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Investment Company Act of 1940 — Sections 12(d)(1)(A) and (B) and 17(a)
Franklin Templeton Investments

April 3, 2015

RESPONSE OF THE OFFICE OF CHIEF COUNSEL
DIVISION OF INVESTMENT MANAGEMENT

IM Reference No. 2014128159
File No. 132-3

Your letter dated April 1, 2015 requests assurance that we would not recommend enforcement action to the Securities and Exchange Commission (“Commission”) under Sections 12(d)(1)(A) and (B) and 17(a) of the Investment Company Act of 1940 (“1940 Act”) against an investment manager that is under the direct or indirect control of Franklin Templeton Investments (“FTI,” and such manager, “FTI Manager”),[1] or an open-end investment company registered under the Investment Company Act of 1940 (“1940 Act”) within the FTI group of investment companies, as defined in Section 12(d)(1)(G)(ii) of the 1940 Act,[2] that is advised by an FTI Manager (each, a “Fund” and together, the “Funds”) if, under the circumstances described below, the Fund purchases or otherwise acquires shares of another Fund in excess of the limits in Section 12(d)(1)(A) of the 1940 Act and the other Fund sells its shares to the acquiring Fund in excess of the limits in Section 12(d)(1)(B) of the 1940 Act.

I. BACKGROUND

You represent as follows:

• Various Funds currently invest a portion of their respective assets directly in similar floating rate instruments. FTI intends to create a Fund (a “Central Fund”), to be offered exclusively to the Funds, to centralize the portfolio management of floating rate instruments.[3]
• FTI believes that the creation of the Central Fund would reduce the trading and settlement costs and other operational inefficiencies associated with managing each Fund’s investments in floating rate instruments separately. Subsequent to the formation of the Central Fund, the various Funds that currently invest directly in floating rate instruments instead would invest some or all of the relevant portions of their respective portfolios in shares of the Central Fund. FTI believes that the Central Fund could obtain greater efficiencies as a result of aggregation of virtually identical assets in the Central Fund because of the larger base of assets that would result from the investments by the respective Funds in the Central Fund.
• A Fund would invest in the Central Fund in reliance on Section 12(d)(1)(G) of the 1940 Act.[4]
• Some Funds that would benefit from investing in the Central Fund, however, may be Funds (“Underlying Funds”) in which other Funds (“Funds of Funds”) invest in reliance on Section 12(d)(1)(G) of the 1940 Act. Under the terms of Section 12(d)(1)(G), each Underlying Fund has adopted a policy that the Underlying Fund will not acquire securities of another registered open-end investment company in reliance on Section 12(d)(1)(G) or Section 12(d)(1)(F) of the 1940 Act. In order to invest in shares of the Central Fund, an Underlying Fund would have to modify this policy to allow for this exception. By modifying its policy, however, the Underlying Fund would cause the Fund of Funds arrangement of which it is a part to no longer be eligible to rely on Section 12(d)(1)(G) (or on the implicit exemption from Section 17(a)).[5]

Your letter requests our assurance that we would not recommend enforcement action to the Commission under Sections 12(d)(1)(A) and (B) and 17(a) of the 1940 Act against an Underlying Fund, a Fund of Funds or an FTI Manager if the Underlying Fund invests in the Central Fund as described in your letter.

II. ANALYSIS

Section 12(d)(1)(A) of the 1940 Act, in relevant part, prohibits a Fund from purchasing or otherwise acquiring securities issued by another Fund if immediately after the acquisition the acquiring Fund: (i) owns more than three percent of the outstanding voting stock of the acquired Fund ("3% Limit"); (ii) has more than five percent of its total assets invested in the acquired Fund ("5% Limit"); or (iii) has more than ten percent of its total assets invested in the acquired Fund and all other investment companies ("10% Limit"). Section 12(d)(1)(B) of the 1940 Act, in relevant part, prohibits a Fund from knowingly selling its securities to another Fund if the sale will cause the acquiring Fund to own more than 3% of the acquired Fund's total outstanding voting stock, or if the sale will cause more than 10% of the acquired Fund’s total outstanding voting stock to be owned by investment companies. Sections 12(d)(1)(A) and (B) were designed to prevent certain abuses that might arise when investment companies invest in other investment companies. Such potential abuses generally include the pyramiding of control and undue influence, the layering of fees, and complex fund of funds structures that are difficult for investors to understand.[6]

Section 12(d)(1)(G) of the 1940 Act, in relevant part, provides a conditional exemption from the 3%, 5% and 10% Limits in Sections 12(d)(1)(A) and (B) for certain fund of funds arrangements within the same group of investment companies, such as the Funds of Funds.[7] One of the conditions in Section 12(d)(1)(G), designed to limit complex fund of funds structures, requires an Underlying Fund to have a policy that prohibits it from investing in shares of other investment companies in reliance on Section 12(d)(1)(F) or (G) of the 1940 Act. This condition would not be met if an Underlying Fund were to invest in the Central Fund in reliance on Section 12(d)(1)(G).

