The author acknowledges the substantial contribution of Lita M.Dwight in the preparation of this outline.
- A unit investment trust ("UIT") is an investment company that invests in a pool of securities and/or other instruments and sells fractional undivided interests in that pool. Section 4(2) of the Investment Company Act of 1940 (the "1940 Act") defines a UIT as an investment company that
- is organized under a trust indenture, contract of custodianship or agency, or similar instrument;
- does not have a board of directors; and
- issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities (but does not include a voting trust).
- Although UITs, like mutual funds, are open-end investment pools that provide diversification, UITs are distinguishable from mutual funds in several key respects. The following table describes briefly some of these differences; a more detailed description of each of these areas is provided herein.
Active management--portfolio securities or instruments may be bought and sold every day
Essentially static portfolio--after the deposit date, securities may be bought or sold only in limited circumstances
May be structured as a corporation or a business trust
Must use a trust format
Actively overseen by a board of directors or trustees
Minimally supervised by a trustee
Shares are redeemable every day at net asset value (minus any applicable deferred sales charge)
Units are redeemable every day at net asset value, but virtually all UIT sponsors maintain a secondary market in units as the preferred alternative to redemption
Usually has a fixed life of anywhere from five to more than thirty years
Pass-Through Tax Treatment
Pursuant to its qualification as a "regulated investment company" (a "RIC") under Subchapter M of the Internal Revenue Code of 1986 (the "Code")
Pursuant to the grantor trust provisions of §671 et seq. of the Code (avoids the RIC diversification requirements, which may be difficult to meet when a UIT has a small number of portfolio securities)
Sold continuously on a "best efforts" basis through a distributor
Sold in a single "firm commitment" offering of a fixed size through a syndicate of underwriters and dealers
Fees and Charges
Generally includes an annual management fee, custody fees, transfer agency fees and other shareholder servicing costs and may include sales charges and/or ongoing distribution fees
Generally includes a sales charge and minimal ongoing trustee's and sponsor's fees
Essentially combined into one form, Form N-1A (which replaced Form N-1 in 1983, which replaced Form S-4 under the 1933 Act and Form N-8B-1 under the 1940 Act in 1978), which continues to be revised and updated
Separate required forms (Form S-6 under the 1933 Act and Form N-8B-2 under the 1940 Act), both of which were adopted in 1942 and neither of which has been substantially revised; however, recently the SEC requested comments on revisions to Form S-6 that would simplify the form
- Background and History
- Evolution of the UIT
- The earliest UITs (pre-1929 stock market crash) were "fixed trusts" created to facilitate an individual issuer's sale of its equity to the public. While a share of common stock might sell for tens or even hundreds of dollars per share, interest in these fixed trusts would sell for $8 to $10. An issuer would deposit its equity shares in a trust and sell pro rata participating interests in the trust, thereby enabling the issuer to offer its stock indirectly at prices significantly below the market price of a single share.
- In the 1930's, due in part to the public's demand for common stock and in part to its mistrust of managed investment companies after the 1929 crash, investors poured money into fixed trusts. By the end of 1931, more than 150 fixed trusts had been organized in the United States and approximately 100 million fixed trust shares had been sold.
- By the end of the 1930's, investment in fixed trusts was declining. Over the next twenty years, the fixed trust market continued to shrink and mutual funds regained credibility and assets.
- By the 1960's, UITs began to reappear, primarily as vehicles for investment in municipal bonds. Until the passage of the Tax Reform Act of 1976, funds established as corporations or business trusts could not pass through tax-exempt income to their shareholders. As grantor trusts, UITs offered the only publicly available pooled investment vehicles investing in a diversified portfolio of municipal bonds. By the late 1970's and the 1980's, municipal bond mutual funds attracted many investors seeking tax-exempt income who might have in the past invested in UITs.
- More recently, as described below, investment in UITs overall has slowed, and equity UITs have surpassed debt UITs as the more popular new issue.
- UITs fall into three general categories:
- Tax-Exempt Debt (Municipal Bond) UITs. As of December 31, 1997, assets in registered tax-exempt UITs aggregated approximately $37.5 billion. Of that amount, a significant percentage were "insured UITs" (i.e., UITs that purchase portfolio insurance guaranteeing the payment of principal and interest on the portfolio securities while in the trust).
- Taxable Debt UITs. This category includes UITs that invest in corporate bonds, government bonds and/or government agency certificates. As of December 31, 1997, assets in taxable debt UITs aggregated approximately $6.5 billion. Some taxable debt UITs are insured, but the majority are not.
- Equity UITs. As of December 31, 1997, assets in equity UITs aggregated approximately $42.0 billion.
