EBSA Federal Register Notice
Proposed Exemptions; ACR Homes, Inc. Employee Stock Ownership Plan and Trust (the ESOP) [04/16/2003]
[PDF Version]
Volume 68, Number 73, Page 18685-18704
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
[Application No. D-11146, et al.]
Proposed Exemptions; ACR Homes, Inc. Employee Stock Ownership
Plan and Trust (the ESOP)
AGENCY: Employee Benefits Security Administration, Labor.
ACTION: Notice of proposed exemptions.
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SUMMARY: This document contains notices of pendency before the
Department of Labor (the Department) of proposed exemptions from
certain of the prohibited transaction restrictions of the Employee
Retirement Income Security Act of 1974 (the Act) and/or the Internal
Revenue Code of 1986 (the Code).
Written Comments and Hearing Requests
All interested persons are invited to submit written comments or
requests for a hearing on the pending exemptions, unless otherwise
stated in the Notice of Proposed Exemption, within 45 days from the
date of publication of this Federal Register Notice. Comments and
requests for a hearing should state: (1) the name, address, and
telephone number of the person making the comment or request, and (2)
the nature of the person's interest in the exemption and the manner in
which the person would be adversely affected by the exemption. A
request for a hearing must also state the issues to be addressed and
include a general description of the evidence to be presented at the
hearing.
ADDRESSES: All written comments and requests for a hearing (at least
three copies) should be sent to the Employee Benefits Security
Administration (EBSA), Office of Exemption Determinations, Room N-5649,
U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC
20210. Attention: Application No. ------, stated in each Notice of
Proposed Exemption. Interested persons are also invited to submit
comments and/or hearing requests to EBSA via e-mail or FAX. Any such
comments or requests should be sent either by e-mail to:
``moffittb@pwba.dol.gov'', or by FAX to (202) 219-0204 by the end of
the scheduled comment period. The applications for exemption and the
comments received will be available for public inspection in the Public
Documents Room of the Employee Benefits Security Administration, U.S.
Department of Labor, Room N-1513, 200 Constitution Avenue, NW.,
Washington, DC 20210.
Notice to Interested Persons
Notice of the proposed exemptions will be provided to all
interested persons in the manner agreed upon by the applicant and the
Department within 15 days of the date of publication in the Federal
Register. Such notice shall include a copy of the notice of proposed
exemption as published in the Federal Register and shall inform
interested persons of their right to comment and to request a hearing
(where appropriate).
SUPPLEMENTARY INFORMATION: The proposed exemptions were requested in
applications filed pursuant to section 408(a) of the Act and/or section
4975(c)(2) of the Code, and in accordance with procedures set forth in
29 CFR part 2570, subpart B (55 FR 32836, 32847, August 10, 1990).
Effective December 31, 1978, section 102 of Reorganization Plan No. 4
of 1978, 5 U.S.C. App. 1 (1996), transferred the authority of the
Secretary of the Treasury to issue exemptions of the type requested to
the Secretary of Labor. Therefore, these notices of proposed
[[Page 18686]]
exemption are issued solely by the Department.
The applications contain representations with regard to the
proposed exemptions which are summarized below. Interested persons are
referred to the applications on file with the Department for a complete
statement of the facts and representations.
ACR Homes, Inc. Employee Stock Ownership Plan and Trust (the ESOP)
Located in Roseville, Minnesota
[Application No. D-11146]
Proposed Exemption
The Department is considering granting an exemption under the
authority of 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, 32847, August 10, 1990). If the exemption
is granted, the restrictions of sections 406(a), 406(b)(1) and (b)(2)
of the Act and the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1)(A) through (E) of the
Code, shall not apply to the past sale on August 28, 2001 (the Stock
Redemption), by the ESOP to the ACR Homes, Inc., the sponsoring
employer (the Employer), of 3,600 shares of the Employer's class A
common stock (the Shares) for $511,250 in cash; provided that the
following conditions were satisfied:
(a) The Stock Redemption was a one-time cash transaction;
(b) The ESOP received the fair market value of the Shares as
determined by an independent, qualified appraiser on the date of the
Stock Redemption; and
(c) The ESOP paid no commissions or other expenses associated with
the Stock Redemption.
EFFECTIVE DATE: If granted, this exemption will be effective as of
August 28, 2001.
Summary of Facts and Representations
1. The ESOP was established by the Employer on January 1, 1995 for
the benefit of its employees. Since 1995, the ESOP has been amended and
restated from time to time to comply with the Act, the Code and the
regulations thereunder. Specifically, the ESOP was amended and restated
on January 1, 1998, to reflect the Employer's status as a subchapter
``S'' corporation, as elected under section 1361 of the Code. It is
represented that the ESOP meets the requirements of sections 401(a),
409, and 4975(e)(7) of the Code, as well as the relevant requirements
of the Act.\1\
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\1\ Section 407(d)(6) of the Act defines the term ``employee
stock ownership plan'' as an individual account plan (A) which is a
stock bonus plan which is qualified, or a stock bonus plan and money
purchase plan both of which are qualified, under section 401 of the
Code, and which is designed to invest primarily in qualifying
employer securities, and (B) which meets such other requirements as
the Secretary of the Treasury may prescribe by regulation.
The Department is providing no opinion herein as to whether such
requirements have been met.
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As of November 25, 2002, the ESOP had approximately 350
participants and beneficiaries. James A. Nelson (Mr. Nelson) and
Dorothy Nelson (Mrs. Nelson, collectively; the Nelsons) are trustees of
the ESOP. After the Stock Redemption, Mr. Nelson and Mrs. Nelson
respectively owned 30.5% and 29.5% of the issued and outstanding shares
of the Employer's stock (the Stock). Mr. Nelson is the president of the
Employer. Mrs. Nelson is a vice-president and secretary of the
Employer.
The Employer is a Minnesota corporation that provides residential
services for people with developmental disabilities. The Employer owns
a subsidiary, ACR Mississippi, Inc., that provides similar services.
2. The Employer has only one class of shares of the Stock (a/k/a,
the Class A Shares). As of December 31, 2000 (i.e., before the Stock
Redemption), there were 1,000,000 Class A Shares authorized and a total
of 40,000 shares issued and outstanding with the following ownership:
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Shareholder Type No. of shares % Ownership
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ESOP.......................................... Class A......................... 19,600 49
James Nelson.................................. Class A......................... 10,400 26
Dorothy Nelson................................ Class A......................... 10,400 25
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Total..................................... ................................ 40,000 100
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An appraisal for the Stock dated June 15, 2001 (the Appraisal), was
prepared by the Hawthorne Company, an independent and qualified
appraising firm in Minneapolis, Minnesota. The Appraisal stated that
each Share of the Stock was worth $140, as of December 31, 2000.
Therefore, as of December 31, 2000, the ESOP's ownership interest in
the Stock (i.e., 19,600 shares) was worth $2,744,000.
3. Under a Stock Redemption Agreement dated August 28, 2001 (the
Agreement), the ESOP sold 3,600 shares of the Stock (i.e., the Shares)
to the Employer for a purchase price of $511,200 or $142 per Share.
This purchase price was determined by an update of the Appraisal, as
discussed more fully below. The Employer paid the entire purchase price
in cash.
The applicant represents that the cash received by the ESOP in the
Stock Redemption was immediately credited to the accounts of
participants in proportion to the Shares that were sold from their
accounts in the Stock Redemption.\2\ The applicant represents that the
Stock Redemption was in the best interest of the ESOP's participants
and beneficiaries. The specific reasons are discussed more fully below.
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\2\ For example, if a participant had 100 Shares allocated to
her account and 18 had been redeemed, after the Stock Redemption,
such account would have been allocated an additional $2,556 of cash
(i.e., $142 per share x 18 shares).
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The Employer financed its purchase of the Shares through two
simultaneous sales of 1,800 of newly-issued shares of the Stock to Mr.
Nelson and Mrs. Nelson, respectively, at the same price of $142 per
Share (the Nelson Sale).\3\
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\3\ The applicant represents that the Nelsons were advised, by a
prior law firm (see discussion in Paragraph 7), to structure the
Stock Redemption as a two-step transaction.
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The applicant represents that the Stock Redemption and the Nelson
Sale decreased the ESOP's ownership of the total outstanding Stock of
the Employer from 49% to 40%, and increased the Nelsons' combined
ownership of the Stock from 51% to 60%.
Following the Stock Redemption on August 28, 2001, the total
outstanding shares of the Stock were owned as follows:
[[Page 18687]]
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Number of
Shareholder Type shares % Ownership
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ESOP......................................... Class A......................... 16,000 40
James Nelson................................. Class A......................... 12,200 30.5
Dorothy Nelson............................... Class A......................... 11,800 29.5
Total.................................... ................................ 40,000 100
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4. As stated earlier, the Appraisal was prepared on June 15, 2001
by Hawthorne Company, an independent qualified appraisal firm (the
Appraiser). The Appraisal considered three valuation approaches: (i)
The market approach, (ii) the income approach, and (iii) the asset
approach. In determining fair market value of the Shares, the Appraisal
primarily relied on the income approach. The Appraisal utilized the
single-period capitalization of cash flows method in the valuation of
the Shares. Using this method, the Appraiser generated an estimate of
the long-term sustainable ``free cash flow'' of the Employer, given its
current operating status.\4\
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\4\ The Appraiser defined ``free cash flow'' as all cash
remaining after operating the business, repaying debt, and investing
in fixed assets. Thus, ``free cash flow'' represents the theoretical
dividend paying capacity of the Employer. The Appraiser then applied
an appropriate capitalization multiple to that estimate of cash
flows.
