil be no higher than the net price to be paid by other purchasers in a comparble
trasaction of similar quantity with respect to the same securities. In each such instace, the
receipt of this representation wil be documented on the trade ticket. 4
2. Merr Lynch wil not charge a Fund any greater commission or other
compensation than what is reasonable and customary for such trasactions, and in no instace
wil Merr Lynch's compensation excee one percent of the purchase price of the securities.
3. The Advisers wil maita the records neeed to confir compliance with
these procedures, including an itemied day recrd of al securities obtaed from Merr
Lynch in its capacity as placement agent,S and a record showing on a day basis the
percentage of the Fund's tota assets represented by securities acquired in diect placement
agency trasactions generay, and .
separtely, the percentage of such trasactions conducted
with Merr Lynch.
4. The Advisers wil report to each Fund's board of directors on a quarerly basis
every diect placement agency trsaction conducted, with Merr Lynch ,as placement agent.
These reports wil conta, with respect to every trsaction, the name of the issuer, the
price of the security, the compensation paid to Merr Lynch by the Fund, whether the
trades were solicited, the percentage of the issue purchased by the Fund and by al other
Funds in the aggregate, and, if applicable, the quote received from other firs actig as
placement agent for the same securities.6 In addition, the Advisers wil monitor these
,4In your letter, you rase issues that arse under sections W(t) and 17(e)(2) of
the Investment
Company Act and section 206(3) of the Advisers Act. We note that direct placement agency
trsactions with Merr Lynch acting as placement agent may give rise to additional issues
under these Acts, including section 36(a) of the Investment Company Act and other provisions
of section 206 of the Advisers Act. Ths letter does not address these issues.
Sy ou state these itemi day recrds wil show for each trsaction the name and quatity
individualy and by ,
al other Funds in the aggregate, the. unit purchase price, the compensation paid, the tie and
of securities purchased, the percentage of the issue purchased by the Fund
date of the trsaction, and either (1) if firs other than Merr Lynch also are actig as
placement agent for that security issuance, the price quoted from at least one such fir, the
name of that fir, and the time and date the quotation was recived, or (2) if no fir other than ,
Merr Lynch is acting as placement agent, that the representation that the net price to be paid
by the Fund wil be no higher than the net price to be paid by other purchasers in comparble
trasactions of simar quantity with respect to the same securities has been received from
Merr Lynch.
6y ou represent that the Advisers wil preserve al records set forth in numbered pargraphs
3 and 4 above for a period not less than six yeas from the end of the last fiscal yea in which
any trasactions occurred, the first two yeas in an easily accessible place. In addition, you
- 4
trasactions continuously and report promptly to the relevant Fund's board of diectors any
instaces in which the procedures were not followed.
5. On at least a quarerly basis, the Fund's board of directors, includig a
majority of the Fund's disinterested diectors, wil determine (1) whether diect placement
agency trasactions with Meri Lynch have been, and wil continue to be, consistent with
the best interests of the Fund and its shareholders, and (2) whether al of the trsactions
effected durig the past quarer complied with the procedures.7 In addition, a majority of
either the Fund's board of diectors or the Fund's disinterested directors wil. amend or
supplement these proceures with other measures at any tie if such actions appe to be
consistent with the best interests of the Fund and its shareholders.8 Further, the practice of
engaging in diect placement agency trasactions with Merr Lynch may be termated at
any time by a majority vote of either the Fund's board of directors or the Fund's
disÙlterested dirtors.
Analysis
1. Sections 10(0 and 17(e)(2) of the Investment Company Act
Section 10(t) of the Investment Company Act, in relevant par, generay prohibits a
registered investment company from purchasing a security durig the existence of any
underwriting or sellg syndicate when the company's investment adviser, or an afilte of
the investment adviser, is one of the pricipal underwriters of the security. Section 10(f)
was designed priary to prevent an underwriter from "dumping" securities on an afilte
investment company in order to stimulate the market in these securities or to relieve the
underwriter or sellg syndicate of securities that are otherwise unmarketable.
9
represent that the Advisers wil preserve permanently in an easily accessible place a written copy
of the procures adopted by each Fund's board of diectors and any modcations and
supplements subsequently made to them. Telephone converstion of Apri16, 1997 between
Rochelle Kauffman Plesset and Brian Kaplowitz of Brown & Woo.
7you reresent that the minutes of each board meetig at which these determinations ar to
be made wil reflect in.deta the reasons for the determinations.
~elephone conversation of March 6, 1997 between Rochelle Kauffman Plesset and Bri
M. Kaplowitz of Brown & Wood.
9See National Aviation Corp., 23 SEC 550, 552 (1946). See also Reprt of the Securities
and Exchange Commission, Investment Trusts and Investment Companes, Par Thee, Chapter
Vl, "Abuses and Deficiencies in the Organtion and Operation of Investment Trusts and
Investment Companes," H.R. Doc. No. 136, 77th Cong., 1st Sess. 2581, 2589 (1940)
(discussing the frequent practice of investment company sponsors "dumping" unmarketable
-5
Section 17(e)(2) of the Investment Company Act governs the purchase or sae of
securities on behal of a registered investment company when a person'afilated with the
company acts as broker. These trasactions are regulated by placing a liit on the
compensation the afilated person may recive. Section 17(e)(2)(C) (which, assumig
Merr Lynch is acting as broker withi the meag of section 17(e)(2), is applicable to the
trasactions described in your letter), liits compensation to one percent of the purchase or
sale price of the securities. Congress designed section 17(e)(2) to addrss potentia confcts
of interests that could arse when a broker arges a securities trasaction for an afilated
investment company.
You maita that section W(t) does not apply to investment company purchases of
securities in diect placement agency trasactions in which the company's investment adviser,
or an affilate of the investment adviser, acts as placement agent. You state that Congress
intended section W(t) to apply-only when (1) securities in an underwritig ate sold through a
syndicate organed for the purpose of distrbutig the securities, and (2) the investent
company purchases securities from a syndicate member other than the afilated person.
First, you maita that section W(t) does not apply to diect placement agency
trasactions becuse no syndicate is formed to distribute the securities. In your view, a
syndicate exists only when two or more pares, organed in a group formed for the purpose
of sellg an issue of securities, have a joint responsibilty for and a fmancia commitment to
the distrbution of the issue (i. e., the underwriting is on a fir commitment (pricipal) rather
thaI a best efforts (agency) basis). You maita that no syndicate exists in diect placement
agency trasactions because the placem.ent agent typicaly acts
alone and places the securities
on a best efforts basis.
Second, you contend that section W(t) does nót apply to an investment company's
purchase of securities through an affilated person in the course of an underwriting. Instead,
you maita that Congress intended section 17 to be the sole provision governg
trsactions diectly between an investment company and its affilted persons. You thus
conclude that the Funds may enter into dit placement agency trsactions in which Merr
Lynch acts as placement agent provided that Merr Lynch complies with the compensation
lits set forth in section 17(e)(2)(C).
The sta has expressed the view that direct private placement trasactions can in
some instaces present the same types of concerns that prompted Congress to enact section
securities on affilted investment companes prior to the adoption of the Investment Company
Act) ("SEC Report").
-6
W(t).lO We believe, however, that your representations and the procedures you propose to
follow adequately address these concerns.
