.. . e." Wli
 

J~N 2719
 

Our Ref. No. 93-39-CC
 R E OF CHIEF COUNSEL County of Los Angeles
 

DIVISION OF INVESTMENT MANAGEMENT File No. 132-3
 

Your letter of January 19, 1993, requests our assurance that
 

we would not recommend that the Çommission take any enforcement
 

action against the County of Los Angeles (the "County"), the
 

County's Deferred Compensation and Thrift Plan (the "Plan"), or
 

the Plan's funding vehicles under the registration provisions of
 

the Securities Act of 1933, the Securities Exchange Act of 1934,


or the Investment Company Act of 1940 if the County changes the
 

administration of the Plan in the manner described in your
 letter. 

The Plan is a deferred compensation plan under Section 457
 

of the Internal Revenue Code. Section 457 generally permits
 

state and local governments to create plans under which their
 

employees may defer receipt (and thus; taxation) of a portion of
 

their current compensation until separation from service. The
 

section provides, however, that plan assets must remain "solely"
 

the property of the employer, "subject only to the claims of the


employer's general creditors." 1./ 

Participation in the Plan is voluntary. Employees may
 

contribute a portion of their earnings each month up to a maximum
 

of $7,500 a year. ~/ Employees are also permitted to direct
 

their contributions among five independently managed investment _
 

options: the Money Market/Depository Fund, the Balanced. Fund, the
 

Stock Index Fund, the Growth Equity Fund, and the Stable Income
 

Fund (the "SIF"). Approximately 75% (or $750 million) of Plan
 

assets is currently invested in the SIF. Of this, approximately
 

$50 miiiion is invested in a guaranteed interest contract issued
 

by the Protective Life Insurance Company, while the balance is
 

invested in a separate account contract issued by the
 

Metropolitan Life Insurance Company.
 

,. 

The County proposes to create a new investment option, the
 

Los Angeles County Investment Fund ("LACIF").:J/ The LACIF will
 

be under direct County management and will invest primarily in


secur i ties backed by income producing County property. The 

County contemplates that the securities will be certificates of
 

participation, backed either by a specific revenue stream or by
 

the general credit of the County. The total amount of Plan
 

1./ Section 457 (b) (6) . 

~/ In the past, the County has made matching contributions for


each dollar contributed, up to 2.5% of earnings. Matching
 

contributions, however, are currently suspended.
 

:J/ All other existing Plan investments and administrative
 

arrangements wiii remain in place.
 
assets that may be allocated to the LACIF will be capped at
 apprtidma"-ly-$-2-a-a-m-.il-l-Ï:ûn--nd-tl-re-l-i-f-fl-iei:e-I-F-wi-l-l-be 

limited. The County will bear the costs associated with the
 

creation of the LACIF.
 

In connection with the cr~ation of the LACIF, the County
 

proposes to provide participants with supplemental _Plan
 

literature and an election form. The supplemental literature
 

will advise participants that they will have a one-time
 

opportuni ty to allocate all or any portion of their current Plan
 

account balance from any existing Plan investment option to the
 

LACIF. The literature will also clearly and prominently
 

disclose, at or near the beginning, the nature and terms of a 457
 

plan, including all the risks associated with this type of plan
 

and the distinction between the "vesting" of participant ,
 

contributions and participant "ownership" of section 457 plan
 

account balances. In addition, the literature will explain the
 

role of the LACIF in meeting the County's budget needs.
 

Participants will receive the supplemental literature and
 

election form at least 30 days before the LACIF begins operating.
 

Transfers to the LACIF will not be permitted after the election
 

period. No transfer to the LACIF will be made unless a
 

participant affirmatively opts in by filling in the election
 

form. with the exception of the LACIF, the County will maintain
 

all of the Plan investments under independent, external
 

management. 

You represent that "no part of the corpus or income of the
 

Plan will -be used for, or diverted to, purposes other than the
 

exclusive benefit of participants or their beneficiaries,
 

provided, however, that all Plan assets will remain subject to
 

the claims of the County's- general creditors to the minimum


extent required by section 457." ~/ 

, 

~/ We note that the County previously has taken the position
 that the County has very limited access to these funds. See
 

Letter from Sandra M. Davis, Treasurer and 
 Tax Collector,


- County of Los Angeles, to Hoyle L. Robinson, Executive 

Secretary of FDIC (Feb. 12, 1990), expressing the view that
 

the County's rights to these funds was based on a "fragile
 technicali ty that these funds actually belong to the 

employer. " See also Letter from David J. Tirapelle,
 

Director, Department of Personnel Administration, State of
 

California, to Hoyle L. Robinson (Mar. 12, 1990) ("in no
 

instance has the State utilized funds on deposit for 457
 

plan participants to bailout from a budget deficiency. The
 

State believes these funds are owed employees and treats
 

them accordingly"); Letter from John Dark, Treasurer and Tax
 

Collector, County of Sacramento, to Hoyle L. Robinson (Mar.
 

