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Decemer 23, 1998

RESPONSE OF TH OFFZCE OF CHZEF COUNSEL

DZVZSZON OF ZNVSTM MAGEM

Our Ref. No. 98-694-CC

Defined Asset Fuds

Pile No. 811-1777

Your letter of November 30, 1998 requests our agreement with

your view that Section 26 (a) (2) (C) of the Investment Company Act

of 1940 (the "Act") does not prohibit the Defined Asset Funds

(the "Trustsll), a family of unit investment trusts (nUITs"), from

paying the costs of updating their registration statements as

described in your letter. .

Facts

The Trusts are organized as UITs and jointly sponsored by

Merrill Lynch, Pierce, Fenner & Smith, Inc., Salomon Smith Barney

Inc., Dean Witter Reynolds, Inc., and PaineWebber Inc. (the

"Sponsors"). The Trusts currently pay the costs of preparing and

filing their initial registration statements. The Sponsors

currently pay the costs of updating the Trusts' registration

statements. The Sponsors also currently maintain, and pay the

costs associated with maintaining, a secondary market for units

of the Trusts.

You propose that in the future, the Trusts, rather than the

Sponsors, would pay the expenses incurred in connection with

updating the Trusts' registration statements. These expenses

consist of legal fees, typesetting fees,

electronic filing

expenses and regulatory filing

fees . Under your proposal, the

Sponsors would continue to pay all direct distribution expenses

of the Trusts (including the costs of maintaining the secondary

market for the Trusts), such as printing and distributing

prospectuses, and preparing, printing and distributing any

advertisements or sales literature. The trust indentures for the

Trusts would provide that expenses for updating the Trusts'

registration statements will be paid by the Trusts. The Trusts'

prospectuses and annual reports would disclose that the expenses

of updating the Trusts' registration statements will be paid by

the Trusts and, for at least one year from the date that the

Trusts' prospectuses first disclose that the Trusts will pay the

expenses, also disclose that these expenses historically have

been paid by UITs' sponsors. Any payments made to reimburse the

Sponsors for updating registration statements would not exceed

the costs incurred by the Sponsors for that purpose.

Analvsis

i.. Requirement to Deliver a Current Prospectus

Section 4 (2) of the Act, in relevant part, defines a UIT as

an investment company that is organized under a trust indenture

...

o~ similar instrument, does not have a board of directors, and

is~ues, only. redeemable securities, each of which represents an

undivided interest in a unit of specified securities. UITs

typically are created by a sponsor that accumulates a fixed

portfolio of securities and deposits the securities with a

trUstee under the terms of a trust indenture. The UIT then

issues units of participation in the portfolio and offers these

units to the public at an offering price that is based u~on the

value of the underlying securities, plus a sales charge.

After completing its iyitial offering, a UIT no longer

offers units to the public. In almost all cases, however, the

sponsor establishes and maintains a secondary market in units

issued by the UIT. In the secondary market, the sponsor

purchases units tendered for redemption by UIT unitholders and

resells the units to new investors at an offering price that is

based4 upon the value of the underlying securities, plus a sales

load.

The Securities Act of 1933 (nSecurities Act n) requires that

preceded by the delivery of a current prospectus. The

securities publicly offered by an issuer be accom~anied or

i

The same entity usually is the sponsor and the depositor of

a UIT. See definition of "depositor" in the General Instructions

to Form N-8B-2, the registration statement under the Act for

UITs .

2

For background on the nature and structure of UITs, see Form

N-7 for Registration of Unit Investment Trusts Under the

Securities Act of 1933 and the Investment Company Act of 19401

Investment Company Act Release Nos. 14513 at nn. 8-14 and

accompanying text (May 14, 1985) ("Release 1451311) and 15612

(Mar. 9, 1987) (IlRelease 1561211) (releases proposing and

reproposing a unified form to register UITs under both the Act

and the Securities Act of 1933).

3

See generally Rule Proposal for Unit Investment Trust StartUp Exemptions and Proposed Revision of. Rule Regarding Pricing of

Investment Company Shares Generally, Investment Company Act

Release No. 10545 (Jan. 8, 1979) (describing UITs and'the

operation of secondary markets by UIT sponsors) .

4

The existence of a secondary market enhances the liquidi ty

of a UIT. In the absence ofa secondary market, a UIT might have

to sell portfolio securities to meet redemption requests. If

redemptions were significantly high, the terms of a UIT' s trust

indenture may require the trustee to terminate the UIT.

