SEC Division of Investment Management staff letter: Davis, Polk & Wardwell

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REPONSE OF TH OFFCE OF CH COUNSEL Davis Polk & Warwell DMSION OF INTM MAAGEM File No. 132-3 Your letter date Apri 23, 1997 reuests our. assurace tht we would not

remmend enforcment action to the. Commsion if cert clients of your fi intendig to rely on the exclusion frm regulation under the Investment Company Act of 1940 (the "Act") provided by Section 3 (c) (7) of the Act issue securities to quaed purchasrs prior to the effective date of roles implementig Section 3 (c) (7), in the maner describe in your letter; The Nationa Securities Markets Improvement Act of 1996 provides tht Section 3(c)(7) wil beme effective on the ealier of Apri 9, 1997, or the date on which the .

Conision completes rolemakg derIDg the term I'investments" under Section 2(a)(51) of the Act. On Apri 9, 1997, the Federa Register publihed a relea in which the-

Commssion adopte such roles (the "Rules"). i The Rules wil be effective on June 9, 1997, 60 days afer publication in the Federa Register ("Efective Date"). The 6O-dy waitig period was establihed pursuat to the Smal Business Regulatory Enorcment Faiess Act of 1996 ("SBRBA"),2 which is designed in par to give Congrss the opportnity to review roles adopted by federa agencies. 3 Issuers intending to rely on
Section 3
(c) (7) may not have anticipated the application of SBRBA's 60-day waitig period to the Rules. You rereent that although Section 3 (c) (7) bee effective on Apri 9, 1997, the unanticipated delay of the effectiveness of the Rules wil impose hadship on a number of tys of issuers that intend to rely on Section 3(c)(7). You state that the 6O-day delay could

materiy afect the abilty of these issuers to meet their expete fundig reuirments and investment deadles. Speifcay, you rerent tht one of your clients currntly relying on the exclusion from regulation under the Act provided by Section 3(c)(1) of the Act-intends to convert to a Section 3(c)(7) fund. You state tht the Rules would provide guidace.as to which of ths issuer's holders ar beneficia owners tht must reive notice and reemption rights before conversion. You also rerent tht other clients of your fi would seek to

rely on the Rules to determe wheter assets held by prosptive investors qua as "investments," includig the provisions spifing the trtment of contrllg interests and.

i Prvate Investment Companes, Investment Company Act Releae No. IC-22597 (Apr.

3, 1997) (adoptig Rules 2a51-1, 2a51-2, 2a51-3, 3c-l, 3c-5 and 3c-6). 2 Pub. L.No. 104-121, §251, 110 Stat. 857 (1996) (coded at 5 D.S.C. §§ 801-808).

3 In addition to reuirg a 60-caenda day waitig period prior to the effective date of major roles, SBRBA also provides for a 60-legislative day period durig which a joint resolution of disapproval under the procures set forth in SBRBA may occur.

2

investor indebtedness.
You maita that it is approprite for an. issuer to rely on the Rules prior to the Efective Date, provided that the issuer: (i) wil issue its seurities only to persons who meet the derintion of quaed purchaser under the Act and the reuirments of the Rules at the ~e of their acquisition of such seurities; (ü) in the event tht the Rules do not tae effect (or contiue) pursuant to a joint reolution of dipproval under the proures set forth in SBRBA (a "Disapproval"), wil fully comply with any new rules that the Commission may adopt in rense to the Disapproval and tae al action necsa to comply with such new roles as if they had ben in effect since Apri 9, 1997; and (il) wil fully comply with al other applicable laws and roles, includig the Rules in their entity. To the extent that

issuers tae action to comply. with any such new rules as if they had ben in effect since Apri 9, 1997, you maita that the fact that issuers relied upon the Rules prior to the Efective Date wil not result in har to investors. We would not remmend enforcement action to the Commision if any issuer intendig to rely on Section 3 (c) (7) of the Act issues securities to quaed purchasers in accrdace with the Rules prior to the Efective Date,4 provided that in the event of a Disapproval, the issuer wil tae al action necssa to comply with any new roles that the

Commission may adopt in respnse to the Disapproval as if they had ben in effect since Apri 9, 1997. Ths response is lited to actions taen by issuers prior to the ealier of the Efective Date, or of any pre-Effective Date Disapproval. Ths respnse expresses the Division's position on enforcement action only, and does not purprt to express any legal

conclusions on the questions presented.
~/i-~
;;~g¡;;heidt
Associate Dirtor and
Chief Counsel
4 Your letter only discusses issues arsing under Rule 2a51-1 (derIDg investments and addrssing -cert other matters) and Rule _2a51-2 (derIDg cert terms for purpses of the

gradfather and consent provisions). Our respnse is not so lited, but rather applies to al of the Rules.

