Proposed Exemptions; MS Commodity Investments Portfolio II, L.P. (The Partnership, et al.) [Notices] [11/24/1997]
Proposed Exemptions; MS Commodity Investments Portfolio II, L.P.
(The Partnership, et al.) [11/24/1997]
Volume 62, Number 226, Page 62622-62646[DOCID:fr24no97-91]
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DEPARTMENT OF LABOR
Pension and Welfare Benefits Administration
[Application No. D-10328, et al.]
Proposed Exemptions; MS Commodity Investments Portfolio II, L.P.
(the Partnership, et al.)
AGENCY: Pension and Welfare Benefits 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
request 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
[[Page 62623]]
include a general description of the evidence to be presented at the
hearing.
ADDRESSES: All written comments and request for a hearing (at least
three copies) should be sent to the Pension and Welfare Benefits
Administration, Office of Exemption Determinations, Room N-5649, U.S.
Department of Labor, 200 Constitution Avenue, N.W., Washington, D.C.
20210. Attention: Application No. ________, stated in each Notice of
Proposed Exemption. The applications for exemption and the comments
received will be available for public inspection in the Public
Documents Room of Pension and Welfare Benefits Administration, U.S.
Department of Labor, Room N-5507, 200 Constitution Avenue, N.W.,
Washington, D.C. 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 (43 FR 47713,October 17, 1978) 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 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.
MS Commodity Investments Portfolio II, L.P. (the Partnership) and
Morgan Stanley Commodities Management, Inc. (MSCM, Collectively the
Applicants), Located in New York, NY
[Application Nos. D-10328 and D-10329]
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, August 10, 1990).
Section I. Covered Transactions
If the exemption is granted, the restrictions of section 406(a) 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 (D), shall
not apply, effective April 3, 1996, to the acquisition or redemption of
units (the Units or Unit) in the Partnership by certain plans (the
Plans or Plan) that invest in the Partnership, where MSCM, the general
partner of the Partnership, and/or its affiliates are parties in
interest and/or disqualified persons with respect to such Plans;
provided that the conditions, as set forth below in Section II are
satisfied as of the effective date of this exemption.<SUP>1</SUP>
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\1\ For purposes of this exemption, references to specific
provisions of Title I of the Act, unless otherwise specified, refer
also to the corresponding provisions of the Code.
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Section II. General Conditions
This proposed exemption, if granted, will be subject to the express
condition that the material facts and representations contained in the
applications are true and complete, and that the applications
accurately describe all material terms of the transactions to be
consummated pursuant to the exemption.
(a) Prior to the investment of the assets of a Plan in the
Partnership, a fiduciary of such Plan (the Plan Fiduciary or Plan
Fiduciaries) who is/are independent of MSCM and its affiliates must
approve such investment.
(b) MSCM has determined and documented and will determine and
document, pursuant to a written procedure, that the decision of a Plan
to invest in the Partnership was and will be made by a Plan Fiduciary
who was and is independent of MSCM and its affiliates and who was and
is capable of making an informed investment decision about investing in
the Partnership.
(c) The independent Plan Fiduciary of each Plan investing in the
Partnership has retained and will retain complete discretion with
respect to transactions initiated by such Plan involving the
acquisition or redemption of Units in the Partnership.
(d) Neither MSCM nor its affiliates has any discretionary authority
or control with respect to the investment of assets by Plans in the
Partnership nor renders investment advice (within the meaning of 29 CFR
2510.3-21(c) with respect to the investment of such assets.
(e) No Plan investing in the Partnership has acquired and held or
will acquire or hold Units in the Partnership that represent more than
20 percent (20%) of the assets of the Partnership.
(f) At the time of any acquisition of Units by a Plan, the
aggregate value of the Units acquired and held by such Plan does not
exceed 10 percent (10%) of the assets of such Plan.
(g) At the time transactions are entered into, the terms of such
transactions are at least as favorable to the Plans as those obtainable
in arm's length transactions with an unrelated party.
(h) No Plan has paid or will pay a fee or commission to MSCM or any
of its affiliates by reason of the acquisition or redemption of Units
in the Partnership.
(i) The total fees paid to MSCM have constituted and will
constitute no more than reasonable compensation, within the meaning of
sections 408(b)(2) and 408(c)(2) of the Act.
(j) Only Plans with assets having an aggregate market value of at
least $25 million have been and will be permitted to invest in the
Partnership, except that in the case of two or more Plans maintained by
a single employer or controlled group of employers, the $25 million
dollar requirement may be met by aggregating the assets of such Plans,
if the assets are commingled for investment purposes in a single master
trust.
(k) Prior to making an investment in the Partnership, the
independent Plan Fiduciary of each potential Plan investor, and/or such
Plan investor's authorized representative has been and will be provided
by MSCM or by an affiliate with a written copy of the following
offering materials:
(1) the Private Placement Memorandum of the Partnership (the
Memorandum) (which contains among other things, a description of the
offering of Units, all material facts concerning the purpose,
structure, and operation of the Partnership, as well as any associated
risk factors, and a description of the relationships existing
[[Page 62624]]
between MSCM, Morgan Stanley Asset Management Inc. (MSAM), Morgan
Stanley & Co. Incorporated (MS&Co), and Morgan Stanley Group Inc. (the
MS Group));
(2) the then-current limited partnership agreement (the LP
Agreement) between MSCM and the investors in the Partnership; and
(3) the then-current subscription agreement (the Subscription
Agreement) (an executed copy of which is delivered to a subscriber and/
or its authorized representative as soon as practicable following such
subscriber's investment in the Partnership) and the Investor
Certification previously furnished by MSCM or its affiliates to the
independent Plan Fiduciaries for completion which contains information
about each potential Plan investor, specifies such Plan's proposed
investment in the Partnership, and documents the fact that the
investment decision is being made by an independent Plan Fiduciary who
is capable of making an informed investment decision about investing in
the Partnership.
(l) With respect to the ongoing participation in the Partnership,
the independent Plan Fiduciary of each Plan invested in the Partnership
has received and will receive, within the time periods specified below,
the following additional written disclosures from MSCM or from its
affiliates:
(1) within ninety (90) days after the close of each fiscal year,
audited financial statements of the Partnership, prepared annually by a
qualified, independent, public accountant including:
(i) a balance sheet; (ii) a statement of income or a statement of
loss; (iii) the net asset value of the Partnership, as of the end of
the two preceding fiscal years; (iv) either: (A) the net asset value
per outstanding Unit as of the end of the reporting period or (B) the
total value of each participant's interest in the Partnership as of the
end of such period; (v) a statement of changes in partner's capital;
and (vi) the amount of the total fees paid to MSCM or to its affiliates
by the Partnership during such period.
(2) within thirty (30) days after the end of each calendar month, a
monthly statement of account prepared by MSCM or by its affiliates
containing the following unaudited financial information:
(i) the total amount of realized net gain or loss on commodity
interest positions liquidated during the reporting period; (ii) the
change in unrealized net gain or loss on commodity interest positions
during such reporting period; (iii) the total amount of net gain or
loss from all other transactions in which the Partnership engaged
during such reporting period; (iv) the total amount of management fees,
advisory fees, brokerage commissions, and other fees for commodity
interests and other investment transactions incurred or accrued by the
Partnership during such reporting period; (v) the net assets value of
the Partnership as of the beginning of such reporting period; (vi) the
total amount of additions to Partnership capital made during such
reporting period; (vii) the total amount of withdrawals from and
redemption of Units in the Partnership during such reporting period;
(viii) the total net income or loss of the Partnership during such
reporting period; (ix) the net assets value of the Partnership as of
the end of such reporting period; and (x) either (A) the net asset
value per outstanding Unit as of the end of such reporting period or
(B) the total value of each participant's interest in the Partnership
as of the end of such reporting period.
(m) The Partnership has not engaged and will not engage in swaps
transactions, as defined in Section III(d) below.
(n) The Partnership has not invested in and will not invest in any
entity in which MS Group or any of its affiliates has an ownership
interest.
(o) Affiliates of MSCM have not invested in and will not invest in
the Partnership.
(p) The non-U.S. commodity trading activities of the Partnership
has been and will be limited to the London Metals Exchange (the LME).
(q) The Applicants have not accepted and will not accept
subscriptions from Plans which permit participants to exercise control
over the decision to acquire or redeem Units;
(r) MSCM has maintained and shall maintain, for a period of six
years, the records necessary to enable the persons described in
paragraph (s) of this Section II to determine whether the conditions of
this exemption have been met, except that (a) a prohibited transaction
will not be considered to have occurred if, due to circumstances beyond
the control of MSCM and/or its affiliates, the records are lost or
destroyed prior to the end of the six (6) year period, and (b) no party
in interest or disqualified person other than MSCM shall be subject to
the civil penalty that may be assessed under section 502(i) of the Act,
or to the taxes imposed by section 4975(a) and (b) of the Code, if the
records have not been maintained or are not maintained, or have not
been available or are not available for examination as required by
paragraph (s) of this Section II below.
(s)(1) Except as provided in subsection (2) of this paragraph (s)
and notwithstanding any provisions of subsections (a)(2) and (b) of
section 504 of the Act, the records referred to in paragraph (r) of
this Section II shall be unconditionally available at their customary
location during normal business hours by:
(a) any duly authorized employee or representative of the
Department or the Internal Revenue Service;
(b) any fiduciary of any Plan investing as a limited partner in the
Partnership or any duly authorized representative of such fiduciary;
(c) any contributing employer to any Plan investing as a limited
partner or any duly authorized employee representative of such
employer;
(d) any participant or beneficiary of any participating Plan
investing as a limited partner, or any duly authorized representative
of such participant or beneficiary; and
(e) any other limited partner.
(2) None of the persons described above in subparagraphs (b)-(e) of
paragraph (s)(1) of this Section II shall be authorized to examine the
trade secrets of MSCM or commercial or financial information which is
privileged or confidential.
Section III. Definitions
For purposes of this exemption:
(a) An affiliate of a person includes--
(1) any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control of
such person. (For purposes of this subsection, the term ``control''
means the power to exercise a controlling influence over the management
or policies of a person other than an individual.)
(2) any officer, director, or partner in such person, and
(3) any corporation or partnership of which such person is an
officer, director, or a 5 percent (5%) or more partner or owner.
(b) A Plan or the Plans has not included and will not include any
individual account plan(s) where participants have the right to
exercise control over the decision to acquire or redeem Units.
(c) A Plan Fiduciary or Plan Fiduciaries is defined as a fiduciary
or fiduciaries of a Plan who is/are independent of MSCM and its
affiliates.
(d) A swap transaction is defined as an individually negotiated,
non-standardized agreement between two parties to exchange cash flows
at specified intervals known as payment or
[[Page 62625]]
settlement dates. The cash flows of a swap are either fixed, or
calculated for each settlement date by multiplying the quantity of the
underlying asset (notional principal amount) by specified reference
rates or prices. Depending upon the type of underlying asset, the great
majority of these transactions are classified into interest rate,
currency, commodity, or equity swaps. Interim payments are generally
netted, with the difference being paid by one party to the other.
EFFECTIVE DATE: If the proposed exemption is granted, the exemption
will be effective retroactively, as of April 3, 1996, the date the
Partnership was organized.
Summary of Facts and Representations
1. The MS Group is a publicly-traded company whose shares are
listed on the New York Stock Exchange. The MS Group is a worldwide
financial services firm employing more than 9,000 people which
provides, directly or through its subsidiaries, services to a large and
diversified group of clients and customers, including corporations,
governments, and individual investors.
One subsidiary of the MS Group is MS&Co, a Delaware corporation
with business offices in New York, New York. MS&Co is a registered
futures commission merchant, a member of the National Futures
Associations (NFA), a registered broker-dealer, a member of the
National Association of Securities Dealers, and a member of most major
United States and foreign commodity exchanges.