5

Section 5 of the Securities Act prohibits the use of the

U. S. mails or interstate commerce to sell a security unless

accompanied or preceded by a prospectus that meets the

requirements of Section 10 (a) of the Securities Act. Section

2

prospectus delivery requirement applies both to initial sales of

UIT units and to fesales of UIT units by a sponsor in the

secondary market. Thus, the continued operation of a UIT

depends, in part, on maintaining a current registration statement

because the UIT' s units cannot be offered for sale unless the

underwriter or sponsor can deliver a current prospectus to

offerees or purchasers.

2 . UIT Expenses

Section 26 (a) (2) of the Act indirectly limits the expenses

that may be paid out of a UITI s assets by prohibiting a depositor

or principal underwriter from selling interests in a UIT unless

the UIT's trust indenture, or similar instrument, specifically

includes the payment limitations in Section 26 (a) (2). Paragraph

(C) of Section 26 (a) (2) provides:

that no payment to the depositor of or a principal

underwriter for (a UIT), or to any affiliated person or

agent of such depositor or underwriter, shall be allowed the.

trustee or custodian as an expense (except that provision

may be made for the payment to any such person of a fee, not

exceeding such reasonable amount as the Commission may

prescribe as compensation for bookkeeping and other

administrative services, of a character normally performed

by the trustee or custodian itself) .

Paragraph (D) requires a UIT i S trustee or custodian to hold all

assets of the UIT in trust, subject only to the charges allowed

by Section 26 (a) (2~, until the assets are distributed to the

UIT's unitholders. Rule 26a-1 under the Act, in relevant part,

10 (a) (3) of the Securities Act requires that information

contained in a prospectus be current.

6

Secondary market transactions in most securities are not

subj ect to the prospectus delivery requirements. UIT depositors,

however, are considered "issuers" under Section 2 (4) of the

Securities Act, and are therefore subject to the prospectus

delivery requirement. See Release 15612 supra note 2, at n.2 and

and

accompanying text; Release 14513, supra note 2 at n.14

accompanying text. See also M. L. Stern & Co. Inc. (pub. avail.

Nov. 18, 1988) (explaining when the prospectus delivery

requirements of the Securities Act apply to resales of UIT units

in a secondary market) .

7

Paragraph (A) of Section 26 (a) (2) limits payments to a UIT IS

trustee or custodian to fees for services, or reimbursements for

expenses, as are set forth in the UIT i S trust indenture or

similar instrument. Paragraph (B) limits payments under

paragraph (A) to payments for services previously performed or to

reimbursement for expenses previously incurred.

3

provides that any payments made under Section 26 (a) (2) (C) may not

exceed the cost of the services rendered.

You represent that your proposal is consistent with

paragraph (C) of Section 26 (a) (2). You acknowledge that the

staff, in E. F. Hutton Tax Exempt Fund (pub. avail. Apr. 11,

1979) (IIHutton"), previously took the position that Section

26(a) (2) prohibits the payment by a UIT's trustee from the UIT's

assets to its sponsor of any expenses related to the maintenance

of a secondary market for units of a UIT. In Hutton, the staff

stated that secondary market expenses include the costs of

keeping a UIT i S registration statement current. The staff also

stated in Hutton that an alternate proposal to have the UIT

itself bear the expenses of maintaining a secondary market would

seem to be an attempt to circumvent Section 26 (a) (2) (C) ofa the

Act, and would therefore violate Section 48 (a) of the Act. In

your view, however, your proposal is consistent with more recent

staff interpretations of Section 26 (a) (2) (C). You state that the

positions taken by the staff in Kemper Sales Company (pub. avail.

Jan. 3, 1985) ("Kemper") and Unit Investment Trust Organizational

Expenses (pub. avail. May 9, 1995) ("Organizational Expenses

Letterll) provide support for your position.

In Kemper, the staff agreed not to recommend enforcement

action to the Commission under Section 26 (a) (2) (C) of the Act if

UITs were to bear the expenses of preparing audited financial

statements for the purpose of maintaining current registration

statements for the UITs. The staff i s position was limited to two

circumstances: (1) the audi t was required by the terms of a UIT i S

trust indenture; or (2) the UIT' s trustee determined that an

audit would be in the best interests of the UIT' s unitholders.

In the Organizational Expenses Letter, the staff stated that

Section 26 (a) (2) does not prohibit a UIT from bearing its own

organizational and initial registration expenses even though

those expenses historically had been paid by a UIT i S sponsor.

