SEC Division of Investment Management staff letter: Adams Express Company

Investment Company Act of i940/ . Secltion 17 (f); Huì~ 3::p.52 : Ä. . ..._ . , . lAc!. .. ---r:Ctl- ~¿¡ Secur i ties anà Exchange Comrni.s~io:1' Lp-~ . 500 North Capitol Str~et (:;.e_\JUon i? Washington, D.C. 20549 : . . . . !:.~('.!.a . Attention: Siàney L. Cimmet, tii~ . . Chief Counsel thailabillty D-i vis ion of Invest~t Hana ".'i., .' \ ~..._~ ,/1 rO JAMCS K. CRIMMINS ;HARLES B. LAUREN :ARL S. ROWE ~RANK B. STONE lO/IALo L. DEMING ~OBERT A. HOWE:S ~ELVIN O. GOODMAN :)AL!L G. PENNOYER, JR. 'ETER il,. WARD . JOHN WILCOX JANET C. BROWN :HARLCS H. HARF, JAVtD R. BAKER 'RHOI.o HENSON ;:oMUND E.HARVEY 'LVIN O. LURIE RAYMOND R. FLET:::HER. JR. EDWARD C. ~cLE:AI~. JR. , CHADBOURNÈ. PARKE'-,WHITESIDE & WOLFF 30 ROCl(EFELLEU PLAZA, NEW YORK. N.Y. 10020 (212) 541-5600 ~ E C E i V t: ~ ,JUj,. 1. tì 1919 STUART D.IlAKE:R ZACHARY SHIMë:R NICHOLAS B. ANGE:LL WILLIAM J. GE:E:N . DONALD I STRAuaEFi DANIEL J. O'NEILL PAUL A. RANDOUR MALCOLM E. M.'RTIN RICHARD R. DAVIS COWARD P. SMITH WILt..IA.M J.CALlSE.JR. EUGENE: R. SU LLIVAN, JR. CHESTER J. HINSHAW RICHARD K. KNEIPPER RICHARD J. NEY BERNARD W. McCARTHY MARC;A E.CARPENI LESLIE: JOHN SCHREYER
CABLE ADDRESS "CHADW~. ..,....
WUI TELEX 620520
WU TELEX 645383 . ....STANNARD DUNN .HÀAOLQ 'L. WARNÉR';JR. F. FRANKLIN.WJON. OF' COUNS'EL Ge:ORG£ E. ZEITLIN , ..i':eOUNSEL July 13, 1979 WASHINGTON, D~C. OFFICE. 1150 17TH STREET,N.W. 2003'$ (202) S72-S0i;o ï".i.il I, . I ". v.""~'. Re: The Adams Express Company File No."811::'?6~4 D'ear Mr. Cimmet:
Reference is made to 0~r letter to you of March 23, 1979 in which we r8quested advice on b~half of The Adams Express Company (~Adams~) as to whether a so-called "stanàby" letter of cr ed it, issued under the - 01 rcumstances descr ibed in said letter, could be used to collateralize a securities loah by a registered investment company in compliance with
Section 17 (f) of the Investment C0mpany Act of 1940 ("1940
Act") and Rule 17f-2 thereunder. In a subsequent tele- 0::-.. phone conversation, you indicat2d that the staff of the Securities and Exchange Commission ("Commission~) would I ~.. appreciat2 certain additional. information in respect of '. . ", ...... . "''''';-''i''
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!' e- ,lDÐOURNE, PARKE. WHITESIDE & WOLFF i'iO.t~ lta..-.... \W \0.' , .'" , Secur i ti es and Exchange Commission 2 July 13, 1979 standby let ter s of credi t. The follow ing is provided as supplemental information in response to this requ~st:

1. "Honor lng" Demands For Payment Under a
   Letter of Credi t
   You have inquired as to the time it might take for the benef iciary of a letter of credi t to collect cash following a demand for payment thereunder. The time wi thin wh ich a bank issuer must "honor" a draft or demand for pay￾ment presented under a letter of credit is ~rescribed by § 5-112 (1) of the Uniform Commercial Code ("UCC") and Art. 8 (d) of the Uniform Customs and Practice for Documentary Credits, 1974 Revision ("UCP"). Pursuarit to. UCC § 5-112 (1) " an issuing bank is permitteà to defer honor until the close of the third banxing àay following receipt of the documentation required by the let ter of credi t al though the presenter may consent to a further extension of time. The Official Com￾ment to S 5-112 (1) indicates that this per iód mayb~ neces￾sary to fulfill the issuer's obligation under UCC § 5-109(2) to examine documents with "care" so as to ascertain whether "on the ir face" they comply wi th the terms of the letter of cred it. "Honor" is defined by uec § 1-201(21) as "to pay or to accept and pay Thus the beneficiary is en- " titled to realize the cash to which he is entitled no later than three business days after making a complying presenta- .....~...,.,. "'..-. '.

