We will frequently be called upon to review the pro forma financial information. Pro forma financial information requirements are described in S-X Article 11; however, while S-X Article 11 is applicable, it has not been written with investment company mergers in mind. Therefore, a certain amount of interpretation may be required both by the registrant and by the SEC.

Item 14 of Form N-14 requires that pro forma financial statements be prepared unless the net asset value of the company being acquired does not exceed 10 percent of the registrant's net asset value. Measurement is to be as of a specified date within 30 days prior to the filing of the registration statement. S-X Article 11 provides that pro forma financial statements are to be presented using the registrant's most recent fiscal year-end. SEC staff comments in this area indicate that the staff requires pro forma financial statements to be prepared as of the registrant's most recent financial statement date, which could mean the semiannual report date. Article 11 also makes a special provision for investment companies, requiring that the funds combine identical periods. In preparing pro forma financial statements, the registrant should also assure that the financial information is sufficiently current. S-X 3-18, which sets forth the special provisions relating to management investment companies, indicates that, if the most recent audited financial statements are as of a date more than 245 days prior to the effective date, interim financial statements within 245 days of the effective date are required. Using semiannual dates with annual pro forma reporting periods would eliminate this issue.

In addition, consideration should be given as to whether the combination of the data from each of the funds provides meaningful information. For example, in a December filing of a registration statement to merge an April 30th year-end fund with a September 30th year-end fund (i.e., the September 30th year-end fund was the acquiring fund) where the September 30th fund only began operations on July 2nd, it would be more appropriate for the pro forma statement of operations to represent the combination of the periods July 1st through September 30th for the acquired fund and the period July 2nd (commencement of operations) through September 30th, an audited period, for the acquiring fund. If the situation were reversed (i.e., the acquiring fund was organized more than a year ago but the acquired fund was organized within the past year), the staff could accept either this approach or the pro forma combination of the full fiscal-year-to-date operations of the acquiring fund with the results since commencement of operations of the acquired fund.

The pro forma financial statements should typically include a statement of assets and liabilities, a statement of operations, a portfolio of investments, and notes to the pro forma statements. The notes should explain the transaction and how the pro forma financial statements were prepared, but consider that the reader of the pro forma financial statements also has the separate financial statements of each of the combining entities. In addition, the pro forma financial statements should include an explanation of each of the pro forma adjustments made.

The pro forma portfolio of investments should include each individual portfolio position and combine identical positions. In some cases, the acquired fund may hold investments that do not conform to the investment policies or restrictions of the acquiring fund. These positions should nonetheless be included in the pro forma portfolio, along with a notation specifically identifying the non-conforming positions and stating that they will be disposed of no later than the consummation date of the merger.

Pro forma adjustments to the statement of operations should include all changes to expenses (e.g., application of the acquiring fund's advisory fee rates to the combined assets, including breakpoints; elimination of duplicative costs) that are expected to result. Termination or reduction of any expense reimbursements or waivers also must be considered. Direct merger costs should not be included as a pro forma adjustment, but should be disclosed as a note to the pro forma statement of operations (SEC 4560.32).

Occasionally, the acquiring fund either has recently adopted a new schedule of management fees, prior to the merger being proposed, or will adopt new fees upon consummation of the merger. Despite Article 11’s requirement that pro forma adjustments only include those directly attributable to the transaction, we believe that pro forma combined management fees should be based on the revised fee schedule. This is because, unlike mergers of commercial companies, Form N-14 also requires the presentation of a pro forma combined fee table based on current applicable fees, and use of the revised fees in the statement of operations will result in a presentation supporting, and consistent with, that information.

Increasingly, acquiring funds establish new share classes to maintain the sales charge/12b-1 structure of an acquired fund after acquisition. For purposes of presenting the exchange of shares on the pro forma balance sheet and any related capitalization table, the acquiring fund should use the same procedures for determining the initial net asset value that are expected to be used on the acquisition date (typically, the net asset value of a currently outstanding share class).

Periodically, fund sponsors convert master/feeder structures to multi-class share structures by merging the various feeders and liquidating the master fund. Pro forma financial statements for this transaction should follow its substance by including the master fund as a combining entity and reflecting its liquidation as an eliminating adjustment. Duplicate costs, such as accounting and administration costs, audit and legal fees, which will be eliminated by liquidation of the master, may be reflected as pro-forma adjustments in the Statement of Operations. Because the feeders share a common master portfolio, a combining schedule of investments is not required.

When three or more funds are to be merged under a single Form N-14, the application of S-X Article 11 can become inordinately complex, as it conceivably requires additional pro forma information for each possible outcome where one or more constituents do not approve the merger. In a "generic" accounting comment letter issued by the SEC staff in November 1995, an alternative method of compliance was proposed; however, its application appears impractical in most cases. SEC staff often will address pro forma requirements where multiple funds are merged on a case-by-case basis. While it is not required, engagement teams encountering such a situation may contact the National Office to obtain information on recent SEC staff positions.