Based on the facts and representations in your letter and as described above, and
without necessary agreeing with your legal analysis that section lO(t) does not apply to any
direct placement agency trasaction involving an investment company and its affilated
persons, we would not recommend that the Commission tae any enforcement action under
section 10(t) or 17(e)(2) if the Funds parcipate in direct placement agency trasactions in
which Merr Lynch acts as placement agent. Ths position is based parcularly on your
representations that (1) Merr Lynch and the Advisers ar separte entities and operate
independently of each other, (2) the manager's compensation is not affected by the amount of
busmess the Fund conducts with Merr Lynch, (3) Merr Lynch wil incur no liabilty to
. an issuer if it fais to place the securities, and (4) the trsactions wil be conducted in
accordace with proceures, described above, that wil be approved by each Fund's board of
directors, includig a majority of the Fund's disinterested directors.
2. Section 206(3) of the Advisers Act
Section 206(3) makes it unlawful for any investment adviser, acting as pricipal for
its own account, knowingly to sell any security to or purchase any security from a client, or
actig as broker for a person other than a client, knowingly to effect any sale or purchase of
any security for the account of such client, without disclosing to the client in writing before
the completion of the trasaction the capacity in which he is acting and obtag the client's
consent to the trsaction. Section 206(3) is intended to address the potenti for self-deag
that could arse when an adviser acts as pricipal in a trsaction with clients or as agent in
connection with a trasaction on behal of a client. U Congress' decision to addrss this
10JoOO Nuveen & Co. Incorporated (pub. avai. Jan. 24, 1989). Speifcaly, a placement
securities on an investment company with which it is afilted
agent could" dump" unmarketable
in order to recive commissions and to enhance its reputation among issuers as being able to sell
"dicult to place" securities and thus attct additional business. See SEC Report, supra note
9, at 2535-36 ("The control öf an investment company by an investment baner naturay
impresses the client, who desirs to be fmance, with the resources that the investment baner
may ca upon to make the fmancing operation successful, such as, sellg some of the securities
to the investment company, securig the company's paricipation in the underwritig
commitment, includig the company in trdig accounts or using the company's funds in
stabiling the market. ").
USee Investment Trusts and Investment Companes: Heags on S. 3580 Before the
Subcomm. of the Comm. on Bang and Currency, 76th Cong., 3d Sess. 320 (1940) ("I thi
it is the Commission's recommendation that al self-deag between the investment counselor
and the client should
be stopped. ") (statement of David Schenker).
-7
concern by requirg disclosure and client consent, rather than by prohibitig these types of
trasactions, suggests that Congress recognied that some of these trasactions could be
beneficial to clients.
12
The Commission and the sta have applied section 206(3) to situations in which the
adviser causes a client to enter into a pricipal or agency trsaction effected by a broker
deaer that controls, is controlled by, or is under common control with, the adviser.13
the Advisers would cause the Funds to enter into diect placement agency
trasactions in which Merr Lynch would act as placement agent, the trasactions would be
Thus, becuse.
subject to section 206(3).
You state that the Advisers wil meet the disclosure and consent requirements of
section 206(3) by having a Fund's portolio manager, who is also an offcer or authoried
signatory of the Fund, enter into a trsaction on behal of the Fund, thereby providig the
or as a
Massachusetts business trst, it acts through its officers or agents, and that in the case of a
portolio manager of a fund, the offcer or agent has full authority to purchase and sell
securities. You also represent that such persons have knowledge of the inormation that is
requir consentY You maita that, when a fund is organ as a corpration
required to be disclosed under section 206(3).15 Thus, you assert that these persons ca
12Rule 206(3)-2 under the Advisers Act provides a non-exclusive method of complice with
the provisions of section 206(3) in connection with cert agency cross trsactions for advisory
clients. The rule permts an adviser or broker-deaer that controls, is
controlled by or is under
common control with the adviser to conduct agency cross trsactions without makg the.
reuired disclosure and obtag client consent prior to each trsaction, provided tht cert
conditions are met. The sae haror is unavaible when either the adviser or broker afilte
(alone or collectively) remmends the trsaction to both the seller and the purchaser, and thus
would be unavaible to Merr Lynch in connection with dit placement agency trsactions.
13See Agency Cross Trasactions for Advisory Clients, Advisers Act ReI. No. 589 (My 31,
1977), 42 FR 29300 (June 8, 1977); In the Matter of Calos Asset Management Inc., Advisers
Act ReI. No. 1594 (Admin. Pr. File No. 3-9166) (Oct. 16, 1996); In the Matter of Concord
Investment Company, Advisers Act ReI. No. 1585 (Admi. Proc. File No. 3-9109) (Sept. 27,
1996); Harmark & Co., ,Inc. (pub. avai. Nov. 11, 1973); Interplan Securities Corp. (pub.
avai. Feb. 23, 1978).
, 14y ou maita that in this situation, imposing the disclosure requirements of section 206(3)
would be tataount to requirg the portfolio manager to make written disclosures to hiself.
l5Telephone conversation of March 6, 1997 between Rochelle Kauffman PIes
M. Kaplowitz of Brown & Wood.
set and Brian
-8
receive notice and give consent for purposes of section 206(3), even if the person giving
consent is also an employee of, or is otherwise affilated with, the adviser.
Based on the facts and representations in your letter and as discussed above, we
would not recommend that the Commission tae any enforcement action under section 206(3)
if the Advisers cause the Funds to engage in diect placement agency trsactions in which
Merr Lynch acts as placement agent. Ths position is based parculaly on your
representation that the trasactions wil be conducted in accordace with procedures (in
parcular, those described in numbered pargraphs 1, 4 and 5 of our response) approved by
the'Fund's board of diectors, including a majority of the Fund's disinterested directors,
prior to commencement of the trsactions.
You should note that any dierent facts or circumstaces might reuire a
conclusion with respect to each of your questions.
R~Jd ~~~CM ~~
Rochelle Kauffman Plesset
Senior Counsel
dierent
B ROW N & WOO 0 LLP
ONE WORLD TRADE CENTER
NEW YORK, N.Y. 10048-0557
TELEPHONE: 212-839-5300
FACSIMILE: 212-839-5599
Investment Company Act of 1940
Section 10 (f)
Section 17 (e)
Investment Advisers Act of
1940 Section 206(3)
January 30, 1997
Office of Chief Counsel
Di vision of Investment Management
Securities and Exchange Commission
450 Fifth Street, N. W.
Judiciary Plaza
Washington, D. C. 20549
Re: Merrill Lvnch Asset Manaqement
Ladies and Gentlemen:
Set forth below is our revised and restated request on
behalf of Merrill Lynch Asset Management, L.P. ("MLAM") and Fund
Asset Management, L.P. ("FAM"), that you confirm that the
Division of Investment Management (the "Division") will not
recommend that the Securities and Exchange Commission (the
"Commission") take any enforcement action under Section 10 (f) or
Section 17 (e) of the Investment Company Act of 1940 (the
"Investment Company Act") or Section 206(3) of the Investment
Advisers Act of 1940 (the "Advisers Act") if registered
investment companies of which MLAM or FAM is the investment
adviser purchase newly issued securities in transactions in which
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill
Lynch"), an affiliated person of MLAM and FAM, acts as placement
agent. i
i
The above request also is intended to encompass any
registered investment company organized in the future and
advised or managed by MLAM or FAM, or any investment
advisory or investment management affiliate or successor of
MLAM or FAM.
