REPONSE OF THE OFFICE OF CHIEF COUNSEL

aii

REPONSE OF THE OFFICE OF CHIEF COUNSEL

DIVISION OF INESTMENT MANAGEMENT

SEP 5 1995 :.

Our Ref. No. 95-176-CC

SMC Capita, Inc.

File No. 132-3

By letter dated July 11, 1995, you request our assurace that we would not

recommend enforcement action to the Commission under section 17 (d) of the Investment

Company Act of 1940 ("Investment Company Act") or rule 17d-l thereunder, or section 206

of the Investment Advisers Act of 1940 ("Advisers Act"), if SMC Capital, Inc. ("SMC"), a

registered investment adviser, aggregates orders for the purchase or sale of securities on

behalf of its clients, as more fully described in your letter.

You state that SMC provides investment advice to a number of different types of

clients, including individuals, employee benefit plans, registered investment companes,

private investment liited partnerships excepted from the defintion of "investment

company" under section 3(c)(1) of the Investment Company Act, and insurance company

investment accounts. Employees and pricipals of SMC invest in certin collective

investment vehicles advised by SMC.

You state that larger orders for the purchase or sale of securities generally may be

executed at lower commission costs on a per-share and per-dollar basis than smaller orders.

SMC believes it is obligated to seek the best possible execution of all trades for all its

clients, including those clients in which persons associated with SMC II are among the

investors, by engaging in the aggregation of orders. 2/ You also state that, if orders are

aggregated in accordance with the standards outlned in your letter, the risk that any

particular client would be or could be systematically advantaged or disadvantaged would be

minimized.

Proposed Aggregation of Orders

Specifcally, SMC prop~ses to aggregate client orders as follows:

1. Policies for the aggregation of transactions wil be fully disclosed in SMC's

Form ADV and separately to SMC's existing clients and the broker-dealers

through which such orders are placed J/;

2. SMC wil not aggregate transactions unless it believes that aggregation is

consistent with its duty to seek best execution (which includes the duty to seek

II A "person associated with an investment adviser," as defined in section 202(a)(17) of

the Advisers Act, includes any partner, officer, or director of the investment adviser

(or any person performing similar functions), or any person directly or indirectly

controllng or controlled by the investment adviser, including any employee of the

investment adviser (other than employees whose functions are clerical or ministerial).

2/ We note that an adviser would not violate its duty to seek best execution merely by

failng to aggregate orders for client accounts. The adviser should, however, disclose

to its clients that it wil not aggregate and the potential consequences of the failure to

aggregate. See In re Mark Bailey, Investment Advisers Act Release No. 1105, 40

SEC Docket 432 (Feb. 24, 1988).

JI Your letter states that the policies for the aggregation of transactions wil be

submitted to and approved by the board of directors of any registered investment

company for which transactions wil be aggregated.

2

'with the terms of SMC's investment

advisory agreement with each client for which trades are being aggregated;

best price) for its clients and is consistent

3. No advisory client wil be favored over any other client; each client that

paricipates in an aggregated order wil participate at the average share price

for all SMC's transactions in that security on a given business day, with

transaction costs shared pro rata based on each client's paricipation in the

transaction;

4. SMC wil prepare, before enterig an aggregated order, a written statement

(the "Alocation Statement") specifying the paricipating client accounts and

how it intends to allocate the order among those clients; M

5. If the aggregated order is filled in its entirety, it wil be allocated among

clients in accordance with the Alocation Statement; if the order is partially

filled, it wil be allocated pro rata based on the Alocation Statement;

6. Notwithstanding the foregoing, the order may be allocated on a basis different

from that specifed in the Alocation Statement if al client accounts receive

fair and equitable treatment and the reason for the different allocation is

explained in writing and is approved in writing by SMC' s compliance officer

no later than one hour after the openig of the markets on the trading day

following the day the order was executed; 5.1

7. SMC's books and records wil separately reflect, for each client account the

orders of which are aggregated, the securities held by, and bought and sold

for, that account;

8. Funds and securities of clients whose orders are aggregated wil be deposited

with one or more banks or broker-dealers, and neither the clients' cash nor

their securities wil be held collectively any longer than is necessar to settle

the purchase or sale in question on a delivery versus payment basis; cash or

M In a telephone conversation on August 29, 1995, Mercer E. Bullard of Wiler,

Cutler & Pickering represented that Allocation Statements, and written statements

explaining any deviations therefrom, wil be maintained as records of SMC in an

easily accessible place for a period of not less than five years, the first two years in

an appropriate office of SMC.

