Eaton Vance of Boston has been given a green light by the SEC chief accountant's office to install a .70 percent 12b-1 "equivalent" distribution program on two of its four senior prime rate bank loan interval funds. The approval was effective May 1.

Shareholders of the Eaton Vance Prime Rate Reserves and the Eaton Vance Classic Senior Floating-Rate Fund approved the addition of the distribution fee last month.

Eaton Vance, with a total of $37 billion in assets, is only the third adviser to attach a 12b-1 fee to an interval fund. Such a distribution plan allows the fund to continue to provide incentives to intermediaries who sell the fund.

"It's one of the few funds where a 12b-1 is a practical reality," said Don Cassidy, closed-end fund analyst with Lipper of New York. While 12b-1 fees are common to open-end mutual funds, they are prohibited on closed-end funds. But interval funds fall between the two fund types.

An interval fund is a hybrid that possesses some characteristics of a closed-end fund and some features of an open-end fund. First allowed by the SEC in 1992 as a method by which fund advisers could avoid the discount which many closed-end funds succumb to, an interval fund's illiquid portfolio resembles that of a closed-end fund's.

But, unlike a closed-end fund which offers a set amount of shares for purchase at its initial public offering then "closes," additional shares of an interval fund are continuously offered on a daily basis. Furthermore, an interval fund usually allows its shareholders to sell some shares back to the adviser on a quarterly, or in some cases on a monthly, basis. And, unlike those of closed-end funds, shares of interval funds do not trade on a stock exchange in a secondary market.

Overall, shareholders' expenses will not be affected, said Eric Woodbury, vice president at Eaton Vance. At the same time it installed the .70 percent distribution fee, Eaton Vance reduced the management and administration fee of its Master Portfolio by an equivalent .70 percent.

Eaton Vance's four senior bank loan funds are organized under a master/feeder (or hub and spoke) structure in which differently priced funds called "spokes" share a common portfolio of securities. Eaton Vance sponsors two other senior secured bank loan fund spokes which do not have 12b-1 fees. The Eaton Vance Advisers Senior Floating-Rate fund is sold through wrap programs. The other is the new Eaton Vance Institutional Senior Floating-Rate Fund which was introduced May 3 and is targeted at independent financial planners' clients. Eaton Vance also has one traditional closed-end senior prime rate fund, the Eaton Vance Senior Income Fund.

Eaton Vance added the 12b-1-like fee, in part, to ease the accounting burden created by the Financial Accounting Standards Board's (FASB) change in accounting rules for closed-end funds initiated in September 1998, (MFMN 10/28/98) said Bill Steul, vice president and chief financial officer at Eaton Vance. That rule required all closed-end fund advisers to take an immediate charge to their balance sheet for start-up costs including commissions paid to dealers who are given incentives by fund advisers to sell closed-ends funds.

Previously, closed-end fund advisers were allowed to capitalize these "start-up" costs and commissions as assets on their books, then annually write off a percentage of the total over a period of, say five, years. The rule affected closed-end funds whose fiscal years began after December 15, 1998.

Moreover, the FASB ruling was retroactive. It required advisers who had been writing off closed-end fund start-up costs since July 24, 1998 to stop doing so and to take an immediate one-time aggregate accounting charge. The change in accounting rules left some advisers with hefty deductions which are sometimes criticized for distorting true financial results. The change also raised questions as to whether the higher cost to entry to the closed-end fund world would mean advisers might not have the resources to bring new products to market.

But under the FASB rule change, closed-end funds that have both a contingent deferred sales charge and a 12b-1 type plan were exempted from this accounting change. The two Eaton Vance senior income funds already had contingent deferred sales charge plans in effect. The addition of a 12b-1-like distribution plan to Eaton Vance's two funds now allows the adviser to qualify to revert back to the favored amortization accounting method, said Steul. It also means that all of Eaton Vance's funds for which it pays commissions in advance will be treated the same from an accounting point of view.

The language of the change "isn't picking on closed-end funds because they are closed-end funds," said Tim Lucas, director of research and technical activity at FASB, and chairman of its Emerging Issues Task Force. The task force also decided that if an interval fund adviser has both a 12b-1 and a contingent deferred sales charge, that combination means the adviser has an asset and can continue to expense it over time, he said.

From an accounting standpoint, this method makes sense for an interval fund, said John Capone, assistant chief accountant with the SEC's Division of Investment Management.

"This was a product that because of the nature of its investment portfolio looked like a closed-end fund but operated like an open-end fund," he said. "It should be accounted for as an open-end fund."

In October 1998, Eaton Vance announced a one-time accounting charge of $36 million which effectively removed from its books its closed-end fund commissions previously being amortized. Also, in the last quarter of 1998, the new accounting rule caused Eaton Vance to take a charge of $30 million for costs associated with sales expenses on its funds.

In the first quarter of 1999 ending January 31, Eaton Vance, whose fiscal year ends in October, took a charge of $47 million. Of that, approximately $20 million was attributable to the costs associated with the continuous offering of its interval funds. The remaining $27 million were the costs associated with the offering of nine new closed-end municipal funds introduced in January, 1999, said Steul. Although final figures are not yet available, due to significantly higher sales of these funds in the second quarter of 1999, Steul expects such expenses for the adviser's third quarter to be in the $20 million to $25 million range. Eaton Vance resumed its original accounting method for the two funds with the start of the firm's fiscal third quarter on May 1.

Eaton Vance is not the only innovative adviser attempting to find satisfactory methods of dealing with the FASB requirement. On April 16, John Nuveen & Co. in Chicago introduced three new closed-end municipal funds that charge a 4.5 percent up-front sales charge deducted from the initial $15 net asset value price. To offset the impact of that sales charge, Nuveen will waive 30 basis points of its 65 basis point management fee for the first five years, according to Lipper. In years six through nine, Nuveen will scale back the waiver by five basis points each year. The full .65 percent management fee begins in the tenth year and remains in effect thereafter.

In recent years, front-end sales charges on closed-end funds have all but vanished as advisers work to make closed-end fund products more attractive. Consequently, advisers who must pay commissions up front to selling broker/dealers out of their own pocket recoup these costs through higher asset-based management fees.

Not only does Nuveen's structure allow the adviser to very quickly recover its costs which must be immediately written down according to the new FASB rules, but investors are given an incentive to stay-put until their savings on management fees offset what they have paid in up-front sales charges.

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