[Federal Register Volume 65, Number 94 (Monday, May 15, 2000)]
[Notices]
[Pages 31029-31036]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-12132]


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SECURITIES AND EXCHANGE COMMISSION


First Allmerica Financial Life Insurance Company, et al.

May 5, 2000.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'').

ACTION: Notice of application for an order of approval pursuant to 
Section 26(b) of the Investment Company Act of 1940 (the ``Act'') and 
an order granting exemptive relief pursuant to Section 17(b) of the 
Act.

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    Summary of Application: Applicants seek an order under Section 
26(b) of the Act approving the proposed substitution of shares of the 
Investment Grade Income Fund of AIT for shares of the Select Income 
Fund of AIT and for shares of Strategic Income Portfolio of Fulcrum 
held by the First Allmerica Separate Accounts and the Allmerica 
Financial Life Separate Accounts to support certain variable life 
insurance contracts or variable annuity contracts (collectively, the 
``Variable Contracts'') issued by First Allmerica or Allmerica 
Financial Life. Applicants also seek an order under Section 17(b) of 
the Act exempting them from Section 17(a) to the extent necessary to 
permit the Applicants, by means of in-kind redemptions and purchases, 
to carry out the above-referenced substitutions of securities.
    Applicants: First Allmerica Financial Life Insurance Company 
(``First Allmerica''); Allmerica Select Separate Account, Allmerica 
Select Separate Account II, Fulcrum Separate Account, Group VEL 
Account, Inheritage Account, Separate Account VA-K and VEL II Account 
(collectively, the ``First Allmerica Separate Accounts''); Allmerica 
Financial Life Insurance and Annuity Company (``Allmerica Financial 
Life''); Allmerica Select Separate Account, Allmerica Select Separate 
Account II, Fulcrum Separate Account, Fulcrum Variable Life Separate 
Account, Group VEL Account, Inheritage Account, Select Account III, 
Separate Account IMO, Separate Account VA-K, VEL Account, VEL II 
Account and VEL Account III (collectively, the ``Allmerica Financial 
Life Separate Accounts''); Allmerica Investment Trust (``AIT'') and the 
Fulcrum Trust (``Fulcrum'') (collectively, the ``Applicants'').
    Filing Date: The application was filed on January 31, 2000, and 
amended and restated on May 3, 2000.
    Hearing or Notification of Hearing: An order granting the 
application will be issued unless the Commission orders a hearing. 
Interested persons may request a hearing on this application by writing 
to the SEC's Secretary and serving Applicants with a copy of the 
request, in person or by mail. Hearing requests must be received by the 
Commission by 5:30 p.m. on May 30, 2000 and must be accompanied by 
proof of service on the Applicants in the form of an affidavit or, for 
lawyers, a certificate of service. Hearing requests should state the 
nature of the writer's interest, the reason for the request and the 
issues contested. Persons may request notification of the date of a 
hearing by writing to the Secretary of the SEC.

ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C. 
20549-0609. Applicants, Richard M. Reilly, President, Allmerica 
Financial Life Insurance and Annuity Company, 440 Lincoln Street, 
Worcester, MA 01653, and copy to George M. Boyd, Esq., First Allmerica 
Financial Life Insurance Company, N-440, 440 Lincoln Street, Worcester, 
MA 01653.

FOR FURTHER INFORMATION CONTACT: Ann L. Vlcek, Senior Counsel, or Keith 
Carpenter, Branch Chief, Office of Insurance Products, Division of 
Investment Management, at (202) 942-0670.

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained for a fee from 
the SEC's Public Reference Branch, 450 Fifth Street, N.W., Washington, 
DC 20549-0102.

Applicants' Representations

    1. First Allmerica was organized under the laws of Massachusetts in 
1844. Effective October 16, 1995, the company converted from a mutual 
life insurance company known as State Mutual Life Assurance Company of 
America to a stock life insurance company and adopted its present name. 
The company is a wholly-owned subsidiary of Allmerica Financial 
Corporation (``AFC'').
    2. Allmerica Financial Life is a life insurance company organized 
under the laws of Delaware in July 1974. Allmerica Financial Life is an 
indirect, wholly-owned subsidiary of First Allmerica, which in turn is 
a wholly-owned subsidiary of AFC.

[[Page 31030]]

