SEC Division of Investment Management staff letter: Investment Company Institute

Investment Company Act - Sections 2(a)(3)(A), 2(a)(3)(C), 2(a)(9), 18(a)(2)(C), 18(a)(2)(D) Investment Company Institute

March 12, 2009

RESPONSE OF THE OFFICE OF CHIEF COUNSEL DIVISION OF INVESTMENT MANAGEMENT

IM Ref. No. 2008811937 Investment Company Institute File No. 132-3

Your letter dated March 12, 2009 requests our assurance that we would not recommend enforcement action to the Securities and Exchange Commission ("Commission") against a liquidity provider ("Liquidity Provider"), any affiliated person of the Liquidity Provider (included in the term "Liquidity Provider"), or any registered closed-end investment company ("Fund") with respect to the Liquidity Provider, under provisions of the Investment Company Act of 1940 (the "1940 Act") and the rules thereunder applicable to affiliated persons of the Funds or affiliated persons of affiliated persons of the Funds ("Affiliate Restrictions") under the circumstances described in your letter.

I. Background

You state that since mid-February 2008, the general loss of confidence in the auction rate securities markets spread to the market for the Funds' auction rate preferred shares ("ARP") and auction failure has been virtually universal since that time. Consequently, most ARP investors have been unable to sell their holdings. 1

You state that it is unlikely that the existing auction markets for ARP will resume normal functioning. You state that, as a result, certain Funds and their investment advisers are developing liquidity protected preferred shares ("LPP") as a permissible investment for registered open-end investment companies that hold themselves out as money market funds in reliance on rule 2a-7 under the 1940 Act ("Money Market Funds") 2 . You state that, although the characteristics of LPP may vary, the central feature of all LPP is that a Liquidity Provider agrees to purchase LPP at its liquidation value preference plus accumulated but unpaid dividends in the event that sell orders exceed buy orders in a remarketing failure (the "Liquidity Feature"). You acknowledge that a Liquidity Provider may be required to purchase all or a large portion of the LPP issued by a Fund in performing its obligations under the Liquidity Feature. You also state that some or all LPP will provide the Liquidity Provider with a contractual right to sell to the Fund, or to an affiliated person of the Fund, such acquired LPP in the circumstances described in your letter (the "Fund Put").

You state that the willingness of a person to act as a Liquidity Provider depends, in large part, upon a high degree of certainty as to the legal implications that service in this capacity may entail. You acknowledge that the EV Letter provides useful guidance 3 . You state, however, that the EV Letter does not address the potential application of the Affiliate Restrictions to a Liquidity Provider. You state that the Affiliate Restrictions could be triggered solely by the Liquidity Provider's acquisition of all or a large portion of the LPP issued by the Fund through the operation of the Liquidity Feature or a Fund Put provided to the Liquidity Provider by the terms of the LPP 4 . You state that, under these facts and circumstances, the application of the Affiliate Restrictions to the Liquidity Provider would unnecessarily hamper the development of LPP as a solution to the ARP liquidity problem.

II. Discussion

A. Section 2(a)(3)(A) of the 1940 Act

Section 2(a)(3)(A) of the 1940 Act defines an "affiliated person" of another person as "any person directly or indirectly owning, controlling, or holding with power to vote, 5 per centum or more of the outstanding voting securities of such other person." Section 2(a)(42) of the 1940 Act defines "voting security" as

any security presently entitling the owner or holder thereof to vote for the election of directors of a company. A specified percentage of the outstanding voting securities of a company means such amount of its outstanding voting securities as entitles the holder or holders thereof to cast said specified percentage of the aggregate votes which the holders of all the outstanding voting securities of such company are entitled to cast.

Section 18(i) of the 1940 Act requires all stock issued by a Fund to be voting stock and have equal voting rights with every other outstanding voting stock, except as provided in section 18(a) of the 1940 Act or as otherwise required by law. Section 18(a) of the 1940 Act, among other things, requires that preferred stock vote as a class on certain matters but does not prohibit preferred stock from voting for the election of directors. Thus, LPP are voting securities, and LPP held by a Liquidity Provider must be included in any determination of whether a Liquidity Provider is an affiliated person, as defined in section 2(a)(3)(A), of a Fund.

You assert that a Liquidity Provider holding all of the LPP issued by a Fund (and none of the common shares) will always hold less than five percent of all of the outstanding voting securities of the Fund. You support your assertion with an example. You state that Funds typically offer common stock at $25 or less per share, with one vote per share, and that ARP were, and LPP are expected to be, offered at $25,000 or more per share, also with one vote per share. 5 Your example presents a Fund with 1,000,000 common shares, each with a net asset value ("NAV") of $25, that can issue a maximum of 1,000 LPP, each with a liquidation value of $25,000, consistent with the asset coverage requirement applicable to preferred stock in section 18(a)(2)(A) of the 1940 Act 6 . Although the common shares and LPP contribute equally to the Fund's $50,000,000 of capital, the LPP represents less than 0.1% of the total voting power of the Fund's 1,001,000 outstanding voting securities. You also state that in practice the LPP issued by a Fund would account for much less than 0.1% of the combined voting power of common shares and LPP because (i) Funds generally maintain asset coverage somewhat higher than 200% and (ii) the NAV of common shares often is less than $25 per share. You therefore conclude that a Liquidity Provider could not become an affiliated person, as defined in section 2(a)(3)(A), of a Fund solely because it acquired all of the LPP issued by that Fund through operation of the Liquidity Facility.

