In a No-Action Letter issued to the Managed Funds Association on February 6, 2014 (the “MFA Letter”), 1 the staff (the “Staff”) of the Division of Investment Management of the Securities and Exchange Commission (the “SEC”) expanded its interpretation of the definition of “Knowledgeable Employee” in Rule 3c-5 under the Investment Company Act of 1940, as amended (the “Investment Company Act”). Background Many private funds rely on Sections 3(c)(1) or 3(c)(7) of the Investment Company Act to be excluded from the definition of “investment company.” These include hedge funds, private equity funds, and other types of pooled investment vehicles. Section 3(c)(1) excludes a fund (a “3(c)(1) Fund”) whose outstanding securities (other than short-term paper) are beneficially owned by not more than 100 persons, and that is not making and does not presently propose to make a public offering of its securities. Section 3(c)(7) excludes a fund (a “3(c)(7) Fund”) whose outstanding securities are exclusively owned by persons who, at the time of acquisition, are “qualified purchasers,” and that is not making and does not presently propose to make a public offering of its securities. Under Rule 3c-5, Knowledgeable Employees are not counted toward the 100-person limit with respect to a 3(c)(1) Fund and are not required to be qualified purchasers with respect to a 3(c)(7) Fund. We collectively refer to 3(c)(1) Funds and 3(c)(7) Funds as the “Covered Funds.” Knowledgeable Employees Rule 3c-5 defines the term “Knowledgeable Employee” to cover two categories of employees. First, the term includes “Executive Officers,” directors, trustees, general partners, advisory board members, and persons serving in similar capacities, of a Covered Fund or an affiliated person that manages the investment activities of a Covered Fund (an “Affiliated Management Person”). The rule defines “Executive Officers” to mean the president, vice president in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions, for a Covered Fund or for an Affiliated Management Person of a Covered Fund. Second, the term includes employees of a Covered Fund or an Affiliated Management Person of a Covered Fund (other than an employee performing solely clerical, secretarial, or administrative functions) who, in connection with their regular functions or duties, participate in the investment activities of such Covered Fund, other Covered Funds, or investment companies managed by such Affiliated Management Person of such Covered Fund, provided that such employees have been performing such functions and duties for the Covered Fund or the Affiliated Management Person, or substantially similar functions or duties for or on behalf of another company, for at least 12 months. In prior guidance, the Staff has said that the following types of employees generally would not be Knowledgeable Employees: (1) marketing and investor relations professionals who explain potential and actual portfolio investments of a fund and the investment decision-making process and strategy being followed to clients and prospective investors, and who, from time to time, interface among the fund, the portfolio managers, and the fund’s clients; (2) research analysts who investigate the potential investments for a fund (unless a research analyst researches all potential portfolio investments and provides recommendations to the portfolio manager); (3) attorneys who, as part of their duties, provide advice with respect to, or who participate in, the preparation of offering documents and the negotiation of related agreements, and who are familiar with investment company management issues and respond to questions or give advice concerning ongoing fund investments, operations, and compliance matters; (4) brokers and traders of a broker-dealer related to a fund who are Series 7 registered; and (5) financial, compliance, operational, and accounting officers of a fund who have management responsibilities for compliance, accounting, and auditing functions of a fund. 2 While the Staff has narrowly construed the types of activities that must be performed to qualify as a Knowledgeable Employee, it has expanded the types of employing entities beyond those specified in the rule. 3 In addition to Covered Funds and investment companies managed by an Affiliated Management Person, Knowledgeable Employees may also be employees of companies excluded from the definition of “investment company” by Section 3(c)(2) 4 , 3(c)(3) 5 , or 3(c)(11) 6 of the Investment Company Act, provided that such employees have been participating in the investment activities of such companies for at least 12 months. 7 In taking this position, the Staff has said that these employees are likely to be as financially knowledgeable and sophisticated as employees who participate in the investment activities of a Covered Fund or an investment company, and Rule 3c-5 is premised on the view that certain persons, because of their financial knowledge and sophistication and their relationship with a Covered Fund, do not need the protection of the Investment Company Act. 8 In addition, the Staff has also indicated flexibility in the category of persons who may be considered “Affiliated Management Persons.” In promulgating Rule 3c-5, the SEC intended that Knowledgeable Employees be limited to persons whose employer managed the Covered Fund in which the employees wanted to invest. 9 The requirement was intended, in part, to ensure that Knowledgeable Employees have access to information about the management of the Covered Fund in which they wish to invest. 