SEC Division of Investment Management staff letter: Lehman Brothers Inc.

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Our Ref. No. 94-114-CC

RESPONSE OF THE OFFICE OF CHIEF COUNSEL Lehman Brothers Inc.

DIVISION OF INVESTMENT MAAGEMENT File No. 132-3

Your letter dated March 3, 1994 seeks our concurrence that a

finance subsidiary organized in the united States as a limited

liabili ty company ("LLC") that issues non-voting preferred equity

interests ("preferred shares") 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"). 1.1

You state that a finance subsidiary established as an LLC

issuing preferred shares will comply fully in all respects with

Rule 3a-5, except that the transaction will involve the issuance

of non-voting preferred shares by an LLC instead of non-voting

preferred stock by a corporation. ZI You state that LLCs, like

corporations, are vehicles that provide limited liability to all

equity owners, but are more flexible than corporations with

respect to, among other things, certain types of financing. You

state that an LLC may issue equity interests to members with the

same rights with respect to distributions, voting exchanges and

conversions, and liquidation rights, as those of common and

preferred stock issued by a corporation. You further state that

the parent company of the LLC, or a company controlled by the

parent company, will own all of the LLC's securities other than

the non-voting preferred shares as required by Rule

3a-5(b) (1) (i). ll

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 nei ther its

structure nor its mode of operation resembles that of an

ii 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, II (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. II

ÂI Telephone conversation on March 8, 1994 between Alison Baur

and Larry Vranka.

:ii Id.

investment company. ~I 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.
-. l
You state that, as is the case with a finance subsidiary

organized as a corporation, the LLC will be formed for the

purpose of financing the business operations of ~t~ parent or

other subsidiaries of its parent, and the proceeds' from the sale

of preferred shares will be loaned by the LLC to its parent

company or companies controlled by the parent company. You

further state that, the preferred shares issued by the LLC would

(i) entitle holders to priority over certain distributions

equivalent to the rights of holders of preferred stock; (ii) have

a liquidation preference that is equivalent to the liquidation

preference for preferred stock; (iii) 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; (i v) be convertible or exchangeable in

compliance with Rule 3a-5 if the terms of the preferred shares

provide for conversion and exchange; 21 and (v) benefit from a

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

Based on the facts and representations in your letter and

telephone conversation, we would not recommend enforcement action

to the Commission if a finance subsidiary organized in the United

states as an LLC that issues non-voting preferred shares as

described in your letter relies on the exemption for finance

subsidiaries under Rule 3a-5. ~I Because this position is based

on the facts and representations made in your letter and

telephone conversation, you should note that any different facts ~st Ces might require a different conclusion.

Alison E.

Attorney
41 Investment Company Act Release No. 14275 (Dec. 20, 1984)

(adopting Rule 3a-5).
5/ Telephone conversation on March 8, 1994 between Alison Baur

and Larry Vranka.

6/ See Inco Limited (pub. avail. Mar. 4, 1994); Merrill Lynch &

Co. (pub. avail. Mar. 2, 1994).

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SIMPSON THACHER 8: BARTLETT
.. P.Ba5BlP WBICB DlCL17DBS PJIl'SloirAL CORPllIOX8

4215 LEINOTON AVENUE
NEW YORK,N.Y. 10017-3909

WRITER'S DIRE!=l D.XAL N:;XrlR

ACT k:: ~ 194-0

SECTION
RULE ~-s￾PUBLI -J
AVAILABILIT 3li J9L
(212) 4&&- 2000
TBLECOPIJUl: 4&&-21502
TELEX: 1291&8
March 3, 1994

Re: Definition of a Finance Subsidiaiy Puruant to

Rule 3a-5 under the Investment Comoanv Act of 1940

Offce of Chief Counsel

Division of Investment Management
Securties and Exchange Commission
450 Fifth Street, N.W.
Washigton, D.C. 20549

Attention: Alison E. Baur
Dear Ms. Baur:
We are wrting on behalf of our client, Lehman Brothers Inc., in connection with a product it is developing and in fuher reference to discussions we recently had with you concerning the definition of a fmance subsidiar under subsection (b) of Rule 3a-5 ("Rule 3a-5") of the Investment Company Act of 1940 (the "1940 Act"). In our view, the issuance of prefered equity interests by a finance subsidiar that is a limited liabilty company (an "LLC") organized in the United States is analogous to the issuance of non-voting preferred stock by a finance subsidiar that is a corporation. We request that the Staff of the Division of Investment Management (the "Stafr') confi that (i) an LLC would fall within the definition of a finance subsidiar, provided that the requirements specified in clauses (i) and (ii) of Rule 3a-5(b)(1) were met and (ii) LONDON HONO KONO TOKYO

COLUMBUS

SIMPSON THACHER & BARTLETT
Securties and Exchange Commission -2- March 3, 1994 preferred equity interests issued by an LLC would constitute "non-voting preferred stock" for puroses of Rule 3a-5.

Limited Liabilty Company as Finance Subsidiary Rule 3a-5(b) provides that a "parent company" and a "company controlled by the parent company" may be a corpration, parership or joint ventue, but the definition of "finance subsidiar" is limited to any corporation that meets the requirements specified

therein. At the time Rule 3a-5 was promulgated, a corporation was generally the only

entity that could satisfy clause (i) of Rule 3a-5(b )(1), which states that a finance subsidiai is a corporation "all of whose securties other than debt securties or non￾voting preferred stock...are owned by its parent company or a company controlled by its parent company." A parership or a joint ventue generally would not fulfill this requirement because, by definition, they are in most cases owned by two or more common equity owners. Since the promulgation of Rule 3a-5, however, many states have adopted statutes authorizing the organization of limited liabilty companies, which, like corporations, are vehicles that provide limited liabilty to all equity owners, but are more flexible than corporations with respect to certin tyes of fInancing and other matters.

