EBSA (Formerly PWBA) Federal Register Notice
Morgan Guaranty Trust Company of New York, et al. [02/08/2000]
[PDF Version]
Volume 65, Number 26, Page 6229-6240
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DEPARTMENT OF LABOR
Pension and Welfare Benefits Administration
[Application Nos. D-10119 and D-10120, et al.]
Morgan Guaranty Trust Company of New York, et al.
AGENCY: Pension and Welfare Benefits Administration, Department of
Labor.
ACTION: Notice of proposed exemptions.\1\
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\1\ The term ``Proposed Exemptions'' refers to the following
individual exemption applications: Application Nos. D-10119 and D-
10120, Morgan Guaranty Trust Company of New York and J.P. Morgan
Investment Management Inc.; Application No. D-10587, Goldman, Sachs
& Co.; Application No. D-10779, The Chase Manhattan Bank;
Application No. D-10820, Citigroup Inc; and Application No. D-10832,
Morgan Stanley Dean Witter & Co.
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SUMMARY: This document contains notices of pendency before the
Department of Labor (the Department) of proposed exemptions from the
prohibited transaction restrictions of the Employee Retirement Income
Security Act of 1974 (the Act) and from the taxes imposed by the
Internal Revenue Code of 1986 (the Code).
The exemptions, if granted, would permit purchases of securities by
the applicants' asset management affiliate on behalf of employee
benefit plans for which such asset management affiliate is a fiduciary,
from underwriting or selling syndicates where the applicants' broker-
dealer affiliate participates as a manager or syndicate member. The
exemptions, if granted, would affect participants and beneficiaries of
the plans investing in such securities.
EFFECTIVE DATE: The exemptions, if granted, would be effective as of
the date of publication of this notice in the Federal Register.
DATES: Written comments and/or requests for a public hearing must be
received by the Department by March 24, 2000.
ADDRESSES: All written comments and/or requests for a public hearing
(preferably, three copies) should be sent to the Office of Exemption
Determinations, Pension and Welfare Benefits Administration, Room N-
5649, U.S. Department of Labor, 200 Constitution Avenue, N.W.,
Washington, D.C. 20210, Attention: Application Nos. D-10119 and D-
10120, et al. The applications pertaining to the proposed exemptions
and the comments received will be available for public inspection in
the Public Documents Room of the Pension and Welfare Benefits
Administration, U.S. Department of Labor, Room N-5638, 200 Constitution
Avenue, N.W., Washington, D.C. 20210.
FOR FURTHER INFORMATION CONTACT: Andrea W. Selvaggio, Janet L.
Schmidt, or Karin Weng of the Department, telephone (202) 219-8194.
(This is not a toll-free number.)
SUPPLEMENTARY INFORMATION: Notice is hereby given of the pendency
before the Department of five applications for exemption from the
restrictions of section 406 of the Act and the sanctions resulting from
the application of section 4975 of the Code, by reason of section
4975(c)(1) of the Code. The exemptions were requested in separate
applications filed pursuant to section 408(a) of the Act and section
4975(c)(2) of the Code, and in accordance with the procedures set forth
in 29 CFR Part 2570, Subpart B (55 FR 32836, August 10, 1990), by the
following entities: Morgan Guaranty Trust Company of New York and J.P.
Morgan Investment Management Inc., Goldman, Sachs & Co., The Chase
Manhattan Bank, Citigroup Inc., and Morgan Stanley Dean Witter & Co.
Effective December 31, 1978, section 102 of Reorganization Plan No. 4
of 1978, 5 U.S.C. App. 1 (1996), generally transferred the authority of
the Secretary of the Treasury to issue exemptions of the type requested
to the Secretary of Labor. Accordingly, this notice of pendency is
being issued solely by the Department.\2\
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\2\ All references in the remainder of the preamble to specific
provisions of Title I of the Act shall refer also to the
corresponding provisions of the Code (if any).
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Summary of Facts and Representations
The facts and representations contained in the applications are
summarized below. Interested persons are referred to the applications
on file with the Department for the complete representations of the
applicants.
The Applicants
The five applicants, diversified financial services firms, have
requested similar exemptive relief. It is represented that the
applicants and their various affiliates are all regulated by other
federal government agencies such as the Securities and Exchange
Commission (the SEC), as well as state government agencies, and
securities regulatory organizations. For convenience, following the
initial description of each of the applicants, below, the applicants
and their affiliates shall be referred to in the remainder of the
notice in generic terms that denote certain roles, namely, ``the
Applicant,'' ``the Asset Manager, ``\3\ or ``the Affiliated Broker-
Dealer.'' \4\
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\3\ To the extent that the Applicant has more than one asset
management affiliate, all references to the Asset Manager herein
shall refer also to the other asset management entity or entities.
\4\ To the extent that the Applicant has more than one
registered broker-dealer affiliate that participates in underwriting
or selling syndicates, all references to the Affiliated Broker-
Dealer herein shall refer also to the other broker-dealer entity or
entities.
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1. Morgan Guaranty Trust Company of New York (MGT) is a New York
Trust Company. J.P. Morgan Investment Management Inc. (JPMIM), is a
registered investment adviser. Both MGT and JPMIM are wholly owned
subsidiaries of J.P. Morgan & Co. (JPM), a Delaware corporation. MGT
and JPMIM (together, the Applicant) provide investment management and
investment advisory services. Hereinafter, the Applicant shall be
referred to as ``the Asset Manager'' when discussing the Applicant's
activities relating to investment management or investment advisory
services. J.P. Morgan Securities Inc., a wholly owned indirect
subsidiary of JPM, is a registered broker-dealer (hereinafter, the
Affiliated Broker-Dealer). It is represented that, as of December 31,
1998, the last day of the
[[Page 6230]]
most recent fiscal year for which information is available, JPMIM and
MGT had $316 billion in total client assets under management. As of
that date, approximately 40 percent of client assets under management
were attributable to employee benefit plans (Client Plans) subject to
the fiduciary responsibility provisions of the Act, including Client
Plans investing in a pooled fund (Pooled Fund).
2. Goldman, Sachs & Co. (Goldman), a New York limited partnership,
is a wholly owned subsidiary and the principal operating subsidiary of
The Goldman Sachs Group, Inc. Goldman is a registered broker-dealer and
investment adviser. Hereinafter, Goldman shall be referred to,
generally, as ``the Applicant'' and, specifically, as ``the Affiliated
Broker-Dealer'' when discussing Goldman's activities as an underwriter.
Goldman, Sachs Asset Management (hereinafter, the Asset Manager) is a
separate operating division of the Applicant and is engaged in the
investment management and investment advisory business. It is
represented that, as of November 26, 1999, the last day of the
Applicant's most recent fiscal year, the Asset Manager had total client
assets under management of $241.4 billion. As of that date,
approximately 12.7 percent of client assets under management were
attributable to Client Plans, including those investing in a Pooled
Fund.
3. The Chase Manhattan Bank (CMB), a New York State bank, is a
subsidiary of The Chase Manhattan Corporation (CMC). Chase Asset
Management (CAM), a registered investment adviser, is a subsidiary of
CMB. CMB and CAM (together, the Applicant) provide investment
management and investment advisory services. Hereinafter, the Applicant
shall be referred to as ``the Asset Manager'' when discussing the
Applicant's activities relating to investment management or investment
advisory services. Chase Securities Inc., a subsidiary of CMC, is a
registered broker-dealer (hereinafter, the Affiliated Broker-Dealer).
It is represented that, as of December 31, 1998, the last day of its
most recent fiscal year for which information is available, CMB had
total client assets under management of approximately $31 billion. As
of that date, CAM had total client assets under management of
approximately $48 billion. As of December 31, 1998, approximately 1.0
percent of client assets of CMB, and approximately 9.6 percent of
client assets of CAM, were attributable to Client Plans, including
those investing in a Pooled Fund.
4. Citigroup, Inc. (Citigroup or the Applicant) is a Delaware
corporation and a diversified holding company. Salomon Smith Barney
Inc. (SSB or the Applicant), a New York corporation, is an indirect
subsidiary of Citigroup. SSB is a registered broker-dealer and
investment adviser. Hereinafter, SSB shall be referred to, generally,
as the ``the Applicant'' and, specifically, as ``the Affiliated Broker-
Dealer'' when discussing SSB's activities as an underwriter. Salomon
Smith Barney Asset Management (hereinafter, the Asset Manager) is a
separate operating division of SSB and is engaged in the investment
management and investment advisory business. It is represented that, as
of September 30, 1999, the last day of its most recent fiscal year, all
of Citigroup's asset management affiliates had, in the aggregate,
client assets under management of approximately $351 billion. As of
that date, approximately 3.7 percent of client asset under management
were attributable to Client Plans, including those investing in a
Pooled Fund.
5. Morgan Stanley Dean Witter & Co. (hereinafter, the Applicant) is
a publicly traded Delaware corporation. The Applicant is a registered
investment adviser. Morgan Stanley Dean Witter Investment Management
Inc. (hereinafter, the Asset Manager) is a wholly owned subsidiary of
the Applicant. The Asset Manager is a registered investment adviser.
Morgan Stanley & Co. Incorporated (hereinafter, the Affiliated Broker-
Dealer) is another wholly owned subsidiary of the Applicant. The
Affiliated Broker-Dealer is a registered investment adviser and broker-
dealer. It is represented that all of the Applicant's asset management
affiliates had, in the aggregate, client assets under management of
approximately $425 billion, as of November 30, 1999, the last day of
their most recent fiscal year. As of that date, approximately 20
percent of client assets under management were attributable to Client
Plans, including those investing in a Pooled Fund.
