SEC Staff Grant No-Action Exemption Under Investment Company Law

On January 13, 2021, staff in the Investment Management Division (staff) of the Securities and Exchange Commission (Commission) issued a letter of no action indicating that it would not recommend any enforcement action to the Commission under section 17 (f) of the Investment Companies Act 1940 (1940 Act) and paragraphs (b) to (f) ) of Rule 17f-2 below, if certain registered management investments companies or series thereof (Funds), or their directors or officers, if the Funds, acting as independent depositories, maintain certain interests in the loans (as defined below) without strictly complying with paragraphs (b) through (e) of Rule 17f-2.


Section 17 (f) of the 1940 Act generally requires a registered investment company to keep its securities and similar investments in the custody of a bank, a member of a national stock exchange, or retain these assets themselves, subject to the rules prescribed by the Commission. Rule 17f-2 of the 1940 Act sets out the conditions under which a fund can act as a self-custodian, which some see as a burden. For example, the rule requires that: (1) Investments of funds (with a few exceptions) must be deposited in the custody of a bank (often referred to as a “vault requirement,” which involves certification or possession physical); (2) the board of directors of the fund must designate a maximum of five “authorized persons” for the fund and adopt a resolution allowing access to the fund’s investments only to two persons acting together; (3) any person depositing or withdrawing investments with the depositary or ordering their withdrawal and delivery from the safekeeping of the fund or other company must sign a specific rating; and (4) investments maintained by a fund must be verified by a full review by an independent accountant retained by the fund at least three times during the year, at least two of which must be on a “surprise” basis. .

Loan interest

The letter is about term or deferred drawing business loans (loans) that are created, negotiated and structured by one or more major lenders, usually made up of banks, insurance companies or other financial institutions. The terms of the loans are usually set out in a credit agreement between the principal lenders, the borrower and the administrative agent who administers the loans on behalf of the syndicate of lenders. In accordance with specific terms and subject to the terms of the credit agreement, prime lenders may sell interest in a loan (interest on the loan) to third parties, including the Funds. The Funds do not receive any certificate of securities or other tangible proof of ownership which could be held with its custodian or which, if endorsed and delivered to a subsequent purchaser or other third party, could be used by such third party to prove its own right to Interest on loans from a Fund. There are a number of stages in the settlement of loan interest purchases, and various documents are executed as part of the settlement process (loan documents). As the Funds point out in the application, possession of the loan documents would be of no value to a purchaser or other purported assignee of interest on a Fund’s loans. Instead, the interest on the loan is reflected in the records kept on behalf of the borrower under the loan (the administrative agent) for the purpose of identifying the owners of all interest on the loan and the amount. of the principal of the loan attributable to each.

The Funds had provided the loan documents to their custodian for safekeeping under Section 17 (f), but this posed a number of issues. In particular, the Funds have suggested that the current practice of keeping records in “sealed envelopes” by fund custodians does little to help achieve the objectives underlying Section 17 (f), at least as regards loan documents. As a result, the Funds have sought to cease delivering Loan Documents to their custodians and instead rely on Rule 17f-2, but with a number of modifications to take into account the particular attributes of this class. ‘particular assets.


Building on an earlier staff non-intervention waiver, the Funds proposed the following instead of the rule requirements:

  • Only a limited number of authorized staff of the Funds would instruct the custodian of the Funds and administrative agents;

  • Passwords or other appropriate security procedures would be used to ensure that only duly authorized persons can pass these instructions;

  • The Funds would reconcile interest on settled loans with the records of administrative officers on a regular basis (ie at least monthly);

  • Interest on loans would be titled or registered with administrative agents in the name of a Fund (and not in the name of the Fund’s investment advisor);

  • Neither the Funds nor their investment advisers are affiliated with administrative agents; and

  • Each Fund would adopt policies and procedures reasonably designed to prevent the violation of the above conditions, as part of the Fund’s compliance program under Rule 38a-1 of the 1940 Act.

Instead of the rule verification requirement, each Fund would be subject to an annual audit during which the Fund’s independent accountant confirms all of the Fund’s investments, including its investments in loan interest, and reconciles interest on the loan with the Fund’s accounting records. The inbound letter noted that a single annual audit, such as that normally performed for mutual funds, provides sufficient custodial protections to investors in pooled investment vehicles under Rule 206 (4) – 2 of the Investment Advisers Act 1940 (Advisers Act). In the letter, staff specifically noted the statement in the incoming letter that the Funds are in compliance with annual audit requirements. This letter reflects the continued interest in investments and loan swaps by non-banks which in turn continue to raise interesting regulatory issues under the 1940 Act and the Advisors Act.

© 2021 Greenberg Traurig, LLP. All rights reserved. Review of national legislation, volume XI, number 48

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