5./ For example, it may be appropriate to deviate from the Alocation Statement when,

subsequent to entering the trade but before the final allocation, SMC determines that

the security in question would be unsuitable for one of the clients designated in the

Allocation Statement.

You also represent that if an aggregated purchase or sale order is partially executed

and allocated on a basis different from that specifed in the Alocation Statement, no

client that is benefitted by the different alocation may effect any purchase or sale,

for a reasonable period following the execution of the aggregated order, that would

result in its receiving or sellg more shares than the number of shares it would have

received or sold had the aggregated order been fully executed.

3

securities held collectively for clients wil be delivered out to the custodian

bank or broker-dealer as soon as practicable following the settlement;

9. SMC wil receive no additional compensation or remuneration of any kid as

a result of the proposed aggregation; and

10. Individual investment advice and treatment wil be accorded to each advisory

client.

You state that SMC has procedures and mechanisms in place that are reasonably designed to

implement its aggregation policies. fi/

Analysis

Section 17(d) of the Investment Company Act provides that the Commission may

adopt rules restricting paricipation by registered investment companies in joint transactions

with afliated persons for the purpose of preventing or liiting participation by such a

company on a basis different from or less advantageous than that of any other paricipant.

Rule 17d-l, in relevant part, provides that no affiiated person of a registered investment

company, and no affilated person of an affiiated person, may paricipate in any joint

enterprise, arrangement, or profit-sharig plan, as defined in the rule, without first obtang

an exemptive order from the Commission. Your letter raises issues under section 17(d)

because SMC proposes to aggregate orders on behalf of registered investment company

clients and other advisory clients in which persons associated with SMC have invested, or

other clients that may be affiiated persons of the registered investment company, or

affiiated persons of such persons. 11

Some element of combination or profit motive must generally be present for section

17(d) and rule 17d-l to apply. 8/ You maintain that the aggregation of orders alone does

fi/ Telephone conversation with Mercer E. Bullard on August 29, 1995. Additionally,

Mr. Bullard represented that SMC wil annually review its aggregation procedures to

ensure that they are adequate to prevent any account from being systematicaly

disadvantaged as a result of the aggregation of orders. If SMC discovers that its

aggregation policies are not being adhered to, SMC wil tae whatever corrective

measures are necessar, including revising its procedures.

1/ Section 2(a)(3) of the Investment Company Act defines an affilated person of another

person to include, among other thigs, any person directly or indirectly owning,

controllg, or holding with power to vote, five percent or more of the outstading

voting securities of the other person, any person five percent or more of whose

outstanding voting securities are directly or indirectly owned, controlled, or held with

power to vote by the other person, or any investment adviser of an investment

company.

?i/ In re Steadman Security Corp., 1974-75 Fed. Sec. L. Rep. (CCH) , 80,038 at

84,848 (Dec. 20, 1974) (rule 17d-l "is concerned with joint enterprises or joint

arngements that are in the nature of a joint venture, i. e., that involve the element

of seekig to realie a profit or gain through the investment of funds. "); SEC v.

Talley Indust.. Inc., 399 F.2d 396, 403 (2d Cir. 1968), cert. denied, 393 U.S. 1015

(continued. . .)

4

not constitute a combination or enterprise conducted for the purpose of makg a profit. A

pattern of aggregating trades on behal of cert clients, you contend, results only from a

commonalty of investment objectives, not from any motive or purpose related to the

execution of the orders. In the alternative, you state that because al of SMC's clients wil

paricipate on equal terms, the proposed aggregation of trades nee not be prohibited in

order to effectuate the policies underlying section 17(d).

We agree that the mere aggregation of orders for advisory clients 9./, includig a

registered investment company, would not violate section 17 (d), provided that the investment

company participates on terms no less advantageous than those of any other paricipant. If a

portolio manager allocates trades in such a way as to disadvantage a registered investment

company, however, a joint enterprise or arngement rasing the concerns section 17(d) was

designed to address may result. 101

We would not recommend enforcement action to the Commission under section 17 (d)

or rule 17d-l thereunder if SMC engages in the practice of aggregating orders for the

purchase or sale of securities on behalf of investment companes and other clients (including

clients in which SMC or persons associated with SMC may have an interest), subject to the

representations made in your letter and the telephone conversations. ill Nor would we

recommend enforcement action to the Commission under section 206 of the Advisers Act if

SMC engages in the proposed aggregation of orders in a manner consistent with seeking best

execution, subject to the representations made in your letter and the telephone

conversations. 121 Section 206 imposes a fiduciary duty on an investment adviser to act in

continued)

?i1 (.. .