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.iADilOURNE.PARKE, WHITESIDE & WOLFF . Secur i ties and Exchange Commission ":.. 3 July 13, 1979 ..~:'s. ¡ .,....;.d.' ~ '. t; tion. Pursuant to UCC S 5-112 (1)., a bank's failure to honor a complying presentation wi thin the specified time consti￾tutes dishonor of the draft or demand and of the letter of credit, giving rise to the beneficiary's right under UCC § 5-115 (1) to recover from the issuer the face amount of the draft or demand together with any incidental damages. Pursuant to Art. 7 of the UCP, an issuing bank must examine all documents wi th llreasonable care" to ascer￾tain that they appear on their face to be in accordance with the terms and conditions of the letter of credit. UCP (I Art. 8 (d) provides that the issuer shall have a "reasonable time" to examine the documents received by it and to deter￾mine, as prov iàed in Ar t. 8 (c), whe ther to claim that the demand for payment was not effected in accordance wi th the terms anà conditions of the letter of credit. Notice of such a claim, stating the reasons therefor, must be given without delay. UCP Art. 8 (e). What constitutes a "rea￾sonable time" for the documentary examination is not speci￾fied. Under both the UCC anà UCP, however,' the parties could agree to a specific time perioà within which the issuer must determine whether to honor a draft or demand for payment. We have been advised that a letter of creàit could be issued with a provision that it be honored on the
0) same day as a presentation of the requir:ed documentation
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ADBOURNE. PARKE. WHITESIDE & WOLFF , f, SecüritiëS and Exchange Commission . 4 July 13, 1979 as well as a provis ion that payment be made in federal or "same-day" funds. Thus, the beneficiary could effectively convert a letter of credi t into cash on the same day as a complyi ng demand for payment, presumably subj ect to the issuer's duty of careful examination of the documents. It is important to emphasize that, as indicated in our prior correspondence, the issuer's obligation to the beneficiary under a letter of credit is an absolute obligation to the beneficiary wholly independent from the benef iciary' s unàer lyi ng transaction with the customer. Accordingly, under both the UCC and the UCP an issuer must honor a àraft or demand for payment upon a complying pre￾sentation without regard to any questions of such parties' performance of their respective obligations pursuant to their underlying contract or arrangement. In the case of a standby letter of credit, the required presentation typically consists of no more than the beneficiary's sight draft and certification of the customer's default in his obligations to the beneficiary. As observeà in one recent legal commentary, "The most significant commercial feature of the standby let ter of credi t is tha tit represents the issuer iS promi se to pay on 1 i ttle or nothing more than the beneficiary's certification of default." Jarvis, I1Stanàby ..-.¥--' -'" .... ......." ". "

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.£ADE10URNE, PARKE, WHITESIDE & WOLFF t'fi" (~,ktV Secur i ties and Exchange Commission 5 July 13, 1979 Letters of Credit - Issuers' Subrogation and Assignment Rights - Part II," 10 U.C.C.L.J. 38, 45 (1977).
2. "Establishment" of a Letter of Credit
You have also inquired as to when a letter ~f credit is "established" as to the respective parties. Pursuant to UCC § 5-106, unless otherwise agreed to, an irrevocable letter of credit is established as regards the customer as soon as the letter of credit is "sent" to him or the letter of credit or an authorizeà written advice of its issuance is sent to the benef iciary; there- 'tP after the letter of credit cannot be modified or revoked without the customer' s consent. The 'letter of creàit i~ established as to the beneficiary wheri he "receives" the letter of credit or an authorized written advice of the issuance thereof; thereafter it can only be modified or revoked wi th the benef iciary' s consent. Thus, the bene￾ficiary cannot rely on the letter of credit as against ,the issuer until ~e receives it, although this would not affect the beneficiary's right to protest its cancellation or modification as against the customer if its issuance ana the terms thereof were agreed to in an underlying contract. The primary legal consequence of establishment of a letter of credi t is that thereafter the issuer can no lon~er take ;@ unilateral action to cancel it or mòdify its terms. .w...._". " "- '"

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JBOURNE. PARKE. WHITESIDE & WOLFF i ßecur i ties and , Exchange Commission 6 July 13, 1979 The UCP does not specifically regulate the point of "establ ishment" of a letter of cred it but, as wi th vir￾tually all terms and condi t ions of a let ter of credi t, the parties can agree as to the terms of its establishment.
3. Status of a Beneficïary Against
an Insolvent Issuer
Further, you have inquired as to the status of a letter of credit as a liability of the issuing bank, speci￾f ically in the event of the bank' s insolvenGY~ The status of a beneficiary holding an outstanding letter of credit of an insolvent issuer will àepend on a number of circum￾stances including applicable law governing the letter of credit and the issuer's insolvency, the particular terms and conditions of the letter of credit, and the stage in the time frame of the transaction in which the insolvency occurs. Thus, it is not practicable to determine in advance Aàams' status as a beneficiary of a letter of credi t wi th respect to the categories of creditors whose claims against the issuing bank's assets must be aiiocated wi thin the tradi tional bankruptcy categor ies of secured, pr ior i ty and general credi tors. There are, however, certain legal principles which apply in general to letter of credit transactions upon the insolvency of an issuing bank. The UCC prescr ibes rules for situations where the issuer becomes insolvent before "~.
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.;ÐOURNE. PARKE, WHITESIDE & WOLFF , i Secur i ties and Exchange Commission 7 July 13, 19"'') tf:", \ï," final payment has been made under a letter of cr'edi t if funds or collateral to secure or meet the issuer's obl iga￾tions under the letter of credi t have been received ei ther before or after the i nsol veney. Pursuant to § 5-117 (1) (a) , drafts or demands for payment are enti tled to payment in preference over depos i tors or other general credi tors of the issuer wi th respect to funds or collateral furnished by the customer to the issuing bank speci f ically as indem￾nity against, or for the purpose of payment.of, drafts' or demands for payment drawn under the letter of credit. UCC § 5-117 (1) (c) also provides that a' charge to a general o or current account maintained 'by the customer for the pur￾pose of so secur ing or indemnifying the bank's payment obligations will be subj ect to the same rule of' preference. The UCP makes no specific reference to the status of an outstanding letter of credit upon an issuer's insol￾veney. The rules of preference codified in UCC § 5-117, however, .are supported by pre-Code case law, indicating that such principles might be applied unàer appropriate circumstances even in instances where the UCC was not ap￾plieable. See~. William H. Sha\Vffiut Corp. v. Bobrick Sales Corp., 260 N.Y. 499, 184 N.E. 68 (1933), aff'g 235 App. Oiv. 665, 255 N.Y.S. 841 (1st Dep't 1932). Whether or not a bank will require its customer (fJ ",'''-'' ", ".

