[Federal Register Volume 61, Number 226 (Thursday, November 21, 1996)]
[Notices]
[Pages 59256-59257]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-29715]
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SECURITIES AND EXCHANGE COMMISSION
[Investment Advisers Act Release No. 1597; 803-100]
BlackRock Financial Management, Inc.; Notice of Application
November 15, 1996.
AGENCY: Securities and Exchange Commission (``SEC'').
ACTION: Notice of Application for Exemption under the Investment
Advisers Act of 1940 (the ``Act'').
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APPLICANT: BlackRock Financial Management, Inc.
RELEVANT ACT SECTIONS: Order requested under section 206A for an
exemption from section 205(a)(1).
SUMMARY OF APPLICATION: Applicant requests an order to permit it to
charge a performance fee to BlackRock Assets Investors (the ``Trust''),
a closed-end investment company. Applicant requests the order because a
limited number of its senior employees or senior employees of a Trust
subsidiary who do not meet the minimum financial standards prescribed
by rule 205-3(b) (1) under the Act may become shareholders of one of
the Trust's feeder funds.
FILING DATES: The application was filed on November 28, 1995, and
amended and fully restated applications were filed on April 26 and
October 3, 1996.
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
applicant 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 10,
1996, and should be accompanied by proof of service on 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
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. Applicant, 345 Park Avenue, New York, N.Y. 10154.
FOR FURTHER INFORMATION CONTACT:
H.R. Hallock, Jr., Special Counsel, 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 Reference Branch.
Applicant's Representations
1. Applicant is an investment adviser registered under the Act. The
Trust and BlackRock Fund Investors I, II and III (the ``Funds'') are
each closed-end, non-diversified management investment companies formed
as Delaware business trusts and registered under the Investment Company
Act of 1940. The Trust and the Funds are organized in a master-feeder
structure. Each Fund invests all of its assets in the Trust, which
conducts all investment operations.
2. The Funds have conducted an offering of interests exempt from
registration under the Securities Act of 1933 pursuant to the exemption
provided by section 4(2) thereof. At the conclusion of this private
offering in the spring of 1995, the Funds had obtained capital
commitments for approximately $560 million from institutional and
higher net worth investors and in turn entered into back-to-back
commitments with the Trust.\1\ The Funds have drawn approximately $130
million in committed capital and have invested that amount in the
Trust.
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\1\ Investors in the Funds signed subscription agreements
restricting the transferability of their shares of investors who do
not meet the objective financial standards set forth in rule 205-3
(b)(1) under the Act. Moreover, consent by the applicable Fund is
required for any transfer other than among affiliates.
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3. Applicant formed the Trust and the Funds to provide
institutional investors with a way to participate in real estate debt
markets. The primary investment objective of the Trust is to earn a
high total rate of return through investment in a portfolio consisting
primarily of subordinate commercial mortgage-backed securities
(``CMBS'') and from its equity investments in mortgage affiliates
engaged in acquiring, working out, pooling and repackaging real estate
debt and issuing CMBS. The Trust and the Funds are scheduled to
terminate on January 17, 2002.
4. The Trust owns BlackRock Capital Finance L.P. (``BCF''), which
was formed to acquire performing and distressed commercial and
residential loans and work out its distressed investments and pool and
repackage its performing mortgage loans as mortgage-backed securities
or otherwise dispose of loans and related properties. Most of the
Trust's approximately $130 million in capital has been invested in BCF.
5. Under an investment advisory agreement between the Trust and
applicant, the Trust will pay to applicant both a semi-annual
management fee equal to .75% per year of the capital commitments
(during the three-year commitment period ending in 1998) or average
capital invested (after the commitment period) and a performance fee
(the ``Performance Fee''). The Performance Fee is payable as of the
first anniversary of the commencement of the Trust's operations, as of
each October 31 thereafter and as of the Trust's termination date.
6. The Performance Fee was extensively negotiated between applicant
and three ``lead investors,'' large institutional investors in Funds II
and III whose commitment represents almost 48% of the capital
commitments of all the Funds. The Performance Fee was designed both to
require that the Trust achieve at least a 10% annualized total return
before applicant is entitled to any Performance Fee and then to further
delay its entitlement to such fees until the investors have received
distributions at least equal to the amount of capital invested in the
Trust.
7. The maximum Performance Fee is 20% of realized total return net
of any unrealized losses plus an interest factor related to the delayed
payment feature discussed above. In order to ``catch up'' after the 10%
minimum annualized return is achieved, the stated rate of the
Performance Fee is 40% on the total return between 10% and 20% per year
and then reverts to the 20% rate for all incremental returns once the
average annual performance has reached 20%.
Applicant's Legal Analysis
1. Section 205(a)(1) of the Act prohibits an investment adviser
from performing under an investment advisory contract that provides for
compensation to the adviser based on a share of capital gains upon or
capital appreciation of a client's funds. Section 206A authorizes the
SEC to exempt any person from any provision of the Act to the extent
necessary or appropriate in the public interest and consistent with the
protection of investors and the purposes of the Act.
2. Rule 205-3 under the Act allows a registered adviser to charge a
fee based upon a share of capital gains or capital appreciation of a
client's account under certain conditions. Paragraph (b)(1) of the rule
requires that the client must
[[Page 59257]]
have either a minimum account size of $500,000 or a net worth over $1
million.
