[Federal Register: April 7, 2000 (Volume 65, Number 68)]
[Notices]
[Page 18354-18377]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07ap00-120]
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DEPARTMENT OF LABOR
Pension and Welfare Benefits Administration
[Application No. D-10678, et al.]
Proposed Exemptions; H. Ray McPhail (Mr. McPhail) and the H. Ray
McPhail Profit Sharing Plan (the Plan)
AGENCY: Pension and Welfare Benefits Administration, Labor.
ACTION: Notice of proposed exemptions.
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SUMMARY: This document contains notices of pendency before the
Department of Labor (the Department) of proposed exemptions from
certain of the prohibited transaction restrictions of the Employee
Retirement Income Security Act of 1974 (the Act) and/or the Internal
Revenue Code of 1986 (the Code).
Written Comments and Hearing Requests
All interested persons are invited to submit written comments or
request for a hearing on the pending exemptions, unless otherwise
stated in the Notice of Proposed Exemption, within 45 days from the
date of publication of this Federal Register Notice. Comments and
requests for a hearing should state: (1) the name, address, and
telephone number of the person making the comment or request, and (2)
the nature of the person's interest in the exemption and the manner in
which the person would be adversely affected by the exemption. A
request for a hearing must also state the issues to be addressed and
include a general description of the evidence to be presented at the
hearing.
ADDRESSES: All written comments and request for a hearing (at least
three copies) should be sent to the Pension and Welfare Benefits
Administration, Office of Exemption Determinations, Room N-5649, U.S.
Department of Labor, 200 Constitution Avenue, NW, Washington, DC 20210.
Attention: Application No. ______, stated in each Notice of Proposed
Exemption. The applications for exemption and the comments received
will be available for public inspection in the Public Documents Room of
the Pension and Welfare Benefits Administration, U.S. Department of
Labor, Room N-5638, 200 Constitution Avenue, NW, Washington, DC 20210.
Notice to Interested Persons
Notice of the proposed exemptions will be provided to all
interested persons in the manner agreed upon by the applicant and the
Department within 15 days of the date of publication in the Federal
Register. Such notice shall include a copy of the notice of proposed
exemption as published in the Federal Register and shall inform
interested persons of their right to comment and to request a hearing
(where appropriate).
SUPPLEMENTARY INFORMATION: The proposed exemptions were requested in
applications filed pursuant to section 408(a) of the Act and/or section
4975(c)(2) of the Code, and in accordance with procedures set forth in
29 CFR Part 2570, Subpart B (55 FR 32836, 32847, August 10, 1990).
Effective December 31, 1978, section 102 of Reorganization Plan No. 4
of 1978, 5 U.S.C. App. 1 (1996), transferred the authority of the
Secretary of the Treasury to issue exemptions of the type requested to
the Secretary of Labor. Therefore, these notices of proposed exemption
are issued solely by the Department.
The applications contain representations with regard to the
proposed exemptions which are summarized below. Interested persons are
referred to the applications on file with the Department for a complete
statement of the facts and representations.
H. Ray McPhail (Mr. McPhail) and the H. Ray McPhail Profit Sharing
Plan (the Plan) Located in Atlanta, Georgia
[Exemption Application No. D-10678]
Proposed Exemption
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR Part
2570, Subpart B (55 FR 32826, 32847, August 10, 1990). If the exemption
is granted, the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1)(A) through (E) of the
Code, shall not apply to the proposed sale (the Sale) of four parcels
of unimproved real property (the Property) and loan (the Loan) from the
Plan to Mr. McPhail,\1\ a disqualified person with respect to the Plan,
provided that the following conditions are met:
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\1\ Since Mr. McPhail is the only participant in the Plan, there
is no jurisdiction under Title I of the Act pursuant to 29 CFR
2510.3-3(b). However, there is jurisdiction under Title II of the
Act pursuant to section 4975 of the Code.
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(1) With respect to the Sale:
(A) The terms and conditions of the Sale will be at least as
favorable to the Plan as those obtainable in an arm's length
transaction with an unrelated party;
(B) The Sale will occur at a price which includes the greater of
$270,000 or the Property's fair market value as established by a
qualified, independent appraiser;
(C) The Sale Price will also include a premium of $30,000 (the
Assemblage Value) due to Mr. McPhail's ownership of unimproved real
property located adjacent to the Property;
(D) The Plan will pay no fees or commissions with respect to the
Sale; and
(E) Mr. McPhail will pay $60,000 or 20% of the Sale Price in cash
with the balance paid for by the Loan; and
(2) With Respect to the Loan:
(A) The interest rate on the Loan (the Interest Rate) will be 7%, a
rate set by the Macon Bank for a real estate loan having terms similar
to the Loan;
(B) The Loan terms are at least favorable to the Plan as those
obtainable in an arm's length transaction with an unrelated party;
(C) The Loan is secured by a first security interest on the certain
real property, which has been appraised by a qualified independent
appraiser to have a fair market value not less than 150% of the
principal amount of the Loan; and
(D) The outstanding balance of the Loan will never exceed 20% of
the assets of the Plan throughout the duration of the Loan;
(E) The fair market value of the collateral remains at least equal
to 150% of the outstanding principal balance plus accrued but not
unpaid interest, throughout the duration of the Loan; and
(3) Should any employee of the Plan Sponsor become eligible for
Plan participation, the new participant will be enrolled in another
qualified retirement plan or the Loan will be immediately repaid.
Summary of Facts and Representations
1. The H. Ray McPhail Company (the McPhail Co.) is a Georgia
company engaged in the purchase and sale of real estate. The McPhail
Co. is solely owned
[[Page 18355]]
by Mr. McPhail and is the sponsor of the Plan. The Plan is a defined
contribution plan located in Atlanta, Georgia and having Mr. McPhail as
its sole participant. The Plan had total assets of approximately
$3,420,136 as of October 31, 1998.
2. The assets of the Plan include the Property. The Property
comprises approximately 3.66 acres of unimproved real property located
in Highlands, North Carolina. The Property is divided into four lots.
Two of the lots are interior lots and the other two lots have frontage
on Lake Sequoyah. The Property was acquired for $293,000 on November
23, 1994 from Elizabeth Nielson, an unrelated party.
3. Since its acquisition, the Property has not generated any income
for the Plan. The Plan has, however, incurred certain expenses as a
result of the Plan's ownership of the Property. In this regard, the
applicant represents that the Plan has incurred a total of $3,169.33 in
property taxes. In addition, the applicant represents that the Plan has
incurred expenses in the amount of $1,685 for consulting fees resulting
from the Plan's attempt to develop the Property.
4. The Property was appraised by Thomas Ringle (Mr. Ringle), an
appraiser independent of the Plan and certified in the State of North
Carolina. Mr. Ringle calculated the Property's fair market value (the
Fair Market Value) using the sales comparison approach and compared the
Property to similar unimproved properties located near the Property.
Based on these comparisons, Mr. Ringle determined the Fair Market Value
to be $270,000 as of June 9, 1998.
Mr. Ringle also calculated an additional value for the Property for
purposes of the Sale (i.e., the Assemblage Value). Mr. Ringle
represents that the Assemblage Value is due to Mr. McPhail's ownership
of unimproved real property located adjacent to the Property and
reflects the higher value property owners are willing to pay for
adjoining parcels of property. Based on his analysis of the Property,
Mr. Ringle calculated that the Assemblage Value to be $30,000.
Mr. Ringle determined that the sales price of the Property for
purposes of the Sale (the Sale Price) should be a sum equal to the Fair
Market Value and the Assemblage Value. As a result, Mr. Ringle
determined the Sale Price to be $300,000.
5. The applicant is proposing the sale of the Property from the
Plan to Mr. McPhail for $300,000 (i.e., the Sale). The applicant
represents that Mr. McPhail proposes to pay 20% of the Sales Price in
cash to the Plan as a down payment on the Property with the Plan
loaning Mr. McPhail the remaining 80% balance (i.e., the Loan). In this
regard, the applicant represents that the Loan will be for 15 years at
seven percent (7%) interest (i.e., the Interest Rate). The Interest
Rate represents an interest rate set by the Macon Savings Bank (Macon)
located in Highlands, North Carolina, for a real estate loan having
similar terms as the Loan. The applicant represents that Macon is an
independent party with respect to the Plan.
As a result, Mr. McPhail proposes the following terms for the Sale:
$60,000 in cash paid by Mr. McPhail to the Plan as a down payment on
the Property; and $2,157.19 paid by Mr. McPhail to the Plan each month
for 179 months. As security on the Loan, Mr. McPhail will pledge the
Property and additional unimproved real property having a fair market
value of $435,000 as of September 3, 1999, as determined by John
Meadows of John Cleveland Realty, an independent real estate broker.
The security interest securing the Loan will be a first security
interest and will be perfected in accordance with North Carolina law.
In addition, the property securing the Loan, will be insured against
casualty loss for an amount which is not less than the Loan balance
throughout the duration of the Loan. The Plan will be listed as a loss
payee on the insurance policy.
6. The applicant represents that the proposed Sale is in the best
interest of the Plan due to the high expense the Plan anticipates will
be necessary for a sale of the Property to unrelated third parties. The
applicant further represents that the Property was originally purchased
by the Plan with the intent that the Plan would resell the Property to
unrelated parties. The applicant notes that, subsequent to the purchase
of the Property by the Plan, the Plan determined that the Property
could not be sold to third parties without the expenditure of Plan
assets on certain costly improvements, including the construction,
grading and paving of a road.
The applicant additionally represents that the proposed Loan is
protective of the Plan since the Loan will be secured with real
property having a fair market value in excess of the Property and the
Interest Rate is set according to current market rates for similar
transactions.
Finally, the applicant represents that the Sale is administratively
feasible since the proposed Sale will allow the Plan to liquidate its
investment in the Property at a price which will maximize value to the
Plan and is a one-time transaction in which the Plan will pay no fees
or transaction costs.
7. In summary, the applicant represents that the proposed
transaction satisfies the criteria of section 4975(c)(2) of the Code
because,
(1) With respect to the Sale:
(A) The terms and conditions of the Sale will be at least as
favorable to the Plan as those obtainable in an arm's length
transaction with an unrelated party;
(B) The Sale will occur at a price which includes the greater of
$270,000 or the Property's fair market value as established by a
qualified, independent appraiser;
(C) The Sale Price will also include a premium of $30,000 (the
Assemblage Value) due to Mr. McPhail's ownership of unimproved real
property located adjacent to the Property;
(D) The Plan will pay no fees or commissions with respect to the
Sale; and
(E) Mr. McPhail will pay $60,000 or 20% of the Sale Price in cash
with the balance paid for by the Loan; and
(2) With Respect to the Loan:
(A) The interest rate on the Loan (the Interest Rate) will be 7%, a
rate set by the Macon Bank for a real estate loan having terms similar
to the Loan;
(B) The Loan terms are at least favorable to the Plan as those
obtainable in an arm's length transaction with an unrelated party;
(C) The Loan is secured by a first security interest on the certain
real property, which has been appraised by a qualified independent
appraiser to have a fair market value not less than 150% of the
principal amount of the Loan; and
(D) The outstanding balance of the Loan will never exceed 20% of
the assets of the Plan throughout the duration of the Loan;
(E) The fair market value of the collateral remains at least equal
to 150% of the outstanding principal balance plus accrued but not
unpaid interest, throughout the duration of the Loan; and
(3) Should any employee of the Plan Sponsor become eligible for
Plan participation, the new participant will be enrolled in another
qualified retirement plan or the Loan will be immediately repaid.
For Further Information Contact: J. Martin Jara of the Department,
telephone (202) 219-8883 (this is not a toll free number).
[[Page 18356]]
Triumph Capital Group, Inc., Located in Boston, MA
[Application No. D-10708]
Proposed Exemption
The Department is considering granting an exemption under the
authority of section 408(a) of the Act and section 4975(c)(2) of the
Code and in accordance with the procedures set forth in 29 CFR part
2570, subpart B (55 FR 32836, 32847, August 10, 1990). If the exemption
is granted, the restrictions of sections 406(a) of the Act and the
sanctions resulting from the application of section 4975 of the Code,
by reason of section 4975(c)(1)(A) through (D) of the Code, shall not
apply, effective July 22, 1997, to the making, by an employee benefit
plan subject to the Act (the Plan), of capital contributions to any
private equity fund (the Triumph Fund) that is organized, sponsored
and/or managed by Triumph Capital Group, Inc. and/or any of its
affiliates (collectively, Triumph) pursuant to a contractual obligation
by a Plan having an interest in the Triumph Fund.\2\
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\2\ As discussed herein, Triumph Funds are generally expected to
be organized as venture capital operating companies that are managed
by Triumph.
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This proposed exemption is subject to the following conditions:
a. At the time the Plan undertakes the obligation to make such
capital contributions (the Determination Date), the Triumph Fund is not
a party in interest with respect to the Plan.
b. The decision to make a capital contribution to a Triumph Fund is
made on behalf of the Plan by a Plan fiduciary which is independent of
and unrelated to Triumph and the portfolio company whose interest is
acquired by the Triumph Fund.
c. Triumph does not otherwise provide investment advice as a
fiduciary to the Plan, within the meaning of the Department's
regulations at 29 CFR 2510.3-21(c), with respect to such Plan's assets
that are invested in the Triumph Fund.
d. At the Determination Date, the Plan has aggregate assets that
are in excess of $50 million; provided, however, that in the case of:
(1) Two or more Plans which are not maintained by the same
employer, controlled group of corporations or employee organization
(the Unrelated Plans), whose assets are invested in a Triumph Fund
through a group trust, an insurance company pooled separate account or
any other form of entity the assets of which are ``plan assets'' under
the Department's regulations at 29 CFR 2510.3-101 (the Plan Asset
Regulation), the foregoing $50 million requirement shall be satisfied
if such trust, separate account, or other entity has aggregate assets
which are in excess of $50 million, provided further that the fiduciary
responsible for making the investment decision on behalf of such group
trust, insurance company pooled separate account, or other entity has--
i. Full investment responsibility \3\ with respect to the plan
assets invested therein; and
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\3\ For purposes of this exemption, the term ``full investment
responsibility'' means that the fiduciary responsible for making the
investment decision has and exercises discretionary management
authority over all of the assets of the group trust or other plan
assets entity.
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ii. Total assets under its management and control, exclusive of the
assets invested in the Triumph Fund, which are in excess of $100
million, for Triumph Funds established after the date this notice of
proposed exemption is published in the Federal Register.
(2) Two or more Plans which are maintained by the same employer,
controlled group of corporations or employee organization (the Related
Plans), whose assets are invested in a Triumph Fund through a master
trust or any other entity the assets of which are ``plan assets'' under
the Plan Asset Regulation, the $50 million requirement shall in any
event be satisfied if such trust or other entity has aggregate assets
which are in excess of $50 million, provided, further, that, in the
case of a Triumph Fund established after the date the notice granting
the exemption is published in the Federal Register, in addition to the
$50 million requirement, if the fiduciary responsible for making the
investment decision on behalf of such master trust or other entity is
not the employer or an affiliate of the employer, then such fiduciary
has total assets under its management and control, exclusive of the
assets invested in the Triumph Fund, which are in excess of $100
million.
e. The Triumph Fund is a party in interest with respect to the Plan
solely by reason of a relationship to a portfolio company which is a
service provider to a Plan, as described in Section 3(14)(H) or (I) of
the Act, including a fiduciary with respect to such Plan.
f. The capital commitment of the Plan (together with the capital
commitments of any other Plans maintained by the same employer,
controlled group of corporations or employee organization) with respect
to the Triumph Fund, does not exceed 15 percent of the total capital
commitments made by all investors with respect to such Triumph Fund,
determined at the later of (i) the Determination Date, or (ii) the date
on which the Triumph Fund first becomes a party in interest with
respect to such Plan.
g. At the Determination Date the percentage of the Plan's assets
committed to be invested in the Triumph Fund does not exceed 5 percent
of the Plan's total assets.
h. At the Determination Date, a Plan's aggregate capital commitment
to all Triumph Funds does not exceed 25 percent of the Plan's total
assets.
i. The Plan receives the following initial and ongoing disclosures
with respect to the Triumph Fund;
(1) A copy of the private placement memorandum applicable to the
Triumph Fund or another comparable document containing substantially
the same information;
(2) A copy of the limited partnership or other agreement
establishing the Triumph Fund;
(3) A copy of the subscription agreement applicable to the Triumph
Fund, if any;
(4) Copies of this proposed exemption and the final exemption, if
granted, once such documents are published in the Federal Register; and
(5) Periodic, but no less frequently than annually, reports
relating to the overall financial position and operational results of
the Triumph Fund, including copies of the Triumph Fund's annual
financial statements.
j. With respect to capital contributions made to a Triumph Fund by
a Plan after the date this proposed exemption is granted, Triumph
maintains or causes to be maintained, for a period of six (6) years
from the date of the transaction, the records necessary to enable the
persons described in paragraph (k) to determine whether the conditions
of the exemption have been met, except that--
(1) A prohibited transaction will not be considered to have
occurred, if due to circumstances beyond the control of Triumph, the
records are lost or destroyed prior to the end of the six year period;
and
(2) No party in interest, other than Triumph, shall be subject to
the civil penalty that may be assessed under section 502(i) of the Act,
or to the taxes imposed by section 4975(a) and (b) of the Code, if the
records are not maintained, or are not available for examination as
required by paragraph (k).
k. (1) Except as provided in paragraph (k)(2) and notwithstanding
any provisions of subsection (a)(2) and (b) of section 504 of the Act,
the records referred to in paragraph (j) are unconditionally available
at their customary location for examination during normal business
hours by--
[[Page 18357]]
(A) Any duly authorized employee or representative of the
Department or the Internal Revenue Service;
(B) Any fiduciary of a Plan which has an interest in the Triumph
Fund and has the authority to acquire or dispose of the interest of the
Plan in the Triumph Fund, or any duly authorized employee or
representative of such fiduciary; and
(C) Any participant or beneficiary of any Plan which has an
interest in the Triumph Fund, or duly authorized representative of such
participant or beneficiary.
