SECURITIES AND EXCHANGE COMMISSION

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON. D.C. 20549

DIVISION OF

INvESTMENT MANAGEMENT

February 28, 1994

Ms. Natalie Shirley

Vice President and General Counsel

ICI Mutual Insurance Company

1401 H Street

Washington, D.C. 20005-2148

Dear Ms. Shirley:

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Your letter dated November 1, 1993, seeks our concurrence

with your view that a proposed revision to the fidelity insurance

bond provided by ICI Mutual Insurance Company ("ICM") to

investment companies does not violate paragraphs (a) and (c) 0 f

Rule 17g-1 under the Investment Company Act of 1940. 1/

The provision in question, section 12A of ICM' s standard

fidelity bond, formerly provided for the automatic termination of

the bond as to any employee where any partner, officer, or

supervisory employee of the insured learns that such employee

commi tted any dishonest or fraudulent act or theft. The

Commission's inspection staff questioned whether this termination

clause violated paragraphs (a) and (c) of Rule 17g-1. In

response, ICM proposes to delete this clause and instead require

in its bond that an insured that learns of a dishonest or

fraudulent act or theft by an employee immediately remove the

employee from a position that would enable the employee to cause

the insured to suffer a loss by such conduct. The insured also

will be required to notify ICM of the particulars of the

employee's conduct wi thin 48 hours of learning of such

1/ Paragraph (a) of Rule 17g-1 requires each registered

management investment company to provide and maintain a

fidelity insurance bond against larceny and embezzlement,

covering each officer and employee of the investment company

who may have access to the securities or funds of the

investment company. Paragraph (c) of the rule further

requires that the bond provide that it shall not be

cancelled, terminated, or modified except after written

notice by the acting party to the affected party and to the

Commission (and, in the case of joint bonds, by the fidelity

insurance company to all registered investment companies

named as insureds and to the Commission) not less than sixty

days prior to the effective date of cancellation,

termination, or modification.

- 2 -

conduct. £I You state that the revised provision does not

operate as a termination provision as to the employee, and,

therefore i does not violate Rule 1 7g-1. You further state that

this provision benefits the insured and its shareholders by

removing dishonest employees from a position of access to an

investment company's assets.

We agree that the proposed provision, standing alone, does

not violate Rule paragraphs (a) and (c) of Rule 1 7g-1. We also

agree that, because the change is not intended for the benefit of

the fidelity insurance company and does not adversely affect the

rights of registered investment companies, the modification may

take effect immediately upon notifying the Commission and the

insureds, without regard to the 60-day waiting period prescribed

by Rule 17g-1(c). 1/

Sincerely,

-'

~..:_'

Barbara Chretien-Dar

Attorney

lJ Provided that the insured complies with the removal and

notification requirements of Section 12A, claims arising

from an employee's conduct will continue to be covered under

the bond. ICM will not terminate the bond as to that

employee except in compliance with the notice and

effectiveness provisions of paragraph (c) of Rule 1 7g-1.

Telephone conversation with Natalie Shirley on February 28,

1994.

1/ We understand that, with respect to each investment company

affected, the change will be initiated by the investment

company and will be approved by a maj ori ty of the investment

company i s disinterested directors. See ICI Mutual Insurance

Company (pub. avail. Jul. 28, 1988) i Federal Insurance

Company (pub. avail. Aug. 15, 1978).

IBM

ICI MUTUAL

INSURACE

COMPANY

November 1, 1993

,~

Mr. Thomas S. Hahnon )

Chief Counsel

Division of Investment Management

Securities and Exchange Commission

450 6th Street, N.W., MIS 10-6

Washington, DC 20549

'-_/

Re: Inves tment Company Blanket Bonds

Dear Mr. Harmon:

As you know, several regional offices of the Securities and

Exchange Commission (" SEC") have stated, in the course of their

investment company inspection program, that the fidelity bonds

issued by ICI Mutual Insurance Company (" ICI Mutual") are not in

compliance with Rule 1 7g-1 under the Investment Company Act of

1940. Specifically, these regional offices have taken the

position that Section 12 (A) of ICI Mutual's standard form of

Investment Company Blanket Bond ("Bond") violates the

requirements ,of Rulê-i7g-1(a) and (c).

In response, ICI Mutual took temporary steps to alleviate

the regional offices' concerns by revising Section 12 (A) to

provide that if an officer, partner or supervisory' employee

("supervisory person") learns that an employee committed a

dishonest or fraudulent act or theft ("bad act"), such employee

must be removed from a position of access to the securities or

funds of the investment company.

