SEC Division of Investment Management staff letter: Goldman Sachs & Co.

APR 2 7 1995
'~LIC
Our Ref. No. 95-110-CC
RESPONSE OF THE OFFICE OF CHIEF COUNSEL Goldman, Sachs & Co. DIVISION OF INVESTMNT MAAGEMENT File No. 132-3 Your letter dated April 24, 1995 seeks our concurrence that

a finance subsidiary organized as a business trust under the

Delaware Business Trust Act ("DBTA"), 1./ or a similar business

trust statute in another state, that issues non-voting preferred

trust certificates (" Preferred Trust Certificates") as described

in your letter, may rely on the exemption for finance

subsidiaries under Rule 3a- 5 under the Investment Company Act of

1940 (the "Investment Company Act"). 2./ You state that a finance subsidiary established as a

business trust issuing Preferred Trust Certificates, and the

related transaction, will comply fully in all respects with Rule 3a- 5, except that the transaction will involve the issuance of non-voting Preferred Trust Certificates by a business trust

instead of non-voting preferred stock by a corporation. Business

trusts are "creatures of contract" in that they are created by a

trust instrument under which property is held and administered by

a trustee for the benefit of persons who are or may become the

beneficiaries of the trust. A Delaware business trust may issue

Preferred Trust Certificates having rights, preferences and

limitations, including voting rights or the express denial of

voting rights, equivalent to those of the preferred stock of a

corporation. All of the ownership interests in the business

trust will be evidenced by one or more classes of Preferred Trust

Certificates and a single class of trust certificates owned by

the parent company or a company controlled by the parent. All of

the interests in the business trust other than the non-voting

Preferred Trust Certificates will be owned by the parent company

or a company controlled by the parent company. á/

1./ Del. Code, Title 12, §§ 3801 et seg.

l/ Generally, Rule 3a- 5 exempts from the definition of

investment company a subsidiary that is organized to finance

the operations of its parent company or companies controlled

by its parent company, provided such companies are not

themselves investment companies under Section 3 (a) of the Investment Company Act. Under paragraph (b) (1) of Rule

3a- 5, "(a) \ finance subsidiary' shall mean any corporation

(i) (a) 11 of whose securities other than debt securities or non-voting preferred stock . . . are owned by its parent

company or a company controlled by its parent company."

á/ You believe that there are several reasons why business

trusts were not included in the definition of finance

subsidiary in Rule 3a-5. You state that when Rule 3a-5 was

adopted in 1984, no parent company, to your knowledge, had (continued. . . )

In the release adopting Rule 3a- 5, the Commission stated

that it was appropriate to exempt a finance subsidiary from all

provisions of the Investment Company Act where neither its

structure nor its mode of operation resembles that of an

investment company. ~/ The Commission stated that it found this

to be the case where the primary purpose of the subsidiary is to

finance the business operations of its parent or other

subsidiaries of its parent, and where any purchaser of the

finance subsidiary's debt instruments ultimately looks to the

parent for repayment and not to the finance subsidiary.

You state that, as in the case of a finance subsidiary

organized as a corporation, the business trust will be formed for

the primary purpose of financing the operations of the parent or

its other subsidiaries, and at least 85% of the proceeds from the

offering of the Preferred Trust Certificates will be invested in

or loaned to the parent or its controlled companies consistent with the requirements of Rule 3a- 5. The Preferred Trust Certificates issued by the business trust would (1) be non￾voting except for limited circumstances that are effectively the

same as those pursuant to which non-voting preferred stockholders

in a corporation issuing securities in reliance of Rule 3a-5

would have voting rights; (2) have a liquidation preference that

is akin to the liquidation preference of preferred stock; (3)

entitle holders to priority for periodic distributions that is

akin to the rights of holders of preferred stock; and (4) will

benefit from a parent's guarantee in compliance with Rule 3a-5.