B. Sections 2(a)(3)(C) and 2(a)(9) of the 1940 Act

Section 2(a)(3)(C) of the 1940 Act defines an "affiliated person" of another person as "any person directly or indirectly controlling, controlled by, or under common control with, such other person." "Control" is defined in section 2(a)(9) of the 1940 Act, in pertinent part, as "the power to exercise a controlling influence over the management or policies of a company." 7 Section 2(a)(9) further establishes a presumption of control with respect to "[a]ny person who owns beneficially � more than 25 per centum of the voting securities of a company." A presumption of non-control is provided to "[a]ny person who does not so own more than 25 per centum of the voting securities of any company." Section 2(a)(9) provides that either presumption may be rebutted by evidence, but will continue "until a determination to the contrary made by the Commission by order either on its own motion or on application by an interested person." 8 Nevertheless, no person may rely on the presumption that ownership of less than 25% of a company's voting securities is not control if a control relationship exists under all the facts and circumstances. 9

You state that the presumption of non-control in section 2(a)(9) of the 1940 Act would apply to a Liquidity Provider that acquired all of a Fund's LPP through operation of the Liquidity Facility because, as discussed above, the LPP's aggregate voting power would be a "tiny fraction" of the Fund's total outstanding voting securities, i.e., much less than 25%. You concede, however, that other rights accruing to the LPP or the Fund Put may preclude reliance on the presumption. You acknowledge that a Liquidity Provider holding all of a Fund's LPP may be able to: (i) elect unilaterally the two directors that section 18(a)(2)(C) of the 1940 Act 10 reserves for the preferred stock; and (ii) defeat unilaterally a proposal that section 18(a)(2)(D) of the 1940 Act 11 requires receive the approval of a majority of the outstanding preferred stock voting as a class. You add that if a Liquidity Provider were able to exercise a Fund Put, that ability might appear to be a means of exerting control over a Fund.

You assert that if a Liquidity Provider holding a majority or more of the LPP issued by a Fund is able to elect unilaterally two directors, that board representation would not give the Liquidity Provider the power to exercise a controlling influence over the management or policies of the Fund, absent other evidence of the power to influence management. You explain that the two directors generally would not constitute a majority of the Fund's directors or a majority of the Fund's directors who are not "interested persons," as defined in Section 2(a)(19), of the Fund (the "Independent Directors"). You state that an external investment adviser, which provides or supervises all the services necessary to operate the Fund, manages each Fund. You state that the 1940 Act requires the vote of a majority of a Fund's directors, including a majority of the Independent Directors, to take critical actions regarding the Fund's investment adviser, such as approval, annual renewal or termination of the investment adviser's contract with the Fund. 12 Thus, you believe that when a Liquidity Provider merely elects two directors and those directors do not represent a majority of the directors or the Independent Directors, that board representation is insufficient to control the Fund, absent other evidence of the power to influence management. You also state that in the past the staff has appeared to recognize that representation on a company's board does not necessarily cause a person to control the company. You state that in one case, the staff recognized that the ability to appoint one of six directors of a registered investment company did not result in control of the company. 13 You state that the staff also recognized that the ability to appoint two out of ten directors of a company, coupled with a significant economic interest, did not constitute control. 14

You also assert that your position is consistent with the legislative history of the 1940 Act. You state that Congress provided for representation of preferred shareholders on a Fund's board as a protective measure to avoid the abuses that occurred prior to enactment of the 1940 Act rather than to give those holders control of a Fund. 15 You note that section 18(a)(2)(C) of the 1940 Act provides for the preferred shareholders to elect a majority of a Fund's directors in the event that the Fund fails to pay dividends due to them for two years. You state that one of the purposes of section 18(a)(2)(D) of the 1940 Act is the protection of preferred shareholders from action taken by the common shareholders (who typically hold substantially all of a Fund's voting securities) that would adversely affect the interests of the preferred shareholders. 16

You contend that the Fund Put does not provide the Liquidity Provider with any meaningful ability to influence the Fund by threatening large redemptions. You note that the Fund Put would be conditioned upon a number of specific events, notice requirements and holding periods, along the lines of those set forth in the EV Letter. You state that the terms of the Fund Put would reduce or eliminate the risk of large redemptions because the Fund will have advance notice of the possibility of a large redemption of the LPP and would have time to accommodate the redemption. You also state that other instances where the LPP might be redeemed in large amounts will be at the option of the Fund, and not the Liquidity Provider, and so do not give rise to the same concerns. For example, the Fund may wish to accelerate redemption under the voluntary redemption provisions of the LPP for economic or business reasons.

C. Application of Affiliate Restrictions to a Liquidity Provider

You state that a Liquidity Provider may become subject to the Affiliate Restrictions to the extent that the Liquidity Provider may be deemed to be an affiliated person, or an affiliated person of an affiliated person, of a Fund under section 2(a)(3)(A) or (C), solely as a result of the Liquidity Provider's acquisition, pursuant to the terms of a Liquidity Feature, of LPP issued by the Fund or the Fund Put. You also state that that the willingness of a person to act as a Liquidity Provider depends, in large part, upon a high degree of certainty as to the legal implications that service in this capacity may entail. You state that, under these facts and circumstances, the application of the Affiliate Restrictions to the Liquidity Provider would unnecessarily hamper the development of LPP as a solution to the ARP liquidity problem.

III. Conclusion

Based on the facts, representations and assumptions set forth in your letter, and without necessarily agreeing with your arguments or your legal analysis, we would not recommend enforcement action to the Commission against a Liquidity Provider or any Fund with respect to the Liquidity Provider, under the Affiliate Restrictions that would be triggered solely by the Liquidity Provider's acquisition, pursuant to the terms of a Liquidity Feature, of LPP issued by the Fund, or by the Fund Put. This response expresses our views on enforcement action only and does not express any legal or interpretive conclusion on the issues presented. Because our positions are based upon the facts, representations and assumptions in your letter, any different facts, representations or assumptions may require a different conclusion.

