Applications, hearings, determinations, etc.: Dow Target Variable Fund LLC,

[Federal Register: December 14, 1998 (Volume 63, Number 239)]

[Notices]

[Page 68803-68806]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr14de98-89]

SECURITIES AND EXCHANGE COMMISSION

[Rel. No. IC-23591; No. 812-11328]

Dow Target Variable Fund LLC

December 8, 1998. AGENCY: Securities and Exchange Commission (the ``SEC'' or the ``Commission'').

ACTION: Notice of application for an order pursuant to Section 6(c) of the Investment Company Act of 1940 (the ``Act'').

APPLICANT: Dow Target Variable Fund LLC.

SUMMARY OF APPLICATION: Applicant seeks an order pursuant to Section 6(c) of the Act exempting Applicant from the provisions of Section 12(d)(3) of the Act to the extent necessary to permit Applicant's portfolios to invest up to 10% of their total assets in securities of issuers that derive more than 15% of their gross revenues from securities related activities.

FILING DATE: The application was filedon September 28, 1998 and amended on December 2, 1998.

Hearing or Notification of Hearing: An order granting the application will be issued unless the SEC orders a hearing. Interested persons may request a hearing by writing to the Secretary of the SEC and serving Applicants with a copy of the request, personally or by mail. Hearing requests must be received by the Commission by 5:30 p.m. on December 29, 1998, and should be accompanied by proof of service on Applicants in the form of an affidavit or, for lawyers, a certificate of service. Hearing requests should be received by the Commission by 5:30 p.m. on December 29, 1998, and should be accompanied by proof of service on Applicants in the form of an affidavit or, for lawyers, a certificate of service. Hearing requests should state the nature of the requester's interest, the reason for

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the request, and the issues contested. Persons who wish to be notified of a hearing may request notification by writing to the Secretary of the Commission.

ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C. 20549. Applicant, One Financial Way, Cincinnati, Ohio 45242.

FOR FURTHER INFORMATION CONTACT: Susan M. Olson, Senior Counsel, or Kevin M. Kirchoff, Branch Chief, Office of Insurance Products, Division of Investment Management, at (202) 942-0670.

SUPPLEMENTARY INFORMATION: The following is a summary of the application. The complete application is available for a fee from the Public Reference Branch of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549 (tel. (202) 942-8090).

Applicant's Representations

1. Applicant is a registered, open-end management investment company (File No. 811-09019). It currently consists of twelve non- diversified portfolios, each named after a calendar month (January Portfolio, February Portfolio, etc.). Applicant was organized under the laws of Ohio as a limited liability company on September 21, 1998. Under Ohio law, a limited liability company does not issue shares of stock. Instead, ownership rights are contained in membership interests. Each membership interest of Applicant (``Interest'') represents an undivided interest in the stocks held in one of Applicant's portfolios.

2. The Interests are not offered directly to the public. The only direct owner of the Interests is The Ohio National Life Insurance Company (``Ohio National Life''), through its variable annuity separate accounts. Those of Ohio National Life's variable annuity owners who have contract values allocated to any of Applicant's portfolios have indirect beneficial rights in the Interests and have the right to instruct Ohio National Life with regard to how it votes the Interests that it holds in its variable annuity separate accounts.

3. Applicant's investment adviser is Ohio National Investments, Inc. (the ``Adviser''). First Trust Advisors L.P. (``First Trust'') is the sub-adviser to each of Applicant's portfolios.

4. Applicant states that each of its twelve portfolios consist of an investment portfolio of the common stocks of the ten companies in the Dow Jones Industrial Average (the ``Dow'') having the highest dividend yield as of the close of business of the last business day of the month preceding the month for which the portfolio is named (the ``Stock Selection Date''). These ten companies are popularly known as the ``Dogs of the Dow.'' Applicant states that on or about the first business day of the month for which a portfolio is named, First Trust will set the proportionate relationships among the ten stocks to be held in that portfolio for the next twelve months. At the end of a portfolio's twelfth month, the portfolio will be re-balanced with a new mix of ten Dogs of the Dow stocks.

5. Applicant states that the objective of each portfolio is to provide above-average total return through both capital appreciation and dividend income. The portfolios may or may not achieve that objective. Applicant states that the ten stocks held in any portfolio are not expected to reflect the entire index, and the prices of Interests are not intended to parallel or correlate with movements in the Dow. Applicant states that, generally, it will not be possible for all of the portfolios' funds to be invested in the prescribed mix of ten stocks at any time. Applicant states that the Adviser and First Trust will try, to the extent practicable, to maintain a minimum cash position at all times. Applicant represents that normally the only cash items held will represent amounts expected to be deducted as charges and amounts too small to purchase additional proportionate round lots of the Dogs of the Dow stocks.

