Alert September 06, 2011

SEC Requests Comment on Issues Related to the Use of Derivatives by Registered Funds and BDCs

The SEC issued a concept release requesting public comment on issues related to the use of derivatives by registered management investment companies and companies that have elected to be treated as business development companies (“BDCs”) under the Investment Company Act of 1940 (collectively, “funds”).  The release is part of a review being conducted by the SEC and its staff to determine whether the regulatory framework, as it applies to funds’ use of derivatives, continues to “fulfill the purposes and policies underlying the Act and is consistent with investor protection.”  The review may ultimately result in regulatory initiatives.  The concept release focuses on the following topics: 

  • Leverage - the Act’s senior securities limitations as applied to derivatives (and related SEC and staff guidance), industry practice with respect to coverage and asset segregation, criticisms of the Act’s requirements in this area and other approaches to limiting the use of derivatives, including those taken by non-U.S. regulators;
  • Diversification - valuation practices and issuer determinations for derivatives when classifying funds as diversified or non‑diversified under Section 5(b)(3) of the Act;
  • Exposure to Securities-Related Issuers - potential exposure to securities industry‑related issuers subject to Section 12(d)(3) of the Act because of the business activities of a derivatives counterparty or the issuer of reference assets, and methods of valuing derivatives when a fund relies on the conditional exemption for investment in securities industry-related issuers provided by Rule 12d3-1 under the Act;
  • Fund Industry Concentration Policies - industry exposure through derivatives counterparties and issuers of reference assets, and valuation methods for derivatives when determining industry concentration; and
  • Valuation of Derivatives in Determining Fund Net Asset Values. 

The concept release notes that the SEC may consider other significant derivatives-related issues under the Act, such as those related to disclosure, at a later date.  Comments on the concept release may be submitted no later than 60 days after its publication in the Federal Register.