Federal Register, Volume 79 Issue 98 (Wednesday, May 21, 2014)

[Federal Register Volume 79, Number 98 (Wednesday, May 21, 2014)]
[Notices]
[Pages 29226-29230]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-11684]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72173; File No. 811-02815]

Copley Fund, Inc.; Notice of Application

May 15, 2014.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice of an application for exemptive relief.

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Summary of Application: Applicant requests an order exempting it from
rule 22c-1 under the Investment Company Act of 1940 (``Company Act'')
and rule 4-01(a)(1) of Regulation S-X.

Applicant: Copley Fund, Inc. (``Copley'' or ``Fund'').

Filing Date: The application (together with the exhibits, the
``Application'') was filed on September 4, 2013.

Hearing or Notification of Hearing: Interested persons may request a
hearing by writing to the Commission's Secretary and serving applicant
with a copy of the request, personally or by mail. Hearing requests
should be received by the Commission by 5:30 p.m. on June 9, 2014, and
should be accompanied by proof of service on the applicant, in the form
of an affidavit or, for lawyers, a certificate of service. Hearing
requests should state the nature of the writer's interest, the reason
for the request, and the issues contested. Persons who wish to be
notified of a hearing may request notification by writing to the
Commission's Secretary. Absent a request for a hearing that is granted
by the Commission, the Commission intends to issue an order under the
Company Act denying the Application.

ADDRESSES: Secretary, Securities and Exchange Commission, 100 F Street
NE., Washington, DC 20549-1090; Applicant, 5348 Vegas Drive, Suite 391,
Las Vegas, Nevada 89108.

FOR FURTHER INFORMATION CONTACT: David Joire, Senior Counsel, or Nadya
Roytblat, Assistant Chief Counsel, at (202) 551-6825, Division of
Investment Management, Chief Counsel's Office.

SUPPLEMENTARY INFORMATION: The following is a summary of the
application. The complete application may be obtained via the
Commission's Web site at http://www.sec.gov/rules/other.shtml or by
calling (202) 551-8090.

I. Background

A. The Applicant

1. Copley is a Nevada corporation registered under the Company Act
as an open-end management investment company (``open-end fund'') that
issues redeemable securities.\1\ Copley has been operating since 1978
and invests primarily in U.S. equity securities. The Application states
that Copley's ``stated investment objective is the generation and
accumulation of dividend income'' and ``[i]ts secondary objective is
`long-term capital appreciation.''' The Application also states that
``[k]ey to the Fund's investment objective is its strategy, contrary to
most other [open-end] funds, of not distributing dividends and capital
gains to shareholders but rather accumulating them within the Fund.''
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\1\ Section 4(3) of the Company Act defines a ``management
company'' as any investment company other than a face-amount
certificate company or a unit investment trust. Section 5(a)(1) of
the Company Act defines an ``open-end company'' as a management
company which is offering for sale or has outstanding any redeemable
security of which it is the issuer. Section 2(a)(32) of the Company
Act defines ``redeemable security'' to mean any security, other than
short term paper, under the terms of which the holder, upon
presentation to the issuer or to a person designated by the issuer,
is entitled (whether absolutely or only out of surplus) to receive
approximately his proportionate share of the issuer's current net
assets, or the cash equivalent thereof.

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[[Page 29227]]

