April 22, 2020

SEC Provides Temporary Additional Flexibility to Registered Investment Companies to Borrow and Lend

The Securities and Exchange Commission (SEC) recently issued an order (Order) permitting registered open-end funds (other than money market funds) (Open-End Funds) and insurance company separate accounts registered as unit investment trusts (Separate Accounts) to more easily lend to and borrow from affiliates for the purpose of satisfying investor redemptions. The measure is intended to provide Open-End Funds and Separate Accounts with additional flexibility to navigate the market volatility caused by the current outbreak of coronavirus disease while still meeting their obligations to investors.

As set forth in more detail below, the Order provides the following temporary exemptive relief from the Investment Company Act of 1940 (1940 Act), subject to certain conditions:

  • Open-End Funds and Separate Accounts may borrow money from certain noninvestment company affiliates.
  • Registered investment companies (RICs) with an existing interfund lending order (Existing IFL Order) have additional flexibility to make loans and to borrow.
  • Any RIC that does not currently have exemptive relief may use interfund lending arrangements.
  • Open-End Funds may enter into lending arrangements or borrowings that deviate from their fundamental policies.

The Order was effective on March 23, 2020 and will continue until at least June 30, 2020.

Open-End Fund or Separate Account Borrowing From Non-Fund Affiliate

The Order provides that Open-End Funds, Separate Accounts and their affiliates are exempt from Sections 12(d)(3), 17(a) and 18(f)(1)1 of the 1940 Act to the extent necessary to allow the fund or separate account to borrow money from an affiliated person2 that is not itself a RIC or a bank, subject to the following conditions:

  • The Open-End Fund’s board of directors, including a majority of the disinterested directors, or the insurance company on behalf of the Separate Account, reasonably determines that such borrowing (i) is in the best interests of the fund and its shareholders, and (ii) will be for the purpose of satisfying shareholder redemptions.
  • Prior to relying on the relief for the first time, the Open-End Fund or Separate Account notifies the SEC staff via email at IM-EmergencyResponse@sec.gov stating that it is relying on this Order.

Interfund Lending

Registered Investment Companies with Existing Interfund Lending Exemptive Orders

The Order also provides additional flexibility for RICs with an Existing IFL Order to lend and borrow. In particular, a RIC with an Existing IFL Order may:

  • Make loans in an aggregate amount that does not exceed 25% of its current net assets at the time of the loan, notwithstanding any lower limitation in an Existing IFL Order.
  • Borrow (if the RIC is permitted under an Existing IFL Order to be a borrower3) or make loans through the facility for any term notwithstanding any conditions limiting the term of such loans, so long as (i) the term of any interfund loan made in reliance on the Order does not extend beyond the expiration of the temporary relief, (ii) the board of directors of the RIC, including a majority of the disinterested directors, reasonably determines that the maximum term for interfund loans to be made in reliance on the Order is appropriate, and (iii) the loans will remain callable and subject to early repayment on the terms described in the Existing IFL Order.
  • Rely on the SEC relief permitting deviations from fundamental lending or borrowing policies (subject to the conditions described below), notwithstanding any condition of the Existing IFL Order that limits fundamental restrictions or nonfundamental policies.

In each case, any loan under the facility must otherwise be made in compliance with the conditions of the Existing IFL Order. In addition, prior to relying on the relief for the first time, a RIC with an Existing IFL Order must:

  • Notify the SEC staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on the Order.
  • Disclose on its public website that it is relying on an SEC exemptive order that modifies the terms of its Exiting IFL Order to permit additional flexibility to provide or obtain short-term funding from its interfund lending and borrowing facility.

Registered Investment Companies Without Existing Interfund Lending Exemptive Orders

Importantly, the Order allows any RIC that is not currently able to rely on an Existing IFL Order to establish and participate in an interfund lending and borrowing facility in compliance with the conditions of any order permitting such a facility that the SEC has issued within the last 12 months (Recent IFL Precedent).