(2) None of the persons described in paragraph (k)(1)(B) and
(k)(1)(C) shall be authorized to examine trade secrets of Triumph or
commercial or financial information which is privileged or
confidential.
Effective Date: If granted, this proposed exemption will be
effective as of July 22, 1997.
Summary of Facts and Representations
1. Triumph Capital Group, Inc., is a Delaware corporation which,
together with its affiliates (collectively referred to herein as
``Triumph'') has organized, sponsored and/or managed six (6) private
equity (or high-yield debt) funds, involving total capital commitments
of approximately one (1) billion dollars. The investors in the Triumph
Funds are primarily sophisticated institutional investors, including
employee benefit plans that are subject to the Act, private
foundations, government plans, endowments and other tax exempt
organizations, and a few wealthy individuals. The applicant represents
that private equity funds, such as the Triumph Funds, allow Plans,
particularly those having significant asset bases, to achieve greater
diversification by asset class. As such, many of the investors in the
existing Triumph Funds, and many potential investors in future Triumph
Funds, will be Plan investors that are covered by the Act.
2. Each Triumph Fund in which any Plan invests is organized and
operated so that the assets of such Triumph Fund will not be deemed to
be ``plan assets'' under the Plan Asset Regulation. In most cases, this
results from the fact that the Triumph Fund is operated in a manner
which causes such Fund to qualify as a venture capital operating
company.\4\ In some cases, it may be the result of the fact that the
equity participation in the Triumph Fund by benefit plan investors is
not significant (i.e., 75 percent or more of the equity interest in the
entity is held by non-benefit plan investors).\5\
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\4\ The Department's regulation at 29 CFR 2510.3-101(c) defines
the term ``operating company'' as an entity that is primarily
engaged, directly or through a majority-owned subsidiary or
subsidiaries, in the production or sale of a product or service
other than the investment of capital. The term ``operating company''
includes a ``venture capital operating company.''
29 CFR 2510.3-101(d) provides, in part, that an entity is a
``venture capital operating company'' if at least 50 percent of its
assets are invested in venture capital investments, and the entity,
in the ordinary course of its business, actually exercises
management rights with respect to one or more operating companies in
which it invests. 29 CFR 2510.3-101(d)(3) explains that a venture
capital investment is an investment in an operating company (other
than a venture capital operating company) as to which the investor
has or obtains management rights. The term ``management rights'' is
defined under 29 CFR 2510.3-101(d)(3)(ii) to mean contractual rights
directly between the investor and an operating company to
substantially participate in, or substantially influence the conduct
of, the management of the operating company.
\5\ The Department's regulation at 2510.3-101(f)(1) states, in
pertinent part, that equity participation in an entity by benefit
plan investors is ``significant'' on any date, if immediately after
the most recent acquisition of any equity interest in the entity, 25
percent or more of the value of any class of equity interests in the
entity is held by benefit plan investors.
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3. The Triumph Funds have typically been structured as limited
partnerships with Triumph serving as general partner and, in some
cases, having an interest as limited partner. (Triumph Funds organized
in the future may be organized using different structures, such as
limited liability companies.) The Triumph Funds are managed by Triumph
which receives a pre-specified management fee as well as a pre-
specified incentive allocation after investors have received
distributions in excess of their capital contributions plus a pre-
specified minimum rate of return. Because the Triumph Funds are
generally expected to be organized as venture capital operating
companies, the applicant represents that none of the Triumph Funds will
hold ``plan assets'' and that the compensation paid to Triumph by the
Triumph Funds will not be subject to the prohibitions under the Act.
\6\
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\6\ The Department is providing no opinion with regard to
whether a Triumph Fund is a venture capital operating company or
whether the equity participation by Plans investing in a Triumph
Fund is not significant. In addition, the Department is not
expressing any views with respect to the compensation that is paid
to Triumph by a Triumph Fund.
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One of Triumph's more recent funds, Triumph Partners III, L.P., has
aggregate capital commitments of approximately $595,550,000 from 49
individual and institutional investors. Of the institutional investors,
6 investors are Plans that are covered under the provisions of the Act.
These Plans have made a total capital commitment to Triumph Partners
III, L.P. of $170,300,000.
4. Triumph Funds typically involve multiple closings with investors
making their investment commitments (and therefore having a
Determination Date) over a six to nine month period. Because of this
staging, Triumph proposes, for purposes of the 15% limit contained in
condition (f) above, to test each Plan investor's capital commitment
with respect to the Triumph Fund in relation to the total capital
commitments made by all the investors with respect to such Triumph
Fund, at the later of (a) the Determination Date, or (b) the date on
which the Triumph Fund first becomes a party in interest with respect
to such Plan investor.
Each investor in a Triumph Fund, including each Plan investor,
enters into a binding commitment to make capital contributions to the
Triumph Fund in an amount specified by the investor. However, the
investors' capital commitments typically are not funded at the outset.
Rather, the capital is drawn down over time as the Triumph Fund
identifies and makes its venture capital and other investments.
Generally, capital is called down in installments ranging from 2.5
percent to 10 percent of the total commitment. In most cases, all of
the capital commitments will have been drawn down within 3 to 5 years
of the establishment of the Triumph Fund.
5. The Triumph Funds' investments include a wide variety of
portfolio companies.\7\ Specifically, the Triumph Funds may acquire
interests in portfolio companies which are involved, either directly or
through subsidiaries, in various aspects of the financial services
industry. Triumph believes that the flexibility to acquire such
investments is necessary to enable the Triumph Funds to maximize
investment opportunities and investment returns. In Triumph's view,
business opportunities can arise in connection with start-up or later-
stage companies (including spinoffs and management buy-outs of existing
[[Page 18358]]
business operations) in virtually any type of business.
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\7\ According to the applicant, the term ``portfolio company''
refers to each of the operating companies in which a private equity
fund has made an investment. Thus, for example, when a private
equity fund, such as a Triumph Fund, makes an investment in a start-
up, high tech company, that company becomes one of the private
equity fund's portfolio companies and will remain so as long as the
private equity fund retains its investment in that high tech
company. Similarly, if a private equity fund acquires an interest in
an investment management firm, the investment management firm will
become a portfolio company of the private equity fund.
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6. Triumph Funds may acquire interests in portfolio companies that
are involved in providing money management services, brokerage services
or other types of services which may be utilized by Plans and
institutional investors. The portfolio company may be, or may become, a
party in interest with respect to one or more Plans which hold an
interest in the Triumph Fund when such portfolio company, or any
subsidiary thereof, performs services for a Plan. The services may
include fiduciary services (e.g., management of assets of the Plan
other than those invested in a Triumph Fund). In no event will the
portfolio company or its subsidiary act in a fiduciary capacity with
respect to the assets of the Plan that are invested in the Triumph
Fund.
If the Triumph Fund owns, directly or indirectly, a 10 percent or
more interest in a service provider to a Plan, Triumph notes that the
Fund will become a party in interest with respect to such Plan under
section 3(14)(H) or (I) of the Act.\8\ Since a Triumph Fund frequently
purchases a 10 percent or more interest in a portfolio company, Triumph
represents that it is possible that a Triumph Fund could become a 10
percent or more owner of a service provider and a party in interest
with respect to each Plan as to which the portfolio company (or one of
its subsidiaries) is a service provider. Once a Triumph Fund becomes a
party in interest with respect to a Plan, Triumph states that the Plan
would be prohibited from engaging in any transaction with that Triumph
Fund.
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\8\ In this regard, it is noted that the corresponding section
of the Code relating to ``disqualified persons'' (see section
4975(e)(2)(H) and (I)) does not contain a similar provision which
would make the owner of 10 percent or more of a service provider a
disqualified person with respect to a Plan. Nevertheless, because
the service provider is a ``disqualified person'' under section
4975(e)(2)(B) of the Code, Triumph has requested that the exemption
extend to both the Code and the Act in order to avoid any potential
concerns regarding the possibility of indirect prohibited
transactions.
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If a Triumph Fund were to become a party in interest with respect
to a Plan, Triumph is concerned that a capital contribution made by the
Plan subsequent to the Triumph Fund's becoming a party in interest
would violate section 406(a)(1)(D) of the Act notwithstanding the fact
that the capital contribution is being made pursuant to a pre-existing
binding contractual commitment made by the Plan at a time when the
Triumph Fund was not a party in interest. Therefore, to resolve these
potential technical violations of the Act, Triumph has requested an
administrative exemption from the Department.\9\
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\9\ The Department is providing no opinion in this proposed
exemption regarding whether, or to what extent, a Plan engaging in
the subject transaction with a Triumph Fund would violate section
406(a) of the Act, once the Triumph Fund becomes a party in interest
with respect to the Plan, under the circumstances described herein.
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7. The requested exemption is subject to a number of conditions
that will apply both retroactively and prospectively. First, the
Triumph Fund's party in interest status will, in all cases, arise after
the Determination Date, i.e., after the Plan investor has made a
binding commitment to invest in the Triumph Fund, including its
commitment to make future capital contributions to the Triumph Fund.
Second, the decision to undertake the obligation to make a binding
commitment must be made on behalf of the Plan by a Plan fiduciary which
is independent of and unrelated to Triumph and the portfolio company.
Third, Triumph must not otherwise provide investment advice to the
Plan, within the meaning of the Department's regulation at 29 CFR
2510.3-21(c) (defining when an investment adviser to a plan becomes a
fiduciary by reason of the advice), with respect to such Plan's assets
that are invested in the Triumph Fund. Fourth, at the Determination
Date, the Plan must have aggregate assets that are in excess of $50
million, subject to special rules addressing investments in a Triumph
Fund by entities holding the assets of multiple plans, such as group
trusts and master trusts. Fifth, at the later of the Determination Date
or the date on which the Triumph Fund first becomes a party in interest
with respect to such Plan investor, the capital commitment of the Plan
(together with the capital commitments of any other Plans maintained by
the same employer, controlled group of corporations, or employee
organization) with respect to the Triumph Fund, must not exceed 15
percent of the total capital commitments with respect to such Triumph
Fund. Sixth, at the Determination Date, the percentage of the Plan's
assets committed to be invested in the Triumph Fund must not exceed 5
percent of the Plan's total assets. Seventh, at the Determination Date,
a Plan's aggregate capital commitment with respect to all Triumph Funds
must not exceed 25 percent of such Plan's total assets.
8. The conditions of the proposed exemption also require that each
Plan receive the following initial and ongoing written disclosures from
Triumph: (a) A copy of the private placement memorandum applicable to
the Triumph Fund or another comparable document containing
substantially the same information; (b) a copy of the limited
partnership or other agreement establishing the Triumph Fund; (c) a
copy of the subscription agreement applicable to the Triumph Fund, if
any; (d) copies of the proposed exemption and the final exemption, if
granted, once such documents are published in the Federal Register; and
(e) periodic, but no less frequently than annually, reports relating to
the overall financial position and operational results of the Triumph
Fund including copies of the Triumph Fund's annual financial
statements. In addition, with respect to capital contributions made to
a Triumph Fund by a Plan after the date this proposed exemption is
granted, Triumph will maintain or cause to be maintained for a period
of six (6) years from the date of each transaction, records of each
Plan investing in a Triumph Fund and each portfolio company comprising
a Triumph Fund. Such records will enable the Department and other
persons to determine whether the terms and conditions of the exemption
are being met.
9. If the exemption is not granted, Triumph represents that it and
the Triumph Funds would be required to make one of several adjustments
designed to avoid the prohibited transaction concern that is the
subject of this request. However, Triumph states that it does not
believe these adjustments would be in the best interest of existing or
prospective Plan investors. In this regard, Triumph represents that it
might attempt to avoid the problem by not acquiring any portfolio
companies which are, directly or indirectly, service providers to any
of a Triumph Fund's Plan investors. However, Triumph does not consider
this alternative satisfactory because it would limit the Triumph Fund's
potential range of investments and diminish the expected investment
return of such Fund. Moreover, Triumph points out that a portfolio
company which is not a service provider at the time of the Triumph
Fund's investment might become a service provider at some time in the
future. Under these circumstances, Triumph represents that it would be
impractical to restrict the activities of all portfolio companies in
which the Triumph Fund invests to assure that no such portfolio company
would ever become a service provider to any Triumph Fund's Plan
investors. According to Triumph, such restriction
[[Page 18359]]
would be contrary to the best interest of the Triumph Funds and their
investors, particularly, their Plan investors.
As another alternative, Triumph represents that it could limit the
offering of interests in the Triumph Funds to those Plans which could
take advantage of Prohibited Transaction Exemption (PTE) 84-14 (49 FR
9494 March 13, 1984), the Class Exemption for Plan Asset Transactions
Determined by Independent Qualified Professional Asset Managers (QPAMs)
or PTE 96-23 (61 FR 15975, April 10, 1996), the Class Exemption for
Plan Asset Transactions Determined by In-House Asset Managers
(INHAMs).\10\ However, Triumph believes that such an approach would be
unduly restrictive and not in the best interest of the Plans since
relatively few Plans could take advantage of PTE 96-23. In addition, in
the absence of this proposed exemption, each Plan would be forced to
hire a QPAM in order to meet the conditions of PTE 84-14, and incur an
additional expense in order to invest in a Triumph Fund, if the Plan's
named fiduciary would otherwise make that decision itself.
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\10\ PTE 84-14 permits various parties which are related to
employee benefit plans to engage in transactions involving plan
assets if, among other conditions, the assets are managed by QPAMs
(i.e., banks, savings and loan associations, insurance companies or
investment advisers registered under the Investment Advisers Act of
1940), which are independent of the parties in interest involved in
such transactions and meet certain specified financial standards.
PTE 96-23 permits various transactions involving employee benefit
plans whose assets are managed by INHAMs and parties in interest to
such plans, who are service providers, or their affiliates (other
than the INHAM and its affiliates).
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10. In summary, it is represented that the proposed transactions
satisfy the statutory criteria of section 408(a) of the Act because:
(a) The Triumph Fund's party in interest status with respect to the
Plan will arise after the Plan has made its binding commitment to
invest in the Triumph Fund, including its commitment to make future
capital contributions to the Triumph Fund; (b) the decision by a Plan
to make capital contributions to the Triumph Fund has been and will be
made on behalf of the Plan by a Plan fiduciary which is independent of
and unrelated to Triumph and the portfolio company that is acquired by
the Triumph Fund; (c) Triumph will not otherwise provide investment
advice to the Plan, within the meaning of 29 CFR 2510.3-21(c) of the
Act, with respect to such Plan's assets that are invested in the
Triumph Fund; (d) at the later of the Determination Date, or the date
on which the Triumph Fund first becomes a party in interest with
respect to such Plan investor, the capital commitment of the Plan
(together with the capital commitment of any other related Plans
maintained by the same employer, controlled group of corporations, or
employee organization) will not exceed more than 15 percent of the
total outstanding capital commitments made by all investors with
respect to the Triumph Fund; (e) at the Determination Date, the
percentage of the Plan's assets committed to be invested in the Triumph
Fund has not and will not exceed 5 percent of the Plan's total assets,
and the Plan's aggregate commitment to all Triumph Funds has not and
will not exceed 25 percent of the Plan's total assets; (f) a Plan
investing in a Triumph Fund has or will have, either alone or in
combination with other plans, assets that are in excess of $50 million
(as described under the conditions contained herein); and (g) Triumph
has made or will make written disclosures to the Plan regarding the
Triumph Fund, both at the time of the initial commitment to invest in
such Fund as well as on an ongoing basis.
Notice to Interested Persons
Those persons who may be interested in the pendency of the
requested exemption include fiduciaries of Plans whose assets are
currently invested in a Triumph Fund. Accordingly, the Department has
determined that the only practical form of providing notice to such
Plan fiduciaries is the distribution, by Triumph, of a copy of the
proposed exemption by first class mail within 15 days of the date of
publication of the pendency notice in the Federal Register. The notice
will include a copy of the notice of proposed exemption, as published
in the Federal Register, as well as a supplemental statement, as
required pursuant to 29 CFR 2570.43(b)(2), which shall inform
interested persons of their right to comment on the pending exemption.
Comments with respect to the proposed exemption are due 45 days after
the date of publication of the proposed exemption in the Federal
Register.
For Further Information Contact: Ms. Janet Schmidt of the
Department, telephone (202) 219-8881. (This is not a toll-free number.)
The Fidelity Mutual Life Insurance Company (In Rehabilitation)
(FML) Located in Radnor, PA
[Application No. D-10712]
Proposed Exemption
Based on the facts and representations set forth in the
application, the Department is considering granting an exemption under
the authority of section 408(a) of the Act and in accordance with the
procedures set forth in 29 CFR Part 2570, Subpart B (55 FR 32836,
32847, August 10, 1990).\11\
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\11\ For purposes of this exemption, reference to provisions of
Title I of the Act, unless otherwise specified, refer also to the
corresponding provisions of the Code.