(1969) (whie section 17 (d) is not limited to the typical joint venture, "some element

of 'combination' is required").

9./ Advisory clients include collective investment vehicles in which the adviser, its

principals or employees have an interest.

101 In re Kemper Financial Services. Inc., Investment Advisers Act Release No. 1387,

Fed. Sec. L. Rep. (CCH) , 85,237 (Oct. 20, 1993). The anti-fraud provisions of the

federal securities laws also would apply to transactions that were allocated in order to

benefit certin clients over others. In paricular, section 17 G) of the Investment

Company Act and rule 17j-l(a) thereunder, in relevant part, generay prohibit any

affilated person of a registered investment company, in connection with the purchase

or sale by such person of a security held or to be acquired by such registered

investment company, from defrauding such registered investment company.

Therefore, these provisions prohibit fraudulent practices in connection with

aggregated trades in which an investment company and affilated persons of the

investment company paricipate. See also section 206 of the Advisers Act.

ill SMC states that it wil alocate trades at an average price and, if not completely

filed, on a pro rata basis. Although you have not asked us to express an opinon on

any other allocation method, we note that there may be other alocation methods that

advisers can use without violating section 17(d) or section 206.

121 The fact that an aggregated order results in best execution, however, does not

necessariy remove the transaction from section 206 or section 17(d), if the adviser

(continued. . .)

" "f: \ ,

5

the utmost good faith with respect to its clients, and to provide full and fai disclosure of al

material facts. 131 Consistent with its fiduciar duties, SMC wil alocate trades on an

equitable basis with respect to both its investment company and non-investment company

clients. Our position with respect to section 206 is based paricularly on the following

representations: (1) the practice of aggregating orders wil be fully disclosed in SMC's

Form ADV and separtely to SMC's existing clients, and (2) no advisory client, including

those clients in which SMC or persons associated with SMC have a direct or indirect

beneficial interest, wil be favored by SMC over any other client and each client who

paricipates in an aggregated order wil paricipate at the average share price with al

transaction costs shared on a pro rata basis. 141

Because this position is based on the facts and representations made in your letter and

the telephone conversations noted above, you should note that any different facts or

circumstances might require a different conclusion. 151

~M(~

Kame McMilan

Senior Counsel

12/(.. .

continued)

derives a personal gain from the transaction or favors certin clients over others. See

SEC v. Talton R. Embry and Magten Asset Management, Litigation Release No.

13777 (Sept. 9, 1993). In Embry, the Commission alleged that the pricipal of the

adviser aggregated his own purchases with those of his clients, including some

registered investment companies, and then immediately sold the securities he had

purchased for himself at a higher price in pre-arrnged sales. Although the pricipal

may have obtained best execution for his clients, he was enjoined from violating

section 206 and section 17 (d) because he aggregated the trades to make a profit for

himself.

UL SEC v. Capital Gains Research Bureau. Inc., 375 U.S. 180, 184 (1963).

141 This letter does not address any issues regarding the aggregation of orders that may

arise under the Employee Retirement Income Security Act of 1974 ("ERSA"), such

as whether aggregating trades for proprietary accounts with trades for ERISA

accounts violates the exclusive benefit rule of section 404(a) of ERISA, or constitutes

a prohibited transaction under section 406 of that Act.

151 Your letter does not request relief with respect to the aggregation of orders involving

privately placed securities, and therefore we express no opinon with respect to the

aggregation of such securities.

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-NOT ADITTED IN O. C.

Investment Company Act

17(d)/Rule 17d-l

July 11, 1995

Jack W. Murphy

Chief Counsel

Division of Investment Management

Securities and Exchange Commission

Mail Stop 10-6

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Dea Mr, Murphy:

We are writing to request clarfication of the application of the Investment

Advisers Act of 1940 (the" Advisers Act"), as amended, and the Investment Company Act of

1940 (the "Investment Company Acttl), as amended, to the aggregation of orders. We

request that the Division of Investment Management confi that it wil not recommend

enforcement action if SMC Capita, Inc., a registered investment adviser (the "Applicat"),

aggregates orders in the manner described below.

