On June 1, 2018, the SEC’s Division of Investment Management (Staff) issued a no-action letter to the Investment Company Institute (ICI) stating that the Staff would not recommend enforcement action against a mutual fund or its SEC-registered transfer agent (TA) under Section 22(e) of the Investment Company Act of 1940 (1940 Act) if the TA, acting on behalf of the mutual fund, “temporarily delays for more than seven days the disbursement of redemption proceeds from the mutual fund account of a Specified Adult held directly with the [TA] based on the [TA’s] reasonable belief that financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted.” For purposes of this relief, a “Specified Adult” is “(A) a natural person age 65 and older; or (B) a natural person age 18 and older who the transfer agent reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests,” and “financial exploitation” means “(A) the wrongful or unauthorized taking, withholding, appropriation, or use of a Specified Adult’s funds or securities; or (B) any act or omission by a person, including through the use of a power of attorney, guardianship, or any other authority regarding a Specified Adult, to (i) obtain control, through deception, intimidation or undue influence, over the Specified Adult’s money, assets or property, or (ii) convert the Specified Adult’s money, assets or property.” With the no-action letter, the Staff seeks to enable TAs to act to protect shareholder accounts held directly with the mutual fund and serviced by the TA—i.e., “direct-at-fund” accounts—to the same extent that broker-dealers may do so under FINRA Rule 2165, which permits a FINRA member to place a temporary hold on suspicious disbursements where there is concern about potential financial exploitation of seniors and other vulnerable investors.
Section 22(e) of the 1940 Act prohibits a fund from suspending the right of redemption or postponing the date of payment upon redemption of any redeemable security in accordance with its terms for more than seven days after the tender of such security to the fund or its designated agent. Under FINRA Rule 2165—which was approved by the SEC in February 2017—when a FINRA member has a reasonable belief that financial exploitation of a Specified Adult has occurred, is occurring, has been attempted or will be attempted, the member firm may, but is not required to, place a temporary hold on the disbursement of funds or securities from the Specified Adult’s account, subject to certain conditions. In contrast, as the ICI explained in its letter to the Staff requesting no-action assurance, “when a fund’s [TA] suspects financial exploitation in a direct-at-fund account, it cannot lawfully delay the disbursement of redemption proceeds while it investigates the situation . . . because the [TA] is acting as an agent of the fund … and it is the [TA] that ensures a mutual fund’s compliance with Section 22(e)’s seven-day redemption period.” In sum, as the ICI noted, “[t]he requirements of Section 22(e) may put certain mutual fund shareholders who own their shares direct-at-fund at a greater risk of harm from financial abuse than shareholders protected by FINRA’s rule.”
The Staff provided the no-action assurance sought by the ICI for the limited circumstances described in the ICI’s letter and subject to certain conditions that correspond generally to the conditions imposed on broker-dealers under FINRA Rule 2165. The conditions applicable to TAs generally require, among other things, prompt notification of the temporary hold to authorized parties, immediate initiation of an internal review of the facts and circumstances, maintenance of the delayed redemption proceeds in the TA’s “Demand Deposit Account” and compliance with certain record retention requirements. In addition, as part of the fund’s compliance policies and procedures required pursuant to Rule 38a-1 under the 1940 Act, the fund must establish escalation and periodic reporting protocols requiring the TA to provide information about circumstances in which the TA relied on the Staff’s no-action position.
The no-action letter is available at: https://www.sec.gov/divisions/investment/noaction/2018/investment-companyinstitute-060118-22e.htm
The ICI’s request for no-action relief is available at: https://www.sec.gov/divisions/investment/noaction/2018/ investment-company-institute-060118-22e-incoming.pdf