[Federal Register Volume 61, Number 182 (Wednesday, September 18, 1996)]
[Notices]
[Pages 49155-49171]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-23926]
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DEPARTMENT OF LABOR
Pension and Welfare Benefits Administration
[Application No. D-10034, et al.]
Proposed Exemptions; Dimensional Fund Advisors Inc. (DFA)
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 restriction 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
Unless otherwise stated in the Notice of Proposed Exemption, all
interested persons are invited to submit written comments, and with
respect to exemptions involving the fiduciary prohibitions of section
406(b) of the Act, requests for hearing within 45 days from the date of
publication of this Federal Register Notice. Comments and request 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
[[Page 49156]]
interest in the exemption and the manner in which the person would be
adversely affected by the exemption. A request for a hearing must also
state the issues to be addressed and include a general description of
the evidence to be presented at the hearing. A request for a hearing
must also state the issues to be addressed and include a general
description of the evidence to be presented at the hearing.
ADDRESSES: All written comments and 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.
Dimensional Fund Advisors Inc. (DFA) Located in Santa Monica,
California
Application No. D-10034]
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 C.F.R. Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990.) If the exemption
is granted, the restrictions of sections 406(a), 406(b)(1) and (b)(2)
of the Act and the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1) (A) through (E) of
the Code, shall not apply to the proposed in-kind transfers of the
assets of employee benefit plans (the Client Plans) for which DFA or an
affiliate act as a fiduciary 1 and which are held in DFA sponsored
group trusts (the Group Trusts) to the DFA Investment Trust Company
(the Master Fund), in exchange for the shares of the Master Fund, an
open-end investment company registered under the Investment Company Act
of 1940 (the 1940 Act), for which DFA acts as investment advisor;
provided that the following conditions are satisfied:
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\1\ The applicant states that no retirement plan established by
DFA is invested in any of the Group Trusts, and no relief is being
requested herein on behalf of any of DFA's own plans. Accordingly,
the Department is not proposing relief for in-kind transfers
involving any plan established and maintained by DFA or its
affiliates or subsidiaries.
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(a) A fiduciary (the Second Fiduciary) who is acting on behalf of
each affected Client Plan and who is independent of and unrelated to
DFA, as defined in paragraph (g) of Section III below, will receive
advance written notice of the in-kind transfer of the Client Plan's
assets held in a subtrust of a Group Trust to a corresponding series of
the Master Fund in exchange for the shares of the Master Fund, and the
investment of such assets in the corresponding series of the Master
Fund, and will receive full written disclosures concerning the Master
Fund described in paragraph (c) of Section II below;
(b) On the basis of such information described in paragraph (c) of
Section II below, the Second Fiduciary will authorize in writing the
in-kind transfer of the Client Plan's assets from a subtrust of a Group
Trust to the corresponding series of the Master Fund in exchange for
the shares of the Master Fund, and the investment of such assets in the
corresponding series of the Master Fund. Such authorization is to be
consistent with the responsibilities, obligations, and duties imposed
on fiduciaries by Part 4 of Title I of the Act;
(c) No sales commissions, redemption fees or other fees are paid by
the Client Plans in connection with the in-kind transfer of the Group
Trust's assets, in exchange for the shares of the Master Fund;
(d) The transfers will be one-time transactions for each subtrust
of a Group Trust for which a comparable series of the Master Fund
exists;
(e) Each Group Trust receives shares of the Master Fund which have
a total net asset value that is equal to the value of the Client Plans'
all or pro rata share of the Group Trust's assets on the date of the
transfer;
(f) The current market value of the Group Trust's assets to be
transferred in-kind in exchange for the shares of the Master Fund, is
determined in a single valuation performed in the same manner at the
close of the same business day with respect to any such transfer, using
independent sources in accordance with the procedures set forth in Rule
17a-7 (Rule 17a-7) under the 1940 Act, as amended from time to time or
any successor rule, regulation, or similar pronouncement and the
procedures established by DFA pursuant to Rule 17a-7 for the valuation
of such assets. Such procedures must require that all securities for
which a current market price cannot be obtained by reference to the
last sales price for transactions reported on a recognized securities
exchange or NASDAQ, be valued based on the average of the highest
current independent bid and lowest current independent offer, as of the
close of business on the last business day preceding the day of the
Group Trust transfer, determined on the basis of reasonable inquiry
from at least three sources that are broker-dealers or pricing services
independent of DFA;
(g) No later than 30 days after completion of each in-kind transfer
of Group Trust's assets to the Master Fund, DFA will send by regular
mail to each Second Fiduciary, who is acting on behalf of each affected
Client Plan and who is independent of and unrelated to DFA, as defined
in paragraph (g) of Section III below, written confirmation containing
the following information:
1. the identity of each security that was valued for purposes of
the transaction in accordance with Rule 17a-7(b)(4) under the 1940 Act;
2. the price of each such security involved in the transaction; and
3. the identity of each pricing service or market maker consulted
in determining the value of such securities;
(h) No later than 90 days after completion of each in-kind transfer
of
[[Page 49157]]
the Group Trust's assets to the Master Fund, DFA will send by regular
mail to the Second Fiduciary, who is acting on behalf of each affected
Client Plan and who is independent of and unrelated to DFA, as defined
in paragraph (g) of Section III below, written confirmation that
contains the following information:
1. the number of Group Trust's units held by the Client Plan
immediately before the transfer (and the related per unit value and the
total dollar amount of such Group Trust's units transferred); and
2. the number of shares in the Master Fund that are held by the
Client Plan following the transfer (and the related per share net asset
value and the total dollar amount of such shares received);
(i) The transferred securities will be valued using the same
methodology in the Group Trusts and in the Master Fund;
(j) DFA will not execute an in-kind transfer of the Client Plan's
assets unless the Second Fiduciary of each affected Client Plan
affirmatively consents to the in-kind transfer in writing; and
(k) There will be no penalty to a Client Plan for not participating
in the in-kind transfer.
Section II--General Conditions
(a) DFA maintains for a period of six years the records necessary
to enable the persons described below in paragraph (b) to determine
whether the conditions of this exemption have been met, except that (1)
a prohibited transaction will not be considered to have occurred if,
due to circumstances beyond the control of DFA, the records are lost or
destroyed prior to the end of the six-year period, and (2) no party in
interest other than DFA 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 are not maintained
or are not available for examination as required by paragraph (b)
below.
(b) (1) Except as provided in paragraph (b)(2) and notwithstanding
any provisions of section 504(a)(2) and (b) of the Act, the records
referred to in paragraph (a) are unconditionally available at their
customary location for examination during normal business hours by--
(i) Any duly authorized employee or representative of the
Department or the Internal Revenue Service,
(ii) Any fiduciary of the Client Plans who has authority to acquire
or dispose of shares of the Funds owned by the Client Plans, or any
duly authorized employee or representative of such fiduciary, and
(iii) Any participant or beneficiary of the Client Plans or duly
authorized employee or representative of such participant or
beneficiary;
(2) None of the persons described in paragraph (b)(1)(ii) and (iii)
of Section II shall be authorized to examine trade secrets of DFA, or
commercial or financial information which is privileged or
confidential; and
(c) A Second Fiduciary who is acting on behalf of a Client Plan and
who is independent and unrelated to DFA, as defined in paragraph (g) of
Section III below, will receive in advance of the investment by a
Client Plan in the Master Fund full written disclosure of information
concerning the Master Fund which shall include, but not be limited to
the following:
(1) A current copy of SEC Form N-1A (regarding the registration of
an open end investment company under the 1940 Act) 2 with respect
to the Master Fund, plus certain additional information as specified in
the Advisory Opinion 94-35A 3;
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2 Form N-1A requires the registrant to answer a series of
questions regarding financial information, management of the fund,
risk factors and expenses.
3 In the Advisory Opinion 94-35A (AO 94-35A) issued by
the Department to DFA, DFA requested an advisory opinion with regard
to certain disclosures required by the Securities Act of 1933 (the
1933 Act), and which are provided by DFA to independent plan
fiduciaries in connection with the plans' investment in a certain
open-end investment company to which DFA serves as an investment
advisor (the Core Fund), and which is registered under the 1940 Act,
but not under the 1933 Act. Specifically, DFA requested an advisory
opinion that a receipt by the independent plan fiduciary of the Core
Fund's Form N-1A and the additional information as specified in AO
94-35A complies with the prospectus disclosure requirement of
paragraph (d) of section II of PTCE 77-4. In AO 94-35A, the
Department stated that the disclosure of the Core Fund's Form N-1A
information and the additional information as specified in AO 94-35A
to an independent plan fiduciary, in lieu of a prospectus, will
satisfy the prospectus disclosure requirement of paragraph (d) of
section II of PTCE 77-4, provided that the additional information as
specified in AO 94-35A contains all the information, otherwise
included in a prospectus, that is relevant to the independent
fiduciary's decision as to whether to approve the purchase and sale
of shares in the Core Fund.
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(2) A table listing management fees for the most recent completed
fiscal period, all other expenses broken down by category and total
portfolio operating expenses;
(3) A chart showing the effect of such fees on an investment in the
Master Fund over one, three, five and ten years; and
(4) A list of per share income and capital changes for shares
outstanding throughout the year, including investment income, expenses,
net investment income, dividends from net investment income, net
realized and unrealized gains (losses) on securities; distributions
from net realized gains (losses) on securities; net increase (decrease)
in net asset value, net asset value at the beginning of the period, net
asset value at the end of the period, expenses to average net assets,
portfolio turnover rate, and number of shares outstanding at the end of
the period.
Section III--Definitions
For purposes of this proposed exemption:
(a) The term ``DFA'' means Dimensional Fund Advisors Inc., and any
affiliate thereof as defined below in paragraph (b) of this section.
(b) An ``affiliate'' of a person includes:
(1) Any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with the person;
(2) Any officer, director, employee, relative, or partner in any
such person; and
(3) Any corporation or partnership of which such person is an
officer, director, partner, or employee.
(c) The term ``control'' means the power to exercise a controlling
influence over the management or policies of a person other than an
individual.
(d) The term ``Fund'' or ``Funds'' shall include the DFA Investment
Trust Company, such additional series as may be added to the DFA
Investment Trust Company, or any other diversified open-end investment
company or companies registered under the 1940 Act for which DFA serves
as an investment advisor and may also serve as a custodian, shareholder
servicing agent, or transfer agent.
(e) The term ``net asset value'' means the amount for purposes of
pricing all purchases and sales calculated by dividing the value of all
securities, determined by a method as set forth in the Fund's SEC Form
N-1A and statement of additional information, and other assets
belonging to each of the portfolios in the Fund or the Fund, less the
liabilities charged to each such portfolio or the Fund, by the number
of outstanding shares.
(f) The term ``relative'' means a ``relative'' as that term is
defined in section 3(15) of the Act (or a ``member of the family'' as
that term is defined in section 4975(e)(6) of the Code), or a brother,
a sister, or a spouse of a brother or a sister.
