From

Readings on the Investment Company Actand the Investment Advisers Act

Larry D. BarnettSchool of Law

Widener UniversityWilmington, Delaware

Copyright © 2008by

Larry D. BarnettAll rights reserved

Additional materials © 2008by

C. Steven Bradford

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Chapter 3. Structural Aspectsof an Investment Company

A. Name

In the Matter ofCivil and Military Investors Mutual Fund, Inc.

Securities and Exchange Commission Release No. IC-2723June 9, 1958

1958 SEC LEXIS 405

. . .This is a proceeding to determine whether the name of Civil and Military

Investors Mutual Fund, Inc. ('registrant'), a registered investment company, and specifically the words 'Civil and Military Investors' in such name, are deceptive or misleading in violation of Sections 35(a) and 35(d) of the Investment Company Act of 1940 ('Act').1

. . .In November 1954, registrant was organized under the name 'Government

Personnel Mutual Fund, Inc.' and became registered with us as an investment company. In the course of proceedings pursuant to Section 35 of the Act with respect to such name, registrant changed its name to 'The Private Investment Fund for Governmental Personnel, Inc.' After hearings we found, among other things, that such name, and specifically the words 'Governmental Personnel' therein, were deceptive and misleading as implying that registrant's securities had investment and

1 ?Section 35(a) of the Act provides:'It shall be unlawful for any person, in issuing or selling any security of which

a registered investment company is the issuer, to represent or imply in any manner whatsoever that such security or company has been guaranteed, sponsored, recommended, or approved by the United States or any agency or officer thereof.'

Section 35(d) of the Act provides in pertinent part:'It shall be unlawful for any registered investment company hereafter to adopt

as a part of the name or title of such company, or of any security of which it is the issuer, any word or words which the Commission finds and by order declares to be deceptive or misleading.'

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other advantages for the civilian and military government personnel to whom sales were to be restricted, in violation of Section 35(d) of the Act, and as implying approval of registrant and its securities by the United States, in violation of Sections 35(a) and 35(d) of the Act. In March 1957 registrant adopted its present name.

Registrant is a Delaware corporation with its principal office in Washington, D.C. . . . It proposes to operate as an open-end, diversified, management investment company seeking long-term growth of principal and income primarily through diversified holdings of selected common stocks. The sale of registrant's shares will not be restricted to personnel of federal, state and local governments, including military personnel, although sales efforts will be directed to them. Registrant's directors include former high government officials and a retired general.

We stated in The Private Investment Fund for Governmental Personnel, Inc.4

that, in determining whether the name of an investment company is deceptive or misleading, we must carry out the Congressional policy . . . of affording broad protection to investors against fraud and misrepresentation of all types in the sale of securities. We must give due recognition, as have the courts, to the fact that 'the investing and usually naive public needs special protection in this specialized field'; and must take into account the effect which the name may have not only on the sophisticated and informed investor, but also on the unwary and the ignorant. Actual deception of investors need not be shown, it being sufficient if the name of the company is found to have a tendency or capacity to deceive or mislead; and it is appropriate to take into account that a newly adopted name not only does not have the benefit of any clarifying effect which long usage might have supplied but also has no trade value which might warrant permitting continued use of a misleading name in conjunction with a qualifying statement designed to prevent deception.

With these as general guiding principles, we turn to a consideration of the issues presented.

Implication of Investment and Other Advantages

With respect to the issue presented of whether registrant's name is deceptive or misleading within the meaning of Section 35(d) of the Act as implying investment and other advantages for government personnel that do not in fact exist, the contentions of [our Division of Corporate Regulation] and registrant are almost identical with those advanced in the Private Investment Fund case, and the evidence presented is substantially the same. The Division contends that registrant's name, no less than its previous name, indicates that the sale of registrant's shares will be directed to government personnel and accordingly implies that registrant will provide unique investment or other advantages for them. It asserts that government personnel are not a homogeneous group having a special investment need, and that they will be

4 437 S.E.C. 484, 487-8 (1957).

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misled by the name into believing that they are, that registrant will serve such need, and that other investment companies will not do so.

Registrant admits that its new name will indicate to government personnel that the fund is directed to them, but it denied that the name implies investment or other advantages for government personnel over other mutual funds. It asserts that the name merely implies and was intended to imply features which registrant believes will 'interest and appeal to' government personnel as investors. Registrant argues that there is a degree of homogeneity in government personnel and asserts that they have greater stability of income and employment than non-governmental personnel, higher median income, more established fringe benefits, greater proportionate participation in the United States Savings Bond program and a greater preference for mutual fund periodic purchase plans, and do not have the same opportunity to participate in employee stock purchase plans.

Registrant claims that the stability of governmental personnel would cause registrant to enjoy a redemption experience superior to that of mutual funds generally, and sufficiently good to justify an offering of shares to such personnel on terms which would be markedly better than those offered by funds organized in the past 10 years and would compare favorably with the terms prevailing in the industry. It points to the fact that sales commissions will be a maximum of 71/2% of the public offering price, and asserts that no significant fund has been organized in the past 10 years with a sales load as low. It states that registrant is the only fund of general distribution which will offer a program for the accumulation of shares with periodic investments of $50 or $100 at a sales load of 71/2%, that the accumulation of shares will be possible with an initial payment of only $50 without payment of a bank service charge and as little as $25 with a 25 cents bank service charge, periodic payments and bank charges thereafter being in the same small amounts, and that such initial minimum payments are considerably lower than are generally required by other mutual funds. Registrant also points out that while it will pay the standard management-advisory fee of 1/2 of 1% per annum of average net assets, unlike most funds it will pay progressively lower fees on assets in excess of $25 million, and that while several major funds also apply lower fees on assets in excess of certain amounts, such amounts are considerably greater than $25 million.

In addition, registrant asserts that it offers other features which it believes will appeal to government personnel such as an all-common stock portfolio which would provide a degree of protection against inflation and a board of directors which includes men of outstanding reputation and experience in government service.

We are of the opinion that registrant's present name, like its previous name, implies that registrant is particularly suited to meet the investment needs of government personnel and will provide investment or other advantages for them not available in other mutual funds. Since in our view such advantages do not in fact exist, such implication renders the name misleading and deceptive. We are unable to find that governmental personnel constitute a homogeneous group with a peculiar

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investment need or with characteristics which would give financial advantages to a mutual fund directed to them and would make the fund specially suited to them. Such personnel have widely varying financial positions and investment needs, particularly since the group consists not only of federal employees, but also of state, county and municipal employees, and all classes of military personnel. Like private employees, they vary greatly in their incomes and family responsibilities and they are engaged in a great variety and range of occupations. Whether or not the median income and stability of employment of government personnel are greater than in the case of private employees, we think that such a comparison is not a valid one, and that a more appropriate comparison would be between such government personnel as are likely to become mutual fund investors and potential investors generally.8 In any event, we do not consider that the average median income of so heterogeneous a group as that to which registrant's shares are to be offered is particularly significant. While generally speaking the employment of civilian government personnel is relatively stable, it has not been shown that such investors are in a significantly more favorable situation than investors who are not civilian government employees.

Nor does the record indicate the suitability of a special common stock investment program for so diverse a group as civil and military personnel. While their salary levels are in large part established by legislative action and may to some extent tend to lag in periods of inflation, the record does not show that government personnel have not provided themselves with as much protection against inflation through acquisition of common stock or otherwise and have a greater need for investment in diversified common stocks than non-governmental personnel. The alleged fact that a larger percentage of federal than private employees purchase United States Savings Bonds does not indicate the suitability of a common stock fund for those government workers who own little or no bonds, as compared to a form of investment which consists largely or partly of bonds, or other senior securities. And while federal employees have certain uniform fringe benefits such as retirement rights and sick leave, many private corporations provide similar benefits. In any event, registrant proposes to follow the same basic investment policy -- that of long-term growth of principal and income primarily through diversified holdings of selected common stocks -- as that of a number of other mutual funds which are available generally to government employees whose financial situation makes investment in such a fund desirable.

With respect to registrant's 7 1/2% sales charge and . . . [terms for the accumulation of shares through periodic investments], the record indicates that these features are not significantly more favorable, and in some respects are less favorable, than the terms available in other mutual funds. . . .

8 8While, as registrant points out, government personnel do not have as great a proportion of low incomes as non-government personnel, neither do they have as great a proportion of high incomes.

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With respect to the reductions in registrant's management-advisory fees on assets in excess of $25 million, whether such lower charges will ever become effective will of course depend upon future sales of registrant's shares, and any benefit to be derived therefrom by the shareholders will depend upon whether registrant's total expenses, including the management-advisory fee, are less than those of other mutual funds.

Nor do we perceive any advantage to government personnel in the fact that registrant's board of directors is in part composed of men who formerly occupied important positions in the federal government and have experience with problems of government personnel. There is no indication that these men have had any investment or financial experience which would qualify them as investment managers, and their familiarity with the problems of government personnel will provide no apparent advantage for such personnel in their capacity as investors.

Registrant asserts that the names of other mutual funds registered with us, such as a number which begin with the name of a state and Teachers Association Mutual Fund of California, Inc., indicate that such funds are directed to particular groups, and contends that it would be arbitrary to require registrant, as a condition to using its name, to show unique investment advantages for the group to which its fund is directed. However, we think that registrant's name presents a materially different situation. The use of the name of a state in the title of a fund does not in our opinion imply that the fund is designed to meet the investment needs of the residents of the particular state, nor does it imply other advantages to such residents. With respect to the Teachers Association fund, the name of that fund is identified with and descriptive of an existing local organization of teachers, California Teachers Association-Southern Section, which authorized and approved the creation of the fund. The fund sells shares exclusively to members and employees of that Association and their families, and the officers and directors of the fund include officers, directors and members of the Association. The shares are distributed and sold through a wholly-owned subsidiary of the Association, no sales being made through brokers or dealers, and the sales load is only 2% and covers all distribution expenses. While the fund pays a management-advisory fee of 1% as compared to the prevailing fee of 1/2 of 1%, the manager of the fund pays all other expenses except taxes and interest, whereas registrant must pay all expenses, including the management-advisory fee, custodian fees, transfer agent fees, legal and accounting fees, and fees of technical advisors, and is entitled to reimbursement of such expenses by its distributor only to the extent that they exceed 1% of registrant's average net assets.

We conclude that the implication inherent in registrant's name that the fund has special investment or other advantages for government employees or military personnel that, as we have found, do not in fact exist, renders that name misleading and deceptive within the meaning of Section 35(d) of the Act.

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Implication of Approval by United States

Registrant contends that its name, and specifically the use of the words 'Civil and Military' in such name, does not convey a misleading impression of recommendation, sponsorship or approval of registrant or its securities by the United States in violation of Sections 35(a) and 35(d) of the Act. In The Private Investment Fund for Governmental Personnel, Inc., we found that the fact that the words 'Government' and 'Government Personnel' were used in a number of official government publications to refer to the United States government and its employees, together with the implication in the name that the fund was directed exclusively to such employees, and the Federal government's increasing interest and participation in projects for the welfare of its employees such as group life insurance, created the implication of at least approval of registrant and its shares by the United States. In the instant case, however, we do not think that the phrase 'Civil and Military', in association with the word 'Investors', carries an official flavor such as we found attached to the words 'Governmental Personnel'. Accordingly, we are of the opinion that neither registrant's name in its entirety, nor the words 'Civil and Military' in such name, would be likely to carry an implication that registrant or its securities have been sponsored, recommended, or approved by the United States. We accordingly find that registrant's name does not violate Section 35(a) of the Act.

Conclusion

We have found that registrant's name implies that registrant will provide special investment and other advantages for government personnel that do not in fact exist. Accordingly, we shall issue an order declaring registrant's name and specifically the words 'Civil and Military Investors' in such name to be deceptive and misleading in violation of Section 35(d) of the Act.

. . .

By the Commission . . .

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Civil and Military Investors Mutual Fund, Inc.v. Securities and Exchange Commission

288 F.2d 156 (D.C. Cir. 1961)

OPINION OF THE COURT

Petitioner Civil and Military Investors Mutual Fund, Inc., seeks review of an order of the respondent Securities and Exchange Commission declaring petitioner's name to be deceptive and misleading in violation of Section 35(d) of the Investment Company Act of 1940 . . . .

Petitioner, an investment company registered under the Act, proposes to sell mutual fund shares by means of 'Accumulation Plans.'1 . . . [I]n 1957 petitioner adopted its present name, 'Civil and Military Investors Mutual Fund, Inc.' . . . [T]he Commission found that the present name 'implies that (petitioner) will provide special investment and other advantages for government personnel that do not in fact exist,' and issued an order declaring it deceptive and misleading.

Petitioner then filed a motion before the Commission seeking modification of this order because of changes in the terms of the offering . . . . The principal changes were two: (1) elimination of a 71/2% sales commission; and (2) the decision to sell its shares only to Federal, state and local government employees. . . .

. . . [T]he Commission entered an order denying the petition for modification, stating, in part, in its findings:

'We are unable to find that either the changed terms of the proposed offering or the asserted interest of government personnel in accumulation plans renders not deceptive or misleading the implication which is inherent in (petitioner's) name that (petitioner) is particularly suited to meet the investment needs of such personnel.'. . .Petitioner urges that its name is intended to imply, and does imply, only that

its sales will be restricted to government employees, and not that this group will derive special advantages from the plan. At the same time it contends that its plan does provide advantages for government personnel, in that the terms of acquisition will be of special interest to such personnel. The Commission, on the other hand, argues that the name does not merely describe the group addressed, but raises an expectation in that group of an investment advantage which goes to the very heart of the transaction. There is, concededly, nothing unique about the type of securities the

1 1Unlike the method of share acquisition known as 'Regular Account' buying, by which investors purchase specified numbers of shares in distinct transactions, the 'Accumulation Plan' permits investors to make payments of a specified sum on a regular or irregular basis, with each payment being used in full to buy as many shares as possible plus a fractional share.

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Fund proposes to acquire, or the financial terms offered. Many investment companies offer accumulation plans. Many do not charge a sales commission. Therefore, in the Commission's view, it is irrelevant that the means of acquisition of petitioner's shares -- the accumulation plan buying provisions -- may be a desirable arrangement, since the implication raised by the name suggests more than that. But in any case, the Commission contends, petitioner failed to establish even that the accumulation plan feature is of unique interest to government employees.

We believe, taking the record as a whole, that the Commission's determination has substantial evidentiary support. We cannot say that it was unreasonable for the Commission to conclude that the name in question implies a unique and material advantage to a particular group, and that the expectations raised by the name may have a harmful tendency to mislead and deceive prospective investors.

The Commission has not found an actual intent to deceive, on the part of petitioner and its managers, and we find no suggestion of any such intent. What it has found is a harmful tendency inherent in the name itself. That is enough. The Commission is entitled to insist that the public be led to look to the essential merits of an investment offered to it, rather than to matters extraneous to those merits. We find in this case no such arbitrary or unreasonable action as would warrant disturbing the Commission's determination.

Affirmed.

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Note

In The First Safe Fund (publicly available January 9, 1972), 1972 SEC NOACT LEXIS 159, the Commission staff received an inquiry regarding a proposed open-end investment company that would have ". . . protection of capital as its primary objective. The company will have two funds, one fund for investing in United States government securit[ies] and high quality corporate and utility bonds, and a second fund for investing in high grade municipal tax-exempt bonds. . . . [T]he proposed name of the company is 'The First Safe Fund'. . . ." The staff responded: "In our view use of the word 'safe' in the proposed Fund's name would be misleading within the meaning of Section 35(d) of the Investment Company Act because it could be taken to mean that, in addition to principal, investment return of a particular rate is assured, which, of course, is not the case as government, corporate and utility bond rates vary. Also, since the Fund will invest in government securities, use of the word 'safe' might imply government guarantee of the Fund. The latter implication is prohibited by Section 35(a) of the Act."

In Wright Investors Service (publicly available March 14, 1974), 1974 SEC NOACT LEXIS 1785, a mutual fund was being organized ". . . that will combine the advantages of a fund offering current high interest rates with those of a fund offering potential equity growth, through the medium of a single investment company. The proposed Fund [to be named the Wright Savings and Equity Shares] will also permit virtually unrestricted exchange privileges between 'Savings' and 'Equity' Shares within the Fund at little or no cost to the individual investor. It is our belief that such a Fund will meet the needs and the demands of the small investor who seeks profes-sional management." The SEC staff concluded that ". . . in our view, use of the word 'Savings' in the proposed Fund's name would be misleading within the meaning of Section 35(d) of the Investment Company [Act] of 1940. The reason for our view is that the name could be taken to mean that the 'savings shares' being offered are comparable to savings accounts in a bank, which are commonly insured by the federal government. It may occur to you that some explanation in the prospectus would obviate this problem, but under applicable Commission decisions, an explanation in the company's prospectus to the effect that the shares are not insured by the federal government would not cure the deceptive or misleading character of the name. . . ."

In National Securities & Research Corporation (publicly available January 21, 1974), 1974 SEC NOACT LEXIS 1331, the name of a registered investment company was to be changed from the "National Securities Funds" to the "Savest Funds." The company explained that " 'Savest' is, of course, a meld of 'save' and 'invest.' Mutual funds are designed as a savings vehicle in which a broad cross section of the public may accumulate a professionally managed investment program for long term goals." The staff, however, concluded the new name would violate the Investment Company Act: "it [is] our view that the name 'Savest' is misleading

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within the meaning of Section 35(d) . . . in that it sounds like 'Safest' and may also have connotations of savings accounts, which are commonly government-guaranteed. Accordingly, we are not able to state that we would not recommend any action to the Commission if the name is used."

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Note

To implement amended section 35(d), the Securities and Exchange Commission adopted Rule 35d-1 to specify names that are materially deceptive or misleading. Investment Company Names, Release No. IC-24828, 66 Fed. Reg. 8509 (Feb. 1, 2001). At the time the Rule was promulgated, four out of five registered investment companies were estimated to have names that were subject to the Rule. Id. at 8515 n.49. Read Rule 35d-1.

