SEC Division of Investment Management staff letter: PNC Bank N.A.

',., '-P--B-"-l-I~l:, ~ama-5"'Al~ll~ 1997 I I'UBUO 6-( 0::4 7 ~~~~~-==-------~.~ Our' Ref. No. 97-17-CC RESPONSE OF THE OFFICE OF ~EL PHS ~a~i, N.A. DIVISION OF INVESTMENT MANAGEMENT File No. 132-3 Your letter dated June 9, 1997 requests our assuranc~ that we would not recommend enforcement action to the Commission under Sections 17(a), 21(b) or 17(d) of the Investment Company Act of 1940 ("1940 Act") and Ru~e 17d-1 thereunder, if registered investment companies advised by PNC Bank, National Association ("PNC Bank") or an affiliate of PNC Bank {the "Funds") for which PNC Bank or an affiliate of PNC Bank acts as custodian (the "Custodian") are compensated by the Custodian for cash balances maintained overnight with the Custodian, as described in your letter. Facts PNC Bank, a wholly owned indirect subsidiary of PNC Bank Corp., serves as the Funds' custodian. The Funds are advised by direct and indirect wholly owned subsidiaries of PNC Bank. ~/ You state that a number of the Funds are sold exclusively to institutional investors. In order to respond to the needs of those investors, the Funds have determined that theyne~d the flexibility to extend the time of day up to which they.will accept purchase and redemption orders. 2/ You state that the Funds are concerned, however, that extending the time for purchase and redemptions may cause the Funds to hold. pools of excess cash late in the day for which appropriate i~vestments are not available. ~/ The Funds have determined that 'they'¥Quld be adversely affected if they e~tend their purchase and redemption times without being compensated by the Custodian for the use of excess cash. The Funds therefore propose to receive compensation from the Custodian in a number of forms, including custodian fee credits, reimbursement of fees of other service providers affiliated with the Custodian, and cash payments. The ~/ In some instances, PNC Bank serves as a sub-adviser for certain Funds for which it.performs back office sub-advisory functions. 2./ Your letter does not request relief with respect to any issues that may be raised by a Fund's determination to extend the time of day up to which it will accept purchase and'redemption orders, including issues under Rule 22c-1 under the Investment Company Act, and therefore we express no opinion with respect to.such matters. ~/ You note that funds typically invest their excess cash in overnight repurchase agreements. The ,Funds believe, .however, that overnight repurchase agreements will not be available on a consistent basis late in the day, primarily due to the limited supply of eligible collateral at that time.

compensation will in all cases be equal to the net effective federal funds rate ("daily market rate") applicable to the cash ) balances maintained with the Custodian. ~/ The Custodian proposes to return to each Fund the full amount of the return that the Custodian·receives on a Fund's overnight cash balance, based on the application of the daily market rate to that balance. ~/ You represent that no significant benefit will accrue to the Custodian or its affiliates as a result of the maintenance of the Fund's excess cash balances with the Custodian. 6/ You state that the Custodian may charge a nominal transaction fee commensurate with similar fees charged by others' for performing services of the same nature and quality, for effecting the proposed transactions. The transaction fee would cover the Custodian's cost for making daily determinations of available cash, calculating the applicable compensation due the Funds, and maintaining appropriate records. 2/ You represent that the Custodian will not provide a greater benefit to any non-affiliated investment company with respect to its overnight cash balances than the Custodian provides to a Fund with respect to its overnight cash balances. . ~/ The daily market rate will be the average effective daily federal funds rate determined'bythe Federal Reserve Bank of New York, less the reserve requirement "haircut" charged by the Federal Reserve on those balances. ~/ If the return on the excess cash balance is treated as a. custodian fee credit, the Fund would be required to reflect this credit in its financial statements as a reduction in fees or expenses. Rule 6-07.2(g) (2) of Regulation S-X. Q/ You note that PNC Bank and certain of its affiliates provide investment advisory, custodial, accounting, administrative, and transfer agency services to the Funds and, with respect to certain of those services, are compensated based upon a percentage of assets under management. To the extent that any benefit provided to a Fund pursuant to the proposed transactions incrementally increases the Fund's assets or induces additional shareholder purchases, PNC Bank and it a.ffiliates may indirectly benefit. 2/ Section 36(b) of the 1940 Act imposes a fiduciary duty on a fund's investment adviser with respect to the receipt of compensation paid by the fund to the adviser or an affiliate of the adviser. The above-described fees paid'to the Custodian would be subject to Section 36(b) of the 1940 Act. ) 2

You represent that the board of directors of each Fund will review the proposed transactions initially and on at least an annual basis thereafter in order to confirm the propriety of the transactions. In particular, each Fund's board, including a majority of the Fund's independent directors, will determine that: (1) participation in the proposed transactions is in the best interest of the Fund and its shareholders; (2) participation is necessary or desirable for the operation of the Fund; (3) the Custodian can perform the proposed transactions in a manner at least equal in nature and quality to that which could be provided by others; (4) the rate of compensation received by the Fund for cash balances maintained overnight pursuant to the proposed transactions is fair and reasonable; and (5) any fees charged in connection with the proposed transactions are fair and reasonable in light of the usual and customary fees charged by others for performing services of the same manner and quality. ~/ Analysis
Section 17(a) (3) of the 1940 Act generally prohibits an . affiliated person of an investment company, or an affiliated
person of such person, from borrowing money or other property from the investment company. Section 21(b) generally prohibits a registered management investment company from lending money or other property to any person that controls or is under common control with the investment company, unless the loan is from an investment company to a company that owns all of the outstanding securit '.esof the investment company. Together, these provisions generally prohibit an affiliate? party with potentially . conflicting interests from causing an investment company to engage in lending transactions that are detrimental to the interest of the investment company and its shareholders. ~/ ~/ Moreover, you represent that each Fund's portfolio manager, after reviewing anticipated sources of purchases and redemptions and other sources of cash flow, will make a good faith determination as to the amount of cash the .portfolio manager expects to have available for investment during normal business hours, and absent unusual circumstances, will invest that cash in accordance with the Fund's investment policies and practices. You repre~ent that as a result, the amount of a Fund's excess cash will not be subject to the custodian'S desire to have additional sources of cash for its banking operations. ~/ Section 2(a) (3) (E) of the 1940 Act provides that a fund'S investment adviser is an affiliated person of that fund, and
Section 2(a) (3) (C) provides that an entity directly or
indirectly controlling or controlled by another entity is an affiliated person of that entity. As a result, PNC Bank may be considered to be an affiliated person of an affiliated

