SEC Division of Investment Management staff letter: County of Los Angeles — SEC — US

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J~N 2719

Our Ref. No. 93-39-CC
R E OF CHIEF COUNSEL County of Los Angeles

DIVISION OF INVESTMENT MANAGEMENT File No. 132-3

Your letter of January 19, 1993, requests our assurance that

we would not recommend that the Çommission take any enforcement

action against the County of Los Angeles (the "County"), the

County's Deferred Compensation and Thrift Plan (the "Plan"), or

the Plan's funding vehicles under the registration provisions of

the Securities Act of 1933, the Securities Exchange Act of 1934,

or the Investment Company Act of 1940 if the County changes the

administration of the Plan in the manner described in your letter. The Plan is a deferred compensation plan under Section 457

of the Internal Revenue Code. Section 457 generally permits

state and local governments to create plans under which their

employees may defer receipt (and thus; taxation) of a portion of

their current compensation until separation from service. The

section provides, however, that plan assets must remain "solely"

the property of the employer, "subject only to the claims of the

employer's general creditors." 1./ Participation in the Plan is voluntary. Employees may

contribute a portion of their earnings each month up to a maximum

of $7,500 a year. ~/ Employees are also permitted to direct

their contributions among five independently managed investment _

options: the Money Market/Depository Fund, the Balanced. Fund, the

Stock Index Fund, the Growth Equity Fund, and the Stable Income

Fund (the "SIF"). Approximately 75% (or $750 million) of Plan

assets is currently invested in the SIF. Of this, approximately

$50 miiiion is invested in a guaranteed interest contract issued

by the Protective Life Insurance Company, while the balance is

invested in a separate account contract issued by the

Metropolitan Life Insurance Company.

,.
The County proposes to create a new investment option, the

Los Angeles County Investment Fund ("LACIF").:J/ The LACIF will

be under direct County management and will invest primarily in

secur i ties backed by income producing County property. The County contemplates that the securities will be certificates of

participation, backed either by a specific revenue stream or by

the general credit of the County. The total amount of Plan

1./ Section 457 (b) (6) .
~/ In the past, the County has made matching contributions for

each dollar contributed, up to 2.5% of earnings. Matching

contributions, however, are currently suspended.

:J/ All other existing Plan investments and administrative

arrangements wiii remain in place.

assets that may be allocated to the LACIF will be capped at apprtidma"-ly-$-2-a-a-m-.il-l-Ï:ûn--nd-tl-re-l-i-f-fl-iei:e-I-F-wi-l-l-be limited. The County will bear the costs associated with the

creation of the LACIF.

In connection with the cr~ation of the LACIF, the County

proposes to provide participants with supplemental _Plan

literature and an election form. The supplemental literature

will advise participants that they will have a one-time

opportuni ty to allocate all or any portion of their current Plan

account balance from any existing Plan investment option to the

LACIF. The literature will also clearly and prominently

disclose, at or near the beginning, the nature and terms of a 457

plan, including all the risks associated with this type of plan

and the distinction between the "vesting" of participant ,

contributions and participant "ownership" of section 457 plan

account balances. In addition, the literature will explain the

role of the LACIF in meeting the County's budget needs.

Participants will receive the supplemental literature and

election form at least 30 days before the LACIF begins operating.

Transfers to the LACIF will not be permitted after the election

period. No transfer to the LACIF will be made unless a

participant affirmatively opts in by filling in the election

form. with the exception of the LACIF, the County will maintain

all of the Plan investments under independent, external

management.
You represent that "no part of the corpus or income of the

Plan will -be used for, or diverted to, purposes other than the

exclusive benefit of participants or their beneficiaries,

provided, however, that all Plan assets will remain subject to

the claims of the County's- general creditors to the minimum

extent required by section 457." ~/ , ~/ We note that the County previously has taken the position that the County has very limited access to these funds. See