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Section I. Covered Transactions
If the exemption is granted, the restrictions of section 406(a) of
the Act and the sanctions resulting from the application of section
4975 of the Code, by reason of section 4975(c)(1)(A) through (D) of the
Code, shall not apply to (1) the receipt of certain stock (the Plan
Stock) issued by Fidelity Insurance Group, Inc. (Group), a wholly owned
subsidiary of FML, or (2) the receipt of plan credits (the Plan
Credits), by or on behalf of a mutual member (the Mutual Member) of
FML, which is an employee benefit plan (the Plan), other than the
Employee Pension Plan of Fidelity Mutual Life Insurance Company (the
FML Plan), in exchange for such Mutual Member's membership interest
(the Membership Interest) in FML, in accordance with the terms of a
plan of rehabilitation (the Third Amended Plan of Rehabilitation),
approved by the Pennsylvania Commonwealth Court (the Court) and
supervised by both the Court and a rehabilitator (the Rehabilitator)
appointed by the Pennsylvania Insurance Commissioner (the
Commissioner).
This proposed exemption is subject to the following conditions set
forth below in Section II.
Section II. General Conditions
(a) The Third Amended Plan of Rehabilitation is approved by the
Court, implemented in accordance with procedural and substantive
safeguards that are imposed under Pennsylvania law and is subject to
review and/or supervision by the Commissioner and the Rehabilitator.
The Court determines whether the Third Amended Plan of Rehabilitation
is fair and equitable to Mutual Members.
(b) Each Mutual Member has an opportunity to vote and comment on
the Third Amended Plan of Rehabilitation at hearings held by the Court
after full written disclosure is given to such Mutual Member by FML of
the terms of the Plan.
(c) Participation by all Mutual Members in the Third Amended Plan
of Rehabilitation, if approved by the Court, is mandatory, although
Mutual Members may disclaim Plan Stock.
(d) Any determination by a Mutual Member which is a Plan to receive
Plan Stock or Plan Credits is made by one or more independent
fiduciaries of such
[[Page 18360]]
Plan and not by FML, Group or Fidelity Life Insurance Company (FLIC).
Consequently, neither FML nor any of its affiliates will exercise
investment discretion nor render ``investment advice'' within the
meaning of 29 CFR 2510.3-21(c) with respect to an independent Plan
fiduciary's decision to elect Plan Stock or Plan Credits.
(e) Twenty percent of the Plan Stock is allocated to a Mutual
Member based upon voting rights and eighty percent is allocated to a
Mutual Member on the basis of the contribution of the Mutual Member's
insurance or annuity contract (the Contract) to the surplus of FML. The
contribution to FML's surplus is the actuarial calculation of both the
historical and expected future profit contribution of the Contracts
that have contributed to the surplus (i.e., the net earnings) of FML.
The actuarial formulas are approved by the Court and the Commissioner.
(f) The value of Plan Stock or Plan Credits that will be received
by a Mutual Member will reflect the aggregate price paid by an
independent investor (the Investor) to Group for common Stock (the
Common Stock) and for plan credit shares (the Plan Credit Shares) in
convertible preferred stock (the Preferred Stock) issued by Group.
(g) All Mutual Members that are Plans participate in the
transactions on the same basis as all other Mutual Members that are not
Plans.
(h) No Mutual Member pays any brokerage commissions or fees in
connection with the receipt of Plan Stock or Plan Credits.
(i) All of FML's obligations to contractholders (the
Contractholders) of the company which are Mutual Members remain in
force upon endorsement and transfer to FLIC and are not affected by the
Third Amended Plan of Rehabilitation.
Section III. Definitions
For purposes of this proposed exemption:
(a) The term ``FML'' means the Fidelity Mutual Life Insurance
Company (In Rehabilitation) and any affiliate of FML as defined in
paragraph (c) of this Section III.
(b) The term ``FLIC'' means the Fidelity Life Insurance Company and
any affiliate of FLIC as defined in paragraph (c) of this Section III.
(c) An ``affiliate'' of FML or FLIC includes--
(1) Any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with FML or FLIC; (For purposes of this paragraph, the term ``control''
means the power to exercise a controlling influence over the management
or policies of a person other than an individual.) or
(2) Any officer, director or partner in such person.
(c) The term ``Mutual Member'' means a Contractholder whose name
appears on FML's records as an owner of an FML Contract on the Record
Date of the Third Amended Plan of Rehabilitation.
(d) The term ``Investor'' means the person (e.g., individual,
corporation, partnership, joint venture, etc.) selected by the
Rehabilitator and approved by the Court to be the purchaser under the
Investment Agreement.
(e) The term ``Group Stock'' refers to shares of Group Common Stock
and to Group Preferred Stock, which will have a cumulative, annual
dividend equal to 7 percent of its liquidation value. The Preferred
Stock will be Series A stock having a par value of $0.01 per share and
a liquidation preference and a redemption value of $25 per share.
(f) The term ``Plan Stock'' means the 3 million shares of Group
Common Stock and the 2.8 million of Group Preferred Stock that will be
allocated to Mutual Members.
(g) The term ``Plan Credit'' means either (1) additional paid up
insurance for a traditional life policy or (2) credits to the account
values for Contracts that are not traditional (such as a flexible
premium policy). Under FML's Third Amended Plan of Plan of
Rehabilitation, Plan Credits are to be allocated to certain Mutual
Members in lieu of Plan Stock.
(h) The term ``Plan Credit Shares'' includes those shares of Plan
Stock (i.e., the 15,000 to 180,000 shares of Group Common Stock) and
any shares of Group Preferred Stock to be issued and sold by Group to
the Investor to fund Plan Credits.
(i) The term ``Policyholder Stock'' means those shares of Group
Common or Group Preferred Stock that will be issued and distributed to
Mutual Members, consisting of Plan Stock plus any shares of Group Stock
(in excess of Plan Stock) issued for purposes of correcting errors in
the allocation of Plan Stock, less Plan Credit Shares and any
disclaimed shares.
(j) The term ``Investor Stock'' means the 3.1 million shares of
Group Common Stock (other than Plan Stock) and the Plan Credit Shares
which, under the Third Amended Plan of Rehabilitation, are sold to the
Investor pursuant to bid procedures and the Investment Agreement.
Summary of Facts and Representations
1. FML is a mutual life insurance company that was founded in 1878
and organized to conduct a life insurance business in Pennsylvania. FML
maintains its principal place of business at 250 King of Prussia Road,
Radnor, Pennsylvania. Prior to the rehabilitation proceedings that are
described herein, FML was licensed to issue life insurance policies in
47 states and the District of Columbia.
Because FML has been organized as a mutual form of life insurance
company, it has no stockholders. Instead, the owners of its Contracts
(i.e., the Contractholders) have a dual legal relationship with FML. In
this regard, the Contractholders are vested with rights in the company,
such as such as the right to vote and the right to an allocable portion
of the divisible surplus. In addition, the Contractholders have
contractual rights under their Contracts with FML.
FML has approximately 3,997 Contracts that are related to qualified
Plans. FML also sponsors the FML Plan, a defined benefit plan, which
had 254 participants and total assets of $17,282,009 as of December 31,
1998.
2. FML owns all of the stock of Group, a Pennsylvania-domiciled
stock corporation. Group, in turn, owns all of the stock of FLIC, also
a Pennsylvania corporation. Group purchased the FLIC stock from an
unrelated party on June 30, 1995. FLIC is a stock life insurance
company duly licensed, chartered and domesticated in Pennsylvania and
is qualified to conduct a life insurance business in substantially all
jurisdictions where FML has business, except in New York and New
Hampshire. FLIC has filed applications for licenses to conduct business
in these states.
3. During late 1990, the Pennsylvania Insurance Department began
monitoring FML's operations because of concern over FML's extensive
real estate holdings, decline in surplus and unrealized capital losses.
In response to an increase in Contract surrenders and loan requests for
the period October 26 to November 5, 1992, the Pennsylvania Insurance
Department and FML's Board of Directors petitioned the Court for an
Order of Rehabilitation. As a result, FML was placed in rehabilitation
by an order of the Court on November 6, 1992, pursuant to the
Pennsylvania Insurance Department Act, as amended. Under the Order of
Rehabilitation, a moratorium was imposed on cash distributions,
Contract surrenders, withdrawals and policy loans, except in certain
hardship situations. At the time of the rehabilitation, FML had assets
with a book value of approximately $1.2 billion. Of this amount, a
significant portion of FML's assets was comprised
[[Page 18361]]
of real estate and mortgages which were non-performing, illiquid and
overvalued.
4. On June 30, 1994, the Rehabilitator filed the original Plan of
Rehabilitation for The Fidelity Mutual Life Insurance Company (the
Original Plan of Rehabilitation) with the Court. The Original Plan of
Rehabilitation called for the transfer of FML insurance policies to
``Newco,'' the name designated for the stock life insurance company
that was to be purchased by FML and Group. Under the Original Plan of
Rehabilitation, all Contractholders of FML would be allocated one share
of Group Stock, all Mutual Members would be made whole for any
``Impairment'' \12\ through the allocation of Group Stock, and any
remaining Group Stock would be allocated to creditors on a pro rata
basis. Contractholders could opt out of the Original Plan of
Rehabilitation, surrender their policies and receive the liquidation
value of their cash surrender values plus one share of Group Stock.
Contractholders remaining with Newco would also be subject to a
continued moratorium charge (i.e., a charge based upon the suspension,
by the Court, of cash distributions, Contract surrenders, withdrawals
and policy loans) of 16 percent during the first year and 8 percent
during the second year if they surrendered their policies. Further, a
trust was to be created under the Original Plan of Rehabilitation to
hold the stock during the moratorium period and then dispose of such
stock by distributing it to Contractholders and creditors. Finally, the
Original Plan of Rehabilitation provided that an Investor could provide
a capital infusion to Newco through Group that would be sufficient to
meet risk-based capital requirements and that such Investor would
receive unspecified securities of Group in return. Notice was sent to
Contractholders and other interested persons of the filing of the
Original Plan and objections were due by November 1, 1994.
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\12\ Under the Original Plan, the term ``Impairment'' was
defined as ``* * * the sum of (a) the loss of interest which would
have been credited to Participating Contractholders in the normal
course of business had FML not been placed in rehabilitation, as
determined by the Receiver, and (b) the loss of liquidity due to the
limited access of Participating Contractholders to their cash
values, as determined by the Receiver.''
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5. After the filing of the Original Plan of Rehabilitation with the
Court in June 1994, the Rehabilitator proceeded to work with an
investment banker to solicit and select an Investor.\13\ On January 12,
1995, the Rehabilitator filed an Amended Plan for the Rehabilitation of
The Fidelity Mutual Life Insurance Company (the First Amended Plan of
Rehabilitation) with the Court which included an Investment Agreement
executed by the Presidential Life Insurance Company (Presidential). The
framework for the First Amended Plan of Rehabilitation was similar to
the Original Plan, with additional definition. The First Amended Plan
of Rehabilitation provided that 10 million shares of Group Stock would
be placed in a stock trust to be distributed to Contractholders for
Impairment \14\ and thereafter, if any shares remained, to creditors
with allowed claims. The First Amended Plan of Rehabilitation also
provided that Group could sell up to 49.9 percent of Group Common Stock
to Presidential in exchange for an investment of up to $45 million and
could sell $25 million in debt instruments to the Presidential Life
Corporation. The moratorium charge applicable to Contractholder cash
values upon surrender after closing was reduced to 14 percent during
the first year and 8 percent during the second year. Further, the
liquidation value that Contractholders would receive if electing to opt
out of the First Amended Plan of Rehabilitation was approximately 89
percent of their cash surrender value. Notice of the filing of the
First Amended Plan of Rehabilitation was provided to all
Contractholders and other interested persons and objections had to be
filed by March 31, 1995.
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\13\ It is represented that many of the objections concerning
the Original Plan of Rehabilitation related to the fact that the
Plan had not included an Investor and that there was no certainty
that an Investor could be found.
\14\ Impairment under the First Amended Plan of Rehabilitation
was defined as ``* * * the loss of liquidity due to the lack of
access of Participating Contractholders to their Surrender Values
measured from the Rehabilitation Date to the Closing Date * * *''
Aggregate Impairment was estimated to have a value of $40 million as
of September 30, 1994.
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6. In January 1995, a new Commissioner was appointed who became the
new Rehabilitator for FML. In March 1995, the Court approved the
appointment of a Policyholder Committee at the request of a group of
former FML agents. Subsequently, the Policyholder Committee engaged
counsel, an accounting firm and an investment banking firm. Also, in
March 1995, a bidder who was not selected as the Investor objected to
the First Amended Plan of Rehabilitation and ultimately sought
permission to intervene and propose an alternative rehabilitation plan.
In May 1995, the Policyholder Committee filed objections to the First
Amended Plan of Rehabilitation and specifically objected to the
selected investor, Presidential. Also in May 1995, Presidential
petitioned the Court for permission to intervene in the rehabilitation
proceedings. In early September 1995, the Deputy Rehabilitator for FML
resigned and a Deputy Commissioner from the Pennsylvania Insurance
Department was assigned to oversee the daily affairs of FML.
Negotiations with the Policyholder Committee, Presidential, and the
objecting bidder continued during the remainder of 1995 through 1996.
In May 1996, Presidential filed a petition for payment of expenses and
liquidated damages under the 1995 Stock Purchase Agreement and the
Policyholder Committee and former FML agents objected to that petition.
7. On June 25, 1996, the Rehabilitator filed the Second Amended
Plan for the Rehabilitation of The Fidelity Mutual Life Insurance
Company (the Second Amended Plan of Rehabilitation) with the Court. The
framework for the Second Amended Plan was substantially the same as the
predecessor Plans but there were significant differences. For example,
the concept of Plan Credits was introduced for the first time. In
addition, Group could sell 35 percent of its issued and outstanding
common stock to the Investor under bid procedures to be approved by the
Court. However, Group could not issue any debt instruments. The other
65 percent of the Group Stock was to be allocated to Contractholders
and creditors, except that the stock would no longer be held and
distributed by a stock trust, but would be distributed directly to the
Contractholders and creditors around the Closing Date. Based on an
assumed Closing Date of June 30, 1997, Impairment had increased to an
estimated total of $57.1 million. Also, the Liquidation Value as of
September 30, 1995 was estimated to be 95 percent of the cash surrender
value of any Contractholder who elected to opt out of the Plan. The
moratorium period of two years in the previous Plans was reduced to one
year and the moratorium charge would be equal to the Liquidation
Discount (5 percent of September 30, 1995).
Notice of the filing of the Second Amended Plan of Rehabilitation
was not sent to Contractholders and other interested persons because
the Policyholder Committee filed significant objections to both the
Notice Package and the Second Amended Plan of Rehabilitation, including
an objection asserting that the Contractholders should receive cash
rather than Group Stock for Impairment. In July 1996,
[[Page 18362]]
Presidential filed a motion asking the Court to enjoin any new Investor
selection process until their claim for relief was addressed. The
Presidential claim was finally settled and approved by the Court in
March 1997.
8. Negotiations with the Policyholder Committee continued and the
Third Amended Plan for the Rehabilitation of The Fidelity Mutual Life
Insurance Company (i.e., the Third Amended Plan of Rehabilitation) was
filed with the Court on June 30, 1998. The Plan included several
significant improvements for Contractholders due to the improved
financial condition of FML.\15\ For example, under the Third Amended
Plan of Rehabilitation, there are no moratorium charges after the
Closing Date and Contractholders may immediately surrender their
Contracts for the full cash surrender value. Consequently, no opt out
period is necessary to allow the option of immediate surrender.
Further, all creditor claims will be paid in full with 6 percent
interest.
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\15\ In this regard, since its rehabilitation, FML has improved
the investment quality of its assets and its financial strength. In
addition, FML has stabilized its revenue and achieved levels of
surplus in excess of minimum state regulatory requirements. Further,
FML has continued to pay dividends to Contractholders under
participating Contracts and excess interest credits under other
Contracts (e.g., universal life and deferred annuity contracts).
By an order of the Court dated April 30, 1996, FML increased
policyholder dividends and declared interest crediting rates of
certain Contracts beginning in 1996. In addition, FML petitioned the
Court to pay an increased one-time policyholder dividend and
declared interest credit beginning in 1999 because of its financial
capacity to do so and in recognition of the fact that the
policyholder dividends and declared interest credits paid on its
Contracts had generally been lower during the period of
rehabilitation than those for comparable policies of other insurers.
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Subject to the approval of the Court, the Rehabilitator is
proposing that FML transfer, on the Closing Date,\16\ pursuant to
assumption reinsurance and transfer agreements, its insurance
operations to FLIC, which will continue as a wholly owned subsidiary of
Group and a successor to FML. In addition, FML will modify the terms of
the FML Contracts by endorsement prior to their transfer to and
assumption by FLIC. Group Common Stock and Preferred Stock \17\ that
has been denominated as Plan Stock will be allocated and then
distributed to Mutual Members in exchange for their Membership
Interests in FML rather than for the Impairment of their Contracts,
except that Contractholders of certain tax-qualified retirement funding
accounts (who have impediments to holding stock generally), will be
entitled to have Plan Credits made to their Contracts in lieu of
receiving Plan Stock.
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\16\ The Closing Date of the rehabilitation under the Third
Amended Plan of Rehabilitation is expected to occur after December
31, 2000.
\17\ The Rehabilitator has been advised by outside securities
and tax counsel that the Preferred Stock constitutes equity rather
than debt. Additionally, the Rehabilitator has relied upon a private
letter ruling issued by the Internal Revenue Service on July 14,
1999 which treats the Preferred Stock and the Common Stock as equity
rather than as debt.
