UNITED STATES
 

SECURITIES AND EXCHANGE COMMISSION
 

WASHINGTON. D.C. 20549
 

DIVISION OF
 

INVESTMENT MANAGEMENT 

January 27, 1994
 

Mr. David S. Butterworth
 ACT -:C.v\ ~6 l~VD Managing Director


D. S. Butterworth & Co., Inc. SECTION 

1853 William Penn Way RULE --:t.- - ¿


P.O. Box 10695
 PUBLIC Lancaster, PA 17605-0695
 

A V AILiiBILllY
 N127-J1~ . I Re: Charter Funds, File No. 811-5411;
 

Our Ref. No. 93-403
 

Dear Mr. Butterworth: 

Your letter of July 2, 1993 requests our assurance that we
 

would not recommend that the Commission take any enforcement
 

action under Section 17 (f) of the Investment Company Act of 1940
 

(the "1940 Act") if the Charter Funds (the "Trust") retains an


affiliate, Charter Guaranty Company, Inc. ("Charter Guaranty"),
 

as its custodian in the manner described in your letter.
 

The Trust proposes to retain Charter Guaranty as its
 

administrator, shareholder servicing agent, and custodian.
 

Charter Guaranty, in turn, will enter into sub-custodial
 

agreements with various banks. ii Your letter states that
 Charter Guaranty is not a bank qualified under Section 26(a) (1) 

of the 1940 Act or a member of a national securities exchange.
 

Your letter also states that David S. Butterworth owns both
 

Charter Guaranty and the Trust's adviser.
 

Section 17 (f) requires every management investment company
 

to place its securities and similar investments in the custody of


(1) a bank or banks qualified under Section 26 (a) (1), ~i (2) a 

ii Your letter indicates that Charter Guaranty will enter into
 

some of these sub-custodial agreements to take advantage of
 

the book entry system of the Depository Trust Company
 

("DTC"). You should note that Rule 17f-4 imposes certain


requirements on investment companies or qualified custodians
 

who deposit some or all of a company's securities with a
 

qualified depository, like DTC. See Mutual Investment Fund
 

of Connecticut, Inc. (pub. avail. Nov. 20, 1986).
 

2.1 Section 26 (a) (1) provides that the trustee or custodian 

shall be a bank which has "at all times aggregate capital,
 

surplus and undivided profits of a specified minimum amount,
 

which shall be not less than $500,000." Section 26 applies
 

~ to unit investment trusts and is relevant to management


investment companies, like the Trust, only to the extent
 
company that is a member of a national securities exchange, in
 

accordance with Commission regulations, or (3) the investment
 company itself, in accordance with Commission regulations (i. e. , 

self-custody). Rule 17f-2 sets forth the conditions under which
 

a registered management investment company may maintain custody
 

of its securities and other assets.
 

The staff has interpreted Rule 17f-2 to apply to any
 

arrangement between an investment company and its investment
 

adviser where the adviser also serves as custodian or
 

sub-custodian. dl The staff believes that the principal policy
 

of section 17 (f) is to ensure that securities and other assets
 

owned by the investment company are maintained in such a manner
 

that they will be subject to adequate independent scrutiny and
 

that this policy would be frustrated if an investment adviser
 

rendering custodial services was not subject to additional
 

safeguards such as those in Rule 1 7f-2, particularly the
 

verifications required by paragraph (f). ~I The staff has
 

interpreted the rule to further include an arrangement where an
 

investment company's adviser and custodian are wholly-owned
 

subsidiaries of the same corporation, and the adviser and
 

custodian share common directors and officers. ~I We believe
 

that the same concerns under section 17 (f) are present in your
 

proposed arrangement where the investment adviser and custodian
 

are both wholly-owned by the same individual.
 

that section 17 (f) references the definition of bank in
 

Section 26 (a) (1). Your letter states that the Trust will
 

comply with paragraphs (2) through (4) of section 26(a);
 

however, these provisions do not apply to management
 

investment companies.
 

dl See American National Growth Fund, Inc. (pub. avail. Oct. 4,


1991) (adviser served as custodian); The Mutual Fund Group
 

(pub. avail. Dec. 12, 1989) (adviser served as


sUb-custodian); Mutual Investment Fund of Connecticut, Inc.
 

(adviser served as custodian); Pegasus Income & Capital


Fund, Inc. (pub. avail. Dec. 31, 1977) (adviser served as


custodian) . 

~I Paragraph (f) of Rule 17f-2 requires that an independent
 public accountant verify by complete examination the
 

securities and similar investments held by a self-custodian
 

at least three times annually.
 

~I See IPI-Income & Price Fund (pub. avail. Dec. 12, 1980).
 See also Composite Group of Funds (pub. avail. Mar. 2,
 

1987) (Rule 17f-2 applied to arrangement where sUbsidiary of


custodian served as investment adviser). 

