25630 Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations

1Unless otherwise noted, all references to rules

17f–5, 17f–4, and 7d–1 (or any paragraph of those

rules) will be to 17 CFR 270.17f–5, 270.17f–4, and

270.7d–1, as amended by this release.

2See Exemption for Custody of Investment

Company Assets Outside the United States,

Investment Company Act Release No. 14132 (Sept.

7, 1984) [49 FR 36080 (Sept. 14, 1984)]. Section

17(f) of the Investment Company Act, which

governs fund custody arrangements, does not

address the use of a foreign custodian. The

Commission adopted rule 17f–5 under its

exemptive authority in section 6(c) of the Act [15

U.S.C. 80a–6(c)] and under its authority in section

38(a) of the Act [15 U.S.C. 80a–38(a)].

3See Custody of Investment Company Assets

Outside the United States, Investment Company Act

Release No. 22658 (May 12, 1997) [62 FR 26923

(May 16, 1997)] (the ‘‘1997 Release’’).

4See Custody of Investment Company Assets

Outside the United States, Investment Company Act

Release No. 23815 (Apr. 29, 1999) [64 FR 24489

(May 6, 1999)] (the ‘‘Proposing Release’’), at nn.4–

10 and accompanying text.

5The history of rule 17f–5 is discussed in greater

detail in the introductory section of the Proposing

Release. See Proposing Release, supra note 4, at

nn.2–17 and accompanying text.

6See Custody of Investment Company Assets

Outside the United States, Investment Company Act

Release No. 23201 (May 21, 1998) [63 FR 29345

(May 29, 1998)]. A further extension remains in

effect today. See Custody of Investment Company

Assets Outside the United States; Extension of

Compliance Date, Investment Company Act Release

No. 23814 (Apr. 29, 1999) [64 FR 24488 (May 6,

1999)] (extending compliance date until the

Commission acts on 1999 proposals or May 1,

2000). The compliance date for the amended

definition of ‘‘eligible foreign custodian’’ remained

June 16, 1998. Compliance with the 1997

Amendments will become moot when amended

rule 17f–5 and new rule 17f–7 take effect. See infra

notes 38 to 40 and accompanying text (discussing

effective date and compliance date for amended

rule and new rule; prior to the compliance date, a

fund may comply with the 1997 Amendments or

follow other compliance options).

7See Proposing Release, supra note 4, at nn.13 &

15 and accompanying text. The submitted proposal

(the ‘‘ICI/Bank Proposal’’) would have deemed fund

assets maintained with a depository to be subject

to reasonable care if eight objective criteria were

met. See id. at n.16. Under a revised joint proposal

submitted in 1999, the foreign custody manager

would have (i) considered other information known

to it that established certain compliance problems,

and (ii) monitored depository arrangements for

material changes. See id.

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 270

[Release Nos. IC–24424, IS–1221; File No.

S7–15–99]

RIN 3235–AH55

Custody of Investment Company

Assets Outside the United States

AGENCY: Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Commission is adopting

a new rule and rule amendments under

the Investment Company Act to address

the custody of investment company

assets outside the United States. The

rule and rule amendments establish new

standards governing the maintenance of

an investment company’s assets with a

foreign securities depository. These

standards are designed to provide a

framework under which an investment

company can protect its assets while

maintaining them with a foreign

securities depository.

DATES: Effective Date: June 12, 2000.

Compliance Date: July 2, 2001. Section

III of this release contains more

information on transition prior to the

compliance date.

FOR FURTHER INFORMATION CONTACT: Jaea

F. Hahn, Attorney, Office of Regulatory

Policy, at (202) 942–0690, or Thomas

M.J. Kerwin, Senior Counsel, at (202)

942–0660, in the Division of Investment

Management, Securities and Exchange

Commission, 450 5th Street NW,

Washington DC 20549–0506.

SUPPLEMENTARY INFORMATION: The

Securities and Exchange Commission

(‘‘Commission’’) today is adopting new

rule 17f–7 [to be codified at 17 CFR

270.17f–7], amendments to rule 17f–5

[17 CFR 270.17f–5] and conforming

amendments to rule 7d–1 [17 CFR

270.7d–1] and rule 17f–4 [17 CFR

270.17f–4] under the Investment

Company Act of 1940 [15 U.S.C. 80a]

(the ‘‘Investment Company Act’’).1

Table of Contents

Executive Summary

I. Background

II. Discussion

A. Foreign Securities Depositories: Rule

17f–7

1. Eligible Securities Depository

2. Risk Analysis, Monitoring and

Notification

3. Exercise of Care

B. Foreign Bank Custodians: Rule 17f–5

C. Conforming Amendments

III. Effective Date

IV. Cost-Benefit Analysis

V. Effects on Efficiency, Competition and

Capital Formation

VI. Paperwork Reduction Act

A. New Rule 17f–7

B. Amendments to Rule 17f–5

VII. Summary of Final Regulatory Flexibility

Analysis

A. Need for and Objectives of the Rule and

Rule Amendments

B. Significant Issues Raised by Public

Comments

C. Small Entities Subject to the Rules

D. Projected Reporting, Recordkeeping, and

Other Compliance Requirements

E. Agency Action to Minimize Effects on

Small Entities

VIII. Statutory Authority

Text of Rules

Executive Summary

The Commission is adopting new rule

17f–7 under the Investment Company

Act and amendments to rule 17f–5, the

rule that governs the custody of the

assets of registered management

investment companies (‘‘funds’’) with

custodians outside the United States.

The new rule and rule amendments will

permit funds to maintain their assets in

foreign securities depositories based on

conditions that reflect the operations

and role of these depositories.

Depositories are systems for the central

handling of securities in which

transactions in securities are processed

through adjustment of electronic

account records rather than delivery of

certificates.

The rule and amendments we are

adopting today establish basic standards

for foreign depositories that funds may

use, and generally require that a fund’s

contract with its global custodian

obligate the custodian to analyze and

monitor the custody risks of using a

depository, and provide information

about the risks to the fund or its adviser,

as well as any information regarding

material changes in the risks. Unlike

amended rule 17f–5, rule 17f–7 does not

contain any provisions regarding the

delegation of authority under the rule.

Decisions to maintain assets with a

depository would be made by the fund

or its adviser, based upon information

provided by the global custodian.

I. Background

Rule 17f–5 was adopted in 1984,2 and

extensively revised in 1997 (‘‘1997

Amendments’’) to reflect significant

developments in foreign investment by

U.S. funds and the Commission’s greater

experience with foreign custody

arrangements.3 The 1997 Amendments

expanded the types of foreign banks and

securities depositories that may serve as

custodians of fund assets, and required

that the selection of a foreign custodian

be based on whether the fund’s assets

will be subject to reasonable care if

maintained with that custodian.4 In

1998, as a result of difficulties

experienced by funds, their advisers and

bank custodians in applying the

standards of rule 17f–5 to the use of

foreign depositories, representatives of

funds asked the Commission to delay

the compliance date for the 1997

Amendments.5 The Commission

suspended the compliance date for most

of the 1997 Amendments in May 1998.6

Representatives of funds and bank

custodians then submitted a proposal to

further amend rule 17f–5 to change the

standards by which foreign depositories

are evaluated.7

Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations 25631

8See Proposing Release, supra note 4.

9The commenters included an individual

attorney, an investment adviser, a bank custodian,

a depository operator, two trade associations and a

bar association. The comment letters and a

summary of the comments prepared by the

Commission staff are available in the Commission’s

Public Reference Room, 450 5th Street, NW,

Washington, DC (File No. S7–15–99).

10Commenters representing the bank custodians

and the Investment Company Institute expressed a

preference for the ICI/Bank Proposal. As we noted

in the Proposing Release, we did not believe the

ICI/Bank Proposal would adequately resolve the

issues raised because the reliance on limited

objective criteria may not adequately identify the

potential risks of depository arrangements in a

changing global marketplace. In addition, we were

concerned that the ICI/Bank Proposal might unduly

narrow the evaluation of potential risks and reduce

incentives to provide relevant information to funds.

See Proposing Release, supra note 4, at n.19 and

accompanying text.

11We are also adopting conforming amendments

to rules 7d–1 and 17f–4 substantially as proposed.

12See rule 17f–7(b)(2). One commenter noted that

some funds may not contract directly with the

custodian that is primarily responsible for global

custody arrangements. Instead, a fund may contract

with a domestic custodian that subcontracts with a

global custodian to handle the fund’s foreign

custody arrangements. The risk analysis and

monitoring requirements of rule 17f–7 reflect these

alternative arrangements by providing that the

Primary Custodian ‘‘or its agent’’ (i.e., the global

custodian) may furnish the information required by

the rule. See rule 17f–7(a)(1)(i).

