Copley Fund, Inc. v. Securities and Exchange Commission

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued May 4, 2015 Decided August 11, 2015
No. 14-1142
COPLEY FUND, I NC.,
PETITIONER
v.
SECURITIES AND EXCHANGE COMMISSION ,
RESPONDENT
On Petition for Review of an Order
of the Securities & Exchange Commission
Paul M. Honigberg argued the cause for petitioner. With
him on the briefs was Philippe M. Salomon.
Stephen G. Yoder, Senior Counsel, Securities and
Exchange Commission, argued the cause for respondent.
With him on the brief were Michael A. Conley, Deputy
General Counsel, John W. Avery, Deputy Solicitor, and
William K. Shirey, Assistant General Counsel.
Before: BROWN, SRINIVASAN and P ILLARD, Circuit
Judges.
Opinion for the Court filed by Circuit Judge SRINIVASAN .

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SRINIVASAN , Circuit Judge: Copley Fund, Inc., a mutual
fund regulated by the Securities and Exchange Commission,
asked the Commission for an exemption from rules governing
the calculation and reporting of Copley’s deferred tax
liability. The Commission denied Copley’s exemption
request, and Copley now seeks review in this court. Copley’s
arguments fail to carry the high burden required to overturn
the Commission’s denial of an exemption. We therefore deny
Copley’s petition for review.
I.
Copley is an open-end mutual fund, meaning that it
issues redeemable securities to its shareholders. 15 U.S.C.
§ 80a-5(a)(1). Nearly all open-end funds elect to be treated as
“regulated investment companies” under subchapter M of the
Internal Revenue Code, 26 U.S.C. §§ 851, et seq. If a fund
makes that election, the fund itself avoids corporate taxation
for capital gains and dividends associated with its holdings as
long as it satisfies certain conditions, including that it
distribute at least 90% of its taxable income to shareholders
each year. Id. §§ 851-55, 860. The tax liability then rests
with the shareholders rather than with the fund.
Copley, unlike most open-end mutual funds, has never
made a subchapter M election. Copley therefore is subject to
taxation at both the fund and shareholder levels. The
potential advantage of such an arrangement, as described by
Copley, is that a shareholder incurs no tax liability in
connection with the fund’s holdings until she ultimately
redeems her shares. Copley itself, however, must pay
corporate tax at the fund level each year on any capital gains
and dividends attributable to securities in its portfolio.

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The dispute in this case arose because the market value of
Copley’s portfolio appreciated significantly from the time
Copley originally purchased the securities in its fund. As a
result, Copley would face a significant amount of unrealized
federal income tax liability if it were forced to sell its
appreciated holdings. The Commission maintains that the
applicable rules require Copley to calculate, and report, its
deferred tax liability based on the amount of tax Copley
would owe if its entire stock portfolio were to be liquidated.
In Copley’s view, the Commission’s approach unduly inflates
the amount of deferred tax liability it must recognize. Copley
therefore seeks an exemption from the operation of two
Commission rules.
The first rule, Rule 22c-1, concerns the calculation of a
fund’s “net asset value,” 17 C.F.R. § 270.22c-1(a), which in
turn affects the price paid to redeeming shareholders.
Because Copley is an open-end fund, its investors have a
statutory entitlement to redeem their shares at any time in
exchange for a “proportionate share of [Copley’s] current net
assets,” i.e., the fund’s net asset value. 15 U.S.C. §§ 80a-
2(a)(32), 80a-5(a)(1). Rule 22c-1 implements the requirement
that the redemption price paid to a shareholder must equal an
allocable share of the fund’s net asset value: “[n]o registered
investment company issuing any redeemable security . . . shall
. . . redeem . . . any such security except at a price based on
the current net asset value of such security.” 17 C.F.R.
§ 270.22c-1(a). A related rule, Rule 2a-4, provides that, when
determining net asset value, “[a]ppropriate provision shall be
made for Federal income taxes if required.” Id. § 270.2a-
4(a)(4). Additionally, the redemption price must be
determined in a manner that treats redeeming and non-
redeeming shareholders equally, such that the price paid to
liquidating shareholders does not result in an unfair dilution