    3. Each Applicant separate account is a ``separate account'' as 
defined by Rule 0-1(e) under the Act, and is registered under the Act 
as a investment trust. Each of the 19 Applicant separate accounts is a 
segregated asset account of the indicated Applicant insurance company. 
Each of the respective Applicant separate accounts is used by the 
Applicant insurance company of which it is a part to fund certain 
variable annuity or variable life contracts. Applicant insurance 
companies may issue additional variable contracts funded by Applicant 
separate accounts in the future. Certain sub-accounts of the respective 
Applicant separate accounts are dedicated to owning shares of one of 
the investment portfolios of AIT or one of the investment portfolios of 
Fulcrum (AIT and Fulcrum are sometimes referred to collectively herein 
as the ``Underlying Funds''). Accordingly, each AIT or Fulcrum sub-
account reflects the investment performance of that portfolio of AIT or 
Fulcrum in which the sub-account invests.
    4. Each Applicant separate account is administered and accounted 
for as part of the general business of the Applicant insurance company 
of which it is a part. The income, gains or losses (realized or 
unrealized) of each Applicant separate account are credited to or 
charged against the assets of that separate account, without regard to 
income, gains or losses of such Applicant insurance company.
    5. As noted above, each of the Applicant separate accounts serves 
as a funding vehicle for certain Variable Contracts. The terms and 
conditions, including charges and expenses, applicable to the 
respective Variable Contracts are described in separate registration 
statements relating to each Variable Contracts. As the Variable 
Contracts are currently structured, holders of any of the Variable 
Contracts (``Contractholders'') may select one or more of the 
investment options available under the Variable Contract held by the 
allocating premiums payable under such contracts to that sub-account of 
the relevant Applicant separate account that corresponds to the 
investment option desired. Thereafter, Contractholders accumulate 
funds, on a tax-deferred basis, based on the investment experience of 
the selected sub-account(s). Contractholders may, during the life of 
the contract, make unlimited transfers of accumulation values among the 
sub-accounts available under the Variable Contract held. Depending on 
the type of Variable Contract, the first six or twelve transfers in a 
contract year are guaranteed to be free of any transfer charge. The 
Applicant insurance companies do not currently charge for additional 
transfers but reserve the right to do so. Applicants represent that the 
relief requested here will not affect any charge to which any 
Contractholder would otherwise be subject, or affect any right or 
privilege to which any Contractholder would otherwise be entitled 
(except for the substitution in the underlying investment options, as 
described herein).
    6. AIT is a Massachusetts business trust that was established on 
October 11, 1984 and is registered under the Act as an open-end 
diversified investment company. AIT currently consists of 14 different 
Funds: Select Emerging Markets Fund, Select Aggressive Growth Fund, 
Select Capital Appreciation Fund, Select Value Opportunity Fund, Select 
International Equity Fund, Select Growth Fund, Select Strategic Growth 
Fund, Growth Fund, Equity Index Fund, Select Growth and Income Fund, 
Select Income Fund, Investment Grade Income Fund, Government Bond Fund 
and Money Market Fund (collectively, the ``Funds,'' and each, a 
``Fund''). Currently, shares of each Fund are purchased only by the 
separate accounts established by First Allmerica or Allmerica Financial 
Life for the purpose of funding variable annuity contracts and variable 
life insurance contracts. Two AIT Funds are involved in the proposed 
substitutions discussed in this application.
    7. The fist AIT Fund involved in the proposed substitution is AIT's 
Investment Grade Income Fund (``IGIF'').\1\ IGIF seeks as high a level 
of total return, which includes capital appreciation as well as income, 
as is consistent with prudent investment management. To achieve its 
goal, the Fund invests in investments grade debt securities such as 
bonds and other corporate debt obligations; obligations issued or 
guaranteed by the U.S. Government, its agencies or instrumentalities; 
and market instruments, including commercial paper, bankers 
acceptances, and negotiable certificates of deposit. The Fund also may 
make investments in mortgage-backed and asset-backed securities. The 
Fund may invest up to 25% of its assets in foreign securities (not 
including its investments in American Depository Receipts or ADRs) and 
up to 25% of its assets in debt obligations of supranational entities. 
Investment techniques the Fund may employ include: entering into 
financial futures contracts and related options, forward commitments, 
purchasing options, repurchase agreements and stand-by commitments; 
investing in restricted securities, stripped mortgage-backed securities 
and when-issued securities; lending portfolio securities; and writing 
covered options.
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    \1\ Subject to the completion of the proposed substitutions, the 
name of this Fund will be changed to the Select Investment Grade 
Income Fund.
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    8. The second AIT Fund involved in the proposed substitution is 
AIT's Select Income Fund (``SIF''), which seeks a high level of current 
income. SIF invests primarily in investment grade, fixed-income 
securities. Examples of the types of securities in which the Fund 
invests are corporate debt obligations such as bonds, notes and 
debentures, and obligations convertible into common stock; commercial 
paper; obligations issued or guaranteed by the U.S. Government, its 
agencies or instrumentalities; and debt securities backed by various 
types of financial assets. The Fund may also invest in mortgage-backed 
and asset-backed securities. The Fund's investments in corporate debt 
securities are not limited to any particular type of company or 
industry. The Fund may invest up to 25% of its assets in foreign 
securities (not including its investments in ADRs), up to 35% of its 
assets in money market instruments, and up to 25% of its assets in debt 
obligations of supranational entities. The Fund invests primarily (and 
in practice invests exclusively) in investment grade securities rated 
in the four highest grades by Moody's Investors Services or Standard & 
Poor's Rating Services or similar rating organizations, and in unrated 
securities. Investment techniques the Fund may employ include: entering 
into financial futures contracts and related options, forward 
commitments, forward contracts on foreign currencies, purchasing 
options, repurchase agreements and stand-by commitments; investing in 
high yield securities, restricted securities, stripped mortgage-backed 
securities and when-issued securities; lending portfolio securities; 
and writing covered options.
    9. Overall management services are provided to AIT by Allmerica 
Financial Investment Management Services, Inc. (``AFIMS'' and/or the 
``Manager''), an indirect, wholly-owned, subsidiary of AFC. AFIMS is an 
investment adviser registered under the Investment Advisers Act of 
1940, as amended. Under the terms of a management agreement between AIT 
and AFIMS (the ``Management Agreement''), AFIMS manages AIT's business 
affairs and has general responsibility for the management of the 
investments of the

[[Page 31031]]

