SEC Division of Investment Management staff letter: Letter to Investment Company Registrants

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON. D.C. 20549

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February 3, 1995bectiQl' g .(11,"."""".""",;;""", '...cL.,"...."...._.,~..~.." ¡ t r.::~.: 1 0 '. _''.. .,rl ..., ..~~ ..~.: -',;~,..;,~.l~*ii....:;~-;-~1r-~~~:~; .c!' ;.,:.~-,-....~.¿,..~.:.,..;~ E'ub11(' " J I q 1S ~,,"2 f:ilab1l1 ty Fe b r U~,~ t_"'m"'.J.~1i.'..I1:ii:t?¡ji;;i!Wi.;;¡¿'ii.'; Dear Registrant: ~IU' ._- ~'iJr~.tIMr~iI, :~~~''*~~~l-bl~;,'i.'. The Division of Investment Management (the II Division ") has prepared this letter to assist investment conip.any registrants in preparig disclosure fiings in 1995. These comments represent the views of the staf of the Division and are not necessarily those of the Securities

and Exchange Commission (the "Commission") and should not be considered of precedential

. value in any court or other official forum. The comments in this letter apply to filings made on Forms N-IA, N-2, N-14 and S-6, unless otherwise indicated. ., This letter covers disclosure and procedura developments since February 25, 1994 when the staf issued its last ~'generic comment letter. II Accounting-related matters of interest to

registrants and their independent public accountants can be found in the accompanying letter from Lawrence A. l'riend, Chief Accountant of the Division, that supplements his letter dated November 1, 1994 addressed to chief financial officers. Genera guidance for variable annuity, varable life, and other insurance company investment contract registrnts can be found in a letter dated October 21, 1994 from Brenda D. Sneed, Assistant Director, Office of Insurance Products.
I. FIING PROCEDURS

A. Post-Effecive Amendments Under Rules 485 and 486

The Commission adopted amendments to Rule 485 under the Securities Act of 1933 (the "1933 Act") to revise the procedures by which open..end investment companies ("mutual funds") fie post-effective amendments to registration statements. These amendments became effective on October 11, 1994. See Investment Company Act Release No. 20486 (August 17, 1994). The amendments to Rule 485:
(1) permit mutual funds to fie post-effective amendments under paragraph (b) of Rule 485 ("B-Amendments") for certin purposes not previously covered by the Rule. These . , purposes include, among others, delaying the effective date of a previously fied post-effective amendment, updating a fund's discussion of its pedormance, revising disclosure regarding a mutual fund's portolio manager and adding interim financial statements; '(2) give the Division delegated authority to suspend the abilty of a mutual fund to fie

B-Amendments for a specifed time if the fund has fied a B-Amendment under circumstances in which pargraph (b) is not available; .

(3) permit B-Amendments to become effective up to 30 days after fiing; (4) enable the Division to permit certin typs of post-effective amendments not

otherwise eligible to be fied under Rule 485(b) to become effective immediately upon filing.

,.;

See new subpargraplì (b)(l)(jx) of Rule 485. Acting under this authority, the staf of the Division has permitted th~' -automatic effectiveness of a post -effective amendment to a registration statement fied by one fund in a fund complex when the amendment reflects substatialy identical revisions to those contaed in a post -effective amendment of another fund in the complex previously reviewed. Requests ,pursuant to this new provision should be addressed in writing to the Assistant Director, Offce of Disclosure and Review. Insurance company investment contract registrats should send their requests to the Assistat Director, Office of Insurance Products; and (5) provide that amendments fied under pargraph (a) (" A-Amendments ") adding new series wil not become effective until 75 days afer filg. A mutual fund may designate a

longer period - up to 95 days - before the A-Amendment beComes effective. The Commission has also adopted new Rule 486. Ths new rule permits closed-end management investment companies and business development companies that periodically repurchase their shares in accordace with Rule 23c-3 under the Investment Company Act of registration statements that become effective automatically. and 1940 (the "1940"Act") to fie certin post-:.effective amendments

B. Amendments to Proxy Rules

The Commission has revised the proxy rules . applicable to investment companies the Securities Exchange Act of 1934 tthe II 1934 Act"). See ("funds") under the 1940 Act and.