13See rule 17f–7(b)(1)(i) and (ii). As proposed, the

definition of eligible securities depository would

have applied only to the depository system itself.

At one commenter’s suggestion, we have expanded

the definition of eligible securities depository to

include the operator of a depository system. 14See rule 17f–7(b)(1)(iii) to (vi). The following

requirements reflect five of the eight requirements

suggested in the ICI/Bank Proposal. See supra note

7. 15As proposed, rule 17f–7 would have required

an eligible securities depository to treat a fund no

less favorably than other participants with respect

to all conditions generally, rather than

‘‘safekeeping’’ conditions. Two commenters

suggested that the rule should permit different

business conditions, such as different credit terms

or volume-adjusted fees, because they do not imply

different levels of safekeeping protection. We agree

with this point and have modified the rule

accordingly. See rule 17f–7(b)(1)(iii).

16As proposed, rule 17f–7 would have required

an eligible securities depository to be subject to

periodic ‘‘review,’’ rather than ‘‘examination,’’ by

regulators or auditors. The change in the final rule

is intended to distinguish this requirement from the

requirement that a foreign financial regulatory

authority regulate the depository. See rule 17f–

7(b)(1)(vi).

17See Proposing Release, supra note 4, at nn.32–

34 and accompanying text. Interpretations by

Commission staff have treated U.S.-based transfer

agents as depositories when they maintain records

of the ownership of uncertificated securities not

held in a conventional depository. See, e.g.,

American Pension Investors Trust, SEC No-Action

Letter (Feb. 1, 1991) (custodian for fund of funds

could maintain fund’s investments in uncertificated

shares of underlying funds with the domestic

transfer agents of those funds acting as deemed

depositories); FundVest, SEC No-Action Letter

(Nov. 21, 1984) (similar position).

18 In the case of Russia, for example, hundreds of

registrars typically are used to record securities

transfers. See Proposing Release, supra note 4, at

n.33 and accompanying text.

19 In urging the Commission to continue to

address the use of transfer agents on a case-by-case

basis, commenters suggested that it would be

burdensome to obtain a risk analysis of the many

transfer agents (such as the registrars in Russia) that

funds might use, and that transfer agents may not

meet all of the requirements of an eligible securities

depository. We note, however, that the staff

provided no-action assurance in the past to allow

funds to hold assets with foreign transfer agents that

perform some custodial functions, based upon

representations that the transfer agents would be

subject to similar oversight. Those no-action letters

were issued in reliance on representations that,

among other things, the transfer agents’ activities

would be monitored, independent auditors would

verify the share registry, and the fund’s board of

directors would receive quarterly reports. See, e.g.,

Templeton Russia Fund, Inc., SEC No-Action Letter

(Apr. 18, 1995) and Russia Growth Fund, Inc., SEC

No-Action Letter (May 20, 1997). Because rule 17f–

7 does not address the use of foreign transfer agents,

funds should continue to follow the applicable noaction letters or exemptive relief on which they rely

to hold assets with those transfer agents.

20See rule 17f–7(a)(1)(i)(A). A local subcustodian

or other agent may prepare the initial risk analysis

on behalf of the primary custodian.

21See id. We recognize that in certain emergency

circumstances a fund may need to move its assets

to a depository in order to protect its assets before

a risk analysis of the new depository can be

prepared. In those circumstances, we would expect

the initial risk analysis of the new depository to be

provided as soon as possible after the fund places

its assets with that depository. See infra ‘‘Part III.

Effective Date,’’ for a discussion of the treatment of

fund assets in the custody of a foreign securities

depository before the fund’s depository

arrangements are subject to the requirements of rule

17f–7.

Last year, we proposed amendments

to rule 17f–5 and a new rule 17f–7.8 We

received letters from seven commenters

on the proposals.9 Commenters

generally favored the proposals, but also

recommended changes.10 We are

adopting new rule 17f–7 with

modifications that respond to certain of

the issues raised by commenters; we are

adopting the amendments to rule 17f–5

substantially as proposed.11

II. Discussion

A. Foreign Securities Depositories: Rule

17f–7

New rule 17f–7 permits a fund to

maintain assets with a foreign securities

depository if certain conditions are met.

First, the depository must be an

‘‘eligible securities depository’’ as

described below. Second, the fund’s

‘‘primary custodian’’ must provide the

fund or its adviser with an analysis of

the custodial risks of using the

depository, monitor the depository on a

continuing basis and notify the fund of

any material changes in risks associated

with using the depository. The rule

defines a primary custodian (often

referred to as a ‘‘global custodian’’) as a

U.S. bank or qualified foreign bank (as

defined by rule 17f–5) that contracts

directly with the fund to provide

custodial services for foreign assets.12

1. Eligible Securities Depository.

Under the rule, funds and their

custodians may maintain their assets

with a foreign securities depository only

if it is an ‘‘Eligible Securities

Depository.’’ An eligible securities

depository must act as or operate a

system for the central handling of

securities that is regulated by a foreign

financial regulatory authority.13 In

addition, an eligible securities

depository must: 14

• (Hold assets on behalf of the fund

under safekeeping conditions no less

favorable than those that apply to other

participants; 15

• (Maintain records that identify the

assets of participants, and keep its own

assets separated from the assets of

participants;

• (Provide periodic reports to

participants; and

• (Undergo periodic examination by

regulatory authorities or independent

accountants.16

The proposed rule included within

the definition of eligible securities

depository certain foreign transfer

agents that perform custodial functions

analogous to those of a depository.17

Commenters urged that the rule not

address these types of arrangements,

which are found in countries such as

Russia and Ukraine.18 Commenters

pointed out that while some transfer

agents may be analogous to securities

depositories, others clearly are not, and

some transfer agents perform some but

not all the functions of a depository. We

have decided to accept the

recommendations of these commenters,

and will continue to address the use of

these transfer agents on a case-by-case

basis.19

2. Risk Analysis, Monitoring and

Notification. The definitional

requirements for an eligible securities

depository described above are

minimum requirements that all foreign

securities depositories must meet before

a fund may rely on the rule to place

fund assets with them. We also are

adopting, as a condition for use of the

rule, a requirement that the custody

risks of using the eligible securities

depository be analyzed and monitored

by the primary custodian or its agent.

Rule 17f–7 requires that a fund’s

primary custodian 20 furnish the fund or

its investment adviser an analysis of the

custody risks of using an eligible

securities depository before the fund

places its assets with the depository.21

The fund’s contract with its primary

custodian also must require the

custodian to monitor these risks on a

25632 Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations

22See rule 17f–7(a)(1)(i)(B). The proposed rule

would have required the primary custodian to

‘‘continuously’’ monitor the custody risks of using

a foreign depository. One commenter argued that

the term ‘‘continuously’’ could imply that the

primary custodian must learn of material changes

affecting a depository more quickly than it learns

of developments affecting other subcustodians such

as a foreign bank. As adopted, rule 17f–7 mirrors

a requirement imposed in the United Kingdom that

custodians be subject to a ‘‘continuing risk

assessment.’’ See United Kingdom Securities and

Futures Authority, Board Notice 433, New

Safekeeping Rules, Custody Rule 4–107(1),

Assessment of Custodian (July 21, 1997) (after a

firm makes an appropriate risk assessment of an

eligible custodian, it must undertake a ‘‘continuing

risk assessment’’). The requirement that monitoring

of custody risk occur on a ‘‘continuing basis’’ better

reflects the Commission’s view, expressed in the

Proposing Release, that there should be an ongoing

assessment of the custody risks associated with a

depository, and that the level of this monitoring

should be based on the specific facts and

circumstances related to the foreign depository and

the country in which the depository operates. See

Proposing Release, supra note 4, at nn.38–43 and

accompanying text. As with the preparation of the

initial risk analysis, a local subcustodian or other

agent may monitor custody risks on behalf of the

primary custodian. 23A commenter suggested that a primary

custodian should be permitted to suspend its

monitoring and notification activities if political

developments or other circumstances interfere with

these obligations. The Commission anticipates that

exceptional developments will be addressed in a

report to the fund and that the primary custodian,

in performing its duties under the contract, will

make a reasonable effort to continue to monitor

further developments or to resume monitoring as

soon as practicable in these circumstances. 24One commenter pointed out that certain

transnational depositories may perform depository

and global custodial functions. Under the rule, the

risk analysis of a transnational depository that also

performs custodial functions should take into

consideration any information reasonably available

to the primary custodian from the depository

regarding its custodial network (e.g., the local bank

subcustodian’s internal controls, financial strength,

and information regarding enforceability of

judgments).