Douglas Scheidt Associate Director and Chief Counsel

1 As of February, 2008, Funds had outstanding ARP with an aggregate liquidation value equal to nearly 20% of the $330 billion auction rate securities market. See Thomas J. Herzfeld Advisors, Inc., The Investor's Guide to Closed-End Funds , March 2009, at 16 (noting that there was $63.883 billion in closed-end ARP outstanding prior to February 2008, of which, as of February 25, 2009, $31.067 billion has been redeemed or is pending redemption pursuant to an announcement by the issuer).

2 You state that LPP as discussed in your letter is substantially similar to the LPP that was the subject of Eaton Vance Management , SEC Staff No-Action Letter (June 13, 2008) (the "EV Letter") available at http://www.sec.gov/divisions/investment/noaction/2008/eatonvance06132008.pdf . You state that the differences between the LPP in the EV Letter and other versions of LPP being contemplated in the market are immaterial to the issue presented in your letter.

3 The EV Letter states that: (i) we would not recommend enforcement action to the Commission against a Money Market Fund under sections 34(b) and 35(d) of the 1940 Act and rule 22c-1 thereunder if the Money Market Fund purchases LPP, provided that the Money Market Fund otherwise complies with the requirements of rule 2a 7 under the 1940 Act; (ii) we concur that LPP would not be redeemable securities, as defined in section 2(a)(32) of the 1940 Act; and (iii) the Division of Corporation Finance, subject to certain conditions, would not recommend enforcement action to the Commission against a Fund, a Liquidity Provider, or any other third party, under sections 13(e) and 14(d) of the Securities Exchange Act of 1934 and rules 13e-4 and Regulations 14D and 14E thereunder in connection with the purchase of LPP not sold in the remarketing process.

4 As described in the EV Letter, the Liquidity Provider may exercise the Eaton Vance version of the Fund Put only with respect to LPP that it has been unable to sell, after at least three months, in weekly remarketings. In addition, Eaton Vance Management represented that the holding period under the Fund Put would conform to the guidance provided by the Internal Revenue Service ("IRS") regarding the treatment of a security such as LPP as equity rather than as debt for Federal income tax purposes. That IRS guidance essentially requires that the Liquidity Provider hold LPP for six months, instead of three months, before the Fund Put is exercisable. IRS Notice 2008-55 (June 26, 2008). You state that other versions of LPP being contemplated in the market may have different holding periods.

5 You state that, in nearly every instance, ARP have one vote per share, and you expect that LPP also will have one vote per share. See Drexel Burnham Lambert Inc. (TARPS) , SEC Staff No-Action Letter (June 14, 1989) (no-action position under section 18(i) of the 1940 Act concerning a Fund's issuance of preferred stock at $100,000 per share and common stock at $15 per share where each share would have one vote; except as otherwise required by the 1940 Act, the common shares and the preferred shares would vote together as a single class). You also concede that if, as a result of a different class structure, the number of votes attributable to preferred shares exceeds five percent of a Fund's total outstanding voting securities, your analysis would not be applicable to that Fund.

6 Section 18(a)(2)(A) of the 1940 Act prohibits a Fund from issuing or selling a senior security that is stock unless immediately after such issuance or sale it will have "an asset coverage of at least 200 per centum."

7 The Commission has held that the term "controlling influence" means the "'act or process, or power of producing an effect which may be without apparent force or direct authority and is effective in checking or directing action, or exercising restraint or preventing free action.'" See In the Matter of Investors Mutual, Inc. , et al., Investment Company Act Release No. 4595 (May 11, 1966) at text preceding n.12 (citation omitted), aff'd, Phillips v. SEC , 388 F.2d 964 (2d Cir. 1968) (" Investors Mutual "). Furthermore, a controlling influence:

need not be actually exercised; the latent power to exercise it is sufficient . . . . And those exercising a controlling influence need not necessarily be able to carry their point, since such influence may be effective without accomplishing its purpose fully. . . . In applying [these principles], however, it must be borne in mind that control determinations involve issues of fact which cannot be resolved by use of a mathematical formula. They require a careful appraisal of the over-all effect of the various relationships and other circumstances present in [each] particular case, some of which may point to one inference while others to an opposite one.

Id. at text accompanying nn.13-15 (citations omitted).

8 A presumption of control or non-control may be rebutted in a judicial proceeding, as well as by Commission order. If a presumption is successfully rebutted, the determination may be applied retroactively. See In the Matters of Fundamental Investors, Inc. , et al., Investment Company Act Release No. 3596 (Dec. 27, 1962).

See Investors Mutual ; Exemption of Transactions by Investment Companies with Certain Affiliated Persons, Investment Company Act Release No. 10698 (May 16, 1979) at n.2 ("no person may rely on the presumption that less than 25 percent ownership is not control when, in fact, a control relationship exists under all the facts and circumstances").

10 Under section 18(a)(2)(C) of the 1940 Act, the holders of any preferred stock outstanding, voting as a class, have the exclusive right to elect at least two directors at all times and to elect a majority of the Fund's directors if at any time the dividends on the preferred stock are unpaid in an amount equal to two full years' dividends.