MSCM, a Delaware corporation, is a wholly-owned subsidiary of the
MS Group. Since June 4, 1992, MSCM has been a registered commodity pool
operator and commodity trading advisor and, as of the same date, has
been a member of the NFA in such capacities. Currently, MSCM serves as
the trading advisor for several U.S. and offshore funds. As of January
31, 1997, MSCM had $10 million in total assets and $8.5 million in
total shareholder's equity. As of January 31, 1997, MSCM had total
assets under management of approximately $130,740,000.
Another wholly-owned subsidiary of the MS Group, MSAM, a Delaware
corporation, is registered with the Securities and Exchange Commission
as an investment adviser, is registered with the Commodity Futures
Trading Commission as a commodity trading advisor, and is a member of
the NFA in such capacity. MSAM also meets the definition of a
``qualified professional asset manager'' as contained in Part V of the
Department's Prohibited Transaction Class Exemption 84-14.<SUP>2</SUP>
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\2\ The final exemption for PTCE 84-14 was published in the
Federal Register on March 13, 1984, (49 FR 9494), and the proposed
exemption was published in the Federal Register on December 21,
1982, (47 FR 56945).
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2. The Partnership is a Delaware limited partnership with offices
in New York, New York. The aggregate fair market value of the total
assets of the Partnership, as of August 15, 1996, was approximately $15
million. The Partnership was organized on April 3, 1996, in order to
trade, buy, sell, or otherwise acquire, hold, or dispose of commodity
futures contracts (the Commodity Interests) on U.S. commodity exchanges
and on non-U.S. commodity exchanges. It is represented that the
Partnership may engage in the business of trading commodity interests
directly or through partnerships, joint ventures, or similar
arrangements.
It is represented that the trading strategy of the Partnership has
been and will be applied to a broad range of commodities, including
commodity interests on metals, energy products, grains, livestock, and
other commodities selected by MSCM from time to time. It is represented
that the assets of the Partnership has consisted and will consist
solely of cash, Treasury securities, and positions with respect to
exchange-traded futures contracts. Further, the Applicants have agreed
as a condition of this exemption that the Partnership will not engage
in swaps transactions, as defined in Section III(d) above.
The Applicants represent that the Partnership has invested and will
invest solely in assets for which independent, objective pricing
information is readily available. In this regard, the Applicants state
that the Partnership's open futures positions are valued by reference
to the closing price for each futures contract on the applicable
commodity exchange. It is represented that the current value of any
Treasury securities has been and will be determined by reference to
prices established in over-the-counter transactions by persons
unaffiliated with MSCM.
It is further represented that the trading strategy of the
Partnership has been and will be limited in the following manner: (a)
The Partnership has maintained and will maintain only long positions in
Commodity Interests; (b) The Partnership has traded and will trade only
futures contracts that are or may be traded on U.S. commodity exchanges
or the LME; (c) the Partnership has not traded and will not trade
interests on financial instruments (including stock indices) and
foreign currencies; (d) the underlying value of the positions entered
into in the commodity interest markets has been and will be targeted at
1.0 times the assets of the Partnership; (e) at the time of the initial
closing and thereafter upon every portfolio reweighting: a minimum of
10 percent (10%) of the Partnership's assets has been and will be
exposed to commodity sectors in energy, precious metals, and base
metals; a maximum of 25 percent (25%) of the Partnership's assets have
been and will be exposed to any one sector; and a maximum of 15 percent
(15%) of the Partnership's assets have been and will be exposed to one
particular commodity.
The Applicants have agreed that as a condition of this exemption,
any non-U.S. commodity trading activities of the Partnership will be
limited to the LME, which is subject to substantial regulation by the
Securities and Futures Authority and the Securities Investment Board in
the United Kingdom.
3. MSCM, as the sole discretionary general partner of the
Partnership, controls, conducts, and manages the business of the
Partnership, including executing various documents on behalf of the
Partnership, determining the distributions, if any, of profits and
income, and supervising the liquidation of the Partnership. It is
represented that the affairs of the Partnership will be wound up and
the Partnership liquidated as soon as practicable upon the first to
occur of: (a) December 31, 2026, or (b) certain other terminating
events, as set forth in the LP Agreement.
In addition, MSCM has retained MSAM, an affiliate of MSCM, as the
trading advisor for the Partnership and cash management advisor with
overall responsibility for the investment of the assets of the
Partnership and for the Partnership's trading. MSAM has selected MSCM
to make trading decisions on behalf of the Partnership of Commodity
Interests on all U.S. exchanges and on the LME. It is represented that
notwithstanding any such delegation, MSAM remains liable to the
Partnership for the trading of Commodity Interests on behalf of the
Partnership, to the same extent as if MSAM alone were making the actual
trading decision regarding such Commodity Interests.
With respect to the trading of Commodity Interests by the
Partnership, MSCM has retained: (1) MS&Co to act as the futures
commission merchant with respect to trading by the Partnership on U.S.
exchanges; and (2) Morgan Stanley International Limited to act as the
futures commission merchant with respect to trading by the Partnership
on the LME. In this regard, the Applicants
[[Page 62626]]
have represented that, in connection with the Partnership's commodity
trading activities, any transaction on the LME with respect to which it
eventuates that an affiliate of MSCM is the formal counterparty, will
be a ``blind transaction'' (i.e., one in which the identity of the
counterparty is not within the knowledge or control of MSCM or any
affiliate thereof). The Applicants represent that, in connection with
any commodity trading on the LME, the Partnership and any affiliates of
MSCM will retain independent floor brokers. Although it is possible
that the Partnership and an affiliate of MSCM will use the same floor
broker, the Applicants represent that MSCM will instruct any floor
broker retained on behalf of the Partnership not to cross trades with
an affiliate of MSCM.
4. The Partnership pays monthly to MSCM an administrative fee (the
Administrative Fee) computed daily and equal to a percentage of the net
assets of the Partnership, as of the beginning of each day (before
deduction of an incentive fee (the Incentive Fee) described below). It
is represented that MSCM, as general partner, is responsible for paying
all of the ordinary administrative expenses, brokerage commissions, any
per transaction service charges, and any other similar fees with
respect to trading by the Partnership. To the extent any expenses
exceed the amount of the Administrative Fee paid to MSCM, the
Partnership is not responsible for the payment of any such additional
expenses. However, it is represented that MSCM received from the
Partnership reimbursement for organizational expenses and initial
offering costs.
Further, the Partnership pays monthly to MSAM for services, as
described above, a management fee (the Management Fee) computed daily
and equal to a percentage of the net assets of the Partnership as of
the beginning of each day, before deduction of the Incentive Fee, as
more fully described in the paragraph below. In consideration for
making trading decisions with respect to the Partnership with regard to
its commodity interest trading, MSAM pays to MSCM 80 percent (80%) of
such Management Fee and 100 percent (100%) of the Incentive Fee.
With respect to the Incentive Fee, it is represented that the
Partnership pays to MSAM at the end of each annual incentive period an
Incentive Fee equal to a percentage of the amount that the
Partnership's net performance exceeds a target return. Net performance
equals the realized and unrealized trading profits and losses of the
Partnership plus interest income credited to the Partnership, less the
Management Fee, the Administrative Fee, and other fees and costs of the
Partnership (but not including the Incentive Fee, initial offering
costs, and extraordinary expenses). Net Performance is measured over a
period of not less than one (1) year. The target return against which
this performance is compared is a predetermined objective index. It is
represented that the calculation of the Incentive Fee complies with the
terms and conditions of SEC Rule 205-3 and is reviewed by an
independent accounting firm as part of an annual audit of the
Partnership's financial statements.<SUP>3</SUP>
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\3\ The Applicants maintain that the Incentive Fee structure,
described herein, is comparable in several respects to the
performance fee arrangements previously reviewed by the Department
of Labor in certain advisory opinion letters, 86-20A. 86-21A, and
89-31A. In this regard, the Applicants have not requested relief for
the receipt of the Incentive Fee by MSAM and/or by its affiliates.
The Department, herein, offers no opinion as to whether the
Incentive Fee structure violates any provision of the prohibited
transaction provisions of section 406 of the Act, nor is the
Department providing relief, herein, for the receipt by MSCM or by
its affiliates of any Incentive Fee.
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5. It is represented that Units in the Partnership have been and
will be offered to investors under exemptions from registration,
pursuant to section 4(2) of the Securities Act of 1933 (the 1933 Act)
and Rule 506 of Regulation D promulgated thereunder.<SUP>4</SUP> It is
represented that, as the Partnership is not a private investment
company, it is not required to limit the number of its investors to
100.
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\4\ Rule 506 provides a special exemption for limited offers and
sales of securities by an issuer without regard to the dollar amount
of the offering. In particular, Rule 506(b)(2)(i) limits to 35 the
number of non-accredited investors in an offering.
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The Memorandum provided for an initial offering of Units in the
Partnership for sale through MS&Co for a period of thirty (30) days
from the date of the Memorandum (i.e., May 23, 1996), subject to the
discretion of MSCM to shorten or extend such period. No minimum amount
of sales of Units was necessary in order for the initial offering to
close. In this regard, it is represented that the date of the initial
closing was July 1, 1996.
Following the initial closing, Units in the Partnership have been
and will be continually offered on a daily basis through MS&Co to new
investors who are qualified and to existing limited partners of the
Partnership in a private offering (the Continuous Offering). In this
regard, the Partnership may continue indefinitely to sell Units,
subject to the discretion of MSCM which may at any time or from time to
time terminate and recommence the offering. The Applicants have agreed,
as a condition of this exemption, that affiliates of MSCM will not be
permitted to invest in the Partnership.
After the initial offering, the minimum investment in the
Partnership per subscriber is $5,000,000, with a $50,000 minimum for
additional investments by existing limited partners in the Partnership,
subject to exceptions at the discretion of MSCM. There is no limit on
the total capitalization of the Partnership. It is represented that as
of April 2, 1997, the capital of the Partnership totaled $25,400,000.
During the Continuous Offering, Units have been and will be issued
as of the close of business each business day at a price per Unit equal
to the net asset value per Unit, as of the date of issuance. The net
asset value of a Unit is defined as net assets allocated to capital
accounts divided by the aggregate number of Units. It is represented
that the net assets of the Partnership are determined in accordance
with generally accepted accounting principles consistently applied
under the accrual basis of accounting. It is represented that the
market values of the Commodity Interests of the Partnership are
determined by MSCM in good faith on a basis consistently applied in
accordance with generally accepted accounting principles.
6. The Applicants maintain that the assets of the Partnership may
be deemed to be plan assets pursuant to 29 CFR 2510.3-101 of
regulations issued by the Department (the Plan Asset Regulations).
Under the Plan Asset Regulations, when a plan acquires an equity
interest in an entity, such as the Partnership, which interest is not a
publicly offered security (as in the case of the Units), nor a security
issued by an investment company registered under the Investment Company
Act of 1940, the underlying assets of the entity will be deemed to
include plan assets, if 25 percent (25%) of the outstanding interests
of such entity are held by ``benefit plan investors,'' as defined in
the Plan Asset Regulations. It is anticipated that prior to the grant
of this proposed exemption the equity participation by Plans in the
Partnership may exceed 25 percent (25%) of the total value of all of
the Partnership Units. If and when such event occurs, the underlying
assets of the Partnership will constitute ``plan assets'' within the
meaning of 29 CFR 2510.3-101. Accordingly, the Applicants have
requested that the exemption be effective, as of April 3, 1996, the
date on which the Partnership was organized.
[[Page 62627]]
7. Once the assets of the Partnership are deemed to be assets of
the Plans which invest in the Partnership, by virtue of its
discretionary authority and control over such assets as general
partner, MSCM becomes a fiduciary within the meaning of section 3(21)
of the Act, and a party in interest, pursuant to section 3(14)(A) of
the Act, with respect to any Plan which invests in the Partnership.
