On October 12, 2018, the SEC’s Division of Investment Management issued a no-action letter to the Independent Directors Council (“IDC”) regarding the oversight of affiliated transactions. Under the Investment Company Act, Rules 10f-3, 17a-7, and 17e-1 are commonly referred to in the fund industry as the “affiliated transaction rules” and are each an Exemptive Rule for mutual funds.
These Exemptive Rules were adopted to allow for certain types of affiliated transactions to occur with specific board involvement. The fund(s) board must follow certain criteria in order for the fund(s) to remain in compliance while conducting these transactions. Specifically, the board, including a majority of the directors who are not “interested persons” of the fund(s), must:
- Adopt procedures that are reasonably designed to provide that the transactions comply with the conditions of the Exemptive Rule;
- Make and approve such changes to those procedures as the board deems necessary; and
- 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.
It is the third bullet point above that the new no-action letter addresses.
In its incoming letter, the IDC took the position that Rule 38a-1 has changed the role of the board. It stated that the board’s role is one of oversight and not involvement in the day to day activities of a fund’s compliance program as that role has been delegated to the Chief Compliance Officer (“CCO”) of the fund(s) who was approved and appointed by the board. The CCO has a duty to inform the board of significant compliance events at the fund or its service providers. Therefore, the board should be able to accept a simple written representation from the fund CCO stating that all affiliated transactions effected during the preceding quarter were in compliance with the procedures adopted by the board in accordance with the relevant Exemptive Rule. In short, the CCO makes the determination instead of the board.
The SEC accepted this position by IDC and granted the no-action relief. In the Staff response letter, the SEC stated that this approach is consistent with Rule 38a-1 and removes a requirement of boards that duplicates certain functions normally performed by the CCO.
The Staff believes this new position will allow directors to focus more on the conflict of interest issues posed by the affiliated transactions and determine if the transactions are in the best interest of the fund and its shareholders.