Funds, subject to the control of the Board of Trustees of AIT.
    10. AFIMS, at its expense, has contracted with investment sub-
advisers to manage the investments of the Funds. Each sub-adviser has 
been selected on the basis of various factors including management 
experience, investment techniques and staffing, and is authorized to 
engage in portfolio transactions on behalf of the applicable Fund 
subject to such general or specific instructions as may be given by the 
trustees and/or AFIMS. Allmerica Asset Management, Inc. (``AAM'') 
serves as sub-adviser for IGIF. Incorporated in 1993, AAM has 
approximately $13 billion under management as of December 31, 1999. AAM 
serves as investment adviser to investment companies and affiliated 
insurance company accounts. Standish, Ayer & Wood, Inc. (``SAW'') 
serves as sub-adviser for SIF. Founded in 1993, the firm had 
approximately $44 billion in assets under management as of December 31, 
1999. SAW manages portfolios for pension plans, financial institutions 
and endowment and foundation funds.
    11. AFIMS is responsible for the payment of all fees to the sub-
advisers. Other than the expenses specifically assumed by AFIMS under 
the Management Agreement, all expenses incurred in the operation of AIT 
are borne by AIT, including fees and expenses associated with the 
registration and qualification of AIT's shares under the Securities Act 
of 1933; other fees payable to the SEC; independent accountant, legal 
and custodian fees; association membership dues; taxes; interest; 
insurance premiums; brokerage commissions; fees and expenses of the 
trustees who are not affiliated with AFIMS; expenses for proxies, 
prospectuses and reports to shareholders; and Fund recordkeeping 
expenses and other expenses. A prospectus for AIT accompanies the 
prospectus of each of the Variable Contracts that offers one or more of 
the Funds as an investment option.
    12. For its services, AFIMS is entitled to receive a fee from each 
Fund at AIT, based on the average daily net asset value of each Fund. 
In addition, AFIMS has voluntarily undertaken to reimburse each Fund 
for its fees and expenses that exceed the applicable expense limitation 
set for that Fund. The expenses which are subject to the voluntary 
expense limitations include management fees; independent accountant, 
legal and custodian fees; recordkeeping expenses; fees and expenses of 
the trustees who are not affiliated with AFIMS; association membership 
dues and insurance; expenses for proxies, prospectuses and reports to 
shareholders; and fees associated with the registration of Fund shares. 
AFIMS has declared voluntary expense limitations for IGIF and SIF of 
1.00% of each Fund's average daily assets. The expense limitations may 
be removed at any time after a Fund's first fiscal year of operations 
with notice to existing shareholders. Actual expenses have been well 
below such expense limitations for both Funds.
    13. Fulcrum is a Massachusetts business trust that was established 
on September 8, 1993 and commenced operations on February 1, 1996. 
Prior to September 1, 1998, the Trust's name was ``The Palladian 
Trust.'' Fulcrum is registered under the Act as an open-end diversified 
investment company and currently consists of five different portfolios; 
Global Interactive/Telecomm Portfolio, the International Growth 
Portfolio, the Growth Portfolio, the Value Portfolio and the Strategic 
Income Portfolio (collectively, the ``Portfolios,'' and each, a 
``Portfolio'').
    14. The Fulcrum Strategic Income Portfolio (``SIP'') is the only 
Fulcrum Portfolio involved in the proposed substitution discussed in 
this application. SIP seeks to make money for investors by investing 
for high current income and capital appreciation in a variety of fixed-
income securities. SIP invests primarily in investment grade corporate 
debt securities and securities issued or guaranteed as to principal or 
interest by the U.S. Government or its agencies or instrumentalities; 
below investment-grade corporate debt securities; and foreign 
securities which include government debt of developed and emerging 
markets, corporate obligations of foreign companies, and debt 
obligations of supranational entities. Debt securities in which SIP may 
invest include bonds, notes, debentures, mortgage-backed and asset-
backed securities, and other similar instruments. Although SIP may 
invest up to 50% of its assets in below investment grade securities, or 
junk bonds, SIP has generally invested most of its assets in investment 
grade securities. Investment techniques the Fund may employ include: 
commercial paper, indexed securities, securities of other investment 
companies, restricted securities, variable and floating rate securities 
and warrants; foreign currency transactions, futures contracts, 
repurchase agreements, reverse repurchase agreements, short sales 
against the box, and short sales; leveraging; purchasing options; and 
lending portfolio securities.
    15. AFIMS serves as overall manager of Fulcrum, and is responsible 
for managing Fulcrum's daily business and has general responsibility 
for the management of the investments of the Portfolios. Portfolio 
managers (the ``Portfolio Managers'') have been hired to handle the 
day-to-day investment management of the Portfolios. The Portfolio 
Managers' activities are subject to general oversight by the trustees 
and AFIMS. AAM serves as Portfolio Manager of SIP. For these services, 
each Portfolio pays an overall management fee, computed and accrued 
daily and paid monthly, based on its average daily net assets. The 
overall fee varies based on the performance of that Portfolio (after 
expenses) compared to that of an appropriate benchmark. The Portfolio 
Manager receives 80% of the fee, and AFIMS receives the remaining 20%. 
For the period beginning on the effective date of a Portfolio manager 
agreement with a new Portfolio Manager and ending with the last day of 
the twelfth full calendar month thereafter, each Portfolio pays a 
monthly advisory fee calculated at an annual rate of 0.80% of the 
Portfolio's average daily net assets. After the first 12 full calendar 
months with a new Portfolio Manager, as described above, each Portfolio 
pays a monthly advisory fee equal to a basic fee, plus or minus an 
incentive fee. The fee might be reduced if absolute performance is 
negative. The monthly basic fee equals one-twelfth of the annual basic 
fee rate of 2.0% multiplied by average daily net assets over the 
previous 12 months. The incentive fee ranges from -2.0% to +2.0% on an 
annual basis, depending on a comparison of the Portfolio's performance 
(reflecting a deduction of portfolio expenses) and the performance of a 
selected benchmark index over the past 12 months. The monthly incentive 
fee, like the monthly basic fee, is calculated by multiplying one-
twelfth of the incentive fee rate on an annual basis by the average 
daily net assets over the previous 12 months. Accordingly, the total 
fee could range from 0.0% to an annual rate of 4.0%, depending on 
performance.
    16. AFIMS has agreed to limit operating expenses and reimburse 
those expenses to the extent that each Portfolio's ``other expenses'' 
(i.e., expenses other than management fees) exceed the expense 
limitations set for the Portfolios. AFIMS has guaranteed these expense 
limitations through June 30, 2000. For the two years following the date 
that the expense limitations end and subject to certain conditions, 
each Portfolio will reimburse AFIMS for

