SEC Division of Investment Management staff letter: Puerto Rico Balanced Fund, Inc. — SEC — US

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CR 29 /997: . . .~~~i!r~jr~;?2J£~?¿¿ Ref. No. 97-16-CC

Puerto Rico Balanced
RESPONSE OF THE OFFICE OF CHIEF COUNSEL Fund, Inc. DIVISION OF INVSTMNT MAAGEMENT File No. 132 -3

By letter dated January 10, 1997, you seek assurance that

the staff will not recommend enforcement action to the Commission

if the Puerto Rico Balanced Fund, Inc. (the "Fund") does not

"Investment Company Act") in reliance on Section 6 (a) (1) of the

Investment Company Act.

Facts ..~
You represent that the Fund will be organiied as a Puerto

Rico corporation and will register with the Office of the

Commissioner of Financial Institutions of Puerto Rico as a non-

diversified closed-end or open-end management investment company

under the Investment Companies Act of Puerto Rico. You represent

that the Fund's principal office will be located in Puerto Rico,

and the Fund's official books and records will be maintained in

Puerto Rico. You also represent that a majority of the Fund's

officers and directors will be Puerto Rico residents, and the

Fund's hoard meetings and any shareholder meetings will take

place in Puerto Rico.

You state that the Fund's investment objective will be to

seek both capital appreciation and current income exempt (in

whole or in part) from federal and Puerto Rico income taxes. You

state that the Fund will invest its assets in both equity and

debt securities. You further state that the Fund intends to

enter into transactions such as repurchase agreements, reverse

repurchase agreements, and swaps for non-speculative purposes

("hedging transactions"). You state that while the Fund intends

to invest in securities of Puerto Rico issuers i and engage in

hedging transactions with Puerto Rico counterparties, the Fund

also intends to invest in securities of issuers, and engage in

hedging transactions with counterparties, organized and domiciled

outside of Puerto Rico. You maintain that non- Puerto Rico

counterparties often offer the most favorable terms on certain types of transactions.

You represent that the Fund intends to conduct its portfolio

securities and other transactions with Puerto Rico broker-dealers

whenever possible, subject to best price and best execution. You

also state, however, that the Fund intends to use non-Puerto Rico

broker-dealers, because many of the Fund's securities, including

securities of some Puerto Rico issuers, will be traded outside of

Puerto Rico.' i You represent that the ;Fund's portfolio investments will be ' managed by PaineWebber Incórporated of Puerto Rico ("PW Puerto

Rico"), alone or jointly wi'th another Puerto Rico financial

institution (together, the "Advisers,,).1 You state that in order

to obtain investment expertise with respect to equity and

corporate debt s~~urities of non-Puerto Rico issuers, the

Advisers expect to enter into separate sub-investment advisory

agreements with one or more United Stat,es sub-advisers (the "Sub- Advisers"). With respect to certain matters, such as the selection of specific equity securities (and possibly corporate

debt securities), you state that the Sub-Advisers will have full

investment discretion, although they will be accountable to the

Advisers and, ultimately, the Fund, for these decisions. You

state that the Advisers will have sole authority for making

investment decisions for the Fund as to all other securities and

related transactions, such as income securities. other than corporate debt. 2 ._,.,~ You state that a Puerto Rico financial institution (the

"Administrator") will act as administrator for the Fund. You

state that this entity will have full responsibility to assure

that the Fund is provided such services as: (i) preparing the

Fund's financial statements and coordinating with the Fund's

outside auditors in connection with their annual audit; (ii)

monitoring and assisting in the Fund's compliance with all

applicable laws and regulations; and (iii) calculating the Fund's

expense accruals. You also represent that the Administrator,

with the assistance of the Advisers and Sub-Advisers, will have

the responsibility for valuing the Fund's portfolio investments.

The Administrator will also be responsible for (i) calculating

the net asset value of the Fund's common stock (the "Common

Stock"), and (ii) paying other service providers, all of which

will be done from Puerto Rico.

You represent that a custodian bank (the "Custodian")

located in Puerto Rico will hold the Fund's investments, other

than those held in book-entry form. You also represent that the

same or another Puerto Rico financial institution (the "Transfer

Agent") will act as transfer agent for the Fund.

You state that the Fund proposes to issue debt securities,

such as commercial paper and medium-term notes (the "Debt

Securities") and Common Stock (the Common Stock and the Debt

Securities referred to together as the "Securities"). You

represent that the Fund will offer and sell the Securities only

You state that PW Puerto Rico is a broker-dealer

registered under the Securities Exchange Act of 1934 that has its

sole place of business, and is incorporated, in Puerto Rico. PW

Puerto Rico is a wholly owned subsidiary of PaineWebber

Incorporated, a Delaware corporation.