In the Release adopting the Rule, the Commission pointed out that:the 80% investment requirement is not intended to create a safe harbor for investment company names. A name may be materially deceptive and misleading even if the investment company meets the 80% re-quirement. Index funds, for example, generally would be expected to invest more than 80% of their assets in investments connoted by the applicable index. . . .

Id. at 8511.

The Commission elaborated further on the scope of the Rule, saying that:the rule does not apply to fund names that incorporate terms such as >growth= and >value= that connote types of investment strategies as opposed to types of investments. The Division [of Investment Management] will continue to scrutinize investment company names not covered by the proposed rule. In determining whether a particular name is misleading, the Division will consider whether the name would lead a reasonable investor to conclude that the company invests in a manner that is inconsistent with the company's intended investments or the risks of those investments.

Id. at 8514.

The terms >small, mid, or large capitalization= and >index= suggest a focus on a particular type of investment, and investment companies that use these terms will be subject to the 80% investment requirement of the rule. The term >balanced,= however, does not suggest a particular investment focus, but rather a particular type of diversification among different investments, and >balanced= funds will not be subject to the rule. The Division takes the position that an investment company that holds itself out as >balanced= should invest at least 25% of its assets in fixed income senior securities and should invest at least 25% of its assets in equities. . . .

The term >foreign= indicates investments that are tied economically to countries outside the United States, and an investment

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company that uses this term would be subject to the 80% requirement. The terms >international= and >global,= however, connote diversification among investments in a number of different countries throughout the world, and >international= and >global= funds will not be subject to the rule. We would expect, however, that investment companies using these terms in their names will invest their assets in investments that are tied economically to a number of countries throughout the world. . . .

Id. at 8514 n.42.

Following the Release that adopted Rule 35d-1, the staff of the Division of Investment Management explained how the Rule applies to a number of situations. Investment Company Institute (publicly available Dec. 4, 2001), 2001 SEC NOACT LEXIS 824. In a question-and-answer format, the staff wrote inter alia:

. . .Q: Are funds with the term >municipal= in their names treated like tax-exempt funds under rule 35d-1(a)(4)?A: Yes. The terms >municipal= and >municipal bond= in a fund's name suggest that the fund's distributions are exempt from income tax. Therefore, funds that use these terms in their names would be expected to comply with rule 35d-1(a)(4). However, funds that use the term >municipal= rather than >tax-exempt= may count securities that generate income subject to the alternative minimum tax toward the 80% investment requirement, while funds that use the term >tax-exempt= may not.. . .Q: Does rule 35d-1 apply to funds that use the terms >small-cap,= >mid-cap,= and >large-cap?=A: Yes. Terms such as >small-, mid-, or large-capitalization= suggest a focus on a particular type of investment, and investment companies that use these terms will be subject to the 80% investment requirement of the rule. As a general matter, an investment company may use any reasonable definition of these terms and should define these terms in its discussion of its investment objectives and strategies in its prospectus. In developing a definition of the terms >small-, mid-, or large-capitalization,= registrants should consider all pertinent references, including, for example, industry indices, classifications used by mutual fund rating organizations, and definitions used in financial publications. Definitions and disclosure inconsistent with common usage, including definitions relying solely on average capitalization', are considered inappropriate by the staff.

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Q. How does rule 35d-1 apply to a fund that uses the term >high-yield= in its name?A: The term >high-yield= is generally understood in the financial and investment community to describe corporate bonds that are below investment grade, commonly defined as bonds receiving a Standard & Poor's rating below BBB or a Moody's rating below Baa. Therefore, a fund using the term >high-yield= in its name generally must have a policy to invest at least 80% of its assets in bonds that are below investment grade.

However, a fund that uses the term >high-yield= in conjunction with a term such as >municipal= or >tax-exempt= that suggests that the fund invests in tax-exempt bonds would not be required to invest at least 80% of its assets in bonds that meet these rating criteria. Because the market for below investment grade municipal bonds is smaller and relatively less liquid than its taxable counterpart, tax-free high-yield bond funds have historically invested to a greater degree in higher grade bonds than taxable high-yield funds. As a result, the use of the term >high-yield= together with a term suggesting that the fund invests in tax-exempt bonds suggests that the fund has an investment strategy of pursuing a higher yield than other municipal or tax-exempt bond funds.. . .Q: Does rule 35d-1 apply to a fund that uses the term >tax-sensitive= in its name?A: No. The term >tax-sensitive= connotes a type of investment strategy rather than a focus on a particular type of investment. Therefore, use of the term >tax-sensitive= in a fund's name will not require the fund to comply with the 80% investment requirement of rule 35d-1.

We remind funds, however, that a particular fund name may be misleading under the antifraud provisions of the federal securities laws, even if it is not covered by rule 35d-1. In determining whether a particular name is misleading, the Division considers whether the name would lead a reasonable investor to conclude that the fund invests in a manner that is inconsistent with the fund's intended investments or the risks of those investments.Q: How does rule 35d-1 apply to a fund that uses the term >income= in its name?A: Rule 35d-1 would not apply to the use of the term >income= where that term suggests an investment objective or strategy rather than a type of investment. When used by itself, the term >income= in a fund's name generally suggests that the fund emphasizes the

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achievement of current income and does not suggest a type of investment. For example, fund companies offering a group of >life cycle= funds, each of which invests in stocks, bonds, and cash in a ratio considered appropriate for investors with a particular age and risk tolerance, sometimes use the term >income= to describe the fund that places the greatest emphasis on achieving current income. Similarly, the term >growth and income= does not suggest that a fund focuses its investments in a particular type of investment, but rather suggests that a fund invests its assets in order to achieve both growth of capital and current income. Likewise, the term >equity income= suggests that a fund focuses its investments in equities and has an investment objective or strategy of achieving current income. By contrast, a term such as >fixed income= suggests investment in a particular type of investment and would be covered by rule 35d-1.. . .Q: Would rule 35d-1 require a fund that uses a term such as >intermediate term bond= in its name to invest at least 80% of its assets in intermediate term bonds?A: No. The Division takes the position that a >short-term,= >intermediate-term,= or >long-term= bond fund should have a dollar-weighted average maturity of, respectively, no more than 3 years, more than 3 years but less than 10 years, or more than 10 years. Such a fund should, however, invest at least 80% of its assets in bonds in order to comply with rule 35d-1. Compliance with the Division=s maturity guidelines is not intended to act as a safe harbor in determining whether a name is misleading. There may be instances where the dollar-weighted average maturity of a fund's portfolio securities may not accurately reflect the sensitivity of the fund's share price to changes in interest rates.. . .

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Discussion Problem 3.1

Morningstar, one of the major services that monitors and evaluates mutual funds, studied fifteen stock funds whose names contained the phrase "blue chip" and concluded that "these funds employ a very different definition of the term blue chip than do the news media or the general public." Don Phillips, True Blue?, MORNINGSTAR INVESTOR 3 (May 1995). The portfolios of the fifteen funds generally consisted of growth stocks of mid-size domestic companies whose earnings per share had increased much more rapidly than earnings per share in the market as a whole. "These are hardly the characteristics of mature, staid businesses," Morningstar noted, implying that stock should be deemed "blue chip" only if the company issuing the stock is "mature" and "staid." Id. The definition of "blue chip" found in other sources is not inconsistent. For example, one source uses the term "blue chip" to refer to the securities of companies that have been able to maintain earnings and pay dividends over a long period of time, with the result that the securities carry a below-average risk investors will lose principal or suffer a decline in income. DAVID L. SCOTT, WALL STREET WORDS 36 (rev. ed. 1997). Another source defines "blue chip" as common stock issued by a company that has achieved national recognition, that has acquired a reputation for quality in its management and products, and that has had a long history of growth in profits and the payment of divi-dends. John Downes & Jordon E. Goodman, BARRON'S FINANCE & INVESTMENT HANDBOOK 202 (4th ed. 1995).

Given their portfolios, the fifteen funds can be expected to perform quite differently than the Dow Jones Industrial Average, which is composed of thirty "blue chip" stocks. Downes & Goodman, supra, at 608. Thus, the Morningstar study reported that on one day in 1995 the Dow Jones Industrial Average rose 0.7% but the net asset value of the shares of the fifteen funds either remained unchanged or declined. Six of the funds on this day saw the net asset value of their shares fall by 0.5% or more.

Should the Securities and Exchange Commission regulate use of the phrase "blue chip" in the names of stock mutual funds? If so, under what conditions should a stock fund be allowed to include "blue chip" in its name? What requirements should be imposed on the portfolio of such a fund?

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B. Financial Requirements

In the Matter ofRobbinsdale Federation Investment Fund, Inc.

Securities and Exchange Commission Release No. IC-8525October 1, 1974

1974 SEC LEXIS 2584

. . .These are proceedings with respect to an application filed pursuant to Section

6(b) of the Investment Company Act of 1940 by Wilson Anderson, Jr. ("applicant"), on behalf of Robbinsdale Federation Investment Fund, Inc. ("fund"), a proposed open-end investment company, requesting exemptions from all or some of the provisions of that Act.I

Applicant and the eight other organizers of the fund are school teachers employed by the Robbinsdale, Minnesota school district, and are among approximately 1,000 such teachers who are members of the Robbinsdale Federation of Teachers ("RFT"). The fund will issue redeemable securities without sales load and will purchase securities for investment. Participation will be limited to RFT members and former members and their immediate families.2 Management of the fund's portfolio will be vested in a board of directors elected by the shareholders,

I IEditor's note: Section 6(b) of the Investment Company Act provides that, "[u]pon application by any employees' security company, the Commission shall by order exempt such company from the provisions of this title and of the rules and regulations hereunder, if and to the extent that such exemption is consistent with the protection of investors. In determining the provisions to which such an order of exemption shall apply, the Commission shall give due weight, among other things, to the form of organization and the capital structure of such company, the persons by whom its voting securities, evidences of indebtedness, and other securities are owned and controlled, the prices at which securities issued by such company are sold and the sales load thereon, the disposition of the proceeds of such sales, the character of the securities in which such proceeds are invested, and any relationship between such company and the issuer of any such security."

An employees' securities company is defined in section 2(a)(13) of the Investment Company Act.

2 2Former RFT members and their immediate families would not be eligible to make further purchases of fund shares after termination of RFT membership.

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with costs of administration paid out of the proceeds from sale of the fund's shares. The fund will not retain any investment adviser or manager on a permanent basis and will act as its own underwriter.

. . .We thus come to the request for an exemption from Section 14(a) of the Act,

which applicant states is most crucial and without which the fund will not be organized. Section 14(a) among other things provides that a registered investment company shall not make a public offering of its securities unless it has a net worth of at least $100,000, or it has received firm agreements from not more than 25 persons to purchase its securities in an aggregate amount which when added to its net worth will equal at least $100,000. In the latter event arrangements must be made whereby any proceeds paid in will be refunded on demand in the event the net proceeds received by the company do not result in its having a net worth of at least $100,000 within 90 days after its Securities Act registration statement becomes effective.

The application states that it is anticipated that most if not all fund shareholders will purchase their stock through small monthly payments of $10 to $20 per month. Applicant estimates that it would be at least two years before investments in the fund aggregated $100,000.

Applicant argues that the primary objective of the minimum capital requirement of Section 14(a) is to prevent a "fly-by-night" irresponsible promoter from forming an investment company on a shoestring, and that there is no need for the requirement in this case. Applicant contends that there are no promoters involved with the fund,9 arguing that the fund's organizers will be on an equal footing with their fellow employee-investors and will not stand to profit except to the extent that the fund's shares appreciate, and so the question of financial responsibility is moot.

It is true that one of the objectives of Section 14(a) was to discourage the formation of investment companies by the "fast-buck, fly-by-night, office-in-your-hat, tipster-with-some-fancy-ideas promoter." We agree with applicant that this is not such a case. And we sympathize with the desire of a group of apparently responsible persons to reduce the cost and burden of acquiring an investment in a varied portfolio of securities. But guarding against the danger of irresponsible promoters is not Section 14(a)'s sole purpose. It also seeks to protect public investors against the likelihood that their investment in a new company will be consumed by inescapable overhead and operating expenses, such as filing and printing costs and legal and accounting fees. Moreover, if a fund has only enough capital to purchase very small amounts of securities, its brokerage costs may be so high as to defeat the very purpose for which it was formed.

9 9To the contrary, applicant and the other organizers are promoters within the meaning of Section 2(a)(30) of the Act, which defines a promoter of a company as one "who, acting alone or in concert with other persons, is initiating or directing . . . the organization of such company."

18

This is not to say that we would necessarily require applicant to have the $100,000 net worth specified by Section 14(a). But the proposed fund, at least for some time to come, will lack any semblance of the capital Congress considered the bare minimum11 needed by an investment company.12 Absent other factors which would provide some assurance of financial stability,13 we are constrained to deny this application. Accordingly, IT IS ORDERED that the application on behalf of Robbinsdale Federation Investment Fund, Inc. for exemption from all or some of the provisions of the Investment Company Act be, and it hereby is, denied.

By the Commission. . . .

1 11Section 1(b) of the Act declares that the national public interest and the interests of investors are adversely affected "(8) when investment companies operate without adequate assets or reserves." See also testimony . . . that it was felt that any amount less than $100,000 would be too small to cover the necessary overhead and operating expenses of a minimum company, and testimony . . . that investors had suffered substantial losses in small investment companies where expenses devoured all of their income even when they were not fly-by-nights, and that the Commission did not contemplate undoing the effect of the $100,000 requirement in Section 14(a) through the issuance of rules or the use of exemptive actions pursuant to Section 6. Hearings on H.R. 10065 before a Subcommittee of the House Committee on Inter-state and Foreign Commerce, . . . (1940).

2 12Neither extended discussion nor statistical compilations are needed to demonstrate that the $100,000 deemed essential by the Congress of 1940 was a far higher figure in real terms than that same $100,000 is today.

3 13Cooperation of the employer with the employees in the management of the company is not essential to its status as an employees' securities company. But Congress apparently contemplated such cooperation, . . . and the existence of such cooperation could under certain circumstances offer sufficient assurance of organizational and financial stability to supplant the requirements of Section 14(a). Thus, . . . where an exemption from various provisions of the Act, including Section 14(a), was granted pursuant to Section 6(b), the Commission noted among other factors conducive to the granting of the exemptions that the employer matched the contributions of each employee to the special fund in that case, that all expenses of the special fund were to be paid by the employer, and that the employer guaranteed that on liquidation each employee would receive an amount at least equal to his contributions . . . .

19

C. The Board of Directors: Interested and Affiliated Persons

*Section 9 Of The Investment Company Act

Section 9 of the Investment Company Act is commonly referred to as the Act's "bad boy" provision (although it covers "bad girls" as well). You should read ' 9(a), (b), and (c).

Section 9(a) prohibits certain persons from serving as an "employee, officer, director, member of an advisory board, investment adviser, or depositor of any registered investment company, or principal underwriter for any registered open-end company, registered unit investment trust, or registered face-amount certificate company."2 Three categories of persons are automatically subject to the ' 9(a) prohibition: (1) persons who have been convicted in the last ten years of certain securities-related crimes;3 (2) persons who, because of misconduct, have been enjoined by a court from engaging in specified securities activities;4 (3) any company that has an affiliated person who falls within one of the first two categories.5

The SEC may grant an exemption to anyone subject to the ' 9(a) prohibition if it finds that the prohibition, as applied to that person is "unduly or disproportionately severe or that the conduct of such person has been such as not to make it against the public interest or protection of investors to grant such application."6 Section 9(b) allows the SEC to extend the prohibition to additional persons who don't fall within ' 9(a) if it finds that those persons have engaged in certain specified securities violations.7 Section 9(b) is not a self-operative provision; a person who has engaged in one of the activities listed in ' 9(b) but who does not fall within ' 9(a) is not barred

2Investment Company Act ' 9(a).

3Investment Company Act ' 9(a)(1).

4Investment Company Act ' 9(a)(2).

5Investment Company Act ' 9(a)(3). The definition of "affiliated person" is in ' 2(a)(3) of the Act.

6Investment Company Act ' 9(c).

7Investment Company Act ' 9(b).

20

unless the SEC enters an order barring him. Section 9(a), on the other hand, is self-operative; a person who falls within ' 9(a) is automatically barred unless the SEC uses its ' 9(c) power to grant an exemption.

21

Note

In enacting the Investment Company Act (ICA), the U.S. Supreme Court has found,I

Congress was concerned about the potential for abuse inherent in the structure of investment companies. A mutual fund is a pool of assets, consisting primarily of portfolio securities, and belonging to the individual investors holding shares in the fund. Congress was concerned because

'[m]utual funds, with rare exception, are not operated by their own employees. Most funds are formed, sold, and managed by external organizations, [called 'investment advis-ers,'] that are separately owned and operated. . . . The advisers select the funds' investments and operate their businesses. . . .

Since a typical fund is organized by its investment adviser which provides it with almost all management services . . . , a mutual fund cannot, as a practical matter sever its relationship with the adviser. Therefore, the forces of arm's-length bargaining do not work in the mutual fund industry in the same manner as they do in other sectors of the American economy.' S. Rep. No. 91-184, p. 5 (1969).

As a consequence, '[t]he relationship between investment advisers and mutual funds is fraught with potential conflicts of interest'. . . .

The cornerstone of the ICA's effort to control conflicts of interest within mutual funds is the requirement that at least 40% of a fund's board be composed of independent outside directors.11 ' 10(a). As originally enacted, ' 10 of the Act required that these 40% not be officers or employees of the company or 'affiliated persons' of its adviser. 54 Stat. 806. In 1970, Congress amended the Act to strengthen further the independence of these directors, adding the stricter requirement that the outside directors not be 'interested persons.' See '' 10(a), 2(a)(19). To these statutorily disinterested directors, the Act assigns a host of special responsibilities involving supervision of management and financial auditing. . . .

I I Quoted passages are from Burks v. Lasker, 441 U.S. 471, 480-485 (1979).

1 11 Under certain circumstances, independent directors must constitute a majority rather than 40% of the board. See ' 10(b).

