SEC Division of Investment Management staff letter: State Street Bank & Trust Company

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FEB 2 8 1995

! PUBLLC Our Ref. No. 95-35-CC

State Street Bank &

"~ESPONSE OF THE OFFICE OF CHIEF COUNSEL Trus t Company

~IVISION OF INVESTMENT MAAGEMENT File No. 132-3

By letter dated January 16, 1995, you request that the staff

confirm that the use of "omnibus accounts" is permissible under

Rule 17f-5 under the Investment Company Act of 1940 (the

"Investment Company Act") .
State Street Bank and Trust Company ("State Street") is a

provider of custody services to the investment company industry.

Currently, State Street maintains individual accounts for each of

its customers at each foreign custodian in its global custody

network. State Street proposes to convert to an omnibus account

arrangement pursuant to which securities of its customers would

be maintained in a single account at each foreign custodian in

the name of State Street on behalf of its customers. The omnibus

account would hold only securities of State Street's customers,

and would not include any proprietary positions of State Street.

Under this arrangement, the foreign custodian would identify on

its books that the securities deposited in each omnibus account

are being held for State Street, as custodian for its customers,

and State Street would identify on its books each customer's

ownership of securities deposited in the omnibus account.

Pursuant to Rule 1 7f-5 (a) (1) (iii) (D), the written contract

governing the manner in which a custodian will maintain an

investment company's assets must provide that "adequate records

will be maintained identifying the assets as belonging to the

company. " You state that there is confusion within the

investment company industry regarding whether omnibus account

arrangements comply with Rule 17f-5 (a) (1) (iii) (D). We believe that omnibus account arrangements, in which a foreign custodian

identifies assets on its books as belonging to a primary

custodian on behalf of its customers, and the primary custodian

identifies the assets on its books as belonging to specific

customers, are consistent with the provisions of Rule 17f-5, including paragraph (a) (1) (iii) (D) . ,/ ÎIYI 1:~ j

iV' k,ú . C~.L'j ii?'
Janice M. Bishop

: At torney
\ /

1940 Act Rule 17£-5

Go ROO N .A.L T MAN BUTOWSKY WEITZEN SHALOV & WEIN ! 14 WEST 47TH STREET NEW YORK. N.Y. 10036-1510 JORIE SYBUL ADAMS BONNIE D. PODOLSK" WRITER'S DIRECT DIAL NUMBER THEODORE ALTMAN ELLIS L. REEM ER 12121 626- 0842 ~ORDAN L. BLEZNICK MICHAEL B. REUBEN DAVID M. BUTOWSKY. P.C. DOUGlA S. RICH RONALD M. FElMAN VICTOR J. ROCO TELEPHONE 12121626-0800 RAYMOND S. FERSKO KEITH L. SCHAITKIN TELEÇ.OPIER 12121626-0799 JEFFREY M. GUSSOFF BARRY D. SHALOV STEPHEN A. HELMAN STUART M. STRAUSS RICHARD M. HERVEY BRUCE J. WEIN C. LEONARD GORDON PAUL RICHARD KARAN MARC WEITZEN DENNIS H. GREENWALD IRVING H. PICARD LAWRENCE J. ZWEIFACH ..AVIER HERNANDEZ COUNSEL REBECCA A. BERLOW VIRGINIA .._ HARNISCH .-..... ......ll-. /7li. ..,~~~i-~ l..rl..Ji.i.:l4.,,¡....~~"',."'...."í. GEORGE L. BISCHOF JON D. KAPLON DAVID M. BRENSILBER JONATHAN KLEIN DENNIS M. BRESNAN NANCY D. LIEBERMAN (",(~1_1 (l A- of (q tfò JUNE H. BRETTLER JEFFREY P. BURNS' ANDREW H. CHARLES CARIN F. MUHLBAUM LAWRENCE A. LONDON i i .

