SEC Division of Investment Management staff letter: David S. Butterworth

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON. D.C. 20549

DIVISION OF

INVESTMENT MANAGEMENT
January 27, 1994

Mr. David S. Butterworth
ACT -:C.v\ ~6 l~VD Managing Director

D. S. Butterworth & Co., Inc. SECTION 1853 William Penn Way RULE --:t.- - ¿

P.O. Box 10695
PUBLIC Lancaster, PA 17605-0695

A V AILiiBILllY
N127-J1~ . I Re: Charter Funds, File No. 811-5411;

Our Ref. No. 93-403

Dear Mr. Butterworth:
Your letter of July 2, 1993 requests our assurance that we

would not recommend that the Commission take any enforcement

action under Section 17 (f) of the Investment Company Act of 1940

(the "1940 Act") if the Charter Funds (the "Trust") retains an

affiliate, Charter Guaranty Company, Inc. ("Charter Guaranty"),

as its custodian in the manner described in your letter.

The Trust proposes to retain Charter Guaranty as its

administrator, shareholder servicing agent, and custodian.

Charter Guaranty, in turn, will enter into sub-custodial

agreements with various banks. ii Your letter states that Charter Guaranty is not a bank qualified under Section 26(a) (1) of the 1940 Act or a member of a national securities exchange.

Your letter also states that David S. Butterworth owns both

Charter Guaranty and the Trust's adviser.

Section 17 (f) requires every management investment company

to place its securities and similar investments in the custody of

(1) a bank or banks qualified under Section 26 (a) (1), ~i (2) a ii Your letter indicates that Charter Guaranty will enter into

some of these sub-custodial agreements to take advantage of

the book entry system of the Depository Trust Company

("DTC"). You should note that Rule 17f-4 imposes certain

requirements on investment companies or qualified custodians

who deposit some or all of a company's securities with a

qualified depository, like DTC. See Mutual Investment Fund

of Connecticut, Inc. (pub. avail. Nov. 20, 1986).

2.1 Section 26 (a) (1) provides that the trustee or custodian
shall be a bank which has "at all times aggregate capital,

surplus and undivided profits of a specified minimum amount,

which shall be not less than $500,000." Section 26 applies

~ to unit investment trusts and is relevant to management

investment companies, like the Trust, only to the extent

company that is a member of a national securities exchange, in

accordance with Commission regulations, or (3) the investment company itself, in accordance with Commission regulations (i. e. , self-custody). Rule 17f-2 sets forth the conditions under which

a registered management investment company may maintain custody

of its securities and other assets.

The staff has interpreted Rule 17f-2 to apply to any

arrangement between an investment company and its investment

adviser where the adviser also serves as custodian or

sub-custodian. dl The staff believes that the principal policy

of section 17 (f) is to ensure that securities and other assets

owned by the investment company are maintained in such a manner

that they will be subject to adequate independent scrutiny and

that this policy would be frustrated if an investment adviser

rendering custodial services was not subject to additional

safeguards such as those in Rule 1 7f-2, particularly the

verifications required by paragraph (f). ~I The staff has

interpreted the rule to further include an arrangement where an

investment company's adviser and custodian are wholly-owned

subsidiaries of the same corporation, and the adviser and

custodian share common directors and officers. ~I We believe

that the same concerns under section 17 (f) are present in your

proposed arrangement where the investment adviser and custodian

are both wholly-owned by the same individual.

that section 17 (f) references the definition of bank in

Section 26 (a) (1). Your letter states that the Trust will

comply with paragraphs (2) through (4) of section 26(a);

however, these provisions do not apply to management

investment companies.

dl See American National Growth Fund, Inc. (pub. avail. Oct. 4,

1991) (adviser served as custodian); The Mutual Fund Group

(pub. avail. Dec. 12, 1989) (adviser served as

sUb-custodian); Mutual Investment Fund of Connecticut, Inc.

(adviser served as custodian); Pegasus Income & Capital

Fund, Inc. (pub. avail. Dec. 31, 1977) (adviser served as

custodian) .
~I Paragraph (f) of Rule 17f-2 requires that an independent public accountant verify by complete examination the

securities and similar investments held by a self-custodian

at least three times annually.

~I See IPI-Income & Price Fund (pub. avail. Dec. 12, 1980). See also Composite Group of Funds (pub. avail. Mar. 2,

1987) (Rule 17f-2 applied to arrangement where sUbsidiary of

custodian served as investment adviser).