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The Appraiser represents that it utilized an 18% required annual
rate of return in the past valuations of the Shares. Because the
Appraiser did not believe the risk profile of the Employer had changed
since the last valuation, it continued to utilize an 18% required
annual rate of return in the Appraisal. By subtracting an estimate of
long-term growth from the required rate of return, the Appraiser
arrived at a capitalization rate of 9.5%. This capitalization rate of
9.5% was applied to the projected net cash flow figure. Under this
methodology, the Appraisal established a fair market value of a
minority interest in the Stock at $140 per Share as of December 31,
2000.
5. An update to the Appraisal was prepared on August 28, 2001 (the
Update), which was the date of the Stock Redemption. The Update stated
that the ESOP should sell 3,600 Shares to the Employer for the purchase
price of $511,200, or $142 per Share.\5\ In preparing the Update, the
Appraiser reviewed the Employer's current annual financial statements;
the Employer's operational status as of August 28, 2001; the Stock
Redemption Agreement; the Employer's Board of Directors' minutes
approving the Stock Redemption, and subscription agreements between the
Employer and the Nelsons. In addition, the Appraiser held discussions
with representatives of the Employer regarding the current operations,
financial condition, future prospects, projected operations and
performance of the Employer. Finally, the Appraiser considered any
restrictions on transferability associated with the Shares.\6\
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\5\ The Update was actually characterized as a ``fairness
opinion'' by the Appraiser. Under the Update, the Appraiser
concluded that the ESOP would not be receiving less than fair market
value for the Stock. In response to the Department's request for
more specificity regarding the valuation, the Appraiser noted, by
letter dated March 6, 2003, that they were of the opinion that on
August 28, 2001, the fair market value of the Stock was
approximately $141.00 per share.
\6\ The appraiser further maintains that its method of valuation
of the Shares follows the guidelines set forth by the IRS's Revenue
Ruling 59-60, 1959-1 Cum. Bull. 237 [as modified by Rev. Rul 68-609
(1968-2 C.B. 327)] for the valuation of corporate securities. In
addition, the Appraiser followed the guidelines of the Valuation
Advisory Committee of the ESOP Association [incorporating the
Department's Proposed Regulations Relating to the Definition of
``Adequate Consideration'' (see 53 FR 17632; May 17, 1988)], the
Uniform Standards of Professional Appraisal Practice, the American
Society of Appraisers, and the Institute of Business Appraisers.
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6. The Stock Redemption was a one-time cash transaction. The ESOP
did not pay any commissions or other expenses associated with the sale.
The applicant represents that the fair market value of the Shares was
determined by an independent, qualified appraiser at the time of the
transaction. In this regard, the Employer paid the ESOP $142 per Share,
in accordance with the Appraiser's valuation of the Stock, as stated in
the Update, at the time of the transaction. The applicant maintains
that the sale was in the best interest and protective of the ESOP and
its participants and beneficiaries at the time of the transaction.
Among other things, the sale increased the liquidity and
diversification of the ESOP's portfolio. The sale enabled the ESOP to
realize a portion of the gains that had been earned on the investment,
following its acquisition of the Stock in 1996. Specifically, the
transaction allowed the ESOP's participants to realize a reasonable
rate of return from the appreciation of the Stock over a 5-year period.
7. The applicant's current legal counsel states that at the time of
the sale, the Employer was represented by another law firm. The
applicant states that the prior law firm failed to advise the Employer
that the Stock Redemption would be a prohibited transaction under the
Act. In this regard, the applicant maintains that the prior law firm
drafted the legal documents governing all aspects of the Stock
Redemption and the subsequent sale to the Nelsons. The Employer
represents that it understood, from the nature of the prior law firm's
involvement in designing and documenting the transaction, that the law
firm did not see any legal obstacles to completing the transaction.
When the Employer's current legal counsel discovered the prohibited
transaction, the applicant promptly applied to the Department to
request a retroactive exemption.
8. In summary, the applicant represents that the transaction
satisfied the statutory criteria of section 408(a) of the Act and
section 4975(c)(2) of the Code because:
(a) The Stock Redemption was a one-time cash transaction;
(b) The ESOP received the current fair market value for the Shares,
as established by an independent, qualified appraiser;
(c) The ESOP paid no commissions or other expenses associated with
the Stock Redemption; and
(d) The Stock Redemption provided the ESOP and its participants and
beneficiaries with more liquidity, a reasonable rate of return on its
investment in the Stock, and an opportunity to diversify the overall
investment portfolio.
FOR FURTHER INFORMATION CONTACT: Ekaterina A. Uzlyan of the Department
at (202) 693-8540. (This is not a toll-free number.)
Lehman Brothers Holding Inc. (LBHI) and Lehman Brothers Inc. (LBI), et
al. (Collectively, the Applicants) Located in New York, NY
[Application No. D-11164]
Proposed Exemption
Based on the facts and representations set forth in the
application, the Department is considering granting an exemption under
the authority of section 408 of the Act (or ERISA) and section
4975(c)(2) of the Code and in accordance with the procedures set
[[Page 18688]]
forth in 29 CFR Part 2570, Subpart B (55 FR 32836, August 10, 1990).\7\
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\7\ For purposes of this proposed exemption, references to
provisions of Title I of the Act, unless otherwise specified, refer
also to the corresponding provisions of Title II of the Code.
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Section I. Covered 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
April 16, 2003, to the purchase of any securities by LBHI and LBI and
their affiliates, (collectively, the Asset Manager), on behalf of
employee benefit plans (the Client Plans), including Client Plans
investing in a pooled fund (the 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 LBI and its affiliates (collectively, the Affiliated Broker-
Dealer) are 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''
(the Eligible Rule 144A Offering), as defined in SEC Rule l0f-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
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 Section I of this exemption; or
(3) Such securities are fully guaranteed by a person who has issued
securities described in paragraphs (a)(1)(i)(B), (C), or (D) of Section
I, and who has been in continuous operation for not less than three
years, including the operation of any predecessors.
(c) The amount of such securities to be purchased by the Asset
Manager on behalf of a Client Plan 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 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 in purchasing
such securities does not exceed three percent of the fair market value
of the total net assets of the Client Plan, 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
[[Page 18689]]
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(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 of this Section I, the following information and
materials must be provided in hard copy or in electronic form by the
Asset Manager to the Independent Fiduciary of each single Client Plan:
(1) A copy of the notice of proposed exemption and of the final
exemption as published in the Federal Register; and
(2) Any other reasonably available information regarding the
covered transactions that the Independent Fiduciary requests.
(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 continue to be
subject to the requirement to provide any reasonably available
information regarding the covered transactions that the Independent
Fiduciary requests.
(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 in hard copy or in electronic form 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 the notice of proposed
exemption and of the final exemption 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 paragraph (1) of this Section I(k)
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 participation in covered transactions as a
Pooled Fund investor. Further, the instructions will identify the Asset
Manager and its Affiliated Broker-Dealer and state that this exemption
may be unavailable unless the Independent Fiduciary is, in fact,
independent of those persons. Such fiduciary must advise the Asset
Manager, in writing, if it is not an ``Independent Fiduciary,'' as that
term is defined in Section II(g) of this exemption.
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 Applicants or an
affiliate thereof. However, in-house plans must notify the Asset
Manager, as provided above.
(1) 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 described in Section I(k)(1) and (2). 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 Applicants 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 continue to be subject to the
requirement to provide any reasonably available information regarding
the covered transactions that the Independent Fiduciary requests.
(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 this 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;
(viii) The price at which any such securities purchased during the
period were sold; and
(ix) 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 in the quarterly report a
representation that the Asset Manager has received a written
certification signed by an officer of the Affiliated Broker-Dealer, as
described in paragraph (g)(2) of this Section I, affirming that, as to
each offering covered by this exemption during the past quarter, the
Affiliated Broker-Dealer acted in compliance with Section I(e), (f),
and (g) of this exemption, and that a copy of such certification will
be provided to the Independent Fiduciary upon request;
(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;
(4) Disclose to the Independent Fiduciary in the quarterly report,
any instance during the past quarter where the Asset Manager was
precluded for any period of time from selling a security purchased
under this
[[Page 18690]]
exemption in that quarter because of its status as an affiliate of the
Affiliated Broker-Dealer and the reason for this restriction;
(5) Provide explicit notification, prominently displayed in each
quarterly report, to the Independent Fiduciary of a single Client Plan,
that the authorization to engage in the covered transactions may be
terminated, without penalty, by the Independent Fiduciary on no more
than five days' notice by contacting an identified person; and
(6) Provide explicit notification, prominently displayed in each
quarterly report, to the Independent Fiduciary of a plan investing in a
Pooled Fund, that the Independent Fiduciary may terminate investment in
the Pooled Fund, without penalty, by contacting an identified person.
(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 l44A 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 PTE 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 20 percent of the assets of a Pooled Fund, at the
time of a covered transaction, is 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 Section I(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 sanctions
imposed by section 4975(a) and (b) of the Code, if such records are not
maintained, or not available for examination, as required by Section
I(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 Section I(s)
and notwithstanding any provisions of subsections (a)(2) and (b) of
section 504 of the Act, the records referred to in Section I(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;
(ii) Any fiduciary of a Client Plan, or any duly authorized
employee or representative of such fiduciary;
(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 subparagraphs (s)(1)(ii)--(iv)
of this Section I 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 Section I (s)(2) 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 ``Asset Manager'' means any asset management affiliate
of any Applicant (as ``affiliate'' is defined in Section II(c)) that
meets the requirements of this exemption.
(b) The term ``Affiliated Broker-Dealer'' means any broker-dealer
affiliate of any Applicant (as ``affiliate'' is defined in paragraph
(c) of this Section II) that meets the requirements of this exemption.
