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Fidelity Advisor Korea Fund, Inc. (Mar. 7, 2001) (Redemption Fees)

Fidelity Advisor Korea Fund, Inc. (Mar. 7, 2001) (Redemption Fees)

Wednesday, 07 March 2001 08:00

No-Action Letter under:
Investment Company Act –
Sections 2(a)(32), 5(a)(1),
11(a), 18(f)(1), 34(b);
Rule 11a-3

Fidelity Advisor Korea Fund, Inc

March 7, 2001

RESPONSE OF THE OFFICE OF CHIEF
COUNSEL DIVISION OF INVESTMENT MANAGEMENT
Our Ref. No. 00-511167
File No. 811-8608

Your letter dated February 22, 2001 requests our assurance that we would not recommend enforcement action to the Commission under Section 34(b), Section l8(f)(1), or Section 11 (a) of the Investment Company Act of 1940 (the “Act”) or Rule lla-3 under the Act, if, upon the reorganization of the Fidelity Advisor Korea Fund, Inc. (the “Fund”), a closed-end investment company, into an open-end series (the “New Fund”) of Fidelity Advisor Series VIII, the New Fund imposes a 4% redemption fee on shares that it issues to Fund shareholders in exchange for their Fund shares and that are redeemed or exchanged out of the New Fund fewer than 200 calendar days after the reorganization (the “4% Redemption Fee”).1

Factual Background –The Reorganization

You state that the Fund commenced operations on October 31, 1994. Since August 1998, the Fund’s shares generally traded at a significant discount to net asset value.2 To eliminate the discount, the Fund’s manager, Fidelity Management & Research Company (“FMR”),3 proposed to reorganize the Fund as an open-end fund (the “Reorganization”). The Fund’s directors and shareholders and the New Fund’s trustees and initial shareholder approved the Reorganization, which was completed on June 30, 2000.4 To effect the Reorganization, the New Fund issued Class A Shares (“Reorganization Class A shares”) to all Fund shareholders (“Reorganization Class A shareholders”) in exchange for their Fund shares5

You state that the investment adviser to the Fund, FMR, is also the investment adviser to the New Fund. You also state that the investment objectives and investment policies and restrictions of the New Fund are substantially the same as those that the Fund had,6 except that certain fundamental and non-fundamental investment restrictions were changed to conform to those typically associated with Fidelity’s open-end international equity funds.

The 4% Redemption Fee

You state that the 4% Redemption Fee will apply to Reorganization Class A shares that are redeemed or exchanged out of the New Fund fewer than 200 days after the Reorganization. The 4% Redemption Fee will not be imposed on Reorganization Class A shares that are held for a longer period, on other Class A shares,7 or on other classes of shares that the New Fund issues. You state that the 4% Redemption Fee will be paid to the New Fund, and will benefit all shareholders of the New Fund who have not previously redeemed or exchanged all of their shares, including Reorganization Class A shareholders who remain in the New Fund.

Reasons for the 4% Redemption Fee

You assert that when a closed-end fund’s shares trade at a significant discount to not asset value, arbitrageurs and other short-term traders historically have purchased shares of the closed-end fund in anticipation of an open-ending of the fund. You assert that these traders use this opportunity to profit from the difference between the cost of purchasing closed-end fund shares at a discount to net asset value, and the proceeds of redeeming open-end fund shares at net asset value.

You assert that this short-term trading may be harmful to a new open-end fund that is created from a closed-end fund trading at a discount, such as the New Fund, and to shareholders who invest in the new fund for the long term, because: (a) the new fund may be forced to sell a substantial amount of its portfolio securities to meet arbitrage-related redemptions and exchanges; (b) the forced sales of portfolio securities may occur at inopportune times and, therefore, disrupt portfolio management strategies;8 (c) the new fund may incur high costs in effecting the forced sales,9 including brokerage commissions, adverse impacts on the market prices of some securities as the result of the forced sales, and losses of profits or invested capital; (d) costs related to the market impact of forced sales may be magnified for a fund that invests in emerging markets where securities are thinly traded;10 and (e) without a redemption fee or similar measure, these high costs and other adverse effects will be borne by the new fund and its long-term investors rather than the arbitrageurs and other short-term traders who cause them. You assert that the viability of the New Fund could suffer as a result of this kind of short-term trading.

You state that when FMR, the directors of the Fund, and the trustees of the New Fund considered the Reorganization, they had reason to believe that arbitrageurs and other short-term traders were purchasing shares of the Fund. FMR proposed the 4% Redemption Fee to protect the New Fund and shareholders who choose to remain investors in the New Fund from the activities of arbitrageurs and other short-term traders.11 Specifically, the 4% Redemption Fee was intended, in part, to discourage arbitrage and other short-term trading activity by making this activity less profitable. To the extent that arbitrage and other short-term trading would still occur,12 the 4% Redemption Fee was intended to protect the New Fund and shareholders who choose to remain investors in the New Fund by recouping some of the costs of the related redemptions and exchanges.13 You state that the 4% Redemption Fee would force redeeming shareholders, rather than shareholders who choose to remain investors in the New Fund, to bear a portion of the costs imposed by their redemptions.

You state that FMR proposed, and the Fund’s directors and the New Fund’s trustees agreed, to impose the 4% Redemption Fee on redemptions and exchanges that occur during the 199 days after the Reorganization, the time period during which FMR had estimated that arbitrage-related redemptions or exchanges of the Reorganization Class A shares were most likely to occur.14 You state that the 199-day duration formed part of FMR’s recommendation to the directors of the Fund and the trustees of the New Fund regarding the terms of the 4% Redemption Fee.

Costs Recouped by the 4% Redemption Fee

You state that the payment of the 4% Redemption Fee to the New Fund will help offset anticipated portfolio and administrative costs associated with potentially large levels of redemptions (including exchanges) of Reorganization Class A shares during the 199 days after the Reorganization, as well as investment opportunity and market costs that may result from the forced liquidation of portfolio securities to effect these redemptions (including exchanges) during that period (collectively, “Portfolio/Administrative Costs”). To project the New Fund’s Portfolio/Administrative Costs, FMR evaluated complex-wide average trading costs (including market impact, as well as commissions and other transaction-related expenses) incurred by the Fidelity mutual funds and other accounts managed by FMR and its affiliates in connection with trading securities on Korean markets over the prior three years. IS In April 2000, two months after the trustees of the New Fund had approved the terms of the 4% Redemption fee, the trustees reviewed the methodology used to support the 4% Redemption Fee and the results of applying that methodology to FMR’ s trading history in securities on Korean markets over the prior three years15. The trustees determined that the 4% Redemption Fee was reasonably related to the Portfolio! Administrative Costs expected to be incurred by the New Fund from redemptions (including exchanges) by Reorganization Class A shareholders.16 You state that the reasonableness of the terms of the 4% Redemption Fee was an appropriate matter for the business judgment of the trustees of the New Fund, with input from FMR.

