Fund Boards May Rely on CCO Representations in Lieu of Quarterly Board Determinations Under Rules 10f-3, 17a-7 and 17e-1

The Staff of the SEC’s Division of Investment Management has issued a no-action letter permitting a fund’s board to rely on written representations from the fund’s CCO in lieu of quarterly determinations that the fund’s transactions made pursuant to certain exemptive rules were effected in compliance with the fund’s procedures.1

Background

Sections 10(f), 17(a) and 17(e) of the Investment Company Act of 1940 generally prohibit certain transactions involving a registered investment company and its affiliated persons.2 Rules 10f-3, 17a-7 and 17e-1 (each, an Exemptive Rule) under the 1940 Act provide certain exemptive relief from these statutory prohibitions. Reliance upon an Exemptive Rule is subject to several conditions, including conditions applicable to the fund’s board. Among other things, each Exemptive Rule requires that the fund’s board, including a majority of the independent directors,3 “(i) adopt procedures that are reasonably designed to provide that the transactions comply with the conditions of the Exemptive Rule, (ii) make and approve such changes to those procedures as the board deems necessary, and (iii) determine no less frequently than quarterly that all transactions made pursuant to the Exemptive Rule for the preceding quarter were effected in compliance with such procedures.”4

No-Action Relief: CCO Written Representation In Lieu of Board Determinations

In the IDC Letter, the Staff stated that it “would not recommend enforcement action to the Commission for violations of Sections 10(f), 17(a) or 17(e) of the [1940] Act” if a fund’s board receives, “no less frequently than quarterly, a written representation from the [fund’s CCO] that transactions effected in reliance [upon an Exemptive Rule] complied with the procedures adopted by the board pursuant to the relevant Exemptive Rule, instead of the board itself determining compliance.”

The Staff agreed with the position taken in the Incoming Letter that the no-action relief “is consistent with the Commission’s approach in adopting Rule 38a-1 and would allow boards to avoid duplicating certain functions commonly performed by, or under the supervision of, the CCO.” The Staff indicated that, while its position “would not change the board’s oversight role with respect to a fund’s overall compliance program,” it would “facilitate the directors’ ability to focus on conflict of interest concerns raised by affiliated transactions, including whether a fund engaging in the types of affiliated transactions permitted by the Exemptive Rules is in the best interest of that fund and its shareholders.”

Conclusion

The IDC Letter represents a welcome development for fund directors, whose “responsibilities have accumulated” over time.5 Indeed, the IDC Letter will “better allow directors to dedicate their time and attention to ‘areas where director oversight is most valuable,’”6 rather than routine reviews of the technical details of transactions made pursuant to an Exemptive Rule.