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You assert that an investment company's excess cash balances arise as an incident to an investment company's normal operations, and that no indicia ofa loan, such as terms regarding amount or duration, accompany the maintenance of excess balances with a custodian. You argue, therefore, that the maintenance of an investment company's excess cash balances with its custodian should not be viewed as a loan for purposes of these provisions. You also maintain that the proposed arrangement does not present the potential for overreaching that Sections 17(a) (3) and 21(b) were designed to address. You represent that each Fund will receive the entire amount of the daily market rate applicable to the Fund's overnight cash balances, which will be determined independently by the marketplace. The Custodian, therefore, will have no. discretion to determine the rate of compensation that a Fund r~ceives, and will receive only a nominal transaction fee. .
Section 17(d) of the 1940 Act and Rule 17d-l thereunder
prohibit an atfiliated person of an investment company, or an affiliated person of such person, acting as principal, from. participating in a joint enterprise or other joint arrangement or profit-sharing plan with such company without first obtaining an order from the Commission. The purpose of Section 17(d) and Rule 17d-1 is to protect investment companies from participating in . transactions with affiliated persons on inequitable terms. 10/ Rule 17d-l(c) _enerally defines a joint enterprise' to include any contract or arrangement whereby an investment company and· an . affiliate "have a joint or joint and several participation, or share in the profits of such enterprise or undertaking." You believe that the arrangement described above does not constitute a joint enterprise or other joint arrangement or profit-sharing plan within the meaning of Section 17(d) and Rule 17d-l. You note that the staff has permitted custodians to provide custodial services to their affiliated investment person of the Funds because·the Funds' investment advisers are affiliated p~rsons of the Funds they advise, and because· of the control r~lationship that exists between PNC Bank and the investment advis~rs. In addition, PNC Bank also may be considered a direct affiliate of certain Funds for which it perfo~ certain back office sub-advisory functions. 10/ Hearings Bef. a Subcomm~ of the Comm. on Banking and Currency on S. 3580 at 37, 767-68 (1940). 4

I companies. 11/ Further, in Norwest Bank Minnesota, N.A. (pub. avail. May 25, 1995) ("Norwest"), the staff indicated that service arrangements between an investment company and an affiliate under which compensation paid to the affiliate would not be based on a share of the revenue generated by the service provider's efforts would not constitute a joint arrangement under
Section 17(d) and Rule 17d-1. As noted above, the Custodian
receives no share of the daily market rate applicable to a Fund's ! overnight cash balances and, other than a nominal transaction fee, the Custodian will receive no fees with respect to the proposed transaction. Although the Funds' advisers and certain other affiliates may be~efit from an increase in the Funds' assets as' a res~·t of the proposed transaction, the staff and courts have taken the jPo.sition that the prohibitions of Section 17(d) and Rule 17d-1 fO not reach every economic relationship between an investment company and its affiliates; rather, "some element of combination" must first be established. 12/ You maintain that the proposed arrangement does not establish the . degree of combination required by'Section 17(d) and Rule 17d-1. Based on the facts and representations in your letter, and in particular, your representation that no significant benefit will accrue to the Custodian or its affiliates as a result of the maintenance of the Fund's excess cash balances, we would not ;recormnend enforcement a~tion to the Cormnission pursuant to 'Sectioris 17(a) (3), 2.1(b), or 17(d), or Rule 17d-1 thereunder, if . the Custodian compensates a Fundbased·upon.thed~ily market rate _.... -. ~:..•. 11/ ~, ~, Composite Group of Funds (pub~ avail. Mar. 2, 1987); IPI-Income & Price Index Fund (pub. avail. Dec. 12, 1980) . . 12/ See SEC v. Talley Industries. Inc., 399 F.2d 396, 403 (2d Cir. 1968), ~. denied, 393 U.S. 1015 (1969) .. SlliiQ Norwest (" In ourl view, a service arrangement between a fund and an affiliated person of the fund under which compensation islnot based on a share of the revenue gen.erated by th service p.rovider's efforts is not a ' joint enterprise' or,;ther joint arrangement or profit-sharing plan."); The F,$x-fund (pub. avail. Nov. 22, 1985) (a service arrangement was not deemed a joint arrangement subject to Rule 17d-1, when the affiliated service provider's compensation was based on a percentage of the fund's net assets.). \ h :
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applicable to a Fund's overnight cash balances a~ described above and in your letter. ~/ You should note that different facts or representations might require a different conclusion. ~:t.(}~ Senior Counsel 13/ You also·lJ.ave requested relief under Sections 17(a) (1) and 17(a) (2) of the 1940 Act. Because we believe that your proposal does not raise an issue under these provisions, we have not addressed them in our response. ) 6 i

PNC Bank, N.A. 2155855441 Tel j. Robert Dugan
1600 Market Street 2155857260 Fax C..ourutl
28th Floor
P.O. Box 7648
Philadelphia. PA 19101
PNClBANK
Investment Company ACt of 1940:
Sec.tion: 17(a)( I)
17(a)(2)
17(a)(3)
17(d)
21(b)
Rule: 17d-l
June 9, 1997
Mr. Douglas J. Scheidt
Chief Counsel
Division of Investment Management
Securities and Exchange Commission
Mail Stop 10 - 6
450 Fifth Street, N.W.
Washington, D.C. 20549 , ;
Re: No-Action Request Regarding Compensation for Overnight Cash Balances Dear Mr. Scheidt:
On behalf of PNC Bank, National Association ("PNC Bank"), registered investment companies advised by PNC Bank or an affiliate ofPNC Bank for which PNC Bank or an affiliate of PNC Bank acts as custodian (the "Funds"), and affiliates of PNC Bank that serve as custodian for any ofthe Funds (such entities, together with PNC Bank, referred to as the "Custodian"),this request is being made to garner assurance that the staff ofthe.Division ofInvestment Map.agement (the "Staff') would not recommend any enforcement action to the Securities and Exchange Commission (the "Commission") under Sections 17(a)(I), 17(a)(2), 17(a)(3), 17(d), or 21(b) ofthe Investment Company Act of 1940(the "1940 Act") or Rule 17d-l thereunder if the respective investment portfolios (the "Portfolios") ofthe Funds are compensated by the Custodian for cash balances maintained overnight with the Custodian as described below. Underlying this request is the'premise that (i) investment companies with non-affiliated custodians are permitted to be compensated by their custodian for cash balances maintained overnight with the custodian, (ii) if the Funds are not permitted to be similarly compensated, they m:\r\misc\CUSTBEN.NAL