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,bBOUJiNEÜPAHKE. WHITESI..DE & WOLFP ~ec rltieS and - , Exchange Commission 8 July 13, 1979 to proviàe any prepayment or secur i ty. in connection wi th issuance of a standby letter of creàit depends on a var iety of factors, ínclud ing the pr ior banki ng relat ionship, if any, .between the bank and the customer and the bank 's eval￾uation of the credit risks involved in the loan of its credit. In a sale transaction in which paymer.t by the is￾suer in the ordinary course of the transactio~ is expecteà, arrangements for prepayments or segregating funds to secure reimbursement of the issuer for amounts drawn down under the letter of credit may be more common than in transactions involving a stanàby letter of creàit, which contemplate pay￾Absent circumstances which would give rise to a beneficiary's right to status as a preferred or even a secured creditor of an issuing bank, authoritiesinàicate that a benef iciary is generally considered to rank as a general creditor with depositors, including holders of ¡ I ¡ i ( t i I r r , certificates of deposit, and would share ratably with such general creditors in the distribution of assets of the in￾solvent bank. H. Harfield, Bank Credits and Acceptances 257 (5th Eà. 1974); B. Kozolchcyk, Commercial Letters of Credit in the Americas 331 (1966); 5B Michie, Banks and Bank￾ing, § 313, at 234-36 (rev. ed. 1973 & Supp. 1979). ", ",

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.ÁDÐOUBNEÜPARRE.WHITESWE & WOLFF tiec ritieS ana ~I Exchange Commission 9 July 13, 1979 ¡ i￾Ii ". ~ A letter of credit is not, however, reflected as a liabilí ty on the balance s~eet of the issuing bank, nor is the customer's obligation to reimburse the bank treated as an asset. Generally, letters of credit are treated as "contingent liabilities", like other exec~tory contracts, al though pursuant to appl icable banking regula￾tion the total amounts of letters of creàit outstanding must be adequately disclosed in the bank's published financial statements. The fact that letters of credit are not carried as a liabili ty on the balance sheet of a bank does not, however, preclude the benefi~iary from asserting a claim :t) to share ra tably in the assets of an insolvent bank. Ther e is an almost total absence of case law concerning the status of a beneficiary under a standby letter of credit upon the issuing bank's insolvency. In one recent decision, however, - the united States Court of Appeals for the Ninth Circuit held that claims of creditors based on standby letters of cred it issued by a national bank pr ior to its insolvency were provable as contingent contract obI igations in the national bank's receivership anà, thus, the beneficiaries were entitled to share ratably with other gener.al creditors in the distr ibution of the bank's assets. First Empire (.j~, \ ' Bank v. Federal Deposit Insurance Corp., 572 F.2d 1361 (9th Cir. 1978), cert. denied, 99 S. Ct. 293 (1979). In First '. . -°0 '.,
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, /ùÐou§~t:Jti:tFti?l?l!T¿f:fl&,)E & WOLFF Exchange Commission ~,:"'" \lO (~ (J 10 July 13, 1979 Empire, a central concern was whether a standby letter of cr~dit was a contingent claim which was of a worth or amount which could be determined "by recognized methods of compu￾tation at a time consistent with the expeditious settlement of estates." rd. at 1369. In that case, the customers had defaulted on their underlying obligations by the time the ac￾tion against the bank's receiver was filed and prior to any dis￾tribution of assets. Because the claims were based on letters of credit which were in existence before the insolvency and were not dependent on any new contractual obligations arising later 1 the court held that the bank's liabili ty on the stand- ¡ by letters of credit was absolute and cer.tain in amount, and under applicable equi table pr inciples the letters of credi t were provable in the ir face amount. As a practical mat ter, under the terms of the proposed letter of credit described in our prior corresponàence, a claim based on a letter of credi t would be a provable contingent lia￾bility under the principles relied upon in the First Empire case. Adams would be author izeà to terminate the loan or require a sub￾stitrition consisting of cash or government securities as col￾lateral if there has been, or events have occurred which may reasonably be expected to result in, a material adverse change in the financial condition of the issuer. Thus, even assuming tha t Adams had not made a demand for payment under a 12 t te r ", .....~. " ....,.

.:bBOl@êl~tfi~-ttIi.èVgIltftSØJE & WOLFF / l Exchange Commission ~i ' 11 July 13, 1979 ~ of credit until public announcement of the issuing bank's insolvency, it coulà immeàiately terminate the loan and re￾call the loaned securities or require a substitution of col￾late~al. If the, borrower defaulted at this time Adams then could demand payment and, thus, have a provable contingent claim against the bank if its demand was not timely honored. In addition, since the underlying transaction be￾tween the beneficiary and the customer is independent of the issuer's obligation to the customer, Adams still would have recourse against the customer if its claim was not satisfied .". ~\I due to the issuer's insolvency. See uce §§ 5-115 and 2-325 (2):
This right is only lost if the customer and beneficiary have agreed that the letter of creàit will serve as the absolute source of payment. See ~. Greenough v. Munroe, 53 F. 2d 362 (2nd Cir. 1931); H. Harfield, Bank Credits and Acceptances 244 ( 5 th ed. 1974).
4. Possible Conflict of Interest of Issuer
As a final matter, you noted that our pr ior cor￾respondence ind icated tha t if the Commission responàed favorably to use of letters of creàit as collateral, Aàams would,consider accepting a letter of credit issued by its -' present bank custodian. In this regard, you inquired whether consideration had been given to any possible con￾fl ic ts of inter est wh ich might ar i se f rom the cus toà ian fj .~.-~. . ~-- ". ","

