[Federal Register Volume 64, Number 188 (Wednesday, September 29, 1999)]
[Proposed Rules]
[Pages 52476-52483]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-25253]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 270
[Release No. IC-24050; File No. S7-21-99]
RIN 3235-AH56
Treatment of Repurchase Agreements and Refunded Securities as an
Acquisition of the Underlying Securities
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Commission is proposing for public comment a new rule and
related rule amendments under the Investment Company Act of 1940 that
would affect the ability of investment companies to invest in
repurchase agreements and pre-refunded bonds under the Act. The
proposed rule would generally codify and update staff positions that
have permitted investment companies to ``look through'' counterparties
to certain repurchase agreements and issuers of municipal bonds that
have been ``refunded'' with U.S. government securities and treat the
securities comprising the collateral as investments for certain
purposes under the Act.
DATES: Comments must be received on or before November 23, 1999.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 5th Street,
N.W., Washington, D.C. 20549-0609. Comments also may be submitted
electronically at the following E-mail address: rule-comments@sec.gov.
All comment letters should refer to File No. S7-21-99; this file number
should be included on the subject line if E-mail is used. Comment
letters will be available for public inspection and copying in the
Commission's Public Reference Room, 450 5th Street, N.W., Washington,
D.C. 20549. Electronically submitted comment letters also will be
posted on the Commission's Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Marilyn Mann, Senior Counsel, Office
of Regulatory Policy, at (202) 942-0690, or Alison M. Fuller, Assistant
Chief Counsel, Office of Chief Counsel, (202) 942-0660, Division of
Investment Management, Securities and Exchange Commission, 450 5th
Street, N.W., Washington, D.C. 20549-0506.
SUPPLEMENTARY INFORMATION: The Commission today is requesting public
comment on proposed rule 5b-3 [17 CFR 270.5b-3] and conforming
amendments to rules 2a-7 [17 CFR 270.2a-7] and 12d3-1 [17 CFR 270.12d3-
1] under the Investment Company Act of 1940 [15 U.S.C. 80a] (the
``Act'').\1\
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\1\ Unless otherwise noted, all references to rule 2a-7 or rule
12d3-1, or to any paragraph of those rules, will be to 17 CFR
270.2a-7 and 17 CFR 270.12d3-1, respectively.
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Table of Contents
Executive Summary
I. Background
A. Repurchase Agreements
B. Pre-Refunded Bonds
II. Discussion
A. Proposed Rule 5b-3(a): Treatment of Repurchase Agreements
B. Proposed Rule 5b-3(b): Treatment of Pre-Refunded Bonds
C. Availability of Rule 12d3-1 for Repurchase Agreements
D. Conforming Amendments to Rule 2a-7
E. Request for Comments
III. Cost-Benefit Analysis
IV. Summary of Initial Regulatory Flexibility Analysis
V. Statutory Authority
Text of Proposed Rule and Rule Amendments
Executive Summary
Repurchase agreements provide investment companies (``funds'') with
a convenient means to invest excess cash on a secured basis, generally
for short periods of time. In a typical fund repurchase agreement, a
fund enters into a contract with a broker, dealer or bank (the
``counterparty'' to the transaction) for the purchase of securities.
The counterparty agrees to repurchase the securities at a specified
future date or on demand for a price that is sufficient to return to
the fund its original purchase price, plus an additional amount
representing the return on the fund's investment.
The Commission is proposing a rule that would permit funds to
``look through'' certain repurchase agreements to the securities
collateralizing the agreements for various purposes under the Act.
Because a fund looks to the collateral as the ultimate source of
repayment for its loan, the Commission staff has taken a ``no-action''
position in order to allow funds to treat certain repurchase agreements
as investments in the securities making up the collateral rather than
as a loan to the counterparty. Proposed rule 5b-3 would codify these
positions and allow a fund to treat a repurchase agreement as an
acquisition of the underlying collateral in determining whether it is
in compliance with the investment criteria for diversified funds set
forth in section 5(b)(1) of the Act.\2\ The proposed rule also would
codify staff no-action positions that allow a fund that enters into a
repurchase agreement with a counterparty that is a broker-dealer to
``look through'' the repurchase agreement to the underlying collateral
for purposes of section 12(d)(3) of the Act, which prohibits a fund
from acquiring an interest in a broker-dealer.\3\ The proposed rule
would require the value of the collateral at all times to be sufficient
to fully cover the amount payable under the repurchase agreement (that
is, the amount that the counterparty would repay the fund to repurchase
the securities). In addition, the fund must evaluate whether the
counterparty is creditworthy and the repurchase agreement must qualify
for an exclusion from any automatic stay of creditors' rights under the
federal
[[Page 52477]]
Bankruptcy Code or other insolvency laws.
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\2\ 15 U.S.C. 80a-5(b)(1).
\3\ 15 U.S.C. 80a-12(d)(3).
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Proposed rule 5b-3 would provide similar ``look-through'' treatment
for purposes of section 5(b)(1) of the Act in the case of investments
in pre-refunded bonds, the repayment of which has been fully funded by
escrowed U.S. government securities. As in the case of repurchase
agreements, a fund may view its investment in pre-refunded bonds as an
investment in the escrowed government securities rather than in the
original bonds.
The conditions proposed for the treatment of repurchase agreements
and pre-refunded bonds under the proposed rule would be substantially
the same as those required by rule 2a-7, the rule governing money
market funds, and would codify and update long-standing staff no-action
positions.
I. Background
A. Repurchase Agreements
Repurchase agreements provide funds with a means to invest idle
cash at competitive rates for periods as short as overnight.
Economically, they may be viewed as loans from the fund to the
counterparty in which the securities that the fund purchases serve as
collateral for the loan and are placed in the possession or under the
control of the fund's custodian during the term of the agreement.\4\ By
investing in repurchase agreements, funds can expand their available
options for the productive investment of short-term cash. At the same
time, fund participation in the market for repurchase agreements
benefits other market participants by enhancing their ability to borrow
to meet their short-term needs.
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\4\ See The Handbook of Fixed Income Securities 198 (Frank J.
Fabozzi ed., 5th ed. 1997). Most repurchase transactions involve
Treasury bills and other U.S. government securities, but bank
certificates of deposit and bankers' acceptances, as well as
commercial paper from major corporations, are used as well. See
Jeanne L. Schroeder, Repo Madness: The Characterization of
Repurchase Agreements Under the Bankruptcy Code and the U.C.C., 46
Syracuse L. Rev. 999, 1005 (1996). When the counterparty lends to,
rather than borrows from, the fund, the transaction is termed a
``reverse repurchase agreement.'' Reverse repurchase agreements
raise issues under section 18 of the Act [15 U.S.C. 80a-18] because
they can be viewed as the issuance by the fund of a senior security.