Investment Company AètRelease No. 206i4 (October 13, 1994). The revised rules were effective on November 23, 1994 ard apply to al proxy statements fied on or after Januar 23,
1995. Signicant changes reflected in the new rules include:
revised proxy rules consolidate the fund-specifc . Roorganiation of Rules: The

disclosure'requirements of the Commission's proxy rules into a new Item 22 in Schedule 14A under the J934 Act, which sets forth general proxy statement requirements. The other items in Schedule 14A, unless they specifically state otherwise, continue to apply to funds. . Summary Table: When a proxy statement solicits votes on different proposals from shareh91ders of more than one fund, a portfolio'.of a senes fund, or a class of a multiple class fund, the new rules require a table at the beginning of the proxy .statement that summares each proposal and indicates which shareholders are being requested to approve each proposal. . Fee Table: The new rules require a fee table in proxy statements that conta proposals that would result, directly or indirectly, in increased fees or expenses. The fee table must compare the,proposed fees and expenses to those currep-tly in effect. . Elecion of Directors: The revised rules continue to require basic information

concernng directors and nominees, such as business background and relationships with certin affiiates of the fund.' This information is now required for the past five yeas. Proxy requirements for the election of directors no longer include detaed information about the fund's investment advisor (including the investment advisor's balance sheet), the advisory agreement, or the fund's brokerage arrgements. . Management Compensation: The amended rules require a table setting forth the amount of compensation a director received, pension or retirement benefits accrued by the fund for each director, and estimated annual retirement benefits for each director. The compens~tion
table also must disclose the aggregate remuneration reeived by a director from all funds in the

same fund complex. "Fund complex" is defined broadly for these purposes as two or more funds that hold themselves out to investors as related companies or that have a common investment advisor. For disclosure in a proxy statement of compensation of directors serving on more than one board of directors of funds in a, fund complex with different fiscal years, the staf has stated that it would not object if:
(1) disclosure of compensation from each fund (columns (1)-(4) of the compensation table) is for the ,most recently completed fiscal year of that fund or, where compensation can be reasonably estimated or is a presently quantifiable amount, for a fiscal yea that wil be

completed within two months of the' date of fiing of the proxy statement; and (2) disclosure of aggregate compensation from the fund complex (column (5) of the compensation table) is for the most recently completed calendar year or, where compensation can be reasonably estimated or is a presently quantifable amount, for a calendar year that wil be completed withîn two months of the date of fiing of the proxy statement. ,. To make the disclosure of compensation unifòrm, the new rules also amended fuiid registration statement forms to require the same compensation table as in Item 22. This information should' be reflected in the first post-effective amendment fied on or afer January 23, 1995 and may be fied under Rule 485(b) if it is otherwise eligible for such a filig. New registration statements should include the table with amounts estimat~ for the first fiscal yea, but using aCtual fund complex inormation if it is available. . Investment Advisory Contract and Distribution Plans: The amended rules retain most

of the disclosure requirements concerning shareholder approval of investment advisory contracts and impose similar requirements for distribution plans. The rules, however, no longer require the inclusion of an investment advisor's balance sheet or extensive discussion of brokerage

arrngements. There is a new requirement for a discussion of the material factors considere by the board of directors' in recommending the advisory . contract for shareholder approval, including a discussion of soft dollar arrngements that benefit the investment advisor. . Annual Reports: In .conneCtion with the proxy rules revisions, the Commission eliminated for funds the requirement in Rule 14a-3(b) under the 1934 Act that an annual report accompany or precede a proxy statement. Item 22 requires that the proxy statement state that the fund's most recent annual and semi-annual report are available upon request.
C. Registration of Additional Shares Pursuant to Rule 24e-2

Section 24(e)(1) of the 1940 Act provides that registration statements under the 1933 Act
relating to certn investment companies may be amended after their effective dates to increase the amount of securities proposed to be offered. Section 24(e)(1) further provides that a fiing fee, calculated in the manner specified in Section 6(b) of the 1933 Act, be paid at the time of fiing of the amendment. Pursuant to Rule 24e-2 under the 1940 Act, mutual funds and unit

investment trusts registering additional securities pursuant to Section 24(e)(1) may, in calculating the filing fee, make an adjustment for the amount of securities of the same class redeemed or repurchased by the issuer in its previous fiscal year. Registrants are reminded' that Rule 24e- 2 permits the preservation of net redemption credits only if a post-effective amendment contaning the information required by Rule 24e

"

