[Federal Register Volume 63, Number 144 (Tuesday, July 28, 1998)]
[Proposed Rules]
[Pages 40231-40237]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-20088]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release Nos. IC-23325, IA-1736; File No. S7-22-98]
RIN 3235-AH02


Temporary Exemption for Certain Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Commission is proposing for public comment amendments to 
the rule under the Investment Company Act of 1940 that permits an 
investment adviser, in certain circumstances, to advise an investment 
company temporarily under a contract that the investment company's 
shareholders have not approved. The proposed amendments would expand 
the exemption provided by the rule to include new advisory contracts 
entered into as a result of a merger or similar business combination 
involving the fund's adviser or a controlling person of the adviser, 
and would lengthen the period during which the adviser may serve under 
a contract without shareholder approval. The proposed amendments are 
intended to enable more investment advisers to rely on the rule rather 
than seek individual exemptions from the Commission, subject to 
conditions designed to protect the interests of investors pending the 
shareholder vote.

DATES: Comments must be received on or before September 30, 1998.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Mail Stop 6-9, Securities and Exchange Commission, 450 
5th Street, NW., Washington, DC 20549. Comments also may be submitted 
electronically at the following E-mail address: <a href="/cdn-cgi/l/email-protection#cebcbba2abe3ada1a3a3aba0babd8ebdabade0a9a1b8"><span class="__cf_email__" data-cfemail="87f5f2ebe2aae4e8eaeae2e9f3f4c7f4e2e4a9e0e8f1">[email protected]</span></a>. 
All comment letters should refer to File No. S7-22-98; this file number 
should be included on the subject line if E-mail is used. Comment 
letters will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 5th Street, NW., Washington, DC 
20549. Electronically submitted comment letters also will be posted on 
the Commission's Internet web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Marilyn Mann, Senior Counsel, or 
Penelope W. Saltzman, Assistant Chief, (202) 942-0690, Office of 
Regulatory Policy, Division of Investment Management, Mail Stop 5-6, 
Securities and Exchange Commission, 450 5th Street, NW., Washington, DC 
20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission (the 
``Commission'') today is requesting public comment on amendments to 
rule 15a-4 (17 CFR 270.15a-4) under the Investment Company Act of 1940 
(15 U.S.C. 80a) (the ``Investment Company Act'' or the ``Act'').

Table of Contents

I. Executive Summary
II. Background
III. Proposed Amendments to Rule 15a-4
    A. Board Approval
    B. Adviser Mergers
    1. Terms and Conditions
    2. Placement of Advisory Fees in Escrow
    3. Costs of Shareholder Solicitation
    C. Length of Exemptive Period
    D. Availability of Exemption After Shareholder Vote
    E. General Request for Comment
IV. Cost-Benefit Analysis
V. Summary of Initial Regulatory Flexibility Analysis
VI. Statutory Authority
    Text of Proposed Rule

I. Executive Summary

    The Commission is proposing for public comment amendments to rule 
15a-4 under the Investment Company Act. Rule 15a-4 permits an 
investment adviser to an investment company (``fund'') to serve 
temporarily under a contract that has not been approved by the fund's 
shareholders. The proposed amendments would extend the rule to new 
advisory contracts entered into as a result of a merger or similar 
business combination involving the fund's adviser or a controlling 
person of the adviser, in connection with which the adviser or a 
controlling person of the adviser receives a benefit (collectively, 
``adviser mergers''). The amendments also would increase the maximum 
number of days the investment adviser could serve under the rule and 
clarify the timing of board approval of the fund's advisory contract. 
The proposed amendments would enable more investment advisers to rely 
on the rule rather than seek an individual exemption from the 
Commission, subject to conditions designed to protect the interests of 
investors pending the shareholder vote.

II. Background

    Section 15(a) of the Investment Company Act prohibits a person from 
serving as an investment adviser to a fund except under a written 
advisory contract that the fund's shareholders have approved. \1\ 
Section 15(a) also requires that an advisory contract must provide for 
its automatic termination upon its assignment.\2\ An advisory contract 
that continues in effect for more than two years must be approved 
annually by either the fund's board of directors or its shareholders. 
\3\
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    \1\ 15 U.S.C. 80a-15(a). Section 15(a) requires that a majority 
of the fund's outstanding voting securities approve the contract. 
Section 2(a)(42) of the Act (15 U.S.C. 80a-2(a)(42)) defines a vote 
of a majority of the outstanding voting securities of a fund to mean 
the vote of shareholders representing (a) 67 percent or more of the 
voting securities present at the meeting, if the holders of more 
than 50 percent of the fund's outstanding voting securities are 
present or represented by proxy, or (b) more than 50 percent of the 
outstanding voting securities of the fund, whichever is less.
    \2\ 15 U.S.C. 80a-15(a)(4). An ``assignment'' of an investment 
advisory contract includes a transfer of the contract to another 
investment adviser as well as a transfer of a controlling block of 
the investment adviser's voting securities. 15 U.S.C. 80a-2(a)(4).
    \3\ 15 U.S.C. 80a-15(a)(2).
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    Section 15(a) is designed to give shareholders a voice in a fund's 
investment advisory contract and to prevent trafficking in fund 
advisory contracts.\4\ One of section 15(a)'s unintended effects, 
however, is to leave a fund without an investment adviser if the fund's 
contract with the adviser is terminated before the fund's shareholders 
can vote on a new contract.\5\ A fund could face this

