March 11, 2015

Thursday, 12 June 2003 08:00

No-Action Letter under Investment Company Act of 1940 Section 7 and 3( c )(10)

Mercy Investment Program, Inc.

June 12, 2003 Response of the Office of Chief Counsel Division of Investment Management File No. 132-3 IM Ref. No. 2003612826 By letter dated June 10, 2003, you seek our assurance that we would not recommend enforcement action to the Commission under Section 7 of the Investment Company Act of 1940 (the “1940 Act”) if Mercy Investment Program, Inc. (“MIP”) permits participants in its asset management program to pledge their interests in MIP to third-party lenders to secure loans in certain limited circumstances, but does not register MIP as an investment company under the 1940 Act.

FACTS

The Sisters of Mercy (the “Sisters”) are a Roman Catholic order of nuns. All of the various U.S. regional communities of the Sisters and their affiliated entities (together, the “Participants”) primarily engage in religious and charitable activities in direct service to the sick, poor and uneducated in and through schools, hospitals, affordable housing developments, emergency shelters, retirement centers, women’s centers and retreat centers. You state that the Participants may engage in the following or similar activities directly and exclusively in furtherance of the Participants’ charitable and tax-exempt activities: remodeling a spiritual retreat center, building a nursing home, building an adult care facility, renovating a Mercy Center social services center, purchasing and renovating an inner-city building to house a drop-in program for mentally challenged adults, or building a “House of Mercy” disadvantaged neighborhood assistance facility. The Participants are not-for-profit organizations exempt from federal taxation under Section 501(c)(3) of the Internal Revenue Code (“IRC”). The Participants formed MIP in 1999 to create an asset management program to pool their operating and other assets. MIP is a non-profit, non-stock corporation that is exempt from federal taxation under Section 501(c)(3) of the IRC. You state that MIP is not an investment company in reliance on Section 3(c)(10) of the 1940 Act.1 You state that each Participant may contribute only those assets to MIP over which the Participant has immediate, unrestricted, and exclusive use, benefit and enjoyment. You state that from time to time the Participants have need of funds to further their charitable and tax-exempt activities. MIP proposes to permit the Participants each to pledge their respective interests in MIP to third-party lenders as collateral for loans for such activities. You state that the Participants’ ability to offer their interests in MIP as collateral for such loans would provide the Participants with the opportunity to obtain competitive financing for these activities and to obtain the full financial benefit of these assets. You state that under MIP’s proposal the proceeds of the Participants’ loans which are collateralized by Participants’ interests in MIP would be used exclusively for “charitable” and “religious” purposes within the meaning of Section 3(c)(10) under the 1940 Act and Section 501(c)(3) of the IRC. You also state that MIP and the Participants would comply with the Charitable Pooling Representations, as defined below, except with respect to the proposed pledges of interests in MIP to third-party lenders described in your letter and as reflected herein. You also state that MIP would ensure that no Participant would pledge its interest in MIP to a third-party lender unless: (1) in the case of a loan default, the pledged interest would, under the terms of the pledge and MIP’s governing instruments, automatically liquidate into cash;2 (2) under the terms of the pledge and MIP’s governing instruments, the investment risk would remain with the Participant; (3) under the terms of the pledge and MIP’s governing instruments, the lender would at no time have anything other than a security interest in a Participant’s interest in MIP; and (4) under the terms of the pledge, the lender would have no right to convert any amount of the loan into an interest in MIP, but rather, would only have the right to the cash proceeds from the automatic liquidation of the pledged interest in MIP.