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of the value of the securities still held by non-redeeming
shareholders. See 15 U.S.C. § 80a-22(a).
The second Commission rule from which Copley seeks
an exemption, Rule 4-01 of Regulation S-X, governs the
manner in which a fund reports its deferred tax liability on its
financial statements. Under that rule, “[f]inancial statements
filed with the Commission which are not prepared in
accordance with generally accepted accounting principles
[GAAP] will be presumed to be misleading or inaccurate,
despite footnote or other disclosures, unless the Commission
has otherwise provided.” 17 C.F.R. § 210.4-01(a)(1); see 15
U.S.C. §§ 80a-8, 80a-29.
Copley historically recognized only a small percentage of
its total potential tax liability. Copley reasoned that, based on
its actual experience with redemption requests, satisfaction of
those requests on any given day would require selling no
more than a small percentage of its stock portfolio. In 2007,
however, the Commission’s Division of Investment
Management issued a letter to Copley expressing that Copley
must recognize the total value of its potential tax liability.
The Division of Enforcement later warned that it would ask
the Commission to seek injunctive relief if Copley declined to
comply. Copley then began to recognize the full value of its
potential tax liability. Because a fund’s net asset value
depends in part on the amount of its tax liability, Copley’s
change in calculation of that liability in turn reduced its net
asset value per share by more than 20%.
In September 2013, Copley formally sought an
exemption from Rules 22c-1 and 4-01, concerning,
respectively: (i) determination of the net asset value at which
Copley’s shareholders would be entitled to redeem their
shares, which in turn depends on the amount of Copley’s tax

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liability; and (ii) reporting of Copley’s tax liability on its
financial statements. Copley proposed that it would account
for and report only a small percentage of its tax liability (with
the percentage equaling a given multiple of either the fund’s
historic average or its historic maximum redemption rate).
According to Copley, its proposed alternatives would have
resulted in it recognizing a tax liability equal to between 8%
and 10% of its total potential tax liability.
On May 15, 2014, the Commission issued a notice
expressing its preliminary view that Copley’s exemption
request should be denied. Copley Fund, Inc., Exchange Act
Release No. 34-72,173, 2014 WL 1943920 (May 15, 2014)
(Notice). The Commission explained that a fund’s net asset
value equals the difference between its liabilities and its
assets. Notice ¶ 7. Consequently, when a fund understates a
liability (such as its tax liability), the fund’s “net asset value
will be overstated, as will the price at which the fund’s
redeemable securities are sold and redeemed.” Id. And
because an open-end fund must honor shareholder
redemptions, a “high level of redemptions necessitating
liquidation of a large portion of its portfolio” would result in
disparate treatment of redeeming and non-redeeming
shareholders. Id. ¶ 13.
In particular, the Commission explained, redeeming
shareholders would “receiv[e] a price for their shares that
reflects more than their pro-rata share of the net asset value of
the Fund” (because their realized net asset value would not
account for the full tax liability), “while the price of the shares
held by the remaining shareholders would reflect less than
their pro-rata share of the net asset value” (because accrual of
the full tax liability upon redemption would be allocated to
the remaining shareholders). Id. The Commission explained
by way of example that, if 60% of Copley’s shareholders

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redeemed their shares on a given day and Copley had
recognized only a fraction of its total tax liability per its
proposal, the redeeming shareholders would have received a
net asset value of nearly $14 per share as the redemption price
while the non-redeeming shareholders would have been left
holding shares with a diluted net asset value of less than $12
per share. Id. ¶ 14. Because that kind of disparate treatment
would “produc[e] an unfair and inequitable result among
Copley’s shareholders,” the Commission preliminarily
declined to allow Copley an exemption from Rule 22c-1. Id.
¶ 15.
The Commission also declined to grant Copley an
exemption from Rule 4-01’s requirement to report deferred
tax liability in accordance with GAAP in Copley’s financial
statements. Having determined that Copley must base its net
asset value on its full potential tax liability, the Commission
concluded that Copley’s reporting of only a fraction of its
total tax liability in its financial statements would be
“unnecessarily confusing to investors and contrary to the
policy behind the . . . disclosure requirements” of the
Investment Company Act of 1940. Id. ¶¶ 4 n.6, 18.
On June 19, 2014, the Commission issued an order
formally denying Copley’s exemption request “for the reasons
stated in the notice.” Copley Fund, Inc., Investment
Company Act Release No. IC-31,088, 2014 WL 2770563
(June 19, 2014). Copley now petitions for review of the
Commission’s denial of an exemption.
II.
We review the Commission’s factual findings for
substantial evidence and “will set aside its legal conclusions
only if ‘arbitrary, capricious, an abuse of discretion, or