11 Section 18(a)(2)(D) of the 1940 Act requires that a majority of the outstanding preferred stock issued by a Fund, voting as a class, approve: (i) any plan of reorganization adversely affecting the holders of such preferred stock; or (ii) "any action requiring a vote of security holders as in section 13(a) provided." Section 13(a) of the 1940 Act requires the approval of a majority of a registered investment company's outstanding voting securities to: (i) change its subclassification from a closed-end to an open-end investment management company or its subclassification from a diversified to a nondiversified company; (ii) borrow money, issue senior securities, underwrite securities issued by other persons, purchase or sell real estate or commodities or make loans to other persons, except in each case in accordance with the recitals of policy contained in its registration statement; (iii) deviate from its policy in respect of concentration of investments in any particular industry or group of industries as recited in its registration statement, deviate from any investment policy which is changeable only if authorized by shareholder vote, or deviate from any policy recited in its registration statement pursuant to section 8(b)(3) of the 1940 Act; or (iv) change the nature of its business so as to cease to be an investment company 12

See sections 15(a), 15(b) and 15(c) of the 1940 Act.

See National Liquid Reserves, Inc. , SEC Staff No Action Letter (Mar. 29, 1980). See also Investors Mutual (presumption of non-control not rebutted where, among other factors, holder of 15% of voting stock of company elected two seats on company's ten-member board of directors but failed to reach accord with 33% shareholder; evidence did not support conclusion that such holder actually exercised a controlling influence over the company's management and policies; and other shareholders continued to exercise a dominant role and to retain a substantial pecuniary interest in the company).

See American Century Companies, Inc./J.P. Morgan & Co. Incorporated , SEC Staff No-Action Letter (Dec. 23, 1997).

See Report of the Securities and Exchange Commission on Investment Trusts and Investment Companies, Part 3, Chapter 5, H.R. Doc. No. 279, 76th Cong., 1st Sess. 1790-96 (1939).

See Hearings Before a Subcommittee of the Committee on Interstate and Foreign Commerce, House of Representatives, 76th Cong. 3rd Sess. 1046-47 (1940) (statement of Commissioner Robert E. Healy).

Incoming Letter

The Incoming Letter is in Acrobat format.

http://www.sec.gov/divisions/investment/noaction/2009/ici031209.htm

---

I
""1 INVESTMENT . COMPANY
'I,,/~ INSTITUTE
1401 HStreet, NW. Washington, DC 20005-2148, USA 202/326-5800 www.icLorg VIA EMAIL March 12, 2009 Douglas Scheidt, Esq. Associate Director and ChiefCounsel Division ofInvestment Management Securities and Exchange Commission 100 F Street, N.E. Washington. DC 20549 Re: Liquidity ProtectedPriferred Shares Dear Mr. Scheidt:
The Investment Company Institute] is writing with respect to liquidity protected preferred shares ("LPP") issued by closed-end investment companies. LPP was the subject ofa no-action letter last year from the Staffto Eaton Vance Management. 2 We are writing with respect to an issue not addressed in the EV Letter - whether a firm serving as liquidity provider for the LPP or its affiliate (a "Liquidity Provider") would be deemed to control, or otherwise to be an affiliated person of, a registered closed-end investment company (a "Fund") issuing LPP solely on the basis of (a) the Liquidity Provider's acquisition ofLPP pursuant to the LPP's liquidity feature and (b) contractual arrangements between the Fund and the Liquidity Provider regarding LPP ofthe type described in the EV Letter, such as the right ofthe Liquidity Provider to require the Fund to repurchase its LPP in certain circumstances (taken together, the "Liquidity Facility"). For the reasons expressed below, we request your assurance that the Staffwould not recommend enforcement action to the Securities and Exchange Commission ("Commission") against a Liquidity Provider or any Fund (with respect to the Liquidity Provider) under provisions ofthe Investment Company Act of 1940 (the" 1940 Act") and the rules thereunder applicable to a Fund, an I The Investment Company Institute ("ICI") is the national association ofU.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). ICI seeks to encourage adherence to high ethical standards, ptomote public understanding, and otherwise advance the interests offunds, their shareholders, directors, and advisers. Members ofICI manage total assets of$1 0.14 trillion and serve over 93 million shareholders. 2 See Eaton Vance Management, SEC No-Action Letter aune 13,2008), available at http://www.sec.gov/ divisions/investment/noaction/2008/eatonvance061308.pdf(the "EV Letter").

March 12, 2009 affiliated person ofa Fund, or an affiliated person ofan affiliated person ofa Fund that would be triggered solely by the operation ofthe Liquidity Facility as described in this letter (the "Affiliate Restrictions").
I. Factual Background: ARP, LPP and the Need for Further StaffAssurances
As ofthe end of2007, more than halfofall Funds had auction rate preferred shares ("ARP") outstanding with a total liquidation preference ofapproximately $64 billion, accounting for nearly twenty percent ofthe $330 billion auction rate securities market.3 ARP permits Funds to engage in leverage to the benefit ofthe Funds' common shareholders. Funds typically issue ARP that pay dividends at rates set through auctions (or in a few cases, remarketings) held every seven or 28 days. Bids are filled to the extent shares are available, and sell orders are filled to the extent there are bids. ARP auctions had operated successfully for more than twenty years,4 but have consistently failed since mid-February 2008.5 The failed auctions were not caused by defaults under the ARP terms or credit quality concerns with Fund investments, but rather simply because there were more shares offered for sale than there were bids. The initial auction failures created a general loss ofconfidence in the auction rate securities markets, which then spread to the ARP market, causing ARP auction failures that have been virtually universal since mid-February 2008. It is unlikely, given all ofthis, that the existing auction markets will resume normal functioning. ARP holders have continued receiving dividends from Funds at a "maximum rate" equal to a stated spread over a particular market benchmark rate provided in the ARP's governing documents. Because auctions are not providing liquidity and there is no established secondary market, however, ARP holders wanting to sell their shares have been unable to do so. This loss ofliquidity has created significant hardship and uncertainty for many ARP holders who may have viewed ARP as akin to a liquid cash alternative. In order to address the current ARP illiquidity and seek to reduce the current cost ofleverage, many Funds and their investment advisers are evaluating various alternatives. Some Funds may seek to redeem ARP in favor ofusing debt financing as a form ofleverage. Other Funds are seeking to issue LPP by engaging a Liquidity Provider to provide a Liquidity Facility with terms substantially as described in the EV Letter. 3 See Thomas]. Herzfeld Advisors, "The Investors Guide to Closed-End Funds," at 16 (March 2009) (noting that there was $63.883 billion in closed-end ARP outstanding prior to February 2008, ofwhich, as ofFebruary 25, 2009, $31.067 billion has been redeemed or is pending redemption pursuant to an announcement by the issuer). ICI data shows that these fUnds had a market value of$127 billion in common shares outstanding as ofyear-end 2007. 4 See, e.g:, Thomas]. Herzfeld Advisors, The Investors Guide to Closed-End Funds, at 3 (April 2008). S See, e.g., "New Trouble in Auction Rate Securities," The New York Times, p. Cl (February 15, 2008).