Requested Exemption
6. Each Applicant requests exemptive relief permitting purchases of
securities by the Asset Manager, for the Asset Manager's Client Plans,
including Pooled Funds, from underwriting or selling syndicates in
which the Affiliated Broker-Dealer participates as a manager or member.
Each Applicant states that such purchases would be made from an
underwriter or broker-dealer other than the Affiliated Broker-Dealer
and that the Affiliated Broker-Dealer would not receive any selling
concessions with respect to the securities sold to Client Plans.
7. Each Applicant represents that where the Affiliated Broker-
Dealer is a member of an underwriting or selling syndicate, the Asset
Manager makes purchases of securities for its Client Plans in
compliance with Prohibited Transaction Exemption (PTE) 75-1 (40 FR
50845, October 31, 1975), Part III. PTE 75-1, Part III, provides a
class exemption, under certain conditions, for a plan fiduciary to
purchase securities from an underwriting or selling syndicate of which
the fiduciary or an affiliate is a member. However, relief under PTE
75-1 is unavailable if the fiduciary or its affiliate is a manager of
the underwriting or selling syndicate.
8. Regardless of whether the fiduciary or its affiliate is a
manager or member of the underwriting or selling syndicate, PTE 75-1 is
also unavailable for the purchase of unregistered securities, including
securities that have been purchased by an underwriter for resale to
``qualified institutional buyers'' (QIBs), pursuant to SEC Rule 144A
(17 CFR 230.144A) under the Securities Act of 1933 (the 1933 Act)(Rule
144A Securities). Rule 144A is frequently used for sales of securities
of foreign issuers to U.S. investors who are QIBs. Each Applicant
states that syndicates selling securities pursuant to Rule 144A are
functionally equivalent to syndicates selling securities in registered
offerings.
9. Each Applicant represents that the Affiliated Broker-Dealer is
frequently involved in securities offerings as a manager of
underwriting or selling syndicates, or as a manager or member of a
syndicate selling Rule 144A Securities. Each Applicant further asserts
that the inability of the Asset Manager to purchase securities for its
Client Plans from such syndicates can be detrimental to those accounts
because the accounts can lose important investment opportunities.
10. According to each Applicant, there has been considerable
consolidation in the nation's financial services industry since 1975,
resulting in more situations where a plan fiduciary may be affiliated
with the manager of an underwriting syndicate.\5\
[[Page 6231]]
In addition, many plans have expanded their investment portfolios in
recent years to include foreign securities. As a result, the exemption
provided in PTE 75-1, Part III, is often unavailable for purchases of
certain securities that may be appropriate plan investments.\6\
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\5\ For further background, see ``The Costs Imposed on Pension
Plans by ERISA's Prohibited Transactions Provisions,'' December
1998, Anthony Saunders and Ingo Walter. This study, by Professors
Saunders and Walter of the Stern School of Business of New York
University, discusses the consolidation of the financial services
industry. It was privately commissioned by J.P. Morgan (see
Application Nos. D-10119 and D-10120). The study estimates the
economic loss to plans resulting from their investment managers'
inability to purchase securities from affiliated underwritings by
examining the one-day, one-week, and one-month investment returns on
various initial public offerings (IPOs) during the years 1991
through 1996. In response to the Department's request for additional
information, Professor Walter explained, in a letter dated August
20, 1999, why short periods were selected for calculating the
hypothetical returns:``The fact that IPOs do not have significant
excess performance over the long run is well documented in finance
and is known to all mutual and pension fund managers. Indeed, long-
term relative performance of IPOs (i.e., those held for a period
over 3 years) is significantly below market performance as measured
by standard indices such as the S&P 500 . . .''
\6\ Under the Gramm-Leach-Bliley Act, signed into law by the
President on November 12, 1999, certain provisions of the Glass-
Steagall Act and the Bank Holding Company Act of 1956, as amended,
are repealed. The Department notes that the effect of such law will
likely be further consolidation of the financial services industry.
The new law will facilitate cross-ownership and control among bank
holding companies and securities firms through the creation of
``financial holding companies'' that will be permitted to engage in
a broad range of financial and related activities, including
underwriting and dealing activities.
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Investments in Offered Securities
11. Each Applicant represents that the Asset Manager makes
investment decisions on behalf of, or renders investment advice to, its
Client Plans in accordance with the governing document of the
particular Client Plan or Pooled Fund and the guidelines and objectives
established in the investment management or advisory agreement. Since
the Client Plans are covered by Title I of the Act, such investment
decisions are also subject to the fiduciary responsibility provisions
of the Act.
12. Each Applicant states, therefore, that a decision to invest in
particular securities is made on the basis of price, value, and a
Client Plan's investment criteria, not on whether the securities are
currently being sold through an underwriting or selling syndicate. Each
Applicant further asserts that the Asset Manager has little incentive
to make purchases from offerings for which the Affiliated Broker-Dealer
is an underwriter that are not in the interests of the Client Plans
because the Asset Manager's compensation for its services is generally
based upon assets under management. If the assets under its management
do not perform well, the Asset Manager will receive less compensation
and could lose clients.
13. Each Applicant states that the Asset Manager generally
purchases securities in large blocks because the same investments will
be made across several of its accounts. If there is a new offering of
an equity or fixed income security that the Asset Manager had otherwise
intended to purchase, it may be able to purchase the security through
the offering syndicate at a lower price than it would pay in the open
market, without transaction costs and with a reduced market impact if
it is buying a relatively large quantity. This is because a large
purchase in the open market can cause an increase in the market price
and, consequently, in the cost of the securities. Purchasing from an
offering syndicate can thus reduce the costs to the Asset Manager's
Client Plans.
14. However, absent an individual exemption, if the Affiliated
Broker-Dealer is a manager of the syndicate underwriting the offering,
the Asset Manager is currently foreclosed from purchasing any
securities from that underwriting syndicate. If the Asset Manager then
purchases the same securities in the secondary market, the Client Plans
may incur greater costs because the market price is often higher than
the offering price, and because of transaction and market impact costs.
Alternatively, the Asset Manager may have foregone other investment
opportunities because of its decision to purchase in the offering, and
these opportunities, if still available, may have become more
expensive.
Underwriting of Securities Offerings
15. Each Applicant represents that the Affiliated Broker-Dealer
manages and participates in firm commitment underwriting syndicates for
registered offerings of both equity and debt securities. While equity
and debt underwritings may operate differently with regard to the
actual sales process, the basic structures are the same. In a firm
commitment underwriting, the underwriting syndicate acquires the
securities from the issuer and then sells the securities to investors.
16. Each Applicant represents that while, as a legal matter, the
syndicate assumes the risk that the securities might not be
distributable, as a practical matter, this risk is reduced, in marketed
deals, through ``building a book'' (i.e., taking indications of
interest) prior to pricing the securities. Each Applicant asserts that,
consequently, there is little incentive for the underwriters to use
their discretionary accounts (or the discretionary accounts of their
affiliates) to buy up the securities as a way to avoid underwriting
liabilities.
17. Each syndicate has a lead manager, who is the principal contact
between the syndicate and the issuer and who is responsible for
organizing and coordinating the syndicate. The syndicate may also have
co-managers, who generally assist the lead manager in working with the
issuer to prepare the registration statement to be filed with the SEC
and in distributing the underwritten securities. While equity
syndicates typically include additional members that are not managers,
more recently, membership in many debt syndicates has been limited to
lead and co-managers.
18. Where more than one underwriter is involved, the lead manager,
who has been selected by the issuer, contacts other underwriters, and
the underwriters enter into an Agreement Among Underwriters. Most lead
managers have a form of agreement. This document is then supplemented
for the particular deal by sending an ``invitation telex'' setting
forth particular terms to the other underwriters.
19. The arrangement between the syndicate and the issuer is
embodied in an underwriting agreement, which is signed on behalf of the
underwriters by one or more of the managers. The underwriting agreement
provides, subject to certain closing conditions, that the underwriters
are obligated to purchase the underwritten securities from the issuer
in accordance with their respective commitments. This obligation is met
by using the proceeds received from the buyers of the securities in the
offering, although there is a risk that the underwriters will have to
pay for a portion of the securities, in the event that not all of the
securities are sold.
20. However, each Applicant represents that, generally, the risk
that the securities will not be sold is small because the underwriting
agreement is not executed until after the underwriters have obtained
indications of interest in purchasing the securities from a sufficient
number of investors to acquire all the securities being offered. Once
the underwriting agreement is executed, the underwriters immediately
begin contacting the investors to confirm the sales, first orally and
then by written confirmation, and sales are finalized within hours and
sometimes minutes. The underwriters are anxious to complete the sales
as soon as possible because until they ``break syndicate,'' they cannot
enter the market. In many cases, the underwriters will act as market-
markers for the security. A market-maker holds itself out as willing to
buy or sell the security for its own account on a regular basis.
