5 MAY 1993
 

~P-BLI ~ ~Our Ref~No .-9-3-;rs-s-.;cc--­ Def ined Asset FundsEquity Income Fund-


RESPONSE OF THE OFFICE OF CHIEF COUNSEL Select Ten Series
 

DIVISION OF INVESTMENT MAAGEMENT File No. 33-46S42
 

Your letter of April S, 1993, requests our assurance that we
 

would not recommend enforcement action to the Commission under
 

sections 17 (a) (1) or 17 (a) (2) of the Investment Company Act of 

1940 ("1940 Act") if an existing unit investment trust ("Trust")
 

of the Select Ten Series, a series of the Defined Asset Funds ­

Equity Income Fund, which has reached its mandatory termination
 

date, ("Terminating Trust") sells portfolio securities to a unit
 

investment trust of the same series in formation ("New Trust") in
 

compliance with all provisions of Rule 17a-7 under the 1940 Act
 

except paragraph (e). ii
 

Each Trust invests in securities in accordance with a
 

strategy described in "Beating the Dow," by John Downes and
 

Michael O'Higgins. Under this strategy, a Trust invests 10% of
 

its assets in each of the ten stocks in the Dow Jones Industrial
 

Average ("DJIA") with the highest dividend yield. You state that
 

each Trust holds these securities for approximately one year, and
 

that the sponsor will offer a New Trust for the following year as
 

each Trust terminates. You also state that generally there is
 

some overlap from one year to the next in the ten securities
 

having the highest dividend yield in the DJIA. You state that to
 

date each Terminating Trust has sold, and each New Trust has
 

purchased, all of its securities on the New York Stock Exchange.
 

In the two most recent cases where a Terminating Trust sold
 

portfolio securities which were identical to those purchased by a
 

New Trust, the purchase and sale commissions were approximately


$150,000. 

section 17(a)(1) generally makes it unlawful for an
 

affiliated person of a registered investment company, or any
 

affiliated person thereof, acting as principal, knowingly to sell


any security or other property to the company. section 17 (a) (2) 

generally makes it unlawful for the same persons, acting as
 

ii The staff believes that an offer to unitholders to invest
 

redemption proceeds upon the liquidation of an existing
 

series into a new series, at net asset value plus a reduced
 

sales charge (a "rollover option"), is an exchange offer for
 purposes of section 11 (c) of the 1940 Act. section 11 (c) 

prohibits any offer of exchange of the securities of a unit
 

investment trust for the securities of any other investment
 

company absent a Commission order. The Select Ten Series
 

prospectus states that the sponsors have received exemptive
 

orders under Section 11 (c) which they believe permit them to
 

offer a rollover option.
 
principal, knowingly to buy any security or other property from
 

--tone-. ï.nvestoment--compa-ny-.---Ru.L.e-1-7-a---7-exempts--.f-r.om-the---proh 
 ibit ions.

of section 17 (a) certain purchases and sales between registered
 

investment companies and certain affiliated persons, where the
 

affiliation arises solely by reason of having a common investment
 

adviser, common directors, and/or common officers. You state
 

that each Trust may be considered an affiliated person of each
 

other Trust because they share the same sponsors and/or the same
 

trustees. Because a New Trust would not be affiliated with a
 

Terminating Trust through any relationship specified in the Rule,
 

they may not rely on the exemption provided therein. Of course,
 

where a transaction subject to section 17 (a) is not exempted from
 

section 17(a) by Rule 17a-7, section 17(b) provides a specific
 

mechanism by which the transaction might proceed. That provision
 

permi ts a person to file an application for an order exempting a
 

proposed transaction from section 17 (a). The Commission may
 

exempt a proposed transaction from Section 17 (a), if (1) the
 

terms of the transaction are fair and reasonable and do not
 

involve overreaching; (2) the transaction is consistent with the
 

investment company's policies; and (3) the proposed transaction
 

is consistent with the general purposes of the 1940 Act.
 

Paragraph (e) of Rule 17a-7 requires the board of directors,
 

including a majority of the disinterested directors, of the
 

investment company to (1) adopt procedures pursuant to which
 

these purchases and sales are effected, which are reasonably
 

designed to ensure compliance with paragraphs (a) through (d) of
 

the Rule; (2) review at least annually the continuing
 

appropriateness of these procedures; ~/ and (3) determine at
 

least quarterly that all purchases and sales made during the
 

preceding quarter were effected in compliance with such


procedures. 

The requirements that the board of directors adopt
 

appropriate procedures and review such transactions are
 

fundamental to the exemption the Rule provides. They were added
 

to the Rule in 1981, the last time the Commission modified the
 

Rule. In proposing paragraph (e) to Rule 17a-7, the Commission
 

stated its belief that these requirements accorded with its
 

general objective of "enhancing, insofar as feasible, the role of
 

investment company directors and particularly disinterested
 

directors as watchdogs of shareholder interests. The Commission
 

believes that the first line of responsibility for determining
 

compliance with the proposed amendment should be with each
 

~/ While the Commission has proposed eliminating the annual
 director review requirement from certain rules, including
 

Rule 17a-7, it has not proposed deleting the other board of
 

directors' requirements. Investment Company Act ReI. No.
 