(g) The term ``Second Fiduciary'' means a fiduciary of a Client
Plan who is independent of and unrelated to DFA. For purposes of this
exemption, the Second Fiduciary will not be deemed to be independent of
and unrelated to DFA if:
[[Page 49158]]
(1) Such Second Fiduciary directly or indirectly controls, is
controlled by, or is under common control with DFA;
(2) Such Second Fiduciary, or any officer, director, partner,
employee, or relative of the fiduciary is an officer, director, partner
or employee of DFA (or is a relative of such persons);
(3) Such Second Fiduciary directly or indirectly receives any
compensation or other consideration for his or her own personal account
in connection with any transaction described in this exemption.
If an officer, director, partner or employee of DFA (or relative of
such persons), is a director of such Second Fiduciary, and if he or she
abstains from participation in (i) the choice of the Client Plan's
investment manager advisor, (ii) the approval of any such purchase or
sale between the Client Plan and the Funds, and (iii) the approval of
any change in fees charged to or paid by the Client Plan in connection
with any of the transactions described in Section I above, then
paragraph (g)(2) of this Section III shall not apply.
Summary of Facts and Representations
1. DFA is a registered investment advisor under the Investment
Advisors Act of 1940. DFA was organized in May 1981, and is engaged in
the business of providing investment management services to
institutional investors (including pension and profit sharing plans,
endowment funds and governmental agencies). As of February 1, 1995, DFA
had approximately $10.5 billion in assets under management, of which
approximately $4.969 billion were held in the Group Trusts. DFA
currently sponsors three tax-exempt Group Trusts qualified under
Revenue Ruling 81-100. The Group Trusts hold assets of the Client Plans
for which DFA serves as a fiduciary and an investment manager as
defined in section 3(38) of the Act. Approximately $3.7 billion, or 74
percent of the Group Trusts assets are ERISA Client Plan assets.
2. DFA has full investment authority for the Group Trusts, which
are divided into various subtrusts, each with a distinct investment
objective and strategy. DFA represents that it does not receive any
fees from the Group Trusts. The initial decision and authorization to
participate in a subtrust of a Group Trust is made by the Second
Fiduciary of each Client Plan. A Client Plan which invests in the Group
Trust then negotiates an investment management agreement with DFA,
which specifies the types and amounts of services performed for such
Client Plan, under which the Client Plan pays DFA an investment
management fee.4
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4 The Department expresses no opinion as to whether the
provision of services by DFA or its affiliates to the Client Plans
satisfies the requirements for statutory exemption, as set forth in
section 408(b)(2) of the Act and 29 CFR 2550.408(b)(2) of the
Department's regulation. To the extent that such provision of
services to the Client Plans by DFA or its affiliates does not
satisfy the requirements of section 408(b)(2) of the Act, the
Department, herein, is offering no relief.
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3. As of January 31, 1995, the Group Trusts held investments of
thirty-eight (38) Client Plans. Of these Client Plans, 2 have invested
more than $500 million; 7 have invested between $100 million and $500
million; 10 have invested between $50 million and $100 million; 7 have
invested between $25 million and $50 million; and 12 have invested
between $1.113 million and $25 million. It is represented that the
investor Client Plans range in size from $57 million to $45 billion.
4. DFA also serves as the investment advisor to the DFA Investment
Trust Company (the DFA Investment Trust Company), a diversified, open-
end management investment company organized as a Delaware business
trust on October 27, 1992, and registered under the 1940 Act. The DFA
Investment Trust Company is currently comprised of seven series, each
of which operates as a diversified investment company and represents a
separate class of the DFA Investment Trust Company shares of beneficial
interest. Each of the series has specific investment objectives,
policies and investment limitations. DFA represents that in the future
it may add additional series to the DFA Investment Trust Company, or
create similar open-end management investment companies (collectively;
the Master Fund).
Currently, these series are: the U.S. 6-10 Small Company Series,
the U.S. Large Company Series, the DFA One-Year Fixed Income Series,
U.S. Small Cap Value Series, the U.S. Large Cap Value Series, the DFA
International Value Series and the Emerging Market Series. DFA serves
as investment advisor to each of the series, and it manages the
investment and reinvestment of the series' assets.
5. The shares of the Master Fund are sold only to the DFA sponsored
investment companies, to DFA sponsored group trusts, to separately
managed accounts forming a part of qualified plans, and to other large
institutional investors. The Master Fund is valued in accordance with
regulations issued by the Securities and Exchange Commission (SEC) for
valuing mutual capital under the 1940 Act. The applicant represents
that, as required under the 1940 Act, the fees for the Master Fund are
set at the series level, and must be charged with respect to all assets
invested in such series. The Master Fund, however, does not impose a
fee under the SEC Rule 12b-1.
6. It is represented that the Master Fund is the master of the
master-and-feeder arrangement. The master is an open-end management
investment company registered under the 1940 Act in which the feeders
purchase shares. The feeders include other open-end investment
companies, collective investment vehicles (such as the Group Trusts),
and/or other large institutional investors. A master-and-feeder
arrangement exists where multiple investment vehicles and institutional
investors with identical investment objectives pool their assets by
investing in a single investment company having the same investment
objective. This arrangement enables the feeder funds which invest in
the Master Fund to spread the fixed costs of portfolio management and
fund administration over a greater number of investment dollars and to
achieve economies of scale. DFA represents that it is in the interest
of the Client Plans to utilize the master-and-feeder arrangement.
The investment management fees at the master level reflect only the
costs of investing the assets in the Master Fund. Other fees are paid
at the feeder level. At the feeder level a client enters into an
investment management agreement (IMA) with DFA. Pursuant to the terms
of IMA, the types and amounts of services performed for each client are
individually negotiated with such client. Once the assets are invested
in the Master Fund, the net fee at the feeder level will be determined
by subtracting from each client's gross fee under the IMA that client's
pro rata share of the investment advisory fee paid by the Master
Fund.5 DFA states that this fee arrangement would be covered by
the Prohibited Transaction Class Exemption 77-4 (42 FR 18732, April 8,
1977) (PTCE 77-4).6
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\5\ In this regard, DFA submitted the following example. XYZ
company pension plan signs an IMA under which it agrees to pay DFA
60 basis points for all services provided under the IMA. DFA invests
the XYZ pension plan assets in the Master Fund, which has an
investment advisory fee of 40 basis points. In accordance with PTCE
77-4, DFA will offset the 40 basis point investment advisory fee at
the Master Fund level from the 60 basis point fee at the group trust
or feeder level. The XYZ pension plan will pay DFA 20 basis points
under the IMA with respect to the assets invested in the Master
Fund.
\6\ PTCE 77-4, in pertinent part, permits the purchase and sale
by an employee benefit plan of shares of a registered, open-end
investment company when a fiduciary with respect to the plan is also
the investment adviser for the investment company, provided that,
among other things, the plan does not pay an investment management,
investment advisory or similar fee with respect to the plan assets
invested in such shares for the entire period of such investment.
Section II(c) of PTCE 77-4 states that this condition does not
preclude the payment of investment advisory fees by the investment
company under the terms of an investment advisory agreement adopted
in accordance with section 15 of the Investment Company Act of 1940.
Section II(c) states further that this condition does not preclude
payment of an investment advisory fee by the plan based on total
plan assets from which a credit has been subtracted representing the
plan's pro rata share of investment advisory fees paid by the
investment company.
The Department notes that fees for services other than
investment advisory services (i.e., secondary services such as
administrative services) may be received by an investment advisor or
its affiliate, provided that the conditions of PTCE 77-4 are met.
(See the Advisory Opinions 93-12A and 93-13A issued by the
Department).
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[[Page 49159]]
7. Accordingly, DFA is requesting an exemption to permit the in-
kind transfer of the Client Plans' assets held in the subtrusts of the
Group Trusts to the corresponding series of the Master Fund in exchange
for the shares of the Master Fund. DFA represents that these transfers
would otherwise comply with the PTCE 77-4 as interpreted by the
advisory opinions issued by the Department, except for the fact that
the transfers will be in-kind.7 In accordance with PTCE 77-4, the
investment management, investment advisory or similar fees generated at
the Master Fund level will directly offset the plan level fees with
respect to the Client Plans' assets invested in the Master Fund.
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\7\ In this regard, the Department is of the view that the
relief provided by PTCE 77-4 is unavailable for the purchase and
sale of shares in mutual funds other than for cash. (See Advisory
Opinion 94-35A issued by the Department).
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8. A Second Fiduciary who is independent of DFA will be provided
with advance written notice of the transfer and full written disclosure
concerning the Master Fund, including a current copy of SEC Form N-1A
(regarding the registration of an open end investment company under the
1940 Act) with respect to the Master Fund, plus the additional
information as specified in AO 94-35A which shall include but not be
limited to the following: (1) A table listing management fees for the
most recent completed fiscal period, all other expenses broken down by
category and total portfolio operating expenses; (2) a chart showing
the effect of such fees on an investment in the Fund over one, three,
five and ten years; and (3) a list of per share income and capital
changes for a share outstanding throughout the year, including
investment income, expenses, net investment income, dividends from net
investment income, net realized and unrealized gains (losses) on
securities; distributions from net realized gains (losses) on
securities; increase (decrease) in net asset value, net asset value at
the beginning of the period, net asset value at the end of the period,
expenses to average net assets, portfolio turnover rate, and number of
shares outstanding at the end of the period. On the basis of such
information, the Second Fiduciary will authorize in writing the in-kind
transfer of the Client Plan's assets in the Group Trust to the Master
Fund in exchange for the shares of the Master Fund.
9. DFA will not execute an in-kind transfer of the Client Plan's
assets unless the Second Fiduciary affirmatively consents to the
transfer. Also, no sales commissions or other fees will be paid by the
Client Plans in connection with the purchase of the Master Fund's
shares through an in-kind transfer of the Group Trust's assets. The
transfers will be one-time transactions between subtrusts of the Group
Trusts and series of the Master Fund that have the same investment
objectives. Furthermore, the transferred securities will be valued at
the time of the transfer using the same methodology in the subtrust of
the Group Trust as in the Master Fund's corresponding series.
10. DFA represents that valuation of assets transferred in-kind to
the Master Fund will be established by reference to independent
sources. All assets transferred in-kind will be valued in accordance
with Rule 17a-7 8 under the 1940 Act, as amended from time to time
or any successor rule, regulation or similar pronouncement, and the
procedures established by DFA pursuant to Rule 17a-7 for the valuation
of such assets. Such procedures require that all securities for which a
current market price cannot be obtained by reference to the last sale
price on a recognized securities exchange or NASDAQ, will be valued on
an average of the highest current independent bid and lowest current
independent offer, as of the close of business on the business day
preceding the transfer, determined on the basis of reasonable inquiry
from at least three sources that are broker dealers or pricing services
independent of DFA.
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\8\ Rule 17a-7 permits transactions between investment funds
that use the same investment advisor, subject to certain conditions.
Rule 17a-7(b) requires, among other things, that such transactions
be effected at the ``independent current market price'' for each
security, involve only securities for which market quotations are
readily available, involve no brokerage commissions or other
renumeration, and comply with valuation procedures adopted by the
board of directors of the investment company to ensure that all
requirements of the Rule are satisfied.
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Further, DFA represents that not later than 30 days after
completion of the in-kind transfers it will send by regular mail to
each affected Client Plan, written confirmation of the identity of each
security that was valued for purposes of the transaction in accordance
with Rule 17a-7(b)(4), the price of each such security involved in the
transaction; and the identity of each pricing service or market maker
consulted in determining the value of such securities. The securities
subject to valuation under Rule 17(a)-7(b)(4) include all securities
other than ``reported securities'', as the term is defined in Rule
11Aa3-1 under the Securities Exchange Act of 1934, or those quoted on
the NASDAQ system or for which the principal market is an exchange.