21. Each Applicant represents that the process of ``building a
book'' or soliciting interest occurs as follows. In an equity offering,
after a registration statement is filed with the SEC and while it is
under review by the SEC
[[Page 6232]]
staff, representatives of the issuer and the managers conduct meetings
with potential investors, who learn about the company and the
securities and receive a preliminary prospectus. The underwriters
cannot make any firm sales until the registration statement is declared
effective by the SEC. Prior to the effective date, while the investors
thus cannot become legally obligated to make a purchase, they indicate
whether they have an interest in buying, and the managers compile a
``book'' of investors who are willing to ``circle'' a particular
portion of the issue. These indications of interest are sometimes
referred to as a ``soft circle'' because investors cannot be legally
bound to buy the securities until the registration statement is
effective. However, each Applicant represents that investors generally
follow through on their indications of interest, and would be expected
to do so, barring any sudden adverse developments (in which case it is
likely that the offering would be withdrawn), because if they do not
follow through, the underwriters will be reluctant to sell to them in
future offerings.
22. Assuming that the meetings have produced sufficient indications
of interest, each Applicant represents that the issuer and the managers
together will set the price of the securities and ask the SEC to
declare the registration effective. After the registration statement
becomes effective and the underwriting agreement is executed, the
underwriters contact those investors who have indicated an interest in
purchasing securities in the offering to execute the sales. Each
Applicant represents that offerings are often oversubscribed, and many
have an over-allotment option that the underwriters can exercise to
acquire additional shares from the issuer. Where an offering is
oversubscribed, the underwriters decide how to allocate the securities
among the potential purchasers. However, if an issue is a ``hot
issue,'' i.e., it is selling in the market at a premium above its
offering price, the underwriters may not hold this hot issue in their
own accounts, nor sell it to their officers and directors. A hot issue
may also not be sold to the personal accounts of those responsible for
investing for others, such as officers of banks, insurance companies,
mutual funds, and investment advisers. (NASD Manual & Notices to
Members, IM-2110-1)
23. Each Applicant represents that debt offerings may be
``negotiated'' offerings, ``competitive bid'' offerings, or ``bought
deals.'' ``Negotiated'' offerings, which often involve non-investment
grade securities, are conducted in the same manner as an equity
offering with regard to when the underwriting agreement is executed and
how the securities are offered. ``Competitive bid'' offerings, in which
the issuer determines the price for the securities through competitive
bidding rather than negotiating the price with the underwriting
syndicate, are performed under ``shelf'' registration statements
pursuant to SEC Rule 415 under the 1933 Act (17 CFR 230.415).\7\
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\7\ Rule 415 permits an issuer to sell debt as well as equity
securities under an effective registration statement previously
filed with the SEC by filing a post-effective amendment or
supplemental prospectus.
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24. In a competitive bid offering, prospective lead underwriters
will bid against one another to purchase debt securities, based upon
their determinations of the degree of investor interest in the
securities. Depending on the level of investor interest and the size of
the offering, a bidding lead underwriter may bring in co-managers to
assist in the sales process. Most of the securities are frequently sold
within hours, or sometimes even less than an hour, after the securities
are made available for purchase.
25. Because of market forces and the requirements of Rule 415, the
competitive bid process is generally available only to issuers of
investment-grade securities who have been subject to the reporting
requirements of the Securities Exchange Act of 1934 (the 1934 Act) for
at least one year.
26. Occasionally, in highly-rated debt issues, underwriters ``buy''
the entire deal off of a ``shelf registration'' before obtaining
indications of interest. These ``bought'' deals involve issuers whose
securities enjoy a deep and liquid secondary market, such that an
underwriter has confidence without pre-marketing that it can identify
purchasers for the bonds.
Structure of Diversified Financial Services Firms
27. Each Applicant represents that there are internal policies in
place that restrict contact and the flow of information between
investment management personnel and non-investment management
personnel. These policies are designed to protect against ``insider
trading,'' i.e., trading on information not available to the general
public that may affect the market price of the securities. Diversified
financial services firms must be concerned about insider trading
problems because one part of the firm--e.g., the mergers and
acquisitions group--could come into possession of non-public
information regarding an upcoming transaction involving a particular
issuer, while another part of the firm--e.g., the investment management
group--could be trading in the securities of that issuer for its
clients.\8\
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\8\ The Insider Trading and Securities Fraud Enforcement Act of
1988 required brokers and dealers to maintain and enforce written
policies and procedures that are ``reasonably designed . . . to
prevent the misuse in violation of [the federal securities laws] . .
. of material, nonpublic information by such broker or dealer or any
person associated with such broker or dealer.'' (Section 15(f) of
the 1934 Act (15 U.S.C. 780(f)); see also Rules 342 and 351 of the
NYSE and SEC Regulation M (17 CFR 242.100(a)(3)).
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28. Each Applicant states that its business separation policies and
procedures are also designed to restrict the flow of any information to
or from the Asset Manager that could limit its flexibility in managing
client assets, and of information obtained or developed by the Asset
Manager that could be used by other parts of the organization, to the
detriment of the Asset Manager's clients.
29. Each Applicant states that major clients of the Affiliated
Broker-Dealer include investment management firms that are competitors
of the Asset Manager. Similarly, the Asset Manager deals on a regular
basis with broker-dealers that compete with the Affiliated Broker-
Dealer. If special consideration were shown to an affiliate, such
conduct would likely adversely affect the relationships of the
Affiliated Broker-Dealer and of the Asset Manager with firms that
compete with that affiliate. Therefore, a goal of each Applicant's
business separation policy is to avoid any possible perception of
improper flows of information between the Affiliated Broker-Dealer and
the Asset Manager, in order to prevent any adverse impact on client and
business relationships.
Underwriting Compensation
30. Each Applicant represents that the underwriters are compensated
through the ``spread,'' or difference, between the price at which the
underwriters buy the securities from the issuer and the price at which
the securities are sold to the public. The spread is divided into three
components.
31. The first component includes the management fee, which
generally represents an agreed upon percentage of the overall spread
and is allocated among the lead manager and co-managers. Where there is
more than one managing underwriter, the way the management fee will be
allocated among the managers is generally agreed upon prior to
soliciting indications of interest (the process of ``building a
book''). Thus, according to each Applicant, such management fee
allocations are not
[[Page 6233]]
reflective of the amount of securities that particular managers sell in
an offering.
32. The second component is the underwriting fee, which represents
compensation to the underwriters (including the non-managers, if any)
for the risks they assume in connection with the offering and for the
use of their capital. This component of the spread is also used to
cover the expenses of the underwriting that are not otherwise
reimbursed by the issuer.
33. The first and second components are received without regard to
how the underwritten securities are allocated for sales purposes or to
whom the securities are sold. The third component of the spread is the
selling concession, which generally constitutes 60 percent or more of
the spread. The selling concession compensates the underwriters for
their actual selling efforts. The allocation of selling concessions
among the underwriters follows the allocation of the securities for
sales purposes, except to the extent that buyers designate other
broker-dealers (who may be other underwriters as well as broker-dealers
outside the syndicate) to receive the selling concessions from the
securities they purchase.
34. Securities are allocated for sales purposes into two
categories. The first and larger category is the ``institutional pot,''
which is the pool of securities from which sales are made to
institutional investors. Selling concessions for securities sold from
the institutional pot are generally designated by the purchaser to go
to particular underwriters or broker-dealers. When securities are sold
from the institutional pot, the managers sometimes receive a portion of
the selling concessions, referred to as a ``fixed designation,'' \9\
attributable to securities sold in this category, without regard to who
sold the securities or to whom they were sold. For securities covered
by this proposed exemption, however, the Affiliated Broker-Dealer may
not receive, either directly or indirectly, any compensation that is
attributable to the fixed designation generated by purchases of
securities by the Asset Manager on behalf of its Client Plans.
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\9\ A fixed designation is sometimes referred to as an ``auto
pot split.''
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35. The second category of allocated securities is ``retail,''
which are the securities retained by the underwriters for sale to their
retail customers. The underwriters receive the selling concessions from
their respective retail retention allocations. Securities may be
shifted between the two categories based upon whether either category
is oversold or undersold during the course of the offering.
36. Each Applicant asserts that the Affiliated Broker-Dealer's
inability to receive any selling concessions, or any compensation
attributable to the fixed designations generated by purchases of
securities by the Asset Manager's Client Plans, removes the primary
economic incentive for the Asset Manager to make purchases that are not
in the interests of its Client Plans from offerings for which the
Affiliated Broker-Dealer is an underwriter. The reason is that the
Affiliated Broker-Dealer will not receive any additional fees as a
result of such purchases by the Asset Manager.
Rule 144A Securities
37. Each Applicant represents that a number of the offerings of
Rule 144A Securities in which the Affiliated Broker-Dealer participates
represent good investment opportunities for the Asset Manager's Client
Plans. Particularly with respect to foreign securities, a Rule 144A
offering may provide the least expensive and most accessible means for
obtaining the securities. However, PTE 75-1, Part III, does not include
a category for Rule 144A Securities, regardless of whether the
Affiliated Broker-Dealer is a manager or member of the underwriting or
selling syndicate. Therefore, absent an individual exemption, the Asset
Manager is foreclosed from purchasing such securities for its Client
Plans in offerings in which the Affiliated Broker-Dealer participates.
38. Each Applicant states that Rule 144A, which was adopted in
1990, acts as a ``safe harbor'' exemption from the registration
provisions of the 1933 Act for sales of certain types of securities to
QIBs. QIBs include several types of institutional entities, such as
employee benefit plans and commingled trust funds holding assets of
such plans, which own and invest on a discretionary basis at least $100
million in securities of unaffiliated issuers.
39. Any securities may be sold pursuant to Rule 144A except for
those of the same class or similar to a class that is publicly traded
in the United States, or certain types of investment company
securities. This limitation is designed to prevent side-by-side public
and private markets developing for the same class of securities.