2(b) is fied in the year immediately following the fiscal year in which the net redemptions

occur.
D. EDGAR Implem~ntation
Mandated electronic filing on theCorrmission's Electronic Data Gathering, Analysis, and Retrieval ("EDGAR") System began for some investment company registrants on April 26,
1993. See Rulemaking for EDGAR System -- Investment Companies and Institutional Investment
Managers, Investment Company Act Release No. 19284 (58 FR 14848 (Mar. 18, 1993)). On

December 19,,1994, the Commission made final the EDGAR ìnterim rules and adopted minor and technical amendments to thpse rules. See Rulemaking for, EDGAR System, Investment Company Act Release No. IC-20783 ("Release No. 20783") (59 FR 67752 (Dec. 30, 1994)). Release No. 20783 also contains the phase-in schedule and phase-in list establishing the timetables by which investment company registrants who are not already electronic filers wil become subject to mandated electronic filing. Phase-in wil recómmence on January 30, 1995. Investment company I:egistrants assigned to the remaining phase-in groups wil be phased in as set forth below: " IM-03 Januar 30, 1995

IM-04 March 6, 1995

IM-05 Mayl,""1995

IM-06 November 6, 1995 ..
To ascertin the phase-in group to which an investment company registrant is assigned, the registrat should consult the Investment Management Phase-In, List published as Appendix C to Release No. 20783 and the phase-in and electronic fiing rules found in Regulation S- T (17

CFR Part 232).
A registrant makng filgs on EDGAR must furnish the Commission a paper èopy of its first electronic filg made after its phase-in date. The paper copy may be either a traditional paper copy or a computer prit-out of the EDGAR fùing (with the confidential information in the header blanked out or omitted). The paper copy must incluqe the legend required by Rule 902(g) of Regulation S-T and should be mailed to OFIS Filer Support, SEC Operations Center, 6432 General Green Way, Alexandria, Virginia 22312-2413, and be received no later than six business days after the electronic filing. .

Registrants are also reminded that all correspondence (including cover letters and requests for acceleration) relat~ to electronic filings must also be submitted electronically. See Rule 101(a) of Regulation S:. T. Electronically submitted cover letters should include the information requested in Comment LA of the February 22, 1993, and Comment LD of the February 25, 1994, generic comment letters. . Investment company registrants are required to furnsh a Financial Data Schedule as an exhibit to certin filings that are submitted electronically, namely registration statements on

Forms S-6, N-l, N-IA, N-2, N-3, N-4, and N-5; FonT N-SAR; and certin proxy materials

(as specified inItem 22(a)(4) of Schedule 14A). However, there are circumstances under which this requirement would not be applicable. For example, ail initial fiing of Form S-6 typically does not include financial statements; they are furnshed in pre-effective amendments.

Therefore, the instructions to Form'S-6 provide that a Financial Data Schedule is required when any amendment to that form is fied electronically. In addition, the staff has taen the position thåf a Financial Data Schedule nee not be submitted with the fiing of a registration statement or amendment on Forms S-6, N-l, N-IA, N-2, N-3, N-4, or N-5 containing no financial . ,

information or containing only information concerning initial capitalization. Of course, a registration statement contang financial information incoiporated by reference from another source, such as the annual report to shareholders, would require as an exhibit a Financial Data
Schedule. For the specific requirements for Financial Data Schedules, see Rule 483(e) of
Regulation C.

Questions regarding the EDGAR phase-in may be directed to Anthony A. Vertuno, Division of Investment Management, at 202-942-0591. Questions regarding the EDGAR rules may be direted to Ruth Armfield Sanders, Division of Investment Management, at 202-942 0633, or to Mr. Vertno. E. Filings Under Rule 497

Registrants are reminded that they may not materially alter the nature of the fund contemplated in the last pre-effective amendment by merely fiing a Rule 497(b) or (c) prospectus that makes those material changes. For example, if a new fund designed to invest pnmariy in domestic equity securities, afer the effective date of its registration statement but before the comiÌencement of its public offerig, changes its investment objective and.policies so that it becomes an emerging markets fund, a post-effective amendment fied under Rule 485(a), rather than a Rule 497 prospectus, should be the vehicle for reflecting the change. r n. DISCLOSUR COMMENTS ,; A. Disclosure Regarding Management's Discussion of Fund,Perfonnance

Registrats including their Management's Disçussion of Fund Performance in the annual report are reminded that Item 32( c) of Form N - i A requires an undertg to furnish to. each person to whom a prospetus is delivered, upon request and without charge, a copy of the registrat's latest anual report to shareholders. In addition, Item 3 (Condensed Financial

Information) of Form N-IA requirs the prospetus to disclose that further information about theregistrat's performance is contaned in the annual report, which may be obtained without

charge.
B. Fund Names and Guide 1

Guide 1 to' Form N-IA provides, in pertinent part, that if a registrant's name suggests that it wil invest primariy in a particular type of security, industry or industries; the registrant

should have an investment policy that requires, under normal circumstances, at least 65 percent of the value of its tota assets wil be invested in the indicated type of security or industry.