[[Page 40232]]

situation, for example, if a controlling shareholder of the fund's 
adviser suddenly dies and control of the adviser passes to an heir.\6\ 
To prevent funds from being harmed as a result of the loss of advisory 
services for a period of time, the Commission adopted in 1980 rule 15a-
4, which provides a temporary exemption from the requirement that a 
fund's shareholders approve its advisory contract.\7\ The rule permits 
a fund to be advised under a short-term contract while shareholder 
approval is obtained for a new advisory contract.
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    \4\ Hearings on S. 3580 Before the Subcomm. of the Senate Comm. 
on Banking and Currency, 76th Cong., 3d Sess. 253 (1940) (statement 
of David Schenker).
    \5\ If an investment advisory contract is terminated by a 
foreseeable assignment, an investment adviser may be required, under 
its fiduciary duty, to continue providing advisory services to the 
fund until the shareholders approve a new contract. See Exemptions 
for Certain Investment Advisers and Principal Underwriters of 
Investment Companies, Investment Company Act Release No. 10809 (Aug. 
6, 1979) (44 FR 47100, 47102 (Aug. 10, 1979)) (''1979 Proposing 
Release'').
    \6\ See, e.g., American-South African Investment Company 
Limited, Investment Company Act Release Nos. 6398 (Mar. 22, 1971) 
(36 FR 5819 (1971)) (notice) and 6456 (Apr. 14, 1971) (order) 
(investment adviser received exemption from section 15(a) for period 
between death of indirect owner of 50 percent of outstanding shares 
of investment adviser and annual meeting of shareholders).
    \7\ 17 CFR 270.15a-4. See also 1979 Proposing Release, supra 
note , at 47101.
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    Under rule 15a-4, a person may serve as an adviser to a fund for up 
to 120 days under a contract that the fund's shareholders have not 
approved (``interim contract'') \8\ when (i) the previous advisory 
contract has not been renewed, (ii) the fund's directors or 
shareholders terminate the advisory contract, or (iii) the contract is 
assigned (and therefore terminates) under circumstances in which the 
investment adviser, or a controlling person of the adviser, does not 
receive any money or other benefit. The rule requires the fund's board 
of directors, including a majority of the directors who are not 
interested persons of the fund (``independent directors''), to approve 
the interim contract, \9\ and limits the compensation under the interim 
contract to the amount the adviser could have received under the most 
recent advisory contract approved by shareholders (``previous 
contract'').\10\
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    \8\ The interim contract may terminate at the earlier of the 
expiration of the 120-day period or the date on which shareholders 
approve a new contract with the adviser. Alternatively, the fund may 
enter into a new contract with the adviser which, if approved by 
shareholders, continues past the 120-day period. In the latter case, 
the term ``interim contract'' refers to the contract during the time 
the exemption is in effect.
    \9\ Rule 15a-4(a) (17 CFR 270.15a-4(a)). Under section 15(c) of 
the Act, a fund's independent directors must approve the terms of an 
investment advisory contract before it can go into effect. 15 U.S.C. 
80a-15(c). A fund's directors have a duty to request, and the 
adviser has a duty to furnish, all information reasonably needed to 
evaluate the terms of the proposed advisory contract. Id. In 
reviewing the advisory contract, the independent directors' role is 
to represent the interests of shareholders by acting as 
``independent watchdogs'' and furnishing an independent check on the 
fund's management. See Burks v. Lasker, 441 U.S. 471, 484-85 (1979); 
see also Division of Investment Management, SEC, Protecting 
Investors: A Half Century of Investment Company Regulation 255-57 
(1992) (``Protecting Investors Report'').
    \10\ Rule 15a-4(b) (17 CFR 270.15a-4(b)).
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    Based on its experience with the rule since 1980, and in light of 
developments in the financial services industry, the Commission is 
proposing three amendments to rule 15a-4. These amendments would (i) 
clarify the timing of board approval of an interim contract, (ii) 
expand the rule to permit the fund to operate under an interim contract 
entered into as a result of an adviser merger, and (iii) lengthen the 
amount of time a fund can operate under an interim contract from 120 to 
150 days. As discussed in more detail below, the amendments would 
largely codify prior Commission exemptive orders, which effectively 
permitted advisers or their affiliates to consummate a merger before 
the fund's shareholders voted on a new advisory contract rather than 
delay the merger in order to obtain shareholder approval.

Proposed Amendments to Rule 15a-4

A. Board Approval

    Under section 15 of the Act and rule 15a-4, the board of directors 
of a fund must approve an interim contract at or before the time the 
fund enters into the interim contract. If an assignment results from an 
unforeseeable event, board approval of the interim contract before the 
assignment may be impracticable. In addition, with no prior notice of 
the assignment, members of the board may not be immediately available 
to meet to approve the interim advisory contract.<SUP>11</SUP>
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    \11\ Section 15(c) of the Act requires the board to vote ``in 
person'' to approve an investment advisory contract. 15 U.S.C. 80a-
15(c). Historically, the Commission has taken the view that the ``in 
person'' requirement must be satisfied by a meeting at which the 
directors are physically present. See Provisions of Investment 
Company Amendments Act of 1970 (Pub.L. 91-547) Concerning Approval 
of Investment Advisory Contracts and Other Matters Which Should Be 
Considered by Registrants in Connection With Their 1971 Annual 
Meetings, Investment Company Act Release No. 6336 (Feb. 2, 1971) (36 
FR 2867, 2867 & n.3 (Feb. 11, 1971)). Section 15(c) does not by its 
terms specify that the in person requirement means that board 
members must be physically present. Under the laws of some states, a 
similar requirement can be met by a meeting at which directors are 
present through the means of a conference call or audiovisual 
conference. See, e.g., Del. Code Ann. tit. 8, Sec. 141(i) (1991); 
Md. Code Ann., Corps. & Ass'ns Sec. 2-409(d) (1993). The 
Commission's historic view is based on the legislative history of 
section 15(c), which indicates that the provision meant directors 
were required to be ``personally present'' to vote at meetings. H.R. 
Rep. No. 1382, 91st Cong., 2d Sess. 25-26 (1970); S. Rep. No. 184, 
91st Cong., 1st Sess. 39 (1969).
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    The Commission has granted an exemption from the board approval 
requirement of section 15(c) when death of a controlling shareholder of 
a fund's investment adviser has resulted in an assignment of the fund's 
advisory contract.<SUP>12</SUP> The proposed amendments would provide 
similar exemptive relief in this type of situation by allowing the 
board seven calendar days to approve an interim contract in 
circumstances in which the current rule would permit an investment 
adviser to serve a fund temporarily under a contract without 
shareholder approval. The proposed amendments also would facilitate a 
special meeting to approve an interim contract, by permitting the 
fund's board of directors to participate by telephone or similar means 
of communication that allows all participants to hear each other at the 
same time.<SUP>13</SUP>
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    \12\ See, e.g., American-South African Investment Company 
Limited, supra note (permitting board approval one week after 
termination of advisory contract caused by death of controlling 
shareholder of the investment adviser).
    \13\ Proposed rule 15a-4(b)(1)(ii).
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    The Commission requests comment regarding this proposed amendment. 
The Commission's rules previously have not provided this grace period 
for board approval. Have boards been able to meet the requirements of 
section 15(c) without a grace period when an advisory contract is 
terminated as a result of an unforeseeable assignment? Does seven days 
give the board sufficient time to review the interim contract and vote? 
Should the rule provide a longer period for approval but not provide an 
exemption from the requirement to vote in person?

