SEC Division of Investment Management staff letter: Defined Asset Funds - Equity Income Fund - Select Ten Series

5 MAY 1993

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RESPONSE OF THE OFFICE OF CHIEF COUNSEL Select Ten Series

DIVISION OF INVESTMENT MAAGEMENT File No. 33-46S42

Your letter of April S, 1993, requests our assurance that we

would not recommend enforcement action to the Commission under

sections 17 (a) (1) or 17 (a) (2) of the Investment Company Act of 1940 ("1940 Act") if an existing unit investment trust ("Trust")

of the Select Ten Series, a series of the Defined Asset Funds Equity Income Fund, which has reached its mandatory termination

date, ("Terminating Trust") sells portfolio securities to a unit

investment trust of the same series in formation ("New Trust") in

compliance with all provisions of Rule 17a-7 under the 1940 Act

except paragraph (e). ii

Each Trust invests in securities in accordance with a

strategy described in "Beating the Dow," by John Downes and

Michael O'Higgins. Under this strategy, a Trust invests 10% of

its assets in each of the ten stocks in the Dow Jones Industrial

Average ("DJIA") with the highest dividend yield. You state that

each Trust holds these securities for approximately one year, and

that the sponsor will offer a New Trust for the following year as

each Trust terminates. You also state that generally there is

some overlap from one year to the next in the ten securities

having the highest dividend yield in the DJIA. You state that to

date each Terminating Trust has sold, and each New Trust has

purchased, all of its securities on the New York Stock Exchange.

In the two most recent cases where a Terminating Trust sold

portfolio securities which were identical to those purchased by a

New Trust, the purchase and sale commissions were approximately

$150,000.
section 17(a)(1) generally makes it unlawful for an

affiliated person of a registered investment company, or any

affiliated person thereof, acting as principal, knowingly to sell

any security or other property to the company. section 17 (a) (2) generally makes it unlawful for the same persons, acting as

ii The staff believes that an offer to unitholders to invest

redemption proceeds upon the liquidation of an existing

series into a new series, at net asset value plus a reduced

sales charge (a "rollover option"), is an exchange offer for purposes of section 11 (c) of the 1940 Act. section 11 (c) prohibits any offer of exchange of the securities of a unit

investment trust for the securities of any other investment

company absent a Commission order. The Select Ten Series

prospectus states that the sponsors have received exemptive

orders under Section 11 (c) which they believe permit them to

offer a rollover option.

principal, knowingly to buy any security or other property from

--tone-. ï.nvestoment--compa-ny-.---Ru.L.e-1-7-a---7-exempts--.f-r.om-the---proh ibit ions. of section 17 (a) certain purchases and sales between registered

investment companies and certain affiliated persons, where the

affiliation arises solely by reason of having a common investment

adviser, common directors, and/or common officers. You state

that each Trust may be considered an affiliated person of each

other Trust because they share the same sponsors and/or the same

trustees. Because a New Trust would not be affiliated with a

Terminating Trust through any relationship specified in the Rule,

they may not rely on the exemption provided therein. Of course,

where a transaction subject to section 17 (a) is not exempted from

section 17(a) by Rule 17a-7, section 17(b) provides a specific

mechanism by which the transaction might proceed. That provision

permi ts a person to file an application for an order exempting a

proposed transaction from section 17 (a). The Commission may

exempt a proposed transaction from Section 17 (a), if (1) the

terms of the transaction are fair and reasonable and do not

involve overreaching; (2) the transaction is consistent with the

investment company's policies; and (3) the proposed transaction

is consistent with the general purposes of the 1940 Act.

Paragraph (e) of Rule 17a-7 requires the board of directors,

including a majority of the disinterested directors, of the

investment company to (1) adopt procedures pursuant to which

these purchases and sales are effected, which are reasonably

designed to ensure compliance with paragraphs (a) through (d) of

the Rule; (2) review at least annually the continuing

appropriateness of these procedures; ~/ and (3) determine at

least quarterly that all purchases and sales made during the

preceding quarter were effected in compliance with such

procedures.
The requirements that the board of directors adopt

appropriate procedures and review such transactions are

fundamental to the exemption the Rule provides. They were added

to the Rule in 1981, the last time the Commission modified the

Rule. In proposing paragraph (e) to Rule 17a-7, the Commission

stated its belief that these requirements accorded with its

general objective of "enhancing, insofar as feasible, the role of

investment company directors and particularly disinterested

directors as watchdogs of shareholder interests. The Commission

believes that the first line of responsibility for determining

compliance with the proposed amendment should be with each

~/ While the Commission has proposed eliminating the annual director review requirement from certain rules, including

Rule 17a-7, it has not proposed deleting the other board of

directors' requirements. Investment Company Act ReI. No.