r'JacUon i ALEXANDRA POE M. JEAN CONNOLLY MICHAEL E. RAKA" .'-. "'l- - CLIFFORD S. DICKSON LOUISA S. RUFFINE DANIEL A. ETNA HOLLY G. RUSSELL ?~ .::~~l ~ / -;l - 'J BARBARA E. FEINMAN ERIC D. SACKS KIM B. FIELDS ¡::.lbl1(' BRUCE D. SHAPIRO DEBORAH A. GARFIELD LYLLIAN S. SIMINS i. "'!~ilabil1 ty :......~ :; / 2~' / q c; KAREN B. GOLDFARB CLAIRE R. TELECKI JEFFREY S. GERON LISA A. STANCATI . V" '" '~ ~.,.'.'~,~........~

HILLEL Y. GOLDSTEIN ..UDSON K. VICKERS LOUISE E. HAMBURG.... ISAAC M. ZUCKER .ADMITTED IN OHIO ONLY "ADMITTED IN NEW .JERSEY ONLY January 16, 1995

Chief Counsel,

Division of Investment Management

Securities and Exchange Commission

450 5th Street, N. W.

Washington, D.C. 20549

Dear Mr. Murphy:

This firm represents State Street Bank and Trust

Company (" State Street II) a leading provider of custody

services to the mutual fund industry. As described below,

in connection with a proposed change by State Street in the

manner in which accounts of its investment company clients

would be maintained, an issue has been raised regarding the

extent to which omnibus accounts i which are commonly

maintained by global custodians on behalf of their

investment company clients, are permissible under Rule 1 7f - 5 under the Investment Company Act of 1940. This letter

describes the issue and the reasons why interpretative or no

action relief with respect thereto is appropriate.

A PARTNERSHIP WHICH INCLUDES A PROFESSIONAL CORPORATION

Currently State Street maintains individual

accounts for each of its customers at each foreign custodian

in its global custody network. It now proposes to convert

to an omnibus account arrangement pursuant to which

securities of State Street's customers would be maintained

at each such foreign custodian in a single account in the

name of State Street on behalf of its customers. State

Street believes that omnibus accounts will be easier and

less costly to administer than individual accounts. We have

advised State Street that omnibus accounts are permissible

under Rule 1 7f-5. Certain of State Street's clients,

however have expressed concern about the extent to which

Rule 17f-5 currently authorizes the use of omnibus accounts

and have indicated that they would not be willing to consent

to the use of omnibus accounts without an explicit statement

by the Securities and Exchange Commission (the "Commission")

or its staff confirming the appropriateness of their use.

Thus, absent an explicit staff pronouncement on this issue

State Street will be effectively precluded from converting

to the use of omnibus accounts. To the extent State Street

is so precluded it will be placed at a major competitive

disadvantage relative to its competitors because the use of

omnibus accounts is prevalent in the industry. Indeed, to

State Street's knowledge, most other custodian banks

currently maintain omnibus accounts with the foreign

custodians in their custody networks. The resistance State

Street has encountered from certain of its clients

indicates, however, that notwithstanding the common use of

omnibus accounts and their apparent acceptance by customers

of its competitors and by the Commission itself, there is

confusion within the mutual fund industry as to the extent

to which omnibus accounts are permitted under Rule 1 7f-5. In view of the foregoing, State Street requests

that the Commission's staff issue an interpretive or no

action letter confirming that the use of omnibus accounts is

permissible under Rule 1 7f-5.1 This letter sets forth the

basis for our request.

Backqround
State Street maintains custody of foreign

securities of its customers through a network of foreign custodians. Each foreign custodian qualifies as an "eligible foreign custodian" (within the meaning of Rule

17f-5) or ïs otherwise exempt from such requirement by the

terms of an exemptive order issued by the Commission. In addition, each foreign custodian has entered into a contract

with State Street that satisfies the requirements of Rule -- 1 7f-5. Under State Street's existing foreign custody arrangements, the securities of a customer to be held by a

foreign custodian are deposited with the foreign custodian

in a separate account established by State Street with the

foreign custodian for the specific customer. At all times,

the securities held in the account by the foreign custodian

are identified on the books of the foreign custodian as

belonging to the customer. In addition, at all times, State

Street maintains records identifying the customer as the

owner of all securities held through the foreign custody

network for that customer.