B. Adviser Mergers

    Since 1980, a growing number of mergers in the financial services 
industry <SUP>14</SUP> has led to a growing number of requests for 
exemptive relief from

[[Page 40233]]

section 15(a) of the Act.<SUP>15</SUP> Adviser merger transactions can 
result in the assignment (and thus the automatic termination) of 
advisory contracts, <SUP>16</SUP> but are not covered by rule 15a-4 
because the adviser will have received money or other benefits as a 
result of the transaction.<SUP>17</SUP>
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    \14\ See Financial Services Consolidation Hits Mutual Fund 
Industry in '97, USA Today, Dec. 18, 1997, at 14E (noting the many 
mergers in the mutual fund industry in 1997, and predicting that the 
trend would continue in 1998); Investment Counseling, Inc., Re-
Thinking Strategic Activity 1 (1997) (showing the increase in 
mergers and acquisitions in the money management industry in 1995 
and 1996 over 1992-1994); Tim Quinson, Banks Add More Investment 
Services With Focus On Fund Firms, The Dallas Morning News, Dec. 28, 
1997, at 9H (many large U.S. banks recently purchased managers of 
mutual funds); Barry P. Barbash, Mutual Fund Consolidation and 
Globalization: Challenges for the Future, Remarks to the Mutual Fund 
and Investment Management Conference 1-2 (Mar. 23, 1998) (during the 
past year, the Commission's Division of Investment Management 
received from funds and advisory firms an average of one merger-
related exemptive application each week) (available on the Internet 
at <http://www.sec.gov/news/speeches/spch208.htm>).
    \15\ Since rule 15a-4 was adopted in 1980, the Commission has 
issued over 50 orders temporarily exempting funds and their 
investment advisers from the shareholder approval requirement in 
connection with assignments resulting from a merger or acquisition 
involving the fund's investment adviser. Over half of these orders 
have been issued since the beginning of 1996.
    \16\ See supra note .
    \17\ When the Commission adopted rule 15a-4 in 1980, it decided 
not to extend the rule to cover adviser mergers because they were 
``foreseeable.'' See Exemptions for Certain Investment Advisers and 
Principal Underwriters of Investment Companies, Investment Company 
Act Release No. 11005 (Jan. 2, 1980) (45 FR 1860, 1861 n.2 (Jan. 9, 
1980)) (''1980 Adopting Release'').
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    In response to these requests for relief, the Commission has 
granted exemptions from section 15(a) in a variety of circumstances in 
which applicants stated it was necessary to conclude a transaction 
before a shareholder vote could be held, or when the meeting to hold a 
shareholder vote on the advisory contract could be combined with 
another previously scheduled shareholder meeting to occur after the 
adviser merger.<SUP>18</SUP> Applicants have represented that it is 
often impracticable to obtain shareholder approval of an advisory 
contract prior to an adviser merger without causing a substantial delay 
in closing the transaction. These delays can result in significant 
adverse effects, such as the loss of key personnel of the investment 
adviser, that could be detrimental to fund shareholders.<SUP>19</SUP>
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    \18\ See, e.g., Cash Reserve Management, Inc., Investment 
Company Act Release Nos. 16172 (Dec. 11, 1987) [52 FR 47985 (Dec. 
17, 1987)] (notice) and 16202 (Jan. 5, 1988) [39 SEC Docket 1602 
(Jan. 19, 1988)] (order) (acquisition of investment adviser through 
tender offer); Mutual Fund Group, Investment Company Act Release 
Nos. 21629 (Dec. 28, 1995) [61 FR 365 (Jan. 4, 1996)] (notice) and 
21696 (Jan. 23, 1996) [61 SEC Docket 555 (Feb. 20, 1996)] (order) 
(meetings to be held after the assignment to vote on fund mergers); 
see also Kenneth S. Gerstein, Acquisitions of Mutual Fund Advisors: 
Some Practical Issues Under the Investment Company Act, Investment 
Law., Apr. 1994, at 12, 13.
    \19\ See, e.g., General Securities, Inc., Investment Company Act 
Release Nos. 18884 (Aug. 7, 1992) [57 FR 37020 (Aug. 17, 1992)] 
(notice) and 18927 (Sept. 3, 1992) (52 SEC Docket 1776 (Sept. 22, 
1992)) (order) (delaying the closing of the merger could cause 
defections of investment adviser's registered representatives, 
possibly threatening adviser's viability and diminishing the 
services provided to the fund); Kidder, Peabody Investment Trust, 
Investment Company Act Release Nos. 20818 (Jan. 4, 1995) [60 FR 2803 
(Jan. 11, 1995)] (notice) and 20865 (Jan. 27, 1995) [58 SEC Docket 
2092 (Feb. 28, 1995)] (order) (delaying the closing of the 
transaction until shareholders could vote on new advisory contracts 
would result in substantial defections by portfolio managers, 
advisory employees, and supervisory personnel).
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    Rule 15a-4 is designed to deal with unforeseeable assignments of 
advisory contracts by permitting the board to act on an emergency basis 
to prevent the fund from being harmed by the absence of advisory 
services.<SUP>20</SUP> By contrast, adviser mergers are often 
foreseeable, will benefit the adviser, and typically occur as a result 
of a transaction in which the fund is not a participant and in which 
its interests are not represented.<SUP>21</SUP> In these cases, fund 
boards have more opportunity to protect the interests of the fund by, 
among other things, more closely evaluating the services it will 
receive under an interim contract (i.e., after the merger or 
acquisition of the fund's investment adviser or a controlling person of 