6. The Dow consists of 30 stocks selected by Dow Jones & Company, Inc. as representative of the broader domestic stock market and of American industry. Applicant states that the Dow Jones & Company, Inc. is not affiliated with it and has not participated, and will not participate, in any way in the creation of the portfolios or the selection of the stocks purchased by the portfolios.

7. Applicant states that until the end of the initial month of a portfolio, Interests may be purchased by variable annuity separate accounts of Ohio National Life. After the initial month of a portfolio, no further Interests in that portfolio may be purchased until eleven months later. Interests may be redeemed at any time.

8. Applicant states that any purchase of Interests made after the initial business day of the month for which the portfolio is named, will duplicate, as nearly as is practicable, the original proportionate relationships of the ten stocks held by that portfolio. Because the prices of each of the ten stocks will change nearly every day, the ratio of the price of each to the total price of the entire group of ten will also change daily. However, Applicant states that the proportion of stocks held by that portfolio will not change materially as a result of the sales of additional Interests after the first business day of the month for which the portfolio is named.

9. Applicant states that it is not a ``regulated investment company'' under Subchapter M of the Internal Revenue Code of 1986, as amended (the ``Code''). Nonetheless, Applicant states that it does not pay federal income tax on its interest, dividend income or capital gains. As a limited liability company whose interests are sold only to Ohio National Life, Applicant states that it is disregarded as an entity for purposes of federal income taxation. Applicant states that Ohio National Life, through its variable annuity separate accounts, is treated as owning the assets of the portfolios directly and its tax obligations thereon are computed pursuant to Subchapter L of the Code (which governs the taxation of insurance companies). Applicant states that under current tax law, interest, dividend income and capital gains of Applicant are not taxable to Applicant, and are not currently taxable to Ohio National Life or to contract owners, when left to accumulate within a variable annuity contract.

10. Section 817(h) of the Code provides that in order for a variable contract which is based on a segregated asset account to qualify as an annuity contract under the Code, the investments made by that account must be ``adequately diversified'' in accordance with Treasury regulations.

11. Applicant states that each portfolio must comply with the Section 817(h) diversification requirements. Therefore, Applicant states that the Adviser and First Trust may depart from the portfolio investment strategy, if necessary, in order to satisfy these Section 817(h) diversification requirements. Applicant represents that under all circumstances, except in order to meet Section 817(h) diversification requirements, the common stocks purchased for each portfolio will be chosen solely according to the formula described above and will not be based on the research opinions or buy or sell recommendations of the Adviser or First Trust. Applicant represents that neither the Adviser nor First Trust has any discretion as to which common stocks are purchased. Applicant states that securities purchased for each portfolio may include securities of issuers in the Dow that derived more than 15% of their gross revenues in their most recent fiscal year from securities related activities.

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    Applicant's Legal Analysis

1. Section 12(d)(3) of the Act, with limited exceptions, prohibits an investment company from acquiring any security issued by any person who is a broker, dealer, underwriter or investment adviser. Rule 12d3-1 under the Act exempts from Section 12(d)(3) purchases by an investment company of securities of an issuer, except its own investment adviser, promoter or principal underwriter or their affiliates, that derived more than 15% of its gross revenues in its most recent fiscal year from securities related activities, provided that, among other things, immediately after any such acquisition the acquiring company has invested not more than 5% of the value of its total assets in the securities of the issuer. Each of Applicant's portfolios undertakes to comply with all of the requirements of Rule 12d3-1, except the condition in subparagraph (b)(3) prohibiting an investment company from investing more than 5% of the value of its total assets in securities of a securities related issuer.

2. Section 6(c) of the Act provides that the Commission by order upon application, may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes thereof, from any provision of the Act or any rule or regulation thereunder, if and to the extent that the 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.

3. Applicant states that Section 12(d)(3) was intended: (a) to prevent investment companies from exposing their assets to the entrepreneurial risks of securities related businesses; (b) to prevent potential conflicts of interest; (c) to eliminate certain reciprocal practices between investment companies and securities related businesses; and (d) to ensure that investment companies maintain adequate liquidity in their portfolios.