The staff reasoned that: (1)

the express language of Section

26 (a) (2) did not prohibit the practice; and (2) the proposed

26 (a) (2) of the Act was intended to prevent, particularly the

expense allocation would not lead to the abu~es that Section

a Section 48 (a) makes it "unlawful for any personß'directly or

indirectly, to cause to be done any act or thing through or by

means of any other person which it would be unlawful for such

person to do under the provisions of (the Act) or any rule,

regulation, or order thereunder. II

9 The legislative history of the Act demonstrates that the

restrictions and limitations contained in Section 26 (a) (2) were

intended by Congress

to prevent or mitigate abuses in the

investment company industry that were identified by the

Commission in a series of reports. S. Rep. No. 1775, 76th Cong.,

3d Sess. 8, 18 (1940); H.R. Rep. No. 2639, 76th Cong., 3d'Sess.

22 (1940). Some of the abuses described in the Commission's

.,

4

assessment of II hidden charges II against UITs by their sponsors,

provided that the allocation was adequately disclosed to

investors. The staff concluded that a UIT's payment of its own

organizational and initial registration expenses is consistent

with paragraph (C) of Section 26 (a) (2) because the expenses are

legitimate business expenses paid to parties unaffiliated with

the UIT i S sponsor for services that are necessary to the

operatio£ of the UIT and that do not directly benefit the

sponsor. 0 As a result, the sponsor would not receive any hidden

fees, even when directly reimbursed for organizational expenses,

because (1) the sponsor would be reimbursed only for its costs

and (2) the UIT's payment of its organizational expenses would be

prominently disclosed to investors.

We believe that Section 26 (a) (2) (C) does not prohibit a UIT

from paying the expenses of updating its registration statement,

including payments to reimburse the UIT' ¥i sponsor for its costs

incurred in providing updating services. The Commission has

stated that Section 26 (a) (2) (C) was designed "to preserve trust

assets and prevent securityholders from being subjected to

purported i administrative i fees which, instead of compensating

the depositor for administrative services actually rendffed, in

fact provide additional remuneration to the depositor." The

Commission also has stated that II (t) he purpose of (Section

26 (a) (2)) is to prohibit the depositor from 'realjng hidden

profits' through purported administrative fees."

A UIT's payment of the expenses of updating its registration

statement, similar to its payment of its own organizational and

reports included examples of UIT sponsors reaping hidden profits

through practices such as: buying securities for the UIT at the

(lower) bid price and selling them to the UIT at the (higher)

asking price; charging the UIT odd-lot brokerage commissions even

when the sponsor purchased the portfolio securities in round

lots; adding brokerage commissions to the base price of units and

calculating the sales load on the increased amount; adjusting the

offering price to the next highest eighth of a dollar; and

retaining the interest earned on the UIT' s cash. Securities and

Exchange Commission, Investment Trusts and Investment Companies,

Fixed and Semifixed Investment Trusts, Ch. 10 (1940) " reprinted

as H.R. Doc. No. 567, 76th Cong., 3d Sess. (1940). _..

io

Organizational Expenses Letter at n. 6.

ii

To the extent that this position is inconsistent with

Hutton, Hutton is superseded.

i2

Payment of Administrative Fees to the Depositor or Principal

Underwriter of a Unit Investment Trust, Investment Company Act

Release No. 13705 at n.5 (Jan. 9, 1984) (proposing Rule 26a-1) .

i3

I d . at text accompanying n. 3 .

5

auditing expenses, would not provide the kind of direct

remuneration to the sponsor that Section 26 (a) (2) (C) was intended

to prevent. Updating expenses, like organizational and auditing

expenses, are legitimate business expenses that are necessary to

the operation of the Trusts and do not directly benefit the

Sponsors. While the payments of updating expenses by the Trusts

indirectly benefit the Sponsors because the Sponsors otherwise

would bear the expenses, we believe that these expenses are not

the type of charges that directly benefit UIT sponsors in the 14

manner deemed abusive by Congress in enacting Section 26 (a) (2) .

We believe that the Trusts i payment of updating expenses, as

described in your letter, would not constitute hidden profits to

the Sponsors. The Trusts will fully disclose the expenses in

their prospectuses and annual reports and, for at least one year

from the date that the Trusts i prospectuses first disclose the

expenses, the prospectuses also will disclose that these expenses

historically have been paid by UITs' sponsors. Nor are updating

expenses tl~ kind of "hidden chargesn about which Congress was

concerned. To the extent that updating expenses are paid

directly to the Sponsors, the payments will be limited to the

Sponsors' costs, as required by Rule 26a-l.