19192 (Dec. 30, 1992).

• 2

investment company's directors." '1/ Because of the importance of

paragraph (e), we are unwilling to permit these unit investment

trusts to rely on Rule 17a-7. 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 sections 17 (a) (1) or 17 (a) (2) if a Terminating Trust sells portfolio securities to a New Trust, or a New Trust buys

portfolio securities from a Terminating Trust, in the manner

descr ibed in your letter.
~J. ~
Monica L. Parry

Senior Counsel

'1/ Investment Company Act Rel. No. 11136 (Apr. 21, 1980)

(proposing amendments to Rule 1 7a-7) .

• 3

DAVIS POLK & WARDWELL

450 LEXINGTON AVENUE

• I CHASE "MANHATTÄl'-P-LAZA----
  NEW YORK, N. Y. 10005
• NEW YORK,-N~Y 10-0-17---
  212-450-4000
  1 FREDERICK'S PLACE
  LONOON EC2R 6AS
  FAX: 212-450-4600
  1300 I STREET, N.W. 2-1, MARUNOUCHI I-CHOME WASHINGTON, D. C. 20005 CHIYODA-KU. TOKYO 100 WRITER'S DIRECT NUMBER: 4, PLACE DE LA CONCORDE MESSETURM 75008 PARIS 6000 FRANKFURT AM MAIN 1

1940 Act: Section 17 (a) and Rule 17a- 7 April 8, 1993

AM -l C t\ (t: i 9'1 (2)
Off ice of the Chief Counsel
SECTION Division of Investment Management
Securities and Exchange Commission RULE í 7 CL ~7 450 Fifth Street, N.W. PUBLIC 1:- f' C L (J 'S Washington, D. C. 20549 AVAILABILIT ~ 'v . i .

Dear Sirs:
We are special counsel to Merrill Lynch, Pierce,

Fenner & Smith Incorporated and the other Sponsors of

Defined Asset Funds - Equity Income Fund, a unit investment

trust registered under the Investment Company Act of 1940

(the "1940 Act") comprised of various separate portfolios or

series (each, a "Trust"). On behalf of the Sponsors, we

request confirmation from the Staff of the Division of

Investment Management that it will not recommend enforcement

action if, in compliance with Rule 17a-7 under the 1940 Act

(other than paragraph (e) thereof), an existing Trust of the

Select Ten Series which has reached its mandatory

termination date (a "Terminating Trust") sells portfolio

securi ties to a Trust of the Select Ten Series then in

formation (a "New Trust") at the closing sales prices of the

securities on the New York Stock Exchange on the date of sale. Background. The investment objective of each Trust of the Select Ten Series is to seek a greater total

return than the stocks comprising the entire Dow Jones

Industrial Average (the "DJIA"). Each trust acquires

approximately equal values of the ten stocks in the DJIA

having the highest dividend yields as of one or two business

days before the Trust is created and holds those stocks for

approximately on~ year. The Sponsors intend that, as each

Trust terminates, a new Trust will be offered for the next

Office of the Chief Counsel 2 April 8, 1993 year.1 This investment approach is discussed in the book

Beating the Dow by John Downes and Michael 0' Higgins (New

York: Harper Collins, 1991), wherein the authors conclude

that over a twenty year period a strategy of initially

buying the ten highest dividend yielding stocks in the DJIA,

and annually replacing stocks no longer in the highest

yielding ten with new stocks that are, would have produced a

greater annual total return than the DJIA in 15 of the 20

years, and a significantly higher compounded return over the

entire 20 years.

As might be expected, there is normally some

overlap from one year to the next in the stocks having the

highest dividend yields in the DJIA. Accordingly, there is

likely to be some degree of congruity between the portfolios

of a Terminating Trust and a New Trust. In the most recent

case, 9 of the 10 securities were identical. However, as

these Trusts may be considered affiliates of one another, to

date each Terminating Trust2 has, in connection with its

termination, sold all of its securities on the New York

Stock Exchange as quickly as practicable but over a period

of time so as to minimize any adverse impact on the market

price. Likewise, the portfolio of a New Trust is acquired

in purchase transactions on the New York Stock Exchange.