'\ fDBpUBNE, PARI',(E. WHlTESlPE & WOLFF . ~ecur i ties and .-. Exchange Commission 12 July 13, 1979 (1 performing in both capacities. The fact that a particular bank serves as Adams' custodian in accoràance with the provisions of Section 17 (f) of the 1940 Act does not, of course, preclude such bank from performing other banking services for Adams and the proposed arrangements àescr ibed in our pr ior cor respondence regarding issuance of a letter of credi t to Adams would not contravene the provisions of Section 17 (à) of the 1940 Act or the rules and regulations thereunder. Nor does there. appear to be any potential inconsistency between the bank's fiduciary duties and its profess ional respons ibil it ies as cus tod ian for Adams .f) and its serving as an issuer of a let ter of credi t held by Aàams as collateral for a securities loan. In fact, Adams' present custod ian also ser ves as its tr ansfer agent and reg￾istrar and as the agent for its automatic àiviàend reinvest￾ment plan, anà in the past has performed various other banking services for Aàams. Further, under the standby letter of credit Adams is merely the beneficiary of such letter and the issuing bank is primarily concerned with the finan￾cial position of its customer and the customer's ability to re imbur se it for au thor izeà pa:1'TIlen ts made to the benef i￾ciary. Therefore, the bank is performing a service not for Adams, but for its customer who has requested issuance of 'J the'letter of credit and it is difficult for us to construct '..... "

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.ÁDBOURNE, PARKE. WHITESIDE & WOLFF , Securities and Exchange Commission 13 July 13, 1979 any potential conflict of interest in this arrangement. If you desire any further information or if we can be helpful in any ether way~ please contact the under- . signed or Robert A. Howes of this offi=e. Very truly yours, iJ td,/"-' ~ l ,iiI . r~ ~ /.;.-~ J ('f IV l.. Mary Ellen Pindyck 'J' PUBLIC I SEP 201979 Our Ref. No. 79-l0S-CC The Adans Express Canpany File No.Sll-2624 RESPONSE OF THE OFFICE OF CHIEF COUNSEL DIVISION OF INVESTr-1ENT MANAGEMENT Based on the facts and representations in your letters of March 23, 1979 and July 13, 1979, we will not recorrunend any enforcement action to the Commission under section 17 (f) of the Investment Comp:my Act of 1940 and rule 17f-2 thereunder if The Adans Express Canpany (Fund) accepts irrevocable standby letters of cred it as collateral for the loan of thè Fund's ¡;ortfol io /:ZZ~ t:ii, arrl in the manner described by you. Stanley ~~ ~' , Assistant Chief Counsel ETl .. "'_.. ......~. ".

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GA.,t ù' i
5 K.CRIMMINS
LES B LAUREN
S. ~OW~
K D.SiONE to L.ar.MING
RT A.HOWES
IN o.GOODMAN
G. PE~N()'('ER. ..JR.
~Jio.i.V;AnO
WILCOX r C.BROWN
LES H. HARFE'
R. BAKER
LO HEUSON
N D e:. HARVEY
0, LURIE
'NO R. FLE'TCHER..JR,
RO C. McLEAN, JR.
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CIIADDOUH.NE. PARKE. WHITESIDE & WOLFF 30 ROCREI"ELLER PLAZA.NEWYORK.N.y.102/t~t~?;~¡i.f~"'i~'. ø p' .., t, ~'1 .".'.. CAß~~~::::~ :~:;::A~l.r~:- M:i~; -: ,,:'" ~,, S~,"~-:" "J fJi.:'. HENRY J. WOLf'f' WU TELEX 645363 .... ,"" - , ".J Vi.'-l 'r STANNARD DUNN ':'li;/....~.... ø~. ,¡HAROLD L. WAnNER, .JR. J~.'r~:;'~;(J 'r) .-,.., t' ~~,,,:¡ .'":¡;; F.. FRANKLIN MOON '~-'-;¡":Úl;'f !~t.t,,'Yt"t','J; ~~~ OF' COUNSE:L. ~~~"4':'::'')'~~~~.~_l. _ GEORGE E.ZEITLIN COUNSEL STUART D. BAKER 1 ~ ZACHARY SHIMER NICHOLAS B.ANGELL WILL!AM J. GEEN DONALD I STRAUBER DANIEL J. O'NEILL PAUL A. RANCOUR MALceiLM E. MARTIN RICHARD R. DAVIS EDWARD P. SMITH WILLIAM J.CALISE.JR. EUGENE R. SULL.vAN, JR. C.HESTER J. HINSHAW RICHARD K.KNEIPPER RICt-jARO J. NEY BERNARD W. M.CARTHY M~"\r~CIA e:.. CARPENI LESL!E JOHN SCHREYER , ' 1979 WASHINGTON to. C. OFFICE 1150 17TH STREET, N.W. 20036 (2021 872'8050 ì-1arch 23, Investment Company Act of 1940/
Section 17(f)¡ Rule 17f-2 . .
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Secur i ties and Exchanae Commission 500 North Capitol Str~et Washington, D.C. 20549 .."Attention: Sidney L. Cimmet, Esq. Chief Counsel Division of Investment Management Re: The Adams Express Company File No. 811-2624 Dear Mr. Cimmet:
We are counsel to The Adams Express Company ("Ada~s"), a closed-end investment company reg istered under the Investment Company Act of 1940 ("1940 Act") i and as such are writing to you on its behalf to seek an interpretation of the guidelines ("Guidelines") prescribed by the staff of the Securities and Exchange Commi 58 ion (~Comrniss ion") governing the lend ing of portfol io secur it ies by inves tment companies reg i s tered under the 1940 Act. ". . "',