Letter from Sandra M. Davis, Treasurer and Tax Collector,

County of Los Angeles, to Hoyle L. Robinson, Executive
Secretary of FDIC (Feb. 12, 1990), expressing the view that

the County's rights to these funds was based on a "fragile technicali ty that these funds actually belong to the employer. " See also Letter from David J. Tirapelle,

Director, Department of Personnel Administration, State of

California, to Hoyle L. Robinson (Mar. 12, 1990) ("in no

instance has the State utilized funds on deposit for 457

plan participants to bailout from a budget deficiency. The

State believes these funds are owed employees and treats

them accordingly"); Letter from John Dark, Treasurer and Tax

Collector, County of Sacramento, to Hoyle L. Robinson (Mar.

8, 1990) ("Do counties believe that they own the Plan assets?

ûn the-basis of the unique facts and represèntations in yoùr

letter, and without agreeing with your legal analysis, we would

not recommend that the Commission take any enforcement action

against the County, the Plan, or the Plan's funding vehicles

under the registration provisions of the Securities Act of 1933,

the Securities Exchange Act of 1934, or the Investment Company

Act of 1940 if the County changes the administration of the Plan

in the manner described in your letter. The Division of

Corporation Finance and the Division of Market Regulation have

asked us to advise you that they concur with the position of the

Division of Investment Management. Because the Divisions'

position is based on the facts and representations in your

letter, you should note that different facts or representations

might require a different conclusion. Further this response only

expresses the Divisions ' position on enforcement action and does

not purport to express any legal conclusions on the questions

presented.
(J.4J 5llf~
Thomas S. Harman

Associate Director

(Chief Counsel)

No! the ownership language in Section 457 is viewed as a legal fiction").

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.TOC....Ol,.. January 19, 1993

......W
ZUIIC"
1933 Act section 3 (a) (2); 1934
Act section 3 (a) (12); and 1940

Act Section 3 (c) (11)
. ;......._1

BY HA DELIVERY

Act :! l . -A \qyo

Marianne K. Smythe, Esq. Director Section S(i7(1l) . Thomas S! Harman, Esq.

Associate Director Bule

Division of Investment Management
Public
Mail stop 10-6 Availability \ \21\ u

Associate Director (Legal)

Meredi th B. Cross, Esq.

Chief Counsel

Division of Corporation Finance

Mail stop 3-3

securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D. C. 20549
Re: County of Los Anaeles Section 457 Plan

Dear Mses. Smythe, Arms, and Cross and Mr. Harman:

Our client, the county of Los Angeles (tithe County"), is

considering various emergency steps to .address a projected shortfall in its fiscal 1992-93 operating budget in order to avoid

potentially catastrophic consequences for County residents. One

proposal currently under consideration is to create a new

investment option under the County's Deferred Compensation and

Thrift Plan (lithe Plan") pursuant to Section 457 of the Internal

Revenue Code (tithe Code"). This new option would permit Plan

participants who elect to do so to effect a one-time transfer of

all or a portion of their account balances to a County-administered

fund which would purchase County securities, such as securitized

real property leases or installment sales agreements. This

BAKR & MÇKENZIE

Marianne K. Smythe, Esq.
Thomas S~Harman, Esq.

Abigail Arms, Esq.

Meredi th B. Cross, Esq.

proposal would permit the County to finance some of its most

pressing service needs and to avoid discharging substantial numbers

of its employees, while providing Plan participants with an investment option focussed on local municipal assets. As you are aware, this proposal has been the subject of extensive and frui tful discussion between the staff and

representatives of the County, including this Firm. This letter

sets forth the results of those discussions. On behalf of the

County, we ask that the staff assure us that, if the County

proceeds with its proposal in the manner set forth in this letter,

the staff will not recommend that the Commission take enforcement

action under the registration requirements of the Securities Act of

1933, of the Securities Exchange Act of 1934, or of the Investment

Company Act of 1940 against the Plan, the County, or the various

unregistered funding vehicles for the Plan.