Further, the MS Group anticipates that Plans for which the MS Group
or its affiliates perform services will invest in the Partnership. In
this regard, as set forth in the most recent Memorandum, it is
represented that the MS Group or its affiliates provide: (a) Brokerage
services to plans; (b) asset management and/or investment advisory
services to plans; and (c) services to plans as custodian, clearing
agent, and/or trustee. Accordingly, MSCM may also be a party in
interest with respect to Plans which invest in the Partnership by
virtue of the affiliation of MSCM with other entities that are
fiduciaries of Plans or that provide services to such Plans. It is
further represented that other partners of the Partnership, as yet
unidentified, may also be parties in interest with respect to Plans
which invest in the Partnership.
8. The Applicants seek a retroactive exemption for the acquisition
of Units in the Partnership by Plans from MSCM, the general partner of
the Partnership, and other potential parties in interest with respect
to such Plans, which may constitute prohibited transactions between
such Plans and such parties in interest under section 406(a) of the
Act. In this regard, the acquisition of Units by the Plans may be
characterized as an indirect sale by each existing partner of the
Partnership of a portion of its Partnership interest to such investing
Plan (and a corresponding transfer of Plan assets) in violation of
section 406(a)(1)(A) and/or 406(a)(1)(D) of the Act. Likewise, the
redemption of Units by a Plan may be characterized as an indirect sale
of a portion of such Plan's redeemed interest in the Partnership to
each remaining partner (and a corresponding transfer of Plan assets) in
violation of section 406(a)(1)(A) and/or 406(a)(1)(D) of the Act, if a
party in interest to the Plan is involved. Accordingly, the Applicants
request an administrative exemption from the Department with respect to
the acquisition and redemption of Units in the Partnership by Plan
investors.
As discussed above, the Applicants have represented that MSCM and
its affiliates provide various investment-related services to Plans
that may invest in the Partnership and also provide comparable services
to the Partnership. In this regard, the Applicants are of the opinion
that in the ordinary course of trading of commodities futures, any
prohibited transactions that may arise, other than those for which
relief is proposed herein, would result from the Partnership engaging
in trading through a futures commission merchant that is a party in
interest with respect to a Plan invested in the Partnership. To the
extent that the provision of services by MSCM and its affiliates to the
Partnership constitutes an indirect furnishing of services to Plans
invested in the Partnership which is prohibited under section 406(a) of
the Act, the Applicants intend to rely on the statutory exemption
provided by section 408(b)(2) of the Act.\5\ Furthermore, the
Applicants represent that any brokerage fees paid to affiliates of MSCM
have not and will not be expenses of the Partnership but have been and
will be paid by MSCM. Finally, with respect to the selection of MSCM or
an affiliate to provide services to the Partnership for a fee, the
Applicants represent that neither MSCM nor any of its affiliates have
investment discretion or render investment advice with respect to any
assets of the plans used to purchase Units in the Partnership. As a
result, it is the Applicant's opinion that the furnishing of these
services have not and will not constitute an act of self-dealing
prohibited by section 406(b) of the Act.\6\
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\5\ Section 406(b)(2) of the permits any reasonable arrangement
with a party in interest, for services necessary for the
establishment or operation of a plan, provided that no more than
reasonable compensation is received therefor. The Department express
no opinion, herein, as to whether the provision of services to the
Partnership by MSCM and/or its affiliates and the compensation
received therefor satisfy the terms and conditions of section
408(b)(2) of the Act.
\6\ The Applicants believe that the analysis contained in
Advisory Opinion 82-26A (June 9, 1982) is applicable to the
provision of multiple services by MSCM and/or its affiliates. This
opinion involved the provision of multiple services where a
fiduciary did not use the authority, control, or responsibility
which made it a fiduciary to cause the plan to select such fiduciary
or to pay any fee for the provision of services by such fiduciary.
In addition, the Applicants rely on Advisory Opinion 82-62A
(December 8, 1982) which involved a fiduciary's decision to retain
an affiliate to provide services to a plan, where the fee for such
services was paid by the plan sponsor not by the plan and where the
fiduciary of the plan was not in a position to benefit, or to cause
a person to whom the fiduciary had an interest to benefit from such
decision at the expense of such plan. Thus, the Department is not
offering relief, herein, for the provision of multiple services by
MSCM and/or its affiliates.
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9. At the time the application for exemption was submitted to the
Department, it was represented that the Plans that have been or may be
affected by the grant of this proposed exemption could not be
determined. Upon submission of the application, MSCM represented that
it did not anticipate investment in the Partnership by individual
retirement accounts, by Keogh plans, and or by employee benefit plans
which provide for participant-directed investments. However, the
application did not preclude such investment to the extent that such
plans could satisfy the investor certification requirements and other
conditions, as set forth in the Subscription Agreement. The Applicants
anticipate that sponsors or fiduciaries of plans providing for
participant-directed investment may wish to include Units in a
diversified portfolio that is one of several designated investment
alternatives. However, as a condition of the exemption, the Applicants
have agreed not to accept subscriptions by Plans which permit
participants to exercise control over the decision to acquire or redeem
Units.
10. Only Plans with assets having an aggregate market value of at
least $25 million will be permitted to invest in the Partnership,
except that in the case of two or more Plans maintained by a single
employer or controlled group of employers, the $25 million dollar
requirement may be met by aggregating the assets of such Plans, if the
assets are commingled for investment purposes in a single master trust.
In addition, prior to accepting a subscription from a prospective Plan
investor, the Plan Fiduciaries who are independent of the Applicants
and their affiliates complete certain investor certification
representations in the Subscription Agreement. In this regard, each
Plan and/or its authorized representative is required to represent that
such Plan is an ``accredited investor,'' within the meaning of Rule
501(a) of Regulation D promulgated under the 1933 Act, and a
``qualified eligible participant,'' as defined in Rule 4.7 under the
Commodities Exchange Act, as amended. Each Plan and/or its authorized
representative is also required to represent that such Plan, together
with any advisers retained by it, has sufficient knowledge and
experience in financial and business matters so as to be capable of
evaluating the merits and risks of investing in the
Partnership.<SUP>7</SUP> Furthermore, each
[[Page 62628]]
subscriber that is purchasing Units with the assets of a Plan is
required to represent: (a) That it has evaluated for itself the merits
of the investment; (b) that it has not solicited and has not received
from the Partnership, from MSCM, or from any affiliate thereof any
evaluation or investment advice in respect of the advisability of such
an investment in light of the Plan's assets, cash needs, investment
policies or strategy, overall portfolio, or diversification of assets;
(c) that it is not relying on and has not relied on MSCM, or on any
affiliate thereof, for any such investment advice; and (d) that neither
MSCM nor its affiliates has investment discretion with respect to the
assets of the Plan which have been or will be used to acquire or redeem
Units.<SUP>8</SUP>
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\7\ The Department wishes to note that ERISA's general standards
of fiduciary conduct would apply to the investment described in this
proposed exemption, and that satisfaction of the conditions of this
proposal should not be viewed as an endorsement of the investment by
the Department. Section 404 of ERISA requires, among other things,
that a fiduciary discharge his duties with respect to a plan solely
in the interest of the plan's participants and beneficiaries and in
a prudent fashion. Accordingly, the plan fiduciary must act
prudently with respect to the decision to enter into an investment
transaction. The Department further emphasizes that it expects the
plan fiduciary to fully understand the benefits and risks associated
with engaging in a specific type of investment, following disclosure
to such fiduciary of all relevant information. In addition, such
plan fiduciary must be capable of periodically monitoring the
investment, including any changes in the value of the investment.
Thus, in considering whether to enter into a transaction, a
fiduciary should take into account its ability to provide adequate
oversight of the particular investment.
\8\ The Department is not expressing an opinion on whether the
Applicants or their affiliates would be deemed to be fiduciaries
under section 3(21)(A)(ii) of the Act. In this regard, the
Department believes, as a general matter, that when a person is
deemed a fiduciary by virtue of rendering investment advice
described in regulation section 2510.3-21(c)(1)(ii)(B), the presence
of an unrelated second fiduciary acting on the investment adviser's
recommendations on behalf of the Plan is not sufficient to insulate
the investment adviser from fiduciary liability under section 406(b)
of the Act. The Department's regulation section 2510.3-
21(c)(1)(ii)(B) presupposes the existence of a second fiduciary who
by agreement or conduct manifests a mutual understanding to rely on
the investment adviser's recommendations as a primary basis for the
investment of Plan assets. In the presence of such an agreement or
understanding, the rendering of investment advice involving self-
dealing such as the acquisition of Units in the Partnership which
results in the payment of fees to the adviser, will subject the
investment adviser to liability under section 406(b) of the Act. The
Department is unable to conclude that fiduciary self-dealing of this
type (if present) is in the interests or protective of the Plans and
their participants and beneficiaries. If, however, the unrelated
second fiduciary has not agreed to rely on the investment adviser's
recommendations, the investment adviser will not be deemed to be a
fiduciary under section 3(21)(A)(ii) because the requirements of
regulation section 2510.3-(21)(c)(1)(ii)(B) will not be met.
Accordingly, the Department has limited exemptive relief for the
acquisition or redemption of Partnership Units to section 406(a)
violations only.
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11. Prior to investing in the Partnership, each potential investor
and/or its authorized representative (including a Plan and/or a Plan
Fiduciary) has been and will be provided with a copy of: (a) The
Memorandum (which contains, among other things, a description of the
offering and the relationships existing between MSCM, MSAM, MS&Co, and
the MS Group; (b) the then-current LP Agreement; (c) the then-current
Subscription Agreement (an executed copy of which is also delivered to
a subscriber and or its authorized representative, including a Plan
and/or a Plan Fiduciary, as soon as practicable following investment in
the Partnership by such subscriber). Further, the Applicants represent
that a copy of this notice of proposed exemption (the Notice) and a
copy of the final exemption (the Final Exemption), if granted, will be
provided to all Plans that invest in the Partnership subsequent to the
publication of the Final Exemption in the Federal Register.
12. It is represented that MSCM has distributed and will distribute
to each Plan that invests in the Partnership as a limited partner (a)
within ninety (90) days after the close of each fiscal year of the
Partnership, audited financial statements (including a balance sheet; a
statement of income or a statement of loss; the net asset value of the
Partnership, as of the end of the two preceding fiscal years; either
(A) the net asset value per outstanding Unit as of the end of the
reporting period or (B) the total value of each participant's interest
in the Partnership as of the end of such period; a statement of changes
in partner's capital; and the amount of the total fees paid to MSCM or
to its affiliates by the Partnership during such period.
It is also represented that MSCM has distributed and will
distribute to each Plan that invests in the Partnership as a limited
partner within thirty (30) days after the end of each calender month, a
report for such month specifying, among other things: (i) The total
amount of realized net gain or loss on commodity interest positions
liquidated during the reporting period; (ii) the change in unrealized
net gain or loss on commodity interest positions during such reporting
period; (iii) the total amount of net gain or loss from all other
transactions in which the Partnership engaged during such reporting
period; (iv) the total amount of management fees, advisory fees,
brokerage commissions, and other fees for commodity interests and other
investment transactions incurred or accrued by the Partnership during
such reporting period; (v) the net assets value of the Partnership as
of the beginning of such reporting period; (vi) the total amount of
additions to Partnership capital made during such reporting period;
(vii) the total amount of withdrawals from and redemption of Units in
the Partnership during such reporting period; (viii) the total net
income or loss of the Partnership during such reporting period; (ix)
the net assets value of the Partnership as of the end of such reporting
period; and (x) either (A) the net asset value per outstanding Unit as
of the end of such reporting period or (B) the total value of each
participant's interest in the Partnership as of the end of such
reporting period.
13. It is represented that a capital account is established for
each partner in the Partnership, including the Plans. However, in this
regard, it is represented that investors in the Partnership may not
allocate invested funds to any specific investment. Instead, the funds
raised through the offering of Units have been and will be deposited in
an account maintained by the Partnership with MS&Co or to the extent
the Partnership trades on the LME, deposited in certain accounts
maintained with non-U.S. banks and foreign brokers.