BWNY03/9304, i 2
LOS ANGELES. SAN FRANCISCO. WASHINGTON. BEIJING. SÃO PAULO. TOKYO REPRESENTATIVE OFFICE
AFFILIATED WITH BROWN & WOOD, A MULTINATIONAL PARTNERSHIP WITH OFFICES IN LONDON AND HONG KONG
I . Backqround
A. Description of the Parties and the Subiect Transactions.
MLAM and FAM (together, the "Advisers") act as investment
adviser to over 130 registered investment companies (each a
"Fund"). Under each Fund's investment advisory or management
agreement, either MLAM or FAM, subject to the general supervision
of the directors or trustees of the. Fund, provides investment
advisory and management services.
Merrill Lynch, a wholly-owned subsidiary of Merrill Lynch &
Co., Inc. ("ML & Co."), is a registered broker-dealer and
conducts a diversified securities business. The Advisers, which
are also owned and controlled by ML&Co., are "affiliated persons"
of the Funds and of Merrill Lynch within the meaning of Section
2 (a) (3) of the Investment Company Act. Accordingly, Merrill
Lynch is an affiliated person of an affiliated person of the
Funds.
Despite their affiliation, Merrill Lynch and the Advisers
operate as completely separate entities under the umbrella of the
ML & Co. holding company. While Merrill Lynch and the Advisers
are under common control, they have their own separate directors,
officers and employees, each is separately capitalized and each.
maintains its own separate books and records and operates as an
independent profit center2. Consequently, the Advisers operate
completely independently of Merrill Lynch in performing portfolio
management services.
In accordance with the foregoing, all purchase decisions by
the Funds are determined solely by the Advisers. In that regard,
investments for the Funds are the responsibility of one or more
indi viduals employed solely by MLAM or FAM, and who also are
officers or agents of the Fund concerned. These portfolio
managers are not employees of Merrill Lynch, and their lines of
reporting responsibility are solely within MLA or FAM. In
addition, a major determinant of their compensation is the
performance of the Fund or Funds over which they have
responsibility. In no instance is their compensation affected by
the amount of business done with Merrill Lynch.
The Funds purchase securities in accordance with their
investment objectives either as new issues or in secondary market
transactions. New issues of securities are often sold in
underwritten offerings. In other instances, securities may be
2
No director, officer or employee of the Funds is also a
director, officer or employee of Merrill Lynch.
BWNY03/9304,12
2
directly placed by the issuer. The circumstances surrounding
direct placements purchased by the Funds are the subj ect of the
instant no-action request. Our request is made on behalf of all
of the Funds and is intended to be relied upon for all types of
directly placed securities. We have attempted to provide some
general description of direct placement agency transactions and
of the procedures pursuant to which the Funds will engage in such
transactions with Merrill Lynch. However, we note that although
the transactions described herein are all conducted on an agency
basis, the nature and mechanics of direct placements of
securities may differ significantly depending on the type of
securities involved. Thus, a placement of tax-exempt securities
may be conducted in a manner different, for example, than a
placement of short-term U. S. government notes or equity
securities.
In direct placement agency transactions the issuer often
uses a securities firm or bank as placement agent, performing
services that facilitate the sale of the securities. The
placement agent acts solely as an agent for the issuer. As
discussed further herein, the agent does not participate in an
underwriting or selling syndicate as contemplated by Section
10 (f) of the Investment Company Act. Thus, in performing its
functions the placement agent agrees only to use its best efforts
and has no liability on account of any failure tp sell the
securities concerned; the agent does not commit to purchase
securities for its own account and incurs no financial risk in
the sales of the securities. In addition, the bank or securities
firm acts alone and in an individual capacity in selling the
securities, rather than as part of a group formed for that
purpose. Similarly, even where there is more than one entity
involved in a direct placement, such entities do not have the
joint responsibility for or joint interest in the outcome of the
distribution such as typically exists in a syndicate.
A Fund's determination of whether to purchase securities in
a direct placement agency transaction, as is the case with other
purchase decisions, depends on the investment merits and price of
the security. In making that determination, the portfolio
managers will review whatever information they believe necessary
to make an informed decision. As is the case with all purchase
transactions in the primary market, the degree to which the terms
of the transaction may be subj ect to negotiation will vary
depending, among other things, on the issuer, the type of
security involved and the other circumstances under which the
placement is made. That also will be the case in all
transactions with Merrill Lynch. Further, the Advisers undertake
that if and for so long as the Division is unable to concur as an
interpretative matter with the view that Section 10 (f) does not
apply to direct placement agency transactions, any such
BWNY03/9304,12
3
transactions with Merrill Lynch in securities other than money
market instruments of the type which are the subj ect of certain
exemptive orders granted to the Funds 3, will be
conducted only
pursuant to procedures adopted by the boards of directors of the
Funds, including by a maj ority of those directors (" Independent
Directors") who are not "interested persons" of the Funds within
the meaning of Section 2 (a) (19) of the Investment Company Act.
The relevant procedures will be based generally on those
governing transactions of the Funds that are subj ect to Rule
10f-3 under the Investment Company Act and on the guidelines
adopted by certain of the Funds pursuant to the above exemptive
orders. These procedures will be substantially as follows:
1. Before any direct placement agency transaction may be
conducted with Merrill Lynch, MLAM or FAM, on behalf of the Fund,
will be required to obtain such information as it deems necessary
to determine that the transaction is in the best interests of the
Fund. In addition:
(a) If firms other than Merrill Lynch are also placing the
securities under consideration, thenMLAM or FAM, on behalf
of the Fund, will be required to solicit a quote as to the
price of the relevant security from at least one such firm.
The quote will be documented on the trade ticket. In each
instance, a determination will be made that the terms of the
purchase from Merrill Lynch are at least as favorable as
those obtained from the other available sources, if any, and
such determination will be documented; and
(b) If no firm other than Merrill Lynch is placing the
securities under consideration, MLAM or FAM, on behalf of
the Fund, will purchase such securities through Merrill
Lynch only if Merrill Lynch first represents to MLAM or FAM,
as the case may be, that the net price being paid by the
Fund is no greater than the net price being paid for such
securities by any other customer of Merrill Lynch purchasing
such securities in a contemporaneous transaction of similar
quantity. Receipt of such representation will be, documented
on the trade ticket.
3
See Investment Company Act Release Nos. IC-15520 (tax exempt
instruments) and 18748 (taxable instruments), January 5,
)
1987 and June 2, 1992, respectively. The Advisers undertake
that transactions in the above types of money market
instruments will comply with the terms of the relevant
exemptive order, as it may be amended from time to time,
regardless of whether such transactions may technically be
considered principal transactions or agency transactions.
BWNY03/9304,12
4
2. In no instance will the compensation to Merrill Lynch
for securities purchased by the Funds exceed one percent of the
purchase price of the securities purchased by the Funds.
Moreover, Merrill Lynch will not charge the Funds any greater
commission or other compensation than what is reasonable and
customary for such transactions.
3. The traders at Merrill Lynch and the Fund portfolio
managers involved in any direct placement agency transactions
with Merrill Lynch will be required to be thoroughly familiar
with these procedures, will be briefed specifically thereon and
will be approved specifically to conduct such transactions.
Responsibility for such briefings and approvals in the case of a
Fund and the Advisers will rest with the Secretary of the Fund
and counsel for the Advisers and, in the case of Merrill Lynch,
will rest with the Law and Compliance Division of Merrill Lynch.
In the training of personnel of Merrill Lynch, particular
emphasis will be given to the fact that a Fund is to be charged
no greater commission or other compensation than what isreasonable and customary for such transactions.