[[Page 31032]]

any Portfolio expenses it reimbursed pursuant to the expense 
limitations. The limitation on ``other expenses'' for SIP is an annual 
rate of 1.50% of average daily net assets.
    17. In accordance with its authority under the Variable 
Contracts,\2\ and subject to the approval of the Commission under 
Section 26(b) of the Act, Applicant insurance companies have approved a 
proposal to make certain substitutions of shares held in sub-accounts 
of the Applicant separate accounts. Applicants propose to substitute 
shares of IGIF for shares of SIF and for shares of SIP.
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    \2\ Each of the Variable Contracts reserves to the issuing 
Applicant insurance company the right, subject to Commission 
approval, to substitute shares of another management investment 
company held by a sub-account of the separate account issuer of the 
contract. This reservation of right is disclosed in the registration 
statement relating to each Variable Contract.
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    18. Applicants maintain that IGIF and SIF have similar investment 
objectives and seek to achieve these objectives by investing in similar 
types of fixed-income securities and utilizing comparable investment 
strategies. Applicants have concluded that the investment objectives 
and policies of IGIF are sufficiently similar to those of SIF that the 
essential objectives and risk expectations of Contractholders can 
continue to be met. Applicants believe that the proposed substitution 
of IGIF for SIF will benefit Contractholders in that (1) IGIF has a 
lower investment advisory fee schedule than SIF, (2) IGIF has a better 
one- and five-year performance record than SIF, and (3) IGIF has a 
larger asset base than SIF which may provide certain economies of scale 
and lower expenses.
    19. Applicants assert that, as a result of the proposed 
substitution, the Contractholders who currently invest in SIF will 
benefit from the lower investment advisory fee of IGIF. The current 
investment advisory fees paid by each Fund are listed in the following 
chart.
Investment Adviser and Sub-Adviser Fees
    The Manager receives fees computed daily at an annual rate based on 
the average daily net asset value of each Fund as set forth below.

------------------------------------------------------------------------
                                                 Investment
                                                   grade        Select
                                                income fund  income fund
                                                 (percent)    (percent)
------------------------------------------------------------------------
First $50 million.............................         0.50         0.60
Next $50 million..............................         0.45         0.55
Over $100 million.............................         0.40         0.45
------------------------------------------------------------------------

    The Manager pays each sub-adviser fee computed at an annual rate 
based on the average daily net asset value of each Fund as set forth 
below.
    Investment Grade Income Fund: 0.20%.
    Select Income Fund: 0.20%.
    20. Applicants state that IGIF has a better performance record than 
SIF for the one- and five-year periods ended December 31, 1998.
    21. Applicants maintain that, as shown in the table below, IGIF has 
a larger asset base than SIF which may provide certain economies of 
scale, resulting in lower expenses, compared to SIF. The net assets of 
each Fund as of September 30, 1999 were as follows:

------------------------------------------------------------------------
                                                            Net assets
                                                           (in millions)
------------------------------------------------------------------------
Investment grade income fund............................          $250.2
Select income fund......................................          $176.9
------------------------------------------------------------------------

    22. Applicants state that the expense ratio for IGIF is 
significantly lower in comparison to SIF, which is due primarily to the 
difference in the level of investment advisory fees between the two 
Funds. The fees and expenses incurred for the fiscal year ended 
December 31, 1998 by each Fund are as follows:

                     Annual Fund Operating Expenses
          [Expenses deducted from fund assets--as of 12/31/98]
------------------------------------------------------------------------
                                                 Investment
                                                   grade        Select
                                                income fund  income fund
                                                 (percent)    (percent)
------------------------------------------------------------------------
Investment advisory fees......................          .43          .54
Other expenses................................          .09          .10
                                               -------------------------
    Total operating expenses \1\..............          .52         .64
------------------------------------------------------------------------
\1\ Until further notice, the Manager has declared a voluntary expense
  limitation of 1.00% for the Select Income Fund and Investment Grade
  Income Fund.