Such Affiliated Broker-Dealer may participate in an underwriting or
selling syndicate as a manager or member. The term ``manager'' means
any member of an underwriting or selling syndicate who, either alone or
together with other members of the syndicate, is authorized to act on
behalf of the members of the syndicate in connection with the sale and
distribution of the securities being offered, or who receives
compensation from the members of the syndicate for its services as a
manager of the syndicate.
(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 Section
II(f) below).
(f) The term ``Pooled Fund'' means a common or collective trust
fund or pooled investment fund maintained by the Asset Manager.
[[Page 18691]]
(g)(1) The term ``Independent Fiduciary'' means a fiduciary of a
Client Plan who is unrelated to, and independent of, the Asset Manager
and the Affiliated Broker-Dealer. For purposes of this exemption, a
Client Plan fiduciary will be deemed to be unrelated to, and
independent of, the Asset Manager and the Affiliated Broker-Dealer if
such fiduciary represents that neither such fiduciary, nor any
individual responsible for the decision to authorize or terminate
authorization for transactions described in Section I, is an officer,
director, or highly compensated employee (within the meaning of section
4975(e)(2)(H) of the Code) of the Asset Manager or the Affiliated
Broker-Dealer and represents that such fiduciary shall advise the Asset
Manager if those facts change.
(2) Notwithstanding anything to the contrary in this Section II(g),
a fiduciary is not independent if:
(i) Such fiduciary directly or indirectly controls, is controlled
by, or is under common control with the Asset Manager or the Affiliated
Broker-Dealer;
(ii) Such fiduciary directly or indirectly receives any
compensation or other consideration from the Asset Manager or the
Affiliated Broker-Dealer for his or her own personal account in
connection with any transaction described in this exemption;
(iii) Any officer, director, or highly compensated employee (within
the meaning of section 4975(e)(2)(H) of the Code) of the Asset Manager,
responsible for the transactions described in Section I, is an officer,
director, or highly compensated employee (within the meaning of section
4975(e)(2)(H) of the Code) of the Client Plan sponsor or of the
fiduciary responsible for the decision to authorize or terminate
authorization for transactions described in Section I. However, if such
individual is a director of the Client Plan sponsor or of the
responsible 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 this Section II(g)(2)(iii) shall not
apply.
(3) The term ``officer'' means a president, any vice president in
charge of a principal business unit, division or function (such as
sales, administration or finance), or any other officer who performs a
policy-making function for the entity.
(4) In the case of existing Client Plans in a Pooled Fund, at the
time the Asset Manager provides such Client Plans with initial notice
pursuant to this exemption, the Asset Manager will notify the
fiduciaries of such Client Plans that they must advise the Asset
Manager, in writing, if they are not independent, within the meaning of
this Section II(g).
(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)(l996)). For purposes of this exemption,
mortgage-backed or other asset-backed securities rated by a Rating
Organization will be treated as debt securities.
(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 (SEC Rule 144A) (17
CFR 230.144A(a)(1)) under the Securities Act of 1933.
(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.
EFFECTIVE DATE: If granted, this proposed exemption will be effective
as of April 16, 2003.
Summary of Facts and Representations
The Applicants
1. LBHI, a Delaware corporation, is one of the leading global
investment banks. LBHI and its numerous subsidiaries serve
institutional, corporate, retirement plan, government and high net
worth individual clients and customers. The businesses of LBHI and its
subsidiaries include asset management; \8\ capital raising for clients
through securities underwriting and direct placements; corporate
finance and strategic advisory services; merchant banking; securities
sales and trading; research; and the trading of foreign exchange,
derivative products and certain commodities. Hereinafter, LBHI,
together with its affiliates including LBI shall be referred to as the
``Asset Manager'' when discussing their activities relating to
investment advisory and/or investment management services. LBHI and its
affiliates currently have approximately $21 billion in assets under
management. LBI is a wholly owned direct subsidiary of LBHI and is a
U.S. registered broker-dealer.
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\8\ It should be noted that Lincoln Capital Fixed Income
Management Company, LLC, a subsidiary of LBHI, acquired the fixed
income management business of Lincoln Capital Asset Management
Company (Lincoln) as of the close of business on January 31, 2003.
Currently, the fixed income management business of Lincoln has
approximately $27.4 billion in assets under management.
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2. It is represented that the Applicants and their various
affiliates are all regulated by other federal government agencies such
as the SEC, as well as state government agencies, and industry self-
regulatory organizations (e.g., the New York Stock Exchange (NYSE) and
the National Association of Securities Dealers).
Requested Exemption
3. The Applicants request a prohibited transaction exemption that
would permit the purchase of securities by the Asset Manager for its
ERISA-covered Client Plans, including any Pooled Funds, from
underwriting or selling syndicates in which the Affiliated Broker-
Dealer participates as a manager or member. Such purchase would be made
by the Asset Manager for the Client Plans from an underwriter or
broker-dealer, other than the Affiliated Broker-Dealer, and such
Affiliated Broker-Dealer would receive no selling concessions in
connection with the securities sold to the Client Plans. If granted,
the proposed exemption would be effective as the date the proposed
exemption is published in the Federal Register.
4. The Applicants represent that if the Affiliated Broker-Dealer is
a member of an underwriting or selling syndicate, the Asset Manager may
purchase underwritten securities for Client Plans in accordance with
Part III of Class PTE 75-1, (40 FR 50845, October 31, 1975). Part III
of this class exemption provides limited relief from the Act's
prohibited transaction provisions for plan fiduciaries that purchase
securities from an underwriting or selling syndicate of which the
fiduciary or an affiliate is a member. However, such relief is not
available if the Affiliated Broker-Dealer manages the underwriting or
selling syndicate.
5. In addition, regardless of whether a fiduciary or its affiliate
is a manager or merely a member of an underwriting or selling
syndicate, PTE 75-1 does not provide exemptive relief for the purchase
of unregistered securities. This includes those securities that are
purchased by an underwriter for resale to a ``qualified institutional
buyer'' (i.e., a QIB) pursuant to the SEC's Rule 144A under the 1933
Act. Rule 144A is commonly utilized in connection with sales of
securities issued by foreign corporations to U.S. investors that are
QIBs. Notwithstanding the unregistered nature of such shares,
syndicates selling Rule 144A Securities are the functional equivalent
of those selling registered securities.
[[Page 18692]]
6. The Applicants represent that the Affiliated Broker-Dealer
regularly serves as manager of underwriting or selling syndicates for
registered securities, and as a manager or a member of underwriting or
selling syndicates for Rule 144A Securities. Accordingly, the Asset
Manager is currently unable to purchase on behalf of the Client Plans
Rule 144A Securities sold in such offerings, resulting in such Client
Plans being unable to participate in significant investment
opportunities.
7. Since 1975, there has been a significant amount of consolidation
in the financial services industry in the United States. As a result,
there are more situations in which a plan fiduciary may be affiliated
with the manager of an underwriting syndicate.\9\ Further, many plans
have expanded investment portfolios in recent years to include
securities issued by foreign corporations. As a result, the exemption
provided in PTE 75-1, Part III, is often unavailable for purchase of
domestic and foreign securities that may otherwise constitute
appropriate plan investments.\10\
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\9\ For additional information, please see the studies submitted
by the Morgan Guaranty Trust Company of New York and J.P. Morgan
Investment Management Inc. in connection with the exemption
application underlying PTE 2000-25.
\10\ Pursuant to the Gramm-Leach-Bliley Act, signed into law in
November 1999, certain provisions of the Glass-Steagall Act and the
Bank Holding Company Act of 1956, as amended, were repealed. The
effect of such law will likely be further consolidation in the
industry. The law facilitates cross-ownership and control among bank
holding companies and securities firms through the creation of
``financial holding companies'' that are permitted to engage in a
broad range of financial and related activities, including
underwriting and broker-dealer activities.
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Client Plan Investments in Offered Securities
8. The Applicants represent that the Asset Manager makes its
investment decisions on behalf of, or renders investment advice to,
Client Plans pursuant to the governing document of the particular
Client Plan or Pooled Fund and the investment guidelines and objectives
set forth in the management or advisory agreement. Because the Client
Plans are covered by Title I of the Act, such investment decisions are
subject to the fiduciary responsibility provisions of the Act.
9. The Applicants state, therefore, that the decision to invest in
a particular offering 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. The
Applicants further state that, because the Asset Manager's compensation
for its services is generally based upon assets under management, the
Asset Manager has little incentive to purchase securities in an
offering in which the Affiliated Broker-Dealer is an underwriter unless
such a purchase is in the interests of Client Plans. If the assets
under management do not perform well, the Asset Manager will receive
less compensation and could lose clients, costs which far outweigh any
gains from the purchase of underwritten securities.\11\
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\11\ In fact, under the terms of the proposed exemption set
forth below, the Affiliated Broker-Dealer may receive no
compensation or other consideration, direct or indirect, in
connection with any transaction that would be permitted under the
proposed exemption.
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10. The Applicants state that the Asset Manager generally purchase
securities in large blocks because the same investments will be made
across several accounts. If there is a new offering of an equity or
fixed income security that the Asset Manager wishes 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 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 Client Plans.
11. However, absent an exemption, if the Affiliated Broker-Dealer
is a manager of a syndicate that is underwriting a securities offering,
the Asset Manager will be foreclosed from purchasing any securities on
behalf of its Client Plans from that underwriting syndicate. This will
force the Asset Manager to purchase the same securities in the
secondary market. In such a circumstance, the Client Plans may incur
greater costs both because the market price is often higher than the
offering price, and because of transaction and market impact costs. In
turn, this will cause the Asset Manager to forego other investment
opportunities because the purchase price of the underwritten security
in the secondary market exceeds the price that the Asset manager would
have paid to the selling syndicate.
