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SEC Would Change Limits on Offerings

The Securities and Exchange Commission has proposed a rule change that would allow a fund to purchase government securities in a syndicated offering. The SEC is requesting public comment on the Nov. 29 proposal.

The proposal would amend rule 10(f)-3 of the Investment Company Act of 1940. Section 10(f) prohibits a fund from buying any security during an underwriting if the fund has a relationship with an underwriter for the security.

"This provision was designed to protect funds and their investors from the dumping of unmarketable securities on a fund in order to benefit the fund's affiliated underwriter," according to the proposal. However, a provision was included to give the SEC authority to issue rules exempting certain types of transactions from the prohibition, if they are in line with investor protection, according to the proposal.

The SEC issued rule 10(f)-3 in 1958 (and amended it in 1997) to allow funds to purchase securities during an underwriting, with certain conditions, one of which being that the securities had to be registered under the Securities Act of 1933.

The rule has since been amended to allow certain securities to be purchased that were not registered under the Securities Act, such as municipal securities and securities offered through regulated foreign offerings or private institutional offerings, according to the proposal. Government securities are not included among those that are exempted.

"There has been little need to exempt the purchase of government securities from section 10(f), because these securities generally have not been offered through selling syndicates' or underwritings that involve affiliated underwriters to a significant degree," according to the proposal.

That is, until recently.

A few years ago, some companies began seeking exemptions because they said certain government securities that had not been offered, were now being offered, said Curtis Young, senior counsel at the SEC.

"They were urging us to take a look at it and that's really what got the ball rolling," he said.

The SEC believes government securities, now that they are offered, should be included in the exemption.

"Government securities are high-quality investments, and therefore are unlikely to be dumped into a fund," according to the proposal. "Moreover, the circumstances under which government agencies offer their securities to the public appear to be an effective substitute for Securities Act registration for purposes of rule 10(f)-3."

The proposal would also attempt to close a loophole in the existing law. Currently, one of the conditions of 10(f)-3 is that a fund, together with any other fund advised by the same adviser, can not purchase more that 25 percent of an offering. The purpose of that is to ensure that a significant part of the offering is purchased by individuals independent of the adviser, which removes the threat of dumping' and creates a price of the securities that is based on market forces, according to the proposal.

However, the SEC has realized a loophole in the rule. The rule does not require that the adviser include purchases by its other (non-fund) clients. In doing so, an adviser could affect the price of the securities without violating the rule. The SEC is proposing to include "any other account over which the fund's adviser has discretionary authority or otherwise exercises control" in the percentage limit, according to the proposal. The SEC is also contemplating raising the percentage limit if the proposal is adopted and is seeking comments on that as well.