10 The Staff has acknowledged, however, that in certain circumstances, a company that is under common control with the investment adviser to a Covered Fund may be considered an Affiliated Management Person of the Covered Fund because an employee of such an entity generally will have significant access to information about the Covered Fund. 11 Accordingly, the determination of whether an affiliate is an Affiliated Management Person for purposes of determining whether its employees are Knowledgeable Employees depends on the particular facts and circumstances. 12 New Interpretative Guidance The Staff’s updated guidance for determining who may be considered a “Knowledgeable Employee” is discussed below. Executive Officers and Policy-Making Employees As noted above, the first category of Knowledgeable Employees includes “Executive Officers,” which term the rule defines to include vice presidents in charge of a principal business unit, division, or function, and employees who perform policy-making functions. Principal Business Unit The MFA Letter states that the definition of “Knowledgeable Employee” in Rule 3c-5 provides flexibility in determining whether an individual is in charge of a “principal business unit, division, or function,” and that this determination should be made by an investment manager based on the relevant facts and circumstances regarding its business operations. The MFA Letter also states that while not all business units, divisions, or functions are necessarily principal business units, divisions, or functions, it is possible that several of them could each be a principal business unit, division, or function, and that a business unit, division, or function does not need to be part of the investment activities of a Covered Fund in order to be considered principal. The ultimate determination of whether any business unit, division, or function should be deemed principal is a factual determination that must be made on a case-by-case basis. In connection with the foregoing, the Staff agreed that an investment manager’s information technology (“IT”) and investment relations departments may be deemed principal business units under certain circumstances. Examples include: (i) the IT department of an investment manager that employs technologically driven trading models, whose IT professionals are charged with building the models and systems that translate certain quantitative signals into trade orders; (ii) the IT department of an investment manager that employs technology professionals to build performance and risk monitoring systems that interact with the investment program; and (iii) the investor relations department of an investment manager that relies on investor relations personnel to conduct substantive portfolio reviews with investors and to respond to substantive due-diligence inquiries from institutional investors and consultants. Employees Who Make Policy The MFA Letter clarifies that employees without senior manager titles may satisfy the definition of “Executive Officer” by serving as a member of a group or a committee that develops and adopts an investment manager’s policies, even if such employees do not perform policy-making functions by themselves outside of participation on such group or committee. For example, employees that serve as active members of a valuation committee may qualify as Executive Officers under the rule. Participation in Investment Activities The second category of Knowledgeable Employees includes those employees of a Covered Fund or an Affiliated Management Person who regularly participate in the investment activities of such Covered Fund, other Covered Funds, or investment companies managed by such Affiliated Management Person, provided that they have been performing such functions and duties for or on behalf of such Covered Fund or Affiliated Management Person, or substantially similar functions or duties, for or on behalf of another company, for at least 12 months (“Participating Employees”). Research Analysts As discussed above, previous guidance indicated that a research analyst must research all potential portfolio investments and provide recommendations to the portfolio manager in order to be deemed a Knowledgeable Employee. 13 By contrast, the MFA Letter expands this category of Knowledgeable Employee to include a research analyst who researches a portion of a Covered Fund’s portfolio and provides analysis or advice to the portfolio manager with respect to only that portion. Participating Employees The MFA Letter provides that Participating Employees are not limited to those individuals charged with overall responsibility for the investment activity of a Covered Fund, and that other non-executive employees could be considered Participating Employees if they regularly participate in the management of a Covered Fund’s investments (or a portion thereof). While reiterating that the ultimate determination of whether an individual participates in the investment decisions of a Covered Fund is a factual determination that must be made on a case-by-case basis, the MFA Letter states that the following individuals could fall within the category of Participating Employees if they regularly perform such functions or duties and have been doing so for at least 12 months: (i) a member of the analytical or risk team who regularly develops models and systems to implement a Covered Fund’s trading strategies by translating quantitative signals into trade orders or providing analysis or advice that is material to the investment decisions of a portfolio