    23. For the foregoing reasons, Applicants submit that the proposed 
substitution of the shares of IGIF for shares of SIF is in the best 
interest of Contractholders.
    24. Applicants maintain that IGIF and SIP have similar investment 
objectives and seek to achieve these objectives by investing in similar 
types of fixed-income securities and utilizing comparable investment 
strategies. Applicants have concluded that the investment objectives 
and policies of IGIF are sufficiently similar to those of SIP that the 
essential objectives and risk expectations of Contractholders can 
continue to be met. Applicants believe that the proposed substitution 
of IGIF for SIP will benefit Contractholders in that (1) IGIF has a 
larger asset base than SIP which should provide certain economies of 
scale and lower expenses, and (2) IGIF has a better performance record 
than SIP.
    25. Applicants believe that SIP has not grown to a size to allow it 
to operate efficiently. As shown in the table below, IGIF has a larger 
asset base than SIP, which should provide certain economies of scale, 
resulting in lower expenses, compared to SIP. After the proposed 
substitution, SIP would be dissolved. The net assets of SIP and IGIF as 
of September 30, 1999 are as follows:

------------------------------------------------------------------------
                                                          Net assets (in
                                                             millions)
------------------------------------------------------------------------
Fulcrum strategic income portfolio......................            $2.4
AIT investment grade income fund........................           250.2
------------------------------------------------------------------------

    26. Applicants state that the expense ratio for IGIF is 
significantly lower in comparison to SIP. The fees and expenses 
incurred for the fiscal year ended December 31, 1998 by each Fund are 
as follows:

[[Page 31033]]



                     Annual Fund Operating Expenses
[Expenses deducted from fund assets before fee limitations--as of 12/31/
                                   98]
------------------------------------------------------------------------
                                                 Investment   Strategic
                                                   grade        income
                                                income fund   portfolio
                                                 (percent)    (percent)
------------------------------------------------------------------------
Investment advisory fees......................          .43      \2\ .67
Other expenses................................          .09     \3\ 6.49
                                               -------------------------
    Total operating expenses..................      \1\ .52        7.16
------------------------------------------------------------------------
\1\ Until further notice. the investment adviser has declared a
  voluntary expense limitation of 1.00% for the Investment Grade Income
  Fund.
\2\ The Investment advisory fee for the Strategic Income Portfolio
  listed above was based on the performance of the portfolio during 1998
  and can vary from 0% to 4.00%.
\3\ The Manager has agreed to a voluntary expense limitation on the
  ``other expenses'' at an annual rate of 1.50% of the average daily net
  assets of the Strategic Income Portfolio. The expense limitation is
  guaranteed through June 30, 2000. Subject to certain conditions, the
  Strategic Income Portfolio will reimburse the Manager for any
  portfolio expenses it reimbursed pursuant to the expense limitation
  for the two years following the date that the expense limitation ends.

    27. Set forth below are charts showing gross and net operating 
expenses, including investment advisory fees, for IGIF, SIP and SIF for 
the years ended December 31, 1996--December 31, 1999.

----------------------------------------------------------------------------------------------------------------
                                                  Year ended  12/ Year ended  12/ Year ended  12/ Year ended  12/
                                                       31/99           31/98           31/97           31/96
                                                     (percent)       (percent)       (percent)       (percent)
                                                 ---------------------------------------------------------------
                                                   Gross    Net    Gross    Net    Gross    Net    Gross    Net
----------------------------------------------------------------------------------------------------------------
                                          Investment Grade Income Fund
----------------------------------------------------------------------------------------------------------------
Management fees.................................    0.43    0.43    0.43    0.43    0.41    0.41    0.40    0.40
Other expenses..................................    0.07    0.07    0.09    0.09    0.10    0.10    0.12    0.12
                                                 ---------------------------------------------------------------
    Total operating expenses....................    0.50    0.50    0.52    0.52    0.51    0.51    0.52   0.52
----------------------------------------------------------------------------------------------------------------
                                           Strategic Income Portfolio
----------------------------------------------------------------------------------------------------------------
Management fees.................................    0.35    0.23    0.67    0.47    0.41    0.41    0.80    0.80
Other expenses..................................    3.26    1.27    6.49    1.71    6.27    1.20    11.5    6.57
                                                 ---------------------------------------------------------------
    Total operating expenses....................    3.61    1.50    7.16    2.18    6.68    1.61    12.3   7.37
----------------------------------------------------------------------------------------------------------------
                                               Select Income Fund
----------------------------------------------------------------------------------------------------------------
Management fees.................................    0.52    0.52    0.54    0.54    0.59    0.59    0.60    0.60
Other expenses..................................    0.09    0.09    0.10    0.10    0.13    0.13    0.14    0.15
                                                 ---------------------------------------------------------------
    Total operating expenses....................    0.61    0.61    0.64    0.64    0.72    0.72    0.74    0.74
----------------------------------------------------------------------------------------------------------------

    28. Applicants state that IGIF has a better performance record than 
SIP. Applicants have no reason to believe that, in the near term, the 
performance of SIP will match or exceed that of IGIF.
    29. Applicants also believe that the substitution would provide 
Contractholders a more predictable advisory fee. IGIF's investment 
advisory fee is an annual rate of 0.50% of average daily net assets on 
the first $50 million of assets, 0.45% on the next $50 million of 
assets, and 0.40% on assets over $100 million. SIP's advisory fee can 
vary from 0% to 4.00% depending on performance.
    30. For the foregoing reasons, Applicants submit that the proposed 
substitution of the shares of IGIF for shares of SIP is in the best 
interest of Contractholders.
    31. Applicant insurance companies will effect the substitutions as 
soon as practicable following the issuance of the requested order, as 
follows. As of the effective date of the substitutions (``Effective 
Date''), shares of SIF and SIP held by the various Applicant separate 
accounts will be redeemed by the Applicant insurance companies. The 
proceeds of such redemptions, which may be effected in-kind, will then 
be used to purchase the appropriate number of shares of IGIF. Since it 
is anticipated that the proposed substitution will be effected by in-
kind transfer of assets, Contractholders will be fully invested at all 
times. The proposed substitutions will take place at relative net asset 
value with no charge in the amount of any Contractholder's account 
value, cash value or death benefit or in the dollar value of his or her 
investment in any of the Applicant separate accounts. Contractholders 
will not incur any fees or charges as a result of the proposed 
substitutions, nor will their rights nor the Applicant insurance 
companies' obligations under the Variable Contracts be altered in any 
way. All expenses incurred in connection with the proposed 
substitutions, including legal, accounting and other fees and expenses, 
will be paid by the Applicant insurance companies. In addition, the 
proposed substitutions will not impose any tax liability on 
Contractholders. The proposed substitutions will not cause the Variable 
Contract fees and charges currently being paid by existing 
Contractholders to be greater after the proposed substitutions than 
before the