A. Backaround

Section 457 of the Code permits state and local government

create plans under which their employees may defer

receipt (and thus taxation) of a portion of their current

compensation until separation from service. Unlike most other tax-

employers to

favored savings plans, however, Section 457 plans are not "qualified" within the meaning of Section 401 (a) of the Code, and

the ability of employees to exclude from income the sums allocated

to such plans depends on the plan being structured such that the

employee has not, for tax purposes,. actually received any interest

in the plan. 1

1 In this regard, Section 457 of the Code provides that all

deferred compensation, all property and rights purchased therewith,

and all income attributable thereto, "shall remain (until made

available to the participant or beneficiary) solely the property

and rights of the employer (without being restricted to the

provision of benefits under the plan), subject only to the claims

of the employer's general creditors." The Treasury Department has,

however, permitted, by regulation, Section 457 plans to provide

that a participant may direct the investment of the amount of

assets in the plan attributable to his or her deferred compensation

into particular funding vehicles, such as mutual fund shares or

insurance company contracts. See Treas. Reg. S 1.457-2 (j) .

BAKR & MÇKENZIE

Marianne K. Smythe, Esq.
Thomas S. Harman, Esq.

Meredith B. Cross, Esq.

The Los Angeles County Section 457 plan is styled "Horizons - The Deferred Compensation and Thrift Plan." Participation in the

Plan is vOluntary.2 Under the Plan, employees may contribute from

one to 25 percent of their eligible earnings each month to the

Plan, up to a maximum of $7,500 per year. In the past, the County.

has made matching contributions in the amount of 75 cents for each

dollar contributed, up to 2.5 percent of earnings; matching

contributi~ns are currently suspended.

Consistent. with. Regulation 1.457-2 (j), supra note 1, an

employee may direct the investment of Plan assets. equal to his or

her interest in the Plan among five independently managed investment options -- the Money Market/Depository Fund; the Stable

Income Fund (" SIF" ); the Ba lanced Fund; the Stock Index Fund; and the Growth Equity Fund. Transfers, up to one per month, among

investment options are permitted; these occur without charge,

except that transfers to the Money Market/Depository Fund are subject to a 7 percent transfer' fee. Presently, roughly 75 percent (approximately $750 million) of

the aggregate Plan account balances are held in the SIF. Of this

amount, approximately $50 million is invested in a guaranteed

interest contract issued by the Protective Life Insurance Company

("Protective Life"), and. the balance (approximately $700 million)

is invested in a separate .account contract issued by the.

Metropolitan Life Insurance Company ("MetLife"). All Plan record-

keeping and participant interface is handled by Bankers Trust

Company under a contract with the County. 3 .

B. The Proposal

The proposed change in the administration of the Plan involves

the creation of. a new investment option, the Los Angeles County

Investment Fund ("LACIF"). Subject to the limitations described

2 The Los Angeles County Employees Retirement Association

provides County employees with a separate, nonvoluntary retirement

program.
3 Specifically, Bankers Trust maintains records of

participant account balances, provides written materials to

participants, and processes participant transactions, including

Plan withdrawals, changes in participant investment or beneficiary

designations, etc.

BAKR & MCKENZIE

M-ai--nne-K..Smytn-e,E5q.
Thomas S. Harman, Esq.

Meredith B. Cross, Esq.

below, each Plan participant will be entitled to allocate all or a

portion of his or her existing account balance to the LACIF. The

LACIF will have similar characteristics to the SIF, but will be

administered directly by the County. All other existing Plan

investments and administrative arrangements will remain in place.

The details of the County's proposal are set forth below. .