19192 (Dec. 30, 1992).
 

- 2 ­
investment company's directors." '1/ Because of the importance of
 

paragraph (e), we are unwilling to permit these unit investment
 

trusts to rely on Rule 17a-7. Therefore, on the basis of the
 

facts and representations in your letter, we cannot assure you
 

that we would not recommend enforcement action to the Commission


under sections 17 (a) (1) or 17 (a) (2) if a Terminating Trust sells 

portfolio securities to a New Trust, or a New Trust buys
 

portfolio securities from a Terminating Trust, in the manner
 

descr ibed in your letter.
 ~J. ~ 

Monica L. Parry
 

Senior Counsel
 

'1/ Investment Company Act Rel. No. 11136 (Apr. 21, 1980)


(proposing amendments to Rule 1 7a-7) . 

- 3 ­
DAVIS POLK & WARDWELL
 

450 LEXINGTON AVENUE
 

- I CHASE "MANHATTÄl'-P-LAZA----­

NEW YORK, N. Y. 10005 

- NEW YORK,-N~Y 10-0-17---­

212-450-4000 

1 FREDERICK'S PLACE 

LONOON EC2R 6AS 

FAX: 212-450-4600 

1300 I STREET, N.W. 2-1, MARUNOUCHI I-CHOME 

WASHINGTON, D. C. 20005 CHIYODA-KU. TOKYO 100 

WRITER'S DIRECT NUMBER: 4, PLACE DE LA CONCORDE MESSETURM
 75008 PARIS 6000 FRANKFURT AM MAIN 1
 

1940 Act: Section 17 (a) and Rule 17a- 7 

April 8, 1993
 

AM -l C t\ (t: i 9'1 (2) 

Off ice of the Chief Counsel
 SECTION Division of Investment Management 

Securities and Exchange Commission RULE í 7 CL ~7 

450 Fifth Street, N.W.
 PUBLIC 1:- f' C L (J 'S Washington, D. C. 20549
 AVAILABILIT ~ 'v . i .
 

Dear Sirs: 

We are special counsel to Merrill Lynch, Pierce,
 

Fenner & Smith Incorporated and the other Sponsors of
 

Defined Asset Funds - Equity Income Fund, a unit investment
 

trust registered under the Investment Company Act of 1940
 

(the "1940 Act") comprised of various separate portfolios or
 

series (each, a "Trust"). On behalf of the Sponsors, we
 

request confirmation from the Staff of the Division of
 

Investment Management that it will not recommend enforcement
 

action if, in compliance with Rule 17a-7 under the 1940 Act
 

(other than paragraph (e) thereof), an existing Trust of the
 

Select Ten Series which has reached its mandatory
 

termination date (a "Terminating Trust") sells portfolio
 

securi ties to a Trust of the Select Ten Series then in
 

formation (a "New Trust") at the closing sales prices of the
 

securities on the New York Stock Exchange on the date of
 sale. 

Background. The investment objective of each Trust of the Select Ten Series is to seek a greater total
 

return than the stocks comprising the entire Dow Jones
 

Industrial Average (the "DJIA"). Each trust acquires
 

approximately equal values of the ten stocks in the DJIA
 

having the highest dividend yields as of one or two business
 

days before the Trust is created and holds those stocks for
 

approximately on~ year. The Sponsors intend that, as each
 

Trust terminates, a new Trust will be offered for the next
 
Office of the Chief Counsel 2 April 8, 1993 

year.1 This investment approach is discussed in the book
 

Beating the Dow by John Downes and Michael 0' Higgins (New
 

York: Harper Collins, 1991), wherein the authors conclude
 

that over a twenty year period a strategy of initially
 

buying the ten highest dividend yielding stocks in the DJIA,
 

and annually replacing stocks no longer in the highest
 

yielding ten with new stocks that are, would have produced a
 

greater annual total return than the DJIA in 15 of the 20
 

years, and a significantly higher compounded return over the
 

entire 20 years.
 

As might be expected, there is normally some
 

overlap from one year to the next in the stocks having the
 

highest dividend yields in the DJIA. Accordingly, there is
 

likely to be some degree of congruity between the portfolios
 

of a Terminating Trust and a New Trust. In the most recent
 

case, 9 of the 10 securities were identical. However, as
 

these Trusts may be considered affiliates of one another, to
 

date each Terminating Trust2 has, in connection with its
 

termination, sold all of its securities on the New York
 

Stock Exchange as quickly as practicable but over a period
 

of time so as to minimize any adverse impact on the market
 

price. Likewise, the portfolio of a New Trust is acquired
 

in purchase transactions on the New York Stock Exchange.
 

