SEC Division of Corporate Regulation staff letter: Loaning of Portfolio Securities by Registered Investment Companies

I .' . STATE STREET BANK and TRUST COl.IPAr...ry BOSTON; l:IASSACHUSE'I'TS 02101 ~ ".. :
RIOiARO J: DELMAR Vir:E: PF?£:SIOFNT
AREA CODE 517
. TELEPHONE 466.4843
April 7 i 1972
Mr. Alan Rosenblatt,. Chief Counsel
Division of Corporate Regulation
Securities and Exchange Commission
500 North Capitol Street, N. W.
Washington, D. C. 20549
SECURITIES AiJO EXCHANGE COMMISSIOi'l RECEIVED ~.PR 101972 Re: Loaninq of Portfolio Securities by Registered Investment Companies Di\1SION OF GDRl'OMTE REGUL\r1or~ Dear Mr. Rosenblatt:
This letter is intended to answer the' points raised in your December 27, 1971, -reply to 'my letter of November 3, 1971, on the above referenced subject. It is our understanding that if these conditions are met, that the Staff would not recommend any action to the Commission should one of our investment company clients enter ~ . into such a program. . . Pursuant to our discussions and exchange of correspondence, we propose to meet your guidelin~s as follows:
i. To insure a minimum of 100% collateralization of the loan at all
times and to minimize the need for adjustment in the amount of cash collateral, the Bank would suggest an initial cash collateral of 105% of the market value of the securities loaned. The market price would be monitored daily and additional collateral would be requhed if the price rose to a point where the collateral amounted to only 100% of the then current market value of the securities. This would, we presume, insure compliance with your first and second guidelines.
2. In answer to your requirement the.t the Fund be permitted to ter￾minate the loan at any time, it is to be a condition that the lender
may so terminate 1 with the borrower then having the normal settle~ ment time within which to redeliver to the lender the borrowed securitie s . ---..------;----:----.~='" I;, ~.., ~,. \ 1(~A -tt6 . :~ ~.1_:-~--.r.!....-~---.-..-..... ....,...~'..A.....,..........._. . bs.t'!2-.lJ_ffl- ....-- ¡ !,~~~ -1 0. __---------.------------.--. ". :;=~.~~b~.i~ OJ J / i ~ Î 'Ht:"'. ~ 1 .-:; ~;:.:: 5. .:. ~."r / / tL 1:1 7 ri-,... i 7 _____--..--- .

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, _' Mr. Alan Rosenblatt i
Page Two
April i, 1972
Chief Counsel \
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3. The guidelin,e. that the Fund receive reasonable interest on such
   a loan woulu appear to us to be met by the availability of the cash collateral for short-term ';.nvestrrient by the Fund. You have 'indicated that it would be mandatory to have such investments made in sufficiently liquid securities to provide for repayment to the borrower on his demand. It was alsQ your suggestion that such investments be segregated from other short-term securities of the Fund. iNe shall incorporate both of these points in any program which we might suggest to any of our customers. ~
4. We have included as Exhibit A two alternative fee proposals
   which the Bank could offer to' its custömers. While we acknowl- . edge that there are four basic ttansactions which are automatically involved in each loan, there is also the continuing responsibility to monitor the collateral and process additional transactions when￾ever there is a collateral adjustment. Thus, a loan of a security for five weeks which required four increases in cash collateral and investment of such cash requires eight separate transâctions rather than the basic four. Additionally, the determination and collection of income is a continuing and separ~te .responsibility during the term of the loan. Your further comment on this problem would be of assistance. .s. Our approach as to voting rights would be to terminate all loans . prior to any record date involving proxy action. Howev.er, we understand that you may determine that this matter may be left to negotiation between the borrower and lender. Your assistance in the formulation of this proposal is appreciated. We shall pursue the matter further with the other appropriate regulatory authorities. Should any of our customers wish to pursue this program, the Staff would i we as sume, receive changes to the Registration Statement of Fund and would have Íurther op￾portunity to comment at that time. Any additional comment which you could make at this time would be helpful. Very truly yours, R ) rJJ~t,.~u~'--- Richa'rd J. Delmar Vice President ~ JRT:dcw .?