will be competitively disadvantaged vis-a-vis their investment company competitors, and (iii) the proposed transactions have been structured with the intent of eliminating the potential for any conflicts of interest that might arise. PARTIES PNC Bank, a wholly-owned indirect subsidiary of PNC Bank Corp., serves as the Funds' custodian" In that capacity, PNC Bank generally receives and maintains the Funds' cash and portfolio securities, disburses assets upon instruction, collects income due to the Funds, ~d maintains records regarding the foregoing. PNC Bank provides custodial services for approximately $350 billion in assets, including approximately 635 investment company accounts with approximately $210 billion in assets. PNC Bank is a member of the Federal Reserve Banks of Philadelphia and Cleveland, and its activities are regulated by the Office ofthe Comptroller of the Currency. Each ofthe Funds is registered under the 1940 Act as a management investment company. The Portfolios represent a broad mix ofmo~ey market, fixed income, and equity portfolios. A number ofthe Funds are sold exclusively to institutional investors, and therefore these Funds compete on a daily basis in the highly competitive institutional investment company marketplace. The Funds are advised by direct and indirect wholly-owned subsidiaries of PNC Bank.2 As such, PNC Bank may be considered to be an affiliate ofthe Funds.3 'PNC Bank Corp., the thirteenth largest bank holding company in the United States, is a multi-bank holding company with both bank and non-bailk subsidiaries. Through its subsidiaries it provides a full range of banking services to its customers, including corporate banking, consumer banking, real estate banking, mortgage banking, and asset management. As of December 31, 1996, PNC Bank Corp. had total assets of $73.2 billion, total deposits of $45.6 billion, and total shareholders equity of$5.8 billion. As of the same date, PNC Bank had total assets of $57.3 billion, total deposits of $38.4 billion, and totai shareholders equity of $4.6 billion. 2PNC Bank~s investment adviser subsidiaries currently.provide investment advisory serVices to registered investment companies and other accounts totaling approximately $115 billion in assets, and in the aggregate constitute the second largest bank-affiliated manager of investment companies in the country. PNC Bank performs certain back office sub-advisory functions for several ofthe Funds in the form of providing research, credit analysis, and recommendations regarding portfolio investments as well as supplying computer facilities, personnel, and various related services, but it does not exercise investment discretion with respect to any ofthe Funds. 3Section 2(a)(3) of the 1940 Act defines the term "affiliated person" as that term is used throughout the 1940 Act. Section 2(a)(3)(E)states that an investment company's investment ) m:\r\misc\CUSTBEN.NAL 2

PROPOSED TRANSACTIONS
Use ofAffiliated Custodian by the Funds
In order to remain competitive with other investment company complexes, the Funds have determined that they need the flexibility to be able to extend the time of day up to which they will accept purchase and redemption orders.4 The Funds are concerned that, as described more fully below, by virtue of extending their purchase and redemption tiniesthey may hold pools of excess cash late in the day for which appropriate investments are not available. Absent the ability to garner some benefit from this excess cash, shareholder return would be adversely affected and the Funds as a practical matter could be prohibited from extending their purchase and redemption times. . ,
i. Structure of the Proposed Transactions
The Funds are proposing that to the extent they may hold excess cash for which appropriate investments are not available, they be permitted to receive some form of compensation with respect to cash balances that are maintained overnight with the Custodian. This compensation, which might take a number offorms, including custodian fee credits, reimbursement of fees of other service providers affiliated with the Custodian, and cash payments, will in all cases be equal to the average effective daily federal funds rate determined by the Federal Reserve Bank ofNew York, less the applicable reserve requirement "haircut" charged by the Federal Reserve (the "daily market rate"), as applied to those balances, adviser is an affiliated person ofthat investment company. Section 2(a)(3)(C) states that an entity directly or indirectly controlling or controlled by another entity" is an affiliated person of that entity. Section 2(a)(9) of the 1940 Act states that "control" means the power to exercise a controlling influence over the management or policies of a company, and furthermore that control is presumed to exist in situations in which an entity, directly or indirectly through another controlled company, beneficially owns more than 25% of a company's voting securities. Pursuant to these definitions, the Funds' investment advisers are affiliated persons of the respective Funds that they advise, and as a result ofthe control relationship that 'exists between PNC Bank and the investment advisers, PNC Bank may be considered to be an affiliated person ofthose investment advisers. As a result, PNC Bank may be considered to be an affiliated person of an affiliated person ofthe Funds. PNC Bank may also be considered a direct affiliate of certain Funds for which it performs certain back office sub-advisory functions. 4Particularly in the institutional investment company context, in response to th~ demands ofinvestors, investment companies are extending the time ofday up to which purchase and redemption orders will be accepted. Significantly, the Funds expect that because of competitive pressures and the continuing desire ofinvestors for increased purchase and redemption time flexibility, additional investment companies will extend their purchase and redemption times, and purchase and redemption times themselves will continue to expand. m:\r\misc\CUSTBEN,NAL ' 3

