On October 18, 2019, the US Securities and Exchange Commission (the “SEC”) announced that it had voted to propose rule amendments1 intended to improve the efficiency of the exemptive application review procedures available under the Investment Company Act of 1940, as amended (the “1940 Act”).2 If implemented, the amendments would (a) establish an expedited review process for “routine” exemptive applications, and (b) shorten the timeline for all other exemptive applications, herein referred to as “novel” applications. In addition, in the proposed rule amendments, the SEC announced its intent to publicly disseminate the comments made by the staff of the SEC’s Division of Investment Management (the “Staff”) along with the corresponding applicant responses. Once the rule proposal is published in the Federal Register, there will be a 30-day public comment period.
Existing Review Procedures
The 1940 Act, which Congress originally passed with the intent of curtailing rampant abuse in the investment company industry, places a number of prohibitions on investment companies. However, to provide flexibility, the drafters of the 1940 Act empowered the SEC to grant exemptive relief from the provisions of the 1940 Act, provided the exemption is “necessary or appropriate in the public interest and consistent with the protection of investors….”3
Under the existing process, applicants file an application with the SEC requesting exemptive relief. The Staff then reviews the application and may issue comments or request modifications to the application to ensure that the application meets the standards of the 1940 Act. The applicants then respond by filing an amended application. This process continues, and there can be multiple rounds of comments and amendments, until the Staff determines that the requisite standards have been met, or concludes to deny the application. If the Staff determines that the requisite standards have been met, the Staff must also conclude that the application does not present significant new issues of fact or policy (which would require additional review and approval). As the next step, which is generally the final step before an exemptive order is granted, the SEC will publish a notice in the Federal Register giving interested persons an opportunity to request a hearing on the application. If no hearing request is received by the expiration of the period set forth in the notice (which is typically 25 days), the SEC will issue an order granting the exemptive relief.
The comment process for exemptive applications can be lengthy, and the SEC and the Staff have made attempts over time to increase efficiency. In 1993, the SEC proposed amendments to Rule 0-5 to establish expedited review procedures for certain applications, but no final amendments were adopted.4 Then, in 2008, the Staff implemented an internal performance target of providing initial comments on at least 80% of applications within 120 days.5 By 2010, the Staff was meeting this target on a consistent basis, and for exemptive application filed on or after June 1, 2019, the Staff has said it intends to provide initial comments within 90 days of the filing.6 Based on our experience dealing with the historic 120-day review period, the initial filing of an exemptive application typically takes the Staff to the end of the 120-day period to review. Each amendment filing after that typically takes less than 120 days for the Staff to review but can take the full 120 days. As noted above, most applications require multiple cycles of review and comment before the Staff can complete its review and issue a notice. As a result, depending on the nature of relief being sought, the process from filing an initial application to receiving a notice from the Staff can take six to nine months, or longer. The new 90-day standard may reduce that period.
Proposed Amendments to Rule 0-5
The proposed amendments to Rule 0-5 are intended to create further efficiencies in the application review process by characterizing applications into two categories (“novel” or “routine”) and establishing a timeline and review process for each category, as described below.
Expedited Review of Routine Applications
Proposed Rule 0-5(d)(1) would allow applicants to request expedited review for “routine applications,” i.e., applications substantially similar to at least two other applications for which an order granting exemptive relief has been issued within two years of the application’s filing date. Under the proposed rule, a “substantially similar” application is defined as an application (i) requesting relief from the same sections of the 1940 Act and the rules thereunder, (ii) containing identical terms and conditions, and (iii) differing only in terms of factual differences that are not material to the requested relief.7 Examples of such factual differences might include an applicant’s identity, state of incorporation or composition of the board of directors. Unfortunately, the SEC has already flagged several categories of applications as too fact-specific for expedited review,8 noting that, for example, co-investment applications typically have different terms and conditions than those of precedent applications. Finally, applicants would also be required to submit marked copies of the application to show any changes from the two precedents.
Proposed Rule 0-5(f) would establish a 45-day timeline for expedited review, meaning the notice of an application would be issued no later than 45 days from filing. However, notice may be delayed if the SEC determines that the application is ineligible for expedited review, or the Staff determines that further consideration is required. If the Staff concludes that the application is ineligible for expedited review, it may ask the applicant to withdraw and refile the application through the standard review process. If the Staff requests that an applicant amend its application, the 45-day period would pause and would not resume until 14 days after the amended application was filed.9 Additionally, under the proposed rule, if an applicant does not respond to a Staff request for modification of an application within 30 days, the exemptive application would be deemed withdrawn.
The SEC is also proposing a new internal timeline for all other “novel” exemptive applications that do not qualify for expedited review because they seek “largely unprecedented relief or relief for which some [SEC] precedent exists but that raises additional questions of fact, law, or policy.” Under the proposed rule, the Staff would follow a “standard review” process for all such novel exemptive applications. Under the standard review process, the SEC would take action on an application within 90 days of the filing of the initial application and each amendment thereto.10 The “action” would include issuing a notice, providing applicants with comments, or informing the applicants that the application will be forwarded to the Commission for review. If an applicant does not respond in writing to a request for modification within 120 days, the application will be deemed withdrawn. The applicant could refile the application and the 90-day timeframe would restart. Historically, the SEC Staff has deemed such applications to be “inactive” rather than “withdrawn.”
Public Dissemination of Comments
To improve the transparency of the application process, the SEC intends to release to the public the Staff’s comments on applications, and the applicant’s responses to those comments, within 120 days of the final disposition of an application, similar to the current policy of releasing registration statement comment letters.
Impact on Business Development Companies and Other Investment Companies
The proposed amendments to Rule 0-5, if effected as written, could greatly accelerate the timing of the processing of routine requests for exemptive relief, including applications for equity incentive plans. Unfortunately, for most business development companies and their affiliates, co-investment applications will likely not be eligible for this expedited review timeline. However, co-investment applicants would still benefit from the new internal guidelines for the shorter standard review timeline.