SEC Division of Investment Management staff letter: Welsh, Carson, Anderson & Stowe

JUN1.~1~
Our -Ref-. No. 93-118-CC l'" ! Welsh, Carson,
RESPONSE OF THE OFFICE OF CHIEF COUNSEL Anderson & stowe DIVISION OF INVESTMENT MAAGEMENT File No. 132-3 Your letter of March 8, 1993, requests our assurance that we

not recommend enforcement action to the Commission if Welsh,

Carson, Anderson & Stowe ("WCAS") organizes and manages three new

investment limited partnerships (the "Funds") without registering

the Funds under the Investment Company Act of 1940 (the "1940

Actll) in reliance on section 3(c) (1) of the 1940 ~ct, if the

aggregate number of limited partners of all Funds -exceeds one

hundred. lj

WCAS is a private investment firm that currently manages

seven i imi ted partnerships. i; The i imi ted partnerships invest substantial ly in management buy-outs, venture capital

investments, and other private equity and debt investments in the

data prqcessing, financial services, heal thcare, and computer

software industries. 1/ The general partners of the existing

i imi ted partnerships are general partnerships comprised of nine individual general partners of WCAS.

WCAS proposes to organize a new private investment fund (the II Insti tutional Fund ") to invest in egui ty securities of companies in the information services and heal thcare industries. The

Institutional Fund will offer limited partnership interests to a

limited number of institutional investors, most of whom

previously have invested in WCAS-managed venture capital or buy . lj Section 3 (c) (1) excepts from the definition of investment

company any issuer whose outstanding securities (other than

short-term paper) are beneficially owned by not more than

one hundred persons and which is not making and does not

presently propose to make a public offering of its securities. i; You state that WCAS has not registered as an investment

adviser in reliance on Section 203 (b) (3) of the Investment

Advisers Act of 1940 (the "Advisers Act") and Rule

203 (b) (3) -1 thereunder. You have not requested, nor do we express, any opinion with respect to the status of WCAS

under the Adv isers Act.

1/ You hav€ not requested, nor do we express, any opinion with

respect to whether one or more of the Funds could be

integrated with one or more of the existing limited partnerships.

out funds.!/ The minimum investment will be $5 million. It is

anticipated that the-num:er~of investors in the Institutional Fund will be greater than 30 but fewer than 50. ~ The general partner of the Institutional Fund will be a limited partnership

whose general partners will be the general partners of WCAS.

Shortly after the closing of the Institutional Fund, WCAS

proposes to organize two new private investment limited

partnerships, WCAS Healthcare Partners, L.P. (the "Healthcare

Fund") and WCAS Information Partners, L.P. (the "Information Fundll) (collectively, the "Individual Funds"). Y The Individual Funds will invest side by side with the Institutional Fund and

other WCAS funds in all heal thcare industry investments (in the

case of the Heal thcare Fund) and in all information services

investments (in the case of the Information Fund), and will

purchase securities at the same price as is negotiated for the

Insti tutional Fund or other WCAS funds. 1/

Only individuals with prior experience in the heal thcare industry will be permitted to invest in the Heal thcare Fund, and

only individuals with prior experience in the information

services industry will be permitted to invest in the Information

Fund. The minimum investment per person for each of the

Individual Funds will be $25,000, and the maximum will be

1/ The offerees of the Institutional Fund will include pension

and profit sharing plans having total assets of not less

than $100 million, major corporations, insurance companies,

banks, private foundations, and charitable institutions.

.2 You represent that any investor that is a "company" for purposes of Section 3 (c) (1) (A) of the 1940 Act and will hold more than 10% of the partnership interests will be required

to represent that not more than 10% of its assets are

invested in companies that are excluded from the definition

of investment company under Section 3 (c) (1) .
Y Each of the three Funds will be a sèparate limited partnership and will be administered separately. Each Fund

will maintain its own books and records, which will be

separately audited. Creditors of anyone Fund will not have

a claim on the assets of any other Fund, and no limited

partner of one Fund will have a right to share in the

prof its or assets of any other Fund.

11 You expect that the Individual Funds will purchase positions that are approximately three to five percent of the value of

the positions purchased by the Institutional Fund and other

WCAS funds in each heal thcare and information services

investment.