4. MLAM or FAM, on behalf of each Fund engaging in direct
placement agency transactions with Merrill Lynch, will be
required to maintain such records with respect to those
transactions as may be necessary to confirm compliance with these'
procedures. In that regard MLAM or FAM, on behalf of each Fund,
will maintain:
all purchases of
(a) an itemized daily record of
securities encompassed hereby, showing for each transaction:
the name and quantity of securities; the percentage of the
issue being purchased by the Fund and by all other Funds in
the aggregate; the unit purchase price; the commission or
other compensation paid; and the time and date of the
transaction. Such records also will: (i) for each
transaction in the specific security for which a firm other
than Merrill Lynch acts as placement agent, document the
quotation received from such other firm, including: the name
of the firm, the name of the securities, the price quoted,
and the time and date the quotation was received; and (ii)
for each transaction in a specific security for which no
firm other than Merrill Lynch acts as placement agent,
document receipt of the representation described in
paragraph i (b) above; and
(b) a ledger or other record showing, on a daily
basis, the percentage (based on dollar amount) of the Fund's
total assets represented by securities acquired in direct
placement agency transactions generally, and separately, the
BWNY03/9304,lZ
5
percentage (based on dollar amount) of such transactions
entered into with Merrill Lynch.
5. MLAM or FAM, on behalf of each Fund, will be required
to continuously monitor direct placement agency transactions with
Merrill Lynch and report immediately to the board of directors of
the relevant Fund any deviation from the above requirements.
6. MLAM or FAM will report to the board of directors of
each Fund on a quarterly basis each direct placement agency
transaction by that Fund with Merrill Lynch. Those reports will
include the name of the issuer, the price of the security, the
commission or other compensation paid to Merrill Lynch, an
indication of whether or not the trades were solicited, the
percentage of the issue purchased by the particular Fund and by
all other Funds, in the aggregate, and, if available, the
quotation received from other agents for the same securities.
7. The board of directors of each Fund, including-a
majority of the Independent Directors, will review no less
frequently than quarterly the Fund's participation in direct
placement agency transactions with Merrill Lynch and determine
(a) whether transactions effected during the prior quarter
complied with the above procedures, and (b) whether the Funds's
participation in direct placement agency transactions with
Merrill Lynch has been and continues to be in the best interests
of the Fund and its shareholders. The minutes of the board
meeting at which these determinations are made will reflect in
detail the reasons for the determinations.
8. The board of directors of each Fund, including a
maj ori ty of the Independent Directors acting separately, have the
ability at all times to amend or supplement the procedures, or to
terminate the ability of the Fund to engage in direct placement
agency transactions with Merrill Lynch.
B. Leqal Backqround.
Merrill Lynch is a major participant in the primary new
issue market for all types of securities. The extent of Merrill
Lynch's participation in these markets has made it increasingly
necessary for the Funds to be able to purchase securities in
transactions where Merrill Lynch acts as placement agent.
However, since, as noted above, the Funds and Merrill Lynch may
be considered second-tier affiliated persons, the Investment
Company Act places certain strictures on such purchases.
The Investment Company Act, in effect , divides purchase and
sale transactions between an investment company and its
BWNY03/9304,12
6
affiliated persons into two basic categories, principal
transactions and agency transactions. Principal transactions
with an affiliated person were viewed as so potentially harmful
to the investment companies involved that such transactions were
prohibited outright in Section 17 (a) of the Investment Company
Act. See S. Rep. No. 1775, 76th Cong., 3d Sess. 14 (1940).4
"unloading of
For example, Congress was concerned about the
securities upon (investment) companies" and the possibility that
affiliated persons may sell "worthless securities at extravagant
prices to their controlled companies." Id. at 7; H. R. Rep. No.
2639, 76th Cong., 3d Sess. 9 (1940). Congress saw that an
affiliated person holding valueless securities might be tempted
to use the investment company to avoid a loss of the amount paid
for such securities. Those concerns were not considered to exist
to the same degree, however, in the context of agency
transactions where the commission payable to the affiliated
person was appropriately limited; while problems such as the
"unloading" of securities could theoretically exist in those
si tuations, Congress believed that the incentive to do so could
be eliminated by restricting the amount by which the affiliated
person could profit from such activities. Thus, as relevant
here, the primary restriction that the Investment Company Act
places on investment company purchases from an affiliated
placement agent concerns the compensation of the agent.
By acting as placement agent in direct placement agency
transactions, the affiliated person functions as a broker and,
therefore, is subject to Section 17 (e) (2) of the Investment
Company Act. Section 17(e) (2) provides that:
It shall be unlawful for any affiliated person of a
registered investment company, or any affiliated person
of such person . acting as broker, in connection
with the sale of securities to or by such registered
company or any controlled company thereof, to receive
from any source a commission, fee, or other
remuneration for effecting such transaction which
exceeds (A) the usual and customary broker's commission
if the sale is effected on a securities exchange, or
(B) 2 per centum of the sales price if the sale is
effected in connection with a secondary distribution of
such securities, or (C) 1 per centum of the purchase or
sale price of such securities if the sale is otherwise
effected unless the Commission shall, by rules and
regulations or order in the public interest and
4
Section 17 (b) authorizes the Commission to grant exemptions
from the provisions of Section 17 (a) .
BWNY03/9304,12
7
consistent with the protection of investors, permit a
larger commission. 5
Consequently, in the present situation, Merrill Lynch could not
receive compensation from any source in connection with its role
as placement agent for securities purchased by the Funds if such
compensation exceeded one percent of the purchase or sale
price.6
The Division previously confirmed the applicability of
Section 17 (e) (2) to direct placement agency transactions in the
no-action letter of John Nuveen & Co., Inc. (available January
24, 1989) (the "1989 letter"). A no-action position was
requested in the 1989 letter under Section 17 (e) in order that a
group of investment companies could purchase tax-exempt
securities in transactions involving as placement agent the
broker-dealer affiliate of the investment adviser to such
investment companies.
The 1989 letter also was submitted under Section 10 (f) of
the Investment Company Act and Rule 206 (3) -2 of the Advisers Act.
Section 10 (f) of the Investment Company Act generally prohibits
an investment company from purchasing any securities from a
member of an underwriting syndicate of which an affiliated person
of the investment company is a participant. 7 In that regard,
Section 10 (f) prevents circumvention of the policies underlying
Section 17 (a) by an affiliated person indirectly engaging in
5
Agency transactions between an investment company and its
affiliated persons not involving brokerage functions are
subj ect to even gr~ater restrictions. Specifically, Section
17 (e) (1) prohibits any affiliated person of an investment
company from accepting any compensation for acting as agent
in connection with the sale of any property by or to the
company.
6
The Advisers believe, for example, that the typical
placement agent compensation in the case of long-term
tax-exempt securities is in the range of 60 to 150 basis
points (although the 100 basis point limit of Section
17 (e) (2) (C) would apply to transactions subject to the
instant request). The compensation in the case of taxable
securities varies, depending on the type of security and
several other factors. As one example, the typical
compensation in the money market area is in the range of 5
to 12.5 basis points.
7
Rule 10f-3 under the Investment Company Act provides limited
exemptive relief from the provisions of Section 10 (f) .
BWNY03/9304.12
8
..~.;.
principal transactions through an ostensibly unrelated syndicate
member. Rule 206 (3) -2 under the Advisers Act provides a safe
of Section 206 (3) of the Advisers Act.
That Section generally requires that an investment adviser make
certain written disclosures to and obtain the consent of its
client prior to engaging in any principal or agency transactions
harbor from the provisions
with the client.