Underwriting of Securities Offerings
12. The Applicants represent that the Affiliated Broker-Dealer
currently 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.
13. The Applicants represent that while, as a legal matter, a
selling syndicate assumes the risk that the underwritten securities
might not be fully sold, as a practical matter, this risk is reduced,
in marketed deals, through ``building a book'' (i.e., taking
indications of interest from potential purchasers) prior to pricing the
securities. Accordingly, there is no 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.
14. Each selling 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.
15. If more than one underwriter is involved in a selling
syndicate, the lead manager, who has been selected by the issuer of the
underwritten securities, contacts other underwriters, and the
underwriters enter into an ``Agreement Among Underwriters.'' Most lead
managers have a standing form of agreement. This document is then
supplemented for the particular deal by sending an ``invitation telex''
or ``terms telex'' that sets forth particular terms to the other
underwriters.
16. The arrangement between the syndicate and the issuer of the
underwritten securities is embodied in an underwriting agreement, which
is signed on behalf of the underwriters by one or more of the managers.
In a firm commitment underwriting, 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
[[Page 18693]]
to pay for a portion of the securities in the event that not all of the
securities are sold.
17. The Applicants represent 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 sufficient
indications of interest to purchase the securities from a sufficient
number of investors to assure that all the securities being offered
will be acquired by investors. 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. In
registered transactions, the underwriters are particularly 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-makers 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.
18. The Applicants represent that the process of ``building a
book'' or soliciting indications of interest occurs as follows: In a
registered equity offering, after a registration statement is filed
with the SEC and, while it is under review by the SEC staff,
representatives of the issuer of the securities and the selling
syndicate managers conduct meetings with potential investors, who learn
about the company and the underwritten securities. Potential investors
also 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 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, the Applicants
represent 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 or the price range modified and the process restarted),
because, if the investors that gave an indication of interest do not
follow through, the underwriters may be reluctant to include them in
future offerings.
19. Assuming that the marketing efforts have produced sufficient
indications of interest, the Applicants represent that the issuer of
the securities and the selling syndicate 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 that have indicated an interest in purchasing securities in
the offering to execute the sales. The Applicants represent 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
employees, officers and directors. Subject to certain exceptions, 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)
20. The Applicants represent 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 the SEC's Rule 415 under the 1933 Act (17 CFR 230.415).\12\
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\12\ 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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21. 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.
22. 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 1934 Act for at least one (1) year.
23. 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
24. The Applicants represent that there are internal policies in
place that restrict contact and the flow of information between
investment management personnel and non-investment management personnel
in the same or affiliated financial service firms. 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.\13\
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\13\ The Insider Trading and Securities Fraud Enforcement Act of
1988 required broker-dealers to maintain and enforce written
policies and procedures that are ``reasonably designed . . . to
prevent 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(b)(3)).
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25. The Applicants represent that their business separation
policies and procedures are also structured 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
[[Page 18694]]
detriment of the Asset Manager's clients.
26. The Applicants represent 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 have an adverse effect on the relationships of the
Affiliated Broker-Dealer and of the Asset Manager with firms that
compete with such affiliate. Therefore, a goal of the Applicants'
business separation policies 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
27. The Applicants represent that the underwriters are compensated
through the ``spread,'' or difference, between the price at which the
underwriters purchase the securities from the issuer and the price at
which the securities are sold to the public. The spread is divided into
three components.
28. 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 between the
managers and the issuer prior to soliciting indications of interest.
Thus, the allocation of the management fee is not reflective of the
amount of securities that a particular manager sells in an offering.
29. 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 of the securities.
30. The first and second components of the ``spread'' 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 generally follows the
allocation of the securities for sales purposes. However, a buyer of
the underwritten securities may designate other broker-dealers (who may
be other underwriters, as well as broker-dealers outside the syndicate)
to receive the selling concessions arising from the securities they
purchase.
31. Securities are allocated for sales purposes into two
categories. The first and larger category is the ``institutional pot,''
which is the pot 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 other broker-dealers. If securities are
sold from the institutional pot, the selling syndicate managers
sometimes receive a portion of the selling concessions, referred to as
a ``fixed designation,'' \14\ 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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\14\ A fixed designation is sometimes referred to as an ``auto
pot split.''
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32. 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.
33. The Applicants assert 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
34. The Applicants represent 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 these securities. However, PTE 75-1, part III, does not cover
Rule 144A Securities. Therefore, absent an exemption, the Asset Manager
is foreclosed from purchasing such securities for its Client Plans in
offerings in which the Affiliated Broker-Dealer participates.
35. The Applicants state that Rule 144A 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.
36. 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 as is
the reason that Rule 144A transactions are generally limited to debt
securities.
37. 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).
38. 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
[[Page 18695]]
(17 CFR 240.10b-5 and section 17(a) of the 1933 Act (15 USA 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.
39. The Applicants represent that this potential liability for
fraud provides a considerable incentive to the issuer of the securities
and the members of the selling 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 sure
the statements made, in light of the circumstances under which they
were made, are not misleading.
40. The Applicants represent 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 limited to contacting QIBs and there are no general
solicitations for buyers (e.g. no general advertising). In addition,
the Affiliated Broker-Dealer's role in these offerings is typically
that of a lead or co-manager. Generally, there are no non-manager
members in a Rule 144A selling syndicate. However, the Applicants
request that the proposed exemption extend to authorization for
situations where the Affiliated Broker-Dealer acts only as a syndicate
member, not as a manager.
41. According to the Applicant, one of the policy objectives of
Rule 144A 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 placements. See SEC
Staff Report on Rule 144A (August 18, 1994), [1994-95 Transfer Binder]
Fed. Sec. L. Rep. ]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
41. In summary, the Applicants represent that the subject
transactions have satisfied or will satisfy the statutory criteria for
an exemption set forth under section 408(a) of the Act because:
(a) The Client Plans have gained or will gain access to desirable
investment opportunities;
(b) In each offering, the Asset Manager has purchased or 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, have
restricted or 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 has been subject to or will be subject to
percentage limitations;
(e) The Affiliated Broker-Dealer has not permitted and will not be
permitted to receive, either directly, indirectly or through
designation, any selling concession with respect to the securities sold
to the Asset Manager for the account of a Client Plan;
(f) Prior to any purchase of securities, the Asset Manager has made
or will make the required disclosures to an Independent Fiduciary of
each Client Plan and obtain written authorization;
(g) The Asset Manager has provided or 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 has been subject or will be subject to a
minimum size requirement of at least $50 million ($100 million for
Eligible Rule 144A offerings),\15\ with certain exceptions for Pooled
Funds; and
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\15\ 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, or Rules 501-508
thereunder;
(ii) The securities are sold to persons that the seller and any
person acting on behalf of the seller reasonably believe to include
QIBs, as defined in Rule 144A; and
(iii) The seller and any person acting on behalf of the seller
reasonably believe that the securities are eligible for resale to
other QIBs pursuant to Rule 144A.
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(i) The Asset Manager is required or will be required to have total
assets under management in excess of $5 billion and shareholders' or
partners' equity in excess of $1 million.
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;\16\ (2) the proposed exemption covers purchases of Rule 144A
Securities;\17\ (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 the following: (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
[[Page 18696]]
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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\16\ 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.
\17\ 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. In Section I, paragraphs (a) and (b) of the proposed exemption
are derived from PTE 75-1, Part III, and provide the following: (1) The
securities \18\ are part of an issue registered under the 1933 Act, or
if exempt from registration under such Act, fall within specified
categories: (a) Issued or guaranteed by the United States; (b) issued
by a bank; (c) exempt from registration under a federal statute other
than the 1933 Act; (d) registered under the 1934 Act; or (e) are part
of an ``Eligible Rule 144A Offering;\19\ (2) the securities are
purchased for not more than the offering price within a specific time
period,\20\ subject to certain specified exceptions for rights
offerings and debt offerings;\21\ (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 (including the operation of any
predecessors), with certain exceptions.
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\18\ 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 2002-41 (67 FR 54487, August 22,
2002), which granted an amendment to these exemptions.
Further, the Department has noted 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)).
\19\ In Section I, 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 in Section I,
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.
\20\ The language regarding the timing of the purchase differs
slightly from PTE 75-1, Part III. This language is based upon Rule
10f-3 (17 CFR 270.10f-3).
\21\ In Section I, 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. In Section I, 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 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: (1) 10
percent for equity securities; (2) 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 (3) 25 percent for debt securities rated in
the fifth or sixth highest rating categories by at least one of the
Rating Organizations.\22\
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\22\ In Section I, 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 than 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) of Section I provides that the consideration to be
paid by the Client Plan in purchasing the offered securities may not
exceed three percent of the fair market value of such Client Plan'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 the SEC Rule 10f-3.
Underwriting Compensation
6. The proposed exemption requires in paragraph (e) of Section I
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.\23\ Paragraph (f) of Section I 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 proposed exemption. 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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\23\ The Department notes that the intent of the condition in
paragraph (e) of Section I of the proposed exemption is 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) of section I provides that the amount the
Affiliated Broker-Dealer receives in management fees, underwriting
fees, or other compensation 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, signed by an
officer of the Affiliated Broker-Dealer, that the Affiliated Broker-
Dealer complied with the underwriting compensation requirements found
in paragraphs (e), (f), and (g) of section I of
[[Page 18697]]
the proposed exemption, in any offering where the Asset Manager
purchased securities for its Client Plans.\24\
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\24\ The certification required in paragraph (g)(2) of Section I
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) of
section I 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.\25\ Prior to, and subsequent to, execution of the written
authorization, the Asset Manager must provide certain disclosures
described in Section I (i), (j), (k), and (m) to an Independent
Fiduciary of each Client Plan.