-$500,000. The numbe-rof- investors-in each of the Individual Funds will be fewer than 100. ~ You state that the Institutional Fund and the two Individual

Funds are designed for distinct types of investors, and the

differing needs of those investors are reflected in the structure

and operation of the Funds. The tax status of the targeted

investors, for example, will materially influence the operations

of both the Institutional Fund and Individual Funds. Nearly all

of the investors in the Institutional Fund will be institutions

exempt from federal income tax under section 501 of the Internal

Revenue Code of 1986. Because of tax constraints on these

targeted tax-exempt investors, the Institutional Fund will not be

able to employ leverage or certain option and short-sale

investment strategies. By contrast, each Individual Fund will be

permitted to leverage up to 50% of its committed capital and to

purchase and sell options and make short sales. ~ In addition,

to satisfy requirements under the Employee Retirement Income

Security Act of 1974 ("ERISA"), the Institutional Fund will be

required to negotiate for "management rightsll in at least a maj ori ty of its investments. lQ In contrast, because of the relatively small size of their investments, the Individual Funds

ßJ All investors in each of the Individual Funds will be

"accredited investors" within the meaning of Rule 502 under

the Securities Act of 1933.

21 Further, because the 1 imi ted partners of the Individual Funds will be subj ect to federal income tax on distributed

and undistributed profits attributable to Fund transactions,

the Individual Funds will be required to make cash

distributions to limited partners whenever the Individual

Funds' activities generate taxable income to the limited partners. No similar provision is required for the Insti tutional Fund.

1Q You state that because a large proportion of the investors in the Institutional Fund will be pension plans subj ect to

ERISA, the Institutional Fund will conduct its business in

such a manner as to qualify as a "venture capital operating

company," thus avoiding the characterization of the Fund's

assets as "plan assets" subject to ERISA. To qualify, the Insti tutional Fund will be required to structure its investments so that, on predetermined annual valuation

dates, at least 50% of its assets are invested in operating

companies in which the Fund has obtained management rights.

The Institutional Fund, therefore, will follow a strategy of

investing in a small number of buy-out situations in which

it will generally exercise a significant influence over the

management and policies of the portfolio companies.

tor, and will not generally be in a position

to obtain, such rights.

• -will not negotiate

In addition, you state that because investors in the

Individual Funds will be more active in consulting with the

general partners of their respective Funds than the passive role

played by the investors in the Institutional Fund, the Funds will

differ in the manner in which gains and losses are allocated to

their respective general and limited partners. The general

partner of the Institutional Fund will receive a special

allocation of 20% of the net capital gains attributable to

securities sold or distributed over the life of the Institutional Fund. By contrast, the general partners of each of the Heal thcare Fund and the Information Fund will be allocated gains

and losses only in proportion to their respective capital

contributions to these funds.

You also state that in addition to differences in the

structure and operation of the Funds, the expected differences in

portfolio composition and the potential risks and return on

investment in the three Funds would cause a reasonable investor

to regard them as materially different investments. Investments

of the Heal thcare Fund and the Information Fund will be highly

concentrated in their respective core industries, and there is

likely to be very little overlap in investments between the

Heal thcare Fund and the Information Fund. In contrast, you state

that the Institutional Fund will be less focused and more

diversified, due to the much larger amount of capital it has to

invest and the broader spectrum of potential investments it can

make. Thus, although there will be substantial overlap between

the investments of the Heal thcare Fund and the Information Fund

wi th the investments of the Institutional Fund, the portfol io

composi tions of each of the Funds taken as a whole will differ

markedly. Further, you state that the risks and rewards

associated with investments in the Funds should also differ due

to the riskier, more aggressive investment techniques that the

Individual Funds will employ. Specifically, each of the

Individual Funds will be permitted to leverage its investments up

to 50% of its committed capital, but the Institutional Fund will

not be able to employ leverage. In addition, the Individual

Funds will be permitted to employ investment strategies designed

to hedge or lock in investment returns, such as purchasing put

options and selling securities short. The Institutional Fund, in

contrast, may not utilize these techniques.

In determining whether integration is appropriate under the

1940 Act, the staff has previously considered whether a

reasonable investor in two or more entities relying on Section

3 (c) (1) would consider the interests to be materially different.

Relevant to this determination, among other things, is whether

the enti'ti_es share~tb_e~same~i_nyestm~JJtQ0_açti~es,-~()rtt-()iio securities, and portfolio risk/return characteristics. l1 On the basis of the facts and representations in your

letter, and without necessarily agreeing with your legal

analysis, we would not recommend enforcement action to the

Commission under Section 3 (c) (1) if WCAS organizes and manages

the Funds as described in your letter. Because our position is

based on the facts and representations in your letter, you should

note that different facts or representations may require a

different conclusion. Further, this response expresses the

Di vision's position on enforcement action only and does not

purport to express any legal conclusions on the issues presented.

