SEC Division of Investment Management staff letter: LNC Equity Sales Corporation

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Our Ref. No. 97-348-CC

RESPONSE OF THE OFFICE LNC Equity Sales
OF THE CHIEF COUNSEL Corporation DIVISION OF INVESTMENT MAAGEMENT File No. 801-42530 Your letter of November 1, 1996 requests our assurance that

we would not recommend enforcement action to the Commission under

Rule 204-2 (a) (12) under the Investment Advisers Act of 1940 (the "Advisers Act") if LNC Equity Sales Corporation (the "Adviser"),

an investment adviser registered with the Commission, does not

make and keep books and records of personal securities

transactions of advisory representatives in shares of registered

open-end investment companies, variable annuities and variable

life insurance products ("variable insurance products") ,

including those issued by affiliates of the Adviser.

You state that the Adviser is a wholly owned subsidiary of

Lincoln Financial Group, Inc., which is a wholly owned subsidiary

of Lincoln National Corporation. You state that the Adviser's

principal business is as a broker-dealer marketing mutual funds,

limited partnerships, unit investment trusts and coins/precious

metals, and providing asset management and investment timing

services. The Adviser is affiliated with certain entities,

including The Lincoln National Life Insurance Company ("LNL"), a

broker-dealer, registered investment adviser, insurance company

and pension consulting firm. You state that the Adviser and/or

its affiliates are investment advisers or investment sub-advisers

to certain registered open-end investment companies, the shares

of which are sold to separate accounts of LNL to support variable

annui ty and variable life insurance contracts issued by LNL.

Rule 204-2 (a) (12) generally requires an investment adviser to maintain a record of every transaction in a security in which

the adviser or any of its advisory representatives (as defined in

the rule) has, or by reason of such transaction acquires, direct

or indirect beneficial ownership. A purpose of the rule is to

deter advisers and advisory representatives from engaging in

certain practices, including scalping, which could result in the

violation of the fiduciary obligations that advisers owe to their

clients.1 Scalping is a practice whereby a person who obtains

1paragraph (a) (12) of Rule 204-2 was adopted to help implement, among other things, the prohibitions set forth in

Section 206 (4) of the Advisers Act against fraudulent, deceptive

ì or manipulative practices. See Investment Advisers Act Release . No. 203 (Aug. 11, 1966) (adopting paragraph (a) (12) of

Rule 204-2); and Investment Advisers Act Release No. 197

(footnote continued)

information concerning securities recommendations being made by

an investment adviser, prior to the dissemination of such

information, trades on the anticipated short-run market activity

which may ensue from the issuance by the adviser of the

securities recommendations. 2

In a number of no-action letters, the staff has taken the

position that it will not recommend enforcement action under Rule

204-2 (a) (12) if an investment adviser does not make and keep records of transactions by the adviser and its advisory

representatives in shares of unaffiliated open-end investment

companies and interests in variable insurance products issued by

unaffiliated separate accounts. 3 In The Colonial Group, Inc.

(pub. avail. Mar. 10, 1988), the staff indicated that an adviser

need not make and keep records of transactions by the adviser and

its advisory representatives in shares of affiliated money market

funds. Moreover, the Commission has proposed amendments to the

rule that would except from the recordkeeping requirements of

paragraph (a) (12) transactions in shares of open-end investment

companies, without regard to whether the investment companies are

affiliates of the adviser. 4 These positions are based primarily

(Mar. 17, 1966) (proposing the addition of paragraph (a) (12)).
"(A) person associated with an investment adviser who knows that he will have to report his transactions to the investment adviser may hesitate to effect a transaction inconsistent with the adviser's fiduciary obligations to clients . . . ." Investment Advisers Act Release No. 120 (Oct. 16, 1961) (also proposing paragraph fa) (12) ) . 2Investment Advisers Act Release No. 436 (Feb. 21, 1975). See

also SEC v. Capital Gains Research Bureau. Inc., 375 U. S. 180

(1963), in which the Supreme Court held that scalping operates as a fraud or deceit upon any client 'or prospective client within the meaning of Section 206 of the Advisers Act.

3See, ~, Massachusetts Financial Services Company (pub.

avail. Oct. 6, 1992); Lipper Analytical Services, Inc. (pub.

avail. June 5, 1990); TransAmerica Advisors ~ Inc. (pub. ~vail.

Nov. 4, 1988) (excepting transactions in interests in variable

insurance products); Joshua, Lauren & Co. Inc. (pub. avail. Oct.

11, 1988); and The Boston Company, Inc. (pub. avail. Apr. 27,

1987) .
4Investment Advisers Act Release No. 1581 (Sept. 8, 1995)

(the "release"). Footnote 70 to the release indicates that the

staff currently takes the position that transactions in shares of

affiliated open-end funds are exempt from the recordkeeping

requirements. This position is consistent with the treatment of

shares of registered open-end investment companies under Rule

(footnote continued)

2

on a determination that it is unlikely that scalping or any other

improper trading practice would occur with respect to

transactions in shares of open- end investment companies because

there is no trading market for those shares.

We agree that, for purposes of the recordkeeping requirements of paragraph (a) (12) of Rule 204-2, there is no distinction between shares of an affiliated open-end investment

company and an interest in a variable insurance prQ~t_"Jssued by

an affiliated insurance company separate account. 5 A separate

account is organized either as a managed open-end investment

company or as a unit investment trust that invests in a managed

open- end investment company.

On the basis of the facts and representations in your

letter, we would not recommend any enforcement action to the

Commission under Section 204 of the Advisers Act or Rule 204 2 (a) (-12) thereunder if the Adviser does not make and keep records regarding personal securities transactions of the Adviser or its advisory representatives in shares of registered open-end

investment companies and interests in variable insurance

products, including those issued by affiliates of the Adviser.

You should note that any different facts or representations may

require a different conclusion.

~~fIk .~
Alison M. Fuller
Attorney
17j-1 under the Investment Company Act of 1940 (the "1940 Act").

~ Rule 17j -1 requires, among other things, an investment company and its investment adviser to adopt a code of ethics that imposes certain reporting obligations with respect to transactions by their access persons (as defined in the rule) in securities in which the access persons have any direct or indirect beneficial ownership. Paragraph (e) (5) of the ,rule sets forth the definition of security for purposes of the reporting obligations of the rule, and excludes shares of open-end investment companies. Access persons are not required, therefore, to report transactions in shares of registered open- end investment companies. 5We note that, for purposes of the exclusion from the

definition of security set forth in paragraph (e) (5) of Rule 17j￾1 ,under the 1940 Act, there is no distinction between shares of

open-end investment companies and interests in variable insurance

products issued by insurance company separate accounts.

3

JUN-17-97 14:44 From:SAB B ZDzsa7359a T-SDD P,DZ/D7 Job-B74 Sutherland, Asbill & Brenna~~1ND RETURN

An.o\A AUSTIN. NEW YORK WASHIGTON

1275 PENNSYLVA. AVENU. N.W. 'TL: (202) 383-0100 WASHINGTON, IJ.C. zooo4-z404 FAX; (302) 657-359;; FREDERlCl( ll BEI.Y DIRE LI (202) 383.Q126 Inteet lllam~blaw=m November 1, 1996 -.-....~,-- ._-~,.. ~-';,;:,:
Jack W. Murphy. Esq. ADVISERS ACT
Offce of the Associa.te Director (Chief Counsel) Rule 204-it~)( 12) /~., ~, Division of Invèstment Management ,:,. ~ .".-t;.", ..' ~i:
~.. '.- Securities and Exchange Commission lE! ¡:i;'::~'J;~!f, Room 10070, Mail Stop 10;.6 450 Fift Street. N. W. NOV 0 1 igg6 )) Washington, DC 20549 Iih ,~ , ,s. ~/ "Ç.. A ri'" ...~~, u 441' "r."l '" '...'- WI ~ / 'I." F Dear Mr. Murphy:
~ '" 'V ~ -;
On behalf of LNC Equity Sales Corporation (the "AdvIser"), we respectflly request that the Division of Investment Management not recommend enforcement action to the \ Commission pursuant to Rule 204-2(a)(l2) of the Investment Advisers Aet of 1940, as ¡ amended (the n Act") if the Adviser does not make and keep books and records of personal securities transactions of advisory representatives in open-end mutual funds, variable annuities and varable life insurance products, including those issued by affiliates of the Adviser. BackgJound ~ The Adviser is an investment adviser registered under the Act. The Adviser is

a wholly-ownecl subsidiary of Lincoln Financial Group, Inc.. (nLFGIt), Fort Wayne, Indiana. LFG is a wholly-owned subsidiary of Lincoln National Corporation (nLNC"). Fort Wayne. Indiana. Approximately 80% of the Adviser's business is providing investment advice through consultations. Only 5 % of the Adviser's business involves providing investment supervisory services. The other 15% of the Adviser's business is furnshing advice to clients on matters not involving securities. ¡

The Adviser's principal business is as a broker-dealer marketing mutual funds, limited partnerships, unit investment trusts, and coins/precious metas, and providing asset management and investment timing services. The Adviser also offers investments available through security brokerage Including common and prefcITcd stock, mutuii tinds, U.S.

Governent securities, mortgage-backed securities, corporate and municipal bonds, zero coupon bonds, certificates of deposit. and options. ) =

JUN-17-97 14:44 From:SAB B
ZDzsa7aS9a T-SDD P. Da/o7 Job-B74
Jack W. Murphy, Esq.
November 1, 1996
The Adviser is an afliate of the following companies:

Profession~l Financial Planning, Inc. C'PFP"), a wholly-owned subsldiary"'bf'" LFG. PFP is a registered investment adviser and financial plannIng firm; The Lincoln National Life Insurance Company ("LNL"), a wholly-owned subsidiary of LNC. LNL is a broker/ dealer, registered investment adviser. insurance company and pension consulting firm; Lincoln National Investment Management, Inc., a wholly-owned subsidiary of LNC. Lincoln National Investment Management, Inc. is a registered investment adviser and also creates limited partnerships; Vantage Global Advisers, Inc., a wholly-owned subsidiary of LNC. Vantage alobal Advi:sers, Inc. is a registered investment adviser; Lynch & Mayer, Inc. ("L&M"), a wholly-owned SUbsidiary of LNC. L&M ìs a registered investment adviser. The Adviser and/or its affiliates are investment advisers (or sub-advisers) to the following mutual funds, whose shares are sold to separate account~ of LNL to support variable anuity and variable life insurace contracts issued by LNL:
~ Lincoln National Aggressive Growth Fund. Inc.;

Lincoln National Bond. Fund, Inc.;

Lincoln National Capita Appreciation Fund. Inc.;

Lincoln National Equity-Income Fund, Inc.;

Lincoln National Growth and Incame Fund, Inc.;

Lincoln National Internauonal Fund, Inc.;

Lincoln National Mana.ged Fund, Inc.;

Lincoln Nañona Money Market Fund, Inc.;
Lincoln National Global Asset Alloction Fund, Inc.;

Lincoln Nationa Social Awareness Fund, Inc.; and Lincoln National Special Opportuity Fund, Inc. The Adviser isa.so affiliated with Delaware Management Holdings, Inc., a wholly-owned subsidiar of LNC. Delaware Management Holdings, Inc. is the sole owner of Delaware Management Company. Inc., a registered investment adviser (manger of the Delaware Group of mutual funds) and Delaware Distributors, Inc., a broker-dealer. ==

'JUN-17-97 14:45 From:SAB B
202sara59a T-SOO P. 04/07 Job-B74
Jack W. Murphy, Esq.

November I, 1996

Discusion
Rule 204-2(a)(12) specifically requires that all registered aavisé~l"s ÍÌäincan "(a)

record of every transaction in a securìty in which the investment adviser or any advisory representative... of such investment adviser has. or by reason of such transaction acquires,

any direct or indirect beneficial ownership, except (A) transactions effected in any account over which neither the investment adviser nor any advisory representative of the invesunent adviser has any direct or indirect influence or control; and (B) transactions in securities which are direct obligations of the United States. II Rule 204-2 (a)( 12)(i)(A) defines "advisory representative" to include (1) any partner, offcer of director of the investment adviser; (2)

any employee who makes' any recommendation, who participates in the determination of whicl recommendation shall be made, or whose funCtions or duties relate to the determination of which recommendation shall be made: (3) any employee who, in connection with his duties, obtans any information concerning which securities are being recommended prior to the effective di~seinination of such recommendations or of the information concerning such recommendations; and (4) any affiliated person who obrains information concerning securities recommendations being made by such investment adviser prior to the effective dissemìnation of siich recommendations or of the information concerning such recommendations. Rule 204-2(a)(l2) was adopted to "assist the Commission in determining whether a furter rule to prohibit scalping is necessary.... "~l The Commission defined scalp￾ing to mean a "practice whereby an investment adviser, or any person who obtans Information concerning a securities recommendation being made by such investment adviser prior to the '\issemination of such information, trades on the anticipated short-run market activity which may ensue from the issuance by the adviser of the securities recommendations. n'J/ In S.E.C. v, Capital Gains Research Bureau, Inc.,l/ the U. S. Supreme Court found 'scalping' to be a fraudulent and deceptive practice within the meaning of Section 206 of the Act. In Connecticut General Pension Services, Inc.t~ the Division found that "Rule 204-2 was intended to apply only to those instaces where a trading ma.rket existS for y See Investment Advisers Act Release No. 203 (August 11, 1966) (l966~67 Transfer Binder)

FED SEC. L. (CeH) P77,40i. y See Investment Advisers Act Release No. 436 (February 21, 1975) (1974-75 Transfer

Binder) FED. SEC. L. REP. (CCH) P80,1l3.
ì ~/ 375 U.S. 180 (1963).

~/ SEe No-Action Letter, (1982 SEe No-Act. LEXIS25721 (June 21, 1982). ~

JUN-17-97 14:45 From:SAB B ZDzsara59a T-SDD P.D5/DT Job-BT4 Jack W. Murphy, Esq. November 1, 1996 securities recommended by an investment adviser t such mat scalping by the adviser or it(s) cmployc;es is at leaSt a possibilty. Where there is not a tra.ding market for the securities an 'advisory'te-ntative' recommended by the adviser and the possibilty of 'scalping' by

does. not exist, thè purpose of Rule 204-2(a)(12) is not served by req1.i:rng the advisory representative to maintan a record of his or her personal securities transactions."V Based on this principle. three types of investment company securities currently are exempt from the Rule 204-2 reporting requirements: (1) shares of "unaffiliated" mutual funds. (2) shares of "affliated" mutual funds and (3) variable anuity and variable life insurance policies issued by "unafliated" insurance companies. This letter seeks the sraff's concurrence tba~ variable annuity and life insurance policies issued by "affliatedn insurance _ companies arc also exempt, There is no trading market in these securities regardless of whether they are issued by afliates, so scalping is not a possibilty. In a series of no-action lettrs, the Division has excepted the reponing of securities transactions by advisory representatives in unaffliated open~end mutual funds. The Division's position in these letters was ba:cd on the dctcnnination that since there "is no trading market for open-end fund shares, it is unlikely that scalping or any other improper ¡rading practice would occur. "2' The Division has proposed amendments to Rule 2.04-2(a)( If) to formally except from the recordkeeplng requirement trasactions in shares of registered open-end investment companies, without regard to whether they are issued by affiliates)' The proposing release ~No. 1A-1SI8) states in footnote 70 that "...the Division staff also currently taes the position ~, See also Pioneering Managements Corporation (1984-1985 Transfer Binder) FED. SEC. L. REP. (CCH) P',899 and Prudential Insurance Company of America (1977-1978 Transfer Binder) FED. SEC. L. REP. (CCH) P81.414. ~ Massachusetts Financial Services Company. SEC No-Acúon Letter, (1992 SEC No-Act. LEXIS 1043) note 4 (October 6, 1992). See~. Lipper Analytical Services, Inc.. SEe No￾Acuon Letter, (1990 SEC No-Act. LEXIS 882) (June S, 1990); TransAmerica Advisors, Inc. SEC No-Action Letter, (1988 SEC No-Act. LEXIS 1492) (Nov. 4, 1988); The Colonial Oroupi Inc., SEe No-Action Lettr. (1988 SEe No-Act. LEXIS 406) (Mar. 10, 1988); The Boston Company, SEe No-Action Letter, (1987 SEe No-Act. LEXIS 2027). l' See Personal InveSTment Activities of Investment Company Personnel and Codes of Ethics of Investment Companies and their Investment Advisers and Principal Underwriters, Securities and Exchange Commission Release No. 33-7212; IC-2134l; IA-1S18 (1995 SEe LEXIS
2400) (September 8, 1995). '

:=

JWN-17-97 14:45 From:SAB B
2D2Sa7a59a T-SDD P. DS/D7 Job-B74
Jack W. Murphy, Esq.
November 1, 1996

that transac:tions in shares of affilated open-end funds are exempt from the recordkeeping requirements. "!! __._...~="7-.. ~----~:...:;~j' ":.' Neither the proposed amendments nor Release lA-IS18 address whether variable anuities and várable life insuranc:e products are exempt from the reponing require￾ments. However, in a no-action letter to TransAmerica Advisors, Inc., the Division stated tht it "has taen the position that an investment adviser need not maintan records of advisory

representatives' personal securities transactions in shares of "unaffliated" open-end funds. "2/ The Division continued by statig that "because a contractholder's Lnterest in a separate account represents, in effect, an interest in an open-end fund. we believe your request regarding variable insurance products is directly analogous to your request regarding open- . end funds. Thus, we would not recommend any enforcement action if Advisors does not maintain records of its advisory representatives' personal transactions in variable insurance productS issued by unafïilated separate accounts. ..101 Accordingly, for purposes of Rule 204-2(a)( 12) there is no distinction between

shaes of affliated and unaffliated mutual funds - both are exempt from rhose rccordkecpìng

requirements. Since investments in variable. anuity and variable life insurance policies are .tdirectly analogous" to investments in mutual funds, logically there should be no distinction between variable insurance productS issued by affiliated and unaffiiated insurance company separate accounts. Indeed. varable insurance products are by their very nature talored to one specific situation, since by their tenns the benefits depend on the life or death of a specifc nared individuaL. For both mutual funds and variable insurace products there is no trading "market for such securities. l/ See supra note 7 (emphasis added). Previously, the Division had expressed a concern that

"advisory representatives of an adviser manging a. fund's portfolio seeurities. or of an invest￾ment adviser affiliated with that adviser who have thè; abilty to gain access to inforIation

about impending portfolio transactions inVOlving secilrities for which there is an active

seconda market could misuse confidential infonnation.....1 Massachusetts Financial Services

Company, SEe No-Action Letter (1992 SEC No-Act. LEXIS 1043) (October 6, 1992) referring to TransAmerica Advisors, Inc., supra note 6. !! See supra note 6, TransAmerica Advisors, Inc. at 2. Foomme:3 states that "generally speaing, insurance companies may establish separate accounts organized as open-end funds, or separate accounts organized as UITs that invest exclusively in open.end nmds, that issue variablf; anuity or life insurance contracts, which are linked to the performance of the account. " !g Id. at 3-4 (emphasis added).

:;

d JUN-17-97 14:4S From:SAB B

2D2Sa1aS9a T-SDD P.D7/D7Job-B74
Jack W. Murphy, Esq￾November 1 t 1996
Pa2e 6
Conclusion
In light of the foregoing, we respectfully request that the DIVtsîd~àvise uS that it wil recommend no action by the Commission if the Adviser does not maintan records purS\aIt to Rule 204-2(a)(l2) with respect; to transaeiions in affiliated or unaffiliated open-end mutual funds, variable annuities and variable life insurance products. Sincerely, FRB/pn l\ ::