8, 1990) ("Do counties believe that they own the Plan assets?
 

- 2 ­
ûn the-basis of the unique facts and represèntations in yoùr
 

letter, and without agreeing with your legal analysis, we would
 

not recommend that the Commission take any enforcement action
 

against the County, the Plan, or the Plan's funding vehicles
 

under the registration provisions of the Securities Act of 1933,
 

the Securities Exchange Act of 1934, or the Investment Company
 

Act of 1940 if the County changes the administration of the Plan
 

in the manner described in your letter. The Division of
 

Corporation Finance and the Division of Market Regulation have
 

asked us to advise you that they concur with the position of the
 

Division of Investment Management. Because the Divisions'
 

position is based on the facts and representations in your
 

letter, you should note that different facts or representations
 

might require a different conclusion. Further this response only
 

expresses the Divisions ' position on enforcement action and does
 

not purport to express any legal conclusions on the questions


presented. 

(J.4J 5llf~

Thomas S. Harman
 

Associate Director
 

(Chief Counsel)
 

No! the ownership language in Section 457 is viewed as a
 legal fiction"). 

- 3 ­
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..'S _AD _i IT. PC_IIUIt 

.TOC....Ol,.. January 19, 1993


......W 

ZUIIC" 

1933 Act section 3 (a) (2); 1934 

Act section 3 (a) (12); and 1940


Act Section 3 (c) (11) 

.­ ;......._1
 

BY HA DELIVERY
 

Act :! l . -A \qyo


Marianne K. Smythe, Esq. Director Section S(i7(1l) .

Thomas S! Harman, Esq.
 

Associate Director Bule
 

Division of Investment Management
 Public

Mail stop 10-6 Availability \ \21\ u
 

Abigail Ars, Esq.
 

Associate Director (Legal)
 

Meredi th B. Cross, Esq.
 

Chief Counsel
 

Division of Corporation Finance
 

Mail stop 3-3
 

securities and Exchange Commission
 

450 Fifth Street, N.W.


Washington, D. C. 20549 

Re: County of Los Anaeles Section 457 Plan
 

Dear Mses. Smythe, Arms, and Cross and Mr. Harman:
 

Our client, the county of Los Angeles (tithe County"), is
 

considering various emergency steps to .address a projected shortfall in its fiscal 1992-93 operating budget in order to avoid
 

potentially catastrophic consequences for County residents. One
 

proposal currently under consideration is to create a new
 

investment option under the County's Deferred Compensation and
 

Thrift Plan (lithe Plan") pursuant to Section 457 of the Internal
 

Revenue Code (tithe Code"). This new option would permit Plan
 

participants who elect to do so to effect a one-time transfer of
 

all or a portion of their account balances to a County-administered
 

fund which would purchase County securities, such as securitized
 

real property leases or installment sales agreements. This
 
BAKR & MÇKENZIE
 

Marianne K. Smythe, Esq. 

Thomas S~Harman, Esq.
 

Abigail Arms, Esq.
 

Meredi th B. Cross, Esq.
 

January 19, 1993
 

Page 2
 

proposal would permit the County to finance some of its most
 

pressing service needs and to avoid discharging substantial numbers
 

of its employees, while providing Plan participants with an
 investment option focussed on local municipal assets. 

As you are aware, this proposal has been the subject of extensive and frui tful discussion between the staff and
 

representatives of the County, including this Firm. This letter
 

sets forth the results of those discussions. On behalf of the
 

County, we ask that the staff assure us that, if the County
 

proceeds with its proposal in the manner set forth in this letter,
 

the staff will not recommend that the Commission take enforcement
 

action under the registration requirements of the Securities Act of
 

1933, of the Securities Exchange Act of 1934, or of the Investment
 

Company Act of 1940 against the Plan, the County, or the various
 

unregistered funding vehicles for the Plan.
 