22

Congress' purpose in structuring the Act as it did is clear. It 'was designed to place the unaffiliated directors in the role of 'independent watchdogs,'', who would 'furnish an independent check upon the management' of investment companies, Hearings on H. R. 10065 before a Subcommittee of the House Committee on Interstate and Foreign Commerce, 76th Cong., 3d Sess., 109 (1940). This 'watchdog' control was chosen in preference to the more direct controls on behavior exemplified by the options not adopted. Indeed, when by 1970 it appeared that the 'affiliated person' provision of the 1940 Act might not be adequately restraining conflicts of interest, Congress turned not to direct controls, but rather to stiffening the requirement of independence as the way to 'remedy the act's deficiencies.' S. Rep. No. 91-184, pp. 32-33 (1969). Without ques-tion, '[t]he function of these provisions with respect to unaffiliated directors [was] to supply an independent check on management and to provide a means for the representation of shareholder interests in investment company affairs.' Id., at 32.

In short, the structure and purpose of the ICA indicate that Congress entrusted to the independent directors of investment companies, exercising the authority granted to them by state law, the primary responsibility for looking after the interests of the funds' shareholders. . . .

The Securities and Exchange Commission has explained the function of independent directors as follows:I

The critical role of independent directors of investment companies is necessitated, in part, by the unique structure of investment companies. Unlike a typical corporation, a fund generally has no employees of its own. Its officers are usually employed and compensated by the fund's investment adviser, which is a separately owned and operated entity. The fund relies on its investment adviser and other affiliates -- who are usually the very companies that sponsored the fund's organization -- for basic services, including investment advice, administration, and distribution.

Due to this unique structure, conflicts of interest can arise between a fund and the fund's investment adviser because the interests of the fund do not always parallel the interests of the adviser. An investment adviser's interest in maximizing its own profits for the

I IInterpretive Matters Concerning Independent Directors of Investment Companies, Investment Company Act Release No. 24083, 64 Fed. Reg. 59877, 59877-59878 (Nov. 3, 1999).

23

benefit of its owners may conflict with its paramount duty to act solely in the best interests of the fund and its shareholders.

. . .Independent directors play a critical role in policing the

potential conflicts of interest between a fund and its investment adviser. The [Investment Company] Act requires that a majority of a fund's independent directors: approve the fund's contracts with its investment adviser and principal underwriter; select the independent public accountant of the fund; and select and nominate individuals to fill independent director vacancies resulting from the assignment of an advisory contract. In addition, rules promulgated under the Act require independent directors to: approve distribution fees paid under rule 12b-1 under the Act; approve and oversee affiliated securities transactions; set the amount of the fund's fidelity bond; and determine if participation in joint insurance contracts is in the best interest of the fund. Each of these duties and responsibilities is vital to the proper functioning of fund operations and, ultimately, the protection of fund shareholders.

In addition to the requirements of federal law, directors must abide by standards of care prescribed by state statutory and common law. Specifically, directors are subject to state law duties of care and loyalty.13 The duty of care generally requires that directors act in good faith and with that degree of diligence, care and skill that a person of ordinary prudence would exercise under similar circumstances in a like position. The duty of loyalty generally requires that directors exercise their powers in the interests of the fund and not in the directors' own interests or in the interests of another person or organization.

Since July 2002, the Commission has required noninterested persons to comprise a majority of the board of directors of registered investment companies that utilize any of ten specified rules of the Securities and Exchange Commission to gain an exemption from a provision of the Investment Company Act. The noninterested directors of these investment companies, moreover, must be recruited and named by other noninterested directors. Role of Independent Directors of Investment Companies, Release No. IC-24816, 66 Fed. Reg. 3734 (Jan. 16, 2001). The ten rules are:

3 13 The business judgment rule generally protects fund directors from liability for their decisions so long as the directors acted in good faith, were reasonably informed, and rationally believed that the action taken was in the best interests of the fund. . . .

24

$ Rule 10f-3, under which an investment company can acquire securities in a primary offering when the underwriting syndicate includes a broker-dealer affiliated with the investment company;$ Rule 12b-1, under which an investment company can use its assets to pay the expenses of distributing the shares it issues;$ Rule 15a-4(b)(2), under which the board of an investment company can, without the approval of the shareholders of the company, approve an interim contract with an investment adviser when Aa previous contract [is] terminated by an assignment by an investment adviser or a controlling person of the investment adviser in connection with which assignment the investment adviser or a controlling person directly or indirectly receives money or other benefit@ (17 C.F.R. ' 270.15a-4(b)(2));$ Rule 17a-7, under which securities transactions are allowed between an investment company and another client of the adviser of the investment company;$ Rule 17a-8, under which mergers are permitted between certain affiliated investment companies;$ Rule 17d-1(d)(7), under which an investment company and its affiliates can purchase joint liability insurance policies;$ Rule 17e-1, under which an investment company may pay commissions to affiliated brokers in connection with the sale of securities on an exchange;$ Rule 17g-1(j), under which investment companies can maintain joint-insured fidelity bonds;$ Rule 18f-3, under which an investment company can issue multiple classes of voting stock; and$ Rule 23c-3, under which a registered closed-end investment company can offer to repurchase, at periodic intervals, shares it has issued to investors.

The activities to which these rules apply Arequire the independent judgment and scrutiny of independent directors in overseeing activities that are beneficial to funds and investors, but involve inherent conflicts of interest between the funds and their managers.@ Id. at 3736. In mandating that noninterested (i.e., independent) directors form a majority of the board of an investment company that relies on any of these rules, the Commission explained that:

A majority requirement will permit, under state law, the independent directors to control the fund's >corporate machinery,= i.e., to elect officers of the fund, call meetings, solicit proxies, and take other actions without the consent of the adviser. As a result, independent directors who comprise the majority of a board can have a more meaningful influence on fund management and represent shareholders from a position of strength. In short, a board with a majority of

25

independent directors can be more effective in representing investors than a board with a majority of >inside= directors.

Id.

26

*The Chamber of Commerce Case

In January 2004, the SEC proposed to add additional conditions to the ten rules specified in the previous note. For a fund to take advantage of the ten exemptions, at least 75% of its directors would have to be independent and the chairman of the fund’s board of directors would have to be independent. The SEC approved the new rules in August 2004, but the amended rules were promptly challenged by the U.S. Chamber of Commerce.

In June 2005, the D. C. Circuit Court of Appeals held that the SEC violated the Administrative Procedure Act by failing to consider the costs of the proposed rules and by giving inadequate consideration to proposed alternatives. Chamber of Commerce v. SEC, 412 F.3d 133, 143-145 (D.C. Cir. 2005). The Court of Appeals remanded the rules proposal to the SEC.

Eight days later, on essentially the same administrative record, the SEC once again voted to adopt the amendments. The rush was in part because the two conditions had originally passed by a 3-2 vote and the SEC Chairman, one of the proponents, was scheduled to retire the next day.

The Chamber of Commerce again challenged the rules and again won. The Court of Appeals held that the SEC violated the Administrative Procedure Act by relying on cost data outside the original rulemaking record. See Chamber of Commerce v. SEC, 443 F.3d 890 (2006). On December 15, 2006, the SEC proposed the governance rules once again and reopened the comment period.

27

EuroPacific Growth Fund, et al.Securities and Exchange Commission Release No. IC-23307

July 15, 199863 Fed. Reg. 38219

Action: Notice of application for an order under section 6(c) of the Investment Company Act of 1940 (the "Act") for relief from section 2(a)(19) of the Act.

Summary of Application: Applicants request an order under section 6(c) of the Act declaring that a director on the boards of certain registered investment companies[,] who also is an outside director for the parent company of a registered broker-dealer, will not be deemed an "interested person" of the registered investment companies. Applicants: EuroPacific Growth Fund ("EUPAC"), the New Economy Fund ("NEF"), New Perspective Fund, Inc. ("NPF"), SMALLCAP World Fund, Inc. ("SCWF"), The Investment Company of America ("ICA") (collectively, the "Funds"); Capital Research and Management Company ("Capital Research"); and American Funds Distributors, Inc. ("AFD").

Hearing or Notification of Hearing: An order granting the application will be issued unless the SEC orders a hearing. Interested persons may request a hearing by writing to the SEC's Secretary . . . .

Applicants Representations:

1. Each of the Funds is an open-end management investment company registered under the Act. . . .

2. Capital Research, an investment adviser registered under the Investment Advisers Act of 1940, serves as investment adviser to the Funds and certain other registered investment companies. The Funds and these investment companies, together with any future registered investment company advised by Capital Research, are referred to as the "American Funds." AFD, a wholly-owned subsidiary of Capital Research, is the principal underwriter of the Funds.

3. Each Fund has a board of directors ("Board"), a majority of whom are not "interested persons" within the meaning of section 2(a)(19) of the Act. ICA and NPF also have advisory boards, as defined in section 2(a)(1) of the Act, whose members consult with Capital Research and the Funds' Boards.

4. William H. Kling serves as a director of NEF, SCWF, NPF and EUPAC, and as an advisory board member of ICA. Mr. Kling's principal occupation is as President of Minnesota Public Radio. Mr. Kling also is a non-employee director of

28

Irwin Financial Corporation ("Irwin Financial").1 Irwin Financial is a bank holding company that is primarily engaged in the mortgage banking business. One of Irwin Financial's indirect wholly-owned subsidiaries is Irwin Securities, a broker-dealer registered under the Securities Exchange Act of 1934 (the "1934 Act"). Approximately 0.4% of Irwin Financial's net revenues comes from Irwin Securities.2

5. Irwin Securities is a small firm. It does not execute any portfolio transactions for the Funds. Irwin Securities provides de minimis distribution services to the Funds. The gross sales by Irwin Securities of Fund shares during the period 1991 through 1996 was approximately $3.55 million, or 0.003% of the total gross sales of Fund shares by all broker-dealers for the same period. The fees received by Irwin Securities from the sale of Fund shares for the past five years represented approximately 0.017% of Irwin Financial's total net revenues. The Funds have adopted plans pursuant to rule 12b-1 under the Act [17 C.F.R. ' 270.12b-1] and make payments to their distributors, including Irwin Securities, pursuant to those plans.I

Applicants' Legal Analysis:

1. Section 2(a)(19)(A)(v) of the Act defines an "interested person" of a registered investment company to include any broker-dealer registered under the 1934 Act or any affiliated person of the broker-dealer.II Applicants state that Mr.

1 1In 1996, Mr. Kling's aggregate compensation from Irwin Financial was approximately $16,000. As a non-employee director, Mr. Kling also participates in Irwin Financial's mandatory and non-mandatory stock options plans. In April 1997, Mr. Kling was granted 400 stock options, 100 of which are currently vested. The exercise price of the options is $23.375 per share. The market value of Irwin Financial's common stock as of the close of trading on February 26, 1998 was $47.25 per share. In addition, as of March 11, 1997, Mr. Kling beneficially owned 3,404 shares, or approximately 0.03%, of Irwin Financial's common stock, with market value on February 26, 1998 of approximately $160,839. The applicants represent that Mr. Kling's ownership of Irwin Financial's common stock is not material to Mr. Kling since it does not represent a material portion of his financial holdings generally.

2 2This figure is based on Irwin Financial's net revenues in 1996.

I IEditor's note: Under a Rule 12b-1 plan, the assets of an investment company are assessed an annual fee to defray the cost of marketing and selling the shares of the company. John Downes & Jordon E. Goodman, BARRON'S FINANCE & INVESTMENT HANDBOOK 658-659 (4th ed. 1995).

I IIEditor=s note: The current version of section 2(a)(19)(A)(v) became effective

29

Kling may be deemed an affiliated person of Irwin Securities by virtue of his position as a director of Irwin Financial, an entity that controls Irwin Securities within the meaning of section 2(a)(9) of the Act. Because Mr. Kling may be deemed an affiliated person of Irwin Securities, Mr. Kling currently is considered an interested person of the Funds.

. . .3. Applicants believe that, because Mr. Kling's affiliation with Irwin

Securities is solely the result of his position as a non-employee director of Irwin Financial, and because Irwin Securities provides only de minimis distribution services to the Funds, it would be more appropriate to treat Mr. Kling as an independent director. Applicants thus request an order under section 6(c) of the Act declaring that Mr. Kling will not be deemed an interested person under section 2(a)(19) of the Act.3

4. Section 6(c) of the Act provides, in part, that the Commission may exempt any person from any provision of the Act or any rule under the Act if and to the extent the exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. Applicants contend that their request for relief from interested person status for Mr. Kling meets this standard because Mr. Kling's relationship with Irwin Securities is attenuated and poses no real or potential conflict of interest and because Irwin Securities' only business relationship with the Funds involves a de minimis amount of distribution services for the Funds.

5. Applicants state that, in his position as a non-employee director of Irwin Financial, Mr. Kling has no authority or responsibility for the operations of Irwin Securities and does not control or influence the day-to-day management of Irwin Securities. Applicants also represent that Mr. Kling has no material business or professional relationship with Irwin Financial, Irwin Securities, American Funds, Capital Research, AFD or any affiliated person of these entities.

in May 2001. Pub. L. No. 106-102, 113 Stat. 1338 (1999).

3 3Applicants are not requesting relief from the provisions of rule 12b-1(b)(2) that require a rule 12b-1 plan to be approved by the directors of an investment company "who are not interested persons of the company and have no direct or indirect financial interest in the operation of the plan or in any agreements related to the plan." Applicants state that they intend to treat Mr. Kling as a director who meets these requirements, based on Mr. Kling's lack of material business or professional relationship with Irwin Financial and applicants' belief that Mr. Kling's ownership of Irwin Financial's common stock is not a material portion of Mr. Kling's financial holding[s] generally. Applicants represent that, should Mr. Kling develop a direct or indirect financial interest in the operation of the American Funds' rule 12b-1 plans, he will no longer be treated as meeting the above requirements of rule 12b-1.

30

Applicants' Conditions:

Applicants agree that the order granting the requested relief will be subject to the following conditions:

1. [While Mr. Kling serves as an independent director of the American Funds, Irwin Securities will not execute any portfolio transactions for the Funds or for their investment adviser (Capital Research), and just a minority of the independent directors of the Funds will be affiliated with broker-dealers.]

2. No more than 1% of Irwin Financial's gross revenues will come from the distribution of any one American Fund's shares; and no more than 5% of Irwin Financial's gross revenues will come from the distribution of all of the American Funds' shares;

3. No more than 1% of any one of the American Fund's shares, and no more than 5% of all of the American Funds' shares, will be distributed by Irwin Securities; and

4. Irwin Securities will not serve as a "regular broker or dealer," as that term is defined in rule 10b-1 under the Act,II for any American Fund.

By the Commission.

In the Matter of EuroPacific Growth Fund, et al.Securities and Exchange Commission Release No. IC-23374

August 4, 19981998 SEC LEXIS 1640

. . . No request for a hearing was filed, and the Commission did not order a hearing.

The matter has been considered and it is found, on the basis of the information set forth in the application, that the requested exemption is appropriate in

I IIEditor's note: Rule 10b-1, 17 C.F.R. ' 270.10b-1, states in part:AThe term regular broker or dealer of an investment company shall mean:

. . .(c) One of the ten brokers or dealers that sold the largest dollar amount of securities of the investment company during the company's most recent fiscal year.@

31

the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. Accordingly,

IT IS ORDERED, pursuant to section 6(c) of the Act, on the basis of the representations and conditions set forth in the application, effective immediately, that Mr. Kling will not be deemed an interested person of the Funds within the meaning of section 2(a)(19) of the Act.

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SAFECO Asset Management CompanySecurities and Exchange Commission No-Action Letter

Publicly Available December 2, 19771977 SEC NOACT LEXIS 2834

LETTER TO SEC

This letter is a request for a 'no-action' position from the staff with regard to the status of a director of the SAFECO funds . . . in the context of Section 2(a)(19) of the Investment Company Act of 1940 ('the Act'). . . .

The four SAFECO funds are managed by SAFECO Asset Management Company and their shares are distributed by SAFECO Securities, Inc., both wholly-owned subsidiaries of SAFECO Corporation. SAFECO Corporation is a publicly held holding company. Its principal subsidiaries are property and casualty, life and title insurance companies.

The board of directors of each of the four SAFECO funds is composed of five directors, two of whom are 'interested persons' as that term is defined by Section 2(a)(19) of the Act. Late in September 1977 one of the 'disinterested' directors resigned to become a director of a national bank. The remaining directors narrowed their choice of a successor to this position to Dr. Charles E. Odegaard, President Emeritus of the University of Washington. It was determined that Dr. Odegaard was a Trustee of The Teachers Insurance and Annuity Association . . . and a Member of the College Retirement Equities Fund ('CREF'). As trustee and member his sole function is along with the other trustees and members to meet once per year and elect the operating boards of the Teachers Insurance and Annuity Association and CREF. No compensa-tion is paid to these trustees and members. Both the Association and CREF sell annuities and Dr. Odegaard is an annuitant of both.

While the Association owns no SAFECO Common Stock, CREF owns a very small percentage. At September 30, 1977, there were 13,036,958 shares of SAFECO Common Stock outstanding. At that date the total assets of CREF were $4,100,000,000. CREF owned 83,000 shares of SAFECO Common Stock or 0.08% of its total assets and 0.63% of the total SAFECO Common Stock outstanding.

. . .The fact that Dr. Odegaard is an annuitant of CREF came to our attention

recently. We do not believe it changes his status in the context of Section 2(a)(19)(B)(iii) of the Act, but wanted to confirm this with the staff. . . .

It is our position that the very small ownership of SAFECO Common Stock by CREF does not present an interest which would prevent Dr. Odegaard from acting as a 'disinterested' director or cause him to be an 'interested person.' The stock held by CREF is too small to affect the control of SAFECO Corporation and represents only a minuscule part of its assets. We request that the staff take a 'no-action'

33

position with regard to Dr. Odegaard's status in the context of Section 2(a)(19) of the Act in order that he be able to participate as other than an 'interested person.'

. . .