This procedure has resulted in both the Terminating Trust
 

and the New Trust, and, consequently, the holders of units
 

of both Trusts, incurring substantial brokerage commissions
 

on securities of the same issue. Al though commissions vary,
 

the Sponsors estimate that the brokerage charge on a
 

purchase or sale transaction averages approximately 5 cents
 

a share. In the two most recent cases where a Terminating
 

Trust sold portfolio securities which were identical to
 

portfolio securities purchased by a New Trust, aggregate
 

Because each Trust is structured, for federal income
 

tax purposes, as a grantor trust, it is not possible to vary
 

the investments in a Trust to conform to changes in the DJIA
 

and thereby continue the Trust for the next year.
 

2 As a technical matter, holders of units of a 

Terminating Trust who choose to acquire units of a New Trust 

are treated as having redeemed their units of the Terminating 

Trust in kind and received shares in each of the stocks in the 

portfolio of the Terminating Trust. The trustee of the 

Terminating Trust, on behalf of these holders, thereafter 

sells the shares of stock distributed to them on the New York 

Stock Exchange. For purposes of this letter, however, the 

sales should be considered as being made on behalf of the

Terminating Trust. 
Office of the Chief Counsel 3 April 8, 1993 

commissions paid in these purchase and sale transactions
 

were estimated by the Sponsors to be $150,000.
 

Legal Analysis. Unless exempted from Section
 

17 (a), investment companies under common control may be
 

considered affiliates of one another and therefore unable to
 

enter into exchanges of securities without SEC approval.
 

Each Trust is sponsored by Merrill Lynch, Pierce, Fenner &
 

Smith Incorporated, Prudential Securities Inc. and
 

PaineWebber Incorporated. A sponsor (also referred to as a
 

"depositor") is included in the definition of "affiliated
 person" in Section 2 (a) (3) (F) of the 1940 Act. The trustee 

of the Trusts established to date has been either Chase
 

Manhattan Bank, N .A. or The First National Bank of Chicago
 

and Investors Bank & Trust Company, as co-trustees.
 

Accordingly, while we know of no precedent with respect to
 

unit investment trusts, it is likely that each Trust would
 

be considered an affiliate of the others.
 

Rule 17a-7, adopted in 1966, was designed to
 

permi t registered investment companies which might be deemed
 

under common control by reason of common investment
 

advisers, directors and/or officers, to exchange securities
 

with one another at an independently determined price,
 

provided there was no consideration other than cash payment
 

against prompt delivery, the transaction was consistent with
 

the policy of each registered company, and no brokerage
 

commission, fee or other remuneration was paid in connection
 

with the transaction.3 When the Rule was amended in 1981,
 

as explained in ReI. IC-11676 (March 10, 1981), because
 

funds were given greater flexibility in determining the
 

independent price, a new condition (paragraph (e)) required
 

adoption and moni toring4 by the fund's board of directors
 

(including a majority of those directors who are not
 

interested persons) of procedures to assure compliance with
 

the revised rule. Unfortunately, this amendment effectively
 

foreclosed unit investment trusts (which by definition have
 

no board of directors) from realizing similar savings for
 

their holders.
 

We submit that, in the circumstances described
 

above, a sale of securities by a Terminating Trust to a New
 

Trust in a transaction appropriate to the investment
 

3See ReI. IC-11136 (April 21, 1980).
 

4The Commission, in its recent Release No. IC-19192 (December
 

30, 1992), has proposed eliminating the annual director review
 

requirement from certain rules, including Rule 1 7a-7.
 
Office of the Chief Counsel 4 April 8, 1993 

objectives of each, at the closing price on the New York
 

Stock Exchange on the date of the sale, without any
 

brokerage charges or other remuneration except customary
 

transfer fees, if any, satisfies each of the requirements of
 

Rule 1 7a - 7 other than paragraph (e) thereof - i. e ., it meets
 

each of the requirements of Rule 17a-7 as in effect until
 

the 1981 amendment. Satisfying the additional condition of
 

board review is obviously impossible for a unit investment
 

trust. Additionally, the rationale behind the on-going
 

monitoring requirement of paragraph (e) is not applicable to
 

exchange-listed securities, especially where the securities
 

are 10 of the 30 most well established and actively traded
 

stocks in the United States. Accordingly, we hereby
 

request confirmation that the Staff would not recommend


enforcement action under Sections 17 (a) (1) or 17 (a) (2) of 

the 1940 Act if a Terminating Trust sells securities as
 

described above to a New Trust.
 

Please feel free to call the undersigned (at
 212-450-4525), Linda Simpson (at 212-450-4332) or Gary L. 

Granik (at 212-450-4721) if you have any questions regarding
 

this request.
 

submitted,