These issues were addressed in Investment Company Act Release No.
10666 (Apr. 18, 1979) [44 FR 25128 (Apr. 27, 1979)] (``Release
10666'').
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Two provisions of the Act may affect a fund's ability to invest in
repurchase agreements. Section 12(d)(3) of the Act generally prohibits
a fund from acquiring an interest in a broker, dealer, or
underwriter.\5\ Because a repurchase agreement may be considered to be
the acquisition of an interest in the counterparty,\6\ section 12(d)(3)
may limit a fund's ability to enter into repurchase agreements with
many of the firms that act as counterparties.\7\ Section 5(b)(1) of the
Act limits the amount that a fund that holds itself out as being a
diversified investment company may invest in the securities of any one
issuer (other than the U.S. government).\8\ This provision may limit
the amount of repurchase agreements that a diversified fund may enter
into with any one counterparty.
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\5\ With minor exceptions, section 12(d)(3) prohibits an
investment company from purchasing or otherwise acquiring ``any
security issued by or any other interest in the business of any
person who is a broker, a dealer, [or] is engaged in the business of
underwriting.'' The staff has taken the position that fund
repurchase agreements with banks that are engaged in a securities-
related business, including dealing in government securities, may be
subject to the prohibitions of section 12(d)(3). See Letter from
Gerald Osheroff, Associate Director, Division of Investment
Management, to Matthew Fink, General Counsel, Investment Company
Institute (May 7, 1985) (``May 7, 1985 Letter'').
\6\ See American Medical Ass'n Tax-Exempt Income Fund, Inc., SEC
No-Action Letter (Apr. 23, 1978); May 7, 1985 Letter, supra note 5.
\7\ Brokers and dealers (as well as banks that are engaged in
securities related activities) often act as counterparties in
repurchase transactions. See Schroeder, supra note 4, at 1004. If
funds are unable to enter into repurchase agreements with these
counterparties, they effectively may be unable to participate in
this market.
\8\ To be classified as a ``diversified'' fund under section
5(b)(1) of the Act, a fund is required, with respect to 75 percent
of its assets, to invest no more than 5 percent of its assets in the
securities of any one issuer (excluding cash and cash items,
government securities, and securities of other investment
companies). The remaining 25 percent of the fund's assets may be
invested in any manner. Section 13(a)(1) of the Act [15 U.S.C. 80a-
13(a)(1)] prohibits a fund that is classified as a diversified
company from changing to a non-diversified company without
shareholder authorization.
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A fund investing in a properly structured repurchase agreement
looks primarily to the value and liquidity of the collateral rather
than the credit of the counterparty for satisfaction of the repurchase
agreement.\9\ In two separate no-action positions issued in 1979 and
1980, the staff stated that, for purposes of sections 12(d)(3) and
5(b)(1) of the Act, a fund may treat a repurchase agreement as an
acquisition of the underlying collateral if the repurchase agreement is
``collateralized fully.'' \10\ Because most repurchase agreements are
collateralized fully by highly liquid U.S. government securities, this
``look-through'' treatment allowed funds to treat repurchase agreements
as investments in government securities. As a result, a fund could
invest in repurchase agreements with the same counterparty without the
limitations of sections 12(d)(3) or 5(b)(1).\11\
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\9\ See infra note 16 and accompanying text.
\10\ In 1979, the staff announced that it would not recommend
enforcement action under section 12(d)(3) if the repurchase
agreement was ``structured in a manner reasonably designed to
collateralize fully the investment company loan.'' Release 10666,
supra note 4. The following year, the staff applied this no-action
position to a fund's compliance with the diversification
requirements of section 5(b)(1) of the Act. MoneyMart Assets, Inc.,
SEC No-Action Letter (Sept. 3, 1980).
\11\ Repurchase agreements with broker-dealers affiliated with
the fund would, of course, continue to raise serious questions under
sections 17(a) and 17(d) of the Act [15 U.S.C. 80a-17(a), 15 U.S.C.
80a-17(d)]. See Release 10666, supra note 4, at n.24.
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The assumptions underlying the 1979 and 1980 no-action positions
were challenged in the early 1980s as a result of the bankruptcy of
Lombard-Wall, Inc., a large issuer of repurchase agreements, and the
insolvency of several others.\12\ The court in the Lombard-Wall case
held that the purchaser of securities in a repurchase agreement was
subject to the automatic stay of the Bankruptcy Code,\13\ and could not
close out its position without the approval of the bankruptcy
court.\14\ This decision created uncertainty regarding the status of
repurchase agreements under the Bankruptcy Code and exposed a fund to
the risk that it might be unable to liquidate the collateral securities
immediately upon the insolvency of the counterparty.\15\ Because of the
possible adverse effect of counterparty insolvency on a fund's
liquidity, the Commission issued a staff release that added a condition
to the staff's earlier no-action position. In addition to requiring the
repurchase agreement to be fully collateralized, the staff now required
the fund to evaluate the creditworthiness of the counterparty.\16\
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\12\ See In re Lombard-Wall Inc., No. 82 B 11556, bench op.
(Bankr. S.D.N.Y. Sept. 16, 1982).
\13\ 11 U.S.C. 101 et seq.
\14\ See Omnibus Bankruptcy Improvements Act of 1983, S. Rep.
No. 98-65, at 47 (1983) (discussing In re Lombard-Wall Inc.).
\15\ As a consequence, the repurchase agreement might be an
illiquid investment subject to restrictions on the amount of these
investments in a fund's portfolio.
\16\ Investment Company Act Release No. 13005 (Feb. 2, 1983) [48
FR 5894 (Feb. 9, 1983)] (``Release 13005''). Release 13005 called
for the evaluation of the counterparty's creditworthiness to be made
by the fund's board of directors. In a recent letter to the
Investment Company Institute, the staff revised this position to
permit a fund's investment adviser, rather than the fund's board, to
evaluate the creditworthiness of counterparties and otherwise assume
primary responsibility for monitoring and evaluating the fund's use
of repurchase agreements. Investment Company Institute, SEC No-
Action Letter (June 15, 1999).