14. Under current federal and state income tax laws, MSCM (in its
capacity as general partner of the Partnership) may be required to
maintain contributions to the capital of the Partnership in cash for
all fiscal years in amounts which equal at least one percent (1%) of
the aggregate capital contributions to the Partnership by all partners
for all fiscal years (including contributions by MSCM). On July 1,
1996, the date of the closing of the initial offering of Units in the
Partnership, MSCM had contributed $120,694 to the Partnership. As of
January 31, 1997, the aggregate contributions by MSCM to the
Partnership totaled $172,000. The Applicants represent that, MSCM will
not maintain an interest in the Partnership that exceeds one percent
(1%) of the aggregate capital contributions to the Partnership by all
partners. In the event that MSCM's interest in the Partnership exceeds
this amount by more than a de minimis amount, MSCM shall, within five
(5) business days, reduce its interest to the permitted level by
accepting additional subscriptions, if possible, or by withdrawing any
portion of its interest in the Partnership that is in excess of one
percent (1%) of the Partnership's capital, as permitted under the LP
Agreement.
15. It is represented that a limited partner in the Partnership,
including a Plan, may sell or transfer Units or any interest therein in
the Partnership only with the consent of MSCM. Such
[[Page 62629]]
consent may be withheld in the sole discretion of MSCM as general
partner of the Partnership.
A limited partner, including a Plan, may withdraw all or part of
its capital contributions and undistributed profits, if any, by
requiring the Partnership to redeem all or part of its Units, effective
as of the close of each business day. Redemptions may only be made in
amounts greater than or equal to $20,000, unless the limited partner,
including a Plan, is redeeming all of its interest in the Partnership.
A limited partner may not make a partial redemption of Units that would
reduce the net asset value of such limited partner's unredeemed Units,
as of the effective date of the redemption, to less than $5,000,000 or
the amount of such limited partner's initial investment, whichever is
less. Requests for redemption must be made by letter in a form
acceptable to MSCM and must be received by MSCM at its offices at least
two full business days prior to the effective date of the redemption.
In addition, MSCM may, in its sole discretion as general partner,
require any limited partner, including a Plan, to redeem all of its
Units or a portion of such Units upon written notice to such limited
partner. No fee or other charge is payable by a limited partner,
including a Plan, upon redemption of its Units. It is represented that
any distributions to a limited partner from the Partnership in
redemption of Units have been and will be made in cash.
16. It is represented that the requested exemption is protective of
the rights of the participants and beneficiaries of affected Plans in
that the decision to invest in the Partnership has been and will be
made by a Plan Fiduciary who is independent of MSCM and its affiliates.
In this regard, such Plan Fiduciaries retain complete discretion with
respect to transactions initiated by a Plan investor involving the
acquisition or redemption of Units. In addition, investors in the
Partnership are furnished with audited financial statements and
periodic reports that enable the Plan Fiduciaries to monitor the
investment activities of the Partnership and permit such parties to
discharge their oversight responsibilities.
Further protections are afforded by appropriate limitations which
are placed on Plan investment in the Partnership. In this regard, no
single Plan investor is permitted under any circumstances to acquire or
hold an amount of Units which causes the investment by such Plan to
exceed 20 percent (20%) of the total assets of the Partnership. In
addition, at the time of any acquisition of Units by a Plan, the
aggregate value of the Units acquired and held by such Plan has not and
will not exceed 10 percent (10%) of the total assets of such Plan.
17. The Applicants maintain that the terms and conditions of this
proposed exemption provide additional safeguards for the protection of
Plans which invest in the Partnership. In this regard, as a condition
of this exemption, MS&Co and its affiliates have agreed that the
Partnership has not invested and will not invest in any entity in which
MS&Co or any of its affiliates has an ownership interest. In addition,
the Partnership has not engaged and will not engage in swaps
transactions, as defined in Section III (d) above, nor does the
Partnership anticipate making any investment in U.S. or off-shore
funds. Furthermore, it is represented that the Partnership does not
anticipate making any equity investments in entities for which a party
in interest with respect to any Plan invested in the Partnership has an
ownership interest.
18. The Applicants represent that the requested exemption would be
administrative feasible, because the transactions involved have been
and will be well-documented through professionally maintained books and
records which are subject to government review and independent,
certified audits. As such, it is represented that the transactions can
be readily monitored to ensure compliance with the terms of the
exemption. In addition, the Applicants have borne and will bear all of
the costs of the exemption applications and will be responsible for the
costs of notifying interested persons.
19. It is represented that the requested exemption is in the
interest of the affected Plans (and their participants and
beneficiaries) in that the Partnership provides Plans with the type of
investment medium and risk factors that such Plans desire in their
investment portfolios.
Moreover the transactions are in the interest of the Plans which
invest in the Partnership, because no placement fee or other sales
charge has been or will be payable by the Partnership or by investors
in connection with the offering of the Units. In addition, Plans have
been and will be permitted to redeem their investments in the
Partnership upon reasonably short notice, without the payment of fees
or penalties of any sort. In this regard, it is represented that MSCM,
MSAM, MS&Co, the MS Group or their affiliates do not receive any fees
in connection with the acquisition or redemption of Units by Plan
investors.
20. In summary, it is represented that the proposed transactions
meet the statutory criteria for an exemption under section 408(a) of
the Act and section 4975(c)(2) of the Code because:
(a) The participation by Plans in the Partnership has been and will
be approved by Plan Fiduciaries prior investment by Plans in the
Partnership;
(b) The Applicants have instituted and maintained and will
institute and maintain a written procedure and records establishing
criteria for determining that the Plan Fiduciaries are independent of
the Applicants and their affiliates and are sufficiently knowledgeable
to make an informed decision regarding the investment by Plans in the
Partnership;
(c) A Plan Fiduciary maintains complete discretion with respect to
acquiring or redeeming Units in the Partnership on behalf of a Plan;
(d) Neither MSCM nor its affiliates has any discretionary authority
or control with respect to the investment of assets of the Plans in
Units of the Partnership nor renders investment advice with respect to
the investment of those assets;
(e) No Plan has acquired and held or will acquire or hold Units in
the Partnership that represents more than 20 percent (20%) of the
assets of the Partnership;
(f) At the time of any acquisition of Units by a Plan, the
aggregate value of the Units acquired or held by such Plan has not and
will not exceed 10 percent (10%) of the assets of such Plan;
(g) The terms of each acquisition or redemption of Partnership
Units has been and will be at least as favorable to an investing Plan
as those obtainable in an arm's length transaction with an unrelated
party;
(h) No Plan has paid or will pay a fee or commission by reason of
the acquisition or redemption of Partnership Units;
(i) The total fees paid to MSCM or their affiliates with respect to
services rendered have constituted and will constitute no more than
reasonable compensation, within the meaning of sections 408(b)(2) and
408(c)(2) of the Act;
(j) Only Plans with assets having an aggregate market value of at
least $25 million have been and will be permitted to invest in the
Partnership, except that in the case of two or more Plans maintained by
a single employer or controlled group of employers, the $25 million
dollar requirement may be met by aggregating the assets of such Plans,
if the assets are commingled for investment purposes in a single master
trust.
[[Page 62630]]
(k) The Applicants have made and will make periodic written
disclosures to Plans with respect to the financial condition of the
Partnership;
(l) The Partnership has not engaged and will not engage in swaps
transactions, as defined in Section III(d) above;
(m) The Partnership has not invested and will not invest in any
entity in which MS&Co or any of its affiliates has an ownership
interest;
(n) Affiliates of MSCM have not invested in and will not invest in
the Partnership;
(o) The non-U.S. commodity trading activities of the Partnership
has been and will be limited to the LME;
(p) The Applicants have not accepted and will not accept
subscriptions by Plans which permit participants to exercise control
over the decision to acquire or redeem Units; and
(q) As of the effective date of this exemption and thereafter, MSCM
has maintained and shall maintain for a period of time the records
necessary to enable certain persons to determine whether the conditions
of this exemption have been met.
Notice to Interested Persons
Those persons who may be interested in the pendency of the
requested exemption will include prospective Plan investors, and Plan
Fiduciaries of Plans which have already invested in the Partnership.
Because the Applicants are uncertain as to which Plans will invest in
the Partnership, the Department has determined that the only practical
form of providing notice to interested persons of the pendency of this
proposed exemption is the distribution by the Applicants of a copy of
the Notice, as published in the Federal Register, and a copy of the
supplemental statement, in the form set forth in the Department's
regulations under 29 CFR Sec. 2570.43(b)(2) to any Plan investors who
at the time the Notice is published are interested in investing in the
Partnership, and to the fiduciaries of all Plans that are invested in
the Partnership at the time the Notice is published. Such distribution
will be effected by first-class mail within fifteen (15) days of the
publication of the Notice in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Angelena C. Le Blanc of the
Department, telephone (202) 219-8883. (This is not a toll-free number.)
National Rural Utilities Cooperative Finance Corporation (CFC), Located
in Washington, D.C.
[Application No. D-10394]
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).
Section I--Transactions
A. If this proposed exemption is granted, effective November 18,
1997, the restrictions of sections 406(a) of the Act and the taxes
imposed by section 4975(a) and (b) of the Code, by reason of section
4975(c)(1)(A) through (D) of the Code, shall not apply to the following
transactions relating to the refinancing by CFC of certain rural
utility cooperative loans made to the Kansas Electric Power
Cooperative, Inc. (KEPCO), and certain notes issued by KEPCO in
connection with such loans which are assigned to trusts for which CFC
acts as servicer, and certificates evidencing interests in such trusts:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between CFC or an
underwriter and an employee benefit plan when CFC, the underwriter, or
the trustee is a party in interest with respect to such plan;
(2) The direct or indirect acquisition or disposition of
certificates by a plan in the secondary market for such certificates;
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.A.(1) or (2); and
(4) The purchase by CFC of existing notes issued by KEPCO from the
existing trusts and the contribution by CFC of new notes to new trusts
pursuant to the refinancing of KEPCO's existing loans on the scheduled
refinancing date (i.e. December 18, 1997).
B. If the proposed exemption is granted, effective November 18,
1997, the restrictions of sections 406(a) and 406(b) of the Act and the
taxes imposed by section 4975(a) and (b) of the Code, by reason of
section 4975(c) of the Code, shall not apply to transactions in
connection with the servicing, management and operation of a trust,
provided:
(1) Such transactions are carried out in accordance with the terms
of a binding trust agreement; and
(2) The trust agreement is provided to, or described in all
material respects in, the prospectus or private placement memorandum
provided to investing plans before they purchase certificates issued by
the trust.<SUP>9</SUP>
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\9\ In the case of a private placement memorandum, such
memorandum must contain substantially the same information that
would be disclosed in a prospectus if the offering of the
certificates were made in a registered public offering under the
Securities Act of 1933. In the Department's view, the private
placement memorandum must contain sufficient information to permit
plan fiduciaries to make informed investment decisions.
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C. If this proposed exemption is granted, effective November 18,
1997, the restrictions of sections 406(a) of the Act and the taxes
imposed by sections 4975(a) and (b) of the Code, by reason of sections
4975(c)(1)(A) through (D) of the Code, shall not apply to any
transactions to which those restrictions or taxes would otherwise apply
merely because a person is deemed to be a party in interest or
disqualified person (including a fiduciary) with respect to a plan by
virtue of providing services to the plan (or by virtue of having a
relationship to such service provider described in section 3(14)(F),
(G), (H) or (I) of the Act or section 4975(e)(2)(F), (G), (H) or (I) of
the Code), solely because of the plan's ownership of certificates
issued pursuant to this proposed exemption or issued pursuant to
Prohibited Transaction Exemption 89-93 (PTE 89-93, 54 FR 45816, October
31, 1989).<SUP>10</SUP>
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\10\ PTE 89-93 permits, as of July 22, 1987, certain
transactions between CFC and employee benefit plans where CFC may be
deemed to be a party in interest with respect to the plans as a
result of providing services to a trust in situations where the
assets of the trust are considered to be ``plan assets'' as a result
of the plans acquiring significant ownership interests in the trust
in the form of pass-through certificates.
