SEC Division of Investment Management staff letter: The Royce Fund

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Our Ref. No. 94-612-CC
RESPONSE OF THE OFFICE OF CHIEF COUNSEL The Royce Fund DIVISION OF INVESTMNT MAAGEMENT File No. 811-3599 Your letter of September 27, 1994 requests assurance that we

would not recommend enforcement action to the Commission under

Section 12 (d) (3) of the Investment Company Act of 1940 (the

"Act") or Rule 12d3 - 1 thereunder in the event that registered

investment companies advised by Quest Advisory Corp. ("Quest") or

its affiliates (the "Funds") purchase securities issued by

unregistered investment advisers to unregistered investment

companies. You represent that all such purchases would be

subj ect to the restrictions of Rule 12d3 - 1 (b). You state that

Quest is interested in purchasing for the Funds publicly traded

securities of foreign issuers that are investment advisers to

foreign investment companies.

Section 12 (d) (3) of the Act generally prohibits a registered

investment company and companies it controls from acquiring any securi ty issued by a broker, a dealer, an underwriter, an investment adviser of an investment company, or a registered

investment adviser. Rule 12d3 - 1 exempts from the prohibitions of
Section 12 (d) (3) certain acquisitions of securities of issuers

engaged in "securities related activities." 1./ Subparagraph

(d) (1) of the Rule defines "securities related activities" as a person's activities as a broker, a dealer, an underwriter, an

investment adviser registered under the Investment Advisers Act

of 1940, or as an investment adviser to a registered investment

company (emphasis supplied). Thus, the exemption provided by the

Rule would not appear by its terms to extend to acquisitions of

securities issued by an unregistered investment adviser to an

unregistered investment company.

You assert that the history of Rule 12d3 - 1 demonstrates that

the Commission's failure to include a person's activities as an

1./ Rule 12d3 - 1 (b) provides that notwithstanding Section 12 (d) (3), an acquiring company may acquire any security issued by a person that, in its most recent fiscal year,

derived more than 15% of its gross revenues from securities

related activities, provided that: (1) immediately after the

acquisition of any equity security, the acquiring company

owns not more than 5% of the outstanding securities of that

class of the issuer's equity securities; (2) immediately

after the acquisition of any debt security, the acquiring

company owns not more than 10% of the outstanding principal

amount of the issuer's debt securities; and (3) immediately

after any such acquisition, the acquiring company has

invested not more than 5% of the value of its total assets

in the securities of the issuer.

unregistered investment adviser to an unregistered investment

company within the definition of "securities related activities"

was inadvertent. In 1984, the Commission amended Rule 12d- 1 and

redesignated it as Rule 12d3-1. Prior to this amendment,

securities related businesses were defined to include, in the

case of investment advisers, "an investment adviser of an

investment company, or an investment adviser registered under"

the Act. ~/ When the Commission adopted Rule 12d3 - 1, the

definition of securities related activities was limited, with

respect to investment advisers, to registered advisers or

investment advisers to "registered" investment companies. The

release adopting Rule 12d3 - 1 did not explain why the word

"registered" was added to the definition. J./

In 1989, the Commission proposed amendments to Rule 12d3-1

that, among other things, would have amended the definition of

"securities related activities" to include a person's activities

as an investment adviser to an unregistered investment

company. ~/ Footnote 2 of the 1989 Release stated that absent

this change to the definition,

acquiring companies cannot rely on (R) ule 12d3 - 1 to acquire interests in a company that serves as an

(unregistered) investment adviser to an investment

company, foreign or domestic, that is not registered

with the Commission.

For reasons unrelated to the change discussed in footnote 2 of

the 1989 Release, the proposed amendments were never adopted. 2/

In 1993, the Commission proposed and adopted amendments to

Rule 12d3-1, but did not amend the definition of "securities

related activities." Neither the proposing nor the adopting

release discussed the concerns raised in footnote 2 of the 1989

Release. Q/

~/ See Investment Company Act Release No. 4044 (Sept. 4, 1964) (adopting Rule 12d- 1) . J./ See Investment Company Act Release No. 14036 (July 13,
1984) .
~/ See Investment Company Act Release No. 17096 (Aug. 11, 1989)

(the "1989 Release").