DAVIS POLK & WARDWELL

1300 I STREET. N.W. 450 LEXINGTON AVENUE
17-22. AKASAKA 2-CHOME

WASHINGTON. D.C. 20005 MINATO-KU. TOKYO 107
NEW YORK, N.Y. 10017

212-450-4000
4, PLACE DE LA CONCORDE MESSETURM FAX: 2 I 2-450-4800 7S008 PARIS 60308 FRANKFURT AM MAIN

WRITER'S DIRECT NUMBER:
I FREDERICK'S PLACE 3A CHATER ROAD
LONDON EC2R BAB HONG KONG
212-425
April 23, 1997
Re: Effective Date of Section 3(c)(7)
Mr. Douglas J. Scheidt, Esq. Investment Company Act Chief Counsel Section 3 ( c )(7) Division of Investment Management Securities and Exchange Commssion 450 Fifth Street, N.W. Washington, D.C. 20549 Dear Mr. Scheidt:
We represent a number of clients which are in the process of formng the Investment Company Act of 1940. We request your confrmation that the Staff wil not recommend enforcement action under the 1940 Act if, as of the April 9, 1997 effective date of section 3 ( c )(7), these funds issue securities to persons who meet the Qualified Purchaser requirements set forth in rules adopted by the Commssion on April 3 and subsequently published in the Federal Register. private investment companes that intend to rely upon new section 3(c)(7) of

The National Securities Markets Improvement Act of 1996 created section. 3(c)(7), which excludes from regUlation under the 1940 Act privately offered investment companes whose securities are held exclusively by Qualified Purchasers. The new act requires the Commssion to adopt rules that implement
section 3(c)(7), and provides that section 3(c)(7) is effective the earlier of April 9
or the date on which the Commssion completes its rulemakng. Although the Commssion adopted these rules on April 3, it anounced that they would not be effective' until 60 days afer their publication due to a separate statutory requirement requiring delayed effectiveness of regulations. Small Business Regulatory Enforcement Fairness Act of 1996 ("SBREF A"), Pub. L. No. 104-12 l . §251. As a result of this apparently unforeseen complication, there will be an almost two-month period during which the law is effective but the rules implementing its provisions are promulgated but not yet effective. We also understand that there is a60 legislative day period afer effectiveness during which

Mr. Douglas J. Scheidt, Esq. 2 April 23, 1997 Securities and Exchange Commission Congress could disapprove the rules. During both of these periods, Congress could disapprove the rules under the procedures set forth in SBREF A. 1

The delayed effectiveness of these rules imposes undue and unnecessary hardship on 3(c)(7) funds which have timed their formation in anticipation of an April 9 effective date. A delay could materially hinder the ability of these funds to meet their expected funding requirements and investment deadlines. As described below, although section 3(c)(7) is effective on April 9, the Commssion's rules provide practical guidelines for compliance with section 3(c)(7). Thus, it would be extremely useful for these funds to be able to rely upon the Commssion's rules before the date of their effectiveness. We represent one of the largest privately offered funds in the country which has been working over the past two months to convert from section 3(c)(1) to section 3(c)(7) upon adoption of the Commssion's rules. The rules relating to the Grandfather provision would guide the fund in determning which of its holders are beneficial owners that must receive notice and redemption rights before converSion. We also represent a client which is formng a new 3 ( c )(7) fund and has been marketing the fund for several months. Potential investors have signed subscription agreements committing to invest irI the fund, which commitments expire at the end of May (this gave the sponsor six weeks after effectiveness of
section ~(c)(7) to close the fund). If the fund were now to wait until effectiveness
of the rules in June, all of its commitments from investors would expire. It would be 'diffcult for the fund to close without reliance on the rules because it intends to require that investors in the fund certify as to their Qualified Purchaser status, and would like to rely upon the Commssion's rules to ascertain which assets held by prospective investors will count as investments for these purposes. For example, the rules reveal whether secunties of certain controlled issuers would be deemed investments, or whether to deduct leverage from the amount of assets held. The rules also guide the fund in its reliance on the reasonable belief standard in admitting prospective investors. It may also be the case that a potential investor may be a privately offered fund formed before April 30, 1996, in which case the consent provisions relating to the investor's treatment as a Qualified Purchaser would apply. We in fact have a number of other clients that are in various stages of capital raising for 3 (c )(7) funds, and the rules would prove helpful to these funds for the same aforementioned reasons. In many cases, these funds anticipated lWe understand tht issuers do not need no-action relief during the 60 legislative day period afer effectiveness beuse they may then rely upon the provisions of SBREF A.

Mr. Douglas 1. Scheidt, Esq. 3 April 23, 1997 Securities and Exchange Commission the rules becoming effective in April in planning and executing the marketing of the funds.

We believe that it is appropriate to allow an issuer to rely on the Commssion's rules after April 9 but before the rules are effective, as long as (i) its securities wil be sold only to persons who meet the definition of Qualified Purchaser under the 1940 Act and the requirements of the rules at the time of their acquisition of such securities; (ii) in the event that the rules do not take effect or do not continue pursuant to a joint resolution of disapproval under the procedures set forth in SBREF A, the issuer will fully comply with the rules the Commission may adopt in response to the disapproval and take all corrective actions necessary to comply with such new rules as if they had been in effect as of April 9, 1997; and (iii) the issuer will fully comply with all other applicable laws and rules, including the rules adopted by the Commssion in Release No. IC-22597 in their entirety. The ability of issuers to rely upon the Commssion's rules before their effectiveness would not afect Congress' ability to disapprove the rules during the waiting period, and would not harm investors; If Congress did disapprove the rules, as stated. above, the issuers would ensure that their investors received the protection afforded by the new rules the Commssion may adopt. In summary, these clients intend to fully comply with section 3(c)(7) and its related rules as of the date of the effectiveness of section 3(c)(7). We respectfully request ~onfrmation that the Staf would not recommend enforcement action . under the 1940 Act if these issuers sell securities to Qualified Purchasers in the manner described above as of April 9, 1997. The Staf provided similar relief to companies relying on new section 3(c)(2) before its statutory effective date. See Clear, Gottlieb, Steen & Hamlton (Nov. 25, 1996). Please feel free to contact me at (212) 450-4525 or Nora Jordan at (212) 450-4684 if you have any questions regarding this request. Respectfully submitted,

e' ·

Pierre de Saint Phalle