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Section II--General Conditions
A. The relief described under Section I of this proposed exemption
will be available only if the following conditions are met:
(1) The acquisition of certificates by a plan is on terms
(including the certificate price) that are at least as favorable to the
plan as they would be in an arm's-length transaction with an unrelated
party;
(2) The rights and interests evidenced by the certificates are not
subordinated to the rights and interests evidenced by other
certificates of the same trust;
(3) The certificates acquired by the plan have received a rating at
the time of such acquisition that is in one of the three highest
generic rating categories from either Standard & Poor's Ratings Service
(S&P's) or Moody's Investors Service, Inc. (Moody's; together, the
Rating Agencies);
(4) The trustee is not an affiliate of any other member of the
Restricted
[[Page 62631]]
Group. However, the trustee shall not be considered to be an affiliate
of CFC, as servicer, solely because the trustee has succeeded to the
rights and responsibilities of CFC pursuant to the terms of a trust
agreement providing for such succession upon the occurrence of one or
more events of default by CFC;
(5) The sum of all payments made to and retained by the
underwriters in connection with the distribution or placement of
certificates represents not more than reasonable compensation for
underwriting or placing the certificates; the sum of all payments made
to and retained by CFC, as sponsor, pursuant to the assignment of
obligations (or interests therein) to the trust represents not more
than the fair market value of such obligations (or interests); and the
sum of all payments made to and retained by CFC, as servicer,
represents not more than reasonable compensation for CFC's services
under the trust agreement and reimbursement of CFC's reasonable
expenses in connection therewith;
(6) The plan investing in such certificates is an ``accredited
investor'' as defined in Rule 501(a)(1) of Regulation D of the
Securities and Exchange Commission (SEC) under the Securities Act of
1933;
(7) Any swap transaction entered into by KEPCO which is assigned to
a trust is entered into with a bank or other financial institution of
high credit standing, initially Morgan Guaranty Trust Company of New
York (Morgan), with a credit rating of at least AA or an equivalent
rating from the Rating Agencies;
(8) The bank or other financial institution acting as the swap
counterparty to the trust is required, if there is an adverse change in
such counterparty's credit rating, to either: (i) Post collateral with
the trustee of the trust in an amount, determined daily, equal to all
payments owed by the counterparty if the swap transaction were
terminated; or (ii) find a replacement swap counterparty for the trust,
within a specified period under the terms of the swap agreement with
the trust, which has a credit rating of at least AA or an equivalent
rating from the Rating Agencies; provided that if the swap counterparty
fails to abide by its obligations under either (i) or (ii) above, the
swap agreement shall terminate in accordance with the rights and
obligations of each counterparty under the terms thereof, which shall
be enforced by the trustee to protect the rights of certificateholders
of such trust;
(9) Each swap transaction between a trust and Morgan, or other swap
counterparty, in connection with the refinancing of KEPCO's loans
requires payments to be made to the trust monthly (or at such other
times as required under the swap agreement) and requires payments to be
made by the trust no less frequently than semi-annually, but in no
event shall the trust be obligated to make payments to a swap
counterparty more frequently than those which it is entitled to receive
from a swap counterparty;
(10) The certificateholders have the right to exit the transaction
by tendering the certificates to an underwriter (initially, Alex. Brown
& Sons, Inc.) for purchase at par (plus accrued interest) on seven (7)
days' notice;
(11) The U.S. Government guarantees the payment of principal and
interest on the loans made by CFC to KEPCO;
(12) The purchase of notes issued by KEPCO from the existing trusts
is for a price which is at least equal to the outstanding principal
balance of such notes, plus accrued (but unpaid) interest, at the time
of the scheduled refinancing of the loans made by CFC to KEPCO (i.e.
December 18, 1997); and
(13) The certificates are not sold to any plans established and
maintained by KEPCO or CFC, or to plans for which any other member of
the Restricted Group (as defined in Section III.E. below) is an
investment fiduciary for the assets of the plan that are to be invested
in the certificates.
B. Neither CFC nor the trustee shall be denied the relief that
would be provided under Section I of this proposed exemption if the
provision of Section II.A.(6) above is not satisfied with respect to
acquisition or holding by a plan of such certificates, provided that:
(1) Such condition is disclosed in the prospectus or private placement
memorandum; and (2) in the case of a private placement of certificates,
the trustee obtains a representation from each initial purchaser which
is a plan that it is in compliance with such condition, and obtains a
covenant from each initial purchaser to the effect that, so long as
such initial purchaser (or any transferee of such initial purchaser's
certificates) is required to obtain from its transferee a
representation regarding compliance with the Securities Act of 1933,
any such transferees will be required to make a written representation
regarding compliance with the condition set forth in Section II.A.(6)
above.
Section III--Definitions
For purposes of this proposed exemption:
A. Certificate means:
(1) A certificate--
(a) That represents a beneficial ownership interest in the assets
of a trust; and
(b) That entitles the holder to pass-through payments of principal,
interest, and/or other payments made with respect to the assets of such
trust.
For purposes of this proposed exemption, references to
``certificates representing an interest in a trust'' include
certificates denominated as debt which are issued by a trust.
B. Trust means an investment pool, the corpus of which is held in
trust, and consists solely of:
(1) One or more notes issued by KEPCO which shall be guaranteed as
to payment of principal and interest by the U.S. Government, acting
through the U.S. Department of Agriculture's Administrator of the Rural
Utilities Service (RUS), including fractional undivided interests in
any such obligations;
(2) Property which has secured any of the obligations described in
subsection B.(1);
(3) Undistributed cash or temporary investments made therewith
maturing no later than the next date on which distributions are to be
made to certificateholders; and
(4) Rights of the trustee under the trust agreement, and rights
under any insurance policies, third-party guarantees, swap agreements,
contracts of suretyship and other credit support arrangements with
respect to any obligations described in subsection B.(1).
C. Underwriter means an entity which has received an individual
prohibited transaction exemption from the Department that provides
relief for the operation of asset pool investment trusts that issue
``asset-backed'' pass-through securities to plans, that is similar in
format and structure to this proposed exemption (the Underwriter
Exemptions); <SUP>11</SUP> any person directly or indirectly, through
one or more intermediaries, controlling, controlled by or under common
control with such entity; and any member of an underwriting syndicate
or selling group of which such firm or person described above is a
manager or co-manager with respect to the certificates.
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\11\ For a listing of the Underwriter Exemptions, see Section
V(h) of PTE 95-60, 60 FR 35925, July 12, 1995.
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D. Trustee means the trustee of the trust, and in the case of
certificates which are denominated as debt instruments, also means the
trustee of the indenture trust.
E. Restricted Group with respect to a class of certificates means:
[[Page 62632]]
(1) Each underwriter/remarketing agent;
(2) The trustee;
(3) CFC;
(4) KEPCO;
(5) The swap counterparty/liquidity provider; or
(6) Any affiliate of a person described in subsection E.(1)-(5)
above.
F. Affiliate of another person includes:
(1) Any person directly or indirectly, through one or more
intermediaries, controlling, controlled by, or under common control
with such other person;
(2) Any officer, director, partner, employee, relative (as defined
in section 3(15) of the Act), a brother, a sister, or a spouse of a
brother or sister of such other person; and
(3) Any corporation or partnership of which such other person is an
officer, director or partner.
G. Control means the power to exercise a controlling influence over
the management or policies of a person other than an individual.
H. A person will be independent of another person only if:
(1) Such person is not an affiliate of that other person; and
(2) The other person, or an affiliate thereof, is not a fiduciary
who has investment management authority or renders investment advice
with respect to any assets of such person.
I. Sale includes the entrance into a forward delivery commitment
(as defined in subsection J. below), provided:
(1) The terms of the forward delivery commitment (including any fee
paid to the investing plan) are no less favorable to the plan than they
would be in an arm's-length transaction with an unrelated party;
(2) The prospectus or private placement memorandum is provided to
an investing plan prior to the time the plan enters into the forward
delivery commitment; and
(3) At the time of this delivery, all conditions of this proposed
exemption applicable to sales are met.
J. Forward delivery commitment means a contract for the purchase or
sale of one or more certificates to be delivered at an agreed future
settlement date. The term includes both mandatory contracts (which
contemplate obligatory delivery and acceptance of the certificates) and
optional contracts (which give one party the right but not the
obligation to deliver certificates to, or demand delivery of
certificates from, the other party).
K. Reasonable compensation has the same meaning as that term is
defined in 29 CFR 2550.408c-2.
L. Trust Agreement means the agreement or agreements among KEPCO,
CFC and the trustee establishing a trust. In the case of certificates
which are denominated as debt instruments, Trust Agreement also
includes the indenture entered into by the trustee of the trust issuing
such certificates and the indenture trustee.
M. RUS means the U.S. Department of Agriculture, acting through the
Administrator of the Rural Utilities Service or any successor to the
guarantee obligations of such organization.
The Department notes that this proposed exemption, if granted, will
be included within the meaning of the term ``Underwriter Exemption'' as
it is defined in Section V(h) of the Grant of the Class Exemption for
Certain Transactions Involving Insurance Company General Accounts,
which was published in the Federal Register on July 12, 1995 (see PTE
95-60, 60 FR 35925).
EFFECTIVE DATE: This proposed exemption, if granted, will be effective
as of November 18, 1997.
Preamble
On October 31, 1989, the Department granted an individual
administrative exemption under section 408(a) of the Act to CFC (PTE
89-93) for several prohibited transactions relating to CFC's role as a
financial intermediary in the refinancing of various loans to rural
utility cooperatives. CFC now proposes that two of the loans involving
KEPCO that were refinanced using the structure involved in PTE 89-93 be
refinanced through a new series of transactions. CFC requests a new
individual exemption for these refinancing transactions.
CFC states that the restructured KEPCO loans and the trust
structure through which interests in these loans will be offered to
institutional investors, including employee benefit plans, are in many
respects similar to the transactional structure presented in PTE 89-93.
However, under the new refinancing structure, the interest rate on the
trust certificates will be a variable rate rather than a fixed rate
guaranteed by the U.S. Government. The floating rate will be paid
through an interest rate swap transaction between the trust and a bank
or other financial institution acting as a swap counterparty
(initially, Morgan). Thus, the variable rate on the certificates will
not be guaranteed by the U.S. Government, although if the bank fails to
make the variable rate payments, as required, the fixed rate guaranteed
payments on the notes will be applied to the variable rate payments due
on the certificates.
In addition, the new exemption requested by CFC has been expanded
to include: (i) The purchase by CFC of the existing KEPCO notes and the
contribution of amended KEPCO notes to the new trusts; and (ii) the
servicing, management and operation of the trusts in a manner that is
generally the same as the relief provided by the Department in other
exemptions involving asset-backed securities (i.e., the Underwriter
Exemptions).
Summary of Facts and Representations
1. The Applicant. CFC is a tax-exempt, not-for-profit cooperative
association organized in 1969 under the laws of the District of
Columbia. CFC was established by its members to provide them with a
source of financing to supplement the loan programs of RUS (which was
formerly known as the Rural Electrification Administration (REA)), a
guarantor of loans made to rural electric utilities. CFC is a finance
company that makes loans to its rural utility system members to enable
them to acquire, construct and operate electric distribution,
generation, transmission and related facilities. Most CFC long-term
loans to its members are made in conjunction with concurrent loans from
RUS and are secured equally and ratably with RUS' loans by a single
mortgage. The principal and interest obligations under CFC's loans are
guaranteed by RUS (the RUS Guarantee).
CFC also provides guarantees for tax-exempt financings of pollution
control facilities and other properties constructed or acquired by its
members, and provides guarantees of other debt in connection with
certain leases and other transactions of its members. CFC presently has
loans outstanding to its members in the aggregate principal amount of
approximately $8.0 billion and has guaranteed on behalf of members an
additional $2.3 billion in obligations. CFC acts as the servicer under
six trusts that were established in 1988 to refinance certain rural
utility cooperative loans guaranteed by REA in transactions eligible
for the exemption provided by PTE 89-93. CFC also provides financial
advisory services to its members.