25Relevant measures of financial strength might

include the level of settlement guarantee funds,

collateral requirements, lines of credit, or insurance

as compared with participants’ daily settlement

obligations.

26This factor relates to requirements under the

definition of an eligible securities depository.

27We recognize that fund boards do not typically

have the expertise to make day-to-day decisions

regarding foreign depository arrangements, and we

assume that a fund board will delegate these

responsibilities to the fund’s adviser, subject to the

board’s general oversight, even though the rule does

not require delegation. As we stated in the

Proposing Release, when custodial risks are a

material factor in the decision to enter or exit a

market, we would expect the adviser to inform the

board of the risks based on the risk analysis and

other information provided by the primary

custodian or its agent. See Proposing Release, supra

note 4, at nn.51–53 and accompanying text.

28These standards generally require the exercise

of care, but do not set limits on the risks that a fund

or its adviser may find acceptable for the fund’s

depository arrangements.

29See Proposing Release, supra note 4, at text

accompanying nn.35–37.

30Some commenters said that guidance would be

needed on whether the rule would allow for

common insurance exclusions (such as

insurrection, natural disasters, or governmental

action). Some commenters also suggested that

coverage against negligence by a depository (as

distinguished from larceny or embezzlement) might

be unavailable or prohibitively expensive, and that

reasonable coverage limits and deductible amounts

would need to be defined.

31For example, the primary custodian could

determine that certain risks are mitigated by

indemnification or insurance.

32See rule 17f–7(a)(1)(ii). As proposed, rule 17f–

7 also would have required the custodian or

subcustodian to agree to exercise reasonable care in

‘‘all other conduct relating to custody

arrangements.’’ The rule as adopted does not

include this latter provision because, as one

commenter pointed out, it would broadly apply to

some custody activities that may be unrelated to the

use of a depository (e.g., activities not related to

analysis of the depository and monitoring of risks).

33See rule 17f–5(b)(3).

34See Uniform Commercial Code, § 8–504 and

cmt. 3, and § 8–509 (1994) (securities intermediary

must perform its duties under the Code, including

duties to follow certain procedures in maintaining

financial assets and to exercise care in selecting

subcustodians, with ‘‘due care in accordance with

reasonable commercial standards,’’ unless modified

by regulatory requirements or contractual

provisions that meet a ‘‘good faith’’ standard).

35Amended rule 17f–5 uses the term ‘‘foreign

assets’’ in place of ‘‘fund assets’’ to clarify that

assets maintained with a foreign custodian may not

be the exclusive property of the fund. See U.C.C.

§ 8–503(b) and cmt. 1 (1994) (entitlement holder’s

property interest in securities held by its securities

intermediary is a pro rata interest shared with other

customers of the intermediary). The amended rule

also refers to ‘‘maintaining assets with’’ an eligible

foreign custodian rather than ‘‘selecting’’ a

custodian, and uses the term ‘‘eligible foreign

custodian’’ throughout the rule. In addition, the

amended rule provides that the fund’s foreign

custody manager, as well as the fund itself, may

place and maintain fund assets with an eligible

foreign custodian. See amended rule 17f–5.

continuing basis,22 and promptly notify

the fund or its adviser of any material

change.23

We have written the risk analysis

requirements of the rule broadly to

provide custodians with flexibility to

tailor the risk analysis to the specific

risks involved in the use of each

particular depository.24 The rule does

not prescribe specific factors or types of

risk to be considered in a risk analysis.

As a general matter we expect that an

analysis will cover a depository’s

expertise and market reputation, the

quality of its services, its financial

strength,25 any insurance or

indemnification arrangements, the

extent and quality of regulation and

independent examination of the

depository,26 its standing in published

ratings, its internal controls and other

procedures for safeguarding

investments, and any related legal

protections.

Rule 17f–7 does not assign a role to

the investment adviser or fund board,

but is designed to assure that sufficient

material information about depositories

is provided to the fund or adviser in a

timely manner. The decision whether to

place fund assets with a depository

should be made by the adviser (subject

to oversight of the fund’s board) or the

fund, after consideration of the

information provided by the primary

custodian or its agent,27 and based on

standards of care that are generally

applicable to fund advisers and

directors.28 The decision to place fund

assets with a depository does not have

to be made separately, but may be made

in the overall context of the decision to

invest in a particular country.

As proposed, rule 17f–7 would have

permitted a fund to rely on

indemnification or insurance that

adequately protects the fund from all

custody risks of using the depository, as

an alternative to the risk analysis and

monitoring requirement.29 Several

commenters urged that we not adopt

this alternative, and pointed out that, if

we did, they would need guidance on

the scope and amount of

indemnification adequate to meet the

requirements of the rule.30 In light of the

issues raised by commenters and the

likelihood that this alternative would

not be used by funds, we have decided

not to adopt it. Instead, as noted above,

we suggest that insurance and

indemnification arrangements are

factors that a risk analysis would

cover.31

3. Exercise of Care. Rule 17f–7

requires the fund’s contract with its

primary custodian to provide that the

primary custodian will agree to exercise

reasonable care, prudence and diligence

in performing its duties under the rule,

or adhere to a higher standard of care.32

This standard of care is the same

required of foreign custody managers

under rule 17f–5,33 and is similar to

standards for U.S. custodians under

commercial law. 34

B. Foreign Bank Custodians:

Rule 17f–5

Amended rule 17f–5 will continue to

govern a fund’s use of a foreign bank

custodian. As amended, the rule

excludes arrangements with foreign

securities depositories from its scope

because they are addressed by rule 17f–

7. The amended rule also reflects other

clarifying changes from the previous

version of the rule.35 A note to amended

rule 17f–5 (and a similar note to rule

17f–7) explains that when a depository

arrangement involves one or more

foreign bank custodians through which

assets are maintained with the

depository, rule 17f–5 applies to the

fund’s or its custodian’s use of each

foreign bank subcustodian, while rule

Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations 25633

36See Note to amended rule 17f–5; Note to rule

17f–7.

37This change clarifies that an eligible securities

depository may include, for example, a branch of

a U.S. bank that meets the other requirements of the

definition of an eligible securities depository.

38A fund may undertake to comply with new rule

17f–7 and amended rule 17f–5 before the

compliance date. With respect to fund assets in the

custody of a foreign securities depository before it

has begun to comply with rule 17f–7, we expect the

fund or its adviser to determine whether the

depository is an eligible securities depository as

defined by the rule, and to obtain an initial risk

analysis of the depository by the compliance date.

39Compliance with the 1997 Amendments will

become moot when amended rule 17f–5 and new

rule 17f–7 take effect. See supra note 6 (clarifying

the status of the compliance date for the 1997

Amendments). Therefore, the Commission is

extending the compliance date of the 1997

Amendments to the effective date of the rule and

amendments we are adopting today.

40See Custody of Investment Company Assets

Outside the United States, Investment Company Act

Release No. 23201 (May 21, 1998) [63 FR 29345

(May 29, 1998)] at nn.7 & 9 and accompanying text.

The fund may apply any of these alternative

frameworks separately to each foreign custodian or

subcustodian it uses. The fund’s arrangement with

a particular foreign custodian, subcustodian, or

depository should comply in its entirety with

amended rule 17f–5 and new rule 17f–7, or with

rule 17f–5 as amended by the 1997 Amendments,

or with old rule 17f–5 as it existed prior to the 1997

Amendments (but subject to the amended definition

of an eligible foreign custodian).

41Rule 17f–7 should not materially increase a

custodian’s risk of liability because most custodial

contracts will probably continue to limit the

custodian’s liability, particularly with respect to

information it may receive from third parties.

42This information is based on data reported by

funds on Form N–SAR [17 CFR 274.101].

43This estimate is based on staff review of

custody contracts and other research.

44These estimates assume that each of the 15

custodians services an average of 250 client

portfolios within 40 fund complexes, that a single

response by each custodian can simultaneously

address approximately 6 client portfolios in a fund

complex. A ‘‘response’’ may involve the preparation

of risk analyses of depository arrangements, the

monitoring of depositories for material changes in

risks and the preparation of notices for funds of

material changes in risks related to these

depositories.

45These estimates assume that each of the 15

custodians services an average of 250 client

portfolios within 40 fund complexes, that a single

response by each custodian can simultaneously

address approximately 6 client portfolios in a fund

complex. A ‘‘response’’ may involve establishing

bank custody arrangements for approximately 40

fund complexes, preparing reports to fund boards

and monitoring custody functions.