ANALYSIS

Section 3(c)(10) of the 1940 Act excludes from the definition of investment company, among others, “any company organized and operated exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes no part of the net earnings of which inures to the benefit of any private shareholder or individual.” On numerous occasions we have agreed not to recommend enforcement action to the Commission under Section 7 of the 1940 Act if charitable entities pool their assets in common investment pools without registering the pools under the 1940 Act in reliance on the exclusion in Section 3(c)(10) of the 1940 Act,3 provided that the charitable entities represent, among other things, that they will not assign, encumber, or otherwise transfer any part of their interests in the common investment pools (the “Charitable Pooling Representations”).4 The Charitable Pooling Representations are intended to ensure that the fundamental characteristics of the common investment pools remain charitable in nature. Under your proposal, MIP and the Participants will comply with all of the Charitable Pooling Representations, except that the Participants may pledge their interests in MIP to third-party lenders under the circumstances described in your letter. You argue that the Participants’ pledges of their interests in MIP to third-party lenders, under those circumstances, will not change the charitable nature of MIP. You believe that the intent of Section 3(c)(10) of the 1940 Act was to exclude charitable organizations from regulation under the 1940 Act because such organizations lack a profit motive, thus reducing certain concerns that the 1940 Act was designed to prevent. You argue that this intent is maintained under your proposal because the proceeds of any loan collateralized by a Participant’s interest in MIP would be used only for charitable purposes within the meaning of Section 501(c)(3) of the IRC. You also believe that the Charitable Pooling Representations evidenced the staff’s concern that common investment pools maintain their charitable and religious nature by precluding any participation in such pools by, or the assignment of interests in the pools to, non-charitable, non-religious participants. You reason that the prohibition against assigning, encumbering, or otherwise transferring any part of a charitable organizations’ interest in a common investment pool was generally appropriate as a means to ensure that interests in those pools would not be distributed to non-charitable investors. You believe, however, that the circumstances under which a Participant may pledge its interest in MIP, described in your letter and as reflected herein, will prevent any third-party lender from becoming an “investor” in MIP, and will serve as an appropriate substitute for the prohibition against assignment, encumbrance or other transfers of interest in MIP to non-charitable, non-religious participants. Based on the representations in your letter, we would not recommend enforcement action to the Commission under Section 7 of the 1940 Act if, without registering as an investment company under the 1940 Act, MIP allows Participants to pledge their interests in MIP to third-party lenders as security for loans. Our position is based particularly on your representations that the proceeds of the loans collateralized by a Participant’s interest in MIP would be used exclusively for “charitable” and “religious” purposes within the meaning of Section 3(c)(10) under the 1940 Act and Section 501(c)(3) of the IRC, and that MIP and the Participants will comply with the Charitable Pooling Representations, except with respect to the proposed pledges of interests in MIP to third-party lenders. Our position is also based on your representations that no Participant would pledge its interest in MIP to a third-party lender unless: (1) in the case of a loan default, the pledged interest would, under the terms of the pledge and MIP’s governing instruments, automatically liquidate into cash; (2) under the terms of the pledge and MIP’s governing instruments, the investment risk would remain with the Participant; (3) under the terms of the pledge and MIP’s governing instruments, the lender would at no time have anything other than a security interest in a Participant’s interest in MIP; and (4) under the terms of the pledge, the lender would have no right to convert any amount of the loan into an interest in MIP, but rather, would only have the right to the cash proceeds from the automatic liquidation of the pledged interest in MIP. This response expresses our views on enforcement action only and does not express any legal or interpretive conclusion on the issues presented. Because our position is based on the representations in your letter, you should note that any different representations might require a different conclusion. Jennifer Berman Staff Attorney

