Kelley A. Howes
On October 12, 2018, the staff of the SEC’s Division of Investment Management issued a no-action letter to the Independent Directors Council (“IDC”) agreeing that the staff will not recommend enforcement if, in lieu of making certain determinations under Rule 10f-3, 17a-7 and 17e-1 (the “Exemptive Rules”) under the Investment Company Act of 1940 (the “1940 Act”), a fund’s board instead receives from its Chief Compliance Officer (“CCO”) a written representation that transactions entered into reliance on any of the Exemptive Rules were affected in compliance with the related procedures adopted by the board.
In its letter requesting relief, the IDC noted that Rule 38a-1 under the 1940 Act requires a fund to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the federal securities laws. Since the definition of “federal securities laws” includes the Exemptive Rules, continuing to require a fund board to provide oversight of the fund’s overall compliance program and to make specific determinations under the Exemptive Rules appears redundant.
The IDC pointed out that when the Exemptive Rules were initially adopted, more than two decades before the adoption of Rule 38a-1, the board represented the “first line of responsibility for determining compliance” with the Exemptive Rules. When it adopted Rule 38a-1, however, the Commission imposed on a fund’s board the responsibility for approving a CCO responsible for administration of the fund’s compliance program. This gives fund boards “direct access to a single person with overall compliance responsibilities for the fund.” Moreover, the Commission recognized that the proper role of a fund’s director is to “exercise oversight of the fund’s compliance program without becoming involved in the day-to-day administration of the program.”
The SEC staff agreed that the IDC’s position was consistent with the Commission’s approach when it adopted Rule 38a-1 and “would allow boards to avoid duplicating certain functions commonly performed by, or under the supervision of, the CCO.” Moreover, according to the staff, this position “will 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.”
In its letter, the Commission staff noted that it continues its review of whether existing responsibilities of fund boards are “appropriate and carried out in a manner that serves the shareholders’ best interests.” We are hopeful that such review will result in similar positions. In the meantime, however, this interim relief is a step in the right direction. It balances the need for a board to continue to carefully consider conflicts of interests inherent in affiliated transactions without requiring the board to become directly involved in the compliance process. Rather, it appropriately moves the board’s role to one of oversight of the compliance function, consistent with Rule 38a-1.
At an upcoming meeting, boards should review, together with a fund’s CCO, any necessary changes to existing compliance policies to reflect the staff’s no-action position. Among other things, the board should ensure that any reporting it will receive will appropriately detail the number and types of transactions effected under each Exemptive Rule during a reporting period.
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