2 Telephone conver~ation among Edward Rubenstein, Brian Kaplowitz, and Susan Matti~ínko (Apr. 8, 1997). 2

to individuals having their principal residence in Puerto Rico,

and entities having their principal office and place of business in Puerto Rico (1~.Puerto Rico residents") . 3 In addition, you represent that the Fund's prospectus, and each certificate for

the Securities, will state that the Securities may be sold,

pledged, hypothecated, or otherwise transferred only to Puerto

Rico residents. You further represent that the Fund's prospectus

will inform investors that if they cease to be Puerto Rico

residents, they must liquidate their investment in the Fund as

soon as it is economically feasible to do so.

You represent that the initial offering of the Common Stock

will be conducted by one or more underwriters,~each of which will

be a Puerto Rico resident. You represent that;the underwriters

. will include PW Puerto Rico and BP Capital Markets, Inc., a

subsidiary of Banco Popular de Puerto Rico, which is a financial

institution chartered and having its principal office and place

of business in Puerto Rico. Broker-dealers that are residents in

Puerto Rico, including PW Puerto Rico and BP Capital Markets,

Inc., will also be responsible for sales of the Debt Securities.

You also represent that the secondary market for the Securities

will be made solely by broker-dealers that are Puerto Rico

residents. Thus, you maintain that neither the issuance of, nor

trading in, the Securities will have a nexus to the United States

or anywhere else outside of Puerto Rico.

Analysis
Section 6 (a) (1) exempts from regulation under the Investment Company Ac t :
Any company organized or otherwise created under the laws of

and having its principal office and place of business in Puerto Rico, the Virgin Islands,' or any other possession of the United States; but such exemption shall terminate if any

3 You maintain that because of certain tax advantages,

which are available only to Puerto Rico residents, and the mix

and types of portfolio securities that the Fund will own, the

Fund would not, as an economic matter, be a suitable investment

vehicle for anyone other than Puerto Rico residents. You state

that dividends or interest generated from an investment in the

Fund will be exempt from Puerto Rico and United States income tax

only in the hands of individuals residing in Puerto Rico and

entities organized in Puerto Rico, or elsewhere outside of the

United States with their principal place of business in Puerto

Rico. Moreover, you state that in order for the Fund to comply

with the intra-state offering exemption from registration under

Section 3 (a) (11) of the Securities Act of 1933, and Rule 147

thereunder, the Fund may otfer its Securities only to Puerto Rico residents. rr 3

security of which such company is the issuer is offered for

sale or sold after the effective date of this title, by such

company or an underwriter therefor, to a resident of any

State other ,.than the State in which such company is

organized.
You maintain that the Fund should be viewed as meeting the

requirements of Section 6 (a) (1) of the Investment Company Act,

notwithstanding that the Fund proposes to (i) retain one or more United States entities as Sub-Advisers; (ii) invest in' securities of non- Puerto Rico issuers and enter into hedging transactions with non-Puerto Rico counterparties; and (iii) conduct portfolio

securities transactions with non-Puerto Rico broker-dealers. We

agree. In determining whether a fund has its~~rincipal office

and place of business in Puerto Rico," for pUrpgses of Section 6 (a) (1), the staff considers the totality of a fund's contacts with Puerto Rico, and does not consider anyone factor to be controlling. As a general matter, we believe that the

jurisdiction in which a fund invests its assets should not be a

factor in determining the location of its principal place of

business for purposes of Section 6 (a) (1) .4 Based on the facts and representations in your letter, we

would not recommend enforcement action to the Commission if the

Fund relies on Section 6 (a) (1) of the Investment Company Act and

does not register as an investment company under the Investment Company Act. Because this response is based on the facts and representations in your letter ,you should note that different facts or representations may require a different conclusion.

Edward
Senior
4 This response supersedes NTO, Inc. (pub. avail. May 23,

1979) (staff unable to agree that a fund's principal place of

business was Puerto Rico when, among other things, investment

decisions would be made by a non- Puerto Rico investment adviser, and 80% of the fund's assets would be invested in non-Puerto Rico

) securities traded on non-Pu~rto Rico securities exchanges).

; i
I'
4

8 ROW N & WOO D LLP
ONE WORLD TRADE CENTER

NEW YORK. N.Y. 10048-0557

TELEPHONE: 212-839-5300
FACSIMILE: 212-839-5599
'cp. Ar mm'io:: (,((;"'\ Investment Company Act of 1940

:!t1'Ji Section 6(a) (1)
PtTLIO AV~ t. l '1. "ll cr
January 10, 1997

, .~

Office of Chief Counsel -;

Division of Investment Management

Securities and Exchange Commission

450 Fifth Street, N. W.

Judiciary Plaza

Washington, D. C. 20549

Attention: John O'Hanlon, Esq.

Re: Puerto Rico Balanced Fund, Inc.