3. Although the Performance Fee is assessed against the Trust
(rather than directly against investors in the Funds), paragraph (b)(2)
of the rule requires in effect that each investor in each of the Funds
must meet the objective financial test of $500,000 under management or
$1,000,000 in net worth set forth in paragraph (b)(1). Applicant
represents that, except for the objective financial qualifications
established by rule 205-3, all the other requirements of rule 205-3 are
satisfied.\2\
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\2\ Rule 205-3 requires, first, that the adviser's compensation
must be based upon a formula that includes realized capital losses,
and under certain conditions, unrealized capital depreciation.
Second, the compensation must be based upon performance over a
period of not less than one year. Third, the adviser must disclose
certain information to the client. Finally, the adviser must
reasonably believe that the advisory contract represents an arm's-
length arrangement and that the client understands the performance
fee and its risks.
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4. Individuals who do not have $1,000,000 in net worth and who are
employees either of applicant or of BCF seek to invest in Fund III in
amounts less than $500,000. These individuals do not satisfy the
objective financial test set out in rule 205-3(b)(1). Consequently,
rule 205-3 does not permit, and section 205(a)(1) would prohibit,
applicant from charging the Performance Fee to the Trust if such
individuals invest in Fund III. Applicant requests that the SEC allow
it to charge the Performance Fee to all investors, including the non-
qualifying employees of applicant and BCF.
5. Applicant represents that each of the individuals in question
has a college degree or graduate school training and years of
experience in the mortgage securities investment business and is
closely involved in the daily business of applicant or BCF. In
addition, such non-qualifying personnel all hold positions of vice-
president and above (including principal and managing director).
Accordingly, each of these individuals has a professional understanding
of the risk associated with the Trust's investment program as well as
the degree of risk being undertaken by applicant in achieving the
program.
6. Applicant argues that the financial sophistication of the non-
qualifying employees is exactly what the SEC sought to assure by
imposing the exemptive conditions of rule 205-3. In the adopting
release, the SEC stated that the objective financial criteria set forth
in rule 205-3 are intended to assure that the rule will be limited to
advisory contracts with clients who are financially sophisticated and
capable of bearing the increased risks associated with incentive fee
arrangements.\3\ In addition, applicant states that it will make a good
faith judgment as to the sophisticated nature of each investor relative
to the affairs of the Trust.
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\3\ See Investment Advisers Act Release No. 996 (Nov. 14, 1985)
(adopting rule 205-3).
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7. Applicant further states that each of the individual employees
who does not qualify under rule 205-3(b)(1) is an ``accredited
investor,'' as such term is defined in rule 501 of Regulation D under
the Securities Act of 1933.\4\ Each such employee who chooses to invest
in Fund III also would execute a binding subscription agreement
committing to invest between $25,000 and $100,000.
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\4\ Rule 501 of Regulation D defines an accredited investor to
include, as here relevant, any natural person having an income of
greater than $200,000 for each of the previous two years and an
expectation of the same income level for the current year.
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8. Substantially all of applicant's most senior personnel who do
qualify under rule 205-3(b)(1) have committed up to $28 million for
Fund III and also share in applicant's profits through incentive
compensation plans. Applicant believes that the fact that they have
substantial amounts at stake moderates any incentive to take the kinds
of investment risks that concerned Congress when it adopted section
205(a)(1) and tends to ensure a community of interest with all other
investors, including the proposed non-qualifying investors.
9. Applicant believes that there is also a strong commonality of
interest between the qualifying personnel and non-qualifying employees
who may wish to invest in Fund III, because the two groups work closely
together in conducting the business of the Trust or BCF. The non-
qualifying employees are, for example, actively involved in meeting
with prospective sellers and buyers of real estate debt, structuring
potential transactions, and preparing financial statements and reports
to investors. These functions all require a high degree of financial
sophistication. As members of the term who expect to make the Trust
successful, they would like to be able to participate in that success
along with the more senior personnel through an equity investment.
10. Applicant believes that the terms of the Performance Fee
eliminate the ability--and any incentive--for applicant to engage in
speculative trading practices or artificially enhance its fee by
loading profits into one year and losses into another year. The
Performance Fee takes into account both realized and unrealized losses,
but only realized gains. In addition, it is measured only against
cumulative performance over the life of the Trust and is payable only
after a cumulative minimum return to investors has been achieved.
Further, its accrual and payment are further delayed to minimize the
possibility that Performance Fees paid for good performance in the
early years could not be recovered by the Trust in later years if
performance fell. Applicant also notes that investors in the Funds will
receive annual and semi-annual reports with attached financial
statements regarding the Funds, the Trust and the Trust's ``downstream
affiliates'' as well as tax information regarding those entities,
including BCF.
Applicant's Conditions
Applicant agrees that any order granting the requested exemptive
relief may be made subject to the following conditions.
1. Applicant's investment advisory arrangement with the Trust will
satisfy all the conditions of rule 205-3 of the Act, except for the
objective financial standards set forth in paragraph (b)(1) thereof as
they apply to the ``non-qualifying'' employees of applicant or BCF.
2. Applicant will use its best efforts to ensure that no shares of
any of the Funds or any interests therein are transferred to any person
that does not satisfy the applicable objective financial standards of
rule 205-3(b)(1).
For the SEC, by the Division of Investment Management, under
delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-29715 Filed 11-20-96; 8:45 am]
BILLING CODE 8010-01-M