~ ~.ct~

John K. Carter
Attorney
~
11 See Equitable capital Management corporation (pub. avail.
Jan. 6, 1992): Monument Capital Management, Inc. (pub.

avail. ~uly 12, 1990): PBT Covered option Fund (pub. avail.
Feb. l7, 1979). The fact that an investor is prohibited from purchasing interests in more than one entity does not

determine whether integration is appropriate.

1940 Act/3(c)(l)

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-MICH..EL DOWNEy RiCE:
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Secur i ties and Exchange Commission ~
Judiciary Plaza

450 Fifth Street, N.W.

Washington, D.C. 20549

Attention: Office of the Chief Counsel

Division of Investment Management

Welsh. Carson. Anderson & stowe

Ladies and Gentlemen:

We are writing on behal f of Welsh, Carson, Anderson &

Stowe, a New York private investment firm ("WCAS"), to request

confirmation that the staff (the "Staff") of the Securities and

Exchange Commission will not recommend enforcement action against

WCAS if it proceeds to organize and manage three new investment

1 imited pa~tnerships (the "Fundsll) in the manner described below.

Specifical~y, we seek confirmation that the Funds will not be

integrated i for the purpose of applying the exclusion from the definition of "investment company" in Section 3 (c) (1) of the Investment Company Act of 1940 (the "Act"), if the aggregate

number of limited partners of all Funds exceeds one hundred.

This letter details and expands on matters we have discussed

informally with Mr. John Carter of the Division of Investment

Management.
WCAS is a private investment firm that currently

manages seven institutionally funded limited partnerships with

aggregate committed capital of $1.3 billion.' The existing

WCAS has not registered as an investment adviser in reli ance on the exemption provided by Section 203 (b) (3) of the Investment Advisers Act, as amended, and Rule 203 (b) (3) -1 there￾under. We are not requesting a no-action position on this issue. , 1l927.3

limi ted partnerships were organized at various times between 1979

and 1990 and their committed capital has been substantially in￾vested in management buy-outs, venture capital investments and

other private equity and debt investments in the data processing,

financial services, heal thcare and computer software industries.

All of these existing funds are closed-end and do not accept new

partners, or new capital contributions by existing partners,

after their original formation. None of the existing funds has

accepted any new partners or any new capital commitments since

January 1991.

The general partners of the existing funds are general

partnerships comprised of individual general partners of WCAS.

The individual general partners of WCAS are Patrick J. Welsh,

Russell L. Carson, Bruce K. Anderson, Richard H. stowe,

Charles G. Moore, III, Thomas E. McInerney, Andrew M. Paul, James

B. Hoover and Laura VanBuren.

The investors in WCAS' existing funds include approxi￾mately seventy-five institutional investors, principally pension

and profit-sharing plans of major U.s. corporations, state

retirement systems, insurance companies, private foundations and

university endowment funds, as well as a small number of wealthy

indi v iduals. The minimum investment in any of the existing funds is $1 million.

Insti tutional Fund

WCAS proposes to organize a new private investment fund

(hereinafter referred to as the "Institutional Fund"), along the

lines of the existing funds, to invest in equity securities of

companies in the information services and heal thcare industries.

The Institutional Fund will be organized as a Delaware limited partnership, and wil 1 offer 1 imi ted partnership interests to a 1 imi ted number of very substantial institutional investors, most

of whom have invested in previous venture capital or "buy-out"

funds organi zed by WCAS. 2

2 The offerees of the Institutional Fund will include pen￾sion and profit sharing plans having total assets of not less

than $100 million, major corporations, insurance companies,

banks, private foundations and chari table institutions.

"2927.3

The minimum investment in the Institutional Fund will be

$5 million, and it is anticipated that the numer of investors in

the Institutional Fund will be greater than 30 but fewer than 50.
Any investor that is a "company" for purposes of Section 3 (c) (1) (A) of the Act and would hold more than 10% of the partnership

interests will be required to represent that not more than 10% of

its total assets are invested in companies that are exempt from

the definition of "investment company" under Section 3 (c) (1) .
The offering and sale of interests in the Institutional Fund will

not be registered under the Securities Act of 1933 (the "Securi ties Act"), in rel iance on Section 4 (2) thereof. The total commi tted capital of the Institutional Fund is expected to exceed

$500 mill ion.
The general partner of the Institutional Fund will be a 1 imi ted partnership whose general partners will be the general partners of WCAS. It will be solely responsible for selecting investments of and making all decisions with respect to the

activities of the Institutional Fund.