As of May 31, 1996, CFC's 1051 members were generally non-profit
cooperative electric utilities and service organizations and
represented approximately 95 percent of the total number of such
entities in the United States. As of December 31, 1995, CFC's member
systems owned approximately $66.5 billion (before depreciation of $19.4
billion) in total utility plants and
[[Page 62633]]
equipment. Funds for CFC's programs are derived primarily from the sale
to its members of its subordinated debt, the sale of collateral trust
bonds, medium-term notes and commercial paper in the capital markets
and from retained earnings. As of May 31, 1996, outside investors held
approximately $1 billion of CFC collateral trust bonds, $604 million of
CFC medium term notes and $4.7 billion of CFC commercial paper. CFC has
approximately $1.0 billion principal amount of bonds listed on the New
York Stock Exchange and registered under Section 12(b) of the
Securities Exchange Act of 1934.
In the refinancing transactions that are the subject of this
proposed exemption, CFC will act as the servicer of the new trust that
will be established for purposes of holding the note or notes (with the
RUS Guarantee) that are issued by KEPCO, a rural utility cooperative
(KEPCO Notes). In addition, there will be a fixed to floating interest
rate swap entered into between KEPCO and Morgan Guaranty Trust Company
of New York (Morgan), a financial counterparty of high credit standing.
The interest rate swap will be assigned to the trust by KEPCO. CFC will
service the KEPCO Note(s) and the RUS Guarantee in accordance with the
terms and conditions of the trust agreement (the Trust Agreement) under
which the trust (the Trust) will be established.
2. The Trustee. The Trustee, which is The First National Bank of
Chicago (First Chicago), is the legal owner of the assets in the Trust.
The Trustee is also a party to, or beneficiary of, all the documents
and instruments deposited in the Trust. The Trustee is responsible for
enforcing all the rights created by the Trust in favor of the
certificateholders. In the proposed transactions, the Trustee will be
an independent entity and, therefore, will be unrelated to CFC, KEPCO,
the swap counterparty and the underwriter. The Trustee will monitor and
administer the swap agreement that will be assigned to the Trust.
CFC represents that the Trustee will be a substantial financial
institution or trust company experienced in trust activities. The
Trustee receives a fee for its services, which will be specified in the
trust agreement and will be disclosed in the prospectus or private
placement memorandum relating to the offering of the certificates.
3. The Underwriter. It is anticipated that the certificates will be
registered under the Securities Act of 1933 and will be sold in a
public offering on a firm commitment basis. Each underwriter will be an
entity which has received an individual prohibited transaction
exemption from the Department that provides relief for the operation of
asset pool investment trusts that issue so-called ``asset-backed''
pass-through securities to plans (an Underwriter Exemption), an
affiliate of such entity, or a member of an underwriting syndicate of
which such entity is a manager or co-manager (see Section III.C above).
The lead underwriter will act as the remarketing agent (Remarketing
Agent) with respect to the certificates. If the certificates are sold
to institutional investors in a private placement under Section 4(2) of
the Securities Act and Rule 144A thereunder, the registered broker-
dealer acting as placement agent will also act as the Remarketing Agent
with respect to the certificates. The role of the Remarketing Agent is
described further below.
4. The Swap Counterparty. The swap counterparty will be a bank or
financial institution of high credit standing with a credit rating of
at least AA or an equivalent rating from the Rating Agencies. As noted
earlier, initially the swap counterparty will be Morgan. Morgan will
continue to be the swap counterparty unless there is an event, such as
a credit rating downgrade of Morgan, which requires a replacement of
the swap counterparty under the terms of the swap. Thus, if there is
such an adverse change in Morgan's credit rating, the swap agreement
will require Morgan to either: (i) post collateral with the Trustee of
the Trust in an amount, determined daily, equal to all payments owed by
Morgan if the swap transaction were to be terminated by KEPCO; or (ii)
find a replacement swap counterparty for the Trust, within a specified
period, which has a credit rating of at least AA or an equivalent
rating from the Rating Agencies. Otherwise, the swap agreement will
terminate in accordance with its terms and the Trustee will be
responsible for enforcing all rights created in favor of the
certificateholders of the Trust.
The Subject Transactions
5. The proposed transactions for which exemptive relief is
requested are described by the Applicant in the context of certain
refinancing arrangements involving loans that were made by CFC to KEPCO
(i.e. Kansas Electric Power Cooperative Inc). These refinancing
transactions were initiated with the cooperation of the U.S. Department
of Agriculture, acting through the Administrator of RUS. The Applicant
represents that the subject transactions have been designed to further
a U.S. Congressional policy to facilitate the reduction of the
financing costs for rural electric power cooperatives and to reduce the
U.S. Government's possible exposure as the guarantor of the debt of
such cooperatives.
6. In 1988, KEPCO had outstanding certain loans from the U.S.
Federal Financing Bank (the FFB Loans) which were guaranteed by RUS
(then, the REA). Pursuant, to Section 306A of the Rural Electrification
Act of 1936, as amended (the RE Act) and the implementing regulations
thereunder (the Regulations), the FFB loans were refinanced in the
following manner.
First, CFC loaned KEPCO the amount necessary to prepay the FFB
Loans pursuant to a Loan Agreement, dated as of February 15, 1988 (the
Loan Agreement). To evidence its repayment obligations to CFC, KEPCO
executed three lender loan notes (the Notes). Then, CFC deposited each
of the three Notes in a separate grantor trust--Trust K-1, Trust K-2,
and Trust K-3 (collectively, the 1988 Trusts), pursuant to three Trust
Agreements between CFC, KEPCO and First Chicago, as Trustee. The
original REA guarantee of the FFB Loans (the Guarantees) was
transferred to each of the Notes before they were deposited in the 1988
Trusts.
The obligations of (i) CFC to service the Notes while they were in
the 1988 Trusts, (ii) the U.S. Government acting through the
Administrator of the REA, as guarantor, to guarantee payment of
principal and interest (as defined in the Loan Agreement) on the Notes
under the Guarantees, and (iii) the Trustee with respect to the
Guarantees, were contained in a Loan Guarantee and Servicing Agreement
dated February 15, 1988 (the Loan Guarantee Agreement). Trust K-1,
Trust K-2, and Trust K-3 issued certificates of beneficial interest in
the assets of the 1988 Trusts (the Series 1988 Certificates) to CFC as
depositor of the 1988 Trusts. CFC then sold the Series 1988
Certificates (other than from Trust K-3) to investors pursuant to a
registered public offering of the Series 1988 Certificates. The
Applicant states that these transactions were the subject of the relief
provided by PTE 89-93, and similar refinancing transactions were
effected for other rural electric cooperatives.
Note One and Note Two (the Outstanding Notes), which were deposited
in Trust K-1 and Trust K-2, respectively, will mature on December 4,
2002 and December 4, 2017, respectively. <SUP>12</SUP> Pursuant to the
terms of the Loan Agreement, Note One and Note
[[Page 62634]]
Two will become available for purchase at the election of KEPCO by a
purchaser designated by KEPCO on any business day on or after the day
immediately prior to December 15, 1997. The Series 1988 Certificates
representing ownership interests in Trust K-1 and Trust K-2 are subject
to purchase or redemption upon the prepayment or purchase of the
Outstanding Notes.
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\12\ Note Three, originally deposited in Trust K-3, matured by
its terms on December 4, 1988, and the certificates representing
ownership interests in Trust K-3 were redeemed and Trust K-3 was
terminated by the Trustee.
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7. The Proposed Refinancing Transaction. KEPCO and RUS are
proposing to refinance the Outstanding Notes using the transactions
described below. KEPCO will redeem the outstanding Series 1988
Certificates by exercising, on December 18, 1997 (the Refinancing
Date), the right given in the Loan Agreement to have the Outstanding
Notes purchased by CFC at a specified premium over par <SUP>13</SUP>
(plus accrued interest), and the Outstanding Notes will thereafter be
amended (the Amended Outstanding Notes) to reduce the guaranteed
interest rate payable by KEPCO or by RUS, as guarantor of the
Outstanding Notes.
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\13\ This premium amount will be distributed to the
certificateholders of the Series 1988 Certificates issued by Trust
K-1 and Trust K-2.
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CFC will direct the Trustee (i.e. First Chicago), as trustee of
Trust K-1 and Trust K-2, to terminate Trust K-1 and Trust K-2 after the
owners of the Series 1988 Certificates are paid in full. The Trustee
will be directed to transfer the Amended Outstanding Notes, with the
Guarantees attached, to a single new grantor trust (the Series 1997
Trust) established pursuant to the Trust Agreement. The Trustee of the
Series 1997 Trust will be First Chicago.
This refinancing structure was designed to lock in current interest
rates for new loans to KEPCO as of the preliminary closing date for
such refinancing (December 20, 1996), instead of waiting until the
actual Refinancing Date (December 18, 1997) when rates may be higher.
In particular, KEPCO has entered into a forward interest rate swap
agreement (the Swap Agreement) with Morgan as the swap counterparty.
KEPCO will assign its right to receive and make payments under the Swap
Agreement, effective as of the Refinancing Date, to the Trustee for the
Series 1997 Trust (i.e. First Chicago). Morgan is currently rated AAA
by S&P and Aa1 by Moody's. The Swap Agreement will require Morgan to
post collateral with the Trustee, for the benefit of certificate-
holders, if Morgan's credit ratings are reduced to below AA or an
equivalent rating by the Rating Agencies during the term of the Swap
Agreement. Such collateral must be in the form of highly stable and
liquid fixed-income securities, such as short-term debt securities
issued and/or guaranteed by the U.S. Government or an agency or
instrumentality thereof or debt securities issued by non-U.S.
Government entities which have credit ratings comparable to those of
the certificates. The amount of such collateral will be determined
daily and will be equal to all payments owed by Morgan under the Swap
Agreement in the event the swap were terminated.
Pursuant to the terms of the Swap Agreement, KEPCO will agree to
pay a fixed rate of interest to Morgan on each December 4th and June
4th following the Refinancing Date until the maturity of the Amended
Outstanding Notes. In return, Morgan will agree to pay to KEPCO a
variable rate of interest at the times interest is payable on the
Series 1997 Certificates. As noted earlier, KEPCO will assign its right
to receive and make payments under the Swap Agreement to the Trustee on
the Refinancing Date. On such date, CFC will deposit the Amended
Outstanding Notes, with the RUS Guarantees attached, into the Series
1997 Trust. The Series 1997 Trust will issue certificates of beneficial
interest (the Series 1997 Certificates) which will have interest
distributable to holders of the Series 1997 Certificates (the Series
1997 Certificateholders) at a variable market rate of interest. The
variable market rate will be initially set by the Remarketing Agent,
and reset weekly by the Remarketing Agent, based on an independent
index for 30-day commercial paper known as the H.15 Index, which is
compiled daily by the New York Federal Reserve Bank. The variable rate
of interest on the Series 1997 Certificates will determine the variable
rate of interest payable to the Trustee by Morgan pursuant to the Swap
Agreement, which payments will be distributed monthly to the Series
1997 Certificateholders, or at other times as set forth in the Series
1997 Trust Agreement. The initial variable rate on the certificates
will be known to investors, including plans, approximately one week
before the Refinancing Date.
When installments or payments are made by KEPCO on the Amended
Outstanding Notes, the funds are placed in a segregated account
established in the name of the Trustee (on behalf of
certificateholders) to hold funds received between distribution dates.
The account is under the sole control of the Trustee. However, the
account's assets are invested at the direction of CFC in short-term
securities described in the Trust Agreement which have received a
rating comparable to the rating assigned to the certificates. In
addition, CFC will furnish a report on the operation of the Trust to
the Trustee on a monthly basis.