SEC REPLY

Based on the foregoing, it appears that Dr. Odegaard comes squarely within the definition of interested person in Section 2(a)(19)(B)(iii) of the Investment Company Act of 1940. As a CREF variable annuitant he has an indirect beneficial interest in a security issued by the controlling person of the Funds' investment adviser and principal underwriter. For this reason we cannot give the no-action assurance you request. However, if you believe the facts so warrant, you may wish to consider filing an application pursuant to Section 6(c) of the Act to exempt Dr. Odegaard from the definition of interested person.I

I IEditor's note: In response to an application filed by the SAFECO Funds under section 6(c), the Securities and Exchange Commission declared Dr. Odegaard not to be an interested person. Employing the language of section 6(c), the Commission "found that the granting of the application is appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act." Investment Company Act Release No. 10164 (March 20, 1978), 1978 SEC LEXIS 1994.

34

Note

In a 1999 release, the Commission discussed section 2(a)(19)(B)(iii) in the context of a proposed rule dealing with ownership by a director of shares of an index fund:

Section 2(a)(19) disqualifies an individual from being considered an independent director if he knowingly has any direct or indirect beneficial interest in a security issued by the fund's investment adviser or principal underwriter, or by a controlling person of the adviser or underwriter. A fund director, for example, who owns securities issued by the fund's adviser (or its parent company) could not be an independent director. This provision was designed to ensure that an independent director does not have a financial interest in the organizations that are closely associated with the fund or that would benefit from payments that the independent director is charged with scrutinizing.

If a director owns securities of an index fund that seeks to replicate a securities market index that includes securities of the fund's adviser (or principal underwriter or a controlling person of the adviser or principal underwriter), an issue could arise whether the director knowingly has an indirect beneficial interest in the securities of the adviser (or principal underwriter or controlling person). We believe that this attenuated interest in the adviser's or underwriter's securities is not the type of interest Congress intended to prohibit independent directors from owning when it adopted section 2(a)(19). An index fund's investment decision-making process is dictated by the goal of mirroring the performance of a market index, and thus is largely mechanical. Because index fund portfolios typically are spread among a large number of issuers, ownership of their shares is unlikely to have a material effect on the independent judgment of a fund director.

Role of Independent Directors of Investment Companies, Release No. IC-24082, 64 Fed. Reg. 59826, 59838 (Nov. 3, 1999).

The Rule adopted by the Commission became effective in 2001 and reads as follows (17 C.F.R. ' 270.2a19-3):

If a director of a registered investment company (>Fund=) owns shares of a registered investment company (including the Fund) with an investment objective to replicate the performance of one or more broad-based securities indices (>Index Fund=), ownership of the Index Fund shares will not cause the director to be considered an >interested person= of the Fund or of the Fund's investment adviser

35

or principal underwriter (as defined by section 2(a)(19)(A)(iii) and (B)(iii) of the Act).

The Rule applies only to an index fund whose index is Abroad-based.@ According to the Commission, Aa >broad-based index= is an index that >provides investors with a performance indicator of the overall applicable stock or bond markets, as appropriate. An index would not be considered to be broad-based if it is composed of securities of firms in a particular industry or group of related industries.=@ Role of Independent Directors of Investment Companies, Release No. IC-24816, 66 Fed. Reg. 3734 , 3740 n.66 (Jan. 16, 2001).

Although A[t]he new rule does not address an independent director's ownership of securities of an actively managed fund that owns shares of the fund's adviser, underwriter or any of their controlling persons,@ the Commission stated that Awe do not believe an independent director who owns shares of an actively managed fund would ordinarily >knowingly= have an indirect beneficial interest in the issuers of securities the fund holds, and thus ownership of such fund would not cause a director to be an >interested person= as defined by section 2(a)(19) of the Act.@ Id. at 3740 n.65.

36

Twentieth Century Investors, Inc.Securities and Exchange Commission No-Action Letter

Publicly Available February 19, 19721972 SEC NOACT LEXIS 805

LETTER TO SEC

You are aware of my letter of June 11, 1971 with respect to Twentieth Century's unaffiliated director, Frederick J McCoy. He owns 3.3% of the common stock and 5% of the preferred stock of the investment adviser, and 2.5% of the common stock and 5% of the preferred stock of the principal underwriter. Accordingly, while unaffiliated, he is an interested person of the investment advisor and of the principal underwriter under Section 2(a)(19)(B)(iii) because he has a beneficial interest in securities issued by the investment advisor and the principal underwriter.

In my letter of June 11 I suggested that he could make a bona fide gift of the stock to a member of his family and thus avoid being an interested person. I still have not received a reply in writing to my letter of June 11, but Mr. Golden has read me his reply over the phone. His letter is to the effect that if Dr. McCoy were to make a gift to a person who he is legally obligated to support then he would have an indirect beneficial interest in the securities and would still be an interested person under the sub-paragraph just cited.

I have now inquired by telephone whether the same result were to follow if he were to make a gift to a member of his family who he is not obligated to support. In particular, he is thinking of giving the stock to his parents, who are independent and who he does not support. You have responded orally that since Dr. McCoy's parents are members of his immediate family, he would still be an interested person if he were to give the stock to them. I respectfully submit that such a conclusion misconstrues the statute. Subsection (19)(B)(ii) refers to a member of the immediate family of any natural person who is an affiliated person. Thus, if Dr. McCoy's parents are affiliated persons, then he is an affiliated person also. However their stock ownership is not sufficient to make them affiliated, and accordingly he is not affiliated either. If they are not affiliated, then he is not affiliated, and neither is he, under Paragraph (ii), interested.

I see nothing in the statute which makes a person interested because a member of his immediate family is interested, and that is what prompted my inquiry in the first place. Since the family relationship was so carefully made significant as to affiliated persons, the failure to do so in case of interested persons indicates a deliberate intention to render the family relationship immaterial in the definition of interested persons.

37

The only conceivable way in which Dr. McCoy, if he were to make the gift to his parents, could be characterized as interested would be under Sub-paragraph (iii), as a person having a beneficial interest in securities issued by the investment advisor or principal underwriter. It is my belief that if he were to give the stock away, and particularly if he has no obligation to support the donee, that he would no longer have any direct or indirect beneficial interest in the securities.

. . .I should mention, by way of background, that Dr. McCoy's first choice would

be to sell the stock, but there is no market for it, and it is extremely difficult to find a buyer. Accordingly his only practical alternatives are to make a gift or to resign from the Board. We are reluctant to see him follow the latter course, because we value his judgment.

SEC REPLY

Based on the foregoing, and your oral representation that Dr. McCoy's parents are persons of independent means who are not expected in the foreseeable future to become dependents of Dr. McCoy, and if as asserted in your letter Dr. McCoy makes a bona fide gift to his parents retaining no direct or indirect beneficial interest in the securities, and following the transfer neither of his parents is an affiliated person of the investment adviser or underwriter, this Division will not recommend any action to the Commission if Dr. McCoy is not treated as an 'interested person' as that term is defined in Section 2a 19(B) of the Act for the purposes of complying with the requirements of Section 10 of the Act, in reliance upon your opinion as counsel that he is not an 'interested person' as defined.

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Interpretive Matters Concerning Independent Directorsof Investment Companies

Investment Company Act Release No. 24083Securities and Exchange Commission

November 3, 199964 Fed. Reg. 59877

. . .The Commission has the authority to issue an order under [subsections (A)

(vii) and (B)(vii) of] section 2(a)(19) of the [Investment Company] Act when it finds that a person has or had a "material business or professional relationship" with certain specified persons and entities, including some fund affiliates ("Specified Entities"). Section 2(a)(19) does not define a "material business or professional relationship." The legislative history, however, indicates that a business or professional relationship would be material if it "might tend to impair the independence of [a] director."33 The legislative history also states that "[o]rdinarily, a business or professional relationship would not be deemed to impair independence where the benefits flow from the director of an investment company to the other party to the relationship. In such instances the relationship is not likely to make the director beholden to that party."34

. . . [The staff is here providing] guidance about the types of professional and business relationships between a director and a Specified Entity that may be considered to be material. . . .36

Positions as Material Business or Professional Relationships

The staff believes that a fund director may be treated as "interested" [under sections 2(a)(19)(A)(vii) and (B)(vii)] if he or she currently holds or held, at any time since the beginning of the last two completed fiscal years of the fund (the "two-year period"), certain positions with a Specified Entity. The staff would consider a position that a director holds with a Specified Entity as a "material business or professional relationship" if it would tend to impair a director's independence by providing incentives for the director to place his or her own interests over the

3 33H.R. Rep. No. 1382, 91st Cong., 2d Sess. 14 (1970); S. Rep. No. 184, 91st Cong., 1st Sess. 33 (1969).

4 34Id.

6 36The examples discussed in this release are not exhaustive and are provided for illustrative purposes only. There may be other relationships that would be viewed by the staff as material under section 2(a)(19).

39

interests of fund shareholders. The key factors in evaluating whether a director's position with a Specified Entity would tend to impair his or her independence include the level of the director's responsibility in the position and the level of compensation or other benefits that the director receives or received from the position.

For instance, the staff would consider an individual who served as the fund's portfolio manager during the two-year period to have had a material business or professional relationship with the fund and its investment adviser. . . . The staff believes that a fund's former portfolio manager must be viewed as having had a material business or professional relationship with the fund and its adviser because he or she would have had significant responsibilities with the fund and the adviser, and likely would have received substantial compensation and other benefits from the adviser and/or the fund. Indeed, the staff would view the former portfolio manager's position as material due to the manager's responsibility in the position even if the manager had not received substantial compensation from [the] adviser or the fund. Similarly, the staff believes that former directors, officers, and employees of the fund's investment adviser or principal underwriter could be viewed as having had a material business or professional relationship with a Specified Entity, depending on the facts and circumstances.38

In addition, a fund director who at any time during the two-year period also was a director, officer or employee of a current or former holding company of the fund's investment adviser may be treated as interested by reason of a material business or professional relationship with the controlling person of the fund's adviser (a Specified Entity). As described above, the staff's analysis of the materiality of the relationship would focus on, among other things, the level of the director's responsibility with the holding company and the level of compensation or other benefits that the director received from the position.

The staff believes that not every position that a director holds or held with a Specified Entity would be deemed to impair his or her independence. For example, a director of a fund who also is a director of another fund managed by the same adviser generally would not be viewed as an interested person of the fund under section 2(a)(19) solely as a result of this relationship. Material Transactions as Material Business or Professional Relationships

The staff believes that a fund director may be treated as "interested" if he or she has, at any time during the two-year period, directly or indirectly engaged (or proposed to engage) in any material transactions (or proposed material transactions)

8 38In addition, the staff notes that many former officers and employees of a fund's investment adviser or principal underwriter may own securities issued by the adviser or underwriter. Such persons are interested persons of the fund by virtue of sections 2(a)(19)(A)(iii) and (B)(iii).

40

with a Specified Entity. Such a relationship could result from a single transaction or from multiple transactions. These transactions may be structured as service arrangements, including legal, investment banking, and consulting services, or other business transactions, such as business and personal loans, and real estate purchases.41

In addition, a material business or professional relationship with a Specified Entity may result from a fund director's position with, or ownership interest in, an entity that engages in material transactions with a Specified Entity.

For example, the staff believes that a fund director may be treated as "interested" if the fund's investment adviser manages or managed for the director, at any time during the two-year period, an advisory or brokerage account, and the adviser favors, or creates the expectation that it will favor, the account over the other accounts that it manages. In the staff's view, a director would receive favored treatment, for instance, if the adviser charged the director no fees or fees that were lower than the fees that it charged for similar types of accounts, or accorded the director's account special treatment regarding portfolio management decisions or securities allocations. By favoring the director's account over other accounts that it manages, the adviser may create an incentive for the director to act in a manner that will preserve or increase the favorable treatment. In this instance, significant economic benefits from the relationship between the director and the adviser would flow to the director, or the director may have the expectation that significant economic benefits would flow in the future to the director.44

The staff believes that a fund director who serves as a chief executive officer of any company for which the chief executive officer of the fund's adviser serves as a director also may be treated as "interested." The relationship between the fund director and the adviser's chief executive officer may tend to impair the director's independence because the adviser's chief executive officer has the power to vote on matters that affect the director's compensation and status as chief executive officer of the company. In this instance, the fund director may act with respect to fund matters in a manner to preserve his or her relationship with the company and with the

1 41See, e.g., Alpha Investors Fund, SEC No-Action Letter (Jan. 9, 1972) (director who is a partner at a law firm that provides legal services to an entity that controls the fund's adviser may be interested under section 2(a)(19)(B)[(vii)] because the director has a material business or professional relationship with that entity).

4 44For an example of a relationship in which the staff believed that significant economic benefits did not flow to the director, see Securities Groups, SEC No-Action Letter (Apr. 20, 1981) (staff stated that a nominated director's participation in a symposium sponsored by the parent of the fund's adviser did not constitute a material relationship because "the $2,000 paid to him for taking part in that seminar is not so significant as to tend to impair his independence were he to serve as a disinterested director of the fund").

41

adviser's chief executive officer, rather than in the interest of the fund's shareholders.45

A fund director may be deemed to have indirectly engaged in a material transaction with a Specified Entity through his or her interest in a company that conducted business with the Specified Entity.46 In determining whether the director would have a material business or professional relationship with a Specified Entity due to his or her interest in the company and the company's transaction with the Specified Entity, the staff would look to the nature and significance of the director's interest in the company and the company's interest in the transaction. In particular, the staff would focus on the significance of any economic or other benefit that would flow to the director. For example, a fund director who had a controlling interest in a company that conducted material business with a fund would likely receive significant economic benefits, either directly or indirectly, as a result. Such a director may be treated as interested because the director may have a material business or professional relationship with the fund as a result of having indirectly engaged in a material transaction with the fund.

A material relationship resulting from a proposed material transaction with a Specified Entity might include the negotiation of a service contract between a company controlled by the director and the Specified Entity. During the negotiation of such a contract (and even if such contract is never finalized), the director may be concerned about interests other than those of the fund and its shareholders. As a result, the process of negotiating a material transaction may tend to impair the director's independence, and thus may itself create a material business or professional relationship with a Specified Entity for purposes of section 2(a)(19).

. . .

5 45See Southwestern Investors, Inc., SEC No-Action Letter (June 13, 1971) (fund director who is an officer and director of company A may not be disinterested if the president of a company that indirectly controls the fund's investment adviser and principal underwriter also serves as a director of company A). . . .

6 46See also The MONY Fund, Inc., SEC No-Action Letter (Jan. 29, 1972) (director who is a senior officer of a company that contracted with company A, which wholly owns the fund's investment adviser, to find a vice president for company A, may have a material relationship with a controlling person of the fund's adviser).

42

S&P Counselors Fund, Inc.Securities and Exchange Commission No-Action Letter

Publicly Available January 2, 19721972 SEC NOACT LEXIS 153

LETTER TO SEC

. . .S&P Counselors Fund, Inc. (the 'Fund') is a registered investment company

under the [Investment Company] Act and its shares are registered under the Securities Act of 1933. The investment adviser of the Fund is Standard & Poor's Counseling Corporation (the 'Adviser'). The Fund is a 'no-load' fund; its principal underwriter is InterCapital Distributors, Inc. (the 'Underwriter'). Both the Adviser and the Underwriter are wholly-owned subsidiaries of Standard & Poor's/InterCapital Inc. ('InterCapital').

. . .A further question is raised with regard to the interpretation of the possible

applicability [to] the additional circumstances described below of Section 2(a)(19)(A)(iii) and 2(a)(19)(B)[(vii)] of the Act as amended by the Investment Company Amendments Act of 1970.

One of the directors of the Fund is Dr. Jerome Cohen, who has been Professor of Finance and Dean of Graduate Studies, Bernard Baruch School of Business and Public Administration, City University of New York, since 1957. He is also co-author of a book entitled 'Investment Analysis and Portfolio Management.' Dr. Cohen has recently retired and now holds the titles of Dean Emeritus and Professor Emeritus at the City University.

Another director of the Fund is Arthur Zeikel, who is also a director of the Adviser and Chairman of the Board of InterCapital, of which he is one of eight directors. Under the by-laws of InterCapital, the President of that company, not the Chairman of the Board, is the chief executive officer. All of the outstanding shares of InterCapital are owned by Standard & Poor's Corporation and Mr. Zeikel has an option to acquire 8% of InterCapital's authorized stock. It is contemplated that Mr. Zeikel, a former student of Dr. Cohen, will collaborate with him in a proposed revision of the above-mentioned book, will be shown as a co-author and will share in royalties when the revision is published. In connection with work on the revision Dr. Cohen will have available to him the library facilities of the City University as well as his own personal library and office. His writing will be done at his own office. However, it is believed that use of the specialized financial library of InterCapital would also be helpful. It is therefore proposed that InterCapital's library facilities be made available to him, together with use of some space and a telephone on the premises of InterCapital as a matter of convenience during the period that he is

43

working with Mr. Zeikel or using library materials. It is expected that this period will commence on or about January 1, 1972 and continue until work on the book is completed, which is expected to be approximately June to September 1972.

The question raised by the foregoing is whether the proposed arrangements described above constitute a 'material business or professional relationship' with the Adviser or Underwriter, or any controlling person of either of them, such that Dr. Cohen might be considered an 'interested person' of the Fund as defined in Sections 2(a)(19)(A)(iii) and 2(a)(19)(B)[(vii)] of the Act. As legal counsel for the Fund, its Adviser, Underwriter and InterCapital, it is my opinion that the proposed arrangements do not constitute a material business or professional relationship within the purpose and intent of the Act in view of the fact that the facilities proposed to be provided by InterCapital and the assistance of Mr. Zeikel in work on the book are not likely to affect the judgment as director of the Fund of a man with the stature, independence and valued reputation of Dr. Cohen. However, it would be appreciated if the Staff would express its views as to whether or not it would concur in this opinion.

. . .

SEC REPLY

. . .With respect to the proposed arrangements among Dr. Jerome Cohen, Mr.