The daily market rate serves as a proxy for the rate of return a bank would typically expect to be able to realize on a customer's cash balances. As a nonnal incident to the business of banking, when the cash balances ofa bank's customers, which are reflected in the bank's account at the Federal Reserve, are not being used by a customer, they are generally available to the bank in order for it to carry on its banking operations. Therefore, as with any banking institution, cash balances maintained by the Custodian in its account at the Federal Reserve, including cash balances maintained by both affiliated and non-affiliated investment company· custodialclients, are used by the Custodian in the course ofits daily operations. Cash balances currently available to and utilized by the Custodian include those ofthe Funds. The intent of the proposedtransactions is to enable the Custodian to provide compensation to the Funds for those balances in an amount commensurate with a current market rate applicable to those balances.
ii. Shareholder Protections
The proposed transactions will be structured so that no significant incremental benefit will accrue to the Custodian or its affiliates as the result ofsuch transactions.s In particular, the Custodian.will return to the Fund the full amount of the return the Custodian receives on a Portfolio's overnight cash balances based on the application of the daily market rate to those balances.6 Moreover, each Portfolio's portfolio manager, after reviewing anticipated sources of purchases and redemptions and other sources of cash flow into and out ofthe Portfolio, will make a good f~ith detennination to the amount of cash the portfolio manager expects to have 5PNC Bank and certain of its affiliates provide investment advisory, custodial; accounting, administrative, and transfer agency services to the Funds, and with respect to certain of those services are compensated based upon a percentage of assets under management. As a result, to the extent that any benefit provided to a Fund pursuant to the proposed transactions either incrementally increases the Fund's assets or induces additional shareholder purchases, PNC Bank and its affiliates may indirectly benefit from such accretion. 6The Custodian may charge a nominal transaction fee in connection with effecting the proposed transactions. This fee will be one which is fair and reasonable in light of the usual and customary fees charged by others for perfonning services of a similar nature and quality. The fee would be designed to cover the additional expense to the Custodian to monitor the excess cash balances of the respective Portfolios on a daily basis, detenninethe appropriate daily market rate to be applied to those balances, perfonn the accounting necessary to calculate the benefit due to . each Portfolio, and maintain records relating to the transactions for the respective Portfolios. The transaction fee will be comparable to the transaction fee charged by PNC Bank to its investment company clients for overnight repurchase agreement transactions entered into with PNC Bank, which transactions similarly relate to overnight positio~s and require PNC Bank to make daily detenninations of available cash, calculate applicable compensation, and maintain appropriate records. \ ;" m:\r\rnisc\CUSTBEN.NAL 4

available for investment during normal business hours, and absent- unusual circumstances affecting the Portfolio, will invest that cash in accordance with the Portfolio's investment pqlicies and practices. As a result, the amount ofa Portfolio's excess cash will be tied to its investment operations, its cash flow and projected cash needs, and the availability of appropriate investment options, and will not be subject to influence by external factors such as the Custodian's desire to have an additional, albeit given the scope ofthe Custodian's oPerations a " de minimis, source of cash to carry on its banking oPerations. The benefit provided to the Portfolios will be based upon the daily market rate, which is determined indePendently by the marketplace, and therefore the Custodian will have no discretion to,determine the rate of comPensation a Portfolio'receive~. Finally, the Custodian will not be permitted to provide a larger benefit to any ~-affilia~ed investment company portfolio with resPect to its overnight cash balances than it provides{'o a Portfolio with respect to its overnight cash balances. As an independent check on the operation ofthe proposed transactions, the Board of Directors of each Fund, including a majority ofthe Board's non-interested members, will review the transactions initially and on at least an annual basis thereafter in order to confirm the propriety of the transactions. Each Board would also be free to examine the proposed transactions on a more frequent basis should it so desire. In particular, each Fund's Board, includ:ing a majority ofthe directors who are not interested persons (as defined in section 2(a)(19) ofthe 1940 Act) ofthe Fund, will 'determine that (i) participationin the proposed transactions is in the best interest 'of the Fund and its shareholders, (ii) such participation is '_ necessary or desirable fosflre operation of the Fund, (iii} the Custodian can perform the proposed transactions in a manner at least equal in nature and quality to that whicli could be provided by others, (iv) the rate of compensation received by the Fund for cash balances maintained overnight pursuant to the proposed transactio:.s is fair and reasonable, and (v) any fees charged in connection with the PJ;'9po~dtransactions are fair and reasonable in light of the usual and customary fees c>artled by others for performing serviceii ofthe same nature and quality. In orderto ensure that each Portfolio will receive the benefit it is due with respect to its overnight cash balances, and that no Portfolio will have a claim on the benefit due to any other Portfolio, the Custodian will Perform the proposed transactions and will account for such transactions separately with respect to each Portfolio. The Custodian will maintain and preserve for a period of at least six years from the end ofthe fiscal year in which it particular Portfolio receives compensation from the Custodian pursuant to the proposed transactions, the first two years in
an easily accessible pl,ace, a written record relating to cash balances maintained overnight by the Portfolio wi~ the Custodian. The record will include, with resPect to each date on which cash balances are spaintained, (i) the amount retained, (ii) the daily market rate . applicable to those balances,1and (iii) the amount of compensation received by the Portfolio with resPect to those balances. {/ As a result ofthe f(}~egoing procedures and protections, there will be neither the incentive nor the opportunity for the Custodian to engage in overreaching in connection with the proposed transactions. m:\r\misc\CUSTBEN.NAL 5

Use of Custodians by Other Investment Companies Although PNC Bank and the Funds are aware ofseveral investment company complexes that receive compensation for cash balances maintained overnight with their custodian, empirical evidence regarding the extent of this practice is not generally available. Nonetheless, such a practice is clearly permissible, and PNC Bank and the Funds believe that a substantial number of investment company complexes are engaging in the practice.' At the request of investment company clients, custodians may enter into an arrangement whereby, in exchange for the investment company maintaining cash with the custodian in below market or non-interest bearing accounts, the custodian will reduce the custody fee payable by the investmenlcompany. These arrangements are provided as an integral part of a custodian's custodial services. Because an investment company's excess cas~, as with any other excess cash held by a custodian, flows through the banking system and may be used by the custodian to help facilitate its daily operations, that excess cash has a certain value that attaches to it. In a compensating balance arrangement, the custodian returns all or a portion ofthat value to the investment company. In effect, the custodian acts as the repository ofthe value that attaches to the excess cash, and then returns that value to the investment company just as it would any other dividend or interest payment that attaches to any other asset ofthe investment company that is held by the custodian. . Apart from the affiliation issue referenced above, the only substantive difference between the compensating balance arrangements typically undertaken by custodians and the·transactions that are proposed in this letter is that pursuant to the transactions proposed in this letter the Custodian will receive no significant incremental benefit for the cash balances maintained by a Portfolio, but rather will return to the Portfolio an amount based on the application of the daily market rate to those balances. 'The Commission itself appears to have implicitly approved ofthe practice. For example, in adopting amendments to investment company accounting rules and disclosure requirements regarding brokerage/~ervice arrangements and expense offset arrangements, the Commission recognized that compensating balance arrangements exist, and chose to regulate rather than to prohibit this practice. Payment for Investment Company Services with Brokeraie Commissions, Investment Company Act Release No. 21221, at pi>. 9-14 (july 21, 1995) (adopting release); Payment for Investment Company Services with Brokerage Commissions, Investment Company Act Release No. 20472 (August 11, 1994) (proposing release). . m:\r\misc\CUSTBEN.NAL 6