March 12, 2009
LPP is a new type ofpreferred stock that will be issued by a Fund and eligible for purchase by open-end investment companies that hold themselves out as money market funds in reliance on Rule 2a-7 under the 1940 Act. Although there are a number ofdifferent versions ofLPP being contemplated in the market, the main features are substantially similar to the LPP described in the EV Letter. Any differences are immaterial to the issue presented in this letter, which exists in all ofthe different structures by operation ofthe central feature ofLPP - a Liquidity Facility pursuant to which, in the event ofa remarketing failure, a Liquidity Provider would purchase LPP at its liquidation preference plus accumulated but unpaid dividends. It is possible that a Liquidity Provider could acquire all or a large portion ofan LPP issue through the operation ofthe Liquidity Facility.6 While LPP holds great promise to resolve some ofthe current liquidity concerns with ARP, the willingness ofa party to serve as a Liquidity Provider depends, in large part, on a high degree ofcertainty with respect to any potential legal issues with the LPP. The EV Letter goes a long way towards providing this certainty, but we have been advised that some Liquidity Providers are less willing to serve in this capacity unless the assurance sought in this letter is provided by the Staff In particular, we are concerned that the Affiliate Restrictions could be triggered solely by the Liquidity Provider's acquisition ofall or a large portion ofthe LPP issued by the Fund through the operation ofthe Liquidity Feature or a Fund Put provided to the Liquidity Provider by the terms ofthe LPP, which would prevent the Liquidity Provider from, for example, engaging in certain transactions with the Fund or any other registered investment company in its complex as principal or agent.? Under these facts and circumstances, the application ofthe Affiliate Restrictions to the Liquidity Provider would unnecessarily hamper the development ofLPP as a solution to the ARP liquidity problem. 6 Funds and Liquidity Providers are evaluating various options to ensure that Liquidity Providers do not hold LPP indefinitely. Three ofthese features were described in the EV Letter: 1) an escalation ofdividend rates following failed remarketings; 2) a mandatory repurchase ofthe LPP held by the Liquidity Provider after a stated period oftime (e.g., six months) and/or upon the occurrence ofpredefined conditions (e.g., the Liquidity Provider owns more than a certain percentage ofthe outstanding LPP); and 3) a conditional contractual right, given to the Liquidity Provider, to sell (put) the LPP to an affiliate ofthe Fund (e.g., the Fund's investment adviser or its parent) after a stated period oftime and/or upon the occurrence ofpredefined conditions. For purposes ofthis letter, we define the second and third ofthese features, where the Liquidity Provider has the contractual right to sell acquired LPP to the Fund, or an
affiliated person ofthe Fund, under specific circumstances, as the "Fund Put." Some or all LPP will have a Fund Put. The versions ofLPP being contemplated that have a Fund Put may have different holding periods before the Fund Put takes effect. 7 Section 17(a) ofthe 1940 Act, for example, generally makes it unlawful for any affiliated person of a registered fund, acting as principal, knowingly to sell any security or other property to such registered company or purchase from such registered company, any security or other property.

March 12, 2009
Page 40f 10
II. Effect ofOwnership ofLPP and the Right to Elect Directors
A. LPP Holders WillAlways Hold Less than Five Percent ofOutstanding Voting Securities LPP will be an equity security that entitles the owner or holder to vote for the election ofthe Fund's directors and, accordingly, is a "voting security" as defined by Section 2(a)(42) ofthe 1940 Act.8 As required by Section 18(a)(2)(C) ofthe 1940 Act, the holders ofthe LPP and any other preferred stock outstanding, voting as a class, are entitled to elect at least two directors at all times, and to elect a majority ofthe directors if at any time the dividends on the LPP are unpaid in an amount equal to two full years' dividends on the LPP, and to continue to be entitled to elect a majority ofthe directors until all dividends in arrears are paid or otherwise provided for. It is possible that a Liquidity Provider may become the holder ofa majority ofthe outstanding shares ofthe Fund's preferred stock, such that it would have the unilateral power to elect two ofa Fund's directors. It would not be possible, however, for a Liquidity Provider to hold five percent or more ofthe total outstanding voting stock ofa Fund in any ofthe existing ARP capital structures or contemplated LPP capital structures such that it may become an affiliate ofthe Fund within the meaning ofSection 2(a)(3)(A) ofthe 1940 Act.9 Funds typically offer common stock at a price per share ofbetween $15 and $25. ARP typically is, and LPP is expected to be, offered at a liquidation preference ofat least $25,000 per share. In nearly every instance, ARP have one vote per share. We expect that LPP also will have one vote per share. Given the requirement for 200% asset coverage on preferred stock, 10 a Fund will always have more common stock than preferred stock outstanding, measured by the value ofthe outstanding shares. There also will be significantly more shares ofcommon stock than preferred stock. Two provisions ofthe 1940 Act bear directly on the calculation ofownership ofa Fund's total outstanding voting securities. First, Section 18(i) ofthe 1940 Act requires that, except as set forth in
Section 18(a) (or as otherwise required by law), every share ofstock issued by a Fund "shall be a voting
stock and have equal voting rights with every other outstanding voting stock ...." Second, Section 2(a)(42) ofthe 1940 Act provides that "a specified percentage ofthe outstanding voting securities ofa company means such amount ofits outstanding voting securities as entitles the holder or holders thereofto cast said specified percentage ofthe aggregate votes which the holders ofall the outstanding voting securities ofsuch company are entitled to cast." 8 Section 2(a)(42) ofthe 1940 Act defines "voting security" as "any security presently entitling the owner or holder thereof to vote for the election ofdirectors ofa company." 9 Section 2(a)(3)(A) ofthe 1940 Act defines an affiliated person as "any person directly or indirectly owning, controlling, or holding with power to vote,S per centum or more ofthe outstanding voting securities ofsuch other person." 10 Section 18(a) ofthe 1940 Act requires Funds to have asset coverage of at least 200 percent for preferred stock, both immediately after issuance ofthe stock and upon the declaration of any dividend or distribution.