As an alternative to this arrangement, State

Street proposes to establish an omnibus account with each

foreign custodian. Each omnibus account will be used

exclusively for the deposit of foreign securities of

customers of State Street. Under this arrangement (referred

to herein as an "Omnibus Account Arrangement"), the foreign

custodian will identify on its books that the securities

deposited in each omnibus account are being held for State . Street, as custodian for its customers, and State Street will identify on its books each customer's ownership of the

securities deposited in the omnibus account. Through the

¡State Street is a member of the Coalition of Custodian

Banks which has previously submitted to the Commission

proposed revisions to Rule 1 7f-5. This letter is written in

State Street' s indi~idual capacity and not as a member of the Coalition. i

Omnibus Account Arrangement, the customer's securities will

at all times be segregated from the assets of the foreign

custodian and State Street. Opinions will be secured by

State Street from local counsel confirming that holding

securities in omnibus accounts will not adversely affect the

ability of State Street or the customer to recover the

customer's assets in the event of bankruptcy or insolvency

of the foreign custodian.

The Issue
Rule 17f-5 provides a means by which foreign

securities owned by a registered investment company may be

held in custody outside the United States by a custodian

that would otherwise not be eligible to serve as a custodian

under Section 17 (f) of the 1940 Act or through a securities

depository that would otherwise not qualify for use under Rule 17f-4. Rule 17f-5 provides, in relevant part, that an investment company may place and maintain in the care of an

"eligible foreign custodian" (as defined in the Rule) the

company's foreign securities, provided that certain

conditions of the Rule are satisfied. Among other things,

the Rule requires the directors of the investment company to

approve, as consistent with the best interests of the

investment company and its shareholders, a written contract

governing the manner in which such custodian will maintain

the company's assets. Under Rule 17f-5, the contract for

such custody arrangements must provide, among other things,

that "adequate records will be maintained identifying the

assets as belonging to the company. II

The issue presented is whether Rule 1 7f-5 requires a foreign custodian to maintain records identifying all assets as belonging to each specific investment company or whether Rule 17f-5 permits the use of Omnibus Account Arrangements, in which a foreign custodian identifies assets on its books as belonging to aU. S. custodian on behalf of its customers and the U. S. custodian identifies the assets on its books as belonging to specific customers. As discussed below, the relevant history of Rule 17f-5 indicates that omnibus accounts were intended to be permi t ted.

History of Rule 17f-5

The Commission initially proposed Rule 17f-5 for

comment in April 1982. See SEC Rel. No. 40-12354 (April 15,

1982) (the "Proposing Release" and the "Proposed Rule") .
The Proposed Rule required directors of an investment

company to approve, as consistent with the best interests of

the investment company, a custody contract that would govern

the manner in which the securities will be maintained. The

Proposed Rule did not identify specific terms required to be

included in the custody contract. Rather, the Proposed Rule

included instructions identifying the factors that should be

considered by directors with respect to such custody

contract. Instructions 3 (c) and 3 (d) of the Proposed Rule

provided that directors of an investment company should

consider whether the investment company's securities "will

be adequately segregated in an account which contains only

assets of the company or only assets of the deposi tinq

intermediary for its customer" and whether "adequate records

will be maintained by the foreign entity identifying the

securities as belonging to the company or as belonqing to

the depositinq intermediary for its customers" (emphasis

added). In this manner, the Proposed Rule explicitly

endorsed the use of Omnibus Account Arrangements.

In the Proposing Release, the Commission explained

its interpretation of "adequate segregation" and "adequate

records" and distinguished between situations in which an

investment company deposits assets directly with a foreign

custodian and situations in which securities are deposited

with the foreign custodian through an intermediary U. S.

custodian:
Adequate segregation has been most recently

interpreted to mean that the custodian with which

the company is dealing directly should maintain

the securities in an account which contains only

the company's assets. If the company is dealing

with the custodian indirectly, the custodian

should segregate securities in an account which

contains only assets held by the depositing

intermediary for its customers.... If the company

chooses to depqsit the securities first with a

qualified U. S. ¡custodian which in turn deposits

the securities with a foreign entity, the books of

the U. S. custodian should identify the securities

as belonging to the company and the books of the

foreign entity should identify the securities as

'belonging to the U. S. custodian for its customers.