This procedure has resulted in both the Terminating Trust

and the New Trust, and, consequently, the holders of units

of both Trusts, incurring substantial brokerage commissions

on securities of the same issue. Al though commissions vary,

the Sponsors estimate that the brokerage charge on a

purchase or sale transaction averages approximately 5 cents

a share. In the two most recent cases where a Terminating

Trust sold portfolio securities which were identical to

portfolio securities purchased by a New Trust, aggregate

Because each Trust is structured, for federal income

tax purposes, as a grantor trust, it is not possible to vary

the investments in a Trust to conform to changes in the DJIA

and thereby continue the Trust for the next year.

2 As a technical matter, holders of units of a Terminating Trust who choose to acquire units of a New Trust are treated as having redeemed their units of the Terminating Trust in kind and received shares in each of the stocks in the portfolio of the Terminating Trust. The trustee of the Terminating Trust, on behalf of these holders, thereafter sells the shares of stock distributed to them on the New York Stock Exchange. For purposes of this letter, however, the sales should be considered as being made on behalf of the Terminating Trust.

Office of the Chief Counsel 3 April 8, 1993 commissions paid in these purchase and sale transactions

were estimated by the Sponsors to be $150,000.

Legal Analysis. Unless exempted from Section

17 (a), investment companies under common control may be

considered affiliates of one another and therefore unable to

enter into exchanges of securities without SEC approval.

Each Trust is sponsored by Merrill Lynch, Pierce, Fenner &

Smith Incorporated, Prudential Securities Inc. and

PaineWebber Incorporated. A sponsor (also referred to as a

"depositor") is included in the definition of "affiliated person" in Section 2 (a) (3) (F) of the 1940 Act. The trustee of the Trusts established to date has been either Chase

Manhattan Bank, N .A. or The First National Bank of Chicago

and Investors Bank & Trust Company, as co-trustees.

Accordingly, while we know of no precedent with respect to

unit investment trusts, it is likely that each Trust would

be considered an affiliate of the others.

Rule 17a-7, adopted in 1966, was designed to

permi t registered investment companies which might be deemed

under common control by reason of common investment

advisers, directors and/or officers, to exchange securities

with one another at an independently determined price,

provided there was no consideration other than cash payment

against prompt delivery, the transaction was consistent with

the policy of each registered company, and no brokerage

commission, fee or other remuneration was paid in connection

with the transaction.3 When the Rule was amended in 1981,

as explained in ReI. IC-11676 (March 10, 1981), because

funds were given greater flexibility in determining the

independent price, a new condition (paragraph (e)) required

adoption and moni toring4 by the fund's board of directors

(including a majority of those directors who are not

interested persons) of procedures to assure compliance with

the revised rule. Unfortunately, this amendment effectively

foreclosed unit investment trusts (which by definition have

no board of directors) from realizing similar savings for

their holders.

We submit that, in the circumstances described

above, a sale of securities by a Terminating Trust to a New

Trust in a transaction appropriate to the investment

3See ReI. IC-11136 (April 21, 1980).

4The Commission, in its recent Release No. IC-19192 (December

30, 1992), has proposed eliminating the annual director review

requirement from certain rules, including Rule 1 7a-7.

Office of the Chief Counsel 4 April 8, 1993 objectives of each, at the closing price on the New York

Stock Exchange on the date of the sale, without any

brokerage charges or other remuneration except customary

transfer fees, if any, satisfies each of the requirements of

Rule 1 7a - 7 other than paragraph (e) thereof - i. e ., it meets

each of the requirements of Rule 17a-7 as in effect until

the 1981 amendment. Satisfying the additional condition of

board review is obviously impossible for a unit investment

trust. Additionally, the rationale behind the on-going

monitoring requirement of paragraph (e) is not applicable to

exchange-listed securities, especially where the securities

are 10 of the 30 most well established and actively traded

stocks in the United States. Accordingly, we hereby

request confirmation that the Staff would not recommend

enforcement action under Sections 17 (a) (1) or 17 (a) (2) of the 1940 Act if a Terminating Trust sells securities as

described above to a New Trust.

Please feel free to call the undersigned (at 212-450-4525), Linda Simpson (at 212-450-4332) or Gary L. Granik (at 212-450-4721) if you have any questions regarding

this request.

submitted,