March 12, 2009
Applying these sections to a Fund's capital structure, it is clear that a Liquidity Provider will never be an affiliated person ofa Fund within the meaning ofSection 2(a)(3)(A) ofthe 1940 Act as a result ofits ownership ofLPP because ARP and LPP wUl constitute a tiny fraction, typically less than
0.1 %, ofa Fund's total outstanding voting securities. The following example illustrates this point:
Shares
1,000,000
1,000
1,001,000
Description
Common stock, valued at $25
Preferred stock, $25,000 liquidation preference Total, both common and preferred Value $25,000,000 $25,000,000 $50,000,000 Percentage ownership of total outstanding voting securitiesll 99.9% 0.1% 100% This example presents an extreme case, where the preferred stock's value at issuance is the same as the common stock's value. The actual percentage ownership oftotal outstanding voting securities represented by preferred stock would typically be much less than 0.1 % because, in practice, Funds often have common stock initially priced at less than $25 and maintain a coverage ratio somewhat higher than 200%. Both ofthese facts would translate into an even lower percentage ownership ofvoting securities attributable to the preferred stock. B. Analysis ofSections 2(a)(3)(C) and (D) ofthe 1940Act and RelatedAffiliatedPerson Provisions A Liquidity Provider that acquires a substantial amount ofLPP wUl have both the ability to elect directors and a substantial economic interest in the Fund, which raises the question ofwhether the Liquidity Provider is an "affiliated person" ofthe Fund within the meaning ofSection 2(a)(3)(C) or (D) ofthe 1940 ActY These provisions define an "affiliated person" as: "(C) any person directly or indirectly controlling, controlled by, or under common control with, such other person; (D) any officer, director, partner, copartner, or employee ofsuch other person...." Section 2(a)(9) defines "control" as "the power to exercise a controlling influence over the management or policies ofthe company, unless such power is solely the result ofan official position with such company." Section 2(a)(9) ofthe 1940 Act includes a presumption, rebuttable only by a Commission determination or a judicial finding to the contrary, that a person does not control a company ifthe person owns 25% or II Number ofshares in the class divided by the total number ofoutstanding shares. 12 See 1S( Real Property Securities Fund, SEC N0-Action Letteraanuary 18, 1973) (noting that the mere fact that a fund does not own more than 5% ofthe voting securities of a venture does not preclude the finding of an affiliation by the Commission through a control relationship) (notes omitted).

March 12, 2009 less ofthe company's outstanding voting securities. 13 Even with 100% ownership ofthe LPP, the hypothetical Liquidity Provider in the example would own far less than 5% ofthe total outstanding voting securities ofthe Fund, and thus, as discussed above, the Fund and Liquidity Provider would not be affiliated by virtue ofshare ownership under sections 2(a)(3)(A) or (B) ofthe 1940 Act. The Liquidity Provider would also have a presumption of non-control under section 2(a)(9) ofthe 1940 Act by virtue ofowning much less than 25% ofthe total outstanding voting securities ofthe Fund.14 Ofcourse, our analysis would not apply to any Fund where, as a result ofa different class structure, preferred shares exceeded 5% ofits total outstanding voting securities. Whether a person has "the power to exercise a controlling influence over the management or policies" ofa company necessarily depends on the facts and circumstances ofthe relationship. In the typical case ofa Liquidity Provider acting in its capacity as such, however, we do not believe such power would be present. The Liquidity Provider is not a typical preferred shareholder. We do not anticipate that it will seek to acquire shares as an investment or to influence management; rather, it would typically only acquire shares when and to the extent that it is contractually required to do so. Ifthe Liquidity Provider becomes a shareholder, it will be contractually required to make good faith efforts to dispose ofits shares as soon as possible. As noted above, ifthose efforts fail, certain structures contemplate a Fund Put - either a mandatory repurchase ofthe LPP by the Fund or a conditional right for the Liquidity Provider to put the LPP to the Fund or another party.IS Theoretically, a Liquidity Provider could seek to exert influence over a Fund by threatening a large redemption. The nature ofthe repurchase provisions, however, significantly reduces or eliminates this risk. The mandatory repurchase provisions operate mechanically upon the occurrence ofspecified events, giving the Liquidity Provider no ability to dictate the timing ofthe redemption. Structures that include a Fund Put place a number ofconditions on that put right, such that it is only exercisable upon the occurrence ofspecified events, after the expiration ofa period oftime, and upon written notice to 13 We understand that a Commission order rebutting a presumption ofcontrol can have retrospective as well as prospective effect. See Fundamental Investors, Inc., 41 SEC 285 (1962). 14 Based upon the same methodology, money market funds' purchase ofLPP will not violate the prohibition on owning more than 3% ofthe total outstanding voting stock of another investment company in section 12(d)(1 )(A)(i). As a practical matter, money market funds' ownership ofLPP would be limited by the 5% and 10% thresholds in sections 12(d)(1)(A)(ii) and (iii), respectively, because those thresholds are calculated based upon the value ofthe money
market fund's assets, rather than the total outstanding voting stock ofthe Fund issuing LPP. IS See note 6, supra.