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Congress later amended the Bankruptcy Code to resolve this
uncertainty.\17\ As amended, the
[[Page 52478]]
Bankruptcy Code now protects participants in repurchase agreements from
the Code's automatic stay and preference avoidance provisions when the
collateral consists of U.S. government and agency obligations,
certificates of deposit, and eligible bankers' acceptances.\18\ In
1996, when we amended the money market fund rule (rule 2a-7, which had
codified the staff's position on repurchase agreements in connection
with that rule's diversification requirements),\19\ we tied the
availability of the ``look-through'' more directly to the preferred
treatment given to repurchase agreements under the Bankruptcy Code and
related insolvency statutes.\20\ We noted that if the collateral did
not qualify for special treatment under these statutes, a fund could
encounter significant liquidity problems if a large percentage of its
assets were invested in a repurchase agreement with a bankrupt
counterparty. In that case, the credit risks assumed by the fund would
be directly tied to the counterparty rather than the issuers of the
underlying collateral.\21\
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\17\ Before the passage of the Bankruptcy Amendments and Federal
Judgeship Act of 1984, Pub. L. No. 98-353, 98 Stat. 333 (1984)
(``BAFJA''), the treatment of a repurchase agreement under the
Bankruptcy Code depended upon whether it was characterized as a
secured loan or a purchase and sale transaction. If the transaction
was characterized as a secured loan, the borrower-counterparty would
retain at least an equitable interest in the securities, and the
securities would be subject to the automatic stay provisions of the
Bankruptcy Code, preventing the lender from taking any action
against the borrower's property. If the transaction was
characterized as a purchase and sale, the repurchase obligation
would be viewed as an executory contract, which the bankruptcy
trustee could accept or reject. Until acceptance or rejection, the
fund would be exposed to the market risk of the securities.
Regardless of the transaction's characterization, it was unclear
whether ``mark-to-market'' payments (the payments required to keep
the repurchase agreement fully collateralized) could be voided by
the trustee as preferential transfers. The BAFJA amendments removed
qualifying repurchase agreements from the operation of the
Bankruptcy Code's automatic stay and preference avoidance
provisions. See 11 U.S.C. 101(47) (defining repurchase agreement);
11 U.S.C. 559 (protecting repurchase agreement participants from the
Bankruptcy Code's automatic stay provisions).
\18\ See 11 U.S.C. 101(47); 11 U.S.C. 559. The Federal Deposit
Insurance Act also provides preferred treatment to repurchase
agreements in which a bank is the counterparty. See 12 U.S.C.
1821(e)(8)(A), (C) (affording preferred treatment to ``qualified
financial contracts''); 12 U.S.C. 1821(e)(8)(D)(i) (defining
qualified financial contracts to include repurchase agreements); 12
U.S.C. 1821(e)(8)(D)(v) (defining repurchase agreement).
In broker-dealer insolvencies, the buyer's ability to liquidate
the repurchase agreement collateral is subject to the possible
imposition of a judicial stay obtained by the Securities Investor
Protection Corporation (``SIPC''). Representatives of SIPC, however,
have indicated that SIPC would consent, and urge the trustee to
consent, to the liquidation of repurchase agreement collateral upon
SIPC's receipt of certain documentation, including an affidavit from
the buyer that it has a perfected security interest in the
collateral. See Letter from Michael E. Don, President, SIPC, to Seth
Grosshandler, Cleary, Gottlieb, Steen & Hamilton (Feb. 14, 1996);
Letter from Michael E. Don, Deputy General Counsel, Office of the
General Counsel, SIPC, to Eugene Marans, Cleary, Gottlieb, Steen &
Hamilton (Aug. 29, 1988).
\19\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 18005 (Feb. 20, 1991) [56 FR 8113
(Feb. 27, 1991)], at nn. 30-33 and accompanying text.
\20\ See Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 19959 (Dec. 17, 1993) [58 FR
68585 (Dec. 28, 1993)] (``1996 Amendments Proposing Release''), at
nn. 168-74 and accompanying text; Revisions to Rules Regulating
Money Market Funds, Investment Company Act Release No. 21837 (Mar.
21, 1996) [61 FR 13956 (Mar. 28, 1996)] (``1996 Amendments Adopting
Release''), at nn. 116-19.
\21\ 1996 Amendments Proposing Release, supra note 20, at n.172.
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The Commission is proposing a new rule 5b-3 that would codify the
staff's positions that a fund may look through a fully collateralized
repurchase agreement to the underlying securities for purposes of
sections 5(b)(1) and 12(d)(3) of the Act,\22\ supplemented by the
requirement of rule 2a-7 that the repurchase agreement qualify for an
exclusion from any automatic stay of creditors' rights under applicable
insolvency law. Because the conditions for looking through a repurchase
agreement for purposes of sections 5(b)(1) and 12(d)(3) are
substantially the same as the conditions under rule 2a-7, the
Commission is proposing to codify the same standard for all three
purposes.
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\22\ The Commission expects to withdraw the staff positions if
we adopt the proposed rule.
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B. Pre-Refunded Bonds
Pre-refunded bonds are municipal bonds the repayment of which has
been fully funded by a deposit into escrow of U.S. government
securities. From time to time, a municipality may choose to refund
previously issued bonds prior to their call date by issuing a second
bond, the proceeds of which are used to purchase U.S. government
securities. These securities are placed in escrow, and the principal
and interest on the escrowed securities are used to pay off the
original bonds.\23\ The holders of the original bonds no longer look to
the municipal issuer for repayment, but rather to the escrowed
securities.
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\23\ See, e.g., Robert Zipf, How Municipal Bonds Work 44-47
(1995).
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In 1993, the staff issued a no-action position permitting funds,
under certain conditions, to look through pre-refunded bonds to the
escrowed government securities for purposes of the section 5(b)(1)
diversification requirements.\24\ When the Commission amended rule 2a-7
in 1996, it codified this position for purposes of the money market
fund diversification requirements, but omitted the condition that the
pre-refunded bonds of any one issuer could account for no more than 25
percent of the fund's assets.\25\ The Commission proposes to codify
this revised treatment of pre-refunded bonds for purposes of section
5(b)(1).\26\
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\24\ T. Rowe Price Tax-Free Funds, SEC No-Action Letter (June
24, 1993). In the letter, the Division of Investment Management
agreed not to recommend any enforcement action if a fund treated an
investment in municipal bonds refunded with escrowed government
securities as an investment in the government securities for
purposes of section 5(b)(1). This no-action position was based on
certain representations, including that (1) the deposit of the
government securities was irrevocable and pledged only to the debt
service on the original bonds, (2) payments from the escrow would
not be subject to the preference provisions or automatic stay
provisions of the Bankruptcy Code, and (3) no fund would invest more
than 25 percent of its assets in the pre-refunded bonds of any
single municipal issuer.
\25\ The Commission also eliminated the 25 percent limitation
for funds other than money market funds that rely on the staff no-
action position set forth in T. Rowe Price Tax-Free Funds. 1996
Amendments Adopting Release, supra note 20, at n.122.
\26\ The Commission expects to withdraw the staff position if we
adopt the proposed rule.