- In contrast to previous years, the majority of UIT assets currently are held in equity UITs. Although debt UITs outnumber equity UITs in terms of dollars deposited, equity UITs became the more popular new UIT issue in the 1990's. For example, in 1997, approximately 423 new debt UITs were registered as compared to approximately 337 new equity UITs; however, dollars deposited in new equity UITs during the year aggregated approximately $35.9 billion as compared to approximately $2.6 billion in debt UITs.
- The discrepancy between the number of outstanding trusts and the dollar amount of assets in equity UITs as compared to debt UITs may in part be due to the difference in lifespan--equity UITs tend to have a life of one year, whereas debt UITs will have a longer life, based on the maturity of the bonds in which they invest (typically five to thirty years or more).
- Equity UITs often focus on:
- A specific market sector (e.g., telecommunications, utilities, "blue chip" stocks, healthcare, interests in real estate investment trusts ("REITs") or stocks related to the Internet); or
- A defined number of stocks consistent with a stated investment objective (e.g., the "Strategic Ten," "Top Fifteen," "Target Five" or, colloquially, "Dogs of the Dow" UITs, which typically invest in a portfolio of top-yielding stocks listed on the Dow Jones Industrial Average or another index or in a portfolio of stocks hand-picked by a widely recognized portfolio manager). Some interesting regulatory issues have been raised by these UITs; see, e.g., National Equity Trust (Notice: 1940 Act Release No. 21965, May 24, 1996; Order: 1940 Act Release No. 22019, June 17, 1996). In this order, the Securities and Exchange Commission ("SEC") granted exemption from Section 12(d)(3) of the 1940 Act, which prohibits an investment company from acquiring any security issued by any person who is a broker, dealer, underwriter or investment adviser (a "securities-related issuer"). Rule 12d3-1(b) exempts from Section 12(d)(3) purchases by an investment company of securities of such issuers if, among other things, immediately after the acquisition the investment company had invested not more than 5% of its total assets in the securities of that issuer. This "Top Ten" equity UIT sought exemption to enable it to invest, in equal amounts (i.e., approximately 10% per portfolio security), in the ten highest-yielding common stocks on the Dow Jones Industrial Average, one or more of which could be a securities-related issuer. See also Van Kampen American Capital Equity Opportunity Trust (Notice: 1940 Act Release No. 22083, July 19, 1996; Order: 1940 Act Release No. 2214, August 14, 1996).
- Decreased Overall Investment in UITs. In contrast to 1997 levels of UIT investment, at December 31, 1990 there were approximately 11,200 tax-exempt UITs with assets aggregating approximately $92 billion; approximately 700 taxable UITs with assets aggregating approximately $9.5 billion; and approximately 170 equity UITs with assets aggregating approximately $4 billion. Total UIT assets in 1997 were approximately $86 billion, a significant decrease from $105 billion in 1990.
- Corporate Structure. Pursuant to Section 26 of the 1940 Act, UITs are organized under a trust indenture or similar custodianship agreement. The trust indenture governs the administration of the UIT as well as the activities of those associated with it, including the trustee, sponsor and evaluator. Among other things, Section 26 requires that a UIT's indenture:
- Designate as trustee a bank having a minimum capital of at least $500,000;
- Set forth the fees to be paid to the sponsor, trustee and underwriters;
- Vest responsibility for custody of UIT assets with the trustee or other equity qualified to serve as custodian of investment company assets under the 1940 Act;
- Provide for termination of the trust, the conditions for distribution of the trust's assets upon termination plus any objective criteria to be used to determine when securities may be disposed of during the life of the trust; and
- Require the sponsor to keep books and records and make appropriate periodic reports to unitholders.
- Series. A UIT generally comprise multiple consecutive series. Each series has a single portfolio. Series of a UIT may all have the same investment objectives and policies, or they may all be different. Each series requires an indenture that contains general information about the trust plus information specific to that series. A UIT may meet this requirement either:
- by executing a separate new indenture for each series; or
- by executing a base indenture at inception of the trust, containing generic trust information, and a brief supplemental trust agreement setting forth information unique to each series at the inception of that series.
- Portfolio Insurance. UITs can purchase insurance that will guarantee scheduled principal and interest payments on securities held in the portfolio. Often a UIT can obtain a AAA rating from a nationally recognized statistical rating service by obtaining insurance on the bonds while in trust. UIT insurance does not, however, protect the investor against devaluation of the portfolio securities if interest rates rise or if a bond rating is downgraded and may not guarantee that the UIT will receive scheduled interest if the bond is called. Investors must therefore be cautioned that although insurance affords a measure of protection, it does not unconditionally guarantee that the investor will not lose money.
- The Registration Process. Investment companies are required to register both the shares or units they issue under the provisions of the Securities Act of 1993 (the "1993 Act") and the issuing entity itself under the provisions of the 1940 Act.