A. Backaround
 

Section 457 of the Code permits state and local government
 

create plans under which their employees may defer
 

receipt (and thus taxation) of a portion of their current
 

compensation until separation from service. Unlike most other tax-


employers to 


favored savings plans, however, Section 457 plans are not 

"qualified" within the meaning of Section 401 (a) of the Code, and
 

the ability of employees to exclude from income the sums allocated
 

to such plans depends on the plan being structured such that the
 

employee has not, for tax purposes,. actually received any interest
 

in the plan. 1
 

1 In this regard, Section 457 of the Code provides that all
 

deferred compensation, all property and rights purchased therewith,
 

and all income attributable thereto, "shall remain (until made
 

available to the participant or beneficiary) solely the property
 

and rights of the employer (without being restricted to the
 

provision of benefits under the plan), subject only to the claims
 

of the employer's general creditors." The Treasury Department has,
 

however, permitted, by regulation, Section 457 plans to provide
 

that a participant may direct the investment of the amount of
 

assets in the plan attributable to his or her deferred compensation
 

into particular funding vehicles, such as mutual fund shares or


insurance company contracts. See Treas. Reg. S 1.457-2 (j) . 
BAKR & MÇKENZIE
 

Marianne K. Smythe, Esq. 

Thomas S. Harman, Esq.
 

Abigail Ars, Esq.
 

Meredith B. Cross, Esq.
 

January 19, 1993
 

Page 3
 

The Los Angeles County Section 457 plan is styled "Horizons -­

The Deferred Compensation and Thrift Plan." Participation in the
 

Plan is vOluntary.2 Under the Plan, employees may contribute from
 

one to 25 percent of their eligible earnings each month to the
 

Plan, up to a maximum of $7,500 per year. In the past, the County.
 

has made matching contributions in the amount of 75 cents for each
 

dollar contributed, up to 2.5 percent of earnings; matching
 

contributi~ns are currently suspended.
 

Consistent. with. Regulation 1.457-2 (j), supra note 1, an
 

employee may direct the investment of Plan assets. equal to his or
 

her interest in the Plan among five independently 
 managed investment options -- the Money Market/Depository Fund; the Stable


Income Fund (" SIF" ); the Ba lanced Fund; the Stock Index Fund; and 

the Growth Equity Fund. Transfers, up to one per month, among
 

investment options are permitted; these occur without charge,
 

except that transfers to the Money Market/Depository Fund are
 subject to a 7 percent transfer' fee. 

Presently, roughly 75 percent (approximately $750 million) of
 

the aggregate Plan account balances are held in the SIF. Of this
 

amount, approximately $50 million is invested in a guaranteed
 

interest contract issued by the Protective Life Insurance Company
 

("Protective Life"), and. the balance (approximately $700 million)


is invested in a separate .account contract issued by the.
 

Metropolitan Life Insurance Company ("MetLife"). All Plan record-


keeping and participant interface is handled by Bankers Trust
 

Company under a contract with the County. 3 .
 

B. The Proposal
 

The proposed change in the administration of the Plan involves
 

the creation of. a new investment option, the Los Angeles County
 

Investment Fund ("LACIF"). Subject to the limitations described
 

2 The Los Angeles County Employees Retirement Association
 

provides County employees with a separate, nonvoluntary retirement
 

program. 

3 Specifically, Bankers Trust maintains records of
 

participant account balances, provides written materials to
 

participants, and processes participant transactions, including
 

Plan withdrawals, changes in participant investment or beneficiary


designations, etc. 
BAKR & MCKENZIE
 

M-ai--nne-K..Smytn-e,E5q. 

Thomas S. Harman, Esq.
 

Abigail Ars, Esq.
 

Meredith B. Cross, Esq.
 

January 19, 1993
 

Page 4
 

below, each Plan participant will be entitled to allocate all or a
 

portion of his or her existing account balance to the LACIF. The
 

LACIF will have similar characteristics to the SIF, but will be
 

administered directly by the County. All other existing Plan
 

investments and administrative arrangements will remain in place.
 

The details of the County's proposal are set forth below. .
 

