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January 7, 1994
Division of Investment Management
office of General Counsel Subject: Letter from Congressmen Dingell and Gonzalez re:
Merger of Dreyfus and Mellon This memorandum responds to Chairmen Dingell and Gonzalez's December 20, 1993 letter in which they ask several questions regarding the proposed merger between Dreyfus Corporation ("Dreyfus") and Mellon Bank Corporation ("Mellon"). Chairmen Dingell and Gonzalez asked that we analyze relevant federal securities law issues relating to the proposed merger. Our responses correspond to the respective questions.
We understand that the Mellon/Dreyfus merger is intended to be so constructed as to minimize the concerns we raise in this memorandum. However, we are troubled that there are insufficient legal safeguards of the type we consider important, and that other entities, faced with different circumstances, may behave less responsibly.
On December 6, 1993, Mellon and Dreyfus announced their agreement to merge in a transaction valued at $1.85 billion.1/ The staff understands that Dreyfus will become a subsidiary of Mellon Bank.
Dreyfus is a registered investment adviser that advises, among other things, the sixth largest family of mutual funds in the United States. Mellon is the 21st largest bank holding company in the United States (according to asset size) and is the parent of Mellon Bank. Mellon Bank is the investment adviser to one family of funds, the Laurel Funds, with $3.3 billion in assets.21 Mellon Bank currently ranks 22nd among banks in mutual fund assets under management. Mellon also purchased Boston Group Holdings in 1993. Boston Group Holdings is the parent of Boston
See MELLON BANK & DREYFUS, Mellon Bank Corporation and the Dreyfus Corporation to Merge in Stock Transaction valued at $1.85 Billion, Dec. 6, 1993 (the "Press Release").
See Lipper Analytical Services, LIPPER DIRECTORS' ANALYTICAL DATA (4th ed., 1993) ("Lipper"). All asset figures are as of September 30, 1993.
Company Advisers, which administers 147 mutual funds with $60.5 billion in assets managed by independent advisers; it also advises the Boston Company funds with $1.3 billion in assets under management. 3/ Dreyfus advises mutual funds with $72.2 billion in assets. 41 After the merger is completed and Mellon Bank assumes responsibility for managing the Boston Company funds, Mellon Bank and its affiliates, including Dreyfus, will be the largest bank mutual fund investment adviser, with $76.8 billion in mutual fund assets under management, or four percent of all mutual fund assets.5/ Mellon estimates that, after the merger, over 50% of its revenues will be from fees for financial services, including mutual fund advisory fees. 6/
The Mellon/Dreyfus merger is one of the most dramatic examples of the recent growth of bank involvement in the mutual fund industry. Currently 113 banks or bank subsidiaries advise 943 mutual funds.// Bank mutual funds have $204 billion in assets, an increase of 29% since December 31, 1992.8/ Mutual funds overall have grown about 19% since December 31, 1992, to $1.9 trillion.2/ Banks also are increasingly active in selling mutual fund shares to the public.
The Mellon/Dreyfus merger, as we understand it from the facts currently available, raises in a more highly visible context the concerns that we have previously expressed with respect to banks' involvement with mutual funds generally. These
See id. The Boston Company's preliminary proxy statement, filed with the Commission on December 17, 1993, indicates that Mellon intends to integrate the Boston Company funds and the Laurel Funds into a single fund complex with Mellon Bank as the investment adviser. Boston Advisers, a subsidiary of Mellon Bank, currently advises the Boston Company funds.
Currently, Provident National Bank is the largest bank mutual fund investment adviser, managing $19.9 billion in mutual fund assets. See id.
See Lipper Analytical Services, LIPPER BANK RELATED FUND
concerns include the risk of investor confusion, certain conflicts of interest, and the need for particular and focused disclosure. It also, in our view, makes even more apparent the desirability of functional regulation, and of legislation to redress all of these concerns definitively.
A. Distribution and Sales Activities
Shares of the Dreyfus funds currently are distributed by Dreyfus Service Corporation, a wholly owned subsidiary of Dreyfus. The staff understands that, to satisfy the requirements of the Glass-Steagall Act, shares of the Dreyfus funds will be distributed by an unaffiliated entity after the completion of the merger.19/ The staff, therefore, does not anticipate that the distribution of Dreyfus funds' shares will present a conflict of interest.