- Unit Registration. UITs may register units in either of two ways. Units can be registered in a finite amount like traditional non-investment company and closed-end fund offerings. Alternatively, UITs may, like other open-end funds, register an indefinite number of units at the outset and pay for units sold (less units redeemed or repurchased) after the close of each fiscal year end.
- Rule 487. Each series of a UIT is a separate issuer and therefore a separate offering under the 1933 Act. Originally, each series was reviewed by the SEC staff and declared effective individually, even if the only meaningful difference between series was the date and the series number. In 1982, however, the SEC adopted Rule 487 under the 1933 Act, which allows subsequent series of a UIT to elect to become effective automatically similar to the way that post-effective amendments for mutual funds may become effective automatically pursuant to Rule 485(b). Under Rule 487, a new UIT series will become effective at the time and on the date designated by the registrant on the following conditions:
- The UIT is not engaged in the business of investing in mutual fund shares;
- The proposed time and date of effectiveness are set forth on the facing sheet of the series' registration statement;
- The UIT designates one or more previous series that were reviewed and declared effective by the SEC staff (i.e., did not go effective automatically pursuant to Rule 487) and represents that:
- the portfolio securities do not differ materially in type or quality from those in the previous series; and
- except as necessary to identify portfolio securities or essential financial information with respect thereto, disclosure does not differ materially from that set forth in the previous series;
- The UIT has complied with requirements for distribution of a preliminary prospectus as set forth in Rule 460 under the 1933 Act; and
- If it has counsel, the UIT files a letter of such counsel stating that the registration statement does not contain any disclosure that would render it ineligible to become effective automatically pursuant to the rule.
- Rule 24f-2. Rule 24f-2 under the 1940 Act provides that a UIT may register an indefinite amount of units at its inception. Each year, the UIT keeps track of units sold and redeemed or repurchased during the year. Ninety days after the end of the UIT's fiscal year, the UIT files a Rule 24f-2 Notice, in which it nets units sold against units redeemed or repurchased. The net number of units is the number used to calculate filing fees for the year, which are paid at that time.
- Amendments adopted on October 11, 1997 to Rule 24f-2 permit a UIT to "net" units redeemed in previous fiscal years without having to preserve those redemption credits by filing a post-effective amendment to the UIT's registration statement.
- Proposed Rule 24f-3. In 1987, the SEC proposed Rule 24f-3, which would have required each UIT series to register a definite number of units in connection with its initial public offering but would permit the series to register an indefinite number of units, without additional fees, to cover its secondary market resales. Most UITs do not actively redeem units--instead, sponsors maintain a secondary market in the units to provide liquidity and minimize depletion of trust assets. When a sponsor maintains a secondary market and a unit is resold, that unit must be reregistered. Because UITs typically do not issue new units, indefinite registration is only relevant to these secondary market resales of units. In years in which repurchases equal or exceed resales, no registration fees would be due. Thus, the rule would have tailored registration fee payments more closely to the business practices of UITs. Although the rule was never adopted, it remains proposed and may in the future be reconsidered by the SEC.
- Disclosure Forms. Most investment companies, including mutual funds, meet the dual registration requirement by filing one integrated registration form that satisfies the requirements of both the 1933 and 1940 Acts. Unlike mutual funds, UITs must file separate registration forms under each Act.
- Form N-8B-2. The trust itself registers as an investment company under the 1940 Act on Form N-8B-2. Form N-8B-2 is filed in connection with the initial series of a UIT and thereafter must be amended whenever there is a material change affecting any of the information therein. Form N-8B-2 requires a detailed description of the trust, including:
- The name (including a complete history of any name changes), address and jurisdiction of organization;
- Significant aspects of the indenture and any contracts into which the trust has entered;
- Description of the securities being offered;
- Description of all sales loads, fees, charges and expenses;
- Information regarding the sponsor/depositor, including its history and operations and its officers, directors and employees and their compensation;
- Distribution and redemption arrangements, including information regarding the principal underwriter(s);
- Information regarding the trustee, custodian and any other service providers;
- Information regarding portfolio insurance, if applicable;
- Significant tax consequences of investment in the trust;
- Audited financial statements in accordance with Regulation S-X under the 1933 Act; and
- Exhibits, including, but not limited to, the indenture and all material contracts.
- Form S-6. Each series of UIT is a separate registrant for 1933 Act filing purposes and must file its own registration statement on Form S-6. The Form S-6 generally includes the prospectus for the relevant series, which must cover a significant amount of the information required by Form N-8B-2.