B. Copley's Status Under the Internal Revenue Code (``Code'')

2. Virtually all open-end funds take advantage of special
provisions in the Code, known as Subchapter M, that enable them to
avoid a layer of tax at the corporate, i.e., fund, level.\2\ Under
Subchapter M, an open-end fund that elects status as a ``regulated
investment company'' (``RIC'') and meets certain requirements, one of
which is to distribute at least 90% of investment company taxable
income, in any taxable year, does not pay federal taxes at the fund
level.\3\
3. Copley has never availed itself of RIC status under the Code, so
that, according to the Application, its shareholders ``are able to
defer dividend and capital gains taxes [at the shareholder level] until
redemption.'' Copley instead has elected to be treated as a ``C
Corporation'' under the Code and thus is subject to federal taxation at
the fund level.\4\ A shareholder of Copley, therefore, is subject to
two layers of tax--once (indirectly) at the fund level and again
(directly) at the shareholder level.\5\ Copley has significant
unrealized gains in its portfolio and a federal income tax liability
(``federal income tax liability'') would arise if those gains were
realized by the Fund (i.e., if Copley were to sell any of its portfolio
securities that had appreciated in value since the Fund acquired them).
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\2\ See sections 851-855 and 860 of the Code.
\3\ Id.
\4\ See section 11 of the Code.
\5\ A shareholder of a RIC and a shareholder of an open-end fund
that is a C Corporation pay taxes at the shareholder level on any
distributions from the fund and on any capital gains on the fund
shares that they redeem. The Application states that Copley does not
make any distributions to its shareholders.
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II. The Application

4. The Application concerns the provision that Copley should make
for its federal income tax liability for purposes of (i) calculating
the current net asset value on which the price of Copley's redeemable
securities must be based under rule 22c-1 under the Company Act, and
(ii) preparing Copley's financial statements filed with the Commission
as required by the Company Act. Copley currently makes a provision for
federal income taxes for both purposes in the full amount of federal
income tax that would be due if the full amount of Copley's existing
unrealized gains were realized. Copley's current provision for federal
income taxes is consistent with generally accepted accounting
principles (``GAAP'').\6\
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\6\ Specifically, Financial Accounting Standards Board
(``FASB'') Accounting Standards Codification Topic 740, Income Taxes
(``ASC 740'') indicates that financial statements should reflect
deferred tax liabilities and assets for the future tax consequences
of events that have been recognized in an entity's financial
statements or tax returns. FASB ASC 740-10-10-1(b). ASC 740
incorporates an assumption that the assets and liabilities of an
entity will be recovered and settled at their carrying amounts for
financial statement reporting purposes, which may be different from
their carrying amounts for income tax purposes. Differences between
book and tax carrying amounts that are caused by differences in the
timing of recognition of transactions or events for financial
reporting versus income tax purposes are referred to as temporary
differences. See FASB ASC 740-10-25-20. ASC 740 provides examples of
such differences. Revenues or gains that are taxable after they are
recognized as income for financial reporting purposes are included
as an example of a temporary difference. See FASB ASC 740-10-25-
20(a). Unrealized gains on investments, which are taxable after they
are recognized in the financial statements (i.e., they are generally
taxable only when the investments are sold), represent a temporary
difference on which a deferred tax liability must be recognized; the
recognized deferred tax liability is calculated by multiplying the
temporary difference (i.e., the unrealized gains) by the expected
tax rate at the expected time of reversal. See generally FASB ASC
740-10-10-3 (indicating that the objective is to measure a deferred
tax liability using the enacted tax rate expected to apply to
taxable income in the periods in which the deferred tax liability is
expected to be settled).
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5. The Application requests an exemption from rule 22c-1 under the
Company Act and rule 4-0l(a)(l) of Regulation S-X so that Copley could
estimate a provision for federal income tax liability for both purposes
using one of two formulas developed by Copley and described in the
Application (together, the ``Proposed Method'').\7\ The Proposed Method
would result in a provision for Copley's federal income tax liability
that is less than the full amount of federal income tax that would be
due if the full amount of Copley's existing unrealized gains were
realized,\8\ and thus is inconsistent with GAAP. In support of its
request for exemptions, the Application argues that ``the entire
[federal income tax liability] would be due only in the unlikely event
the entire portfolio were liquidated.'' The Application further argues
that the ``use of the full liquidation value method has produced a
skewed and unreasonable result--Copley's per share [net asset value]
does not reflect the realistic value of the Fund,'' and that using the
Proposed Method would ``fairly and accurately [reflect] a realistic tax
liability.''
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\7\ One of the formulas would be based on a quarterly
calculation of Copley's historical portfolio turnover rate over the
past five or ten years. The alternative formula would be based on
the highest daily redemptions of Fund shares during the previous
five years.
\8\ The Application includes an extensive discussion of Copley's
use, for a period of time prior to 2007, of a methodology similar to
the Proposed Method, as well as Copley's subsequent discussions with
the staff of the Commission's Division of Enforcement, resulting in
Copley changing its methodology to make a provision for federal
income tax liability in the full amount of federal income tax that
would be due if the full amount of Copley's existing unrealized
gains were realized. The Application also discusses a letter from
the staff of the Commission's Division of Investment Management to
Copley's counsel, dated April 5, 2013, available at http://www.sec.gov/divisions/investment/noaction/2013/copley-fund-040513-22c1.pdf, in which the staff rejected Copley's request for assurance
that it would not recommend enforcement action to the Commission if
Copley were to make a provision for federal income tax liability
according to the Proposed Method.
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III. Legal Analysis