17f–7 applies to the subcustodian’s use

of the depository itself.36

C. Conforming Amendments

Conforming amendments to rules 17f–

4 and 7d–1 clarify references to rule

17f–5 by adding a reference to rule 17f–

7. One commenter recommended that

the word ‘‘foreign’’ be deleted from the

reference to a ‘‘foreign eligible securities

depository’’ in the proposed amendment

to rule 17f–4 because it is too restrictive.

As adopted, the amendment to rule 17f–

4 does not include the word ‘‘foreign,’’

and refers instead to an ‘‘eligible

securities depository’’ as defined in new

rule 17f–7.37

III. Effective Date

New rule 17f–7 and the amendments

to rule 17f–5 will be effective June 12,

2000. Compliance with the new rule

and rule amendments will not be

required until July 2, 2001.38 In the

interim, a fund may operate its foreign

custody arrangements in accordance

with the new rule and amendments or

with the 1997 Amendments to rule 17f–

5,39 or it may comply with ‘‘old’’ rule

17f–5 as it existed prior to the 1997

Amendments (but subject to the

definition of an eligible foreign

custodian under the 1997

Amendments).40

IV. Cost-Benefit Analysis

The Commission is sensitive to the

costs and benefits of its rules. In the

Proposing Release, we requested

comments and specific data regarding

the costs and benefits of the proposed

rule and rule amendments, but

commenters did not address any

specific costs or quantify any benefits.

New rule 17f–7 and the amendments

to rule 17f–5 respond to concerns

expressed by global custodians and fund

managers that rule 17f–5, as amended in

1997, is not workable. The new rule and

rule amendments also address our

concerns that, as a result of global

custodians’ unwillingness to assume

delegated responsibilities under rule

17f–5, obligations to evaluate

depositories’ custodial capabilities may

fall to fund boards, which lack the

relevant knowledge and expertise to

make these evaluations.

We believe that new rule 17f–7 will

benefit investors by establishing a

workable framework under which assets

may be maintained in foreign

depositories consistent with the investor

protection goals of the Investment

Company Act. In adopting this rule, we

recognize that investment in many

foreign countries presents custodial

risks that cannot be avoided, including

the use of local securities depositories.

The rule seeks to reduce the risks by

requiring that fund advisers (or funds)

be fully apprised of these risks when

they make the decision to invest in the

country on an ongoing basis. The rule

will also benefit funds and their

shareholders by freeing fund boards of

the responsibility to make findings

concerning foreign depositories that

often remained with them after the 1997

Amendments because of global

custodians’ refusals to accept delegated

responsibility. As a result, fund boards

should have more time to address other

issues that are important to investors.

New rule 17f–7 and the amendments

to rule 17f–5 may impose costs.

Although the new rule sets minimum

requirements for depositories, it does

not dictate a standard for custody risks.

A depository may fail, causing losses to

investors, despite the diligence of global

custodians, funds and advisers.

Global custodians should not incur

materially greater costs under new rule

17f–7, which generally requires them to

perform duties they may perform

already under custodial contracts.41

Rule 17f–7 may have the effect of

requiring global custodians to exercise a

greater degree of vigilance in monitoring

depositories (or to refrain in the future

from reducing their diligence) because it

requires them to monitor a depository

‘‘on a continuing basis,’’ and in this

respect may impose some costs. It is

unlikely, however, that these costs will

be material, since many custodians

already monitor their foreign

subcustodians, the countries in which

these subcustodians are located, and

foreign securities depositories. Existing

custodial agreements with funds may

need to be amended because of rule 17f–

7 and the amendments to rule 17f–5. We

expect that global custodians may pass

on additional costs to mutual funds, but

that the costs are unlikely to materially

affect overall fund expense ratios, in

part because custodial fees are not

calculated on an hourly basis.

The Commission staff estimates that

approximately 3,690 fund portfolios

will be affected by rule 17f–7 and the

amendments to rule 17f–5.42 The staff

estimates that during the first year after

rule 17f–7 goes into effect,

approximately 15 global custodians (or

their agents) 43 will make an average of

80 responses per custodian, and that

each response will require

approximately 10 hours, for a total

annual burden for global custodians of

12,000 hours.44 The staff estimates that

during the first year after the

amendments to rule 17f–5 go into effect,

approximately 15 global custodians will

be required to make an average of 80

responses per custodian concerning the

use of foreign custodians other than

depositories, requiring 10 hours per

response.45 In addition, during that first

year, the staff estimates that each

custodian will require approximately 96

hours for an additional ‘‘response’’

under rule 17f–5, which involves

renegotiating the custodial contract with

the fund and establishing a system to

monitor custody arrangements for the

fund. The total annual burden

associated with the amendments to rule

25634 Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations

46Commission staff estimates that there are 3,690

portfolios with securities held by a foreign

custodian or foreign securities depository, and that

these portfolios are divided among approximately

1,327 registered funds with approximately 650 fund

complexes that may share the same investment

adviser, board of directors, U.S. bank custodian or

all of these entities. Each board of directors and its

delegates for a fund complex could therefore meet

rule 17f–7’s requirements by simultaneously

approving similar arrangements for some 6

portfolios in the same complex. The estimated hour

burdens are based on discussions with

representatives of funds about the burdens of

analogous requirements in another custody rule.

47These estimates assume that one adviser

manages 6 portfolios, and that each adviser would

make 3 responses annually requiring a total of 25

hours for each adviser. A ‘‘response’’ may involve

addressing depository compliance with minimum

requirements, and reviews of risk analyses and

notifications for the fund complex. The staff also

assumes that fund boards will delegate most of the

responsibility for reviewing risk analyses and

notifications to a fund’s adviser. To the extent fund

boards do not delegate these responsibilities, funds

will bear the costs of reviewing risk analyses and

notifications.

48The staff estimates that 2 hours of board or

adviser time will be required annually to make the

necessary findings concerning foreign custody

managers required by amended rule 17f–5.

49This estimate assumes that without the

amendments, under rule 17f–5, approximately 650

investment advisers would have to make an average

of 3 responses per adviser annually (requiring a

total of approximately 44 hours for each adviser) to

address depository arrangements. The 44 hours

include: 10 hours establishing custody

arrangements with depositories and making

‘‘reasonable care’’ determinations, 24 hours

monitoring depository arrangements, and 10 hours

reporting to fund boards.

50 15 U.S.C. 80a–2(c).

51 44 U.S.C. 3501–3520. 52The titles of the collections of information are

‘‘Custody of Investment Company Assets Outside

the United States’’ and ‘‘Custody of Investment

Company Assets with a Foreign Securities

Depository.’’ The OMB control numbers for the

rules are as follows: rule 17f–7 (3235–0529, expires

Aug. 31, 2002); rule 17f–5 (3235–0269, expires Aug.

31, 2002). 53 44 U.S.C. 3506(c)(1)(B)(v).

17f–5 for global custodians during the

first year will be approximately 13,440

hours (15 global custodians × 896 hours

per global custodian).

Under rule 17f–7, funds or their

advisers will bear the cost of evaluating

the information provided by global

custodians and making decisions

regarding the continued use of a

depository (and in this respect,

continued investment in the country

where the depository is located). We

believe that in the context of foreign

depository arrangements, this allocation

of costs is appropriate in light of (i) the

unwillingness of global custodians to

assume responsibilities that may

overlap with investment decisions and

(ii) the extent to which the decision to

use a foreign depository may affect an

investment strategy that contemplates

investment in a particular foreign

market. An adviser’s costs (and the

related fund’s costs) should not

materially increase because of the rule,

since decisions concerning use of a

depository likely are part of the overall

decision to invest in a country, and are

decisions that funds and their advisers

made prior to adoption of rule 17f–7.

Savings under rule 17f–5 may offset

increased costs to funds and their

advisers with respect to new rule 17f–

7, since fund directors will no longer

have to make time-consuming

‘‘reasonable care’’ determinations

regarding foreign depositories.

The staff estimates that during at least

the first year after rule 17f–7 goes into

effect, approximately 650 investment

advisers 46 may make an average of 3

responses per adviser under the new

rule, requiring a total of approximately

25 hours for each adviser.47 The total

annual burden for funds and their

advisers under rule 17f–7 will be

approximately 16,250 hours. The staff

further estimates that during the first

year after the amendments to rule 17f–

5 go into effect, the total annual burden

associated with the rule’s requirements

will be approximately 7,380 hours

(3,690 portfolios × 2 hours per

portfolio).48 The removal of custody

arrangements involving securities

depositories from amended rule 17f–5

may eliminate as many as 28,600

burden hours from the current total

burden hours for funds and their

advisers.49

It is unclear whether the new rule and

rule amendments will increase or

decrease investments in funds holding

foreign securities. Custody risks are only

one factor investors may consider before

deciding to invest in a particular fund.