Endnotes

1 In requesting relief, you have assumed that: (i) the Participants’ interests in MIP are exempt from registration under Section 3(a)(4) of the Securities Act of 1933; (ii) MIP need not register as an investment company under the 1940 Act in reliance on Section 3(c)(10) of the 1940 Act; and (iii) MIP, its Board of Directors and its Investment Committee are exempt from registration under Section 203(b)(4) of the Investment Advisers Act of 1940. You have not asked for our position, and we take none, with respect to such assumptions. 2 If, in the case of a loan default, the value of the pledged interest was less than the remaining amount of the loan, the Participant would remain liable for the deficit. If the value of the pledged interest was greater than the remaining amount of the loan, the excess liquidated amount would be returned to the Participant. 3 See Daughters of Charity National Health System, Inc. (pub. avail. Apr. 3, 1998); National Association of Congregational Christian Churches (pub. avail. Aug. 11, 1995); American Heart Association (pub. avail. Feb. 26, 1993); Northeastern Pennsylvania Synod of the Evangelical Lutheran Church in America (pub. avail. May 3, 1988); Catholic Foundation Investment Trust (pub. avail. Feb. 17, 1983). Such entities often form common investment pools in order to benefit from greater economies of scale and the possibility of access to better investment managers. Because common investment pools are arguably formed for the purpose of investing and reinvesting in securities, participants in such pools have sought our assurances that we would not recommend enforcement action to the Commission under Section 7 of the 1940 Act if they do not register the pools under the 1940 Act in reliance on Section 3(c)(10) of the 1940 Act. 4 The charitable entities also represent, as part of the Charitable Pooling Representations, that: (1) the common investment pool must be organized and operated at all times exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes; (2) no part of the common investment pool’s net earnings may inure to the benefit of a private shareholder or individual; (3) the common investment pool and each participant must be exempt from taxation under Section 501(c)(3) of the IRC; (4) each participant may invest only funds over which it has immediate, unrestricted, and exclusive use, benefit and enjoyment; (5) participants will not invest assets that are attributable to a retirement plan providing for employee contributions or variable benefits; (6) certified public accountants annually will prepare a written report on the common investment pool, and will send the report to participants; and (7) each participant will be informed that the common investment pool is not an investment company registered under the 1940 Act.

Incoming Letter

Odin, Feldman & Pittleman, P.C. ATTORNEYS AT LAW 9302 LEE HIGHWAY, SUITE 1100 FAIRFAX, VIRGINIA 22031-1215 www.ofplaw.com WRITER’S DIRECT DIAL NUMBER AND E-MAIL ADDRESS (703) 218-2151 mark.d’ [email protected] FACSIMILE (703) 218-2160 Thirty-One Years of Service June 19, 2003 BY HAND DELIVERY Office of Chief Counsel Division of Investment Management U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Attn: Douglas J. Scheidt, Esq. Re: Mercy Investment Program, Inc. Dear Mr. Scheidt: Mercy Investment Program, Inc. (“MIP”) has asked us to request on its behalf a No-Action letter from the staff of the Commission (the “Staff”) to obtain the Staff’s assurance that it would not recommend enforcement action to the Commission under Section 7 of the Investment Company Act of 1940 (the “1940 Act”) if MIP permits participants in its asset management program to pledge their interests in MIP to third-party lenders to secure loans in certain limited circumstances, but does not register MIP as an investment company under the 1940 Act.

Facts

The Sisters of Mercy (the “Sisters”) are a Roman Catholic order of nuns. All of the various U.S. regional communities of the Sisters and their affiliated entities (together, the “Participants”) primarily engage in religious and charitable activities in direct service to the sick, poor and uneducated in and through schools, hospitals, affordable housing developments, emergency shelters, retirement centers, women’s centers and retreat centers. The Participants are not-for-profit organizations exempt from federal taxation under Section 501(c) (3) of the Internal Revenue Code (“IRC”). For many years several of the Participants have informally pooled their operating, retirement and other funds to obtain access to more sophisticated money managers than each is able to attract on its own. Until 1999 these Participants operated this asset management program somewhat informally. In 1999 the Participants formed MIP, a non-profit, non-stock 501(c) (3) corporation, to give the program more organizational structure. MIP operates much the way various other pooled charitable fund programs described in the no-action letters identified below do. The Participants deposit money with a single institutional custodian. The Board of Directors and Investment Committee of MIP interview, select and evaluate various professional, registered investment managers. MIP makes the investment goals of the various managers known to the Participants. The Participants are solely responsible for choosing when, how much and with which manager(s) they allocate their funds held by the custodian. Funds are allocated, deposited and withdrawn only by specific authority of the Participant in question. Subject to certain administrative limitations, the Participants are free to withdraw their funds at will. The custodian provides written reports to MIP monthly for distribution to the Participants. Apart from the evaluation, selection and replacement of the managers, MIP’s role is as administrative intermediary between the Participants, on the one hand, and the custodian and the managers, on the other. As MIP is a non-profit, non-stock membership corporation, a Participant’s only financial interest in MIP consists of its funds under investment, which I will refer to here as its “account” for simplicity’s sake. We have made the following assumptions in requesting the relief requested in this letter: (i) the Participants’ accounts in MIP are exempt from registration under Section 3(a)(4) of the 1933 Act because MIP is a “charitable” or “religious” organization within the meaning of Section 501(c)(3) of the IRC; (ii) MIP need not register as an investment company under the Investment Company Act of 1940 in reliance on Section 3(c)(10) for similar reasons; and (iii) MIP, its Board of Directors and its Investment Committee are exempt from registration under Section 203(b)(4) of the Investment Advisers Act of 1940, again, for similar reasons. We are seeking no relief with respect to these assumptions.