Based on the facts and representations in your letter, we

would not recommend enforcement action to the Commission if a

finance subsidiary organized as a business trust under the DBTA,

or a similar business trust statute in another state, that issues

á/ ( . . . continued) proposed to use a business trust as a finance subsidiary, so

the Commission would not have considered whether to include

business trusts within the scope of the rule. In addition,

at the time the rule was adopted, finance subsidiaries were

commonly established to offer their securities to

institutional investors. At that time, some state

investment laws applicable to institutional investors were

generally more restrictive as to investments in securities

issued by non- corporate issuers. The existence of these

state law restrictions, therefore, made it less likely that

the Commission would have considered whether business trusts

should be included in the rule's definition of finance subsidiary. ~/ Investment Company Act Release No. 14275 (Dec. 20, 1984) (adopting Rule 3a-5) .

• 2

Preferred Trust Certificates as described in your letter, relies on the exemption for finance subsidiaries under Rule 3a- 5. 2/ Because this position is based on the facts and representations

made in your letter, you should note that any different facts or

circumstances might require a different conclusion.

~~ - ..
Alison E. Baur

Senior Counsel

2/ See also Andrews & Kurth L. L. P. (pub. avail. Apr. 5, 1994)

(staff granted no-action relief so that a finance subsidiary

organized as a limited partnership could rely on Rule 3a￾5); (Lehman Brothers Inc. (pub. avail. Mar. 8, 1994) (staff

granted no-action relief so that a finance subsidiary

organized as a limited liability company could rely on the

rule); Inco Limited (pub. avail. Mar. 4, 1994) (same);

Merrill Lynch & Co. (pub. avail. Mar. 2, 1994) (same).

• 3

Investment Company Act of 1940

Rule 3a-5

SULLIVAN & CROMWELL
NEW YORK TELEPHONE: (212) 556 -4000

TELEX: 62694 (INTERNATIONAL) 127616 (DOMESTIC)

CAElLE ADDRESS: LADYCOURT, NEW YORK 12§ (jMt~~0J~/OOOJ¡-2J¡98 FACSIMILE:(212) 556-3566 (125 ElROAD STREET)

.. ~...,... (212) 556- 379.2_(2.Q...s;ARK.AV.ENUE1."~'""'-'--'-'" ..-., .... 250 PARK AVENUE, NEW YORK 10177-0021 1701 PENNSYLVANIA AVE., N. W., WASHINGTON, D. C. 20006-5605

leA of ~ Ci4ü 44 SOUTH FLOWER STREET, LOS ANGELES 90071-2901 e, PLACE VENDÔME,75001 PARIS ST. OLAVE'S HOUSE,9& IRONMONGER LANE, LONDON EC2V 6EY . d :).9.::'.l:.on 101 COLLINS STREET, MELElOURNE 3000 2-1, MARUNOUCHII-CHOME, CHIYODA-KU, TOKYO 100 '3 - S NINE QUEEN'S ROAD, CENTRAL, HONG KONG ,1e~...- .0. lie I April 24, 1995 ¡ l,',1)i1 i t.y i+ d-~( q5~.w..~...~... ,..;...i.......~~.~~__"""'P--.-... Office of the Chief Counsel,

Division of Investment Management,

Securities and Exchange Commission,

450 Fifth Street, N. W. ,

Washington, D.C. 20549.

Attention: Alison E. Baur, Esq.

Re: Business Trusts as Finance Subsidiaries

Pursuant to Rule 3a-5

Ladies and Gentlemen:

We are writing on behalf of Goldman, Sachs & Co.,

in connection with transactions under consideration by their

clients, to request confirmation that the staff of the

Division of Investment Management (the "Staff") interprets

Rule 3a-5 under the Investment Company Act of 1940 to be

available for (x) a finance subsidiary established as a

business trust under the Delaware Business Trust Act (Dela.

Code, Title 12, §§ 3801 et sea.) or a similar business trust

statute in another state (y) issuing non-voting preferred

trust certificates ("Preferred Trust Certificates"), as

further described below.