Creation of the LACIF

The LACIF will be under direct County management. The County

proposes to administer the LACIF primarily by selling to it County

securities backed by income-producing County property. It is

initially contemplated that these securities will be certificates

of participation ("COPS"), backed either by a specific revenue

stream or by the general credit of the county.. To the extent that

In the first case (revenue-baçked securities), the County

would sell an existing rêvenue-producing property to a non-profit

corporation ("NPC") indirectly controlled by the. County. The NPC

would immediately sell the property back to the County pursuant to

a conditional sales contract under which the County would be

obligated to make periodic installment payments, a portion of which.

would be designated as and constitute interest. The NPC would

assign its rights to receive the County installment payments to a

trustee bank, which would be instructed to execute and deliver to

the NPC COPs representing fractional, undivided interests in the

county installment payments. The NPC would sell the COPs to the

SIF. The proceeds of sale of the COPs received by the NPC would be

paid to. the County as consideration for. the purchase of the

property by.the NPC. The revenues derived by the County from the property would be pledged to the payment of the installment payments, and the general funds of the County would not be

obligated to make such payments if the revenues were insufficient.

In the second case, the County would lease one or more

buildings to the NPC, which would immediately sublease the

buildings back to the County. The County would be obligated to pay

rent to the NPC from its general funds each year, in consideration

for the use and occupancy of the buildings. A portion of each rent

payment would be designated as and constitute interest. The NPC

would assign its rights to receive rent under the sublease to a

trustee bank, which would be instructed to execute and deliver COPs

as described in the previous example. The proceeds of sale of the

COPs received by the NPC would be paid to the County as advance

BAKR & MÇKENZIE

M-a-r-i-ain-eK-.Smythe-Esq .
Thomas S. Harman, Esq.

Meredi th B. Cross, Esq.

the LACIF is not invested ~in COPs or similar County ~ecurities, it

will be invested in liquid money market instruments in accordance

with the County's policies for lnvesting excess cash.

The total amount of Plan assets which may be allocated to the

LACIF will be capped, and the life of the LACIF will be limited.

The County presently contemplates that the caf on allocations to

the LACIF will be approximately $200 million. Further, the cap

will gradually decrease to zero over some period of time (probably

in the range of ten years). At the end of the life of the LACIF,

any remaining balance will. be transferred to the SIF, unless

participants select another investment option..

The County will agree to credit participant account balances

allocated to the LACIF with a rate of return more attractive than

" the rate credited to SIF accounts. This may be - accomplished by

setting a guaranteed minimum LACIF rate of return greater than the

minimum SIF rate; by providing that the LACIF will provide the same

rate of return as the SIF rate, plus a specific p=emium; or in some

other manner. While the exact method of calculating the LACIF

return has not yet been determined, the .objective will be to

provide a return "sweetener" that will attract Plan participants to

the LACIF.

Disclosure and Participant Election Process

In connection with the creation of the LACIF, each Plan

participant will be sent supplemental Plan literature describing the change in Plan investment options. . All current Plan participants will also receive an election form. This disclosure

will advise participants that they will have a one-time opportunity

to allocate all or any portion of their current Plan account

balance from any existing Plan investment option to the LACIF. It will also explain the County's fiscal 1993 budget needs, the role

of the LACIF in meeting those needs, and the options available to

rent under the lease from. the County to the NPC.

.5 The amount of the cap will be approximately $150 million,

plus an amount sufficient to. allow for anticipated participantdirected transfers out of .the LACIF. While we currently believe

that this cushion will be approximately $50 million, the actual

amount will be determined by studying the transfer experience of

the SIF.

BAKR & MÇKENZIE

Marianne K. Smythe, Esq.
Thomas S. Harman, Esq.

Abigail Arms, Esq.

Meredi th B. Cross, Esq.

the County in the event that the LACIF is not funded to the full

amount of its cap.6 In addition, this new material will include

language at or near the beginning of such material which clearly

and prominently informs participants of the nature and terms of a

Section 457 plan; of all of the risks to which the assets of such

a plan are subject; and of the distinction between the "vesting" of

participant contributions and participant lIownership" of Section

457 plan account balances. The County will bear the expenses

associated with the creation of the LACIF, with the preparation of

the Plan disclosure documents necessitated by the creation of the

LACIF, and with the LACIF election process.