Because of the structure of the refinancing, the credit behind the
Series 1997 Certificates will be bifurcated. First, if KEPCO fails to
pay the Trustee any amounts on the KEPCO Notes, Series 1997
Certificateholders will look to the guarantee provided by the U.S.
Government (acting through RUS) for payment of principal, which will
continue to be distributed to Series 1997 Certificateholders annually
each December 15. Second, Series 1997 Certificateholders will look to
the credit of Morgan for the variable rate payments of interest to be
made on the Series 1997 Certificates.<SUP>14</SUP> If Morgan fails to
make any variable rate payment when due, amounts received by the
Trustee from KEPCO (or RUS as guarantor) for interest on the Amended
Outstanding Notes, less a servicing fee payable to CFC, will become
payable, to the extent of the amount of the defaulted payment, to the
Series 1997 Certificateholders. Morgan, or another financial
institution of comparable credit standing selected by Morgan, will
provide liquidity support for the tender rights (Tender Rights) that
attach to the Series 1997 Certificates. The Tender Rights will enable
certificateholders to sell the Series 1997 Certificates back to the
Remarketing Agent at any time upon seven (7) days notice.
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\14\ Morgan has the obligation to continue to make timely
payments under the Swap Agreement even in the event of a default by
KEPCO. In such instances, Morgan will look to the guarantee provided
by the U.S. Government for future payments of interest on the
Amended Outstanding Notes, which the Trustee will use to make the
semi-annual payments to Morgan under the Swap Agreement.
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As noted earlier, the documentation executed and delivered for the
KEPCO refinancing will be executed in three closings:
(i) The preliminary closing on December 20, 1996, at which time
most of the operative documents were executed and delivered (the
Preliminary Closing);
(ii) The Deposit Date closing on November 18, 1997 (the Deposit
Date Closing), at which time the offering documentation was delivered
and CFC deposited the purchase price for KEPCO's Outstanding Notes with
the Series 1988 Trustee and gave advance notice that the purchase is to
occur on December 18, 1997; and
(iii) The Refinancing Date closing on December 18, 1997, at which
time KEPCO's Outstanding Notes will be purchased by CFC from the 1988
Trusts
[[Page 62635]]
and the amended Outstanding Notes will be delivered to the Trustee of
the Series 1997 Trust, after which the Series 1997 Certificates will be
issued and sold to investors.
The Applicant states that in order to eliminate or to minimize
creditors' risks, forward purchase transactions are structured so that
as little as possible is left to the discretion of the parties after
the first commitment is made. Consequently, virtually all of the
binding commitments for the proposed refinancing were made at the
Preliminary Closing. The fixed rate payable to Morgan by KEPCO under
the Swap Agreement (i.e. 7.654 percent per annum) was established at
the time of the signing of such Agreement. That fixed rate, plus the
servicing fee payable to CFC, will determine the new guaranteed
interest rate on the Amended Outstanding Notes, effective upon the sale
of the Certificates to the Underwriters on the Refinancing Date.
KEPCO and CFC entered into a First Amendment to the Loan Agreement
at the Preliminary Closing which obligates CFC, subject to certain
conditions, to provide the funds for the purchase of Note One and Note
Two on the Deposit Date Closing. In addition, the First Amendment to
the Loan Agreement contains the operative amendments to the Loan
Agreement, which will serve to reduce the interest rate on the
Outstanding Notes and to remove any call protection or call premium
from the Outstanding Notes. The amendments will become effective on the
Refinancing Date. However, if upon issuance of the Certificates to CFC
the Certificates are not sold to the Underwriter for any reason, CFC
will hold the Certificates and receive the existing fixed interest rate
on the Amended Outstanding Notes. Pursuant to a separate agreement,
KEPCO will make up any loss CFC may incur in funding the carrying of
the Certificates and will receive a credit for any ``float'' CFC
realizes while holding the Certificates. The RUS does not guarantee any
such additional payments to CFC that may be required from KEPCO.
8. The Sale of the Certificates. At the Preliminary Closing, KEPCO
and CFC entered into a forward certificate purchase agreement with
Alex. Brown & Sons, Inc. (Alex Brown), as Underwriter of the Series
1997 Certificates, pursuant to which KEPCO and CFC obligated
themselves, subject to certain conditions, to sell the Series 1997
Certificates to Alex Brown on the Refinancing Date. Alex Brown
committed to purchase and resell the Series 1997 Certificates at par on
such date in a firm commitment public offering registered with the SEC.
The prospectus (or private placement memorandum if the sale to
investors is converted to a private placement under SEC Rule 144A) for
the Certificates will provide detailed information about the Amended
Outstanding Notes, the RUS Guarantee, the Trust, the Swap Agreement,
and the rights and entitlements of the Series 1997 Certificateholders.
The compensation payable to CFC, as servicer of the Trusts, and to the
Trustee will be set forth in the Trust Agreement and will be described
in detail in the prospectus relating to the Series 1997 Certificates.
The Applicant states that once the lower fixed guaranteed interest
rate on the Amended Outstanding Notes is established and the Series
1997 Certificates are sold to investors, neither the KEPCO nor RUS will
ever have to pay more than such rate. Morgan, as the swap counterparty,
will be paying the ``market rate'' on the Series 1997 Certificates for
the remaining terms of the Notes. Consequently, Morgan has an interest
in insuring that the Series 1997 Certificates are sold at an
appropriate market rate and that such rate is reset weekly at an
appropriate market rate. If investors (including plans) are not
satisfied with the variable interest rates paid on the Series 1997
Certificates, as reset weekly by the Remarketing Agent, then such
Certificateholders may exercise their Tender Rights to require the
Remarketing Agent to repurchase the Certificates at par plus accrued
interest. In such instances, Morgan or another qualified financial
institution of comparable credit quality will stand behind the
Remarketing Agent with liquidity support to enable that entity to honor
the Tender Rights.
The rate payable for the Series 1997 Certificates will be
determined by a Remarketing Agent (initially, Alex Brown) as being the
minimum rate of interest necessary, in the Remarketing Agent's
judgment, to enable the Remarketing Agent to sell the Series 1997
Certificates at par. As noted above, when the Series 1997 Certificates
are in the ``weekly rate mode'', the Certificateholders will have the
right at all times to exercise their Tender Rights to tender their
Certificates for repurchase by the Remarketing Agent at par (plus
accrued interest) on any business day upon seven (7) days
notice.<SUP>15</SUP> CFC, as servicer, will verify and confirm to the
Trustee the information provided by Morgan and the Remarketing Agent
for the variable interest rate payments.
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\15\ As noted earlier, the 7-day reset by the Remarketing Agent
will be priced based on the H.15 Index, a 30-day commercial paper
index, which is compiled daily by the New York Federal Reserve Bank.
The H.15 Index is readily available to fixed income investors
through data services, conversations with broker-dealers, on-line
reports, and other transactions in which such investors participate.
This information would be used by certificateholders on a continuous
basis to determine both the anticipated level of repricing as well
as to evaluate whether the repriced certificates continue to meet
their investment needs.
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Although the Series 1997 Trust Agreement permits the swap
counterparty (i.e. Morgan) and the Remarketing Agent (i.e. Alex Brown)
to lengthen the interest reset period from seven (7) days (and the
right to tender Certificates would exist only at the end of such longer
reset period), any such change will result in a mandatory repurchase of
all outstanding certificates (at par plus accrued interest) before it
becomes effective. Thus, any Certificateholders that want to continue
to invest in the Certificates under the new conditions will have to
make an affirmative decision to do so. As stated above, in order to
assure the operation of these provisions regarding Tender Rights of
Certificateholders, KEPCO will enter into a liquidity protection
agreement with Morgan pursuant to which Morgan will agree to provide,
or cause another qualified financial institution of comparable credit
quality to provide, a liquidity facility during the term of the Swap
Agreement.
The Swap Agreement will be in effect until the maturity of the
Series 1997 Certificates. After the Refinancing Date, the financial
condition or performance of KEPCO will not affect the requirement of
Morgan's performance under the Swap Agreement. However, KEPCO and RUS
(should RUS become the payor of the Amended Outstanding Notes pursuant
to the Guarantees) will have the right to terminate the Swap Agreement
and prepay or purchase the Amended Outstanding Notes at any time after
the Refinancing Date (after providing notice as specified in the Loan
Agreement and the Trust Agreement). There are no prepayment penalties
attached to KEPCO's right to prepay the Amended Outstanding Notes.
However, with respect to the resulting termination of the Swap
Agreement, prior to prepaying or purchasing the Amended Outstanding
Notes, any termination payment owing under the Swap Agreement must be
paid by KEPCO (or RUS). Consequently, depending on market conditions
and interest rates, KEPCO (or RUS) could be obligated to make a payment
to Morgan or could be entitled to receive a
[[Page 62636]]
payment from Morgan, in the event of termination of the Swap
Agreement.<SUP>16</SUP>
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\16\ In no event will the Trust be obligated to make termination
payments to Morgan, or another swap counterparty, in the event KEPCO
purchases the Amended Outstanding Notes.
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The Applicant states that the refinancing is intended to emulate,
as closely as possible, the 1988 refinancing, except that the
certificates will have a variable rate of return. The parties to the
1997 transaction are the same as the parties to the 1988 transaction
with the exception of Morgan and Alex Brown--the parties involved in
making the Series 1997 Certificates available as variable rate
securities. As with the 1988 refinancing, the Applicant anticipates
that the Certificates will be acquired by employee benefit plans
subject to the Act.
CFC is participating in this transaction to facilitate the
refinancing of the existing loans (as evidenced by Note One and Note
Two) to KEPCO under applicable U.S. Department of Agriculture
regulations and guarantee programs. CFC does not intend to take a
proprietary interest in the Amended Outstanding Notes. The purchase of
the Amended Outstanding Notes by CFC and the contribution of such Notes
to the Series 1997 Trust will occur virtually simultaneously and will
be for the same consideration. CFC will continue to receive servicing
fees for the Series 1997 Trust (as discussed below) and a fee for the
30-day period between its prepayment of the purchase price for the
Amended Outstanding Notes and the closing of the sale of the Series
1997 Certificates to the Underwriters on the Refinancing Date.
The Series 1997 Certificates will have received one of the three
highest ratings available from either S&P or Moody's, or both. The
Applicant states that these ratings will be based, in part, on the RUS
Guarantee and the high credit standing of Morgan as the swap
counterparty and the liquidity provider.
In this regard, the entire KEPCO refinancing transaction (including
the proposed swap transaction) has been reviewed by Moody's and S&P for
the purpose of rating the certificates. S&P has concluded the
following: (a) the long-term rating on the certificates would be the
lower of (i) ``AAA'', based on the guarantee provided by the U.S.
Government acting through the Administrator of the RUS, or (ii) the
rating of the swap counterparty (i.e. Morgan, which is currently rated
``AAA''). The short-term rating on the certificates would be the short-
term rating of the entity providing the standby certificate purchase
agreement. This entity will be either Morgan or another financial
institution that is rated P-1, the highest short-term credit rating
available. Moody's has also concluded that the certificates would be
rated Aa1 (long-term) and P-1 (short-term), based on the guaranty
provided by the U.S. Government, the swap agreement with Morgan, and
the standby certificate purchase agreement provided by either Morgan or
another P-1 rated entity.