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otherwise not in accordance with law.’” Wonsover v. SEC,
205 F.3d 408, 412 (D.C. Cir. 2000) (citing 5 U.S.C.
§ 706(2)(A)) (internal punctuation omitted). Because Copley
challenges the Commission’s denial of an exemption, our
review is “highly deferential.” Universal City Studios LLLP
v. Peters, 402 F.3d 1238, 1242 (D.C. Cir. 2005). We will set
aside the Commission’s denial of an exemption only if “the
agency’s reasons are so insubstantial as to render that denial
an abuse of discretion.” Id. (internal quotation marks
omitted). The Commission did not abuse its discretion here.
Copley’s primary argument is that the Commission’s
denial of an exemption was “based solely” on “hypothetical
speculation” rather than on Copley’s actual redemption
history. Appellant Br. 37 (capitalization omitted). Noting
that the highest daily redemption rate in Copley’s thirty-six-
year existence affected less than 6% of its then-outstanding
shares, Copley asserts that the Commission erred in
predicating its denial of an exemption on a hypothetical
scenario contemplating shareholders’ redemption of 60% of
Copley’s shares in one day.
Copley misunderstands the Commission’s rationale. The
Commission explained that, even though it knew of Copley’s
actual redemption history, Copley “cannot control or fully
anticipate the level . . . of [future] shareholder redemptions.”
Notice ¶ 12. “However unlikely” a large redemption event
“may seem to Copley,” the Commission observed, such an
event was “a possibility that Copley may not rule out,” given
the entitlement of Copley’s shareholders to redeem their
shares at net asset value. Id. And because a high level of
redemptions could result in substantially disparate treatment
of non-redeeming shareholders, the Commission determined
that the grant of an exemption to Copley would run “counter
to one of the primary principles underlying the Company

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Act”: that “redemptions of redeemable securities should be
effected at prices that are fair, and which do not result in
dilution of shareholder interests or other harm to
shareholders.” Id. ¶¶ 7, 13.
That rationale for the Commission’s denial of an
exemption lies comfortably within agency discretion. Indeed,
the Company Act requires that a redemption price based on
“net asset value” be calculated in a manner “eliminating or
reducing” any “dilution of the value” of shares held by non-
redeeming shareholders “which is unfair” to those
shareholders. 15 U.S.C. § 80a-22(a).
Copley counters that a large redemption event would not
necessarily generate a significant tax bill—if, for instance, the
impetus to redeem shares came about in reaction to a stock
market crash that also eliminated any gains in Copley’s
portfolio. The Commission’s 60% scenario, however, was
only an “illustrative fact pattern” used to highlight the
disparate treatment of shareholders under a given set of
circumstances. Notice ¶ 14. As the Commission notes on
appeal—and Copley does not dispute—some degree of
disparate treatment would occur “whenever Copley’s actual
tax liability exceeds its recorded partial deferred tax liability.”
Appellee Br. 33, 42 n.18. The Commission committed no
abuse of discretion in invoking an example to illustrate that
result.
Copley similarly takes issue with an article cited by the
Commission for the proposition that “[r]edemptions
necessitating liquidation of a substantial amount of an open-
end fund portfolio, while infrequent, have in fact been
experienced by several open-end funds.” Notice ¶ 12 n.16.
According to Copley, it is less likely to confront a substantial
redemption event than the funds analyzed in the article