Proposed MIP Activity

MIP does not currently permit any of the Participants to pledge their accounts in MIP as collateral for a loan or other obligation of a Participant, and currently no such pledges or liens exist. However, the Participants have expressed to MIP their need to have the ability to leverage their MIP accounts to get the full benefit of them as they would any comparable asset to advance their charitable and tax-exempt activities. The ability to offer their assets invested through MIP as collateral would provide the Participants with the opportunity to obtain competitive financing for these charitable projects and to obtain the full financial benefit of these assets. In general, prohibiting these Participants from pledging their accounts as collateral for legitimate loans prevents them from leveraging their assets and getting the most value out of their limited resources to pursue their religious and charitable purposes. The Participants would use the proceeds of these loans exclusively for “charitable” and “religious” activities within the meaning of Section 501(c)(3) of the IRC and Section 3(c)(10) of the 1940 Act. By way of illustration, the Participants may engage in the following or similar projects directly and exclusively in furtherance of the Participants’ charitable and tax-exempt purposes: remodeling a spiritual retreat center, building a nursing home, building an adult care facility, renovating a Mercy Center social services center, purchasing and renovating an inner-city building to house a drop-in program for mentally-challenged adults, or building a “House of Mercy” disadvantaged neighborhood assistance facility. MIP proposes to permit the Participants to leverage their accounts in MIP by pledging them as collateral to secure loans from banks and other third-party lenders. The pledges would be permitted on the following terms:

  1. The pledges would be to secure loans the proceeds of which would be used exclusively for “charitable” and “religious” purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code and Section 3(c)(10) of the 1940 Act.
  2. In the case of a loan default, the pledged account would by its terms and by the terms of MIP’s governing instruments automatically liquidate into cash. The effect of this would be that the lender would not become a Participant in MIP nor would it be able to retain or transfer the pledged account as an account.
  3. By the terms of the pledge and by the terms of MIP’s governing instruments the investment risk would stay with the Participant. That is, if the pledged account is worth more than the debt owed the lender, the excess liquidated cash would be returned to the Participant. Conversely, if the account is worth less than the debt, the Participant would remain liable for the deficit.
  4. Under the terms of the pledge and MIP’s governing instruments the lender would at no time have anything other than a security interest in the pledging Participant’s MIP account.
  5. Under the terms of the pledge, the lender would have no right to convert any amount of the loan into an account in MIP, but rather, would only have the right to the cash proceeds from the automatic liquidation of the pledged interest in MIP.

MIP makes the following representations (“Charitable Pooling Representations”) about MIP, the Participants and their interests in MIP:

  1. MIP is organized and will be operated at all times exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes
  2. No part of MIP’s net earnings may inure to the benefit of a private shareholder or individual
  3. MIP and each Participant is and will be exempt from taxation under Section 501(c)(3) of the IRC
  4. Each Participant may invest only funds over which it has unrestricted and exclusive use, benefit and enjoyment
  5. Participants will not invest assets that are attributable to a retirement plan providing for employee contributions or variable benefits
  6. Certified public accountants annually will prepare a written report on MIP, and will send the report to Participants.
  7. Each Participant has been and will be informed that MIP is not an investment company registered under the 1940 Act
  8. The Participants will not assign, encumber or otherwise transfer any part of their interests in MIP other than as described, and consistent with the representations made, in this letter.