As support for the foregoing interpretation, the

Proposing Release cited the exemptive order that had been

issued to Chase Manhattan Bank, N .A. ("Chase"). See SEC

Rel. No. 40-12053 (Nov. 20, 1981) (referred to herein as the

"Chase Order"). The Chase Order, which had exempted Chase

from the provisions of Section 17(f) and Rule 17f-4 to the

extent necessary to permit Chase to deposit foreign

securities with foreign custodians, explicitly contemplated

that Chase would maintain custody of foreign securities as

an intermediary U. S. custodian through the use of Omnibus

Account Arrangements. Accordingly, the Chase Order required

the custody contract between Chase and the foreign custodian

to include the following provisions (referred to herein as

the "Omnibus Account Provisions") :
Where securities are deposited by (Chase) with a

foreign bank or securities depository, (Chase)

shall identify on its books as belonging to the

investment company the securities shown on

(Chase's) account on the books of the foreign bank

or securities depository.

Where securities are deposited by a foreign bank

with a securities depository, (Chase) shall cause

the foreign bank to identify on its books as

belonging to (Chase), as agent, the securities

shown on the foreign bank's account on the books

of the securities depository.

---

(Chase) will deposit securities in an account with

a foreign bank which includes only assets held by

(Chase) for its customers.

Subsequent; to the Proposing Release, the

Commission issued ad exemptive order to Bank of New York

("BONY") that also contained the Omnibus Account Provisions.

See SEC ReI. No. 40-12858 (Sept. 14, 1982) (referred to

herein as the "BONY Order") . 2

The Commission reproposed Rule 1 7f -5 in January 1984. See SEC Rel. No. 40-13724 (January 17, 1984) (referred to herein as the "Reproposing Release" and the II Reproposed Rule"). As in the Proposed Rule, the Reproposed Rule required the directors of an investment company to

approve, as consistent with the best interests of the

company and its shareholders, a written contract between the

company and the foreign custodian and, in connection

therewith, to consider specific factors, which were set

forth as instructions to the Reproposed Rule. Instructions 3 (c) and 3 (d) of the Reproposed Rule required the directors of an investment company to consider whether the company's

"certificated assets would be maintained in an account which

contains only assets of the company" and whether II adequate

records would be maintained by the foreign custodian

identifying the assets as belonging to the company. II

The Reproposing Release identified six modifications to the scope of the Proposed Rule. Neither the manner in which securities were to be adequately

segregated nor the manner in which records should be

maintained were identified as areas in which modifications

were made.

In September 1984 the Commission adopted Rule 1 7f - 5 in substantially its present form. See SEC ReI. No. 40-14132 (Sept. 7, 1984) (referred to herein as the

2Subsequent to the BONY Order, the Division of

Investment Management took the position that it would not

recommend enforcement action to the Commission if other U. S.

custodian banks and registered investment companies made use

of foreign custody arrangements that conformed to the

conditions outlined in the Chase Order, the BONY Order and

the Proposed Rule. ,See,~, Mitsubishi Bank of

California, SEC No-Section letter (October 1, 1982).

"Adopting Release") . 3 As adopted, Rule 1 7f-5 requires directors to approve, as consistent with the best interests of the investment company, a written contract that will govern the manner in which the foreign custodian will maintain custody of the company's assets. However, rather than offering instructions to directors with respect to appropriate considerations bearing on the approval requirement (as was the approach in the Proposed Rule and the Reproposed Rule), Rule 1 7f-S, as adopted, requires each contract to satisfy specific requirements, including the requirement that "adequate records will be maintained identifying the assets as belonging to the company." Rule 1 7f-5 (a) (1) (iii) (D). While the requirements parallel in large part the instructions contained in the Reproposed Rule, Instruction 3 (c), relating to the requirement of adequate segregation of assets was deleted, in considerätion of commentator suggestions that in a book- entry environment physical segregation of assets is no longer practicable. Furthermore, Instruction 3 (d), was revised to delete any reference to the specific records that must be maintained by a foreign custodian. Instead the rule simply requires that adequate records be maintained identifying the assets as belonging to the investment company. The rule as adopted does not specify the records which must be maintained nor does it specify the manner in which records must be maintained by either the foreign custodian or the U. S. custodian. In discussing the conditions to Rule 1 7f-5, including the condition relating to the maintenance of adequate records, the Commission stated in the Adopting Release that:
With the exception of the conditions relating to