- The initial Form S-6 filing for the first series issued by a UIT will generally follow the procedures for any initial public offering of an investment company. The registration statement is filed, together with any supporting information regarding the similarity of the UIT to other UITs that have been reviewed and made effective by the Division of Investment Management staff. The staff then takes approximately thirty days to review and comment. After the staff has provided its comments, the UIT responds and any points that need clarification or negotiation are addressed. When the staff and the UIT have reached an agreement, the UIT will request acceleration of the effective date for the registration statement to the date of deposit of the securities, and the trust commences operations on that day.
- Subsequent series filed pursuant to Rule 487 become effective at the designated time as described above. A typical subsequent filing, therefore, will consist of a facing page and cross reference sheet, a prospectus of a series previously reviewed by the staff, and any required exhibits. The staff will review certain elements of the prospectus, including the performance information, before accelerating the effective date.
- On October 7, 1998, the SEC requested public comment on whether Form S-6 should be revised to streamline the updating process. The SEC requested comments on ways to both enhance the quality, utility and clarity of the information provided and reduce the administrative burdens on both sponsors and the SEC staff. The comment period ended on December 7, 1998.
- Form N-4. Separate accounts offering variable annuity contracts that are registered as UITs file registration statements on Form N-4. These UITs are highly specialized vehicles established and maintained by insurance companies, and the considerations specific to them are not addressed in this outline.
- Proposed Form N-7. In 1985, the SEC proposed Form N-7 as the integrated registration form for UITs.
- Form N-7 as originally proposed was inspired by mutual fund Form N-1A. Like Form N-1A, Form N-7 contemplated a three-part format (Parts A, B and C). Part A (the prospectus) would contain information integral to an investment decision. The prospectus would be provided to each investor upon his or her investment. Part B (the statement of additional information or "SAI") would contain additional information that might be of interest to investors, and it would be available to investors at no charge upon request. Part C would contain information for the SEC only.
- Industry response to proposed Form N-7 was overwhelmingly negative. In anticipation of the proposal, UIT sponsors had uniformly endorsed the idea of streamlining and modernizing UIT disclosure documents, eliminating the substantial redundancy between Form N-8B-2 and S-6 and codifying the various disclosure positions taken over the years by the SEC staff in no-action and interpretive letters. Once the proposal was released, however, commenters maintained that the SEC had not in fact simplified UIT disclosure but instead had replaced one element of redundancy with another by continuing to require substantially similar information in the prospectus that would in large part be repeated in the SAI. For insured UITs, the proposal also would have required inclusion of the insurer's financial statements, to which the UIT industry vehemently objected.
- The SEC reproposed Form N-7 in 1987. In the reproposal, the three-part format was abandoned in favor of the two-part format, but the prospectus would be divided into two parts: (1) specific information about the units being issued in that series followed by (2) more generic information about the trust. Information about insurers was still required, however, and the industry continued to object.
- There were some concessions to industry comment evident in the 1987 reproposal, however--for example, the requirement to provide annually audited financial statements for units resold on the secondary market would have been eliminated. Because each UIT series has an essentially fixed portfolio, UIT sponsors maintained the costs of requiring an annual audit of the same portfolio every year would far outweigh the benefits to the unitholders. Accepting the validity of the industry's argument, the new proposal required only unaudited annual financial statements. The reproposal as a whole, however, generated a new avalanche of comment, and no further action has been taken on Form N-7 to date.
- Interestingly, even though Form N-7 has not been adopted, certain aspects of the proposals have been incorporated into practice. For example, when determining whether the name of a fixed income UIT (and mutual fund as well) complies with the requirements of the 1940 Act, the SEC staff now makes reference to the definition of terms that describe portfolio maturity like "short term," "intermediate term" and "intermediate/long term" to the definitions set forth in guide 20.--"Maturity of Trust Portfolio" to the reproposal of form N-7.
- Although the Division of Investment Management announced an intention to consider recommending that the SEC repropose Form N-7 for public comment, at the date of this publication, the SEC has not issued a proposal. The SEC has, however, solicited comments on potential amendments to Form S-6 (see IV.B.2.C. above).
- Selected Disclosure Issues
- Fees. A typical UIT prospectus contains an "essential information" page which sets forth the pertinent information about the series being offered, including:
- The dollar amount and number of units offered:
- The components of the public offering price, including the value of the securities and applicable sales charges;
- Redemption and secondary market repurchase prices;
- Sponsor's, evaluator's and trustee's fees; and
- Record, distribution and termination dates.
- Estimated Current Return. Fixed income UITs are often sold largely based on the return that investors can expect to receive. Calculation and disclosure of potential return has been the subject of much debate in the UIT industry and at the SEC. For a time in the mid-1980's, the Division of Investment Management staff required that UITs submit their computerized spreadsheets when requesting acceleration so that the staff could apply its own analysis to the disclosure of potential return.