The RIC must satisfy the terms and conditions for relief in the recent IFL precedent (including with respect to whether it may participate as a borrower), except:

  • It may rely on the relief provided to RICs with Existing IFL Orders (described above), subject to its terms and conditions.
  • It need not satisfy the condition in the Recent IFL Precedent requiring prior disclosure in its registration statement or shareholder report.
  • Money market funds may not participate as borrowers in the interfund facility.

In addition, prior to relying on the Order for the first time, the RIC must:

  • Notify the SEC staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on the Order and identifying the Recent IFL Precedent that it is relying on.
  • Disclose on its public website, prior to relying on the relief for the first time, that it is relying on the relief to utilize an interfund lending and borrowing facility.
  • To the extent it files a prospectus supplement, or a new or amended registration statement or shareholder report, while it is relying on this relief, updates its disclosure regarding the material facts about its participation or intended participation in the facility.

Deviations From Fundamental Policy With Respect to Lending and Borrowing

The Order also allows Open-End Funds to engage in otherwise lawful lending and borrowing transactions that deviate from any relevant policy in such fund’s registration statement without prior shareholder approval, subject to the following conditions:

  • The board of directors of the Open-End Fund, including a majority of the disinterested directors, reasonably determines that such lending or borrowing is in the best interests of the fund and its shareholders.
  • The Open-End Fund promptly notifies its shareholders by filing a prospectus supplement and including a statement on the applicable fund’s public website of the deviation.
  • Prior to relying on the relief for the first time, the Open-End Fund notifies the SEC staff via email at IM-EmergencyResponse@sec.gov stating that it is relying on this Order.

Practice Points

It should be noted that the coverage of the different forms of relief provided by the Order varies in scope. The ability to borrow from a non-fund affiliate applies only to registered open-end funds, other than money market funds, and to insurance company separate accounts that are unit investment trusts. The ability to borrow and lend in excess of the restrictions of an Existing Interfund Order, or to rely on a Recent IFL Order, applies to all RICs subject to the conditions of the interfund orders (e.g., a closed-end fund or money market fund could participate in an interfund facility as lender, but generally not as borrower). The ability to deviate from a fundamental policy applies only to registered open-end funds other than money market funds.

A chart setting forth the coverage, terms and conditions of relief under the Order is shown below.

Coverage of Relief
Relief Granted
Conditions for Relief
Open-End Fund (other than a Money Market Fund) or Insurance Company Separate Account and their Affiliates
  • A registered open-end fund or insurance company separate account is exempt from Section 12(d)(3) to the extent necessary to permit it to borrow money from any affiliated person, or affiliated person of such affiliated person, that is not itself a registered investment company.
  • An affiliated person of an open-end fund or separate account, or an affiliated person of such affiliated person, is exempt from Section 17(a) to the extent necessary to permit it to make collateralized loans to such open-end fund or separate account.
  • An open-end fund is exempt from Section 18(f)(1) to the extent necessary to permit it to borrow money from any affiliated person, or an affiliated person of such affiliated person, that is not a bank and is not itself a registered investment company.
  1. The board of directors of an open-end fund, including a majority of disinterested directors, or the insurance company on behalf of the separate account, reasonably determines that such borrowing is:
    1. In the best interests of the registered investment company and its shareholders
    2. For the purpose of satisfying shareholder redemptions
  2. Prior to relying on the relief for the first time, the open-end fund or separate account notifies the SEC staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on this Order.

Registered Investment Companies with Existing Interfund Lending Orders

Any registered investment company currently able to rely on an SEC order permitting an interfund lending and borrowing facility (“existing IFL order”) may:

  1. Make loans through the facility in an aggregate amount that does not exceed 25% of its current net assets at the time of the loan notwithstanding any lower limitation in the existing IFL order.
  2. Borrow (if permitted under the existing IFL order to be a borrower) or make loans through the facility for any term notwithstanding any conditions limiting the term of such loans, provided that:
    1. The term of any interfund loan made in reliance on this Order does not extend beyond the expiration of this temporary relief.
    2. The board of directors of the registered investment company, including a majority of the disinterested directors, reasonably determines that the maximum term for interfund loans to be made in reliance on the Order is appropriate.
    3. The loans will remain callable and subject to early repayment on the terms described in the existing IFL order.
  3. Avail itself of the SEC relief permitting deviations from fundamental lending or borrowing policies (set forth below), notwithstanding any condition of the existing IFL order that limits fundamental restrictions or nonfundamental policies.