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II. Discussion
A. Proposed Rule 5b-3(a): Treatment of Repurchase Agreements
Proposed rule 5b-3 would permit a fund to treat the acquisition of
a repurchase agreement as an acquisition of the underlying securities
for purposes of sections 5(b)(1) and 12(d)(3) of the Act, if the
obligation of the seller to repurchase the securities from the fund is
``collateralized fully,'' as defined in the proposed rule.\27\
Consistent with the staff's no-action positions, the proposed rule also
would require the board of directors or its delegate to evaluate the
counterparty's creditworthiness.\28\ A similar requirement would be
added to rule 2a-7.\29\
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\27\ Proposed rule 5b-3(a). A fund would be permitted to look
through only that portion of the repurchase agreement that is
collateralized fully. Any agreement or portion of an agreement that
is not collateralized fully would be treated as a loan by the fund
to the counterparty. Even if a repurchase agreement is
collateralized fully, a fund may elect to look to the counterparty
rather than the underlying securities in meeting the diversification
requirements of section 5(b)(1).
\28\ Id. See Release 13005, supra note 16; Investment Company
Institute, supra note 16.
\29\ Proposed rule 2a-7(c)(4)(ii)(A). This requirement is not
new. In Investment Company Act Release No. 22383 (Dec. 10, 1996) [61
FR 66621 (Dec. 18, 1996)] (proposing technical amendments to rule
2a-7), at note 32, the Commission stated that a money market fund
must continue to evaluate the counterparty's creditworthiness in
order to minimize the risk of becoming involved in bankruptcy
proceedings, consistent with the no-action position stated in
Release 13005.
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The proposed rule generally would incorporate the definition of
``collateralized fully'' currently employed in rule 2a-7.\30\ A
repurchase
[[Page 52479]]
agreement would be collateralized fully if: (i) the value of the
underlying securities (reduced by the costs that the fund reasonably
could expect to incur if the counterparty defaults) is, and at all
times remains, at least equal to the agreed resale price; \31\ (ii) the
collateral for the repurchase agreement consists entirely of cash
items, U.S. government securities, or other securities of a high
quality; \32\ and (iii) the repurchase agreement qualifies for an
exclusion from any automatic stay of creditors' rights against the
counterparty under applicable insolvency law in the event of the
counterparty's insolvency.\33\
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\30\ Rule 2a-7(a)(5).
\31\ Proposed rule 5b-3(c)(1)(i) requires the value of the
securities collateralizing the repurchase agreement to be, and
during the entire term of the agreement to remain, at least equal to
the resale price. The term ``resale price'' is defined in paragraph
(c)(7) of the proposed rule as the acquisition price paid to the
seller plus the accrued resale premium, i.e., the return on
investment specified in the agreement. Consistent with prior staff
positions, the market value of the securities held as collateral
must be marked to market daily during the entire term of the
agreement to ensure that the collateral is at all times at least
equal to the resale price, and the repurchase agreement should
provide for the delivery of additional collateral if the market
value of the securities falls below the resale price. See Letter
from Gerald Osheroff, supra note 5. Under the proposed rule, the
fund's expected return on its investment may be either the full
amount specified in the agreement or the daily amortization of the
difference between the purchase price and the resale price specified
in the agreement. This allows the counterparty to add to the
collateral as interest on the loan accrues. See 1996 Amendments
Proposing Release, supra note 20, at n.176 and accompanying text.
\32\ Proposed rule 5b-3(c)(1)(iv). Any securities other than
government securities must be rated in the highest rating category
by the ``requisite NRSROs.'' Id. See also infra text accompanying
notes 41-43 (describing this proposed quality requirement and
requesting comment). ``Requisite NRSROs'' are defined in paragraph
(c)(6) of the proposed rule as any two NRSROs, or, if only one NRSRO
has issued a rating at the time the fund acquires the security, that
NRSRO. ``NRSRO'' is defined in paragraph (c)(5) as any nationally
recognized statistical rating organization, as that term is used in
paragraphs (c)(2)(vi)(E), (F) and (H) of rule 15c3-1 [17 CFR
240.15c3-1] under the Securities Exchange Act of 1934 [15 U.S.C.
78a-mm], that is not an ``affiliated person,'' as defined in section
2(a)(3)(C) of the Act [15 U.S.C. 80a-2(a)(3)(C)], of the issuer of,
or any insurer or provider of credit support for, the security.
\33\ Proposed rule 5b-3(c)(1)(v).
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The rule 2a-7 definition of ``collateralized fully'' also requires
either the fund or its custodian to have physical possession of the
collateral or a book entry to be maintained in the name of the fund or
its custodian.\34\ This provision derived from a Commission staff
position requiring funds to acquire actual or constructive possession
of repurchase agreement collateral.\35\ In lieu of this requirement,
the proposed rule would require the fund to perfect its security
interest in the repurchase agreement collateral and maintain the
collateral in an account with the fund's custodian or a third party
that qualifies as a custodian under the Act.\36\ This proposal, which
we believe generally would not require a change from current practice,
is intended to update the definition of ``collateralized fully'' in
light of the 1994 revisions to the Uniform Commercial Code, which
address the evolution of the indirect system for holding
securities.\37\ The updated requirement would, we believe, more
accurately reflect the steps that a fund should take to protect its
interests in repurchase agreement collateral. The Commission requests
comment on this proposal. Should the definition of collateralized fully
specifically require funds to perfect their security interests in
repurchase agreement collateral by obtaining ``control'' of the
collateral? \38\
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\34\ Rule 2a-7(a)(5)(ii).
\35\ See Release 13005, supra note 16, at n.2 and accompanying
text. In Release 13005, the Division stated that the requirement of
actual or constructive possession was intended to ensure that the
fund would be able to liquidate the collateral immediately upon any
default or insolvency of the seller. Constructive possession
included the transfer of book-entry securities. See id. The staff
also provided guidance with respect to the custody requirements in a
letter from Kathryn McGrath, Director, Division of Investment
Management, to Matthew Fink, General Counsel, Investment Company
Institute (June 19, 1985). Among other things, the letter noted the
staff's position that ``a repurchase agreement is fully
collateralized only if the collateral is in the actual or
constructive possession of the investment company.'' The letter also
noted that the staff would consider a fund to have constructive
possession of collateral when the collateral has been transferred to
the fund's custodian or to the care of a third party to the
repurchase agreement that would qualify as a custodian for fund
assets under section 17(f) of the Act [15 U.S.C. 80a-17(f)].
\36\ Proposed rule 5b-3(c)(1)(ii), (iii).