Fund managers may have more

information regarding custodial risks

because of the new rule and

amendments, and this may affect their

decisions regarding where to invest a

fund’s assets, or in some cases, when to

remove a fund’s assets from a country.

The new rule and rule amendments may

affect competition among custodians,

but are unlikely to significantly change

the tasks that custodians currently

perform. The rules allow third parties to

prepare risk analyses and monitor

depositories for changes in risks for

custodians. It is unclear whether

custodians will pass the costs of

utilizing these third party service

providers to funds or investors. Many

custodians already may be using the

services of these providers.

V. Effects on Efficiency, Competition

and Capital Formation

Section 2(c) of the Investment

Company Act requires the Commission,

when engaging in rulemaking that

requires it to consider or determine

whether an action is consistent with the

public interest, to consider whether the

action will promote efficiency,

competition and capital formation.50

The Commission has considered these

factors.

As discussed above, the Commission

anticipates that new rule 17f–7 and the

amendments to rule 17f–5 will provide

a workable framework under which a

fund can protect its assets while

maintaining them with a foreign

securities depository. These rule

changes may marginally promote

efficiency in custody arrangements

involving foreign assets by better

delineating the responsibilities of fund

boards, fund advisers and custodians

with respect to custody of investment

company assets outside the United

States, whether an eligible foreign

custodian or an eligible securities

depository holds them. It is unlikely

that the rule changes will have any

material effect on competition among

custodians, because the rules do not

substantially change the duties of

custodians, or increase the potential

universe of custodians or depositories.

The rule changes should also have little

effect on domestic capital formation

because the rules relate only to foreign

custody of fund assets. There are

relatively few funds affected by the new

rule and amendments, compared to the

total number of funds. Similarly, the

total dollar amount invested in funds

affected by the rule and amendments is

also relatively small, compared to the

total amount invested in all funds.

VI. Paperwork Reduction Act

Certain provisions of new rule 17f–7

and the amendments to rule 17f–5

contain ‘‘collection of information’’

requirements within the meaning of the

Paperwork Reduction Act of 1995.51

The Commission submitted the

collection of information requirements

contained in the rule and rule

amendments to the Office of

Management and Budget (‘‘OMB’’) for

review in accordance with 44 U.S.C.

3507(d) and 5 CFR 1320.11.52 An

agency may not conduct or sponsor, and

a person is not required to respond to,

a collection of information unless the

agency displays a valid OMB control

number.53

A. New Rule 17f–7

New rule 17f–7 contains some

collection of information requirements.

Under the rule, an eligible securities

depository must meet certain minimum

standards. The fund or its investment

Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations 25635

54These estimates assume that one adviser

manages 6 portfolios, and that each adviser will

make 3 responses annually requiring a total of 25

hours for each adviser to address depository

compliance with minimum requirements, and

reviews of risk analyses or notifications for the

adviser’s fund complex. The 25 hours would

include 5 hours spent to verify depository

compliance with minimum requirements, and 20

hours spent to review risk analyses or notifications

for the fund complex.

55These estimates assume that each of 15

custodians services an average of 250 client

portfolios within 40 fund complexes, that a single

response by each custodian can simultaneously

address approximately 6 client portfolios in a fund

complex, and that each custodian makes

approximately 80 annual responses requiring 10

hours per response to prepare risk analyses of

depository arrangements and monitor risks, and to

provide notices of material changes in risks to its

clients.

56This information is based on data reported by

funds on Form N–SAR [17 CFR 274.101].

57The staff estimates that these 3,690 portfolios

are divided among approximately 1,327 registered

funds within approximately 650 fund complexes

that may share the same investment adviser, board

of directors, U.S. bank custodian, or all of these

entities. Each board of directors and its delegates for

a fund complex could therefore meet rule 17f–5’s

requirements by simultaneously approving similar

arrangements for some 6 portfolios in the same

complex. The estimated hour amounts are based on

discussions with representatives of funds about the

burdens of analogous requirements in another

custody rule.

58This estimate is based on staff review of

custody contracts and other research.

59These estimates assume that each of 15

custodians services an average of 250 client

portfolios within 40 fund complexes, that a single

response by each custodian can simultaneously

address approximately 6 client portfolios in a fund

complex, and that each custodian makes

approximately 80 responses annually requiring 10

hours per response to establish bank custody

arrangements for approximately 40 fund complexes

and report to their fund boards, and one response

annually requiring 96 hours per response to

establish a system to monitor custody arrangements

for these clients.

60The number of responses may decline

substantially after the first year because some

responses made during that year (e.g., negotiating

a custodial contract with a fund or establishing a

Continued

adviser will generally determine

whether the depository complies with

those requirements based on

information provided by the fund’s

primary custodian. The depository

custody arrangement also must meet

certain conditions. The fund or its

adviser must receive from the primary

custodian (or its agent) an initial risk

analysis of the depository arrangements,

and the fund’s contract with its primary

custodian must state that the custodian

will monitor risks and promptly notify

the fund or its adviser of material

changes in risks. The primary custodian

and other custodians also must agree to

exercise reasonable care.

The staff estimates that during the

first year after rule 17f–7 goes into

effect, approximately 650 investment

advisers will review an average of 3 risk

analyses per adviser under the rule,

requiring a total of approximately 25

hours for each adviser. Each of these

‘‘responses’’ by an adviser may address

depository compliance with the

minimum requirements of the rule, and

require the adviser to review risk

analyses or notifications of material

changes in risks related to a

depository.54 The total annual burden

associated with these requirements of

the rule during the first year is

estimated to be approximately 16,250

hours (650 advisers × 25 hours per

adviser). The staff further estimates that

during the first year after the proposed

rule goes into effect, approximately 15

global custodians will make an average

of 80 responses per custodian under the

rule that will require approximately 10

hours per response.55 A ‘‘response’’ by

a global custodian may involve the

preparation of the risk analysis, the

monitoring of depository risks or the

preparation of subsequent notifications

of material changes in depository risks.

The total annual burden associated with

these requirements of the new rule is

estimated to be approximately 12,000

hours (15 custodians × 800 hours).

Therefore, the total annual burden

associated with all collection of

information requirements of new rule

17f–7 during the first year after its

adoption is estimated to be 28,250 hours

(16,250 + 12,000).

B. Amendments to Rule 17f–5

The amendments to rule 17f–5 do not

substantively change the rule’s

collection of information requirements,

which will continue to apply when a

fund (i.e., a registered management

investment company) maintains its

assets with a foreign bank custodian.

The amendments remove custody

arrangements with foreign securities

depositories from the rule, however, so

that the rule’s requirements no longer

apply to these custody arrangements. In

general, therefore, the amendments

reduce the information collection

burdens of rule 17f–5.

The requirements of amended rule

17f–5 that may call for the collection of

information are substantially the same

as under the current rule. The fund’s

board of directors must find that it is

reasonable to rely on each delegate it

selects to act as the fund’s foreign

custody manager. The delegate must

agree to provide written reports that

notify the board when the fund’s assets

are placed with a foreign custodian and

when any material change occurs in the

fund’s custody arrangements. The

delegate must agree to exercise

reasonable care, prudence, and

diligence, or to adhere to a higher

standard of care. When the foreign

custody manager selects an eligible

foreign custodian, it must determine

that the fund’s assets will be subject to

reasonable care if maintained with that

custodian, and that the written contract

that governs each custody arrangement

will provide reasonable care for fund

assets. The contract must contain

certain specified provisions or others

that provide at least equivalent care.

The foreign custody manager must

establish a system to monitor the

contract and the appropriateness of

continuing to maintain assets with the

eligible foreign custodian.

The Commission’s staff estimates that

during the first year after the

amendments go into effect,

approximately 3,690 fund portfolios 56

will be required to make an average of

one response per portfolio under

amended rule 17f–5, requiring

approximately 2 hours of director time

per response, to make the necessary

findings concerning foreign custody

managers.57 A ‘‘response’’ by a fund

portfolio may involve the directors

making certain findings concerning

foreign custody managers, and the

review and ratification of custodial

contracts. The total annual burden

associated with these requirements of

the amended rule during the first year

is estimated to be approximately 7,380

hours (3,690 portfolios × 2 hours per

portfolio). The staff further estimates

that during the first year after the

amended rule goes into effect,

approximately 15 global custodians 58

will be required to make an average of

80 responses per custodian concerning

the use of foreign custodians other than

depositories, requiring approximately

10 hours per response, plus one

additional response per custodian that

requires approximately 96 hours per

response.59 A ‘‘response’’ by a custodian

under the amended rule may involve

negotiating new custodial contracts with

funds, establishing bank custody

arrangements for fund complexes,

preparing reports for funds and

establishing a system to monitor

custody arrangements. The total annual

burden associated with these

requirements of the rule during the first

year is estimated to be approximately

13,440 hours (15 global custodians ×

896 hours per global custodian).