40. Buyers of Rule 144A Securities must be able to obtain, upon
request, basic information concerning the business of the issuer and
the issuer's financial statements, much of the same information as
would be furnished if the offering were registered. This condition does
not apply, however, to an issuer filing reports with the SEC under the
1934 Act, for which reports are publicly available. The condition also
does not apply to a ``foreign private issuer'' for whom reports are
furnished to the SEC under Rule 12g3-2(b) of the 1934 Act (17 CFR
240.12g3-2(b)), or to issuers who are foreign governments or political
subdivisions thereof and are eligible to use Schedule B under the 1933
Act (which describes the information and documents required to be
contained in a registration statement filed by such issuers).
41. Sales under Rule 144A, like sales in a registered offering,
remain subject to the protections of the anti-fraud rules of federal
and state securities laws. These rules include Section 10(b) of the
1934 Act and Rule 10b-5 thereunder (17 CFR 240.10b-5) and Section 17(a)
of the 1933 Act (15 U.S.C. 77a). Through these and other provisions,
the SEC may use its full range of enforcement powers to exercise its
regulatory authority over the market for Rule 144A Securities, in the
event that it detects improper practices.
42. Each Applicant asserts that this potential liability for fraud
provides a considerable incentive to the issuer and offering syndicate
to insure that the information contained in a Rule 144A offering
memorandum is complete and accurate in all material respects. Among
other things, the lead manager typically obtains an opinion from a law
firm, commonly referred to as a ``10b-5'' opinion, stating that the law
firm has no reason to believe that the offering memorandum contains any
untrue statement of material fact or omits to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which they were made, are not misleading.
43. Each Applicant represents that Rule 144A offerings generally
are structured in the same manner as underwritten registered offerings.
The major difference is that a Rule 144A offering uses an offering
memorandum rather than a prospectus that is filed with the SEC. The
marketing process is the same in most respects, except that the selling
efforts are generally limited to contacting QIBs and that there are no
general solicitations for buyers (e.g., no general advertising). In
addition, the Affiliated Broker-Dealer's role in these offerings has
been as a lead or co-manager. While, generally, there are no non-
manager members in the syndicate, each Applicant also requests relief
for situations where the Affiliated Broker-Dealer acts only as a
syndicate member, not as a manager.
44. According to each Applicant, one of the policy objectives of
Rule 144A
[[Page 6234]]
was to attract more foreign issuers to the United States, and Rule 144A
has been achieving this objective--from April 1990 through December
1993, the first three years of Rule 144A, over $25.6 billion in foreign
securities was sold under Rule 144A, representing more than one-fourth
of Rule 144A placements. See SEC Staff Report on Rule 144A (August 18,
1994), [1994-95 Transfer Binder] Fed. Sec. L. Rep. para. 85,428
(Question 1). This figure continued to hold in 1998, at 30.4 percent,
so that foreign issuer Rule 144A offerings have kept pace with the
rapid growth of Rule 144A offerings overall. (Securities Data Company,
Inc.)
Summary
In summary, the proposed transactions will satisfy the statutory
criteria for an exemption under section 408(a) of the Act because: (a)
The Client Plans will gain access to desirable investment
opportunities; (b) in each offering, the Asset Manager will purchase
the securities for its Client Plans from an underwriter or broker-
dealer other than the Affiliated Broker-Dealer; (c) conditions similar
to those of PTE 75-1, Part III, will restrict the types of securities
that may be purchased, the types of underwriting or selling syndicates
and issuers involved, and the price and timing of the purchases; (d)
the amount of securities that the Asset Manager may purchase on behalf
of Client Plans will be subject to percentage limitations; (e) the
Affiliated Broker-Dealer will not be permitted to receive, either
directly, indirectly, or through designation, any selling concessions
with respect to the securities sold to the Asset Manager; (f) prior to
any purchase of securities, the Asset Manager will make the required
disclosures to an independent fiduciary (Independent Fiduciary) of each
Client Plan and obtain written authorization; (g) the Asset Manager
will provide regular reporting to an Independent Fiduciary of each
Client Plan with respect to all securities purchased pursuant to the
exemption, if granted; (h) each Client Plan will be subject to a
minimum size requirement of at least $50 million ($100 million for
``Eligible Rule 144A Offerings''),\10\ with certain exceptions for
Pooled Funds; and (i) the Asset Manager must have total assets under
management in excess of $5 billion and shareholders' or partners'
equity in excess of $1 million.
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\10\ SEC Rule 10f-3(a)(4) (17 CFR 270.10f-3(a)(4)) states that
the term ``Eligible Rule 144A Offering'' means an offering of
securities that meets the following conditions:
(i) The securities are offered or sold in transactions exempt
from registration under section 4(2) of the Securities Act of 1933
[15 U.S.C. 77d(2)], rule 144A thereunder [Sec. 230.144A of this
chapter], or rules 501-508 thereunder [Secs. 230.501-230.508 of this
chapter];
(ii) The securities are sold to persons that the seller and any
person acting on behalf of the seller reasonably believe to include
qualified institutional buyers, as defined in Sec. 230.144A(a)(1) of
this chapter; and
(iii) The seller and any person acting on behalf of the seller
reasonably believe that the securities are eligible for resale to
other qualified institutional buyers pursuant to Sec. 230.144A of
this chapter.
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Discussion of Proposed Exemption
1. The exemptive relief for underwritings proposed herein is
similar to that provided in PTE 75-1, Part III. Under PTE 75-1,
exemptive relief is subject to a number of conditions and limitations,
including the following: (1) The plan fiduciary or its affiliate may
not be a manager of the underwriting or selling syndicate; (2) the
purchase must be from a person other than the plan fiduciary or its
affiliate; (3) the types of securities that may be purchased and the
price and timing of the purchases are circumscribed; (4) the amount of
securities purchased on behalf of each plan may not exceed three
percent of the offering; and (5) the consideration paid may not exceed
three percent of the plan's total net assets (one percent, if the
consideration involved exceeds $1 million).
2. The exemptive relief proposed herein differs from that provided
by PTE 75-1 in the following respects: (1) The proposed exemption
covers transactions where the plan fiduciary is affiliated with a
manager, as well as a member, of the underwriting or selling syndicate;
\11\ (2) the proposed exemption covers purchases of Rule 144A
Securities; \12\ (3) percentage limitations on the amount of securities
that may be purchased have been modified to provide an aggregate
limitation on a fiduciary's purchases for all Client Plans from a
particular offering; and (4) the proposed exemption provides additional
conditions, including: (a) The transaction is not part of an agreement,
arrangement, or understanding designed to benefit the plan fiduciary or
its affiliate; (b) neither a manager nor a member of the underwriting
or selling syndicate may receive any selling concessions with respect
to the securities purchased for Client Plans by its affiliate; (c)
prior to any purchase of securities on behalf of a Client Plan, certain
disclosures are provided to an Independent Fiduciary of each such
Client Plan and written authorization is obtained; (d) periodic
reporting regarding the covered transactions is provided to an
Independent Fiduciary of each Client Plan; and (e) investing plans and
their investment managers must meet certain minimum size requirements.
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\11\ In restricting the scope of PTE 75-1, Part III, to exclude
transactions where the plan fiduciary is affiliated with the
syndicate manager, the Department was concerned that the syndicate
manager, as distinguished from a mere member of a syndicate, has a
greater interest in the success of the sale of the new securities.
If an affiliate of the managing underwriter is an investment manager
for plans, those plans could provide a potential market for the less
attractive offerings of underwritten securities. This proposed
exemption contains certain safeguards and conditions that are
designed to address these potential conflict of interest situations.
\12\ The Department notes that the provisions of the Act do not
preclude plans from investing in any securities sold by an
underwriting or offering syndicate, including those securities sold
pursuant to Rule 144A. The exemptive relief provided by PTE 75-1,
Part III, and the additional relief sought here are required because
of the affiliation between the plan fiduciary and a member of the
underwriting or selling syndicate.
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Types of Securities and Offerings
3. Paragraphs (a) and (b) of the proposed exemption are derived
from PTE 75-1, Part III, and provide the following: (1) The securities
\13\ are part of an issue registered under the 1933 Act, or if exempt
from registration under such Act, fall within specified categories:
issued or guaranteed by the United States; issued by a bank; exempt
from registration under a federal statute other than the 1933 Act;
registered under the 1934 Act; or are part of an Eligible Rule 144A
Offering--a change from PTE 75-1, Part III, as noted
[[Page 6235]]
above; \14\ (2) the securities are purchased for not more than the
offering price within a specific time period,\15\ subject to certain
specified exceptions for rights offerings and debt offerings; \16\ (3)
the securities are sold pursuant to a firm-commitment offering, in
which the syndicate members are committed to purchasing all the
securities being offered, subject to certain exceptions for rights
offerings and over-allotment options; and (4) the issuer of the
securities has been in continuous operation for not less than three
years, with certain exceptions.
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\13\ With respect to any purchase of asset-backed securities by
a Client Plan, the Department notes that this proposed exemption
provides relief only for the transactions described herein and does
not cover any additional prohibited transactions that may occur as a
result of a purchase of such securities. For example, additional
prohibited transactions may occur by operation of the ``look-through
rule'' contained in the Department's regulation defining ``plan
assets'' for purposes of plan investments (see 29 CFR 2510.3-101).
Such additional prohibited transactions may be covered by one of the
Department's existing individual exemptions for asset-backed
securities. A listing of such exemptions is provided in the text of
the operative language of PTE 97-34 (62 FR 39021, July 21, 1997),
which granted an amendment to these exemptions.