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,~:' ALTEre~ATE FEE PROPOSALS
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Fee Proposal 1. ., . -......~ . ~'-
Recei ve and vault returned securities ¡return colla teral to borrower Deli ver loaned securities i receive and deposit loan) collateral ) ) Recei vei. ~~y for and safekeep short term instrument) ) , Deliver short term instr~unenti. receive and deposit) collateral ) ) ) ) t. ... $60/loan ~' ,. ". - ~ .'.. 'J" ,; i~,:; "I r ~,~)/i) J d i\ _. \j 'JI ~ Process collateral changes ) $lO/change n'. monitor collateral i loaned securities 1 de te rmin e) ) $2/day Adminis ter loan i. e. i ànd collect income on Fee Proposal 2. 0. 10% of interest On collateral with $50 minimum and $250 maximum for services shown in fee proposal l. Discussion ~ Assuming a $300M loan for 40 days i with' no marks to market, proposal 1. would call for a fee of $140 ($60 round trip charge plus 40 days at $2 per day). Thus the fund i s earnings would be $1558 ($16~8 interest on $300M at 5% for 40 days less $140). Assurning similar conditions i the fee under proposal 2. would be $170, and the fund's earnings would be $1528 ($1698 less $170). Reconunenda tion State Street Bank recommends fee proposal number 1. as being most equi table to all parties concerned.

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    Mt. Richard J. Delmar, Vice President
    State Street Bank and Trust Company
    Boston, MA02101
    The fol lowing is a clarification of my interpretation dated December. 27, 1971, as well as a further interpretation as to whether the Investment Co~?any Act of 1940 prohibits a mutual fund from lending its portfolio secur:i ties. Guideline (3) of my interpretation: All stock loans should be .made in accordance .vi th the rules of the New York. Stock. Exchange vihich require the borrower, after notice, .to redeliver the borrowed securities within the (~ ...

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! nórmal settlement time of five days. Guideline (4): "reasonable interest uu i=.u...l. ~vaii" cuu~"; ';'i.L~ude ::l..:.. '::",..";'5 :;i¡C.:;t~;"6 ::r.c cash';:,cl~.i::.:::-:.~:.:: :-..i;;~ yielding short-term investments which give maximum liquidity to pay back the Qorrower when t~e securi ties are returned. The type of investment for the cash collateral is a decision for directors of the fund and should not be delegated to anyone unless such person serves as an investment adviser meeting the requirements of Section 15 of the Investment Company Act. In addition, we would not insist o~ separate segregation of investments relating to the lending, of portfolio securities. Guideline (5): A fund can pay rea￾sonable custodial fees to its custodian in connection with the lending of portfolio securities. However, the feeS t~ be charged should be negotiated between the fund and the custodian, reduced to a contract, and approved by the fund directors. We will not pass on the fee proposals of State Street Bank and Trust Company as they ar~ sub3ect to nego~iation with each separate fund. Guideli~e (6): We would nat object if voting rights pass with the lending of securities. However, this does not relieve the directors of a fund of their fiduciary obligatio~ to vote proxies. If the fund management has knowledge that a material event will occur affecting an investment on loan, the directors would be obligated to call such loan in time to vote the proxies. (7) If the fundamental policies of the fund, or those which may not be changed without shareholder approval, do not permi t lending of port￾folio securi ties, shareholder approval of the change in investment policy must be obtained prior to engaging in the practice. (8) Although a fund receiyes Ð-ll dividends and interest income on loaned securities from the borrower, we u~derstand that such monies received may, for tax purposes be treated as other incomé (not dividend or interest income) thus possibly affecting the Sub-chapter M status of the fund. (9~ The fund that engages in the practice of lending its portfolio securities must make the following disclosures in its prospectus; that one of its policies is the lending of portfolio seturities, that the voting rights may pass with the lending of securities; however, the diiectors will be obligated to call loans to vote' proxies if a material event affecting t~e investment is to occur, that. the lending of portfolio securities may adversely affect p8SS through tax treat￾ment afforded Ilregulated"' investme'nt companies by Sub-'chapter M of the Internal Revenue Code. Alan Rosenblat, Chief Counsel ~ (JA~ Division of Corporate Regulation Securi ties. and Exchange Commission Hay 22, 1972 GHB:hb '"