To the extent that the Funds are not able to receive compensation from the Custodian for overnight cash balances maintained with the Custodian as other investment companies are able to receive compensation from their custodian for such balances, these other investment companies hold an undue competitive advantage over the Funds. The intent ofthe reliefrequested in this letter is to rectify this competitive imbalance, and in tum to provide the Funds the ability to extend their purchase and redemption times in response to the demands ofthe investing public and the competitive pressures ofthe marketplace. REASONS FOR RELIEF As indicated above, the expansion of a Portfolio's purchase and redemption times could create a pool of late day money that, given the historical dearth of late day investment opportunities, could end up as idle cash in a Portfolio's investment portfolio. The pool of late day money might be the result of a late day purchase, or it might be the result of assets that were held in cash until the close ofthe redemption period in anticipation of potential redemption requests that were never made. Whatever the cause, the Funds will be placed at a competitive disadvantage vis-a-vis their investment company competitors ifthey are not able to realize some benefit from this excess cash. At least two distinct disadvantages will burden the Funds if they are not able to utilize the Custodian with respect to compensation for overnight cash balances as other investment companies are permitted to utilize their custodian for such balances. First, the Funds will in practical terms be inhibited from extending their purchase and redemption times. Second, even should the Funds attempt to extend their purchase and redemption times in 'order ~o. keep apace of the industry trend, they may be forced to.dilute shareholder return as a result of holding idle cash without receiving any benefit from that cash.8 8The Funds spent a considerable amount oftime and effort attempting to employ a non￾affiliated subcustodian in order to alleviate at least a portion ofthe problems discussed above. Because a significant portion of the Funds' client base is composed of banks and other financial institutions, however, many ofwhich own more than 5% of ~me or more ofthe Portfolios, a large number oflikely subcustodians were considered to be unavailable because oftheir potentially affiliated status. Other viable candidates either were not interested in the relatively small size of the business as a standalone proposition or were willing to un~ertake the business only in exchange for additional business relationships to which the Funds were not willing to accede. Ultimately, given the size and experience ofthe subcustodian options that remained available to .. the Funds, and the economic and operational inefficiencies that the use of a subcustodian would entail (e.g., the need to transfer cash'back and forth between the Custodian and the subcustodian and to maintain the cash
on both the Custodian's and the subcustodian's books, with the accompanying risk of errors in calculation and transmission th~t inevitably accompaniesthe movement ofmoney, as well as the cost of establishins the subcustodial relationship), the Funds determined that the use of a subcustodian in order to receive some return on their excess cash ,/ m:\r\misc\CUSTBEN,NAL 7

Effect on Purchase and Redemption Time Flexibility Without the ability to receive some form of compensation with respect to the excess cash that is expected to result from the expansion of purchase and redemption times, the Funds anticipate that the drag on the Funds' perfonnance created by this excess cash could as a practical matter deny them the flexibility to respond to consumer demand by extending their purchase and redemption times. If the Funds are denied this flexibility that is available to other investment companies, given the intense competition for assets and growing investor sentiment for .expanded purchase and redemption times, the Funds contemplate that they will be forced to forfeit assets to those investment companies that have been able to extend their purchase and redemption times. Such forfeiture could result in rising costs for the Funds' shareholders and a decreased ability ofthe Funds to effectively manage and diversify their remaining assets. The expectations of investors, and particularly institutional investors to which a number of the Funds are marketed, regarding how late in the day purchases and redemptions should be available has recently begun to shift significantly. Not surprisingly, the purchase and redemption times of investment companies have begun to shift with them. Institutional investors in particular have a strong preference for later purchase and redemption cut-off times. As investors learn to interact on a more global basis, as e~onomies become ever more interconnected, and as the pace of busines~ continues its rapid acceleration ) due to the increasing breadth and versatility of communications technology, this preference can be expected to inten~ify. Institutional investors seek later purchase and redemption cut-off times because earlier in the day, as the result ofa number of factors including that their investment portfolios and cash needs may be in a state of flux, their system processing capabilities may lag real time transactions, and they may periodically receive cash receipts late in the day, they often do not know the extent oftheir cash needs or cash availability. Additionally, due to the time difference between the West Coast and the financial centers on the East Coast, the growing number of West Coast investors are typically required to make their investment decisions earlier in their business day. As a result, other matters being relatively equal, investors with these types of issues will migrate to those investment companies that offer them greater purchase and redemption time flexibility. The Funds are concerned that if they are constrained from offering the same type of purchase and redemption time flexibility as their competitors, they may begin to experience a diminution of assets and their shareholders may collaterally begin to experience the negative effects that such a diminution would engender. These negative effects could include reduced was not a feasible alternative.
m:\r\misc\CUSTBEN.NAL 8