I. &m

The Applicat provides investment advice to a number of different tys of

investors, including individua accunts, ERSA accunts, mutu funds, private investment

limited parerships exempt from registrtion as investment companes under Section 3(c)(1)

of the Investment Company Act, and insurace company investment accunts. In severa

instaces where the client advise by the Applicat is not an individua but rather is an

investment vehicle -- for example, a registered investment compay or a Section 3(c)(I)

parnership -- employees and pricipals of the Applicat ar investors in tht entity as well,

Jack W. Murphy

July 11, 1995

Page 2

It is generaly true in the execution of orders in the marketplac that, up to a

point, larger orders may be execute at lower commission costs on a per-share and per-dollar

basis than smaler orders. In view of the acknowledged duty that any investment adviser has

to sek the best possible execution for his client, the Applicat believes it is obligate to sek

the lowest possible execution cost for al its clients -- including clients in which employee

and/or principals of the Applicat ar among the investors -- by engaging in aggregation of

orders. In addition, the Applicat believes that if it aggregates orders under the circum­

staces outlned below, the risk that any parcular account would be or could be systemati­

caly

advantaged (or disadvantaged) would be minimized.

II. Le2al Back~round

The Commission has addresse the question of aggregation of orders in at leat

three no-action letters. In Weston Capita Management. Inc., (1977-1978 Trasfer Volume)

Fed. Sec. L. Rep. (CCH) 1 81,408 (Aug. 11, 1977), Weston Capita sought no-action assur­

ance for a proposa to aggregate trdes for certn of its advisory clients. In justifyng its

proposa, Weston Capita emphasize that the aggregation of orders did not mea that

accunts were in any way being managed on a poled basis. lg. at p. 88,874. Weston

Capita furter proposed to adopt the following six conditions in conducting its order aggre­

gation activity:

1. Weston Capita would not own or trde any securities for

its own account.

2. The written approval of clients would be obtaned before

aggregation of their trdes began.

3. Each account would be managed on an individual basis

and at the opening of each account Weston Capita would

obtan from the client information regarding the client's

financial circumstaces and objectives.

4. Weston Capita's agreements with its clients would pro­

vide that under no circumstaces would it obtan direct

custody of any client funds or securities.

5. Weston Capita would recive no additional compensation

ol" remuneration of any kind as a result of the propose

procedure.

Jack W. Murphy

July 11, 1995

Page 3

6. Aggregation of trdes would ocur only if tres in the

sae security were indicate for more than one accunt

at the sae time.

Ba upon the representations of Weston Capita, the Commission staf grat­

ed the request for no-action relief. In pacular, the staf wrote:

· (We would not recmmend that the Commission ta action

under the Investment Advisers Act of 1940 or the Investment

Company Act of 1940 against Weston Capita Management, Inc.

(' Adviser') if it aggregates contemporaeous purchase or sell

orders of its segregated advisory accunts for the exclusive

purpose of achieving lower per share brokerage commission

costs for orders provided that (1) the argement for aggrega­

tion has been disclosed previously to each client for whom an

order is aggregated, (2) the Adviser does not breach his duty to

act in the individua best interet of eah client which duty

reuires, in par, that no advisory accunt be favored over any

other advisory account and, thus, that each account parcipate in

an aggregated order at the average share price, (3) only the

accounts of advisory clients be aggregate, and (4) individual

investment advice is provided each account. "

IQ. at p. 88.873. Similar requests for relief have been grated by the staf more recntly,

with similar conditions, in Piette and Associates. Limited, (1981-1982 Trasfer Volume)

Fed. Sec. L. Rep. (CCH) 1 77,065 (Aug. 18, 1981), and Owen T. Wilkinson & Associate.

In, (1987-1988 Trasfer Volume) Fed. Sec. L. Rep. (CCH) 178,556 (Feb. 3, 1988).

Although Weston, ~, and Wilkinson each required, as a condition, that

"only the accunts of advisory clients be aggregate,. these lettrs do not offer guidace as

to the stars intended meaing of this limitation. More speificaly, these previous no-action

letters have not addressed the importt question of the point at which investment by an

adviser or its affiiates in a vehicle in which unaffiliate persons also have invested becomes

so significat that aggregation of client orders should not be permitted. It seems obvious, for

example, that where the adviser's ownership is at a low level -- perhaps a one percent inter­

est as genera parner of an investment limited parership -- the parership should be con­

=

Jack W. Murphy

July 11, 1995

Page 4

sidered to be an "advisory client" of the adviser as tht term wa use by the staf in

Weston.!1

m. Discuson

As note above, the Applicat believes tht it ca most effectively sek best

execution for al its advisory clients if it aggregate order for advisory clients in the maner

that includes advisory client accunts in which affite persns of the Applicat have an

investment interet. The Applicat therefore seks the stas assurace that it would not

recommend enforcement action if the Applicat engages in the aggregation of client orders

on the following basis:Y

1. Policies for aggregation of trsactions wil be fully disclosed in the

Applicat's Form ADV and separtely to the Applicat's current clients

and the broker/deaers though whom such orders are place;