Further, the Department notes that, under the Department's plan
asset regulation, if a plan invests in a publicly-offered security,
the plan's assets will not include, solely by reason of such
investment, any of the underlying assets of the entity issuing the
security (i.e., the ``look-through rule'' will not apply and the
operations of the entity will not be subject to scrutiny under the
prohibited transaction provisions of the Act). The regulation
defines a ``publicly-offered'' security as one that is freely
transferable, widely-held, and registered under the federal
securities laws. For this purpose, a class of securities is
considered ``widely held'' if it is owned by 100 or more investors
who are independent of the issuer and of one another (see 29 CFR
2510.3-101(b)(3)).
\14\ Paragraph (a)(1)(ii) of the proposed exemption requires
that if the securities are equity securities in an Eligible Rule
144A Offering, the offering syndicate shall obtain a legal opinion
regarding the adequacy of the disclosure in the offering memorandum.
This condition may be satisfied by the type of ``10b-5'' opinion
customarily obtained in connection with such offerings. The
Department believes that requiring such review by a law firm will
help insure that the offering memorandum meets federal securities
law standards. The Department notes that paragraph (c) of the
proposed exemption requires debt securities to be rated by at least
one independent nationally recognized statistical rating
organization, thus insuring that sufficient information about those
securities and their issuer will be available to investors.
\15\ The language regarding the timing of the purchase differs
slightly from PTE 75-1, Part III. This language is based upon Rule
10f-3, as amended in 1997 (17 CFR 270.10f-3; 62 FR 42401, August 7,
1997).
\16\ Paragraph (a)(2)(ii) of the proposed exemption permits
certain purchases of debt after the first day of the offering.
Should the debt be downgraded after the offering commences and prior
to being purchased for a Client Plan, the Department expects that
the Asset Manager would consider whether, prior to purchase, the
price was adjusted to reflect the downgrade.
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Percentage Limitations on the Amount of Purchased Securities
4. Paragraphs (c) and (d) of the proposed exemption contain
percentage limitations applicable to the amount of purchased
securities. The first percentage test in paragraph (c) provides that
the amount of securities to be purchased by the Asset Manager on behalf
of a particular Client Plan or Pooled Fund may not exceed three percent
of the total amount of securities being offered. Paragraph (c) further
provides percentage limitations on the aggregate amount of securities
that the Asset Manager may purchase for all its Client Plans, including
Pooled Funds, from the total amount of securities being offered: 10
percent for equity securities; 35 percent for debt securities rated in
one of the four highest rating categories by at least one nationally
recognized statistical rating organization, i.e., Standard & Poor's
Rating Services, Moody's Investors Service, Inc., Duff & Phelps Credit
Rating Co., or Fitch IBCA, Inc., or their successors (collectively, the
Rating Organizations); and 25 percent for debt securities rated in the
fifth or sixth highest rating categories by at least one of the Rating
Organizations.\17\
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\17\ Paragraph (c)(4) of the proposed exemption requires that
when calculating the percentages of securities purchased in an
Eligible Rule 144A Offering, one must consider any concurrent public
offering. The Department notes that any concurrent offering will
necessarily be in a foreign securities market, since Rule 144A is
unavailable where there is a concurrent domestic offering.
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5. Paragraph (d) provides that the consideration to be paid by the
Client Plan or Pooled Fund in purchasing the offered securities may not
exceed three percent of the fair market value of such Client Plan's or
Pooled Fund's total net assets. However, paragraph (d) eliminates the
requirement contained in PTE 75-1, Part III, that, if the consideration
involved exceeds $1 million, it may not exceed one percent of the fair
market value of the plan's total assets. This modification by the
Department parallels the amendment in 1997 of SEC Rule 10f-3.
Underwriting Compensation
6. The proposed exemption requires in paragraph (e) that any
purchase of securities by the Asset Manager pursuant to the exemption
may not be part of an agreement, arrangement, or understanding designed
to benefit the Asset Manager or an affiliate.\18\ Paragraph (f) further
provides that the Affiliated Broker-Dealer may not receive, either
directly, indirectly, or through designation, any selling concession,
or other consideration that is based upon the amount of securities
purchased by the Asset Manager's Client Plans pursuant to the
exemption. Those selling concessions would be allocated to members of
the syndicate who are not affiliated with the Asset Manager. The
Affiliated Broker-Dealer may also not receive, either directly or
indirectly, that portion of the fixed designation that is attributable
to securities purchased pursuant to the exemption. The Affiliated
Broker-Dealer is not precluded from receiving management fees,
underwriting fees, or other consideration that is not based upon the
amount of securities actually sold to the Asset Manager's Client Plans.
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\18\ The Department notes that the intent of the condition in
paragraph (e) of the proposed exemption was not to deny direct
benefits to other parties to a transaction but, rather, to exclude
relief for transactions that are part of a broader overall
agreement, arrangement, or understanding designed to benefit parties
in interest.
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7. Paragraph (g) provides that the amount the Affiliated Broker-
Dealer receives in management fees, underwriting fees, or other
consideration may not be increased for the purpose of offsetting the
reduction of the Affiliated Broker-Dealer's compensation from selling
concessions. Further, the Affiliated Broker-Dealer must provide the
Asset Manager with a written certification that the Affiliated Broker-
Dealer complied with the underwriting compensation requirements found
in paragraphs (e), (f), and (g) of the proposed exemption, in any
offering where the Asset Manager purchased securities for its Client
Plans. This certification will also be part of the quarterly report
which the Asset Manager provides to the Independent Fiduciaries of the
Client Plans.\19\
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\19\ The certification required in paragraph (g)(2) of the
proposed exemption is necessary because the Asset Manager and its
Client Plans must monitor compliance with all the conditions of the
exemption, if granted. However, the Asset Manager would not normally
have access to the Affiliated Broker-Dealer's records detailing each
underwriter's share of the compensation from a particular
underwriting, as those records are considered confidential. Such
records are required to be maintained pursuant to SEC and NASD rules
and would, of course, be made available to the Department pursuant
to the terms of the exemption, if granted.
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Disclosures
8. The proposed exemption requires in paragraphs (h) and (l) that
the Asset Manager obtain written authorization from an Independent
Fiduciary of each Client Plan, including each fiduciary of a plan that
invests in a Pooled Fund, before engaging in the covered
transactions.\20\ Prior to, and subsequent
[[Page 6236]]
to, execution of the written authorization, the Asset Manager must
provide certain disclosures described in paragraphs (i), (j), (k), and
(m) to an Independent Fiduciary of each Client Plan. In addition, the
Asset Manager must provide a termination form, at least annually, that
enables the Independent Fiduciary to terminate the authorization
without penalty.
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\20\ In this regard, the Department notes that the fiduciary
responsibility provisions of the Act apply to the decision of an
Independent Fiduciary to authorize the Asset Manager to invest in
securities covered by this proposed exemption (Covered Securities)
and to the decision to continue such authorization. Section
404(a)(1) of the Act requires, among other things, that a fiduciary
of a plan must act prudently, solely in the interest of the plan's
participants and beneficiaries, and for the exclusive purpose of
providing benefits to participants and beneficiaries. Accordingly,
the Independent Fiduciary must act ``prudently'' with respect to the
decision to authorize investment in these Covered Securities and the
decision to continue such authorization.
The Department wishes to emphasize that it expects that the
Independent Fiduciary, prior to authorizing investment in these
Covered Securities, will fully understand the potential risks and
rewards associated with investing in the initial offering of a
security, following disclosure by the Asset Manager of all relevant
information pertaining to the proposed transactions. Such
consideration must necessarily include the fact that the Asset
Manager's affiliate may be the managing underwriter. In addition,
the Independent Fiduciary must be capable of periodically monitoring
the actions taken by the Asset Manager in the performance of its
duties. Thus, in considering whether to enter into transactions of
the kind described herein, the Independent Fiduciary should take
into account its ability to provide adequate oversight of the Asset
Manager.
The Department further notes that, under section 405(a) of the
Act, any plan fiduciary (including an investment manager) will have
co-fiduciary liability for any breach of fiduciary responsibility of
another plan fiduciary: (1) if he knowingly participates in or
conceals such breach; (2) if, by his failure to comply with section
404(a)(1) of the Act, he enables another fiduciary to commit such a
breach; or (3) if he has knowledge of the breach of another
fiduciary and he fails to make a reasonable effort, under the
circumstances, to remedy the breach.
Finally, the granting of the exemption proposed herein should
not be viewed as an endorsement by the Department of any plans'
participation in the covered transactions.
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Periodic Reporting
9. Paragraph (n) of the proposed exemption requires that at least
once every three months, the Asset Manager provide a report to an
Independent Fiduciary of each Client Plan containing information about
the Covered Securities purchased during the previous quarter. The
Department modeled paragraph (n), in part, on the reporting provisions
of Rule 10f-3 (17 CFR 270.10f-3).\21\ The preamble to the 1997
amendments to Rule 10f-3 states that this rule ``permits an investment
company that is related to certain participants in an underwriting to
purchase securities during an offering, if certain conditions are
met.'' \22\ The SEC explained the origin of its rule as follows:
\21\ PTE 75-1, Part III, was based, in part, on a prior version
of Rule 10f-3.
\22\ 62 FR 42401, Aug. 7, 1997.
