Tag Archives: GRT Capital Partners

Group of investors request SEC to exempt them from regulations over new Investment Complex

15 Jan

9/01/14

A group of institutional investors has requested numerous exemptions from the SEC’s regulations over funds of funds to extend the remit of three feeder funds, enabling collective ownership by said investors in a complex of Affiliated Funds.

The investment group invoked the ‘public interest’ in support of most of their requested exemptions, arguing in depth that the violations Act 12(D)(1), 17(B) and 6 (C) were intended to prevent were either not relevant in this case, or that the group had taken sufficient precautions to prevent abuses of shareholder interests.

The funds established by the applicants comprise The Advisors’ Inner Circle Fund, The Advisors’ Inner Circle Fund II and Bishop Street Funds. From December 10, 2012, AIC offered shares of 45 series, AIC II offered shares of 36 series and BSF offered shares of 4 series;  “each pursue different investment objectives and principal investment strategies.” All three trusts are registered in Massachusetts, each as an open-end management investment company.

The investors making the application incorporate Citigroup First Investment Management Americas LLC, Cornerstone Advisors Inc., PNC Capital Advisors LLC, Frost Investment Advisors LLC, and GRT Capital Partners, LLC. All act in an advisory capacity over other specialist funds within their company group, with extensive oversight over their investment approaches. GRT currently serves as investment adviser for two series of AIC II: the GRT Value Fund and the GRT Absolute Return Fund.

The applicants first laid out how their proposal complied with existing SEC requirements. Their current arrangement was classified as an Affiliated Fund of Funds Arrangement (under Section 12(d)(1)(G), which allows a registered open-end fund or unit investment trust (UIT) to acquire an unlimited number of shares in other registered open-end funds and UITs that are part of the same “group of investment companies”. This collective is commonly known as a “fund complex”. The fund which capitalises on this exception, an “affiliated fund of funds” is limited in the forms of other securities it can possess as well as its shares of registered funds in the same group of investment companies.

These restrictions at times give birth to master-feeder arrangements, where an Affiliated, Underlying or ‘feeder’ fund is created solely for the purpose of investing in its ‘master’ fund, which orchestrates a diversified portfolio and strategy. Those investing in the ‘feeder’ fund must be part of the investment group constituting the ‘master’ fund, in order to be permitted to gain a sufficient, significant interest in the underlying fund’s common stock. To reduce transaction costs and to bypass the aforementioned controls on the type of security held, a distributor fund of funds is incorporated to periodically redistribute assets between complex members’ portfolios.

SEI Investments Distribution Co. was the designated ‘Distributor’. The distributor serves as principal underwriter and distributor for the shares of the trusts’ funds. Acting as co-advisers to the proposed fund of funds are Abbot Downing Investment Advisors, Bishop Street Capital Management; Abbot Downing is a distinct identifiable department of Wells Fargo Bank, N.A. and presently serves as investment adviser for AIC II series, the Clean River Fund series.

Previously, the Securities Act under the stipulations of Section 12(d)(1)(A) restricted investment by open-ended funds or unit investment trusts in other funds. The measures “were designed to prevent fund of funds arrangements that have been used in the past to enable investors in an acquiring fund to control the assets of an acquired fund and use those assets to enrich themselves at the expense of acquired fund shareholders,” explains the SEC (http://www.sec.gov/rules/final/2006/33-8713.pdf).

Investment was capped at 3% in the acquired fund’s outstanding voting securities, and the buyer was prevented from investing 5% or more of its stock in any one fund; or investing more than 10% of its stock in total in other funds. Under Section 12(d)(1)(B), an investment adviser or dealer-broker of the company whose securities are being acquired cannot sell more than 10% of its outstanding stock to other funds.

Due to the subsequent difficulty for some funds in sourcing adequate finance, an amendment to the act enabled unlimited numbers of positions in ‘unaffiliated funds,’ with the same 3% cap on the size of the stake in the fund. The buyer was also prevented from influencing shareholder votes, and is restricted in its ability to exchange shares of the acquired fund. The only way of bypassing these rules is by claiming the interested parties are part of the same ‘investment group,’ and thus affiliated funds.

Many of these restrictions do not apply to affiliated funds, or groups of investment companies, under Section(d)(1)(G) of the act, provided the aggregate sales and distribution-related fees of the acquiring company and the acquired company are not excessive. And, the applicants explain in their own words, that:

“the acquired company has a policy that prohibits it from acquiring securities of registered open-end management investment companies or registered unit investment trusts in reliance with Section 12(D)(1)(F) or (G) of the Act.”

And additionally, if you are still following these gymnastic contortions in legal parlance, that “the acquiring company holds only securities of acquired companies that are part of the same ‘group of investment companies,’ government securities, and short-term paper.”