Ladies and Gentlemen:

We are writing in connection with the proposed

organization of the Puerto Rico Balanced Fund, Inc. (the "Fund"),

to request that the Division of Investment Management (the

"Division") confirm that it will not recommend enforcement action

to the Securities and Exchange Commission (the "Commission") if

the Fund offers and sells its securities and conducts its

operations in the manner described herein in reliance upon the

exemption from registration under the Investment Company Act of

1940, as amended (the "1940 Act"), contained in Section 6 (a) (1) thereof. Granting our request will require the following

modifications to the requirements first set forth in the no-

action letter issued by the Division to Puerto Rico Investors

Tax-Free Fund, Inc. ("Puerto Rico Fund I") on October 5, 1994

(the "October 5 Letter"), which is attached hereto: (i) the

elimination of the requirement ~hat a specified percentage of the

Fund's assets be invested in Puerto Rico securities; and (ii) the

elimination of the requirement that transactions in such

securities be conducted with Puerto Rico broker-dealers.

Section 6 (a) (1) exempts from 1940 Act registration any issuer organized and having its principal office and principal

place of business in Puerto Ric~, provided that the issuer's

securities are not offered; or sold to United States citizens who

are not residents of Puer:~ Rico. As described more fully below,

we believe the proposed structure of the Fund meets the

requirements of Section 6"(a) (1) .
LOS ANGELES' SAN FRANCISCO' WASHINGTON

BEIJING' HONG KONG' LONDON' SÃO PAULO

TOKYO REPRESENTATIVE OFFICE

FACTS
A. The Fund

The Fund, like Puerto Rico Fund I and several

subsequently organized affiliated funds identical or similar to

Puerto Rico Fund I (together, the "Existing Puerto Rico Funds"),

will be organized as a Puerto Rico corporation and will register

with the Office of the, Commissioner of Financial Institutions of

Puerto Rico as a non-diversified closed-end or open-end

management investment company under the Investment Companies Act

of Puerto Rico, Act No.6 of October 19, 1954, as amended. The

Fund's principal office will be located in Puerto Rico. As

required under Puerto Rico law, the official books and records of

the Fund will be maintained in Puerto Rico and~ as noted below, a

majority of the Fund's officers and directors ,ill be Puerto Rico

residents. In addition, the Fund's board meetings and any

shareholder meetings will take place in Puerto Rico.

As explained in more detail below, the Fund will invest

in corporate and municipal debt securities, as well as equity

securities, including common and preferred stock, of various

issuers. The issuers of those securities may be organized both

within and outside of Puerto Rico. The Fund also may enter into

various types of other transactions with counterparties within and outside of Puerto Rico. These transactions include, for example, repurchase agreements, reverse repurchase agreements and

interest rate and other swaps.

The Fund's investment objective and, accordingly, its portfolio composition, will differ from that of the Existing Puerto Rico Funds. The investment obj ecti ve of each of the Existing Puerto Rico Funds (in the case of the fifth Existing

Puerto Rico Fund, one of two investment objectives) is to achieve

a high level of current income that is exempt from federal and

Puerto Rico income taxes, consistent with the preservation of

capital. The Existing Puerto Rico Funds, which invest primarily

in debt securities, invest at least 67% of their total assets in

securities issued by the Commonwealth of Puerto Rico and its

political subdivisions, Puerto Rico mortgage-backed securities

and other Puerto Rico tax-exempt securities (the "Puerto Rico

Obligations"). (Although the October 5 letter contemplates a 70%

requirement, the Existing Puerto Rico Funds now adhere to a 67%

limit in reliance on a subsequent no-action letter granted to

Merrill Lynch Puerto Rico Tax-Exempt Fund, Inc. on May 26, 1995.)

In contrast, the Fund will seek to achieve both capital

appreciation and current income exempt (in whole or in part) from

Federal and Puerto Rico income taxes. The Fund will invest a

substantial portion of its assets in equity securities, primarily

common stock, to achieve c~pital appreciation. It also may

invest in equity securities consisting of preferred stock for

income purposes. However~ ¡it is anticipated that the Fund will

seek to achieve current income primarily through investment in various types of debt securities. 2 9667.15

While it is intended that the Fund will purchase

securi ties of Puerto Rico issuers whenever it is prudent to do

so, the Fund will require the maximum flexibility to invest

particularly in equity securities of issuers domiciled outside of

Puerto Rico in order to meet its investment obj ecti ve. i The Fund will also invest in corporate and other debt securities of

non-Puerto Rico issuers.
Similarly, the Fund will engage in transactions, such

as repurchase agreements, reverse repurchase agreements and swaps

for hedging and other purposes, with counterparties located

outside of Puerto Rico where those counterparties offer favorable

terms. For example, the Fund may enter into interest rate swap

agreements with non-Puerto Rico entities. The Fund intends to

use these transactions to hedge its portfolio~aecúrities and Debt

Securities, as defined below, and not as a speç~lative investment. . The Fund intends to conduct its portfolio securities

and other transactions with Puerto Rico broker-dealers wherever

possibl~, subj ect to best price and execution. However, given

that many of the Fund's securities, including securities of some

Puerto Rico issuers, will be traded outside of Puerto Rico, and

that non-Puerto Rico counterparties often offer the most

favorable terms on certain types of transactions, it would be

impractical to require the Fund to conduct a minimum percentage

of transactions with Puerto Rico broker-dealers.