March 12, 2009 the Fund. 16 In each case, a Fund will have previously negotiated the terms ofany repurchase rights associated with the LPP. As a result, the Fund will have sufficient advance warning ofthe possibility of a large redemption ofthe LPP and, as such, should be able to plan for its eventuality. I? Moreover, the Liquidity Provider is a service provider to the Fund and its rights as such are limited by contract. As a service provider, it would not have any contractual right to participate in or influence a Fund's day-to-day management activities (e.g., how the Fund invests, or the selection of parties with which the Fund does business). Importantly, it cannot cause the Fund to deal, or increase its dealings, with the Liquidity Provider for the Liquidity Provider's own financial benefit, which will be subject to the Fund Board's fiduciary oversight and management's monitoring. As a preferred shareholder, the Liquidity Provider would have the right to vote its shares, but the exercise ofany such voting rights should not cause it to be deemed to control the Fund. With respect to any vote ofallshareholders in the Fund, the Liquidity Provider will own, as discussed above, a tiny fraction (at most) ofthe total outstanding voting securities and would not be able to significantly influence the outcome ofthe vote. The Liquidity Provider may be able to influence the outcome ofmatters requiring the approval ofpreferred shareholders voting as a class. Section 18(a)(2)(D) ofthe 1940 Act requires approval by a majority ofa Fund's preferred shareholders, voting as a class, ofany plan ofreorganization adversely affecting the preferred shareholders or any action requiring a shareholder vote as provided in Section 13(a) of 1940 Act. Section 13(a) requires shareholders to approve matters such as changing from closed-end to open-end status, changing policies on leverage, or changing fundamental investment policies. One ofthe purposes ofSection 18(a)(2)(D) presumably is to protect the holders ofpreferred stock from action taken unilaterally by common shareholders (who, as a class, typically hold substantially all ofa Fund's voting securities) that has an adverse effect on the preferred shareholders' investments. In order for a Liquidity Provider to adequately assess its risk in entering into an agreement with a Fund, it needs to evaluate the types ofassets in which the Fund will invest and the policies the Fund will abide by in managing its portfolio. A Liquidity Provider would also be expected to seek a degree ofcertainty that such policies will not be changed. As a result, we do not expect that Liquidity Providers would be willing to cede their right to vote on these types ofissues. Rather, we expect that Liquidity Providers would view their ability to vote on these types ofactions-and indeed to prevent such actions ifthey hold a substantial amount ofLPP-as an important mechanism to protect their 16 See, e.g., the EV Letter. 17 Othet instances where the
LPP might be redeemed in large amounts will be at the option ofthe Fund, and not the Liquidity Provider, and so do not give rise to the same concerns. For example, the Fund may wish to accelerate redemption under the voluntary redemption provisions ofthe LPP for economic or business reasons.

March 12, 2009 interests. IS
We believe that the ability ofa Liquidity Provider to vote against, and effectively prevent, actions subject to Section 18(a)(2)(D) does not constitute control or a controlling influence over the Fund for several reasons. The power to vote-even the power to veto-does not mean that a Liquidity Provider can direct the Fund to take action. It is merely the power to prevent the Fund from taking action that it deems adverse to its status as a preferred shareholder and Liquidity Provider. The ability to prevent adverse actions does not necessarily place control ofthe issuer in the hands ofthe holders of the preferred stock. Thus, protective vetoes or consent rights more extensive than those provided by
Section 13 and granted to minority shareholders have not generally been viewed as constituting a
controlling influence, even when coupled with board representation. For example, in American Century Companies) Inc. ,19 the Stafffound that a right to prevent a company from engaging in certain actions that altered the structure or business ofthe company did not result in a control relationship. We believe that the voting rights granted to preferred shareholders under Section 18(a)(2)(D) are similar in nature to the negative consent rights discussed in American Century. We also note that similar consent rights and restrictions are often included in credit agreements, and lenders to registered investment companies are not considered to control the investment company as a result ofthose agreements. Moreover, as a practical matter, Fund management generally will remain in control ofthe Fund's policies and operations and hold the right to decide when changes in such matters will be brought to a vote ofshareholders. Fund management is unlikely to present matters covered by section 18(a)(2)(D) for a shareholder vote ifit believes that its proposal will fail to gain approval by preferred shareholders whether or not the Liquidity Provider is the primary holder ofthe LPP. It is more likely that management may choose to redeem the LPP (thereby eliminating the influence ofLPP shareholders on the outcome) or, ifthe Liquidity Provider has been required to purchase all ofthe LPP, delay the vote for a few months until after a mandatory repurchase or Fund Put has occurred. Liquidity Providers also may be able to influence the outcome ofan election for the two directors attributable to the preferred shareholders, or as a majority preferred shareholder, to have the unilateral power to elect them. Those directors, however, should not be considered to be controlled by the Liquidity Provider. Directors have a fiduciary duty imposed by state law to act in the interest ofall shareholders, and it would be inconsistent with this duty for directors to advance the interests ofthe Liquidity Provider at the expense ofother shareholders and the Fund generally. In addition, the two directors generally would not constitute a majority ofthe Fund's directors or a majority ofthe Fund's 18 In fact, liquidity agreements between Funds and their Liquidity Providers may provide similar consent rights, so that the Liquidity Provider will have the contractual power to prevent a Fund from engaging in these types oftransactions regardless ofwhether it owns LPP. 19 American Century Companies, Inc., SEC No-Action Letter (Dec. 23, 1997) ("American Century").