1. Creation of the LACIF
 

The LACIF will be under direct County management. The County
 

proposes to administer the LACIF primarily by selling to it County
 

securities backed by income-producing County property. It is
 

initially contemplated that these securities will be certificates
 

of participation ("COPS"), backed either by a specific revenue
 

stream or by the general credit of the county.. To the extent that
 

· In the first case (revenue-baçked securities), the County
 

would sell an existing rêvenue-producing property to a non-profit
 

corporation ("NPC") indirectly controlled by the. County. The NPC
 

would immediately sell the property back to the County pursuant to
 

a conditional sales contract under which the County would be
 

obligated to make periodic installment payments, a portion of which.
 

would be designated as and constitute interest. The NPC would
 

assign its rights to receive the County installment payments to a
 

trustee bank, which would be instructed to execute and deliver to
 

the NPC COPs representing fractional, undivided interests in the
 

county installment payments. The NPC would sell the COPs to the
 

SIF. The proceeds of sale of the COPs received by the NPC would be
 

paid to. the County as consideration for. the purchase of the
 

property by.the NPC. The revenues derived by the County from the
 property would be pledged to the payment of the installment

payments, and the general funds of the County would not be
 

obligated to make such payments if the revenues were insufficient.
 

In the second case, the County would lease one or more
 

buildings to the NPC, which would immediately sublease the
 

buildings back to the County. The County would be obligated to pay
 

rent to the NPC from its general funds each year, in consideration
 

for the use and occupancy of the buildings. A portion of each rent
 

payment would be designated as and constitute interest. The NPC
 

would assign its rights to receive rent under the sublease to a
 

trustee bank, which would be instructed to execute and deliver COPs
 

as described in the previous example. The proceeds of sale of the
 

COPs received by the NPC would be paid to the County as advance
 
BAKR & MÇKENZIE
 

M-a-r-i-ain-eK-.Smythe-Esq . 

Thomas S. Harman, Esq.
 

Abigail Ars, Esq.
 

Meredi th B. Cross, Esq.
 

January 19, 1993
 

Page 5
 

the LACIF is not invested ~in COPs or similar County ~ecurities, it
 

will be invested in liquid money market instruments in accordance
 

with the County's policies for lnvesting excess cash.
 

The total amount of Plan assets which may be allocated to the
 

LACIF will be capped, and the life of the LACIF will be limited.
 

The County presently contemplates that the caf on allocations to
 

the LACIF will be approximately $200 million. Further, the cap
 

will gradually decrease to zero over some period of time (probably
 

in the range of ten years). At the end of the life of the LACIF,
 

any remaining balance will. be transferred to the SIF, unless
 

participants select another investment option..
 

The County will agree to credit participant account balances
 

allocated to the LACIF with a rate of return more attractive than
 

" the rate credited to SIF accounts. This may be - accomplished by
 

setting a guaranteed minimum LACIF rate of return greater than the
 

minimum SIF rate; by providing that the LACIF will provide the same
 

rate of return as the SIF rate, plus a specific p=emium; or in some
 

other manner. While the exact method of calculating the LACIF
 

return has not yet been determined, the .objective will be to
 

provide a return "sweetener" that will attract Plan participants to
 

the LACIF.
 

2. Disclosure and Participant Election Process
 

In connection with the creation of the LACIF, each Plan
 

participant will be sent supplemental Plan literature describing
 the change in Plan investment options. . All current Plan 

participants will also receive an election form. This disclosure
 

will advise participants that they will have a one-time opportunity
 

to allocate all or any portion of their current Plan account


balance from any existing Plan investment option to the LACIF. It 

will also explain the County's fiscal 1993 budget needs, the role
 

of the LACIF in meeting those needs, and the options available to
 

rent under the lease from. the County to the NPC.
 

.5 The amount of the cap will be approximately $150 million,
 

plus an amount sufficient to. allow for anticipated participantdirected transfers out of .the LACIF. While we currently believe
 

that this cushion will be approximately $50 million, the actual
 

amount will be determined by studying the transfer experience of
 

the SIF.
 
BAKR & MÇKENZIE
 

Marianne K. Smythe, Esq. 

Thomas S. Harman, Esq.
 

Abigail Arms, Esq.
 

Meredi th B. Cross, Esq.
 

January 19, 1993
 

Page 6
 

the County in the event that the LACIF is not funded to the full
 

amount of its cap.6 In addition, this new material will include
 

language at or near the beginning of such material which clearly
 

and prominently informs participants of the nature and terms of a
 

Section 457 plan; of all of the risks to which the assets of such
 

a plan are subject; and of the distinction between the "vesting" of
 

participant contributions and participant lIownership" of Section
 

457 plan account balances. The County will bear the expenses
 

associated with the creation of the LACIF, with the preparation of
 

the Plan disclosure documents necessitated by the creation of the
 

LACIF, and with the LACIF election process.
 