Your Assertions Regarding the Legality of the 4% Redemption Fee

You generally assert that a fund may impose a redemption fee in an amount that is reasonably related to anticipated, legitimate, transaction-related costs associated with redemptions. You further assert that the imposition of a redemption fee that is greater than 2% of the net asset value of the redeemed shares complies with the Act if the fund’s board determines that the fee is reasonably related to the anticipated costs associated with redemptions.

You specifically assert that the special circumstances arising out of the Reorganization of the Fund into the open-end New Fund justify the imposition of the temporary 4% Redemption Fee. FMR anticipated a large level of redemptions and exchanges by arbitrageurs and other Reorganization Class A shareholders who would want to realize the immediate increase in the value of their shares resulting from the Reorganization. You assert that the New Fund’s trading costs associated with these redemptions and exchanges would generally be higher than those of other types of funds because the New Fund is a single-country emerging markets fund. Thus, you assert that the 4% Redemption Fee is reasonably necessary to discourage arbitrage and other short term trading activity, reimburse the New Fund for the high costs and other adverse effects of this activity, and protect the interests of non-redeeming shareholders and the viability of the New Fund. Finally, you assert that the 4% Redemption Fee complies with the Act and rules and related interpretations because FMR and the trustees of the New Fund determined that the 4% Redemption Fee is Reasonably related to the New Fund’s anticipated Portfolio/Administrative Costs of redemptions and exchanges by Reorganization Class A shareholders during the 199 days following the Reorganization.

  1. Section 34(b)

You state that the New Fund’s registration statement represents that the New Fund is an “open-end company,” as defined in Section 5(a)(1) of the Act,17 and that the New Fund issues “redeemable securities,” as defined in Section 2(a)(32) of the Act.18 You assert that the New Fund’s imposition of the 4% Redemption Fee is not inconsistent with these representations, and that the representations therefore do not implicate Section 34(b) of the Act.19

In particular, you assert that the imposition of the 4% Redemption Fee would not prevent a shareholder who redeems or exchanges from receiving “approximately his proportionate share of the issuer’s current net assets,” as required by Section 2(a)(32). You state that the price received by a shareholder who redeems or exchanges Reorganization Class A shares would be based on the current net asset value of the New Fund. You assert that under the special circumstances of this case, the 4% Redemption Fee reasonably reflects the costs attributable to the redeeming shareholder’s own actions. You further assert that the New Fund’s statements about its open-end status and the redeemable nature of its shares are not untrue or misleading because they are accompanied by full disclosure of the 4% Redemption Fee.

  1. Section 18(f)(1)

You assert that the 4% Redemption Fee raises an issue under Section 18(f)(1) of the Act concerning whether the imposition of the 4% Redemption Fee may create a separate class of senior securities with respect to the distribution of the New Fund’s assets.20 Reorganization Class A shares that are redeemed or exchanged out of the New Fund fewer than 200 calendar days after the Reorganization are subject to the 4% Redemption Fee. Other shares, such as Class A shares that are otherwise acquired, redeemed, or exchanged, or shares of other classes, are not subject to the 4% Redemption Fee.

You assert that the shares that are not subject to the 4% Redemption Fee should not be deemed to constitute a separate class of senior securities under Section 18(f)(1).21 You assert that FMR and the trustees of the New Fund may distinguish between Reorganization Class A shareholders and other investors in Class A shares or other classes of shares, because Reorganization Class A shareholders (who received their shares of the New Fund based on their former holdings of Fund shares) may have a substantially greater incentive to redeem or exchange shares of the New Fund shortly after the Reorganization. You note that the staff has agreed not to recommend enforcement action under Section 18(f)(1) with respect to a 2% redemption fee imposed on shares held for less than one year when, among other things, the fund’s directors had adopted a resolution determining that “the size of the 2% [redemption fee] is reasonable in relation to the anticipated out-of-pocket costs to the [f)und of redemptions of purchased shares held less than one year.22

You assert that FMR and the New Fund’s trustees determined that the 4% Redemption Fee is reasonably related to the New Fund’s anticipated Portfolio/Administrative Costs of redemptions (including exchanges) by Reorganization Class A shareholders occurring fewer than 200 days after the Reorganization. You also assert that the 4% Redemption Fee applies equally to all Reorganization Class A shareholders who initiate such redemptions or exchanges.

In addition, you assert that the 4% Redemption Fee does not create a “senior security” because, by definition, a senior security that is stock must have “priority over any other class as to distribution of assets or payment of dividends.,,23 You assert that the term “priority” implicitly requires a liquidation preference, or other right under which the value of senior securities must be paid in full before junior securities are paid.24 You assert that the holders of shares not subject to the 4% Redemption Fee are not entitled to any liquidation preference or other right to receive a payment of assets or dividends before the holders of shares subject to the 4% Redemption Fee, and therefore the shares not subject to the 4% Redemption Fee do not have priority over other shares.

  1. Section 11(a) and Rule 11a-3

Finally, you assert that the New Fund’s imposition of the 4% Redemption Fee on exchanges of Reorganization Class A shares will not violate Section 11(a) of the Act25 because the fee will be consistent with Rule 11 a-3 under the Act.26 You assert that, in light of the special circumstances applicable here, the 4% Redemption Fee is reasonably related to the costs to the New Fund of processing the types of redemptions and exchanges of the Reorganization Class A shares for which the fee is charged, as generally required by Rule Ila-3(b)(2)27 that the 4% Redemption Fee is reasonably intended to compensate the New Fund for Portfolio/Administrative Costs that are directly related to the redemptions and exchanges, as generally required by Rule11 a-3(a)(7).28

Discussion

During the legislative hearings on the Act, the Commission characterized the right of mutual fund shareholders to receive the net asset value of their shares upon redemption as “the most important single attribute which induces purchases of the securities of open-end companies.,,29 The Commission further stated that “the importance of the redemption feature of open-end securities appears to the Commission beyond question.30

Congress incorporated the Commission’s views into the Act by requiring that the securities of an open-end investment company be “redeemable”,31 which in turn requires that fund shareholders receive approximately their proportionate share of the issuer’s current net assets, or its equivalent in cash, upon redemption.32 The effect of these requirements, as the Commission has recognized, is that:

The imposition of any charge or fee upon the redemption of fund shares raises serious questions. …A fee payable upon redemption may take the securities issued by the fund outside the definition of a “redeemable security.,,33

Because the imposition of a redemption fee by an open-end fund raises serious questions about the redeemability of the fund’s shares, the Commission has adopted rules that permit funds to impose only limited redemption fees, and the staff has taken no-action positions consistent with those rules. The Commission and staff positions recognize certain principles, including that:

  • A redemption fee must be paid directly to the fund.34 It may not be paid to other persons, such as the fund’s principal underwriter.35
  • A redemption fee may recoup or offset only limited types of administrative expenses caused by shareholder.redemptions,36 i.e., the following expenses that are “directly related to” processing shareholder redemptIon requests: 37