During a recent conversation with Larry Stadulis, he noted

that while he recognized the important policy reasons for

encouraging the removal of an employee who has committed a bad

act from access to fund assets, he wanted to be certain that the

investment company is not in violations bf Rule 17g-1 if ICI

Mutual denied coverage for losses res~ing from the dishonest or

fraudulent act or theft of an employee where a supervisory person

knew the employee had previously committed a bad act and failed

to remove such employee from an access position.

The following is a brief background of the termination

section of the Bond and a discussion of the reasons the proposed

revision complies with Rule 1 7g-1.

I . Background

A. Present Section 12 (A)

10:2 South \Vinooski i\venue PO BoX 730 Burlington. Vermont 05402-0730

(802) 8G3-00SX¡ I~\X (802) 658-6191

Mr. Torn C:~

November í;93

. Page 2

Currently, Section 12 (A) of the standard form of the Bond

provides:

This Bond shall terminate

A. as to any Employee as soon as any

partner , officer or

supervisory employee of the Insured, who is not in

collusion with such Employee, learns that such Employee

committed any Dishonest or Fraudulent Act (s) or Theft,

then intni.nsit :.n the custody of ::;:.ch

but such coverage shall not terminate with respect to

Property

Employee

As set forth in our letter dated May 20, 1993 to Thomas S.

Harman, Associate Director, Division of Investment Management,

ICI Mutual believes that Section 12 (A) of the standard form of

Bond is in technical compliance with Rule 17g-1 (a) and (c). In

addition to the provision's technical compliance with the Rule,

the policy reasons for including it in the Bond are compelling.

If a bond did not contain the substance of Section 12 (A) , 'an

no incentive

employer, such as-an--investment adviser, would have

to carefully check the background of prospective employees. ,As

stated in Newhard, Cook & Company v. Insurance Company of

'North

America, 929 F .2nd 1355 (8th Cir. 1991), "This incentive

minimizes fraud which benefits both the investment industry and

its customers. II A failure to minimize fraud could result in a

loss of public confidence and higher premiums. In addition, it

is unrealistic for an insurance company to be expected to cover

the dishonest or fraudulent acts or thefts of an employee who has

previously committed bad acts, particularly at an affordable

price.

Notwithstanding our arguments to the contrary" you have

inãicated that thé staff continues to believe that' Section 12 (Ai

of the ICI Mutual standard form of Bond, violates Rule 17g-1 (a)

and ( c) .

Section 12 (A), or language similar to Section 12 (A), has

been, for many years, a standard provision in fidelity bonds.

ICI Mutual (and likely most insurers offering this type of

coverage) is, for commercial reasons, unable to delete this

provision and take the risk of continuing to offer coverage for

the acts of an employee who is known to have previously committed

bad acts and now has access to fund assets. Anobvious

alternative, is to require the insured to immediately dismiss any

Mr. Tom Stadulis

November 1, 1993

',"'Page ,3 ;, ", "

employee ~who has previously committed a bad act. 1 However, this

solution may be unacceptable to insureds.

B. Revised Section 12 (A)

To avoid either of the above Draconian results, and in

response to the comments of the regional offices, ICI Mutual

amended Section 12 (A) to provide as follows:

A. Any Insured who learns that an Employee has committed

any Disnonest or Fraudulent Act (3) or Theft 3hall

immediately remove such Employee from a position that

will enable such Employee to cause the Insured to

suffer a loss by any Dishonest or Fraudulent Act (s) or

Theft. The Insured, within forty-eight hours of

learning that an Employee has committed any Dishonest

or Fraudulent Act (s) or Theft shall notify the

Underwriter (ICI Mutual), with full and complete

Theft. '

particulars of such Dishonest or

Fraudulent Act (s) or

For the purposes of this subsection, knowledge that an

Employee has committed any Dishonest or Fraudulent

Act (s) or Theft which is possessed or discovered by any

officer, partner or supervisory employee of any

Insured, who is not in collusion with such Employee,

shall constitute knowledge or discovery by such

Insured.2

lInsureqs frequently dismiss employees once they learn that

such employee has committed a bad act. Under current Section

12 (A) it is not unusual for insureds to request that the Bond be

reinstated as to a particular employee who has committed a bad

act, if the bad act was of a trivial nature or occurred many

years ago.