You argue, however, that an Underlying Fund’s investment in the Central Fund would be circumscribed in a manner that addresses the concerns underlying Sections 12(d)(1)(A) and (B), so that the three-tier arrangement in which a Fund of Funds invests in an Underlying Fund which in turn invests in the Central Fund would be consistent with the purposes and policies underlying those provisions. Specifically, you represent that the three-tier arrangement will be on the following terms:

• The investment by a Fund of Funds in an Underlying Fund would comply with the provisions of Section 12(d)(1)(G) except that the Underlying Fund would have an exception to its policy not to acquire securities of a registered open-end investment company in reliance on Section 12(d)(1)(G) solely for the purpose of acquiring shares of the Central Fund for purposes of efficient portfolio management.
• An Underlying Fund will not exceed the 5% Limit with respect to an investment in shares of a Central Fund, or the 10% Limit with respect to investments in investment companies, including the Central Fund, and companies relying on Section 3(c)(1) or 3(c)(7) of the 1940 Act.
• The FTI Manager to an Underlying Fund will waive management fees otherwise payable by the Underlying Fund to the FTI Manager in an amount equal to any management fees paid by the Central Fund to an FTI Manager.
• Shares of the Central Fund will not be subject to a sales load, redemption fee, or a distribution fee under a plan adopted in accordance with Rule 12b-1 under the 1940 Act.
• The Central Fund will not acquire securities of any investment company or company relying on Section 3(c)(1) or 3(c)(7) of the 1940 Act in excess of the limits contained in Section 12(d)(1)(A) of the 1940 Act.
• Shares of the Central Fund will be sold solely to the Funds.
• Prior to the initial investment by an Underlying Fund in the Central Fund, the board of directors (“Board”) of each of the Fund of Funds and the Underlying Fund, including a majority of the disinterested Board members, will consider (i) the reasons for the Underlying Fund’s proposed investment in the Central Fund, and (ii) the benefits expected to be realized from such investment by the Fund of Funds or the Underlying Fund, as appropriate, and its shareholders. In the event of a material change in the investment policies, strategies, objectives or restrictions of the Fund of Funds, the Underlying Fund, or the Central Fund, the Board, including a majority of the disinterested Board members, of the Fund of Funds or the Underlying Fund, as appropriate, will consider the continuing appropriateness of the Underlying Fund’s investment in the Central Fund.

You state that the three-tier arrangement described above would be created for the purpose of efficient portfolio management that will benefit the shareholders of all of the Funds involved. You also state that, because no more than 10% of an Underlying Fund’s total assets may be invested in investment companies, including the Central Fund, and companies relying on Section 3(c)(1) or 3(c)(7) of the 1940 Act, the Underlying Fund would not itself be a fund of funds, and the three-tier structure therefore would not be so complex as to raise the concern under Sections 12(d)(1)(A) and (B) of the 1940 Act.[8] You state that the utilization of a Central Fund also would be appropriately disclosed to shareholders of the Underlying Funds and the Funds of Funds. You further state that the three-tier structure would not raise the concern about layering of fees because (i) the FTI Manager to an Underlying Fund would waive management fees otherwise payable by the Underlying Fund to the FTI Manager in an amount equal to any management fees paid by the Central Fund to an FTI Manager, and (ii) shares of the Central Fund would not be subject to a sales load, redemption fee, or a distribution fee under a plan adopted in accordance with Rule 12b-1 under the 1940 Act. Finally, you state that, because the investment by a Fund of Funds in an Underlying Fund would comply with the provisions of Section 12(d)(1)(G) except for the Underlying Fund’s ability to invest in the Central Fund, the sale of shares of an Underlying Fund to the Fund of Funds, and the redemption of shares of an Underlying Fund by the Fund of Funds, would not raise the concerns underlying Section 17(a) of the 1940 Act.[9]

III. CONCLUSION

Based on the facts and representations set forth in your letter, and without necessarily agreeing with your legal analysis, we would not recommend enforcement action to the Commission under Sections 12(d)(1)(A) and (B) and 17(a) of the 1940 Act if a Fund of Funds purchases or otherwise acquires shares of an Underlying Fund that, in turn, purchases or otherwise acquires shares of the Central Fund in reliance on Section 12(d)(1)(G) of the 1940 Act as described in your letter. This response expresses our views on enforcement action only and does not express any legal or interpretive conclusion on the issues presented. Because our position is based upon the facts and representations made in your letter, any different facts or representations may require a different conclusion.

Incoming Letter

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The Incoming Letter is in Acrobat format.