On June 20, 2016, the staff of the SEC’s Division of Investment Management, in consultation with the Office of the Chief Accountant and the Division of Corporation Finance, issued a no-action letter to Fidelity Management & Research Company (FMR) assuring that, for at least the next 18 months from issuance, and subject to certain conditions set forth in the letter, the staff would not recommend enforcement action to the SEC if a registered fund or other entity (a Fidelity Entity) in its “investment company complex” (as defined by Regulation S-X) employs a registered public accounting firm (an Audit Firm), that has relationships causing non-compliance with certain independence requirements under the so-called “Loan Provision.”
Rule 2-01(c) under Regulation S-X sets forth a non-exclusive list of circumstances that are considered inconsistent with an Audit Firm’s independence, including the Loan Provision. The Loan Provision provides that an Audit Firm is not independent when the Audit Firm has a loan from “record or beneficial owners of more than ten percent of the audit client’s equity securities.” An “audit client,” in turn, is defined to include any affiliate of the audit client and, when the audit client is an entity within an “investment company complex,” it also includes every entity within the investment company complex, regardless of whether the Audit Firm actually provides audit services to those other entities.
FMR’s request for no-action relief refers to discussions with Audit Firms about the “scope of their lending relationships,” and identifies “one or more of the following circumstances, each of which could have potential implications under the Loan Provision” (collectively, Lending Relationships):
- An institution that has a lending relationship with an Audit Firm holds of record, for the benefit of its clients or customers (for example, as an omnibus account holder or custodian), more than 10% of the shares of a Fidelity Entity;
- An insurance company that has a lending relationship with an Audit Firm holds more than 10% of the shares of a Fidelity Entity (in this case, a Fidelity registered fund) in separate accounts that it maintains on behalf of its insurance contract holders;
- An institution that has a lending relationship with an Audit Firm acts as an authorized participant or market maker to a Fidelity exchange-traded fund and holds of record or beneficially more than 10% of the shares of a Fidelity Entity.
The No-Action Relief
As noted, the SEC staff provided temporary no-action relief to a Fidelity Entity that employs an Audit Firm that has a Lending Relationship causing non-compliance with the Loan Provision.
The SEC staff conditioned its temporary no-action assurance on the following requirements:
- the Audit Firm has complied with Public Company Accounting Oversight Board (PCAOB) Rule 3526(b)(1) and (2) (the provision governing independence communications), or, with respect to any Fidelity Entity to which Rule 3526 does not apply, has provided substantially equivalent communications;
- the non-compliance of the Audit Firm is with respect to the Lending Relationships; and
- notwithstanding such non-compliance, the Audit Firm has concluded that it is objective and impartial with respect to the issues encompassed within its engagement.
In granting this no-action relief, the SEC staff cited the Audit Firm’s representation to FMR that, notwithstanding the Firm’s non-compliance with the Loan Provision due to a Lending Relationship, following an evaluation of the impact of this lending relationship on its independence, the Audit Firm has been able to maintain its impartiality and objectivity with respect to the planning for and execution of the Fidelity funds’ audits, emphasizing, among other things, that the institution with which it has a lending relationship is not able to impact the impartiality of the Audit Firm or assert any influence over the Fidelity fund whose shares the institution owned or its investment adviser. Also important to the SEC staff in this regard was FMR’s representation that “those responsible for the oversight of the Fidelity Funds have not reached a different conclusion with respect to the Audit Firm’s objectivity and impartiality.”
Notably, the no-action letter indicates that more stringent requirements are needed in connection with certain shareholder votes. If shareholders are voting on: (1) the election of trustees or directors; (2) the appointment of an independent auditor; or (3) “other matters that similarly could influence the objectivity and impartiality of the independent auditor,” the Fidelity Entity must make “reasonable inquiry” as of the record date of the shareholder meeting regarding the impact of the Loan Provision. Reasonable inquiry could include the review of available ownership records and contacting applicable owners to inquire whether a lending institution in a Lending Relationship owns of record or beneficially more than 10% of the shares of a Fidelity Entity. FMR represented that if the reasonable inquiry reveals that an institution in a Lending Relationship can exercise discretionary voting authority with respect to at least 10% of the Fidelity Entity’s shares, the Fidelity Entity would not rely on the relief granted by the staff in the no-action letter and would instead take “other appropriate action, consistent with its obligations under the federal securities laws.”
The SEC staff concluded that it would not object to a Fidelity Entity relying on an audit opinion from an Audit Firm “that has identified a failure” to comply with the Loan Provision, “where the failure to comply with the Loan Provision is limited to the Lending Relationships, including making a reasonable inquiry, as described within this letter and where the Audit Firm’s judgment remains objective and impartial.”
A copy of the no-action letter is available at: http://edgar.sec.gov/divisions/investment/noaction/2016/fidelity-management- research-company-062016.htm