Arthur Zeikel and InterCapital, it is our view that such arrangements may constitute a 'material business or professional relationship' within the meaning of Section 2(a)(19)(B)[(vii)]. Accordingly, we can not assure you that in the circumstances described above we will not recommend that the Commission issue an order determining Mr. Cohen and Mr. Zeikel to be interested persons as provided in this Section.

44

Travelers Equities Fund, Inc.Securities and Exchange Commission No-Action Letter

Publicly Available January 11, 19821982 SEC NOACT LEXIS 1857

LETTER TO SEC

This is to request a no-action letter from the staff of the Division of Investment Management to the effect that it will not recommend that the Commission take any enforcement action under the Investment Company Act of 1940 (the "Act") if the [Travelers Equities Fund, Inc., the Travelers Fund A for Variable Annuities, the Travelers Fund A-1 for Variable Annuities, the Travelers Fund B for Variable Contracts, the Travelers Fund B-1 for Variable Contracts, the Travelers Insurance Company, Travelers Equities Sales, Inc., the Travelers Investment Management Company, and Keystone Massachusetts, Inc.] continue to treat Mr. Robert E. McGill, III as not an "interested person" within the meaning of Section 2(a)(19) for all purposes under the Act.

Statement of Facts

The Travelers Fund A for Variable Annuities, The Travelers Fund A-1 for Variable Annuities, The Travelers Fund B for Variable Contracts, and The Travelers Fund B-1 for Variable Contracts (collectively, the "Variable Funds") and Travelers Equities Fund Inc. ("TEFI", and collectively with the Variable Funds, the "Funds"), are open-end, diversified management investment companies registered pursuant to Section 8 of the Act. The Travelers Investment Management Company ("TIMCO") is the investment adviser to each of the Funds under the terms of written investment advisory contracts in compliance with Section 15 of the Act. TIMCO is registered as an investment adviser pursuant to the Investment Advisers Act of 1940. The Travelers Insurance Company (the "Insurance Company") is the principal underwriter for the Variable Funds under the terms of written underwriting contracts in compliance with Section 15 of the Act. Travelers Equities Sales, Inc. ("TESI") is a principal underwriter for TEFI under the terms of a written underwriting contract in compliance with Section 15 of the Act. TIMCO, the Insurance Company and TESI are each wholly-owned subsidiaries of The Travelers Corporation . . . .

Each of the Funds presently has a Board of Directors or Board of Managers, as the case may be, composed of the same six persons. Two of such persons presently may be deemed to be interested persons of the Funds, as that term is defined in Section 2(a)(19) of the Act. Robert E. McGill, III has been a member of the Board of Directors of TEFI since 1974 and a member of the Board of Managers

45

of the Variable Funds since 1975. He is not one of the two persons referred to above as interested persons.

Mr. McGill is a limited partner in the Charter Oak Heritage Group, a Connecticut limited partnership (the "Limited Partnership"). The Limited Partnership was formed for the purpose of acquiring, leasing, renovating, owning and operating certain real property in Hartford, Connecticut (the "Property"). A total of seventeen limited partnership units were offered and sold pursuant to an Offering Memorandum dated May 15, 1979, as amended. On September 26, 1979, Mr. McGill purchased one limited partnership unit by payment of $5,200 cash and a note in the amount of $29,000, payable in three installments due in 1980, 1981 and 1982. The Insurance Company made a permanent mortgage loan on the Property (the "Loan") on January 27, 1981. The Loan is secured by the Property. The Loan is in the principal amount of $1,445,000, having an interest rate of 10.25% and a term of 180 months. A portion of the Loan in the amount of $1,170,000 has been funded and the remaining portion of the Loan, in the amount of $275,000, is to be funded at a later date if certain conditions are met.

Mr. McGill is Vice President-Finance and Secretary of The Dexter Corporation ("Dexter"), a publicly-held corporation in Windsor Locks, Connecticut. As an employee of Dexter, he has elected to have one-half of his interest in The Employees' Savings and Profit-Sharing Income Trust of Dexter (the "Dexter Plan") held under a group annuity contract issued by the Insurance Company.

"Interested Person" as defined in the Act

[The letter quotes sections 2(a)(19)(A)(vii), 2(a)(19)(B)(vii), and 2(a)(19)(A)(iii).]

. . . [T]he legislative history indicates that a relationship might be material if "it might tend to impair the independence of such director." . . .

Mr. McGill Should Not be Determined to be an Interested Person by Reason of his Limited Partnership Interest

The Limited Partnership Agreement, pursuant to which the Limited Partnership was formed, expressly limits the powers of a limited partner. Article XII states that:

The Limited Partners shall not participate in any way in the control or management of the business of the Partnership. The Limited Partners are not agents of the Partnership and have no authority to act for, or bind, the Partnership in any manner.

This provision is consistent with the provisions of the Connecticut Uniform Limited Partnership Act. A letter of intent and commitment letter from the Insurance Company with respect to the mortgage loan were negotiated and entered into on

46

behalf of the Limited Partnership by one or more of its General Partners before Mr. McGill became a Limited Partner. The commitment letter contained conditions which had to be met before the Loan was funded. The General Partners directed the efforts of the Limited Partnership in meeting these conditions and conducted all negotiations with the Insurance Company concerning them. Since the Loan is to the Limited Partnership and since only the General Partners may act for the Limited Partnership in these matters, Mr. McGill has had no direct involvement with the Insurance Company with regard to these matters.

Because a substantial portion of the economic benefits of an investment in the Limited Partnership are the projected tax deferrals, suitability standards have been established for investors. Mr. McGill has represented in writing that he has met the following standards set forth in the Offering Memorandum: (i) he has a net worth (exclusive of homes, home furnishings and personal automobiles) in excess of $175,000 and expects to have an estimated income taxable at a rate of 50% or higher for federal income tax purposes for at least seven years; (ii) he has adequate means of providing for his current needs and personal contingencies and has no need for liquidity in his investment in the Units; (iii) his overall commitment to investments which are not readily marketable or transferable is not disproportionate to his net worth and his investment in the Units will not cause such overall commitment to become excessive; further, the loss of the entire investment will not materially affect his standard of living; and, (iv) by virtue of his own investment acumen, business experience or independent financial advice, he is capable of evaluating the risks and merits of investing in the Units. This indicates that Mr. McGill's investment, as described above, is not material as to him.

. . .Consequently, we believe that Mr. McGill's Limited Partnership interest

would not tend to impair his independence as a director of the Funds.

Mr. McGill Should Not be Determined to be an Interested Person by Reason of his Interest in the Dexter Plan

The Dexter Plan offers eligible employees of Dexter the opportunity to choose among three investment funds for the purpose of investing contributions to the Dexter Plan. One such investment fund is the group annuity contract issued by the Insurance Company to the Trustee of the Dexter Plan. Mr. McGill's participation in the Dexter Plan is on the same terms and conditions as any other eligible employee of Dexter. He has no personal right in the group annuity contract, since it is issued to the Trustee of the Dexter Plan, and he must look to the Dexter Plan for benefits thereunder. A committee of the Board of Directors of Dexter administers the Dexter Plan. It has been delegated the responsibility for choosing the group annuity contract as an investment fund to be offered under the Dexter Plan and negotiating the terms thereof. Although Mr. McGill, in his position as Vice President-Finance and

47

Secretary, has performed ministerial functions in collecting information for the committee to consider in fulfilling its duties, he has no responsibility or authority to recommend or select the group annuity contract as an investment fund for the Dexter Plan.

. . .

. . . As stated above, Mr. McGill is a potential annuitant under a group annuity contract issued by the Insurance Company to the Trustee of the Dexter Plan. The group annuity contract pays a fixed rate of return as determined yearly by the Insurance Company and is funded in the General Account of the Insurance Company, which is prohibited by insurance law from holding securities of the parent of the Insurance Company. Thus, any actions Mr. McGill takes with respect to the Funds cannot have any affect [sic] on the performance of the General Account and thus can have no affect [sic] on the potential size of his annuity or other benefits under the Dexter Plan.

Consequently, we believe that Mr. McGill's interest in the Dexter Plan would not tend to impair his independence as a director of the Funds.

Conclusion

Based on the reasons set forth above, it is our opinion that Mr. McGill should not be deemed to be an interested person of the entities on whose behalf this request is made. Therefore, we request your concurrence that the staff of the Division will not recommend any enforcement action to the Commission if they continue to treat Mr. McGill as not an "interested person" within the meaning of Section 2(a)(19) for all purposes under the Act.

SEC REPLY

Based upon the facts and representations made in your letter, we would not recommend to the Commission that enforcement action be commenced pursuant to Sections 2(a)(19)(A)[(vii)] and 2(a)(19)(B)[(vii)] of the Investment Company Act of 1940 ("Act") if the named entities continue to treat Mr. Robert E. McGill, III as not an "interested person" within the meaning of said sections for all purposes under the Act. The facts as you state them do not indicate that a material business or professional relationship, which "might tend to impair the independence" of Mr. McGill as a director of the Funds, exists with the insurance company by reason of his interest in the Dexter Plan or by reason of his limited partnership interest.

48

Southwestern Investors, Inc.Securities and Exchange Commission No-Action Letter

Publicly Available June 13, 19711971 SEC NOACT LEXIS 1204

LETTER TO SEC

In order to bring themselves in compliance with the provisions of the Investment Company Amendments Act of 1970 . . ., [Southwestern Investors, Southwestern Investors Growth Fund, and Fund of the Southwest] plan to make one change in the composition of their Boards of Directors in order that three out of five members of each Board will be persons who are not "interested persons" of either the investment company or its principal underwriter.

The new director whom it is proposed to add to the Board of each of the investment companies as a disinterested director is DeWitt T. Ray, Jr. Mr. Ray has been President of Guardian Savings & Loan Association (Guardian) in Dallas since 1960, and is one of Guardian's five directors. Two of Guardian's other directors are relatives of Mr. Ray. William H. Seay is also a director of Guardian, but is not related to any of the other members of the Board by blood or marriage and the fifth member of the Board is not related to any of the other members of the Board by blood or marriage.

Mr. Seay is President of Southwestern Life Insurance Company (Southwestern Life) of Dallas, which is the wholly-owning parent of a subsidiary which, in turn, is the wholly-owning parent of Southwestern Management & Research Corp. (SWMR), the principal underwriter and investment adviser of each of the three investment companies.

Mr. Seay receives $4,500 annually in director's fees from Guardian, consisting of $250 per month and a bonus of $1,500. Each director of each of the three investment companies receives from the investment adviser of each company a flat fee of $50 per month, plus a fee of $50 for each monthly directors' meeting attended. Thus a director of all three investment companies who attended each monthly directors' meeting of each company during a year would receive from the investment adviser an aggregate of $3,600 in the year for his services to the three investment companies.

Neither Mr. Ray, his family or Guardian owns any shares of stock of Southwestern Life. Mr. Seay owns one qualifying share of Guardian stock, Southwestern Life does not own any Guardian stock, and Mr. Seay presently has a deposit with Guardian of approximately $7,000. Southwestern Life has no deposits with Guardian. There are no joint ventures or participations between Guardian and Southwestern Life.

49

With regard to whether Mr. Ray, if he were a director of the three investment companies[,] might be considered to be an interested person of the investment adviser or principal underwriter, it would appear to me that Mr. Ray would not be an "affiliated" person of SWMR since I do not believe that it could be properly said that Mr. Seay controls both Mr. Ray and SWMR and that accordingly Mr. Ray and SWMR are under common control. The Board of Directors of Guardian, of which Mr. Seay is a member, does elect Mr. Ray to the office of President of Guardian, but Mr. Seay casts only one of five votes on the Board, and three members of the Board of Guardian, including Mr. Ray, are relatives. Mr. Seay is President of Southwestern Life, the wholly owning parent of a subsidiary which owns SWMR, the investment adviser and principal underwriter of each of the three companies. It is my conviction that it would be unduly straining to say that both Mr. Ray and SWMR are under the common control of Mr. Seay.

Section 2(a)(19)(B)[(vii)] of the Investment Company Act . . . provides that an interested person of an investment adviser or principal underwriter is a person whom the Commission by order shall determine to be an interested person by reason of having had at any time since the beginning of the last two fiscal years of the investment company a material business or professional relationship with the adviser or underwriter or with the principal executive officer or any controlling person of the adviser or underwriter. The only business or professional relationships between Messrs. Seay and Ray are as shown above, and it does not appear to me that any of them would be sufficient to cause the Commission to determine that Mr. Ray has had such a material business or professional relationship with Mr. Seay, who is a controlling person of SWMR, as to cause Mr. Ray to be considered to be an interested person of the investment adviser or principal underwriter.

I would appreciate your advising me whether the staff of the Commission would, in the light of the facts stated above, consider Mr. Ray to be an interested person in any of the investment companies or in the investment adviser and principal underwriter of the investment companies if he is elected to the Boards of Directors of the investment companies.

. . .

SEC REPLY

Regarding your question as to whether Mr. Ray has a material business relationship within the meaning of Section 2(a)(19)(B)[(vii)], the legislative history of that Section indicates that such a relationship would be material if it "might tend to impair the independence" of a director. As a director of Guardian, Mr. Seay has the power to vote on matters affecting in a substantial way Mr. Ray's status as President of Guardian, which we believe might tend to impair Mr. Ray's independence as a director of the three investment companies. Therefore, if Mr. Ray is added to the

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board of each of the investment companies as a disinterested director, we cannot assure you we will not recommend that the Commission bring a proceeding under Section 2(a)(19)(B)[(vii)] to declare him to be an interested person by virtue of having a material business relationship with the principal executive officer of the investment adviser and principal underwriter of each of the three investment compa-nies. In this connection, we consider SWMR, its parent and Southwestern Life to be one entity for the purposes of the Investment Company Act.

We express no opinion concerning your question as to whether Mr. Ray is an interested person of SWMR within the meaning of Section 2(a)(19)(B)(i) by virtue of being subject to common control with SWMR by Mr. Seay, and thus an affiliated person of SWMR. A determination of control or noncontrol depends upon all of the actual facts. Section 2(a)(9) provides that a person is not a controlling person if he has the power to exercise controlling influence over the management or policies of a company solely as a result of an official position with such company. However, the facts you presented do not negate the possibility that Mr. Seay has such power over Southwestern Life and SWMR or, if he does have such power, that he possesses it solely as a result of his official position with Southwestern Life. Also, although Section 2(a)(9) provides that a natural person shall be presumed not to be a controlled person, you have not presented sufficient facts to negate the possibility that Mr. Seay controls Mr. Ray.

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Note

In First Australia Fund, Inc. (publicly available October 8, 1987), 1987 SEC NOACT LEXIS 2552, the SEC staff elaborated on the issue of control:

Under Section 2(a)(3)(C) of the 1940 Act, a person is affiliated with another when the person controls, or is controlled by, or is under common control with the other person. Section 2(a)(9), in part, defines control as 'the power to exercise a controlling influence over the management or policies of a company,' but carves out an exception for those persons whose power is solely the result of an official position with the company. . . . The Commission, in describing the nature of the 'controlling influence' referred to in Section 2(a)(9), has stated that 'Congress intended to include within the orbit of 'control' situations where less than absolute and complete domination of a company is present.'11 Controlling influence includes not only the active exercise of power, but also latent existence of power to exert controlling influence. In determining the existence of this latent power, consideration may be given to possible future events which would result in the invocation of the latent power. . . .

As a general matter, 'the burden of overturning the presump-tion against control of a natural person is not one that will be lightly assumed or easily carried to success.' While the question of control of an individual may present some 'difficult problems of concept and proof,' and may involve issues of fact which cannot be resolved by the use of a mathematical formula, the Commission is free (and, perhaps, may be required) to consider every piece of evidence in determining whether a case can be made for rebutting the negative presumption available with respect to individuals. Accordingly, a determination of control or noncontrol depends upon all of the actual facts. Among the factors the Commission may take into account in determining the existence of control over directors are: (1) selection or nomination of the director by the controlling party; (2) existence of family ties; (3) social relations; (4) former business associations between the director and the controlling person; (5) the amount of time spent by directors at meetings; (6) respective ages; (7) participation in recommending, evaluating and terminating policies; (8) independent knowledge of corporate affairs; (9) interlocking directors and officers, together with share ownership; and (10) actual domination and operation.

1 11 In this regard, a controlling influence may be seen in a suscep-tibility to domination, namely, some indirect means of influence short of actual direction.

52

AIM FundsSecurities and Exchange Commission No-Action Letter

Publicly Available April 3, 20022002 SEC No-Act. LEXIS 330

LETTER TO SEC

We are writing on behalf of . . . [the AIM Funds] and Carl Frischling, Esq. to request the assurance of the Division of Investment Management (the ADivision@) that, under the facts presented, it will not recommend to the Securities and Exchange Commission (the ACommission@) that it take enforcement action against the AIM Funds under the Investment Company Act of 1940, as amended (the A1940 Act@), if the AIM Funds were to treat Mr. Frischling as a director/trustee who is not an Ainterested person@ of the AIM Funds as that term is defined in Section 2(a)(19)(A)(iv) of the 1940 Act.

Facts

. . . A I M Advisors, Inc., a registered investment adviser (AAIM@), serves as investment adviser for each AIM Fund.

Carl Frischling . . . [serves] as either a director or trustee (collectively, a Adirector@) for [the AIM Funds] . . . . Mr. Frischling is also a partner in the law firm of Kramer Levin Naftalis & Frankel LLP (AKramer Levin@). Mr. Frischling joined Kramer Levin=s New York office in 1994.

For more than ten years, law firms of which Mr. Frischling and Susan J. Penry-Williams, Esq. were members have represented the independent directors of the AIM Funds. Since September 1994, Kramer Levin has served as legal counsel to the independent directors of the AIM Funds. Mr. Frischling and Ms. Penry-Williams, partners at Kramer Levin, are the primary attorneys responsible for the representation of the independent directors. Both Mr. Frischling and the independent directors of the AIM Funds anticipate that Kramer Levin will continue to represent the independent directors in the future.