Because nearly all of the investors in the Institu￾tional Fund will be institutions exempt from federal income tax

under Section 501 of the Internal Revenue Code of 1986, the

investment pol icies of the Institutional Fund will be subject to

certain constraints imposed by such investors. . First, the Insti￾tutional Fund will be required to adopt investment strategies

that will avoid generating "unrelated business taxable income"

for its tax-exempt 1 imi ted partners. This restriction will

prevent th~ Institutional Fund from employing any form of lever￾age in structuring its investments: from structuring investments

in a manner that could generate income that might not be consid￾ered capital gains, interest, dividend or other forms of exempt

income under the applicable Internal Revenue Code provisions: and

from sell ing owned securities short, effecting "uncovered" short

sales or purchasing put options as a means of "locking in" gains

on restricted securities that are not yet eligible for sale or

distribution to the partners.

Second, due to the fact that a large proportion of the

investors in the Institutional Fund will be pension plans subject

to the Employee Retirement Income Security Act of 1974 ("ERISA"),

the Institutional Fund will also be required to conduct its business in such a manner as to qual i fy as a "venture capital operating ~ompany", thus avoiding the characterization of the

112927.3

Fund's assets as "plan assets" subject to ERISA.3 In order to so

qualify, the Institutional Fund will be required to structure its

investments so that, on predetermined annual valuation dates, at

least 50% of its assets are invested in operating companies in

which the Institutional Fund has obtained "management rights. ,,4

Therefore, the Institutional Fund will follow a strategy of

investing in a small number of buy-out situations in which the Insti tutional Fund will generally exercise a significant influ￾ence over the management and policies of the portfolio companies.

The Institutional Fund, like the other Funds, will

generally purchase securities of private issuers with the inten￾tion of disposing of such securities in the public securities

markets, or distributing them to its partners, after the class of

securities is registered under the Securities Exchange Act of

1934. Since the securities acquired by the Institutional Fund

will be "restricted securities" within the meaning of Rule 144

under the Securities Act, resales of such securities in the

publ ic securities markets wil 1 have to satisfy the requirements of Rule 144. Due to the preference of institutional investors not to hold restricted securities, the agreement of limited

partnership of the Institutional Fund will prohibit distributions

of securities that are not freely salable under paragraph (k) of

Rule 144. Therefore, the Institutional Fund will have to hold

portfol io securities for a minimum of three years before they can

be distributed to the partners.

The agreement of 1 imi ted partnership of the Insti tu￾tional Fund will provide a standard profit allocation formula for

an institutional venture capital fund, in which the general

partner will be allocated 20% of the excess of net profits over

net losses realized over the entire twelve-year life of the Fund,

as wel 1 as its pro rata share of profits and losses (based on its

1% capital contribution).

3 See 29 CFR 2510.3-101.

4 "Management rights" are contractual rights running di￾rectly between the Institutional Fund and a portfol io company,

which give the Institutional Fund rights to substantially partic￾ipate in or substantially influence the management of the portfo￾lio company. See 29 CFR 2510.3-10l(d) (3) (ii). 1'2927.3

Individual Funds

Shortly after the closing of the Institutional Fund,

WCAS proposes to organize two new investment limited partner￾ships, WCAS Healthcare Partners, L.P. (hereinafter called the

"Healthcare Fund") and WCAS Information Partners, L.P. (hereinaf￾ter called the "Information Fund" and, together with the Health-

care Fund, the "Individual Funds"). The Individual Funds will

invest side by side with the Institutional Fund and other WCAS

funds in all heal thcare industry investments (in the case of the

Heal thcare Fund) and in all information services investments (in

the case of the Information Fund), and will purchase securities

at the same price as is negotiated for the Institutional Fund or

other WCAS fund. It is expected that the Individual Funds will

purchase approximately three to five percent of the total posi￾tions taken by the Institutional Fund and other WCAS funds in all heal thcare and information services investments, and that the total committed capital of each of the Heal thcare and Infor￾mation Funds will be approximately $5 million to $10 million.

Interests in the Individual Funds will be offered only

to individuals who are known to WCAS through its previous invest￾ments in the heal thcare and information services industries.

Only individuals with prior experience in the healthcare indus￾try will be permitted to invest in the Healthcare Fund, and only indi v iduals with prior experience in the information services industry will be permitted to invest in the Information Fund.

These individuals will invest a minimum of $25,000, but in no

event more than $500,000 per person. The investors in the

Individual Funds will also consult with the general partners of

these Funds regarding finding investments and developing rela￾tionships between the portfolio companies that will permit all

three Funds to maximize the values of their investments.
5 The

opportuni ty to invest in the Individual Funds will be offered

only to individuals who the general partners believe have the

ability to benefit the Funds in this manner, and such consulting

represents, in effect, a portion of the consideration that the

individual limited partners are required to furnish in exchange

for their partnership interests.