MIP and the Participants will comply with the “Charitable Pooling Representations.”

No-Action Request

We wish to confirm that, for the reasons expressed, and under the conditions outlined in this letter, the Staff would not recommend any enforcement action under Section 7 of the 1940 Act if, without registering as an investment company under the 1940 Act, MIP were to permit its Participants to pledge their interests in MIP to third-party lenders to secure loans to be used solely for charitable purposes within the meaning of Section 501(c)(3) of the IRC and Section 3(c)(10) of the 1940 Act.

Analysis

Our question relates to the significance of a very specific criterion that appears repeatedly in the cited no-action letters. In most of the cited no-action letters the applicant states, and the Staff notes approvingly, that the participants may not “assign, encumber or otherwise transfer” (emphasis added) their interests in these various programs. However, neither the applicant nor the Staff discusses the significance of these restrictions or their rationale. Instead, the Staff simply refers to these restrictions approvingly in granting relief. See, for example, the following no-action letters: Daughters of Charity (April 3, 1998), National Association of Congregational Christian Churches (August 11, 1995), American Heart Association (February 26, 1993), Young Men’s Christian Associations (April 29, 1991), AASCU Capital Fund (October 19, 1988), Northeastern Pennsylvania Synod of the Evangelical Lutheran Church in America (May 3, 1988), Catholic United Investment Trust (March 28, 1983), Catholic Foundation Investment Trust (February 17, 1983), Religious Participants Trust (February 18, 1982), Protestant Episcopal Church in the Diocese of California (Diocesan Trust for Parish Funds) (February 4, 1979). Our inference is that the intent of Section 3(c)(10) of the 1940 Act was to exclude charitable organizations from regulation under the 1940 Act because such organizations lack a profit motive, thus reducing certain concerns that the 1940 Act was designed to prevent. We believe this intent is maintained under MIP’s proposal because the proceeds of any loan would be used only for charitable and religious purposes within the meaning of Section 501(c)(3) of the IRC and therefore will not change the charitable nature of MIP. We also infer that the Staff is concerned about “public distribution” issues under the Securities Act of 1933, and, under the other federal securities laws in general, maintaining the charitable and religious nature of the MIP program by eliminating the possibility of participation in MIP by, or the assignment of accounts in these programs to, non-charitable, non-religious participants. We believe that the prohibition against assigning, encumbering, or otherwise transferring any part of a charitable organizations’ interest in a common investment pool was generally appropriate as a means to ensure that interests in those pools would not be distributed to non-charitable investors. The restrictions proposed above for MIP’s collateralization program are intended to address this concern, and will serve as an appropriate substitute for the prohibition against assignment, encumbrance or other transfers of interest in MIP to non-charitable, non-religious participants. By the governing agreement between MIP and its Participants the Participants will be prohibited from transferring or in any way assigning their accounts. In addition, their ability to pledge or otherwise encumber their accounts in MIP will be limited in such a way that neither the lender nor any other third party would be in position to own or hold an account in MIP and instead would be entitled to the cash value only. Finally, by limiting a pledgee-lender’s rights upon default to receiving only the cash value of the pledging Participant’s account, and that only to the amount owed, and by leaving the investment risk with the pledging Participant, the integrity of MIP’s religion and charity-based exemptions under the Acts would be preserved.

Conclusion

We respectfully request the no-action position enunciated above, as well as the opportunity for a conference in advance of any adverse determination. In accordance with Securities Act Release No. 6269 (December 5, 1980) we have enclosed 7 additional copies of this letter. Please feel free to call me on my direct line: 703-218-2151 if you have any questions or if I can provide additional information. Thank you. Sincerely, Mark V. D’Amico, Esq.

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