1

Investment Companies and Investment Advisers

Professor Bradford

April 23, 2007

8:30 a.m.

Three Hours

INSTRUCTIONS

1. This is a partially open book exam. You may use the course materials, the statute book, and any materialsprepared exclusively by you. You may not use any other materials, written, digital, or recorded. You may not consult with or communicate with any other person during this exam.

2. This exam has seven (7) pages, including the instructions. The page numbers appear on the top right-hand corner of each page. Please check to be sure that this copy has all the pages.

3. You have three hours (3:00) to complete the exam. You must turn in your answers in this room, even if you are taking the exam somewhere else in the building. If you finish more than five minutes early, you may turn in your answers in the Dean’s Office.

4. The exam consists offive(5) questions. The recommended time for each question is as follows:

Question 1……………………..……..30Minutes

Question 2………………..…………..35 Minutes

Question 3…………………..………..35 Minutes

Question 4..…………………………..45 Minutes

Question 5……………………………35 Minutes

Each question will be weighted in accordance with its recommended time.

5. Do not spend all of your time writing. Think about the issues and organize your answers before writing. Be concise. Be organized. Long, disorganized, rambling answers will be penalized, as will merely “dumping” portions of your notes or outline into your answers rather than answering the question posed.

6. This exam will require you to interpret and apply many of the statutory provisions and regulations we have examined. YOU SHOULD NOT JUST STATE GENERAL PRINCIPLES, BUT SHOULD CITE THE RELEVANT SECTIONS AND SUBSECTIONS OF THE STATUTES AND REGULATIONS AND EXPLAIN HOW THE LANGUAGE OF THOSE RULES APPLIES TO THE FACTS OF THE QUESTION.

7. If you believe that additional facts are needed to answer a question, state exactly what those facts are and how they would affect your answer. If you believe that a question is ambiguous or unclear, note the ambiguity or lack of clarity and indicate how it affects your answer.

8. The Honor Code is in effect.

  1. Good luck and have a pleasant summer.

Instructions Concerning Taking the Exam on a Computer

10. You must take the exam on a computer that has the latest version of the Exam 4 software installed. Use the OPEN mode. If you have not previously installed the Exam 4 software, please notify the exam administrator immediately.

11. Be sure to enter your exam number in the Exam ID field. (Do not use your NU Card ID number or your social security number.) You will be required to enter your exam number twice. Select the course name from the drop-down box. Be sure you find the folder for this course, because that is where your exam will be stored. Verify that the information is correct just before you select “Begin Exam.”

12. Do not worry about headers, footers, page numbers, or double spacing your exam; the software does all that for you when the exam is printed.

13. When you are finished, please submit your exam electronically. A pop-up box will show the status of your exam. It should show a black bar with 100% in it and a message that says, “Your file has been successfully stored.” If you do not get this message, please see Vicki in the Registrar’s office immediately.

14. If you have any technical problems during the exam, please report them immediately to the Dean’s Office; we will assume you had no technical problems until when you reported them. Be prepared to finish your exam by writing it. (Regular notebook paper is O.K.)

DO NOT TURN THIS PAGE UNTIL YOU ARE GIVEN THE SIGNAL TO BEGIN.

Question 1

(30 Minutes)

The Cortes Fund is a registered investment company. Its investment adviser is Infidelity Investments.

Infidelity has been having trouble attracting personnel, so it has decided to set up a retirement plan for its employees. The Infidelity employees will contribute 5% of each month’s salary to the retirement plan and Infidelity will match that amount.Infidelity employees won’t be able to cash out of the Fund until they either retire or quit working for Infidelity.

Infidelity has hired a new employee, Jones, to handle employee questions and to handle routine administration of the plan (making sure the right amount is deducted from each paycheck and so on).

All of the money will be invested in the Cortes Fund; Infidelity will be treated identically to all other Fund investors. Infidelity has presented documentation of its plan to Cortes, and Cortes has no objection.

Discuss whether investing the retirement money in the Cortes Fund violates the Investment Company Act.

Question 2

(35 Minutes)

You are the general counsel for Omega Corporation, a Delaware corporation whose common stock is traded on the New York Stock Exchange. Omega recently acquired 51% of the voting securities of Hedgco, a hedge fund. Hedgco’s only business is trading securities, but it falls within section 3(c)(7) of the Investment Company Act, so it is not registered as an investment company.

Omega also owns interests in several other companies, none of which is in the business of investing, reinvesting, owning, holding, or trading in securities. Omega owns 98% of the voting stock of Trainco, which operates a railroad. Omega owns 40% of the voting stock of Compco, which sells computers and computer peripherals in retail outlets. Compco is not a manufacturer; it sells equipment manufactured by others. Omega also owns 40% of the voting stock of Paperclips, Inc., which owns a chain of discount office supply stores.