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Section 10(f) of the Investment Company Act was designed to
address one of the major abuses noted in the period before enactment
of the Investment Company Act--the use of funds by underwriters that
controlled these funds as a ``dumping ground'' for unmarketable
securities. \23\
\23\ Id.
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Under Rule 10f-3, the Board of Directors of the investment company
(including the directors who are not ``interested persons'' of the
investment company) is responsible for monitoring compliance.\24\
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\24\ The information that the Board of Directors uses to monitor
compliance must be included as an exhibit to the fund's semi-annual
publicly available reports to the SEC, known as the Form N-SAR.
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10. Because the transactions covered by this proposed exemption are
similar in nature to those covered by Rule 10f-3, the Department has
determined that it is appropriate to adopt similar reporting
requirements as in that rule. In addition to the items required to be
reported by investment companies under Rule 10f-3, the proposed
exemption requires that the Asset Manager report to the Independent
Fiduciary the price at which any securities purchased during the
reporting period were sold and the market value at the end of the
reporting period of each security purchased during such period.\25\
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\25\ See paragraph (n) of the proposed exemption.
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11. The additional information should help the Independent
Fiduciary monitor compliance with the exemption, if granted. The
Independent Fiduciaries of the Client Plans would play a similar role
to that of the Board of Directors of an investment company, i.e., they
have a fiduciary duty to monitor the activities of the Asset
Manager.\26\ In monitoring compliance, the Independent Fiduciary should
bear in mind that the Asset Manager's subsequent decision to hold or
sell a security purchased pursuant to the exemption, would not be
covered by the exemption, if granted.\27\
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\26\ With respect to the directors' duty, the SEC stated in the
preamble to Rule 10f-3:
A fund's board should be vigilant in reviewing the procedures
and transactions required by 10f-3 as well as in conducting any
additional reviews that it determines are needed to protect the
interests of investors, particularly if the fund purchases
significant amounts of securities in reliance on 10f-3. For example,
the board should consider monitoring how the performance of
securities purchased in reliance on rule 10f-3 compares to
securities not purchased in reliance on the rule, or to a benchmark
such as a comparable market index. Such monitoring would enable the
board to determine not only whether existing procedures are being
followed, but whether the procedures are effective in fulfilling the
policies underlying section 10(f).(62 FR at 42406) (See also
footnote 52, 62 FR at 42406.)
\27\ The Department notes that this proposed exemption would
provide relief from the self-dealing and conflict of interest
provisions of Part 4 of Title I of the Act for purchases of
securities by the Asset Manager from an underwriting or selling
syndicate in which an affiliate of the Asset Manager participates as
a manager or member of such syndicate. It would not provide relief
from any acts of self-dealing not directly arising from a purchase
of the Covered Securities. Thus, no relief would be available for
any violation of section 406(b) of the Act that may arise after the
purchase. For example, because it is well-documented that securities
purchased in IPOs may not perform well in the long term (see
footnote 4), a violation of the Act could occur if the Asset
Manager's decision regarding the holding or sale of the Covered
Securities by the Client Plan was influenced by the interests of the
Affiliated Broker-Dealer.
The Affiliated Broker-Dealer's interest in the security may
extend beyond the sale of the security. As the SEC noted in its
preamble to Regulation M, addressing Regulation M's protections
against price manipulation: ``[I]mmediately following an offering *
* * underwriters now engage in substantial syndicate-related market
activity, and enforce penalty bids in order to reduce volatility in
the market for the offering security.'' 62 FR 519, 521 (January 3,
1997). The SEC defines penalty bid as ``an arrangement that permits
the managing underwriter to reclaim a selling concession from a
syndicate member in connection with an offering when the securities
originally sold by the syndicate member are purchased in syndicate
covering transactions.'' SEC Regulation M (17 CFR 242.100(b)). For
further background on the role of underwriters, see ``Corporate
Finance and the Securities Laws, (2d ed. 1997),'' Charles J.
Johnson, Jr. and Joseph McLaughlin, Aspen Publishers; ``Securities
Industry Association: Capital Markets Handbook,'' edited by Bruce S.
Foester, Aspen Publishers (1999). Recent Developments in
Underwriting of IPO's: Spinning and Penalty Bids, Meredith B. Cross
and Christine Sarudy Roberts, 1084 PLI/Corp 595 (Nov. 1998).
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12. Further, the Asset Manager must report any instance during the
past quarter where the Asset Manager was precluded from trading in any
security purchased under the exemption for any period of time because
of its status as an affiliate of the Affiliated Broker-Dealer. For
example, the security could be placed on a watch or restricted list due
to activities of the Affiliated Broker-Dealer, and these restrictions
could prevent the Asset Manager from trading the security. Such a
situation could arise where a security was purchased by the Asset
Manager pursuant to this proposed exemption on the first day of the
offering and the rest of the offering was not selling well. In this
situation, SEC Regulation M, \28\ or the general anti-fraud or anti-
manipulation provisions of the securities laws, \29\ may limit the
Asset Manager's ability to subsequently trade in that security,
although these restrictions will generally not apply to the Asset
Manager if the proper business separations are in place between the
Affiliated Broker-Dealer and the Asset Manager (see, e.g., Regulation
M, 17 CFR 242.100(b)(3)). Should the Asset Manager's ability to trade a
security purchased on behalf of a Client Plan be restricted, this
information may be relevant to the decision whether or not to continue
to permit purchases under the exemption.
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\28\ A security might be put on a restricted list, for example,
if the offering was not completely sold before the security began
trading in the market. In this instance, the restricted period for
purposes of Regulation M (17 CFR 242.101(a)) continues until all
securities are sold. See, generally, ``Corporate Finance and the
Securities Laws, (2d ed. 1997),'' Charles J. Johnson, Jr. and Joseph
McLaughlin, Aspen Publishers; ``Securities Industry Association:
Capital Markets Handbook,'' edited by Bruce S. Foester, Aspen
Publishers (1999).
\29\ These rules include Section 17(a) of the 1933 Act (15
U.S.C. 77q(a)) and Sections 9, 10(b), and 15(c) of the 1934 Act (15
U.S.C. 78i, 78j(b) and 78o(c)).
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Minimum Size Requirements
13. The proposed exemption applies only to Client Plans with total
net assets of at least $50 million, as provided in paragraph (o). In
the case of a Pooled Fund, however, the $50 million requirement will be
met if 50 percent or more of the units of beneficial interest in such
Pooled Fund are held by plans having total net assets of at least $50
[[Page 6237]]
million. In the case of an Eligible Rule 144A Offering, each Client
Plan must have at least $100 million in securities. For a Pooled Fund,
the $100 million requirement will be met if 50 percent or more of the
units of beneficial interest in such Pooled Fund are held by plans
having at least $100 million in assets and the Pooled Fund itself
qualifies as a QIB, as determined pursuant to Rule 144A (17 CFR
230.144A(a)(F)). The Department believes that these minimum size
requirements will help insure that the Client Plans have the resources
and investment sophistication needed in order to monitor the Asset
Manager's investment performance with respect to the covered
transactions.
14. Further, the proposed exemption applies only if the Asset
Manager is a ``qualified professional asset manager'' (QPAM), as
defined under Part V(a) of PTE 84-14, (49 FR 9494, 9506, March 13,
1984),\30\ subject to the following modifications: The Asset Manager
has as of the last day of its most recent fiscal year, total client
assets under its management and control in excess of $5 billion and
shareholders' or partners' equity in excess of $1 million.
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\30\ PTE 84-14 provides a class exemption, under certain
conditions, for transactions between a party in interest with
respect to an employee benefit plan and an investment fund
(including a single customer or pooled separate account) in which
the plan has an interest and which is managed by a QPAM.
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General Information
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and section 4975(c)(2) of the Code does
not relieve a fiduciary or other party in interest or disqualified
person from certain other provisions of the Act and the Code, including
any prohibited transaction provisions to which the exemption does not
apply and the general fiduciary responsibility provisions of section
404 of the Act, which require, among other things, that a fiduciary
discharge his or her duties respecting a plan solely in the interest of
the participants and beneficiaries of such plan and in a prudent manner
in accordance with section 404(a)(1)(B) of the Act; nor does it affect
the requirements of section 401(a) of the Code that the plan operate
for the exclusive benefit of the employees of the employer maintaining
the plan and their beneficiaries;
(2) Before an exemption may be granted under section 408(a) of the
Act and section 4975(c)(2) of the Code, the Department must find that
the exemption is administratively feasible, in the interests of the
affected plans and their participants and beneficiaries, and protective
of the rights of those participants and beneficiaries; and
(3) The proposed exemptions, if granted, will be supplemental to,
and not in derogation of, any other provisions of the Act and the Code,
including statutory or administrative exemptions. Furthermore, the fact
that a transaction is subject to an administrative or statutory
exemption is not dispositive of whether the transaction is, in fact, a
prohibited transaction.
(4) The proposed exemptions, if granted, will be subject to the
express condition that the material facts and representations contained
in the applications accurately describe all material terms of the
transactions that are the subject of the exemptions.
Proposed Exemption
The Department is considering granting an exemption under the
authority of section 408(a) of the Employee Retirement Income Security
Act of 1974 (the Act) and section 4975(c)(2) of the Internal Revenue
Code of 1986 (the Code) and in accordance with the procedures set forth
in 29 CFR Part 2570, Subpart B (55 FR 32836, August 10, 1990).