B. The Fund's Service Providers

Investment Advisorv Arranaements. As is the case with

the Existing Puerto Rico Funds, the Fund's portfolio investments

will be managed by PaineWebber Incorporated of Puerto Rico

(" PaineWebber Puerto Rico"), alone or jointly with another Puerto

Rico financial institution (together, the "Investment Advisers") .

PaineWebber Puerto Rico is a broker-dealer registered under the

Securities Exchange Act of 1934, as amended (the "1934 Act II) , having its sole place of business in Puerto Rico. PaineWebber

Puerto Rico, which is a wholly-owned subsidiary of PaineWebber

Incorporated, a Delaware corporation, also is incorporated in

Puerto Rico.
The Investment Advisers expect to enter into a separate

sub-investment advisory agreement with each of one or more United

States sub-advisers (the II
Sub-Advisers " ), one of which may be Mitchell Hutchins Asset Management Inc., an affiliate of

PaineWebber Puerto Rico, which would advise primarily with

respect to the Fund's equity investments. The retention of the

Sub-Advisers is necessary primarily to obtain investment

) i Of course, the Fund will comply with any applicable investment requirements imposed by Puerto Rico law. For purposes of our request, however, the Division should assume that no such requirements are applicable. 3 9667.15

expertise with respect to equi,ty and corporate debt securities of non-Puerto Rico issuers. With respect to certain matters, such as the selection

of specific equtty securities (and possibly, corporate debt

securities), the Sub-Advisers will have full investment

discretion, although they will be accountable to the Investment

Advisers and, ultimately, the Fund, for these decisions. In

other areas, the Sub-Advisers will act in a more consultative

role. For example, it is expected that the Sub-Advisers will provide information and advice concerning such matters as general economic conditions and overall asset allocation and other

security-specific advice. This consultative advice, while

substantively valuable to the Investment Advisers, will be nonbinding on the Investment Advisers and the Fung. Thus, the

Investment Advisers will have sole authority for making

investment decisions for the Fund as to all other securities and

related transactions, as they do for the Existing Puerto Rico

Funds.
Administrative Arranqements. As is the case with the Existing Puerto Rico Funds, a Puerto Rico financial institution

will act as administrator (the "Administrator") for the Fund.

This entity will have full responsibility to assure that the Fund

is provided with such services as (i) preparing the Fund's

financial statements and coordinating with the Fund's outside

auditors in connection with their annual audit, (ii) monitoring

and assisting in the Fund's compliance with all applicable laws

and regulations, and (iii) calculating the Fund's expense accruals. The portfolio investments of the Fund will be valued in

Puerto Rico by the Administrator with the assistance of the Investment Advisers and the Sub-Advisers, as is the case with the

Existing Puerto Rico Funds. The net asset value of the common

stock (the II Common Stock") issued by the Fund will be calculated

in Puerto Rico, and payments to other service providers will be

made from within Puerto Rico. The official records of the Fund

must, under Puerto Rico law, and will be maintained by the Fund

in Puerto Rico.

Custodial and Transfer Aqencv Arranqements. The

investments of the Fund (other than those held in book-entry form

including, among others, those that are eligible for deposit with

The Depository Trust Company (IIDTCII)) will be physically held by

a custodian bank (the "Custodian") located in Puerto Rico. The

same or another Puerto Rico financial institution (the "Transfer

Agent") also will act as transfer agent for the Fund, as is the

case with the Existing Puerto Rico Funds. Transfer agency

functions will include,for example, (i) issuing and recording

the appropriate number of, shares of Common Stock as authorized

and holding such shares in the appropriate shareholder account;

(ii) effecting transfers" øf shares of Common Stock by the registered owners thereof, ,upon receipt of appropriate documentation issued by the Fund; (iii) preparing and

9667.15 4

transmitting payments for dividends and distributions declared by

the Fund; (iv) acting as agent for shareholders pursuant to any

dividend reinvestment plan of the Fund; and (v) issuing

replacement certificates for those certificates alleged to have

been lost, stoleD or destroyed. The Transfer Agent will perform

similar functions with respect to any debt securities issued by

the Fund.

Auditinq Arranaements. Fund audits will be conducted

by Puerto Rico resident partners/managers of a nationally

recognized public accounting firm with operations in Puerto Rico.

C. Securi ties Issued by the Fund

The Fund proposes to issue the Commòñ Stock and debt

securities, such as commercial paper and mediùm-term notes (the

"Debt Securities" and, together with the Common Stock, the

"Securities"). Both types of Securities will be offered and sold

only to residents of Puerto Rico, as described below. 2 For

purposes of the discussion herein, entities having their

principal office and principal place of business located in

Puerto Rico are referred to as residents of Puerto Rico.