This position is based on the facts and circumstances set

forth in your letter. Any different facts or circumstances may

require a different conclusion. '

tJ-iLJQ/~

Wendy Finck Friedlander

Senior Counsel

14

See supra note 9.

15

Id.

6

r

DAVIS POLK & WARDWELL

1300 I STREET, N.W.

450 LEXINGTON AVENUE

NEW YORK, N.Y. 100 17

WASHINGTON, D.C. 20005

i 5, AVENUE MATIGNON

75008 PARIS

17'22, AKASAKA 2'CHOME

MINATO-KU, TOKYO 107

2 i 2'''50'''000

FAX 2 I 2'..50'..800

ME5SETURM

60308 FRANKFURT AM MAIN

I FREDERICK'S PLACE

WRITER'S DIRECT

LONDON EC2R 8AB

3.0 CHATER ROAD

(212) 450-4525

HONG KONG

Investm~i:t Company Act

Section 26(a)(2)(C)

November 30, 1998

Securities and Exchange Commission

450 Fifth Street, N. W.

Washington, D.C. 20549

Attention: Douglas Scheidt, Esq.

Chief Counsel

Division of Investment Management

Re: Allocation of Expenses Incured to

Update UIT Re¡istrtion Statements

Dear Mr. Scheidt:

By letter dated May 9, 1995, the Sta of

andenforcement

Exchange action if a

Commission (the "Sta') advised us that it wouldthe

notSecurties

recommend

unit investment trst bear its own organzational expenses. Unit Trust Organizational

Expenses (available 5/9/95). On behalf of

Merrll Lynch, Pierc, Fenner & Smith

Incorprated, Agent for the Sponsorsl (the "Sponsors'') of

the Defined Asset Funds

the Staff with respect to the permissibilty of individua UITs to bear expenses related to

family of

unt investment trts ("UITs''), we hereby request similar confirmatian from

IThe other sponsors are curently Salomon Smith Barey Inc., Dean Witter Reynolds,

Inc. and Paine Webber Incorprated.

,.

Douglas Scheidt, Esq.

2

November 30, 1998

updating trt registration statements pursuat to the Securties Act of 1933 (the "1933

Act").

1. The Proposal

Historically, the Sponsors have paid all the costs of maitaning a secondar

market in tr unts and reoffering units acquired in the secondar market, including the

costs of anualy updating a trt's i 933 Act registrtion statement. 2 The Sponsors

propose that, in the futue, certin expenses related to the prepartion and fiing of

post-effective amendments would be borne by the trts themselves. These expenses

consist of

the anua legal expenses for the prepartion of

post

-effective amendments to

the trts' registrtion statements, the associated typesetting, electronic filing and related

charges of a financial printer and regulatory filing fees, if any. The Sponsors wil

continue to bear all costs of printing and distrbuting prospectues and of preparng,

printing and. distrbuting any advertising and promotional material. The updating

expenses to be borne by a trst under the proposal would be immaterial on a pei: unt

basis. The legal fees and printing expenses associated with the anua amendment to

trt registrtion statements tota $3,700 per trt, per year. The weighted average cost is

estimated to be $0.21 per year on a unit of about $ 1000. Ths level of expense would.

have only a minal impact of approximately 0.024% on an investor's retu.

We submit tht ths proposa is consistent with the way

mutu fuds that have not

adopted distrbution plans pursuat to Rule 12b- 1 allocate expenses of anua prospectus

updates and with the provisions of

the Investment Company Act of 1940 (the "1940

Act"), as discussed belöw. Furhermore, except in limited circumstaces when the

Sponsors prepay thd par expenses (in which case the charge will not exceed the

amount of ihe payments made), the expenses borne by the trts will involve payments by

the trtee to thd paries, in paricular regulators, lawyers and priters -- not to the

Sponsors.

2Since 1978, the cost of

an anual audit ofa trt's fmancial statements has, as

provided in the indentue, been borne by the trt. Ths practice was approved in Kemper

Sales Company, avail 1/3/85.

Douglas Scheidt, Esq.

3

November 30, 1998

II. Le~al Analysis

Section 26 of the 1940 Act requires inclusion of certn provisions in the

indentue establishing a trust. The purose of Section 26(a)(2) is to preserve the assets of

registered investment companies and to prevent untholders from bearng

"admnistrative" fees which, instead of compensating the custodian for its services,

actuly provide additional profit to the sponsors. ~,~, Unit Investment Trust

Organizational Expenses. .

