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Securities and Exchange Commission
Southeastern Growth Fund, Incorporated
Publicly Available May 22, 1986
LETTER TO SEC
January 29, 1986
Division of Investment Management
Securities and Exchange Commission
450
Fifth Street, NW
Washington, D.C. 20549
Attn: Chief Counsel
Dear Sirs:
We are writing to request the advice of the Division that it would not recommend to the Commission that it take action if Southeastern Growth Fund, Inc. (the "Fund") amends its 12b-1 distribution plan to provide that a distribution fee will not be paid with regard to that portion of the Fund's assets attributable to an investment in the Fund by any employee benefit plan whose investment in the Fund would otherwise violate Section 406 of the Employee Retirement Income Security Act of 1974 (ERISA).
The Fund is a diversified, open-end investment company which was incorporated under the laws of Virginia on January 7, 1985. It is registered under the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund seeks long-term capital growth by investing in a diversified portfolio of securities, primarily common stocks of companies that are domiciled or whose principal business is located in the Southeastern United States.
Wheat First Securities, Inc. ("Wheat") acts as distributor of the Fund's shares. Wheat Investment Advisors, Inc. ("WIA") serves as investment advisor and administrator of the Fund. Both Wheat and WIA are wholly-owned subsidiaries of WFS Financial Corporation ("WFS").
The Fund does not charge sales commissions (i.e. the Fund is a "no-load" fund). However, Wheat receives a fee for its services under the Fund's "Plan of Distribution Pursuant to Rule 12b-1" (the "Distribution Plan"). Wheat receives a distribution fee which is accrued daily and paid monthly at a rate of 1% per year of the Fund's average daily net assets.
WFS maintains for its employees an Employee Benefit Plan (the "Plan") under ERISA and would like to have the flexibility to invest a portion of the Plan's assets in the Fund. However, an investment by the Plan in the Fund may violate Section 406 of ERISA unless Wheat complies with Prohibited Transaction Exemption 77-3, 42 F.R. 18734 (PTE 77-3) by waiving the distribution fee for the portion of the Fund's assets attributable to the Plan.
Section 406 of ERISA provides in pertinent part:
(a)(1) A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect ... (D) transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan ...
Wheat is a "party in interest", as defined by ERISA Section 3(14), with respect to the Plan. Since the Plan's investment in the Fund arguably would benefit Wheat through the Distribution Plan, ERISA counsel to the Plan advised that the transaction may be found to violate the prohibited transaction rule of ERISA Section 406(a)(1) unless Wheat complies with PTE 77-3.
PTE 77-3 allows a mutual fund "in-house" plan to invest the assets of its employee benefit plan in its own mutual fund provided it complies with the following four conditions:
(a) The plan does not pay any investment management, investment advisory or similar fee to such investment advisor, principal underwriter or affiliated person. This condition does not preclude the payment of investment advisory fees by the investment company under the terms of its investment advisory agreement adopted in accordance with section 15 of the Investment Company Act of 1940.
(b) The plan does not pay a redemption fee in connection with the sale by the plan to the investment company of such shares unless (1) such redemption fee is paid only to the investment company, and (2) the existence of such redemption fee is disclosed in the investment company prospectus in effect both at the time of the acquisition of such shares and at the time of such sale.
(c) In the case of transactions occurring more than 60 days after the granting of this exemption, the plan does not pay a sales commission in connection with such acquisition or sale.
(d) All other dealings between the plan and the investment company, the investment advisor or principal underwriter, are on a basis no less favorable to the plan than such dealings are with other shareholders of the investment company.
While the other conditions are met, condition (c) that the Plan does not pay a sales commission in connection with its investment in the Fund may not be met since the distribution fee paid to Wheat is utilized in part to compensate sales brokers for their efforts in selling shares of the Fund. Indeed, Rule 12b-1 of the 1940 Act explicitly contemplates use of the distribution fee to pay brokers' sales commissions. Rule 12b-1 provides that a company is a distributor "if it engages directly or indirectly in financing any activity which is primarily intended to result in the sale of shares issued by such company including ... compensation of underwriters, dealers and sales personnel." Thus, this sales aspect of the distribution fee seems to preclude the Fund's compliance with PTE 77-3, even though payment of the fee to Wheat is not directly related to sales and the fee would not be a sales commission or sales load within the meaning of the 1940 Act.