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,ÁD00RNE. PÀR!(E. WIIITESIDE & WOLFl" e Sidney L. Cimmet, Esq. 2 March 23, 1979 Specifically, our inquiry concerns Guideline (1) which, as originally enunciated by the staff, required that the lender receive from the borrower 100% cash collateral .j equal to the full market value of the secur i ties loaned. State Street Bank and Trust Co. (Available January' 29~ 1972 and September 29, 1972). In response to subsequent inquir ies regarding the use of forms of non-cash collateral either partially or wholly in lieu of cash, which were con￾sidered as essentially "cash equivalents" 'or providing . . . "maximum liquidi ty", the staff indicated that it would 4.. \0 not object to the use of certain alternative forms of col￾lateral. As presently interpreted by the staff, Guideline (1) permits an investment company to, accept secur i ties issued or guar an teed by the U. S Government or its agencies as the sole collateral for a secur i ties loan providing all other Guidelines concerning collateral are met. Lionel . D. Edie Capi tal Fund, Inc. (Available May 15, 1975) i Salomon Brothers (May 4, 1975) i Standard Shares, Inc. (Available August 24, 1974). Adams has from time to time entered into vari￾ous securi ties loan agreements in compliance wi th each of the Guidelines as then interpreted by the staff, incluà￾ing arrangements pursuant to which U. S. Government and /O'~,. , .. ~ agency secur i ties have been accepted as the exclusive se- ", " .~.~

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I , l j~OjURNE.P'\RKE. WHITESIDE & WOLFF / D Sidney L. Cimmet, Esq. 3 March 23, 1979 cur i ty for the loan. We have been advised by the manage￾ment of Adams of the following:
Recently certain of Adams' major insti- : . tutional borrowers have proposed that Adams enter into a form of secur i ties loan agreement ("Proposed Agreement") which would authorize the borrower to collateralize the loan with a letter of credi t, ei ther in lieu of or in . . combination wi th cash and/or government secur i- , ' i , ties. Specifically, it has been proposed
4. that the borrower would arrange for issuance
of an irrevocable, non-negotiable letter of credi t in a form acceptable to Adams by any such a letter of crecti t which would be drawn -~. i .1 i ¡ L i bank of Adams' choi ce. Adams' present bank custodian has indicated that it would issue for the account of the brokerage firm in a face amount at least equal to 102% of the aggregate current market value of the outstanding secur￾ities, on loan to that firm. Under the terms of the proposed letter of credit, Adams would be authorized to draw down the full face amount, or any portion thereof, at any time by presenting its sight -" ", . '.

~ ./ l:NE. PARKE. WIIlTEStDE & WOLFF I; ! j￾r,~ '\J ':J . " Sidney L. Cimmet, Esq. 4 March 23, 1979 ~ ; i I , i I draft accompan~ed by an affidavit certifying (1) that the borrower is in default of its ob- .ligations under the terms and conditioris of the underlying secur i ties loan agreement thereby . enti tl ing Adams to apply collateral to cure the default (~.~., to purchase replacement securi￾ties if the borrower has failed to return the loaned secur i ties in accordance wi th the terms . . of the underlying agreement); and (ii) that the
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amount being drawn down represents th~ current market value of the outstanding loaned securities on the date thereof or the amount required to' cure any other borrower default (~.S., nonpayment of the loan premi um when due or dividends and interest accruing on the loaned secur i ties) . The date of expiration of the proposed letter of credi t will be mutually agreed upon by Adams and the borrower and it is anticipated that ini tially the term will be' six months. The proposed letter of credit would also au￾thorize Adams' to draw down on the day immediately preceding its expiration date an amount equal to the current market value of all outstanding loaned securities on that date by presenting
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I " .:--~-.. .~..... -.-.........,...-..........~.-'...............~..__.--';... ..........-......-..~ ...-'~-....,.. . -.~.......-.... ..... ,&.......JEj // / I ibBOURNE. PAinm, WHITESIDE & WOLFF . ~ Sidney L. Cimmet,Esq. 5 March 23, 1979 f I ! ¡ i ¡ its sight draft accompanied by an affidavi t certifying as to such market value; provided, however, that pursuant to the Proposed Agree￾ment, Adams would agree not to present such sight draft if any of the following cond it ions are met: (i) the borrower has arranged for issuance of a new letter of credi t in a form and amount, and by a bank, acceptable to Adams, . . commencing concurrently with maturation of the ,.. expiring letter of credit; (ii) the parties have mutually agreed upon, and have obtained "'1l J the bank i s consent to, an extension of the expiring letter of credit; (iii) the borrower has deposited alternative forms of collateral permitted by the Proposed Agreement (i.e., cash -', , I and government securities) in substitution for the expiring letter credit; or (iv) the loan :
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LnNE. PAHKE. WHITESIDE & WOLFF / ' /1 , ~ Sidney L. Cimmet, Esq. the cash as collateral or apply it in accordance 6 March 23, 1979 l j wi th the terms of the Proposed Agreement. For purposes of complying wi th the require￾ment of Guideline (2) that collateral be adjusted to reflect changes in the market value of the ' loaned secur i ties, the Proposed Agreement would provide that in marking to market (which is done on a daily basis by Adams) any increases in the amount of collateral needed to -cover . .
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fluctuations in the market value of the loaned secur i ties could be satistied by the deposi t of (~ cash or government securities. Any increase in the amount of collateral required of a more perma- i I ¡ i I I ¡ nent nature, however, resul ting from an increase in ei ther the amount or market value of secur i ties on loan may, with the lender's consent, be satisfieã by amendment of the letter of credit' increasing its face amount or by issuance of an addi tional letter of credi t. Under the terms of the Proposed Agreement, the value of the collateral at all times must be equal to at least 102% of the market value of all outstanding loaned secu￾rities, but only cash or g6vernment securities, ., if any, may be withdrawn as collateral at the , " ............ ....-.--. " ""