A. Rules 22c-1 and 2a-4 Under the Company Act

6. As an open-end fund, Copley issues redeemable securities under
the terms of which all of the holders, upon presentation to Copley or
to a person designated by Copley, are entitled to receive approximately
their proportionate share of Copley's current net assets or the cash
equivalent thereof.\9\ Rule 22c-1 under the Company Act states, in
relevant part, that no registered investment company issuing any
redeemable security shall sell, redeem, or repurchase any such security
except at a price based on the ``current net asset value'' of such
security which is next computed after receipt of a tender of such
security for redemption or of an order to purchase or sell such
security. Rule 2a-4 under the Company Act defines the term ``current
net asset value'' for use in computing periodically the price of a
fund's shares to mean one determined substantially in accordance with
the provisions of the rule. Rule 2a-4(a)(4) provides, in relevant part,
that in determining the current net asset value, ``[a]ppropriate
provision shall be made for Federal income taxes if required [by the
open-end fund].'' An open-end fund that has elected RIC status under
the Code generally would not need to make a ``provision . . . for
Federal income taxes'' under rule 2a-4(a)(4), because it would not be
subject to federal taxation at the fund level.\10\ In contrast, Copley,
which has chosen to be a C Corporation and thus is subject to federal
taxation at the fund level, must make an ``appropriate provision . . .
for Federal

[[Page 29228]]

income taxes'' in computing its current net asset value under rule 2a-4
for purposes of complying with rule 22c-1 under the Company Act. The
Commission is aware of several other existing open-end funds that have
chosen to be C Corporations and to which this provision of rule 2a-
4(a)(4) is relevant; none of these funds has requested an exemption
relating to this provision.
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\9\ See supra note 1 (definition of ``redeemable security'').
\10\ An open-end fund that has elected RIC status under the Code
may be subject to a 4% excise tax on undistributed income to the
extent that the open-end fund does not satisfy certain distribution
requirements for a calendar year. See Code Section 4982 ``Excise Tax
on Undistributed Income of Regulated Investment Companies.''
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7. Under rule 22c-1, an open-end fund may sell and redeem its
redeemable securities only at a price based on its current net asset
value, which equals the value of the fund's total assets minus the
amount of the fund's total liabilities. Under rule 2a-4, an open-end
fund generally must value its assets at their market value, in the case
of securities for which market quotations are readily available, or at
fair value, as determined in good faith by the fund's board of
directors, in the case of other securities and assets.\11\ When
calculating its current net asset value for purposes of rule 22c-1, an
open-end fund: (i) adds up the current values of all of its assets
(using their market values or fair values, as appropriate), which
reflect any unrealized gains; and (ii) subtracts all of its
liabilities, which include an appropriate provision for federal income
taxes on any unrealized gains. If the open-end fund understates a
liability, among other consequences, the calculated current net asset
value will be overstated, as will the price at which the fund's
redeemable securities are sold and redeemed. As a result, investors
purchasing the fund's shares will pay too much for them, redeeming
shareholders will receive too much for their shares, and the net asset
value of shares held by the remaining shareholders may be reduced
correspondingly when the full amount of the liability must be paid.
This outcome would be counter to one of the primary principles
underlying the Company Act, which is that sales and redemptions of
redeemable securities should be effected at prices that are fair, and
which do not result in dilution of shareholder interests or other harm
to shareholders.\12\
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\11\ See also section 2(a)(41) of the Company Act defining the
term ``value.''
\12\ See Investment Trusts and Investment Companies: Hearings on
S.3580 Before a Subcommittee of the Senate Committee on Banking and
Currency, 76th Cong., 3d Sess. 136-38 (1940) (hearings that preceded
the enactment of the Company Act). In addition, all funds must
accurately calculate their net asset values to ensure the accuracy
of their payment of asset-based fees, such as investment advisory
fees, as well as the accuracy of their reported performance.
Statement Regarding ``Restricted Securities,'' Investment Company
Act Release No. 5847 (Oct. 21, 1969).
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B. Rule 4-01(a)(1) of Regulation S-X