See, e.g., Delaware Limited Liability Company Act (Dela. Code Title 6, §§ 18-101 et seq.). A limited liabilty company, in our view, can meet the requirements of Rule 3a-5(b)(1). As is the case with a corporation. the parent company of an LLC (or a company controlled by its parent company) can own all of its securities other than debt

SIMPSON THACHER "& BARTLETT
Securties and Exchange Commission -3- March 3, 1994 securities or non-voting preferred equity interests as required by clause (i) of Rule 3a￾5(b)(1). The requirements of Rule 3a-5 are intended to ensure that neither the strctue nor the mode of operation of any fmance subsidiaiy wil resemble that of an

investment company, and that the fiance subsidiar will act essentially as a conduit for the parent to raise capital for the purose of financing the business operations of its parent or other subsidiares of its parent which are not investment companies. We believe that a finance subsidiar that is organized as an LLC rather than as a corporation can be strctued to meet all of such requirements, while providing to its parent the greater flexibilty afforded by an LLC in raising capitaL. Preferred Equity Interests as Non-Voting Preferred Stock Although an LLC would not issue "stock" to its "stockholders" like a corporation, the flexibilty provided by LLC statutes generally permits the issuace of varous types of equity "interests" to "members," with terms and provisions like those of common and preferred stocks of any cotprate vehicle, i.e., they can be given the sae rights with respect to distrbutions, voting, exchanges and conversions, and liquidation rights. Just as a corporation may issue different classes of stock, an LLC may provide for classes or groups of members having different rights, powers and duties, including rights, powers and duties senior to existing classes and groups of members. Our client is proposing the use of an LLC that would issue both common equity interests (or "common shares") and preferred equity interests (or "preferred

SIMPSON THACHER & BARTLETT
Securties and Exchange Commission -4- March 3, 1994 shares"). All of the common shares would be owned by the "parent company" of the LLC or a "company controlled by the parent company" (in each case as defined in Rule 3a-5(b)). The LLC would issue and sell its preferred shares to investors. The proceeds from the sale of preferred shares would be loaned by the LLC to its parent company or companes controlled by the parent company for the purose of financing the operations of such entities. Payments of interest and principal on the loan or loans from the LLC would fund the payment of scheduled distrbutions and redemption and liquidation distrbutions on the preferred shares. The obligations of the LLC in respect of the preferred shares would be guanteed by the parent company puruant to a guantee complying with the provisions of Rule 3a-5. The preferred shares would have the following ters, which are equivalent to rights of preferred stock issued by a corpration:
Priority Over Certain Distributions. If distrbutions have not been made in ful on the prefered shares in accordace with their tenns (which terms will be determined at the tie of the offering of the preferred shares), the LLC will not (i) pay or declar any distrbutions on any common shares or any other interests of the LLC ranking junior to the preferred shares as to distrbutions; or (ii) redeem, purchase or otherwise acquire any common shares or any other interests of the LLC ranking junior to the preferred shares as to distrbutions, until in each case such time as all accumulated arears of unpaid distrbutions on the preferred shares have been paid in full. Liquidation Preference. In the event of any vOlUítar or involuntaiy liquidation, dissolution or winding up of the LLC, the holders of the preferred shares at

SIMPSON THACHER & BARTLETT

Securties and Exchange Commission -5- March 3, 1994 the time outstanding wil be entitled to receive out of the assets of the LLC available for distrbution to members, before any distrbution of assets is made to holder of common shares or any other interests of the LLC ranking junior to the preferred shares as regards parcipation in assets of the LLC, an amount equal to the aggregate of the liquidation preference of the prefered shares and all accumulated arears of unpaid distrbutions. Voting Rights. Holders of the preferred shares will not be entitled to any voting rights, except for limted circumstances that are effectively the same as those pursuant to which non-voting preferred stockholders in a corporation issuing securties in reliance on Rule 3a-5 would have voting rights. Conversion and Exchange. If the term of the preferred shares so provide, the preferred shares wil be convertible or exchangeable only for securties issued by the

parent company in accordance with the terms of such preferred shares. For the foregoing reasons, we respectfully request the Staffs confination

that (i) a finance subsidiar that is organized in the United States as a limited liabilty company would fall within the defition of a fiance subsidiar, provided that the requirements specified in clauses (i) and (ii) of Rule 3a-5(b)( 1) of the 1940 Act were met, and (ii) preferred interests in such limited liability company possessing the attbutes described above would be characterized as "non-voting preferred stock" for puroses of Rule 3a-5 of the 1940 Act.

SIMPSON THACHER & BARTLETT

Securties and Exchange Commission -6- March 3, 1994 If you have any questions or require any additional information regarding the foregoing request, please call Andrew R. Keller at (212) 455-3577 or Lawrence Vrana, Jr. at (212) 455-7387. Please acknowledge receipt of this letter by stamping the enclosed copy and retug it in the enclosed self-addressed, staped envelope.

Veiy trly your,
/i~xi~~ß~
SIMPSON THACHER & BARTLETT