5 Under Section 17-303 of the Delaware Uniform Limited

Partnership Act, limited partners of the Information and

Heal thcare Funds may consult with or advise the general partner

wi th respect to any matter, including the business of the Fund,

wi thout jeopardizing their status as limited partners and the

limitation on liability associated therewith.

112927.3

The numer of investors in each of the Individual Funds

will be fewer than 100, all of whom will be "accredited inves￾tors" within the meaning of Rule 502. The offering and sale of

interests in the Individual Funds will be not be registered under

the Securities Act, in reliance on Rule 506 of Regulation D.

The management structures of each of the Individual

Funds will reflect the narrower investment objectives and invest￾ment focuses of the two Funds as compared with the Institutional

Fund. The Information Fund will be managed primarily by Messrs.

Anderson and McInerney, two partners of WCAS with extensive

experience in the data processing and computer industries, who

will be the general partners of the general partner of the

Information Fund. The Heal thcare Fund will be managed primarily

by Messrs. Welsh and Carson, each of whom has extensive experi ence in the heal thcare industry, who will be the general partners of the general partner of the Heal thcare Fund. By contrast, the Insti tutional Fund will be managed by all the partners of WCAS

(all of whom will be general partners of the general partner of

the Institutional Fund), reflecting the more varied and diversi￾f ied investment focus of the Institutional Fund.

Unl ike the Institutional Fund, which will not be able

to employ leverage, each of the Individual Funds will be per-

mi tted to leverage its investments to the extent of up to 50% of

its committed capital. Because the Individual Funds will be

relatively small, the ability to use leverage may be important in

affording the Funds a broader range of investment opportunities

than would otherwise be available to them. Leverage will also

generally make investment in the Individual Funds more risky,

while creating the possibil i ty of greater returns on investment.

The general partners of the Individual Funds will also be per-

mi tted to employ investment strategies designed to hedge or lock in investment returns, such as purchasing put options and selling

securities short. None of these strategies may be employed by

the Institutional Fund.

Further, because partners of the Individual Funds will

be taxpayers, rather than tax-exempt institutions, the Individual

Funds will be required to make cash distributions to their

partners to cover tax liabilities of the limited partners arising

out of Fund transactions.

Unlike the Institutional Fund, the Individual Funds

will be free to distribute restricted securities to their part￾ners. The general partners of the Individual Funds will be in a

"2927.3

posi tion to distribute securities held for only two years, which could then be held or resold by the distributees. 6 This feature of the Individual Fund will enable the limited partners of the

Individual Funds to realize on their investment more quickly than

the investors in the Institutional Fund, for which distributions

may not generally be made for a minimum of three years after the

or ig inal investment.
Al though each of the three Funds will invest primarily

in securities of private companies for long-term appreciation,

the Individual Funds will each have terms of eight years (as

compared to the twelve-year term of the Institutional Fund), re￾flecting the fact that the smaller amounts invested by the

Heal thcare Fund and the Information Fund can be more easily

liquidated, and that the individuals who will be their limited

partners prefer a medium-term investment vehicle.

The Individual Funds will also compensate their general

partners differently than the Institutional Fund compensates its general partner. Unl ike the general partner of the Institutional Fund, the general partners of the Heal thcare and Information

Funds will be allocated only their pro rata share of profits and

losses (based on the general partners i 1% capital contribution),

and will not receive any special allocation of profits over the

life of the Funds.7

Each of the three Funds will be a separate limited

partnership and will be administered separately. Each Fund will

maintain i ts own books and records, which will be separately audi ted. Çredi tors of anyone Fund will not have a claim on the assets of any other Fund, and no limited partner of one Fund will

have a right to share in the profits or assets of any other Fund.

6 For a period of two years following the distribution, or

until sales may be made under Rule 144 (k), distributees would be

required to aggregate sales among themselves and with the Part￾nership for purposes of the Rule 144 volume limitation.

7 A management company affiliated with WCAS will receive a

management fee for services rendered to the Funds based on com￾mi tted capital, in the case of the Institutional Fund, or assets

under management, in the case of the Heal thcare and Information Funds. These fees are in addition to the allocations of profits and losses to the general partners of the respective Funds.