(a) brokerage expenses incurred in connection with the liquidation of portfolio securities necessitated by the redemption; (b) processing or other transaction costs incident to the redemption and not covered by any administrative fee; (c) odd-lot premiums; (d) transfer taxes; (e) administration fees; (f) custodian fees; and (g) registrar and transfer-agent fees (collectively, “Administrative Costs”).38

  • A fund may not impose a redemption fee greater than the lesser of: (a) an amount approximating, or “reasonably related to,”39 the anticipated, specific Administrative Costs identified above; or (b) 2% of the net asset value of the redeemed shares,40 even if the fund’s approximate, anticipated Administrative Costs exceed 2%. As the Commission observed in a similar context:

While the 2 percent ceiling may not cover the cost of effecting redemptions where the amount redeemed is small, it strikes an appropriate balance between recouping legitimate investment-related expenses and addressing the redeemability concerns of the Act.41

In sum, an open-end fund generally may not impose a redemption fee unless it is (a) paid directly to the fund, and (b) no greater than the lesser of: (i) an amount approximating, or reasonably related to, the anticipated, specific Administrative Costs identified above; or (ii) 2% of the net asset value of the redeemed shares.

Limited Exception

We believe that the Reorganization presents special circumstances that warrant a limited exception to the staff’s general position on redemption fees. Several factors in combination heightened the possibility that short-term traders could adversely affect the interests of the New Fund’s long-term investors and the viability of the New Fund. The closed-end Fund’s shares had been trading at a significant discount to net asset value. FMR, the Fund’s directors, and the New Fund’s trustees believed that, soon after the Reorganization, a substantial number of arbitrageurs and other Fund shareholders would redeem or exchange the shares of the New Fund that they would acquire in the Reorganization. Because the New Fund is a single-country emerging markets fund, it would likely incur significant costs in selling large amounts of portfolio securities to meet the anticipated redemptions and exchanges.

Accordingly, on the basis of the particular facts and representations set forth in your letter, but without necessarily agreeing with your legal analysis, we would not recommend enforcement action to the Commission against the New Fund under Section 34(b). Section 18(f)(1), or Section 11(a) of the Act or Rule lla-3 under the Act if the New Fund imposes the 4% Redemption Fee as described above.42

Our position is based on, and limited by, the facts and representations contained in your letter. We particularly rely on your representations that:

(a) The Reorganization involved the conversion of the closed-end Fund into the open-end New Fund;

(b) Because the Fund’s shares traded at a significant discount to net asset value, FMR. the Fund’s directors, and the New Fund’s trustees believed that, soon after the Reorganization, a substantial number of arbitrageurs and other Fund shareholders would redeem or exchange the shares of the New Fund that they would acquire in the Reorganization;

(c) The high costs associated with forced asset sales would be magnified by the New Fund’s concentration of its assets primarily in a single emerging market;

(d) FMR, the Fund’s directors, and the New Fund’s trustees concluded that the 4% Redemption Fee was necessary to discourage short-term trading, compensate the New Fund for the high costs and other adverse effects of that trading, and protect the interests of non-redeeming shareholders and the viability of the New Fund;

(e) FMR and the New Fund’s Trustees determined that the 4% Redemption Fee was reasonably related to the Portfolio/Administrative Costs expected to be incurred by the New Fund from the anticipated redemptions and exchanges during the 199 days after the Reorganization;

(f) The 199-day duration of the 4% Redemption Fee is a limited period that reflected FMR’s estimate of the time during which arbitrage-related redemptions or exchanges of Reorganization Class A shares were most likely to occur; and

(g) The holders of a majority of the Fund’s outstanding shares (who had the right to receive the Reorganization Class A shares subject to the 4% Redemption Fee) approved the Reorganization after receiving a proxy statement that disclosed the 4% Redemption Fee and other matters.