9. Disclosure. The prospectus (or private placement memorandum) to
be issued in connection with the original issuance of the Series 1997
Certificates, will contain information material to a fiduciary's
decision to invest in the Certificates, including:
(i) Information concerning the payment terms of, and the rating of,
the Series 1997 Certificates;
(ii) A description of the operation of the Trust as a separate
entity and of how the Trust was formed by CFC;
(iii) Identification of First Chicago as the independent trustee
for the Trust;
(iv) A description of the assets contained in the Trust (i.e. the
Amended Outstanding Notes, the RUS Guarantee and the swap, including
their principal terms and their material legal aspects, as well as
financial information regarding Morgan, as the swap counterparty);
(v) A description of CFC, its role in the refinancing and its role
as the servicer of the Trust;
(vi) A description of the Trust Agreement, including a description
of the procedures for collection of payments on the Notes, the payments
to be made under the Swap Agreement and the procedures for making
distributions to certificateholders; a description of the accounts into
which such payments are deposited and from which such distributions are
made; identification of the servicing compensation that may be deducted
from any payments before distributions are made to certificateholders;
a description of periodic statements to be provided to the Trustee and
provided to or made available to certificateholders by the Trustee; and
a description of the events that constitute events of default under the
Trust Agreement and a description of the Trustee's and the
certificateholders' remedies with respect thereto;
(vii) A description of the RUS Guarantee;
(viii) A general discussion of the principal federal income tax
consequences of the purchase, ownership and disposition of the pass-
through certificates by a typical investor;
(ix) A general discussion of the fiduciary and prohibited
transaction considerations that are to be taken into account by a
fiduciary under the Act considering the purchase of the Series 1997
Certificates, <SUP>17</SUP> including a brief description of the
exemption (if granted) and a discussion of the potential need for
compliance by plan investors with certain prohibited transaction class
exemptions issued by the Department in connection with the swap
transaction; <SUP>18</SUP>
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\17\ The Department wishes to note that ERISA's general
standards of fiduciary conduct would apply to the investment
described in this proposed exemption, and that satisfaction of the
conditions of this proposal should not be viewed as an endorsement
of the investment by the Department. Section 404 of ERISA requires,
among other things, that a fiduciary discharge his duties with
respect to a plan solely in the interest of the plan's participants
and beneficiaries and in a prudent fashion. Accordingly, the plan
fiduciary must act prudently with respect to the decision to enter
into an investment transaction. The Department further emphasizes
that it expects the plan fiduciary to fully understand the benefits
and risks associated with engaging in a specific type of investment,
following disclosure to such fiduciary of all relevant information.
In addition, such plan fiduciary must be capable of periodically
monitoring the investment, including any changes in the value of the
investment. Thus, in considering whether to enter into a
transaction, a fiduciary should take into account its ability to
provide adequate oversight of the particular investment.
\18\ See PTE 84-14, 49 FR 9494, March 13, 1984 (regarding
transactions entered into for plans by a ``qualified professional
asset manager'' or ``QPAM''), PTE 90-1, 55 FR 2891, January 29, 1990
(regarding transactions entered into by insurance company separate
accounts), PTE 91-38, 56 FR 31966, July 12, 1991 (regarding
transactions entered into by bank collective investment funds), PTE
95-60, 60 FR 35925, July 12, 1995 (regarding transactions entered
into by insurance company general accounts), or PTE 96-23, 61 FR
15975, April 10, 1996 (regarding transactions entered into for plans
by ``in-house'' asset managers). In this regard, the Department is
not providing any opinion in this proposed exemption as to whether
the conditions of such class exemptions would be met for a swap
transaction between the Trust and Morgan, or any other bank or
financial institution acting as a swap counterparty to the Trust.
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(x) A description of the underwriters' plan for distributing the
pass-through certificates to investors, including the structure and
operation of the variable interest rate reset mechanism; and
(xi) Information about the scope and nature of the secondary market
for the certificates, the operation of the put rights, the role of the
liquidity provider and financial information regarding the liquidity
provider (which will be Morgan or a financial institution of comparable
credit standing).
10. The RUS Guarantee. The Applicant states that RUS has endorsed
on each Outstanding Note its guarantee of the timely payment of
principal and interest on such Note and, on or before the Preliminary
Closing, will have consented to an amendment of each Outstanding Note
to lower the
[[Page 62637]]
guaranteed interest rate thereon and to make the other amendments
described below for the servicing of the Outstanding Notes. The RUS
Guarantee is a full faith and credit obligation of the United States of
America. RUS will be required to pay the Trust the amount of any
principal and interest not paid when due on an Outstanding Note within
five business days of notice of such default from CFC, acting in its
capacity as servicer.
11. Servicing of KEPCO's Loans. CFC will contract with RUS and the
Trust to service the Amended Outstanding Notes, thereby establishing an
agency relationship (as the ``Servicer'') with respect to the Trustee
in a manner that complies with the RE Act and the Regulations and
described in the terms of the Trust Agreement.
Under the Trust Agreement, the Trustee appoints the Servicer as its
attorney-in-fact to prosecute any claims to enforce or collect on each
Amended Outstanding Note and Guarantee. However, the Servicer as such
attorney-in-fact may not rescind, cancel, release, waive or reschedule
the right to collect the unpaid balance on any such Note from KEPCO or
RUS. If a court holds that the Servicer is not entitled or able to
enforce an Amended Outstanding Note or Guarantee, the Trustee, on
behalf of the Trust, is obligated to take such steps as the Servicer
deems necessary to enforce such Note or Guarantee.
In administering, servicing and enforcing an Amended Outstanding
Note or Guarantee according to the terms of the Trust Agreement, the
Servicer after a default in payment on such Note is obligated to
exercise such of the rights and powers vested in it by the Trust
Agreement and to use the same degree of care and skill in their
exercise as a prudent person would exercise or use under the
circumstances in the conduct of such person's own affairs. Prior to a
default in payment on an Amended Outstanding Note, the Servicer is
obligated to perform only those duties that are specifically set forth
in the Trust Agreement. The Servicer has no liability for any error of
judgment made in good faith by it (unless it is proved that the
Servicer was negligent in ascertaining the pertinent facts) or for any
action it takes or omits to take in good faith in accordance with a
direction received by it from the Trustee or the Certificateholders.
In addition to enforcing the Trustee's rights under the Amended
Outstanding Note (including the RUS Guarantee) held by the Trust, CFC
as the Servicer for the Trust is obligated to fulfill a number of
administrative and notice functions under the Trust Agreement. For
example, the Servicer is obligated to deliver a notice to KEPCO and the
Trustee specifying the date any payment is due on the Note held by such
Trust and the amount of such payment. The Servicer is responsible for
notification of RUS of any default in the payment of interest and
principal on the Amended Outstanding Note held in the Trust. The
Servicer is obligated to submit to RUS reports assessing the causes
behind, and seriousness of, the default. The Servicer is also obligated
to notify RUS of any known violations, defaults or conditions which
might lead to a default or violation by KEPCO under the Loan Agreement,
the Loan Guarantee Agreement or an Amended Outstanding Note. The
Servicer is further obligated to notify RUS of any redemption of the
Amended Outstanding Note held by a Trust and to calculate the amount
payable on such Note and the related Certificates pursuant to any
redemption or purchase of such Note.
The Servicer will handle the billing of Note payments from KEPCO,
and will notify RUS promptly of any default under a Loan and of adverse
developments affecting KEPCO, but payments on the Note will be made
directly to the Trustee and not to CFC. The Trustee will be responsible
for monitoring and enforcing the Swap Agreement. In this regard, the
Servicer will verify and confirm to the Trustee the information
provided by Morgan and the Remarketing Agent with respect to the
variable rate of return. The Servicer will also prepare for
distribution by the Trustee to Certificateholders regular semiannual
reports concerning distributions on the Certificates and its fees, as
well as tax information required by Certificateholders. No less often
than annually, an independent public accountant will audit the books
and records of the Trust. Upon completion, copies of the auditor's
reports will be provided to the Trustee.
12. Servicing Compensation. The Servicer will be compensated out of
payments on the KEPCO Notes. The servicing fee (out of which the
Servicer will pay the Trustee's fees and expenses) will total not more
than approximately \1/10\ of one (1) percent per annum of the principal
amount of the Notes. Because the return to the certificateholders is
based upon the floating rate payments made under the Swap Agreement,
these reimbursements will not affect the payments to
certificateholders.
The Servicer may transfer its duties and obligations with the
consent of 51 percent of the certificateholders and the swap
counterparty. The Servicer may also be terminated following certain
defaults or events of bankruptcy relating to the Servicer. The
insolvency of the Trustee or the Servicer will not affect the
certificateholders' rights, because the Servicer will not hold any
Trust assets, and assets held in a fiduciary capacity by the Trustee
should not be subject to claims of the Trustee's general creditors.
13. Description of Certificates. Each Certificate will represent a
fractional undivided interest in the Trust. The Certificates will be
issued in denominations of $100,000 (and in integral multiples of
$5,000 above such amount), and will not be divisible into certificates
with original principal amounts below $100,000. The Certificates will
be transferable, and may be listed on a national securities exchange.
Payments on the Certificates will represent a pass-through of both (i)
payments of principal received by the Trustee on the KEPCO Notes held
by the Trust, and (ii) the payments to be made by Morgan under the Swap
Agreement.<SUP>19</SUP> Interest on the KEPCO Notes will be payable
semi-annually, whereas interest on the floating-rate Certificates will
be paid monthly (or on such other periodic basis as may be reset in
accordance with the Trust Agreement). Principal payments on both the
KEPCO Notes and the Certificates will be payable annually for the
period during which each Note amortizes.
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\19\ It should be noted that the notional principal amount for
the swap transaction between the Trust and Morgan, used to determine
the payments to be made between the parties, initially will be
$57,390,000. As principal payments on the KEPCO Notes are received
by the Trustee and passed-through to the certificateholders, the
notional principal amount for the swap transaction will be adjusted
to equal the outstanding principal balance of the certificates. It
should also be noted that, based on the confirmation statement
submitted by Morgan, all payments made between the parties will be
based on the applicable notional principal amount, the day count
fractions, the fixed or floating rates (determined by objective
third party sources) designated under the swap agreement, calculated
on a one-to-one ratio and not on a multiplier of such rates or with
formulas that produce leveraged amounts. However, because the
payments will be made between the parties on different dates, there
will be no netting of payments. Thus, both parties will be
responsible for making the full payments that are due on the
designated dates (i.e. semi-annually for KEPCO and monthly for
Morgan).
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The Certificates will be prepaid at any time a Note is prepaid. The
Notes will be prepayable at the KEPCO's option in whole (but not in
part) at any time at par. KEPCO will be required to accompany its
notice of prepayment (to be given in advance in order to permit the
Trustee in turn to notify certificateholders of the impending
retirement of the Certificates) with cash
[[Page 62638]]
equal to the amount that will be due on such Note at the time of
prepayment. This procedure will assure that funds will be available for
the prepayment of the Note at the appropriate time. These funds will be
invested in obligations issued by the United States or in repurchase
agreements.
With the exception of prepayments by KEPCO, all payments on the
Note obligations are supported by the full faith and credit of the
United States. If KEPCO defaults in making its payments or in its other
obligations to RUS, RUS has the option either to pay under the RUS
Guarantee principal and interest as they fall due on the KEPCO Note, to
proceed against KEPCO and to assume KEPCO's obligations under the KEPCO
Note or, if KEPCO could at that time make an optional prepayment of the
KEPCO Note, to optionally prepay or purchase the Note. The Trustee (or
the Servicer as its agent), and not the certificateholders, will
enforce payments due on the KEPCO Notes (or the RUS Guarantee) and the
Trustee will enforce payments due under the Swap Agreement. However, a
specified percentage of certificateholders may direct the time, method
and place of exercising any remedy available to the Trustee or the
Servicer, subject to customary trust indenture exceptions. The Trustee
may not resign until the Trust is liquidated and the proceeds
distributed to certificateholders, unless a successor Trustee has been
designated and has accepted such trusteeship.
14. Distributions for the Certificates. Scheduled distributions on
the Certificates attributable to payments of principal on the KEPCO
Notes will be made 11 days (in the case of regular payments of
principal) following the corresponding payment on the Note. This
interval will allow time for the Servicer to notify RUS if there is a
default by KEPCO in making a payment on the Note and to permit the five
business days that RUS has requested before it is obligated to make a
payment under the guarantee to elapse before the payment date on the
Certificates. As a consequence, if KEPCO defaults, the |