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Therefore, FML requests an administrative exemption from the
Department with respect to the receipt of Plan Stock or the receipt of
Plan Credits by Mutual Members that are Plans. FML is not requesting,
nor is the Department providing, exemptive relief with respect to the
receipt of Plan Stock by the FML Plan because it believes such stock
will constitute ``qualifying employer securities'' within the meaning
of section 407(d)(5) of the Act. Therefore, FML represents that the
acquisition of Plan Stock by the FML Plan will satisfy the requirements
of section 408(e) of the Act.\18\
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\18\ However, the Department expresses no opinion herein on
whether such distributions will satisfy the terms and conditions of
section 408(e) of the Act.
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9. As with the other Plans of Rehabilitation, under the Third
Amended Plan of Rehabilitation, an independent party (i.e., the
Investor), approved by the Court, will be selected pursuant to bid
procedures \19\ to purchase Common Stock from Group so that immediately
after the Closing Date, the Investor will own more than 50 percent of
such Common Stock. The Investor will acquire Preferred Stock only
through the required purchase of Plan Credit Shares but not through the
bid process.
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\19\ The bid procedures, which will strictly control the
selection process for the Investor as well as the post-closing
activities of the Investor, are designed to prevent any negotiation
among potential Investors because the winning bid is to be
determined solely on the basis of the bid price per share, the
financial condition of the Investor and the statutory requirements
of the Pennsylvania Rehabilitation Statute.
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Under the Third Amended Plan of Rehabilitation, the Investor may be
a foreign or domestic entity such as a life/health insurer, a property/
casualty insurer, an investment company or other investment fund, a
joint venture, general partnership or a limited partnership. In
addition, the Investor may be required to satisfy certain ratings or
capitalization criteria. For example, if the Investor is a property/
casualty insurer, it must have an A.M. Best rating of at least A-, a
minimum Total Adjusted Capital of $500 million, and a ratio of Total
Adjusted Capital to Authorized Control Level Risk Based Capital of 5:1
or better. If the Investor is not a publicly-rated entity but is an
investment company or other investment fund, it must have a net worth
of at least $500 million and minimum available equity of $150 million.
Further, the Investor must be either a Qualified Institutional Buyer
within the meaning of Rule 144A under the Securities Exchange Act of
1933 (the 1933 Act), an Institutional Accredited Investor within the
meaning of Rule 501(a)(1), (2), (3) or (7) under the 1933 Act, or a
sophisticated institutional investor not requiring the protections of
the registration requirements of the 1933 Act.
10. The rehabilitation strategy, which is aimed at maximizing the
interests of FML's Contractholders and creditors, is to transfer FML's
insurance operations into a stock life insurance company. The
Contractholders and creditors will be provided benefits in accordance
with the priorities for distribution to be determined under the
Pennsylvania law applicable to insurance company rehabilitations.\20\
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\20\ It is represented that the Rehabilitator has been advised
by outside rehabilitation counsel and attorneys for the Pennsylvania
Insurance Department that the Pennsylvania Insurance Company Mutual
Stock Conversion Act (Conversion Act), which governs the
demutualization of an insurer under Pennsylvania law, will not be
applicable to FML's situation. It was determined that the Third
Amended Plan of Rehabilitation did not contemplate a conversion
transaction since the assets of FML would be transferred to a
separate company (FLIC) by assumption reinsurance and FML would then
be liquidated. Also, it was determined that the Conversion Act would
not apply to a company in rehabilitation or liquidation because
conflicts would exist with the applicable Pennsylvania
rehabilitation/liquidation laws.
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Thus, the treatment of FML's Contracts and the Contractholder's
interests thereunder is a significant aspect of the Third Amended Plan
of Rehabilitation. These Contracts include, but are not limited to,
traditional ordinary life insurance Contracts and universal life
insurance Contracts.
11. Section 2.01 of the Third Amended Plan of Rehabilitation
specifies a classification of claims (the Claims) and interests and
priorities governing the receipt of distributions. The rights provided
the Contractholders under section 2.04 of the Third Amended Plan of
Rehabilitation (for the Contracts to be modified by endorsement in FML
and reinsured by FLIC) will have a Class 3 priority (along with certain
other Claims under the Contracts), following certain secured and
administrative claims which are classified as Class 1 and Class 2
Claims. Classes 4 through 9 Claims provide for claims for governments,
general creditors, employees, debt holders, etc. Class 10, the last and
residual category,
[[Page 18363]]
provides for the Claims of the Membership Interests of FML's Mutual
Members.
Allowed Claims 1 through 9 will be paid in full in cash. Each
Contractholder having a Contract in force on the Closing Date will have
his or her Contract assumed and reinsured by FLIC as of the Closing
Date. In addition, at Closing, Class 10 Claims will be satisfied by an
allocation of Plan Stock in exchange for the Mutual Member's
relinquishment of his or her membership interest in FML.\21\ No other
class of Claims will be paid or satisfied either partially or totally
by a distribution or allocation of Plan Stock or Plan Credits.\22\
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\21\ Even though Mutual Members are deemed ``Contractholders''
for purposes of claims distribution, they are not entitled to
receive cash as are Class 3 Claimants. Instead, Mutual Members will
be entitled to receive Plan Stock. Class 3 Claims include claims for
losses under the insurance policy such as death proceeds, annuity
proceeds or investment values. Class 10 Claims, which represent the
claims of shareholders or other owners, are not deemed ``loss
claims'' under a policy. Rather, such claims are deemed analogous to
mutual membership interests.
\22\ Article IV of the Third Amended Plan of Rehabilitation
generally provides that the policyholder eligible to participate in
the distribution of Plan Stock or Plan Credits resulting from such
Plan is ``the Person specified in the Contract, or in a subsequent
document, as the 'Contractholder' or 'owner' of such Contract, or
any similar designation in the Contract, as shown on the books and
records of FML.'' FML further represents that its insurance
contracts that provide benefits under an employee benefit plan,
typically designate the employer that sponsors the plan, or a
trustee acting on behalf of the plan, as the Contractholder or owner
of the policy. In regard to those Contracts that designate the
employer or trustee as Contractholder or owner of the policy, FML
represents that under Article IV of the Third Amended Plan of
Rehabilitation, it will make distributions resulting from such Plan
to the employer or trustee as Contractholder or owner of the
Contract.
In general, it is the Department's view that, if an insurance
policy is purchased with assets of an employee benefit plan,
including participant contributions, and if there exist any
participants under the plan (as defined at 29 CFR 2510.3-3) at the
time when FML incurs the obligation to distribute Plan Stock or Plan
Credits, then such consideration would constitute an assets of such
employee benefit plan. Under these circumstances, the appropriate
plan fiduciaries must take all necessary steps to safeguard the
assets of the plan in order to avoid engaging in a violation of the
fiduciary responsibility provisions of the Act.
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12. Under Section 4.05 of the Third Amended Plan of Rehabilitation,
any Contract held in connection with a qualified retirement plan or an
arrangement described in section 401(a), 403(a) or 408 of the Code,
other than a Contract held by a trustee under a plan described in
section 401(a) of the Code, (i.e., a Non-Trusteed Tax-Qualified
Retirement Funding Contract) will be allocated Plan Credits in lieu of
Plan Stock in exchange for the relinquishment of the Mutual Member's
Membership Interest under such Contract. The Plan Credits allocated to
such Mutual Member's Contract will be equal in value to the Plan Stock
otherwise allocable to the Non-Trusteed Tax-Qualified Retirement
Funding Contract.
13. As noted above, the Plan Stock allocated to Mutual Members for
Class 10 Claims will consist of Group Common Stock and Preferred Stock.
Twenty percent of the Plan Stock will be allocated based on voting
rights \23\ and 80 percent will be allocated based on a Contract's
contribution to FML's surplus. If a Mutual Member has two or more
Contracts, the Plan Stock allocated to such Mutual Member, based on
voting rights, will be allocated in equal portions to each such
Contract.
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\23\ Voting rights are set forth in the FML By-laws which
provide: ``At all meetings, each member shall be entitled to one
vote irrespective of the number of policies or amount of insurance
held by a member.''
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14. Each Mutual Member which is a Class 10 Claimant will be
allocated Group Common Stock and Preferred Stock, in the ratio of 3
shares of Common Stock to 2.8 shares of Preferred Stock. At closing,
the total value of the Plan Stock, immediately prior to the sale of
Common Stock to the Investor, is projected at approximately $100
million. Of this amount, 70 percent of the value of the Plan Stock will
be represented by the Preferred Stock, which will have an estimated
value of $70 million. The 30 percent remaining Plan Stock will consist
of Common Stock and it will have a value of approximately $30 million.
If desired, a Mutual Member may disclaim any interest in the Plan
Stock. Although the Mutual Member will receive no consideration for any
disclaimed Stock, such Mutual Member will continue to retain all
benefits.
The distribution of the Group Stock will occur at Closing when
Group will issue and distribute Plan Stock on behalf of FML to Mutual
Members. FML, simultaneously, will return all Group Stock to Group for
cancellation. Disclaimed shares will not be issued or, if issued, will
be canceled and returned to Group.
15. There will be 40 million shares, par value $.01 per share, of
Common Stock authorized and 6.1 million shares of such stock
outstanding at the Closing Date. The Common Stock will have voting
rights of one vote per share.
Group will sell approximately 3.1 million shares of its Common
Stock to the Investor in a private placement pursuant to bid procedures
approved by the Court and utilize the majority of the sale proceeds to
supplement the capital of FLIC. FML will designate a maximum of 3
million shares of the remaining Common Stock as the ``Common Stock
component'' of Plan Stock. Included in this amount will be between
15,000 and 180,000 shares of Common Stock allocable to Mutual Members
who will receive Plan Credits in lieu of Plan Stock.\24\
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\24\ It should be noted that the value of the Plan Stock or Plan
Credits that will be received by a Mutual Member will reflect the
bid price paid by the Investor for Group Common Stock. Because the
bid process does not allow the Investor to bid on or purchase
Preferred Stock (except for the Plan Credit Shares), there is no
means of establishing an immediate market value. Consequently, the
$25 per share liquidation value as described herein is deemed to
approximate the fair market value of such stock. The Investor will
also be required to purchase Preferred Stock at that price as well.
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In addition, Group will sell to the Investor the shares of Common
Stock and Preferred Stock equal to the Plan Credits \25\ and contribute
to the capital of FLIC the sales proceeds of such sale. Consequently,
the Investor will own, at the Closing Date, more than 50 percent of the
total outstanding Group Common Stock, and such percentage will increase
to the extent there are disclaimed shares and Plan Credits which
require the Investor to purchase more Plan Stock.
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\25\ In other words, if a Mutual Member is eligible to receive
Plan Credits, the Common Stock allocated to that Mutual Member will
become part of the Plan Credit Shares that will be purchased by the
Investor in order to fund the purchase of Plan Credits for the
Mutual Member.
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At the Closing Date, Group will have authorized 10 million shares
and will have outstanding 2.8 million shares of Preferred Stock, all of
which will be allocated as Plan Stock. There will be no other class of
Preferred Stock.
The Preferred Stock will have a liquidation preference and
redemption value of $25 per share. The holders of Preferred Stock will
be entitled to cumulative annual dividends, payable quarterly, at the
rate of 7 percent per annum of the liquidation preference, resulting in
an annual dividend of $1.75 per share. Shares of Preferred Stock will
be non-voting except (a) when four quarterly dividends on such class of
stock are in arrears, (b) for certain matters pertaining to that class
of stock, or (c) as otherwise required by law. Upon liquidation of
Group, a share of Preferred Stock will be entitled to a distribution
preference of $25 per share plus the amount of any accrued but unpaid
dividends. Group, at its option, may redeem shares of Preferred Stock
at any time after 20 years from the later of the issue date and the
Closing Date, at a redemption price of $25 per share plus the amount of
any accrued but unpaid dividends.
[[Page 18364]]
A share of Preferred Stock is convertible into shares of Common
Stock at any time at the option of the holder. The number of shares of
Common Stock that will be received by a Mutual Member upon such a
conversion will be determined by dividing $25 by the result of
multiplying 1.20 times the price per share paid by the Investor for the
Common Stock (which price will be determined by the competitive bidding
process approved by the Court). The conversion rate for the Preferred
Stock is also subject to various anti-dilution provisions.
16. Under Section 4.10 of the Third Amended Plan of Rehabilitation,
Policyholder Stock \26\ will be issued pursuant to the exemption from
the registration requirements provided in section 3(a)(10) of the 1933
Act. In addition, Policyholder Stock will be publicly-traded and listed
on the NASDAQ National Market or the New York or American Stock
Exchange, as determined by the Rehabilitator prior to Closing.
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\26\ As noted in Section III(i) of the Definitions,
``Policyholder Stock'' refers to those shares of Group Common or
Group Preferred Stock that will be issued and distributed to Mutual
Members. Thus, it consists of Plan Stock plus any shares of Group
Stock (in excess of Plan Stock) that are issued for purposes of
correcting errors in the allocation of Plan Stock, less Plan Credit
Shares and any disclaimed shares.
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Investor Stock will be issued in a private placement pursuant to
the exemption from the registration requirements of the 1933 Act
provided by section 4(2) thereof and the rules and regulations
thereunder. Neither Policyholder Stock nor Investor Stock will be
registered under the 1933 Act.
Group Stock will be registered under section 12(g) of the
Securities Exchange Act of 1934.
17. Since the participation by all Mutual Members in the Third
Amended Plan of Rehabilitation will be mandatory (although Mutual
Members may disclaim Plan Stock), any determination by a Mutual Member
which is a Plan to receive Plan Stock or Plan Credits will be made by
one or more Plan fiduciaries which are independent of FML and its
affiliates. As a result, neither FML nor any of its affiliates will
exercise investment discretion nor render ``investment advice'' within
the meaning of 29 CFR 2510.3-21(c) with respect to an independent Plan
fiduciary's decision to elect to receive Plan Stock or Plan Credits.
In addition, all Mutual Members that are Plans will participate in
the transactions on the same basis as all other Mutual Members that are
not Plans. Moreover, no Mutual Member will pay any brokerage
commissions or fees in connection with the receipt of Plan Stock or
Plan Credits. Finally, all of FML's Contractholder obligations will
remain in force upon endorsement and transfer to FLIC and will
essentially be unaffected by the Third Amended Plan of Rehabilitation.
18. Mutual Members will not be restricted from selling or otherwise
transferring the Plan Stock received, including converting the
Preferred Stock to Common Stock, although Group, its affiliates and the
Investor are subject to restrictions on purchasing or redeeming such
Stock.\27\ In addition, Group will not be precluded from establishing a
commission-free purchase or sales program after the Rehabilitation
which would allow Mutual Members who receive a small number of shares
of Plan Stock the opportunity to round-up those shares or sell such
shares for a temporary period without the payment of any sales
commissions.\28\ It is not contemplated that FLIC or any of its
affiliates will be engaged in such transactions.
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\27\ Specifically, Section 5.08 of the Third Amended Plan of
Rehabilitation provides that for one year after closing, the
Investor may not purchase or enter into an agreement to purchase
Group Stock from Group or the shareholders of Group, or take other
action which would result in the Investor being affiliated with
Group. In addition, Section 5.09 of the Third Amended Plan provides
that for one year after closing, Group and any company controlled
directly or indirectly by Group will not purchase or redeem nor
enter into an agreement to purchase or redeem, Group Stock from
Mutual Members that, when combined with the value of Plan Credit
Shares, has an aggregate value that exceeds 50 percent of the value
of the Plan Stock.
\28\ FML has still not determined how many shares of Plan Stock
will constitute the ``small number of shares'' required for a Mutual
Member to participate in the commission-free purchase and sales
program nor has it decided on the duration of such program.
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19. The Plan will be approved by and be under the continued
jurisdiction of the Court. The Court's review will include, among other
matters, (a) a determination, after hearings available to
Contractholders, creditors and other interested parties, the procedural
and substantive fairness of the terms and conditions of the allocation
and distribution of the Plan Stock in exchange for Membership
Interests, including a review of the methodology for allocating Plan
Stock based on the basis of contribution to surplus and voting rights
and (b) approval of the modification, by endorsement, of the terms and
conditions of the Contract.
FLIC and Group will be subject to the jurisdiction of the Court and
the supervision of the Rehabilitator prior to and through the Closing
Date. In addition, the Court will retain, after the Closing Date,
exclusive jurisdiction over Group and FLIC to enforce the provisions of
the Third Amended Plan of Rehabilitation to ensure that its intent and
purposes are carried out and given effect.
FML will discontinue its business operations, liquidate and
dissolve shortly after completing all transfers. FLIC will continue the
business of FML in a substantially unchanged manner after the transfer
from FML by receiving premiums, paying claims and generally
administering the assumed Endorsed Contracts.
Further, for a period of 2 years following the Closing Date, the
Investor will not be allowed to cause a change to the business plan for
FLIC without the prior written approval of the Department if the change
might reasonably result in the dissolution of FLIC or the operation of
FLIC in a ``run off'' mode.
20. In summary, it is represented that the proposed transactions
will satisfy the statutory criteria for an exemption under section
408(a) of the Act because:
(a) The Third Amended Plan of Rehabilitation will be implemented in
accordance with procedural and substantive safeguards that are imposed
under Pennsylvania law and by the Court and will be subject to review
and supervision of the Court and/or the Rehabilitator.
(b) The Court will review the terms of the Third Amended Plan of
Rehabilitation and will approve such Plan following a determination and
public hearing or hearings that the Plan is fair and equitable to all
Mutual Members.
(c) Each Mutual Member will have an opportunity to participate in
any hearing or hearings before the Court regarding the approval of the
Third Amended Plan of Rehabilitation.
