June 6, 1997
On May 28, the Securities and Exchange Commission (SEC) issued a press release
saying they were instituting proceedings against the Trustees of the Parnassus
Fund and Parnassus Investments (PI), its investment adviser. The SEC staff said
that the Trustees and PI overvalued the shares of a company called Margaux, Inc.
from December of 1990 to January of 1993. They further maintain that the fund
made a loan of $100,000 to Margaux on April 28, 1989, that violated the Fund's
investment policies of not making loans. Finally, the SEC charged that Parnassus
Investments used credits from brokerage commissions known as "soft dollars" to
purchase $67,000 worth of computer equipment that PI used for transfer agent and
fund accounting work. Investment regulations allow the use of soft dollars, but
the SEC maintains that these soft dollar credits were not permissible. Because
of press reports about these SEC charges, I wanted to write shareholders a
letter giving some background.
First of all, I would like to say that we think there is no merit to any of
these charges. Although the SEC staff has tried to get us to settle these
charges, we have chosen not to do so because we don't think we have done
anything wrong. We have chosen to accept the bad publicity created by the SEC's
accusations and fight the agency in a trial-like hearing. I would like to talk
to you about all three charges: the valuation of Margaux, the loan to Margaux
and the soft dollars.
Regarding valuation, Margaux was delisted from the NASDAQ stock market on August
30, 1990. This meant that there was no real market for the company's stock so
the Trustees had to value the stock according to fair value. The last quote on
NASDAQ was 34.4 cents a share and we left the stock at that level because we
thought that that was an accurate assessment of the company's fair value.
The SEC implies that we should have marked Margaux's shares down to very low
values because of isolated, nonrepresentative trades. We disagree with the SEC's
contention. We felt, based upon our analysis of Margaux's business, that marking
down the price to unrealistically low levels on the basis of a few shares traded
would hurt shareholders and would not be representative of Margaux's fair value.
Our decision proved to be a wise one. Margaux was sold to another company called
Dover Diversified in 1995 for 27 cents a share -- far above the low prices the
SEC wanted us to use.
After Margaux went into Chapter 11 reorganization, the Fund invested $100,000 in
Margaux in the form of a convertible debenture. The company needed money for
working capital and we thought it would be a good investment since the company
had a lot of value and we could convert our $100,000 into stock. The Fund's
investment policies state that we can invest in "convertible debt securities"
and the Margaux investment was a convertible debt security. However, Margaux's
Chapter 11 reorganization plan had to be approved by the court so our investment
had to be confirmed by the court to be convertible. Since some months lapsed
between the time we put up the $100,000 and the time we got court confirmation
of convertibility, the SEC is claiming that the investment was a loan and not an
equity investment. (The Fund does not make loans.) In my view, the SEC is making
a highly technical argument that is wrong. Both Margaux and the Fund knew the
investment was convertible debt and we had to act quickly to get the working
capital to the company. In the final analysis, the court confirmed the
convertibility and we did quite well on the investment. We acquired the stock
for 6.7 cents a share and sold it for 27 cents.
The final issue is soft dollars. Parnassus Investments used soft dollars to
purchase computer hardware and software to use in the Fund's transfer agent and
fund accounting functions as well as for research. The SEC agrees that our use
of soft dollars for research was justified, but not for accounting or transfer
agent work. I disclosed to the independent Trustees that we were using soft
dollars to purchase computers and software. PI receives a fee from the Fund for
providing transfer agent and fund accounting services and PI reduced the fee it
would otherwise charge to compensate for the use of soft dollars. In this way,
we saved the Fund and the shareholders money by keeping our fees low. The SEC
maintained that PI was getting a benefit from the soft dollars that should not
be allowed. We disagreed with the SEC, but because of the controversy, PI paid
the Fund $67,000 in cash to resolve the issue. The payment was made almost two
years ago.
We think the SEC is out of line in pursuing these charges. The dollar amounts
are small and the costs of litigating will undoubtedly be greater than what
could be arrived at in settlement. However, the issue is one of principle.
Should the government be second guessing the good faith business decisions of
your Trustees and Fund Manager? We are confident in our position. Undoubtedly
there will be many twists and turns before resolution of this matter. In the
meantime, I wanted to give the shareholders some background on the issues. A
hearing will be scheduled for later this year and we'll give you a report as
soon as we know the outcome.
Yours truly,
Jerome L. Dodson
President
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