Attorneys Express Concerns With Final Regs on Widely Held Fixed Investment Trusts

Dear Mr. Solomon, Mr. Desmond, Ms. Hammer, Mr. Korb, Ms. Maloy and Ms. Colson:

We would like to thank the Department of Treasury ("Treasury") and the Internal Revenue Service ("Service") for the detailed and thoughtful work that was obviously put into the final regulations on reporting for widely held fixed investment trusts (the "Final Regulations") issued January 24, 2006. It appears clear from the Final Regulations that the intent of the Treasury and the Service is that widely held fixed investment trusts continue to be viable investment vehicles, but that they should be subject to increased compliance in reporting and disclosure obligations. The industry is committed to coming into compliance with its reporting obligations. However, we are writing on behalf of our clients to express their significant concerns with certain portions of the Final Regulations, many of which were not included in prior proposed regulations and about which our clients have not had an opportunity to comment.

Among our clients who sponsor U.S. unit investment trusts ("UITs") are Van Kampen Funds Inc., First Trust Portfolios LP, Claymore Securities, Inc. and Fixed Income Securities LP (collectively, the "Sponsors"). UITs are investment companies that are required to be registered under the Investment Company Act of 1940 (the "1940 Act"). The UITs offered by our clients are relatively fixed portfolios of equity or debt securities that have maturities that range from approximately 13 months to 30 years. A vast majority of the UITs are structured to constitute trusts within the meaning of Treas. Reg. § 301.7701-4(c) and are treated as grantor trusts under Subpart E of Subchapter J of the Internal Revenue Code. UITs are "widely held fixed investment trusts," as defined in Treas. Reg. § 1.671-5(b)(22).

Pursuant to the 1940 Act, a UIT is an investment company that (i) is organized under a trust indenture, (ii) does not have a board of directors and (iii) issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities. Our clients generally serve as the promoter, sponsor, depositor, principal underwriter and supervisor of the UIT. As such, they are generally responsible for organizing new UITs, depositing securities or contracts to establish new UITs, preparing registration statements and offering documents, underwriting units of UITs, supervising the portfolios of UITs, fulfilling the regulatory requirements imposed on UITs and supporting a secondary market for certain UITs. The costs associated with these activities are significant for the Sponsors with per trust costs ranging from $50,000 to $100,000. In the aggregate, our clients offer approximately 650 new UITs each year and are offering more than 200 UITs in the primary market at any point in time.

To establish a UIT, a sponsor generally assembles a portfolio of securities or contracts for securities that are deposited with a trustee. In exchange for the deposit, the sponsor receives units of the UIT that represent a pro rata share of the portfolio. These units are eventually distributed to the public, typically through broker-dealers and banks that are paid commissions for their participation. The vast majority of new UITs are initially created with a relatively small seed deposit (approximately $100,000 -- $150,000) to satisfy statutory requirements. In response to investor demand, these UITs are expected to grow considerably over the primary offering period (generally several months and possibly longer if portfolios are exactly replicated) through the addition of securities by a supplemental deposit process. Our clients currently have approximately 200 UITs that are actively engaged in the supplemental deposit process. The supplemental deposit process is vital to the long-term viability of these UITs. UITs that do not acquire enough assets expose investors and/or the sponsor to unreasonable operating expenses, excessive organizational expenses that cannot be recouped from the UIT, premature termination, poor execution of securities transactions because of their small size and relative poor performance as compared to more fully funded UITs. Because UITs are statutorily required to immediately respond to the redemption requests of investors, the problems associated with UITs that do not reach a necessary size are only made worse over time as redemption requests are submitted.

As noted below under "Issues," the Final Regulations have created a great deal of uncertainty for all sponsors. Because sponsors are currently unable to determine how to comply with the Final Regulations, many sponsors are contemplating terminating the sale of interests in all UITs that are treated as grantor trusts until all material tax reporting issues can be resolved. Considering that our clients have approximately 200 UITs that are currently being offered, the substantial cost of each UIT, and the potential impact on investors and the sponsors of prematurely terminating the supplemental deposit process for these UITs, such a termination would be extremely costly and burdensome both to the sponsors and to investors.