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\25\ 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 (the 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. In Section I, paragraph (n) of the proposed exemption requires
that at least on a quarterly basis, the Asset Manager provide a report
to an Independent Fiduciary of each Client Plan and of each plan
investing in a Pooled Fund 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).\26\
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\26\ PTE 75-1, Part III, was based, in part, on a prior version
of Rule 10f-3.
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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. However, 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.\27\
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\27\ See Section I(n) of the proposed exemption, below.
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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.
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.\28\
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\28\ 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, 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)).
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12. Further, the Asset Manager must report any instance during the
past quarter where the Asset Manager was precluded from selling any
security purchased under the exemption for any period of time because
of its status as an affiliate of the Affiliated Broker-Dealer. 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,\29\ or the general anti-fraud or anti-
manipulation provisions of the securities laws,\30\ 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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\29\ A security might be put on a restricted list, for example,
if the offering was not completely sold before the security begins
trading in the market. In this instance, the restricted period for
purposes of Regulation M (17 CFR 242.101(a))) continues until all of
the securities are sold.
\30\ 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) of
Section I. 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 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
[[Page 18698]]
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 are necessary
to insure an appropriate level of plan investor sophistication for 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),\31\ 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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\31\ 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.
FOR FURTHER INFORMATION CONTACT: Ms. Silvia Quezada of the Department
at (202) 693-8553. (This is not a toll-free number.)
Goldman, Sachs & Co. and Its Affiliates Located in New York, New York
[Application No. D-11169]
Proposed Exemption
The Department is considering granting an exemption under the
authority of 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 32847, August 10, 1990).
Section I--Transactions
If the exemption is granted, the restrictions of sections
406(a)(1)(A) through (D) of the Act and the sanctions resulting from
application of section 4975 of the Code, by reason of section
4975(c)(1)(A) through (D) of the Code, shall not apply to any purchase
or sale of securities, in the context of a portfolio liquidation or
restructuring, between (i) Goldman, Sachs & Co. (Goldman) and its
current and future affiliates, including certain foreign broker-dealers
or banks (the Foreign Affiliates, as defined in Section III below),
(collectively, the Applicant) and (ii) employee benefit plans (the
Plans) with respect to which the Applicant is a party in interest,
provided that the conditions set forth in Section II are satisfied.
Section II--Conditions
A. The Applicant customarily purchases and sells securities for its
own account in the ordinary course of its business as a broker-dealer
or bank;
B. The Applicant (including an affiliate) does not have
discretionary authority or control with respect to the investment of
the Plan assets involved in the transaction, nor renders investment
advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to
those assets.
Notwithstanding the foregoing, the Applicant may be a directed
trustee (as defined in Section III below) with respect to the Plan
assets involved in the transaction.
In addition, although the Applicant does not have discretionary
authority or control over such Plan assets at the time of the
transaction and has not used its discretion to appoint the transition
broker-dealer, it may act as a fiduciary with respect to the Plan
assets involved in the transaction, solely as: (i) The investment
manager of such assets to be managed as an Index or Model-Driven Fund;
or (ii) the investment manager of such assets who supplies a list of
securities or other investments to be purchased, which list is prepared
without regard to the identity of the broker-dealer and without
reference to the portfolio being liquidated or restructured, and is
substantially the same list that would be provided to other similarly
situated investors with substantially similar investment guidelines and
objectives, or is substantially similar to the investments in existing
portfolios managed in the same style.
Lastly, a transaction will not fail to meet the requirements of
this section if the Applicant is being terminated as a manager of the
Plan assets involved in the transaction, its investment discretion is
terminated prior to the commencement of the portfolio liquidation or
restructuring, and the Applicant has not used its discretion to appoint
the transition broker-dealer;
C. The transaction is a purchase or sale, for no consideration
other than cash;
D. The terms of any transaction are at least as favorable to the
Plan as those obtainable in a comparable arm's length transaction with
an unrelated party;
E. An Independent Fiduciary has given prior approval that the
transaction may be effectuated as a principal transaction and at a
price that--
(1) For an equity security, is specified in advance by the
Independent Fiduciary and is a stated dollar amount, or is based on an
objective measure (as of a specified date or dates), including, but not
limited to, the closing price, the opening price, or the volume-
weighted average price; or
(2) For a fixed income security, is a stated dollar amount, or is
within the bid and asked spread, as of the close of the relevant market
(or another predetermined time on a specified date or dates), as
reported by an independent third party reporting service or a publicly
available electronic exchange or trading system;
F. In the case where the price for any transaction is not based on
an objective measure, the Independent Fiduciary has given prior
approval for the transaction, specifying whether the transaction is to
be agency or principal, either on a security-by-security basis, or
based on the whole portfolio or an identifiable part of the portfolio
(such as all debt securities, all equity securities, all domestic
securities, or the like);
G. All purchases and sales executed on a principal basis are
effected within two days following the Independent Fiduciary's
direction to purchase or sell a given security--except that, with the
approval of the Independent Fiduciary, the Applicant may extend such
initial period for a time not exceeding two additional days, on the
same terms;
H. The Independent Fiduciary is furnished with confirmations
including the relevant information required under Rule 10b-10 of the
Securities Exchange Act of 1934 (the 1934 Act), to the extent required
under Rule 10b-10, as well as a report, within five business days after
the transaction is completed, containing the following information with
respect to each security:
(1) The identity of the security;
(2) The date on which the transaction occurred;
(3) The quantity and price of the securities involved; and
(4) Whether the transaction was executed with the Applicant as
principal or agent;
I. Each Plan shall have total net assets with a value of at least
$100 million. For purposes of the net assets test, where a group of
Plans is maintained by a single employer or controlled group of
employers, as defined in section 407(d)(7) of the Act, the $100 million
net assets requirement may be met by aggregating the assets of such
Plans, if the assets are pooled for investment purposes in a single
master trust;
J. The Applicant complies with all applicable securities or banking
laws relating to the transaction;
K. Any Foreign Affiliate is a registered broker-dealer or bank
subject to regulation by a governmental agency, as described in Section
III, B, and is in
[[Page 18699]]
compliance with all applicable rules and regulations thereof in
connection with any transaction covered by the proposed exemption;
L. Any Foreign Affiliate, in connection with any transaction
covered by the proposed exemption, is in compliance with the
requirements of Rule 15a-6 (17 CFR 240.15a-6) of the 1934 Act, and
Securities and Exchange Commission (SEC) interpretations thereof,
providing for foreign affiliates a limited exemption from U.S. broker-
dealer registration requirements;
M. Prior to any transaction, the Foreign Affiliate enters into a
written agreement with the Plan in which the Foreign Affiliate consents
to the jurisdiction of the courts of the United States for any civil
action or proceeding brought in respect of the subject transactions. In
this regard, the Foreign Affiliate must (i) agree to submit to the
jurisdiction of the United States; (ii) agree to appoint an agent for
service of process in the United States, which may be an affiliate (the
Process Agent); and (iii) consent to service of process on the Process
Agent;
N. The Applicant maintains, or causes to be maintained, within the
United States for a period of six years from the date of any
transaction, such records as are necessary to enable the persons
described in Paragraph O, below, to determine whether the conditions of
the exemption have been met, except that--
(1) A party in interest with respect to a Plan, other than the
Applicant, shall not 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 O; and
(2) This record-keeping condition shall not be violated if, due to
circumstances beyond the Applicant's control, such records are lost or
destroyed prior to the end of the six year period; and
O. Notwithstanding any provisions of subsections (a)(2) and (b) of
section 504 of the Act, the Applicant makes the records referred to in
Paragraph N, above, unconditionally available within the United States
during normal business hours at their customary location to the
following persons or a duly authorized representative thereof: (1) The
Department, the Internal Revenue Service, or the SEC; (2) any fiduciary
of a Plan; (3) any contributing employer to a Plan; (4) any employee
organization any of whose members are covered by a Plan; and (5) any
participant or beneficiary of a Plan. However, none of the persons
described in Items (2) through (5) of this subsection is authorized to
examine the trade secrets of the Applicant, or commercial or financial
information which is privileged or confidential.
Section III--Definitions
A. The term ``Goldman'' means Goldman, Sachs & Co. and its current
and future affiliates, including the Foreign Affiliates (as defined in
Paragraph C, below); each domestic affiliate must be one of the
following: (i) A broker-dealer registered under the 1934 Act; (ii) a
reporting dealer who makes primary markets in securities of the United
States Government or of any agency of the United States Government
(``Government securities'') and reports daily to the Federal Reserve
Bank of New York its positions with respect to Government securities
and borrowings thereon; or (iii) a bank supervised by the United States
or a State. Goldman, including its current and future affiliates,
including the Foreign Affiliates, are collectively referred to herein
as ``the Applicant.''
B. The term ``affiliate'' shall include: (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, or 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 or partner. For purposes of
this definition, the term ``control'' means the power to exercise a
controlling influence over the management or policies of a person other
than an individual.