, ',/'/ gR~E. PARIm. WllITESIDE & WOLFF I / / I~ A.':' i '. ø . , Sidney L. Cimmet, Esq. ,7 March 23, 1979 borrower's option if the value of the collateral at any given time exceeds 104% of the value of tbe outstanding loaned secur i ties. Thus, after a letter of credit has been issued, its face amount would not be adjusted prior to maturation to r~- flect marking to market decreases. The borrower and the lender, however, by mutual consent may agree at any time that a letter of credi t be can- , . celled and reissued in a different face amount or ~ith different terms and conditions specified therein, , Ii l... provided that the foregoing are in compliance wi th the relevant provisions of the Proposed Agreement. A bas ic understanding of the concept and mechanics of a letter of credi t is essential to evaluate whether it is an acceptable form of collateral for secur i ties loans by registered investment companies. In its most basic form, a letter of credi t is a commi tment by a ban~ or other . entity (the "issuer") in accordance with the instruc￾tions and for the adcount of the applicant (the "customer") which is issued in favor of a third party (the "beneficiary") whereby the issuer is obligated for a specific time per iod to make payment to or to pay drafts drawn by the beneficiary upon presentation of stipulated documents, provided the terms and conditions of the letter of credit have been complied with. ....,. ........, " ",

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/ . ¡ÄiOOURNE. PARKE, Wiiin~SIDI': & WOLFF' / ~ r' , / J ,~ . Sidney L. Cimmet, Esq. 8 March 23, 1979 Typically three distinct agreements are involved in a transaction involving a letter of credit: Ci) the underlying agreement between the customer and the benefi￾ciary; C i i) the agreement between the issuer and its cus￾tomer setting forth the terms and condi tions under 'which the issuer agrees to issue the letter of credit and the arrangements governing the customer i s obligation to reim￾burse the issuer for payments to the beneficiary; and (iii), th~ letter of credi t itself, which is an agreement between the issuer and the beneficiary entirely separate and indepen- ¡ øent of the agreements descr i bed in clauses (i) and (i i) . Because the letter of credit is an independent contrac~, the issuer's obligation is considered to be absolute assuming compliance with the terms of the letter of credit, and the ultimate risk in such transactions resides with the issuing bank who must accurately assess the financial abili ty of its customer to reimburse the issuer for authorized payments . made to the beneficiary. For assuming such risk, the issuer typically charges a fee to the customer which is a percentage of the face amount of the letter of credit and is based on its duration and the risks involved. The legal pr inciples governing a letter of credi t have been codified in Article V of the Uniform Commercial Code ("UCC") and in the Uniform Customs and Practice for , " ""0 ",

7, i / r ì4uoUHNE, PARlCE. WHITESIDE & WOLf'!"
" Sidney L. Cimmet, Esq. 9 Ma r c h 23, 1979 Documentary Credits, 1974 Revision ("UCP").* The only formal requirements for the creation of a valid letter of . credi t under the UCC are that the credi t (l.£., the issuer's "engagement II to honor the beneficiary's demands for payment upon speci f ied terms) be in wr i ting and signed by the issuer (UCC § 5-104 (1)). Thus the terms of the credit are left , almost entirely to the parties' agreement. Under both the UCC and the UCP the issuer is obligated to honor a draft or demand for payment which complies wi th the terms of the rel- .. ! () evant credit without reference to their compliance with the terms of the underlying contract between the beneficiary and the customer (UCC § 5-114 (1); UCP, General Provisions and Definitions, Item (c) and Art. 3). Although an issuer is

• Subject to certain conflict of law rules and de￾pending on the jurisdiction involved, the parties may stip￾ulate which body of law, or both, will govern the letter of credit.
  The Comptroller of the Currency has by regulation per- mi tted national banks to iS3ue letters of credi t permissible under the uce and the UCP, and prescribed the following condi￾tions for issuance thereof "as a matter of sound banking, practice": (1) e~ch letter should conspicuously state that it is a letter of credi t or be conspicuously enti tIed as such; (2) the bank's undertaking must contain a specified ex￾piration date or be for a def ini te term; (3) the bank's under￾taking must be limited in amount; (4) the bank's obligation to pay must aríse only upon the presentation of a draft or specific documents, and the bank must not be called upon to determine disputed questions of fact or law at issue between the customer and the beneficiary; and (5) the bank's customer must ha~e an unqualified obligation to reimburse the bank for payments made under the letter of credit. Interpretive Ruling 7.70l6~ 12 C.F.R. § 7.7016 (1977). ' .J , .-....-... ...... -.
  ,.,.. '....
  ",