2. The policies for aggregation of trsations of any registered

investment company wil be submitt to and approved by the board of

directors of such company;

3. The Applicat shall not aggregate trsactions unless it believes such

aggregation is consistent with its duty to seek best execution (which

shall include best price) for its clients and is consistent with the terms

of the Applicant's investment advisory agreements;

4. No advisory accunt will be favore over any other accunt; and each

account that parcipates in an aggregate order wil parcipate at the

average share price for all trsactions of the Applicat in that security

on a given business day, with al trsaction costs shaed on a pro rata

basis;

l' Indee, if such a one percnt interet were someow to .contate. the advisory natu of

the essential relationsp beeen the adviser and the investmt vehcle, no invest paersp could ever

have its orders aggregate with those of other clients (since advisers actig as genera paers almost invarably

have a one perct interet to satisfy cert ta concern).

'Y The Applicat is not reuesting relief with ret to the followig prour for tres

involving privately plac seurties. However, Applicat believes th the priciples underlying thes

proure would apply equaly to aggrgate tres involving su seurties.

Jack W. Murphy

July 11, 1995

Page 5

5. The Applicat wi compose, before enterig an aggregate order, a

wrtt statement (the "Aloction Statement") as to how the order will

be alocte among the varous accunts;

6. If the aggregate order is fied in its entity, it shal be alocte

among the acunts in acrdace with the Aloction Statement; if the

order is pary fied, it shal be alocte pro rata bas on the

Aloction Statement;

7. Notwthstading the foregoing, the order may be alocte on a basis

different from that speified in the Aloction Statement if al accunts

of clients whose orders are allocte recive fai and equitale

trtment and the reaon for such different aloction is explained in

writing and is approved in wrtig by the Applicat's compliance

officer no later than one hour after the opening of the markets on the

trding day following the day on which the order is execute;

8. If an agregate order is pay filed and alocte on a basis differ­

ent from that speified in the Alloction Statement, no accunt that is

benefite by such different aloction may effect any purchas or sae,

for a reonable period following the execution of the aggregate order,

that would result in it reciving or sellng more shares than the amount

of shares it would have recived or sold had the aggregated order been

completely fuled;

9. The Applicat's books and recrds wil separtely reflect, for each

account of a client whose orders are aggregate, the seurities held by,

and bought and sold for, each accunt;

10. Funds and seurities of clients whose orders are aggregated wil be

deposite with one or more banks or broker-deaers, and neither the

clients' cah nor their securities will be held collectively for the clients

any longer than is necsa to sette the purchas or sae in question

on a delivery versus payment basis; cah or seurities held collectively

for clients will be delivere out to the bank or broker-deaer having

custody of the client's accunt as soon as practicable following

settement;

11. The Applicat wil recive no additiona compensation or remuneration

of any kind as a result of the propose proure; and

Jack W. Murphy

July 11, 1995

Page 6

12. Individua investment advice and trtment will be acrded to eah

advisory client's acunt.

We believe that permittng aggregation under the foregoing conditions, rearless of the level

of the adviser's interest in the trsaction, is fully Consistent with both the Advisers Act and

the Investment Company Act, eah of which is addresse seartely below.

A. Investment Advisers Act of 1940

The proposa to aggregate orders of wholly non-proprieta acunts and

accunts in which employees or pricipals of an Applicat own some stok or parership

interest implicates a number of duties under the Advisers Act. Thes duties of the adviser

include the duty of disclosurel' and the duty to treat each client faily.~' The Applicat's

proposed course of action is consistent with each of these duties.

1. Dut of Disclosure

The duty of disclosure wil be satisfied by conditions #1 and #2 abve, which

require that the proposa be fully disclose to clients and speificaly approved by clients'that

are registered investment companies. The disclosure (on Form ADV) will also explai that

aggregation should, on average, reduce slightly the costs of execution and that the adviser

wil not aggregate a client's order if, in a parcular instace, it believes that aggregation

would cause the client's costs of execution to be increaed.

2. Dut to Treat Eah Client Fairly

The duty to treat each client faily will be satisfied by conditions #4 though

#8 above, which require -- among other things -- tht no advisory accunt be favore by the

Adviser over any other account and that each client who parcipates in an agggate order

wil parcipate at the average share price,l/ with al trsation costs sha on a pro rata

basis. In addition, a policy of permittig aggregation as desribed in ths lettr wi gretly

simplify the policing of an adviser's investment pratices as it will be eay to determine

11

~

~ 17 C.F.R. § 275.204-3.

See, ~, Wilkinson, SUDra; se also Piette, ~.

