[Federal Register Volume 60, Number 226 (Friday, November 24, 1995)]
[Notices]
[Pages 58116-58118]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-28616]
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SECURITIES AND EXCHANGE COMMISSION
[Investment Company Act Rel. No. 21502; International Series Release
No. 885; 812-8654]
Merrill Lynch, Pierce, Fenner & Smith Incorporated, et al.;
Notice of Application
November 13, 1995.
AGENCY: Securities and Exchange Commission (the ``SEC'').
ACTION: Notice of application for exemption under the Investment
Company Act of 1940 (the ``Act'').
APPLICANTS: Merrill Lynch, Pierce, Fenner, & Smith Incorporated
(``Merrill Lynch''), Smith Barney Inc., Prudential Securities
Incorporated, Dean Witter, Reynolds Inc., PaineWebber Incorporated,
Corporate Income Fund, Equity Income Fund, The Fund of Stripped
(``Zero'') U.S. Treasury Securities, Government Securities Income Fund,
International Bond Fund, The Merrill Lynch Fund of Stripped (``Zero'')
U.S. Treasury Securities, The Mortgage-Backed Income Fund, Defined
Asset Funds, Municipal Investment Trust Fund, and The Tax-Exempt
Mortgage Fund.
RELEVANT ACT SECTIONS: Order requested under section 6(c) from section
26(a)(2)(D) of the Act.
SUMMARY OF APPLICATION: Applicants request an order to permit the
trustees for certain unit investment trusts to deposit trust assets in
the custody of foreign banks and securities depositories.
FILING DATE: The application was filed on October 27, 1993 and amended
on May 23, 1995, August 10, 1995, and October 23, 1995.
HEARING OR NOTIFICATION OF HEARING: An order granting the application
will be issued unless the SEC orders a hearing. Interested persons may
request a hearing by writing to the SEC's Secretary and serving
applicants with a copy of the request, personally or by mail. Hearing
requests should be received by the SEC by 5:30 p.m. on December 8,
1995, and should be accompanied by proof of service on the applicants,
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
reasons for the request, and the issues contested. Persons who wish to
be notified of a hearing may request such notification by writing to
the SEC's Secretary.
ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C.
20549. Applicants, c/o Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Unit Investment Trusts, P.O. 9051, Princeton, New Jersey
08543-9051.
[[Page 58117]]
FOR FURTHER INFORMATION CONTACT:
Marilyn Mann, Special Counsel, at (202) 942-0582, or Robert A.
Robertson, Branch Chief, at (202) 942-0564 (Division of Investment
Management, Office of Investment Company Regulation).
SUPPLEMENTARY INFORMATION: The following is a summary of the
application. The complete application may be obtained for a fee from
the SEC's Public Research Branch.
Applicants' Representations
1. Corporate Income Fund, Equity Income Fund, The Fund of Stripped
(``Zero'') U.S. Treasury Securities, Government Securities Income Fund,
International Bond Fund, The Merrill Lynch Fund of Stripped (``Zero'')
U.S. Treasury Securities, The Mortgage-Backed Income Fund, Defined
Asset Funds, Municipal Investment Trust Fund, and The Tax-Exempt
Mortgage Fund (the ``Funds'') are registered investment companies made
up of one or more series (the ``Series'') of separate unit investment
trusts registered or to be registered under the Securities Act of 1933.
Each Series is created by a trust indenture (an ``Indenture'') among
its sponsors and a trustee and is sponsored by one or more of the
following: Merrill Lynch, Smith Barney Inc., Prudential Securities
Incorporated, Dean Witter Reynolds Inc., and PaineWebber Incorporated
(the ``Sponsors''). Pursuant to powers of attorney executed by each of
the other Sponsors, Merrill Lynch acts as agent for the Sponsors for
purposes of taking action under the Indentures (including, among other
things, selecting securities to be deposited or liquidated). Applicants
request that any order granted pursuant to the application extend to
any future unit investment trust sponsored by one or more of the
Sponsors that becomes a party to an Indenture, and any future sponsor
of one or more of the Series that becomes a party to an Indenture and
for which Merrill Lynch acts as agent for purposes of taking action
under the Indentures.
2. In 1987, the SEC issued an order (the ``Euroclear Order'') \1\
that permits any trustee of a Series to deposit securities and other
assets of any such Series with Morgan Guaranty Trust Company of New
York, Brussels office, as operator of the Euroclear System
(``Euroclear'') or Central de Livraison de Valeurs Mobilieres, S.A.
(``Cedel'').\2\ However, as discussed below, various Series of
Corporate Income Fund, Equity Income Fund, and International Income
Fund now invest in foreign securities that either are not eligible for
settlement through Euroclear or Cedel or for which those depositories
are not used in the ordinary course of settling securities transactions
in those securities. Applicants thus request an order to permit the
trustees for the Funds to deposit Fund assets in the custody of all
foreign banks and securities depositories that meet the requirements
described below.