(d) Although participation by all Mutual Members in FML's Third
Amended Plan of Rehabilitation will be mandatory (although Mutual
Members may disclaim Plan Stock), the determination of whether a Mutual
Member receives Plan Stock or Plan Credits will be made by one or more
independent fiduciaries of such Plan and not by FML, Group or FLIC. As
a result, FML nor any of its affiliates will exercise investment
discretion nor render ``investment advice'' within the meaning of 29
CFR 2510.3-21(c) with respect to the decision by the independent Plan
fiduciary to elect Plan Stock or Plan Credits.
(e) After each Mutual Member is allocated its share of Plan Stock
based on voting rights, the remaining consideration will be allocated
based
[[Page 18365]]
upon actuarial formulas that take into account each Mutual Member's
contribution to the surplus of FML, which formulas have been approved
by the Rehabilitator and the Court.
(f) The value of Plan Stock or Plan Credits that will be received
by a Mutual Member will reflect the prices paid by the Investor for
Group Common Stock and for Plan Credit Shares.
(g) All Plans will participate in the exemption transaction on the
same basis as other Mutual Members that are not Plans.
(h) No Plan will pay any brokerage commissions or fees in
connection with receipt of Plan Stock or Plan Credits.
(i) FML's Contractholder obligations will remain in force upon
endorsement and transfer to FLIC.
Notice to Interested Persons
FML will provide notice of the proposed exemption to Mutual Members
which are Plans within 5 days of the publication of the notice of
proposed exemption in the Federal Register. Such notice will be
provided to interested persons by first class mail and will include a
copy of the notice of proposed exemption as published in the Federal
Register as well as a supplemental statement, as required pursuant to
20 CFR 2570.43(b)(2) which shall inform interested persons of their
right to comment on the proposed exemption. Comments with respect to
the notice of proposed exemption are due within 35 days after the date
of publication of this pendency notice in the Federal Register.
For Further Information Contact: Ms. Jan D. Broady of the Department,
telephone (202) 219-8881. (This is not a toll-free number.)
McDonald Investments Inc. (McDonald) Located in Cleveland, Ohio
[Application No. D-10857]
Proposed Exemption
I. Transactions
A. Effective January 4, 2000, the restrictions of sections 406(a)
and 407(a) of the Act, and the taxes imposed by section 4975(a) and (b)
of the Code by reason of section 4975(c)(1)(A) through (D) of the Code,
shall not apply to the following transactions involving trusts and
certificates evidencing interests therein:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between the
sponsor or underwriter and an employee benefit plan when the sponsor,
servicer, trustee or insurer of a trust, the underwriter of the
certificates representing an interest in the trust, or an obligor is a
party in interest with respect to such plan;
(2) The direct or indirect acquisition or disposition of
certificates by a plan in the secondary market for such certificates;
and
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.A.(1) or (2).
Notwithstanding the foregoing, section I.A. does not provide an
exemption from the restrictions of sections 406(a)(1)(E), 406(a)(2) and
407 for the acquisition or holding of a certificate on behalf of an
Excluded Plan by any person who has discretionary authority or renders
investment advice with respect to the assets of that Excluded Plan.\29\
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\29\ Section I.A. provides no relief from sections 406(a)(1)(E),
406(a)(2) and 407 for any person rendering investment advice to an
Excluded Plan within the meaning of section 3(21)(A)(ii) and
regulation 29 CFR 2510.3-21(c).
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B. Effective January 4, 2000, the restrictions of sections
406(b)(1) and 406(b)(2) of the Act, and the taxes imposed by section
4975(a) and (b) of the Code by reason of section 4975(c)(1)(E) of the
Code, shall not apply to:
(1) The direct or indirect sale, exchange or transfer of
certificates in the initial issuance of certificates between the
sponsor or underwriter and a plan when the person who has discretionary
authority or renders investment advice with respect to the investment
of plan assets in the certificates is (a) an obligor with respect to 5
percent or less of the fair market value of obligations or receivables
contained in the trust, or (b) an affiliate of a person described in
(a); if:
(i) The plan is not an Excluded Plan;
(ii) Solely in the case of an acquisition of certificates in
connection with the initial issuance of the certificates, at least 50
percent of each class of certificates in which plans have invested is
acquired by persons independent of the members of the Restricted Group
and at least 50 percent of the aggregate interest in the trust is
acquired by persons independent of the Restricted Group;
(iii) a plan's investment in each class of certificates does not
exceed 25 percent of all of the certificates of that class outstanding
at the time of the acquisition; and
(iv) immediately after the acquisition of the certificates, no more
than 25 percent of the assets of a plan with respect to which the
person has discretionary authority or renders investment advice are
invested in certificates representing an interest in a trust containing
assets sold or serviced by the same entity.\30\ For purposes of this
paragraph B.(1)(iv) only, an entity will not be considered to service
assets contained in a trust if it is merely a subservicer of that
trust;
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\30\ For purposes of this proposed exemption, each plan
participating in a commingled fund (such as a bank collective trust
fund or insurance company pooled separate account) shall be
considered to own the same proportionate undivided interest in each
asset of the commingled fund as its proportionate interest in the
total assets of the commingled fund as calculated on the most recent
preceding valuation date of the fund.
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(2) The direct or indirect acquisition or disposition of
certificates by a plan in the secondary market for such certificates,
provided that the conditions set forth in paragraphs B.(1)(i), (iii)
and (iv) are met; and
(3) The continued holding of certificates acquired by a plan
pursuant to subsection I.B.(1) or (2).
C. Effective January 4, 2000, the restrictions of sections 406(a),
406(b) and 407(a) of the Act, and the taxes imposed by section 4975(a)
and (b) of the Code by reason of section 4975(c) of the Code, shall not
apply to transactions in connection with the servicing, management and
operation of a trust, provided:
(1) Such transactions are carried out in accordance with the terms
of a binding pooling and servicing agreement; and
(2) The pooling and servicing agreement is provided to, or
described in all material respects in, the prospectus or private
placement memorandum provided to investing plans before they purchase
certificates issued by the trust.\31\
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\31\ In the case of a private placement memorandum, such
memorandum must contain substantially the same information that
would be disclosed in a prospectus if the offering of the
certificates were made in a registered public offering under the
Securities Act of 1933. In the Department's view, the private
placement memorandum must contain sufficient information to permit
plan fiduciaries to make informed investment decisions. For purposes
of this proposed exemption, references to ``prospectus'' include any
related prospectus supplement thereto, pursuant to which
certificates are offered to investors.
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Notwithstanding the foregoing, section I.C. does not provide an
exemption from the restrictions of section 406(b) of the Act, or from
the taxes imposed by reason of section 4975(c) of the Code, for the
receipt of a fee by a servicer of the trust from a person other than
the trustee or sponsor, unless such fee constitutes a ``qualified
administrative fee'' as defined in section III.S.
D. Effective January 4, 2000, the restrictions of sections 406(a)
and 407(a) of the Act, and the taxes imposed by sections 4975(a) and
(b) of the Code by
[[Page 18366]]
reason of sections 4975(c)(1)(A) through (D) of the Code, shall not
apply to any transactions to which those restrictions or taxes would
otherwise apply merely because a person is deemed to be a party in
interest or disqualified person (including a fiduciary) with respect to
a plan by virtue of providing services to the plan (or by virtue of
having a relationship to such service provider described in section
3(14)(F), (G), (H) or (I) of the Act or section 4975(e)(2)(F), (G), (H)
or (I) of the Code), solely because of the plan's ownership of
certificates.
II. General Conditions
A. The relief provided under Part I is available only if the
following conditions are met:
(1) The acquisition of certificates by a plan is on terms
(including the certificate price) that are at least as favorable to the
plan as they would be in an arm's-length transaction with an unrelated
party;
(2) The rights and interests evidenced by the certificates are not
subordinated to the rights and interests evidenced by other
certificates of the same trust;
(3) The certificates acquired by the plan have received a rating
from a Rating Agency (as defined in section III.W.) at the time of such
acquisition that is in one of the three highest generic rating
categories;
(4) The trustee is not an affiliate of any other member of the
Restricted Group. However, the trustee shall not be considered to be an
affiliate of a servicer solely because the trustee has succeeded to the
rights and responsibilities of the servicer pursuant to the terms of a
pooling and servicing agreement providing for such succession upon the
occurrence of one or more events of default by the servicer;
(5) The sum of all payments made to and retained by the
underwriters in connection with the distribution or placement of
certificates represents not more than reasonable compensation for
underwriting or placing the certificates; the sum of all payments made
to and retained by the sponsor pursuant to the assignment of
obligations (or interests therein) to the trust represents not more
than the fair market value of such obligations (or interests); and the
sum of all payments made to and retained by the servicer represents not
more than reasonable compensation for the servicer's services under the
pooling and servicing agreement and reimbursement of the servicer's
reasonable expenses in connection therewith;
(6) The plan investing in such certificates is an ``accredited
investor'' as defined in Rule 501(a)(1) of Regulation D of the
Securities and Exchange Commission under the Securities Act of 1933;
and
(7) In the event that the obligations used to fund a trust have not
all been transferred to the trust on the closing date, additional
obligations as specified in subsection III.B.(1) may be transferred to
the trust during the pre-funding period (as defined in section III.BB.)
in exchange for amounts credited to the pre-funding account (as defined
in section III.Z.), provided that:
(a) The pre-funding limit (as defined in section III.AA.) is not
exceeded;
(b) All such additional obligations meet the same terms and
conditions for eligibility as those of the original obligations used to
create the trust corpus (as described in the prospectus or private
placement memorandum and/or pooling and servicing agreement for such
certificates), which terms and conditions have been approved by a
Rating Agency. Notwithstanding the foregoing, the terms and conditions
for determining the eligibility of an obligation may be changed if such
changes receive prior approval either by a majority of the outstanding
certificateholders or by a Rating Agency;
(c) The transfer of such additional obligations to the trust during
the pre-funding period does not result in the certificates receiving a
lower credit rating from a rating agency upon termination of the pre-
funding period than the rating that was obtained at the time of the
initial issuance of the certificates by the trust;
(d) The weighted average annual percentage interest rate (the
average interest rate) for all of the obligations in the trust at the
end of the pre-funding period will not be more than 100 basis points
lower than the average interest rate for the obligations which were
transferred to the trust on the closing date;
(e) In order to ensure that the characteristics of the receivables
actually acquired during the pre-funding period are substantially
similar to those which were acquired as of the closing date, the
characteristics of the additional obligations will be either monitored
by a credit support provider or other insurance provider which is
independent of the sponsor, or an independent accountant retained by
the sponsor will provide the sponsor with a letter (with copies
provided to the Rating Agency, the underwriter and the trustees)
stating whether or not the characteristics of the additional
obligations conform to the characteristics of such obligations
described in the prospectus, private placement memorandum and/or
pooling and servicing agreement. In preparing such letter, the
independent accountant will use the same type of procedures as were
applicable to the obligations which were transferred as of the closing
date;
(f) The pre-funding period shall be described in the prospectus or
private placement memorandum provided to investing plans; and
(g) The trustee of the trust (or any agent with which the trustee
contracts to provide trust services) will be a substantial financial
institution or trust company experienced in trust activities and
familiar with its duties, responsibilities and liabilities as a
fiduciary under the Act. The trustee, as the legal owner of the
obligations in the trust, will enforce all the rights created in favor
of certificateholders of such trust, including employee benefit plans
subject to the Act.
B. Neither any underwriter, sponsor, trustee, servicer, insurer,
nor any obligor, unless it or any of its affiliates has discretionary
authority or renders investment advice with respect to the plan assets
used by a plan to acquire certificates, shall be denied the relief
provided under Part I, if the provision of subsection II.A.(6) above is
not satisfied with respect to acquisition or holding by a plan of such
certificates, provided that (1) such condition is disclosed in the
prospectus or private placement memorandum; and (2) in the case of a
private placement of certificates, the trustee obtains a representation
from each initial purchaser which is a plan that it is in compliance
with such condition, and obtains a covenant from each initial purchaser
to the effect that, so long as such initial purchaser (or any
transferee of such initial purchaser's certificates) is required to
obtain from its transferee a representation regarding compliance with
the Securities Act of 1933, any such transferees will be required to
make a written representation regarding compliance with the condition
set forth in subsection II.A.(6) above.
III. Definitions
For purposes of this proposed exemption:
A. ``Certificate'' means:
(1) A certificate--
(a) That represents a beneficial ownership interest in the assets
of a trust; and
(b) That entitles the holder to pass-through payments of principal,
interest, and/or other payments made with respect to the assets of such
trust; or
(2) A certificate denominated as a debt instrument--
[[Page 18367]]
(a) That represents an interest in a Real Estate Mortgage
Investment Conduit (REMIC) or a Financial Asset Securitization
Investment Trust (FASIT) within the meaning of section 860D(a) or
section 860L, respectively, of the Code; and
(b) That is issued by, and is an obligation of, a trust; with
respect to certificates defined in (1) and (2) above for which McDonald
or any of its affiliates is either (i) the sole underwriter or the
manager or co-manager of the underwriting syndicate, or (ii) a selling
or placement agent.
For purposes of this proposed exemption, references to
``certificates representing an interest in a trust'' include
certificates denominated as debt which are issued by a trust.
B. ``Trust'' means an investment pool, the corpus of which is held
in trust and consists solely of:
(1) (a) Secured consumer receivables that bear interest or are
purchased at a discount (including, but not limited to, home equity
loans and obligations secured by shares issued by a cooperative housing
association); and/or
(b) Secured credit instruments that bear interest or are purchased
at a discount in transactions by or between business entities
(including, but not limited to, qualified equipment notes secured by
leases, as defined in section III.T); and/or
(c) Obligations that bear interest or are purchased at a discount
and which are secured by single-family residential, multi-family
residential and commercial real property (including obligations secured
by leasehold interests on commercial real property); and/or
(d) Obligations that bear interest or are purchased at a discount
and which are secured by motor vehicles or equipment, or qualified
motor vehicle leases (as defined in section III.U); and/or
(e) ``Guaranteed governmental mortgage pool certificates,'' as
defined in 29 CFR 2510.3-101(i)(2); and/or
(f) Fractional undivided interests in any of the obligations
described in clauses (a)-(e) of this section B.(1);
(2) property which had secured any of the obligations described in
subsection B.(1);
(3) (a) Undistributed cash or temporary investments made therewith
maturing no later than the next date on which distributions are to be
made to certificateholders; and/or
(b) Cash or investments made therewith which are credited to an
account to provide payments to certificateholders pursuant to any yield
supplement agreement or similar yield maintenance arrangement to
supplement the interest rates otherwise payable on obligations
described in subsection III.B.(1) held in the trust, provided that such
arrangements do not involve swap agreements or other notional principal
contracts; and/or
(c) Cash transferred to the trust on the closing date and permitted
investments made therewith which:
(i) Are credited to a pre-funding account established to purchase
additional obligations with respect to which the conditions set forth
in clauses (a)-(g) of subsection II.A.(7) are met and/or;
(ii) Are credited to a capitalized interest account (as defined in
section III.X.); and
(iii) Are held in the trust for a period ending no later than the
first distribution date to certificateholders occurring after the end
of the pre-funding period.
For purposes of this clause (c) of subsection III.B.(3), the term
``permitted investments'' means investments which are either: (i)
Direct obligations of, or obligations fully guaranteed as to timely
payment of principal and interest by the United States, or any agency
or instrumentality thereof, provided that such obligations are backed
by the full faith and credit of the United States or (ii) have been
rated (or the obligor has been rated) in one of the three highest
generic rating categories by a rating agency; are described in the
pooling and servicing agreement; and are permitted by the rating
agency; and
(4) Rights of the trustee under the pooling and servicing
agreement, and rights under any insurance policies, third-party
guarantees, contracts of suretyship, yield supplement agreements
described in clause (b) of subsection III.B.(3) and other credit
support arrangements with respect to any obligations described in
subsection III.B.(1).
Notwithstanding the foregoing, the term ``trust'' does not include
any investment pool unless: (i) the investment pool consists only of
assets of the type described in clauses (a) through (f) of subsection
III.B.(1) which have been included in other investment pools, (ii)
certificates evidencing interests in such other investment pools have
been rated in one of the three highest generic rating categories by a
Rating Agency for at least one year prior to the plan's acquisition of
certificates pursuant to this proposed exemption, and (iii)
certificates evidencing interests in such other investment pools have
been purchased by investors other than plans for at least one year
prior to the plan's acquisition of certificates pursuant to this
proposed exemption.
C. ``Underwriter'' means:
(1) McDonald;
(2) Any person directly or indirectly, through one or more
intermediaries, controlling, controlled by or under common control with
McDonald; or
(3) Any member of an underwriting syndicate or selling group of
which McDonald or a person described in (2) is a manager or co-manager
with respect to the certificates.
D. ``Sponsor'' means the entity that organizes a trust by
depositing obligations therein in exchange for certificates.
E. ``Master Servicer'' means the entity that is a party to the
pooling and servicing agreement relating to trust assets and is fully
responsible for servicing, directly or through subservicers, the assets
of the trust.
F. ``Subservicer'' means an entity which, under the supervision of
and on behalf of the master servicer, services obligations contained in
the trust, but is not a party to the pooling and servicing agreement.
G. ``Servicer'' means any entity which services obligations
contained in the trust, including the master servicer and any
subservicer.
H. ``Trustee'' means the trustee of the trust, and in the case of
certificates which are denominated as debt instruments, also means the
trustee of the indenture trust.
I. ``Insurer'' means the insurer or guarantor of, or provider of
other credit support for, a trust. Notwithstanding the foregoing, a
person is not an insurer solely because it holds securities
representing an interest in a trust which are of a class subordinated
to certificates representing an interest in the same trust.