economies of scale, higher fixed expense ratios, reduced opportunities for the Funds to diversify assets, and diminished influence of the Funds in the securities markets. Conversely, ifthe Funds are permitted to utilize the Custodian in order to gamer some benefit from their excess cash, they will from a practical standpoint be in a position to extend their purchase and redemption times, thereby helping to maintain a competitive balance in the industry as well as potentially inducing asset growth in the Funds. Such asset growth would carry with it the potential attendant benefits of increased economies ofscale, lower fixed expense/asset ratios, broader asset diversification, and greater strength and leverage in the securities markets. Effect on Performance If a Portfolio were to extend its purchase and redemption times, It is expected that there will be days on which it will hold uninvested cash at the end ofthe day. Ifthe Portfolio is not· able to find an appropriate investment outlet for that cash, its performance and·in tum shareholder return would suffer. Typically, a Portfolio would invest its excess cash in overnight repurchase agreements pending investment in other eligible investments. Given the ease and reliability with which repurchase agreements can be entered into on an overnight basis, they are by far the overnight investment option of choice. However, based upon the extensive experience of the Funds' investment advisers in the money markets, the Funds expect that overnight repurchase agreements will simply not be available on a consistent basis late in the day. Because repurchase agreement counterparties attempt to sell out their collateral inventory relatively early in the trading day to avoid holding excess collateral at the end ofthe day, the supply of eligible collateral typically dries up by 3:00 p.m. Eastern time. Without available eligible collateral, repurchase agreements are not a viable investment option for the Funds. Further exacerbating the severely limited to non-e~istent supply of eligible collateral later in the day, a number ofthe Portfolios are money market portfolios that are governed by Rule 2a￾7 under the 1940 Act. These Portfolios are as a practical matter strictly constrained by the diversification requirements ofthat Rule as to the types ofrepurchase agreement collateral they mayaccept.9 Additionally, these Portfolios, as well as the other Portfolios that are not money 9Pursuant to Rule 2a-7, repurchase agreements receive special portfolio diversification treatment if among other things they are collateralized entirely by securities ofthe U.S. Government (or certain ofits agencies or instrumentalities) or by securities that have received the highest rating from the requisite number of rating organizations. m:\r\misc\CUSTBEN.NAL 9

market portfolios, are subject to stringent eligible collateral requirements pursuant to their own . internal repurchase agreement guidelines. 10 . Repurchase agreements are not necessarily the only overnight investment option open to a Portfolio; depending upon a particular Portfolio's investment policies, other overnight investmentoptions may also be theoretically available. In addition, not all ofthe Portfoljos are permitted to invest in repurchase agreements. However, as with eligible repurchase agreement collateral, other short-term investments, such as short-term Treasury and agency notes and short￾term tax-exempt instruments, also tend to disappear from the market supply relatively early in the day. Furthermore, the government securities wire closes at 3:00 p.m. Eastern time, and since almost all government securities are traded through the Federal Reserve's Book-Entry System, these securities are generally not available after that time. Finally, a number ofthese short-term securities are simply not available, or are available only by coincidence, on an overnight basis. As a result ofthe general lack of supply of eligible repurchase agreement collateral and other types of securities later in the day, the Funds anticipate that to the extent they hold cash late in the day there will likely not be an acceptable investment outlet for that cash. Therefore, should a Portfolio extend·its purchase and redemption times, with the Ilkely result that it will hold excess cash at the end ofthe day, absent the ability to receive some benefit from the Custodian with respect to that excess cash, the Portfolio's performance and the return provided to shareholders will suffer. LEGAL ANALYSIS The 1940 Act's conflict of interest rules generally seek to protect investment companies and their shareholders from the undue and potentially adverse influence that an investment company's affiliates may have over the investment company by ensuring that the terms of any transactions between the investment company and its affiliates do not involve overreaching or self-dealing on the part of the affiliate, and that the terms of such transactions are reasonable and fair and do not improperly discriminate against the investment company. PNC Bank submits that, notwithstanding the Funds' affiliation with the Custodian, inasmuch as the Funds can expect to realize a substantial benefit by utilizing the Custodian as proposed in this letter, and pursuant to the structure of the proposed transactions (and notwithstanding the nominal transaction fee that the Custodian may charge)the Custodian is not expected to receive any significant incremental benefit from engaging in those transactions, the interestS ofthe Funds and 10Although the repurchase ~greement guidelines applicable to the Portfolios are not entirely uniform, as a general matter they follow the requirements ofRule 2a-7, with the non￾money market Portfolios also able to accept collateral ~at is deemed to be of comparable
quality to eligible collateral that has received the highest rating from the requisite number ofrating organizations. m:\r\misc\CUSTBEN.NAL 10

• their shareholders can best be served by allowing the Funds to receive some compensation with
  respect to cash balances maintained overnight with the Custodian.
  Section 17(d) and Rule 17d-l
  Section 17(d) of the 1940 Act and Rule 17d-l thereunder generally prohibit an
  " investment company affiliate, acting as principal, fror.n participating in or effecting any transaction in connection with a "joint enterprise or other joint arrangement or profit-sharing plan" in which the investment company is a participant. Rule 17d-1 (c) defines a "joint enterPrise or other joint arrangementof.profit~sharingplan" to include any contract or arrangement concerning an enterpri~' or under!aking whereby an investment company and an affiliate of the investment company "have a jo~nt or joint and several participation, or share in the profits of such enterprise or undertaking.T' , ' In Norwest Bank Minnesota. N.A. (available May 25, 1995) ("Norwest Bank"), the Staff noted that the prohibitions of Section 17(d) and Rule 17d-1 do not reach every economic relationship between an investment company and its affiliates; rather, some "element of , combination" must first be established. The Staff elaborated that it did "not believe that the mere provision of services to a fund by an affiliated person, without more, establishe[d] the degree of combination required by section 17(d) and rule 17d-1," and furthermore that in its opinion "a , service arrangement between a fund and an affiliated person of the fund under, which , compensation [paid to the affiliated service provider] is not based on a share of the revenue generated by the service"'prb'vider's efforts is not a 'joint arrangement [prohibited by section 17(d) and tule 17d-l]."\ ' , As described ab9Ve,.1he.Custodian receives no share ofthe daily market rate as applied to a Portfolio's overnig~)ash balances. Rather, that entire ?ffiount is returned to the Portfolio. In fact, other than th91l6'ininal transacti~n fee that the Custodian may charge, the Custodian will rec>:,ive no fees with respect to the proposed transactions. The fact that the return provided to a fortfolio is based upon the daily market rate, which is determined independently_ by the marketplace, and that the Custodian has no stake in the amount of benefit provided to a Portfolio, serves to eliminate any incentive that the Custodian might have to take any undue risk with a Portfolio's excess cash or to otherwise engage in activities that might be detrimental to the Funds. .' Moreover, the Staff h~'consistentlypermitted affiliated service providers to provide

services in the ordinary coursi of business to the investment companies with which they are

affiliated. II In particular, the Staff has permitted affiliated custodians to provide custodial