Because of the tax advantages of the Fund, which are

available only to Puerto Rico residents, and the mix and types of

portfolio securities it owns, the Fund would not, as an economic

suitable investment vehicle for anyone other than

residents of Puerto Rico . Dividends or interest generated from

an investment in the Fund will only be exempt from Puerto Rico

and United States income tax in the hands of individuals residing

in Puerto Rico and entities organized in Puerto Rico or elsewhere

outside of the United States with their principal place of

matter, be a

business in Puerto Rico. 3
2 As noted above, the Fund proposes to enter into swaps, repurchase and reverse repurchase agreements with entities that are not residents of Puerto Rico. We believe that these transactions should not be deemed to violate the requirements of Section 6 (a) (1) of the 1940 Act. 3 Under Section 933 of the Internal Revenue Code of 1986, as amended (the "Code"), the Puerto Rico source income of individuals who are bona fide residents of Puerto Rico during the entire taxable year in which dividends or interest is earned is not subject to United States income tax. Also, the Puerto Rico source income of Puerto Rico or non-United States juridical persons generated by their operations in Puerto Rico is not effectively connected with a trade or business conducted in the United States and, as such, is not subject 'to United States income tax. See Code Sections 871 (b), 882 ~a) and 864 (c) (4) (A). Interest payments made by the Fund will, constitute Puerto Rico source income,

(continued. . . )
9667.15 5

The Securities will be offered exclusively to

individuals who have their principal residence in Puerto Rico,

and to persons, other than individuals, whose principal office

and principal place of business are located in Puerto Rico, and

the prospectuses"offering the shares of Common Stock and the Debt

Securitieg (each a, "Prospectus") will so state.4 In addition,

as will be stated in each Prospectus and in a legend on the

certificates for the Securities, such Securities may be sold,

pledged, hypothecated or otherwise transferred only to Puerto

Rico residents. Each Prospectus also will inform those investors

who cease to be residents of Puerto Rico of their obligation to

liquidate their investment in the Fund as soon as it is

economically feasible to do so. While the Fund acknowledges that

it is uncertain how such an obligation may be enforced, it is

worth noting that investors who no longer resicl in Puerto Rico

will no longer have available the tax benefits-.~that make the Fund

an attractive investment.

The initial offering of Common Stock will be conducted

by one or more underwriters, each of which will be a resident of

Puerto Rico. The underwriters will include PaineWebber Puerto

Rico and BP Capital Markets, Inc. ("BP Capital Markets"), a

subsidiary of Banco Popular de Puerto Rico, which is a financial

institution chartered and having its principal office and place

of business in Puerto Rico. BP Capital Markets is a broker-

dealer registered under the 1934 Act that has its sole place of

business in Puerto Rico. The secondary market for shares of

Common Stock will be made solely by broker-dealers resident in

Puerto Rico, including PaineWebber Puerto Rico and BP Capital Markets. Thus, neither the issuance of, nor trading in, shares of Common Stock will have a nexus to the United States or

anywhere else, outside of Puerto Rico.

The Debt Securities of the Fund will be designed to

produce ihcome that is exempt (in whole or in part) from United

States and Puerto Rico income taxes for eligible investors.

Accordingly, the Debt Securities will be offered, sold or

transferred solely to residents of Puerto Rico. Such sales and

transfers also will be made solely by broker-dealers residents in

Puerto Rico, including PaineWebber Puerto Rico and BP Capital

Markets.

3 ( . . . continued) pursuant to the interplay between Section 861 (a) (1) and

Section 1.863-6 of the regulations promulgated under the

Code.
The above requirements must be met for the Fund to

comply with the intr~~state offering exemption from

registration under the Securities Act of 1933, as amended

(the "1933 Act"), próvided by Section 3 (a) (11) of the 1933 Act and Rule 147 thereunder. 6 4 9667.15

The foregoing describes the proposed operations of the Fund. The issues that are the subject of the instant request involve: (i) the retention of one or more United States entities

as sub-advisers; (ii) whether the Fund should be restricted in

its ability to invest in securities of non-Puerto Rico issuers

and enter into various types of transactions with non-Puerto Rico

counterparties; and (iii) whether the Fund's portfolio securities

and other transactions need to be conducted with Puerto Rico

broker-dealers. For the reasons set forth more fully below, we believe that the Fund may properly rely on Section 6 (a) (1) notwithstanding the retention of a United States sub-adviser and

the elimination of restrictions on portfolio securities and other

transactions. We further believe that while the operations of

the Fund present a particularly compelling case for granting this

request, the same conclusion should extend to~gther funds having

a similar Puerto Rico nexus (~, the Existing Puerto Rico

Funds), regardless of their investment objectines.

DISCUSSION
I. Section 6 (a) (1) of the 1940 Act

Section 6 (a) of the 1940 Act provides in relevant part
that:
The following investment companies are exempt from

the provisions of (the 1940 Act) :

(1) Any company organized or otherwise

created under the laws of and having its

principal office and place of business in

Puerto Rico, the Virgin Islands, or any other

possession of the United States; but such

exemption shall terminate if any security of

which such company is the issuer is offered

for sale or sold after the effective date of

(the 1940 Act), by such company or an

underwriter therefor, to a resident of any

State other than the State in which such

company is organized.