manager (in contrast to someone who merely writes the code to a program used by the portfolio manager); ) a trader who regularly is consulted for analysis or advice by a portfolio manager during the investment process and whose analysis or advice is material to the portfolio manager’s investment decisions based on the trader’s market knowledge and expertise (in contrast to a trader that simply executes investment decisions made by the portfolio manager); (iii) a tax professional who is regularly consulted for analysis or advice by a portfolio manager, typically before the portfolio manager makes investment decisions, and whose analysis or advice is material to the portfolio manager’s investment decisions, such as when a tax professional’s analysis of whether income from an offshore fund’s investment may be considered “effectively connected income,” is material to a portfolio manager’s decision to invest in certain debt instruments (in contrast to a tax professional who merely prepares the tax filings for a Covered Fund); and (iv) an attorney who regularly analyzes legal terms and provisions of investments and whose analysis or advice is material to the portfolio manager’s investment decisions, such as where the attorney’s legal analysis of tranches of a distressed debt investment is material to a portfolio manager’s decision to invest in the loan (in contrast to an attorney who negotiates agreements that effectuate transactions evidencing the investment decisions of the portfolio manager, or an attorney or compliance officer who evaluates whether an investment is permitted under a Covered Fund’s governing documents). Separate Accounts As noted above, the Staff has previously stated that an employee who participates in the investment activities of a company excluded from the definition of “investment company” by Section 3(c)(2), 3(c)(3), or 3(c)(11) of the Investment Company Act may also be deemed a Knowledgeable Employee because such employee is likely to be as financially knowledgeable and sophisticated as an employee who participates in the investment activities of a Covered Fund or an investment company. The MFA Letter expands this concept by permitting an employee of an Affiliated Management Person who participates in the investment activities of “Covered Separate Accounts” to be eligible for Knowledgeable Employee status. The MFA Letter notes that such an employee is also likely to be as financially knowledgeable and sophisticated as an employee who participates in the investment activities of a Covered Fund or investment company. For purposes of the MFA Letter, “Covered Separate Accounts” refer to separate accounts (or a portfolio (or portion thereof) of a separate account) for clients that are “qualified clients” 14 and are otherwise eligible to invest in the Covered Funds advised by the Affiliated Management Person, and whose accounts pursue investment objectives and strategies that are substantially similar to those pursued by one or more of those Covered Funds. Employees of Related Advisers in Control Relationships The Staff recently issued a separate No-Action Letter (the “Relying Adviser Letter”) in which it stated that it would not recommend enforcement action under the Advisers Act if a “filing adviser” filed a single Form ADV on behalf of itself and “relying advisers” that are affiliated with the filing adviser as part of a single advisory business, under certain circumstances. 15 The MFA Letter states that if a filing adviser and its relying adviser(s) collectively conduct a single advisory business as described in the Relying Adviser Letter, then each of the filing adviser and relying adviser(s) may be an Affiliated Management Person of a Covered Fund. As a result, Knowledgeable Employees of a filing adviser or any of its relying advisers may be treated as Knowledgeable Employees with respect to any Covered Fund managed by the filing adviser or its relying advisers, provided that the employees meet the other conditions of the rule. As discussed above, determining whether an Affiliated Management Person includes each affiliated entity of a Covered Fund that participates in investment activities of the investment management company depends on the relevant facts and circumstances. In making this determination, the Staff has considered the ability of an employee of an affiliated entity to have access to information about the Covered Fund. Given the nature of the factors to be met in order to be considered a single advisory business under the Relying Adviser Letter, the Staff believes that employees of affiliated advisers that are deemed to conduct a single advisory business would generally have significant access to information about the Covered Funds managed by the other affiliated advisers within the single advisory business. Conclusion The MFA Letter represents a significant expansion of the Staff’s interpretation of which types of employees constitute “Knowledgeable Employees” for purposes of the Investment Company Act. Although the analysis of who meets such criteria is based on a facts and circumstances test, the MFA Letter acknowledges that such analysis can be flexible. In addition, the MFA Letter identifies specific examples of the types of employees that may qualify as Knowledgeable Employees who may not have qualified under the Staff’s prior guidance. In order to verify compliance with the current advice, an investment adviser should document the facts and circumstances that support its conclusion that any particular employee is a Knowledgeable Employee for these purposes.