- In 1990, in a generic comment letter to investment company registrants (a so called "Dear Registrant" letter), Carolyn Lewis, assistant Director of the Division of Investment Management, outlined guidelines for permissible performance measurements for UITs. In the 1990 letter, Ms. Lewis states the Division's position that estimated current return, or "ECR," a commonly used performance measure in UIT prospectuses, may be "misleading and should be used as the single measure of performance." The letter indicated that UITs should refer to estimated long-term return (sometimes called "ELTR"). Under the 1990 letter and its progeny, UITs should use internal rate of return, or "IRR," a long-term measurement based on outflows of cash to unitholders, and may consider using the "Wesolowski-Hicks Formula," or "WHF," which takes into account the yield to maturity of each bond and weights the yield by the maturity and market value of the bond.
- At that time, to qualify for accelerated treatment a UIT had to calculate the difference between the ECR and the ELTR. In general, if the difference was more than 25 basis points (40 in the case of UITs with dollar-weighted average maturities of over 15 years) above the ELTR, ECR could not be used unless accompanied by an ELTR calculation or, in some case, could not be used at all.
- In any case, the prospectus was required to describe any number used, the method of calculation and the reason for any discrepancies between the ECR, IRR and/or WHF. Percentage measurement of potential performance was mandatory, and disclosure of dollar amounts "that sales personnel could readily use to calculate estimated current return" was not acceptable. Registrants were directed to prepare a cash flow statement in all cases and, if yield to maturity for each security is not shown in the prospectus, the UIT was directed to be prepared to submit supplementally a list of these yields as well as the cash flow tables and the calculations of the VHF.
- After the issuance of the 1990 letter, the Division of Investment Management staff continued to reexamine the calculation of ECR. In August 1995, the staff of the Division issued a no-action letter stating that it would not recommend enforcement action if a UIT utilized a modified ELTR formula, as proposed by the Investment Company Institute, that takes into account the impact of sales charges on an investor's return.
- In November 1995, in conversations with a UIT registrant, the Division of Investment Management liberalized its restrictions in connection with the use of the "Modified ELTR." The UIT maintained that consideration of sales charges in the calculation of the Modified ELTR often results in deviation between it and ECR of more than 25 basis points. The staff stated that it would not object if UITs continued to provide ECR in their prospectuses even if ECR deviates from Modified ELTR by more than 25 (or 40) basis points, as long as the other conditions set forth in the 1990 letter were met.
- On November 22, 1995, in 1940 Act Release No. 21538, the staff proposed rule and form amendments that would require fixed income UITs to calculate their yield pursuant to an "Estimated Yield Formula" that was substantially similar to the Modified ELTR. Unlike the Modified ELTR, the Estimated Yield Formula would not provide for compounding. The proposing release also requested input on calculation of tax-equivalent yield and proposed treatment of accrued interest, market discount on tax-exempt securities and UITs that invest in preferred stock, asset backed securities and adjustable rate securities. In addition, the release requested comment on whether the Estimated Yield Formula should be abandoned in favor of the traditional IRR calculation. On January 11, 1996, the staff extended the comment period on the proposal to March 29, 1996, but as yet no action has been taken.
- Prospectus Delivery Requirement. On November 13, 1997, in Release No. IC-22884, the SEC proposed for public comment new Rule 154 that would allow investment companies to satisfy their disclosure obligations with respect to two or more investors sharing the same household by sending a single document under certain circumstances. The SEC is actively considering comments to this proposal and has announced its intention to adopt a rule in 1999.
- Plain English Requirement. On March 13, 1998, in Release No. IC-23064, the SEC adopted amendments to Rule 421 of the 1933 Act that set forth plain English requirements for registration statements filed by public issuers, including investment companies. The plain English requirements were adopted to make prospectuses simpler, clearer and more useful to investors. Unlike mutual funds, UITs must comply with the plain English requirements only for new registration statements. The effective date of the new amendments for UITs was October 1, 1998.
- Year 2000 Problem. On October 1, 1998, in Release No. IC-23476, the SEC adopted new Rule 204-5 and Form ADV-Y2K under the 1940 Act. The new rule requires registered investment companies, including UITs, to file reports regarding their plans for addressing the Year 2000 computer problem. The reports are designed to provide both the SEC and investors with information regarding the company's plans to address the problem. The rule and form became effective on November 13, 1998.
- The Creation, Offering and Sale of Units
- Deposit. Typically, the sponsor/depositor accumulates securities in anticipation of the creation of a UIT series. On the date of deposit, the securities, or, in lieu thereof, contracts to purchase securities, together, with any insurance policies or letters of credit related to the portfolio securities, are deposited in the trust. In return, the sponsor receives certificates representing units of the series which it then offers to the public.