~ ~ Charles Schwab & Co., SEC No-Action Le, 199 LEXIS No-Act. 543 (Mar. 13,

199) (prmtting asigng of averge pnce pe sh to aggrgat order); Dea Witt & Co., SEC No-

Action Ler, 1977 LEXIS No-Act. 1836 (Jul. 14, 1977) (sa); Kidder. Peaboy & Co.. SEC No-Acton

Ler. 1976 LEXIS No-Act. 90 (Apr. 18, 1976) (sa).

Jack W. Murphy

July 11, 1995

Page 7

whether the policy has been adhere to and whether eah client, therefore, ha be trte

faily.

On the other hand, preluding aggregation of accunts pose a number of

problems. First, precluding aggregation of accunts where advisory persnnel own an inter­

est could eliminate or reduce the cost savigs that ca be obtaned from aggregation.

Secnd, there appes to be only one remote, theoretica conflct of interet

that would be avoided if the Applicat were prohibite from aggregating accunts where

affiliate persons of an adviser own interets. Th is, there might be a concern tht aggr

gation of orders could cause an adviser to purchas unsuitale seunties for one client

account so as to reduce the execution costs for an acunt in which advisory employee

owned an interest. However, the gains from aggregation in terms of reduce execution costs

are highly unlikely to provide incentives to an adviser to acquire unsuitable investments for

one client account.

Third, precluding aggregation of accunts in the circumstace propose above

wil greatly complicate the adoption and monitonng of policies to prevent conflcts of inter­

est, thereby increaing administrtive costs and non-cmpliace nsks to investment advisers

whose principals and employees are, to parphra, "willng to put their money where their

advice is." For example, where an adviser wishes to acquire the sae seunties for two

accounts that canot be aggregate becuse one is owned by affiliates, how is the adviser to

determine which account's orders get filled first? One possibilty is that the order of fi be

radomize; another is that the nght to go first rotate in a fixed order. In either cae, the

result would be that the accounts would be depnved of the ecnomies of scae that aggrega­

tion allows, and one or more accunts could be inadvertntly "front runned." Another policy

is one that alloctes the best pnced orders after the fact to accounts that do not include any

advisory personnel and the remainder to the accunts that include advisory personnel. Such

a policy, however, would be unfair to the unaffiliate persons who invest in accounts in the

latter category (and to whom the Applicat owes fiduciar duties). Such a policy also would

likely dnve affiate persons of an adviser to invest wholly indepndently of the adviser's

clients, thereby dnving up execution costs for all concerned and reducing the commonalty

interest between such persons and advisory clients. Indee, in the recnt discussions of

personal trding by mutual fund portfolio managers, the statement has been made reptely

that it is better for portfolio managers to invest with their clients than separtely from them.

*****

In sum, we believe that the proposa above to permit the Applicat to agg­

gate orders as long as the procures set fort above ar followed is fully consistent with the

terms of, and the policies underlying, the Advisers Act.

Jack W. Murphy

July 11, 1995

Page 8

B. Investment Company Act of 1940

The aggrgaton of client orders also rase an issue under the Investment

Company Act, beuse the agregation of orders of a registere investment compay ("RIC")

with an affite of or underwter for the RYC, or an afte of either, may be a prohibite

joint trsaction under the Investment Company Act. Section 17(d) of the Investment

Company Act and .Rule 17d-l promulgate thereunder generay prohibit an affiiate of or

principal underwter for a RIC, or an affiate of either, frm effectig any trsation in

which the RIC, or a company controlled by the RYC, is a "joint or joint and severa" parci­

pant, without the prior approval of the Commission.!'

It appes that the Commission currently taes the position that aggregatig

orders of RICs with orders of their affiliates or affiiates of their affiliates is not a joint trs­

action. We know of no enforcement action brought by the Commission on the ground th

such a trsaction was effecte without its prior approval, and, in a recnt enforcement

action brought under Section l7(d), the Commission implied that aggregation alone would

not constitute a joint trsaction. In 1993, the Commission brought an enforcement action

against Kemper Financial Services, Inc. for effectig joint trsactions in violation of Section

17(d) and Rule 17d-1.21 Kemper exercise discretionar authority in aggregating orders for

advisory clients, including two mutual funds and a Kemper employee profit-sharg plan.

Kemper did not designate the client for which the orders were entered and alocte tres

with more favorable execution prices to the profit-shang plan. The Commission's Order

nowhere suggests that the violation of the joint trsation provision arose by virte of the

very fact of aggregation. Rather, the Commission stated that the joint trsaction "arose

from the manner in which" the trdes were allocte, implying that trdes may be aggregate

between RICs and their affiliates without trggering the joint trsaction prohibition if proper

alloction procures are followed.!' Based on Kemper, we believe that the aggregation of

~

15 U.S.C. § 80a-17(d); 17 C.F.R. § 270.

17d-L.

