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Parties Involved:
Copley Fund, Inc.
Petitioner
Securities and Exchange Commission
Respondent

Document Text:

United States Court of Appeals 

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued May 4, 2015 Decided August 11, 2015 

No. 14-1142 

COPLEY FUND, INC., 

PETITIONER

v. 

SECURITIES AND EXCHANGE COMMISSION, 

RESPONDENT

On Petition for Review of an Order 

of the Securities & Exchange Commission 

Paul M. Honigberg argued the cause for petitioner. With 

him on the briefs was Philippe M. Salomon. 

Stephen G. Yoder, Senior Counsel, Securities and 

Exchange Commission, argued the cause for respondent. 

With him on the brief were Michael A. Conley, Deputy 

General Counsel, John W. Avery, Deputy Solicitor, and 

William K. Shirey, Assistant General Counsel. 

Before: BROWN, SRINIVASAN and PILLARD, Circuit 

Judges. 

Opinion for the Court filed by Circuit Judge SRINIVASAN. 

USCA Case #14-1142 Document #1567153 Filed: 08/11/2015 Page 1 of 11
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SRINIVASAN, Circuit Judge: Copley Fund, Inc., a mutual 

fund regulated by the Securities and Exchange Commission, 

asked the Commission for an exemption from rules governing 

the calculation and reporting of Copley’s deferred tax 

liability. The Commission denied Copley’s exemption 

request, and Copley now seeks review in this court. Copley’s 

arguments fail to carry the high burden required to overturn 

the Commission’s denial of an exemption. We therefore deny 

Copley’s petition for review. 

I. 

Copley is an open-end mutual fund, meaning that it 

issues redeemable securities to its shareholders. 15 U.S.C. 

§ 80a-5(a)(1). Nearly all open-end funds elect to be treated as 

“regulated investment companies” under subchapter M of the 

Internal Revenue Code, 26 U.S.C. §§ 851, et seq. If a fund 

makes that election, the fund itself avoids corporate taxation 

for capital gains and dividends associated with its holdings as 

long as it satisfies certain conditions, including that it 

distribute at least 90% of its taxable income to shareholders 

each year. Id. §§ 851-55, 860. The tax liability then rests 

with the shareholders rather than with the fund. 

Copley, unlike most open-end mutual funds, has never 

made a subchapter M election. Copley therefore is subject to 

taxation at both the fund and shareholder levels. The 

potential advantage of such an arrangement, as described by 

Copley, is that a shareholder incurs no tax liability in 

connection with the fund’s holdings until she ultimately 

redeems her shares. Copley itself, however, must pay 

corporate tax at the fund level each year on any capital gains 

and dividends attributable to securities in its portfolio. 

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The dispute in this case arose because the market value of 

Copley’s portfolio appreciated significantly from the time 

Copley originally purchased the securities in its fund. As a 

result, Copley would face a significant amount of unrealized 

federal income tax liability if it were forced to sell its 

appreciated holdings. The Commission maintains that the 

applicable rules require Copley to calculate, and report, its 

deferred tax liability based on the amount of tax Copley 

would owe if its entire stock portfolio were to be liquidated. 

In Copley’s view, the Commission’s approach unduly inflates 

the amount of deferred tax liability it must recognize. Copley 

therefore seeks an exemption from the operation of two 

Commission rules. 

The first rule, Rule 22c-1, concerns the calculation of a 

fund’s “net asset value,” 17 C.F.R. § 270.22c-1(a), which in 

turn affects the price paid to redeeming shareholders. 

Because Copley is an open-end fund, its investors have a 

statutory entitlement to redeem their shares at any time in 

exchange for a “proportionate share of [Copley’s] current net 

assets,” i.e., the fund’s net asset value. 15 U.S.C. §§ 80a2(a)(32), 80a-5(a)(1). Rule 22c-1 implements the requirement 

that the redemption price paid to a shareholder must equal an 

allocable share of the fund’s net asset value: “[n]o registered 

investment company issuing any redeemable security . . . shall 

. . . redeem . . . any such security except at a price based on 

the current net asset value of such security.” 17 C.F.R. 

§ 270.22c-1(a). A related rule, Rule 2a-4, provides that, when 

determining net asset value, “[a]ppropriate provision shall be 

made for Federal income taxes if required.” Id. § 270.2a4(a)(4). Additionally, the redemption price must be 

determined in a manner that treats redeeming and nonredeeming shareholders equally, such that the price paid to 

liquidating shareholders does not result in an unfair dilution 

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of the value of the securities still held by non-redeeming 

shareholders. See 15 U.S.C. § 80a-22(a). 