- 2 ­

6 
Even if the Trust complied with all of the requirements of
 Rule 1 7f-2, we do not have enough information about Charter 

Guaranty to determine whether Charter Guaranty can serve as the
 

Trust's custodian. Paragraph (d) of Rule 17f-2 generally
 

requires that access to the investment company's securities be
 

limited to (1) certain officers or employees of the company, (2)
 

certain officers or emolovees of the bank or other comoany in
 

whose safekeeping the investments are olaced, and (3) the
 

independent public accountant for purposes of the verifications
 

required by paragraph (f). Paragraph (b) of the rule generally
 

requires that an investment company with self-custody place its
 

investments in the safekeeping of "a bank or other company whose
 

functions and physical facilities are supervised by Federal or
 

state authority." As custodian, Charter Guaranty would have
 

access to the Trust's securities. Your letter states that
 

Charter Guaranty is not a bank; it does not address, however,
 

whether Charter Guaranty falls within the meaning of "other
 

company whose functions and physical facilities are supervised by
 Federal or state Authority" in Rule 17f-2 (b). &.1 

Finally, we question whether, under your proposed
 

arrangement, Charter Guaranty properly can be characterized as
 

the Trust's "custodian." It is not clear from your letter that
 

Charter Guaranty will provide any custodial functions to the


Trust. 

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 Section 17 (f) of the
 

1940 Act if the Trust retains Charter Guaranty as its custodian.
 

Sincerely, 

C¡~ 5. ()/~
 Julia s. Ulstrup
 

Senior Counsel
 

&.1 See American National Growth Fund, Inc. (registered broker-


dealer affiliate as custodian under Rule 1 7f-2) and
 

Composite Group of Funds (savings and loan affiliate as
 

custodian under Rule 17f-2). See also Principal
 

Preservation Portfolios (Aug. 15, 1988) (registered broker-


dealer affiliate as safekeeping entity under


Rule 17f-2 (b) ) . 

- 3 ­
--

1940 Actjl7 (f)
 

!Ø.7 §l~mo,d ,g. ~., §/W. 'l­

.\ . I Investment Managcmcnt 

July 2, 1993
 

. 1
 

Thomas Harman
 

Chief Counsel
 

Securities and Exchange Commission
 

Division of Investment Management
 

450 Fifth street, N.W.
 

Washington, DC 20549
 

Re: Charter Funds
 

Rcgistrntion No. JJ-19JG0
 

Dear Mr. Harman:
 

D.S. Butterworth & Co. requests on behalf of the Charter Funds (the
 

"Trust") that the staff of the Division of Investment Management
 

(the "Staff") advise the Trust that it will not recommend any


enforcement action to the Securities and Exchange Commission
 

pursuant to Section 17(f) of the Investment Company Act of 1940,
 

as amended (the "1940 Act"), if the Trust retains an affiliated
 

non-bank, non-securities exchange member custodian, but otherwise
 

complies with Section 26 (a) of the 1940 Act.
 

The Trust intends to retain Charter Guaranty Company, Inc.
 

("Charter Guaranty") as its administrator and shareholder servicing


agent ; additionally, the Trust intends (pending the outcome of this
 

request) to retain Charter Guaranty as its custodian. This firm
 

is owned by David S. Butterworth, as are D.S. Butterworth & Co.,
 the adviser, and Charter Securi ties Corp. , the principal underwriter. The Trust, a "series" type fund, is closely 

affiliated with the adviser and is designed primarily to make the


adviser's investment management services and reasonable
 

diversification available to its smaller clients. These closely
 

affiliated companies serve the Trust through what are believed to
 

be very practical and inexpensive relationships, the services of
 

which would not otherwise be economically feasible using larger
 

non-affiliated firms.
 

The custodian agreement with Charter Guaranty provides that "no
 

trustee, officer, employee or agent of the Trust, and no officer,
 

director, employee or agent of the Custodian, shall have physical
 

access to the assets of the Trust maintained by the Custodian or
 

be authorized or permitted to withdraw any investments of the
 

Trust, nor shall the Custodian deliver any assets of the Trust to
 any such person. No officer, director i employee or agent of the 

Custodian who holds any similar posi tion with the Trust shall have
 

1853 Wiliam Penn Way, P.O. Box 10695, Lancaster. P A 17605-0695 717-291-2100 
Thomas Harman, page 2. July 2, 1993 

physical access to the assets of the Trust" . Additionally, in
 

complying with Section 26 (a) of the 1940 Act, the Trust through
 

Charter Guaranty' ultimately designates custody of. its portfolio
 

securities with" (1) .. .one or more trustees or custodia,l1s,"each of
 which is a bank... (2) provides, in substance, (A.) ,that during the 

life of the trust the trustee or custodian, if not otherwise
 

remunerated, may charge... for its expenses as are provided for in
 

such instrument; (B) that no such charge or collection shall be
 

made except for services theretofore performed or expenses
 

thereto for incurred; (C) that no payment to the depositor of or a
 

principal underwriter for such trust, or to any affiliated person
 

or agent of such depositor or underwriter, shall be allowed the
 

trustee or custodian as an expense (except that provision may be
 

made for the payment to any person of a fee, not exceeding such
 

reasonable amount as the Commission mñy prescribe as compensation
 

for performing bookkeeping and other administrative services, of
 

a character normally performed by the trustee or custodian itself) ;
 

and (D) that the trustee or custodian shall have possession of all
 

securi ties and other property in which the funds of the trust are
 

invested, all funds held for such investment, all equalization,
 

redemption, and other special funds of the trust, and all income
 

upon, accretions to, and proceeds of such property and funds, and
 shall segregate and hold the same in trust (subj ect only to the

charges and collections allowed under clauses (A), (B), and (C) J 

until distribution thereof to the security holders of the trust;
 

