On March 8, 2017, the staff of the SEC's Division of Investment Management (the Staff) issued a no-action letter (the No-Action Letter) stating that it would not recommend enforcement action to the SEC under Section 12(d)(1)(A) or (B) of the 1940 Act against: (i) a foreign investment company that is not registered under the 1940 Act (a Foreign Feeder Fund), if the Foreign Feeder Fund acquires (1) securities of a single 1940 Act-registered open-end fund (a U.S. Master Fund) in excess of the limits of Section 12(d)(1)(A) of the 1940 Act and, for certain Foreign Feeder Funds, (2) Foreign Currency Instruments (as defined in the No-Action Letter); and (ii) the U.S. Master Fund and its principal underwriter (the Master Fund Principal Underwriter) and any broker or dealer for selling the U.S. Master Fund's securities in excess of the limits of Section 12(d)(1)(B) of the 1940 Act to a Foreign Feeder Fund (the Proposed Structure). As explained in the letter to the Staff seeking no-action assurance (the Incoming Letter), the Proposed Structure would enable global investment managers to efficiently offer investment products across several foreign jurisdictions. The law firm that submitted the request (the Applicant) asserts in the Incoming Letter that the "Proposed Structure would be beneficial to the U.S. mutual fund industry and could potentially attract significant assets to the U.S. and create significant scale to the benefit of investors in U.S. Master Funds."
Section 12(d)(1)(A) of the 1940 Act, in relevant part, prohibits a registered or unregistered investment company (an acquiring fund) from investing in the securities of a registered fund (the acquired fund) if immediately after the acquisition the acquiring fund: (i) owns more than 3% of the outstanding voting securities of the acquired fund; (ii) has more than 5% of its total assets invested in the acquired fund; or (iii) has more than 10% of its total assets invested in the acquired fund and all other acquired funds. Section 12(d)(1)(B) of the 1940 Act prohibits an acquired fund, its principal underwriter and any broker or dealer registered under the Exchange Act, from knowingly selling the acquired fund's securities to any acquiring fund and any companies controlled by such acquiring funds if, immediately after the sale: (i) more than 3% of the acquired fund's outstanding voting securities would be owned by the acquiring fund or companies controlled by it; or (ii) more than 10% of the acquired fund's outstanding voting securities would be owned by the acquiring fund and other funds and companies controlled by them.
Section 12(d)(1)(E) of the 1940 Act provides a conditional exemption from the restrictions in Sections 12(d)(1)(A) and (B) of the 1940 Act that is relied upon by, among others, private funds and foreign investment companies to invest in U.S.-registered funds. Absent no-action relief from the Staff, as applied to the Proposed Structure, Section 12(d)(1) (E) would require that: (1) the principal underwriter for the Foreign Feeder Fund must be a broker or dealer registered under the Exchange Act or a person controlled by such broker or dealer; (2) the U.S. Master Fund's securities are the only investment security held by the Foreign Feeder Fund; and (3) the Foreign Feeder Fund purchases or otherwise acquires securities issued by the U.S. Master Fund pursuant to an arrangement with the U.S. Master Fund or its principal underwriter whereby the Foreign Feeder Fund is obligated: (i) either to seek instructions from its shareholders with regard to the voting of all proxies with respect to the U.S. Master Fund's securities and to vote such proxies only in accordance with such instructions, or to vote the shares held by it in the same proportion as the vote of all other shareholders of the U.S. Master Fund's securities; and (ii) to refrain from substituting the U.S. Master Fund's securities unless the SEC shall have approved such substitution in the manner provided in Section 26 of the 1940 Act. However, as the Applicant explains in the Incoming Letter, a Foreign Feeder Fund may not be able to comply with certain provisions of Section 12(d)(1)(E) because of its structure and the laws and/or market practices of the foreign jurisdiction in which it operates. As examples, the Applicant notes that the laws and/or market practices of the foreign jurisdiction in which a Foreign Feeder Fund operates: (i) may prohibit the Foreign Feeder Fund from directly voting the shares of the applicable U.S. Master Fund, which could be viewed as precluding compliance with the "pass through" or "echo" voting requirements under Section 12(d)(1)(E); or (ii) not require the Foreign Feeder Fund to distribute its securities through a principal underwriter or a principal underwriter that is, or that is controlled by, a broker-dealer registered under the Exchange Act.
In granting the no-action relief, the Staff allowed the following deviations from the conditions of Section 12(d)(1)(E):
- a Foreign Feeder Fund: (a) may have a principal underwriter that either controls or is under common control with an Exchange Act-registered broker-dealer (Foreign Principal Underwriter); and (b) will have as its investment adviser an adviser (Feeder Fund Adviser) that (i) controls, is controlled by, or is under common control with (Control Affiliate), the investment adviser to the U.S. Master Fund (Master Fund Adviser) and the Master Fund Principal Underwriter and (ii) may be registered under the Advisers Act;
- a Foreign Feeder Fund may hold certain investment securities other than the securities of the U.S. Master Fund, but will do so solely for purposes of hedging either: (a) the performance of the U.S. Master Fund, measured in the U.S. dollar, against the currency of the foreign jurisdiction in which the Foreign Feeder Fund's securities are primarily offered and sold (Designated Currency); or (b) if the U.S. Master Fund seeks to approximate the return of an index, the U.S. dollar and/or foreign currency exposure of the U.S. Master Fund to the Foreign Feeder Fund's Designated Currency; and
- a Foreign Feeder Fund may either abstain from voting or withhold voting the U.S. Master Fund's shares, rather than pass through such vote to the Foreign Feeder Fund's shareholders or vote proportionately to the vote of the U.S. Master Fund's other shareholders.
In allowing the foregoing deviations from Section 12(d)(1)(E), and in view of, in particular, the potential absence of a principal underwriter or depositor for a Foreign Feeder Fund or participation in the Proposed Structure by a Foreign Principal Underwriter, the Staff required that:
- the Foreign Feeder Fund will have an investment adviser that is a Control Affiliate of the Master Fund Adviser and Master Fund Principal Underwriter;
- to the extent the Feeder Fund Adviser is not registered under the Advisers Act, such Feeder Fund Adviser must make its books and records with respect to the activities of the Foreign Feeder Fund available to the SEC and its Staff, designate the Master Fund Adviser as its agent for service of process in the U.S. with respect to the Foreign Feeder Fund, and consent to the jurisdiction of the U.S. courts and the SEC with respect to its activities in connection with the Foreign Feeder Fund;
- the Foreign Feeder Fund will be organized in, and regulated under the laws of, jurisdictions whose securities regulators have entered into a cooperation agreement with the SEC; and
- no Foreign Feeder Fund will offer or sell its securities in the U.S., either publicly or privately, or sell its securities to any "U.S. person," as defined in Rule 902(k) of Regulation S; each Foreign Feeder Fund's transactions with its shareholders will be consistent with the definition of "offshore transactions" in Rule 902(h) of Regulation S; and no Foreign Feeder Fund, Feeder Fund Adviser, Foreign Principal Underwriter, any of their respective affiliates, or any person acting on behalf of any of the foregoing, will engage in any "directed selling efforts," as defined in Rule 902(c) of Regulation S, with respect to securities of the Foreign Feeder Fund in the U.S.
The No-Action Letter is available at: https://www.sec.gov/divisions/investment/noaction/2017/dechert-030817-12d1.htm.