8. Under the Company Act, Copley is required to file with the
Commission a registration statement and annual reports, which must
contain Copley's financial statements.\13\ The form and content of and
requirements for the financial statements filed pursuant to the Company
Act are set forth in Regulation S-X. Rule 4-0l(a)(l) of Regulation S-X
states, in relevant part, that ``[f]inancial statements filed with the
Commission which are not prepared in accordance with [GAAP] will be
presumed to be misleading or inaccurate, despite footnote or other
disclosures, unless the Commission has otherwise provided.'' \14\
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\13\ Sections 8(b) and 30 of the Company Act require the filing
of registration statements and annual reports, respectively.
\14\ Rule 4-01 of Regulation S-X is made applicable to
investment companies registered under the Company Act by rule 6-03
of Regulation S-X.
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C. Section 6(c) of the Company Act

9. Although the Application requests an exemption from rule 22c-1
under the Company Act and rule 4-01(a)(1) of Regulation S-X pursuant to
section 36(a) of the Exchange Act, the Commission is considering the
requested exemptions under section 6(c) of the Company Act because the
provisions of rule 22c-1 under the Company Act and rule 4-01(a)(1) of
Regulation S-X are made applicable to Copley by the requirements of the
Company Act and the rules thereunder. Section 6(c) of the Company Act
provides, in relevant part, that the ``Commission, . . . by order upon
application, may conditionally or unconditionally exempt any person . .
. from any provision or provisions of [the Company Act] . . . or of any
rule or regulation thereunder, if and to the extent that such exemption
is necessary or appropriate in the public interest and consistent with
the protection of investors and the purposes fairly intended by the
policy and provisions of [the Company Act].''

IV. The Commission's Preliminary Views

A. Rule 22c-1 Under the Company Act

10. Rule 22c-1 under the Company Act, as described above, prohibits
Copley from selling or redeeming its redeemable securities at a price
other than one based on the ``current net asset value,'' as defined in
rule 2a-4 under the Company Act. Copley seeks to sell and redeem its
redeemable securities at a price that reflects Copley's provision, in
accordance with the Proposed Method, for less than its full federal
income tax liability that would arise if the unrealized gains in
Copley's portfolio were realized by the Fund. If the Proposed Method
results in an ``appropriate provision . . . for Federal income taxes''
under rule 2a-4(a)(4), then the price of Copley's redeemable securities
would be based on the ``current net asset value'' as defined in rule
2a-4(a)(4) and Copley would not need an exemption from rule 22c-1. On
the other hand, if the Proposed Method does not make an ``appropriate
provision . . . for Federal income taxes'' under rule 2a-4(a)(4), the
price of Copley's redeemable securities would not be based on the
``current net asset value'' as defined in rule 2a-4 and would cause
Copley to violate rule 22c-1, unless the Commission issues an order
exempting Copley from rule 22c-1. Because the Commission, for the
reasons discussed below, preliminarily believes that the Proposed
Method would not result in an ``appropriate provision . . . for Federal
income taxes'' under rule 2a-4(a)(4), the Commission preliminarily
believes that Copley, in order to avoid violating rule 22c-1, would
need an exemption from rule 22c-1 to be able to sell and redeem its
shares at a price that is not based on the ``current net asset value,''
as defined in rule 2a-4.
11. Copley seeks an exemption from rule 22c-1 to be able to
determine the price at which its redeemable securities may be purchased
or redeemed based on a net asset value that would reflect less than the
full amount of the federal income tax liability that would arise if all
of the Fund's existing unrealized gains were realized, calculated based
on the Proposed Method (``Proposed Method NAV'').\15\ The Application's
justification for the use of the Proposed Method is that it would
``provide its current and future investors with a more fair and
accurate presentation of its [net