Therefore, the total burden of all

collection of information requirements

of rule 17f–5 during the first year after

its amendment is estimated to be

approximately 20,820 hours (7,380 +

13,440).60

25636 Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations

system to monitor custody arrangements) will

suffice for some time thereafter.

61See supra note 57.

62These estimates assume that one adviser

manages 6 portfolios, and that each adviser would

make 3 responses annually requiring a total of 44

hours to approve depository custody arrangements

for each fund complex, report to fund boards, and

establish a system to monitor depository

arrangements for the fund complex. The 44 hours

would include 10 hours spent to establish custody

arrangements with depositories and make

‘‘reasonable care’’ determinations, 24 hours spent to

monitor depository arrangements, and 10 hours

spent to report to fund boards.

63A bank is considered by the Small Business

Administration to be a small entity if it has less

than $100 million in assets. See 13 CFR 121.201

(1999). See also 5 USC 601(3). A bank’s assets are

determined by averaging its total assets reported for

each of the last four quarters. See 13 CFR 121.201

at n.7. 64A fund is considered a small entity if it,

together with other investment companies in the

same group of related investment companies, has

net assets of $50 million or less. See 17 CFR 270.0–

10. An adviser is considered a small entity if it has

assets under management of less than $25 million,

has total assets of less than $5 million, and is not

in a control relationship with other advisers or

persons that are not small entities. See 17 CFR

275.0–7. Most funds that invest in foreign securities

are part of a fund complex that holds net assets of

more than $50 million, and are advised by advisers

with assets under management of $25 million or

more.

The staff estimates that the

amendments’ removal of custody

arrangements involving securities

depositories from rule 17f–5 will

eliminate as much as 28,600 additional

burden hours currently imposed by the

rule’s collection of information

requirements. This estimate assumes

that without the amendments,

approximately 650 investment

advisers 61 would have to make an

average of 3 responses per adviser

annually (i.e., making reasonable care

determinations), requiring a total of

approximately 44 hours for each

adviser, to address depository

arrangements.62

As reflected in the following summary

of the burden hours associated with the

collection of information requirements

in old rule 17f–5, rule 17f–5 as

amended, and new rule 17f–7, the staff

estimates that the net effect of the new

rule and rule amendments will be to

reduce the total annual paperwork

burden by 350 hours:

Rule Paperwork burden hours

Old rule 17f–5 ...................... 49,420 hours.

Rule 17f–5 as amended ...... 20,820 hours.

New rule 17f–7 .................... 28,250 hours.

Net reduction ....................... 350 hours.

The information collection

requirements imposed by the new rule

and rule amendments are required for

those funds that decide to rely on the

rules to obtain the benefit of

maintaining assets in foreign custody

arrangements. Funds that do not

maintain assets in foreign custody

arrangements are not required to rely on

the rules. Responses to the collections of

information will not be kept

confidential.

VII. Summary of Final Regulatory

Flexibility Analysis

The Commission has prepared a Final

Regulatory Flexibility Analysis

(‘‘FRFA’’) in accordance with 5 U.S.C.

604 relating to new rule 17f–7, the

amendments to rule 17f–5, and the

conforming amendments to rules 7d–1

and 17f–4. A summary of the Initial

Regulatory Flexibility Analysis

(‘‘IRFA’’), which was prepared in

accordance with 5 U.S.C. 603, was

published in the Proposing Release. The

following is a summary of the FRFA.

A. Need for and Objectives of the Rule

and Rule Amendments

Rule 17f–5 governs the custody of the

assets of registered management

investment companies (‘‘funds’’) with

custodians outside the United States.

The Commission amended the rule in

1997 to modernize its conditions. In

1998, representatives of funds and bank

custodians informed the Commission

that some conditions of the rule

presented problems regarding the use of

foreign securities depositories.

The Commission is adopting new rule

17f–7 and amendments to rule 17f–5,

pursuant to the authority set forth in

sections 6(c), 7(d), 17(f), and 38(a) of the

Investment Company Act [15 U.S.C.

80a–6(c), –7(d), –17(f), and –37(a)], to

permit funds to maintain their assets in

foreign securities depositories based on

conditions that reflect the operations

and role of these depositories. New rule

17f–7 establishes new provisions for the

use of depositories. The rule requires

every foreign securities depository that

holds fund assets to meet specified

minimum standards. The rule also

requires a custody arrangement with a

depository to meet certain risk-limiting

conditions. The fund or its adviser must

receive an initial risk analysis of the

depository arrangement from the

primary custodian (or its agent), and the

fund’s contract with its primary

custodian must state that the custodian

will monitor those risks and notify the

fund or its adviser of material changes

in the risks. The primary custodian and

other custodians involved in the

depository arrangement also must agree

to exercise reasonable care.

The amendments to rule 17f–5

remove custody arrangements with

foreign securities depositories from the

rule. This eliminates the applicability to

depository arrangements of

requirements that certain findings be

made by the fund board, its investment

adviser or global custodian, and that

certain specified terms or equivalent

protections appear in the rules of the

depository. The conforming

amendments to rules 7d–1 and 17f–4

clarify references to rule 17f–5 by

adding a reference to rule 17f–7 as well.

B. Significant Issues Raised by Public

Comments

The Commission received no public

comments on the IRFA.

C. Small Entities Subject to the Rules

The new rule and rule amendments

affect, among other persons, the

approximately 15 global custodians that

act as foreign custody managers for

funds under rule 17f–5 and as primary

custodians under rule 17f–7. None of

these global custodians likely qualifies

as a small entity, because each

custodian is a major bank with a global

branch network or global ties to other

banks.63 The new rule and rule

amendments also affect the funds that

invest in foreign markets and their

investment advisers. Few if any of the

affected funds and advisers are small

entities.64

On balance, the impact of the new

rule and rule amendments on global

custodians, funds, and advisers is not

expected to be great, because the

burdens of the new rule’s requirements

will be offset in part by the elimination

of burdens by amended rule 17f–5. For

this reason, and because few if any of

the affected entities would qualify as

small entities, the new rule and rule

amendments are unlikely to have a

significant impact on a substantial

number of small entities.

D. Projected Reporting, Recordkeeping,

and Other Compliance Requirements

New rule 17f–7 establishes new

requirements for arrangements with

depositories. As described above, the

new rule requires each foreign securities

depository that holds fund assets to

meet specified minimum requirements.

Depository arrangements also must meet

other risk-limiting conditions. The fund

or its adviser must receive an initial risk

analysis of the depository arrangement

from the primary custodian (or its

agent), and the fund’s contract with its

primary custodian must state that the

custodian will monitor the risks and

promptly notify the fund of any material

changes in risks. The primary custodian

and other custodians also must agree to

exercise reasonable care.

Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations 25637

The amendments to rule 17f–5 retain

existing reporting, recordkeeping, and

other compliance requirements of the

rule without substantive changes,

insofar as they apply to custody

arrangements with a foreign bank

custodian. The amendments would

remove a custody arrangement with a

foreign depository from the rule,

eliminating the necessity for compliance

with the rule’s requirements in these

arrangements.

E. Agency Action To Minimize Effects

on Small Entities

The Regulatory Flexibility Act directs

the Commission to consider significant

alternatives that would accomplish the

stated objective, while minimizing any

significant economic impact on small

entities. In considering adoption of the

new rule and amendments, the

Commission considered: (i) establishing

different compliance or reporting

standards that take into account the

resources available to small entities; (ii)

clarifying, consolidating or simplifying

the compliance requirements for small

entities; (iii) using performance rather

than design standards; and (iv)

exempting small entities from coverage

of all or part of the rule.

We believe that further clarification,

consolidation, or simplification of the

compliance requirements is not

necessary. In addition, performance

standards are impracticable with respect

to the amendments and new rule. The

Commission believes that different

requirements for small entities would

also be inconsistent with the protection

of investors, particularly in light of the

fact that rule 17f–7 establishes only

minimum requirements for foreign

securities depositories.

As discussed above, none of the

global custodians affected by new rule

17f–7 or the amendments to rule 17f–5

and few, if any, of the affected funds

and advisers are likely to be considered

small entities for purposes of the

Regulatory Flexibility Act. As further

discussed above, the impact of the

amendments is likely to be limited,

because burdens under the new rule

will be offset in part by reduced burdens

by amended rule 17f–5. Therefore, the

potential impact of the new rule and

rule amendments on small entities will

not be significant.