'ii' h:
liSee, ~, Unified Growth Fund (available June 28, 1990) (typesetting, printing, and shareholder report distribution); Flex-Fund (available November 22, 1985) (transfer agency and a~counting services); Federated Securities Corp. (available October 21, 1983) (concluding that m:\r\misc\CUSTBEN.NAL 11

s~iDvestment companies with which they are affiliated. 12 As discussed above, PNC BfI~lIovides custodial services to the Funds. The provision of compensation for ~sis merely an extension of those services, and is similar to services ;~~~erinvestment company custodians for their clients. !~ngaffiliates to provide services to their affiliated investment companies, the StMQ ']~'y required that the compensation paid to the affiliated service provider be fair and -'C....81dtbat other adequate safeguards be in place to prevent overreaching. Apart fmsal.·~transaction fee! which is required to be commensmate with similar fees charged b.yl- -.:which must be reviewed by ea~h Fund's Board of Directors on a periodic baSis, the CUnllta"'not charge the Funds any additional fee for carrying out the proposed tmF~-.!5Qthat the concern regarding the amount of fees that may be charged, while itln,...the present context essentially a moot point. In addition, as described above, oihe....,~will also be instituted with respect to the proposed transactions in order to e"'B'dQi\llP!it'erreaching, including requiring the respective Funds' Boards of Directors to rearminations regarding the propriety of those transactions. These Board dele MM"aresimilar to those typically required by the Staff in the affiliated service priiJO\l-q:n· .~.J}. IE.•... betto Section 17(c) of the 1940 Act Congress had permitted services provided incidmt~M,lessor-lessee relationship between affiliated persons, and because presumably CoDOt intend~d to prohibit such services as impermissible joint transactions pursuant to ~\l(dlafter having permitted them pursuant to Section 17(c), therefore Congress as a gen~did not intend to prohibit service arrangements between affiliated persons). ~~ U' Composite Group of Funds (available· March 2, 1987); IPI-Income & Price Index :rPM'(available December 12, 1980). I~ ~orwest Bank. The Board determinations proposed in this letter differ in three respects ftQm the determinations provided for in Norwest Bank. First, in amplification ofthe detenninaU<lP that the proposed transactions be in the best interests of a Fund, a Fund's Board will speciflc@Uy determine that the rate of compensation received by the Fund pursuant to the proposed tN\Osactions is fair and reasonable. This specific determination was not required in Norwesta_. Second, in view ofthe fact that it would. be an extremely difficUlt proposition for a Fund's Board to conclude that any single vehicle for a Fund's excess cash is so vital that the Fund's.survival depends upon the ability to use that vehicle, rather than determine that the proposed transaetionsare "necessary" for the operation ofthe Fund, the Fund's Board will determine tb3t the proposed transactions are "necessary or desirable" for the operation ofthe Fund. Thi'~ because the nominal transaction fees that may be charged in connection with effecting ~proposed transactions will be insignificant in comparison to a Fund's overall
operationJ,.amount of these fees will be reviewed on an.annual as opposed to a quarterly basis. B~~()fthe de minimis nature of the transaction fees, it is submitted that to require a , .. } m:\r\misc\CtJ~·NAL 12

Sections 17(a)(1) and 17(a)(2)
) In general, Sections 17(a)(I) and 17(a)(2) ofthe 1940 Act, respectively, prohibit an investment company affiliate, acting as principal, from selling securities or other property to, or purchasing·securities or other property from, an affiliated investment company. In order to fall within the parameters of Section 17(a)(I) or 17(a)(2), a transaction must involve the "purchase" or "sale" of "securities" or "property." Because, it is submitted, the proposed transactions do not involve the purchase or sale ofsecurities or property, but rather are merely an extension ofthe custodial services provided by the Custodian, the provisions of Section 17(a)(1) and 17(a)(2) do not apply to the proposed transactions. The purchase or sale of a security or property involves the exchange of value between two parties with respect to that security or property. In point of fact, in offering the transactions proposed in this letter the Custodian is simply offering an upgrade or an enhanced service with respect to the manner in which it maintains a Fund's cash. No separate purchase or sale transaction occurs between a Portfolio and the Custodian. Furthermore, it would be an unusual interpretation to consider an investment company's custody account to be a security. It is worth noting that ifCpngress had intended to include a bank custody account as a "security" pursuant to Section 2(a)(36) of the 1940 Act, 'it could have done so, but it did not. Moreover,while weare aware that in certain circumstances the Staffhas considered certificates of deposits and money market deposit accounts to be securities,14 not only did those circumstahces entail different policy considerations than those presented in the present case,15 but more importantly, due to the different expectations that attach to them, .c~rtificates of Fund's Board to review these fees on a more frequent basis would be an inefficient use ofthe Board's time. Of course, a Board would be free to request information regarding such fees at any time, and the Custodian would stand ready to provide such information. 14See Merrill. Lynch. Pierce. Fenner & Smith. Inc. (available October 28, 1982) (certificates of deposit); Kemper Financial Services. Inc. (av~ilable November 29, 1985) (money m~ket deposit accounts). Contra Marine Bank y. Weaver, 455 U.S. 551 (1982) (due to the protections afforded by the highly regulated nature of banks, as well as the presence of FDIC insurance, certificates ofdeposit are not securities because they do not involve the risk ofloss to an investor that typically accompanies a security); Wolfv. Banco de Mexico. S.A., 739 F.2d 1458 (9th Cir. 1984), cert. denied, 469 U.S. 1108 (1985) (focusing on the protections afforded by. bank regulations, even in the absenc~ ofdeposit insurance, to conclude that certificates ofdeposit are not securities). 15Prior situations in which the Staff has determined certificates ofdeposit and money market deposit accounts to be securities have typically involved
situations in which a commingled investment vehicle was expected to hold certificates of deposit or money market m:\r\misc\CUSTBEN.NAL 13