[[Page 31034]]

proposed substitutions. The proposed substitutions (and any transfer in 
advance of the substitution) will not be subject to a transfer charge 
and will not be counted toward any limit on transfers guaranteed not to 
be subject to a transfer charge.
    32. Two of the Applicant separate accounts, the First Allmerica 
Inheritage Account and Allmerica Financial Life VEL Account III, 
currently have sub-accounts that invest in SIF and IGIF. Applicant 
insurance companies may in the future cause the First Allmerica 
Inheritage Account and Allmerica Financial Life VEL Account III to 
combine those sub-accounts that hold shares of IGIF. The combination of 
those subaccounts that hold shares of IGIF would not have any impact on 
the value of the Variable Contracts involved, the fees or rights of the 
Contractholders, or diminish in any way the obligations of the 
Applicant insurance companies under any Variable Contract. The 
Applicant insurance companies would bear the costs of any such 
combination, including any legal and/or accounting fees relating to 
them, and the Contractholders would not incur any fees or charges as a 
result of such combination. in addition, any such sub-account 
combination would not result in any adverse tax consequences to the 
Contractholders, or any change in the economic interest or contract 
values of any Contractholders.
    33. By supplements to the various prospectuses for the Variable 
Contracts and Applicant separate accounts, all owners of the Variable 
Contracts will be notified of the Applicant insurance companies' 
intention to take the necessary actions, including seeking the order 
requested by this application, to substitute shares of the Underlying 
Funds as described herein. The supplements for the Applicant separate 
accounts will advise Contractholders that from the date of the 
supplement until the date of the proposed substitution, each owner may 
make one transfer of all amounts allocated to the SIF or SIP sub-
account to another sub-account without that transfer being counted 
toward the limit on transfers guaranteed not to be subject to a 
transfer charge. The supplements also will inform Contractholders that 
the Applicant insurance companies will not exercise any rights reserved 
under any of the Variable Contracts to impose additional restrictions 
on transfers until at least 30 days after the proposed substitutions. 
With these supplements, Contractholders will also receive a current 
prospectus relating to IGIF (unless the Contractholders has already 
received that prospectus).
    34. In addition to the prospectus supplements distributed to owners 
of Variable Contracts, within five days after the proposed 
substitutions, and Contractholders who were affected by the 
substitutions will be sent a written notice informing them that the 
substitutions were carried out and that they may make one transfer of 
all account value under a Variable Contract invested in any one of the 
affected sub-accounts on the date of the notice to another sub-account 
available under their Variable Contract without that transfer counting 
as one of the number of transfers per year guaranteed to be free of 
charge. The notice will also reiterate the fact that the Applicant 
insurance companies will not exercise any rights reserved by either 
under any of the Variable Contracts to impose additional restrictions 
on transfers until at least 30 days after the proposed substitutions. 
The notice as delivered in certain states also may explain that, under 
the insurance regulations in those states. Contractholders who are 
affected by the substitutions may exchange their Variable Contracts for 
fixed-benefit life insurance contracts or annuity contracts, as 
applicable, issued by the Applicant insurance companies (or one of 
their affiliates) during the 60 days following the proposed 
substitutions.
    35. The Applicant insurance companies are also seeking approval of 
the proposed substitutions from any state insurance regulators whose 
approval may be necessary or appropriate.