- Evaluation. The Evaluator certifies that it has made an evaluation of the securities, typically at the close of business on the business day prior to the deposit date, and that the valuation as set forth in the prospectus and used in the calculation of the offering price is accurate.
- Underwriting. Prior to the date of deposit, the sponsor assembles a syndicate of underwriters and provides them with a preliminary prospectus or "red herring" (typically a prospectus for an earlier, similar series). The underwriters ascertain interest in the series to be created using this preliminary prospectus. When the underwriters have received sufficient "indicators of interest," the sponsor accelerates the effectiveness of the registration statement for the series and the units are sold. At that point, an "agreement among underwriters" may be executed obligating each underwriter to sell a specified number of units of that series.
- Sales Charges. The unit sales charge can be a front-end charge, a deferred charge or a combination of the two.
- When units are sold on a front-end sales charge basis, the public offering price of the unit generally will be equal to the aggregate offering price of the underlying securities divided by the number of units plus a sales charge equal to a certain percentage of the price. Front-end sales charges are often reduced for bulk purchases (e.g., more than 250 units), pursuant to Rule 22d-1 under the 1940 Act.
- When units are sold on a deferred sale charge basis, collection of all or part of the sales charge is deferred over a period subsequent to the settlement date for the purchase of units. Typically, the deferred sales charge is deducted from the unitholder's distributions on the units during the collection period until the total amount of the sales charge is paid. If a unitholder redeems his or her units before the sale charge is paid in full, the remainder of the sales charge is deducted from the redemption proceeds. If overall distribution income is insufficient to pay the sale charge, the trust can be directed to sell securities to make up the difference.
- Rule 22c-1 under the 1940 Act requires that the price of a redeemable security issued by an investment company for purposes of sale, redemption or repurchase be based on the security's current net asset value. Since a deferred sales charge imposed upon redemption or repurchase is calculated based on the net asset value of the unit when it was purchased, imposition of the deferred sales charge may raise issues under Rule 22c-1. In addition, Rule 22d-1 does not technically apply to deferred sales loads that are reduced for bulk purchases. UITs that impose deferred sales loads have therefore obtained exemptive orders addressing these issues. See e.g., O.C.C. Distributors, et al. (Notice: 1940 Act Release No. 22363, December 9, 1996).
- UITs that invest primarily in shares of investment companies have received exemptive relief to permit them to charge sales charges in excess of the 1.5% limitation imposed by Section 12(d)(1)(F)(ii) of the 1940 Act. That section permits an investment company to purchase shares of another investment company without regards to the restrictions imposed by Section 12(d)(1)(A) of the 1940 Act as long as the acquiring company (i.e., the UIT) does not charge a sales load of more than 1.5%. Applicants maintain, among other things, that Section 12 of the 1940 Act was intended to curb abuses inherent when a managed fund that already charges substantial management fees purchases shares of other managed funds, such as fee layering, imposition of undue control through the threat of large scale redemptions, acquisition of voting control and creation of a confusing "pyramid" structure. These concerns are not relevant to the UIT structure, according to the applicants, in large part due to their simplified, unmanaged structure. See, e.g., Van Kampen American Capital Equity Opportunity Trust et al. (Notice: 1940 Act Release No. 22293, October 21, 1996; Order: 1940 Act Release No. 22338, November 18, 1996).
- Secondary Market Sales and Repurchases. Although units of a UIT are by definition redeemable, generally one or more of the sponsors will maintain a secondary market in the units to avoid depletion of assets. In addition, since sponsors often base the secondary market repurchase price on the offering price of the underlying securities rather than the bid price (on which the redemption price is based), the unitholder will generally realize a better price on repurchase rather than redemption.
- Exchange Offers. Section 11(c) of the 1940 Act prohibits an offer of exchange of UIT units for the units of another UIT (or for any other investment company securities). UITs that are part of a complex often include a privilege allowing their holders to exchange their units for units of another UIT in the complex, or to roll over their units from a series that is terminating into another UIT in the complex, at a reduced sales charge. To offer this privilege, however, the UIT must obtain an exemptive order from the SEC. See, e.g., O.C. Distributors, et al., supra.
- The Key Participants
- The Depositor/Sponsor
- Underwriter. The sponsor(s) is usually one or all of the underwriters of the UIT offering. It is responsible for establishing the trust and incurs all the organizational expenses.
- Accumulator. In most circumstances, the sponsor (or one of the sponsors) is the entity responsible for purchasing and holding the securities that will comprise the portfolio (sometimes called the "accumulator").
- Recordkeeping and Oversight. In addition, the sponsor is responsible for maintaining unitholder records and instructing the trustee on the disposition of securities should funds be needed to meet redemptions or in other circumstances in which sale of securities might be appropriate.