The reason for such terminations is based on the fact that UITs created before February 23, 2006 will not necessarily be able to satisfy the qualified non-mortgage widely held fixed investment trust ("NMWHFIT") exception set forth in the Final Regulations and take advantage of simplified asset disposition reporting. The Final Regulations indicate that the qualified NMWHFIT exception is satisfied if a NMWHFIT has a "start-up date" that is before February 23, 2006. "Start-up date" is defined as the date on which substantially all of the assets have been deposited with the trustee of the widely held fixed investment trust ("WHFI trust"). Unfortunately, because many UITs utilize supplemental deposits, the definition of "start-up date" causes serious concern that many UITs organized before February 23, 2006 (including many organized long before the release of the Final Regulations on January 24, 2006) may not qualify for the exception. To avoid being ineligible for the exception, many sponsors may be compelled to close the offerings of those UITs prematurely.

As stated below under "Issues," while the Sponsors would prefer to delay the February 23, 2006 date to some later time, they are extremely anxious to clarify the date of applicability of the NMWHFIT exemption as it relates to UITs. Clarification can easily be accomplished by stating that for UITs the qualified NMWHFIT exception is satisfied if the registration statement of the UIT is declared effective by the Securities and Exchange Commission and offered to the public prior to February 23, 2006. This change can be made by amending § 1.671-5(c)(2)(iv)(E) as follows:

We respectfully request that this clarification be addressed immediately because the Sponsors must address the issue of whether UIT offerings should be terminated well before February 23, 2006 since the Sponsors must have sufficient time to notify the broker-dealer community and investors of the decision to close the UIT offerings and the reasons therefor if our request is not resolved in the manner requested. The substantive issues raised by the Final Regulations referred to in this letter and other UIT industry letters may be addressed in the near future, but we hope that our current request can be positively answered as soon as possible.

ISSUES

Uncertainty regarding the application of the effective date referred to above is caused by several new provisions in the Final Regulations. Provided below is a summary of the issues that we have identified to date regarding the Final Regulations. We hope this will be part of a continuing dialogue in which these and any other issues that arise may be discussed.

1. Practical Availability of the Safe Harbors.

The Final Regulations provide a safe harbor for a NMWHFIT if substantially all the income of the NMWHFIT is interest and dividends and all NMWHFIT interests have identical value and rights. Treas. Reg. § 1.861-5(f). The Final Regulations provide a separate exception from reporting in regard to redemptions if substantially all of the income of the NMWHFIT consists of dividends. Treas. Reg. § 1.861-5(c)(2)(v)(C).

a. Definition of Substantially All. "Substantially all" is not defined in the Final Regulations. "Substantially all" is defined in a variety of other sections of the Internal Revenue Code of 1986, as amended (the "Code"), and other regulations. Taxpayers may speculate as to the intended meaning of "substantially all" in the context of the Final Regulations, but the lack of a definition creates great uncertainty as to the practical availability of the safe harbor given the supplemental deposit process used in the UIT industry. We respectfully request that the Treasury define "substantially all" in the context of the Final Regulations and delay the beginning of the transition periods until such guidance is provided.

b. Treatment of Gains for Purposes of Substantially All Test. The Final Regulations do not appear to exclude gains from the sale of property held by a trust from the "substantially all" test for purposes of determining whether substantially all of the "income" is dividends and interest. WHFI trusts that are registered as UITs under the 1940 Act are required to allow their unit holders to redeem their units on a daily basis. Although a UIT may intend to only realize interest and dividends throughout the entire expected life of the UIT, a UIT cannot place restrictions on the number or percentage of unit holders that choose to redeem their units at any particular time. Thus, although the UIT only holds securities to generate interest and dividends, the UIT may, at any time, be required to fund a redemption that could generate gains that would cause the UIT to violate the "substantially all" requirement. We respectfully request that gains from the sale of assets held to generate dividends and interest are excluded from the "substantially all" test.