Applicants' Legal Analysis

    1. Section 26(b) states that it ``shall be unlawful for any 
depositor or trustee of a registered unit investment trust holding the 
security of a single issuer to substitute another security for such 
security unless the Commission shall have approved such substitution. 
The Commission shall issue an order approving such substitution if the 
evidence establishes that it is consistent with the protection of 
investors and the purposes fairly intended by the policy and provisions 
of this title.'' The purpose of Section 26(b) is to protect the 
expectation of investors in a unit investment trust that the unit 
investment trust will accumulate the shares of a particular issuer and 
to prevent unscrutinized substitutions which might, in effect, force 
shareholders dissatisfied with the substituted security to redeem their 
shares, thereby possibly incurring either a loss of the sales load 
deducted from initial purchase payments, an additional sales load upon 
reinvestment of the redemption proceeds, or both. Section 26(b) affords 
this protection to investors by preventing a depositor or trustee of a 
unit investment trust holding the shares of one issuer from 
substituting for those shares the shares of another issuer, unless the 
Commission approves that substitution.
    2. Applicants request that the Commission issue an order pursuant 
to Section 26(b) of the Act approving the substitutions by the 
Applicant insurance companies of shares held by the Applicant separate 
accounts as follows: (1) shares of IGIF for shares of SIF; and (2) 
shares of IGIF for shares of SIP.
    3. Applicants state that the Variable Contracts expressly reserve 
for the Applicant insurance companies the right, subject to compliance 
with applicable law, to substitute shares of another investment company 
for shares of an investment company held by a separate account or a 
sub-account of a separate account. Applicants maintain that the 
prospectuses for the Variable Contracts and the separate accounts 
contain appropriate disclosure of this right. Applicants note that the 
Applicant insurance companies each reserved this right of substitution 
both to protect themselves and their Contractholders in situations 
where either might be harmed or disadvantaged by circumstances 
surrounding the issuer of the shares held by one or more of their 
separate accounts and to afford the opportunity to replace such shares 
where to do so could benefit itself and Contractholders.
    4. Applicants state that, in the case of the proposed substitution 
of shares of IGIF for shares of SIF, SIF would be replaced by a Fund 
with a similar investment objective but which has a lower investment 
advisory fee, a better long-term performance record, and a larger asset 
base, potentially resulting in lower expenses. Applicants maintain 
that, in the case of the proposed substitution of shares of IGIF for 
shares of SIP, the interests of Contractholders will be better served 
primarily because SIP would be replaced by a Fund with similar 
investment objectives but which has a larger asset base, potentially 
resulting in lower expenses, and a better performance record.
    5. Applicants generally submit that the proposed substitutions meet 
the standards that the Commission and its staff have applied to similar 
substitutions that have been approved in the past.
    6. Applicants anticipate that Contractholders will be at least as 
well off with the proposed array of separate accounts and sub-accounts 
after the proposed substitutions as they have

[[Page 31035]]

been with the array of separate accounts and sub-accounts offered prior 
to the substitutions. Applicants maintain that the proposed 
substitutions retain for Contractholders the investment flexibility 
which is a central feature of the Variable Contracts. Applicants 
represent that, if the proposed substitutions are carried out, all 
Contractholders will be permitted to allocate purchase payments and 
transfer account values between and among the same number of separate 
accounts or sub-accounts as they could before the proposed 
substitutions.\3\
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    \3\ No sub-accounts will be combined at the time the proposed 
substitution is effected. The number of underlying investment 
options for each of the 19 Applicant separate accounts currently 
varies from six to 24.
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    7. Applicants submit that neither of the proposed substitutions is 
of the type that Section 26(b) was designed to prevent and that, unlike 
traditional unit investment trusts where a depositor could only 
substitute an investment security in a manner which permanently 
affected all the investors in the trust, the Variable Contracts provide 
each Contractholder with the right to exercise his or her own judgment 
and transfer account values into other sub-accounts. Applicants state 
that, moreover, the Variable Contracts will offer Contractholders the 
opportunity to transfer amounts out of the affected sub-accounts into 
any of the remaining sub-accounts without cost or other disadvantage. 
Applicants contend, therefore, that the proposed substitutions will not 
result in the type of costly forced redemption which Section 26(b) was 
designed to prevent.
    8. Applicants state that the proposed substitutions also are unlike 
the type of substitution which Section 26(b) was designed to prevent in 
that, by purchasing a Variable Contract, Contractholders select much 
more than a particular investment company in which to invest their 
account values. Applicants explain that Contractholders may also select 
the specific type of insurance coverage offered by either or both of 
the Applicant insurance companies under their Variable Contract as well 
as numerous other rights and privileges set forth in the Variable 
Contract. Applicants also believe that Contractholders may have 
considered each or both Applicant insurance companies' size, financial 
condition, type and reputation for service in selecting their Variable 
Contract. Applicants represent that these factors will not change as a 
result of the proposed substitutions.
    9. Applicants request an order of the Commission pursuant to 
Section 26(b) of the Act approving the proposed substitutions by the 
Applicant insurance companies. Applicants submit that, for all of the 
reasons stated above, the proposed substitutions are consistent with 
the protection of investors and the purposes fairly intended by the 
policy and provisions of the Act.
    10. Applicants request an order pursuant to Section 17(b) of the 
Act exempting them from the provisions of Section 17(a) of the Act to 
the extent necessary to permit them to effect (i) the substitutions 
proposed in this application by means of in-kind redemptions and 
purchases of shares and (ii) any subsequent consolidation of sub-
accounts of the Applicant separate accounts as discussed in this 
application.
    11. Sections 17(a)(1) and (2) of the Act, in relevant part, 
prohibit any affiliated person of a registered investment company, or 
any affiliated person of such a person, or any principal underwriter 
for such company (collectively, ``Transaction Affiliates''), acting as 
principal, from knowingly selling to or purchasing from that registered 
investment company any security or other property.
    12. Section 2(a)(3) of the Act defines the term ``affiliated person 
of another person'' in relevant part as: (A) any person directly or 
indirectly owning, controlling, or holding with power to vote, 5 
percent or more the outstanding voting securities of such other person; 
(B) any person 5 percent or more of whose outstanding voting securities 
are directly or indirectly owned, controlled, or held with power to 
vote, by such other person; and (C) any person directly or indirectly 
controlling, controlled by, or under common control with, such other 
person.
    13. Applicants submit that they may be deemed to be Transaction 
Affiliates of one another based upon this definition. Applicants state 
that, because the proposed substitutions may be affected by means of an 
in-kind redemption and a subsequent purchase of shares, also in an in-
kind transaction, the substitutions may be deemed to involve on or more 
purchases or sales of securities or property between Transaction 
Affiliates. Applicants state that, because the Applicant separate 
accounts (as well as other separate accounts of the Applicant insurance 
companies) are registered collectively with the Commission as a single 
unit investment trust of which the Applicant insurance companies are 
the depositors, the Applicant separate accounts are affiliates persons 
of each other. Applicants further state that, because all of the 
Applicant separate accounts are under the common control of the 
Applicant insurance companies, they are all affiliated persons of each 
other.
    14. Applicant assert that, while they do not concede that Section 
17(a) applies to the proposed substitutions, the combining of sub-
accounts under the Applicants separate accounts, because it could be 
deemed to involve the transfer of assets from one entity to another, 
arguably would involve these entities, acting as principal, in buying 
and selling securities or other property from one to another in 
contravention of Section 17(a).
    15. Section 17(b) of the Act provides that the Commission may, upon 
application, grant an order exempting any proposed transaction from the 
provisions of Section 17(a) if the evidence establishes that (1) the 
terms of the proposed transaction, including the consideration to be 
paid or received, are reasonable and fair and do not involve 
overreaching on the part of any person concerned; (2) the proposed 
transaction is consistent with the policy of each registered investment 
company concerned, as recited in its registration statement and reports 
filed under the Act; and (3) the proposed transaction is consistent 
with the general purposes of the Act.
    16. Applicants submit that, to the extent that the substitutions 
and any subsequent combination of sub-accounts that hold identical 
securities are deemed to involve principal transactions among 
Transaction Affiliates, the manner in which such substitutions and any 
combinations are to be implemented is sufficient to assure that such 
transactions do not involve overreaching on the part of any Applicant 
or other person, and are fair and reasonable and consistent with the 
policies and purposes underlying the Act. Applicants further submit 
that the facts and procedures recited in their application demonstrate 
that neither the Underlying Funds nor any of the Applicant separate 
accounts will be participating in the substitutions or any subsequent 
combination on a basis less advantageous than that of any other 
participant. Finally, Applicants state that, but for the fact that the 
substitutions may be effected by means of in-kind redemption and 
purchase transactions, rather than in cash, the procedures described in 
their application would comply with all of the conditions of Rule 17a-7 
under the Act.\7\
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    \7\ Applicants note that Rule 17a-7 under the Act is not 
available to them in connection with the substitutions because: (i) 
affiliations among the Applicants do not rise solely by reason of 
having common investment advisers, director and/officers; and (ii) 
the contemplated redemptions and subsequent purchases of shares of 
IGIF may be effected in-kind and not for cash.