- Qualifications. The 1940 Act addresses the identity of the sponsor to ensure its integrity by prohibiting certain persons with questionable backgrounds from serving as a sponsor. Similarly, the 1940 Act and the rules thereunder impose strict limitations on the fees a sponsor may receive from the trustee, and any reimbursement of expenses incurred by the sponsor is prohibited unless deemed reasonable by the SEC.
- Compensation. The sponsor's compensation consists of the sales charge that constitutes a portion of the sales price of the units and also from the spread between the price it sells portfolio securities to the trust and what it paid for those securities. A sponsor may also be compensated for providing certain portfolio supervisory services, although these fees are subject to limits.
- Expenses. Originally, sponsors bore all of the costs of organizing the UIT and offering units, including printing, legal, registration, and accounting fees. In 1995, however, the SEC staff expressed its view that a UIT could bear certain organization expenses, such as the cost of preparing and printing its registration statement and organizing documents, registration of units and the initial audit. See Letter to Pierre de St. Phalle, Esq. (May 9, 1995).
- Maintenance of a Secondary Market. The SEC staff has consistently taken the position that a UIT sponsor who maintains a secondary market is the "issuer" of those units as defined under Section 2(4) of the 1933 Act. As a result, a sponsor that maintains a secondary market is obligated to maintain an "evergreen" prospectus for the series. In addition, any dealer selling units of a UIT must deliver a current prospectus if the sponsor, or any person acting as an underwriter, is making a market in the units. For example, if one of the underwriters has not yet sold its allotment of units, any dealer in those units must comply with the prospectus delivery requirements. Failure to comply creates a right of recision for the purchaser under Section 12 of the 1993 Act.
- The Trustee
- Services. The services the trustee of a UIT provides are mainly administrative in nature. The trustee's responsibilities include:
- Collecting and disbursing the interest and dividends due on the trust's portfolio to the unitholders;
- Performing the trust's recordkeeping needs and fulfilling its reporting requirements;
- Ensuring that the trust's expenses are properly paid; and
- In conjunction with the trustee's recordkeeping responsibilities, the trustee is required, pursuant to the indenture, to provide unitholders with an annual report disclosing certain specified matters.
- Requirements. In an effort to protect investors from certain past abuses in the industry, Section 26 of the 1950 Act sets forth minimum requirements for the trustee. In particular Section 26(a)(1) requires that the trustee be a bank having at all times an aggregate capital of not less than $500,000, to ensure its solvency. In addition, to prevent abandonment of the trust, Section 26(a)(3) prohibits the trustee from resigning until the UIT is fully liquidated or a successor is appointed.
- Fees. For its services the Trustee receives a continuing fee based on the total value of the trust. In addition, the trustee may retain the proceeds from the UIT held in non-interest bearing accounts awaiting distribution.
- The Evaluator
- Services. The evaluator values the portfolio securities as required by the indenture. Typically valuation will be done on a daily basis during the initial offering period and less frequently thereafter. In addition, the evaluator may perform portfolio supervisory services such as designating particular securities to be sold in consideration of specified factors for an asset-based fee.
- Fees. The evaluator receives either a fixed annual fee or a fee per evaluation for the purpose of meeting redemptions or for repurchases and resales on the secondary market.
- Affiliated Evaluators. It is not required that the evaluator be independent from the sponsor; in fact, the evaluator may be and often is one of the sponsor's affiliates.
- The Evolving Definition of "Fixed Portfolio of Securities"
- UITs are distinguishable from mutual funds in that their portfolio is essentially fixed at the time of their creation. The SEC view has traditionally been that once the composition of a UIT portfolio is established, it may be changed only in very limited and narrow circumstances. In the past, the fixed nature of the UIT portfolio has strictly limited its investment options. The SEC's view is based in part on its belief that congress did not deem it necessary to require UITs to have a board of directors because they have virtually no portfolio activity.
- In recent years, however, UITs have sought SEC approval to substitute or eliminate portfolio securities in certain specified circumstances. The definition of appropriate circumstances, however, seems to have broadened significantly through the SEC staff positions articulated in these no-action letters.
- Municipal Investment Trust Fund (pub. avail. April 28, 1986) ("Municipal Investment"). The sponsors of this UIT sought no-action relief in connection with a proposal to purchase securities for a portfolio on a monthly basis to replace any securities liquidated or otherwise disposed of. In denying no-action relief, the SEC staff clarified its views regarding portfolio substitution. In particular, the staff quoted Guide 10 to proposed Form N-7, which states that the term "specified securities" in Section 4(2) of the 1940 Act requires that "any additional securities deposited in a trust ... substantially replicate the initial composition of the trust portfolio both as to specific securities and actual maturities of that portfolio."