Each Group Trust will receive shares of the Master Fund that have a
total net asset value equal to the value of the Client Plans' all or
pro rata share of the Group Trust's assets on the date of the transfer,
based on the current market value of the Group Trust's assets as
determined in a single valuation also performed in the same manner at
the close of the same business day.
In addition, no later than 90 days after completion of each in-kind
transfer, DFA will send by regular mail to the Second Fiduciary written
confirmation of the number of Group Trust's units held by the Client
Plan immediately before the transfer (and the related per unit value
and the total dollar amount of such Group Trust's units transferred),
and the number of shares in the Master Fund that are held by the Client
Plan following the transfer (and the related per share net asset value
and the total dollar amount of such shares received).
11. With respect to ongoing disclosure, DFA will, as necessary, and
in accordance with requirements of the 1940 Act, provide Client Plans
with updated copies of SEC Form N1-A with respect to the Master Fund.
DFA will also update, as necessary, additional information identified
in AO 94-35A, which is provided by DFA to its Client Plans.
12. DFA represents that the proposed transfers are in the interest
and protective of the Client Plans. No sales commissions or other fees
will be paid by the Client Plans in connection with the purchase of the
Master Fund's shares through an in-kind transfer of the Group Trust's
assets. Furthermore, to the extent that it is not possible for DFA to
determine a price for a particular security pursuant to Rule 17(a)-7,
such security will remain in the Group Trust. In structuring the
transactions as described herein, DFA will eliminate
[[Page 49160]]
commission costs, market maker's spread and any potential for adverse
market impact. The savings from in-kind purchases would directly
benefit the Group Trusts and the Client Plans that participate in them.
DFA also maintains that there will be no penalty to a Client Plan for
not participating in the in-kind transfer. If a Client Plan chooses not
to participate in the transfer, DFA has the option of not transferring
any assets from a particular subtrust of the Group Trust as long as
that Client Plan remains in that subtrust. DFA may also segregate the
Client Plan's proportionate share of Group Trust's assets into a
separate subtrust, and then transfer the remaining assets to the Master
Fund.
13. In summary, the applicant represents that the transaction
satisfies the statutory criteria of section 408(a) of the Act and
section 4975(c)(2) of the Code because:
(a) No sales commissions, redemption fees or other fees are paid by
the Client Plans in connection with the in-kind transfer of Group
Trust's assets in exchange for the shares of the Master Fund;
(b) A Second Fiduciary who is acting on behalf of each affected
Client Plan and who is independent of and unrelated to DFA, as defined
in paragraph (g) of Section III, receives advance written notice of the
in-kind transfer of the Group Trust's assets and the disclosures
described in paragraph (c) of Section II;
(c) No later than 30 days after completion of each in-kind transfer
of Group Trust's assets to the Master Fund, the Second Fiduciaries for
affected Client Plans will receive written confirmation of the identity
of each security that was valued for purposes of the transaction in
accordance with Rule 17a-7(b)(4), the price of each such security, and
the identity of the pricing service or market maker consulted;
(d) No later than 90 days after completion of each in-kind transfer
of the Group Trust's assets to the Master Fund, DFA will mail to the
Second Fiduciary a written confirmation of the number of Group Trust's
units held by each affected Client Plan immediately before the transfer
(and the related per unit value and the aggregate dollar value of such
Group Trust's units transferred), and the number of shares in the
Master Fund that are held by each affected Client Plan following the
transfer (and the related per share net asset value and the aggregate
dollar value of such shares received);
(e) Each Group Trust will receive shares of the Master Fund that
are equal to the value of the Client Plans' all or pro rata share of
the Group Trust's assets on the date of the transfer, as determined in
a single valuation performed in the same manner at the close of the
same business day with respect to any such transfer, in accordance with
the procedures set forth in Rule 17a-7 under the 1940 Act, as amended
from time to time or any successor rule, regulation, or similar
pronouncement;
(f) On the basis of such information described in paragraph (c) of
Section II, the Second Fiduciary will authorize in writing the in-kind
transfer of the Client Plan's assets held in the subtrust of the Group
Trust to the corresponding series of the Master Fund in exchange for
the shares of the Master Fund, and the investment of such assets in the
corresponding series of the Master Fund. Such authorization is to be
consistent with the responsibilities, obligations, and duties imposed
on fiduciaries by Part 4 of Title I of the Act;
(g) DFA will not execute an in-kind transfer of the Client Plan's
assets unless the Second Fiduciary of each affected Client Plan
affirmatively consents to the in-kind transfer in writing;
(h) The transfers will be one-time transactions for each subtrust
of a Group Trust for which a comparable series of a Master Fund exists;
and
(i) there will be no penalty to a Client Plan for not participating
in the in-kind transfer.
Notice to Interested Persons
DFA represents that it will distribute by first class mail a copy
of the notice of pendency of this proposed exemption (the Notice)
within fifteen (15) days of the date of such Notice in the Federal
Register to the fiduciaries of any of the Client Plans which are
invested in any of the Group Trusts on the date of publication of such
Notice in the Federal Register. The distribution to interested persons
shall include a copy of the Notice as published in the Federal Register
and a supplemental statement, as required pursuant to 29 CFR
2570.43(b)(2) which informs all interested persons of their right to
comment on and/or request a hearing with respect to the proposed
exemption. DFA also will provide a copy of the proposed exemption and/
or a copy of the final exemption, if granted, to any Second Fiduciary
of a Client Plan upon request. Comments and requests for a public
hearing are due within forty-five (45) days following the publication
of the proposed exemption in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Ekaterina A. Uzlyan of the Department,
telephone (202) 219-8883. (This is not a toll-free number.)
First National Bank of Anchorage Common Trust Fund (the Fund) Located
in Anchorage, Alaska
[Application No. D-10117]
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 C.F.R. Part
2570, Subpart B (55 FR 32836, 32847, August 10, 1990.) If the exemption
is granted, the restrictions of sections 406(a), 406 (b)(1) and (b)(2)
of the Act and the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1)(A) through (E) of the
Code, shall not apply to the prospective sales of certain defaulted
real estate mortgages (the Mortgages) by the First National Bank of
Anchorage Common Trust Fund (the Fund) to the First National Bank of
Anchorage (the Bank), a party in interest with respect to the Fund,
provided that the following conditions are satisfied:
(1) The sales will be one-time cash transactions;
(2) the Fund will incur no costs in connection with the sales;
(3) the Fund will sell each Mortgage for the greater of fair market
value, or its outstanding principal balance plus accrued, but unpaid
interest, and penalty charges at the time of the sale;
(4) the independent fiduciaries (the Independent Fiduciaries)
appointed to act on behalf of the Fund in these transactions will
review and determine that a Mortgage is in default, has been properly
declared to be in default by the Bank in accordance with the
Comptroller of Currency regulations, and that the prospective sale of a
Mortgage is in the best interest of the Fund;
(5) neither of the Independent Fiduciaries will derive more than 5%
of his gross annual income from the Bank for each fiscal year that he
serves in an independent fiduciary capacity with respect to the
transactions described herein;
(6) the Mortgages will be purchased, rather than segregated, by the
Bank;
(7) the borrowers on the Mortgages will be unrelated third parties;
(8) the conditions of the Prohibited Transaction Exemption 90-60
(PTE 90-60) have been met. PTE 90-60, which expired September 12, 1995,
provided retroactive and prospective relief for sales of the Mortgages
by the Fund to the Bank;
[[Page 49161]]
(9) the Bank maintains for a period of six years, the records
necessary to enable persons described in (10) below to determine
whether the conditions of this proposed exemption have been met, except
that a prohibited transaction will not be considered to have occurred
if, due to the circumstances beyond the control of the Bank or its
affiliates, the records are lost or destroyed prior to the end of the
six-year period; and
(10) (i) Except as provided in paragraph (ii) of this subsection
(10) and notwithstanding any provisions of subsections (a)(2) and (b)
of section 504 of the Act, the records referred to in subsection (9)
above are unconditionally available at their customary location for
examination during normal business hours by--
(A) Any duly authorized employee or representative of the
Department or the Internal Revenue Service,
(B) Any fiduciary of a plan participating in the Fund, who has
authority to acquire or dispose of the interests of the plan, or any
duly authorized employee or representative of such fiduciary,
(C) Any contributing employer to any plan participating in the
Fund, or any duly authorized employee or representative of such
employer, and
(D) Any participant or beneficiary of any plan participating in the
Fund, or any duly authorized employee or representative of such
participant or beneficiary.
(ii) None of the persons described in subparagraphs (B) through (D)
of this subsection (10) shall be authorized to examine trade secrets of
the Bank, any of its affiliates, or commercial or financial information
which is privileged or confidential.
Summary of the Facts and Representations
1. The First National Bank of Anchorage (the Bank) is a bank
organized in the state of Alaska, and it provides banking and trust
services. The Bank is subject to periodic examinations by the
Comptroller of the Currency. The Bank's principal business offices are
located at 646 West Fourth Avenue in Anchorage, Alaska, and the Bank
maintains 27 banking locations within this geographic area.
2. The Fund is a common trust fund established by the Bank on
November 2, 1965. The Fund is established pursuant to the Comptroller
of Currency Regulations section 9.18(a)(1) (OCC Regulations), and
contains assets of participating estates, trusts, and employee benefit
plans (the Participating Trusts). Current investors in the Fund include
three defined contribution profit sharing plans. The Trust Committee of
the Bank (the Trust Committee) has investment discretion with respect
to the Fund. The Bank is the sponsor and fiduciary of the Fund.
The Fund is maintained in accordance with the rules and regulations
of the Comptroller of Currency. As required by the regulations, the
Fund performs annual internal audits. Also, the Fund is valued
quarterly and audited annually by an independent accounting firm. For
the 1996 Fund year, KPMG Peat Marwick will perform the quarterly
valuations and the annual audit of the Fund. The Fund is also subject
to periodic audits by the Comptroller of Currency.
3. The Bank was granted an individual exemption by the Department
in 1990 (PTE 90-60), for the past and prospective sales of certain
defaulted real estate mortgages (the Mortgages) by the Fund in which
the Participating Trusts invest, to the Bank, a party in interest with
respect to the Fund. PTE 90-60 provided retroactive relief as of August
5, 1980, and remained effective for a five year period from September
12, 1990, which was the date the final grant appeared in the Federal
Register. PTE 90-60 expired September 12, 1995. The applicant
represents that the prospective portion of PTE 90-60 was never used by
the Bank. With respect to the prospective transactions entered into
after September 30, 1988, PTE 90-60 contained conditions that were
substantially similar to those proposed herein.