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Even if the Trust complied with all of the requirements of Rule 1 7f-2, we do not have enough information about Charter Guaranty to determine whether Charter Guaranty can serve as the

Trust's custodian. Paragraph (d) of Rule 17f-2 generally

requires that access to the investment company's securities be

limited to (1) certain officers or employees of the company, (2)

certain officers or emolovees of the bank or other comoany in

whose safekeeping the investments are olaced, and (3) the

independent public accountant for purposes of the verifications

required by paragraph (f). Paragraph (b) of the rule generally

requires that an investment company with self-custody place its

investments in the safekeeping of "a bank or other company whose

functions and physical facilities are supervised by Federal or

state authority." As custodian, Charter Guaranty would have

access to the Trust's securities. Your letter states that

Charter Guaranty is not a bank; it does not address, however,

whether Charter Guaranty falls within the meaning of "other

company whose functions and physical facilities are supervised by Federal or state Authority" in Rule 17f-2 (b). &.1 Finally, we question whether, under your proposed

arrangement, Charter Guaranty properly can be characterized as

the Trust's "custodian." It is not clear from your letter that

Charter Guaranty will provide any custodial functions to the

Trust.
Therefore, on the basis of the facts and representations in

your letter, we cannot assure you that we would not recommend

enforcement action to the Commission under Section 17 (f) of the

1940 Act if the Trust retains Charter Guaranty as its custodian.

Sincerely,
C¡~ 5. ()/~
Julia s. Ulstrup

Senior Counsel

&.1 See American National Growth Fund, Inc. (registered broker-

dealer affiliate as custodian under Rule 1 7f-2) and

Composite Group of Funds (savings and loan affiliate as

custodian under Rule 17f-2). See also Principal

Preservation Portfolios (Aug. 15, 1988) (registered broker-

dealer affiliate as safekeeping entity under

Rule 17f-2 (b) ) .

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--
1940 Actjl7 (f)

!Ø.7 §l~mo,d ,g. ~., §/W. 'l
.\ . I Investment Managcmcnt
July 2, 1993

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Thomas Harman

Chief Counsel

Securities and Exchange Commission

Division of Investment Management

450 Fifth street, N.W.

Washington, DC 20549

Re: Charter Funds

Rcgistrntion No. JJ-19JG0

Dear Mr. Harman:

D.S. Butterworth & Co. requests on behalf of the Charter Funds (the

"Trust") that the staff of the Division of Investment Management

(the "Staff") advise the Trust that it will not recommend any

enforcement action to the Securities and Exchange Commission

pursuant to Section 17(f) of the Investment Company Act of 1940,

as amended (the "1940 Act"), if the Trust retains an affiliated

non-bank, non-securities exchange member custodian, but otherwise

complies with Section 26 (a) of the 1940 Act.

The Trust intends to retain Charter Guaranty Company, Inc.

("Charter Guaranty") as its administrator and shareholder servicing

agent ; additionally, the Trust intends (pending the outcome of this

request) to retain Charter Guaranty as its custodian. This firm

is owned by David S. Butterworth, as are D.S. Butterworth & Co., the adviser, and Charter Securi ties Corp. , the principal underwriter. The Trust, a "series" type fund, is closely affiliated with the adviser and is designed primarily to make the

adviser's investment management services and reasonable

diversification available to its smaller clients. These closely

affiliated companies serve the Trust through what are believed to

be very practical and inexpensive relationships, the services of

which would not otherwise be economically feasible using larger

non-affiliated firms.

The custodian agreement with Charter Guaranty provides that "no

trustee, officer, employee or agent of the Trust, and no officer,

director, employee or agent of the Custodian, shall have physical

access to the assets of the Trust maintained by the Custodian or

be authorized or permitted to withdraw any investments of the

Trust, nor shall the Custodian deliver any assets of the Trust to any such person. No officer, director i employee or agent of the Custodian who holds any similar posi tion with the Trust shall have

1853 Wiliam Penn Way, P.O. Box 10695, Lancaster. P A 17605-0695 717-291-2100

Thomas Harman, page 2. July 2, 1993 physical access to the assets of the Trust" . Additionally, in

complying with Section 26 (a) of the 1940 Act, the Trust through

Charter Guaranty' ultimately designates custody of. its portfolio

securities with" (1) .. .one or more trustees or custodia,l1s,"each of which is a bank... (2) provides, in substance, (A.) ,that during the life of the trust the trustee or custodian, if not otherwise

remunerated, may charge... for its expenses as are provided for in

such instrument; (B) that no such charge or collection shall be

made except for services theretofore performed or expenses

thereto for incurred; (C) that no payment to the depositor of or a

principal underwriter for such trust, or to any affiliated person

or agent of such depositor or underwriter, shall be allowed the

trustee or custodian as an expense (except that provision may be

made for the payment to any person of a fee, not exceeding such

reasonable amount as the Commission mñy prescribe as compensation

for performing bookkeeping and other administrative services, of

a character normally performed by the trustee or custodian itself) ;

and (D) that the trustee or custodian shall have possession of all

securi ties and other property in which the funds of the trust are

invested, all funds held for such investment, all equalization,

redemption, and other special funds of the trust, and all income

upon, accretions to, and proceeds of such property and funds, and shall segregate and hold the same in trust (subj ect only to the charges and collections allowed under clauses (A), (B), and (C) J until distribution thereof to the security holders of the trust;