\ , ", l~ounNE. PAnKE. WllITESIO" & WOLPF ,/': / / () Sidney L. Cin~et, Esq. 10 March 23, 1979 obligated to examine any required documentation for compliance wi th the terms of the cred it and may refuse to honor the Dene- . . ficiary's demand for payment due to noncompliance or inherent defects such as forgery or fraud in the transaction, the issuer is not authorized to investigate, nor does it assume any responsibili ty for, the underlying transaction between the customer and the benef iciary, and it must honor complying . . demands whether or not the customer consents (UCC §§ 5-109 and 5-114(1): UCP, General Provisions and Definitions, Item
(c~ and Arts. 7-9). The beneficiary who presents a draft or ....
demand for payment thereby warrants to all interested parties ¡ that the necessary conditions of the credit have been complied o with (UCC§ 5-111 (1) ) . In the event of a wrongful dishonor or cancella￾tion or repudiation of the letter of credi t wi thout the beneficiary's consent, the benef iciary' s remedies against the issuer include the right to recover t~e face amount of the draft plus incidental damages and interest (UCC §§ 5-115 (1) and 2-710). The benef iciary' s claim against the issuer is not subj~ct to any defenses of the issuer against its customer and the issuer cannot dishonor a complying demand on the grounds that the customer fraudulently induced the issuer to issue the credi t, fai led to provide the promised consideration for the credit, or became bankrupt following issuance of the credit, .) --, ,J '''.

'7
.I /.
I' ¡(¡mOURNE. PARKE. WHITESIDE Be WOLFF - // ' S~dney L. Cimmet, Esq. 11 March 23, 1979 rendering worthless any ultimate claim by the issuer for re￾imbursement. An irrevocable letter of credit may be revdked or modi f ied only wi th the consent of the custorner once it is "established" as to him and with the consent of the benefici￾ary once it is "established" as to him (Uee § 5-106 ~2); UCP Art. 3). The tradi tional commercial letter of credi twas de￾signed as a mechanism to insure payment in international sale of' goods transactions. Domestic uses for letters of cred it, . . . however, have been expanded far beyond a payment function and ù ... there has been an increasing use of the so-called "standby" letter of credit as a financing or security- devtce in connec￾tion with nonsale transactions. Unlike sales transactions in , ¡ ¡ which the issuer expects to make payments under the credit upon performance of the underlying agreement, transactions involving a standby letter of credi t only contemplate payment in the event of nonperformance of or othet'specified default under the underlying agreement' between the beneficiary and the customer. Among the more widespread uses of standby I I letters of credit are as security in lieu of cash collateral or a performance bond in connection wi th the performance of a construction contract, as a back-up source of payment to support the issuance of commercial paper, and as a payment mechanism for deferred compensation agreements. A standby J ....~. ,'. ~"' "-..... ~-. ", ",

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12m N E. PAllKE. W III TES IDE & WOI.FP rj ~ . ~ (~ .ò Sidney L. Cimmet, Esq. 12 March 23, 1979 letter of credi t is, however, capable of adaptation to innum￾erable situations where the credit of a financially solvent. and reliable third party is substi tuted and, as defined by the Boarß of Governors of the Federal Reserve System, broadly in￾cludes "an obligation to the beneficiary on the part of the issuer · · · (3) to make payment on account of any default by the (customer) in the performance of an obligation." 12 C.F.R. .. i I , i § 208.8(d)ei) (1977). In certain respects, a standby letter of credit func￾tions as a guarantee. The documents required fo~ presentation¡ 4.. ;. by the beneficiary under a standby letter of credi t usually con￾sist of only a draft accompanied by the beneficiary's certifi￾cation that the customer has defaulted in its obligations under the underlying agreement. Unlike a guarantee however, in which recovery is based on., the guarantor's secondaryliabili ty for .t'he obligor's default under the obligor's primary obligations, the issuer is primarily liable under its letter of credit to the beneficiary wi th respect to its obligations under such credi t. Recovery from the issuer by the beneficiary requires I i I ¡ only presentation of the requisi te documents and compliance with the terms of the letter of credit; whether the 6ustomer has in fact failed to per form its obligations pursuant to the underlying agreement does not affect the issuer's pr i￾mary obligation to pay the beneficiary upon presentation of .:;" -. ...~..
,.~....
. ", .1 ....

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" I ' iZUNNE' PANKE, WllITESlDE & WOLFF.
1/ /~
ø Sidney L. Cimmet, Esq.
.
13 March 23, 1979 complying documentation. The issuer's liabili ty is independ￾ent o~ the parties' rights pursuant to the underlying agree￾ment and the issuer neither promises to perform its customer's obligations nor guarantees that its customer will perform them. Thus, commentators have observed that the "hallmark" of a letter of credit is that at a certain point it becomes "as good as cash." Armstrong, "The Letter of Credit as a . . Lending Device in a Tight Money Market," 22 Bus. Law. 1105, 1109 (1967); ~ Verkuil, "Bank Solvency and Guaranty Letters of Credit," 25 Stan. L. Rev. 716 (1973). "'" From the benef iciary' s point of view, the pr incipal tJ risks attendant to acceptance of a standby letter of credi t as collateral for a securities loan are (i) that the issuer will be unable to make payment in accordance wi th the terms of the letter of credi t due, for example, to its insolvency or a force majeure (such as riots, strikes or other interruptions of bus iness) and (i i) the issuer's wrongrul refusai to honor the beneficiary's complying demands for payment." Adams would seek to minimize any risk of insolvency by setting high stand￾ards of issuer eligibility. We understand that a letter of credi t may not be accepted from an issuer proposed by a bor￾rower unless Adams' Board of Directors has given its prior approval to such issuer arid to the aggregate maximum face () amounts of all letters of credi t which may be issued there- ..................... ". , J. " ".