4. A potential conflict could occur, for example, if an investment company purchased securities or other interests in a broker-dealer to reward that broker-dealer for selling fund shares, rather than solely on the basis of investment merit. Applicant states that this concern does not arise in this situation. Applicant states that generally, neither the Applicant, the Adviser nor First Trust has discretion in choosing the common stock or amount purchased. Applicant states that the stock must first be included in the Dow (which along with Dow Jones & Company, Inc., is unaffiliated with Applicant, the Adviser or First Trust). In addition, the stock must also qualify as one of the ten companies in the Dow that has the highest dividend yield as of the Stock Selection Date.

5. Applicant states that identical exemptive relief from Section 12(d)(3) has recently been granted to a management investment company for a structure which also involves investment options underlying variable annuities. In addition, Applicant states that Section 12(d)(3) relief has been granted to unit investment trusts with no discretion to choose the portfolio securities or the amount purchased, but with discretion to sell portfolio securities to the extent necessary to meet redemptions.

6. Applicant states that the Adviser and First Trust are obligated to follow the investment formula described above as nearly as practicable. Applicant states that, like prior applications for Section 12(d)(3) relief, securities purchased for each portfolio will be chosen with respect to the specified formula. Applicant states that the only time any deviation from the formula would be permitted would be where circumstances were such that the investments of a particular portfolio would fail to be ``adequately diversified'' under the Section 817(h) diversification requirements, and would thus cause the annuity contracts to fail to qualify as an annuity contract under the Code. Applicant states that the likelihood of this exception arising is extremely remote. In such a situation, Applicant states that it must be permitted to deviate from the investment strategy in order to meet the Section 817(h) diversification requirements and then only to the extent necessary to do so. Applicant states that this limited discretion does not give rise to the potential conflicts of interest or to the possible reciprocal practices between investment companies and securities related businesses that Section 12(d)(3) is designed to prevent.

7. Applicant states that the liquidity of a portfolio is not a concern here since each common stock selected will be a component of the Dow, listed on the New York Stock Exchange, and among the most actively traded securities in the United States.

8. In addition, Applicant states that the effect of a portfolio's purchase of the stock of parents of broker-dealers would be de minimis. Applicant states that the common stocks of securities related issuers represented in the Dow are widely held with active markets and that potential purchases by a portfolio would represent an insignificant amount of the outstanding common stock and trading volume of any of these issuers. Therefore, Applicant argues that it is almost inconceivable that these purchases would have any significant effect on the market value of any of these securities related issuers.

9. Another possible conflict of interest which has raised concern is where broker-dealers may be influenced to recommend certain investment company funds which invest in the stock of the broker-dealer or any of its affiliates. Applicant states that because of the large market capitalization of the Dow issuers and the small portion of these issuers' common stock and trading volume that would be purchased by a portfolio, it is extremely unlikely that any device offered by a broker-dealer to a customer as to which investment company to invest in would be influenced by the possibility that a portfolio would be invested in the broker-dealer or a parent thereof.

10. Finally, another potential conflict of interest could occur if an investment company directed brokerage to an affiliated broker-dealer in which the company has invested to enhance the broker-dealer's profitability or to assist it during financial difficulty, even though the broker-dealer may not offer the best price and execution. To preclude this type of conflict, Applicant agrees, as a condition of this application, that no company whose stock is held in any portfolio, nor any affiliate of such a company, will act as broker or dealer for any portfolio in the purchase or sale of any security.

11. Applicant represents that the terms of the relief requested are consistent with the relief previously granted in similar applications. Applicant states that the terms of the relief requested are consistent with the standards set forth in Section 6(c) of the Act.

    Applicant's Conditions

    Applicant and each portfolio of Applicant agrees that any order granting the requested relief from Section 12(d)(3) shall be subject to the following conditions:

1. The common stock is included in the Dow as of the Stock Selection Date;

2. The common stock represents one of the ten companies in the Dow that have the highest dividend yield as of the Stock Selection Date;

3. As of close of business on the Stock Selection Date, the value of the common stock of each securities related issuer represents approximately 10% of the value of any portfolio's total assets, but

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   in no event more than 10.5% of the value of the portfolio's total assets; and

4. No company whose stock is held in a portfolio, nor any affiliate thereof, will act as broker or dealer for any portfolio in the purchase or sale of any security for that portfolio.

   Conclusion

   For the reasons summarized above, Applicant asserts that the order requested is 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.

   For the Commission, by the Division of Investment Management, pursuant to delegated authority. Margaret H. McFarland, Deputy Secretary.

   [FR Doc. 98-33073Filed12-11-98; 8:45 am]

   BILLING CODE 8010-01-M