Thomas M. J. Kerwin
Senior Counsel

Footnotes

1 This letter confirms the position that the staff communicated orally to you before the reorganization became effective, i.e., before the New Fund began to impose the 4% Redemption Fee.
2 You state that the discount at which the Fund’s shares traded generally ranged from 15% to 25% during the twelve months ended December 31,1999. You state that the discount had narrowed to 9.3% as of March 31, 2000, after the Fund announced publicly on February 10,2000 that the Fund’s directors had approved a proposal to seek shareholder approval to reorganize the fund into an open-end fund, and that the 4% Redemption Fee would apply.
3 You state that FMR is registered with the Commission as an investment adviser under the Investment Advisers Act of 1940.
4 You state that the directors of the Fund approved the Reorganization, including the 4% Redemption Fee, on February 10, 2000, and that the trustees of the New Fund approved the Reorganiztaion and the 4% Redemption Fee on Februarry 17, 2000. The holders of a majority of the Fund’s outstanding shares approved the Reorganization on June 14, 2000, after receiving a proxy statementthat disclosed the 4% Redemption Fee and other matters. Shareholders did not vote on the 4% Redemption Fee as a separate item from the Reorganization. You state that the initial shareholder of the New Fund approved the Reorganization, including the 4% Redemption Fee, before the Reorganization.
5 You state that the New Fund issued the Reorganization Class A shares to each Fund shareholder in an amount that reflected the shareholder’s share of the net asset value of the Fund at the closing date of the Reorganization, based on the relative net asset values of the Reorganization Class A shares and the Fund shares. You state that the New Fund has offered Reorganization Class A shareholders and other investors the opportunity to purchase additional Class A shares and other classes of shares.
6 The Fund’s Form N-23c-3, dated February 19, 1999, states that the investment objective of the Fund was to seek long-term capital appreciation by investing primarily in equity and debt securities of Korean issuers. The New Fund’s prospectus, filed June 28, 2000, states that the investment objective of the New Fund is to seek long term capital appreciation, and that the New Fund’s principal investment strategies include normally investing at least 65 % of its total assets in equity and debt securities of Korean issuers.
7 You state that the New Fund can distinguish between Reorganization Class A shares and other Class A shares through a number of methods, including procedures for tracing beneficial ownership through intermediaries such as broker-dealers or banks (such as the fund networking services of the National Securities Clearing Corporation).
8 The New Fund’s prospectus, filed June 28, 2000, notes that “short-term or excessive trading into and out of the fund may harm performance by disrupting portfolio management strategies and by increasing expenses.” The prospectus adds that “the fund may reject any purchase orders…, particularly from market timers or investors who, in FMR’s opinion, have a pattern of short-term or excessive trading of whose trading has been or may be disruptive to the fund.”
9 See id. The New Fund’s prospectus, filed June 28, 2000, states that the 4% Redemption Fee is a “trading fee” that “is paid to the fund rather than Fidelity, and is designed to offset the brokerage commissions, market impact, and other costs associated with fluctuations in fund asset levels and cash flow caused by short-term shareholder trading.
10 0 You assert that a single-country emerging markets fund would generally incur trading costs higher than those incurred by other types of funds.
11 1 You state the FMR and the Fund’s directors from time to time considered alternatives to imposing the 4% Redemption Fee, but ultimately decided that without the 4% Redemption Fee, the Reorganization of the Fund would not have been in the best interest of shareholders.
12 2 You state that FMR and the Fund’s directors and the New Fund’s trustees had reason to believe that some arbitrageurs would retain their Fund shares or buy additional shares even after the announcement of the 4% Redemption Fee.
13 3 See supra note 9.
14 You also assert that FMR and the Fund’s directors and the Fund’s directors and the new Fund’s trustees believed that a holding period in this general range may tend to confirm that a shareholder has engaged in short-term trading that may increase costs to the New Fund to a significant degree.
15 You state that for this purpose, trading costs were based on the difference between the price received in the market for each sale, and the price of the security at the time the decision to sell was made. The methodology used by FMR compared trade execution prices to the closing price of the security on the day before FMR first starts selling the security. You further state that the total cost measured by this methodology approximates the total cost to remaining shareholders involved in satisfying a redemption, assuming that Reorganization Class A shares are redeemed at net asset value based on closing market price on a given day, and that fund management places sell trades to satisfy the redemption on the next business day. You assert that the 4 % Redemption Fee recognizes that FMR would have less discretion than under normal trading circumstances over the timing of when to sell the New Fund’s portfolio securities because of the anticipated high levels of redemptions (including exchanges) following the Reorganization. You state that FMR believes that this “package cost” methodology is :.the most appropriate measure of the market impact costs because in these circumstances the methodology captures the change in a security’s price over the entire period required to satisfy the trade order.
16 . You state that in February 2000, when the trustees of the New Fund approved the terms of the 4 % Redemption Fee, the trustees received a summary of FMR’s methodology, including a description of the manner in which market impact costs were estimated, and the results of applying the methodology to FMR’s trading history in securities on Korean markets over the prior three years.
17 7 Section 5(a)(I) of the Act defines “open-end company” as “a management company which is offering for sale or has outstanding any redeemable security of which it is the issuer.”
18 Section 2(a)(32) of the Act defines “redeemable security” as “any security, other than short-term paper, under the terms of which the holder, upon its presentation to the issuer or to a person designated by the issuer, is entitled (whether absolutely or only out of surplus) to receive approximately his proportionate share of the issuer’s current net assets, or the cash equivalent thereof.”
19 9 Section 34(b) of the Act, in relevant part, makes it unlawful for “any person to make any untrue statement of a material fact in any registration statement, application, report, account, record, or other document filed or transmitted” under the Act.
20 Section 18(f)(1) of the Act makes it “unlawful for any registered open-end company to issue any class of senior security or to sell any senior security of which it is the issuer,” except for certain bank borrowings with 300% asset coverage.
21 Section 18(g) of the Act defines “senior security” to include, in relevant part, “any stock of a class having priority over any other class as to distribution of assets or payment of dividends.”
22 See Neuberger & Berman Genesis Fund, Inc. (pub. avail. Sept. 27, 1988).
23 See note 21.
24 You state that senior securities having priority over junior securities normally include preferred securities or debt securities.
25 Section 11 (a) of the Act generally makes it unlawful for a registered open-end investment company to make an exchange offer to a shareholder of the same company, or to a shareholder of another open-end company, “on any basis other than the relative net asset values of the respective securities to be exchanged,” except with Commission approval, or in accordance with rules prescribed by the Commission.
26 Rule lla-3(b)(2) under the Act generally permits a registered open-end investment company that makes an exchange offer to a shareholder of the same company, or to a shareholder of another open-end company within the same group of investment companies, to charge a redemption fee on the exchanged security if, among other conditions, “any scheduled variation of [the] redemption fee [is] reasonably related to the costs to the fund of processing the type of redemptions for which the fee is charged.” See also Neuberger & Berman Genesis Fund, Inc., supra note 22 (fund board determined that the size of the 2 % redemption fee is reasonable in relation to the fund’s anticipated out-of-pocket costs of redemptions). Rule lla-3(a)(7) defines a redemption fee as “any fee (other than a sales load, deferred sales load or administrative fee) that is paid to the fund and is reasonably intended to compensate the fund for expenses directly related to the redemption of fund shares.”
27 See Rule lla-3(b)(2), supra note 26. You assert that the 4% Redemption Fee may be viewed as a “scheduled variation” of a redemption fee because the 4% Redemption Fee would not apply to every class of stock issued by the New Fund, but would apply only to Reorganization Class A shares that are redeemed or exchanged during the 199 days after the Reorganization.
28 See Rule 11a-3(a)(7), supra note 26.
29 See Investment Trusts and Investment Companies: Hearings on S. 3580 Before a Subcomm. of the Senate Comm. On Banking and Currency, 76th Cong., 3d Sess. at 985 (1940) (memorandum introduced by David Schenker, Chief Counsel, SEC Investment Trust Study) (“Schenker Testimony”). See also Offers of Exchange Involving Registered Open-End Investment Companies and Unit Investment Trusts, Investment Company Act Release No. 16504, at n.43 (July 29, 1988) (revised proposal of Rule 11a-3) (“the shareholder’s right of redemption is fundamental to the concept of an open-end investment company”).
30 See Schenker Testimony, supra note 29.
31 See Section 5(a)(1), supra note 17.
32 See Section 2(a)(32), supra note 18.
33 See Investment Company Act Release No. 16504, supra note 29, at text accompanying n.43 and text preceding n.45 (revised proposal of Rule lla-3).
34 See Rule lla-3(a)(7), supra note 26 (definition of “redemption fee”); Exemption for Certain Open-End Management Investment Companies to Impose Deferred Sales Loads, Investment Company Act Release No. 22202 at n.9 (Sept. 9, 1996) (adopting amendments to Rule 6c-l0) (“[t]he rule is not applicable to certain charges that may be imposed by a mutual fund to compensate the fund for the cost of redeeming shares and that are paid directly to the fund”); SEC, REPORT ON THE PUBLIC POLICY IMPLICATIONS OF INVESTMENT COMPANY GROWTH, H.R. REP. No. 2337, 89th Cong., 2d Sess. at 58 n.156 (1966) (“PPI Report”) (“redemption fees are paid directly to the fund and inure to the benefit of its remaining shareholders”). See also Rule 23c-3(b)(I) under the Act (closed-end interval fund may deduct from repurchase proceeds a repurchase fee not to exceed 2% of the proceeds; fee must be paid to the fund).
35 See Investment Company Act Release No. 16504, supra note 29, at text accompanying n.43 and text preceding n.45 (revised proposal of Rule lla-3).
36 See Investment Company Act Release No. 16504, supra note 29, at text accompanying n.45 (revised proposal of Rule lla-3). (purpose of redemption fee is to “compensate the fund for its expenses incident to redemption of fund shares” and “to offset the costs of redeeming fund shares”); Separate Accounts Funding Flexible Premium Variable Life Insurance Contracts, Investment Company Act Release No. 15651, at text following n.74 (Mar. 30,1987) (adopting amendments to temporary Rule 6e-3(T¬ª (recognizing that staff informally has taken position that a fund may impose a limited redemption fee to “cover legitimate expenses that may be incurred to make the payment in cash to a redeeming shareholder”); PPI Report, supra note 34, at 58 n.156 (“[r]edemption fees serve two purposes: (1) they tend to deter speculation in the fund’s shares; and (2) they cover the fund’s administrative costs in connection with the redemption”); John P. Reilly & Associates (pub. avail. July 12, 1979) (limiting redemption fee to “administrative expenses associated with redemption”).
37 See Rule lla-3(a)(7), supra note 26 (redemption fee must be reasonably intended to compensate the fund for “expenses directly related to the redemption of fund shares”); Rule lla-3(b)(2), supra note 26 (any scheduled variation of a redemption fee on an exchange must be reasonably related to “the costs to the fund of processing the type of redemptions for which the fee is charged”). See also Rule 23c-3(b)(I) (repurchase fee must be reasonably intended to compensate the interval fund for “expenses directly related to the repurchase”); Periodic Repurchases by Closed-End Management Investment Companies; Redemptions by Open-End Management Investment Companies and Registered Separate Accounts at Periodic Intervals or with Extended Payment, Investment Company Act Release No. 18869 at n.90 and accompanying text (July 28, 1992) (proposing Rule 23c-3) (repurchase fee must be intended to compensate interval fund for expenses directly related to repurchase, such as costs incurred in disposing of portfolio securities or in borrowing to make payment for repurchased shares; open-end funds “may impose similar redemption fees”).
38 See Investment Company Act Release No. 15651, supra note 36, at text following n.74 (adopting amendments to temporary Rule 6e-3(T); Offers of Exchange Involving Registered Open-End Investment Companies, Investment Company Act Release No. 17097, at n.37 (Aug. 3, 1989) (adopting Rule lla-3); Investment Company Act Release No. 16504, supra note 29, at n.43 (revised proposal of Rule 11a-3). We note that the Commission and the staff have never included investment opportunity or marketing costs in the types of costs recouped or offset by redemption fees. In the context of redemption fees imposed on exchanges, however, the Commission has stated that the “inclusion [in a redemption fee] of costs, other than those directly related to processing exchanges,” would be considered by the Commission or staff on a case-by-case basis. Investment Company Act Release No, 17097 at n.37.
39 See Rule lla-3(b)(2), supra note 26 (any scheduled variation of a redemption fee on an exchange must be “reasonably related to” the costs to the fund of processing the type of redemptions for which the fee is charged); Neuberger & Berman Genesis Fund, Inc., supra note 22 (fund board determined that the size of the 2% redemption fee is “reasonable in relation to” the fund’s anticipated out-of-pocket costs of redemptions). The amount of a redemption fee need not precisely equal the Administrative Costs identified above. Investment Company Act Release No. 16504, supra note 29, at n.42 (revised proposal of Rule lla-3); Neuberger & Berman Genesis Fund, Inc., supra note 22.
40 See Neuberger & Berman Genesis Fund, Inc., supra note 22 (staff agreed not to recommend enforcement action concerning a 2 % redemption fee); John P. Reilly & Associates, supra note 36 (redemption fee should not exceed 2%); Investment Company Act Release No. 16504, supra note 29, at n.43 (revised proposal of Rule 11a-3) (acknowledging the staffs position in John P. Reilly & Associates); Investment Company Act Release No. 15651, supra note 36, at n.74 and accompanying text (adopting amendments to temporary Rule 6e-3(T)) (acknowledging the staffs position in John P. Reilly & Associates). See also Rule 23c-3(b)(1) (repurchase fee may not exceed 2 %).
41 Investment Company Act Release No. 15651, supra note 36, at text following n.74 (adopting amendments to temporary Rule 6e-3(T)). In that release, the Commission also declined to incorporate in temporary Rule 6e-3(T) a provision for relief from the 2% limit of Section 10(d)(4) of the Act to permit the recovery of higher redemption-related processing costs. Id. at text accompanying nn.71-74.
42 We also would not recommend enforcement action with respect to the duration of the 4 % Redemption Fee, insofar as it applies to Reorganization Class A shares that are redeemed or exchanged during the 199 days after the Reorganization. See Neuberger & Berman Genesis Fund, Inc., supra note 22 (staff agreed not to recommend enforcement action concerning a 2 % redemption fee imposed on shares held for less than one year). See also Investment Company Act Release No. 17097, supra note 38, at text accompanying n.38 (adopting Rule lla-3) (noting that a fund could charge a redemption fee after a certain number of exchanges, or on exchanges effected within a specified time after purchase, if the fund meets the conditions of the rule).