Section I--Transactions
If the exemption is granted, the restrictions of section 406 of the
Act and the sanctions resulting from the application of section 4975 of
the Code, by reason of section 4975(c)(1) of the Code, shall not apply
to the purchase of any securities by the Asset Manager on behalf of
employee benefit plans (Client Plans), including Client Plans investing
in a pooled fund (Pooled Fund), for which the Asset Manager acts as a
fiduciary, from any person other than the Asset Manager or an affiliate
thereof, during the existence of an underwriting or selling syndicate
with respect to such securities, where the Affiliated Broker-Dealer is
a manager or member of such syndicate, provided that the following
conditions are satisfied:
(a) The securities to be purchased are--
(1) either:
(i) part of an issue registered under the Securities Act of 1933
(the 1933 Act) (15 U.S.C. 77a et. seq.) or, if exempt from such
registration requirement, are (A) issued or guaranteed by the United
States or by any person controlled or supervised by and acting as an
instrumentality of the United States pursuant to authority granted by
the Congress of the United States, (B) issued by a bank, (C) exempt
from such registration requirement pursuant to a federal statute other
than the 1933 Act, or (D) are the subject of a distribution and are of
a class which is required to be registered under section 12 of the
Securities Exchange Act of 1934 (the 1934 Act) (15 U.S.C. 781), and the
issuer of which has been subject to the reporting requirements of
section 13 of that Act (15 U.S.C. 78m) for a period of at least 90 days
immediately preceding the sale of securities and has filed all reports
required to be filed thereunder with the Securities and Exchange
Commission (SEC) during the preceding 12 months; or
(ii) part of an issue that is an ``Eligible Rule 144A Offering,''
as defined in SEC Rule 10f-3 (17 CFR 270.10f-3(a)(4)). Where the
Eligible Rule 144A Offering is of equity securities, the offering
syndicate shall obtain a legal opinion regarding the adequacy of the
disclosure in the offering memorandum;
(2) purchased prior to the end of the first day on which any sales
are made, at a price that is not more than the price paid by each other
purchaser of securities in that offering or in any concurrent offering
of the securities, except that--
(i) if such securities are offered for subscription upon exercise
of rights, they may be purchased on or before the fourth day preceding
the day on which the rights offering terminates; or
(ii) if such securities are debt securities, they may be purchased
at a price that is not more than the price paid by each other purchaser
of securities in that offering or in any concurrent offering of the
securities and may be purchased on a day subsequent to the end of the
first day on which any sales are made, provided that the interest rates
on comparable debt securities offered to the public subsequent to the
first day and prior to the purchase are less than the interest rate of
the debt securities being purchased; and
(3) offered pursuant to an underwriting or selling agreement under
which the members of the syndicate are committed to purchase all of the
securities being offered, except if--
(i) such securities are purchased by others pursuant to a rights
offering; or
(ii) such securities are offered pursuant to an over-allotment
option.
(b) The issuer of such securities has been in continuous operation
for not less than three years, including the operation of any
predecessors, unless--
(1) such securities are non-convertible debt securities rated in
one of the four highest rating categories by at least one nationally
recognized statistical rating organization, i.e., Standard & Poor's
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Rating Services, Moody's Investors Service, Inc., Duff & Phelps Credit
Rating Co., or Fitch IBCA, Inc., or their successors (collectively, the
Rating Organizations); or
(2) such securities are issued or fully guaranteed by a person
described in paragraph (a)(1)(i)(A) of this exemption; or
(3) such securities are fully guaranteed by a person who has issued
securities described in (a)(1)(i)(B), (C), or (D) and this paragraph
(b).
(c) The amount of such securities to be purchased by the Asset
Manager on behalf of any single Client Plan or any Pooled Fund, does
not exceed three percent of the total amount of the securities being
offered. Notwithstanding the foregoing, the aggregate amount of any
securities purchased with assets of all Client Plans (including Pooled
Funds) managed by the Asset Manager (or with respect to which the Asset
Manager renders investment advice within the meaning of 29 CFR 2510.3-
21(c)) does not exceed:
(1) 10 percent of the total amount of any equity securities being
offered;
(2) 35 percent of the total amount of any debt securities being
offered that are rated in one of the four highest rating categories by
at least one of the Rating Organizations; or
(3) 25 percent of the total amount of any debt securities being
offered that are rated in the fifth or sixth highest rating categories
by at least one of the Rating Organizations; and
(4) if purchased in an Eligible Rule 144A Offering, the total
amount of the securities being offered for purposes of determining the
percentages for (1)-(3) above is the total of:
(i) the principal amount of the offering of such class sold by
underwriters or members of the selling syndicate to ``qualified
institutional buyers'' (QIBs), as defined in SEC Rule 144A (17 CFR
230.144A(a)(1)); plus
(ii) the principal amount of the offering of such class in any
concurrent public offering.
(d) The consideration to be paid by the Client Plan or Pooled Fund
in purchasing such securities does not exceed three percent of the fair
market value of the total net assets of the Client Plan or Pooled Fund,
as of the last day of the most recent fiscal quarter of the Client Plan
prior to such transaction.
(e) The transaction is not part of an agreement, arrangement, or
understanding designed to benefit the Asset Manager or an affiliate.
(f) The Affiliated Broker-Dealer does not receive, either directly,
indirectly, or through designation, any selling concession or other
consideration that is based upon the amount of securities purchased by
Client Plans pursuant to this exemption. In this regard, the Affiliated
Broker-Dealer may not receive, either directly or indirectly, any
compensation that is attributable to the fixed designations generated
by purchases of securities by the Asset Manager on behalf of its Client
Plans.
(g)(1) The amount the Affiliated Broker-Dealer receives in
management, underwriting or other compensation is not increased through
an agreement, arrangement, or understanding for the purpose of
compensating the Affiliated Broker-Dealer for foregoing any selling
concessions for those securities sold pursuant to this exemption.
Except as described above, nothing in this paragraph shall be construed
as precluding the Affiliated Broker-Dealer from receiving management
fees for serving as manager of the underwriting or selling syndicate,
underwriting fees for assuming the responsibilities of an underwriter
in the underwriting or selling syndicate, or other consideration that
is not based upon the amount of securities purchased by the Asset
Manager on behalf of Client Plans pursuant to this exemption; and
(2) The Affiliated Broker-Dealer shall provide to the Asset Manager
a written certification, signed by an officer of the Affiliated Broker-
Dealer, stating the amount that the Affiliated Broker-Dealer received
in compensation during the past quarter, in connection with any
offerings covered by this exemption, was not adjusted in a manner
inconsistent with Section I, paragraphs (e), (f), or (g), of this
exemption.
(h) In the case of a single Client Plan, the covered transaction is
performed under a written authorization executed in advance by an
independent fiduciary (Independent Fiduciary) of the Client Plan.
(i) Prior to the execution of the written authorization described
in paragraph (h) above, the following information and materials must be
provided by the Asset Manager to the Independent Fiduciary of each
single Client Plan:
(1) a copy of this notice of proposed exemption and of the final
exemption, if granted, as published in the Federal Register;
(2) any other reasonably available information regarding the
covered transactions that the Independent Fiduciary requests; and
(3) a termination form, with instructions specifying how to use the
form, expressly providing that the authorization described in paragraph
(h) may be terminated without penalty by the Independent Fiduciary on
no more than five days' notice.
(j) Subsequent to an Independent Fiduciary's initial authorization
permitting the Asset Manager to engage in the covered transactions on
behalf of a single Client Plan, the Asset Manager will, at least
annually, provide the Independent Fiduciary with another termination
form and the information specified in subparagraph (i)(2) and (3)
above.
(k) In the case of existing plan investors in a Pooled Fund, such
Pooled Fund may not engage in any covered transactions pursuant to this
exemption, unless the Asset Manager has provided the written
information described below to the Independent Fiduciary of each plan
participating in the Pooled Fund. The following information and
materials shall be provided not less than 45 days prior to the Asset
Manager's engaging in the covered transactions on behalf of the Pooled
Fund pursuant to the exemption:
(1) a notice of the Pooled Fund's intent to purchase securities
pursuant to this exemption and a copy of this notice of proposed
exemption and of the final exemption, if granted, as published in the
Federal Register;
(2) any other reasonably available information regarding the
covered transactions that the Independent Fiduciary requests; and
(3) a termination form expressly providing an election for the
Independent Fiduciary to terminate the plan's investment in the Pooled
Fund without penalty to the plan. Such form shall include instructions
specifying how to use the form. Specifically, the instructions will
explain that the plan has an opportunity to withdraw its assets from
the Pooled Fund for a period at least 30 days after the plan's receipt
of the initial notice described in subparagraph (1) above and that the
failure of the Independent Fiduciary to return the termination form by
the specified date shall be deemed to be an approval by the plan of its
continued participation in covered transactions as a Pooled Fund
investor.
For purposes of this paragraph, the requirement that the
authorizing fiduciary be independent of the Asset Manager shall not
apply in the case of an in-house plan sponsored by the Applicant or an
affiliate thereof.
(l) In the case of a plan whose assets are proposed to be invested
in a Pooled Fund subsequent to implementation of the procedures to
engage in the covered transactions, the plan's investment in the Pooled
Fund is subject to the prior written authorization of an Independent
Fiduciary, following the receipt by the Independent Fiduciary of the
materials
[[Page 6239]]
described in subsections (1), (2), and (3) of paragraph (k) and an
explanation of the plan's ability to terminate its investment in the
Pooled Fund. For purposes of this paragraph, the requirement that the
authorizing fiduciary be independent of the Asset Manager shall not
apply in the case of an in-house plan sponsored by the Applicant or an
affiliate thereof.