C. The term ``Foreign Affiliate'' means an affiliate of Goldman
that is subject to regulation as a broker-dealer or bank by: (1) The
Securities and Futures Authority or the Financial Services Authority in
the United Kingdom, (2) the Federal Authority for Financial Services
Supervision, i.e., der Bundesanstalt fuer Finanzdienstleistungsaufsicht
(the BAFin) in Germany, (3) the Ministry of Finance and/or the Tokyo
Stock Exchange in Japan, (4) the Ontario Securities Commission and/or
the Investment Dealers Association, or the Office of the Superintendent
of Financial Institutions, in Canada, (5) the Swiss Federal Banking
Commission in Switzerland, or (6) the Australian Prudential Regulation
Authority or the Australian Securities & Investments Commission, and/or
the Australian Stock Exchange Limited, in Australia, or any
governmental regulatory authority that is a successor in interest to
any such regulator.
D. The term ``security'' shall include equities, fixed income
securities, options on equity or fixed income securities, government
obligations, and any other instrument that constitutes a security under
U.S. securities laws. The term ``security'' does not include swap
agreements or other notional principal contracts.
E. The term ``index'' means a securities index that represents the
investment performance of a specific segment of the public market for
equity or debt securities in the United States and/or foreign
countries, but only if--
(1) The organization creating and maintaining the index is--
(i) Engaged in the business of providing financial information,
evaluation, advice, or securities brokerage services to institutional
clients,
(ii) A publisher of financial news or information, or
(iii) A public securities exchange or association of securities
dealers;
(2) The index is created and maintained by an organization
independent of the Applicant; and
(3) The index is a generally accepted standardized index of
securities that is not specifically tailored for the use of the
Applicant.
F. The term ``Index Fund'' means any investment fund, account, or
portfolio trusteed or managed by the Applicant, in which one or more
investors invest, and--
(1) Which is designed to track the rate of return, risk profile,
and other characteristics of an independently maintained securities
index (as ``index'' is defined in Paragraph E, above) by either (i)
replicating the same combination of securities that compose such index,
or (ii) sampling the securities that compose such index based on
objective criteria and data;
(2) For which the Applicant does not use its discretion, or data
within its control, to affect the identity or amount of securities to
be purchased or sold;
(3) That contains ``plan assets'' subject to the Act, pursuant to
the Department's regulations (see 29 CFR 2510.3-101, Definition of
``plan assets''--plan investments); and
(4) That involves no agreement, arrangement, or understanding
regarding the design or operation of the Fund that is intended to
benefit the Applicant or any party in which the Applicant may have an
interest.
G. The term ``Model-Driven Fund'' means any investment fund,
account, or portfolio trusteed or managed by the Applicant, in which
one or more investors invest, and--
[[Page 18700]]
(1) Which is composed of securities, the identity of which and the
amount of which, are selected by a computer model that is based on
prescribed objective criteria using independent third party data, not
within the control of the Manager, to transform an Index (as defined in
Paragraph E, above);
(2) Which contains ``plan assets'' subject to the Act, pursuant to
the Department's regulations (see 29 CFR 2510.3-101, Definition of
``plan assets''--plan investments); and
(3) That involves no agreement, arrangement, or understanding
regarding the design or operation of the Fund, or the utilization of
any specific objective criteria, that is intended to benefit the
Applicant or any party in which the Applicant may have an interest.
H. The term ``Plan'' means an employee benefit plan that is subject
to the fiduciary responsibility provisions of the Act.
I. The term ``Independent Fiduciary'' means a fiduciary of a Plan
who is unrelated to, and independent of, the Applicant. For purposes of
the proposed exemption, a Plan fiduciary will be deemed to be unrelated
to, and independent of, the Applicant if such fiduciary represents that
neither such fiduciary, nor any individual responsible for the decision
to authorize or terminate authorization for transactions described in
Section I, is an officer, director, or highly compensated employee
(within the meaning of section 4975(e)(2)(H) of the Code) of the
Applicant and represents that such fiduciary shall advise the Applicant
if those facts change.
(1) Notwithstanding anything to the contrary in this Section III,
I, a fiduciary is not independent if:
(i) Such fiduciary directly or indirectly controls, is controlled
by, or is under common control with the Applicant;
(ii) Such fiduciary directly or indirectly receives any
compensation or other consideration from the Applicant for his or her
own personal account in connection with any transaction described in
the proposed exemption;
(iii) Any officer, director, or highly compensated employee (within
the meaning of section 4975(e)(2)(H) of the Code) of the Applicant,
responsible for the transactions described in Section I, is an officer,
director, or highly compensated employee (within the meaning of section
4975(e)(2)(H) of the Code) of the Plan sponsor or the fiduciary
responsible for the decision to authorize or terminate authorization
for transactions described in Section I. However, if such individual is
a director of the Plan sponsor or the responsible fiduciary, and if he
or she abstains from participation in (A) the choice of the Plan's
broker-dealer or bank executing the transactions covered herein, and
(B) the decision to authorize or terminate authorization for
transactions described in Section I, then Section III, I(1)(iii) shall
not apply.
(2) The term ``officer'' means a president, any vice president in
charge of a principal business unit, division or function (such as
sales, administration or finance), or any other officer who performs a
policy-making function for the entity.
J. The term ``directed trustee'' means a Plan trustee whose powers
and duties with respect to any assets of the Plan involved in the
portfolio liquidation or restructuring are limited to (i) the provision
of nondiscretionary trust services to the Plan, and (ii) duties imposed
on the trustee by any provision or provisions of the Act or the Code.
The term ``nondiscretionary trust services'' means custodial services
and services ancillary to custodial services, none of which services is
discretionary. For purposes of the proposed exemption, a person who is
otherwise a directed trustee will not fail to be a directed trustee
solely by reason of having been delegated, by the sponsor of a master
or prototype Plan, the power to amend such Plan.
Effective Date: This proposed exemption, if granted, will be
effective as of February 6, 2003.
Summary of Facts and Representations
1. The Goldman, Sachs entities (the GS Entities) collectively form
a leading global investment banking, securities and investment
management firm that provide a wide range of services worldwide to a
substantial and diversified client base that includes corporations,
financial institutions, governments, and high-net-worth individuals.
The Goldman, Sachs Group, Inc. is a financial holding company
incorporated under Delaware law in May 1999 and headquartered in New
York, New York, and is the parent company of Goldman, Sachs & Co.
(i.e., Goldman) and other principal subsidiaries. As of May 31, 2002,
the GS Entities collectively had approximately $327.2 billion in
assets, and approximately $18.86 billion in shareholders' equity.
2. Goldman's Foreign Affiliates that are covered by the proposed
exemption are subject to regulation as a broker-dealer or bank by the
following: (i) The Securities and Futures Authority or the Financial
Services Authority in the United Kingdom, (ii) the Federal Authority
for Financial Services Supervision, i.e., the BAFin in Germany, (iii)
the Ministry of Finance and/or the Tokyo Stock Exchange in Japan, (iv)
the Ontario Securities Commission and/or the Investment Dealers
Association, or the Office of the Superintendent of Financial
Institutions, in Canada, (v) the Swiss Federal Banking Commission in
Switzerland, or (vi) the Australian Prudential Regulation Authority or
the Australian Securities & Investments Commission, and/or the
Australian Stock Exchange Limited, in Australia, or any governmental
regulatory authority that is a successor in interest to any such
regulator.
The Applicant requests an individual exemption for Goldman and its
current and future affiliates, including the Foreign Affiliates
identified above, which would permit principal transactions with
employee benefit plans (i.e., the Plans), as described herein.
The Applicant represents that the Foreign Affiliates are subject to
regulation by a governmental agency in the foreign country in which
they are located. The Applicant states that registration of a foreign
broker-dealer or bank with the governmental agency in these cases
addresses regulatory concerns similar to those addressed by
registration of a broker-dealer with the SEC under the 1934 Act. The
rules and regulations set forth by the above-referenced agencies and
the SEC share a common objective: the protection of the investor by the
regulation of securities markets. The foreign regulatory regimes have
been described in detail in numerous other exemptions previously
granted by the Department [see, e.g., Prohibited Transaction Exemption
(PTE) 2000-57 (65 FR 56341, September 18, 2000), granted to Goldman,
Sachs & Co.].
Further, the Applicant represents that, in connection with the
transactions covered by the proposed exemption, the Foreign Affiliates'
compliance with any applicable requirements of Rule 15a-6 (17 CFR
240.15a-6) of the 1934 Act (as discussed further in Item 9, below), and
SEC interpretations thereof, providing for foreign affiliates a limited
exemption from U.S. registration requirements, will offer additional
protections to the Plans.
3. The Applicant represents that it customarily purchases and sells
securities for its own account in the ordinary course of its business
as a broker-dealer or bank. Such trades are referred to as principal
transactions. In the subject principal transactions with Plans,
occurring in the context of a portfolio liquidation or restructuring,
[[Page 18701]]
the Applicant may be a party in interest with respect to such Plans.
The Applicant believes that the principal transactions at issue may
fall outside the scope of relief provided by PTE 75-1 (40 FR 50845,
October 31, 1975), Part II,\32\ because that class exemption is
unavailable where the broker-dealer's affiliate is the trustee of a
Plan, even if only a directed trustee. In addition, because PTE 75-1
provides an exemption only for U.S. registered broker-dealers and U.S.
banks, it is unavailable for the Applicant's Foreign Affiliates.\33\
Thus, the Applicant seeks an individual exemption permitting it to
execute principal transactions with Plans in the situations described
above.
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\32\ PTE 75-1, Part II, provides a class exemption, subject to
certain conditions, from section 406(a) of the Act and section
4975(c)(1)(A) through (D) of the Code, for principal transactions
between employee benefit plans and U.S. registered broker-dealers or
U.S. banks that are parties in interest with respect to such plans.
PTE 75-1, Part II(d) states, among other things, that ``such broker-
dealer, reporting dealer or bank is not a fiduciary with respect to
the plan, and such broker-dealer, reporting dealer or bank is a
party in interest or disqualified person with respect to the plan
solely by reason of section 3(14)(B) of the Act or section
4975(e)(2)(B) of the Code, or by reason of a relationship to a
person described in such sections.''