The Underlying Funds whose shares are being acquired by the investment trusts within the complex will have a severely restricted choice of investment policies, their major purpose the transfer of capital to unit and open-ended investment trusts and companies in the investment group. Investment Advisers acting for the funded funds will be licensed to accept capital transfers in their role as Affiliated Parties. Naturally there are constrictions too which limit the size of monetary transfers and exchanges, even between affiliated companies. The applicants detail how they intend to bypass these rules below:

Section 17(b) of the Act authorizes the Commission to grant an order permitting a transaction otherwise prohibited by Section 17(a) if it finds that (a) the terms of the proposed transaction are fair and reasonable and do not involve overreaching on the part of any person concerned; (b) the proposed transaction is consistent with the policies of each registered investment company involved; and (c) the proposed transaction is consistent with the general purposes of the Act.

Section 6(c) of the Act permits the Commission to exempt any person or transactions from any provision of the Act if 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. Because multiple transactions could occur between a Fund of Funds and an Unaffiliated Fund, and because the Commission may interpret its authority under Section 17(b) as extending only to a single transaction and not a series of transactions, Applicants are also seeking relief pursuant to Section 6(c).

And the list of proposed exemptions from the Act goes on, evoking Section 12(D)(1)(J) as grounds for immunity from the requirements of Section 12(D)(1). The provisions of Section 12(D)(1) prevent a registered investment company from purchasing or acquiring a security or business interest from someone who is a broker, dealer, underwriter, investment company adviser or investment adviser.

The 12D-1 limit allows registered investment companies, on a case-by-case basis, to purchase securities from other firms engaged in the business activities prohibited under Section 12(d)(3) of the Investment Company Act: namely, small loan, factoring and finance companies. Securities can only be purchased from companies which derived no more than 15% of their total gross revenues over the previous three fiscal years from the businesses listed above. Furthermore, the registered investment company and all affiliated companies must not own more than 10% of the total outstanding voting stock of the portfolio company immediately after the securities acquisition. The proposed immunity from these universally applied limits is again justified on the basis of shareholders’ and the public’s interest.

They give due credence to the Commission’s autonomy of judgement, while implying that the rules may not apply in this particular case, stating that: “The Commission should consider… the extent to which a proposed arrangement is subject to conditions that are designed to address conflicts of interest and overreaching by a participant in the arrangement, so that the abuses that gave rise to the initial adoption of the Act’s restrictions against investment companies investing in other investment companies are not repeated.”

Finally, they detail the precautionary measures they have taken to prevent the potential abuse of the management fee structure; or of holding undue sway over one of the underlying companies’ management policy, purely by virtue of the fact it is directly answerable to the master companies’ investment advisors. The first condition will be forestalled by establishing a Board of the Fund of Funds, including a majority of the trustees who are not “interested persons”, as described in Section 2(a)(19) of the Act, who will rule that the advisory fees charged under advisory contracts for the principal investment funds are “in addition to, rather than duplicative of, services provided pursuant to any Underlying Fund’s advisory contract(s).” And moreover, that it is equal to the fee that would have been exacted by an Unaffiliated Investment Company for the same services.

The section condition will be met through a clause stipulating that if either an Advisory Group or Subadvisory Group becomes a holder of over 25% of the outstanding voting securities of the Unaffiliated Fund, the group nominally in charge of policy direction will vote its shares of the Unaffiliated Fund in the same proportion as the vote of all other holders of its shares. For reasons unknown, this contingency will only be triggered in the case of a 25% majority interest occurring “as a result of a decrease in the outstanding voting securities of an Unaffiliated Fund, an Advisory Group or a Subadvisory Group.”

One final exemption requested from the existing law is the proposal that the applicants be permitted to buy shares directly from ETFS of registered investment funds, rather than by the secondary market.

To sum up, an impressive intellectual case has been made by the applicant parties (Citigroup First Investment Management Americas LLC, Cornerstone Advisors Inc., PNC Capital Advisors LLC, Frost Investment Advisors LLC, and GRT Capital Partners, LLC., SEI Investments Distribution Co, Abbot Downing Investment Advisors and Bishop Street Capital Management). It is based on the assumption that they have enough safeguards in place to prevent the abuse of acquired investment funds’ shareholder interests that necessitated the Act’s relevant provisions in the first place. But considering that the acquired funds in question seem to have been created purely to serve the interests of the firms which will act, through the distributor, as both their investment advisers and managers, it seems their essential premise of the ‘public interest’ might be a shaky one. Will this consideration be outweighed by the possible benefits of such a large, balanced and diversified pool of investments?

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