!' In re Kemoer Financial Service. Inc., Admistrve Proing File No. 3-8207, (1993

TRSFER BINER) Fed. Sec. L. Rep. (CCH , 85,237 (Oct. 20, 1993).

!' hL at 84,597 (emphais added). BY ~ Notice of Proosa to Amd Rule 17d-l bv the

Adootion of Rule 17d-Hd)(4), Investmet Compy Act Relea No. 7035, 1972 SEC LEXIS 1485, at "'-3

(Mar. 9, 1972) (.Section 17(d) . . . and Rule 17d-l . . . may be deeme to prohibit affiiat persns of, and

pricipal underwters for, a (RIC) or affiliate persn of suh persns. . . frm combing, for the purse of

execution, their orders for the purha or sae of seurties with an order of suh (RC). .); Notice of

Withdrawal of Prooose Rule 17d-Hd)(4), Investmet Compy Act Relea No. 9170, 1976 SEC LEXIS 2376

(Feb. 19, 1976); Doul!las Mercr, SEC No-Action Le, (1971-1972 TRSFER BINER) Fed. Sec. L.

Rep. (CCH) , 78,662 (Jan. 8, 1972) (prmttig aggregation of RIC ordrs with ordrs of affliat unde ce­

(contiue... )

Jack W. Murphy

July 11, 1995

Page 9

orders for RICs, or compaes contrlled by RICs, with orders of thei afte doe not

constitute a joint trsaction under Section 17(d) and Rule 17d-1.

Moreover, it is generay acte tht an element of combintion, pattrn of

conduct, or profit motive must be prent for Section 17(d) and Rule 17d-l to apply.!1 The

aggregation of orders doe not alone constitute a combination or pattrn or an enterpnse

conducte for the purpse of makg a profit. The decsion to aggate is not the product

of an understading among the paes to engage in a pattrn of bevior; rather, it is merely

a discrete incident of independent decisions made by the pares to purcha the sae seunty

at the sae time. Any "pattrn. of aggregating tres among ce entities would result

only from a commonality of investment objectives, and not from any motive or purpse

relate to the execution of the order.

Nor is it necsa to treat the aggregation of orders of RICs and their affi­

ates as a joint trsaction to effect the policies underlying the joint trsaction prohibition.

As the Commission has state:

.Section I7(d) and Rule I7d-I, taen together, ar designed to

enable the Commission to pass upon trsactions in which a

conflct of interest may result in investment companies or their

controlled companies parcipatig on a basis different frm or

less advantageous than other parcipants."!!

!I(u.continued)

ta conditions peding adoption of propose Rule 17d-1(d)(4)); RoDe & OnlY. SEC No-Action Letter, 1972

LEXIS No-Act. 378 (Jan. 8, 1972) (sae).

!' ~ Rule 17d-1(c); 17 C.F.R. § 270.

17d-1(c) (reuirig parcipaon in "entense or under-

tag" or shag of profits of sa); SEC v. Talley Indust.. Inc., (1967-1969 TRSFER BINER) Fed.

Sec. L. Rep. (CCH) , 92,240, at 97,103 (2d Cir. 1968) ("some elemet of 'combinon' is reui" for Se­

tion i7(d) to apply), cert. denied, 393 U.S. 1015 (1969); In the Matter of Steama Secntv Com., Investment

Company Act Relea No. 9830, (1977-1978 TRSFER BINER) Fed. Sec. L. Rep. (CCH , 81,243, at

88,339-13 (June 29, 1977) (reuirig a "ca nexus or a quid pro quo" beee the relevant trtions in

order to prove the nec elemet of "some sort of 'combintion'" under Setion 17(d)); In the Matter of

Stema Secuntv Com., Admistrye Prog File No. 3-3101, (1974-1975 TRSFER BINER) Fed.

Sec. L. Rep. (CCH) , 80,038, at 84,848 (Déc. 20, 1974) (reuig profit motive or elemet of investmt to

suta Section 17(d) violation).

~ Amendment to Rule 1 7d- 1 Exemots Stock Plans of Controlled Portfolio Comoanes, Inves­

met Company Act Relea No. 6154, (1969-1970 TRSFER BINER) Fed. Se. L. Rep. (CCH) , 77,847,

at 84,00 (Aug. 10, 1970). Section 17(d) authori the Commssion to prebe rues therder "for the

purse of limiting or preventing pacipation by (a RIC) or contrlled compy on a bas differet frm or

les advantageous th tht" of other pacipats. 15 U.S.C. § 80a-17(d).