Under paragraph (b) (1) of Rule 3a-5,

"A ' finance subsidiary' shall mean any corporation

(i) All of whose securities other than debt

Office of the Chief Counsel,

Division of Investment Management -2 securities or non-voting preferred stock meeting

the applicable requirements of paragraphs (a) (1) through (a) (3) or directors' qualifying shares are

owned by its parent company or a company con￾trolled by its parent company". (Emphasis added)

The term .corporation" is not defined. By contrast, and as

discussed further in Part B below, under paragraph (b) (2) "A

, parent company' shall mean any corporation. partnership or joint venture . . ." (emphasis added) which in turn satisfies certain other conditions. Similarly, the term "preferred stock" is not defined.

In our view, for the reasons discussed further

below, construing a business trust to be the equivalent of a

corporation, and non-voting Preferred Trust Certificates to

be the equivalent of non-voting preferred stock, is consis￾tent with the fundamental purpose of Rule 3a- 5 as enunciated

in the proposing and adopting releases. * Our request for interpretive advice is premised on the assumption that the

finance subsidiary established as a business trust issuing

Preferred Trust Certificates, and the related transaction,

will fully comply in all respects with Rule 3a-5, except

that the transaction will involve the issuance of non-voting

Preferred Trust Certificates by a business trust instead of

non-voting preferred stock by a corporation.

• Release No. IC-14275 (December 14, 1984) (the "Adopting
  Release"); Investment Company Act Release No. 12679

(September 22, 1982).

Office of the Chief Counsel,

Division of Investment Management -3 A. Background - - Description of Business Trusts and Assumptions

Business trusts are "creatures of contract" in the

sense that they are created by a trust instruent under

which property is held and administered by a trustee for the

benefit of such persons who are or may become the benefi￾ciaries of the trust. Beneficial ownership interests are

commonly evidenced by trust certificates. Several states

have adopted statutes in recent years pursuant to which

beneficial owners of business trusts that conform to the

statutes' requirements are entitled to the same limitation

of personal liability extended to stockholders of private

corporations. One such statute is the Delaware Business

Trust Act ("DBTA").

Because the business trust statutes differ

somewhat from state to state, and the area will continue to

additional states consider adoption of business

trust statutes, it will be helpful to frame our request for

interpretive advice based upon the DBTA, as an example.

However, the principles involved, and we believe your

interpretive position, should be equally applicable to

business trusts entitled to limited liability under similar

statutes in other states.

evolve as

The DBTA provides substantial flexibility as to

the terms under which a Delaware business trust may be

established and operated as well as the terms of the bene￾ficial ownership interests in a Delaware business trust.

DBTA § 3801 (a) defines a "business trust" to mean:

Office of the Chief Counsel,
Division of Investment Management -4 Dan unincorporated business association which

(i) is created by a trust agreement under which

property is or will be held, managed, adminis￾tered, controlled, invested, reinvested and/or

operated, or business or professional activities

for profit are carried on or will be carried on,

by a trustee or trustees for the benefit of such

person or persons as are or may become entitled to

a beneficial interest in the trust property . . .

and (ii) files a certificate of trust pursuant to

Section 3810 of this Chapter."

DBTA § 380i (b) defines the term "beneficial owner" to mean

"any owner of a beneficial interest in a business

trust, the fact of ownership to be determined and

evidenced (whether by means of registration, the

issuance of certificates, or otherwise) in

conformity to the applicable provisions of the

governing instrument of the business trust."

Pursuant to DBTA Section § 3803 (a), beneficial

owners of Delaware business trusts are "entitled to the same

limitation of personal liability extended to stockholders of

private corporations for profit."
DBTA § 3806 (a) provides that the business and

affairs of a Delaware business trust shall be managed by or

under the direction of its trustees. DBTA § 3806 (a) goes on

to provide, however, that

" (t) 0 the extent provided in the governing instrument of a business trust, any person

(including a beneficial owner) shall be entitled

to direct the trustees in the management of a

business trust."