\37\ See generally UCC, Revised Article 8--Investment Securities
(With Conforming and Miscellaneous Amendments to Articles 1, 4, 5,
9, and 10) (1994 Official Text with Comments), 2C Uniform Laws
Annotated (West Supp. 1997), Prefatory Note at I.D., II.B., II.C.,
II.D. As of April 1, 1999, the 1994 amendments to UCC Article 8 had
been adopted by 48 states, the District of Columbia, and Puerto
Rico. The most recent information regarding the status of proposed
UCC revisions in the state legislatures can be obtained by
contacting the National Conference of Commissioners on Uniform State
Laws at (312) 915-0195.
\38\ Under the 1994 revisions to the UCC, the primary means to
perfect a security interest in investment securities is by obtaining
``control'' of the securities. See UCC, Revised Article 8, Secs. 8-
106, 9-115(4). In general, obtaining ``control'' means taking the
steps necessary to place a secured lender in a position where it can
have the collateral sold off without the further cooperation of the
debtor. See UCC, Revised Article 8, Prefatory Note at II.D.
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We understand that some funds engage in ``hold-in-custody''
repurchase agreements (``HIC repos'')\39\ with their custodians as a
means of investing cash that they receive late in the business day.
Some commentators have suggested that these transactions entail the
risk that the fund would not be able to liquidate the collateral
promptly if the custodian were to become insolvent.\40\ The Commission
requests comment on risks posed by these transactions and whether HIC
repos should be considered ``collateralized fully'' under rule 5b-3.
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\39\ In a HIC repo, the seller merely segregates the collateral
during the term of the agreement, rather than transferring it to the
buyer or to a third party. Ellen Taylor, Trader's Guide to the Repo
market 25-26 (1995).
\40\ See Seth Grosshandler, Lech Kalembka & Daniel Feit,
Securities, Forward and Commodity Contracts and Repurchase and Swap
Agreements Under U.S. Insolvency Laws (1995), available in LEXIS,
721 PLI/Comm 401, 434 (qualified financial contract provisions do
not protect the right of a purchaser of securities under a HIC repo
to compel delivery of the securities from the FDIC as conservator or
receiver); see also id. at 416 (Bankruptcy Code does not appear to
protect the right of a purchaser of securities under a HIC repo to
compel delivery of the securities from the bankrupt).
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Most repurchase agreements are collateralized with U.S. government
securities, and the staff positions with respect to section 5(b)(1)
have limited the collateral to those securities.\41\ Under the proposed
rule, cash collateral also could be used, as well as other high quality
securities. The Commission is proposing to limit the high quality
securities that may be used as collateral based on the same standards
currently contained in rule 2a-7 for money market funds.\42\ The high
quality requirement is designed to limit a fund's exposure to the
ability of the counterparty to maintain sufficient collateral.\43\ In
addition, use of this rule 2a-7 standard would permit a fund complex to
establish uniform criteria for repurchase agreements among funds.
Comment is requested whether the rule should include these minimum
quality standards for collateral. Are there any other criteria that
would be preferable?
---------------------------------------------------------------------------
\41\ See MoneyMart Assets, supra note 10. The staff's no-action
positions with respect to the treatment of repurchase agreements for
purposes of section 12(d)(3) did not expressly limit the type of
eligible collateral. See Release 10666, supra note 4; Release 13005,
supra note 16.
\42\ Rule 2a-7(a)(5)(iii); see also supra note 32.
\43\ Securities of lower quality may be subject to greater price
fluctuation. In the event of a steep drop in the market value of the
collateral, it may be difficult for the counterparty to deliver
additional securities sufficient to ensure that the repurchase
agreement remains fully collateralized. If the counterparty does not
deliver sufficient additional securities and thus defaults, the fund
may be unable to realize the full value of the repurchase agreement
upon liquidation of the collateral. In addition, high quality
securities are generally more liquid than lower quality securities.
A fund could more readily liquidate high quality securities in the
event of a counterparty default.
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As discussed above, the proposed rule also requires the fund to
evaluate the counterparty's creditworthiness.\44\ This evaluation,
which currently is required
[[Page 52480]]
under staff no-action positions, is designed to require the fund to
determine whether the counterparty presents a serious risk of becoming
involved in bankruptcy proceedings.\45\ The Commission requests comment
on the need for this evaluation of the counterparty's creditworthiness
in light of the proposed requirement that repurchase agreements qualify
for the preferred treatment now given to certain repurchase agreements
under the Bankruptcy Code.\46\
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\44\ See supra note 28 and accompanying text.
\45\ See Release 13005, supra note 16, at n.6.
\46\ When we proposed amendments to rule 2a-7 in 1993, we
requested comment on the need for a credit risk determination in
light of the amendments to the Bankruptcy Code. 1996 Amendments
Proposing Release, supra note 20, at n.173 and accompanying text.
Most commenters urged that the determination be retained.
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B. Proposed Rule 5b-3(b): Treatment of Pre-Refunded Bonds
Proposed rule 5b-3 would codify for purposes of section 5(b)(1) the
conditions specified in the staff's no-action position permitting a
fund to treat an investment in a ``refunded security'' as an investment
in the escrowed U.S. government securities for purposes of section
5(b)(1).\47\ The rule, however, would not limit the amount of pre-
refunded bonds of any one issuer that a fund could acquire.\48\
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\47\ Proposed rule 5b-3(b).
\48\ See T. Rowe Price Tax-Free Funds, supra note 24.
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Under the proposed rule, a ``refunded security'' would be defined
as a debt security the principal and interest payments of which are to
be paid by U.S. government securities that have been irrevocably placed
in an escrow account and are pledged only to the payment of the debt
security.\49\ The escrowed securities must not be redeemable prior to
their final maturity, and the escrow agreement must prohibit the
substitution of the escrowed securities unless the substituted
securities are also U.S. government securities.\50\ Finally, an
independent certified public accountant must have certified to the
escrow agent that the escrowed securities will satisfy all scheduled
payments of principal, interest and applicable premiums on the refunded
securities.\51\ This treatment corresponds to the treatment given to
pre-refunded bonds in rule 2a-7.\52\
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\49\ Proposed rule 5b-3(c)(4).
\50\ Proposed rule 5b-3(c)(4)(i), (ii).
\51\ Proposed rule 5b-3(c)(4)(iii). The proposed rule makes an
exception to the certification requirement if the refunded security
has received the highest rating from an NRSRO. Id.
\52\ See rule 2a-7(a)(20), (c)(4)(ii)(B); see also 1996
Amendments Proposing Release, supra note 20, at section II.A.3.