Jack W. Murphy

July 11, 1995

Page 10

As discuss abve, the aggregation of RIC orders with orders of afte would pret

mima risk tht the RIC - or any parcipat - in the trsation ,would be tr unfaly.

To the contr, the very purpse of aggation is to ensure tht al pares pacipate on

the sae basis, and the risks of unfai trtment would be greter if the orders of RICs were

required to be execute seartely from orders of non-RICs.

Finy, excludig the aggation of orders from the joint trsation prohibi­

tion would be consistent with positions th the Commission and its staf have ta in ano­

gous situtions. In the 1970s, the sta grte no-action relief under Section 17(d) and Rule

17d-1 in connection with the purchas of errrs and omissions policies by a RIC and its

affiate.ll The pares purchas the insurace on a joint basis in order to obta bulk

discounts on premiums. In 1979, the Commission coified the stars no-action positions by

amending Rule i 7d-1 to exempt joint purchas of liabilty policies by RICs and their affi­

ates.1Y Similarly, in 1973 the Commission amended Rule 17g-1 under the Investment

Company Act to exempt joint purchas of fidelity bonds by RICs and their affilte from

the joint trsation prohibition.ill Thus, the Commission and its staf have previously ex­

empte from the joint trsaction prohibition trsactions that involve the aggregatig of

purchases of services by a RIC and affuiate pares for the purpse of obtaing bulk dis­

counts. !!'

!! ~ St. Paul Capital Fund. Inc. SEC No-Action Letter (1979 TRSFER BINER) Fed. Sec.

L. Rep. (CCH) , 82,056 (Mar. 16, 1979); Mather Fund. Inc., SEC No-Action Leter, (1978 TRSFER

BINER) Fed. Sec. L. Rep. (CCH) , 81,695 (Feb. 6, 1978); Capital Prervation Fund. Inc., SEC No-Action

Ler, (1976-1977 TRSFER BINDER) Fed. Se. L. Rep. (CCH) , 81,022 (Nov. 27, 1976); Partenon

Fund. Inc., SEC No-Action Letter, (1975-1976 TRSFER BINER) Fed. Sec. L. Rep. (CCI , 80,451

(Mar. 3, 1976).

ll Exemption of Certin Joint Purchas of Liabilty Insurace Policies, Investmt Company Act

Relea No. 10891, (1979-1980 TRSFER BINER) Fed. Sec~ L. Rep. (CCH) , 82,317 (Oct. 4, 1979).

17¡-1; Adoption of Amendments to Rule 172-1 under the Investment Com­

panv Act of 1940 to Provide That Fidelity Bonds Reauire Purst to the Rule Shall COmDiv with Certin New

ll 17 C.F.R. § 275.

and Revise Provisions, Investmet Company Act Relea No. 8267, (1973-1974 TRSFER BINER) Fed.

Sec. L. Rep. (CCH) , 79,703 (Mar. 14, 1974).

~ The Commssion ha taen the potion th, when -there is litte likelihoo th pacipaon

by (a RIC in a tration) will ret in unfai or divantageous trtmt- to the RIC or compes con­

trlled by the RIC, it is relevant -th the antifr provisions of the fedra seurties laws ar also applicale

to joint trations in which registere investmet compes or their contrlled compes parcipate. ­

Adoption of Amendment to Rule 17d-l Under the Invesment Company ct of 1940 Exemptin2 Cerin Joint

Trasactions Involvin2 Re2Ìstere Investment Comoaies, Investmt Company Act Relea No. 8542 (1974­

1975 TRSFER BINDER) Fed. Sec. L. Rep. (CCI , 79,982, at 84,528 (Oct. 15, 1974) (amending Rule

17d-! to exempt cert affiliate trtions from Rule). As discus above, we believe th the antifrud

(contiue..)

Jack W. Murphy

July 1 I, 1995

Page 11

IV. Conclusion

For al the foregoing rens, we retfy request tht the staf grt th

reuest for no-action relief set fort abve. If you have any questions, plea do not hesta

absence, plea ca Mercr E. Bullard at 202-663­

to ca me at 202-663-6733 (or, in my

64).

Yours try,

L /1JJ­

Erc R. Markus

.!(...contîue)

provisions of the Advise Act, and the fiduciar dutes imp therder, provide amle protetion api

the minimal risk of self-deaing prete by the ag¡gaton of ord.