4. The Fund was established by the Bank to collectively invest and
reinvest monies received by the Bank in its capacity as fiduciary and
trustee of estates, trusts and retirement plans. As authorized by the
OCC Regulations, the Fund also invests in first mortgage loans which
were originated by the Fund and secured by real property. The borrowers
on the Mortgages are independent third parties unrelated to the Bank
and the Plans investing in the Fund. Occasionally, some Mortgages go
into default. However, over the preceding five years, no Mortgages have
gone into default. The Fund currently contains one Mortgage which is
not in default. The applicant represents that any Mortgages in default
would represent a small percentage of the net asset value of the Fund,
which as of June 30, 1995 was $7,443,065. In this regard, approximately
20% of the participation interests in the Fund are owned by the
Participating Trusts.
5. The applicant represents that under OCC Regulations, the Bank
has two alternative methods to protect the Fund when a Mortgage owned
by the Fund goes into default. The Bank may either segregate the
defaulted Mortgages from the remainder of the Fund or it may purchase
such Mortgages thereby permitting the Fund to reinvest the proceeds.
The OCC Regulations section 9.18(b)(7)(ii) specifies that a segregated
investment shall be administered separately, realizing its own separate
gains and losses, pro-rata, with regard to all participants in the
Fund. Accordingly, the applicant represents that because each
segregated account bears its own costs and realizes its own income, and
except for borrowings, cannot receive any further investment in the
account, it is possible that liquidating an account for a defaulted
investment would mean significant losses to such account, and the final
proceeds of the liquidating account would be significantly less than
the value of the assets prior to segregation.
However, in the case of the Bank purchasing a mortgage, the OCC
Regulations section 9.18(b)(8)(ii) state that:
``Any bank administering a collective investment fund may purchase
for its own account from such fund any defaulted fixed income
investment held by such fund, if in the judgement of the board of
directors the cost of segregation of such investment would be greater
than the difference between its market value and its principal amount
plus interest and penalty charges due. If the bank elects to so
purchase such investment, it must do so at its market value or the sum
of the costs (i.e., outstanding principal plus accrued unpaid interest,
and penalty charges, whichever is greater.'' The time period available
for a decision with respect to either segregation or purchase of a
mortgage is 60 days when the required payment was not received.
6. The Bank will purchase defaulted Mortgages from the Fund for the
outstanding principal balance, plus accrued but unpaid interest and
penalty charges. As stated in the Summary of the Facts and
Representations of the notice preceding PTE 90-60 (the Summary), the
Board of Directors of the Bank (the Board of Directors) determined that
this practice is a superior alternative to segregation because the
costs of retaining and segregating the mortgages are substantial. If
the Fund were to retain and segregate the Mortgages under the OCC
Regulations, it would, as owner of the Mortgages, incur the costs of
foreclosure in order to realize on the collateral of a mortgage loan.
Pursuant to the retroactive relief provided under PTE 90-60, the Bank
has in the past
[[Page 49162]]
purchased defaulted Mortgages from the Fund for outstanding principal
balance, plus accrued interest and penalty charges at the time of the
purchase.
7. With respect to any prospective purchases of the Mortgages, the
Bank obtained determinations of value from an independent appraiser and
from a business advisor, who also have rendered their opinions under
PTE 90-60. The first determination of value is rendered by Kenneth C.
Hume, who is an independent business advisor in the state of Alaska,
and a former president of the Alaska State Bank. Mr. Hume was also
employed as an assistant vice president with the Bank of California,
and a regional vice president with the First National Bank of Oregon
(First Interstate), and therefore has experience with transactions
involving a bank and its trust department. Mr. Hume concluded on March
5, 1996, that the ``upper limit'' of a fair market value of a mortgage
in default would be the outstanding principal balance plus accrued
interest, insurance, taxes, and penalties. Mr. Hume also stated that it
is in the interest of the Fund to sell the defaulted mortgages and
reinvest these proceeds.
8. A second determination of value, dated April 23, 1996, was
prepared by David T. McCabe, an independent, qualified real estate
appraiser, who has experience as an arbitrator and a general partner
with the Alaska Mortgage Group. Mr. McCabe stated that the ``upper
limit'' of the fair market value of a mortgage in default is the
outstanding principal balance plus accrued but unpaid interest and
penalties. Mr. McCabe also stated that it is in the interest of the
Fund to sell the defaulted mortgages and reinvest these proceeds.
9. The purchases of defaulted Mortgages will be one-time cash
transactions for the greater of fair market value, or the outstanding
principal balance plus accrued, but unpaid interest, and penalty
charges at the time of the sale. A decision as to the ``default''
status of a mortgage will be made by the Trust Committee in accordance
with the Comptroller's Handbook for National Trust Examiners,
Precedents and Opinions for Collective Investment Funds, section
9.5740. This section specifies that: ``Any mortgage which is in default
for a period of 60 days or more should be removed from the fund before
admissions or withdrawals are made. * * * If the loan is not made
current before two valuation dates occur (i.e., 60 days), it should be
removed from the account. Within this limitation, the trust investment
committee could properly be given discretionary authority as to the
segregation or sale of such defaulted mortgages.'' After the Trust
Committee informs the Board of Directors regarding default of a
Mortgage, the Board of Directors makes the decision to purchase the
defaulted Mortgage. As was permitted by PTE 90-60, in the past the Bank
has always purchased, rather then segregated, the Mortgages.
10. The applicant represents that the Bank's prospective purchases
of the Mortgages will continue to be desirable for the Fund.
Segregation of a defaulted Mortgage is not a viable alternative because
the high costs of segregation are ultimately detrimental to the Fund.
These costs would be imposed upon the segregated mortgage assets alone,
thereby reducing the amounts ultimately disbursed to the Participating
Trusts in the Fund when the segregated accounts are liquidated, after
foreclosure. In addition to the foreclosure costs, the Fund would
sustain the loss of additional accounting and administrative expenses
incurred in the segregation of the Mortgages into ``liquidating
accounts'' in the Fund. The likely consequence of segregation is that
the final proceeds of the liquidating account available for
distribution to the Participating Trusts in the Fund will be
significantly less than the value of the assets prior to segregation.
In this regard, the applicant represents that the Mortgages will always
be purchased, rather than segregated, by the Bank.
11. The applicant also appointed Mr. Hume and Mr. McCabe as the
Independent Fiduciaries to monitor prospective purchases of the
Mortgages by the Bank.9 In this regard, Mr. McCabe and Mr. Hume
represent that they accept the fiduciary duties and liability set forth
in section 404 of the Act regarding fiduciary duties. With respect to
the prospective transactions described herein, Mr. McCabe and Mr. Hume
will review and determine that a Mortgage is in default, has been
properly declared in default by the Bank in accordance with the OCC
Regulations, and that the sale of a Mortgage is in the best interest of
the Fund. Neither Independent Fiduciary will derive more than 5% of his
gross annual income from the Bank for each fiscal year that he serves
in an independent fiduciary capacity with respect to the transactions
described herein. The applicant represents that it is probable, given
the nature and the scope of the Bank's business and the size of the
city of Anchorage, that Mr. McCabe and Mr. Hume had a borrower/lender
relationship with the Bank in the past five years. However, this
relationship was de minimus and would not affect their independent
judgement as the Independent Fiduciaries.
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9 The applicant states that the purpose of having two
Independent Fiduciaries is to provide at least one source of
independent review, in the event that one of the Independent
Fiduciaries is not available at the time when a mortgage must be
declared in default by the Bank.
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12. In summary, the applicant represents that the transaction
satisfies the statutory criteria of section 408(a) of the Act and
section 4975(c)(2) of the Code because:
(1) The sales will be one-time cash transactions;
(2) the Fund will incur no costs in connection with the sales;
(3) the Fund will sell each Mortgage for the greater of fair market
value, or its outstanding principal balance plus accrued, but unpaid
interest, and penalty charges at the time of the sale;
(4) two Independent Fiduciaries appointed to act on behalf of the
Fund in these transactions will review and determine that a Mortgage is
in default, has been properly declared to be in default by the Bank in
accordance with the Comptroller of Currency regulations, and that the
prospective sale of a Mortgage is in the best interest of the Fund;
(5) neither of the Independent Fiduciaries will derive more than 5%
of his gross annual income from the Bank for each fiscal year that he
serves in an independent fiduciary capacity with respect to the
transactions described herein;
(6) the Mortgages will be purchased, rather than segregated, by the
Bank;
(7) the conditions of the Prohibited Transaction Exemption 90-60
(PTE 90-60) have been met. PTE 90-60, which expired September 12, 1995,
provided retroactive and prospective relief for sales of the Mortgages
by the Fund to the Bank; and
(8) the borrowers on the Mortgages will be unrelated third parties.
Notice to Interested Persons
The applicant maintains that parties who may be interested in the
pendency of this requested exemption include plan administrators of the
plans participating in the Fund. It is represented that within ten (10)
days of the date of publication of the notice of proposed exemption
(the Notice) in the Federal Register, notification to interested
parties will be provided by first class mail or by delivery. Such
notification will include a copy of the Notice, as published in the
Federal Register, and a copy of the supplemental statement, as
required, pursuant to 29 CFR 2570.43(b)(2). The notification will
inform such interested parties of their right to comment or
[[Page 49163]]
request a hearing within a time period specified in the notification.
For Further Information Contact: Ekaterina A. Uzlyan, U.S.
Department of Labor, telephone (202) 219-8883. (This is not a toll-free
number.)
HSBC Securities, Inc. (HSBC) Located in New York, New York
[Application No. D-10316]
Proposed Exemption
I. Transactions
A. The restrictions of sections 406(a) and 407(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 involving trusts and certificates evidencing
interests therein:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between the
sponsor or underwriter and an employee benefit plan when the sponsor,
servicer, trustee or insurer of a trust, the underwriter of the
certificates representing an interest in the trust, or an obligor 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;
and
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.A.(1) or (2).
Notwithstanding the foregoing, section I.A. does not provide an
exemption from the restrictions of sections 406(a)(1)(E), 406(a)(2) and
407 for the acquisition or holding of a certificate on behalf of an
Excluded Plan by any person who has discretionary authority or renders
investment advice with respect to the assets of that Excluded
Plan.10
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10 Section I.A. provides no relief from sections 406(a)(1)(E),
406(a)(2) and 407 for any person rendering investment advice to an
Excluded Plan within the meaning of section 3(21)(A)(ii) and
regulation 29 CFR 2510.3-21(c).
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B. The restrictions of sections 406(b)(1) and 406(b)(2) of the Act
and the taxes imposed by section 4975(a) and (b) of the Code by reason
of section 4975(c)(1)(E) of the Code shall not apply to:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between the
sponsor or underwriter and a plan when the person who has discretionary
authority or renders investment advice with respect to the investment
of plan assets in the certificates is (a) an obligor with respect to 5
percent or less of the fair market value of obligations or receivables
contained in the trust, or (b) an affiliate of a person described in
(a); if:
(i) the plan is not an Excluded Plan;
(ii) solely in the case of an acquisition of certificates in
connection with the initial issuance of the certificates, at least 50
percent of each class of certificates in which plans have invested is
acquired by persons independent of the members of the Restricted Group
and at least 50 percent of the aggregate interest in the trust is
acquired by persons independent of the Restricted Group;
(iii) a plan's investment in each class of certificates does not
exceed 25 percent of all of the certificates of that class outstanding
at the time of the acquisition; and
(iv) immediately after the acquisition of the certificates, no more
than 25 percent of the assets of a plan with respect to which the
person has discretionary authority or renders investment advice are
invested in certificates representing an interest in a trust containing
assets sold or serviced by the same entity.11 For purposes of this
paragraph B.(1)(iv) only, an entity will not be considered to service
assets contained in a trust if it is merely a subservicer of that
trust;
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\11\ For purposes of this exemption, each plan participating in
a commingled fund (such as a bank collective trust fund or insurance
company pooled separate account) shall be considered to own the same
proportionate undivided interest in each asset of the commingled
fund as its proportionate interest in the total assets of the
commingled fund as calculated on the most recent preceding valuation
date of the fund.