112927.3

Section 3 (c) (1) . and Inteqration

Section 3(c)(1) of the Act provides in pertinent part:
(N) one of the following persons is an investment compa￾ny wi thin the meaning of this title:

(1) Any issuer whose outstanding securities

(other than short-term paper) are beneficial￾ly owned by not more than 100 persons and

which is not making and does not presently

propose to make a public offering of its securities.
Accordingly, an issuer must meet a two-part test to

qualify for an exemption under Section 3 (c) (1) : (1) the out￾standing securities of the issuer must be beneficially owned by

not more than 100 persons (the "beneficial ownership test"): and

(2) the issuer must not be making, and must not propose to make,

a public offering of its securities. The Staff has on many

occasions indicated that an offering conducted in accordance with Rule 146 (formerly), Regulation D (at present) or Section 4 (2) of the Securities Act will be deemed to meet the public offering

test of Section 3 (c) (1) of the Act. See,~, C&S Investment

Funds (July 18, 1977). Since the offerings of interests in the

Funds are proposed to be conducted in accordance with the re￾quirements of Rule 506 or Section 4 (2) of the Securities Act, we

believe that the public offering test under Section 3 (c) (1) of

the Act will be met by each of the Funds.

The issue of integration is raised, however, with

respect to the beneficial ownership test. The staff has applied

the concept of integration in determining whether each of two or

more investment partnerships with the same or a related general partner can satisfy the test set forth in Section 3 (c) (1) . In PBT Covered Option Fund (February 17, 1979), the Staff indicated

that it will integrate offerings of limited partnership interests

for the purposes of determining the number of beneficial owners

of the securities involved if, in economic reality, the ostensi￾bly separate issuers are really one issuer. The standard applied

by the Staff was "whether the interest in one (partnership), as

compared to an interest in a second partnership, would be con￾sidered materially different by a reasonable investor qualified

to purchase both."

Applying this standard, the Staff has looked to a vari￾ety of factors to determine whether investments in different

, 12927.3

investment funds are, in reality, materially different from the

standpoint of a reasonable investor. While the Staff has often

focused on distinguishing characteristics of the funds' invest￾ments and investment strategies -- similarity of investment

objectives, portfolio securities and portfolio risk/return char￾acteristics -- the Staff has also considered the characteristics

of the funds themselves insofar as these materially affect a

reasonable investor's view of the investment. Particularly in

the more recent letters, the Staff has recognized that investment

funds can differ in structure and operation for legitimate busi￾ness reasons, such as the tax status of targeted investors, and

that investments in such funds can therefore be materially dif￾ferent even where the investment objectives, portfolio securities

and portfol io risk/return characteristics of the funds are simi lar.
Where two or more funds are intended for the same class

of investors and have similar structural and operational charac￾teristics, the Staff has generally concentrated on differences in

investment obj ecti ves, portfol io composition and expected levels of risk and return on investment in evaluating differences be￾tween the funds. In Meadow Lane Associates, L. P. (May 24, 1989),

for example, integration was not required where two funds were

targeted at the same types of investors and had similar structur￾al and operational characteristics, but had different investment

obj ecti ves (long-term growth vs. special situations), portfolio

securi ties and risk/reward characteristics. However, in cases

where funds were structured to accommodate particular tax and

other requirements of different classes of investors, those

differences figured prominently in the integration analysis. In

Oppenheimer Arbitrage Partners, L.P. (December 26, 1985), the

Staff found that two partnerships that were designed for dis￾tinctly different groups of investors (taxable vs. tax-exempt)

should not be integrated, even though both funds shared a common

investment obj ecti ve of investing in risk arbitrage transactions.

In that situation, the fact that one fund was precluded from

using leverage, uncovered options and other strategies that could

resul t in unrelated business taxable income to its tax-exempt 1 imi ted partners was a critical distinction between the funds. Similarly, in L. Marvin Moorehead (July 4, 1975), the Staff found

that integration of two funds was inappropriate where the fund

designed for tax-exempt investors adopted somewhat different in￾vestment strategies, including restrictions on the use of lever￾age, to accommodate their needs. Indeed, in at least one letter,

the fact that the funds in issue were designed "for one group of

investors with similar investment profiles" was one of the prin￾cipal reasons that integration was required, and the Staff spe , 12927.3

cifically distinguished the Oppenheimer letter in that regard.