[[Page 29229]]

asset value]'' because ``the entire [federal tax liability] would be
due only in the unlikely event the entire portfolio were liquidated.''
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\15\ The Application provides an example of the difference in
the net asset value per share resulting from the use of the Proposed
Method, as opposed to making a provision for the full federal income
tax liability that would arise if all of the Fund's existing
unrealized gains were realized. The Application points out that,
following Copley's discussions with the staff of the Commission's
Division of Enforcement in 2007, Copley changed its methodology to
provide for the full federal income tax liability in the net asset
value per share of its redeemable securities. The Application states
that, whereas Copley's net asset value per share on February 28,
2007, reflecting the use of a methodology similar to the Proposed
Method, was stated in its annual report as being $54.67, ``the
Restated Annual Report . . . reflect[ed] a per share [net] asset
value for that same date (February 28, 2007) of $42.54.'' The $12.13
reduction in the net asset value per share was a change of 22%.
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12. As an open-end fund under the Company Act, Copley must stand
ready to redeem its redeemable securities daily. Although Copley has
been operating for several decades and the Application states that
``the highest daily redemption in the history of the Fund since
inception was . . . approximately 1.6% of the total outstanding shares
on the date of the redemption,'' Copley cannot control or fully
anticipate the level and amounts of shareholder redemptions and the
resulting need to sell its portfolio investments to satisfy the
redemption requests. However unlikely it may seem to Copley that it may
need to liquidate its entire portfolio to meet redemption requests,
that is a possibility that Copley may not rule out under the Company
Act.\16\ That is because all of the holders of Copley's redeemable
securities are entitled, under the terms of their securities, upon
presentation to Copley or to a person designated by Copley, to receive
approximately their proportionate share of Copley's current net assets
or the cash equivalent thereof.\17\
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\16\ Redemptions necessitating liquidation of a substantial
amount of an open-end fund portfolio, while infrequent, have in fact
been experienced by several open-end funds. See, e.g., L. Jones,
``From Difficult to Disaster: Redemptions' Impact on Funds,''
Morningstar (Feb. 7, 2008), available at http://news.morningstar.com/articlenet/article.aspx?id=227989.
\17\ See supra note 1 (definition of ``redeemable security'').
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13. If Copley were to experience a high level of redemptions
necessitating liquidation of a large portion of its portfolio with
significant unrealized gains, Copley's pricing of its redeemable
securities based on the Proposed Method NAV could result in the
redeeming shareholders receiving a price for their shares that reflects
more than their pro-rata share of the net asset value of the Fund,
while the price of the shares held by the remaining shareholders would
reflect less than their pro-rata share of the net asset value of the
Fund. Copley's use of the Proposed Method could produce this disparate
result because only the net asset value per share of the shares held by
the remaining, non-redeeming shareholders would reflect the full actual
federal income tax expense incurred as a result of the liquidation of
the portfolio, even though the same amount of federal income tax
liability existed, but was not provided for, when the other
shareholders redeemed at a price based on a higher net asset value per
share.
14. For example, consider the following illustrative fact pattern
of an open-end fund that is a C Corporation (``Fund A'') that records a
2.8% federal income tax liability in accordance with Copley's Proposed
Method but is required to pay federal income taxes at a rate of
35%.\18\ As of the close of business on March 30, 2014, Fund A has
total assets comprised of investments valued at $1,400,000, which
reflects $400,000 in unrealized gains,\19\ and total liabilities
comprised of a federal income tax liability on unrealized gains of
$11,200.\20\ Fund A has 100,000 redeemable securities outstanding. As
of the close of business on March 30, 2014, Fund A's net asset value
and net asset value per share (NAV/share) are $1,388,800 \21\ and
$13.888,\22\ respectively. On March 31, 2014, Fund A has no profit or
loss for the day \23\ and shareholders unexpectedly request redemption
of 60,000 shares, which entitles these shareholders to redeem at the
March 31, 2014 closing NAV/share of $13.888.\24\ On April 1, 2014, in
order to raise cash to satisfy the March 31, 2014 shareholder
redemption requests of $833,280,\25\ Fund A sells investments of
$834,000 with a cost basis of $534,000, resulting in realized gains of
$300,000.\26\ Since Fund A realized $300,000 in gains, Fund A would
have a federal income tax liability of $105,000.\27\ However, since
Fund A's net asset value only reflected a $11,200 federal income tax
liability as of March 31, 2014, Fund A has to record an additional
$93,800 \28\ of a federal income tax expense and corresponding federal
income tax liability on April 1, 2014. On April 1, 2014, Fund A has no
other profit or loss \29\ besides recording the federal income tax
expense and corresponding current federal income tax liability of
$93,800 and an additional federal income tax expense and corresponding
federal income tax liability of $2,800.\30\ At the close of business on
April 1, 2014, Fund A has a net asset value of $458,920 \31\ and
redeemable securities outstanding of 40,000,\32\ resulting in an NAV/
share of $11.473.\33\ Therefore, the redeeming shareholders received an
NAV/share of $13.888 on March 31 while the NAV/share of the remaining
shareholders was reduced to reflect the federal income tax accrual on
gains realized by Fund A from selling portfolio securities with
unrealized gains to pay the redeeming shareholders and thus their
shares have an NAV/share of $11.473 on April 1, 2014. Although the same
realized gains ($300,000) had been fully reflected in the net asset
value on March 31 as unrealized gains, only 2.8% of the full 35%
federal income tax liability on those unrealized gains had been
reflected in the net asset value on that day, and the remaining
shareholders were harmed solely as a result of Fund A's use of the
Proposed Method.\34\ If Fund A reflected the full 35% federal income
tax liability in its net asset value prior to receiving the shareholder
redemption requests on March 31, 2014,

