Fund Boards May Rely on CCO Representations in Lieu of Quarterly Board Determinations Under Rules 10f-3, 17a-7 and 17e-1

The Staff of the SEC’s Division of Investment Management has issued a no-action letter permitting a fund’s board to rely on written representations from the fund’s CCO in lieu of quarterly determinations that the fund’s transactions made pursuant to certain exemptive rules were effected in compliance with the fund’s procedures.¹ 

Background 

Sections 10(f), 17(a) and 17(e) of the Investment Company Act of 1940 generally prohibit certain transactions involving a registered investment company and its affiliated persons.² Rules 10f-3, 17a-7 and 17e-1 (each, an Exemptive Rule) under the 1940 Act provide certain exemptive relief from these statutory prohibitions. Reliance upon an Exemptive Rule is subject to several conditions, including conditions applicable to the fund’s board. Among other things, each Exemptive Rule requires that the fund’s board, including a majority of the independent directors,³ “(i) adopt procedures that are reasonably designed to provide that the transactions comply with the conditions of the Exemptive Rule, (ii) make and approve such changes to those procedures as the board deems necessary, and (iii) determine no less frequently than quarterly that all transactions made pursuant to the Exemptive Rule for the preceding quarter were effected in compliance with such procedures.”⁴ 

No-Action Relief: CCO Written Representation In Lieu of Board Determinations 

In the IDC Letter, the Staff stated that it “would not recommend enforcement action to the Commission for violations of Sections 10(f), 17(a) or 17(e) of the [1940] Act” if a fund’s board receives, “no less frequently than quarterly, a written representation from the [fund’s CCO] that transactions effected in reliance [upon an Exemptive Rule] complied with the procedures adopted by the board pursuant to the relevant Exemptive Rule, instead of the board itself determining compliance.” 

The Staff agreed with the position taken in the Incoming Letter that the no-action relief “is consistent with the Commission’s approach in adopting Rule 38a-1 and would allow boards to avoid duplicating certain functions commonly performed by, or under the supervision of, the CCO.” The Staff indicated that, while its position “would not change the board’s oversight role with respect to a fund’s overall compliance program,” it would “facilitate the directors’ ability to focus on conflict of interest concerns raised by affiliated transactions, including whether a fund engaging in the types of affiliated transactions permitted by the Exemptive Rules is in the best interest of that fund and its shareholders.” 

Conclusion 

The IDC Letter represents a welcome development for fund directors, whose “responsibilities have accumulated” over time.⁵ Indeed, the IDC Letter will “better allow directors to dedicate their time and attention to ‘areas where director oversight is most valuable,’”⁶ rather than routine reviews of the technical details of transactions made pursuant to an Exemptive Rule. 

Footnotes 

_{1) Independent Directors Council, SEC Staff No-Action Letter (Oct. 12, 2018) (IDC Letter). Dechert represented the Independent Directors Council in connection with the request for no-action relief. See Independent Directors Council, SEC Staff No-Action Letter (Oct. 12, 2018) (Incoming Letter). All factual statements herein are based solely on publicly-available information. The IDC Letter notes that the term “fund” includes registered management investment companies or separate series thereof, as well as business development companies. See IDC Letter at n.1.
2) Section 10(f) generally prohibits any fund from knowingly purchasing or otherwise acquiring, during the existence of an underwriting or selling syndicate, any security (other than a security of which the fund is the issuer) a principal underwriter of which is one of certain affiliated persons (as that term is defined in Section 2(a)(3) of the 1940 Act) of the fund, or affiliated persons of such affiliated persons of the fund. Cross trades are prohibited by Section 17(a) of the 1940 Act. Cross trades are principal transactions between funds that are affiliated persons, or affiliated persons of affiliated persons, of each other, between separate series of a registered investment company, or between a registered investment company (or separate series thereof) and a person that is an affiliated person of such registered investment company (or affiliated person of such person), solely by reason of having a common investment adviser or investment advisers that are affiliated persons of each other, common directors, and/or common officers. Section 17(e)(2)(A) generally prohibits an affiliated person of a fund, or an affiliated person of such affiliated person, acting as broker, in connection with the sale of securities to or by such fund or any controlled company thereof, from receiving from any source a commission, fee, or other remuneration for effecting such transaction, which exceeds the usual and customary broker’s commission if the sale is effected on a securities exchange.
3) The reference to “independent directors” refers to directors who are not “interested persons” of the fund, as such term is defined in Section 2(a)(19) of the 1940 Act.
4) Incoming Letter.
5) See Dalia Blass, Director, Division of Investment Management, SEC, Keynote Address: ICI Securities Law Developments Conference (Dec. 7, 2017) (Blass Keynote Address).
6) Incoming Letter (quoting Blass Keynote Address).}