- PaineWebber Equity Trust, Growth Stock Series (pub. avail. September 24, 1986) ("PaineWebber I"). The SEC staff again denied no-action relief regarding a potential trust provision concerning portfolio substitution. In its letter PaineWebber stated that the UIT indenture would provide that the trust could sell a portfolio security if:
- such security failed to declare or pay a dividend;
- a legal action had been instituted that could adversely affect potential payment of dividends;
- a breach of covenant or warranty has occurred in any document relating to the issuer of the security that could adversely affect the payment of dividends or otherwise impair its sound investment character.
- a default has occurred with respect to any other outstanding obligations of the issuer;
- the price of the security has so declined or other credit factors exist that would make retention of the security in the portfolio "detrimental to the interests of the unitholders"; or
- the sale is necessary in order to maintain the qualification of the UIT as a RIC.
PaineWebber did not ask for approval of the above-referenced conditions for sale of a portfolio security. Instead, the letter sought no action relief regarding its proposal to enable the UIT to sell a portfolio security if its market value dropped by 15% or more, with the proceeds to be reinvested (1) pro rata in the remaining portfolio securities, (2) in one of five predesignated reinvestment securities or (3) in U.S. Treasury obligations. In denying relief, the SEC staff referred to the Congressional intent associated with the Section 4(2) of the 1940 Act as it had in its Municipal Investment response. Specifically, the staff stated its view that "Congress did not intend that the sponsor of a unit investment trust would be able to sell portfolio securities and reinvest the proceeds from the sale in new securities solely because of the effect of general market conditions or investment performance on the market value of those portfolio securities" and that in its view a UIT may "sell portfolio securities and reinvest the proceeds therefrom in other securities only in extraordinary circumstances, i.e., circumstances indicating that the creditworthiness of economic viability of the issuer of the portfolio security in question is seriously in doubt." Thus, the staff at least implicitly permitted the automatic sale of securities based on conditions as undefined as the avoidance of a situation that could be "detrimental to unitholders" while again, as it had in Municipal Investment, explicitly prohibiting the reinvestment of sale proceeds.
- Prudential Unit Trust (pub. avail. January 20, 1988) ("Prudential"). In this letter, Prudential proposed a trust provision allowing the sponsor to direct the trustee to dispose of a portfolio security whose quality rating, as determined by Prudential's research department, fell below a certain minimum rating and to distribute the proceeds. The staff granted the relief, stating that its determination was based on the facts that:
- the portfolio was comprised of individually rated securities;
- Prudential's research department was solely responsible for the rating of each security and performed this function as part of its service to institutional and individual clients;
- the research department was a totally separate entity and had no connection with the UIT group;
- the disposition of any security would be due to a downgrade in rating by the research department based on an overall evaluation of the issuer's economic viability; and
- the proceeds of any such disposition would not be invested, but would be distributed directly to unitholders.
- Nike Securities L.P. (pub. avail. November 20, 1992). In a further broadening of permissible disposition of portfolio securities, the SEC staff granted no-action relief to a UIT that included in its indenture automatic sale provisions substantially similar to the criteria articulated in PaineWebber I. Nike sought to include additional provisions in the indenture that would require elimination of a portfolio security if its total growth goal reached a predetermined level or termination of the trust if the UIT as a whole reached its predetermined growth goal. In both instances, proceeds would be distributed to unitholders. The proposal further provided that the evaluator would independently compute the total growth goal for each portfolio security as well as for the UIT as a whole at the initial date of deposit and continually reevaluate each security pursuant to fundamental valuation factors. In granting no-action relief the SEC staff stated that "where the UIT indenture permits elimination of securities upon the occurrence of certain specified events, and does not permit the sponsor to purchase new securities . . . the indenture doe not involve management."
- PaineWebber Equity Trust Growth Stock Series (pub. avail. July 19, 1993) ("PaineWebber II"). PaineWebber again sought no-action relief in connection with a proposal to include in its UIT indenture provisions substantially similar to the PaineWebber I provisions for automatic disposal of portfolio securities in certain circumstances. In addition, PaineWebber sought relief to sell in the following circumstances:
- a public tender offer or exchange offer had occurred which led PaineWebber to believe that the sale of the security would be in the unitholders' best interests;
- the entire portfolio had to be sold due to the indenture's mandatory termination provisions; or
- a sale was necessitated to pay trust expenses or to meet redemptions.
PaineWebber II also incorporated the additional criteria for automatic disposal of securities stated in Prudential (i.e., based on a downgrade in the ratings assigned by PaineWebber's research department). In granting the no-action relief, the SEC staff pointed in particular to the fact that the proposal did not provide for the reinvestment of the proceeds from the sale of the security but instead resulted in the distribution of proceeds to unitholders.