[[Page 29230]]

the redeeming shareholders would have redeemed at an NAV/share of
$12.600 \35\ and the remaining shareholders would have held shares with
an NAV/share of $12.600 \36\ (which is $1.127, or approximately 9.8%,
higher than $11.473, their resulting NAV/share when applying the
Proposed Method) on April 1, 2014. This result would have been fair and
equitable to all of Fund A's shareholders.
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\18\ In this example, under the Proposed Method, in lieu of
recording the full federal income tax liability of 35% of unrealized
gains, Fund A records a federal income tax liability of 2.8% of
unrealized gains (which represents 8% times 35%, where 8% is based
on highest daily redemptions of Fund A's shares during the previous
five years).
\19\ Valuation of $1,400,000 reflects $1,000,000 cost and
$400,000 of unrealized gains.
\20\ $11,200 federal income tax liability on unrealized gains
equals $400,000 unrealized gains times 2.8% recorded federal income
tax liability.
\21\ $1,388,800 net asset value equals $1,400,000 total assets
minus $11,200 total liabilities.
\22\ $13.888 NAV/share equals $1,388,800 net asset value divided
by 100,000 shares outstanding.
\23\ Generally, an open-end fund would have daily profit or
loss. However, because this is a simplified example presented solely
for illustrative purposes, we assume that Fund A had no profit or
loss on March 31, 2014.
\24\ Because Fund A recorded no profit or loss on March 31,
2014, the NAV/share as of the close of business on March 31, 2014 is
the same as the NAV/share as of the close of business on March 30,
2014.
\25\ $833,280 redemption requests equal 60,000 shares redeemed
times 13.888 NAV/share.
\26\ For purposes of this simplified example, we assume that all
transactions are recorded on trade date.
\27\ $105,000 federal income tax liability equals $300,000
realized gains times 35% federal income tax rate.
\28\ $93,800 additional tax expense equals $105,000 federal
income tax liability minus $11,200 federal income tax liability on
unrealized gains already reflected in the net asset value.
\29\ See generally supra note 23.
\30\ Subsequent to the sale of investments to meet redemptions,
Fund A has investments valued at $566,000 ($1,400,000 value of
investments prior to sale minus $834,000 investments sold), with a
cost basis of $466,000 ($1,000,000 cost of investments prior to sale
minus $534,000 cost of investments sold) and unrealized gains of
$100,000 ($566,000 value of investments minus $466,000 cost of
investments). Therefore, Fund A, in accordance with the Proposed
Method, records an additional federal income tax liability of $2,800
(2.8% times $100,000 unrealized gains).
\31\ $458,920 net asset value equals $1,388,800 net asset value
prior to redemption minus $833,280 redemptions minus $93,800
additional current federal income tax liability recorded minus
$2,800 additional federal income tax liability recorded.
\32\ 40,000 redeemable securities outstanding equals 100,000
redeemable securities outstanding prior to redemption minus 60,000
shares redeemed.
\33\ $11.473 NAV/share equals $458,920 net asset value divided
by 40,000 redeemable securities outstanding.
\34\ If there had been any investors who purchased Fund shares
on March 31 at the NAV/share of $13.888, they also would have been
harmed by Fund A's use of the Proposed Method because they would
have overpaid for their shares.
\35\ $12.600 NAV/share on March 31, 2014 equals $1,260,000 net
asset value divided by 100,000 shares outstanding, where $1,260,000
net asset value equals $1,400,000 value of investments (inclusive of
an unrealized gain of $400,000) minus federal income tax liability
of $140,000 (where $140,000 equals $400,000 unrealized gains times
35%).
\36\ Shareholders would have redeemed 60,000 shares at the March
31, 2014 NAV/share of $12.600 representing redemptions of $756,000.
To satisfy redemptions, assume for illustrative purposes that Fund A
would have sold the same $834,000 of investments with a cost basis
of $534,000 resulting in a realized gain of $300,000. Fund A would
owe $105,000 of federal income taxes ($300,000 realized gain times
35%), however, under this fact pattern, Fund A already recorded a
federal income tax liability in excess of $105,000 (i.e., Fund A
recorded a federal income tax liability of $140,000), and therefore,
Fund A would not need to record an additional federal income tax
expense and corresponding federal income tax liability. Fund A's net