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C. Availability of Rule 12d3-1 for Repurchase Agreements
The Commission also proposes to amend rule 12d3-1, which provides
an exemption from the prohibition in section 12(d)(3) on acquiring an
interest in a broker-dealer or a bank engaged in a securities-related
business.\53\ The amendment would affect only repurchase agreements
that do not meet the conditions for looking through the agreements to
the underlying collateral. As discussed above, if a fund enters into a
repurchase agreement with a broker-dealer or other counterparty that is
engaged in securities related activities, and the fund is unable to
look through the agreement to the underlying collateral, the fund may
be in violation of section 12(d)(3) of the Act.\54\ Rule 12d3-1
provides an exemption from section 12(d)(3) under certain conditions,
but a note appended to rule 12d3-1 currently makes the rule unavailable
for repurchase agreements that fail to meet the requirements for look-
through treatment set forth in Investment Company Act Release No. 13005
(``Release 13005'').\55\ We are proposing to eliminate that note, and
thus allow funds to rely on rule 12d3-1 even if the repurchase
agreement does not meet the requirements of Release 13005. The
Commission requests comment whether it is appropriate to permit funds
to enter into repurchase agreements with broker-dealers when the
transaction does not meet all of the requirements of proposed rule 5b-
3, but does meet the requirements of rule 12d3-1.\56\
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\53\ See supra note 5.
\54\ See supra notes 5-7 and accompanying text.
\55\ See Release 13005, supra note 16. Rule 12d3-1 provides an
exemption for purchases of securities of any entity that derived
fifteen percent or less of its gross revenues from securities
related activities in its most recent fiscal year, unless the
acquiring company would control the entity after the purchase. If
the entity derived more than fifteen percent of its gross revenues
from securities related activities, the rule provides a limited
exemption based on the amount and value of the securities purchased.
The note to the rule states: ``Note: It is not intended that this
rule should supersede the requirements prescribed in Investment
Company Act Release No. 13005 (Feb. 2, 1983) with respect to
repurchase agreements with brokers or dealers.''
\56\ A fund investing in a repurchase agreement that does not
meet the requirements of the proposed rule would not be able to
``look through'' the agreement and must instead treat the
counterparty to the agreement as the issuer.
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D. Conforming Amendments to Rule 2a-7
We are also proposing conforming amendments to rule 2a-7. These
amendments would add to rule 2a-7 the requirement that a money market
fund must evaluate the counterparty's creditworthiness in order to
treat the acquisition of a repurchase agreement as an acquisition of
the underlying securities.\57\ In addition, the proposed amendments
would replace the definitions of ``collateralized fully,'' ``event of
insolvency,'' and ``refunded security,'' currently set forth in rule
2a-7 with cross references to the corresponding definitions set forth
in proposed rule 5b-3.\58\
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\57\ Proposed rule 2a-7(c)(4)(ii)(A). As noted above, this
merely codifies a current staff requirement. See supra note 29.
\58\ Proposed rule 2a-7(a)(5), (11) and (20) (cross-referencing
proposed rule 5b-3(c)(1), (2), and (4)).
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E. Request for Comments
Any interested persons wishing to submit written comments on the
proposed rule and rule amendments that are the subject of this Release,
to suggest additional provisions or changes to the rules, or to submit
comments on other matters that might have an effect on the proposals
contained in this Release, are requested to do so. The Commission
specifically requests comment whether a fund should be allowed to look
through any other types of investments to underlying securities for
purposes of diversification, the prohibition of section 12(d)(3), or
any other provision of the Investment Company Act. Commenters
suggesting alternative approaches are encouraged to submit suggested
rule text.
The Commission also requests comment whether the proposals, if
adopted, would promote efficiency, competition, and capital formation.
We will consider these comments pursuant to our responsibilities under
section 2(c) of the Investment Company Act.\59\ The Commission
encourages commenters to provide empirical data or other facts to
support their views. For purposes of the Small Business Regulatory
Enforcement Fairness Act of 1996,\60\ the Commission also requests
information regarding the potential impact of the proposed rule and
rule amendments on the economy on an annual basis. Commenters are
requested to provide empirical data to support their views.
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\59\ 15 U.S.C. 80a-2(c).
\60\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996).
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III. Cost-Benefit Analysis
The Commission is sensitive to the costs and benefits imposed by
its rules. For the most part, the proposed rule would codify current
staff positions. By codifying a number of staff no-action positions
issued over a nearly twenty year period, the proposed rule should make
it easier for funds to determine whether, and under what conditions,
[[Page 52481]]
they are permitted to look through repurchase agreements or pre-
refunded bonds to the underlying securities for purposes of sections
5(b)(1) and 12(d)(3) of the Act. In addition, the proposed rule would
use substantially the same standards currently specified in rule 2a-7
for the treatment of repurchase agreements and pre-refunded bonds by
money market funds. With this uniform treatment, fund complexes that
include money market funds may be more efficient in monitoring
compliance with the requirements of the rules for all types of funds.
As discussed above, the proposed rule would be limited to
repurchase agreements in which the underlying collateral consists of
cash items, U.S. government securities, or other securities that meet
certain quality standards. As proposed, the rule tracks the language of
rule 2a-7, generally requiring any ``other securities'' to carry the
highest rating of two national rating agencies (``NRSROs,'' as defined
in the rule). This proposed requirement is intended to ensure that the
market value of the collateral will remain fairly stable and that the
fund will be able to liquidate the collateral quickly in the event of a
default. This limitation on collateral is more restrictive than the
staff's position with respect to the treatment of repurchase agreements
for purposes of section 12(d)(3),\61\ but it is less restrictive than
the staff's position with respect to section 5(b)(1).\62\ Since most
repurchase agreements are collateralized by U.S. government securities,
which clearly fall within the proposed rule's limitations, it appears
that the limitation will not have any significant impact on funds.
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\61\ Release 13005, supra note 16, did not specify the type of
collateral, merely noting that the ``securities most frequently used
in connection with repurchase agreements are Treasury bills and
other United States Government securities.''
\62\ The staff's no-action position in MoneyMart Assets, supra
note 10, was conditioned on the collateral consisting entirely of
U.S. government securities.
---------------------------------------------------------------------------
The proposed rule is limited to repurchase agreements that qualify
for an exclusion from any automatic stay under applicable insolvency
law. Although this requirement is included in rule 2a-7, it was not a
feature of the staff positions, which generally pre-dated the relevant
changes in the Bankruptcy Code. Again, because most repurchase
agreements qualify for an exclusion, this limitation should not have
any significant impact on funds. The limitation will, however, provide
important protections for investors by ensuring that a fund can
liquidate the collateral quickly in the event of the counterparty's
bankruptcy.
The proposed amendment to rule 12d3-1 would eliminate the ``Note''
to the rule that renders the rule unavailable to repurchase agreements.