Frontier capital Management Company, Inc. (July 13, 1988). See

also Lemke and Lins, "Private Investment Companies under Section

3(c) (1) of the Investment Company Act of 1940," 44 Bus. Law. 401, 427 (" (I) ntegration should not apply if the interests in one
section 3 (c) (1) company are offered in the tax-qualified market

and interests in the other are offered in the non-tax-qualified

market. ") .
Most recently, the Staff concluded that two funds

should not be integrated even though they were to have identical

investment portfolios, where the differences between them re￾suI ted from differences in the targeted investors. In Pasadena

Investment Trust (January 22, 1993), the Staff concluded that

integration between a domestic fund and a foreign "feeder" fund

was inappropriate even though the two funds were to have identi￾cal portfolios, investment strategies and risk/return character￾istics (since the feeder fund could only invest in the domestic

fund). Because the foreign fund would be operated in a manner

that reflected the particular tax requirements of non-U. S. inves￾tors and the regulatory requirements of the foreign jurisdiction

in which the feeder fund was to be formed, reasonable investors

would differentiate between them based on their own tax status.

Thus, the of fshore fund could not possibly be considered the equivalent of a concurrently offered domestic investment fund,

even though the two funds invested in identical securities.

In these and other instances, the Staff has examined

investment funds both from the standpoint of their structure and

operational characteristics designed to accommodate the needs of

the particular investors targeted, and from the standpoint of the

funds' investments. Where the differences in either of these two

general areas were considered material to a reasonable investor

and reflected legitimate business concerns, the Staff concluded

that integration was not warranted. Where the differences were

ei ther insubstantial or artificially imposed by the sponsor in

order to avoid registration, the Staff concluded that ostensibly

separate funds should be integrated. See,~, Monument Caoi tal

Manaqement, Inc. (JUlr 12, 1990), Roqers, Casey & Associates,

Inc. (June 16, 1989).

8 Recently, in BOli table Capital Manaqement Corooration

(January 6, 1992), the Staff also reaffirmed the relevance of the

general principles of integration set forth in Securities Act

Release No. 4552, including whether the offerings (i) are part of

the same plan of financing, (ii) involve the issuance of the same

112927.3

We believe that because of differences in the structure

and operation of the three Funds, which stem from the different

tax and regulatory requirements of the targeted groups of inves￾tors, as well as differences between the Funds in investment

objectives, portfolio securities and portfolio risk/return char￾acteristics, none of the three Funds should be integrated for

purposes of Section 3 (c) (1) .
Structure and Operation

The Institutional Fund and the two Individual Funds are

designed for distinct types of investors, and the differing needs

of those investors are reflected in the structure and operation

of the Funds.

First, the tax status of the targeted investors will

materially influence the operations of both the Institutional

Fund and the Individual Funds. In response to tax constraints on

its targeted tax-exempt investors, the Institutional Fund will

not be able to employ leverage or certain option and short-sale

investment strategies. By contrast, the Individual Fund will be

permi tted to leverage up to 50\ of its committed capital and to

purchase and sel 1 options and make short sales. Because the 1 imi ted partners of the Individual Funds will be subj ect to Federal income tax on distributed and undistributed profits

attributable to Fund transactions, the Individual Funds will be

required to make cash distributions to limited partners whenever

the Individual Funds i activities generate taxable income to the 1 imi ted partners. No similar provision is required for the Insti tutional Fund.

Similarly, to satisfy ERISA requirements, the Insti tu￾tional Fund will be required to negotiate for "management rights"

in at least a majority of its investments. The Individual Funds

class of security, (iii) take place at the same time, (iv) re￾quire the same type of consideration and (v) are made for the

same general purpose. There, the Staff concluded that integra￾tion was not warranted, presumably because the "custom crafted"

nature of the capital and management fee structures of the

several funds demonstrated that the offerings were not really

part of the same plan of financing, even though the funds were

sold at roughly the same time and had similar investment obj ec￾ti ves, portfol io securities and, to some degree, risk/reward characteristics. iiZ927.3

will not negotiate for, and (due to the relatively small size of

their investments) will not generally be in a position to obtain,

such rights.

The structures of the Funds also take into account the

perceived preferences of the classes of investors. The Institu￾tional Fund, for example, is not permitted to distribute portfo￾lio securities until they may be freely resold under Rule 144 (k) ,

because institutional investors do not want the burden of comply￾ing with the volume limitations, manner of sale restrictions and

other provisions of Rule 144. The Individual Funds are permitted

to distr ibute securities earlier, reflecting individual inves￾tors' greater willingness to assume the burden of compliance in

exchange for liquidity of their investment.9 The terms of the

Funds, twelve years in the case of the Institutional Fund and

eight years in the case of the Individual Funds, also respond to

the investment horizons of institutional as opposed to individual investors.
Due to the more active role the investors in the Indi￾vidual Funds will play in consulting with the general partners of