c. Uncertainty Regarding Safe Harbor Requirements. The Final Regulations require that, if the safe harbor is used, the safe harbor must be used for the life of the UIT. This requirement, though facially reasonable, creates uncertainty as to the availability of the safe harbor for UITs that reasonably expect that they will meet the requirements for the safe harbor in their first year of existence, but cannot be certain as to whether they will continue to meet the safe harbor because they cannot reasonably control or accurately anticipate the level of redemptions requested in any particular year of the UIT. If a UIT is required to use the safe harbor over its entire life if it uses the safe harbor at all, does that mean a UIT that is not certain it will qualify for the safe harbor over its entire life will be ineligible to use the safe harbor even in years in which the UIT would appear to qualify? We respectfully request that qualification for the safe harbor be based upon reasonable expectations for the first year of the UIT's life (though the importance of this request is reduced if the Treasury grants the request to exclude gain from the sale of property held by a UIT).

d. Definition of Interest. "Interest" is defined for the purposes of the safe harbor by reference to the definitions provided in Code § 6049(b) and the regulations thereunder. Code § 6049(b) excludes from the definition of "interest" interest that is excluded from gross income under Code § 103. This would appear to exclude from qualification under the safe harbor WHFI trusts that invest solely or primarily in tax-exempt bonds. We cannot think of any policy reason why tax-exempt bond trusts should not be eligible for the safe harbor, but, for the sake of clarity, we respectfully request that the Final Regulations be clarified to define "interest" to include tax-exempt interest.

2. Practical Availability of the De Minimis Exception.

The Final Regulations provide a de minimis exception that allows simplified reporting in regard to WHFI trust assets. To qualify for the exception, WHFI trust sales proceeds for a calendar year may not exceed five percent of the aggregate fair market value of all the assets held by the WHFI trust as of the later of January 1st of that year or the WHFI trust's start-up date. WHFI trusts registered as UITs under the 1940 Act are required to allow their unit holders to redeem their units daily. Although a UIT may intend to only realize interest and dividends throughout the entire life of the UIT, a UIT cannot place restrictions on the number or percentage of unit holders that may redeem their units at any particular time. Thus, although the UIT might only hold securities to generate interest and dividends, the UIT may, at any time, be required to fund a redemption that could generate gains that would cause the UIT to violate the de minimis exception. Because the UIT will not know from year to year whether at year-end the UIT will qualify for the current de minimis exception, the UIT will need to prepare to report both as if the de minimis exception does not apply for the current year and as if the exception does apply for such year. We respectfully request that gains from the sale of assets that are sold to fund redemptions should be excluded from the de minimis exception.

3. In-Kind Distributions.

a. A Deemed In-Kind Redemption Exception. The regulations presume that the tax consequences of a sale of assets for an investor redemption fall proportionately on all investors, including the non-redeeming investors. In many cases, we believe that it is more appropriate, under existing tax law, to view a sale for redemption of trust assets as being a two stage process: first, an in-kind division of the assets followed by a sale of those assets on behalf of the redeeming investors. This would mean that the tax consequences of the sale fall entirely on the redeeming investors, as is fair and appropriate.

b. Fractional Shares. It is uncertain how the Final Regulations would treat the distribution of cash in lieu of a distribution of fractional shares under the in-kind redemption exception. In other areas, such as tax-free reorganizations, the Treasury has interpreted the distribution of cash in lieu of fractional shares as a distribution of the shares followed by a purchase of those shares. We respectfully request that the Final Regulations provide similar treatment to WHFI trusts.