asset value after sale of investments and redemption of 60,000
shares would be $504,000 ($1,260,000 net asset value before
redemption minus $756,000 redemption) and Fund A's resulting NAV/
share would be $12.600 ($504,000 net asset value divided by 40,000
shares outstanding).
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15. The Commission therefore preliminarily believes that the
Proposed Method would not result in an ``appropriate provision . . .
for Federal income taxes'' as required by rule 2a-4(a)(4) under the
Company Act. In the Commission's preliminary view, in order to make an
``appropriate provision . . . for Federal income taxes'' under rule 2a-
4(a)(4), Copley must make a provision for the full federal income tax
liability that would arise if all of the Fund's existing unrealized
gains were realized. Making such a provision would result in purchases
and redemptions of Copley's redeemable securities being effected, under
rule 22c-1 under the Company Act, at a price based on a net asset value
that reflects a fair and equitable treatment of all of Copley's
shareholders. In contrast, the exemption from rule 22c-1 requested in
the application to provide for less than the full federal income tax
liability, could result in, among other things, redemptions of Copley's
redeemable securities at prices based on a potentially significantly
higher net asset value per share for some shareholders while the net
asset value of shares held by the remaining shareholders may be reduced
correspondingly when the full federal income tax liability is accrued,
producing an unfair and inequitable result among Copley's shareholders.
16. The Application discusses Copley's ``willingness to convert to
RIC status in the event unforeseen circumstances caused [unrealized]
gains to be realized that consumed the entire amount of accumulated
deferred income taxes it has recognized'' as a way for the Fund to
avoid having to pay more in federal income taxes than the amount
provided for under the Proposed Method. Copley's suggested potential
conversion to RIC status, however, does not change our analysis. In
order to successfully convert to a RIC at a point in time, Copley would
be required to comply with the Code's RIC requirements at all times
during the taxable year, which may not be possible if Copley
encountered the ``unforeseen circumstances'' mid-year or late-year.\37\
Moreover, despite converting to a RIC, Copley still would be subject to
federal income tax on the unrealized gains on securities which existed
prior to conversion to the extent the securities are sold within ten
years after the conversion.\38\ Because Copley, as an open-end fund
that has issued redeemable securities, cannot fully predict whether
securities may need to be sold to meet redemption requests in the ten
years after conversion to a RIC, Copley's contingent intent to convert
to a RIC does not eliminate Copley's potential federal income tax
liability.\39\
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\37\ See section 851 of the Code.
\38\ See Treas. Reg. section 1.337(d)-7.
\39\ The Application discusses certain real estate investment
trusts (``REITs''), which under the Code also may avoid a layer of
tax at the corporate level if they elect ``REIT status'' and meet
certain requirements, as examples of public companies that have
converted from C Corporations and elected REIT status and, by doing
so, avoided incurring a federal income tax liability. The
Application states that ``[Copley is] aware of at least two
entities--Weyerhaeuser and American Tower Corp.--that converted from
C Corporations into [REITs] and, in doing so, have exercised
discretion with respect to accounting for deferred tax
liabilities.'' Among other differences, the REITs discussed in the
Application are not open-end funds, do not issue redeemable
securities and therefore do not face the associated potential need
to sell portfolio assets to satisfy redemption requests.
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17. Based on the foregoing, the Commission's preliminary view is
that an exemption from rule 22c-1 under the Company Act is not
necessary or appropriate in the public interest and is not consistent
with the protection of investors and the purposes fairly intended by
the policy and provisions of the Company Act. Accordingly, absent a
request for a hearing that is granted by the Commission, the Commission
intends to deny Copley's request for an exemption from rule 22c-1 under
the Company Act.

