|June 24, 1999|
H. Rodgin Cohen, Esq.
Dear Mr. Cohen:
This will respond to your letter, on behalf of First Union Corporation, Charlotte, North Carolina ("First Union"), regarding its proposal to provide capital to mutual funds that it advises. You have represented that First Union advises mutual funds through its subsidiaries, and that when First Union becomes aware of investor interest in a type of mutual fund other than the types that First Union currently advises, the company seeks to establish a new fund. In order to establish a new fund, initial capitalization is needed to acquire the necessary securities for the fund. The securities are then held for a period of time in order to establish a performance record for the fund prior to soliciting public investors. To date, third parties have provided the initial capitalization for First Union mutual funds.
First Union now proposes to provide this initial capitalization to mutual funds that it advises, under the conditions described below. The mutual funds capitalized by First Union would not own more than 5 percent of the voting securities of any portfolio company. A majority of directors of each capitalized fund would be independent of First Union. In addition, each fund that is capitalized by First Union would become a part of an established First Union family of funds. First Union does not hold a significant amount of the voting shares of these other funds. Because the shares of all of the funds in each family are aggregated for purposes of voting for directors of the funds, the voting shares that First Union would acquire as a result of capitalizing new funds would always constitute, in the aggregate, a de minimis percentage of the total shares voted for directors of those funds. The shares that First Union votes would be voted in the same proportion as the shares voted by all other shareholders of each fund. Finally, First Union will reduce its interest in each mutual fund that it capitalizes to below 25 percent of the total voting shares of the fund within 6 months after the fund begins issuing its shares.
The investments proposed by First Union must be consistent both with section 4 of the Bank Holding Company Act ("BHC Act") and section 20 of the Glass-Steagall Act. Section 4(c)(7) of the BHC Act and section 225.22(d)(6) of Regulation Y provide that a bank holding company may own or control voting shares of an investment company that is not a bank holding company, that is solely engaged in investing in securities, and that does not own or control more than 5 percent of the outstanding shares of any class of voting securities of any company.1 First Union states that each of the mutual funds in which it invests will not own more than 5 percent of the voting shares of any company and will meet the other terms in the statute and regulation.
Section 20 of the Glass-Steagall Act prevents a member bank from being affiliated with a company that engages principally in, among other things, issuing securities.2 The Board has long held that an open-end investment company (i.e., a mutual fund) is engaged principally in issuing securities because it must continuously issue securities in order to grow or to offset redemptions.3 The Glass-Steagall Act defines an affiliate to include a company, the control of which is held, directly or indirectly, through stock ownership or in any other manner, by the shareholders of a member bank who own or control more than 50 percent of the shares of the bank.4 Under this interpretation, a bank holding company may not control a mutual fund for purposes of the Glass-Steagall Act.5 The Act, however, does not define "control."
As a result of providing initial capitalization to the new mutual funds, First Union would own all or a significant percentage of the shares of these funds for some period of time after they begin operations. First Union has committed to reduce its ownership of voting shares in each of these funds to no more than 24.9 percent within six months of the funds' organization. This six-month period is consistent with time periods the Board has allowed bank holding companies under the BHC Act to divest impermissible nonbanking activities that are acquired as part of the acquisition of other permissible nonbanking activities.6 First Union's objective in providing initial capitalization to the new mutual funds would not be to obtain control over and manage an entity that continuously is marketing securities, but instead to facilitate First Union's primary activity of providing investment advice and other services to the mutual funds, which is a permissible activity for bank affiliates under the Glass-Steagall Act.
Within six months after the initial capitalization, First Union would own less than 25 percent of the shares of any mutual fund to which it has provided initial capitalization. In addition, a majority of directors of each capitalized fund would be independent of First Union. Because of the manner in which directors are elected for the families of funds advised by First Union, First Union would not be able to control, or even significantly influence, the election of the boards of directors of the funds in which it owns shares. There would also be an independent distributor for the shares of the funds advised by First Union.7
Given that First Union's initial capitalization of the new funds would be undertaken solely to facilitate the providing of investment advice and other services to the new funds, and in light of all of the other facts of record and First Union's commitments and representations, the Board would not take enforcement action under the Glass-Steagall Act if First Union owns or controls 25 percent or more of the voting shares of these funds for a period not to exceed six months after the funds first issue shares. Likewise, the Board concludes that under its proposed capitalization plan, First Union would not, after the initial six-month period, control the mutual funds that it capitalizes for purposes of the Glass-Steagall Act and that the proposal would not be inconsistent with the BHC Act.
These conclusions are based on facts provided by you. Any material change in these facts could result in a different conclusion and should be reported to Board staff. Should you have any questions about this letter, please contact Thomas Corsi of the Board's Legal Division at (202) 452-3275.
Very truly yours,
(Signed) Jennifer J. Johnson
Jennifer J. Johnson
7. In addition to controlling a mutual fund, Regulation Y also prohibits a bank holding company from sponsoring or organizing such a company. 12 C.F.R. § 225.125(f). Although sponsoring or organizing a mutual fund is not among the activities that section 20 expressly prohibits for bank affiliates, the sponsor or organizer of a mutual fund typically engages in functions that are explicitly covered in section 20, such as distributing the shares of the new mutual fund, or controlling the mutual fund indefinitely. As explained above, the shares of the mutual funds First Union would capitalize would be distributed by an independent party and First Union's control over the funds would terminate within a relatively short time frame.Return to text
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