Open-Ended Mutual Funds

The SEC’s Division of Investment Management issued updated guidance regarding the definition of “knowledgeable employees” under Rule 3c-5 of the Investment Company Act of 1940.  See Managed Funds Ass’n, SEC No-Action Letter, avail. 2/6/14, https://www.managedfunds.org/wp-content/uploads/2014/02/Staff-Response-to-MFA-3c-5-Letter-Final-Outgoing-2-6-14-no-sigs.pdf

The SEC staff explained that “private funds” include private equity funds, hedge funds, and other pooled investment vehicles, excluded from the definition of an “investment company.”  Investment Company Act Rule 3c-5 permits a knowledgeable employee of a private fund – “covered fund”- or a knowledgeable employee of an affiliated person managing the investments of a covered fund – “affiliated management person”- to invest in a covered fund, without being subject to certain conditions under Investment Company Act Section 3 that otherwise apply.

The SEC staff clarified the definition of a knowledgeable employee by analyzing the various categories of the term under Rule 3c-5.  The staff confirmed that it will not recommend enforcement action against covered funds if they treat certain employees of covered separate accounts as knowledgeable employees.  The staff further explained that other employees may also qualify as knowledgeable employees, depending on the facts and circumstances.

The letter recommended that investment managers maintain a written record of employees that have been “permitted to invest in a Covered Fund as knowledgeable employees” and should be able to explain why a particular employee qualifies as a knowledgeable employee.

This guidance provides a road map for those employees acting in this type of fund sphere.

FINRA has published guidance on its new marketing Rule 2210.  See http://www.finra.org/Industry/Issues/Advertising/P197604

 

FINRA has indicated that retail communications that will now be subject to this filing requirement has to be filed by February 19, 2013.  FINRA suggested that retail communications relating closed-end funds and structured products must be filed.  FINRA wants, among other things, filed certain presentation scripts and correspondence.  However, mutual fund manager communications relating to past performance do not have to be filed.

 

Bottom line, compliance officials have more to worry about than ever.

 

Recently, in a settled SEC enforcement action, a mutual fund manager allegedly used an option strategy, but the SEC believed it was more speculative than hedging.  See http://www.sec.gov/litigation/admin/2012/33-9377.pdf.

The SEC focused on the fact that the prospectus only permitted options for hedging, instead, the SEC claimed option trading was used to speculate.  The SEC cited that the amount of options purchased were significantly higher than one would see if the strategy was purely hedging.  Moreover, the cost for these options transactions were a significant amount of the entire portfolio.

Obviously, the SEC is looking at fund trading.  Although the SEC did not make a specific bright line as to difference between heding and speculation, this matter certainly provides some guidance moving forward.