The Securities and Exchange Commission’s Division of Investment Management has issued a no-action letter confirming that the Division’s Staff would not object if fund boards cease to make quarterly independent compliance findings under Rules 17a-7, 10f-3 and 17e-1, in light of the compliance rule framework required by Rule 38a-1 and the important and active role of a chief compliance officer reporting directly to the board.
For decades, mutual fund directors have turned to quarterly reports on affiliated cross trades, participation in affiliated underwritings and affiliated brokerage; the reports themselves state that the trades are in compliance with the applicable rule or the chief compliance officer adds remarks to that effect. Then directors are asked to make their own findings that the transactions comply with the law.
With the advent of Rule 38a-1 in 2004, the broader compliance rule framework and the important and active role of a chief compliance officer, boards and others increasingly asked whether requiring boards to make an independent compliance finding was duplicative or misplaced. Last week, relief came.
In response to a suggestion by the Independent Directors Council, the Securities and Exchange Commission’s Division of Investment Management issued a no-action letter confirming that the Division’s Staff would not object if fund boards cease to make these findings and instead receive a quarterly compliance certificate from the chief compliance officer. The specific board findings that would be superseded by the letter are those required quarterly under Rule 17a-7 (governing affiliated cross trades), Rule 10f-3 (governing participation in affiliated underwritings) and Rule 17e-1 (governing affiliated brokerage transactions).
While this comes as a relief to many fund boards, and we expect most fund organizations will seek to rely on the no-action letter, it also requires some steps to implement. The firm’s Rule 17a-7, Rule 10f-3 and Rule 17e-1 procedures will require amendment to record the new arrangements, and the nature of the chief compliance officer’s quarterly certificate will need to be agreed.
The SEC Staff also signaled subtly that their expectation is that these changes might be an opportunity to enhance the board’s role in overseeing conflicts of interest. Taking that cue, it is possible that some boards will ask themselves and their chief compliance officers whether new reporting might be in order—e.g., highlighting particular trades or trends for discussion—with a goal of a more nuanced assessment as to how these policies and procedures operate over time.