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(2) The direct or indirect acquisition or disposition of
certificates by a plan in the secondary market for such certificates,
provided that the conditions set forth in paragraphs B.(1)(i), (iii)
and (iv) are met; and
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.B.(1) or (2).
C. The restrictions of sections 406(a), 406(b) and 407(a) 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 pooling and servicing arrangement; and
(2) the pooling and servicing 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.12
\12\ 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.
---------------------------------------------------------------------------
Notwithstanding the foregoing, section I.C. does not provide an
exemption from the restrictions of section 406(b) of the Act or from
the taxes imposed by reason of section 4975(c) of the Code for the
receipt of a fee by a servicer of the trust from a person other than
the trustee or sponsor, unless such fee constitutes a ``qualified
administrative fee'' as defined in section III.S.
D. The restrictions of sections 406(a) and 407(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.
II. General Conditions
A. The relief provided under Part I is 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 Corporation
(S&P's), Moody's Investors Service, Inc. (Moody's), Duff & Phelps Inc.
(D & P) or Fitch Investors Service, Inc. (Fitch);
(4) The trustee is not an affiliate of any member of the Restricted
Group. However, the trustee shall not be considered to be an affiliate
of a servicer solely because the trustee has succeeded
[[Page 49164]]
to the rights and responsibilities of the servicer pursuant to the
terms of a pooling and servicing agreement providing for such
succession upon the occurrence of one or more events of default by the
servicer;
(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 the 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 the servicer represents not
more than reasonable compensation for the servicer's services under the
pooling and servicing agreement and reimbursement of the servicer's
reasonable expenses in connection therewith; and
(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 under the Securities Act of 1933.
B. Neither any underwriter, sponsor, trustee, servicer, insurer,
nor any obligor, unless it or any of its affiliates has discretionary
authority or renders investment advice with respect to the plan assets
used by a plan to acquire certificates, shall be denied the relief
provided under Part I, if the provision of subsection 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 subsection II.A.(6) above.
III. Definitions
For purposes of this 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; or
(2) a certificate denominated as a debt instrument--
(a) that represents an interest in a Real Estate Mortgage
Investment Conduit (REMIC) within the meaning of section 860D(a) of the
Internal Revenue Code of 1986; and
(b) that is issued by and is an obligation of a trust;
with respect to certificates defined in (1) and (2) above for which
HSBC is either (i) the sole underwriter or the manager or co-manager of
the underwriting syndicate, or (ii) a selling or placement agent.
For purposes of this 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) either
(a) secured consumer receivables that bear interest or are
purchased at a discount (including, but not limited to, home equity
loans and obligations secured by shares issued by a cooperative housing
association);
(b) secured credit instruments that bear interest or are purchased
at a discount in transactions by or between business entities
(including, but not limited to, qualified equipment notes secured by
leases, as defined in section III.T);
(c) obligations that bear interest or are purchased at a discount
and which are secured by single-family residential, multi-family
residential and commercial real property (including obligations secured
by leasehold interests on commercial real property);
(d) obligations that bear interest or are purchased at a discount
and which are secured by motor vehicles or equipment, or qualified
motor vehicle leases (as defined in section III.U);
(e) ``guaranteed governmental mortgage pool certificates,'' as
defined in 29 CFR 2510.3-101(i)(2);
(f) fractional undivided interests in any of the obligations
described in clauses (a)-(e) of this section B.(1);
(2) property which had 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 pooling and servicing
agreement, and rights under any insurance policies, third-party
guarantees, contracts of suretyship and other credit support
arrangements with respect to any obligations described in subsection
B.(1).
Notwithstanding the foregoing, the term ``trust'' does not include any
investment pool unless: (i) The investment pool consists only of assets
of the type which have been included in other investment pools, (ii)
certificates evidencing interests in such other investment pools have
been rated in one of the three highest generic rating categories by
S&P's, Moody's, D & P, or Fitch for at least one year prior to the
plan's acquisition of certificates pursuant to this exemption, and
(iii) certificates evidencing interests in such other investment pools
have been purchased by investors other than plans for at least one year
prior to the plan's acquisition of certificates pursuant to this
exemption.
C. ``Underwriter'' means:
(1) HSBC;
(2) any person directly or indirectly, through one or more
intermediaries, controlling, controlled by or under common control with
HSBC; or
(3) any member of an underwriting syndicate or selling group of
which HSBC or a person described in (2) is a manager or co-manager with
respect to the certificates.
D. ``Sponsor'' means the entity that organizes a trust by
depositing obligations therein in exchange for certificates.
E. ``Master Servicer'' means the entity that is a party to the
pooling and servicing agreement relating to trust assets and is fully
responsible for servicing, directly or through subservicers, the assets
of the trust.
F. ``Subservicer'' means an entity which, under the supervision of
and on behalf of the master servicer, services loans contained in the
trust, but is not a party to the pooling and servicing agreement.
G. ``Servicer'' means any entity which services loans contained in
the trust, including the master servicer and any subservicer.
H. ``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.
I. ``Insurer'' means the insurer or guarantor of, or provider of
other credit support for, a trust. Notwithstanding the
[[Page 49165]]
foregoing, a person is not an insurer solely because it holds
securities representing an interest in a trust which are of a class
subordinated to certificates representing an interest in the same
trust.
J. ``Obligor'' means any person, other than the insurer, that is
obligated to make payments with respect to any obligation or receivable
included in the trust. Where a trust contains qualified motor vehicle
leases or qualified equipment notes secured by leases, ``obligor''
shall also include any owner of property subject to any lease included
in the trust, or subject to any lease securing an obligation included
in the trust.
K. ``Excluded Plan'' means any plan with respect to which any
member of the Restricted Group is a ``plan sponsor'' within the meaning
of section 3(16)(B) of the Act.
L. ``Restricted Group'' with respect to a class of certificates
means:
(1) each underwriter;
(2) each insurer;
(3) the sponsor;
(4) the trustee;
(5) each servicer;
(6) any obligor with respect to obligations or receivables included
in the trust constituting more than 5 percent of the aggregate
unamortized principal balance of the assets in the trust, determined on
the date of the initial issuance of certificates by the trust; or
(7) any affiliate of a person described in (1)-(6) above.
M. ``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.
N. ``Control'' means the power to exercise a controlling influence
over the management or policies of a person other than an individual.
O. 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.
P. ``Sale'' includes the entrance into a forward delivery
commitment (as defined in section Q 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 the delivery, all conditions of this exemption
applicable to sales are met.
Q. ``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).
R. ``Reasonable compensation'' has the same meaning as that term is
defined in 29 CFR 2550.408c-2.
S. ``Qualified Administrative Fee'' means a fee which meets the
following criteria:
(1) the fee is triggered by an act or failure to act by the obligor
other than the normal timely payment of amounts owing in respect of the
obligations;
(2) the servicer may not charge the fee absent the act or failure
to act referred to in (1);
(3) the ability to charge the fee, the circumstances in which the
fee may be charged, and an explanation of how the fee is calculated are
set forth in the pooling and servicing agreement; and
(4) the amount paid to investors in the trust will not be reduced
by the amount of any such fee waived by the servicer.
T. ``Qualified Equipment Note Secured By A Lease'' means an
equipment note:
(1) which is secured by equipment which is leased;
(2) which is secured by the obligation of the lessee to pay rent
under the equipment lease; and
(3) with respect to which the trust's security interest in the
equipment is at least as protective of the rights of the trust as would
be the case if the equipment note were secured only by the equipment
and not the lease.
U. ``Qualified Motor Vehicle Lease'' means a lease of a motor
vehicle where:
(1) the trust holds a security interest in the lease;
(2) the trust holds a security interest in the leased motor
vehicle; and
(3) the trust's security interest in the leased motor vehicle is at
least as protective of the trust's rights as would be the case if the
trust consisted of motor vehicle installment loan contracts.
V. ``Pooling and Servicing Agreement'' means the agreement or
agreements among a sponsor, a servicer and the trustee establishing a
trust. In the case of certificates which are denominated as debt
instruments, ``Pooling and Servicing Agreement'' also includes the
indenture entered into by the trustee of the trust issuing such
certificates and the indenture trustee.
Summary of Facts and Representations
1. HSBC is a New York-based international banking and financial
services organization. HSBC is a 100% indirect subsidiary of HSBC
Holdings plc (Holdings), a multi-bank holding company registered under
the Bank Holding Company Act of 1956, as amended, and the rules and
regulations thereunder. Holdings is the largest bank in the world
ranked by shareholders' equity. HSBC was incorporated on December 12,
1969, as Carroll, McEntee & Co. (with the current name adopted on April
11, 1994). HSBC provides a wide range of commercial and retail banking
and trust services. HSBC 13 also provides various other financial
services, including commercial banking, merchant banking, and capital
holding markets services.
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\13\ For purposes of this exemption, ``HSBC'' shall include HSBC
and its affiliates, except where the context otherwise requires.
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Together with its affiliates, HSBC is a financial services
organization servicing the financial needs of individuals, businesses,
governments and financial institutions. As to the capital markets, HSBC
engages in securities transactions as both principal and agent and
provides underwriting, research and other financial services. HSBC is
actively involved in the issuance and trading of corporate debt and
other fixed-income securities (including mortgage and asset-backed
securities), U.S. government securities and equity securities.
HSBC represents that it has the legal authority to underwrite
asset-backed securities. By order dated February 20, 1996, the Board of
Governors of the Federal Reserve granted HSBC the power to underwrite
and deal in residential mortgage-related and consumer-receivable
related securities and all types of debt securities, including
securities issued by a trust, partnership, limited liability company or
other vehicle secured by or
[[Page 49166]]
representing interests in debt obligations (such as asset-backed
securities). In each case, HSBC's power to so underwrite and deal is
subject to a framework of structural and operating limitations set
forth in the applicable order, including a condition that it does not
derive more than a certain percentage of its gross revenues from such
activities.
Trust Assets
2. HSBC seeks exemptive relief to permit plans to invest in pass-
through certificates representing undivided interests in the following
categories of trusts: (1) Single and multi-family residential or
commercial mortgage investment trusts; 14 (2) motor vehicle
receivable investment trusts; (3) consumer or commercial receivables
investment trusts; and (4) guaranteed governmental mortgage pool
certificate investment trusts.15
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\14\ The Department notes that PTE 83-1 [48 FR 895, January 7,
1983], a class exemption for mortgage pool investment trusts, would
generally apply to trusts containing single-family residential
mortgages, provided that the applicable conditions of PTE 83-1 are
met. HSBC requests relief for single-family residential mortgages in
this exemption because it would prefer one exemption for all trusts
of similar structure. However, HSBC has stated that it may still
avail itself of the exemptive relief provided by PTE 83-1.