\1\ Merrill Lynch, Pierce, Fenner & Smith Incorporated,
Investment Company Act Release Nos. 15739 (May 14, 1987) (notice)
and 15813 (June 16, 1987) (order).
\2\ As conditions to the Euroclear Order, the Funds agreed to
include in their trust indentures provisions for custody
arrangements that (i) assign to the Trustee the supervisory and
monitoring duties which, under rule 17f-5, are assigned to the
boards of directors of management investment companies and (ii)
require the Trustee to indemnify the Funds against losses occurring
by reason of the gross negligence, bad faith, or willful misconduct
of Euroclear or Cedel.
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3. Increasingly, transactions in foreign securities must be settled
by book entry through specified clearing systems with related
securities depositories. Without the requested relief, effecting a
trade in securities held in those depositories means that the
securities must be physically transported in certificate form for
deposit with a foreign branch of a U.S. bank and then retransported and
redeposited upon sale.
4. In addition, certain countries by law or regulation mandate use
of a particular depository as the only means of holding a security. In
other markets, maintaining securities outside a depository is not
consistent with prevailing custodial practices. In some markets,
anticipated time delays, as well as the costs, of maintaining
securities with the nearest foreign branch of a U.S. bank, have led the
Sponsors to determine not to invest Fund assets in those markets.
5. The authority to use the custodial services of foreign banks
will permit the Funds to invest in countries in which U.S. banks are
not authorized to operate or in which U.S. banks are not members of the
depository in which the desired securities are held. Even if a U.S.
bank is available, there may be settlement advantages to using a local
bank.
Applicants' Legal Analysis
1. Under sections 2(a)(5) and 26(a)(1), the trustee of a unit
investment trust must be a bank that is subject to regulation by the
U.S. government or one of the states. Section 26(a)(2)(D) requires that
the trust indenture provide that the trustee ``shall have possession of
all securities and other property in which the funds of the trust are
invested * * * and shall segregate and hold the same in trust * * *
until distribution thereof to the security holders of the trust.''
Under these sections, the only foreign entity that qualifies as a unit
investment trust custodian is an overseas branch of a U.S. bank.\3\
\3\ See Custody of Investment Company Assets Outside the United
States, Investment Company Act Release No. 21259 (July 27, 1995).
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2. Section 6(c) provides that the SEC may conditionally or
unconditionally exempt any person, security, or transaction, or any
class or classes of persons, securities, or transactions, from any
provision of the Act or 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 Act.
3. The Sponsors and the Funds request an order under section 6(c)
exempting them and any bank that acts as trustee (a ``Trustee'') \4\
for any Series from section 26(a)(2)(D) to the extent necessary to
permit a Trustee to deposit, or to cause or permit the deposit of,
foreign securities (as defined in rule 17f-5, and any amendments
thereto), cash, and cash equivalents in amounts reasonably necessary to
effect foreign securities transactions of any Series with (1) any
company that is an ``eligible foreign custodian'' as defined in rule
17f-5 or any amendments thereto and (2) any other company (a
``Qualifying Custodian'') that fails to meet the definition of eligible
foreign custodian solely because it does not meet the shareholders'
equity requirement of rule 17f-5(c)(i) or (ii), whichever is
applicable. Under the proposed arrangement, each Trustee would provide
custody services pursuant to arrangements that would be the same as
those applicable to registered management investment companies except
that (i) the Trustee would perform the duties that, under rule 17f-5,
are assigned to the boards of directors of management investment
companies; (ii) the Trustee would provide indemnification against
losses due to negligence of the foreign custodian; and (iii) in the
case of foreign custodians that fail to meet the shareholders' equity
requirements of the rule, the Trustee or an affiliated person of the
foreign custodian would provide indemnification against losses due to
[[Page 58118]]
bankruptcy or insolvency of the foreign custodian.
\4\ The current Trustees are The Bank of New York, The Chase
Manhattan Bank, N.A. (each acting as sole trustee), and the Bank of
New York and Shawmut Bank, N.A. (acting as co-trustees for certain
Series). The Sponsors may use other trustees in the future.
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4. Applicants believe that the requested exemption is closely
analogous to, and appropriate in light of, the foreign custodial
arrangements available to management companies under rule 17f-5. Rule
17f-5 permits management companies to use foreign banks that meet the
rule's capital requirements, transnational securities depositories, and
securities depositories that operate the central system for handling
securities or equivalent book-entries in a particular country. In
addition, applicants believe that securities held by a foreign
custodian, subject to the conditions listed below, will be at least as
effectively protected as the same securities would be if directly
deposited with a foreign branch of a United States bank, or shipped to
the United States for custody. Applicants also believe that the
exposure to certain custodial risks is reduced when securities are held
through certain foreign securities depositories rather than through a
foreign branch of a United States bank since securities held in those
depositories do not have to be physically transported in certificate
form for deposit outside the system to effect a trade and then
retransported and redeposited upon sale.