Frequently, fund names have suggested that all, or substantially all, of a particular fund's assets wil be invested in a certin type of security., industry, country, or geographic

region. In such cases, the staff believes that the fund's investment policy should conform with the higher threshold implied by its name.
C. Updated Risk Disclosure

A fund's prospectus disclosure must adequately inform investors as to the risk factors peculiar to the fund (e.g., investment strategies, assumptions, practices or techniques) or its

portfolio of securities. See, for example; Item 4 of Form N-IA and Guide 21 thereto and Item 8 of Form N-2. Over time, with changes in the marketplace or in the fund's portfolio or

investment strategy or practices, the signicace of some risk factors may change, or new ones on the Commission to identify these changing areas of risk. signicance and new areas of risk disclosure. Registrants are reminded that they have may be introduced. Registrats cannot rely

a duty, on an ongoing basis, to analyze fund risk and review prospectus risk disclosure, and to update prospectus disclosure when appropriate.
il. Recent Staff Positions
c,.
A. Shareholder Approval of New Funds' Assigned Advisory Contracts Following

Acquisition of Advisor
In a letter to the Investment Company Institute (pub. avaiL. Nov. 6, 1992), the staff stated that a fund no longer would be asked to underte, in its initial registration statement, to hold a shareholderß' meeting to approve, among other thigs, the fund's investment advisory

contract. The sta recently considered shareholder approval in the context of a fund whose

advisor was acquired by another entity shortly after the commencement of the fund's public offering of its securities. In that case, the staf said that it would not object if the ,fund's

contract with the ad¥Ïsor was not re-approved by the fund's shareholders afer the acquisition. The facts that the staf found persuasive were: (1) the advisor was acquired shortly (e.g., less than six weeks) after the fund began offering its shares to the public; (2) the initial shareholder of the fund had approved the pre-acquisition contract and also woild approve the post￾acquisition advisory contract; (3) the post-acquisition advisory contract would conta the same' material terms as the pre-acquisition contract; (4) the persons who signicantly contribute to the investment advice relied on to manage the fund's portfolio were expected to remain the acquisition ,and assignment to shareholders through prospectus disclosure. same; and (5) the fund would disclose the impending

B. Advertising Past Performance Following a Reorganization'

In Nonh American Security Trust (pub. avaiL. August 5, 1994) the staff stated that it would not recommend enforcement action under Rule 482 under the 1933 Act or Rule 34b-l under the i 940 Act if a fund formed as a result of merging three other funds advertised its historical pedormance using, for periods prior to the reorganiztion, the pedormance data of the predecessor fund that it most closely resembled. The staf said ,that, in determining whether any predecessor fund resembles a new or surviving fund closely enough to justify the use of the predecessor fund's pedormance, the factors to be considered are the funds': (i) investment advisors; (ii) investment objectives, policies, and restrictions; (ii) expense structures and expense ratios; (iv) asset sizes; and (v) portfolio compositions. The staff believes that the survivor ofa business combination for accounting purposes (i.e., the fund whose financial statements ar cared forward), typicaly wil be the fund whose historical pedormance may

be used by a new or surviving fund. While this letter involved mutual funds, the same rationale would apply to a merger of closed-end funds.
C. Diversification Issues: Privately Issued Asset~Backed and Mortgage-Backed

Securities
In Hyperion Capital Management, Inc. (pub. avail. August 1, 1994) the staff grated no￾action assurance if, forthe purposes of determining compliance with Section 5(b)(1) of the 1940'

Act, a fund treats each underlying pool of assets backing certin privately issuoo mortgage- ) backed and asset-backed securities, rather than the sponsor or depositor of the pool, as a