Kramer Levin serves as legal counsel only to the independent directors. (Our firm [Ballard Spahr Andrews & Ingersoll] serves as counsel to the AIM Funds and to AIM.) Neither Mr. Frischling nor Kramer Levin currently serves as legal counsel, nor have they at any time during the last two fiscal years of each AIM Fund provided legal services, to any of the AIM Funds, AIM, A I M Distributors, Inc. (AAIM Distributors@) (the wholly owned subsidiary of AIM that acts as the distributor of shares of the AIM Funds) or any of their control persons. In addition, neither Mr. Frischling nor any law firm at which he was employed during the past ten years has provided legal services to the AIM Funds, AIM, AIM Distributors or any of their

53

control persons during such ten-year period. There are no material business or professional relationships between either Mr. Frischling or Kramer Levin and the AIM Funds, AIM, AIM Distributors or any of their control persons. . . .

The AIM Funds in the past have paid, and will continue to pay, Kramer Levin for the legal fees incurred in representing the independent directors.12 Based primarily on this fact and out of an abundance of caution, the AIM Funds have treated Mr. Frischling as an interested director throughout his tenure. . . .

. . . Based on the facts and representations set forth herein, we request that the Division concur in our view that Mr. Frischling is not an Ainterested person@ of the AIM Funds as that term is defined in Section 2(a)(19)(A)(iv).

As Mr. Frischling is not an interested person of the adviser, distributor or their affiliates, we believe that he should be eligible to vote with other disinterested directors on investment advisory contracts and principal underwriting contracts. Until recently, Mr. Frischling has served on the Audit Committees of those AIM Funds for which he serves as a director or trustee. Mr. Frischling has voluntarily taken a temporary leave of absence from these Committees pending the determination of his status as an interested person. If Mr. Frischling is deemed not to be an interested person he will be eligible to serve on the Audit Committees of the AIM Funds. . . .

. . .

Legal Analysis

Section 2(a)(19)(A) of the 1940 Act defines Ainterested person@ with respect to an investment company, as relevant here, to include:

A(iv) any person or partner or employee of any person who at any time since the beginning of the last two completed fiscal years of such company has acted as legal counsel for such company.@Mr. Frischling does not fall within the express terms of this statutory

provision. Neither he nor Kramer Levin serves nor have they at any time during the last two years served as legal counsel Afor such company@ (i.e., the investment company with regard to which interested person status is relevant); rather, Kramer Levin serves as legal counsel to the independent directors of such company. (Our firm serves as counsel to the AIM Funds.) Therefore, Mr. Frischling is neither a Aperson@ nor a Apartner or employee of any person@ who has acted as legal counsel for the AIM Funds. In addition to the fact that Mr. Frischling is not an interested person based on the legal standard set forth in Section 2(a)(19)(A)(iv), as

2 12Although the AIM Funds pay Kramer Levin for legal fees provided to the independent directors of the AIM Funds, the hiring and firing of legal counsel to such directors is solely within the discretion of such directors.

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set forth above Mr. Frischling has acted and continues to act independently from the AIM Funds and their management.

We believe that the AIM Funds may properly treat Mr. Frischling as an independent director. We do not believe that he should be deemed to be an interested person solely because Kramer Levin serves as legal counsel to the independent directors. We also do not believe that the fact that the AIM Funds pay Kramer Levin=s legal fees should have any effect on the analysis.

. . .As discussed above, Kramer Levin=s service as legal counsel for the

independent directors is a relationship that is not included in the express terms of Section 2(a)(19)(A)(iv). Although we agree with the Commission that the interests of an investment company and its independent directors are very frequently aligned, we do not believe that they are always aligned. The Commission itself has recognized that there are instances, such as litigation, where the interests of an investment company and its independent directors may not be aligned.5 The Commission also has recognized the argument that the close association counsel to an investment company generally has with such company=s investment adviser may influence such counsel=s representation of the independent directors.6 As a factual matter, Mr. Frischling has a close association with the independent directors of the AIM Funds both by virtue of his serving as a director/trustee and by virtue of Kramer Levin's representation of the independent directors. Because neither he nor Kramer Levin currently represents or have in the past represented the AIM Funds or their management personnel, Mr. Frischling does not have a close association with the AIM Funds other than in his capacity as a director or trustee.

Further, based on the legislative history of Section 2(a)(19), we submit that Congress did not intend for the term Ainterested person@ of an investment company to cover persons serving as legal counsel for such company=s independent directors. A new paragraph (19), defining the new term Ainterested person,@ was added to Section 2(a) of the 1940 Act by the Investment Company Amendments Act of 1970 (the A1970 Amendments@). Section 2(a)(19) was intended to cover those persons who are affiliated persons of an investment company and other persons who may not be independent of the investment company=s management. Indeed, the legislative history of the 1970 Amendments states that Section 2(a)(19) was intended to cover persons having Astrong ties@ to the managers of an investment company or Asubstantial business or professional relationships with the investment company or its adviser-underwriter. . . .@8

5 5See [Role of Independent Directors of Investment Companies, Release No. IC-24082 (Oct. 14, 1999).]

6 6See id.

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The Commission=s Report on the Public Policy Implications of Investment Company Growth (the AReport@), which underlies the 1970 Amendments, recommended adding Section 2(a)(19) because certain Aclose relationships [with an investment company=s investment adviser, principal underwriter or regular broker] derogate from directors= ability to represent effectively the interests of shareholders.@ . . . As stated in the Report, Aif unaffiliated directors are to serve an important function in representing the interests of shareholders in investment company affairs, those directors should not be persons with economic or family relationships with management which are inconsistent with the independent role in investment company affairs that the [1940] Act contemplates they should play.@

With respect to persons serving as legal counsel (and their partners and employees), Congress implemented the Commission=s recommendations in the Report in Section 2(a)(19) by classifying legal counsel to an investment company as interested persons in subparagraph (A)(iv) and by classifying legal counsel to the investment company=s adviser or its principal underwriter as interested persons in subparagraph (B)(iv). Although there does not appear to be any relevant legislative history on this point, in order for Congress to classify legal counsel to an investment company as an interested person Congress must have concluded that the interests of the investment company may be adverse to its shareholders because the investment company could be controlled by management. The legislative history does not address specifically the status of counsel to the independent directors of an investment company under Section 2(a)(19).

We believe that the legislative history of Section 2(a)(19) clearly shows that Congress and the Commission were concerned about conflicts of interest between an investment company=s shareholders and the management of such investment company. It is in this context that Section 2(a)(19)(A)(iv) was added to the 1940 Act. Although Congress apparently concluded that legal counsel for an investment company should be deemed to be an interested person because management may exercise control over the investment company, there is no reason to extend this analysis to legal counsel for the independent directors of an investment company where legal services are not also provided to such investment company, its adviser, its distributor or any of their control persons. At the time of the 1970 Amendments, both Congress and the Commission were undoubtedly aware that independent directors of investment companies had the ability to retain their own legal counsel. If Congress or the Commission wanted to include legal counsel to independent directors of investment companies as interested persons because they felt that such counsel were subject to conflicts of interest with the shareholders of such investment companies, they would have explicitly defined such counsel as interested persons in the 1970 Amendments.

8 8S. Rep. No. 184, 91st Cong., 1st Sess. 32 (1969).

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In addition, as a practical matter, the independent directors must be independent from management and must represent only the interests of shareholders of the investment company; otherwise, they would not qualify as independent directors. If the independent directors are not interested persons, their legal counsel should not be interested persons either. Provided that there are no material business or professional relationships between legal counsel to the independent directors and management, such counsel will not be subject to the conflicts of interest that Section 2(a)(19) was designed to address.

Finally, we note that Congress has recognized that legal counsel to an investment company should not be deemed to be an interested person if such counsel does not have ties to the investment company=s management that could impair its ability to act independently with respect to the investment company. In the House Report that accompanied the 1970 Amendments, the committee recognized that, although all legal counsel for investment companies would be defined as interested persons, under Section 6(c) of the 1940 Act the Commission Acould exempt any such person upon an appropriate showing that he, in fact, is in a position to act independently on behalf of the investment company and its shareholders in dealing with the company=s investment adviser or principal underwriter.@13 In our view, legal counsel who serves the independent directors of an investment company, but does not represent the investment company or its adviser, its distributor or any of their control persons, does not have ties to the management of the investment company that could impair his ability to act independently with respect to such company or its independent directors.

No-Action Request

Accordingly, on behalf of the AIM Funds, we respectfully request that the Division assure the AIM Funds that, under the facts presented, it will not recommend that the Commission take enforcement action against the AIM Funds under the 1940 Act if the AIM Funds were to treat Mr. Frischling as a director/trustee who is not an Ainterested person@ of the AIM Funds as that term is defined in Section 2(a)(19)(A)(iv) of the 1940 Act.

. . .

SEC REPLY

. . .Section 2(a)(19)(A)(iv) of the Act defines an interested person of a fund as

Aany person or partner or employee of any person who at any time since the

3 13H.R. Rep. No. 1382, 91st Cong., 2d Sess. 15 (1970).

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beginning of the last two completed fiscal years@ of such fund Ahas acted as legal counsel for@ the fund. You state that the legislative history of Section 2(a)(19) does not address the issue of whether acting as legal counsel for the independent directors of a fund is the equivalent of acting as legal counsel for the fund. You believe that a person who acts solely as legal counsel for the independent directors of a fund is not also acting as legal counsel for the fund and thus is not an interested person of the fund under Section 2(a)(19)(A)(iv). You note, however, that the Commission recently stated that the interests of a fund, its shareholders and its independent directors are nearly always aligned.1 You are concerned that this statement should not be interpreted to mean that a person who acts as legal counsel for a fund=s independent directors is also acting as the fund=s legal counsel.

We agree that a person would not be an interested person of a fund under Section 2(a)(19)(A)(iv) of the Act solely because that person acts as legal counsel for the fund=s independent directors. As a matter of policy, however, because of the factual nature of the inquiry, we generally will not respond to any no-action request regarding whether, for purposes of Section 2(a)(19)(A)(iv), a person=s activities are limited to acting solely as legal counsel for the independent directors of a fund. In addition, we note that the fact that a fund pays the legal expenses of the independent directors= legal counsel, incurred by the independent directors in their official capacity for the fund, would not, by itself, mean that such counsel is acting as the fund=s legal counsel for purposes of Section 2(a)(19)(A)(iv).

1 1See Role of Independent Directors of Investment Companies, Investment Company Act Release No. 24816 (Jan. 2, 2001) n.44.

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G.T. Global Growth Series et al.Securities and Exchange Commission No-Action Letter

Publicly Available February 2, 19961996 SEC NOACT LEXIS 323

LETTER TO SEC

On behalf of G.T. Global Growth Series, G.T. Global Variable Investment Series, G.T. Global Variable Investment Trust, G.T. Global Developing Markets Fund, Inc., G.T. Investment Funds, Inc., G.T. Investment Portfolios, Inc., G.T. Greater Europe Fund, Global High Income Portfolio, Global Investment Portfolio, Growth Portfolio (referred to hereinafter collectively as the "Funds" and individually as a "Fund") and Frank S. Bayley (referred to hereinafter collectively as the "Applicants"), we hereby request that the Staff of the Division of Investment Management ("Staff") advise us that it will not recommend that the Securities and Exchange Commission (the "Commission") take enforcement action against the Funds, under Section 2(a)(19) of the Investment Company Act of 1940, as amended ("1940 Act"), if the Funds were to treat Mr. Bayley as an independent director/trustee and that the Staff confirm our interpretation that under the facts presented, the Funds can treat Mr. Bayley as a director/trustee who is not an interested person of the Funds as that term is defined in Section 2(a)(19) of the 1940 Act.

I. Background

[All but two of the Funds] are open-end management investment companies registered under the 1940 Act. G.T. Greater Europe Fund and G.T. Global Developing Markets Fund, Inc. are closed-end management investment companies registered under the 1940 Act. G.T. Capital Management, Inc. ("G.T. Capital") serves as investment adviser for each Fund. G.T. Global Financial Services, Inc. ("G.T. Financial") serves as the distributor or principal underwriter for those open-end companies that publicly offer and sell their shares on an ongoing basis. G.T. Capital and G. T. Financial are each part of the G.T. Group, a global investment advisory organization. G.T. Capital and G.T. Financial are wholly owned by G.T. Capital Holdings, Inc., which is in turn wholly owned by G.T. Holding Luxembourg S.A. G.T. Holding Luxembourg S.A. is wholly owned by BIL GT Group Limited, which is in turn 99.7% owned by the Prince of Liechtenstein Foundation. The Prince of Liechtenstein Foundation is wholly owned by the Princely Family of Liechtenstein.

Frank S. Bayley has served as either a director or trustee (referred to hereinafter collectively as a "director") for each Fund since 1984, or as of the commencement of operations in the case of Funds that were organized after 1984.

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Throughout his tenure, the Funds have treated Mr. Bayley as an independent director because he is not an "interested person" of the Funds as that term is defined in Section 2(a)(19) of the 1940 Act. Mr. Bayley is also a partner of Baker & McKenzie, a law firm with offices worldwide. Mr. Bayley joined the firm's San Francisco, California, office as a partner in 1986. Baker & McKenzie is the world's largest law firm with more than fifty offices and more than 500 partners. As discussed more fully below, the law firm's Hong Kong office has acted and may continue to act as legal counsel to the Bank in Liechtenstein Aktiengesellschaft ("Bank in Liechtenstein"). Bank in Liechtenstein is controlled by the Prince of Liechtenstein Foundation, which, as noted above, also controls BIL G.T. Group Limited.

Commencing in December 1994, Baker & McKenzie's Hong Kong office rendered legal services to Bank in Liechtenstein pursuant to a limited engagement regarding various matters primarily involving tax advice for clients or potential clients of the Bank in Liechtenstein. Baker & McKenzie's Hong Kong office may render similar legal services to Bank in Liechtenstein in the future, although the firm has not been retained for any such engagement.

Mr. Bayley has advised the Boards of Directors/Trustees (referred to hereinafter collectively as the "Boards") of the Funds that he is not involved in, in any way responsible for, or, other than in the most general terms, familiar with, any matters relating to Baker & McKenzie's representation of Bank in Liechtenstein. All such matters were, or are, handled by another partner who is not a partner at the same office in which Mr. Bayley works. Mr. Bayley did not help the firm's Hong Kong office obtain Bank in Liechtenstein as a client. Mr. Bayley was not even aware that Bank in Liechtenstein was in the process of retaining the firm's Hong Kong office. The legal work performed by his firm was unrelated directly or indirectly to G.T. Capital, G.T. Financial or the Funds. Mr. Bayley has represented that the fees billed and paid to Baker & McKenzie's Hong Kong office by Bank in Liechtenstein represented or are expected to represent less than 1/300 of 1% of the firm's total revenues for the past year and that the office currently anticipates that the percentage of the firm's total revenues received from Bank in Liechtenstein in future years will not exceed 1/300 of 1% of the firm's total revenues. Mr. Bayley's financial interest in the revenues of Baker & McKenzie is less than 1/10 of 1%.

Mr. Bayley has no professional or business relationships with Bank in Liechtenstein or any of its affiliates other than his position as a director of the Funds. Furthermore, Mr. Bayley has never participated in Baker & McKenzie's represen-tation of Bank in Liechtenstein. Therefore, there has never been any direct contact between Bank in Liechtenstein and Mr. Bayley except in connection with Mr. Bayley's service as a director of the Funds.

II. Discussion

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[The letter quotes paragraph (A)(iii) and paragraph (B)(iv) of section 2(a)(19).]

Mr. Bayley does not fall within the terms of either of these statutory provisions. Neither Mr. Bayley nor any of the law offices of Baker & McKenzie has at any time acted as legal counsel for the investment adviser to the Funds (G.T. Capital) or the principal underwriter for those open-end companies that publicly offer and sell their shares on an ongoing basis (G.T. Financial). Thus, Mr. Bayley is neither a "person" nor a "partner . . . of any person" who has acted as legal counsel for G.T. Capital or G.T. Financial.

In light of the Staff's previous interpretations of Section 2(a)(19), we seek the Staff's confirmation that Mr. Bayley can continue to be treated as a Fund director who is not an "interested person" of any of the Funds. In particular, the Staff has previously taken the position that a director of an investment company who has provided, or is a partner of someone who has provided, legal services to a person under common control with the investment adviser of the investment company, and therefore is an affiliated person of the investment adviser as that term is used in Section 2(a)(3)(C) of the 1940 Act, may be deemed an interested person of the investment company within the meaning of Section 2(a)(19)(A)(iii).2 Under such a rationale, Mr. Bayley could be considered an "interested person" of the Funds, G.T. Capital and G.T. Financial merely because Baker & McKenzie's Hong Kong Office has provided legal services, and may continue to do so in the future, to an entity which is an affiliated person, or an affiliated person of an affiliated person, of the Funds, G.T. Capital and G.T. Financial.

It is our opinion that the express terms of Section 2(a)(19) do not reach such relationships. Further, we believe that Congress did not intend for the term "interested person" of an investment company to encompass them. The 1970 Amendments to the 1940 Act devised the term "interested person" of an investment company and of an investment adviser or principal underwriter to cover the many individuals who are affiliated persons of the investment company and other individuals who might not be independent of the investment company's management. For example, Section 2(a)(19) includes within the category of persons defined as "interested persons" of an investment company those who are registered as broker-dealers or affiliated persons of such broker-dealers.I Also included are persons who

2 2Vestaur Securities, Inc., 1973 SEC No-Act Lexis 3780 (Jan. 4, 1973).

I IEditor=s note: Paragraphs (A)(v) and (B)(v) of section 2(a)(19) covered Aany broker or dealer registered under the Securities Exchange Act of 1934 or any affiliated person of such a broker or dealer.@ The paragraphs were amended, effective in May 2001, by the Gramm-Leach-Bliley Act, Pub. L. No. 106-102, '' 213, 225, 113 Stat. 1338 (1999). The versions of paragraphs (A)(v) and (B)(v) that are reproduced earlier in this chapter are the current, i.e., amended, versions.