\15\ Guaranteed governmental mortgage pool certificates are
mortgage-backed securities with respect to which interest and
principal payable is guaranteed by the Government National Mortgage
Association (GNMA), the Federal Home Loan Mortgage Corporation
(FHLMC), or the Federal National Mortgage Association (FNMA). The
Department's regulation relating to the definition of plan assets
(29 CFR 2510.3-101(i)) provides that where a plan acquires a
guaranteed governmental mortgage pool certificate, the plan's assets
include the certificate and all of its rights with respect to such
certificate under applicable law, but do not, solely by reason of
the plan's holding of such certificate, include any of the mortgages
underlying such certificate. The applicant is requesting exemptive
relief for trusts containing guaranteed governmental mortgage pool
certificates because the certificates in the trusts may be plan
assets.
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3. Commercial mortgage investment trusts may include mortgages on
ground leases of real property. Commercial
mort gages are frequently secured by ground leases on the underlying
property, rather than by fee simple interests. The separation of the
fee simple interest and the ground lease interest is generally done for
tax reasons. Properly structured, the pledge of the ground lease to
secure a mortgage provides a lender with the same level of security as
would be provided by a pledge of the related fee simple interest. The
terms of the ground leases pledged to secure leasehold mortgages will
in all cases be at least ten years longer than the term of such
mortgages.16
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16 Trust assets may also include obligations that are secured
by leasehold interests on residential real property. See PTE 90-32
involving Prudential-Bache Securities, Inc. (55 FR 23147, June 6,
1990 at 23150).
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Trust Structure
4. Each trust is established under a pooling and servicing
agreement between a sponsor, a servicer and a trustee. The sponsor or
servicer of a trust selects assets to be included in the trust. These
assets are receivables which may have been originated by a sponsor or
servicer of the trust, an affiliate of the sponsor or servicer, or by
an unrelated lender and subsequently acquired by the trust sponsor or
servicer.
On or prior to the closing date, the sponsor acquires legal title
to all assets selected for the trust, establishes the trust and
designates an independent entity as trustee. On the closing date, the
sponsor conveys to the trust legal title to the assets, and the trustee
issues certificates representing fractional undivided interests in the
trust assets. HSBC, alone or together with other broker-dealers, acts
as underwriter or placement agent with respect to the sale of the
certificates. All of the public offerings of certificates presently
contemplated are to be underwritten by HSBC on a firm commitment basis.
In addition, HSBC anticipates that it may privately place certificates
on both a firm commitment and an agency basis. HSBC may also act as the
lead underwriter for a syndicate of securities underwriters.
Certificateholders will be entitled to receive monthly, quarterly
or semi-annual installments of principal and/or interest, or lease
payments due on the receivables, adjusted, in the case of payments of
interest, to a specified rate--the pass-through rate--which may be
fixed or variable.
When installments or payments are made on a semi-annual basis,
funds are not permitted to be commingled with the servicer's assets for
longer than would be permitted for a monthly-pay security. A segregated
account is 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, who invests the
account's assets in short-term securities which have received a rating
comparable to the rating assigned to the certificates. In some cases,
the servicer may be permitted to make a single deposit into the account
once a month. When the servicer makes such monthly deposits, payments
received from obligors by the servicer may be commingled with the
servicer's assets during the month prior to deposit. Usually, the
period of time between receipt of funds by the servicer and deposit of
these funds in a segregated account does not exceed one month.
Furthermore, in those cases where distributions are made semi-annually,
the servicer will furnish a report on the operation of the trust to the
trustee on a monthly basis. At or about the time this report is
delivered to the trustee, it will be made available to
certificateholders and delivered to or made available to each rating
agency that has rated the certificates.
5. Some of the certificates will be multi-class certificates. HSBC
requests exemptive relief for two types of multi-class certificates:
``strip'' certificates and ``fast-pay/ slow-pay'' certificates. Strip
certificates are a type of security in which the stream of interest
payments on receivables is split from the flow of principal payments
and separate classes of certificates are established, each representing
rights to disproportionate payments of principal and interest.17
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17 It is the Department's understanding that where a plan
invests in REMIC ``residual'' interest certificates to which this
exemption applies, some of the income received by the plan as a
result of such investment may be considered unrelated business
taxable income to the plan, which is subject to income tax under the
Code. The Department emphasizes that the prudence requirement of
section 404(a)(l)(B) of the Act would require plan fiduciaries to
carefully consider this and other tax consequences prior to causing
plan assets to be invested in certificates pursuant to this
exemption.
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``Fast-pay/slow-pay'' certificates involve the issuance of classes
of certificates having different stated maturities or the same
maturities with different payment schedules. Interest and/or principal
payments received on the underlying receivables are distributed first
to the class of certificates having the earliest stated maturity of
principal, and/or earlier payment schedule, and only when that class of
certificates has been paid in full (or has received a specified amount)
will distributions be made with respect to the second class of
certificates. Distributions on certificates having later stated
maturities will proceed in like manner until all the certificateholders
have been paid in full. The only difference between this multi-class
pass- through arrangement and a single-class pass-through arrangement
is the order in which distributions are made to certificateholders. In
each case, certificateholders will have a beneficial ownership interest
in the underlying assets. In neither case will the rights of a plan
purchasing a certificate be subordinated to the rights of another
certificateholder in the event of default on any of the underlying
obligations. In particular, if the amount available for
[[Page 49167]]
distribution to certificateholders is less than the amount required to
be so distributed, all senior certificateholders then entitled to
receive distributions will share in the amount distributed on a pro
rata basis.18
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18 If a trust issues subordinated certificates, holders of such
subordinated certificates may not share in the amount distributed on
a pro rata basis with the senior certificateholders. The Department
notes that the exemption does not provide relief for plan investment
in such subordinated certificates.
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6. For tax reasons, the trust must be maintained as an essentially
passive entity. Therefore, both the sponsor's discretion and the
servicer's discretion with respect to assets included in a trust are
severely limited. Pooling and servicing agreements provide for the
substitution of receivables by the sponsor only in the event of defects
in documentation discovered within a short time after the issuance of
trust certificates (within 120 days, except in the case of obligations
having an original term of 30 years, in which case the period will not
exceed two years). Any receivable so substituted is required to have
characteristics substantially similar to the replaced receivable and
will be at least as creditworthy as the replaced receivable.
In some cases, the affected receivable would be repurchased, with
the purchase price applied as a payment on the affected receivable and
passed through to certificateholders.
Parties to Transactions
7. The originator of a receivable is the entity that initially
lends money to a borrower (obligor), such as a home owner or automobile
purchaser, or leases property to a lessee. The originator may either
retain a receivable in its portfolio or sell it to a purchaser, such as
a trust sponsor.
Originators of receivables included in the trusts will be entities
that originate receivables in the ordinary course of their business,
including finance companies for whom such origination constitutes the
bulk of their operations, financial institutions for whom such
origination constitutes a substantial part of their operations, and any
kind of manufacturer, merchant, or service enterprise for whom such
origination is an incidental part of its operations. Each trust may
contain assets of one or more originators. The originator of the
receivables may also function as the trust sponsor or servicer.
8. The sponsor will be one of three entities: (i) A special-purpose
or other corporation unaffiliated with the servicer, (ii) a special-
purpose or other corporation affiliated with the servicer, or (iii) the
servicer itself. Where the sponsor is not also the servicer, the
sponsor's role will generally be limited to acquiring the receivables
to be included in the trust, establishing the trust, designating the
trustee, and assigning the receivables to the trust.
9. The trustee of a trust is the legal owner of the obligations in
the trust. The trustee is also a party to or beneficiary of all the
documents and instruments deposited in the trust, and as such is
responsible for enforcing all the rights created thereby in favor of
certificateholders.
The trustee will be an independent entity, and therefore will be
unrelated to HSBC, the trust sponsor or the servicer. HSBC 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 paid by the servicer or sponsor. The method
of compensating the trustee which is specified in the pooling and
servicing agreement will be disclosed in the prospectus or private
placement memorandum relating to the offering of the certificates.
10. The servicer of a trust administers the receivables on behalf
of the certificateholders. The servicer's functions typically involve,
among other things, notifying borrowers of amounts due on receivables,
maintaining records of payments received on receivables and instituting
foreclosure or similar proceedings in the event of default. In cases
where a pool of receivables has been purchased from a number of
different originators and deposited in a trust, the receivables may be
``subserviced'' by their respective originators and a single entity may
``master service'' the pool of receivables on behalf of the owners of
the related series of certificates. Where this arrangement is adopted,
a receivable continues to be serviced from the perspective of the
borrower by the local subservicer, while the investor's perspective is
that the entire pool of receivables is serviced by a single, central
master servicer who collects payments from the local subservicers and
passes them through to certificateholders.
Receivables of the type suitable for inclusion in a trust
invariably are serviced with the assistance of a computer. After the
sale, the servicer keeps the sold receivables on the computer system in
order to continue monitoring the accounts. Although the records
relating to sold receivables are kept in the same master file as
receivables retained by the originator, the sold receivables are
flagged as having been sold. To protect the investor's interest, the
servicer ordinarily covenants that this ``sold flag'' will be included
in all records relating to the sold receivables, including the master
file, archives, tape extracts and printouts.
The sold flags are invisible to the obligor and do not affect the
manner in which the servicer performs the billing, posting and
collection procedures related to the sold receivables. However, the
servicer uses the sold flag to identify the receivables for the purpose
of reporting all activity on those receivables after their sale to
investors.
Depending on the type of receivable and the details of the
servicer's computer system, in some cases the servicer's internal
reports can be adapted for investor reporting with little or no
modification. In other cases, the servicer may have to perform special
calculations to fulfill the investor reporting responsibilities. These
calculations can be performed on the servicer's main computer, or on a
small computer with data supplied by the main system. In all cases, the
numbers produced for the investors are reconciled to the servicer's
books and reviewed by public accountants.
The underwriter will be a registered broker-dealer that acts as
underwriter or placement agent with respect to the sale of the
certificates. Public offerings of certificates are generally made on a
firm commitment basis. Private placement of certificates may be made on
a firm commitment or agency basis. It is anticipated that the lead and
co-managing underwriters will make a market in certificates offered to
the public.
In some cases, the originator and servicer of receivables to be
included in a trust and the sponsor of the trust (although they may
themselves be related) will be unrelated to HSBC. In other cases,
however, HSBC may originate or service receivables included in a trust,
may sponsor a trust and/or may underwrite certificates.
Certificate Price, Pass-Through Rate and Fees
11. In some cases, the sponsor will obtain the receivables from
various originators pursuant to existing contracts with such
originators under which the sponsor continually buys receivables. In
other cases, the sponsor will purchase the receivables at fair market
value from the originator or a third party pursuant to a purchase and
sale agreement related to the specific offering of certificates. In
other cases, the sponsor will originate the receivables itself.
[[Page 49168]]
As compensation for the receivables transferred to the trust, the
sponsor receives certificates representing the entire beneficial
interest in the trust, or the cash proceeds of the sale of such
certificates. If the sponsor receives certificates from the trust, the
sponsor sells all or a portion of these certificates for cash to
investors or securities underwriters.