Incoming Letter

Kirkpatrick & Lockhart LLP
1800 Massachusetts Avenue. NW Second Floor
Washington, DC 20036-1800 2027789000
www.kl.com

Robert C. Hacker
202.778.9016
Fax: 202.778.9100
[email protected]

February 22, 2001

Investment Company Act/34(b); 18(f)(1); 11(a); Rule 11a-3

Douglas J. Scheidt, Esq.
Associate Director and Chief Counsel
Division of Investment Management
Securities and Exchange Commission
450 Fifth Street, N. W.
Washington, D.C. 20549

Re: Imposition of a Temporary 4% Redemption fee

We are writing to you on behalf of the Fidelity Advisor Korea Fund, an open-end series of Fidelity Advisor Series VIII (the “New Fund”) to request staff assurance that it would not recommend enforcement action to the Securities and Exchange Commission \SEC”) under Section 34(b). Section 18(f)(1). or Section 11 (a) and Rule 11 a-3 thereunder of the Investment Company Act of 1940 (“1940 Act”) if, upon the reorganization of the Fidelity Advisor Korea Fund, Inc. (“Fund”) into the New Fund (the “reorganization”), the New Fund imposes a 4% redemption fee on Class A shares issued to Fund shareholders in exchange for their Fund shares that are redeemed or exchanged out of the New Fund less than 200 calendar days after the reorganization (the “4% redemption fee”).