the investment adviser). Therefore, the Commission has granted 
exemptive relief from section 15(a) in connection with adviser mergers 
only upon certain additional conditions designed to protect the fund's 
interests until shareholders have had an opportunity to approve a new 
advisory contract. The Commission is proposing to codify the relief 
provided in these orders based on similar conditions, as described 
below.
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    \20\ See 1980 Adopting Release, supra note 17, at n.2; see also 
1979 Proposing Release, supra note , at 47102. The 1979 Proposing 
Release stated that the Commission intended the rule to cover 
assignments of advisory contracts that were not reasonably 
foreseeable, such as assignments resulting from the death of a 
controlling shareholder of the adviser. Id. at 47101-02. When an 
investment adviser assigns a contract under reasonably foreseeable 
circumstances, such as pursuant to a merger, ``the investor 
protection concerns expressed by Congress with respect to section 
15(a) are better fulfilled when investment company shareholders are 
provided the opportunity to approve any successor investment 
advisory contract prior to the successor adviser's serving the 
company.'' Id. at 47102. The 1979 Proposing Release also noted that 
the rule would not extend the period during which an investment 
company must comply with section 15(a) requirements regarding annual 
continuance of investment advisory contracts. Id. at n.8.
    \21\ See Stephanie A. Djinis, Acquisition of a Mutual Fund 
Adviser: The Role of Fund Directors, 29 Sec. & Commodities Reg. 135, 
135-36 (June 19, 1996) (adviser may inform fund's board about merger 
plans after negotiating the transaction, and the board is not in a 
position to reject the merger); Gerstein, supra note 18, at 12 
(neither a fund, nor its shareholders, are parties to the 
acquisition of the fund's adviser).
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1. Terms and Conditions
    In considering requests for exemptive relief in connection with 
adviser mergers, the Commission has required certain actions by the 
fund's board of directors and certain provisions in the interim 
contract, which are designed to preserve the quality of advisory and 
other services that the fund received before the merger until the 
shareholders vote on a new contract. The Commission is proposing to 
incorporate these conditions in rule 15a-4. In the case of an adviser 
merger, the proposed amendments would require that: (i) The interim 
contract generally contain the same terms and conditions as the 
previous contract; <SUP>22</SUP> (ii) the interim contract be approved 
by the fund's board of directors, including a majority of the 
independent directors, before the interim contract begins; 
<SUP>23</SUP> and (iii) the board, including a majority of independent 
directors, find that the scope and quality of the advisory services to 
be provided under the interim contract will be at least equivalent to 
the scope and quality of the services provided under the previous 
contract.<SUP>24</SUP> The Commission requests comment whether the rule 
should require the board to make specific findings regarding the 
interim contract. If so, should the rule require any additional 
findings by the fund's board regarding the interests of investors?
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    \22\ Proposed rule 15a-4(b)(2)(v). The requirement concerning 
the terms and conditions of the interim contract is designed to 
ensure that the contract does not vary from the previous contract 
with respect to important matters such as indemnification, the 
adviser's standard of care, and the allocation of expenses between 
the adviser and the fund. The interim contract would, however, have 
effective and termination dates that are different from the dates of 
the previous contract and could contain other differences that the 
fund's board of directors determines are immaterial.
    \23\ Proposed rule 15a-4(b)(2)(ii).
    \24\ Proposed rule 15a-4(b)(2)(iii). Thus, the interim contract 
could provide for lower advisory fees, but not a lower level of 
service. The Commission anticipates that the information needed to 
make this additional finding generally would be similar to the 
information the independent directors examine in fulfilling their 
responsibilities under section 15(c) and could include information 
on the services to be provided under the interim contract, such as 
the quality of the investment adviser's personnel (especially in 
light of any personnel changes) and the investment adviser's past 
performance and compliance records.
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    If the quality of the advisory services provided to the fund 
diminishes during the performance of the interim contract, the board 
may need to consider whether to terminate the contract and seek to 
employ another adviser. In order to allow the board to act quickly, the 
proposed rule would require that the interim contract permit the board 
to terminate the contract on no more than 10 calendar days' written 
notice to the adviser.<SUP>25</SUP>
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    \25\ Proposed rule 15a-4(b)(2)(iv).
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    The Commission requests comment whether the rule should specify 
actions the directors should take to monitor the adviser's performance 
during the exemptive period. Should the rule require the adviser to 
report to the directors regarding changes in personnel