The Commission believes that funds should be allowed to rely on rule
12d3-1 in cases in which a repurchase agreement does not meet all of
the conditions of proposed rule 5b-3. This amendment will provide
additional flexibility for funds without impairing investor interests.
The Commission requests comment on the costs and benefits of the
proposed rule and rule amendments. To the extent possible, please
quantify any significant costs or benefits.
IV. Summary of Initial Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis (``IRFA'') in accordance with 5 U.S.C. 603 regarding proposed
rule 5b-3, and the conforming amendments to rules 2a-7 and 12d3-1. The
IRFA indicates that the new rule would codify the staff's position that
a fund may look through a fully collateralized repurchase agreement to
the underlying securities for purposes of sections 5(b)(1) and 12(d)(3)
of the Act, and add the requirement of rule 2a-7 that the repurchase
agreement qualify for an exclusion from any automatic stay of
creditors' rights under applicable insolvency law. The IRFA indicates
that proposed rule 5b-3 also would permit a fund to treat the
acquisition of certain pre-refunded bonds as an acquisition of the
escrowed securities for purposes of section 5(b)(1) of the Act. In
addition, the IRFA explains that the proposed amendment to rule 12d3-1
would eliminate the ``Note'' appended to the rule in order to allow
funds to rely on rule 12d3-1 even if the repurchase agreement is not
collateralized fully. Finally, the IRFA states that the conforming
amendments to rule 2a-7 are intended to simplify and update the
provisions of that rule that address repurchase agreements and refunded
securities.
The IRFA sets forth the statutory authority for the proposed rule
and rule amendments. The IRFA also discusses the effect of the proposed
rule and rule amendments on small entities. For purposes of the
Investment Company Act and the Regulatory Flexibility Act, a fund is a
small entity if the fund, together with other funds in the same group
of related funds, has net assets of $50 million or less as of the end
of its most recent fiscal year.\63\
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\63\ 17 CFR 270.0-10.
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The IRFA states that proposed rule 5b-3 will affect (i) any fund
that invests in a repurchase agreement with a broker, dealer,
underwriter, or bank that is engaged in a securities-related business,
when the investment may otherwise be prohibited by section 12(d)(3) of
the Act, and (ii) any fund that holds itself out as a diversified
investment company under section 5(b)(1) of the Act and that invests in
repurchase agreements or pre-refunded bonds.
As of December 31, 1998, there were approximately 4,300 registered
funds. Of this number, the Commission staff estimates that there are
approximately 269 funds that are small entities. These funds could be
affected by the proposed rule's treatment of investments in repurchase
agreements for purposes of section 12(d)(3) of the Act. As of December
31, 1998, there were approximately 2,500 registered funds with one or
more portfolios that hold themselves out to be diversified companies.
Of this number, the Commission staff estimates that there are
approximately 73 funds that are small entities. These funds could be
affected by proposed rule's treatment of investments in repurchase
agreements and pre-refunded bonds for purposes of section 5(b)(1) of
the Act.
The IRFA explains that the proposed rule should not have a
significant economic impact on these funds, including those that are
small entities. It would not effect significant changes to the current
treatment of repurchase agreements and pre-refunded bonds, but instead
would codify and update a number of no-action positions that have been
taken by the Commission staff.
The IRFA states that the proposed amendment to rule 2a-7 would
affect money market funds. As of December 31, 1998, there were
approximately 300 registered funds with one or more portfolios that are
money market funds. Of this number, it is estimated that approximately
3 were small entities. The proposed amendment, however, would only
update one aspect of rule 2a-7, and it appears that the updated
provision would not require a change from current practice. The
proposal thus should not have a significant economic impact on a
substantial number of small entities.
The IRFA states that the proposed amendment to rule 12d3-1 will
affect any fund that invests in a repurchase agreement with a broker,
dealer, underwriter, or bank that is engaged in
[[Page 52482]]
a securities-related business, when the investment may otherwise be
prohibited by section 12(d)(3) of the Act. As stated above, there were
approximately 4,300 registered funds as of December 31, 1998, of which
approximately 269 funds were small entities. These funds would benefit
from the proposed amendment to rule 12d3-1, which would allow funds to
rely on that rule even if the repurchase agreement does not meet the
requirements of the Commission staff positions.
The IRFA explains that the proposed rule and rule amendments would
not impose any new reporting or recordkeeping requirements. The
proposals do not involve major changes in compliance requirements
because they mainly codify existing Commission staff positions. The
IRFA states that the definition of ``collateralized fully'' in proposed
rule 5b-3 supplements prior staff positions by requiring that the
repurchase agreement qualify for an exclusion from any automatic stay
of creditors' rights under applicable insolvency law. The definition
also has been updated to reflect the 1994 revisions to the UCC. It
appears, however, that this change generally would not require a change
from current practice. There are no rules that duplicate, overlap or
conflict with the proposed rule and rule amendments.
The IRFA discusses the various alternatives considered by the
Commission that would accomplish the stated objective, while minimizing
any significant adverse impact on small entities. In connection with
the proposed rule and rule amendments, the Commission considered the
following alternatives: (a) The establishment of differing compliance
or reporting requirements or timetables that take into account the
resources available to small entities; (b) the clarification,
consolidation, or simplification of compliance and reporting
requirements under the rule for small entities; (c) the use of
performance rather than design standards; and (d) an exemption from
coverage of the rule, or any part thereof, for small entities. The IRFA
notes that the proposed rule and rule amendments are not intended to
effect major substantive changes to the current treatment of repurchase
agreements and pre-refunded bonds, but would essentially codify a
number of no-action positions taken by the Commission staff. Because
the proposed rule and rule amendments are designed to clarify the
appropriate treatment of investments by funds in repurchase agreements
and pre-refunded bonds for various purposes of the Act, and to provide
investment flexibility for funds of all sizes, it would be inconsistent
with the purposes of the Regulatory Flexibility Act to propose to
exempt small entities from their coverage. Further clarification,
consolidation, or simplification of the proposals, or specification of
different compliance standards for small entities, would not be
appropriate, because the proposals set forth the minimum standards
consistent with investor protection. For the same reasons, the use of
performance standards would be inappropriate. Overall, it appears that
the proposed rule and rule amendments would not have an adverse effect
on small entities.
The IRFA states that the Commission encourages the solicitation of
comments with respect to any aspect of the IRFA. Comment is
specifically requested on the number of small entities that would be
affected by the proposed rule and rule amendments, and the likely
impact of the proposals on small entities. A copy of the IRFA may be
obtained by contacting Marilyn Mann, Securities and Exchange
Commission, 450 5th Street, N.W., Washington, D.C. 20549-0506.
