In a recently issued no-action letter to Franklin Templeton Investments, SEC staff stated that it would not recommend enforcement action against an open-end or closed-end registered investment company if its funds participate in the government-offered Term Asset-Backed Securities Loan Facility (TALF). Prior to this no-action letter, although investment companies were included in the definition of an “eligible company” able to participate in TALF, they were unsure how to participate in TALF loans without violating the limitations on senior securities and custodial requirements set forth in the 1940 Act.

Section 18 of the 1940 Act generally restricts the ability of funds to issue or sell senior securities without meeting certain asset coverage requirements. In a policy statement published in Release No. IC-10666 (Apr. 18, 1979), the SEC took the position that the restrictions of Section 18 also applied to reverse repurchase agreements, firm commitments and standby commitments, and noted that it would view securities with comparable effects on a fund’s capital structure in the same manner. The SEC further stated that the concerns underlying Section 18, however, could be alleviated if an investment company establishes and maintains segregated accounts to cover the fund’s obligations created by transactions in such securities. In its request for no-action relief, Franklin Templeton said that TALF loans would affect a fund’s capital structure in a manner analogous to the effect of reverse repurchase agreements, and proposed to address the asset coverage requirements of Section 18 by establishing and maintaining separate accounts in the manner set forth in Release No. IC-10666 for reverse repurchase agreements. In response, the SEC agreed that it would not recommend enforcement under Section 18 of the 1940 Act if the funds took TALF loans without treating the borrowing as a senior security for purposes of compliance with Section 18.

Section 17(f) and the rules thereunder set forth various requirements with regard to the custody of fund securities. The TALF program, however, is structured in a manner such that a primary dealer may hold assets as an agent of the fund in violation of the requirements of Rule 17f-1. Franklin Templeton’s request for no-action relief noted that the safekeeping concerns underlying Rule 17f-1 and Section 17(f) were not raised by the TALF program. In response, the SEC staff stated that it would not recommend enforcement under Section 17(f) with respect to the funds’ participation in the “unique custody arrangement necessitated by the TALF program.”

For a copy of the no-action letter please see: