SEC Division of Investment Management staff letter: M.D.C. Holdings

SKADDEPI ARPS SLATE MEAGHER FLOM
919 THIRD AVENUE
NEW YORK 10022-9931
CASLE ADDRESS OWE IEAW S1REET
SIIARSLAW NEW YORSI 212735-3000 .0510W $USEt1S 02108 m-ooo TELECOPItR III EIGHTEENTH STREET N.W 812 752-1054 .SHlNGTON D.C 20008 9105453-800 DIRECT OI OWE 10OWET 1ORE 735 IU4NIGT0W OCLRE 91101 005 515 SOUTh F1OUCR05 $ThEET LOS ANGELES CAUFORNIA $0071 023415-4500 REST CW D91VE November 12 1986 oooLuNoIseoeoe 1302 4O000 4o 1940 Act/3 5C csX Thomas Lemke Esq ui 4i Chief Counsel ub1ic Division of Investment Maa4thbt Securities and -Exchange ommifiib 450 Fifth Street N.W Washington D.C 20549 Re M.D.C Holdings Inc Dear Mr Lemke On behalf of our client M.D.C Holdings Inc M.D.C we respectfully request your confirmation that the Securities and Exchange Commission will take no action if the REIT as defined below invests in Quali￾fled Residual Interests as defined below Based upon and subject to our analysis set forth herein and recog nizing that there appears to be no controlling legal precedent on the issue we believe that such Qualified Residual Interests should be treated as mortgages and other liens on and iflterests in real estate under Sec tion 3c5C of the Investment Company Act of 1940 as amended the p1940 Act The Real Estate investment Trust -- LOC has formed subsidiary corporation the UIT ich intends to offer substantially all of its common stock to Lnveto in registered public offering thr� tS OiO r.gi$t.red broktr-deal.rs under the Securities Exchange Act of 1934 as amended and to qual ify as real estate investment trust under Sections 856- 860 of the Internal Revenue Code of 1986 the lR

Thomas Lemke Esq
November 12 1986
Page Two
The REIT expects to generate income principally by investment directly or thrrugh one or more of its subsidiaries in conventional or governmentally insured fixed rate mortgage loans secured by single-family resi dential properties the Mortgage Loans and in other mortgage-related assets including but not limited to fully modified pass-through mortgage-backed certifi cates guaranteed by the Government National Mortgage Association Mortgage Participation Certificates issued by the Federal Home Loan Mortgage Corporation Guaranteed Mortgage Pass-Through Certificates issued by the Federal National Mortgage Association or privately issued mort gage certificates collectively the Mortgage Certifi cates The REIT may sell to third parties such Mort gage Loans or Mortgage Certificates directly or through one or more of it.s subsidiaries or pledge them directly or through such entities as collateral for the issuance of collateralized mortgage obligations the Bonds which it intends to sell II The Proposed Transactions The REIT also proposes to purchase participa tions Residual Interests which evidence fractional undivided interests in certain entities organized by non￾affiliates the Entities which have issued Bonds se cured by Mortgage Loans Mortgage Certificates and cer tain other funds and accounts the Collateral Each such Entity will have been formed as either trust or partnership under state law Each such Entity whether trust or partnership will be exempt from registration under the 1940 Act because either it is primarily engaged in apurcbaeing or otherwise acquiring mortgages and other liens on and interests in real estate and is not in the business of issuing redeemable securities face-amount certificates of the installment type or peri odic payment plan certificates under Section 3c5 of the 1940 Act andd at the time that it issued its Bonds it received an opinion of counsel to that effect or it or another entity on its behalf has received an order undr Section 6c of the 1940 Act exempting it from 111 the basis Of certain representations made by it in an application for such order In the former case the assets of the Entity will consist of under the requirements of present law at

Thomas Lemke Esq
November 12 1986
Page Three
least 55 percent Mortgage Loans or Mortgage Certificates which represent 100 percent the fractional undivided interests in the mortgage loans which make up such cer tificates Whole Pool Mortgage Certificates In the latter its assets will likely not consist of at least 55 percent Mortgage Loans or Whole Pool Mortgage Certif cates The PElT at all times intends to have more than 55 percent of its assets which must be countered under the asset test under Section 3c5C of the 1940 Act invested in Mortgage Loans Whole Pool Mortgage Certifi cates or Qualified Residual Interests Each trust will have been formed pursuant to trust agreement the Trust Agreement entered into by depositor and trustee the Owner Trustee while each partnership will have been formed pursuant to partner ship agreement the Partnership Agreement entered into between the partners Hereinafter tue Trust Agreement and the Partnership Agreement are known collectively as Entity Agreemeniza Trust Entities In the case of an Entity which is trust under state law the Trust Agreement will have established the trust and authorLzed the Owner Trustee to issue the Re sidual Interests and the Bonds purchase or otherwise acquire the Collateral pledge such Collateral to an indenture trustee the Indenture Trustee and enter into or cause its designee to enter into an underwriting agreement to selL the Bonds Generally the Trust Agree ment will have aLso provided that the Owner Trustee will pay to the holders of such Residual Interests their pro rata share of the excess of principal and interest income from the Collateral over the sum of principal and inter est expense on the Bonds plus other expenses associated with the ongoing maintenance of the Bonds the Residual Income The Trust Agreement can provide that more than one series of Bonds may be issued by any one trust and that any such trust will be dissolved when all of the Bonds arepaid Currently the Trust Agreement also includes certain provisions which permit the Entity to be viewed as either partnership or grantor trust under the Code

Thomas Lemke Esq
November 12 1986
Page Four
thus permitting Lt to forego federal income taxation on its Residual Income at the trust level These provisions generally include the following First the Trust Agree ment provides that Residual Interests may only be trans ferred to holders which meet certain minimum net worth requirements Second it provides that holders of Resid ual Interests are liable for all expenses of the Entity except for debt service on the Bonds Third it provides that holders of Residual Interests representing some percentage greater than or equal to 50% of the fractional undivided interests in the Entity the Applicable Per centage control all non-ministerial activities of the Entity Included in these activities are for example the decision to effect any optional redemption of the Bonds and the decision to remove the Indenture Trustee Fourth it provides that the Entity will not terminate on the bankttiptcy death or incapacity of any holder of Residual Interest Finally it provides that the Entity must meet certain eg$ty requirements at the time that it issues the Bonds and continue to meet them on an ongoing basis The Entity may meet the latter limitation by either creating reserve fund when substantial portion of the Residual Interests are sold or creating it over time from Residual Income which would otherwise have been paid to the holders of such Residual Interests Partnership Entities In the case of an Entity which is partnership under state law the Partnership Agreement will generally be written to comply with the Uniform Limited Partnership Act of the state where the partnership is formed The purposes of the partnership will likely be limited to acquiring Mortgage Loans or Mortgage Certificates and issuing and selling one or more series of Bonds secured thereby and any activity incidental thereto or connected therewith Normally the Partnership Agreement will designate one partner as the general partner of the part nership and the others as limited partners thereof The limited partners will not be liable thereunder for the debts of the partnership though the general partner will be so liable Certain provisions of the Partnership Agreement will establish the method by which credits and charges will be made to each of the partners capital accounts The Partnership Agreement will provide that

Thomas temke Esq
November 12 1986
Page Five
management of the affairs of the partnership will be controlled exclusively by theHgeneral partner and that the general partner will have no authority to act in contravention of the limited purposes of the partnership stated in the Partnership Agreement The Partnership Agreement will provide that an Applicable Percentage of the holders of Residual Interests in the partnership may remove the general partner and that the death dissolu tion bankruptcy or incapacity of any limited partner will not act to terminate the partnership However such acts of the general partner will so terminate it except in certain instances during any period when the Bonds are still outstanding The Partnership Agreement will place other limitations on the ability of any partner to transfer his Residual Interest Currently the Partnership Agreement includes certain provisions which will permit the Entity to quali fy as partnership subject to taxation under Subchapter of the Code First as has been stated any Residual Interest of the partnership will be transferable only under certain circumstances Second the general partner wilL be required always to hold more than de minimis Residual Interest in the partnership probably greater than 10 percent interest And third the general part ner will be liabLe for debts of the partnership The Tax Reform Act of 1986 On October 22 1986 the Tax Reform Act of 1986 the TRA of 1986 was enacted The TRA of 1986 makes certain changes to the scheme of federal income taxation of Residual Interests In general the TRA of 1986 per mits Entities which have been formed prior to December 31 1991 to continue to forego federal income taxation at the Entity level In addition it permits Entities to elect under new Section 860D of the Code to be taxed as real estate mortgage investment conduits or REMICs Generally 8peaking REMIC is also not treated as an entity sAb3ect to taxation under the Code Moreover the REMIC provisions explicitly grant real estate-related asset statue to such interests under the Code as long as the assets which make up the entity represent real-estate related assets Entities which elect REMIC status gener ally are not required to comply with the additional tax-

Thomas Leake Esq
November 12 1986
Page Six
related requirements outlined above which are necessary for them not to be viewed as association taxable as corporation under the Code though some or all of these provisions may be included for other reasons in the Enti ty Agreements The REIT Purchases The RET only intends to purchase Residual Interests from Entities which have the characteristics specified above such interests being referred to as Qualified Residual Interests Qualified Residual Interests of EntLties which have elected to qualify as REMICs are referred to hereinafter as REMIC Qualified Residual Interests while Qualified Residual Interests which have not so elected are referred to hereinafter as Non-REMIC Qualified Residual Interests III Analysis Based upon and subject to our analysis set forith herein and recognizing that there appears to be no controlling lega.L precedent on the issue it is our opin ion that REMIC Qualified and Non-REMIC Qualified Residual Interests should be treated as mortgages and other liens on and interests in real estate under Section 3c5C of the 1940 Act As more fully discussed below the TRA of 1986 and its legislative history undoubtedly indicate Congressional policy to clarify the definition of real estate-related asset under federal law This crys tallization in Congressional thinking should not be un dermined by adopting contrary position under the 1940 Act Were such position adopted real estate invest ment trust such as the REIT would be substantially inhibited from acquiring REMIC Qualified Residual Inter ests Furthermore there appears to be no substantial economic differences between REMIC Qualified Residual Interests and Non-REMIC Qualified Residual Interests Both will produce the same after-tax net cash flow to holder and the entities in which they represent-an

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Thomas Lemke Esq
November 12 1986
Page Seven
interest are considered for the purposes of the Code as pass-through entities i.e entities which are not sub ject to federal income taxes Therefore there should be no reasonable basis for distinguishing between the two for the purposes of Section 3c5C of the 1940 Act QLlified Residual Interests Any Qualified Residual Interest should be con sidered mortgage and other liens on and interests in the real estate as that term is defined under Section 3c5C of the 1940 Act because of the recent clarifi cation of Congressional intent regarding the nature of residual interests as real estate-related assets under federal law evidenced in the TEA of 1986 In this re gard it is instructive first to look generally at the applicable provisions of the TEA of 1986 Section 671 of the TEA of 1986 defines residual interest as any interest in pool of real estate-related assets which has elected to be treated as REMIC and which is not regular interest The term regular interest means an interest in REMIC the terms of which are fixed on the startup day and which -- unconditionally entitles the holder to receive specified principal airiount or other similar amount and There appears to be two limited exceptions to this rule First the Conference Agreement interpretting new Section 860E of the Code appears to indicate that if the value of the residual interest of REMIC is lens than two percent of the combined value of such interest and its regular interests then thrift institution with net operating losses may not offset those losses against its income from such REMIC residual iflterest Second for an entity subject to tax under Section 51 of the Code which holds an interest in real estate investment trust which in turn holds REMIC residual interest income from such interest is unrelated business taxable income

Thomas Lemke Esq
November 12 1986
Page Eight
provides that interest payments or other similar amounts if any at or before maturity are payable based on fixed rate or to the extent provided in regulations at variable rate An interest shall not fail to meet the require ments of subparagraph merely because the timing but not the amount of the principal payments or other similar amounts may be contingent on the extent of prepayments on qualified mortgages and the amount of income from permitted investments REMIC is any entity to which an election to be treated as REMIC applies for the taxable year and all prior taxable years all of the interests in which are regular interests or residual interests which has and only class of residual interests and all distributions if any with respect to such interests are pro rata as of the close of the 4th month ending after the startup day and each quarter ending thereafter substantially all of the assets of which consist of qualified mortgages and permitted investments and which has taxable year which is calendar year REMIC status is governed by an election under new Section 860Db of the Code The REMIC provisions apply to regu lar and residual interests issued after January 1987 Assuming proper election Bonds issued after that time will clearly be regular interests under the Code and the REMIC Qualified Residual Interests associated therewith will clearly be residual interests

Thomas Lemke Esq
November 12 1986
Page Nine
REMIC Qualified Residual Interests Clarification of the real estate-related asset status of residual interests under federal law and there by REMIC Qualified Residual Interests occurs as the re suit of change in Section 856c6C of the Code
Section 856c6C of the Code defines an interest in
real property for the purposes of Part III Subchapter of the Code regarding real estate investment trusts To qualify as real estate investment trust under the Code an entity must at the close of each quarter of any tax able year have at least 75 percent of the value of its total assets represented by real estate assets including interests in real property cash and cash items includ ing receivables or government securities Subject to an exception not here relevant Section 671b1 of the TRA of 1986 modifies the definition of an interest in real property by inserting subparagraph after said subparagraph New subparagraph states that regular or residual interest in REMIC shall be treated as an interest in real property and any amount includible in gross income with respect to such an interest shall be treated as interest Emphasis added The Conference Agreement for the TRA of 1986 confirms this characterization It states that regular and residual interests are treated as real estate assets under section 856c6 For the purposes of applying the asset test stated in Section 856c5 of the Code the amount of the real estate investment trusts investment in the residual interest is the value allocable to such interest In that regard the Conference Agreement likewise states that the case of residual interest the fair market value of the residual interest and not the fair market value of all of the REMICs assets is used in applying the asset test of Section 856c5 As the test under Section 3c5C of the 1940 Act is basically also an asset test we believe that Qualified Residual Interests should be evaluated under such section on essentially the same basis Footnote continued

Thomas Lemke Eag
November 12 1986
Page Ten
Thus as result of the changes effectuated by the TRA of 1986 the Code undoubtedly permits real estate investment trust to invest solely in residual interests that have qualified as REMICs We believe that this recent expression of Congressional policy permitting real estate investment trust to invest in REMIC residu al interests is not frustrated by other federal laws including Section 3c5C of the 1940 Act Were one to conclude that REMIC residual interests were not mort gages and other liens on and interests in real estate emphasis added real estate investment trust would be substantially inhibited in its ability to acquire REMIC residual interests In such case the enactment into law by Congress of this crystallization of its policy regarding real estate related assets would not have the intended effect of decreasing the uncertainty with re spect to investment in such assets For this reason we believe that REMIC Qualified Residual Interests should clearly be treated as such interests in real estate under Section 3c5C of the 1940 Act In further support of this proposition we note that Congress intent is reflected in at least three other changes to the Code made in the TRA of 1986 Sec tion 671b2 states that REMIC residual interests shall be treated as qualifying real property loans for the purposes of Section 593 of the Code Section 593 of the Code defines the method by which any mutual savings bank domestic building and loan association or cooperative bank without capital stock may calculate its reserves for bad debts Such reserves are used to calculate its bad debt deductions under Section 166 of the Code Section 671b3 states that REMIC residual interests shall be Footnote continued from previous page Since Entities are by their nature fairly highly leveraged we believe that it would be unfair to credit the REIT with the value ofthe Mortgage Loans or Mortgage Certificates owned by them rather than the net value of the REITs investment in them in determining whether the REIT is principally en gaged in permitted activities under Section 3c5C thereof

Thomas Lemke Esq
November 12 1986
Page Eleven
treated as qualifying properties for the purposes of
Section 7701a19 of the Code which defines domestic
building and loan assodiation for the purposes of the Code Finally Section 671b4 of the TRA of 1986 amends Section 582c of the Code by providing that REMIC residual interests shall be treated as an evidence of indebtedness thereunder Section 582 of the Code defines certain special rules applicable to banks regarding their deductions for bad debt losses under Section 166 of the Code Without question Congress has seen fit to state clearly and emphatically that REMIC residual interests for all purposes of the Code and by implication for all purposes of federal law are real estate-related assets Non-REMIC Qualified Residual Interests With respect to Non-REMIC Qualified Residual Interests we believe that such interests should also be treated as mortgages and other liens on and interests in real estate because there is no substantial difference between them and REMIC Qualified Residual Interests In both cases the pre-tax cash flow of holder of such interests will be determined on the basis of the differ ences between principal and interest receipts on the Collateral over the sum of principal and interest pay ments on the Bonds plus other administrative expenses of the Entities In both cases federal income taxes will not be imposed on the Entities so that all other vari ables being equal after-tax cash flows to such holders will not differ Furthermore in both cases the Enti ties will be structured identically for state law pur poses although in the case of Entities which issue Non REMIC Qualified Residual Interests certain provisions in their Entity Agreements which permit them to be treated as pass-through entities for federal income tax purposes need not be included in the Entity Agreements of Entities which issue REMIC Qualified Residual Interests However these provisions may be included for other reasons such as for rating agency purposes or to insure prudent admin istration of the Entities by their equity holders Lastly in both cases since the Entities only differ See footnote on page seven hereof

Thomas Lemke Esq
November 12 1986
Page Twelve
with respect to their election as to REMIC status under the federal income tax laws the holders of interests in the Entities will have virtually identical rights in the Collateral held by the Entities and vis-a-vis holders of Bonds We believe that it would clearly contradict recent Congressional policy which has been enacted into law to conclude that Qualified Residual Interests which are issued by Entities which have not elected or cannot elect to be REMICs do not qualify as mortgages and other liens on and interests in real estate Quite to the contrary it is clear that because Non-REMIC Quali fied Residual Interests represent virtually the same economic interests as REMIC Qualified Residual Interests Congress looking to the substance of the relationship between the holders of such interests and the real estate assets held by the Entities which issued them intended that such interests should also be treated as mortgages and other liens on and interests in real estate for the purposes of Section 3c5C of the 1940 Act IV Conclusion For the reasons stated above we believe that the Qualified Residual Interests acquired by the REIT are qualified real estate-related assets under Section 3c5C of the 1940 Act For your convenience we have enclosed copies of the applicable provisions of the TRA of 1986 and the applicable sections of the Conference Agreement If you have any questions concerning the foregoing please do not hesitate to contact the under signed at 212 735-3840 or Richard Kadlick at 212 735-2716 both of this office Sincerely Gtie

P1 JAN
LXir Ref No 86608CC
RESPONSE OF Onici ui CriuFtOUNSEL M.D .C Ho Inc DIVISION OF INVES94ENT MANAGEMENT File No 132-3 In your letter of November 12 1986 you request our assurance that we would not recommend any enforcement action to the Commission under the Investment Cctnpany Act of 1940 Act if M.D.C Holdings Inc.s subsidiary corporation the REIT invests in various mortgagerelated assets including participations Residual Interests in various partnerships and trusts Entities which invest in real estaterelated assets and treats these Residual Interests as mortgages and other liens on and interests in real estate for purposes of Section 3c You argue that to the extent these Residual Interests comply with new
Section 860D of the Internal Revenue Code Code they should be deemed
to be mortgages and other liens on and interests in real estate under
Section 3c of the Act In addition you assert that in amending
the Code Congress did not intend companies investing in these Residual Interests to be subject to regulation under the Act We are unable to assure you that we would not recommend any enforcement action to the Commission if the REIT treats Residual Interests as mortgages and other liens on and interests in real estate for purposes of Section 3c Although the Entities may not be deemed to be investment companies by virtue of exemptive orders under Section 6c of the Act or in reliance on Section 3c of the Act 1/ the staff has not viewed interests in similar entities to cane within the phrase mortgages and other liens on and interests in real estate under Section 3c 2/ In the past the staff has granted noaction requests where an issuer acquired wholepool Government National Mortgage Association GNMA certificates i.e certificates comprising an undivided interest in the entire pool of mortgages backing the certificates wholepool Federal National Mortgage Association FNMA certificates and wholepool Federal Home Loan Mortgage Corporation FHL certificates to permit these certif cates to be treated as mortgages and other liens on and interests in real real estate for purposes of Section 3c of the Act See e.g Landmark Funding Corp pub avail Sept 20 1984 American Home Finance Mortgage Corp pub avail May 11 1981 However the Division has declined to grant noaction with respect to issuers treating partialpool GNMA FNMA or FHMLC certificates as mortgages and other liens on and interests in real estate for purposes of Section 3c See e.g Nottingham Realty Securities Inc pub avail Apr 19 1984 Arlington Investment Ccinpany pub avail Aug 31 1974 2/ See e.1 Realex Capital Corp pub avail Mar 19 1984 holding that limited partnership interest in partnership relying on Section 3c does not come within the phrase Urban Land Investments Inc pub avail Nov 1971 see also Investment Company Act Rel No 3140 Nov 29 1960 stating that trust investing to substantial extent in other real estate investment trusts or in companies engaged in the real estate business might not qualify for the exception set forth in Section 3c

In addition although Congress amended the Code to provide passthrough tax treatment to entities electing to be taxed as real estate mortgage investment conduits RE74ICs neither the legislation nor the legislative history addresses the regulation of RE1ICs or similar entities under the Act Thus although the action of Congress may evidence an intent to facilitate the development of the market in mortgages and mortgagerelated assets we cannot conclude that Congress intended either RE7ICs to be excepted fran the definition of an investment company under the Act or interests in RE74ICs to be deemed mortgages and other liens on and interests in real estate under Section 3c Our position on this question is supported by other recent Congressional action regarding the market in mortgages and mortgagerelated assets In enacting the Secondary rtgage Market Enhancement Act of 1984 3/ Congress intended to broaden the market in mortgages and mortgagerelated assets 4/ However the Senate Committee on Banking Housing and Urban Affairs rejected proposed amendment to exclude certain companies investing in real estaterelated securities fran the Acts coverage stating that the Act facilitates development of the private secondary mortgage market adequately and contains important protections for investors coming within the definition of the term investment company .. 5/ treover the Committee believed that the Commissions power under Section 6c of the Act would permit the Commission to deal with any problems that arise under the Investment Company Act in the area of mortgage backed securities in manner that assures adequate investor protection ... 6/ Accordingly we are unable to agree with your conclusion that interests in the Entities would constitute mortgages and other liens on and interests in real estate under Section 3c of the Act Gerald Lins Attorney 3/ Pub 98440 98 Stat 1689 1984 4/ The report of the Senate Ccmmittee on Banking Housing and Urban Affairs states that bill is expressly designed to encourage this broadening of the market for mortgagebacked securities by encouraging more extensive involvement of the private sector in the formation of conduits for the flow of mortgage capital ran investors to lenders and homebuyers Rep No 293 98th Cong 1st Sess 1983 5/ Id at 6/ Id