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separte issuer provided that (1) in the event of the sponsor's banptcy, the sponsor's creitors would have no reourse agàinst the pool, and (2) the holder of the asset-backed or

mortgage-backed security would look to the pool for payment.
In J.P. Morgan StruCtured Obligations Corp. (pub. avaiL. July 27; 1994) the staf declined to grant no-action assurance if a fund treted certn notes as instniments issued or

guartee by the U.S. Government or an agency theref ("Governent Securities") for puipses of pargraph (d)(I) of Rule 2a-7 under the 1940 Act. Although the tnist issuing the

notes would hold Government 'Securities, the trust also proposed to enter into 'an interest rate and/or currncy exchange agrement ("Swap Agrement") that the staf concluded would materily alter the trost's credit risk. The staff's conclusion was based on two factors. First, under the Swap Agreement purchasers of the notes were reuir to look to the obligation of

the swap counterparty to make scheduled payments and to pledge additional collateraL. Second, alt~o~gh'the potes were to.be collateralized full~, if swap counterparY ins~lyency occ~rr, the anticipated Federal DepOSIt Insurance Corporation treatment would not mitigate the nsks as to

treat the notes as equivalent to Government Securities.
D. Rule t2b-l Carry-Forwards

Under the NASD's Rules of
Fair Prctice, mutual funds calculate a "remaining amountl, i.e., the appropriate maximum aggregate sales charge minus the amount of sales chages paid or accrued, including asset.:based sales charges, front-end and deferr sales charges, plus the pennitted interest. See NASD Notice to Members 93-12, Questions an A.nswers About New NASD Rules Governing Investment Company Sales Charges- Artcle ILL, Sections 26(b) an (d) o/the Rules 0/ Fair Practice (February 1993). 'The staff wil not 'raise objections under Section

17(d) of the 1940 Actor the rules thereunder if a Rule 12b-l plan alows for the trasfer of a

portion of a mutual fund's "remaining amount" in the event of an exchange between series of the same mutual fund or between affiliated mutual funds (or a combination theref), under the following conditions: (1) the arrgement is conducted in accordce with Section 26(d)(2)(D) of the NASD's Rules of Fair Practice, as described more fully in NASD Notice to Members 93-12; and (2) the carr-forward arrngement is implemented in accordnce with Rule .l2b-l ' reuirements. Speifically, Section 26(d)(2)(D) pennits mutual funds to increse their "remaining amount" by treating the shares received through an exchange as new gross sales, provided the amount of the increase is deducted from the "remaining amount" of the mutual fund out of which the shares are exchanged. ' F. Money Market Funds The Commission and the Division have provided guidance concerning certn floating rate and other securities that are inappropriate for money market funds. See Investment Company Act Release No. 19959 (Dec. 17, 1993) and the letter dated June 30, i 994 from Barr Barbash, Director of the Division, to the Investment Company Institute. The June 30, 1994 letter also states that, although acquisition of a parcular'security may not be expressly prohibited by Rule 2a-7 under the 1940 Act, this does not mean that the security ~s necessarily an appropriate investment for a money market fund. An advisor must determine not only that holding the security is not expressly prohibited by the Rule, but also that the security meets the general rule applicàble to all investments by a money market fund:
that investment in the security is consistent with maintaining a stable net asset value per shar.

~ -4._ ,
G. Bundling of Proxy Proposals

Issues have been raised recently with the staff about whether proposals presented for shareholder approvals may be II bundled " , i.e., submitted and voted upon together in fund proxies. In accordace with Rule 14a-4 under the 1934 Act, a matter should be voted upon

separately if the 1~40 Act, state law, or a fund's organizational documents (charter, by-laws) require a matter under consideration to be submitted to shareholders.

The staff has not objected to II bundling " proxy proposals in the following circumstances:
a. Ministerial proposals. Proposals involving editorial or non-substantive

changes to fund documents. b. Inextricably Intenwned Proposals. The staff has not required separate preposals if the proposals would be impractical to separate. .
c. Merger Proposals. A vote to merge with another fund may carr with it
approv~ of new ~dvisory contracts, Rule 12b- i plans, and other matters . necessary to implement the m~rger.

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The staf continues to strongly encourage registrats to tae the initiative to review, simplify and improve fund prospectuses. See Comment IT.A in the February 25, 1994 generic comment letter describing the staff's expeited review proedures for prospectuses in this regard; . We hope that this letter wil assist you in prearng fiings in 1995. Of course, it is not intended to replace the disclosure comment pross. You should diret any questions about specifc company fiings to the staff member responsible for reviewing that company's

documents.
Sincerely, ()J!l ~
~~i-; B. Lewis

Assistant Director . .