[[Page 40234]]

or other matters? <SUP>26</SUP> The Commission also requests comment on 
the maximum 10-day notice the interim contract may require before 
termination of the interim contract. Is this type of provision 
necessary? If it is, should the rule provide a shorter or longer 
maximum notice period (e.g., 5 or 20 days)? Commenters who believe that 
a shorter or longer notice period is needed should explain why, and 
specify the number of days they believe would be appropriate.
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    \26\ Prior exemptive orders have required that the investment 
adviser report to the fund's board during the exemptive period any 
material changes in the adviser's personnel, in order to permit the 
directors to monitor the scope and quality of services provided to 
the fund. See, e.g., Nations Fund Portfolios, Inc., Investment 
Company Act Release Nos. 21801 (Mar. 4, 1996) [61 FR 9511 (Mar. 8, 
1996)] (notice) and 21854 (Mar. 25, 1996) (61 SEC Docket 1821 (Apr. 
23, 1996)) (order).
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2. Placement of Advisory Fees in Escrow
    Orders for exemptive relief from section 15(a) have been 
conditioned on placing advisory fees earned during the interim period 
in an escrow account payable to the adviser only when and if the fund's 
shareholders approve a new contract with the adviser. The escrow 
requirement was designed to allow shareholders, in effect, to 
subsequently ratify the investment adviser's compensation under the 
interim contract.
    The proposed amendments would include a modified escrow 
requirement. The provision would require that advisory fees earned 
under the interim contract be held in an interest-bearing escrow 
account with a bank or the fund's custodian.<SUP>27</SUP> If the 
shareholders approve the new advisory contract, the escrowed fees would 
be paid to the investment adviser in accordance with the interim 
contract.<SUP>28</SUP> If the shareholders do not approve the new 
contract, however, the adviser would be compensated out of the escrowed 
fees for the actual costs of performing the interim contract, so long 
as the costs do not exceed the total compensation the adviser would 
have received under the interim contract.<SUP>29</SUP> Any remaining 
escrowed fees would be returned to the fund.
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    \27\ Proposed rule 15a-4(b)(2)(vi)(A).
    \28\ Proposed rule 15a-4(b)(2)(vi)(B).
    \29\ Proposed rule 15a-4(b)(2)(vi)(C). This procedure is similar 
to that permitted by rule 18f-2(c)(2) (17 CFR 270.18f-2(c)(2)), 
which allows an investment adviser to continue to advise a series 
fund without approval from the series shareholders pending approval 
of a new contract as long as the adviser's compensation is limited 
to the lesser of actual costs or the amount it would have received 
under the advisory contract.
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    Most of the prior exemptive orders required all the escrowed fees 
to be returned to the fund if shareholders did not approve a new 
contract with the investment adviser. The proposed change from the 
condition in prior exemptive orders is intended to allow shareholders 
to withhold an adviser's profits if the shareholders do not approve a 
new contract with that adviser, while providing for compensation for 
services rendered by the adviser.<SUP>30</SUP>
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    \30\ Placing the fees in escrow until the shareholders vote on 
the new contract also may encourage the investment adviser to obtain 
the shareholder vote as soon as possible.
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    The Commission requests comment on the proposed escrow requirement. 
Do the escrow arrangements encourage investment advisers to obtain 
shareholder approval prior to the adviser merger? Does this approach 
create economic burdens for investment advisers, especially smaller or 
less capitalized advisers?
3. Costs of Shareholder Solicitation
    In most investment adviser business combinations, the advisers bear 
the expenses of the transaction.<SUP>31</SUP> Applicants have stated in 
requests for exemptive relief that funds would not pay any of the costs 
of soliciting shareholder approval of the new advisory contract after 
an adviser merger, and the orders have included this representation as 
a condition for relief.<SUP>32</SUP> The Commission is not proposing to 
include this condition in the rule because it does not appear to be 
relevant to the question of whether relief should be granted from the 
shareholder approval requirement of section 15(a). If an advisory 
contract is terminated as a result of an adviser's action (such as an 
adviser merger) that benefits the adviser, however, issues may arise 
under other sections of the Investment Company Act if the fund pays the 
costs of soliciting shareholder approval of a new 
contract.<SUP>33</SUP> The Commission requests comment whether, in 
light of these issues, rule 15a-4 should require that the parties to an 
adviser merger, rather than the fund, pay the costs associated with the 
transaction.
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    \31\ See 1 Thomas P. Lemke et al., Regulation of Investment 
Companies Sec. 24.02[1][c] (1997).
    \32\ See, e.g., Merrill Lynch & Co., Inc., Investment Company 
Act Release Nos. 22947 (Dec. 19, 1997) (62 FR 67420 (Dec. 24, 1997)) 
(notice) and 22997 (Jan. 12, 1998) (66 SEC Docket 981 (Feb. 10, 
1998)) (order); USLIFE Income Fund, Inc., Investment Company Act 
Release Nos. 22664 (May 16, 1997) (62 FR 28079 (May 22, 1997)) 
(notice) and 22701 (June 11, 1997) (64 SEC Docket 2011 (July 8, 
1997)) (order).
    \33\ See 1979 Proposing Release, supra note 5, at n.13 (if a 
fund were to bear any of the costs caused by an adviser merger, 
including costs associated with conducting a special shareholders' 
meeting, payment of those costs might constitute compensation to the 
investment adviser and might raise questions regarding the 
availability of section 15(f) (15 U.S.C. 80a-15(f)) (creating safe 
harbor under which investment advisers may receive a benefit in 
connection with a sale of securities of, or a sale of any other 
interest in, an investment adviser that results in an assignment of 
an investment advisory contract, if certain conditions are met), 
section 15(a)(1) (15 U.S.C. 80a-15(a)(1)) (advisory contract must 
precisely describe all compensation to be paid under the contract) 
and section 36(b) (15 U.S.C. 80a-35(b)) (investment adviser's 
fiduciary duty with respect to the receipt of compensation for 
services, or of payments of a material nature, paid by the fund or 
its shareholders)). But see Travelers Group Inc., et al., Investment 
Company Act Release Nos. 22873 (Nov. 3, 1997) (62 FR 60540 (Nov. 10, 
1997)) (notice) and 22911 (Nov. 26, 1997) (65 SEC Docket 2962 (Dec. 
23, 1997)) (order) (adviser to pay costs of soliciting shareholder 
approval of new advisory contract, except that if solicitation is in 
conjunction with fund's annual meeting at which other matters are to 
be discussed, fund may pay portion of costs).
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    The Commission also requests comment generally on the proposed 
amendment to rule 15a-4 to exempt advisory contracts temporarily from 
the shareholder approval requirement in the context of adviser mergers. 
Do the proposed conditions adequately protect fund shareholders against 
overreaching by the investment adviser?