\33\ Goldman, and certain foreign affiliates thereof, obtained
an individual exemption PTE 2000-57 (65 FR 56341, September 18,
2000) from the Department to engage in principal transactions, among
other things, with employee benefit plans, effective April 15, 1999.
In this regard, the Department notes that the relief provided by PTE
2000-57 may not cover the principal transactions described in this
proposed exemption.
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As a condition of the proposed exemption, the Applicant (including
an affiliate) may not have discretionary authority or control with
respect to the investment of the Plan assets involved in the
transaction, nor render investment advice (within the meaning of 29 CFR
2510.3-21(c)) with respect to those assets. However, the Applicant may
be a directed trustee of the Plan (as discussed further in Item 5,
below).
In addition, this condition will be deemed met if the Applicant is
the ``legacy manager'' whose appointment as a manager of plan assets
has been terminated prior to the commencement of the portfolio
liquidation or restructuring, since the legacy manager would not have
been involved in the selection of the ``transition broker-dealer'' and
would no longer be acting as a fiduciary with respect to the assets
involved in the liquidation or restructuring.
This condition will also be met if the Applicant is the
``destination manager,'' who was not involved in the selection of the
transition broker-dealer but provides such broker-dealer with a list of
securities to be purchased for the Plan with the proceeds of the
securities being liquidated, so long as the list represents those
securities in an Index or Model-Driven Fund.
Similarly, this condition will be met if the destination manager
prepares for the Plan sponsor (i.e., the Independent Fiduciary) a list
of securities to be purchased for the Plan with the proceeds of the
securities being liquidated, so long as that list is prepared without
regard to the identity of the transition broker-dealer and without
reference to the portfolio being liquidated or restructured, and is
substantially the same list that would be provided to other similarly
situated investors with substantially similar investment guidelines and
objectives, or is substantially similar to the investments in existing
portfolios managed in the same style.
Thus, the Applicant may be retained as an investment manager for
the Plan with respect to some or all of the portfolio resulting from
the liquidation or restructuring (as discussed further in Item 6,
below), provided that an Independent Fiduciary has given prior approval
for the principal transactions, as part of the liquidation or
restructuring, and the other conditions set forth herein are met.\34\
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\34\ The Department notes that the proposed exemption is
unavailable for any principal transaction occurring upon or after
the Applicant's assumption of responsibility as an investment
manager for the Plan assets that would be involved in such
transaction (notwithstanding the transactions described herein).
Once the transition has been completed and the purchases and sales
have been consummated, the destination manager will then assume
fiduciary responsibility for the portfolio, and the proposed
exemption will not apply to any subsequent principal transactions
with an affiliate, as described herein, unless the manager is
terminated (i.e., a ``legacy'' investment manager).
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4. The Applicant represents that when sponsors of Plans terminate
an investment manager, it is customary to hire a broker-dealer to
liquidate the portfolio of the terminated manager and/or create the
portfolio of the newly hired manager. An Independent Fiduciary,
generally the Plan sponsor, hires a broker-dealer to perform these so-
called ``transition services.'' The Independent Fiduciary instructs the
broker-dealer to purchase or sell a list of securities within a
specified period. The list of securities to be sold is from the
portfolio held by the Plan at the time the manager is terminated. The
list of securities to be purchased is from a list prepared by the new
manager (who may or may not be affiliated with the Applicant).
Generally, the transition broker-dealer takes both the legacy
portfolios and the destination portfolios, matches any securities that
appear in both, and allocates such securities to the appropriate
destination managers ratably. Then the remaining legacy securities are
sold, the cash proceeds placed in the appropriate custody account, and
the destination securities are purchased.
The Applicant represents that, while the Independent Fiduciary may
specify that the transactions are to be executed by the broker-dealer
as agent in markets where such transactions are typical,\35\ it is
often the case that the markets involved require principal
transactions, such as is the case for NASDAQ National Market securities
or fixed income securities.
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\35\ The Applicant represents that where securities are to be
purchased or sold on an agency basis, the Applicant will comply with
the safe harbor provided by 29 CFR 2510.3-21(d) for the execution of
a securities transaction.
Further, the Department notes that PTE 86-128 (51 FR 41686,
November 18, 1986) provides a class exemption permitting, among
other things, persons who serve as fiduciaries for employee benefit
plans to effect or execute securities transactions as an agent for
the plan, provided the conditions set forth therein are met.
---------------------------------------------------------------------------
The Applicant represents that often the Independent Fiduciary and
the transition broker-dealer will agree that certain principal
transactions will be effected at a price determined by an objective
reference outside the control of the transition broker-dealer,
including, but not limited to, the opening or closing price of the
security for the day on the principal exchange on which the security is
traded, the volume-weighted average price \36\ for the day, or the
price as reported by an independent reporting service for that
particular day. In such case, the Applicant represents that the price
at which the principal transaction will occur will be determined by
market forces and not by the broker-dealer.
---------------------------------------------------------------------------
\36\ For purposes of the proposed exemption, the term volume-
weighted average price means the weighted average of the price of
each trade that was reported for the security on a given day.
---------------------------------------------------------------------------
Prior to any transaction that is not based on an objective
reference for pricing, as in the case of a security that is not
publicly traded, the Independent Fiduciary shall specify whether the
transaction is to be agency or principal, either on a security-by-
security basis, or based on the whole portfolio or an identifiable part
of the portfolio (such as all debt securities, all equity securities,
all domestic securities, or the like). According to the Applicant, the
Independent Fiduciary can assess the fairness of pricing for a non-
publicly-traded security by one of the following means: (i) Review the
value at which the security is being carried by the Plan; (ii) review
the price that other dealers are quoting and the prices at which the
[[Page 18702]]
security has been trading in the recent past; or (iii) canvass other
holders of the security regarding an appropriate trading price.
Regardless of the type of investment, any principal transaction
will be for cash, and the terms at least as favorable to the Plan as
those obtainable in a comparable arm's length transaction with an
unrelated party.
5. The Applicant represents that purchases and sales of securities
effected as part of transition services will take place as follows. The
Independent Fiduciary of a Plan, after such due diligence as it deems
appropriate under the circumstances, selects a broker-dealer to
purchase or sell a specified portfolio of securities. Where the broker-
dealer selected is the Applicant and an affiliate of the Applicant is
the directed trustee of the Plan, such affiliate must be a fiduciary
that has no discretionary authority or control with respect to the
investment of the Plan assets involved in the transaction (including
determining the broker-dealer to be hired to provide transition
services for the Plan), nor renders investment advice (within the
meaning of 29 CFR 2510.3-21(c)) with respect to those assets.
The Applicant asserts that permitting it to engage in principal
transactions where one of its affiliates is a directed trustee of a
Plan will provide Plans with additional expert broker-dealers
experienced at transition services from which Plans may choose to
implement changes in investment managers or investment strategies.
In such situations, the Applicant believes it may not be able to
rely on the Department's class exemptions providing relief for
principal transactions. For example, the Applicant believes that the
Independent Fiduciary for the subject transactions is unlikely to be a
``qualified professional asset manager'' (QPAM), as defined in PTE 84-
14, (49 FR 9494, 9506, March 13, 1984),\37\ or an ``in-house asset
manager'' (INHAM), as defined in PTE 96-23 (61 FR 15975, April 10,
1996).\38\
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\37\ PTE 84-14 provides a class exemption, subject to 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.
\38\ PTE 96-23 provides a class exemption, subject to 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 an INHAM.
---------------------------------------------------------------------------
6. Although the Applicant may not have discretionary authority or
control over the Plan assets involved at the time of the transaction,
this condition is not violated and the proposed exemption provides
relief for purchases and sales of securities where the Applicant's
affiliate will serve as the new investment manager for such assets,
where such manager has provided a list of securities to be purchased
for the Plan to the transition broker-dealer, as described below.
Where the destination manager will be managing the assets in an
Index Fund (as defined in Section III, F) or a Model-Driven Fund (as
defined in Section III, G), the list of securities to be purchased is
the optimum portfolio that has been identified by the manager's
computer model, or is a slice of the underlying index, or a slice of
the Fund (taking into account round lots and other conventions).
Where the destination manager of an actively managed portfolio
supplies a list of securities that it would purchase if it were to
receive cash, the transition broker-dealer uses that list to assemble
the desired portfolio prior to the date that the destination manager
assumes responsibility for the portfolio. That list is prepared without
reference to the identity of the transition broker-dealer, without
reference to the portfolio being liquidated, and without reference to
the securities held in inventory by the transition broker-dealer. The
Applicant asserts that compliance with condition II.B(ii) can be
demonstrated by comparison with a list that was provided on the same
day to other similarly situated investors with substantially similar
investment guidelines and objectives or by comparison with the holdings
in existing investment portfolios managed in the same style.
