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SECURITIES AND EXCHANGE COMMISSION ......." 7
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DIVISION OF J:::~t ~-'õ''_'~H'' "",,":

INVESTMENT MANAGÈMENT 

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d °,':1 H.eh1l1 ty l'lbY'ifd V'l/ J 1''7"', s' """"'-' "h"~_-t",::." ',: -"~",- r /, I 'i,' , Dear Chief l"nè1I,,:iil gff1f'~1"' ~".-""-""i,e~i'~t&¡;;itúi,.j
 

The accounting staff of the Division of Investment Management has prepared this
 

supplementa letter to our November 1, 1994 letter to assist investment company registrants and 

their independent public accountats in addressing certn timely accounting-related matters.
 

These comments represent the views of the staf of the Division of Investment Management and 

are not necssaly those of 
 the Securities and Exchange Commission (the "Commission"). The comments addressed in this letter apply to fiings made by 
 registered investment companies, including reports to shareholders. While we do not anticipate issuing a regular supplement to 

our annua accounting letter, this letter is precipitated by the occurrence of certain accountingrelated events that we believe merit timely communication. 

A. Applying SF AS 1/ 119 to Invesment Companies
 

In October 1994, the Financial Accouòting Stadads Bod issued Statement of Financial 

Accounting Stadards # i 19, Disclosure About Derivatve Financial Instruments and Fair Value 

of Financial Instruents ("SFAS # 119" or lIthe Stadad") which requires financial statement 

disclosures about certn derivative financial instrments. Paragraph 9 of the Stadard makes 

a distinction between financial instruments held or issued for trading purpses and financial 

instruments held or issued for purpses other than trading. The Staff recognizes that funds
 

could have instruments in their portfolios from both categories, depending on the purpose for 

which the derivative is held or issued. 

Investment companies should designate each derivative covered by the Standard as either 

held or issued for trading purpses or held or issued for purpses other than trading, and 

should make the designation at the time the derivative financial instrument is acquired. Funds

have a continuing obligation to regularly evaluate the appropriateness of the original 

designations which could lead to changes in a designation, and, accordingly, differences in 

disclosure requirements during the holding period of the instrument. 

B. Presntation and Accounting for Enhanced Seurities
 

The staff has recently addressed several issues related to the accounting for and financial 

statement presentation of enhance seurities!. These issues have included 1) the separate
 

valuation of the components of such investments; 2) the appropriate financial statement 

presentation of these components; and 3) the contrbution. to capita to be recognize for the
 

enhancement. 

Enhanced securities include separate and distinct credit mechanisms provided to maintain the 

carrying value of an investment.
 
(1) Valuation 

The credit enhancements have ben segregate into the two commonly used types,
 

typicaly issued through the adviser: non-trasferable put options (which ~xpire at or prior to 

maturity of the enhanced seurity) and non-trsferable letters of credit ("LOCs") (which expire 

at maturity of the enhanced seurity)2. For these enhancements, the staff believes that valuing 

each component separtely is appropriate. For example, a seurity with a market value of 70, 

linked with a 90-day put option (or LOC) allowing the fund to put the security to the adviser 

(or draw against the LOC) for 95, would be valúed at 70; the value attributable to the

enhancement would be 253. 

'I 

(2) Presntation '4 

Separte and distinct disclosure of the components of a credit -enhance security provides 

a more complete and meaingful presentation to fund shareholders, and is required by Items 

6-04.1 and 6-04.3 of Regulation S-X which require the disclosure of investments in securities 

of unaffiliated issuers separte from the disclosure of investments other than seurities. The staff 

would not object to presentation of separte, contiguous disclosure on the face of the portfolio 

of investments schedule of the seurity (at market value without the enhancement) and the 

enhancement (valued at the difference between caing value of the seurity with the 

enhancement and market value of the seurity without the enhancement). For put options, the 

presentation on the portfolio of investments schedule should describe the option as being from 

an affiiate pary (if applicable) with the name and relationship of the affiliate, and any terms 

and conditions of the put discusse in a note to the financial statements. If the enhancement is 

a LOC, the name of the financial institution providing the LOC should be separately disclosed 

in the notes to the financial statements along with the terms, conditions and other arangements 

related to the LOC. 4 Disclosure should also comply with the requirements of Statement of 

Financial Accunting Stadads number 57 - Related Part Disclosures ("SFAS 57"), issued by 

the Financial Accounting Stadads Board. The staff views the relationship between an adviser 

and a financial institution issuing a LOC (as an enhancement) as being encompasse by SF AS 

57. 

(3) Transferrble Enhancements 

The separate valuation and presentation of the components of investments with 

transferable enhancements (regardless of when the enhancement attaches) would not be required. 

The presentation of securities with trsferrble enhancements on the portfolio of investments
 

schedule should identify the name and relationship of the issuer of the enhancement. The terms, 

conditions and other arangements relate to the enhancement should be disclosed in the notes 

to the financial statements.
 

2	 Although not specifically addressed here, "portolio insurance", not tied to an individual security
 

but guaranteeing the timely payment of interest and principal for investments in the portfolio,


is also considered a form of enhancement requiring the disclosure, valuation and capital
 

recognition discussed herein.
 

The views expressed herein do not address and are not meat to resolve the issues presented by 

Sections 17(a) and (d) of the Investment Company Act of 1940 which prohibit certain 

tranactions between an investment company and affliated persons. 

4	 Separate disclosure is not required for the components of a security which at the time of the


funds purchase included a LOC. .
 

2
 
(4) Contribution to Capital 

In keeping with related guidance,:i the staf believes a contrbution to capita is made at 

the time the enhancement (whether transferrable or non-trasferrable) becomes available to the

fund. The amount of the contrbution is measured by the cost of obtaning a similar 

enhancement in an arm's-length transaction. 

Any change in the value of the enhancement would be recorded as unreaized
 

appreciation or depreciation. There would be nò adjustment to contributed capita as a result of 

a change in value of the enhancement or the disposition of that enhancement. 

************** 

This letter contans information of importce to the company's indepndent public 

açcountat; therefore, we encourage these items to be discusse with them. Any questions on 

the contents of this letter or related matters can be addressed to me, Anthony S. Evangelista or 

Janies F. Volk, Assistat Chief Accountats, at (202) 942-0590. 

Very truly yours, 

~M-"U- d, ~--


Lawrence A. Fnend 

Chief Accountat 

See letter to Chief Financial Offcers from Lawrence A. Friend dated November 1, 1994. 

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