2Upon further consideration, ICI Mutual believes that it is

more appropriate to delete Section 12 (A) of the standard form

Bond and use the revised language of Section 12 (A) as a separate

condition of the Bond. As the revised language is no longer

functionally a termination provision of the Bond it would be

confusing to include it under the section in the Bond that is

entitled II

Termination" .

Mr. Tom Stadulis

November 1, 1993

Page 4

II. Re¥Ìsed Provision is in Compliance with Rule 17g-1 (a) and

(c)

Rule 17g-1 (a) requires that fidelity coverage be provided to

cover "each officer and employee... who may. . . have access to

securities or funds of the investment company... 11 By its terms,

this provision requires only that coverage be providedi it does

not dictate the terms and provisions of such coverage. Nor does

it suggest that payment must be made for a loss regardless of the

acts or omissions of ,the

Insured.

The revised provision complies with Rule 17g-1 (a) in that

the provision does not automatically terminate coverage for each

officer and employee who may have access to the assets of the

insureds, ~rovided the terms of the provision have been followed.

Similarly, Rule 17g-1 (c) is not violated by inclusion of the

new provision in the Bond. In relevant part, Rule 17g-1 (c)

requires bonds described in paragraph (b) of the Rule to contain

a provision prohibiting the bond's cancellation, termination or

modification withcnit~~:sïxty ,days' prior written noticefrom the

"acting partyll t6the:"~'affectedi'pa'rtyi~ and to the cornissiön and,

the bond is a'j6îIitinsured bond, by the fidelity insurer

to all registered investment companies named as insureds and to

the Commission.

where

The revised provision fully complies with Rule 17g-1 (c) in

that it does not operate to cancel, terminate or modify the Bond

as to any employee. The provision merely places a requirement to

perform an act, i.e., remove an employee who has committed a bad

act from a position of access to the securities or funds of a

company. This act, which is required only upon knowledge by the

insured of the fact that an employee has committed a bad act, is

fully within the c'Ònti'òl of the insured.

The requirement of the revised provision to remove the

employee from a position of access to the insured's assets is not

unlike other requirements or conditions of the Bond. For

includes a requirement to notify ICI Mutual of

example, the Bond

a merger or consolidation of an investment company, to give

notice of discovery of loss within sixty days of discovery of a

loss and to give ICI Mutual notice if there has been a change in

control of an insured. ObY:l..JJ.S),YJ._failui:e._QI1 the "p.~,r-t_()I,ßn

insured to take t~e, required action could j §()p~r,gA,2..§Lç0y.§E.age

to take the

required action and thus avoid an issue as to coverage.

uñd~~r the BÒ-liq.. - Howevêi;'''l:be íñSur'êër-Iš"ê'asily able

'."

Mr. Tom Stadulis

,November 1, 1993

Page 5

Although these provisions are beneficial to protect the

insurer, they are also necessary to provide the insured with a

reasonably priced product. These provisions allow the insurer to

offer a product at a reasonable price with only minimal

obligations on the part of the insured. Moreover, the obligation

or requirement to remove an employee from an access position has

the positive attribute of encouraging the protection of the

insured and its shareholders and is reasonable for the insurer to

insist upon.

III. Independent Directors Must Approve tIie Form of tij,e Bond

Rule 17g-1(d) requires, in pertinent part, that the bond

shall be in II such reasonable form and amount II as a maj ori ty of

the disinterested directors of the fund shall approve.

Accordingly, the funds directors must review and approve the

terms and conditions of the Bond, including any obligations or

requirements imposed on the insured to maintain coverage. It is

the province of the independent directors to review

fully within

the Bond and establish procedures to accommodate its provisions,

including the removal-'6f an employee who has previously committed

a bad act, from a position of access to the company's assets.

*

*

*

As stated above, striking Section 12 (A) from the standard

form of the Bond and including a provision that requires the

insured to remove an employee that has committed a bad act "from a

position of access to the funds, and securities of the company

does not violate Rule 17g-1. Accordingly, the modification

should be acceptable to the staff. On a related issue, we

believe that the modification suggested above does not adversely

aff¿ct the investin~:nt companies named to

the 'bonds and thus,

would not require 60 days notice to the Commission and each

investment company named to the Bond, provided of course, that

is approved

the change is initiat~d by the investment company and

by a majority of such company's disinterested directors.

I would be happy to discuss this matter further at your

convenience. Please let me know if you have any questions or

comments.

Very truly yours,

ad~~___-~-~d

Natalie Shirley ,

JJ~.. )1 IA

Vice President and

General Counsel