C. Length of Exemptive Period

    Rule 15a-4 currently exempts an investment adviser from the 
shareholder approval requirement for 120 days. This time period was 
adopted to provide a fund adequate time to solicit proxies and obtain a 
quorum of voting shareholders.<SUP>34</SUP> Today, however, the 120-day 
period in many cases may be insufficient time for obtaining shareholder 
approval of the new advisory contract.<SUP>35</SUP> Funds have found it 
difficult to obtain a quorum of shareholders necessary to vote on an 
advisory contract.<SUP>36</SUP> In addition, funds that hold annual 
shareholders' meetings often must call a special meeting to approve the 
advisory contract within

[[Page 40235]]

the 120-day period, which results in additional costs for the fund.
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    \34\ See 1980 Adopting Release, supra note 17.
    \35\ The Commission has issued several orders temporarily 
exempting fund advisers from the shareholder approval requirement of 
section 15(a) when the fund was unable to obtain a quorum within the 
time period allowed by rule 15a-4, or when the fund wished to 
postpone the shareholder vote until its next annual or special 
meeting. See, e.g., The Emerging Germany Fund Inc., Investment 
Company Act Release Nos. 18323 (Sept. 18, 1991) (56 FR 48265 (Sept. 
24, 1991)) (notice) and 18492 (Oct. 16, 1991) (50 SEC Docket 1432 
(Feb. 4, 1992)) (order). The Commission staff also has taken the 
position in a number of no-action letters that an adviser may 
temporarily (pending shareholder approval of the advisory contract) 
provide services to the fund at the lower of the cost to the adviser 
of providing the services or the compensation the adviser would have 
received under the previous contract. See, e.g., NPG Growth Fund, 
Inc., SEC No-Action Letter (July 6, 1975).
    \36\ See Protecting Investors Report, supra note 9, at 272 n.82; 
Lori Pizzani, Avoiding Proxy Voting Bumps, Mutual Fund Market News, 
Apr. 28, 1997, at 1.
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    The Commission proposes to increase the period permitted by the 
rule to 150 days, to allow funds more time to seek shareholder approval 
of the new advisory contract.<SUP>37</SUP> Commenters who believe that 
a longer period is needed should explain why, and specify the number of 
days they believe would be appropriate. Should the rule allow funds 
that hold annual shareholder meetings to postpone the shareholder vote 
on the advisory contract until the next annual meeting?<SUP>38</SUP>
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    \37\ Proposed rule 15a-4(a)(2).
    \38\ A provision related to annual shareholder meetings would, 
as a practical matter, principally affect closed-end funds. The Act 
does not require that shareholders annually elect directors. 
Investment Company Act section 16(a) (15 U.S.C. 80a-16(a)); John 
Nuveen & Co. Inc., SEC No-Action Letter (Nov. 18, 1986). Most open-
end funds are organized in states that do not require annual 
shareholders' meetings. See, e.g., Del. Code Ann. tit. 12, 
Sec. 3806(b)(5) (1995); Md. Code Ann., Corps. & Ass'ns Sec. 2-501(b) 
(1993). See generally Protecting Investors Report, supra note 9, at 
275. Most closed-end funds, however, list their shares on stock 
exchanges and are required to hold annual meetings under stock 
exchange rules. See, e.g., New York Stock Exchange Listed Company 
Manual para. 302.00 (1995).
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D. Availability of Exemption After Shareholder Vote

    The Commission's proposal to extend the exemptive period is 
intended to provide sufficient time to obtain shareholder approval of a 
new advisory contract. Consistent with current rule 15a-4, if the 
shareholders do not approve the new contract before the exemptive 
period expires, the rule would not be available for an additional 
period of time. Thus, for example, if a contract terminates and 
shareholders subsequently vote to terminate the interim contract, the 
adviser will not be able to serve the fund under another interim 
contract under rule 15a-4.<SUP>39</SUP>
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    \39\ See 1979 Proposing Release, supra note 5, at n.12.
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E. General Request for Comment