We are presently seeking a no-action position primarily
because of the need to clarify the applicability of Sections
10 (f) and 206 (3) to direct placement agency transact ions. The
need for such clarification is not limited to the situation of
the Funds. The ability to make the desired purchases is
important to the investment company industry on the whole.
II. Discussion
A. Applicabilitv of Sections 10 (f) and 17 (e) to Direct
Placement Aqencv Transactions
It is our view that direct placement agency transactions
involving an investment company and its affiliated persons are
not within the purview of Section 10 (f). Rather, we believe that
Section 17 (e) was intended by Congress to provide the necessary
protection against any potential abuses inherent in such
transactions. Our conclusion, as described in more detail below,
is based primarily on a review of the role of Section 17 (e) in
legislative history of Section 10 (f) itself.
the statutory scheme and on an examination of the language and
We respectfully request that the Division confirm our
interpretation that Section 17 (e), but not Section 10 (f), applies
to direct placement agency transactions. If the Division does
not concur with our interpretation, however, we request that the
Di vision not recommend that the Commission take any enforcement
action under Section 10 (f) or Section 17 (e) if Merrill Lynch acts
as placement agent in connection with purchases of Securities by
the Funds. In this event, all transactions with Merrill Lynch of
the type described in this request will be subj ect to procedures
substantially as described above. 8 While it is not relevant to
our legal analysis, we also note that the prospectuses or
8
In addition, direct placement transactions with Merrill
Lynch would be appropriately reported to the Commission in
response to Item 77(0) of Form N-SAR. As mentioned earlier,
however, transactions in money market instruments will
instead comply with the procedures set forth in the
exemptive orders cited supra note 3.
BWNY03/9304,12
9
statements of additional information, or both, for each of the
Funds already disclose the possibility that the Funds may conduct
transactions on an agency basis with Merrill Lynch. Those
documents also disclose for Funds that are open-end investment
companies the aggregate dollar amount of brokerage commissions
paid to Merrill Lynch during the last fiscal year and such other
related information as is required by Form N-1A.
Section 10 (f) of the Act provides, in pertinent part:
No registered investment company shall knowingly
purchase or otherwise acquire, durinq the existence of
any underwritinq or sellinq syndicate, any security
a principal underwriter of which is an officer,
director, member of an advisory board, investment
adviser, or employee of such registered company, or is
a person . of which any such officer, director,
employee is an affiliated person . (emphaSis
member of an advisory board, investment adviser, or
added)
An argument could be made that since Section 10 (f) was
intended to regulate certain distributions of securities (i. e. ,
offerings involving an underwriting or selling syndicate), the
Section should be viewed as encompassing any type of transaction
that could be argued to have some element ofa distribution.
Under such a reading of Section 10 (f), that Section would govern
any primary market transaction in securities by an investment
company where an affiliated person of the
company was involved.
We do not believe the Section may properly be read that broadly.
It is our view that Section 17 of the Investment Company Act, not
Section 10 (f), governs transactions directly between an
investment company and its affiliated persons. In addition, we
believe that Section 10 (f) applies only where there is a
syndicate organized for the distribution of the securities in
question. We believe the Section to be inapposite where
securities are directly placed either by a sole placement agent
or by more than one placement agents, provided that there is no
joint responsibility as between such agents to distribute the
issue and that there is lacking the type of financial risk that
characterizes a syndicate.
\
)
Transactions directly between an investment company and its
affiliated persons, whether agency transactions such as direct
placements or principal transactions, are provided for solely and
expressly by Section 17 of the Investment Company Act. Moreover,
as discussed earlier, the statutory scheme reflects a dichotomy
in which agency transactions are not viewed as presenting the
same potential for harm to an investment company as that
presented by principal transactions, whether such principal
BWNY03/9304,12
10
transactions are engaged in directly by the affiliated person or,
as relevant here, indirectly through the use of an unrelated
syndicate member. In that regard, Section 17 (e) (2) specifically
reflects Congress' belief that where the affiliated person is
acting as broker, protection against potential conflicts of
interest is best afforded by limitations on the amount of
compensation that may be received by the affiliated person. See
H.R. Rep. No. 2639, 76th Cong., 3d Sess. 9, 17-18 (1940). See
also United States v. Deutsch, 451 F. 2d 98, 108 (2d Cir. 1971),
cert. denied, 404 U. S. 1019 (1972). Indeed, the Senate Report
accompanying the original bill stated that: "In general, agency
transactions are not affected . ., but brokerage commissions
are limited in the main to standard rates with provision for
special exemptions." See S. Rep. No. 1775, 76th Cong., 3d Sess.
14, 15 (1940).
There is no evidence that Congress believed that a primary
market transaction or any other transaction arguably resembling a
distribution of securities requires the application of Section
10 (f) to provide the necessary investor protection. Indeed,
Section 17 (e) (2) itself applies directly to distribution or
underwriting activities. While the Section refers only to a
person acting as "broker", it is common for a broker's activities
to include participation in a distribution or underwriting of
securi ties. Moreover, the Section expressly contemplates a
broker receiving compensation in connection with a secondary
distribution of securities where the broker's affiliated
investment company either purchases or sells securities in the
distribution. Participation ina secondary distribution, as with
any other distribution, involves underwriting activities. 9 As
recognized
by David Schenker, Chief Counsel to the Commission' s
study of investment trusts and investment companies which led to
the enactment of the Investment Company Act, while Section 17 (e)
generally prohibits an affiliated person acting as agent from
accepting any compensation with respect to purchases or sales by
9
Secondary distributions of securities, while not involving
the issuer as the seller of such securities, present many of
the same securities laws issues as primary offerings of
securities. For example, absent an available exemption,
secondary distributions require registration by the issuer
of the securities under the Securities Act of 1933. See
qenerall v, Loss and Seligman, Fundamentals of Securities
Regulation, 322-356 (3d. Ed. 1995). Primary and secondary
distributions are also viewed similarly under certain
provisions of the Securities Exchange Act of 1934. See,
~, Rule 10b-6 (paragraph (c) (5) of Rule 10b-6 brings
within the Rule's scope any type of distribution, whether
primary or secondary) .
BWNY03/9304,12
11
an investment company, such person "can act as broker for the
(investment company) and he can act as the underwriter or the
distributor of securities." See Investment Trusts and Investment
Com?anies: Hearinqs on S. 3580, Before the Subcomm. on Securities
and Exchanqe of the Senate Comm. on Bankinq and Currency, 76th
Cong., 3d Sess. 262 (1940) (the "Senate Hearinqs"). We view that
statement, and the language of the Section itself, as treating
brokerage, underwriting and distribution activities in the
conjunctive, not the disjunctive. Similarly, one of the
principal iridustry participants in the development of the
Investment Company Act stated in a law review article written
shortly after enactment of the statute that:
Section 17 . limits the commission which any
affiliated person may receive when acting as broker for
an investment company. While he may act as broker in
the distribution of securities owned by an investment
company, he cannot act as distributor if the
transaction takes such form that the affiliated person
buys for his own account in making the distribution.
(emphasis added)
Jaretzki, The Investment Company Act of 1940, 26 Wash. U. L. Q.