FACTUAL BACKGROUND

When we first addressed this question to the staff, the Fund was a closed-end fund managed by Fidelity Management & Research Company (“FMR”), an investment adviser that is registered with the Commission under the Investment Advisers Act of 1940. The Fund commenced operations on October 31,1994. Although there have been times when the Fund’s shares traded at a premium, the Fund’s shares generally traded at a discount since August of 1998.1 To address this problem, FMR proposed to reorganize the Fund as an open-end fund. The Fund’s Directors approved the reorganization, including the 4% redemption fee, on February 10, 2000, and the trustees of the New Fund approved the reorganization, including the 4% redemption fee, on February 17, 2000. The Fund publicly announced on February 10, 2000, that the Fund’s Directors had approved a proposal to seek shareholder approval of the reorganization, and that the 4% redemption fee would apply. On June 14,2000, the holders of a majority of the Fund’s outstanding shares approved the reorganization, after receiving a proxy statement that disclosed the 4% redemption fee and other matters. Fund shareholders did not vote on the 4% redemption fee as a separate item from the reorganization. The initial shareholder of the New Fund approved the reorganization, including the 4% redemption fee, before the reorganization. The reorganization was completed on June 30, 2000.

The Fund and New Fund have the same investment adviser and the same investment objective, to seek long-term capital appreciation. Each Fund seeks to achieve this objective by normally investing at least 65% of its total assets in debt and equity securities of Korean issuers. The New Fund also has substantially the same investment policies and restrictions as the Fund, except that, as was fully disclosed in the reorganization proxy statement, certain of the New Fund’s fundamental and nonfundamental investment restrictions were changed to conform them to those typically associated with Fidelity’s open-end international equity funds.

To effect the reorganization, the New Fund issued Class A shares to all Fund shareholders in exchange for their Fund shares (“Reorganization Class A shares”)(recipients of these shares are referred to as “Reorganization Class A shareholders”). The Reorganization Class A shares will be subject to a temporary redemption fee of 4% if such shares are redeemed or exchanged out of the New Fund less than 200 days following the reorganization. No redemption fee will be imposed on Reorganization Class A shares that are held for a longer period, other Class A shares of the New Fund issued after the reorganization, or on shares of other classes issued by the New Fund.2 The redemption fee would be paid to the New Fund and will benefit all shareholders of the New Fund who have not previously redeemed or exchanged their shares, including, without limitation, Reorganization Class A shareholders who remain in the New Fund.

The payment of the 4% redemption fee to the New Fund would help it to offset anticipated portfolio and administrative costs associated with potentially large levels of redemptions (including exchanges) of Reorganization Class A shares by Kirkpatrick & Lockhart LLP Reorganization Class A shareholders during the 199 days following the reorganization, as well as investment opportunity and market costs that may result from the forced liquidation of portfolio securities to effect these redemptions (including exchanges) during that period (collectively, “Portfolio/Administrative Costs”).

To project the New Fund’s Portfolio/Administrative Costs, FMR evaluated complex-wide average trading costs (including market impact as well as commissions and other transaction-related expenses) incurred by the Fidelity mutual funds and other accounts managed by FMR and its affiliates in connection with trading securities on Korean markets over the past three years. For this purpose, trading costs were based on the difference between the price received in the market for each sale and the price of the security at the time the decision to sell was made. The methodology used by FMR compares trade execution prices to the closing price of the security the day before FMR first starts selling the security. The total cost measured by this methodology approximates the total cost to remaining shareholders involved in satisfying a redemption, assuming that Reorganization Class A shares are redeemed at net asset value based on closing market price on a given day, and that fund management places sell trades to satisfy the redemption on the next business day. The redemption fee also recognizes that FMR would have less discretion over the timing of when to sell the New Fund’s portfolio securities than under normal trading circumstances due to anticipated high levels of redemptions (including exchanges) following the Fund’s reorganization. FMR believes this “package cost” methodology is the most appropriate measure of the market impact costs because in these circumstances it captures the change in a security’s price over the entire period required to satisfy the trade order.

The 199-day duration of the 4% redemption fee reflects FMR’s estimate of the time during which arbitrage related redemptions or exchanges of the Reorganization Class A shares were reasonably likely to occur, as discussed below. The 199-day duration formed part of FMR’s recommendation to the directors of the Fund and the trustees of the New Fund regarding the terms of the 4% redemption fee. A summary of FMR’s methodology (including a description of the manner in which market impact costs were estimated), and the results of applying such methodology to FMR’s trading history in securities on Korean markets over the past three years, was provided to the trustees of the New Fund at the time the trustees approved the terms of the 4% redemption fee in February 2000.

In April 2000, the New Fund’s trustees reviewed the methodology used to support the redemption fee and the results of applying that methodology to FMR’s trading history in securities on Korean markets over the past three years, and determined that the 4% redemption fee is reasonably related to the Portfolio/Administrative Costs expected to be incurred by the New Fund from redemptions (including exchanges) by Reorganization Class A shareholders. The reasonableness of the terms of the 4% redemption fee was an appropriate matter for the directors of the Fund and the trustees of the New Fund to determine in the exercise of their business judgment, with input from FMR.

When a closed-end fund’s shares trade at a significant discount from net asset value, arbitrageurs and other short-term traders historically have purchased shares of the closed-end fund in anticipation of an open-ending of the fund. These traders seize this opportunity to profit from the difference between the cost of purchasing closed-end fund shares at a discount, and the proceeds from redeeming comparable open-end fund shares at net asset value.

This arbitrage activity may be harmful to the new open-end fund, and to shareholders who invest in it for the long term, because: (a) the new open-end fund may be forced to sell a substantial amount of its portfolio securities to meet arbitrage related redemptions and exchanges; (b) the forced sales of portfolio securities may occur at inopportune times and, therefore, disrupt portfolio management strategies; (c) the fund may incur high costs in effecting the forced sales, including brokerage commissions, adverse impacts on the market prices of some securities as the result of the forced sales, and losses of profits or invested capital, (d) costs related to the market impact of forced sales may be magnified for a fund that invests in emerging markets where securities are thinly traded; and (e) without a redemption fee or other similar measure, these adverse investment effects and high costs will be borne by the fund and its long-term investors rather than the arbitrageurs who cause them.

When FMR and the directors and trustees of the Fund and the New Fund, respectively, considered the reorganization, they had reason to believe that arbitrageurs and other short-term traders were purchasing shares of the Fund. Short-term trading is contrary to the stated policies of the New Fund. FMR and the directors and trustees of each fund were concerned that the harms identified above would afflict the New Fund and its long-term investors as a result of this arbitrage activity, and that the long-term viability of the New Fund could suffer

To protect the New Fund and long-term investors from the activities of arbitrageurs and other short-term traders, FMR proposed, and the directors and trustees of the Fund and the New Fund agreed, to impose the 4% redemption fee during the 199-day period while arbitrage-related redemptions (or exchanges) were most likely to occur.3 The 4% redemption fee was intended, in part, to discourage arbitrage and other short-term trading activity by making this activity less profitable. To the extent that arbitrage and other short-term trading would still occur,4 the 4% redemption fee was intended to recoup for the New Fund some of the costs of the related arbitrage-related redemptions and exchanges. As a result, the 4% redemption fee will force redeeming shareholders, rather than shareholders who choose to remain investors in the New Fund, to bear a portion of the costs imposed by their redemptions.