2/ See Investment Company Act Release No. 19204 (Jan. 8, 1993).

Q/ See Investment Company Act Release Nos. 19204 (Jan. 8, 1993) and 19716 (Sept. 23, 1993). 2

We would not recommend that the Commission take enforcement

action under Section 12 (d) (3) of the Act or Rule 12d3 - 1

thereunder if the Funds acquire securities issued by unregistered

investment advisers to unregistered investment companies, subj ect

to the restrictions of Rule 12d3 - 1 (b). This letter expresses the

Division's position on enforcement action only and does not

express any legal conclusions on the issues presented.

~(liW 71. tJÚitup

Ú~nice M. Bishop
Attorney
3

ROSENMAN & COLIN
575 MADISON AVENUE. NEW YORK, NY 10022-2585

TELEPHONE (212J 940-8800
SAMUEL i. ROSENMAN (1896-1973)
CABLE ROCOKAY NEWYORK
RALPH F. COLIN ('900-1985)

TELECOP'ER (212) 940-8776

(2'2) 935-0679 WASHINGTON OFFICE
TELEX 427571 ROSCOL (ITT) 1300 19TH STREE.T. N. W. 9~~ß.a-~ .i r. F kG N Y ~ ~~.. .l',) WASHINGTON, D. C. 20036 TEL E P H 0 N E (202) 463. 7 I 77

-......"""j,..;...,. j.;; '.~ i . '.:...:., .1 (1 v1 01.' 1/1 / /D (....-- Lr _ 7 l. COUNSEL ~ . HOWARD J. KASHNER ~.....'... b;~.l on TEL: (212) 940-6340 .'¡CA--§12(d) (3)--Rule 12d3-1(d) (1) ,lt~.....,..,- JJd~ - 1 fi

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-...,...J; '..._ l/!bll1ty 1;/2¿(/fs .~,t,~.~l.~'r 27, 1994

Jack W. Murphy, Esg.

Chief Counsel

Division of Investment Management

Securities and Exchange Commission

450 Fifth Street, N. W. - stop 10-6

Judiciary Plaza

Washington, DC 20549

Re: The Royce Funds

Dear Mr. Murphy:

We represent Pennsylvania Mutual Fund, The Royce Fund, Royce

Value Trust, Inc. and Royce OTC Micro-Cap Fund, Inc., registered

management investment companies (each, a "Fund" and collectively, the "Funds"). We are writing to you, on behalf of the Funds, to request your advice that the staff of the Division of Investment

Management (the "Staff") of the Securities and Exchange

Commission (the "Commission") interprets section (d) (1) of Rule

12d3-1 (the "Rule") under Section 12 (d) (3) of the Investment Company Act of 1940, as amended (the "Act"), in the manner

described below, so as to permit the Funds and other registered

investment companies and any companies controlled by them to

invest in securities issued by persons who are investment

advisers not registered under the Investment Advisers Act of

1940, as amended (the "Advisers Act"), to investment companies

not registered under the Act. To our knowledge, the Staff has

not previously been requested to grant "no action" relief to

permit such an investment, and no application for an exemptive

order has addressed this issue.

As more fully explained below, Section 12 (d) (3) of the Act makes it unlawful for a registered investment company to invest

in any security issued by a person who is "an investment adviser

of an investment company", and the exemption provided by the Rule

does not expressly extend to securities issued by an investment

Jack W. Murphy, Esg.

adviser to an unregistered investment company. We believe that

the Commission has always intended to have the securities of such an issuer covered by the Rule, that the failure of section (d) (1) of the Rule to treat a person's activities as an unregistered

investment adviser to an unregistered investment company as

"securities related activities" was wholly inadvertent, and that

the circumstances that led the Commission to expand the exemptive

relief afforded by the Rule in July 1984 and September 1993

warrant the interpretation requested by this letter -- l.e.,

treating a person's activities as an investment adviser to an

unregistered investment company as "securities related

activities" for purposes of the Rule.