We believe that the Fund should be viewed as meeting

the requirements of Section 6 (a) (1) of the 1940 Act. As described above, the Fund is incorporated and has its principal

office in Puerto Rico, and should be viewed as having its

principal place of business in Puerto Rico.

A. Retention of Sub-Advisers Outside of Puerto Rico

We believe that
'the fact that sub-advisory services may

be provided to the Fund by one or more entities located outside

of Puerto Rico (~, in xpe United States) does not change the

Fund's essential nature as a Puerto Rico enterprise. To put the

9667.15 7

role of the Sub-Advisers in context, it is worthwhile to again

identify the extensive contacts of the Fund and its service

providers with Puerto Rico. Those contacts are: (1) the Fund

will be incorporated and have its principal office in Puerto

Rico, and will maintain its official books and records in Puerto

Rico, (2) PaineWebber Puerto Rico, a Puerto Rico corporation

doing business solely in Puerto Rico, and possibly another Puerto

Rico financial institution will act as investment adviser (s) to

the Fund, (3) a Puerto Rico financial institution will enter into

an administration agreement with the Fund pursuant to which it

will provide all aspects of Fund administration, (4) the Fund

will be registered and regulated as an investment company under

Puerto Rico law, (5) the Fund will be designed to maximize tax

benefits for Puerto Rico residents, to the extent consistent with

its overall investment objective, (6) the Cus~Qdian will hold all

Fund assets in Puerto Rico, other than those beld in book-entry

form, including DTC-eligible securities" (7) tñe Administrator

will value the Fund's assets in Puerto Rico, (8) a majority of

the Fund's officers and directors will be Puerto Rico residents,

(9) the shares of Common Stock of the Fund, as well as its Debt

Securities, will be sold by Puerto Rico underwriters solely to

Puerto Rico residents, (10) the secondary market for the Common

Stock and the Debt Securities will be maintained in Puerto Rico,

(11) neither such Common Stock nor the Debt Securities may be

transferred to any person that is not a resident of Puerto Rico,

(12) investors in the Fund will be made aware of their obligation

to liquidate their investment in the Fund if they cease to be

residents of Puerto Rico, when such liquidation becomes

economically feasible, (13) the Fund's Transfer Agent will be a

Puerto Rico entity, (14) Fund audits will be conducted by Puerto

Rico resident partners/managers of a nationally recognized public accounting firm with operations in Puerto Rico, and (15) the Fund's board meetings and any shareholder meetings will take

place in Puerto Rico. We believe that these contacts demonstrate

that the Fund is fundamentally a Puerto Rico entity, its

principal place of business is Puerto Rico and it is doing

business in Puerto Rico.

The Division has issued very few' no-action letters

regarding Section 6 (a) (1). Nevertheless, direct support for

advisory services, with full investment discretion, being

rendered outside of Puerto Rico may be found in Merrill Lvnch

Puerto-Rico Tax-Exempt Fund, Inc. (pub. avail. May 26, 1995)

("Merrill Lvnch Puerto Rico"). In Merrill Lvnch Puerto Rico, the Division granted a no-action request under Section 6 (a) (1) to an open-end, non-diversified Puerto Rico investment company (the

"Company"). The Company intended to retain a United States

investment adviser, although it would employ Puerto Rico entities

for administration, transfer agency and custodian services.

As mentioned above and unlike the situation in the

Merrill Lvnch Puerto Rico 'letter, in which the United States

investment adviser made ~l investment decisions, the Sub-

Advisers in the instant case will have investment discretion

solely with respect to equity securities and, pos,sibly, corporate

9667.15 8

debt securities. The Puerto Rico-based Investment Advisers will

have sole investment discretion as to all of the Fund's other

securities. We believe that since the Division has allowed the

retention of a United States adviser with investment discretion

with respect to all investments, the retention of one or more

United States sub-advisers with investment discretion only with

respect to equity and corporate debt investments of the Fund, a

fortiori, should pose no disqualification for the exemption

provided by Section 6(a) (1) of the 1940 Act.s

We recognize that the Company in the Merrill Lvnch

Puerto Rico letter agreed to invest at least 67% of its total

assets in Puerto Rico Obligations and to conduct portfolio

transactions involving Puerto Rico Obligations with Puerto Rico

broker-dealers. However, we do not believe ttrgse facts are

required by Section 6 (a) (1). We believe this ""roposition is supported by analogous no-action responses in the offshore fund

area. While those responses involve Section 7 (d) of the 1940 Act, rather than Section 6 (a) (1), they involve a similar issue of whether a fund organized outside of the United States has

sufficient United States contacts as to require registration

under the 1940 Act. 6
The Division has issued several no-action letters to

the effect that registration of an offshore fund is not required

despite the existence of a United States investment adviser and

s Additional support for certain advisory services being rendered outside of Puerto Rico may be found in Inners~ace Medical Capital Corp. (pub. avail. July 21, 1992) (" Innerspace"). The Innerspace letter involved a Puerto Corporation" ) organized to qualify as