J. ``Obligor'' means any person, other than the insurer, that is
obligated to make payments with respect to any obligation or receivable
included in the trust. Where a trust contains qualified motor vehicle
leases or qualified equipment notes secured by leases, ``obligor''
shall also include any owner of property subject to any lease included
in the trust, or subject to any lease securing an obligation included
in the trust.
K. ``Excluded Plan'' means any plan with respect to which any
member of the Restricted Group is a ``plan sponsor'' within the meaning
of section 3(16)(B) of the Act.
L. ``Restricted Group'' with respect to a class of certificates
means:
(1) Each underwriter;
(2) Each insurer;
(3) The sponsor;
(4) The trustee;
(5) Each servicer;
[[Page 18368]]
(6) Any obligor with respect to obligations or receivables included
in the trust constituting more than 5 percent of the aggregate
unamortized principal balance of the assets in the trust, determined on
the date of the initial issuance of certificates by the trust; or
(7) Any affiliate of a person described in (1)-(6) above.
M. ``Affiliate'' of another person includes:
(1) Any person directly or indirectly, through one or more
intermediaries, controlling, controlled by, or under common control
with such other person;
(2) Any officer, director, partner, employee, relative (as defined
in section 3(15) of the Act), a brother, a sister, or a spouse of a
brother or sister of such other person; and
(3) Any corporation or partnership of which such other person is an
officer, director or partner.
N. ``Control'' means the power to exercise a controlling influence
over the management or policies of a person other than an individual.
O. A person will be ``independent'' of another person only if:
(1) Such person is not an affiliate of that other person; and
(2) The other person, or an affiliate thereof, is not a fiduciary
who has investment management authority or renders investment advice
with respect to any assets of such person.
P. ``Sale'' includes the entrance into a forward delivery
commitment (as defined in section Q below), provided:
(1) The terms of the forward delivery commitment (including any fee
paid to the investing plan) are no less favorable to the plan than they
would be in an arm's-length transaction with an unrelated party;
(2) The prospectus or private placement memorandum is provided to
an investing plan prior to the time the plan enters into the forward
delivery commitment; and
(3) At the time of the delivery, all conditions of this proposed
exemption (if granted) applicable to sales are met.
Q. ``Forward delivery commitment'' means a contract for the
purchase or sale of one or more certificates to be delivered at an
agreed future settlement date. The term includes both mandatory
contracts (which contemplate obligatory delivery and acceptance of the
certificates) and optional contracts (which give one party the right
but not the obligation to deliver certificates to, or demand delivery
of certificates from, the other party).
R. ``Reasonable compensation'' has the same meaning as that term is
defined in 29 CFR 2550.408c-2.
S. ``Qualified Administrative Fee'' means a fee which meets the
following criteria:
(1) The fee is triggered by an act or failure to act by the obligor
other than the normal timely payment of amounts owing in respect of the
obligations;
(2) The servicer may not charge the fee absent the act or failure
to act referred to in (1);
(3) The ability to charge the fee, the circumstances in which the
fee may be charged, and an explanation of how the fee is calculated are
set forth in the pooling and servicing agreement; and
(4) The amount paid to investors in the trust will not be reduced
by the amount of any such fee waived by the servicer.
T. ``Qualified Equipment Note Secured By A Lease'' means an
equipment note:
(1) Which is secured by equipment which is leased;
(2) Which is secured by the obligation of the lessee to pay rent
under the equipment lease; and
(3) With respect to which the trust's security interest in the
equipment is at least as protective of the rights of the trust as would
be the case if the equipment note were secured only by the equipment
and not the lease.
U. ``Qualified Motor Vehicle Lease'' means a lease of a motor
vehicle where:
(1) The trust owns or holds a security interest in the lease;
(2) The trust owns or holds a security interest in the leased motor
vehicle; and
(3) The trust's security interest in the leased motor vehicle is at
least as protective of the trust's rights as would be the case if the
trust consisted of motor vehicle installment loan contracts.
V. ``Pooling and Servicing Agreement'' means the agreement or
agreements among a sponsor, a servicer and the trustee establishing a
trust. In the case of certificates which are denominated as debt
instruments, ``Pooling and Servicing Agreement'' also includes the
indenture entered into by the trustee of the trust issuing such
certificates and the indenture trustee.
W. ``Rating Agency'' means Standard & Poor's Structured Rating
Group (S&P's), Moody's Investors Service, Inc. (Moody's), Duff & Phelps
Credit Rating Co. (D & P) or Fitch IBCA, Inc. (Fitch) or their
successors;
X. ``Capitalized Interest Account'' means a trust account: (i)
which is established to compensate certificateholders for shortfalls,
if any, between investment earnings on the pre-funding account and the
pass-through rate payable under the certificates; and (ii) which meets
the requirements of clause (c) of subsection III.B.(3).
Y. ``Closing Date'' means the date the trust is formed, the
certificates are first issued and the trust's assets (other than those
additional obligations which are to be funded from the pre-funding
account pursuant to subsection II.A.(7)) are transferred to the trust.
Z. ``Pre-Funding Account'' means a trust account: (i) Which is
established to purchase additional obligations, which obligations meet
the conditions set forth in clauses (a)-(g) of subsection II.A.(7); and
(ii) which meets the requirements of clause (c) of subsection
III.B.(3).
AA. ``Pre-Funding Limit'' means a percentage or ratio of the amount
allocated to the pre-funding account, as compared to the total
principal amount of the certificates being offered which is less than
or equal to 25 percent.
BB. ``Pre-Funding Period'' means the period commencing on the
closing date and ending no later than the earliest to occur of: (i) The
date the amount on deposit in the pre-funding account is less than the
minimum dollar amount specified in the pooling and servicing agreement;
(ii) the date on which an event of default occurs under the pooling and
servicing agreement; or (iii) the date which is the later of three
months or 90 days after the closing date.
CC. ``McDonald'' means McDonald Investments Inc. and its
affiliates.
The Department notes that this proposed exemption is included
within the meaning of the term ``Underwriter Exemption'' as it is
defined in section V(h) of Prohibited Transaction Exemption 95-60 (60
FR 35925, July 12, 1995), the Class Exemption for Certain Transactions
Involving Insurance Company General Accounts at (see 60 FR 35932).
Summary of Facts and Representations
1. McDonald is an indirect, wholly-owned, separately capitalized
investment banking and registered broker-dealer subsidiary of KeyCorp
(the Corporation). As of September 30, 1999, McDonald's capitalization
was approximately $310 million. The Corporation is a diversified
financial services company incorporated under the laws of Ohio and a
multi-bank holding company registered under the Bank Holding Company
Act of 1956, as amended. As of September 30, 1999, the Corporation's
consolidated assets were approximately $81 billion. The principal
executive offices of the Corporation are located in Cleveland, Ohio. As
of September 30, 1999, the Corporation directly owned a subsidiary
[[Page 18369]]
bank with offices located in twelve states. In addition, indirectly-
held non-bank subsidiaries of the Corporation offer a wide range of
insurance, securities brokerage, investment banking, venture capital
investment, and consumer finance products and services.
KeyBank, National Association (the Bank), a direct, wholly-owned
subsidiary of the Corporation, is a national banking association
engaged in banking and related activities and is the largest bank in
the Corporation's banking group. As of September 30, 1997, the Bank had
total assets of approximately $80 billion. The principal executive
offices of the Bank are located in Cleveland, Ohio.
McDonald was incorporated in 1983 as an Ohio corporation. McDonald
maintains its principal place of business in Cleveland, Ohio and has
branch offices in 24 states.
McDonald is a member of the National Association of Securities
Dealers and the Securities Investor Protection Corporation and
underwrites and deals in corporate debt securities, commercial paper,
municipal securities, high-yield securities and asset-backed
securities, provides private placement and corporate finance advisory
services, including merger and acquisition advisory services, publishes
research on a wide range of securities and issuers, and engages in the
syndication and arranging and trading of bank loans.
Trust Assets
2. McDonald seeks exemptive relief to permit plans to invest in
pass-through certificates representing undivided interests in the
following categories of trusts: (1) Single and multi-family residential
or commercial mortgage investment trusts; \32\ (2) motor vehicle
receivable investment trusts; (3) consumer or commercial receivables
investment trusts; and (4) guaranteed governmental mortgage pool
certificate investment trusts.\33\
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\32\ The Department notes that PTE 83-1 [48 FR 895, January 7,
1983], a class exemption for mortgage pool investment trusts, would
generally apply to trusts containing single-family residential
mortgages, provided that the applicable conditions of PTE 83-1 are
met. McDonald requests relief for single-family residential
mortgages in this exemption because it would prefer one exemption
for all trusts of similar structure. However, McDonald has stated
that it may still avail itself of the exemptive relief provided by
PTE 83-1.
\33\ Guaranteed governmental mortgage pool certificates are
mortgage-backed securities with respect to which interest and
principal payable is guaranteed by the Government National Mortgage
Association (GNMA), the Federal Home Loan Mortgage Corporation
(FHLMC), or the Federal National Mortgage Association (FNMA). The
Department's regulation relating to the definition of ``plan
assets'' (29 CFR 2510.3-101(i)) provides that where a plan acquires
a guaranteed governmental mortgage pool certificate, the plan's
assets include the certificate and all of its rights with respect to
such certificate under applicable law, but do not, solely by reason
of the plan's holding of such certificate, include any of the
mortgages underlying such certificate. The applicant is requesting
exemptive relief for trusts containing guaranteed governmental
mortgage pool certificates because the certificates in the trusts
may be plan assets.
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3. Commercial mortgage investment trusts may include mortgages on
ground leases of real property. Commercial mortgages are frequently
secured by ground leases on the underlying property, rather than by fee
simple interests. The separation of the fee simple interest and the
ground lease interest is generally done for tax reasons. Properly
structured, the pledge of the ground lease to secure a mortgage
provides a lender with the same level of security as would be provided
by a pledge of the related fee simple interest. The terms of the ground
leases pledged to secure leasehold mortgages will in all cases be at
least ten years longer than the term of such mortgages.\34\
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\34\ Trust assets may also include obligations that are secured
by leasehold interests on residential real property. See PTE 90-32
involving Prudential-Bache Securities, Inc. (55 FR 23147, June 6,
1990 at 23150).
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Trust Structure
4. Each trust is established under a pooling and servicing
agreement between a sponsor, a servicer and a trustee.\35\ The sponsor
or servicer of a trust selects assets to be included in the trust.\36\
These assets are receivables which may have been originated, in the
ordinary course of business, by a sponsor or servicer of the trust, an
affiliate of the sponsor or servicer, or by an unrelated lender and
subsequently acquired by the trust sponsor or servicer.\37\
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\35\ The Department is of the view that the term ``trust''
includes a trust: (a) the assets of which, although all specifically
identified by the sponsor or the originator as of the closing date,
are not all transferred to the trust on the closing date for
administrative or other reasons but will be transferred to the trust
shortly after the closing date, or (b) with respect to which
certificates are not purchased by plans until after the end of the
pre-funding period at which time all receivables are contained in
the trust.
\36\ It is the Department's view that the definition of
``trust'' contained in section III.B. includes a two-tier structure
under which certificates issued by the first trust, which contains a
pool of receivables described above, are transferred to a second
trust which issues securities that are sold to plans. However, the
Department is of the further view that, since the exemption provides
relief for the direct or indirect acquisition or disposition of
certificates that are not subordinated, no relief would be available
if the certificates held by the second trust were subordinated to
the rights and interests evidenced by other certificates issued by
the first trust.
\37\ It is the view of the Department that section III.B.(4)
includes within the definition of the term ``trust'' rights under
any yield supplement or similar arrangement which obligates the
sponsor or master servicer, or another party specified in the
relevant pooling and servicing agreement, to supplement the interest
rates otherwise payable on the obligations described in section
III.B.(1), in accordance with the terms of a yield supplement
arrangement described in the pooling and servicing agreement,
provided that such arrangements do not involve swap agreements or
other notional principal contracts.
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Typically, on or prior to the closing date, the sponsor acquires
legal title to all assets selected for the trust, establishes the trust
and designates an independent entity as trustee. On the closing date,
the sponsor conveys to the trust legal title to the assets, and the
trustee issues certificates representing fractional undivided interests
in the trust assets. Typically, all receivables to be held in the trust
are transferred as of the closing date, but in some transactions, as
described more fully below, a limited percentage of the receivables to
be held in the trust may be transferred during a limited period of time
following the closing date, through the use of a pre-funding account.
McDonald, alone or together with other broker-dealers, acts as
underwriter or placement agent with respect to the sale of the
certificates. All of the public offerings of certificates presently
contemplated have been or are to be underwritten by McDonald on a firm
commitment basis. In addition, McDonald anticipates that it may
privately place certificates on both a firm commitment and an agency
basis. McDonald may also act as the lead underwriter for a syndicate of
securities underwriters.
Certificateholders will be entitled to receive monthly, quarterly
or semi-annual installments of principal and/or interest, or lease
payments due on the receivables, adjusted, in the case of payments of
interest, to a specified rate--the pass-through rate--which may be
fixed or variable.
When installments or payments are made on a semi-annual basis,
funds are not permitted to be commingled with the servicer's assets for
longer than would be permitted for a monthly-pay security. A segregated
account is established in the name of the trustee (on behalf of
certificateholders) to hold funds received between distribution dates.
The account is under the sole control of the trustee, who invests the
account's assets in short-term securities which have received a rating
comparable to the rating assigned to the certificates. In some cases,
the servicer may be permitted to make a single deposit into the account
once a month. When the servicer makes such monthly deposits, payments
received from
[[Page 18370]]
obligors by the servicer may be commingled with the servicer's assets
during the month prior to deposit. Usually, the period of time between
receipt of funds by the servicer and deposit of these funds in a
segregated account does not exceed one month. Furthermore, in those
cases where distributions are made semi-annually, the servicer will
furnish a report on the operation of the trust to the trustee on a
monthly basis. At or about the time this report is delivered to the
trustee, it will be made available to certificateholders and delivered
to or made available to each Rating Agency that has rated the
certificates.
5. Some of the certificates will be multi-class certificates.
McDonald requests exemptive relief for two types of multi-class
certificates: ``strip'' certificates and ``fast-pay/slow-pay''
certificates. Strip certificates are a type of security in which the
stream of interest payments on receivables is split from the flow of
principal payments and separate classes of certificates are
established, each representing rights to disproportionate payments of
principal and interest.\38\
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\38\ It is the Department's understanding that where a plan
invests in REMIC ``residual'' interest certificates to which this
exemption applies, some of the income received by the plan as a
result of such investment may be considered unrelated business
taxable income to the plan, which is subject to income tax under the
Code. The Department emphasizes that the prudence requirement of
section 404(a)(l)(B) of the Act would require plan fiduciaries to
carefully consider this and other tax consequences prior to causing
plan assets to be invested in certificates pursuant to this proposed
exemption.
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``Fast-pay/slow-pay'' certificates involve the issuance of classes
of certificates having different stated maturities or the same
maturities with different payment schedules. Interest and/or principal
payments received on the underlying receivables are distributed first
to the class of certificates having the earliest stated maturity of
principal, and/or earlier payment schedule, and only when that class of
certificates has been paid in full (or has received a specified amount)
will distributions be made with respect to the second class of
certificates. Distributions on certificates having later stated
maturities will proceed in like manner until all the certificateholders
have been paid in full. The only difference between this multi-class
pass-through arrangement and a single-class pass-through arrangement is
the order in which distributions are made to certificateholders. In
each case, certificateholders will have a beneficial ownership interest
in the underlying assets. In neither case will the rights of a plan
purchasing a certificate be subordinated to the rights of another
certificateholder in the event of default on any of the underlying
obligations. In particular, if the amount available for distribution to
certificateholders is less than the amount required to be so
distributed, all senior certificateholders then entitled to receive
distributions will share in the amount distributed on a pro rata
basis.\39\
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\39\ If a trust issues subordinated certificates, holders of
such subordinated certificates may not share in the amount
distributed on a pro rata basis with the senior certificateholders.
The Department notes that the proposed exemption does not provide
relief for plan investment in such subordinated certificates.
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6. The trust will be maintained as an essentially passive entity.
Therefore, both the sponsor's discretion and the servicer's discretion
with respect to assets included in a trust are severely limited.
Pooling and servicing agreements provide for the substitution of
receivables by the sponsor only in the event of defects in
documentation discovered within a short time after the issuance of
trust certificates (within 120 days, except in the case of obligations
having an original term of 30 years, in which case the period will not
exceed two years). Any receivable so substituted is required to have
characteristics substantially similar to the replaced receivable and
will be at least as creditworthy as the replaced receivable.
In some cases, the affected receivable would be repurchased, with
the purchase price applied as a payment on the affected receivable and
passed-through to certificateholders.
In some cases the trust will be maintained as a Financial Asset
Securitization Investment Trust (``FASIT''), a statutory entity created
by the Small Business Job Protection Act of 1996, adding sections 860H,
860J, 860K and 860L to the Code. In general, a FASIT is designed to
facilitate the securitization of debt obligations, such as credit card
receivables, home equity loans, and auto loans, and thus, allows
certain features such as revolving pools of assets, trusts containing
unsecured receivables and certain hedging types of investments. A FASIT
is not a taxable entity and debt instruments issued by such trusts,
which might otherwise be recharacterized as equity, will be treated as
debt in the hands of the holder for tax purposes. However, a trust
which is the subject of the proposed exemption will be maintained as a
FASIT only where the assets held by the FASIT will be comprised of
secured debt; revolving pools of assets or hedging investments will not
be allowed unless specifically authorized by the exemption, if granted,
so that a trust maintained as a FASIT will be maintained as an
essentially passive entity.