The FRFA is available for public

inspection in File No. S7–15–99, and a

copy may be obtained by contacting Jaea

F. Hahn, Attorney, at (202) 942–0690,

Office of Regulatory Policy, Division of

Investment Management, Securities and

Exchange Commission, 450 5th Street,

NW, Washington, DC 20549–0506.

VIII. Statutory Authority

The Commission is adopting new rule

17f–7, amending rule 17f–5, and

adopting conforming amendments to

rules 7d–1 and 17f–4 pursuant to

authority set forth in sections 6(c), 7(d),

17(f), and 38(a) of the Investment

Company Act [15 U.S.C. 80a–6(c), 80a–

7(d), 80a–17(f) and 80a–37(a)].

List of Subjects in 17 CFR Part 270

Investment companies, Reporting and

recordkeeping requirements, Securities.

Text of Rules

For the reasons set out in the

preamble, title 17, chapter II of the Code

of Federal Regulations is amended as

follows:

PART 270—RULES AND

REGULATIONS, INVESTMENT

COMPANY ACT OF 1940

1. The authority citation for part 270

continues to read in part as follows:

Authority: 15 U.S.C. 80a–1 et seq., 80a–

34(d), 80a–37, 80a–39 unless otherwise

noted:

* * * * *

2. Section 270.7d–1 is amended by

revising the introductory text of

paragraph (b)(8)(v) to read as follows:

§ 270.7d–1 Specification of conditions and

arrangements for Canadian management

investment companies requesting order

permitting registration.

* * * * *

(b) * * *

(8) * * *

(v) Except as provided in § 270.17f–5

and § 270.17f–7, applicant will appoint,

by contract, a bank, as defined in

section 2(a)(5) of the Act (15 U.S.C. 80a–

2(a)(5)) and having the qualification

described in section 26(a)(1) of the Act

(15 U.S.C. 80a–26(a)(1)), to act as trustee

of, and maintain in its sole custody in

the United States, all of applicant’s

securities and cash, other than cash

necessary to meet applicant’s current

administrative expenses. The contract

will provide, inter alia, that the

custodian will:

* * * * *

3. Section 270.17f–4 is amended by

revising the introductory text of

paragraph (b) to read as follows:

§ 270.17f–4 Deposits of securities in

securities depositories.

* * * * *

(b) A registered management

investment company (investment

company) or any qualified custodian

may deposit all or any part of the

securities owned by the investment

company in an Eligible Securities

Depository as defined in § 270.17f–7 in

accordance with the provisions of

§ 270.17f–7 and applicable provisions of

§ 270.17f–5, or in:

* * * * *

4. Section 270.17f–5 is revised to read

as follows:

§ 270.17f–5 Custody of investment

company assets outside the United States.

(a) Definitions. For purposes of this

section:

(1) Eligible Foreign Custodian means

an entity that is incorporated or

organized under the laws of a country

other than the United States and that is

a Qualified Foreign Bank or a majorityowned direct or indirect subsidiary of a

U.S. Bank or bank-holding company.

(2) Foreign Assets means any

investments (including foreign

currencies) for which the primary

market is outside the United States, and

any cash and cash equivalents that are

reasonably necessary to effect the

Fund’s transactions in those

investments.

(3) Foreign Custody Manager means a

Fund’s or a Registered Canadian Fund’s

board of directors or any person serving

as the board’s delegate under paragraphs

(b) or (d) of this section.

(4) Fund means a management

investment company registered under

the Act (15 U.S.C. 80a) and incorporated

or organized under the laws of the

United States or of a state.

(5) Qualified Foreign Bank means a

banking institution or trust company,

incorporated or organized under the

laws of a country other than the United

States, that is regulated as such by the

country’s government or an agency of

the country’s government.

(6) Registered Canadian Fund means

a management investment company

incorporated or organized under the

laws of Canada and registered under the

Act pursuant to the conditions of

§ 270.7d–1.

(7) U.S. Bank means an entity that is:

(i) A banking institution organized

under the laws of the United States;

(ii) A member bank of the Federal

Reserve System;

(iii) Any other banking institution or

trust company organized under the laws

of any state or of the United States,

whether incorporated or not, doing

business under the laws of any state or

of the United States, a substantial

portion of the business of which

consists of receiving deposits or

exercising fiduciary powers similar to

those permitted to national banks under

the authority of the Comptroller of the

Currency, and which is supervised and

examined by state or federal authority

having supervision over banks, and

25638 Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations

which is not operated for the purpose of

evading the provisions of this section; or

(iv) A receiver, conservator, or other

liquidating agent of any institution or

firm included in paragraphs (a)(7)(i),

(ii), or (iii) of this section.

(b) Delegation. A Fund’s board of

directors may delegate to the Fund’s

investment adviser or officers or to a

U.S. Bank or to a Qualified Foreign

Bank the responsibilities set forth in

paragraphs (c)(1), (c)(2), or (c)(3) of this

section, provided that:

(1) Reasonable Reliance. The board

determines that it is reasonable to rely

on the delegate to perform the delegated

responsibilities;

(2) Reporting. The board requires the

delegate to provide written reports

notifying the board of the placement of

Foreign Assets with a particular

custodian and of any material change in

the Fund’s foreign custody

arrangements, with the reports to be

provided to the board at such times as

the board deems reasonable and

appropriate based on the circumstances

of the Fund’s arrangements; and

(3) Exercise of Care. The delegate

agrees to exercise reasonable care,

prudence and diligence such as a person

having responsibility for the safekeeping

of the Fund’s Foreign Assets would

exercise, or to adhere to a higher

standard of care, in performing the

delegated responsibilities.

(c) Maintaining Assets with an

Eligible Foreign Custodian. A Fund or

its Foreign Custody Manager may place

and maintain the Fund’s Foreign Assets

in the care of an Eligible Foreign

Custodian, provided that:

(1) General Standard. The Foreign

Custody Manager determines that the

Foreign Assets will be subject to

reasonable care, based on the standards

applicable to custodians in the relevant

market, if maintained with the Eligible

Foreign Custodian, after considering all

factors relevant to the safekeeping of the

Foreign Assets, including, without

limitation:

(i) The Eligible Foreign Custodian’s

practices, procedures, and internal

controls, including, but not limited to,

the physical protections available for

certificated securities (if applicable), the

method of keeping custodial records,

and the security and data protection

practices;

(ii) Whether the Eligible Foreign

Custodian has the requisite financial

strength to provide reasonable care for

Foreign Assets;

(iii) The Eligible Foreign Custodian’s

general reputation and standing; and

(iv) Whether the Fund will have

jurisdiction over and be able to enforce

judgments against the Eligible Foreign

Custodian, such as by virtue of the

existence of offices in the United States

or consent to service of process in the

United States.

(2) Contract. The arrangement with

the Eligible Foreign Custodian is

governed by a written contract that the

Foreign Custody Manager has

determined will provide reasonable care

for Foreign Assets based on the

standards specified in paragraph (c)(1)

of this section.

(i) The contract must provide:

(A) For indemnification or insurance

arrangements (or any combination) that

will adequately protect the Fund against

the risk of loss of Foreign Assets held in

accordance with the contract;

(B) That the Foreign Assets will not be

subject to any right, charge, security

interest, lien or claim of any kind in

favor of the Eligible Foreign Custodian

or its creditors, except a claim of

payment for their safe custody or

administration or, in the case of cash

deposits, liens or rights in favor of

creditors of the custodian arising under

bankruptcy, insolvency, or similar laws;

(C) That beneficial ownership of the

Foreign Assets will be freely

transferable without the payment of

money or value other than for safe

custody or administration;

(D) That adequate records will be

maintained identifying the Foreign

Assets as belonging to the Fund or as

being held by a third party for the

benefit of the Fund;

(E) That the Fund’s independent

public accountants will be given access

to those records or confirmation of the

contents of those records; and

(F) That the Fund will receive

periodic reports with respect to the

safekeeping of the Foreign Assets,

including, but not limited to,

notification of any transfer to or from

the Fund’s account or a third party

account containing assets held for the

benefit of the Fund.

(ii) The contract may contain, in lieu

of any or all of the provisions specified

in paragraph (c)(2)(i) of this section,

other provisions that the Foreign

Custody Manager determines will

provide, in their entirety, the same or a

greater level of care and protection for

the Foreign Assets as the specified

provisions, in their entirety.

(3)(i) Monitoring the Foreign Custody

Arrangements. The Foreign Custody

Manager has established a system to

monitor the appropriateness of

maintaining the Foreign Assets with a

particular custodian under paragraph

(c)(1) of this section, and to monitor

performance of the contract under

paragraph (c)(2) of this section.