    The Commission requests comment on the proposed rule amendments 
that are the subject of this release, suggestions for additional 
provisions or changes to the rule, and comments on other matters that 
might have an effect on the proposals contained in this release. The 
Commission requests comment whether the proposals, if adopted, would 
promote efficiency, competition, and capital formation. Comments will 
be considered by the Commission in satisfying its responsibilities 
under section 2(c) of the Investment Company Act.<SUP>40</SUP> The 
Commission encourages commenters to provide data to support their 
views.
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    \40\ Section 2(c) requires the Commission, when it engages in 
rulemaking and is required to consider whether an action is 
consistent with the public interest, to consider, in addition to the 
protection of investors, whether the action will promote efficiency, 
competition, and capital formation. 15 U.S.C. 80a-2(c).
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IV. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. The proposed amendments are likely to result in cost savings 
for investment advisers <SUP>41</SUP> by removing the need to seek 
exemptive relief in the case of adviser mergers. Based on orders issued 
in 1997, the Commission estimates that the total annual cost savings 
for investment advisers resulting from the proposed amendments would be 
approximately $260,000, and possibly more. In 1997, the Commission 
issued 13 orders granting exemptive relief in connection with adviser 
mergers at an estimated cost to the applicants of $20,000 for each 
application. The Commission expects that cost savings could be greater 
in the future because the steady increase in orders issued in 
connection with adviser mergers over the past three years appears 
likely to continue in 1998.<SUP>42</SUP> The requirements of the rule 
with respect to director findings should not be burdensome in view of 
the fact that section 15(c) already requires the fund's independent 
directors to review and approve the new advisory contract. In addition, 
cost savings could be realized by funds and advisers not governed by 
paragraph (b)(2) of the rule in that directors may participate in the 
meeting to approve the advisory contract ``by any means of 
communication that allows all directors participating to hear each 
other simultaneously during the meeting.'' This provision could result 
in savings in time and travel costs.
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    \41\ One of the standard conditions to the adviser merger orders 
is that the costs of the exemptive application will be paid by the 
adviser or advisers.
    \42\ The Commission issued 6, 11, and 13 orders granting 
exemptive relief in connection with adviser mergers in 1995, 1996, 
and 1997, respectively. The Commission already has received five 
applications in the first quarter of 1998.
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    Unlike most prior exemptive orders, the proposed amendments would 
not prohibit funds from paying costs associated with soliciting 
shareholder approval of a new advisory contract after an adviser 
merger. Thus, the proposed amendments could result in increased costs 
if funds bear those expenses in the future. In most investment adviser 
business combinations, however, the advisers bear the costs of the 
transaction.<SUP>43</SUP> In addition, applicants have represented that 
advisers will bear the costs of soliciting shareholder approval of a 
new advisory contract after an adviser merger. While the Commission 
cannot predict what will happen if the proposed amendments are adopted, 
we believe that advisers are likely to continue to pay these costs and, 
therefore, the proposed amendments are not likely to result in 
increased shareholder solicitation costs for funds.
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    \43\ See 1 Lemke, supra note 31, at Sec. 24.02(1)(c).
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    The Commission requests comment on the potential costs and benefits 
of the rule and of the proposed amendments or any suggested 
alternatives to the proposed amendments. Data is requested concerning 
these costs and benefits.
    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,<SUP>44</SUP> the Commission also requests information 
regarding the potential impact of the proposed rule on the economy on 
an annual basis. Commenters are requested again to provide data to 
support their views.
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    \44\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996).
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V. Summary of Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (``IRFA'') in accordance with 5 U.S.C. 603 regarding the 
proposed amendments to rule 15a-4. The following summarizes the IRFA.
    Existing rule 15a-4 provides a temporary exemption in certain 
circumstances from the requirement that shareholders approve an 
investment advisory contract. The rule does not, however, cover interim 
contracts entered into as a result of adviser mergers. Due to the 
growing number of acquisitions and mergers in the financial services 
industry, the Commission has received a growing number of applications 
for exemption from the shareholder approval requirement in connection 
with adviser mergers. In addition, funds have advised the Commission 
that the 120-day exemptive period in rule 15a-4 is too short to obtain 
shareholder approval of an advisory contract.
    The proposed amendments would extend rule 15a-4 to adviser mergers, 
extend the length of the exemptive period to 150 days, and clarify the 
timing of board approval of the fund's advisory contract. The proposed 
amendments would significantly reduce the need to file exemptive 
applications, resulting in cost and time savings for funds and 
investment advisers.
    The Commission is proposing to amend rule 15a-4 pursuant to the 
authority set forth in sections 6(c) and

[[Page 40236]]

38(a) of the Act. Rule 15a-4 applies to funds (including business 
development companies (``BDCs'')) and their investment advisers. 
<SUP>45</SUP> The rule does not affect funds that do not have an 
external investment adviser <SUP>46</SUP> (i.e., unit investment trusts 
or other funds that are internally managed).
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    \45\ Section 59 of the Act (15 U.S.C. 80a-58) provides, among 
other things, that sections 15(a) and 15(c) of the Act apply to a 
BDC to the same extent as if it were a registered closed-end 
investment company.
    \46\ The vast majority of open-end and closed-end funds are 
externally managed. All face-amount certificate companies currently 
in existence are externally managed. The Commission does not keep 
statistics on how many BDCs are externally managed.
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    An investment adviser is a small entity if it (1) manages less than 
$25 million in assets, (2) has total assets of less than $5 million on 
the last day of its most recent fiscal year, and (3) does not control, 
is not controlled by, and is not under common control with another 
investment adviser that manages $25 million or more in assets, or any 
person (other than a natural person) that had total assets of $5 
million or more on the last day of the most recent fiscal year. 
<SUP>47</SUP> The Commission estimates that there are approximately 820 
investment advisers that advise funds, approximately 180 of which are 
small entities. A fund is a small entity if it, together with other 
funds in the same group of related funds, has net assets of $50 million 
or less as of the end of its most recent fiscal year. <SUP>48</SUP> 
There are approximately 2,600 active open-end funds, approximately 210 
of which are small entities. There are approximately 545 active closed-
end funds, approximately 42 of which are small entities. There are 
approximately 63 BDCs, approximately 33 of which are small entities.
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    \47\ Definitions of ``Small Business'' or ``Small Organization'' 
Under the Investment Company Act of 1940, the Investment Advisers 
Act of 1940, the Securities Exchange Act of 1934, and the Securities 
Act of 1933, Securities Act Release No. 7548 (June 24, 1998) (63 FR 
35508 (June 30, 1998)) (``Small Entity Release'').
    \48\ Id.
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    The Commission believes that the proposed amendments would decrease 
the burdens on small funds and small investment advisers by making it 
unnecessary for them to seek an exemptive order from the Commission in 
order to delay the shareholder vote required by section 15(a). The 
requirements of the rule, as explained above in section III, are 
designed to protect the interests of investment companies, including 
small funds and their shareholders, and therefore an exemption from any 
of those requirements for small entities would not be consistent with 
the protection of investors. The Commission believes that the burden 
these requirements place on small advisers is minimal because the 
requirements generally are intended to maintain the status quo until 
the shareholder vote can be held.
    The Commission is proposing escrow arrangements under the proposed 
rule amendments that differ from the escrow arrangements required under 
most exemptive orders issued to date to funds seeking relief similar to 
that provided by the proposed amendments. The proposed amendments would 
require the advisory fee to be paid under the interim contract to be 
placed in escrow, but would allow an investment adviser to recover its 
costs of performing the interim contract if a fund's shareholders do 
not approve a new advisory contract. Most of the prior exemptive orders 
required that all the escrowed fees be returned to the fund if 
shareholders did not approve a new contract with the investment 
adviser. The proposed changes from conditions imposed under prior 
exemptive orders are designed to allow shareholders to withhold profits 
under an interim contract when the shareholders reject a new contract 
with that adviser, while providing for compensation for services 
provided by the adviser. This provision may be of particular benefit to 
small advisers.
    The Commission has not identified any overlapping or conflicting 
federal rules. The Commission has considered alternatives to the 
proposed rule amendment that would accomplish the objective of the rule 
and minimize the impact on small entities. These alternatives include: 
(i) Establishing different compliance requirements that take into 
account the resources available to small entities; (ii) clarifying, 
consolidating, or simplifying compliance requirements under the rule 
for small entities; (iii) using performance rather than design 
standards; and (iv) exempting small entities from coverage of the rule, 
or any part of the rule.
    The Commission believes that further clarification, consolidation, 
or simplification of the compliance requirements is not necessary. 
Standards contained in the proposed amendment are performance, rather 
than design, standards. <SUP>49</SUP> An exemption from coverage of the 
rule for small advisers or small funds would prevent those entities 
from benefiting from rule 15a-4 and would not be consistent with the 
protection of investors.
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    \49\ Proposed rule 15a-4(b)(2)(iii), (v).
---------------------------------------------------------------------------