The second Commission rule from which Copley seeks 

an exemption, Rule 4-01 of Regulation S-X, governs the 

manner in which a fund reports its deferred tax liability on its 

financial statements. Under that rule, “[f]inancial statements 

filed with the Commission which are not prepared in 

accordance with generally accepted accounting principles 

[GAAP] will be presumed to be misleading or inaccurate, 

despite footnote or other disclosures, unless the Commission 

has otherwise provided.” 17 C.F.R. § 210.4-01(a)(1); see 15 

U.S.C. §§ 80a-8, 80a-29. 

Copley historically recognized only a small percentage of 

its total potential tax liability. Copley reasoned that, based on 

its actual experience with redemption requests, satisfaction of 

those requests on any given day would require selling no 

more than a small percentage of its stock portfolio. In 2007, 

however, the Commission’s Division of Investment 

Management issued a letter to Copley expressing that Copley 

must recognize the total value of its potential tax liability. 

The Division of Enforcement later warned that it would ask 

the Commission to seek injunctive relief if Copley declined to 

comply. Copley then began to recognize the full value of its 

potential tax liability. Because a fund’s net asset value 

depends in part on the amount of its tax liability, Copley’s 

change in calculation of that liability in turn reduced its net 

asset value per share by more than 20%. 

In September 2013, Copley formally sought an 

exemption from Rules 22c-1 and 4-01, concerning, 

respectively: (i) determination of the net asset value at which 

Copley’s shareholders would be entitled to redeem their 

shares, which in turn depends on the amount of Copley’s tax 

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liability; and (ii) reporting of Copley’s tax liability on its 

financial statements. Copley proposed that it would account 

for and report only a small percentage of its tax liability (with 

the percentage equaling a given multiple of either the fund’s 

historic average or its historic maximum redemption rate). 

According to Copley, its proposed alternatives would have 

resulted in it recognizing a tax liability equal to between 8% 

and 10% of its total potential tax liability. 

On May 15, 2014, the Commission issued a notice 

expressing its preliminary view that Copley’s exemption 

request should be denied. Copley Fund, Inc., Exchange Act 

Release No. 34-72,173, 2014 WL 1943920 (May 15, 2014) 

(Notice). The Commission explained that a fund’s net asset 

value equals the difference between its liabilities and its 

assets. Notice ¶ 7. Consequently, when a fund understates a 

liability (such as its tax liability), the fund’s “net asset value 

will be overstated, as will the price at which the fund’s 

redeemable securities are sold and redeemed.” Id. And 

because an open-end fund must honor shareholder 

redemptions, a “high level of redemptions necessitating 

liquidation of a large portion of its portfolio” would result in 

disparate treatment of redeeming and non-redeeming 

shareholders. Id. ¶ 13. 

In particular, the Commission explained, redeeming 

shareholders would “receiv[e] a price for their shares that 

reflects more than their pro-rata share of the net asset value of 

the Fund” (because their realized net asset value would not 

account for the full tax liability), “while the price of the shares 

held by the remaining shareholders would reflect less than 

their pro-rata share of the net asset value” (because accrual of 

the full tax liability upon redemption would be allocated to 

the remaining shareholders). Id. The Commission explained 

by way of example that, if 60% of Copley’s shareholders 

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redeemed their shares on a given day and Copley had 

recognized only a fraction of its total tax liability per its 

proposal, the redeeming shareholders would have received a 

net asset value of nearly $14 per share as the redemption price 

while the non-redeeming shareholders would have been left 

holding shares with a diluted net asset value of less than $12 

per share. Id. ¶ 14. Because that kind of disparate treatment 

would “produc[e] an unfair and inequitable result among 

Copley’s shareholders,” the Commission preliminarily 

declined to allow Copley an exemption from Rule 22c-1. Id.

¶ 15. 

The Commission also declined to grant Copley an 

exemption from Rule 4-01’s requirement to report deferred 

tax liability in accordance with GAAP in Copley’s financial 

statements. Having determined that Copley must base its net 

asset value on its full potential tax liability, the Commission 

concluded that Copley’s reporting of only a fraction of its 

total tax liability in its financial statements would be 

“unnecessarily confusing to investors and contrary to the 

policy behind the . . . disclosure requirements” of the 

Investment Company Act of 1940. Id. ¶¶ 4 n.6, 18. 