(ii) If an arrangement with an Eligible

Foreign Custodian no longer meets the

requirements of this section, the Fund

must withdraw the Foreign Assets from

the Eligible Foreign Custodian as soon

as reasonably practicable.

(d) Registered Canadian Funds. Any

Registered Canadian Fund may place

and maintain its Foreign Assets outside

the United States in accordance with the

requirements of this section, provided

that:

(1) The Foreign Assets are placed in

the care of an overseas branch of a U.S.

Bank that has aggregate capital, surplus,

and undivided profits of a specified

amount, which must not be less than

$500,000; and

(2) The Foreign Custody Manager is

the Fund’s board of directors, its

investment adviser or officers, or a U.S.

Bank.

Note to § 270.17f–5: When a Fund’s (or its

custodian’s) custody arrangement with an

Eligible Securities Depository (as defined in

§ 270.17f–7) involves one or more Eligible

Foreign Custodians through which assets are

maintained with the Eligible Securities

Depository, § 270.17f–5 will govern the

Fund’s (or its custodian’s) use of each

Eligible Foreign Custodian, while § 270.17f–

7 will govern an Eligible Foreign Custodian’s

use of the Eligible Securities Depository.

5. Section 270.17f–7 is added to read

as follows:

§ 270.17f–7 Custody of investment

company assets with a foreign securities

depository.

(a) Custody arrangement with an

eligible securities depository. A Fund,

including a Registered Canadian Fund,

may place and maintain its Foreign

Assets with an Eligible Securities

Depository, provided that:

(1) Risk-limiting safeguards. The

custody arrangement provides

reasonable safeguards against the

custody risks associated with

maintaining assets with the Eligible

Securities Depository, including:

(i) Risk analysis and monitoring. (A)

The fund or its investment adviser has

received from the Primary Custodian (or

its agent) an analysis of the custody

risks associated with maintaining assets

with the Eligible Securities Depository;

and

(B) The contract between the Fund

and the Primary Custodian requires the

Primary Custodian (or its agent) to

monitor the custody risks associated

with maintaining assets with the

Eligible Securities Depository on a

continuing basis, and promptly notify

the Fund or its investment adviser of

any material change in these risks.

(ii) Exercise of care. The contract

between the Fund and the Primary

Federal Register / Vol. 65, No. 86 / Wednesday, May 3, 2000 / Rules and Regulations 25639

Custodian states that the Primary

Custodian will agree to exercise

reasonable care, prudence, and

diligence in performing the

requirements of paragraphs (a)(1)(i)(A)

and (B) of this section, or adhere to a

higher standard of care.

(2) Withdrawal of assets from eligible

securities depository. If a custody

arrangement with an Eligible Securities

Depository no longer meets the

requirements of this section, the Fund’s

Foreign Assets must be withdrawn from

the depository as soon as reasonably

practicable.

(b) Definitions. The terms Foreign

Assets, Fund, Qualified Foreign Bank,

Registered Canadian Fund, and U.S.

Bank have the same meanings as in

§ 270.17f–5. In addition:

(1) Eligible Securities Depository

means a system for the central handling

of securities as defined in § 270.17f–4

that:

(i) Acts as or operates a system for the

central handling of securities or

equivalent book-entries in the country

where it is incorporated, or a

transnational system for the central

handling of securities or equivalent

book-entries;

(ii) Is regulated by a foreign financial

regulatory authority as defined under

section 2(a)(50) of the Act (15 U.S.C.

80a–2(a)(50));

(iii) Holds assets for the custodian

that participates in the system on behalf

of the Fund under safekeeping

conditions no less favorable than the

conditions that apply to other

participants;

(iv) Maintains records that identify

the assets of each participant and

segregate the system’s own assets from

the assets of participants;

(v) Provides periodic reports to its

participants with respect to its

safekeeping of assets, including notices

of transfers to or from any participant’s

account; and

(vi) Is subject to periodic examination

by regulatory authorities or independent

accountants.

(2) Primary Custodian means a U.S.

Bank or Qualified Foreign Bank that

contracts directly with a Fund to

provide custodial services related to

maintaining the Fund’s assets outside

the United States.

Note to § 270.17f–7: When a Fund’s (or its

custodian’s) custody arrangement with an

Eligible Securities Depository involves one or

more Eligible Foreign Custodians (as defined

in § 270.17f–5) through which assets are

maintained with the Eligible Securities

Depository, § 270.17f–5 will govern the

Fund’s (or its custodian’s) use of each

Eligible Foreign Custodian, while § 270.17f–

7 will govern an Eligible Foreign Custodian’s

use of the Eligible Securities Depository.

Dated: April 27, 2000.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 00–11000 Filed 5–2–00; 8:45 am]

BILLING CODE 8010–01–P

DEPARTMENT OF HEALTH AND

HUMAN SERVICES

Food and Drug Administration

21 CFR Parts 203 and 205

[Docket Nos. 92N–0297 and 88N–0258]

RIN 0905–AC81

Prescription Drug Marketing Act of

1987; Prescription Drug Amendments

of 1992; Policies, Requirements, and

Administrative Procedures; Delay of

Effective Date; Reopening of

Administrative Record

AGENCY: Food and Drug Administration,

HHS.

ACTION: Final rule; delay of effective

date; reopening of administrative

record.

SUMMARY: The Food and Drug

Administration (FDA) is delaying until

October 1, 2001, the effective date and

reopening the administrative record to

receive additional comments regarding

certain requirements of a final rule

published in the Federal Register of

December 3, 1999 (64 FR 67720). The

other provisions of the final rule become

effective on December 4, 2000. The final

rule implements the Prescription Drug

Marketing Act of 1987 (PDMA), as

modified by the Prescription Drug

Amendments of 1992 (PDA) and the

FDA Modernization Act of 1997 (the

Modernization Act). FDA is delaying the

effective date for certain requirements

relating to wholesale distribution of

prescription drugs by distributors that

are not authorized distributors of record.

FDA is also delaying the effective date

of another requirement that would

prohibit blood centers functioning as

‘‘health care entities’’ to act as

wholesale distributors of blood

derivatives. The agency is taking this

action to address numerous concerns

about the provisions raised by affected

parties.

DATES: The effective date for §§ 203.3(u)

and 203.50, and the applicability of

§ 203(q) to wholesale distribution of

blood derivatives by health care entities,

added at 64 FR 67720, December 3,

1999, is delayed until October 1, 2001.

The administrative record is reopened

until July 3, 2000, to receive additional

comments on these provisions.

ADDRESSES: Submit written comments

to the Dockets Management Branch

(HFA–305), Food and Drug

Administration, 5630 Fishers Lane, rm.

1061, Rockville, MD 20857. All

comments should be identified with the

docket number found in brackets in the

heading of this document.

FOR FURTHER INFORMATION CONTACT: Lee

D. Korb, Center for Drug Evaluation and

Research (HFD–7), Food and Drug

Administration, 5600 Fishers Lane,

Rockville, MD 20857, 301–594–2041.

SUPPLEMENTARY INFORMATION:

I. Background

PDMA (Public Law 100–293) was

enacted on April 22, 1988, and was

modified by the PDA (Public Law 102–

353, 106 Stat. 941) on August 26, 1992.

The PDMA as modified by the PDA

amended sections 301, 303, 503, and

801 of the Federal Food, Drug, and

Cosmetic Act (the act) (21 U.S.C. 331,

333, 353, 381) to, among other things,

establish requirements for the wholesale

distribution of prescription drugs.

Section 503(e)(1)(A) of the act states

that each person who is engaged in the

wholesale distribution of a prescription

drug who is not the manufacturer or an

authorized distributor of record for the

drug must, before each wholesale

distribution of a drug, provide to the

person receiving the drug a statement

(in such form and containing such

information as the Secretary may

require) identifying each prior sale,

purchase, or trade of the drug, including

the date of the transaction and the

names and addresses of all parties to the

transaction. Section 503(e)(4)(A) of the

act states that, for the purposes of

section 503(e), the term ‘‘authorized

distributors of record’’ means those

distributors with whom a manufacturer

has established an ‘‘ongoing

relationship’’ to distribute the

manufacturer’s products.

On December 3, 1999, the agency

published final regulations in part 203

(21 CFR part 203) implementing these

and other provisions of PDMA (64 FR

67720). Section 203.50 requires that,

before the completion of any wholesale

distribution by a wholesale distributor

of a prescription drug for which the

seller is not an authorized distributor of

record to another wholesale distributor

or retail pharmacy, the seller must

provide to the purchaser a statement

identifying each prior sale, purchase, or

trade of the drug. The identifying

statement must include the proprietary

and established name of the drug, its

dosage, the container size, the number

of containers, lot or control numbers of

the drug being distributed, the business