We are writing this letter on behal f of the Funds, whose

investment objectives include long-term capital appreciation,

because of the interest of Quest Advisory Corp., their investment

adviser, in purchasing for one or more of the Funds publicly-

traded securities of foreign issuers that are investment advisers

to foreign investment companies.

Section 12(d)(3)
section 12 (d) (3) of the Act reads, in pertinent part, as

follows:
"It shall be unlawful for any registered

investment company and any company or companies

controlled by such registered investment company to

purchase or otherwise acquire any security issued by or

any other interest in the business of any person who is

a broker, a dealer, is engaged in the business of

underwriting, or is either an investment adviser of an

investment company or an investment adviser registered

under title II of this Act ...."

As the Commission has previously observed, the legislative

history of Section 12 (d) (3) indicates that its purposes were

"principally to prevent investment companies from exposing their

assets to the entrepreneurial risks of securities related

businesses" and, together with other provisions of the Act, also

"to prevent investment companies from being organized, operated,

managed, or their portfolio securities selected in the interests

of brokers, dealers, underwriters, and investment advisers,

whether or not those entities are affiliated persons of the

companies. " See Exemption for Acquisition by Registered

Investment Companies of Securities Issued bv Persons Enqaqed

Directly or Indirectlv In Securities Related Businesses,

Investment Company Act Release No. 13725 (January 17, 1984) (the

"1984 Proposing Release") .

Jack W. Murphy, Esq.

The legislative history of section 12 (d) (3) does not explain

why (i) Congress believed it necessary to include investment

advisers that were not affiliated persons of registered

investment companies within section 12 (d) (3) 's prohibitions or (ii) such prohibitions do not extend to investment in the

securities of an investment adviser that is not registered under

the Advisers Act and does not have an investment company client.

Rule 12d3-1

In any case, as the Commission stated in the 1984 Proposing Release:
"Whatever view is taken of the original purpose of

section 12 (d) (3), the Commission believes that dramatic
changes in the securities industry since 1940 warrant a re￾examination of the section's prohibitions. While the

section may have been designed to protect investment

companies from entrepreneurial risks, and from being managed

in the interests of affiliated persons or more generally in

the interests of brokers, dealers, underwriters and

investment advisers, evidence indicates that today the

section often prevents investment companies from making

investments that may be in the best interests of their

shareholders. "
Based on these developments, the Commission, in January

1984, proposed amendments to Rule 12d-1, the predecessor of Rule

12d-3, so that investment companies could have broader exemptive

relief from the prohibitions of section 12 (d) (3) as soon as

possible. According to both the 1984 Proposing Release and the

release adopting the amendments (Exemption for Acquisitions bv

Reqistered Investment Companies of Securities Issued bv Persons

Enqaqed Directlv or Indirectly in Securities Related Businesses,

Investment Company Act Release No. 14036 (July 13, 1984) (the

"1984 Adopting Release")), the amendments to then Rule 12d-1

would "permit registered investment companies, or companies

controlled by registered investment companies, to acquire

securities issued by persons that, directly or indirectly, are

brokers, dealers, engaged in the business of underwriting, or

ei ther investment advisers of investment companies or investment

advisers registered under the" Advisers Act. Also, the

Conclusion of the 1984 Adopting Release states that the

Commission "is adopting revised rule 12d3-1 to provide exemptive

relief from section 12 (d) (3) of the Act to enable investment

companies to acquire securities issued by persons that, directly

or indirectly, are brokers, dealers, underwriters, or investment

advisers. "

Jack W. Murphy, Esg.