4. Grandfathering, Transition Rules and Effective Dates.

a. Grandfathering Old Trusts. The Proposed Regulations had an effective date of January 1, 2004. We respectfully request that a WHFI trust formed before such date should be permanently grandfathered from the rules under the Final Regulations unless the WHFI trust is significantly modified.

b. Grandfathering Basis Calculation. Although the Final Regulations appear to be generally effective on January 1, 2007, it is unclear whether the determination of the bases of UIT assets must be redetermined as of such date as if the Final Regulations had always been in effect. We respectfully request that UIT unit holders that have calculated the bases of their units without treating non-pro rata redemption proceeds as reinvestments do not need to recalculate their bases when such trusts become subject to the Final Regulations.

c. Change of Accounting Method. The Final Regulations should clarify that the application of the rules provided in the Final Regulations do not require a request for change of accounting method or an amortization of the impact of such change.

d. February 23, 2006 Transition Rule. As stated above, the Final Regulations provide that simplified asset disposition reporting applies to trusts with a "start-up date" before February 23, 2006. Although the Treasury should be lauded for providing transition relief, the Final Regulations have thrown the UIT industry into turmoil, and it is not currently reasonable to expect that the UIT industry will be prepared by February 23, 2006 to explain the impact of these rules or determine whether a trust reasonably expects that it will be able to comply with the rules. The significance of the February 23, 2006 date is greatly increased by the confusion described above surrounding the safe harbors. Unless the Treasury clarifies the safe harbors by February 23, 2006 in a way that a significant portion of the industry can reasonably anticipate qualifying for them, the industry will need to assume that the full asset-by-asset reporting required by the general rules will apply. Software systems have not yet been developed because the industry has not yet begun talking about the appropriate standardized protocols to convey the information required to be provided to middlemen and taxpayers, and there is a significant question as to whether on February 23, 2006 UITs will be able to reasonably anticipate that they will be able to comply with the general rules. The UIT industry is assuming that the purpose of these Final Regulations was not to kill the industry, but instead to bring the industry into compliance with a reporting regime that the Treasury has accepted. If our suggestion provided above modifying how the February 23, 2006 date applies to UITs is not acceptable, we respectfully request that the February 23, 2006 date be extended to July 1, 2006 to allow the industry to be in a position where it can reasonably anticipate compliance at the beginning of the transition period.

e. January 1, 2007 Date. As mentioned above, the software systems to comply with the rules imposed by the Final Regulations have not yet been developed, and the UIT industry has not yet begun talking about the appropriate standardized protocols to convey the information required to be provided to middlemen and taxpayers. It is at best optimistic that the industry would be in position to begin tracking the information required by the Final Regulations by January 1,2007. We respectfully suggest that the January 1, 2007 date be extended to January 1, 2008 to allow the UIT industry to be in a position where it can reasonably anticipate compliance at the beginning on the effective date.

5. Limited Exception for Qualified Short-Term Trusts.

We recognize that Treasury has already provided a somewhat more beneficial reporting system for a NMWHFIT that terminates within twenty-four months of its start-up date. Treas. Reg. § 1.671-5(f)(1)(iv)(A)(2)(i). However, in UITs with a twenty-four month or less term from the date of the commencement of the public offering to the termination date that do not span more than two consecutive calendar years, the historical pattern has been for the vast majority of the redemptions to occur within the last three months of the trust term. Because the income from asset sales to fund redemptions generally would effectively be bunched into one taxable year, there would seem to be little opportunity for such trusts to manipulate or shift income between investors. In this situation, the benefit to the Treasury from the increased reporting contemplated by the Final Regulations would not seem to balance the increased administrative burden of complying with the general rules of the Final Regulations. We, therefore, respectfully request that trusts with a term of twenty-four months or less that do not span more than two consecutive calendar years from the date of the commencement of the public offering to the termination date be added as an additional exception, qualifying for the special rules under Treas. Reg. §§ 1.671-5(c)(iv)(B), 1.671-5(c)(v)(C), 1.671-5(e)(v)(B) and the safe harbor under Treas. Reg. § 1.671-5(f).

Again, we appreciate greatly the time and effort that has obviously gone into the Final Regulations. We are committed to working with the Treasury to bringing the industry into compliance. We would like to discuss this matter with you as soon as possible. Once the crisis created by the February 23, 2006 deadline is resolved, we would appreciate working with you on any other issues raised by new provisions in the Final Regulations.

Please contact Paul Carman at (312) 845-3443 or Steven Frost at (312) 845-3760 of our office with any questions or comments.