  1. Any loan under the facility is otherwise made in accordance with the terms and conditions of the existing IFL order.
  2. Prior to relying on the relief for the first time, the registered investment company notifies the SEC staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on the Order.
  3. Prior to relying on the relief for the first time, the registered investment company discloses on its public website that it is relying on an SEC exemptive order that modifies the terms of its existing IFL order to permit additional flexibility to provide or obtain short-term funding from its interfund lending and borrowing facility.
Registered Investment Companies without an Existing Interfund Lending Order May establish and participate in such an interfund lending and borrowing facility as set forth in an exemptive order permitting such a facility that the SEC has issued within the 12 months preceding the date of this Order (recent IFL precedent).
  1. The registered investment company must satisfy the terms and conditions for relief in the recent IFL precedent (including with respect to whether it may participate as a borrower), except:
    1. It may rely on the relief provided to registered investment companies with an existing IFL order (described above).
    2. It need not satisfy the condition in the recent IFL precedent requiring prior disclosure in its registration statement or shareholder report.
    3. Money market funds may not participate as borrowers in the interfund facility.
  2. Prior to relying on the relief for the first time, the registered investment company notifies the SEC staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on this Order and identifying the recent IFL precedent that it is relying on.
  3. The registered investment company:
    1. Discloses on its public website, prior to relying on the relief for the first time, that it is relying on the relief to utilize an interfund lending and borrowing facility.
    2. To the extent it files a prospectus supplement, or a new or amended registration statement or shareholder report, while it is relying on this relief, updates its disclosure regarding the material facts about its participation or intended participation in the facility.

Ability of Registered Open-End Investment Companies to Deviate from Fundamental Investment Restrictions and Non-Fundamental Investment Policies An open-end fund is exempt from sections 13(a)(2) and 13(a)(3) of the 1940 Act to the extent necessary to permit it to enter into otherwise lawful lending or borrowing transactions that deviate from any relevant policy recited in its registration statement without prior shareholder approval, subject to the applicable conditions in the Order.
  1. The board of directors of the open-end fund, including a majority of the disinterested directors, reasonably determines that such lending or borrowing is in the best interests of the registered investment company and its shareholders.
  2. The open-end fund promptly notifies its shareholders of the deviation by filing a prospectus supplement and including a statement on the applicable fund’s public website.
  3. Prior to relying on the relief for the first time, the registered investment company notifies the SEC staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on this Order.
  1. Section 12(d)(3) generally prohibits a registered investment company (and any company controlled by a registered investment company) from acquiring securities issued by or other interests in a broker, dealer, underwriter or investment adviser unless certain conditions are met. Section 17(a) of the 1940 Act prohibits certain transactions involving a registered investment company and an affiliated person, including certain purchases and sales of securities and borrowing or lending arrangements. Section 18(f)(1) of the Investment Company Act sets forth certain custody requirements for registered management companies to comply with certain custody requirements.
  2. “Affiliated person” of another person means (A) any person directly or indirectly owning, controlling or holding with power to vote, 5 per centum or more of the outstanding voting securities of such other person, (B) any person 5 per centum or more of whose outstanding voting securities are directly or indirectly owned, controlled or held with power to vote, by such other person, (C) any person directly or indirectly controlling, controlled by or under common control with, such other person, (D) any officer, director, partner, copartner or employee of such other person, (E) if such other person is an investment company, any investment adviser thereof or any member of an advisory board thereof, and (F) if such other person is an unincorporated investment company not having a board of directors, the depositor thereof.
  3. For example, under Existing IFL Orders, registered closed-end funds and money market funds generally may participate in an interfund facility as a lender, but not as a borrower.

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