If there is no available exemption from ERISA Section 406, the Plan cannot invest in the Fund, even though the Distribution Plan complies in all respects with Rule 12b-1 of the 1940 Act. Counsel to the Plan has advised that the relief provided by PTE 77-3 would be available with respect to an investment by the Plan in the Fund if the distribution fee is waived with respect to the Plan's interest in the Fund. The Fund will eliminate any suggestion under PTE 77-3 that there may be a sales aspect inherent in the distribution fee by negotiating an agreement with Wheat to waive the fee as to that portion of the assets of the Fund attributable to an investment by the Plan. This is a simple calculation and will create no administrative burden. The Fund proposes the following procedure. Wheat will pay to the Plan the portion of the distribution fee that Wheat receives on account of the Plan's investment. The Fund will then credit that amount to the Plan's account. Alternatively, the distribution fee will be reduced ex ante by an amount representing the Plan's investment in the Fund.
The Fund's proposal is consistent with other rules under the 1940 Act which allow scheduled variation in the sales terms among classes of investors when certain conditions are met. The Fund represents that the following will be undertaken:
(a) The Fund will apply the variation in payment of the Distribution Fee uniformly to all purchases which are employee benefit plans for which a payment under the Distribution Plan would otherwise violate ERISA Section 406;
(b) The Fund will furnish to existing shareholders and prospective investors adequate information concerning the variation in payment of the Distribution Fee where its payment would violate ERISA Section 406; and
(c) Before making the variation in payment of the Distribution Fee available to purchasers of the Plan's shares, the Plan will revise its prospectus and statement of additional information to describe that new variation.
The Fund will comply with the requirements of Section 12b-1 of the 1940 Act to amend the Distribution Plan. The amendment will be submitted for approval by a vote of the board of directors of the Fund, as well as a vote of the directors who are not interested persons of the Fund and who have no direct or indirect financial interest in the operation of the Distribution Plan or in any agreements related to the Distribution Plan. The votes on the amendment will be cast in person at a meeting of the board of directors called for the purpose of voting on the amendment to the Distribution Plan. Reg. § 270 12b-1(b)(4).
In addition to amending its prospectus and registration statement as discussed above and submitting the proposed change to the board of directors as required by Rule 12b-1, the Fund will submit the amended Distribution Plan to the shareholders for approval even though this is not required under the regulations. From the shareholders viewpoint, the Fund would receive the same net investment from an investment by the Plan as from any other investor, with the portion of the distribution fee attributable to the Plan being refunded to the Plan rather than being paid to Wheat. Thus, Wheat would receive a lesser Distribution Fee than it would if the investment were made by someone else, but the same fee it would receive if the Plan were not to invest. Shareholder approval is anticipated because an investment by the Plan will allow the Fund to make more investments and achieve greater diversity of investment with no adverse effect on the shareholders.
The Fund requests that the staff confirm that it will not recommend enforcement action to the Commission if, under these circumstances, the Fund amends its Distribution Plan to provide that a distribution fee will not be paid with regard to that portion of the Fund's assets attributable to an investment in the Fund by any employee benefit plan whose investment in the Fund would otherwise violate Section 406 of ERISA.
If you require any further information, please contact the undersigned at (804) 644-4131.
Please date-stamp the enclosed copy of this letter to indicate receipt of this filing and return the stamped copy to the messenger making the filing.
Thank you.
Very truly yours,
William L. Taylor
SEC LETTER
April 22, 1986
Publicly Available May 22, 1986
In your letter of January 29, 1986, you request our assurance that we would not recommend any enforcement action to the Commission under the Investment Company Act of 1940 ("Act") if, as described in your letter, Southeastern Growth Fund, Inc. (the "Fund") amends its Distribution Plan, adopted pursuant to rule 12b-1 under the Act, to exempt an employee benefit plan from payment of its pro rata portion of the Fund's expenses incurred under that plan.
Given that rule 12b-1(e) permits a 12b-1 plan to be adopted or continued only if the directors conclude, in the exercise of reasonable business judgment and in light of their fiduciary duties, that there is a reasonable likelihood that the plan will benefit the company and its shareholders, the staff will not provide interpretive responses to requests regarding the merits of a particular 12b-1 plan. See American Pension Investors Trust (pub. avail. Nov. 27, 1985). As a general matter, however, we believe that any waiver or rebate of an investor's pro rata portion of the expenses incurred under a 12b-1 plan would raise serious concerns under both section 36 of the Act and general fiduciary principles. [FN1] We also question strongly whether a board of directors could conclude, as required by paragraph (e) of rule 12b-1, that there is a reasonable likelihood that a 12b-1 plan which provides for such disparate treatment of shareholders will benefit the company and its shareholders.
FN1 See, e.g., section 1(b)(3) of the Act, which declares, in part, that the public interest and the interest of investors are adversely affected "when investment companies issue securities containing inequitable or discriminatory provisions...."
Gerald T. Lins
Attorney
Securities and Exchange Commission.
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