On June 19, 2014, the Commission issued an order 

formally denying Copley’s exemption request “for the reasons 

stated in the notice.” Copley Fund, Inc., Investment 

Company Act Release No. IC-31,088, 2014 WL 2770563 

(June 19, 2014). Copley now petitions for review of the 

Commission’s denial of an exemption. 

 

II. 

We review the Commission’s factual findings for 

substantial evidence and “will set aside its legal conclusions 

only if ‘arbitrary, capricious, an abuse of discretion, or 

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otherwise not in accordance with law.’” Wonsover v. SEC, 

205 F.3d 408, 412 (D.C. Cir. 2000) (citing 5 U.S.C. 

§ 706(2)(A)) (internal punctuation omitted). Because Copley 

challenges the Commission’s denial of an exemption, our 

review is “highly deferential.” Universal City Studios LLLP 

v. Peters, 402 F.3d 1238, 1242 (D.C. Cir. 2005). We will set 

aside the Commission’s denial of an exemption only if “the 

agency’s reasons are so insubstantial as to render that denial 

an abuse of discretion.” Id. (internal quotation marks 

omitted). The Commission did not abuse its discretion here. 

Copley’s primary argument is that the Commission’s 

denial of an exemption was “based solely” on “hypothetical 

speculation” rather than on Copley’s actual redemption 

history. Appellant Br. 37 (capitalization omitted). Noting 

that the highest daily redemption rate in Copley’s thirty-sixyear existence affected less than 6% of its then-outstanding 

shares, Copley asserts that the Commission erred in 

predicating its denial of an exemption on a hypothetical 

scenario contemplating shareholders’ redemption of 60% of 

Copley’s shares in one day. 

Copley misunderstands the Commission’s rationale. The 

Commission explained that, even though it knew of Copley’s 

actual redemption history, Copley “cannot control or fully 

anticipate the level . . . of [future] shareholder redemptions.” 

Notice ¶ 12. “However unlikely” a large redemption event 

“may seem to Copley,” the Commission observed, such an 

event was “a possibility that Copley may not rule out,” given 

the entitlement of Copley’s shareholders to redeem their 

shares at net asset value. Id. And because a high level of 

redemptions could result in substantially disparate treatment 

of non-redeeming shareholders, the Commission determined 

that the grant of an exemption to Copley would run “counter 

to one of the primary principles underlying the Company 

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Act”: that “redemptions of redeemable securities should be 

effected at prices that are fair, and which do not result in 

dilution of shareholder interests or other harm to 

shareholders.” Id. ¶¶ 7, 13. 

That rationale for the Commission’s denial of an 

exemption lies comfortably within agency discretion. Indeed, 

the Company Act requires that a redemption price based on 

“net asset value” be calculated in a manner “eliminating or 

reducing” any “dilution of the value” of shares held by nonredeeming shareholders “which is unfair” to those 

shareholders. 15 U.S.C. § 80a-22(a). 

Copley counters that a large redemption event would not 

necessarily generate a significant tax bill—if, for instance, the 

impetus to redeem shares came about in reaction to a stock 

market crash that also eliminated any gains in Copley’s 

portfolio. The Commission’s 60% scenario, however, was 

only an “illustrative fact pattern” used to highlight the 

disparate treatment of shareholders under a given set of 

circumstances. Notice ¶ 14. As the Commission notes on 

appeal—and Copley does not dispute—some degree of 

disparate treatment would occur “whenever Copley’s actual 

tax liability exceeds its recorded partial deferred tax liability.” 

Appellee Br. 33, 42 n.18. The Commission committed no 

abuse of discretion in invoking an example to illustrate that 

result. 

Copley similarly takes issue with an article cited by the 

Commission for the proposition that “[r]edemptions 

necessitating liquidation of a substantial amount of an openend fund portfolio, while infrequent, have in fact been 

experienced by several open-end funds.” Notice ¶ 12 n.16. 

According to Copley, it is less likely to confront a substantial 

redemption event than the funds analyzed in the article 

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because it invests in a more liquid and diversified portfolio. 

But as with the 60% redemption scenario, the Commission 

referenced the article only for illustrative purposes. The 

Commission recognized that, “[h]owever unlikely” a large 

redemption event might be, Copley “cannot control or fully 

anticipate the level . . . of [future] shareholder redemptions.” 