cash and cash equivalents, all of these conditions

are conditions to the exemptive relief granted

Chase and BONY customers. . . .
3Rule 17f-5 was amended in 1985. The amendments did

not affect the port~ons of the Rule relevant to this

opinion. See SEC R~l. No. 40-14711 (Sept. 11, 1985.)

January 16 i 1995

In the Adopting Release the Commission noted that

it was issuing notices to Chase and BONY indicating its

intent to modify certain conditions of the Chase and BONY

Orders to conform to the conditions in Rule 1 7f-5. The

orders subsequently issued by the Commission modifying the

Chase and BONY Orders to conform to the requirements of Rule

17f-S did not modify the Omnibus Account Provisions of

either Order. See SEC Rel. No. 40-14184 (Octòber 9, 1984)

(modifying the Chase Order) and SEC Rel. No. 40-14183

(October 9, 1984) (modifying the BONY Order) .

Discussion
As indicated above, Proposed Rule 1 7f-5 contained explicit requirements with respect to segregation of assets

and the manner in which records must be maintained. Under

the Proposed Rule, assets were required to be adequately

segregated. That requirement was deleted from the rule as adopted. Moreover, the Proposed Rule specified the manner

in which records were required to be maintained by each of

the U. S. custodian and the foreign custodian. The rule as

adopted does not. Rather, it simply requires that adequate

records be maintained that in some way identify the assets

as belonging to the investment company. In light of the

above, it is significant that the rule as originally

proposed explicitly permitted omnibus accounts. To the

extent that such arrangements were permitted under the

relatively rigid standards of the proposed rule they clearly

must be permissible under the more flexible standards of the

rule as adopted.

Our vi8w in this regard is supported by the fact

that neither the Reproposed nor Adopting Releases suggest in

any way that the use of omnibus accounts was intended to be

prohibi ted. Furthermore, as indicated above, on the same

day that Rule 17f-S was adopted the Commission issued a

release revising the Chase and BONY Orders to the extent

that such orders were inconsistent with Rule 17f-S as

adopted. Significantly, the Omnibus Account Provisions of

such orders were not required to be so modified, apparently

reflecting the Commission's view that such arrangements are

consistent with Rule 1 7f-S. i

.~

Finally, we think it appropriate to note that the

practice of using Omnibus Account Arrangements is common

within the global custody industry. Apart from the Chase

and BONY orders referred to above we are not aware of any

exemptive order or no-action letter obtained by such other

custodians authorizing such practice and, therefore, assume

that each bank is relying on Rule 17f-5 as the basis for its

practice. Of course, each such form of agreement is on file

with the Commission as an exhibit to one or more

registration statements of registered investment companies,

but we are unaware of any obj ection that the Commission or

its staff has raised to the use of such Omnibus Account

Arrangements.
Based upon the foregoing, we have advised State Street that Omnibus Account Arrangements are permissible under Rule 1 7f-5. Nevertheless, as noted above, certain of State Street's clients have obj ected to the use of such arrangements. They have done so, not because of any decision by their fund directors that such arrangements are

adverse to the best interests of the company and its

shareholders, but because of their concern that such

arrangements may.not be permissible under Rule 17f-5.

Gi ven the confusion wi thin the mutual fund

industry regarding the propriety of the use of omnibus

accounts, we believe staff guidance on this matter is

necessary. In view of the foregoing, we request the

issuance of a no-action or interpretive letter concurring

with our view that Omnibus Account arrangements are

permissible under Rule 1 7f - 5.
Sincerely i vf'-- ;I.. ~.

I..i..... / ,i (Ý I"lVL

St' art M. Strauss
SMS/bif i ;I