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because it invests in a more liquid and diversified portfolio.
But as with the 60% redemption scenario, the Commission
referenced the article only for illustrative purposes. The
Commission recognized that, “[h]owever unlikely” a large
redemption event might be, Copley “cannot control or fully
anticipate the level . . . of [future] shareholder redemptions.”
Id. ¶ 12. Copley’s attacks on the Commission’s “hypothetical
speculation” thus afford no basis for setting aside the
Commission’s reasonable conclusion that Copley’s proposal
to provide for only a small fraction of its full potential tax
liability may result in inequitable treatment of redeeming and
non-redeeming shareholders, contradicting a primary purpose
of the Company Act.
Copley’s remaining arguments can be dispensed with in
relatively short order. Copley contends that the Commission
erred in “summarily reject[ing]” its offer to disclose in its
financial statements the mechanics and operation of its
proposed alternative methods for calculating its tax liability.
Appellant Br. 45-46; J.A. 17. Copley’s passing mention of its
disclosure proposal took up a mere two sentences of its
nineteen-page exemption application, see J.A. 17, and the
Commission was “not required to address every argument
advanced by” Copley in a cursory fashion. Town of
Barnstable v. FAA, 740 F.3d 681, 690 (D.C. Cir. 2014)
(internal quotation marks omitted). In any event, disclosure
of Copley’s proposed alternative calculations would not cure
the Commission’s substantive reasons for rejecting those
alternatives in the first place—i.e., the risk of inequitable
treatment of shareholders and the unnecessary confusion to
investors if Copley’s financial reporting did not match the
pricing of its securities.
Copley contends that the Commission’s denial of an
exemption is inconsistent with the flexibility the Commission

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extended to certain real estate investment trusts (REITs) in
accounting for their deferred tax liabilities. But “this is not a
case in which the Commission . . . failed to explain its
different treatment of similarly situated parties.” Mountain
Solutions, Ltd. v. FCC, 197 F.3d 512, 518 (D.C. Cir. 1999).
Rather, the Commission reasonably distinguished its
treatment of REITs, noting that REITs “are not open-end
funds, do not issue redeemable securities and therefore do not
face the associated potential need to sell portfolio assets to
satisfy redemption requests.” Notice ¶ 16 n.39.
Copley fares no better in arguing that the Commission
failed to consider the “actual harm” to investors arising from
Copley’s 2007 adjustment to recognize its full potential tax
liability. Appellant Br. 50 (capitalization omitted). The
Commission expressly acknowledged the change in value to
Copley’s shareholders, noting that, “whereas Copley’s net
asset value per share on February 28, 2007 . . . was stated in
its annual report as being $54.67,” Copley’s adjustment
resulted in “a per share net asset value for that same date . . .
of $42.54. The $12.13 reduction in the net asset value per
share was a change of 22%.” Notice ¶ 11 n.15 (internal
quotation marks omitted). The Commission nonetheless
declined to grant Copley an exemption from the requirement
to recognize its full tax liability for the reasons explained.
Because the Commission set forth its rationale and
“considered” the relevant “objection[],” Town of Barnstable,
740 F.3d at 690, Copley’s “actual harm” argument fails.
Copley’s contention that full recognition of its deferred tax
liability causes a distortion of various financial metrics fails
for largely the same reason: the change in those metrics is the
direct and inevitable consequence of the Commission’s
reasonable decision to deny Copley an exemption from the
obligation to recognize its full potential tax liability.

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Finally, Copley argues that its proposal to recognize only
a fraction of its full tax liability would not infringe the
Commission’s rules in the first place. The Commission’s
interpretations of those rules are not directly at issue because
Copley, in 2007, altered its accounting to comply with the
Commission’s suggested understanding of the rules. J.A. 5.
The question now before us concerns the Commission’s
denial of Copley’s request for an exemption from the rules.
As we have explained, the “very essence” of a request for
exemption “is the assumed validity of the general rule, and
also the applicant’s violation” of that rule unless the
exemption “is granted.” Omnipoint Corp. v. FCC, 213 F.3d
720, 723 n.3 (D.C. Cir. 2000) (citation omitted). To the
extent Copley means instead to contend that the Commission
should have granted an exemption from its rules because the
rules themselves are flexible enough to accommodate
Copley’s proposed alternatives, that argument essentially
merges into Copley’s underlying request for an exemption
from the rules. We reject that argument for the reasons
already discussed.
* * * * *
For those reasons, and in light of the highly deferential
manner in which we review the Commission’s denial of the
requested exemption, we deny Copley’s petition for review.
So ordered.

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