    The Commission encourages the submission of comments on matters 
discussed in the IRFA. Comment specifically is requested on the number 
of small entities that would be affected by the proposed rule 
amendments. Comment also is requested on the effect of the rule 
amendments on investment advisers and funds that are small entities. 
Commenters are asked to describe the nature of any effect and provide 
empirical data supporting the extent of the effect. These comments will 
be placed in the same public file as comments on the proposed rule 
amendments.
    A copy of the IRFA may be obtained by contacting Marilyn Mann, Mail 
Stop 5-6, Securities and Exchange Commission, 450 5th Street, N.W., 
Washington, D.C. 20549.

VI. Statutory Authority

    The Commission is proposing to amend rule 15a-4 pursuant to the 
authority set forth in sections 6(c) and 38(a) (15 U.S.C. 80a-6(c) and 
80a-37(a)) of the Investment Company Act.

List of Subjects in 17 CFR Part 270

    Investment companies, Securities.

Text of Proposed Rule

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is proposed to be 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 270.15a-4 is revised to read as follows:


Sec. 270.15a-4  Temporary exemption for certain investment advisers.

    (a) Definitions. For purposes of this section:
    (1) Fund means an investment company;
    (2) Interim contract means a written contract for a period no 
greater than 150 days that has not been approved by a majority of the 
fund's outstanding voting securities; and
    (3) Previous contract means an investment advisory contract that 
has been approved by a majority of the fund's outstanding voting 
securities and has been terminated.
    (b) Notwithstanding section 15(a) of the Act (15 U.S.C. 80a-15(a)), 
a person may act as investment adviser for a fund under an interim 
contract after the termination of a previous contract as

[[Page 40237]]

provided in paragraphs (b)(1) and (b)(2) of this section:
    (1) In the case of a previous contract terminated by an event 
described in section 15(a)(3) of the Act (15 U.S.C. 80a-15(a)(3)), by 
the failure to renew the previous contract, or by an assignment (other 
than an assignment by an investment adviser or a controlling person of 
the investment adviser in connection with which assignment the 
investment adviser or a controlling person directly or indirectly 
receives money or other benefit):
    (i) The compensation to be received under the interim contract is 
no greater than the compensation the adviser would have received under 
the previous contract; and
    (ii) The fund's board of directors, including a majority of the 
directors who are not interested persons of the fund, has approved the 
interim contract within seven calendar days after the termination, at a 
meeting in which directors may participate by any means of 
communication that allows all directors participating to hear each 
other simultaneously during the meeting.
    (2) In the case of a previous contract terminated by an assignment 
by an investment adviser or a controlling person of the investment 
adviser in connection with which assignment the investment adviser or a 
controlling person directly or indirectly receives money or other 
benefit:
    (i) The compensation to be received under the interim contract is 
no greater than the compensation the adviser would have received under 
the previous contract;
    (ii) The board of directors, including a majority of the directors 
who are not interested persons of the fund, has voted in person to 
approve the interim contract before the previous contract is 
terminated;
    (iii) The board of directors, including a majority of the directors 
who are not interested persons of the fund, determines that the scope 
and quality of services to be provided to the fund under the interim 
contract will be at least equivalent to the scope and quality of 
services provided under the previous contract;
    (iv) The interim contract provides that the fund's board of 
directors or a majority of the fund's outstanding voting securities may 
terminate the contract at any time, without the payment of any penalty, 
on not more than 10 calendar days' written notice to the investment 
adviser;
    (v) The interim contract contains the same terms and conditions as 
the previous contract, with the exception of its effective and 
termination dates, provisions governed by paragraphs (b)(2)(i), 
(b)(2)(iv), and (b)(2)(vi) of this section, and any other differences 
in terms and conditions that the board of directors, including a 
majority of the directors who are not interested persons of the fund, 
finds to be immaterial; and
    (vi) The interim contract contains the following provisions:
    (A) The compensation earned under the contract will be held in an 
interest-bearing escrow account with the fund's custodian or a bank.
    (B) If a majority of the fund's outstanding voting securities 
approve a contract with the investment adviser by the end of the 150-
day period, the amount in the escrow account (including interest 
earned) will be paid to the investment adviser.
    (C) If a majority of the fund's outstanding voting securities do 
not approve a contract with the investment adviser, the investment 
adviser will be paid, out of the escrow account, the lesser of:
    (1) Any costs incurred in performing the interim contract (plus 
interest earned on that amount while in escrow); or
    (2) The total amount in the escrow account (plus interest earned).

    Dated: July 22, 1998.
    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-20088 Filed 7-27-98; 8:45 am]
BILLING CODE 8010-01-U


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