303, 321-322 (1941) .10
Surely if Congress intended in Section 17 (e) to permit an
affiliated person of an investment company to receive
compensation for acting as broker in connection with purchases of
securities by the company in the context of a distribution,
Congress must not have intended at the same time to prohibit such
purchases through the application of Section 10 (f). It is a rule
of statutory construction that "unreasonableness of the result
produced by one among several possible interpretations of a
statute is reason for rej ecting that interpretation in favor of
another which would produce a reasonable result." 2A Sutherland
Statutory Construction § 45.12 (4th Ed. 1984) ("Sutherland").
Similarly, since Section 17 (e) specifically refers to agency
transactions in the context of a distribution, it should be
viewed as controlling over the more general language contained in
Section 10 (f). Specific provisions in a statute control more
general provisions. See Sutherland at § 46.05. The Commission
has recognized the statutory interplay of Sections 10 (f) and 17.
10
We recognize that the situation posed by the cited language
might be construed as contemplating only circumstances where
the affiliated person is acting as broker in connection with
a sale of securities by the investment company. We note,
however, that Section 17(e) (2) refers both to purchases and
sales by the investment company.
BWNY03/9304,12
12
For example, the Commission stated in Investment Company Act
Release No. 14924 (January 29, 1986) (advance notice and request
for comment with respect to Section 10 (f) and Rule 10f-3
thereunder) ("Release 14924") that:
When Congress was considering legislation in 1940
to regulate the investment company industry concern was
voiced over underwriters "dumping" otherwise unmarket
able securities on affiliated investment companies,
either by forcing the investment company to purchase
unmarketable securities from the underwriting affiliate
itself, or by forcing or encouraging the investment
company to purchase such securities from another member
of the syndicate. Concern was also expressed over the
level of underwriting fees earned by affiliated
underwriters in connection with the transactions.
In response to these concerns, Congress included
section 10 (f) in the Investment Company Act to prevent
any registered investment company from purchasing or
otherwise acquiring any security during the existence
of any underwriting or selling syndicate where a
principal underwriter of the security is affiliated
with the investment company except under limited
circumstances. Since section 17 (a) prevents
an investment company from acquirinq any securities
directly from an affiliate or from an affiliate of an
affiliate, the purpose of section 10 (f) is to prevent
an investment company from acquiring any securities
from an unaffiliated member of the underwritinq
syndicate on the premise that the affiliate still has
the potential to pressure the investment company into
making the purchase in order to facilitate the
underwriting. (emphasis added)
Similarly, in Investment Company Act Release No. 21838
(March 21, 1996) ("Release 21838"), announcing proposed
amendments to Rule 10f-3, the Commission stated:
Even in the absence of section 10 (f), a fund
effectively would be prohibited by Section 17 (a) of the
Investment Company Act from purchasing securities directly
from its affiliated underwriters or from an affiliate of its
affiliate .... That section 10 (f) prevents a fund from
acquiring securities from an unaffiliated member of the
underwriting syndicate would seem to reflect the view that
the affiliated underwriter has the potential to pressure the
fund into acquiring the securities through another
underwriter in order to facilitate the underwriting ....
BWNY03/9304,12
13
While the quoted language alludes to principal transactions and,
therefore, to Section 17 (a), it follows logically that the
Commission would view Section 17 (e) as the sole provision
governing agency transactions directly between an investment
company and its affiliated persons.
The obvious question is that if Section 17 (e) governs agency
transactions between an investment company and its affiliated
persons even in a situation resembling a distribution, to what
transactions does Section 10 (f) extend? We believe the answer is
that Section 10 (f) was intended to cover only purchases (a)
during the existence of an underwriting or selling syndicate
(i.e., where two or more parties have a joint responsibility for
and a financial commitment to the distribution of the issue) and
(b) where the purchases are made from a member of the syndicate
other than the affiliated person.
That Section 10 (f) applies only to situations involving a
syndicate where the investment company purchases securities from
a syndicate member other than the affiliated person is made
evident by the express language of the Section. Section 10 (f)
an
specifically states that it applies during the existence of
underwriting or selling "syndicate". While the Investment
Company Act does not define the term "syndicate", the meaning of
the term is clear. Webster's Third New International Unabridqed
Dictionarv defines "syndicate" as "a group of persons or concerns
who combine under a usually temporary agreement to carry out a
particular transaction ((such as) investment houses for
underwriting a bond issue) ." No syndicate exists where an
affiliated person is acting as a placement agent in a direct
placement of securities. Even where there is more than one
placement agent the j oint effort characteristic of an
underwriting would be lacking i for example, in a direct placement
agency transaction there are typically no agreements between the
agents coordinating the selling effort. Moreover, as the
Commission and its staff apparently have recognized, a syndicate
should not be deemed to exist under Section 10 (f) unless the
members thereof have a financial commitment to the distribution
or otherwise incur a financial risk in connection with the
securities being distributed. See Institutional Liquid Assets
(pub. avai'l. December 16, 1981).11 In Release 21838, supra
page 13, at note 64 thereof, the Commission cited the
Institutional Liquid Assets letter in stating that "it may not be
necessary for rule 10f-3 to'permit the purchase of u.S.
Government securities because the arrangements among distributors
11
We acknowledge, however, that the situation in Institutional
Liquid Assets did not involve purchases directly from an
affiliated person.
BWNY03/9304.12
14
of these securities may not always constitute underwriting or
selling syndicates for purposes of section 10 (f) " . Accordingly,
it would seem axiomatic that Section 10 (f) is not applicable to
direct placement transactions that are conducted on an agency
basis.
It has been suggested that one construction of the statutory
language may be that the term "syndicate" relates only to the
term "selling" and not "underwriting". This construction cannot
be sustained either by plain English, by the rationale of Section
10 (f) or by a reading of the authorities interpreting Section
10 (f). For example, in Release 14924, the Commission regularly
deletes "selling" and refers to the term "underwriting
syndicate" . See Release 14924, supra page 13. In one instance,
the Commission reverses the order referring to a "selling or
underwriting syndicate". Id. Clearly, Section 10 (f) was
intended to apply during the existence of an underwriting
syndicate as well as a selling syndicate.
Our view of the scope of Section 10(f) also is supported
fully by the legislative history of the Section. A Commission
representative at the Senate hearings stated with respect to a
predecessor version of Section 10 (f) that the Section means "that
no registered investment company shall purchase any. . product
of the (affiliated) investment banker, even thouqh they do not
buy directly . " (emphasis added). See Senate Hearinqs at
223 (statement of L.M.C. Smith, Associate Counsel, Investment
Trust Study). Likewise, Jaretzki stated in his article that
Section 10 (f) "limits the purchase by an investment company of
securities sold or underwritten bv a syndicate where affiliated
persons are involved in the
syndicate , even thouqh the purchase
is not made from the affiliated person." See Jaretzki, supra,
page 12, at p. 319, note 50. (emphasis added)
Applying Section 10 (f) to agency transactions also would not
further the purposes of the Section. Congress intended the
Section to address concerns about affiliated persons "dumping"
securities (selling unsuitable securities to investment
companies) and "bailing out" (disposing of unwanted securities by
selling them to investment companies). See Re?ort of the
Securities and Exchange Commission, Investment Trusts and
Investment Companies, Part Three, Chapter VI I, H. R. Doc. No. 279,
76th Cong., 2d Sess. 2581, 2589 (1940). See also Senate Hearinqs
at 212-13; Investment Trusts and Investment Companies: Hearinqs
on H.R. 10065 Before a Subcomm. of the Comm. on Interstate and
Foreiqn Commerce, 76th Cong., 3d Sess. 111 (1940). The incentive
to engage in such activities in the context of an underwriting
syndicate is much the same as the incentive for an affiliated
person to sell unsuitable or unwanted securities as principal
directly to an investment company. The incentive is to avoid a
BWNY03/9304.12
15
risk of financial loss. Thus, Congress' purpose in enacting
Section 10 (f) was to close a loophole in the statutory scheme by
regulating situations where underwriters could pressure
affiliated investment companies to purchase underwritten
securities from unaffiliated persons.