As to the terms of the beneficial ownership

interests in a Delaware business trust, DBTA § 3806 (b)

Office of the Chief Counsel,
Division of Investment Management - 5 provides that a Delaware business trust's governing

instrument'
"may contain any provision relating to the . . .

rights, duties and obligations of the . . .

beneficial owners . . . which is not contrary to

any provision or requirement of this Chapter and,

without limitation:

(1) may provide for classes, groups or series of

. . . beneficial owners, or classes, group or

series of beneficial interests, having such

relative rights, powers and duties as the

governing instrument may provide, and may

make provision for the future creation in the

manner provided in the governing instrument of additional classes, groups or series of . . . beneficial owners or beneficial

interests, having such relative rights,

powers and duties as may from time to time be

established, including rights, powers and

duties senior or subordinate to existing

classes, groups or series of . . . benef icial owners or beneficial interests i (2) may establish or provide for the establish￾ment of designated series of . . . beneficial

owners or beneficial interests having

separate rights, powers or duties with

respect to specified property or obligations

of the business trust or profits and losses

associated with specified property or obligations . , (4) may grant to (or withhold from) all or

certain . . . beneficial owners, or a

specified class, group or series of . . .

beneficial owners, the right to vote,

separately or with any or all other classes,

groups or series of . . . beneficial owners,

on any matter, such voting being on a per

Office of the Chief Counsel,

Division of Investment Management - 6 capita, numer, financial interest, class, group, series or any other basis . . .".

Accordingly, we believe that a Delaware business trust may

issue Preferred Trust Certificates having rights, preferences and limitations, including voting rights or the express denial of voting rights, equivalent to those of the preferred stock of a corporation. Our request for interpretive advice is premised on the assumptions that a business trust relying on Rule 3a-5 would be established as, and have the attributes, set forth below:
(a) The business trust will be established

pursuant to a declaration of trust or trust agreement

(in either case, the "Trust Agreement" for such

business trust) with a bank or trust company, as

trustee (the "Trustee"), who is independent from the

parent company (the "Parent") that causes the business

trust to be established as its financing vehicle.

(b) The ownership interests in the business trust

will be evidenced by one or more classes of Preferred

Trust Certificates and a single class of trust

certificates owned by the Parent or a company

controlled by the Parent (in either case, the "Parent

CertificateD and, together with the Preferred Trust

Certificates, the "Certificates"). Accordingly, all of

the interests in the business trust other than the

non-voting Preferred Trust Certificates will be owned

by the Parent or a company controlled by the Parent.

Office of the Chief Counsel,
Division of Investment Management -7 The Parent Certificate will represent approximately 3%

of the aggregate ownership interest in the business

trust, with the remaining ownership interest

represented by the Preferred Trust Certificates. Both

the Preferred Trust Certificates and the Parent

Certificate will,' on their face, specify the payment

entitlements evidenced thereby with respect to

distributions of principal and interest or other income

on the business trust's assets.

(c) Investors in the Preferred Trust Certificates

will have limited liability like that of stockholders

in a corporation in reliance on DBTA § 3803 (a) or a

similar provision in another state's business trust

statute.
(d) At least 85% of the proceeds raised by the

business trust from issuance of Preferred Trust

Certificates will be invested in or loaned to the

Parent or companies controlled by the Parent (the

securities evidencing such investments or loans

collectively, the "Parent Securities") .

(e) The Preferred Trust Certificates and the

Parent Certificate will receive as distributions on

periodic distribution dates specified in the Trust

Agreement their pro rata shares of payments received by

the business trust on the Parent Securities, except

that, in the event of a default or partial payment by

the Parent on the Parent Securities, the payment

entitlement of the Parent as the holder of the Parent

Office of the Chief Counsel,

Division of Investment Management - 8 Certificate will be subordinated to the payment

entitlement of the investors as holders of the

Preferred Trust Certificates. Similarly, if on

liquidation of the business trust* the proceeds from

sale or other liquidation of the business trust's

assets were not sufficient to fully satisfy the payment

entitlements of the Preferred Trust Certificates and

the Parent Certificate with respect to principal, the

payment entitlement with respect to principal of the

Parent as the holder of the Parent Certificate will be

subordinated to the payment entitlement of the

investors as holders of the Preferred Trust

Certificates. The Trust Agreement will provide that

the Trustee is required to distribute to

Certificateholders, on the periodic distribution dates

specified in the Trust Agreement, amounts received by

the Trustee on the Parent Securities.
(f) As a result of the subordination of the

