SEC Staff Grants No-Action Relief to Affiliated Securities Lending Agent

by Goodwin
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The staff of the SEC’s Division of Investment Management granted no-action relief from Section 17(e)(1) of the Investment Company Act of 1940 (the “1940 Act”) to permit an affiliated securities lending agent to negotiate rebate rates on behalf of certain mutual funds, subject to specified guidelines and monitoring procedures. 

Background.  Nuveen Fund Advisors, LLC (the “Adviser”) serves as investment adviser to certain funds (the “Funds”) that participate in a securities lending program for which the Funds’ custodian (the “Bank”) serves as securities lending agent.  By virtue of its ownership of securities of one or more of the Funds, the Bank may be deemed an affiliated person of each Fund as defined in Section 2(a)(3) of the 1940 Act.

Section 17(e)(1) of the 1940 Act and Prior Relief Under the Norwest No-Action Letter.  Section 17(e)(1) of the 1940 Act prohibits an affiliated person of a registered investment company, or any affiliated person of such person, acting as agent, to accept from any source any compensation for the purchase or sale of any property to or for the investment company, except in the course of such person’s business as an underwriter or broker.  In Norwest Bank Minnesota, N.A., SEC No-Action Letter (pub. avail. May 25, 1995) (the “Norwest Letter”), the SEC staff stated that it would not recommend enforcement action under Section 17(e)(1) against an affiliated custodian of a fund if the affiliated custodian was compensated by the fund for providing certain services in connection with a securities lending program.  The fund’s adviser was permitted to delegate to the custodian the tasks of entering into loans with pre-approved borrowers on pre-approved terms and investing cash received as collateral for the loans in instruments pre-approved by the adviser.  The SEC staff took the position that, under these circumstances, the adviser’s delegation of authority to the affiliated lending agent with respect to such matters would present little opportunity for the types of conflicts that Section 17(e)(1) was designed to prevent.  The SEC staff also stated in the Norwest Letter that relief from the prohibition in Section 17(e)(1) would be inappropriate when the lending agent has “unfettered discretion to negotiate loan terms.”

Current Relief.  The Adviser sought no-action relief from Section 17(e)(1) to permit the Bank to negotiate rebate rates with borrowers on behalf of each Fund, subject to guidelines and monitoring by the Adviser and the Board of Directors (“Board”) of the Funds.  The Adviser adopted, and the Board reviewed, guidelines that require the Bank to obtain minimum spreads in negotiating securities loans on behalf of the Funds and to notify the Adviser if a loan earns a spread that is less than the required minimum spread under the guidelines.  The Adviser is responsible for monitoring the continuing appropriateness of the guidelines, and may modify them.  The Bank is also required to monitor market information on rebate rates and report to the Adviser any negotiated rebate amount that is materially more favorable to a borrower than the market rate for a similar loan.  The Adviser provides regular reports to the Board regarding the securities lending activities of the Funds, including with respect to the foregoing matters.

The Adviser asserted that it was not practical for the Bank to submit rebate rates to the Adviser for pre-approval, and that the industry practice for securities loans generally does not involve such pre approval.  Instead, the Adviser argued that appropriate monitoring, oversight and after-the-fact review by the Adviser and the Board should be sufficient to address the conflicts that Section 17(e)(1) of the 1940 Act was designed to prevent.  Based on the guidelines, monitoring and reporting procedures described in the no-action request, the SEC staff agreed with the Adviser.  In granting the relief, the SEC staff reaffirmed its view that relief would be inappropriate where an affiliated lending agent has “unfettered discretion to negotiate loan terms.”  

Nuveen Investment Funds, SEC No-Action Letter (pub. avail. Feb. 13, 2014).

Goodwin Procter represented the parties in securing the no-action relief.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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