The Commission too has recognized that Section 10 (f) is
intended to protect against the situation where an underwriter
has the incentive to in effect dump or bailout. For example, in
Investment Company Act Release No. 10592 (February 13, 1979)
(Rule 10f-3 proposing release), the Commission addressed the
possibility of an underwriter pressuring an affiliated investment
company to create an artificial market for a security, thus
reducing the underwriter's risk of loss created by the position
the underwriter holds in that security through its underwriting
obligation. Similarly, following a public hearing held on an
application filed by National Aviation Corporation for exemption
from Sections 17 (a) and 10 (f), the Commission stated that the
proposed transactions did not violate those Sections because:
The purchase (of securitiesJ by National Aviation
Corporation does not appear to have been proposed for
the purpose of stimulating the market in the securities
or for the purpose of relieving the
underwriting syndicate, or any member thereof, of
securities otherwise unmarketable.
23 S.E.C. 550, 552 (1946) (IlNational Aviation") 12 Similarly,
in Release 21838, the Commission discussed the purposes of
Section 10 (f) as guarding against the possibility that Ilan
underwriter could ... ' dump' unmarketable securities on its
controlled fund ... " and that fund assets might Ilbe used to
absorb the risks of any underwriting in more subtle ways, such as
to facilitate price stabilization in connection with an
underwritingll. Release 21838, supra page 13, at text
accompanying note 21.
That the incentive for the types of abuses that exist during
the existence of an underwriting syndicate does not exist in the
case of agency transactions is particularly evident in direct
placement agency transactions. When a placement agent undertakes
to place an issuer's securities on an agency basis, it neither
expends nor risks its capital. Consequently, it does not own
securities that it may dump on the investment company, it has no
12
\
/
The Applicant in National Aviation sought exemption from
Section 10 (f), as well as Section 17 (a), apparently because
it sought to purchase securities from unaffiliated, as well
as affiliated, members of the syndicate.
BWNY03/9304,12
16
working capital to free up and it has no carrying costs to avoid.
A placement agent undertakes no obligation or responsibility with
respect to the distribution of the security except individually
to use its best efforts to find prospective buyers for the
security and assist in consummating the purchase and sale. These
statements are equally true whether there is only a single
placement agent involved in a transaction or there are several
such agents.
The limited risks and responsibilities of a placement agent
are quite different from those that arise from an underwriting
obligation where the affiliated person is part of a group
obligated to purchase and distribute the securities. Similarly i
the incentive for overreaching through dumping or bailing out is
obviously not significant in an agency transaction since the most
the affiliated person stands to lose is the opportunity to earn a
commission that is limited to one percent.13 There is no risk
of loss of principal because the placement agent does not own the
securities. In thisregardi if Congress had been concerned about
dumping or bailing out in the agency context (i. e. i affiliated
persons pressuring investment companies to purchase so that the
affiliated persons could earn commissions) i Congress undoubtedly
would have prohibited agency transactions in the same fashion
that it did principal transactions in Section 17 (a). There is no
reason why Congress would have relied upon Section 10 (f) to
prohibit agency transactions. 14
13
The one percent commission discussed above is less than the
commissions that would be earned in a typical firm
commitment underwriting for similar securities.
14
Similarly i since Section 17 (a) already prohibits principal
transactions between an investment company and its
affiliated personsi it would be redundant to also prohibit
such transactions under Section 10 (f). That is an
unreasonable construction of the statute and should
therefore be avoided. See Sutherlàndi supra page 12. As
the Division stated in its denial of no-action relief under
Section 10 (f) to Cornerstone First Mortqaqe Bond Fund, Inc.
(pub. avail. August is, 1988) ("Cornerstone"): "An
underwriter that is affiliated with an investment company is
prevented by Section 17 (a) from selling any security as
principal to that company. The purpose of Section 10 (f)
isi where an affiliate is a member of the syndicate
to prevent an investment company from acquiring any
securities from an unaffiliated member of the syndicate .
" Cornerstone at note 4.
BWNY03/9304,12
17
i
The fact that Section 10 (f) is not applicable to independent
dealer offerings also has been recognized implicitly in several
exemptive orders granted by the Commission. Those orders permit
money market funds to conduct principal transactions with
affiliated persons under certain conditions. 15 A number of
issuers, including the Federal Home Loan Mortgage Corporation,
Federal National Mortgage Association, Student Loan Marketing
Association and the International Bank for Reconstruction and
Development, from
time to time offer short-term notes on a
principal basis through dealers for sale to investors at fixed
prices determined by the issuer. The selling arrangements are
made separately with each dealer and do not involve the existence
of any underwriting or selling syndicate. The exemptive orders
permit the money market funds to purchase securities from the
affiliated dealer in primary fixed price dealer offerings. Each
of these orders was granted pursuant to the exemptive authority
contained in Sections 6 (c) and 17 (b), but not Section 10 (f) .
Finally, the contention that Section 10 (f) is applicable
only during the existence of an underwriting syndicate involving
a group of underwriters who have combined and have joint
responsibility to distribute an issue of securities is strongly
supported by the no-action letter issued by the Division to
Institutional Liquid Assets, supra page 14-15. Institutional
Liquid Assets is a money market fund advised by Goldman, Sachs &
Co. ( "Goldman Sachs"). Goldman Sachs was one of six primary
market broker-dealers through which short-term notes issued by
Federal Home Loan Banks (" FHLB") were distributed. The FHLB
notes were distributed through the primary market dealers on a
principal basis with compensation consisting of a .05% dealer
commission. Each dealer had independent arrangements with the
FHLB and thus the various dealers had no joint responsibility as
to the distribution arrangements. ILA sought no-action relief
with respect to purchasing FHLB notes from the five
non-affiliated primary market dealers, arguing that while Goldman
Sachs was clearly a principal underwriter of the FHLB notes,
Section 10 (f) was not applicable
because no underwriting
syndicate existed and Goldman Sachs would not be benefitted by
purchases from the other dealers. The Division responded
favorably to the no-action request. The Division reasoned that
15
See Merrill Lvnch Readv Assets Trust, et al., Investment
Company Act Release Nos. 13550 (September 30, 1983) (notice)
and 13598 (October 26, 1983) (order); CMA Tax-Exempt Fund,
et al., Investment Company Act Release Nos. 15475 (December
11, 1986) (notice) and 15520 (January 5, 1987) (order) and
Shearson Agqressi ve Growth Fund, Inc., et al., Investment
Company Act Release Nos. 14904 (January 17, 1986) (notice)
and 14948 (February 20, 1986) (order).
BWNY03/9304,12
18
since Goldman Sachs had no financial commitment to purchase the
FHLB notes and did not face any financial risk in effecting the
transactions it should not be considered to be a member of an
underwriting or selling syndicate. 16 See also Release 21838 at
note 64.
In sum, it is respectfully submitted that purchases of
securities by an investment company in direct placement agency
transactions in, which the company's affiliated person acts as
placement agent are regulated solely and adequately by Section
17 (e) (2). It is further submitted that applying Section 10 (f) to
such transactions is inconsistent with the express language and
legislative history of Section 10 (f), the statutory design of the
Investment Company Act, the purposes underlying the Section, past
interpretations of the Section and the industry practice that has
developed.