The election period for allocations to the LACIF will be at

least 30 days. That is, participants will be sent the notice and

election form at "least 30 days before the LACIF actually commences

operations. Following the LACIF election period, LACIF

participants will be permitted to transfer all or any portion of

their account balances out of the LACIF in accordance with the same

rules as govern the existing Plan options.- Under those rules,

participants may transfer out of any investment option and into

another once per month, subject only to any pre-disclosed transfer

fees. However, unlike other investment options, transfers (or the

allocation of future deferred income) to the LACIF will not be

permi tted after the LACIF election period.

As described above, the LACIF will be subject to a cap. In

the event that requests are recei vedduring . the LACIF election

period to allocate account balances to the LACIF in excess of the

cap, all ~ccount balances allocated to the LACIF will be accepted

prorata. . Thus, for example, if the LACIF is capped at $200

million, and participants elect to allocate $300 million to the

LACIF during the LACIF election period, 2/3 of the amount each

participant sought to allocate to the LACIF will be accepted. The

portion of each participant's account which is not accepted into

the LACIF will be allocated to other Plan investment options in

accordance with the participant's direction; in the event that no

direction is made, the sums not accepted into the LACIF will remain

in the investment option from which such sums were to have been transferred. 6 We also anticipate that the unions representing County

employees will encourage Plan participants to elect to allocate

some portion of their Plan balances to the LACIF.

BAKR & MÇKENZIE

li-a_r.i.a.nn_e_.K.Jin~the-;--5.q_e Thomas S. Harman, Esq.

Meredith B. Cross, Esq.

Safeguards and Limitations

As a safeguard to Plan participants, the County is committed

to Plan disclosure that will permit Plan participants to exercise

an informed choice concerning whether or not to place all or a

portion of their Plan account balances in the new LACIF investment

option. As additional safeguards, the County has authorized us to

represent, as a condition to the relief sought in this letter,

that, except with respect to the ;operation of the LACIF as

described above -
(a) the County will maintain all of the Plan investments under

independent, external (rather than County) management; and

(b) no part of the corpus or income of the Plan will be used

for, or diverted to, purposes other than the exclusive benefit

of participants or their beneficiaries, provided, however,

that all Plan assets will remain subject to the claims of the

County's general creditors to the minimum extent Tequiredby

Section 457.

C. Relief Requested

We believe that the foregoing proposal is consistent with the

federal securities laws, to the extent those laws apply to the

Plan. As you are aware, the Plan and the interests of participants

therein are not registered under the Securities Act of 1933, the

Securi ties Exchange Act of 1934, or the Investment Company Act of
1940. In our view, the implementation of the proposal as set forth
above will not require the Plan to register nor will it require the Plan or the County to register the interests in the. Plan. Similarly, in our view, the. implementation of the proposal as set

forth above will not preclude any funding vehicle for the Plan from

relying on the exemptions from Securities Act, Securities Exchange

Act, and Investment Company Act registration provided by, respectively, Sections 3 (a) (2), 3 (a) (12), and 3 (c) (11) of those Acts, provided and to the extent that those exemptions are

otherwise available to such funding vehicles.

BAK & MÇKENZIE

Marianne K. Smythe, Esq.
Thomas S. Harman, Esq.

Meredi th B. Cross, Esq.

Accordingly,' we request that the staff advise us .that it will

not recommend enforcement action against the County, the Plan, or

the funding vehicles for any Plan investment option under the

registration provisions of the Securities Act of 1933, of the

Securities Exchange Act of 1934, or of the Investment Company Act

of 1940 if the. County implements the proposed revisions to its

section 457 plan described herein.

We appreciate the staff's cooperation and assistance in

connection with this important matter. If you have questions

concerning this request, please contact David S. Ruder in Baker ~

McKenzie's Chicago office at (312) 861-3733 or Daniel L. Goelzer in

the Firm's Washington office at (202) 45~-7013.

Sincerely,
~ '( Mà~QJY5~¡'

Baker & McKenzie ~