March 12, 2009 directors who are not "interested persons," as defined in Section 2(a)(19), ofthe Fund (the "Independent Directors"). Absent such a majority, the two directors elected by the preferred shareholders would not be able to exert a controlling influence over the Fund or its adviser.20 As a result, we believe that when a Liquidity Provider merely elects two directors and those directors do not represent a majority ofthe directors or the Independent Directors, that board representation is insufficient to control the Fund, absent other evidence ofthe power to influence management. We acknowledge that the requisite element ofcontrol may be present ifthe two directors elected by the Liquidity Provider either 1) represent a majority ofthe entire Board or a majority of Independent Directors, or 2) are officers, directors, partners, copartners or employees ofthe Liquidity Provider. We also acknowledge that other relationships or arrangements between a Liquidity Provider and a Fund or its affiliates could lead to a different conclusion.21 Our position is consistent with prior Staffinterpretations that appear to recognize that board representation, even coupled with an economic interest in a company, does not make a person an affiliate under the 1940 Act. In one set offacts, for example, the ability to appoint one out ofsix directors ofa fund did not result in control ofthat fund. 22 In another situation, the right to elect two of the ten board members coupled with a significant economic interest and certain negative consent rights did not constitute controF3 The requested assurance is also consistent with the legislative intent ofthe 1940 Act. Congress included specific voting rights for preferred shareholders, including the right to elect two directors, to avoid the types ofinequities committed upon holders ofpreferred stock prior to the enactment ofthe 1940 Act,24 but did not intend to give those holders "control" ofa Fund.25 Rather, a Fund would have 20 An external investment adviser provides or supervises all the services necessary to operate and manage each Fund. The 1940 Act requires the vote of a majority ofa Fund's directors, including a majority ofthe Independent Directors, to take critical actions regarding the Fund's investment adviser, such as approval, annual renewal or termination ofthe investment adviser's contract with the Fund. 21 For example, ifthe Liquidity Provider owned sufficient common stock ofthe Fund, such that when combined with its holdings ofpreferred stock, it would own 5% or more ofthe Fund's outstanding voting securities, the Liquidity Provider would not be able to rely upon this letter. 22 Nat'!. Liquid Reserves, Inc., SEC No-Action Letter (February 28,1980). See also Investors Mutual, Inc., 42 SEC 1071, 1078-80, ajj'd, Phillips v. SEC, 388 F.2d 964 (2d Cir 1968). 23 See American Century. 24 See, e.g., Report ofthe Securities and Exchange Commission on Investment Trusts and Investment Companies, Part 3,
Chapter 5, H.R. Doc. No. 279, 76th Cong., 1st Sess. (1939), at pages 1790-96.
25 See Hearings Before a Subcommittee ofthe Committee on Interstate and Foreign Commerce, House ofRepresentatives, 76cl1 Congo 3rd Sess. (1940), at pages 1046-47 (statement ofCommissioner Robert E. Healy). In his statement, Commissioner Healy said:

March 12, 2009 to fail to pay dividends for two years before a holder could gain control by electing a majority ofthe board. There would have been no need for the 1940 Act to specifically provide the ability to elect a majority ofthe board under such circumstances ifCongress had viewed the preferred shareholders as controlling a Fund based on their ability to veto certain actions by voting as a class or elect two ofthe Fund's directors. Section 18(a)(2)(C) itselfsets out a carefully designed framework for when preferred stock holders should and do have the right to exercise control over the Fund (i.e., in the event oftwo years ofpayment defaults).

---

For all ofthe foregoing reasons, we request your assurance that the Staffwould not recommend enforcement action to the Commission against a Liquidity Provider or Fund (with respect to the Liquidity Provider) under the Affiliate Restrictions that would be triggered solely by the circumstances described in this letter. We look forward to discussing our request with you at your earliest convenience. Please feel free to contact me at (202) 326-5815, Bob Grohowski at (202) 371-5430, or Dorothy Donohue at (202) 218-3563 ifyou have any questions or would like additional information. Sincerely, /s/ Karrie McMillan General Counsel cc: AndrewJ. Donohue, Director James M. Curtis, Branch Chief Lily C. Reid, Senior Counsel Division o/Investment Management I do not for a minute believe that we should have a statute here which permits anybody to turn the voting control ofa corporation over to the preferred stock holders merely because the preferred stock happens at a particular moment to be under water, or merely because the dividends have been passed, let us say, for one period or for a year.... Yet, in [some] cases the preferred stock has not had a dividend for 5, 6, 7, or 8 years, and the preferred stock holder is completely helpless.... Ifthis language [in the bill] is not satisfactory, then I should like to suggest that the committee consider a provision...that after dividends have been in arrears for a certain length oftime, the preferred stock holders, voting as a class, can elect X percentage ofthe board ofdirectors.... You might put an additional safeguard by providing that the control ofthe board ofdirectors should not be turned over while the common stock can demonstrate that there is a fair chance...that the dividends can be resumed...