61

have acted as legal counsel to the investment company, its investment adviser or principal underwriter and partners of such persons. The fact that the 1970 Amendments did not include persons, or partners or employees of such persons, who have acted as legal counsel for affiliated persons of an investment company, its investment adviser or principal underwriter when that formulation was used elsewhere in Section 2(a)(19), strongly supports the proposition that Congress did not intend for Section 2(a)(19) to reach that far.

The legislative history of the 1970 Amendments itself does not reflect any policy which calls for extending the definition of "interested persons" to include persons other than those having "strong ties" to the managers of an investment company or "substantial business or professional relationships with the investment company or its adviser-underwriter . . ." (S. Rep. No. 184, 91st Cong., 1st Sess. 32 (1969)). Neither Mr. Bayley nor any partner of any office of Baker & McKenzie has "strong ties" to G.T. Capital or G.T. Financial, or "substantial business or professional relationships" with these entities or the Funds other than as a director of the latter. Therefore, there is no ground on which to base a belief that Baker & McKenzie's representation of Bank in Liechtenstein has impaired or would impair in any manner or otherwise affect Mr. Bayley's ability to exercise sound independent business judgment in the fulfillment of his fiduciary duties and obligations as an independent director of the Funds.

III. Conclusion

It is respectfully submitted that Section 2(a)(19)(A)(iii) cannot be read to include Mr. Bayley as an interested person of the Funds by reason of the aforesaid facts and that Congress did not intend Sections 2(a)(19)(A)(iii) and 2(a)(19)(B)(iv) be construed in such a way as to deem Mr. Bayley an interested person of the Funds, G.T. Capital or G.T. Financial. Moreover, Mr. Bayley does not have the kind of ties to the investment manager or underwriter of the Funds that were of concern to Congress in 1970. Accordingly, we respectfully request that the Staff assure the Funds that it will not recommend that the Commission take enforcement action against the Funds if the Funds were to continue to treat Mr. Bayley as an independent director with respect to Section 2(a)(19) of the 1940 Act and confirm our interpretation that under the facts presented Mr. Bayley is not an interested person of the Funds as that term is defined in Section 2(a)(19) of the 1940 Act and that the Funds can treat him accordingly.

. . .

SEC REPLY

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Your letter . . . requests our assurance that we would not recommend enforcement action to the Commission if certain registered investment companies (the "Funds") advised by G.T. Capital Management, Inc. ("G.T. Capital") do not treat Mr. Frank S. Bayley, a director or trustee of each of the Funds, as an "interested person" of the Funds under subparagraphs (A)(iii) and (B)(iv) of Section 2(a)(19) of the Investment Company Act of 1940 (the "1940 Act").

G.T. Capital and G.T. Global Financial Services, Inc. ("G.T. Financial"), which serves as principal underwriter for certain of the Funds, are indirect, wholly owned subsidiaries (as defined in Section 2(a)(43) of the 1940 Act) of the Prince of Liechtenstein Foundation (the "Foundation"). The Bank in Liechtenstein Aktiengesellschaft (the "Bank") also is a wholly owned subsidiary of the Foundation. The Bank thus is under common control with the Funds' adviser and the principal underwriter of certain of Funds.

In addition to being a director or trustee of each of the Funds, Mr. Bayley is a partner in the San Francisco office of the law firm of Baker & McKenzie. Baker & McKenzie's Hong Kong office has rendered and may continue to render legal services, primarily regarding tax matters, to the Bank. You state that the legal work performed for the Bank by Baker & McKenzie was not related, directly or indirectly, to G.T. Capital, G.T. Financial, or the Funds.2 You further state that Mr. Bayley has no professional or business relationship with the Funds, G.T. Capital, G.T. Financial, or any of their affiliates, other than his positions as a director or trustee of the Funds.

Section 10 of the 1940 Act generally permits no more than 60% of the members of an investment company's board of directors to be interested persons of the investment company. Section 2(a)(19)(A)(iii) of the 1940 Act includes within the definition of "interested person" of an investment company "any interested person of any investment adviser of or principal underwriter for such company." Section 2(a)(19)(B)(iv) in turn defines "interested person" of an investment adviser of or principal underwriter for any investment company to include "any person or partner or employee of any person who at any time since the beginning of the last two completed fiscal years of such investment company has acted as legal counsel for such investment adviser or principal underwriter."

Mr. Bayley has never acted as legal counsel for the Funds' investment adviser or principal underwriter, nor is he the partner or the employee of a person who has provided such legal counsel. You nonetheless request our view with respect to whether the Funds should treat Mr. Bayley as an interested person because of a position taken by the staff in Vestaur Securities, Inc. (pub. avail. Jan. 4, 1973) ("Vestaur"). In Vestaur, the staff indicated that a person (or the partner of a person)

2 2Mr. Bayley has represented that the fees paid by the Bank to Baker & McKenzie amounted to less than 1/300 of 1% of the firm's total revenue for the past year, and that the firm currently anticipates that the percentage of its total revenue that is received from the Bank will not exceed this level in the future.

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who had acted as counsel to a bank that was under common control with a fund's adviser would be considered an interested person of the fund within the meaning of Section 2(a)(19).3 You believe instead that Section 2(a)(19)(B)(iv) should be interpreted in accordance with its plain meaning and therefore should not be extended to a person (or the partner of a person) who has served as legal counsel to an affiliate of a fund's adviser or principal underwriter.4

The legislative history of Section 2(a)(19) supports the conclusion that subparagraph (B)(iv) does not include a person in Mr. Bayley's position, particularly when the statutory language ultimately enacted is compared with the recommenda-tions made in the Commission's Report on The Public Policy Implications of Investment Company Growth (the "PPI Report").5 The PPI Report recommended adding Section 2(a)(19) because certain "close relationships [with fund management] derogate from directors' ability to represent effectively the interests of shareholders."6

While the PPI Report did not specifically recommend that the definition of interested person include legal counsel to the fund, its adviser, or principal underwriter, it did recommend a general provision that would have included within the definition "any

3 3The staff stated without explanation that "for the purpose of this analysis, we consider the adviser and the bank as one entity," but nonetheless granted no-action relief on policy grounds, provided that neither the director nor his law firm would represent the bank in the future. In contrast to Vestaur, the staff recently stated that, absent substantial policy reasons, we generally will not consider affiliated companies to be a single entity. See Salomon Brothers, Inc. (pub. avail. May 25, 1995) [1995 SEC NOACT LEXIS 535]. We note, however, that if intermediaries were created for the purpose of altering a person's status under Section 2(a)(19), the staff would consider whether there was a violation of Section 48(a) of the 1940 Act. [Editor's note: Section 48(a) states that "[i]t shall be unlawful for any person, 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 this subchapter or any rule, regulation, or order thereunder."]

4 4In this regard, you ask the staff to compare the language of subparagraph (B)(iv) of Section 2(a)(19) to other provisions of this section, such as subparagraphs (A)(v) and (B)(v), which expressly include affiliated persons of a registered broker or dealer within the definition of interested person. Moreover, other provisions of the 1940 Act, such as Sections 17(a) and 17(j), expressly apply to affiliated persons of advisers and principal underwriters for registered investment companies, as well as to the advisers and underwriters themselves.

5 5Securities and Exchange Commission, Report on the Public Policy Implications of Investment Company Growth, H.R. Rep. No. 2337, 89th Cong., 2d Sess. (1966).

6 6Id. at 334.

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person who . . . has, or has had within the past years, any material business or professional relationship with affiliated persons [of the fund] and their affiliated persons."7

Congress appears to have implemented this recommendation in the following manner. Persons (and partners and employees of persons) who serve as legal counsel to the fund, its adviser, or its principal underwriter are classified as interested persons in subparagraphs (A)(iv) and (B)(iv). Those individuals who have other types of material business or professional relationships with the fund, its adviser or its principal underwriter are covered by subparagraphs (A)[(vii)] and (B)[(vii)] of Section 2(a)(19). These provisions authorize the Commission to issue orders declaring a person to be an interested person of a fund or its investment adviser or principal underwriter because the person has or has had a material business or professional relationship with the fund, adviser or underwriter, or their controlling persons. Congress required the Commission to issue a formal order before a person can be considered an interested person because of his or her material business or professional relationships, to "eliminate any danger of inadvertent violations of the requirements of the [1940 Act]"9 which were likely because of the subjective nature of the standard. Therefore, while Congress determined through subparagraph (B)(iv) to classify as interested persons all persons (and partners and employees of persons) who serve as legal counsel to the fund, its adviser or principal underwriter, we believe that persons who serve as legal counsel to an affiliate of a fund's adviser or principal underwriter fall outside subparagraph (B)(iv); the classification of such persons is more appropriately determined by reference to subparagraph (B)[(vii)] of the section.11

In light of the foregoing, and based on the facts and representations set forth in your letter, we would not recommend enforcement action to the Commission if the Funds do not treat Mr. Bayley as an interested person under subparagraphs (A) (iii)

7 7Id.

9 9S. Rep. No. 184, 91st Cong., 1st Sess. 34 (1969).

1 11The staff believes that it generally is not appropriate to respond to no-action requests under subparagraph (B)[(vii)] of Section 2(a)(19). We therefore express no view whether Mr. Bayley would be considered an interested person under subpara-graph (B)[(vii)].

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and (B)(iv) of Section 2(a)(19).12 You should note that different facts or circumstances might require a different conclusion.

2 12We note that courts may consider the genuine independence of a board of directors, apart from the directors' classification under Section 2(a)(19), in determining whether there has been a breach of fiduciary duty by the fund's management within the meaning of Section 36 of the 1940 Act. [Editor's note: Section 36(a) authorizes civil actions by the Securities and Exchange Commission where there has been "a breach of fiduciary duty involving personal misconduct" by persons serving registered investment companies in specified capacities, e.g., as a director, officer, or investment adviser. Section 36(b) provides in pertinent part that "the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser." Both the Commission and shareholders of registered investment companies are authorized to bring civil actions against persons covered by section 36(b) -- including the board of directors and the investment adviser of the investment company -- but personal misconduct by a defendant is not required for a violation of section 36(b).]

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Note

Subsequently, the Division of Investment Management considered whether several registered investment companies could treat one of their directors, Douglas H. McCorkindale ("McCorkindale"), as independent rather than interested. First Financial Fund, Inc. (publicly available June 5, 1997), 1997 SEC NOACT LEXIS 662. The staff summarized the facts as follows:

Mr. McCorkindale serves as a director or a trustee for . . . [four registered] investment companies . . . (the 'Funds'). Wellington Management Company, LLP ('Wellington') serves as the investment adviser or sub-adviser to each of the Funds, or to certain portfolios of the Funds.

Mr. McCorkindale also is a limited partner in two investment partnerships (the 'Partnerships') that are not registered under the Investment Company Act pursuant to the exclusion provided by Section 3(c)(1) of the Act. The Partnerships are managed and advised by their general partner, Wellington Hedge Management, LLC ('WHMLLC'). WHMLLC has two members: Wellington and Wellington Hedge Management, Inc. ('WHMI'), both of which are registered investment advisers. Wellington and WHMI are under the common control of Robert W. Doran ('Doran'), Duncan M. McFarland ('McFarland') and John R. Ryan ('Ryan').2

You represent that the limited partners of the Partnerships, including Mr. McCorkindale, have no right to vote or otherwise participate in the management of the Partnerships. You represent that Mr. McCorkindale currently holds less than 5% of the limited partnership interests in each Partnership and that, in the future, his interest in each Partnership will remain under 5%. You further represent that Mr. McCorkindale obtained his interests in the Partnerships on the same terms as the other limited partners and that the offer to him of the opportunity to invest in the Partnerships was not related to any Fund business. Last, you state that Mr. McCorkin-dale has no other relationship with Wellington other than his interest in the Partnerships.

The investment companies, in their letter to the Division of Investment Management, reasoned that:

2 2 Messrs. Doran, McFarland and Ryan are the managing partners of Wellington and the sole shareholders of WHMI.

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Section 2(a)(19)(A)(iii) of the 1940 Act defines as an 'interested person' of an investment company to include, as relevant here, any person who is an 'interested person' of the company's investment adviser.

Section 2(a)(19)(B)(i), in turn, defines an 'interested person' of an investment adviser to include any 'affiliated person' of such investment adviser.

Section 2(a)(3)(D) includes as an 'affiliated person' of an entity, any partner or co-partner of such entity. Section 2(a)(3)(C) defines 'affiliated person' as 'any person directly or indirectly controlling, controlled by, or under common control with, such other person.'

Mr. McCorkindale, as a limited partner in the Partnerships, is a co-partner of WHMLLC, and thereby an affiliated person of WHMLLC under section 2(a)(3)(D). WHMLLC, in turn, is affiliated with Wellington Management under section 2(a)(3)(C) by virtue of being directly or indirectly 'under the common control['] of Messrs. Doran, McFarland, and Ryan. As such, Mr. McCorkindale, an affiliate of WHMLLC, is a 'second-tier' affiliate of Wellington Management, the investment adviser to the Funds.

Section 2(a)(19)(B)(i) of the 1940 Act does not, on its face, reach second-tier affiliations, as the literal language of the section applies only to 'any affiliated person of such investment adviser' (i.e., first-tier affiliates). Nevertheless, were WHMLLC and Wellington Management to be 'collapsed' into a single entity for purposes of section 2(a)(19), Mr. McCorkindale would be a first-tier affiliate of Wellington Management and therefore an 'interested person' of the Funds pursuant to section 2(a)(19)(A)(iii) and 2(a)(19)(B)(i). Because, in the past, the Staff has collapsed second-tier affiliations into first-tier affiliations for purposes of determining an individual's status as an 'interested person' of an investment company under section 2(a)(19), the Funds seek confirmation that the Staff would interpret 2(a)(19) in accordance with its plain meaning in this case.3 It is our view that section 2(a)(19) should not be interpreted so as to reach relationships such as Mr. McCorkindale's in this case . . . .

3 3 See Vestaur Securities, Inc., (Jan. 4, 1973) (collapsing wholly-owned investment adviser and bank subsidiaries into a single entity); Southwestern Investors, Inc., (June 13, 1971) (collapsing parent, subsidiary, and investment adviser and underwriting subsidiary of the subsidiary into one entity) . . . .

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. . . In G.T. Global Growth Series et al., the Staff stated it would not recommend enforcement action where a director of a fund was a partner in a law firm that had acted as outside counsel to a bank under common control with the fund's adviser.4 The director was not 'a person who ... within the last two fiscal years acted as legal counsel for the investment adviser' to the fund within the meaning of section 2(A)(19)(B)(iv) of the 1940 Act. Nevertheless, were the bank and investment adviser to be 'collapsed' into one entity, the director's legal services would then have been considered for the benefit of the collapsed entity, and would render him an 'interested person' of the adviser, and ultimately of the fund as well, under section 2(a)(19)(A)(iii).

The Staff in G.T. Global Growth Series, declining to collapse the two entities, noted the contrast to the 1973 Vestaur letter, where 'without explanation,' the Staff determined 'for the purpose of [that] analysis' to 'consider the adviser and the bank as one entity.' Explaining Vestaur, the Staff noted the letter stood 'in contrast' to the policy subsequently adopted by the Staff in [another letter], wherein '[the Staff] stated that, absent substantial policy reasons, we generally will not consider affiliated companies to be a single entity.' The Staff justified its decision not to 'collapse' the two entities in the G.T. Global Growth Series letter, and its general policy against doing so, by reference to policy considerations it identified as underlying the 1940 Act, and to the Congressional intent as to how these should be effected. The Staff reasoned that those providing legal services or standing in 'any material business or professional relationship' with an affiliate of an underwriter or adviser to a fund should be determined to be interested persons only through application of the subjective, flexible 2(a)(19)(B)[(vii)] standard, and not under the 2(a)(19)(B)(iv) rule. Nonetheless, the Staff noted in its response that if the intermediate entities were created for purposes of altering a person's status under section 2(a)(19), it would consider whether there was a violation of section 48(a) of the 1940 Act, which prohibits persons from doing indirectly what they cannot do directly under the Act.

. . .Mr. McCorkindale's role in the Partnerships is a passive,

limited one. . . . Moreover, the structure adopted by Wellington Management with respect to its investment partnerships in this case

4 4 G.T. Global Growth Series et a1. (Feb. 2, 1996) ("absent substantial policy reasons, [the staff] generally will not consider affiliated companies to be a single entity").

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was not established with a view to effecting [sic] Mr. McCorkindale's status vis-a-vis the Funds. . . .

As noted above, if the collapsing affiliates theory is not applied, Mr. McCorkindale will not be an 'interested person' of the Funds under the plain language of section 2(a)(19). In addition to being consistent with the plain meaning of section 2(a)(19) of the 1940 Act, an interpretation that the Funds need not treat Mr. McCor-kindale as an 'interested person' is consistent with the policies underlying the statute. Mr. McCorkindale's only relationship to the Funds and the investment adviser (other than his service as a director) is as a passive investor in an investment vehicle sponsored by the Funds' adviser. As such, there is little to distinguish his relationship from that of a shareholder in a mutual fund advised by Wellington Management or of an advisory client of that firm. But for the provisions in 2(a)(3)(D) rendering 'partners' and [']co-partners' affiliated persons of each other, Mr. McCorkindale would have no affiliation with the adviser. For example, if Mr. McCorkindale were a shareholder in a mutual fund advised by Wellington Management, the statute would not designate him an affiliate of either Wellington Management or that fund, unless his holding equaled or exceeded 5% of the outstanding voting securities. Most likely because Congress did not foresee the growth in the use of limited partnerships as investment vehicles, the fact that the limited partnership structure was adopted in this case causes a different result. However, as the Commission has previously recognized, limited partners are typically passive investors that need not, as a policy matter, be treated as affiliated persons solely because of their status as such. Management of limited partnerships is typically vested exclusively in the general partner, who exercises full control over the business and affairs of the partnership to the exclusion of the limited partners. The Partnerships described above are structured in just this way.

