Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules 40231

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).

4Hearings 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

Continued

§ 303.14 [Amended]

2. Section 303.14(a)(1)(i) is amended

by removing ‘‘$35,000’’ and adding

‘‘$38,650’’ in its place.

3. Section 303.14(b)(3) is amended by

removing ‘‘$200’’ and adding ‘‘$500’’ in

its place.

4. Section 303.14(d) is revised to read

as follows:

§ 303.14 Allocation factors and

miscellaneous provisions.

* * * * *

(d) New entrant invitations.

Applications from new firms are invited

for any unused portion of any territorial

share.

* * * * *

5. Section 303.14(e) is amended by

removing ‘‘2,640,000’’ and adding

‘‘2,240,000’’ in its place.

Robert S. LaRussa,

Assistant Secretary for Import

Administration.

Allen Stayman,

Director, Office of Insular Affairs.

[FR Doc. 98–20162 Filed 7–27–98; 8:45 am]

BILLING CODE 3510–DS–P 4310–93–P

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.

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: rule-comments@sec.gov.

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

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
40232 Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules

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’’).

6See, 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.

8The 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.

9Rule 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’’).

10Rule 15a–4(b) (17 CFR 270.15a–4(b)).

11Section 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, § 141(i)

(1991); Md. Code Ann., Corps. & Ass’ns § 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).

12See, 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).

13Proposed rule 15a–4(b)(1)(ii).

14See 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>).

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.

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

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.11

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.12 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.13

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 14 has led to a growing number

of requests for exemptive relief from
Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules 40233

15Since 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.

16See supra note .

17When 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’’).

18See, 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.

19See, 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).

20See 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.

21See 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).

22Proposed 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.

23Proposed rule 15a–4(b)(2)(ii).

24Proposed 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.

25Proposed rule 15a–4(b)(2)(iv).

section 15(a) of the Act.15 Adviser

merger transactions can result in the

assignment (and thus the automatic

termination) of advisory contracts, 16 but

are not covered by rule 15a–4 because

the adviser will have received money or

other benefits as a result of the

transaction.17

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.18 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.19

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.20 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.21 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.

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; 22 (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; 23 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.24 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?

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.25

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
40234 Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules

26Prior 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).

27Proposed rule 15a–4(b)(2)(vi)(A).

28Proposed rule 15a–4(b)(2)(vi)(B).

29Proposed 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.

30Placing 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.

31See 1 Thomas P. Lemke et al., Regulation of

Investment Companies § 24.02[1][c] (1997).

32See, 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).

33See 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).

34See 1980 Adopting Release, supra note 17.

35The 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 NoAction Letter (July 6, 1975).

36See 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.

or other matters? 26 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.

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.27 If the shareholders

approve the new advisory contract, the

escrowed fees would be paid to the

investment adviser in accordance with

the interim contract.28 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.29 Any remaining

escrowed fees would be returned to the

fund.

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.30

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.31

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.32 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.33 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.

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.34 Today, however, the

120-day period in many cases may be

insufficient time for obtaining

shareholder approval of the new

advisory contract.35 Funds have found it

difficult to obtain a quorum of

shareholders necessary to vote on an

advisory contract.36 In addition, funds

that hold annual shareholders’ meetings

often must call a special meeting to

approve the advisory contract within
Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules 40235

37Proposed rule 15a–4(a)(2).

38A 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, § 3806(b)(5) (1995); Md. Code Ann., Corps. &

Ass’ns § 2–501(b) (1993). See generally Protecting

Investors Report, supra note 9, at 275. Most closedend 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 ¶ 302.00

(1995).

39See 1979 Proposing Release, supra note 5, at

n.12.

40Section 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).

41One 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.

42The 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.

43See 1 Lemke, supra note 31, at § 24.02(1)(c). 44Pub. L. 104–121, Title II, 110 Stat. 857 (1996).

the 120-day period, which results in

additional costs for the fund.

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.37 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?38

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–4.39

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.40 The

Commission encourages commenters to

provide data to support their views.

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 41 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

1998.42 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.

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.43 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.

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

1996,44 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.

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
40236 Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules

45Section 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.

46The 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.

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. 49Proposed rule 15a–4(b)(2)(iii), (v).

38(a) of the Act. Rule 15a–4 applies to

funds (including business development

companies (‘‘BDCs’’)) and their

investment advisers. 45 The rule does

not affect funds that do not have an

external investment adviser 46 (i.e., unit

investment trusts or other funds that are

internally managed).

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. 47

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. 48 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.

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. 49 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.

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:

§ 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
Federal Register / Vol. 63, No. 144 /Tuesday, July 28, 1998 / Proposed Rules 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 interestbearing 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

DEPARTMENT OF THE INTERIOR

Office of Surface Mining Reclamation

and Enforcement

30 CFR Part 938

[PA–121–FOR]

Pennsylvania Abandoned Mine Land

Reclamation Program

AGENCY: Office of Surface Mining

Reclamation and Enforcement (OSM),

Interior.

ACTION: Proposed rule; reopening of

comment period.

SUMMARY: OSM is reopening the public

comment period on a proposed

amendment to the Pennsylvania

Abandoned Mine Land Reclamation

(AMLR) Plan (hereinafter referred to as

the Pennsylvania Program) under the

Surface Mining Control and

Reclamation Act of 1977 (SMCRA), 30

U.S.C. 1201 et seq., as amended. The

proposed amendment adds a new

section ‘‘F’’ entitled Government

Financed Construction Contracts

(GFCC) to authorize the incidental

removal of coal at AML sites that would

not otherwise be mined and reclaimed

under the Title V program. The

proposed amendment also includes the

Program Requirements and Monitoring

Requirements related to the use of GFCC

for that purpose. The proposed

amendment is intended to improve the

efficiency of the Pennsylvania program

by allowing the Government-financed

construction exemption in Section 528

of SMCRA to be applied in cases

involving less than 50% government

financing only in the limited situation

where the construction constitutes a

government approved and administered

abandoned mine land reclamation

project under Title IV of SMCRA.

DATES: Written comments must be

received by 4:00 p.m., [E.D.T.] August

12, 1998.

ADDRESSES: Written comments should

be mailed or hand delivered to Robert

Biggi, Field Office Director, at the

address listed below. Copies of the

Pennsylvania program, the proposed

amendment, and all written comments

received in response to this document

will be available for public review at the

addresses listed below during normal

business hours, Monday through Friday,

excluding holidays. Each requester may

receive one free copy of the proposed

amendment by contacting OSM’s

Harrisburg Field Office: Mr. Robert J.

Biggi, Director, Harrisburg Field Office,

Third Floor, Suite 3C, Harrisburg

Transportation Center (Amtrack), 415

Market Street, Harrisburg, Pennsylvania

17101. Telephone: (717) 782–4036.

FOR FURTHER INFORMATION CONTACT:

Mr. Robert J. Biggi, Director, Harrisburg

Field Office, Third Floor, Suite 3C,

Harrisburg Transportation Center

(Amtrack) 415 Market Street,

Harrisburg, Pennsylvania 17101.

Telephone: (717) 782–4036.

SUPPLEMENTARY INFORMATION:

I. Background on the Pennsylvania

Program

On July 30, 1982, the Secretary of the

Interior conditionally approved the

Pennsylvania program. Background on

the Pennsylvania program, including

the Secretary’s findings and the

disposition of comments, can be found

in the July 30, 1982 Federal Register (47

FR 33079). Subsequent actions

concerning the AMLR program

amendments are identified at 30 CFR

938.20 and 938.25.