deposit and money market deposit accounts are fundamentally diff~rent from an investment company's custody account. When a depositor obtains a certificate of deposit it expects to . receive a certain return on its money in exchange for surrendering a certain amount of money to a bank for a certain period oftime, whereas when an investment company maintains a custody account with a bank it expects the bank to safeguard its assets and to have ready access to those assets, and any further benefit from excess cash balances maintained in that account is a serendipity. In short, an investment company's custody account serves a custodial rather than a profit-making function, and any enhancements to the custody account do not change the essential custodial nature of that account. Finally, even ifit is conceded that an investment company's custody account constitutes "property," the operation ofthat account does not involve the purchase or sale of property. Banks sell their investment company custody clients services, not property. 16 To the extent a custodian provides compensation to an investment company custody client for excess cash balances maintained with the custodian, it does not do so in the form of a purchase or sale. Rather, as an acconunodation to the investment company, it returns to the investment company all or a portion of the intrinsic value that attaches to the investment company's excess cash. ) deposit accounts, and the issue at hand was w~ether the conuningled investment vehicle would thereby be considered to be holding securities and thus would be subject to registration as an investment company under the 1940 Act. A decision by the Staff that these instruments did not constitute securities would have removed the commingled investment vehicle from the ambit of the 1940 Act, and the investors in that commingled investment vehicle from the protections afforded by the 1940 Act, and therefore policy considerations dictated that the instruments be deemed securities. In the present case, in contrast, the Funds remain subject to the general provisions of the 1940 Act, and shareholders receive the additional protection of the measures described above that are designed to mitigate any potential conflicts of interest between the Custodian and the Funds. 16cr Steadman Security Corporation, Investment Company Act Release No. 9830 (June 29, 1977), at pp. 30-40. In Steadman, in considering whether a party that controlled a number of investment companies had improperly received benefits from several banks with which the party . had caused the controlled investment companies to maintain custody accounts, the Commission determined that banks sell their custody customers services and not property, and that therefore . the maintenance of custody accounts with the banks at issue did not involve the purchase or sale ofthe investment companies' property. Although the custody accounts at issue in Steadman did· not provide for compensating balance
arrangements, that fact s~ould not alter the conclusion that in their custodial capacity banks provide services to their custody clients rather than sell property to or purchase property from those clients. m:\r\misc\CUSTBEN.NAL 14

Sections 17(a)(3) and 21(b)
Section 17(a)(3) ofthe 1940 Act serves generally to prohibit investment company
affiliates from borrowing money or other property from an affiliated investment company. Similarly, Section 21 (b) ofthe 1940 Act generally prohibits investment companies (other than unit investment trusts and face-amount certificate companies) from lending money or other property to any person that controls or is under common control with the investment company. Takentogether, with certain exceptions these two provisions generally prohibit an investment company from making loans to its affiliates. Because excess cash balances maintained by an investment company are not loans, it is submitted that the provisions of Sections 17(a)(3) and 21 (b) do not apply to such balances. Absent unusual circumstances, an ipvestment company attempts to keep itself fully invested at all times in order to maximize the return on its assets. In other words, typically an investment company attempts to maintain a zero excess cash balance. If, however, as a result of its investment operations or other operational requirements (e.g., the need to maintain assets in cash in order to meet anticipated redemptions) an investment company happens to carry an excess cash balance on a particular day, it does not therefore mean that the investment company has made a loan ofthat excess cash. The excess cash balance arises as an incident to, and as a . result of, the investment company's operations. Many investment companies abide by a fundamental investment limitation that, with certain exceptions, prohibits the making of loans to other parties. It would be a surprise indeed to most, if not all, of these investment companies should they suddenly be informed that by reason of carrying excess cash balances they are makin!', loans, and are thereby violating their fundamental policy against making such loans. There simply is no contemplation when an investment company maintains an excess cash balance that it is making a loan. No indicia of a loan, such as terms regarding amount or duration, accompany the maintenance ofthose excess balances. The excess cash balances exist as a fact ofthe normal operating functions of an investment company, and are no more than a well-accepted by-product ofthose functions. As a fundamental component ofits custodial dutie~, an investment company custodian maintains the excess cash balances ofits investment company clients. Because an investment company happens to maintain excess.cash balances on a particular day, which balances are necessarily held by its custodian, does not mean that the investment company has made a loan to that custodian. Finally, the provision of compensation for those excess cash balances, a benefit to the investment company, does not thereby extemporaneously change the character ofthat excess cash balance into a loan.. .f-- CONCLUSION. Given the fact that the proposed transactions are an extension of the services currently provided by PNC Bank to the Funds, and that such transactions are routinely made available by , ! I
m:\r\misc\CUSTBEN.NAL 15

• • • •
  custodians as part of an integrated package of custodial services prqvided to their investment company clients, we do not believe that the proposed transactions involve anything more than the provision ofstandard custody services to the Funds. The Staff has on numerous occasions permitted affiliates to provide services to their affiliated investment companies, and given the protections that underlie and are a part ofthe proposed transactions, the proposed transactions do not warrant any different analysis. In this regard, it bears noting that pursuant to the structure ofthe banking industry as well as the operating features ofinvestment company custody accounts generally, the Funds' excess cash balances are currently available to the Custodian in order for it to carry on its banking operations. The proposed transactions are designed simply to allow the Custodian to provide the Funds with a market-based rate of compensation with respect to those balances. Significantly, the proposed transactions will provide an important benefit to the Funds. In sum, they will allow the Funds to compete on a more equal basis with their investment company competitors, who are currently able to receive compensation from their custodian for their excess cash balances. At the same time, the proposed transactions are structured so as to avoid overreaching on the part of, or undue benefit to, the Custodian or its affiliates. Finally, in order to further ensure the propriety ofthe proposed transactions, the transactions are required to be undertaken pursuant to the independent approval and continuing oversight of each Fund's Board ofDirectors. RELIEF REQUESTED .Based on the foregoing facts and circumstances, PNC Bank bmits that the proposed· transactions represent asignificant benefit to the Funds and that the proposed transactions are not such as were meant to be prohibited by the 1940 Act's conflict of interest rules. Therefore, we request the Staff's confirmation that it would not recommend enforcement action to the Commission pursuantto Sections 17(a)(I), 17(a)(2), 17(a)(3), 17(d), or 21(b) ofthe 1940 Act or Rule 17d-l thereunder should the Custodian compensate the Portfolios for cash balances maintained overnight with the Custodian. Thank you for your attention to this matter. For the convenience ofthe Staff, nine copies ofthis letter are enclosed. Please feel free to contact me by telephoning me collect at 215-585 5441 regarding any questions you may have. Also, we would appreciate having the opportunity to discuss this matter further ifthe Staff is considering anything other than a positive response. cc: Karen L. McMillan, Esq. lana M. Cayne, Esq. , ,