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[[Page 31036]]

    17. Accordingly, Applicants request an order of the Commission 
pursuant to Section 17(b) of the Act to permit the substitutions and 
related transactions described in this application. Applicants submit 
the proposed substitutions are consistent with the policies of each of 
the Applicant separate accounts and the Underlying Funds and with the 
general purposes of the Act.
    18. Applicants assert that the Commission, in recent years, has 
issued several orders pursuant to Sections 17(b) and 26(b) of the Act 
under circumstances similar to those presented in their application, 
each of which provides substantial precedent for the relief requested 
by this application. Applicants submit that these orders involved 
transactions in which registered separate accounts that serve as 
funding vehicles for variable contract were permitted to substitute, by 
means of in-kind redemptions and subsequent purchases, shares of one 
mutual fund for shares and another affiliated mutual fund. Applicants 
state that certain of the transactions also were followed by a 
consolidation of the underlying sub-accounts. Applicants maintain that 
these orders were conditioned on certain representations by the 
respective applicants, which they believe appear to fall into five 
categories:
    (i) The funds to be substituted have objectives, policies and 
restrictions sufficiently similar to the objective of the replaced 
funds so that the policy owners objectives can continue to be met;
    (ii) Variable contract owners would be given sufficient notice of 
information about the substitutions and an opportunity to ``opt out'' 
of the substitution and transfer their policy values, without charge, 
to any other investment option available under the policy held;
    (iii) Substitutions would take place at relative net asset value 
and without the imposition of any additional expense or charge, such 
that no change in the amount of any variable contract owners's 
investment or expenses would result;
    (iv) Neither the rights of variable contract owners, nor the 
obligations of applicant insurance companies under the variable 
contract would be altered as a result of the substitutions; and
    (v) All necessary regulatory requirements would be satisfied prior 
to the effective date of the substitutions, including compliance with 
applicable insurance law and the issuance of the Commission's order 
approving the substitution.
    Applicants represent that the facts and circumstances underlying 
their application meet each of the conditions listed in (i) through (v) 
above and are sufficient to assure that the substitutions and any 
subsequent account combination will be carried out in a manner that is 
consistent with Sections 17(b) and 26(a) of the Act.
    19. Applicants request that the Commission issue an order pursuant 
to Section 17(b) of the Act exempting them from the provisions of 
Section 17(a) of the Act to the extent necessary to permit the 
Applicant insurance companies to carry out the substitution 
transactions described herein. The Applicants represent that, for all 
the reasons stated above, the terms of the proposed substitutions as 
set forth herein, including any consideration to be paid and received, 
are reasonable and fair and do not involve overreaching on the part of 
any person concerned. Furthermore, the Applicants represent that the 
proposed substitutions will be consistent with the policies of the 
Applicant insurance companies and the Underlying Funds as stated in the 
current registration statement and reports filed under the Act by each 
and with the general purposes of the Act.

Conclusion

    Applicants submit that for the reasons and upon the facts set forth 
above, the requested order of approval pursuant to Section 26(b) and 
the requested order granting exemptive relief pursuant to Section 17(b) 
should be granted.

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-12132 Filed 5-12-00; 8:45 am]
BILLING CODE 8010-01-M