12. The price of the certificates, both in the initial offering and
in the secondary market, is affected by market forces, including
investor demand, the pass-through interest rate on the certificates in
relation to the rate payable on investments of similar types and
quality, expectations as to the effect on yield resulting from
prepayment of underlying receivables, and expectations as to the
likelihood of timely payment.
The pass-through rate for certificates is equal to the interest
rate on receivables included in the trust minus a specified servicing
fee.19 This rate is generally determined by the same market forces
that determine the price of a certificate. The price of a certificate
and its pass-through, or coupon, rate together determine the yield to
investors. If an investor purchases a certificate at less than par,
that discount augments the stated pass-through rate; conversely, a
certificate purchased at a premium yields less than the stated coupon.
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19 The pass-through rate on certificates representing
interests in trusts holding leases is determined by breaking down
lease payments into ``principal'' and ``interest'' components based
on an implicit interest rate.
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13. As compensation for performing its servicing duties, the
servicer (who may also be the sponsor or an affiliate thereof, and
receive fees for acting in that capacity) will retain the difference
between payments received on the receivables in the trust and payments
payable (at the pass-through rate) to certificateholders, except that
in some cases a portion of the payments on receivables may be paid to a
third party, such as a fee paid to a provider of credit support. The
servicer may receive additional compensation by having the use of the
amounts paid on the receivables between the time they are received by
the servicer and the time they are due to the trust (which time is set
forth in the pooling and servicing agreement). The servicer typically
will be required to pay the administrative expenses of servicing the
trust, including in some cases the trustee's fee, out of its servicing
compensation.
The servicer is also compensated to the extent it may provide
credit enhancement to the trust or otherwise arrange to obtain credit
support from another party. This ``credit support fee'' may be
aggregated with other servicing fees, and is either paid out of the
interest income received on the receivables in excess of the pass-
through rate or paid in a lump sum at the time the trust is
established.
14. The servicer may be entitled to retain certain administrative
fees paid by a third party, usually the obligor. These administrative
fees fall into three categories: (a) Prepayment fees; (b) late payment
and payment extension fees; and (c) expenses, fees and charges
associated with foreclosure or repossession, or other conversion of a
secured position into cash proceeds, upon default of an obligation.
Compensation payable to the servicer will be set forth or referred
to in the pooling and servicing agreement and described in reasonable
detail in the prospectus or private placement memorandum relating to
the certificates.
15. Payments on receivables may be made by obligors to the servicer
at various times during the period preceding any date on which pass-
through payments to the trust are due. In some cases, the pooling and
servicing agreement may permit the servicer to place these payments in
non-interest bearing accounts maintained with itself or to commingle
such payments with its own funds prior to the distribution dates. In
these cases, the servicer would be entitled to the benefit derived from
the use of the funds between the date of payment on a receivable and
the pass- through date. Commingled payments may not be protected from
the creditors of the servicer in the event of the servicer's bankruptcy
or receivership. In those instances when payments on receivables are
held in non-interest bearing accounts or are commingled with the
servicer's own funds, the servicer is required to deposit these
payments by a date specified in the pooling and servicing agreement
into an account from which the trustee makes payments to
certificateholders.
16. The underwriter will receive a fee in connection with the
securities underwriting or private placement of certificates. In a firm
commitment underwriting, this fee would consist of the difference
between what the underwriter receives for the certificates that it
distributes and what it pays the sponsor for those certificates. In a
private placement, the fee normally takes the form of an agency
commission paid by the sponsor. In a best efforts underwriting in which
the underwriter would sell certificates in a public offering on an
agency basis, the underwriter would receive an agency commission rather
than a fee based on the difference between the price at which the
certificates are sold to the public and what it pays the sponsor. In
some private placements, the underwriter may buy certificates as
principal, in which case its compensation would be the difference
between what it receives for the certificates that it sells and what it
pays the sponsor for these certificates.
Purchase of Receivables by the Servicer
17. The applicant represents that as the principal amount of the
receivables in a trust is reduced by payments, the cost of
administering the trust generally increases, making the servicing of
the trust prohibitively expensive at some point. Consequently, the
pooling and servicing agreement generally provides that the servicer
may purchase the receivables remaining in the trust when the aggregate
unpaid balance payable on the receivables is reduced to a specified
percentage (usually 5 to 10 percent) of the initial aggregate unpaid
balance.
The purchase price of a receivable is specified in the pooling and
servicing agreement and will be at least equal to: (1) The unpaid
principal balance on the receivable plus accrued interest, less any
unreimbursed advances of principal made by the servicer; or (2) the
greater of (a) the amount in (1) or (b) the fair market value of such
obligations in the case of a REMIC, or the fair market value of the
receivables in the case of a trust that is not a REMIC.
Certificate Ratings
18. The certificates will have received one of the three highest
ratings available from either S&P's, Moody's, D&P or Fitch. Insurance
or other credit support (such as surety bonds, letters of credit,
guarantees, or overcollateralization) will be obtained by the trust
sponsor to the extent necessary for the certificates to attain the
desired rating. The amount of this credit support is set by the rating
agencies at a level that is a multiple of the worst historical net
credit loss experience for the type of obligations included in the
issuing trust.
Provision of Credit Support
19. In some cases, the master servicer, or an affiliate of the
master servicer, may provide credit support to the trust (i.e. act as
an insurer). In these cases, the master servicer, in its capacity as
servicer, will first advance funds to the full extent that it
determines that such advances will be recoverable (a) out of late
payments by the obligors, (b) from the credit support provider (which
may be the master servicer or an affiliate thereof) or, (c) in the case
of a trust that
[[Page 49169]]
issues subordinated certificates, from amounts otherwise distributable
to holders of subordinated certificates, and the master servicer will
advance such funds in a timely manner. When the servicer is the
provider of the credit support and provides its own funds to cover
defaulted payments, it will do so either on the initiative of the
trustee, or on its own initiative on behalf of the trustee, but in
either event it will provide such funds to cover payments to the full
extent of its obligations under the credit support mechanism. In some
cases, however, the master servicer may not be obligated to advance
funds but instead would be called upon to provide funds to cover
defaulted payments to the full extent of its obligations as insurer.
Moreover, a master servicer typically can recover advances either from
the provider of credit support or from future payments on the affected
assets.
If the master servicer fails to advance funds, fails to call upon
the credit support mechanism to provide funds to cover delinquent
payments, or otherwise fails in its duties, the trustee would be
required and would be able to enforce the certificate holders' rights,
as both a party to the pooling and servicing agreement and the owner of
the trust estate, including rights under the credit support mechanism.
Therefore, the trustee, who is independent of the servicer, will have
the ultimate right to enforce the credit support arrangement.
When a master servicer advances funds, the amount so advanced is
recoverable by the master servicer out of future payments on
receivables held by the trust to the extent not covered by credit
support. However, where the master servicer provides credit support to
the trust, there are protections in place to guard against a delay in
calling upon the credit support to take advantage of the fact that the
credit support declines proportionally with the decrease in the
principal amount of the obligations in the trust as payments on
receivables are passed through to investors. These safeguards include:
(a) There is often a disincentive to postponing credit losses
because the sooner repossession or foreclosure activities are
commenced, the more value that can be realized on the security for the
obligation;
(b) The master servicer has servicing guidelines which include a
general policy as to the allowable delinquency period after which an
obligation ordinarily will be deemed uncollectible. The pooling and
servicing agreement will require the master servicer to follow its
normal servicing guidelines and will set forth the master servicer's
general policy as to the period of time after which delinquent
obligations ordinarily will be considered uncollectible;
(c) As frequently as payments are due on the receivables included
in the trust (monthly, quarterly or semi-annually, as set forth in the
pooling and servicing agreement), the master servicer is required to
report to the independent trustee the amount of all past-due payments
and the amount of all servicer advances, along with other current
information as to collections on the receivables and draws upon the
credit support. Further, the master servicer is required to deliver to
the trustee annually a certificate of an executive officer of the
master servicer stating that a review of the servicing activities has
been made under such officer's supervision, and either stating that the
master servicer has fulfilled all of its obligations under the pooling
and servicing agreement or, if the master servicer has defaulted under
any of its obligations, specifying any such default. The master
servicer's reports are reviewed at least annually by independent
accountants to ensure that the master servicer is following its normal
servicing standards and that the master servicer's reports conform to
the master servicer's internal accounting records. The results of the
independent accountants' review are delivered to the trustee; and
(d) The credit support has a ``floor'' dollar amount that protects
investors against the possibility that a large number of credit losses
might occur towards the end of the life of the trust, whether due to
servicer advances or any other cause. Once the floor amount has been
reached, the servicer lacks an incentive to postpone the recognition of
credit losses because the credit support amount thereafter is subject
to reduction only for actual draws. From the time that the floor amount
is effective until the end of the life of the trust, there are no
proportionate reductions in the credit support amount caused by
reductions in the pool principal balance. Indeed, since the floor is a
fixed dollar amount, the amount of credit support ordinarily increases
as a percentage of the pool principal balance during the period that
the floor is in effect.
Disclosure
20. In connection with the original issuance of certificates, the
prospectus or private placement memorandum will be furnished to
investing plans. The prospectus or private placement memorandum will
contain information material to a fiduciary's decision to invest in the
certificates, including:
(a) Information concerning the payment terms of the certificates,
the rating of the certificates, and any material risk factors with
respect to the certificates;
(b) A description of the trust as a legal entity and a description
of how the trust was formed by the seller/servicer or other sponsor of
the transaction;
(c) Identification of the independent trustee for the trust;
(d) A description of the receivables contained in the trust,
including the types of receivables, the diversification of the
receivables, their principal terms, and their material legal aspects;
(e) A description of the sponsor and servicer;
(f) A description of the pooling and servicing agreement, including
a description of the seller's principal representations and warranties
as to the trust assets and the trustee's remedy for any breach thereof;
a description of the procedures for collection of payments on
receivables and for making distributions to investors, and a
description of the accounts into which such payments are deposited and
from which such distributions are made; identification of the servicing
compensation and any fees for credit enhancement that are deducted from
payments on receivables before distributions are made to investors; a
description of periodic statements provided to the trustee, and
provided to or made available to investors by the trustee; and a
description of the events that constitute events of default under the
pooling and servicing contract and a description of the trustee's and
the investors' remedies incident thereto;
(g) A description of the credit support;
(h) A general discussion of the principal federal income tax
consequences of the purchase, ownership and disposition of the pass-
through securities by a typical investor;
(i) A description of the underwriters' plan for distributing the
pass-through securities to investors; and
(j) Information about the scope and nature of the secondary market,
if any, for the certificates.
21. Reports indicating the amount of payments of principal and
interest are provided to certificateholders at least as frequently as
distributions are made to certificateholders. Certificateholders will
also be provided with periodic information statements setting forth
material information concerning the underlying assets, including, where
applicable, information as to the amount and number of delinquent and
defaulted loans or receivables.
[[Page 49170]]
22. In the case of a trust that offers and sells certificates in a
registered public offering, the trustee, the servicer or the sponsor
will file such periodic reports as may be required to be filed under
the Securities Exchange Act of 1934. Although some trusts that offer
certificates in a public offering will file quarterly reports on Form
10-Q and Annual Reports on Form 10-K, many trusts obtain, by
application to the Securities and Exchange Commission, a complete
exemption from the requirement to file quarterly reports on Form 10-Q
and a modification of the disclosure requirements for annual reports on
Form 10-K. If such an exemption is obtained, these trusts normally
would continue to have the obligation to file current reports on Form
8-K to report material developments concerning the trust and the
certificates. While the Securities and Exchange Commission's
interpretation of the periodic reporting requirements is subject to
change, periodic reports concerning a trust will be filed to the extent
required under the Securities Exchange Act of 1934.