The election period for allocations to the LACIF will be at
 

least 30 days. That is, participants will be sent the notice and
 

election form at "least 30 days before the LACIF actually commences
 

operations. Following the LACIF election period, LACIF
 

participants will be permitted to transfer all or any portion of
 

their account balances out of the LACIF in accordance with the same
 

rules as govern the existing Plan options.- Under those rules,
 

participants may transfer out of any investment option and into
 

another once per month, subject only to any pre-disclosed transfer
 

fees. However, unlike other investment options, transfers (or the
 

allocation of future deferred income) to the LACIF will not be
 

permi tted after the LACIF election period.
 

As described above, 
 the LACIF will be subject to a cap. In
 

the event that requests are recei vedduring . the LACIF election
 

period to allocate account balances to the LACIF in excess of the
 

cap, all ~ccount balances allocated to the LACIF will be accepted
 

prorata. . Thus, for example, 
 if the LACIF is capped at $200


million, and participants elect to allocate $300 million to the
 

LACIF during the LACIF election period, 2/3 of the amount each
 

participant sought to allocate to the LACIF will be accepted. The
 

portion of each participant's account which is not accepted into
 

the LACIF will be allocated to other Plan investment options in
 

accordance with the participant's direction; in the event that no
 

direction is made, the sums not accepted into the LACIF will remain
 

in the investment option from which such sums were to have been
 transferred. 

6 We also anticipate that the unions representing County
 

employees will encourage Plan participants to elect to allocate
 

some portion of their Plan balances to the LACIF.
 
BAKR & MÇKENZIE
 

li-a_r.i.a.nn_e_.K.Jin~the-;--5.q_e 

Thomas S. Harman, Esq.
 

Abigail Ars, Esq.
 

Meredith B. Cross, Esq.
 

January 19, 1993
 

Page 7
 

3. Safeguards and Limitations
 

As a safeguard to Plan participants, the County is committed
 

to Plan disclosure that will permit Plan participants to exercise
 

an informed choice concerning whether or not to place all or a
 

portion of their Plan account balances in the new LACIF investment
 

option. As additional safeguards, the County has authorized us to
 

represent, as a condition to the relief sought in this letter,
 

that, except with respect to the ;operation of the LACIF as
 

described above -­

(a) the County will maintain all of the Plan investments under
 

independent, external (rather than County) management; and
 

(b) no part of the corpus or income of the Plan will be used
 

for, or diverted to, purposes other than the exclusive benefit
 

of participants or their beneficiaries, provided, however,
 

that all Plan assets will remain subject to the claims of the
 

County's general creditors to the minimum extent Tequiredby
 

Section 457.
 

C. Relief Requested
 

We believe that the foregoing proposal is consistent with the
 

federal securities laws, to the extent those laws apply to the
 

Plan. As you are aware, the Plan and the interests of participants
 

therein are not registered under the Securities Act of 1933, the
 

Securi ties Exchange Act of 1934, or the Investment Company Act of
 1940. In our view, the implementation of the proposal as set forth 

above will not require the Plan to register nor will it require the
 Plan or the County to register the interests in the. Plan. 

Similarly, in our view, the. implementation of the proposal as set
 

forth above will not preclude any funding vehicle for the Plan from
 

relying on the exemptions from Securities Act, Securities Exchange
 

Act, and Investment Company Act registration provided by,
 respectively, Sections 3 (a) (2), 3 (a) (12), and 3 (c) (11) of those 

Acts, provided and to the extent that those exemptions are
 

otherwise available to such 
 funding vehicles. 
BAK & MÇKENZIE
 

Marianne K. Smythe, Esq. 

Thomas S. Harman, Esq.
 

Abigail Ars, Esq.
 

Meredi th B. Cross, Esq.
 

January 19, 1993
 

Page 8
 

Accordingly,' we request that the staff advise us .that it will
 

not recommend enforcement action against the County, the Plan, or
 

the funding vehicles for any Plan investment option under the
 

registration provisions of the Securities Act of 1933, of the
 

Securities Exchange Act of 1934, or of the Investment Company Act
 

of 1940 if the. County implements the proposed revisions to its
 

section 457 plan described herein.
 

* * * 

We appreciate the staff's cooperation and assistance in
 

connection with this important matter. If you have questions
 

concerning this request, please contact David S. Ruder in Baker ~
 

McKenzie's Chicago office at (312) 861-3733 or Daniel L. Goelzer in
 

the Firm's Washington office at (202) 45~-7013.
 

Sincerely, 

~ '( Mà~QJY5~¡'
 

Baker & McKenzie ~