Unfortunately, the actual language of the 1984 amendments to

the Rule, as proposed and as adopted, failed to carry out the

Commission's clearly stated intent concerning securities of

investment advisers to unregistered investment companies. The

proposed amendment's definitions of "securities related

activities" and "securities related business" covered, in the

case of investment advisers, only those registered under the

Advisers Act, and the amendment, as adopted, expanded those

definitions in the case of investment advisers only to

unregistered investment advisers to "registered" investment

companies (thereby including banks (which are generally exempt

from the registration provisions of the Advisers Act and

therefore are not registered investment advisers) within those

definitions). See the 1984 Proposing Release and the 1984

Adopting Release.
Neither the release that proposed eliminating the Rule's two

qualitative conditions (Exemption of Acquisitions of Securities

Issued by Persons Enqaqed in Securities Related Business,

Investment Company Act Release No. 19204 (January 4, 1993) (the

"1993 Proposing Release")) nor the release adopting those

amendments (Exemption of Acquisitions of Securities Issued by

Persons Enqaged in Securities-Related Businesses, Investment

Company Act Release No. 19716 (September 16, 1993) (the "1993

Adopting Release")) addressed the reasons for not expanding the

Rule's definition of "securities related activities" so as to

reach a person's activities as an investment adviser to an investment company, whether registered or unregistered.

That the failures of the 1984 and 1993 amendments to the

Rule to include a person's activities as an investment adviser to

an unregistered investment company were inadvertent is, however,

confirmed by the provisions of the predecessor of the Rule - l.~., Rule 12d-1. Rule 12d-1, adopted in September 1964 to

permi t investment companies to purchase securities of issuers

that derive no more than 15% of their gross revenues from

securities related businesses (subject to certain conditions),

covered, in the case of investment advisers, "an investment

adviser of an investment company, or an investment adviser

registered under the" Advisers Act (paragraph (a)), and thereby

reached the securities of all investment advisers otherwise

subject to section 12 (d) (3) 's prohibitions.
The inadvertency of such failures is also supported by Note

2 to the Commission's unadopted proposal to relax one of Rule

12d3-1's qualitative conditions in order to permit registered

investment companies to acquire the egui ty securities of foreign

securities firms (Acquisition by Reqistered Investment Companies

of the Equity Securities of Foreiqn Securities Firms, Investment

Jack W. Murphy, Esq.

Company Act Release No. 17096 (August 3, 1989)), which reads as

follows:
"Rule 12d3-1(d) (1) defines 'securities-related activities'

as 'a person's activities as a broker, as a dealer, from the

business of underwriting, as an investment adviser

registered under the Investment Advisers Act of 1940, as

amended, or as an investment adviser to a registered

investment company.' Section 12 (d) (3) of the Act, in pertinent part, prohibits an acquiring company from

acquiring any security issued by or any other interest in

'an investment adviser of an investment company.' Proposed

amended rule 12d3-1 would track the language in section

12 (d) (3) by omitting the word 'registered' from the phrase 'investment adviser to a registered investment company' in

the current definition of 'securities-related activities' as

well as in the definition of 'securities-related business.'

Absent this change, acquiring companies cannot rely on rule

12d3-1 to acquire interests in a company that serves as an

investment adviser to an investment company, foreign or

domestic, that is not registered with the Commission."

That proposal was never adopted, and the 1993 amendments to the

Rule inexplicably failed to address the omission.

We believe that the foregoing history of the Rule

demonstrates that the Commission always intended the Rule to

include a person's activities as "an investment adviser to an

investment company", rather than as "an investment adviser to a

registered investment company", within the definition of

"securities related activities" contained in section (d) (1) of

the Rule, and we would very much appreciate obtaining the Staff's

concurrence in our interpretation.

In the event that the Staff does not concur in our

interpretation of the term "securities related activities", then

we request that the Staff advise us that it will not recommend

any enforcement action to the Commission in the event that the

Funds and/or any other registered investment companies to which

Quest Advisory Corp. or any of its affiliates may hereafter be an

investment adviser, invest in the securities of investment

advisers to unregistered investment companies as if a person's

activities as "an investment adviser to an investment company"

were included in the Rule's definition of "securities related

activities". In this latter event, we suggest that the Staff

Jack W. Murphy, Esq.

consider recommending to the Commission an amendment to the

Rule's definition to correct this oversight.

Please call me at (212) 940-6340 if any members of the Staff

have any comments or questions concerning the above.

Very truly yours,

ß~cJ.9fA~~
Howard J. Kashner