an "investment capital fund II under Puerto Rico law and which

was to invest entirely in securities issued by a Delaware

Rico corporation (the II

corporation that had agreed to use the proceeds of the

Corporation's investment to establish a manufacturing

facility in Puerto Rico. The Corporation obtained no-action

assurance and was deemed to have its principal place of

business in Puerto Rico, notwithstanding that it retained a

United States corporation to provide certain necessary

investment expertise. The October 5 Letter itself also

offered partial support by permitting retention of a United

States sub-adviser on a consultative basis.
6 Section 7 (d) generally provides:
No investment company, unless organized or otherwise

created under the laws of the United States or of a State,

and no depositor or trustee of or underwriter for such a'

company not so organ~zed or created, shall make use of the

mails or any means or instrumentality of interstate

commerce, directly ór' indirectly, to offer for sale, sell,

or deliver after sale1 in connection with a public offering,

any security of which such company is the issuer...

9667.15 9

administrator, even when there are investments in securities of

United States issuers and United States broker-dealers may be used. For example, the Division issued such a no-action letter in Shearson International Dollar Reserves (pub. avail. July 15,

1981), where a Luxembourg open-end fund having a Luxembourg

manager and investing primarily in United States dollar-

denominated money market instruments including, among other

things, certificates of deposit of United States and non-United

States banks and interest-bearing deposits therein, had a United

States investment adviser, administrator, sub-custodian and

distributor. Similarly, in Merrill Lvnch & Co., Inc. (pub.

avail. May 12, 1986), the Division issued a positive no-action

letter response with respect to non-United States open-end funds,

notwithstanding the existence of a United States investment

adviser and custodian. But ~ NTO, Inc. (pub~ avail. May 23,

1979) ("NTO, Inc. "), in which the Division de~rmined that

Section 6 (a) (1) was unavailable to a Puerto Rico-incorporated
investment company designed to invest in securities traded in

markets outside of Puerto Rico, and whose investments were

determined by a United States investment adviser and held by a

United States custodian.

The Fund in the instant situation will have fewer

United States contacts than any of the above funds. It will have

a Puerto Rico resident entity performing all of the Fund's day-

to-day administrative and transfer agency functions in Puerto

Rico. The Fund also will have solely Puerto Rico underwriters,

and have custody of all of its assets, other than those that are

eligible for book-entry, in Puerto Rico.

In addi t ion, we note by analogy that under Sect ion 864 (b) (2) (A) (ii) of the Code, the principal office of an

investment company is not determined by the location of its

investment adviser or the nature of its investments. Thus, such

a company may, despite the existence of a United States sub-

adviser and United States investments, be deemed to have its

principal office outside the United States. Under this Code

provision, a corporation that performs "all or a substantial portion" of ten functions (the "ten factors" or "ten commandments") at an office or offices outside of the United

States is considered to have its principal office outside the

Uni ted States. 7

The ten functions are:
(i) communicating with its shareholders (including the

furnishing of financial reports); (ii) communicating with

the general public; (iii) soliciting sales of its own stock;

(iv) accepting the subscriptions of new stockholders; (v)

maintaining its principal corporate records and books of account; (vi) auditLng its books of account; (vii) disbursing payments of dividends, legal fees, accounting fees and officers' and directors' salaries; (viii) (continued. . . ) 10 7

In evaluating whether a corporation's activities fit wi thin the safe harbor, the acti vi ties performed by its agents and service providers are taken into account. We submit that

just as the Fund would thereby be deemed to have its principal

office in Puerta- Rico and not the United States for purposes of

the Code, the Fund should be viewed as having its principal place

of business in Puerto Rico for purposes of Section 6 (a) (1) .8 B. Requirements as to Portfolio

Securities and Other Transactions

and the Use of Puerto Rico Broker-Dealers

While investors in the Existing Puerto Rico Funds will

also benefit if aii of the percentage limitations on the Fund's

assets described in the October' 5 Letter were' ~emoved, the

removal of those limitations is imperative for.khe successful

operation of the proposed Fund. As described above, the Fund

will seek to achieve current income and capital appreciation.

The Fund, therefore, will invest in equity securities, as well as

in a wider variety of types of debt securities, than the Existing

Puerto Rico Funds. While it is intended that the Fund will

purchase equity and debt securities of Puerto Rico issuers

whenever it is prudent to do so, the Fund will require the

maximum flexibility to meet its investment objective. In

addition, the elimination of percentage limitations would avoid

the necessity for the difficult task of defining precisely the

concept of a "Puerto Rico Issuer" in the context of a company

issuing corporate debt or equity securities. In that regard, we

note that there are relatively few public companies in Puerto

Rico in which the Fund could invest, and those that exist tend to

be concentrated in financial services. Consequently, we believe

it is important that the Fund not be required to invest any

minimum percentage of its assets in securities of Puerto Rico issuers. As a corollary, we request that the Fund be exempt from

the requirement of the October 5 Letter that a corresponding 67%

percent of the Fund's investment transactions be conducted with

Puerto Rico broker-dealers. Given that many of the Fund's

securities, including securities of some Puerto Rico issuers,

7 ( . . . continued) publishing or furnishing the offering and redemption price

of the shares of stock issued by it; (ix) conducting

meetings of its shareholders and board of directors; and

(x) making redemptions of its own stock.