1';11' . .. . lDDOURNE. PAIn(E.WHITESIDE & WOLFF , / ' f- / /~'\ ~ Siâney L. Cimmet, Esq. . 14 March 23, 1979 by, and that only banks which, at a minimum, satisfy the qua￾lific~tions under Section 17 (f) of the 1940 Act applicabIe to bank custodians of reg istered investment companies would be eligible for consideration. In addi tion, such bank l s policies wi th respect to issuing letters of credi t, including relevant information in its published financial statements, will be evaluated.* . . As previously noted, it is presently anticipated that Adams l bank custodian would issue such proposed letters of credit, thus providing an issuer whose financial reliability 4... has already been carefully scrutinized and tested and will ( ) 'J" .,

• Federal bank regula tory agenc ies have adopted regula￾tions that place similar "lending limit" restrictions upon
  the issuance of standby letters of credit by state anà national banks. Generally, such restr ictions dictate that standby letters of credit must be combined with all loans for purposes of applying any legal limitations on loans of the state banks and customer lending limitations on loans of the national banks. Exceptions to this general rule are available if the issuing bank hcis been paid, or has set aside separately, an amount equai to its maximum potential liability under the standby letter of credit, or in thè case of s tate banks there is an indep~ndent 1 imi t on standby letters of cr~d it. State banks that are members of the Federal Reserve System are further restricted in that they may not issue a letter of cred it unless their customer has been the subject of a "credit analysis equivalent to that applicable to a potential borrower in an ordinary loan situation." Moreover, these state banks, as well as non￾member state banks insured by the Federal Deposit Insurance Corporation, are required to make adequate disclosure of the amount of all of their outstanding letters of credit in thei r publ i shed financial statements. See 12 C. F. R. §§ 7.1160, 208.8 and 337.2 (1977). ~ " ''J_ ''.

¡¿"'l/ '~ ,
.. ¡'iDDO DR NO. FA li K E. WHITES IDE & WOLI' F ",/ , / " , r'\ ",ø \ r'J " r" ~ '.J . Sidney L. Cimmet, Esq. l5 March 23, 1979 c9ntinue to be moni tored by Adams, as required by the appli￾cable provisions of the 1940 Act. Were Adams to accept sòle￾ly cash or government secur i ties as collateral, such collat￾eral would be required to be deposi ted in the safek~eping of the same issuing bank. We understand, however, that other banks with which Adams has or has had substantial business . dealings have expressed an interest in issuing such proposed letters of cred it and, assuming the foregoing minimum elig i￾bility.standards are met, may be considered as an approved \ssuer. Moreover, Adams will be further insulated from any potential risk of insolvency during the term of the letter of credi t due to events occuring, or becoming known to Adams, subsequent to its ini tial evaluation of the issuer's-', eligibili ty. We have been advised that the Proposed Agreement will provide that if in the sole judgment ?f Adams there has be~n, or events have occurred which may reasonably be expected to result in, a material adverse change in the financial con￾di tion of the issuer, Adams may (i) terminate the loan in respect of an amount of loaned securi ties equal to the face amount of any letter of credit or (ii) require that the bor￾rower substitute as collateral cash or government securities for all or any portion of such letter of credit. In loan arrangements secured by non-cash collateral ......" ", '~ ;- ..~, ". . " . .

fí' l:.,OUnNE,PANKE. WIIITESII)E & WOLPF /¡' ° ' , - rI'o . 'r"\ ",;d Sidney L. Cimmet, Esq. 16 March 23, 1979 such as government secur i ties, the borrower pays a negotiated loan premium to the lender and retains all rights in and ~o the collateral. The borrower is enti tIed to retain all income or interest earned on such collateral and the lender looks solely to the loan premium as its compensation, rather than any return resulting from the income which might be earned on investment of the cash collateral. Accordingly, we have been . Agreement would be a ~egotiated loan premium comparable to advised that the fee payable to Adams pursuant to the Proposed ,0 . that which Adams would receive under existing arrangements 6.. providing for the deposit of non-cash collateral. In this ~:1') context, the sole purpose of collateral is secur i ty for the loan and the most important quali ty of such collateral is that it be readily realizable and provide "maximum liquidityff such that if the borrower defaults, the investment company may easily apply the collateral to replace the loaned secur i ties or cure any other default in the borrower:s obligations. Thus in certain respects a letter of credit may be a more effecti ve form of collateral for secur i ties loans than Treas~ry bills and other u. S. Government and agency securi￾ties. In the event of borrower default, the latter must be liquidated, l.~., converted into cash by sale in the market place, before it can be applied to make the bor.rower whole by ~,'~ replacing the bar rowed secur i ties or cur ing other defaul ts. ""-. ."'~" '.

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..#l' \r; . f) ii
1S March 23, 1979
Sianey L. Cimmet, Esq. advantages to both the borrower and the lender. On the basis of th~ foregoing, we are of the, opinion that a letter of credit, issued under the circumstances described herein, may be used to collateralize, either in whole or in part, a se￾curities loan by a registered investment company in compliance with Section 17 (f) of the 1940 Act and Rule l7f-2 thereunder which requ ire that secur i ties on loan be collaterali zed to the extent of their full market value. We would appreciate your advice as to whether you concur in our view. If any further information is needed or 4~ if we can be helpful in any other way, please contact Mary Ellen Pinãyck of this office by collect telephone at (212) . 541-5800. Very truly yours, CLQ1\w~ -..- \ £k .lt9ld.0.~(cte~ Li11rf i ) " ". ...., ",