these Funds, and the passive role played by the investors in the

Insti tutional Fund, the Funds will also differ in the manner in

which gains and losses are allocated to their general and limited

partners. As is typical in investment funds for institutional

investors, the general partner of the Institutional Fund will

receive a special allocation of 20% of the net capital gains

attributable to securities sold or distributed over the life of

the Fund. By contrast, the general partners of the Heal thcare

Fund and the Information Fund will be allocated gains and losses

only in proportion to their respective capital contributions to these Funds. This feature strongly differentiates the Individual Funds from the Institutional Fund and most other venture capital

funds, and reflects the contribution of knowledge and expertise

that limited partners of the Individual Funds are expected to

make in realizing the Institutional Fund's objectives. Institu￾tional investors are generally unable or unwilling to make such a

contr ibution.
9 The burden of compliance is also lighter when the number

of shares involved is small. Even though distributee partners

will have to aggregate with one another and the Fund for purposes

of the Rule 144 volume limitation on resales, where an Individual

Fund's holdings are less than 1% of the class there will be no

practical need to monitor or coordinate resales.

11?927.3

Portfol io and Risk/Reward Characteristics
In addition to differences in the structure and opera￾tion of the Funds, the expected differences in portfolio composi￾tion and the potential risks and return on investment in the

three Funds would also cause a reasonable investor to regard them

as materially different investments.

The portfolio composition of the three Funds will vary

significantly. Investments of the Heal thcare Fund and the Infor￾mation Fund will be highly concentrated in their respective core

industries, and there is likely to be very little overlap in

investments between the Heal thcare Fund and the Information

Fund.10 The performance of these two Funds will therefore de￾pend largely on the growth and competitive factors in these

industries, and can be expected to diverge over time depending on

the pace of technological advance, changes in the regulatory

env ironment and other factors. In contrast, the Institutional

Fund will be less focused and more diversified, due to the much

larger amount of capital it has to invest and the broader spec￾trum of potential investments it can make. Thus , although there

will be substantial overlap between the investments of each of

the Heal thcare Fund and the Information Fund and the investments of the Institutional Fund, the portfol io compositions of each of

the Funds taken as a whole will differ markedly, and these dif￾ferences should be reflected in varying risks and returns on

investment over the life of the three Funds.

~he risks and rewards associated with investments in

the Funds ~hould also differ due to the riskier, more aggressive

investment itechniques to be employed for the Individual Funds.

As noted above, the Individual Funds may employ leverage and use

investment strategies involving options and short selling, while

the Institutional Fund may not employ any of these techniques.

Perhaps the most significant difference affecting the

risk and rewards to be expected by a reasonable investor is the

20% special allocation to the general partner of net capital

gains, which is present in the Institutional Fund but not in the

Indi vidual Funds. This factor should make an investment in the

Heal thcare Fund or the Information Fund substantially more at￾10 Overlap in the investments of the Heal thcare Fund and

the Information Fund will occur only if investments are made in

companies that provide information services to the heal thcare

industry.
112927.3

tractive than an investment of an equivalent amount of cash (if

such were possible) in the Institutional Fund, and provides a

substantial incentive for the investors in the Individual Funds

to work with the general partner in maximizing the Funds' oppor￾tuni ties.

Conclusion
Given the material differences between the Institu￾tional Fund, the Heal thcare Fund and the Information Fund de￾scribed above, it is highly unlikely that a prospective investor

qualified to invest in any of the Funds would view an investment

in anyone Fund as the same as an investment in any other Fund.

Indeed, the Staff has taken no-action positions with respect to

funds in which the anticipated dissimilarities in targeted inves￾tors, investments and risk/reward characteristics were less

significant than the differences that are expected to emerge

among the Institutional Fund, the Heal thcare Fund and the Infor￾mation Fund. See Oppenheimer Arbitraqe Partners. L.P. and Pasa￾dena Investment Trust, supra.

Therefore, it is our opinion that the Funds should not be integrated for purposes of Section 3 (c) (1) and that each of the Funds should be permitted to offer and sell limited part￾nership interests to not more than 100 persons in reliance upon
Section 3 (c) (1). We respectfully request that the Staff concur
in this opinion and assure us that it will not recommend that the Commission take any action if the Funds are organized and oper￾ated in the manner described above. Should the Staff not concur with our opinion or be willing to take the no-action position requested, we respectful ly ask that you contact the undersigned so that we may have the opportunity to discuss this matter fur ther. Should you have any questions regarding this request,

please do not hesitate to contact the undersigned or Karen C.

Wiedemann of this office at (212) 841-5700.

Very truly yours,

L- /W~~-I~ ,
Mark J. Tannenbaum

"i927.3