Id. ¶ 12. Copley’s attacks on the Commission’s “hypothetical 

speculation” thus afford no basis for setting aside the 

Commission’s reasonable conclusion that Copley’s proposal 

to provide for only a small fraction of its full potential tax 

liability may result in inequitable treatment of redeeming and 

non-redeeming shareholders, contradicting a primary purpose 

of the Company Act. 

 Copley’s remaining arguments can be dispensed with in 

relatively short order. Copley contends that the Commission 

erred in “summarily reject[ing]” its offer to disclose in its 

financial statements the mechanics and operation of its 

proposed alternative methods for calculating its tax liability. 

Appellant Br. 45-46; J.A. 17. Copley’s passing mention of its 

disclosure proposal took up a mere two sentences of its 

nineteen-page exemption application, see J.A. 17, and the 

Commission was “not required to address every argument 

advanced by” Copley in a cursory fashion. Town of 

Barnstable v. FAA, 740 F.3d 681, 690 (D.C. Cir. 2014) 

(internal quotation marks omitted). In any event, disclosure 

of Copley’s proposed alternative calculations would not cure 

the Commission’s substantive reasons for rejecting those 

alternatives in the first place—i.e., the risk of inequitable 

treatment of shareholders and the unnecessary confusion to 

investors if Copley’s financial reporting did not match the 

pricing of its securities. 

 

 Copley contends that the Commission’s denial of an 

exemption is inconsistent with the flexibility the Commission 

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extended to certain real estate investment trusts (REITs) in 

accounting for their deferred tax liabilities. But “this is not a 

case in which the Commission . . . failed to explain its 

different treatment of similarly situated parties.” Mountain 

Solutions, Ltd. v. FCC, 197 F.3d 512, 518 (D.C. Cir. 1999). 

Rather, the Commission reasonably distinguished its 

treatment of REITs, noting that REITs “are not open-end 

funds, do not issue redeemable securities and therefore do not 

face the associated potential need to sell portfolio assets to 

satisfy redemption requests.” Notice ¶ 16 n.39. 

Copley fares no better in arguing that the Commission 

failed to consider the “actual harm” to investors arising from 

Copley’s 2007 adjustment to recognize its full potential tax 

liability. Appellant Br. 50 (capitalization omitted). The 

Commission expressly acknowledged the change in value to 

Copley’s shareholders, noting that, “whereas Copley’s net 

asset value per share on February 28, 2007 . . . was stated in 

its annual report as being $54.67,” Copley’s adjustment 

resulted in “a per share net asset value for that same date . . . 

of $42.54. The $12.13 reduction in the net asset value per 

share was a change of 22%.” Notice ¶ 11 n.15 (internal 

quotation marks omitted). The Commission nonetheless 

declined to grant Copley an exemption from the requirement 

to recognize its full tax liability for the reasons explained. 

Because the Commission set forth its rationale and 

“considered” the relevant “objection[],” Town of Barnstable, 

740 F.3d at 690, Copley’s “actual harm” argument fails. 

Copley’s contention that full recognition of its deferred tax 

liability causes a distortion of various financial metrics fails 

for largely the same reason: the change in those metrics is the 

direct and inevitable consequence of the Commission’s 

reasonable decision to deny Copley an exemption from the 

obligation to recognize its full potential tax liability. 

 

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Finally, Copley argues that its proposal to recognize only 

a fraction of its full tax liability would not infringe the 

Commission’s rules in the first place. The Commission’s 

interpretations of those rules are not directly at issue because 

Copley, in 2007, altered its accounting to comply with the 

Commission’s suggested understanding of the rules. J.A. 5. 

The question now before us concerns the Commission’s 

denial of Copley’s request for an exemption from the rules. 

As we have explained, the “very essence” of a request for 

exemption “is the assumed validity of the general rule, and 

also the applicant’s violation” of that rule unless the 

exemption “is granted.” Omnipoint Corp. v. FCC, 213 F.3d 

720, 723 n.3 (D.C. Cir. 2000) (citation omitted). To the 

extent Copley means instead to contend that the Commission 

should have granted an exemption from its rules because the 

rules themselves are flexible enough to accommodate 

Copley’s proposed alternatives, that argument essentially 

merges into Copley’s underlying request for an exemption 

from the rules. We reject that argument for the reasons 

already discussed. 

* * * * * 

For those reasons, and in light of the highly deferential 

manner in which we review the Commission’s denial of the 

requested exemption, we deny Copley’s petition for review. 

So ordered.

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