Parent Certificate as described in paragraph (e), above, the Preferred Trust Certificates will have a

preference, both as to periodic distributions and upon

liquidation, over such distributions with respect to

any interests in the business trust other than the

• Ordinarily the business trust would not be liquidated

prior to payment of the Parent Securities at their

maturity and distribution of such payment to holders of

Preferred Trust Certificates and, on a subordinated

basis, the Parent Certificate.

Office of the Chief Counsel,

Division of Investment Management -9 Preferred Trust Certificates that is akin to the

preference of preferred stock issued by a corporation.

(g) The Parent will select the initial Trustee

and, subject to eligibility requirements specified in

the Trust Agreement, will have the right to replace the

Trustee unless and until a default on one or more

Parent Securities occurs. Thereafter, only holders of the Preferred Trust Certificates will have the right to

replace the Trustee. Similarly, any other consensual

rights vested by the Trust Agreement in holders of

Certificates will be exercised only by the Parent as

holder of the Parent Certificate prior to the

occurrence of a default under the Parent Securities

subject to the Parent being precluded from amending or

consenting to any waiver of the terms of the Trust

Agreement that would be materially adverse to holders

of Preferred Trust Certificates. Accordingly, the

Preferred Trust Certificates will be non-voting except

for limited circumstances that are effectively the same

as those pursuant to which non-voting preferred

stockholders in a corporation issuing securities in

reliance on Rule 3a-5 would have voting rights.

(h) The Parent will guarantee distribution by the

Trustee to holders of the Parent Trust Certificates, in

accordance with the terms of the Trust Agreement, of

amounts received by the Trustee on the Parent

Securities. Such Parent guarantee in favor of holders

of Preferred Trust Certificates will be in compliance

with Rule 3a- 5.

Office of the Chief Counsel,

Division of Investment Management -10 B. Discussion

Based on and subj ect to the description in Part A,

permitting a finance subsidiary established as a business

trust and issuing Preferred Trust Certificates to rely on

Rule 3a-5 is, in our view, consistent with the basic

purposes of Rule 3a-5. The considerations relevant to this view are essentially the same as those bearing on the

question of whether a limited liability company issuing non￾voting preferred member interests, or a limited partnership

issuing non-voting preferred partnership interests, should

be permitted to rely on Rule 3a-5. The Staff previously has

taken the position that finance subsidiaries organized as

limited partnerships or limited liability companies issuing

non-voting preferred partner interests or preferred member

interests but otherwise complying with the requirements of

Rule 3a-5 may rely on the exemption for finance subsidiaries

under Rule 3a- 5. See Andrews & Kurth L. L. P. (pub. avail. AprilS, 1994) i Lehman Brothers Inc. (pub. avail. March 8,

1994) i Inco Limited (pub. avail. March 4, 1994) i and Merrill

Lynch & Co. (pub. avail. March 2, 1994).

Th~ basic purposes of Rule 3a-5 are succinctly

outlined in the Adopting Release, as follows:

"As stated in the proposing release, the

Commission believes that it is appropriate to

exempt a finance subsidiary from all provisions of

the (1940) Act where neither its structure nor its

mode of operation resembles that of an investment

company. We have found this to be the case where

the primary purpose of the subsidiary is to

finance the business operations of its parent or

other subsidiaries of its parent which are not

Office of the Chief Counsel,

Division of Investment Management -11 investment companies. We have also found this to

be the case where any purchaser of the finance subsidiary's debt instruents ultimately looks to the parent for repayment to the finance subsi￾diary. The rule, therefore, describes a situation

where the finance subsidiary is essentially a

conduit for the parent to raise capital for its

own business operations or for the business

operations of its other subsidiaries."