We believe that this proposal is not inconsistent with Section 26(a)(2)(C). Section

26(a)(2)(C) was designed to ensure that sponsors and depositors could not receive hidden

protits by charging excessive fees to the truts. Municipal Invesiment Trust Fund (avaiL.

6/14/82). While E.F Hutton Tax Exempt Fund (avaiL. 4/11/79), an early Staff

pronouncement. cited Section 26(a)(2)(C) as authority for the proposition that trusts

could not bear the "expenses of maintaining a secondar market," more recent no-action

letters express a less restrictive view by the Staff. Kemper Sales Company (avaiL. 1/3/85),

for example, found that trsts could bear the costs of obtaning anual audited finacial

statements despite the us of these statements by the sponsors in updating the trsts'

registrtion statements, which would in tu allow the sponsors to maintan a secondar

market in unts. Similarly, the Stas response in Unit Investment Trust Organizational

Expenses, citing the practice of mutul fuds generally to bear their own organzational

expenses, agreed that a unit trst also could bear these expenses, including legal fees and

"the cost of preparng and printing its registration statement."

Rule 12b-l(a)(2), applicable only to mutul fuds, defines distrbution as .'any

activity which is primarly intended to result in the sale of shares." Although Rule 12b- 1

is not applicable to unt trsts, our proposal is consistent with the interpretation of

distrbution-related expenses prescribed by Rule 12b-1. We propose that the trst would

pay only for expenses to prepare and fie anua amendments to its registrtion statement

which, like an anua audit, is not an "activity priarly intended to result in the sale of

shares." Under ths proposal, the sponsors of a trt will continue to bear all expenses

related to maintag a secondar market in unts and all marketing and distrbution

expenses.

Furermore, virtly all other issuers which compete with unit investment trts

pay their own updte expenses. The principal other tys of fuds regulated by the 1940

Douglas Scheidt, Esq.

4

November 30, i 998

Act -- mutu fuds and closed-end fuds -- routinely bear the anual

legal fees for the

preparation of post-effective amendments to their registrtion statements, the associated

typesetting, electronic fiing and related expenses of a financial printer and anual

regulatory filing fees if any.J Therefore. issuers of securties that compete with unit

investment truts an ar subject to periodic fiing requirements -- packaged products

such as mutual fuds and closed-end fuds -- pay their own updte expenses.

Consequently, our proposal to charge legal and printing expenses associated with

updating trst registrtion statements is designed to level the playing field on which UITs

compete with mutul funds and closed-end fuds.

Since the anua expense to update a trut's registration statement is de minimus

on a. per unit basis, we believe that existing trsts which have not previously disclosed

this expense may amend their .prospectuses and henceforth bear the update expense, as

was permitted with respect to.audit fees in Kémper Sales Company, We specifically

agree. that for at least a year following implementation of these ~hanges, the fee table

section of

the'

prospectu wil

include disclosure that historically these updting expenses

have been borne by the Sponsors.

In sum, our proposal is reasonable, fair and consistent with both the specific

overall purose of Section 26(a)(2)(C) and the protection of investors. It

has been pointed outrepeatealy in no-action letters and exemptive orders that the purse

of Section 26( a)(2)(C) is to preserve tle assets of registered inyestment companes and to

mandate and

prevent unitholders from bearng fees which actually provide additional profit to the

sponsors. Our proposal involves no payments to the Sponsors (except to reimburse them

for prepayments of permissible third pary expenses). Payments to thrd paries for actul

expenses incured in updating a trt's registration statement, as contemplated by this

proposal, hardly constitute profit to the sponsors. This proposa merely equaizes the

treatment of UITs and competing investment products.

3Neither Section 12(b) (applicable to open-end management companies) nor Secion 23 of

the Act

(applicable to closed-end companies) prohibits mutual fuds and closed-end fuds from bearg the tye of

update expenses proposed here.

Douglas Scheidt, Esq.

5

November 30, 1998

Please call me at (212) 450-4525 (or Gar Granik at (212) 450-4721 or Ken Chase

at (212) 450-4731 in my absence) with any questions or comments you may have.

~AJ~~

Very trly your,

Pierre de Saint Phalle

cc: Mercer Bullard, Esq.

Wendy Friedlander, Esq. ­