Trust Structure With Pre-Funding Account
Pre-Funding Accounts
7. As described briefly above, some transactions may be structured
using a pre-funding account or a capitalized interest account. If pre-
funding is used, cash sufficient to purchase the receivables to be
transferred after the closing date will be transferred to the trust by
the sponsor or originator on the closing date. During the pre-funding
period, such cash and temporary investments, if any, made therewith
will be held in a pre-funding account and used to purchase the
additional receivables, the characteristics of which will be
substantially similar to the characteristics of the receivables
transferred to the trust on the closing date. The pre-funding period
for any trust will be defined as the period beginning on the closing
date and ending on the earliest to occur of: (i) The date on which the
amount on deposit in the pre-funding account is less than a specified
dollar amount, (ii) the date on which an event of default occurs under
the related pooling and servicing agreement, or (iii) the date which is
the later of three months or ninety (90) days after the closing date.
Certain specificity and monitoring requirements described below will be
met and will be disclosed in the pooling and servicing agreement and/or
the prospectus or private placement memorandum.
For transactions involving a trust using pre-funding, on the
closing date, a portion of the offering proceeds will be allocated to
the pre-funding account generally in an amount equal to the excess of
(i) the principal amount of certificates being issued over (ii) the
principal balance of the receivables being transferred to the trust on
such closing date. In certain transactions, the aggregate principal
balance of the receivables intended to be transferred to the trust may
be larger than the total principal balance of the certificates being
issued. In these cases, the cash deposited in the pre-funding account
will equal the excess of the principal balance of the total receivables
intended to be transferred to the trust over the principal balance of
the receivables being transferred on the closing date.
On the closing date, the sponsor transfers the assets to the trust
in exchange for the certificates. The certificates are then sold to
McDonald
[[Page 18371]]
for cash or to the certificateholders directly if the certificates are
sold through McDonald as a placement agent. The cash received by the
sponsor from the certificateholders (or McDonald) for the sale of the
certificates issued by the trust in excess of the purchase price for
the receivables and certain other trust expenses, such as underwriting
or placement agent fees and legal and accounting fees, constitutes the
cash to be deposited in the pre-funding account. Such funds are either
held in the trust and accounted for separately, or are held in a sub-
trust. In either event, these funds are not part of the assets of the
sponsor.
Generally, the receivables are transferred at par value, unless the
interest rate payable on the receivables is not sufficient to service
both the interest rates to be paid on the certificates and the
transaction fees (i.e., servicing fees, trustee fees and fees to credit
support providers). In such cases, the receivables are sold to the
trust at a discount, based on an objective, written, mechanical formula
which is set forth in the pooling and servicing agreement and agreed
upon in advance between the sponsor, the Rating Agency and any credit
support provider or other insurer. The proceeds payable to the sponsor
from the sale of the receivables transferred to the trust may also be
reduced to the extent they are used to pay transaction costs (which
typically include underwriting or placement agent fees and legal and
accounting fees). In addition, in certain cases, the sponsor may be
required by the Rating Agencies or credit support providers to set up
trust reserve accounts to protect the certificateholders against credit
losses.
The pre-funding account of any trust will be limited so that the
percentage or ratio of the amount allocated to the pre-funding account,
as compared to the total principal amount of the certificates being
offered (the pre-funding limit) will not exceed 25%. The pre-funding
limit (which may be expressed as a ratio or as a stated percentage or a
combination thereof) will be specified in the prospectus or the private
placement memorandum.
Any amounts paid out of the pre-funding account are used solely to
purchase receivables and to support the certificate pass-through rate
(as explained below). Amounts used to support the pass-through rate are
payable only from investment earnings and are not payable from
principal. However, in the event that, after all of the requisite
receivables have been transferred into the trust, any funds remain in
the pre-funding account, such funds will be paid to the
certificateholders as principal prepayments. Upon termination of the
trust, if no receivables remain in the trust and all amounts payable to
certificateholders have been distributed, any amounts remaining in the
trust would be returned to the sponsor.
A dramatic change in interest rates on the receivables held in a
trust using a pre-funding account would be handled as follows. If the
receivables (other than those with adjustable or variable rates) had
already been originated prior to the closing date, no action would be
required as the fluctuations in the market interest rates would not
affect the receivables transferred to the trust after the closing date.
In contrast, if interest rates fall after the closing date, loans
originated after the closing date will tend to be originated at lower
rates, with the possible result that the receivables will not support
the certificate pass-through rate. In a situation where interest rates
drop dramatically and the sponsor is unable to provide sufficient
receivables at the requisite interest rates, the pool of receivables
would be closed. In this latter event, under the terms of the pooling
and servicing agreement, the certificateholders would receive a
repayment of principal from the unused cash held in the pre-funding
account. In transactions where the certificate pass-through rates are
variable or adjustable, the effects of market interest rate
fluctuations are mitigated. In no event will fluctuations in interest
rates payable on the receivable affect the pass-through rate for fixed
rate certificates.
The cash deposited into the trust and allocated to the pre-funding
account is invested in certain permitted investments (see below), which
may be commingled with other accounts of the trust. The allocation of
investment earnings to each trust account is made periodically as
earned in proportion to each account's allocable share of the
investment returns. As pre-funding account investment earnings are
required to be used to support (to the extent authorized in the
particular transaction) the pass-through amounts payable to the
certificateholders with respect to a periodic distribution date, the
trustee is necessarily required to make periodic, separate allocations
of the trust's earning to each trust account, thus ensuring that all
allocable commingled investment earnings are properly credited to the
pre-funding account on a timely basis.
The Capitalized Interest Account
8. In certain transactions where a pre-funding account is used, the
sponsor and/or originator may also transfer to the trust additional
cash on the closing date, which is deposited in a capitalized interest
account and used during the pre-funding period to compensate the
certificateholders for any shortfall between the investment earnings on
the pre-funding account and the pass-through interest rate payable
under the certificates.
The capitalized interest account is needed in certain transactions
since the certificates are supported by the receivables and the
earnings on the pre-funding account, and it is unlikely that the
investment earnings on the pre-funding account will equal the interest
rates on the certificates (although such investment earnings will be
available to pay interest on the certificates). The capitalized
interest account funds are paid out periodically to the
certificateholders as needed on distribution dates to support the pass-
through rate. In addition, a portion of such funds may be returned to
the sponsor from time to time as the receivables are transferred into
the trust and the need for the capitalized interest account diminishes.
Any amounts held in the capitalized interest account generally will be
returned to the sponsor and/or originator either at the end of the pre-
funding period or periodically as receivables are transferred and the
proportionate amount of funds in the capitalized interest account can
be reduced. Generally, the capitalized interest account terminates no
later than the end of the pre-funding period. However, there may be
some cases where the capitalized interest account remains open until
the first date distributions are made to certificateholders following
the end of the pre-funding period.
In other transactions, a capitalized interest account is not
necessary because the interest paid on the receivables exceeds the
interest payable on the certificates at the applicable pass-through
rate and the fees of the trust. Such excess is sufficient to make up
any shortfall resulting from the pre-funding account earning less than
the certificate pass-through rate. In certain of these transactions,
this occurs because the aggregate principal amount of receivables
exceeds the aggregate principal amount of certificates.
[[Page 18372]]
Pre-Funding Account and Capitalized Interest Account Payments and
Investments
9. Pending the acquisition of additional receivables during the
pre-funding period, it is expected that amounts in the pre-funding
account and the capitalized interest account will be invested in
certain permitted investments or will be held uninvested. Pursuant to
the pooling and servicing agreement, all permitted investments must
mature prior to the date the actual funds are needed. The permitted
types of investments in the pre-funding account and capitalized
interest account are investments which are either: (i) Direct
obligations of, or obligations fully guaranteed as to timely payment of
principal and interest by, the United States or any agency or
instrumentality thereof, provided that such obligations are backed by
the full faith and credit of the United States, or (ii) have been rated
(or the obligor has been rated) in one of the three highest generic
rating categories by a rating agency, as set forth in the pooling and
servicing agreement and as required by the Rating Agencies. The credit
grade quality of the permitted investments is generally no lower than
that of the certificates. The types of permitted investments will be
described in the pooling and servicing agreement.
The ordering of interest payments to be made from the pre-funding
and capitalized interest accounts is pre-established and set forth in
the pooling and servicing agreement. The only principal payments which
will be made from the pre-funding account are those made to acquire the
receivables during the pre-funding period and those distributed to the
certificateholders in the event that the entire amount in the pre-
funding account is not used to acquire receivables. The only principal
payments which will be made from the capitalized interest account are
those made to certificateholders if necessary to support the
certificate pass-through rate or those made to the sponsor either
periodically as they are no longer needed or at the end of the pre-
funding period when the capitalized interest account is no longer
necessary.
The Characteristics of the Receivables Transferred During the Pre-
Funding Period
10. In order to ensure that there is sufficient specificity as to
the representations and warranties of the sponsor regarding the
characteristics of the receivables to be transferred after the closing
date:
(i) All such receivables will meet the same terms and conditions
for eligibility as those of the original receivables used to create the
trust corpus (as described in the prospectus or private placement
memorandum and/or pooling and servicing agreement for such
certificates), which terms and conditions have been approved by a
Rating Agency. However, the terms and conditions for determining the
eligibility of a receivable may be changed if such changes receive
prior approval either by a majority vote of the outstanding
certificateholders or by a Rating Agency;
(ii) The transfer to the trust of the receivables acquired during
the pre-funding period will not result in the certificates receiving a
lower credit rating from the Rating Agency upon termination of the pre-
funding period than the rating that was obtained at the time of the
initial issuance of the certificates by the trust;
(iii) The weighted average annual percentage interest rate (the
average interest rate) for all of the obligations in the trust at the
end of the pre-funding period will not be more than 100 basis points
lower than the average interest rate for the obligations which were
transferred to the trust on the closing date;
(iv) The trustee of the trust (or any agency with which the trustee
contracts to provide trust services) will be a substantial financial
institution or trust company experienced in trust activities and
familiar with its duties, responsibilities, and liabilities as a
fiduciary under the Act. The trustee, as the legal owner of the
obligations in the trust, will enforce all the rights created in favor
of certificateholders of such trust, including employee benefit plans
subject to the Act.
In order to ensure that the characteristics of the receivables
actually acquired during the pre-funding period are substantially
similar to receivables that were acquired as of the closing date, the
characteristics of the additional obligations subsequently acquired
will be either (i) monitored by a credit support provider or other
insurance provider which is independent of the sponsor, or (ii) an
independent accountant retained by the sponsor will provide the sponsor
with a letter (with copies provided to the Rating Agency, McDonald and
the trustee) stating whether or not the characteristics of the
additional obligations acquired after the closing date conform to the
characteristics of such obligations described in the prospectus,
private placement memorandum and/or pooling and servicing agreement. In
preparing such letter, the independent accountant will use the same
type of procedures as were applicable to the obligations which were
transferred as of the closing date.
Each prospectus, private placement memorandum and/or pooling and
servicing agreement will set forth the terms and conditions for
eligibility of the receivables to be included in the trust as of the
related closing date, as well as those to be acquired during the pre-
funding period, which terms and conditions will have been agreed to by
the Rating Agencies which are rating the applicable certificates as of
the closing date. Also included among these conditions is the
requirement that the trustee be given prior notice of the receivables
to be transferred, along with such information concerning those
receivables as may be requested. Each prospectus or private placement
memorandum will describe the amount to be deposited in, and the
mechanics of, the pre-funding account and will describe the pre-funding
period for the trust.
Parties to Transactions
11. The originator of a receivable is the entity that initially
lends money to a borrower (obligor), such as a home-owner or automobile
purchaser, or leases property to a lessee. The originator may either
retain a receivable in its portfolio or sell it to a purchaser, such as
a trust sponsor.
Originators of receivables included in the trusts will be entities
that originate receivables in the ordinary course of their businesses,
including finance companies for whom such origination constitutes the
bulk of their operations, financial institutions for whom such
origination constitutes a substantial part of their operations, and any
kind of manufacturer, merchant, or service enterprise for whom such
origination is an incidental part of its operations. Each trust may
contain assets of one or more originators. The originator of the
receivables may also function as the trust sponsor or servicer.
12. The sponsor will be one of three entities: (i) a special-
purpose or other corporation unaffiliated with the servicer, (ii) a
special-purpose or other corporation affiliated with the servicer, or
(iii) the servicer itself. Where the sponsor is not also the servicer,
the sponsor's role will generally be limited to acquiring the
receivables to be included in the trust, establishing the trust,
designating the trustee, and assigning the receivables to the trust.
13. The trustee of a trust is the legal owner of the obligations in
the trust. The trustee is also a party to or beneficiary of all the
documents and instruments deposited in the trust, and
[[Page 18373]]
as such is responsible for enforcing all the rights created thereby in
favor of certificateholders.
The trustee will be an independent entity, and therefore will be
unrelated to McDonald, the trust sponsor, the servicer or any other
member of the Restricted Group (as defined in section III.L.). McDonald
represents that the trustee will be a substantial financial institution
or trust company experienced in trust activities. The trustee receives
a fee for its services, which will be paid by the servicer or sponsor
or out of the trust assets. The method of compensating the trustee will
be specified in the pooling and servicing agreement and disclosed in
the prospectus or private placement memorandum relating to the offering
of the certificates.
14. The servicer of a trust administers the receivables on behalf
of the certificateholders. The servicer's functions typically involve,
among other things, notifying borrowers of amounts due on receivables,
maintaining records of payments received on receivables and instituting
foreclosure or similar proceedings in the event of default. In cases
where a pool of receivables has been purchased from a number of
different originators and deposited in a trust, the receivables may be
``subserviced'' by their respective originators and a single entity may
``master service'' the pool of receivables on behalf of the owners of
the related series of certificates. Where this arrangement is adopted,
a receivable continues to be serviced from the perspective of the
borrower by the local subservicer, while the investor's perspective is
that the entire pool of receivables is serviced by a single, central
master servicer who collects payments from the local subservicers and
passes them through to certificateholders.
Receivables of the type suitable for inclusion in a trust
invariably are serviced with the assistance of a computer. After the
sale, the servicer keeps the sold receivables on the computer system in
order to continue monitoring the accounts. Although the records
relating to sold receivables are kept in the same master file as
receivables retained by the originator, the sold receivables are
flagged as having been sold. To protect the investor's interest, the
servicer ordinarily covenants that this ``sold flag'' will be included
in all records relating to the sold receivables, including the master
file, archives, tape extracts and printouts.
The sold flags are invisible to the obligor and do not affect the
manner in which the servicer performs the billing, posting and
collection procedures related to the sold receivables. However, the
servicer uses the sold flag to identify the receivables for the purpose
of reporting all activity on those receivables after their sale to
investors.
Depending on the type of receivable and the details of the
servicer's computer system, in some cases the servicer's internal
reports can be adapted for investor reporting with little or no
modification. In other cases, the servicer may have to perform special
calculations to fulfill the investor reporting responsibilities. These
calculations can be performed on the servicer's main computer, or on a
small computer with data supplied by the main system. In all cases, the
numbers produced for the investors are reconciled to the servicer's
books and reviewed by public accountants.
The underwriter (i.e., McDonald, its affiliate, or a member of an
underwriting syndicate or selling group of which McDonald or its
affiliate is a manager or co-manager) will be a registered broker-
dealer that acts as underwriter or placement agent with respect to the
sale of the certificates. Public offerings of certificates are
generally made on a firm commitment basis. Private placement of
certificates may be made on a firm commitment or agency basis. It is
anticipated that the lead and co-managing underwriters will make a
market in certificates offered to the public.
In some cases, the originator and servicer of receivables to be
included in a trust and the sponsor of the trust (although they may
themselves be related) will be unrelated to McDonald. In other cases,
however, affiliates of McDonald may originate or service receivables
included in a trust or may sponsor a trust.
Certificate Price, Pass-Through Rate and Fees
15. In some cases, the sponsor will obtain the receivables from
various originators pursuant to existing contracts with such
originators under which the sponsor continually buys receivables. In
other cases, the sponsor will purchase the receivables at fair market
value from the originator or a third party pursuant to a purchase and
sale agreement related to the specific offering of certificates. In
other cases, the sponsor will originate the receivables itself.
As compensation for the receivables transferred to the trust, the
sponsor receives certificates representing the entire beneficial
interest in the trust, or the cash proceeds of the sale of such
certificates. If the sponsor receives certificates from the trust, the
sponsor sells all or a portion of these certificates for cash to
investors or securities underwriters.
16. The price of the certificates, both in the initial offering and
in the secondary market, is affected by market forces, including
investor demand, the pass-through interest rate on the certificates in
relation to the rate payable on investments of similar types and
quality, expectations as to the effect on yield resulting from
prepayment of underlying receivables, and expectations as to the
likelihood of timely payment.
The pass-through rate for certificates is equal to the interest
rate on receivables included in the trust minus a specified servicing
fee.\40\ This rate is generally determined by the same market forces
that determine the price of a certificate. The price of a certificate
and its pass-through, or coupon, rate together determine the yield to
investors. If an investor purchases a certificate at less than par,
that discount augments the stated pass-through rate; conversely, a
certificate purchased at a premium yields less than the stated coupon.
---------------------------------------------------------------------------
\40\ The pass-through rate on certificates representing
interests in trusts holding leases is determined by breaking down
lease payments into ``principal'' and ``interest'' components based
on an implicit interest rate.