Omega has no operations of its own; all of its business is conducted through the companies in which it invests. However, Omega’s founder and chairperson is a very conservative investor, so Omega has some of its assets invested directly in federally insured certificates of deposit.

Omega’s investments account for the following percentages of its net income and net assets (exclusive of cash items and Government securities):

Business / Percentage
ownership / Percentage of
net assets / Percentage of
net income*
Certificates of deposit / 100% / 3% / 1%
Trainco / 98% / 46% / 48%
Hedgco / 51% / 45% / 45%
Compco / 40% / 3% / 3%
Paperclips / 40% / 3% / 3%

*NOTE: Percentages of income are calculated including Hedgco’s pre-acquisition income as part of Omega’s net income.

Omega would prefer not to register as an investment company. Discuss whether Omega can avoid registration under the Investment Company Act. (Assume Omega is not entitled to any of the exemptions in § 6.)

Question 3

(35 Minutes)

You are an attorney working for the SEC. Your supervisor has presented you with the following information and asked you to evaluate whether the SEC could successfully challenge the investment adviser’s fee under either the Investment Company Act or the Investment Advisers Act. Discuss.

Adviser Corporation is an investment adviser registered under the Investment Advisers Act. It advises a closed-end fund, The Performance Fund, an investment company registered under the Investment Company Act. The Performance Fund’s shares are publicly traded.

Adviser’s contract with the Fund provides for a Base Fee equal to 2% of the Fund’s average net assets for the year, plus or minus what the contract calls the “Kicker.”The Kicker is calculated by determining the amount the Fund’s net return differs from the net return to the S&P 500, a broad-based stock index. The difference (in percentage points), subject to a maximum of 1.5%, is added or subtracted to the base fee.

To see how the Kicker works, assume the S&P 500 earned a 4% return. If the Fund earned a 5.2% return, the Kicker would be 1.2%, and Adviser’s fee would be 2 + 1.2 = 3.2%. If the Fund earned a return of 7%, the cap on the Kicker would kick in and Adviser’s fee would be only 2 + 1.5 = 3.5%. If the Fund earned a return of only 3.1%, Adviser’s fee would be 2 - .9 = 1.1%.

However, the contract also provides that the Kicker will not be added or subtracted in two consecutive years. So, if an adjustment was made for the Kicker in 2006, the Adviser would receive only the Base Fee of 2.0% in 2007, and the Kicker would not be used again until 2008.

Adviser’s contract has been approved by the Fund’s shareholders and board as required by the Investment Company Act. (NOTE: Your boss asks you to assume that a fee of 3.5% would not be excessive or unreasonable.)

Question 4

(45 Minutes)

The Friendly Fund is an investment company registered under the Investment Company Act. Its investment adviser is Adviser, Inc., and its principal underwriter is Underwriter Corporation. Friendly is managed by a four-person board of trustees. The four trustees are Williams, Xerxes, Young, and Zappa.

The trustees have the following ties relevant to this question. Assume that the trusteeshave no other relevant connections.

  1. Zappa is an employee of Underwriter.
  1. Young is a director, but not an officer or employee, of Adviser.
  1. Xerxes owns shares in an unrelated market-index mutual fund that owns 5% of the voting stock of Parent Corporation, which in turns owns all of the stock of Underwriter.
  1. Williams owns 50% of Quickie Food, a very profitable general partnership that operates a fast-food restaurant. Charley Chief, the CEO of Friendly Fund, owns the other 50% of Quickie Food.
  1. Williams’ spouse works as an administrative assistant to Invesco Corporation, which owns 30% of the stock of Adviser.

Discuss whether the composition of Friendly’s board violates the Investment Company Act.

Question 5

(35 Minutes)

Money Limited Partnership is in the business of buying, selling, and trading securities. That is its only business. Money does not own more than 5% of any other company.

Money has one general partner, General Corporation. Until a month ago, Money had 99 limited partners. However, a month ago, one of its limited partners, Carl Croak, died and left his limited partnership units to his five sons, a transfer allowed by Money’s partnership agreement. As a result, Money now has 104 limited partners.

Money’s limited partners are individuals from all walks of life—everything from corporate executives and financial consultants to fishing guides and forest rangers. Not all of them are wealthy; some have very small investments in Money. Money has only one limited partner that is not an individual: the Acme Retirement Trust, a retirement plan for Acme Corporation, a large manufacturer. The Trust has a 2% limited partnership interest in Money.

The Trust is managed by a five-person board of trustees. The board of trustees is selected by Acme Corporation’s management without the participation of the employees. Employees have no say in how their retirement money is invested by the Trust, except an employee may order the plan trustees not to invest his money in a specified company or industry if the employee believes the company or industry is not “socially responsible.”

Discuss whether Money is an “investment company” as defined in the Investment Company Act of 1940. (Assume that Money’s limited partnership interests are securities.)