23. At or about the time distributions are made to
certificateholders, a report will be delivered to the trustee as to the
status of the trust and its assets, including underlying obligations.
Such report will typically contain information regarding the trust's
assets, payments received or collected by the servicer, the amount of
prepayments, delinquencies, servicer advances, defaults and
foreclosures, the amount of any payments made pursuant to any credit
support, and the amount of compensation payable to the servicer. Such
report also will be delivered to or made available to the rating agency
or agencies that have rated the trust's certificates.
In addition, promptly after each distribution date,
certificateholders will receive a statement prepared by the servicer,
paying agent or trustee summarizing information regarding the trust and
its assets. Such statement will include information regarding the trust
and its assets, including underlying receivables. Such statement will
typically contain information regarding payments and prepayments,
delinquencies, the remaining amount of the guaranty or other credit
support and a breakdown of payments between principal and interest.
Forward Delivery Commitments
24. To date, no forward delivery commitments have been entered into
by HSBC in connection with the offering of any certificates, but HSBC
may contemplate entering into such commitments. The utility of forward
delivery commitments has been recognized with respect to offering
similar certificates backed by pools of residential mortgages, and HSBC
may find it desirable in the future to enter into such commitments for
the purchase of certificates.
Secondary Market Transactions
25. It is HSBC's normal policy to attempt to make a market for
securities for which it is lead or co-managing underwriter. HSBC
anticipates that it will make a market in certificates.
Summary
26. In summary, the applicant represents that the transactions for
which exemptive relief is requested satisfy the statutory criteria of
section 408(a) of the Act due to the following:
(a) The trusts contain ``fixed pools'' of assets. There is little
discretion on the part of the trust sponsor to substitute receivables
contained in the trust once the trust has been formed;
(b) Certificates in which plans invest will have been rated in one
of the three highest rating categories by S&P's, Moody's, D&P or Fitch.
Credit support will be obtained to the extent necessary to attain the
desired rating;
(c) All transactions for which HSBC seeks exemptive relief will be
governed by the pooling and servicing agreement, which is made
available to plan fiduciaries for their review prior to the plan's
investment in certificates;
(d) Exemptive relief from sections 406(b) and 407 for sales to
plans is substantially limited; and
(e) HSBC anticipates that it will make a secondary market in
certificates.
Discussion of Proposed Exemption
I. Differences Between Proposed Exemption and Class Exemption PTE 83-1
The exemptive relief proposed herein is similar to that provided in
PTE 81-7 [46 FR 7520, January 23, 1981], Class Exemption for Certain
Transactions Involving Mortgage Pool Investment Trusts, amended and
restated as PTE 83-1 [48 FR 895, January 7, 1983].
PTE 83-1 applies to mortgage pool investment trusts consisting of
interest-bearing obligations secured by first or second mortgages or
deeds of trust on single-family residential property. The exemption
provides relief from sections 406(a) and 407 for the sale, exchange or
transfer in the initial issuance of mortgage pool certificates between
the trust sponsor and a plan, when the sponsor, trustee or insurer of
the trust is a party-in-interest with respect to the plan, and the
continued holding of such certificates, provided that the conditions
set forth in the exemption are met. PTE 83-1 also provides exemptive
relief from section 406(b)(1) and (b)(2) of the Act for the above-
described transactions when the sponsor, trustee or insurer of the
trust is a fiduciary with respect to the plan assets invested in such
certificates, provided that additional conditions set forth in the
exemption are met. In particular, section 406(b) relief is conditioned
upon the approval of the transaction by an independent fiduciary.
Moreover, the total value of certificates purchased by a plan must not
exceed 25 percent of the amount of the issue, and at least 50 percent
of the aggregate amount of the issue must be acquired by persons
independent of the trust sponsor, trustee or insurer. Finally, PTE 83-1
provides conditional exemptive relief from section 406(a) and (b) of
the Act for transactions in connection with the servicing and operation
of the mortgage trust.
Under PTE 83-1, exemptive relief for the above transactions is
conditioned upon the sponsor and the trustee of the mortgage trust
maintaining a system for insuring or otherwise protecting the pooled
mortgage loans and the property securing such loans, and for
indemnifying certificateholders against reductions in pass-through
payments due to defaults in loan payments or property damage. This
system must provide such protection and indemnification up to an amount
not less than the greater of one percent of the aggregate principal
balance of all trust mortgages or the principal balance of the largest
mortgage.
The exemptive relief proposed herein differs from that provided by
PTE 83-1 in the following major respects: (1) The proposed exemption
provides individual exemptive relief rather than class relief; (2) The
proposed exemption covers transactions involving trusts containing a
broader range of assets than single-family residential mortgages; (3)
Instead of requiring a system for insuring the pooled receivables, the
proposed exemption conditions relief upon the certificates having
received one of the three highest ratings available from S&P's,
Moody's, D&P or Fitch (insurance or other credit support would be
obtained only to the extent necessary for the certificates to attain
the desired rating); and (4) The proposed exemption provides more
limited section 406(b) and section 407 relief for sales transactions.
II. Ratings of Certificates
After consideration of the representations of the applicant and
[[Page 49171]]
information provided by S&P's, Moody's, D&P and Fitch, the Department
has decided to condition exemptive relief upon the certificates having
attained a rating in one of the three highest generic rating categories
from S&P's, Moody's, D&P or Fitch. The Department believes that the
rating condition will permit the applicant flexibility in structuring
trusts containing a variety of mortgages and other receivables while
ensuring that the interests of plans investing in certificates are
protected. The Department also believes that the ratings are indicative
of the relative safety of investments in trusts containing secured
receivables. The Department is conditioning the proposed exemptive
relief upon each particular type of asset-backed security having been
rated in one of the three highest rating categories for at least one
year and having been sold to investors other than plans for at least
one year.\20\
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\20\ In referring to different ``types'' of asset-backed
securities, the Department means certificates representing interests
in trusts containing different ``types'' of receivables, such as
single family residential mortgages, multi-family residential
mortgages, commercial mortgages, home equity loans, auto loan
receivables, installment obligations for consumer durables secured
by purchase money security interests, etc. The Department intends
this condition to require that certificates in which a plan invests
are of the type that have been rated (in one of the three highest
generic rating categories by S&P's, D&P, Fitch or Moody's) and
purchased by investors other than plans for at least one year prior
to the plan's investment pursuant to the proposed exemption. In this
regard, the Department does not intend to require that the
particular assets contained in a trust must have been ``seasoned''
(e.g., originated at least one year prior to the plan's investment
in the trust).
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III. Limited Section 406(b) and Section 407(a) Relief for Sales
HSBC represents that in some cases a trust sponsor, trustee,
servicer, insurer, and obligor with respect to receivables contained in
a trust, or an underwriter of certificates may be a pre-existing party
in interest with respect to an investing plan.\21\ In these cases, a
direct or indirect sale of certificates by that party in interest to
the plan would be a prohibited sale or exchange of property under
section 406(a)(1)(A) of the Act.\22\ Likewise, issues are raised under
section 406(a)(1)(D) of the Act where a plan fiduciary causes a plan to
purchase certificates where trust funds will be used to benefit a party
in interest.
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\21\ In this regard, we note that the exemptive relief proposed
herein is limited to certificates with respect to which First Union
or any of its affiliates is either (a) the sole underwriter or
manager or co-manager of the underwriting syndicate, or (b) a
selling or placement agent.
\22\ The applicant represents that where a trust sponsor is an
affiliate of HSBC, sales to plans by the sponsor may be exempt under
PTE 75-1, Part II (relating to purchases and sales of securities by
broker-dealers and their affiliates), if HSBC is not a fiduciary
with respect to plan assets to be invested in certificates.
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Additionally, HSBC represents that a trust sponsor, servicer,
trustee, insurer, and obligor with respect to receivables contained in
a trust, or an underwriter of certificates representing an interest in
a trust may be a fiduciary with respect to an investing plan. HSBC
represents that the exercise of fiduciary authority by any of these
parties to cause the plan to invest in certificates representing an
interest in the trust would violate section 406(b)(1), and in some
cases section 406(b)(2), of the Act.
Moreover, HSBC represents that to the extent there is a plan asset
``look through'' to the underlying assets of a trust, the investment in
certificates by a plan covering employees of an obligor under
receivables contained in a trust may be prohibited by sections 406(a)
and 407(a) of the Act.
After consideration of the issues involved, the Department has
determined to provide the limited sections 406(b) and 407(a) relief as
specified in the proposed exemption.
NOTICE TO INTERESTED PERSONS: The applicant represents that because
those potentially interested participants and beneficiaries cannot all
be identified, the only practical means of notifying such participants
and beneficiaries of this proposed exemption is by the publication of
this notice in the Federal Register. Comments and requests for a
hearing must be received by the Department not later than 30 days from
the date of publication of this notice of proposed exemption in the
Federal Register.
FOR FURTHER INFORMATION CONTACT: Gary Lefkowitz of the Department,
telephone (202) 219-8881. (This is not a toll-free number.)
General Information
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and/or section 4975(c)(2) of the Code
does not relieve a fiduciary or other party in interest of disqualified
person from certain other provisions of the Act and/or the Code,
including any prohibited transaction provisions to which the exemption
does not apply and the general fiduciary responsibility provisions of
section 404 of the Act, which among other things require a fiduciary to
discharge his duties respecting the plan solely in the interest of the
participants and beneficiaries of the plan and in a prudent fashion in
accordance with section 404(a)(1)(b) of the act; nor does it affect the
requirement of section 401(a) of the Code that the plan must operate
for the exclusive benefit of the employees of the employer maintaining
the plan and their beneficiaries;
(2) Before an exemption may be granted under section 408(a) of the
Act and/or section 4975(c)(2) of the Code, the Department must find
that the exemption is administratively feasible, in the interests of
the plan and of its participants and beneficiaries and protective of
the rights of participants and beneficiaries of the plan;
(3) The proposed exemptions, if granted, will be supplemental to,
and not in derogation of, any other provisions of the Act and/or the
Code, including statutory or administrative exemptions and transitional
rules. Furthermore, the fact that a transaction is subject to an
administrative or statutory exemption is not dispositive of whether the
transaction is in fact a prohibited transaction; and
(4) The proposed exemptions, if granted, will be subject to the
express condition that the material facts and representations contained
in each application are true and complete and accurately describe all
material terms of the transaction which is the subject of the
exemption. In the case of continuing exemption transactions, if any of
the material facts or representations described in the application
change after the exemption is granted, the exemption will cease to
apply as of the date of such change. In the event of any such change,
application for a new exemption may be made to the Department.
Signed at Washington, DC, this 13th day of September, 1996.
Ivan Strasfeld,
Director of Exemption Determinations, Pension and Welfare Benefits
Administration, U.S. Department of Labor.
[FR Doc. 96-23926 Filed 9-17-96; 8:45 am]
BILLING CODE 4510-29-P