. . .For the foregoing reasons, and based on the facts,

circumstances and representations described above, we respectfully request confirmation that the Staff will not recommend enforcement action against the Funds, or any of the other parties hereto, if Mr. McCorkindale serves as an independent director of the Funds. The Staff's concurrence in our position that Wellington Management and WHMLLC should be treated as separate entities in determining the relationship between Mr. McCorkindale and the Funds is also requested. These no action assurances and interpretation are intended only to permit Mr. McCorkindale to serve as an independent director

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or trustee to the Funds and would not affect the status of the Partnerships or the Funds.

. . .

The Division of Investment Management responded as follows:Section 2(a)(19)(A)(iii) of the Investment Company Act

defines an 'interested person' of an investment company to include, in pertinent part, any person who is an interested person of the company's investment adviser. Section 2(a)(19)(B)(i), in turn, defines an 'interested person' of an investment adviser to include any affiliated person of such investment adviser. An 'affiliated person' is defined in Section 2(a)(3) to include: any person owning, controlling, or holding with power to vote, 5% or more of the outstanding voting securities of the other person; any person controlling, controlled by or under common control with the other person; and any officer, director, partner, co-partner or employee of such other person.

Because Mr. McCorkindale is a limited partner of the Partnerships, he is a co-partner of WHMLLC, the general partner of the Partnerships, and hence an affiliated person of WHMLLC. WHMLLC, in turn, is affiliated with Wellington because the two companies are under the common control of Messrs. Doran, McFarland and Ryan.5 Thus, Mr. McCorkindale is a second-tier affili-ate of Wellington, the adviser or sub-adviser to each of the Funds. Mr. McCorkindale does not appear to be an interested person of Wellington because Section 2(a)(19)(B)(i), by its terms, does not reach second-tier affiliations. You note, however, that Mr. McCorkin-dale could be deemed a first-tier affiliate, and thus an interested person, of Wellington if the staff were to 'collapse' WHMLLC and Wellington rather than treating them as separate entities. If Mr. McCorkindale is an interested person of Wellington, he also would be an interested person of the Funds.6

You contend that Mr. McCorkindale's indirect connection with the Funds as a limited partner of two Partnerships advised by an affiliate of the Fund's adviser is not the type of 'co-partner' affiliation that Congress intended to result in an individual being classified as an interested person of an investment company. As Mr. McCorkindale's

5 5 Messrs. Doran, McFarland and Ryan control WHMLLC through their ownership of WHMI, the managing member of WHMLLC.

6 6 See Section 2(a)(19)(A)(iii) of the Investment Company Act.

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limited partnership interests confer no right to participate in the management of the Partnerships, you state that there is little reason to distinguish an investment in the Partnerships from an investment in a mutual fund or other entity organized as a corporation or a trust. Under Section 2(a)(3)(C) [sic], stockholders and trustholders are not included within the definition of an 'affiliated person' unless they own 5% or more of the outstanding voting securities of an entity. Mr. McCorkindale's ownership interest in each Partnership is, and will remain, under 5% of the outstanding limited partnership interests of each Partnership.

We agree that Mr. McCorkindale should not be treated as an interested person of the Funds. The Commission has recognized that, in many circumstances, limited partners and shareholders should be treated comparably. Mr. McCorkindale's role as a passive investor in the Partnerships is, and should be treated as, comparable to that of a shareholder owning less than 5% of the outstanding voting securities of a corporation or trust. Accordingly, we would not classify Mr. McCorkindale as an interested person of Wellington (and therefore an interested person of the Funds) by virtue of his less than 5% interest in the Partnerships managed by an affiliate of Wellington.

. . .For the reasons stated above, our conclusion would be the

same if Wellington, rather than an affiliate of Wellington, managed the Partnerships. It therefore is unnecessary to express our views on your contention that Wellington and WHMLLC (the Wellington affiliate that manages the Partnerships) should be treated as separate entities, rather than 'collapsed' into a single entity, for purposes of determining Mr. McCorkindale's status as an interested person of the Funds.8

8 8 The staff in the past has collapsed second-tier affiliations into first-tier affiliations for purposes of determining an individual's status as an "interested person" under Section 2(a)(19). See, e.g., Vestaur Securities, Inc. . . . ; Southwestern Investors, Inc. . . . . More recently, however, the staff has taken the position that it would not, "absent substantial policy reasons," collapse affiliated entities for purposes of determining a person's status as an interested or affiliated person. See GT Global Growth Series . . . . In this regard, we note your representation that the management structure of the Partnerships was not adopted to prevent Mr. McCorkindale from being an interested person of Wellington or the Funds.

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Based upon the facts and representations in your letter, we would not recommend enforcement action to the Commission if the Funds do not treat Mr. McCorkindale as an 'interested person' as a result of his limited partnership interest in the Partnerships. You should note that any different facts or representations might require a different conclusion.

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Discussion Problem 3.2Dana Block et al.

Securities and Exchange Commission No-Action LetterPublicly Available April 1, 1994

APPLICATION OF DANA BLOCK ET AL.FOR A HEARING AND DISCOVERY

I. Summary of Application

The Dreyfus Corporation ("Dreyfus") manages 130 different mutual funds ("Dreyfus Family of Funds"). The undersigned attorneys, on behalf of stockholders of the Dreyfus Family of Funds, apply . . . for an order by the U.S. Securities and Exchange Commission ("SEC" or "the Commission") under sections 2(a)(19)(A)[(vii)] and (B)[(vii)] of the Investment Company Act of 1940 ("the Act") for a determination that the independent directors of the Dreyfus Family of Funds are "interested persons" . . . .

On December 6, 1993, Dreyfus and Mellon Bank Corporation ("Mellon") jointly announced that they had entered into a definitive agreement to merge pursuant to which Mellon would acquire Dreyfus in a stock transaction valued at $1.85 billion (the "Merger"). Mellon is acquiring Dreyfus in order to gain the benefit from the future income stream derived from the management of the Dreyfus Family of Funds. Although Dreyfus does not "own" this income stream, since its right to it is premised on the assumption that each of the 130 separate funds will continue to hire Dreyfus as the investment adviser, Dreyfus alone will benefit from the Merger, not the Dreyfus Family of Funds or their stockholders.

As a result of Mellon's purchase of Dreyfus, Dreyfus' advisory contracts with the various funds will be automatically terminated. The consummation of the Merger will require, among other things, that a majority of the "independent" directors serving on the board of directors of each fund in the Dreyfus Family of Funds approve the transfer of control. The Merger is premised on the assumption that the independent directors will rubber stamp the new advisory contract and that they will not seek any payment, reduction of fees or entertain competitive bids.1

Applicants hereunder contend that the directors previously identified by Dreyfus and/or the mutual funds under its management as "independent" are in fact "interested" directors and should be declared as such by the Commission.

1 1Applicants were recently made aware that one highly reputable investment adviser, with an excellent record of performance, seeks to manage the stock funds in the Dreyfus Family of Funds on terms far more advantageous to those funds than the existing agreement.

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Specifically, many of these directors are "interested" with respect to the investment companies on whose boards they serve because they serve on the boards of multiple other funds that are part of the Dreyfus Family of Funds. As a result of such service, they earn material sums of money for very limited services. Accordingly, these directors are, within the meaning of ' 2(a)(19)(A)[(vii)], natural persons who have material business or professional relationships with other investment companies having the same investment adviser. In addition, within the meaning of ' 2(a)(19)(B)[(vii)], these directors are "interested" with respect to the investment adviser, Dreyfus, because they are natural persons who have a material business or professional relationship with one or more controlling persons of the investment adviser.

. . .

III. Background

. . . Dreyfus serves primarily as an investment adviser and manager of mutual funds . . . . As of December 1993, the Dreyfus Family of Funds consisted of over 130 separate funds, with some 900,000 investors.

The business of Dreyfus "is primarily dependent on its continuation as manager of its sponsored mutual funds." The net assets of funds managed, advised or administered by Dreyfus total approximately $80 billion, doubling in size since 1988 and making it the sixth largest mutual fund company in the United States. For fiscal year 1992, Dreyfus earned net management, investment advisory and administrative fees of over $278 million, with a net income of over $91 million.

On December 6, 1993, Dreyfus announced in a joint statement with Mellon that the two companies had entered into a definitive merger agreement under which Mellon will acquire Dreyfus. . . .

Mellon is the 21st largest bank holding company in the United States based on its balance sheet assets of approximately $35 billion as of September 30, 1993. In its trust and investment activities -- including mutual fund administration, institutional investment management and personal trusts -- Mellon manages some $135 billion in assets. With the acquisition of Dreyfus, Mellon expects to generate annual revenues of more than $3 billion (including $1.6 billion in fee revenues), making it the 13th largest bank holding company in the United States. It will manage over $215 billion in assets.

. . .Independent directors play an especially important role with respect to

investment advisory contracts. Section 15(c) [of the Act] requires that the independent directors evaluate and approve any advisory contract. In particular, Section 15(c) prohibits an investment company from entering into, renewing, or performing any investment advisory contract unless a "majority of directors, who are

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not parties to such contract or agreement or interested persons of any such party," approve the terms of the agreement. . . .

Under section 15(a)(iv) of the Act, any advisory contract must provide for its "automatic termination in the event of its assignment," which is defined in section 2(a)(4) to include a change of control of the adviser, such as will occur with the acquisition of Dreyfus by Mellon. As a result, the acquisition will result in the automatic termination of each of the advisory contracts between Dreyfus and the funds, requiring new contracts to be approved by the members of the board of directors who are not "interested persons," i.e., those designated by the funds to be "independent."

Because ownership of the investment adviser to the Dreyfus Family of Funds will change through the acquisition from an independent investment company to one owned by a bank, which may have significantly different interests and goals, the role of the independent directors is especially important as a means of protecting the interests of the Dreyfus Fund Stockholders.

. . .

IV. Challenged Directors of the Dreyfus Group of Mutual Funds

. . .

. . . [U]nder section 2(a)(19)(A)[(vii)], the Commission has the right to determine that an individual is "interested" if he or she has had a "material business or professional relationship" with the fund on which he or she serves as director or with any other fund having the same adviser. Similarly, under section 2(a)(19)(B)[(vii)], an individual can be found to be "interested" with respect to an investment adviser if he or she has a material relationship with the adviser or its principal executive officer.

The legislative history of section 2(a)(19)(A)[(vii)] of the Act indicates "that the test for materiality is whether the relationship might tend to impair a director's independence and that this test should be applied on a case-by-case basis to eliminate any danger of inadvertent violations of the requirements of the Act and to adequately implement the basic intent of strengthening independent checks on investment company management." . . .

Members of the boards of directors of the Dreyfus Family of Funds generally serve on multiple boards, receiving for each board up to $8,500 in cash.5 . . .

. . . Although plaintiffs are not in a position to determine precisely which directors serve on how many boards, or how much they are compensated as a result, aggregate director compensation in any substantial amount would clearly demonstrate

5 5Dreyfus Liquid Assets, Inc., for example, pays its non-affiliated directors an annual fee of $6,500, plus $500 for each board meeting attended, of which . . . four are generally scheduled annually.

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that the monetary remuneration would "tend to impair" the "independence" of the director in evaluating whether a proposed investment advisory contract should be accepted.

In this case, directors of a fund who receive such significant remuneration from multiple boards in the Dreyfus Family of Funds clearly have a "material business or professional relationship" with other funds that also use Dreyfus as an adviser, making them "interested persons" under section 2(a)(19)(A)[(vii)].6 At the same time, by serving on multiple boards that are closely aligned with Dreyfus, as the adviser, they also are "interested persons" under section 2(a)(19)(B)[(vii)]. The close relationship between the directors and Dreyfus is emphasized by the fact that virtually all of the executive officers of each fund are also officers or employees of Dreyfus and at least one of the board members is a senior Dreyfus officer. Moreover, Howard Stein, Chairman of the Board and Chief Executive Officer of Dreyfus, serves on many fund boards himself. Thus, directors who serve on multiple boards with Mr. Stein, the "principal executive officer" of Dreyfus, are "interested persons" under the Act for that reason alone.

The statutory scheme enacted by Congress establishes the important role of independent directors in protecting the interests of shareholders. Under the statute, many of the so-called independent directors of the Dreyfus Family of Funds are in fact "interested persons," and therefore do not provide the necessary protection mandated by law. Truly independent directors might well be in a position to bargain for better terms in the investment advisory contracts from Mellon than had been offered by Dreyfus. On the other hand, directors beholden to Dreyfus out of a desire to continue earning substantial sums through their position on multiple boards may not.

Directors who are not "interested" in Dreyfus or the funds under its management will also be in a better position to ensure that revised advisory contracts with a Mellon-owned adviser is in the best interest of fund shareholders. It is possible that because of Mellon's different interests, decisions will be made that could adversely effect [sic] the Dreyfus Fund Stockholders. As reported [elsewhere], "from time to time, [Dreyfus] has waived and may waive certain management fees and/or reimburse certain fund expenses to promote the growth of fund assets." Such decisions benefit fund stockholders through a reduction in fees. Mellon, having paid a huge price for the future stream of income, however, is unlikely to reduce fees and may even seek to increase the fees charged to shareholders, to their detriment. . . .

6 6Section 2(a)(19)(A) of the Act provides that "no person shall be deemed to be an interested person of an investment company solely by reason of . . . his being a member of its board of directors . . ." However, applicants' argument here is that the directors are interested persons because of their service on multiple Dreyfus-sponsored boards.

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V. Request for Relief

For the reasons set forth herein, applicants request the following relief from the Commission:

1. A hearing before the Commission to consider this application . . . ; [and]2. Prior to such hearing, discovery by applicants from Dreyfus and Mellon as

permitted under the Administrative Procedure Act . . . .

MEMORANDUM OF THE DREYFUS FAMILY OF FUNDS

IN OPPOSITION TO THE APPLICATION

APPLICANTS FAIL TO DEMONSTRATE THAT THE NON-INTERESTED DIRECTORS ARE INTERESTED PERSONS BY VIRTUE OF THEIR SERVICE ON MULTIPLE BOARDS

. . . Applicants claim that the Non-Interested Directors "are, within the meaning of ' 2(a)(19)(A)[(vii)], natural persons who have material business or professional relationships with other investment companies having the same invest-ment adviser", and thus are "interested" persons. In other words, according to the Applicants, the Non-Interested Directors each have a disqualifying entanglement because their directorship of other funds constitutes a prohibited material business relationship with other investment companies having the same investment adviser.

However, the clear and unambiguous language of ' 2(a)(19)(A)[(vii)] provides that "no person shall be deemed to be an interested person of an investment company solely by reason of . . . his being a member of its board of directors" . . . . Thus, contrary to the Applicants' claims, the Non-Interested Directors cannot be declared "interested" persons solely by reason of their holding other directorships.

. . .Not surprisingly, the Applicants fail to cite a single instance where the

Commission has determined an independent director to be an "interested" person simply because he or she serves as a director for "other investment companies". Indeed, the Commission has expressly and consistently noted and condoned situations where an independent director serves on mutual funds belonging to the same mutual fund complex. "Interlocking boards of directors within an investment complex are neither prohibited nor uncommon". In the Matter of The Vanguard Group, Inc., SEC Release No. 11645 (February 25, 1981) . . . .

The Applicants further claim that the Non-Interested Directors are interested persons under ' 2(a)(19)(B)[(vii)] of the 1940 Act . . . .

. . . The only argument offered by the Applicants with respect to this Section is that because "Howard Stein, Chairman of the Board and Chief Executive Officer of Dreyfus, serves on many fund boards himself" the "directors who serve on multiple

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boards with Mr. Stein, the 'principal executive officer' of Dreyfus, are 'interested persons' under the Act for that reason alone."

This claim is plainly frivolous; indeed, under the Applicants' interpretation of ' 2(a)(19)(B)[(vii)], any non-interested director who serves on even one board with the same interested director who is the principal executive officer or controlling person of an investment adviser would be an interested person. Since virtually all mutual funds have at least one director who is a principal executive officer or controlling person of an investment adviser on their boards . . . , the Applicants would have the Commission declare all independent directors to be interested persons if they serve on a board with "interested" directors. Applicants' novel interpretation would shock the industry in which many mutual funds have this composition to their boards of directors. Moreover, the 1940 Act contemplates, repeatedly, that mutual fund boards will be comprised, in part, of non-interested directors, and, in part, of interested directors. See, e.g., ' 10(a), 1940 Act (providing that not more than 60% of the directors of an investment company may be "interested persons" of that company, and they would serve with non-interested directors who would comprise at least 40%) . . . .

APPLICANTS FAIL TO DEMONSTRATE THAT THE NON-INTERESTED DIRECTORS ARE "INTERESTED" PERSONS BY VIRTUE OF THEIR COMPENSATION IN RETURN FOR SERVICE ON MULTIPLE BOARDS

. . . [T]he Applicants claim, without any foundation, that because the Non-Interested Directors serve on multiple boards, "as a result of such service, they earn material sums of money for very limited services". . . . Annexed as Exhibit E is a chart which summarizes the fees paid to the Non-Interested Directors by the Funds within The Dreyfus Family of Funds. These fees are reasonable and within the range of fees typically paid to non-interested directors. Exhibit E shows, inter alia, the total compensation for each of the Non-Interested Directors for The Dreyfus Family of Funds. As is clearly demonstrated, total compensation (including meeting fees) for the Non-Interested Directors ranges from about $4,000 to a maximum of $85,000, with the average Non-Interested Director earning less than $40,000 . . . .

The amount of compensation, standing alone, has never been considered enough to demonstrate that a director is an interested person. . . .

SEC REPLY

. . . The Commission has determined that [shareholders of a mutual fund] do not have a right to initiate a hearing under section 2(a)(19). Rather, the discretion to

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initiate such a hearing rests with the Commission, and the Commission has determined not to hold a hearing.I

. . .

I IEditor's note: In Block v. Securities and Exchange Commission, 50 F.3d 1078 (D.C. Cir. 1995), the U.S. Court of Appeals held that a Commission decision not to conduct a hearing under section 2(a)(19) is unreviewable.

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