B. Rule 4-01(a)(1) of Regulation S-X

18. The Commission's preliminary view that, in order to make an
``appropriate provision . . . for Federal income taxes'' under rule 2a-
4(a)(4) under the Company Act, Copley must make a provision for the
full federal income tax liability that would arise if all of the Fund's
existing unrealized gains were realized, also is consistent with GAAP.
The Application, however, requests an ``exemption'' from rule 4-
01(a)(1) of Regulation S-X for Copley to use a non-GAAP methodology in
recording its federal income tax liability in its financial
statements.\40\ If Copley were to use two different methodologies in
calculating its net asset value--a GAAP-consistent methodology for
purposes of pricing Copley's redeemable securities for purchases and
redemptions under rules 2a-4 and 22c-1 under the Company Act, and a
non-GAAP methodology in its financial statements--in the Commission's
preliminary view, the result may be unnecessarily confusing to
investors and contrary to the policy behind the Company Act's
disclosure requirements. Accordingly, absent a request for a hearing
that is granted by the Commission, the Commission intends to deny
Copley's request for an exemption from rule 4-01(a)(1) of Regulation S-
X as not necessary or appropriate in the public interest and as not
consistent with the protection of investors and the purposes fairly
intended by the policy and provisions of the Company Act.
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\40\ The Application does not state how Copley would present the
amount of its federal income tax liability in its financial
statements if the Commission granted the requested exemption. The
Commission assumes that Copley would present the amount according to
its Proposed Method in lieu of presenting the amount determined in
accordance with GAAP.

By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-11684 Filed 5-20-14; 8:45 am]
BILLING CODE 8011-01-P