ANALYSIS

The SEC and its staff have indicated that the imposition of a redemption fee by an open-end investment company raises issues regarding whether the shares of the company are redeemable securities within the meaning of Section 2{a){32) and Section 5{a)(1) of the 1940 Act, and, in certain circumstances, whether the company is issuing a senior security in contravention of Section 18{f){1) of the 1940 Act. In some circumstances, representations that shares subject to a redemption fee are redeemable securities might implicate Section 34{b) of the 1940 Act and its prohibition of untrue statements of material fact. In addition, the imposition of a redemption fee in connection with an exchange of investment company shares must be in accordance with Section 11 (a) and Rule 11 a-3 under the 1940 Act.

Sections 5(a)l1) and 2(a)(32}

Section 5(a)(1) of the 1940 Act defines an open-end investment company (“fund”) as a management company that offers for sale or has outstanding any “redeemable security” of which it is the issuer. Section 2(a)(32) of the 1940 Act generally defines a redeemable security as any security under the terms of which the holder, upon its presentation to the issuer or to a person designated by the issuer, is entitled (whether absolutely or out of surplus) to receive approximately the security holder’s proportionate share of the issuer’s current net assets, or the cash equivalent thereof. The SEC has indicated that it may be materially misleading to market a fund’s shares as redeemable if redemption is then penalized by high redemption charges. See Investment Company Release No. 15651 (March 30,1987) (“Release 15651 “).

It is clear that a fund may impose a redemption fee to cover legitimate transaction-related costs associated with redemptions.5 The staff has recognized that the amount of any such redemption fee should be reasonable in relation to the anticipated costs of redemptions. For example, in Neuberaer & Berman Genesis Fund Inc. (pub. avail. Sep. 27, 1988), the staff took a no-action position under Section 18(f)(1) with respect to a 2% “variable redemption price adjustment.” The variable redemption price adjustment in question applied to all redemptions of shares in the fund held for less than one year (except shares acquired as a result of dividend reinvestment). The staff granted the requested relief, noting that the fund had represented that the adjustment was “reasonable in relation to the anticipated out-of pocket costs to the [f]und of redemptions of purchased shares held less than one year.”6

The staff has consistently found that a 2% redemption fee is reasonable in relation to the costs of redemption. In unusual circumstances, however, a higher redemption fee may be more closely related to the anticipated costs of redemption. In the present case, the New Fund proposes to impose a temporary 4% redemption fee due to special trading circumstances arising out of the reorganization of the Fund into an open-end fund. As noted, FMR anticipates a large level of redemptions and exchanges by Reorganization Class A shareholders after the reorganization because a number of such shareholders may want to realize the immediate increase in the value of their shares resulting from the reorganization. In addition, because the New Fund is a single country emerging markets fund, its trading costs associated with such redemptions and exchanges will generally be higher than those of other types of funds. The 4% redemption fee is also reasonably necessary to discourage arbitrage activity by Reorganization Class A shareholders, reimburse the New Fund for the h1gh costs and adverse investment effects arising from such arbitrage activity, and thus to protect the interests of the non-redeeming shareholders and the viability of the New Fund. Under these special trading circumstances, FMR and the New Fund’s trustees have determined, based upon the methodology discussed above, that a temporary 4% redemption fee is reasonably related to the anticipated costs of redemptions and exchanges by Reorganization Class A shareholders occurring less than 200 days following the reorganization. This determination is appropriately a matter of business judgment to be made by the Board of Trustees, with input from the New Fund’s investment advisor. Thus, given that FMR and the trustees have determined that the redemption fee is reasonably related to the New Fund’s anticipated Portfolio/Administrative Costs of redemptions and exchanges by Reorganization ,Class A shareholders during the 199 days following the reorganization, the redemption fee complies with the 1940 Act and the rules and interpretations thereunder.

Section 34(b)

Section 34(b) makes it unlawful for any person to make any untrue statement of material fact in any reg1stration statement, application, report, account, record or other document filed or transmitted pursuant to the 1940 Act. The New Fund’s registration statement represents that the New Fund is an “open-end company,” as defined in Section 5(a)(1) of the 1940 Act, and that it issues “redeemable securities,” as defined in Section 2(a)(32) of the 1940 Act. The New Fund’s imposition of the 4% redemption fee is not inconsistent with those representations, and the representations therefore do not implicate Section 34(b). The 4% redemption fee does not prevent a shareholder who redeems or exchanges from receiving “approximately his proportionate share of the issuer’s current net assets.” In particular, the price received by a redeeming or exchanging Reorganization Class A shareholder will be based on the current net asset value of the New Fund. The 4% redemption fee will not penalize redemption but will merely reflect costs reasonably attributable to the redeeming shareholder’s own action. Under the special circumstances of this case, the 4% redemption fee reasonably reflects the costs attributable to covered redemptions and exchanges by Reorganization Class A shareholders. Finally, the New Fund’s statements about its open-end status and the redeemable nature of its shares are not untrue or misleading because they are accompanied by full disclosure of the 4% redemption fee.

Section 18(f)(1)

Under Section 18(f)(1) of the 1940 Act, it is unlawful for a fund to “issue any class of senior security.”7 The 4% redemption fee raises a question under Section 18(f)(1) regarding whether the redemption fee creates a separate class of securities (Reorganization Class A shares that are redeemed (or exchanged) out of the New Fund in less than 200 days after the reorganization) with respect to the “distribution of assets” within the meaning of Section 18(g) because that class would be subject to the redemption fee while another class of senior securities (those Reorganization Class A shares that are held for more than 200 days, other Class A shares, and other classes of shares) would not be.

The shares that are not subject to the 4% redemption fee should not be deemed to constitute a separate class of senior securities under Section 18(f)(1). FMR and the trustees of the New Fund may reasonably distinguish among the Reorganization Class A investors who receive their shares of the New Fund in connection with the reorganization, and other Class A investors, or investors in other classes of shares, because the Reorganization Class A investors who receive their shares in the reorganization based on their former holdings of Fund shares may have a substantially greater incentive to redeem or exchange shares of the New Fund shortly after the reorganization. As noted above, the staff has indicated that a 2% redemption fee imposed on shares held for less than one year is permissible under Section 18(f)(1), referring particularly to the fact that a resolution of the Board of Directors of the fund “reflected a finding that the size of the 2% [redemption fee] is reasonable in relation to the anticipated out-of-pocket costs to the Fund of redemptions of purchased shares held less than one year.” See, e.g., Neuberger & Berman Genesis Fung, supra.