---------------------------------------------------------------------------
17. As compensation for performing its servicing duties, the
servicer (who may also be the sponsor or an affiliate thereof, and
receive fees for acting in that capacity) will retain the difference
between payments received on the receivables in the trust and payments
payable (at the pass-through rate) to certificateholders, except that
in some cases a portion of the payments on receivables may be paid to a
third party, such as a fee paid to a provider of credit support. The
servicer may receive additional compensation by having the use of the
amounts paid on the receivables between the time they are received by
the servicer and the time they are due to the trust (which time is set
forth in the pooling and servicing agreement). The servicer typically
will be required to pay the administrative expenses of servicing the
trust, including in some cases the trustee's fee, out of its servicing
compensation.
The servicer is also compensated to the extent it may provide
credit enhancement to the trust or otherwise arrange to obtain credit
support from another party. This ``credit support fee'' may be
aggregated with other servicing fees, and is either paid out of the
interest income received on the
[[Page 18374]]
receivables in excess of the pass-through rate or paid in a lump sum at
the time the trust is established.
18. The servicer may be entitled to retain certain administrative
fees paid by a third party, usually the obligor. These administrative
fees fall into three categories: (a) prepayment fees; (b) late payment
and payment extension fees; and (c) expenses, fees and charges
associated with foreclosure or repossession, or other conversion of a
secured position into cash proceeds, upon default of an obligation.
Compensation payable to the servicer will be set forth or referred
to in the pooling and servicing agreement and described in reasonable
detail in the prospectus or private placement memorandum relating to
the certificates.
19. Payments on receivables may be made by obligors to the servicer
at various times during the period preceding any date on which pass-
through payments to the trust are due. In some cases, the pooling and
servicing agreement may permit the servicer to place these payments in
non-interest bearing accounts maintained with itself or to commingle
such payments with its own funds prior to the distribution dates. In
these cases, the servicer would be entitled to the benefit derived from
the use of the funds between the date of payment on a receivable and
the pass-through date. Commingled payments may not be protected from
the creditors of the servicer in the event of the servicer's bankruptcy
or receivership. In those instances when payments on receivables are
held in non-interest bearing accounts or are commingled with the
servicer's own funds, the servicer is required to deposit these
payments by a date specified in the pooling and servicing agreement
into an account from which the trustee makes payments to
certificateholders.
20. The underwriter will receive a fee in connection with the
securities underwriting or private placement of certificates. In a firm
commitment underwriting, this fee would consist of the difference
between what the underwriter receives for the certificates that it
distributes and what it pays the sponsor for those certificates. In a
private placement, the fee normally takes the form of an agency
commission paid by the sponsor. In a best efforts underwriting in which
the underwriter would sell certificates in a public offering on an
agency basis, the underwriter would receive an agency commission rather
than a fee based on the difference between the price at which the
certificates are sold to the public and what it pays the sponsor. In
some private placements, the underwriter may buy certificates as
principal, in which case its compensation would be the difference
between what it receives for the certificates that it sells and what it
pays the sponsor for these certificates.
Purchase of Receivables by the Servicer
21. The applicant represents that as the principal amount of the
receivables in a trust is reduced by payments, the cost of
administering the trust generally increases, making the servicing of
the trust prohibitively expensive at some point. Consequently, the
pooling and servicing agreement generally provides that the servicer
may purchase the receivables remaining in the trust when the aggregate
unpaid balance payable on the receivables is reduced to a specified
percentage (usually 5 to 10 percent) of the initial aggregate unpaid
balance.
The purchase price of a receivable is specified in the pooling and
servicing agreement and will be at least equal to: (1) The unpaid
principal balance on the receivable plus accrued interest, less any
unreimbursed advances of principal made by the servicer; or (2) the
greater of (a) the amount in (1) or (b) the fair market value of such
obligations in the case of a REMIC, or the fair market value of the
receivables in the case of a trust that is not a REMIC.
Certificate Ratings
22. The certificates will have received one of the three highest
ratings available from a Rating Agency. Insurance or other credit
support (such as surety bonds, letters of credit, guarantees, or
overcollateralization) will be obtained by the trust sponsor to the
extent necessary for the certificates to attain the desired rating. The
amount of this credit support is set by the Rating Agencies at a level
that is a multiple of the worst historical net credit loss experience
for the type of obligations included in the issuing trust.
Provision of Credit Support
23. In some cases, the master servicer, or an affiliate of the
master servicer, may provide credit support to the trust (i.e. act as
an insurer). In these cases, the master servicer, in its capacity as
servicer, will first advance funds to the full extent that it
determines that such advances will be recoverable (a) out of late
payments by the obligors, (b) from the credit support provider (which
may be the master servicer or an affiliate thereof) or, (c) in the case
of a trust that issues subordinated certificates, from amounts
otherwise distributable to holders of subordinated certificates, and
the master servicer will advance such funds in a timely manner. When
the servicer is the provider of the credit support and provides its own
funds to cover defaulted payments, it will do so either on the
initiative of the trustee, or on its own initiative on behalf of the
trustee, but in either event it will provide such funds to cover
payments to the full extent of its obligations under the credit support
mechanism. In some cases, however, the master servicer may not be
obligated to advance funds but instead would be called upon to provide
funds to cover defaulted payments to the full extent of its obligations
as insurer. Moreover, a master servicer typically can recover advances
either from the provider of credit support or from future payments on
the affected assets.
If the master servicer fails to advance funds, fails to call upon
the credit support mechanism to provide funds to cover delinquent
payments, or otherwise fails in its duties, the trustee would be
required and would be able to enforce the certificateholders' rights,
as both a party to the pooling and servicing agreement and the owner of
the trust estate, including rights under the credit support mechanism.
Therefore, the trustee, who is independent of the servicer, will have
the ultimate right to enforce the credit support arrangement.
When a master servicer advances funds, the amount so advanced is
recoverable by the master servicer out of future payments on
receivables held by the trust to the extent not covered by credit
support. However, where the master servicer provides credit support to
the trust, there are protections in place to guard against a delay in
calling upon the credit support to take advantage of the fact that the
credit support declines proportionally with the decrease in the
principal amount of the obligations in the trust as payments on
receivables are passed through to investors. These safeguards include:
(a) There is often a disincentive to postponing credit losses
because the sooner repossession or foreclosure activities are
commenced, the more value that can be realized on the security for the
obligation;
(b) The master servicer has servicing guidelines which include a
general policy as to the allowable delinquency period after which an
obligation ordinarily will be deemed uncollectible. The pooling and
servicing agreement will require the master servicer to follow its
normal servicing guidelines and will set forth the master servicer's
general policy as to the period of time after which delinquent
obligations ordinarily will be considered uncollectible;
[[Page 18375]]
(c) As frequently as payments are due on the receivables included
in the trust (monthly, quarterly or semi-annually, as set forth in the
pooling and servicing agreement), the master servicer is required to
report to the independent trustee the amount of all past-due payments
and the amount of all servicer advances, along with other current
information as to collections on the receivables and draws upon the
credit support. Further, the master servicer is required to deliver to
the trustee annually a certificate of an executive officer of the
master servicer stating that a review of the servicing activities has
been made under such officer's supervision, and either stating that the
master servicer has fulfilled all of its obligations under the pooling
and servicing agreement or, if the master servicer has defaulted under
any of its obligations, specifying any such default. The master
servicer's reports are reviewed at least annually by independent
accountants to ensure that the master servicer is following its normal
servicing standards and that the master servicer's reports conform to
the master servicer's internal accounting records. The results of the
independent accountants' review are delivered to the trustee; and
(d) The credit support has a ``floor'' dollar amount that protects
investors against the possibility that a large number of credit losses
might occur towards the end of the life of the trust, whether due to
servicer advances or any other cause. Once the floor amount has been
reached, the servicer lacks an incentive to postpone the recognition of
credit losses because the credit support amount thereafter is subject
to reduction only for actual draws. From the time that the floor amount
is effective until the end of the life of the trust, there are no
proportionate reductions in the credit support amount caused by
reductions in the pool principal balance. Indeed, since the floor is a
fixed dollar amount, the amount of credit support ordinarily increases
as a percentage of the pool principal balance during the period that
the floor is in effect.
Disclosure
24. In connection with the original issuance of certificates, the
prospectus or private placement memorandum will be furnished to
investing plans. The prospectus or private placement memorandum will
contain information material to a fiduciary's decision to invest in the
certificates, including:
(a) Information concerning the payment terms of the certificates,
the rating of the certificates, any material risk factors with respect
to the certificates, and the fact that principal amounts left in the
pre-funding account at the end of the pre-funding period will be paid
to certificateholders as a repayment of principal;
(b) A description of the trust as a legal entity and a description
of how the trust was formed by the seller/servicer or other sponsor of
the transaction;
(c) Identification of the independent trustee for the trust;
(d) A description of the receivables contained in the trust,
including the types of receivables, the diversification of the
receivables, their principal terms, and their material legal aspects,
and a description of any pre-funding account used or capitalized
interest account used in connection with a pre-funding account;
(e) A description of the sponsor and servicer;
(f) A description of the pooling and servicing agreement, including
a description of the seller's principal representations and warranties
as to the trust assets, including the terms and conditions for
eligibility of any receivables transferred during the pre-funding
period and the trustee's remedy for any breach thereof; a description
of the procedures for collection of payments on receivables and for
making distributions to investors, and a description of the accounts
into which such payments are deposited and from which such
distributions are made; a description of permitted investments for any
pre-funding account or capitalized interest account; identification of
the servicing compensation and any fees for credit enhancement that are
deducted from payments on receivables before distributions are made to
investors; a description of periodic statements provided to the
trustee, and provided to or made available to investors by the trustee;
and a description of the events that constitute events of default under
the pooling and servicing contract and a description of the trustee's
and the investors' remedies incident thereto;
(g) A description of the credit support;
(h) A general discussion of the principal federal income tax
consequences of the purchase, ownership and disposition of the pass-
through securities by a typical investor;
(i) A description of the underwriters' plan for distributing the
pass-through securities to investors;
(j) Information about the scope and nature of the secondary market,
if any, for the certificates; and
(k) A statement as to the duration of any pre-funding period and
the pre-funding limit for the trust.
25. Reports indicating the amount of payments of principal and
interest are provided to certificateholders at least as frequently as
distributions are made to certificateholders. Certificateholders will
also be provided with periodic information statements setting forth
material information concerning the underlying assets, including, where
applicable, information as to the amount and number of delinquent and
defaulted loans or receivables.
26. In the case of a trust that offers and sells certificates in a
registered public offering, the trustee, the servicer or the sponsor
will file such periodic reports as may be required to be filed under
the Securities Exchange Act of 1934. Although some trusts that offer
certificates in a public offering will file quarterly reports on Form
10-Q and Annual Reports on Form 10-K, many trusts obtain, by
application to the Securities and Exchange Commission (SEC), a complete
exemption from the requirement to file quarterly reports on Form 10-Q
and a modification of the disclosure requirements for annual reports on
Form 10-K. If such an exemption is obtained, these trusts normally
would continue to have the obligation to file current reports on Form
8-K to report material developments concerning the trust and the
certificates and copies of the statements sent to certificateholders.
While the SEC's interpretation of the periodic reporting requirements
is subject to change, periodic reports concerning a trust will be filed
to the extent required under the Securities Exchange Act of 1934.
27. At or about the time distributions are made to
certificateholders, a report will be delivered to the trustee as to the
status of the trust and its assets, including underlying obligations.
Such report will typically contain information regarding the trust's
assets (including those purchased by the trust from any pre-funding
account), payments received or collected by the servicer, the amount of
prepayments, delinquencies, servicer advances, defaults and
foreclosures, the amount of any payments made pursuant to any credit
support, and the amount of compensation payable to the servicer. Such
report also will be delivered to or made available to the rating agency
or agencies that have rated the trust's certificates.
In addition, promptly after each distribution date,
certificateholders will receive a statement prepared by the servicer,
paying agent or trustee summarizing information regarding the trust and
its assets, including underlying receivables. Such statement
[[Page 18376]]
will typically contain information regarding payments and prepayments,
delinquencies, the remaining amount of the guaranty or other credit
support and a breakdown of payments between principal and interest.
Forward Delivery Commitments
28. To date, no forward delivery commitments have been entered into
by McDonald in connection with the offering of any certificates, but
McDonald may contemplate entering into such commitments. The utility of
forward delivery commitments has been recognized with respect to
offering similar certificates backed by pools of residential mortgages,
and McDonald may find it desirable in the future to enter into such
commitments for the purchase of certificates.
Secondary Market Transactions
29. It is McDonald's normal policy to attempt to make a market for
securities for which it is lead or co-managing underwriter, and it is
McDonald's intention to make a market for any certificates for which it
is lead or co-managing underwriter, although it is under no obligation
to do so. At times McDonald will facilitate sales by investors who
purchase certificates if McDonald has acted as agent or principal in
the original private placement of the certificates and if such
investors request McDonald's assistance.
Retroactive Relief
30. McDonald represents that it has not engaged in transactions
related to mortgage-backed and asset-backed securities based on the
assumption that retroactive relief would be granted prior to the date
of their application. However, McDonald requests the exemptive relief
granted to be retroactive to January 4, 1999, the date of their
application, and would like to rely on such retroactive relief for
transactions entered into prior to the date exemptive relief may be
granted.
Summary
31. In summary, the applicant represents that the transactions for
which exemptive relief is requested satisfy the statutory criteria of
section 408(a) of the Act due to the following:
(a) The trusts contain ``fixed pools'' of assets. There is little
discretion on the part of the trust sponsor to substitute receivables
contained in the trust once the trust has been formed;
(b) In the case where a pre-funding account is used, the
characteristics of the receivables to be transferred to the trust
during the pre-funding period will be substantially similar to the
characteristics of those transferred to the trust on the closing date,
thereby giving the sponsor and/or originator little discretion over the
selection process, and compliance with this requirement will be assured
by the specificity of the characteristics and the monitoring mechanisms
contemplated under the proposed exemption. In addition, certain cash
accounts will be established to support the certificate pass-through
rate and such cash accounts will be invested in short-term,
conservative investments; the pre-funding period will be of a
reasonably short duration; a pre-funding limit will be imposed; and any
Internal Revenue Service requirements with respect to pre-funding
intended to preserve the passive income character of the trust will be
met. The fiduciary of the plans making the decision to invest in
certificates is thus fully apprised of the nature of the receivables
which will be held in the trust and has sufficient information to make
a prudent investment decision.
(c) Certificates in which plans invest will have been rated in one
of the three highest rating categories by a rating agency. Credit
support will be obtained to the extent necessary to attain the desired
rating;
(d) All transactions for which McDonald seeks exemptive relief will
be governed by the pooling and servicing agreement, which is made
available to plan fiduciaries for their review prior to the plan's
investment in certificates;
(e) Exemptive relief from sections 406(b) and 407 for sales to
plans is substantially limited; and
(f) McDonald anticipates that it will make a secondary market in
certificates (although it is under no obligation to do so).
Notice to Interested Persons: The applicant represents that any
securities offered in reliance upon the proposed exemption prior to the
date the final exemption is published in the Federal Register shall
disclose in the offering memorandum or prospectus: (a) The availability
of the proposed exemption; (b) the right of potentially interested plan
fiduciaries to comment on the proposed exemption; and (c) information
on how an interested plan fiduciary can obtain a copy of the proposed
exemption (once it is available) from McDonald.
Once this proposed exemption is granted, a copy of the exemption
published in the Federal Register shall be distributed to any current
or prospective plan investor in a security offered in reliance upon the
exemption upon request of such investor, and each offering memorandum
or prospectus offering securities in reliance upon the exemption shall
describe and disclose the availability of the exemption.
Comments and requests for a hearing must be received by the
Department not later than 45 days from the date of publication of this
notice of proposed exemption in the Federal Register.
For Further Information Contact: Gary Lefkowitz of the Department,
telephone (202) 219-8881. (This is not a toll-free number.)
General Information
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of the Act and/or section 4975(c)(2) of the Code
does not relieve a fiduciary or other party in interest or disqualified
person from certain other provisions of the Act and/or the Code,
including any prohibited transaction provisions to which the exemption
does not apply and the general fiduciary responsibility provisions of
section 404 of the Act, which, among other things, require a fiduciary
to discharge his duties respecting the plan solely in the interest of
the participants and beneficiaries of the plan and in a prudent fashion
in accordance with section 404(a)(1)(b) of the Act; nor does it affect
the requirement of section 401(a) of the Code that the plan must
operate for the exclusive benefit of the employees of the employer
maintaining the plan and their beneficiaries;
(2) Before an exemption may be granted under section 408(a) of the
Act and/or section 4975(c)(2) of the Code, the Department must find
that the exemption is administratively feasible, in the interests of
the plan and of its participants and beneficiaries, and protective of
the rights of participants and beneficiaries of the plan;
(3) The proposed exemptions, if granted, will be supplemental to,
and not in derogation of, any other provisions of the Act and/or the
Code, including statutory or administrative exemptions and transitional
rules. Furthermore, the fact that a transaction is subject to an
administrative or statutory exemption is not dispositive of whether the
transaction is in fact a prohibited transaction; and
(4) The proposed exemptions, if granted, will be subject to the
express condition that the material facts and representations contained
in each application are true and complete, and that each application
accurately describes all material terms of the transaction which is the
subject of the exemption.
[[Page 18377]]
Signed at Washington, DC, this 30th day of March, 2000.
Ivan Strasfeld,
Director of Exemption Determinations, Pension and Welfare Benefits
Administration, U.S. Department of Labor.
[FR Doc. 00-8448 Filed 4-6-00; 8:45 am]
BILLING CODE 4510-29-P