V. Statutory Authority
The Commission is proposing new rule 5b-3, and is proposing
amendments to rule 2a-7 and to rule 12d3-1, pursuant to the authority
set forth in sections 6(c) and 38(a) of the Act [15 U.S.C. 80a-6(c) and
80a-37(a)].
List of Subjects in 17 CFR Part 270
Investment companies, Reporting and recordkeeping requirements,
Securities.
Text of Proposed Rule and Rule Amendments
For the reasons set out in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
1. The authority citation for part 270 continues to read, in part,
as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39
unless otherwise noted:
* * * * *
2. Section 270.2a-7 is amended by revising paragraphs (a)(5),
(a)(11), (a)(20) and (c)(4)(ii)(A) to read as follows:
Sec. 270.2a-7 Money market funds.
(a) Definitions. * * *
(5) Collateralized Fully means ``Collateralized Fully'' as defined
in Sec. 270.5b-3(c)(1).
* * * * *
(11) Event of Insolvency means ``Event of Insolvency'' as defined
in Sec. 270.5b-3(c)(2).
* * * * *
(20) Refunded Security means ``Refunded Security'' as defined in
Sec. 270.5b-3(c)(4).
* * * * *
(c) Share Price Calculations. * * *
(4) Portfolio Diversification. * * *
(ii) Issuer Diversification Calculations. * * *
(A) Repurchase Agreements. The Acquisition of a repurchase
agreement may be deemed to be an Acquisition of the underlying
securities, provided the obligation of the seller to repurchase the
securities from the money market fund is Collateralized Fully and the
fund's board of directors (or the person delegated by the board under
paragraph (e) of this section) has evaluated the seller's
creditworthiness.
* * * * *
3. Section 270.5b-3 is added to read as follows:
Sec. 270.5b-3 Acquisition of repurchase agreement or refunded security
treated as acquisition of underlying securities.
(a) Repurchase Agreements. For purposes of sections 5 and 12(d)(3)
of the Act (15 U.S.C. 80a-5, 80a-12(d)(3)), the acquisition of a
repurchase agreement may be deemed to be an acquisition of the
underlying securities, provided the obligation of the seller to
repurchase the securities from the investment company is Collateralized
Fully and the board of directors or its delegate has evaluated the
seller's creditworthiness.
(b) Refunded Securities. For purposes of section 5 of the Act (15
U.S.C. 80a-5), the acquisition of a Refunded Security shall be deemed
to be an acquisition of the escrowed Government Securities.
(c) Definitions. As used in this section:
(1) Collateralized Fully in the case of a repurchase agreement
means that:
(i) The value of the securities collateralizing the repurchase
agreement (reduced by the transaction costs (including loss of
interest) that the investment company reasonably could expect to incur
if the seller defaults) is, and during the entire term of the
repurchase agreement remains, at least equal to the Resale Price
provided in the agreement;
(ii) The investment company has perfected its security interest in
the collateral;
(iii) The collateral is maintained with the investment company's
custodian or a third party that qualifies as a custodian under the Act;
[[Page 52483]]
(iv) The collateral consists entirely of cash items, Government
Securities or other securities that at the time the repurchase
agreement is entered into are rated in the highest rating category by
the Requisite NRSROs; and
(v) Upon an Event of Insolvency with respect to the seller, the
repurchase agreement would qualify under a provision of applicable
insolvency law providing an exclusion from any automatic stay of
creditors' rights against the seller.
(2) Event of Insolvency means, with respect to a person:
(i) An admission of insolvency, the application by the person for
the appointment of a trustee, receiver, rehabilitator, or similar
officer for all or substantially all of its assets, a general
assignment for the benefit of creditors, the filing by the person of a
voluntary petition in bankruptcy or application for reorganization or
an arrangement with creditors; or
(ii) The institution of similar proceedings by another person which
proceedings are not contested by the person; or
(iii) The institution of similar proceedings by a government agency
responsible for regulating the activities of the person, whether or not
contested by the person.
(3) Government Security means any ``Government Security'' as
defined in section 2(a)(16) of the Act (15 U.S.C. 80a-2(a)(16)).
(4) Refunded Security means a debt security the principal and
interest payments of which are to be paid by Government Securities
(``deposited securities'') that have been irrevocably placed in an
escrow account pursuant to an agreement between the issuer of the debt
security and an escrow agent that is not an ``affiliated person,'' as
defined in section 2(a)(3)(C) of the Act (15 U.S.C. 80a-2(a)(3)(C)), of
the issuer of the debt security, and, in accordance with such escrow
agreement, are pledged only to the payment of the debt security and, to
the extent that excess proceeds are available after all payments of
principal, interest, and applicable premiums on the Refunded
Securities, the expenses of the escrow agent and, thereafter, to the
issuer or another party; provided that:
(i) The deposited securities shall not be redeemable prior to their
final maturity;
(ii) The escrow agreement shall prohibit the substitution of the
deposited securities unless the substituted securities are Government
Securities; and
(iii) At the time the deposited securities are placed in the escrow
account, or at the time a substitution of the deposited securities is
made, an independent certified public accountant shall have certified
to the escrow agent that the deposited securities will satisfy all
scheduled payments of principal, interest and applicable premiums on
the Refunded Securities; provided, however, an independent public
accountant need not have provided the certification described in this
paragraph (c)(4)(iii) if the security, as a Refunded Security, has
received a rating from an NRSRO in the highest category for debt
obligations (within which there may be sub-categories or gradations
indicating relative standing).
(5) NRSRO means any nationally recognized statistical rating
organization, as that term is used in paragraphs (c)(2)(vi)(E), (F) and
(H) of Sec. 240.15c3-1 of this chapter, that is not an ``affiliated
person,'' as defined in section 2(a)(3)(C) of the Act (15 U.S.C. 80a-
2(a)(3)(C)), of the issuer of, or any insurer or provider of credit
support for, the security.
(6) Requisite NRSROs means:
(i) Any two NRSROs that have issued a rating with respect to a
security or class of debt obligations of an issuer; or
(ii) If only one NRSRO has issued a rating with respect to such
security or class of debt obligations of an issuer at the time the
investment company acquires the security, that NRSRO.
(7) Resale Price means the acquisition price paid to the seller of
the securities plus the accrued resale premium on such acquisition
price. The accrued resale premium shall be the amount specified in the
repurchase agreement or the daily amortization of the difference
between the acquisition price and the resale price specified in the
repurchase agreement.
4. Section 270.12d3-1 is amended by removing the appended Note.
By the Commission.
Dated: September 23, 1999.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-25253 Filed 9-28-99; 8:45 am]
BILLING CODE 8010-01-U