It is currently unclear to what extent shares of Dreyfus funds will be sold through Mellon Bank to banking customers and whether such sales will be made by bank employees or by employees of a registered broker-dealer. sales of mutual fund shares through a bank, particularly sales that take place in a bank's lobby, may confuse investors as to the uninsured nature of the funds. 11/ Chairman Levitt expressed concern about the risk of investor confusion in testimony on November 10, 1993 before the Securities Subcommittee of the Senate Banking, Housing and Urban Affairs Committee. 12/ The ills that can result from such
10/ The merger would, as a result of the Investment Company Act
of 1940 ("Investment Company Act"), cause the automatic termination of each Dreyfus fund's contract with its principal underwriter and will require each fund's board of directors to approve a new contract with a principal underwriter.
11/ The Commission recently conducted a preliminary consumer
survey that found that investors are confused as to the uninsured nature of bank sold mutual funds. The Commission plans to conduct further surveys to ascertain the extent of
investor confusion. 12/ The Commission's staff expressed its concern about the risk
of customer confusion last May when it required any mutual
confusion were demonstrated recently by the massive fraud that took place in connection with the sale of American Continental Corporation's debt securities in Lincoln Savings' branches.
Conflicts of Interest Between Investment Adviser and
The merger creates potential conflicts of interest between Mellon Bank and the Dreyfus funds which it appears they are attempting to address. 13/ To address conflicts of interest of this sort more generally, the Commission has supported legislation that would amend the Investment Company Act to (1) prohibit an investment company from borrowing from an affiliated bank, except as permitted by the SEC; (2) prohibit an investment company from purchasing securities in an underwriting, the proceeds of which are used to retire debt owed by the issuer to a bank that advises the investment company, except as permitted by the SEC; (3) prohibit an investment company from using an affiliated bank as a custodian, except as permitted by the SEC;14) (4) prevent an investment company's investment adviser that also acts as trustee for trust clients from perpetuating itself as the investment adviser even where that continued relationship is not be in the shareholders' best interest; (5) prevent an investment company's investment adviser from using the investment company to support the advisers' other business clients by causing the investment company to purchase securities or other property from those clients; and (6) strengthen the
In a meeting on December 22, 1993, between the Commission's
independence of investment company boards of directors. 15/ For the most part, such legislative amendments are designed to preclude the kinds of abuses that existed historically and were the basis for Glass-Steagall prohibitions.
C. Commission oversight of Dreyfus
As a registered investment adviser, Dreyfus is subject to Commission regulation, examination, and oversight. Banks are excluded from the definition of "investment adviser" under the Investment Advisers Act of 1940 ("Advisers Act"). As a result, banks that advise mutual funds are not required to register as investment advisers, to comply with the Advisers Act and the rules thereunder, or to submit to Commission examination. 16/
The staff has been advised that the parties to the merger intend that Dreyfus will remain a registered investment adviser fully subject to the Commission's regulatory, examination, and oversight authority. 12/ However, if Mellon Bank at some later time decides to assume the role of investment adviser to the Dreyfus funds, as it apparently will do in the case of the Boston Company funds, the Commission could not preclude Mellon Bank from doing so and therefore Mellon Bank's advisory activities would be outside the commission's jurisdiction. This would be detrimental to the Commission's ability to examine the Dreyfus funds and to enforce their compliance with the federal securities laws. It would be more difficult for the commission's examiners to understand fully the funds' operations, and they could be
15/ Because Mellon Bank is a member bank, Section 32 of the
Glass-Steagall Act, 12 U.S.C. S 78, would prohibit any officer, director, or employee of Mellon Bank or its holding
company from being a director of a Dreyfus fund. 16. Bank holding companies are also excluded from the Advisers
Act. If Mellon (the holding company), rather than Mellon
required to register.
December 22, 1993 meeting, that Dreyfus would become a subsidiary of Mellon Bank and that the Dreyfus funds would continue to be advised by a registered investment adviser. Dreyfus has filed a "sticker" to its funds' prospectuses disclosing Dreyfus' agreement to merge with Mellon, and stating that Dreyfus will be a separate subsidiary within the Mellon organization.