(3) provides, in substance, that the trustee or custodian shall not
 resign. . . (4) provides, in substance, (A) that a record will be kept 

by the depositor or an agent...; and (B) that whenever a security
 

is deposited...", as this section states in its entirety.
 

The distinction to be made, however, is that Charter Guaranty
 

contracts with such bank custodian (s) for these services and hot
 

the Trust directly. Any administrative services that can be
 delegated by the bank custodian, such as securities trading, 

affirming transactions with the Depository Trust Company ("DTC"),
 

relaying settlement instructions to brokers, etc., are handled by
 

Charter Guaranty. This also facilitates better communication,
 

electronic data transfer, and coordination of activities between
 

what may eventually be multiple advisers and multiple bank
 

custodians through one entity, Charter Guaranty.
 

Under the Trust's previous plan of business a custodian, Dauphin
 

Deposit Bank and Trust Company ("Dauphin"), was to be retained.
 

Their capabilities were not extraordinary, except for the fact that
 

they are recognized as one of Central Pennsylvania's finest banking
 

institutions and as custodian of the Trust's Pennsylvania tax-


exempt income portfolio their daily pricing of local municipal
 

securities could' prove beneficial in determining the portfolio's
 NAV. There really are no similar benefits afforded to the Trust's 

other portfolios and in such cases Dauphin is simply one more layer
 
Thomas Harman, page 3. July 2, 1993 

adding to their incremental costs. In fact, Dauphin contracts with
 

the Northern Trust Company ("Northern") in Chicago for computer
 

systems and physical/non-DTC eligble securities custody; Northern
 

in-turn then provides Dauphin with access to the Depository Trust
 

Company's book-entry-only securities depository and the National
 

Securities Clearing Corp. settlement and clearance system. The
 

Trust is better served by Charter Guaranty being able to directly
 

contract with DTC agent banks in certain instances, placing itself
 

in the line-up as the first intermediary (and in doing so reduce
 

the Trust's costs), while alternately contracting with select local
 

bank custodians when the benefits of their services are truely
 

worthwhile from a value-added standpoint.
 

The objective of the previous explanation of a custodian and its
 attendant duties is to show that in rea Ii ty it is not a sole-source

relationship, but actually multiple layers with the ultimate
 

"custodian" being (with some exceptions) the Depository Trust


Company. The safeguards intended in section 17 (f) of the 1940 Act 

for the custody of investment company assets seem to be clearly met
 

through the DTC book-entry-only system and/or through DTC agent
 

banks (being one layer removed) and further by restricting access
 

to such assets by affiliated persons otherwise responsible for
 

administering the Trust's activities.
 

In all instances the Trust will, by contract with Charter Guaranty
 

and their contraèt (s) with one or more banks, have custody of its
 

portfolio securities maintained within the requirements of Section
 

26 (a) of the 1940 Act. The Trust's custodian agreement with
 

Charter Guaranty will be "approved by the vote of a majority of the
 outstanding voting securities.. .precisely (describing) all 

compensation to be paid thereunder... shall continue in effect for
 

a period more than two years from the date of its execution, ohly
 

so long as such continuance is specifically approved at least
 

annually by the board of (trustees) or by vote of a majority of the
 

outstanding voting securities of (the Trust)" and will provide that
 ". . . such contract or agreement and any renewal thereof (shall be) 

approved by the vote of a majority of (trustees), who are not
 

parties to such contract or agreement or interested persons of any


such party. . . ", as required of investment advisory and underwriting 

contracts in section 15 of the 1940 Act.
 

The Trust seeks relief from disclosing individually each of the
 

underlying bank custodians in its prospectus while avoiding any
 

interpretation by the Staff of Section 17 (f) of the 1940 Act that
 

could arise in naming Charter Guaranty as custodian whereby such
 

action is construed as creating a self-custodian relationship under
 

subsection 17(f) (3) due to their affiliation; and, therefore,
 

causing the Trust to be required to retain independent accountants
 

to perform the three verifications of their portfolio securities
 

as required by subsection (f) of Rule 17f-2 of the 1940 Act.
 
. . 

Thomas Harman, page 4. July 2, 1993
 

If you should have any questions or require further information
 

concerning this request, please call me. Thank you.
 

Sincerely, G4g,~ David S. Butterworth
 

Managing Director
 

6