As in the case of a conventional finance subsi￾diary in corporate form, the business trusts in the cases we

are describing will be formed for the primary purpose of

financing the operations of the Parent or its other subsi￾diaries, and the proceeds of the Preferred Trust

Certificates will be on-loaned or invested in securities of

the Parent or its controlled companies in compliance with

the requirements of Rule 3a- 5. A business trust finance

subsidiary will be "essentially a conduit for the Parent to

raise capital" to the same extent as a conventional

corporate finance subsidiary. Holders of Preferred Trust

Certificates will have recourse to the guarantor/Parent's

credi t in the same manner r and to the same extent, as

holders of preferred stock of a finance subsidiary estab￾lished as a corporation. The Preferred Trust Certificates

will be non-voting, except for limited voting rights equi￾valent to the voting rights as described above generally

available to holders of otherwise non-voting preferred

stock.
We note that, where paragraph (b) (1) specifies that a finance subsidiary will be a corporation, as quoted

above, paragraph (b) (2), in contrast, provides "a 'parent

Office of the Chief Counsel,

Division of Investment Management

• 12
  company' shall mean any corporation, partnership or ioint

venture . . ." (emphasis added) which in turn satisfies

certain other conditions. The discussion in Part II. C of the Adopting Release indicates that partnerships and joint

ventures were included in the definition of "parent company"

in response to the request of commentators on the Rule, as

initially proposed, in order that the definition be expan￾sive enough to permit projects with multiple sponsors to

rely on the Rule. We have found no indication that the more

expansive definition of parent company should be read to

imply a deliberately restrictive definition of finance

subsidiary.
Al though business trusts have existed for many

years, long pre-dating the adoption of Rule 3a-5, we do not

believe that the existence of business trusts at the time

Rule 3a-5 was adopted should be a significant factor in the

Staff's consideration of whether Rule 3a- 5 may properly be

interpreted to permit finance subsidiaries established as

business trusts to rely on the Rule. First, and most

important, consideration of the eligibility of a business

trust as a finance subsidiary was not an issue in 1984

because, at that time, no parent company (at least to our

knowledge) had proposed to use a business trust as a finance

subsidiary. The reasons for the current interest in using

business trusts as finance subsidiaries arise out of the

interplay of financial reporting and tax considerations

which do not, we believe, implicate the basic purposes of

Rule 3a- 5. Second, legal investment statutes in some states

applicable to certain types of institutional investors have

been revised in recent years to broaden such institutional

investors' ability to purchase securities issued by business

trusts. See, g.g., Sections 1192 and 1192.8 of the

Office of the Chief Counsel,

Division of Investment Management -13 California Insurance Code and Section 653c of the

Pennsylvania Insurance Law. When Rule 3a-5 was adopted in

1984, state legal investment laws applicable to institu￾tional investors were generally more restrictive with

respect to investments in securities issued by non-corporate

issuers than they are today, making it less likely that the

eligibility of a business trust as a finance subsidiary was

a relevant consideration in 1984. This is relevant because

finance subsidiaries established pursuant to exemptive

orders prior to the adoption of Rule 3a-5 and in reliance on

Rule 3a- 5 thereafter were commonly established in connection

with the offering of securities targeted to the institu￾tional market (commercial paper, for example). Third,

limited partnerships also, of course, were in existence in

1984 and long pre-date the adoption of Rule 3a-5. As

indicated above, the Staff nevertheless has taken the

position that finance subsidiaries organized as limited

partnerships issuing non-voting preferred partner interests but otherwise complying with the requirements of Rule 3a- 5 may rely on the exemption for finance subsidiaries under

Rule 3a-5.

---

We respectfully request your confirmation of our

view that Rule 3a-5 may be interpreted to permit a business

trust issuing Preferred Trust Certificates to rely on

Office of the Chief Counsel,
Division of Investment Management -14 Rule 3a- 5. Should you have any questions, please contact the undersigned at 212-558-3669, John E. Baumgardner, Jr.,

at 212-558-3866 or Robert S. Risoleo at 212-558-3570.

Very truly yours,

r~ oJ1. ~. W$~:~ ti~
Mark J. Welshimer