(3) provides, in substance, that the trustee or custodian shall not resign. . . (4) provides, in substance, (A) that a record will be kept by the depositor or an agent...; and (B) that whenever a security

is deposited...", as this section states in its entirety.

The distinction to be made, however, is that Charter Guaranty

contracts with such bank custodian (s) for these services and hot

the Trust directly. Any administrative services that can be delegated by the bank custodian, such as securities trading, affirming transactions with the Depository Trust Company ("DTC"),

relaying settlement instructions to brokers, etc., are handled by

Charter Guaranty. This also facilitates better communication,

electronic data transfer, and coordination of activities between

what may eventually be multiple advisers and multiple bank

custodians through one entity, Charter Guaranty.

Under the Trust's previous plan of business a custodian, Dauphin

Deposit Bank and Trust Company ("Dauphin"), was to be retained.

Their capabilities were not extraordinary, except for the fact that

they are recognized as one of Central Pennsylvania's finest banking

institutions and as custodian of the Trust's Pennsylvania tax-

exempt income portfolio their daily pricing of local municipal

securities could' prove beneficial in determining the portfolio's NAV. There really are no similar benefits afforded to the Trust's other portfolios and in such cases Dauphin is simply one more layer

Thomas Harman, page 3. July 2, 1993 adding to their incremental costs. In fact, Dauphin contracts with

the Northern Trust Company ("Northern") in Chicago for computer

systems and physical/non-DTC eligble securities custody; Northern

in-turn then provides Dauphin with access to the Depository Trust

Company's book-entry-only securities depository and the National

Securities Clearing Corp. settlement and clearance system. The

Trust is better served by Charter Guaranty being able to directly

contract with DTC agent banks in certain instances, placing itself

in the line-up as the first intermediary (and in doing so reduce

the Trust's costs), while alternately contracting with select local

bank custodians when the benefits of their services are truely

worthwhile from a value-added standpoint.

The objective of the previous explanation of a custodian and its attendant duties is to show that in rea Ii ty it is not a sole-source relationship, but actually multiple layers with the ultimate

"custodian" being (with some exceptions) the Depository Trust

Company. The safeguards intended in section 17 (f) of the 1940 Act for the custody of investment company assets seem to be clearly met

through the DTC book-entry-only system and/or through DTC agent

banks (being one layer removed) and further by restricting access

to such assets by affiliated persons otherwise responsible for

administering the Trust's activities.

In all instances the Trust will, by contract with Charter Guaranty

and their contraèt (s) with one or more banks, have custody of its

portfolio securities maintained within the requirements of Section

26 (a) of the 1940 Act. The Trust's custodian agreement with

Charter Guaranty will be "approved by the vote of a majority of the outstanding voting securities.. .precisely (describing) all compensation to be paid thereunder... shall continue in effect for

a period more than two years from the date of its execution, ohly

so long as such continuance is specifically approved at least

annually by the board of (trustees) or by vote of a majority of the

outstanding voting securities of (the Trust)" and will provide that ". . . such contract or agreement and any renewal thereof (shall be) approved by the vote of a majority of (trustees), who are not

parties to such contract or agreement or interested persons of any

such party. . . ", as required of investment advisory and underwriting contracts in section 15 of the 1940 Act.

The Trust seeks relief from disclosing individually each of the

underlying bank custodians in its prospectus while avoiding any

interpretation by the Staff of Section 17 (f) of the 1940 Act that

could arise in naming Charter Guaranty as custodian whereby such

action is construed as creating a self-custodian relationship under

subsection 17(f) (3) due to their affiliation; and, therefore,

causing the Trust to be required to retain independent accountants

to perform the three verifications of their portfolio securities

as required by subsection (f) of Rule 17f-2 of the 1940 Act.

. .
Thomas Harman, page 4. July 2, 1993

If you should have any questions or require further information

concerning this request, please call me. Thank you.

Sincerely, G4g,~ David S. Butterworth

Managing Director

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