According to the Applicant, the choice of a destination manager of
an actively managed portfolio generally precedes and is separate from
any decision regarding the transition broker-dealer. The Independent
Fiduciary has selected the destination manager on the basis of its
investment style and performance, and the Plan's asset allocation
requirements. The destination manager may introduce the transition
broker-dealer to the Independent Fiduciary but is not responsible for
choosing the transition broker-dealer, nor for giving advice on which
the Independent Fiduciary intends to rely as a primary basis for such
choice. When the transition broker-dealer is selected, the Independent
Fiduciary requests that the destination manager provide the list of
securities to be purchased, which is the same list that the destination
manager would provide to any new client with the same investment style
choices, as described above. The Applicant further represents that the
situation should not present an opportunity for self-dealing on the
part of the transition broker-dealer or destination manager, since the
destination manager would not be acting as a fiduciary with respect to
the buy portfolio until after the portfolio is purchased.\39\
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\39\ The Department notes, and the Applicant concurs, that no
relief would be provided under the proposed exemption for any
violation of section 406(b) of the Act by the destination manager or
transition broker-dealer. In this regard, section 406(b) of the Act
prohibits, among other things, a fiduciary for a plan from dealing
with the assets of the plan in his own interest or for his own
account or acting, in his individual or in any other capacity, in a
transaction involving the plan on behalf of a party (or representing
a party) whose interests are adverse to the interests of the plan or
the interest of its participants or beneficiaries.
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7. Generally, the time period for the transition program is
specified in advance by the Independent Fiduciary as of a date certain,
to be completed by a date certain. The Applicant represents that this
time period may vary, based on the size of the portfolio, but,
generally, does not exceed four business days. As a condition of the
proposed exemption, all purchases and sales executed on a principal
basis must be effected within two days following an Independent
Fiduciary's direction to purchase or sell a given security--except
that, with the approval of the Independent Fiduciary, the Applicant may
extend such initial period for an additional two days, on the same
terms.
8. As previously described in Item 4, above, the Applicant
represents that the Independent Fiduciary often specifies an objective
method or reference for pricing, such as the closing price, opening
price, or the volume-weighted average price for the security on a
particular day. In the fixed income markets, it is generally customary
for an Independent Fiduciary to specify that the price be within the
bid-asked spread, as of the close of the relevant market (or another
predetermined time on a specified date or dates). Such benchmarks
provide an Independent Fiduciary with a basis for measuring the
performance of the broker-dealer and satisfying itself that the Plan
obtained best execution.
The Applicant represents that it will provide the Independent
Fiduciary with confirmations that include the relevant information
required under Rule 10b-10 of the 1934 Act, to the extent required
under Rule 10b-10, as well as a report, within five business days after
any principal transaction, which specifies the security, the date of
the transaction,
[[Page 18703]]
the quantity and price paid or received by the Plan, and the manner of
execution (agency or principal). The Applicant states that such
disclosure is meaningful because it can be verified against objective
prices obtainable through independent pricing services available to the
public.
Only Plans with total assets in excess of $100 million are covered
by the proposed exemption. However, for purposes of the net assets
test, where a group of Plans is maintained by a single employer or
controlled group of employers, as defined in section 407(d)(7) of the
Act, the $100 million net assets requirement may be met by aggregating
the assets of such Plans, if the assets are pooled for investment
purposes in a single master trust.
9. Finally, the Applicant notes that many Plans have expanded their
investment portfolios in recent years to include foreign securities.
With respect to the Foreign Affiliates covered by the proposed
exemption, the Applicant represents that Rule 15a-6 of the 1934 Act
provides an exemption from U.S. registration requirements for a foreign
broker-dealer that induces or attempts to induce the purchase or sale
of any security (including over-the-counter equity and debt options) by
a ``U.S. institutional investor'' or a ``major U.S. institutional
investor,'' provided that the foreign broker-dealer, among other
things, enters into these principal transactions through a U.S.
registered broker or dealer intermediary.
The term ``U.S. institutional investor,'' as defined in Rule 15a-
6(b)(7), includes an employee benefit plan within the meaning of the
Act if:
(a) The investment decision is made by a plan fiduciary, as defined
in section 3(21) of the Act, which is either a bank, savings and loan
association, insurance company or registered investment adviser, or
(b) The employee benefit plan has total assets in excess of $5
million, or
(c) The employee benefit plan is a self-directed plan with
investment decisions made solely by persons that are ``accredited
investors,'' as defined in Rule 501(a)(1) of Regulation D of the
Securities Act of 1933, as amended.
The term ``major U.S. institutional investor,'' as defined in Rule
15a-6(b)(4), includes a U.S. institutional investor that has total
assets in excess of $100 million.\40\ The Applicant represents that the
intermediation of the U.S. registered broker or dealer imposes upon the
foreign broker-dealer the requirement that the securities transaction
be effected in accordance with a number of U.S. securities laws and
regulations applicable to U.S. registered broker-dealers.
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\40\ The Department notes that the categories of entities that
qualify as ``major U.S. institutional investors'' has been expanded
by an SEC No-Action letter. See No-Action Letter issued to Cleary,
Gottlieb, Steen & Hamilton on April 9, 1997 (the April 9, 1997 No-
Action Letter).
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The Applicant represents that under Rule 15a-6, a foreign broker-
dealer that induces or attempts to induce the purchase or sale of any
security by a U.S. institutional or major U.S. institutional investor
in accordance with Rule 15a-6 must, among other things:
(a) Provide written consent to service of process for any civil
action brought by or proceeding before the SEC or a self-regulatory
organization;
(b) Provide the SEC with any information or documents within its
possession, custody or control, any testimony of foreign associated
persons, and any assistance in taking the evidence of other persons,
wherever located, that the SEC requests and that relates to
transactions effected pursuant to the Rule;
(c) Rely on the U.S. registered broker or dealer through which the
principal transactions with the U.S. institutional and major U.S.
institutional investors are effected, among other things, for:
(1) Effecting the transactions, other than negotiating their terms;
(2) Issuing all required confirmations and statements;
(3) As between the foreign broker-dealer and the U.S. registered
broker or dealer, extending or arranging for the extension of any
credit in connection with the transactions;
(4) Maintaining required books and records relating to the
transactions, including those required by Rules 17a-3 (Records to be
Made by Certain Exchange Members) and 17a-4 (Records to be Preserved by
Certain Exchange Members, Brokers and Dealers) of the 1934 Act; \41\
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\41\ The Applicant represents that all such requirements
relating to record-keeping of principal transactions would be
applicable for any Foreign Affiliate in a transaction that would be
covered by the proposed exemption.
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(5) Receiving, delivering, and safeguarding funds and securities in
connection with the transactions on behalf of the U.S. institutional
investor or major U.S. institutional investor in compliance with Rule
15c3-3 (Customer Protection--Reserves and Custody of Securities) of the
1934 Act; \42\ and
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\42\ Under certain circumstances described in the April 9, 1997
No-Action Letter (e.g., clearance and settlement transactions),
there may be direct transfers of funds and securities between a Plan
and a Foreign Affiliate. Please note that in such situations (as in
the other situations covered by Rule 15a-6), the U.S. broker-dealer
will not be acting as a principal with respect to any duties it is
required to undertake pursuant to Rule 15a-6.
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(6) Participating in all oral communications (e.g., telephone
calls) between the foreign associated person and the U.S. institutional
investor, other than a major U.S. institutional investor. Under certain
circumstances, the foreign associated person may have direct
communications and contact with the U.S. institutional investor. (See
April 9, 1997 No-Action Letter.)
10. Prior to any transaction, the Foreign Affiliate will enter into
a written agreement with the Plan in which the Foreign Affiliate
consents to the jurisdiction of the courts of the United States for any
civil action or proceeding brought in respect of the subject
transactions. In this regard, the Foreign Affiliate must (i) agree to
submit to the jurisdiction of the United States; (ii) agree to appoint
a Process Agent for service of process in the United States; and (iii)
consent to service of process on the Process Agent.
11. In summary, the Applicant represents that the proposed
transactions will satisfy the statutory criteria for an exemption under
section 408(a) of the Act for the following reasons:
(a) Permitting the Applicant to engage in principal transactions
where its affiliate is the directed trustee of a Plan will provide
Plans with additional expert broker-dealers experienced at transition
services from which Plans may choose as service providers;
(b) Permitting the Applicant to engage in principal transactions,
as described herein, will provide Plans with more predictable and
verifiable pricing and enable transitions to occur in dealer markets in
a timely and efficient manner, by transferring to the broker-dealer the
risk of adverse execution;
(c) An Independent Fiduciary will give prior approval for the
principal transactions and will monitor the prices received by the Plan
through independent, verifiable means; and
(d) An Independent Fiduciary will ensure that securities assembled
for either an Index or Model-Driven Fund or actively managed portfolio
by a transition broker-dealer affiliated with the destination manager
are consistent with the Plan's investment guidelines and objectives.
FOR FURTHER INFORMATION CONTACT: Ms. Karin Weng of the Department,
telephone (202) 693-8540. (This is not a toll-free number.)
General Information
The attention of interested persons is directed to the following:
[[Page 18704]]
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and/or 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/or 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, among other things, require a fiduciary
to discharge his duties respecting the plan solely in the interest of
the participants and beneficiaries of the plan and in a prudent fashion
in accordance with section 404(a)(1)(b) of the Act; nor does it affect
the requirement of section 401(a) of the Code that the plan must
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/or section 4975(c)(2) of the Code, the Department must find
that the exemption is administratively feasible, in the interests of
the plan and of its participants and beneficiaries, and protective of
the rights of participants and beneficiaries of the plan;
(3) The proposed exemptions, if granted, will be supplemental to,
and not in derogation of, any other provisions of the Act and/or the
Code, including statutory or administrative exemptions and transitional
rules. 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; and
(4) The proposed exemptions, if granted, will be subject to the
express condition that the material facts and representations contained
in each application are true and complete, and that each application
accurately describes all material terms of the transaction which is the
subject of the exemption.
Signed at Washington, DC, this 11th day of April, 2003.
Ivan Strasfeld,
Director of Exemption Determinations, Employee Benefits Security
Administration, U.S. Department of Labor.
[FR Doc. 03-9352 Filed 4-15-03; 8:45 am]
BILLING CODE 4510-29-P