The Existing Puerto Rico Funds are foreign corporations under Section 7701 of ,the Code, and because they satisfy the

"ten factor" test unq.er Section 864 (b) (2) (A) (ii) of the

Code, they are not subject to United States federal income

tax on their net income. Thus, they are taxed like offshore funds. '

11
8
9667.15

will be traded outside of Puerto Rico, the above requirement

should be eliminated, particularly in light of the need to obtain

best price and execution. 9, Similarly, the Fund intends to enter

into other transactions with Puerto Rico counterparties when the

terms of those t~ansactions are advantageous to the Fund.

Wi th regard to the foregoing requests, we do not

believe it is necessary under Section 6 (a) (1) for the Fund to

invest in securities of Puerto Rico issuers, enter into a minimum

amount of transactions with Puerto Rico entities, or use Puerto

Rico broker-dealers to any specified degree. As the above-

mentioned no-action responses involving Section 7 (d) of the 1940

Act indicate, the registration of an offshore fund is not

required despite the potential for unlimited investments in

securities of United States issuers or transacbions with United

States broker-dealers or other entities. Furt~ermore, as

indicated above, the "ten factor" test has no provision that a,

corporation invest in securities of non-United States issuers or

conduct trades offshore in order for it to be deemed to have its

principal office outside the United States. In fact, Section 864 (b) (1) (A) of the Code states that trading in stocks or securities through a broker in the United States is not a trade

or business in the United States.

In addition, the Commission staff appears to have taken

a similar view in the context of commodities vehicles relying on

the intrastate offering exemption of Rule 147 under the 1933 Act.

See, ~, C. S. Tradinq Partnership No.2 (pub. avail. May 7,

1981) ("C.S. Trading") i Gem Foods, Inc. (pub. avaiL. August 15,
1977). But ~ Euqene T. Ichinose, Jr. (pub. avail. February 15, 1979). In C. S. Trading, the Division of Corporation Finance

permi t ted a Pennsylvania partnership, among other things, to trade commodities futures through an out-of-state broker on

exchanges located outside of Pennsylvania. 10 Similarly, we

submit that it is not necessary under Section 6 (a) (1) to require

that a minimum percentage of the Fund's investments be in

securities of Puerto Rico issuers.

Finally, we wish to reemphasize that notwithstanding

any relaxation of the above restrictions, the Fund's tax benefits

are available only to persons who are residents of Puerto Rico.

In that regard, the Fund is designed to provide Puerto Rico

9 The Fund intends, however, to conduct its portfolio transactions with Puerto Rico broker-dealers wherever possible, subject to best price and execution. 10 There was, however, a limit on the percentage of the net offering proceeds that the partnership could place with the out-of-state broker to satisfy margin requirements. While it is not clear" the no-action letters seem to indicate that such a~ limitation is intended to address the location of assets rather than the nature of the partnership's portfolio transactions;
9667. is
12

investors with current income, including income exempt (or

partially exempt) from Puerto Rico and Federal income tax (and

capital appreciation). Therefore, we understand that the Fund,

like the Existing Puerto Rico Funds, will be exclusively tailored

to the Puerto R~ço market, will be attractive as an investment

vehicle solely to investors who are residents of Puerto Rico and

will be sold only to Puerto Rico residents.

CONCLUSION
We respectfully submit that the Fund should qualify for the exemption provided by Section 6 (a) (1) of the 1940 Act, notwithstanding the proposed retention of a non-Puerto Rico entity as sub-adviser, the elimination of percentage requirements as to the Puerto Rico nature of the Fund's investment and other transactions and the elimination of the requii;~ment that such transactions be conducted with Puerto Rico bro~er-dealers. The Fund will have numerous and substantial contacts with Puerto Rico such as to make it readily apparent that the Fund's principal place of business is located in Puerto Rico for purposes of Section 6 (a) (1). As required by Section 6 (a) (1), the Fund will sell its Securities only to Puerto Rico residents, and these Securities may subsequently be transferred only to qualified persons. We appreciate your prompt attention to this request.

If you have any comments or questions, please feel free to call

either Brian M. Kaplowitz ((212) 839-5370) or Susan Mattisinko

((212) 839-5428) of Brown & Wood LLP or Victoria E. Schonfeld

((212) 713-8853) of Mitchell Hutchins Asset Management Inc.

Very truly yours,

/;.' . '" -~
/1 ¡

/.)-'-y; l ¡~';':-l, J.l./'

~
9667.15 13