The staff of the U.S. Securities and Exchange Commission Division of Investment Management (Staff) has issued an IM Guidance Update regarding mixed and shared funding (Guidance Update). In the Guidance Update, the Staff acknowledged that the relief provided by mixed and shared funding exemptive orders is infrequently, if ever, relied upon. As a result, the Staff noted that it is not necessary for a fund to obtain a mixed and shared funding order if no person will rely on the relief, and that funds with existing mixed and shared funding orders do not need to comply with the orders if the exemptions are not being relied upon.

While it is still too soon to gauge the impact of the Guidance Update, it has the potential to greatly simplify the operations of insurers issuing variable annuity (VA) and variable life insurance (VLI) contracts, as well as the operations of funds that serve as the underlying investment options in those contracts.

Background on Mixed and Shared Funding

Insurance companies typically issue VLI contracts in reliance on Rules 6e-2 and 6e-3(T) (Insurance Rules) under the 1940 Act, which provide exemptive relief from various provisions of the 1940 Act and rules thereunder. Among the types of relief provided by the Insurance Rules are exemptions from Section 9(a) of the 1940 Act (which Section disqualifies a person convicted of certain offenses, and any company affiliated with that person, from serving in various capacities with respect to a registered investment company) and Sections 13(a), 15(a) and 15(b) of the 1940 Act (which Sections require pass-through voting with respect to investment company shares held by an insurance company separate account through which a VLI contract is issued). The Insurance Rules effectively limit the amount of monitoring required pursuant to Section 9(a) regarding an insurer’s personnel who have no involvement in matters pertaining to registered investment companies. With respect to Sections 13(a), 15(a) and 15(b), the Insurance Rules permit an insurance company to disregard VLI contractholders’ voting instructions in certain limited circumstances.

The relief granted under the Insurance Rules is subject to a number of conditions, and generally precludes investment in an underlying fund that engages in “mixed funding” or “shared funding.” Mixed funding refers to the sale of fund shares to various types of investors, such as when a fund is used as an investment option in VA contracts and/or certain retirement plans in addition to VLI contracts. Shared funding is the sale of fund shares as an investment option in variable insurance contracts issued by multiple unaffiliated insurance companies.

Underlying funds frequently engage in mixed and shared funding, and typically obtain exemptive relief permitting insurance companies and their affiliates to invest in underlying funds engaged in mixed and shared funding while still qualifying for the exemptions that are available under the Insurance Rules. The relief provided by mixed and shared funding orders is available to insurance companies, investment advisers and underwriters – the orders do not provide relief utilized by funds themselves.

Staff Observations

In the Guidance Update, the Staff indicated that a mutual fund is permitted to engage in both mixed and shared funding without obtaining a mixed and shared funding order if no party relies upon the exemptive order. The Staff also encouraged funds to carefully consider whether the relief provided by a mixed and shared funding order is necessary, and whether any person actually requires the relief provided by such an order. The Staff stated that the relief provided by mixed and shared funding orders “may be of limited, or no, practical significance given the infrequency of reliance on the exemptions.” The Staff noted that, rather than relying on the relief provided by mixed and shared funding orders, insurers and their affiliates apparently either comply with Sections 9(a), 13(a), 15(a) and 15(b) of the 1940 Act or rely on other exemptions in the SEC’s rules or under another order.

The Staff further indicated that the participation agreements between insurers that issue variable contracts and the funds that are the investment options thereunder may require compliance with the terms and conditions of a mixed and shared funding order. The Staff stated that if an insurance company is not relying on the exemptions provided by a mixed and shared funding order and no reliance is anticipated in the future, the fund and insurance company may want to consider amending the participation agreement to eliminate the obligation to rely on such an order.

Conclusions

The Guidance Update has the potential to greatly simplify the operations of insurers issuing variable insurance contracts, as well as the operations of funds that serve as underlying investment options in those contracts. While mixed and shared funding relief has become quite routine, obtaining and complying with the relief effectively has been a cost of doing business for underlying funds, and a potential source of delay in entering into new business arrangements with insurers. In light of the Guidance Update, industry practice may evolve so that underlying funds no longer routinely obtain mixed and shared funding relief and incur the related costs and potential delays. For the time being, insurers and underlying funds should carefully evaluate whether they currently rely on existing mixed and shared funding orders. However, underlying funds should continue to comply with existing exemptive orders and participation agreements until the funds have confirmed with the insurers whose separate accounts invest in the funds that such insurers do not, in fact, foresee a need to rely on existing mixed and shared funding exemptive relief.