5. Applicants believe that the use of eligible foreign custodians
and Qualifying Custodians would result in efficiencies, cost savings,
and enhanced liquidity of the Funds' foreign securities. Substantial
costs and inefficiencies currently arise, in part, because all sales of
certain depository-eligible portfolio securities must be settled only
through that depository. Thus, since a unit investment trust that
purchases securities that must be settled through the depository must
also hold those securities outside of the depository, the unit
investment trust must withdraw the securities from the depository, send
them out for registration, and then transport them to an eligible sub-
custodian (i.e., a foreign branch of a United States bank). In order to
subsequently resell the portfolio securities, they must be transported
back to the depository for redeposit.
6. During the delay due to sending securities out for registration,
corporate action information is not readily available. This could lead,
for example, to delays in the crediting of dividends to the Trust for
the benefit of unit holders. In addition, the delay could give rise to
significant liquidity problems if sales of securities were needed to
meet redemptions.
7. If a trust were permitted to hold securities in the foreign
depository, this delay would be virtually eliminated. This is because
securities held in the depository are automatically reregistered in the
name of the depository common nominee and participants may continue to
settle their delivery obligations according to sufficiency of their
book-entry balances in their depository stock clearing accounts, even
when the underlying certificates have been submitted to share
registrars for registration.
8. The Trustees will be required to exercise reasonable care in
selecting foreign custodians, and each Trustee will maintain written
records regarding the basis for the choice or continued use of each
foreign custodian. In addition, the prospectus of each Series will
provide appropriate disclosure regarding foreign securities and foreign
custody. Applicants believe that in view of the cost savings and
increased efficiency and liquidity described above, and the proposed
indemnification and oversight by the Trustees, the requested exemption
is appropriate and should be granted.
Applicants' Conditions
Applicants agree that the order granting the requested relief shall
be subject to the following conditions:
I. Conditions Applicable to All Foreign Custodians
1. The Indenture will contain provisions under which the Trustee
agrees to indemnify the Series against any loss occurring as a result
of willful misfeasance, bad faith, or negligence by the foreign
custodian in the performance of its duties or by reason of the foreign
custodian's reckless disregard of its duties.
2. The Indenture will contain provisions under which the Trustee
agrees to be liable to the Series for any loss occurring as a result of
the Trustee's willful misfeasance, bad faith or negligence in the
performance of its duties under the Indenture or by reason of its
reckless disregard of those duties.
3. The Indenture will contain provisions under which the Trustee
agrees to perform all of the duties assigned by rule 17f-5, as now in
effect or as it may be amended in the future, to boards of directors of
management companies. A Trustee's duties under this condition will not
be delegated.
4. The Series' prospectus will contain such disclosure regarding
foreign securities and foreign custody as is required for management
investment companies by Forms N-1A and N-2.
5. The Trustee will maintain and keep current written records
regarding the basis for the choice or continued use of each foreign
custodian. These records will be preserved for a period of not less
than six years from the end of the fiscal year in which the unit
investment trust was terminated, the first two years in an easily
accessible place. Such records will be available for inspection at the
Trustee's main office during the Trustee's usual business hours, by
unitholders and by the SEC or its staff.
II. Condition Applicable to Foreign Custodians With Insufficient
Shareholders' Equity
1. Any foreign custodian that fails to meet the definition of
``eligible foreign custodian'' solely because it does not meet the
shareholders' equity requirement of rule 17f-5(c)(2) (i) or (ii),
whichever is applicable, shall not be given custody of the assets of
any Series unless and until the Trustee of that Series has entered into
one of the following contractual agreements, which will remain in
effect at all times during which the foreign custodian fails to have
the minimum shareholders' equity specified in rule 17f-5(c)(2):
a. An agreement between the Series, the Trustee, the Sponsors, and
the foreign custodian, which provides that the Trustee will indemnify
the Series against any loss arising out of or in connection with the
bankruptcy or insolvency of the foreign custodian; or
b. An agreement between the Series, the Trustee, the Sponsors, the
foreign custodian, and an affiliated person of the foreign custodian
that (i) is a bank (as defined in section 2(a)(5) of the Act) or bank
holding company or (ii) meets the definition of ``eligible foreign
custodian'' under rule 17f-5(c)(2)(i), which provides that the
affiliated person will indemnify the Series against any loss arising
out of or in connection with the bankruptcy or insolvency of the
foreign custodian.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-28616 Filed 11-22-95; 8:45 am]
BILLING CODE 8010-01-M