In the present case, the 4% redemption fee applies equally to all Reorganization Class A shareholders who redeem or exchange Reorganization Class A shares less than 200 days after the reorganization.8 All of the Fund’s outstanding shareholders were informed of the 4% redemption fee in the proxy statement seeking approval of the reorganization. FMR anticipates potentially large redemptions from Reorganization Class A shareholders after the reorganization because, by redeeming, these shareholders can realize an immediate one-time increase in the value of their shares. Thus, the redemption fee is designed to protect the existing shareholders who do not redeem and new purchasers from having to absorb the costs associated with redemptions by the redeeming Reorganization Class A shareholders. Accordingly, the redemption fee would be consistent with Section 18(f)(1) of the 1940 Act because, as in the Neuberqer & Berman case supra., FMR and the New Fund’s trustees have determined that the redemption fee is reasonably related to the New Fund’s anticipated Portfolio/Administrative Costs of redemptions by Reorganization Class A shareholders occurring less than 200 days following the New Fund’s reorganization. The decision not to impose a redemption fee on shares purchased after the reorganization is a matter of business judgment by the trustees, taking into account the fact that investors who purchase shares at a price based on net asset value (rather than a secondary market trading price) would not have an incentive to redeem immediately in order to realize a windfall profit. The staff has not objected when open-end funds, in appropriate circumstances, have determined to impose redemption fees on some, but not all shareholders.

Finally, the 4% redemption fee does not create a senior security because, by definition, a senior security must have “priority over any other class as to distribution of assets or payment of dividends.” The term “priority” implicitly requires a liquidation preference, or other right under which the value of senior securities must be paid in full before junior securities are paid. Senior securities having “priority” over junior securities normally include debt or preferred securities. New Fund shares not subject to the 4% redemption fee do not entitle their holders to any liquidation preference or other right to receive a payment of assets or dividends before the holders of New Fund shares subject to the 4% redemption fee; and therefore do not have “priority” over other shares.

Section 11(a) and Rule 11 a-3

The New Fund’s imposition of the 4% redemption fee on exchanges of Reorganization Class A shares will not violate Section 11 (a) of the 1940 Act because the fee will be consistent with Rule 11 a-3 under the 1940 Act. Section 11(a) generally prohibits an open-end investment company from making an offer to security holders to exchange their securities on any basis other than the relative net asset values of the respective securities to be exchanged. Rule 11a-3 under the 1940 Act permits a fund to charge a redemption fee in connection with an exchange if, among other conditions, any scheduled variation of a redemption fee is reasonably related to the costs to the fund of processing the type of redemptions for which the fee is charged. Rule 11a-3 defines a redemption fee as any fee (other than a sales load, deferred sales load or administrative fee) that is paid to the fund and is reasonably intended to compensate the fund for expenses directly related to the redemption of fund shares. The SEC has stated that appropriate redemption costs pursuant to Rule 11a-3 include brokerage commissions charged to the fund in connection with any liquidation of portfolio securities necessitated by the redemption, as well as any processing or other transaction costs incident to the redemption and not covered by any administrative fee.9 Accordingly, given the special trading circumstances of the present case, the redemption fee would be consistent with Rule 11 a-3 because the scheduled variation of the redemption fee is reasonably related to the costs to the New Fund of processing the types of redemptions and exchanges of the Reorganization Class A shares for which the fee is charged, as generally required by Rule 11a-3(b)(2).10 In addition, as determined by the trustees of the New Fund with input from FMR, the redemption fee is reasonably intended to compensate the New Fund for Portfolio/Administrative Costs that are directly related to the redemptions and exchanges, as generally required by Rule 11 a-3(a)(7).

* * * *

Based on the foregoing, we respectfully request that the Division of Investment Management would not recommend that the SEC take enforcement action if the New Fund imposes the proposed Redemption fee in the manner described above.

If you have any questions or require any further information, please call the undersigned below at (202) 778-9016.

Sincerely,

Robert C. Hacker

Footnotes

1 In the 12 months ended December 31, 1999, the Fund’s shares generally traded at a discount ranging from 15% to 25%. In February 2000, the Fund’s discount narrowed somewhat, with the announcement that the Fund’s Board had approved a proposal to seek shareholder approval to reorganize the Fund as an open-end fund. As of March 31,2000, the Fund’s shares were trading at a discount of 9.3%. The reorganization was completed on June 30, 2000. Before the reorganization became effective, the staff orally confirmed to us the staff’s position with respect to the proposed imposition of the 4% redemption fee.
2 In the reorganization, the New Fund issued Reorganization Class A shares to each Fund shareholder in an amount that reflected the shareholder’s share of the net asset value of the Fund at the closing date of the reorganization, based on the relative net asset values of the Class A shares and the Fund shares. The New Fund has offered Reorganization Class A shareholders and other investors the opportunity to purchase additional Class A shares and other classes of shares. The New Fund can distinguish between Reorganization Class A shares and other Class A shares through a number of methods, including procedures for tracing beneficial ownership through intermediaries such as brokerdealers or banks (such as the National Securities Clearing Corporation’s fund networking services).
3 In the past FMR and the Fund’s directors from time to time have considered alternatives to imposing a redemption fee. FMR and the Fund’s directors ultimately decided that without the 4% Redemption Fee, the reorganization of the Fund would not have been in the best interests of shareholders.
4 FMR and the directors and trustees of the Fund and the New Fund had reason to believe that some arbitrageurs would keep their Fund shares or buy additional shares even after the announcement of the 4% redemption fee.
5 5 he SEC, in discussing the types of fees that may be charged by separate accounts, stated in Release 15651 that:

The staff has informally taken the position that a company may impose a redemption fee of up to 2 percent on shares held for less than one year (subject to the “at cost” standard) without such a deduction raising redeemability issues. The redemption fee contemplated would be imposed by the investment company to cover legitimate expenses that may be incurred to make the payment in cash to a redeeming shareholder, i.e. brokerage costs and odd-lot premiums, transfer taxes, administration fees, custodian fees, and registrar or transfer-agent fees. See also John P. Reilly & Associates (pub. Avail. Jul. 12, 1979) (where the staff indicated that the shares of a fund that imposes a redemption fee “to cover administrative expenses” would be considered redeemable if the fee did not exceed 2%).

6 These costs were identified in the inquiry letter as portfolio costs (brokerage commissions and OTC bid-asked spreads, as well as investment opportunity and market costs that may result from the forced liquidation of portfolio securities) and administrative costs (custodian, settlement and account processing costs).
7 Section 18(g) of the Act defines “senior security” to include “any stock of a class having priority over any other class as to distribution of assets or payment of dividends.”
8 FMR and the directors and trustees of the Fund and the New Fund believed that a holding period in this general range may tend to confirm that a shareholder has engaged in short-term trading that may increase costs to the New Fund to a significant degree. See, e.g., Neuberqer & Berman Genesis Fund, supra.
9 Investment Company Act Release No. 17097 (Aug. 3, 1989) (adopting release); Investment Company Act Release No. 16504 (Jul. 29, 1988) (proposing release).
10 The 4% redemption fee may be viewed as a “scheduled variation” of a redemption fee because the 4% redemption fee would not apply to every class of stock issued by the New Fund, but would apply only to Reorganization Class A shares that are redeemed or exchanged during the 199 days after the reorganization.

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