(m) Subsequent to an Independent Fiduciary's initial authorization
of a plan's investment in a Pooled Fund that engages in the covered
transactions, the Asset Manager will, at least annually, provide the
Independent Fiduciary with a termination form and the information
specified in subparagraph (k)(3) above.
(n) At least once every three months, and not later than 45 days
following the period to which such information relates, the Asset
Manager shall:
(1) furnish the Independent Fiduciary of each single Client Plan,
and of each plan investing in a Pooled Fund, with a report (which may
be provided electronically) disclosing all securities purchased on
behalf of that Client Plan or Pooled Fund pursuant to the exemption
during the period to which such report relates, and the terms of the
transactions, including:
(i) the type of security (including the rating of any debt
security);
(ii) the price at which the securities were purchased;
(iii) the first day on which any sale was made during this
offering;
(iv) the size of the issue;
(v) the number of securities purchased by the Asset Manager for the
specific Client Plan or Pooled Fund;
(vi) the identity of the underwriter from whom the securities were
purchased;
(vii) the spread on the underwriting;
(ix) the price at which any securities purchased during the period
were sold; and
(x) the market value at the end of such period of each security
purchased during the period and not sold;
(2) provide to the Independent Fiduciary written certifications
signed by an officer of the Affiliated Broker-Dealer, as described in
paragraph (g)(2), affirming that, as to each offering covered by this
exemption during the past quarter, the Affiliated Broker-Dealer acted
in compliance with Section I, paragraphs (e), (f), and (g) of this
exemption;
(3) disclose to the Independent Fiduciary that, upon request, any
other reasonably available information regarding the covered
transactions that the Independent Fiduciary requests will be provided,
including, but not limited to:
(i) the date on which the securities were purchased on behalf of
the plan;
(ii) the percentage of the offering purchased on behalf of all
Client Plans and Pooled Funds; and
(iii) the identity of all members of the underwriting syndicate;
and
(4) disclose to the Independent Fiduciary in the next quarterly
report, whether at any time during the preceding quarter, the Asset
Manager was precluded from trading in a security purchased under this
exemption for any period of time because of its status as an affiliate
of the Affiliated Broker-Dealer and the reason for this restriction.
(o) Each single Client Plan shall have total net assets with a
value of at least $50 million. In addition, in the case of a
transaction involving an Eligible Rule 144A Offering on behalf of a
single Client Plan, each such Client Plan shall have at least $100
million in securities, as determined pursuant to SEC Rule 144A (17 CFR
230.144A). In the case of a Pooled Fund, the $50 million requirement
will be met if 50 percent or more of the units of beneficial interest
in such Pooled Fund are held by plans having total net assets with a
value of at least $50 million. For purchases involving an Eligible Rule
144A Offering on behalf of a Pooled Fund, the $100 million requirement
will be met if 50 percent or more of the units of beneficial interest
in such Pooled Fund are held by plans having at least $100 million in
assets and the Pooled Fund itself qualifies as a QIB, as determined
pursuant to SEC Rule 144A (17 CFR 230.144A(a)(F)).
For purposes of the net asset tests described above, where a group
of Client Plans is maintained by a single employer or controlled group
of employers, as defined in section 407(d)(7) of the Act, the $50
million net asset requirement or the $100 million net asset requirement
may be met by aggregating the assets of such Client Plans, if the
assets are pooled for investment purposes in a single master trust.
(p) The Asset Manager qualifies as a ``qualified professional asset
manager'' (QPAM), as that term is defined under Part V(a) of Prohibited
Transaction Exemption 84-14 (49 FR 9494, 9506, March 13, 1984) and, in
addition, has, as of the last day of its most recent fiscal year, total
client assets under its management and control in excess of $5 billion
and shareholders' or partners' equity in excess of $1 million.
(q) No more than 10 percent of the assets of a Pooled Fund, at the
time of a covered transaction, are comprised of assets of employee
benefit plans maintained by the Asset Manager, the Affiliated Broker-
Dealer, or an affiliate for their own employees, for which the Asset
Manager, the Affiliated Broker-Dealer, or an affiliate exercises
investment discretion.
(r) The Asset Manager and the Affiliated Broker-Dealer maintain, or
cause to be maintained, for a period of six years from the date of any
covered transaction such records as are necessary to enable the persons
described in paragraph (s) of this exemption to determine whether the
conditions of this exemption have been met, except that--
(1) no party in interest with respect to a Client Plan, other than
the Asset Manager and the Affiliated Broker-Dealer, shall be subject to
a civil penalty under section 502(i) of the Act or the taxes imposed by
section 4975(a) and (b) of the Code, if such records are not
maintained, or not available for examination, as required by paragraph
(s); and
(2) a prohibited transaction shall not be considered to have
occurred if, due to circumstances beyond the control of the Asset
Manager or the Affiliated Broker-Dealer, such records are lost or
destroyed prior to the end of the six-year period.
(s)(1) Except as provided in subparagraph (2) of this paragraph (s)
and notwithstanding any provisions of subsections (a)(2) and (b) of
section 504 of the Act, the records referred to in paragraph (r) are
unconditionally available at their customary location for examination
during normal business hours by--
(i) any duly authorized employee or representative of the
Department, the Internal Revenue Service, or the SEC; or
(ii) any fiduciary of a Client Plan, or any duly authorized
employee or representative of such fiduciary; or
(iii) any employer of participants and beneficiaries and any
employee organization whose members are covered by a Client Plan, or
any authorized employee or representative of these entities; or
(iv) any participant or beneficiary of a Client Plan, or duly
authorized employee or representative of such participant or
beneficiary;
(2) none of the persons described in paragraphs (s)(1)(ii)-(iv)
shall be authorized to examine trade secrets of the Asset Manager or
the Affiliated Broker-Dealer, or commercial or financial information
which is privileged or confidential; and
(3) should the Asset Manager or the Affiliated Broker-Dealer refuse
to disclose information on the basis that such information is exempt
from disclosure pursuant to paragraph (s)(2)
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above, the Asset Manager shall, by the close of the thirtieth (30th)
day following the request, provide a written notice advising that
person of the reasons for the refusal and that the Department may
request such information.
Section II--Definitions
(a) The term ``the Affiliated Broker-Dealer'' means any broker-
dealer affiliate of the Applicant (as ``affiliate'' is defined in
paragraph (c)) that meets the requirements of this exemption.
(b) The term ``the Asset Manager'' means any asset management
affiliate of the Applicant (as ``affiliate'' is defined in paragraph
(c)) that meets the requirements of this exemption.
(c) The term ``affiliate'' of a person includes:
(1) any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with such person;
(2) any officer, director, partner, employee, or relative (as
defined in section 3(15) of the Act) of such person; and
(3) any corporation or partnership of which such person is an
officer, director, partner, or employee.
(d) The term ``control'' means the power to exercise a controlling
influence over the management or policies of a person other than an
individual.
(e) The term ``Client Plan'' means an employee benefit plan that is
subject to the fiduciary responsibility provisions of the Act and whose
assets are under the management of the Asset Manager, including a plan
investing in a Pooled Fund (as ``Pooled Fund'' is defined in paragraph
(f) below).
(f) The term ``Pooled Fund'' means a common or collective trust
fund or pooled investment fund maintained by the Asset Manager.
(g) The term ``Independent Fiduciary'' means a fiduciary of a
Client Plan who is unrelated to, and independent of, the Asset Manager.
For purposes of this exemption, a Client Plan fiduciary will not be
deemed to be unrelated to, and independent of, the Asset Manager if:
(1) such fiduciary directly or indirectly controls, is controlled
by, or is under common control with the Asset Manager;
(2) such fiduciary, or any officer, director, partner, employee, or
relative of such fiduciary is an officer, director, partner, or
employee of the Asset Manager (or is a relative of such persons); or
(3) such fiduciary directly or indirectly receives any compensation
or other consideration from the Asset Manager for his or her own
personal account in connection with any transaction described in this
exemption.
If an officer, director, partner, or employee of the Asset Manager
(or a relative of such persons), is a director of such Independent
Fiduciary, and if he or she abstains from participation in (A) the
choice of the Plan's investment manager/adviser and (B) the decision to
authorize or terminate authorization for transactions described in
Section I, then paragraph (g)(2) of this Section II, shall not apply.
(h) The term ``security'' shall have the same meaning as defined in
section 2(36) of the Investment Company Act of 1940 (the 1940 Act), as
amended (15 U.S.C. 80a-2(36)(1996)).
(i) The term ``Eligible Rule 144A Offering'' shall have the same
meaning as defined in SEC Rule 10f-3(a)(4) (17 CFR 270.10f-3(a)(4))
under the 1940 Act.
(j) The term ``qualified institutional buyer'' or ``QIB'' shall
have the same meaning as defined in SEC Rule 144A (17 CFR
230.144A(a)(1)) under the 1933 Act.
(k) The term ``Rating Organizations'' means Standard & Poor's
Rating Services, Moody's Investors Service, Inc., Duff & Phelps Credit
Rating Co., or Fitch IBCA, Inc., or their successors.
Signed at Washington, D.C., this 3rd day of February, 2000.
Ivan L. Strasfeld,
Director of Exemption Determinations, Pension and Welfare
BenefitsAdministration, U.S. Department of Labor.
[FR Doc. 00-2856 Filed 2-7-00; 8:45 am]
BILLING CODE 4510-29-P