B. Applicabili tv of Section 206 (3) to Direct Placement
Aqencv Transactions
Section 206 of the Advisers Act contains the antifraud
provisions of that statute. Subsections (1) and (2) are general
antifraud prohibitions. More specific is Section 206 (3), which
provides, among other things, that it is unlawful for an
investment adviser to knowingly sell a security to a client or
purchase a security from a client unless, prior to the completion
of the transaction, the adviser discloses to the client in
writing the capacity in which the adviser is acting and obtains
the consent of the client to the transaction. This prohibition
applies to both principal and certain agency transactions. 17
The 1989 letter, apparently in response to an inquiry from
the Division, sought no-action relief under Section 206 (3) on the
basis that the boards of directors of the investment companies
concerned had adopted procedures complying with substantially all
16
As noted above supra note 11, however, the Institutional
Liquid Assets letter did not involve purchases from an
affiliated person of the investment company.
17
Specifically, Section 206 (3) makes it unlawful for an
investment adviser II acting as principal for his own account, ,
knowingly to sell any security to or purchase any security
from a client, or acting as broker for a person other than
such client, knowingly to effect any sale or purchase of any
security for the account of such client, without disclosing
to such client in writing before the completion of such
transaction the capacity in which he is acting and obtaining
the consent of the client to such transaction."
BWNY03/9304,12
19
of the requirements of Rule 206 (3) -2 under the Advisers Act.
Rule 206 (3) -2 provides a safe harbor for compliance with Section
206 (3) in the case of agency-cross transactions, provided that
the conditions of the Rule are met. The 1989 letter sought the
Division's concurrence with the position that under the
circumstances, it was not necessary to meet paragraph (5) of the
Rule. Paragraph (5) specifies that neither the investment
adviser with respect to the transaction nor any person
controlling, controlled by or under common control with the
adviser may act as broker for both the advisory client and a
person on the other side of the transaction. That is, the issue
was whether, notwithstanding paragraph (5) of the Rule, the
broker-dealer parent of the investment adviser could act as
placement agent for issuers of the tax-exempt securities while
the adviser purchased such securities for the investment
companies. The Division denied that request.
We believe that the issues addressed in the 1989 letter
Rule 206 (3) -2 are irrelevant to the instant request.
Our request is that the
Division confirm our view that the
requirements of the Section itself are met by the common industry
practice wherein the individual employed by an investment adviser
to engage in portfolio management on behalf of an investment
company is also an officer or otherwise an authorized person of
the investment company. In such capacity, the .officer or other
authorized person will, as explained below, provide the consent
required by the Section, obviating any need to rely on Rule
206(3)-2. Similarly, he or she will have access to such
information as is contained in disclosures made pursuant to the
Section.18 Thus, we respectfully request that the Division
concerning
confirm this interpretation or, al ternati vely, that the Division
not recommend that the Commission take enforcement action under
Section 206 (3) if Merrill Lynch acts as placement agent with
respect to securities purchased by the Funds, provided that the
individual (s) employed by MLA or FAM purchasing such securities
for one or more of the Funds is also an officer or agent, of those
Funds.
Most management-type investment companies (including the
Funds) are organized as corporations or Massachusetts business
trusts. Such entities act through their officers or agents. In
the case of portfolio management for an investment company, such
an officer or agent has full authority to purchase, and sell
18
The disclosure requirements normally applicable under
Section 206 (3) have been set forth in various Commission
releases. See,~, Investment Advisers Act Release No. 40
)
(February 5, 1942) i Investment Advisers Act Release No. 470
(August 20, 1975).
BWNY03/9304,12
20
securities and, in so doing, effectively provide the company's
consent to the purchases and sales.
In effecting portfolio transactions for an investment
company, the individuals concerned must act solely in the best
interests of the company. Thus, for example, if a portfolio
manager or other authorized person receives payments improperly
in connection with the sale of portfolio securities to the
company, the investment adviser may be deemed to have committed a
fraud against the company. That was the situation in Carl L.
Lazzell, Investment Company Act Release No. 17808 (October 18,
1990) ("Lazzell"), in which the Commission brought an
administrative proceeding under various provisions of the Federal
securities laws, including Section 17 (e) of the Investment
Company Act and
Sections 206 (1) and (2) of the Advisers Act.
Similarly, Section 203 (f) of the Advisers Act would provide a
basis for the Commission to proceed against any individuals
violating their fiduciary duties to the company. 19 See also,
Benalder Bavse, Jr., Investment Company Act Release No. T8570
(February 26, 1992). The fiduciary obligations just described
are, however, different from the disclosure and consent
requirements of Section 206 (3). Given the dual capacity of the
portfolio management personnel, the consent required by the
Section will necessarily exist. In addition, imposing the
disclosure requirements of Section 206 (3) would be tantamount to
requiring the individual to make written disclosures to himself,
a strange result.20
19
Section 203 (f) provides, among other things, that "the
Commission, by order, shall censure or place limitations on
the activities of any person associated, seeking to become
associated, or, at the time of the alleged misconduct,
associated or seeking to become associated with an
investment adviser, . if the Commission finds, on the
record after notice and opportunity for hearing i that such
censure, placing of limitations, suspension, or bar is in
the public interest and that such person has committed or
omitted any act or omission enumerated (in certain specified
years of the
provisions of Section 203) within ten
commencement of the proceedings under (the) sub-section .
"
20
While the above cited proceedings were silent on this point,
it may be because each of the portfolio managers in those
proceedings acted as agents of both the investment company
and the investment adviser, that no Section 206 (3) claim was
included in the actions.
BWNY03/9304,12
21
We note also that insofar as Section 17 (e) specifically sets
forth the requirements governing agency transactions between an
investment company and its investment adviser or affiliated
persons thereof, that Section supersedes any more general
requirements applicable to investment advisers under the Advisers
Act. See Sutherland, supra, page 12, at § 46.05. Similarly, it
would be a peculiar result to permit the above direct placement
agency transactions under Section 17 (e) of the Investment Company
Act but to prohibit them under Section 206 (3) of the Investment
Advisers Act.
Conclusion
For the foregoing reasons we believe that Section 10 (f) of
the Investment Company Act is inapplicable to investment company
purchases of securities in transactions where an affiliated
person of the company acts as placement agent for such
securities. Section 10 (f) applies only in circumstances where an
investment company purchases securities during the existence of
an underwriting or selling syndicate of which the affiliated
person is a member, but where the purchases are made from a
syndicate member other than the affiliated person. Nevertheless,
such purchases remain subj ect to the provisions of Section
17 (e) (2) of the Investment Company Act and, in particular,
Subsection (C) thereof. If the Divisionis unable to concur with
our view regarding the appropriate interpretation of Section
10 (f), however, we believe that the circumstances described in
this letter otherwise support a favorable "no-action" response.
We further believe that the requirements of Section 206 (3)
are met where the employee of the investment adviser who is
responsible for purchasing securities on behalf of an investment
company is also an officer or agent of the investment company'.
In those circumstances, the consent required by Section 206 (3)
will by definition be given.
If you have any further questions concerning this matter
please feel free to contact Thomas R. Smith, Jr. at (212)
839-5535 or Brian M. Kaplowitz at (212) 839-5370.
Very truly yours,
~11t /¡tf-l u¡
BWNY03/9304,12
22
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.