Day to Day Dealings with the SEC: Registration Statement Comments; Exemptive Relief; and No-Action Letters Eric S. Purple

December 15, 2011

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Investment Company Interaction with the SEC

Investment companies interact with the SEC in a variety of ways. Three of the most common include: The Registration Statement Comment Process Exemptive Relief No-Action Letters

Although fund directors generally are briefed on these matters in their meetings, they are not usually involved directly in these processes. As a result, some may find it helpful to have a working knowledge of what each process entails as an aid to fund governance.

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Registration Statement Comment Process

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The Comment Process: What is Reviewed?

The Staff of the Division of Investment Management’s Office of Disclosure and Review typically reviews all new registration statement filings (on Forms N-1A or N-2), post-effective amendments filed pursuant to Rule 485(a), and merger registration statements filed on Form N-14, as well as all preliminary proxy filings.

The staff does not typically review routine post-effective amendments that are filed pursuant to Rule 485(b) or proxy filings that do not require preliminary filings.

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The Comment Process: How does the Staff Provide its Comments?

For all new fund filings on forms N-1A (open-end funds) or Form N-2 (closed-end funds) the SEC will provide a written comment letter.

For all post-effective amendments filed pursuant to Rule 485(a) and other reviewed filings, the staff will typically provide oral comments over the telephone to fund counsel.

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The Comment Process: Topics of Comments

Staff comments generally will fall within one of three categories: Perceived deficiencies with respect to complying with the

respective form’s line-item requirements (e.g., a request to provide information explicitly required by a form’s instructions);

Perceived deficiencies with respect to the sufficiency of disclosure (e.g., a request to clarify disclosure or add additional disclosure); and

Perceived regulatory issues under the Investment Company Act of 1940 (e.g., a concern that factual descriptions of activities contained in the prospectus or SAI reflect a failure to comply with the 1940 Act).

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The Comment Process: Resolution of Comments

Upon receipt of the comments from the SEC staff related to a registration statement, fund counsel will examine the comments, and with the help of the fund’s representatives (typically the investment adviser or an administrator), will begin to formulate a response to the SEC in a written response letter.

In some cases, the fund will determine to comply with the SEC staff’s comments in its entirety.

In other cases, the fund will determine that it disagrees with the SEC staff’s comment, and will decline to accept the comment.

(Some responses may be a mix of the two.)

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The Comment Process: Negotiating Comments

In instances in which the fund disagrees with the staff’s position, the response that fund counsel prepares will contain a reasoned explanation of why the fund disagrees with the staff’s position, including legal support for the fund’s position, and will respectfully decline to accept the comment.

Fund counsel will typically discuss the proposed responses with the fund’s SEC staff reviewer.

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The Comment Process: Negotiating Comments (cont.)

During the discussion of the comments, the staff will either agree with the Fund’s position and rescind the comment (or indicate that they have no objection to the fund declining the comment), or the staff will indicate that they disagree with the fund’s position.

In instances in which the Staff disagrees with the Fund’s position, the staff will typically take one of two stances: They will inform the fund that “it is on its own,” or They will indicate that failure to comply with the staff’s

comment could lead to a stop order proceeding.

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The Comment Process: “On your own”

The staff will sometimes indicate that a fund is “on its own.” This is essentially an admission that the fund and the staff agree to disagree; the staff does not agree with the Fund’s position, but it also does not feel strongly enough about the issue to pursue further action.

The staff is clear that the fund bears any risks of failing to comply with the staff’s comments.

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The Comment Process: Threatened Stop Orders

The SEC has the ability under the 1933 Act to issue a “stop order.” The stop order process acts to prevent the effectiveness of a registration statement or a post-effective amendment to a registration statement. Stop orders are subject to a opportunity for a hearing with ten days notice.

The SEC staff will typically raise this possibility in instances in which it feels very strongly about its position.

Other than in very rare instances, a threat of a stop order will be sufficient to end negotiations regarding an SEC comment.

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The Comment Process: Resolution of Comments

Once all of the comments have been negotiated, the fund will file an amended registration statement that reflects any changes made in response to staff comments, and will file a copy of a written response letter from fund counsel that is keyed to the comments that the staff reviewer provided in his or her comment letter or that he or she provided orally.

In the case of proxy statements, comments are resolved orally and a definitive filing is made that reflects the resolution of the staff’s comments.

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The Comment Process: What is the Effect of SEC Comments?

The comment process does not provide the fund with any substantive protections. The staff is very clear on this fact, and requires registrants to make “Tandy” representations as part of its submission to the effect that: The fund is responsible for the adequacy and accuracy of the disclosure; Staff comments or changes to disclosure in response to Staff comments in

the filings reviewed by the Staff do not foreclose the SEC from taking any action with respect to the filing; and

The fund may not assert Staff comments as a defense in any proceeding initiated by the SEC or any person under the federal securities laws of the United States.

What purpose do comments serve? The comment process is designed to supplement the federal securities statutes, and the rules, regulations, and forms that are adopted under them, and provides an informal mechanism in which funds can improve their disclosure and the staff can monitor the operations of the funds.

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Exemptive Relief

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Exemptive Relief – An Overview The 1940 Act provides the SEC with significant discretionary

authority over the application of the 1940 Act. Section 6(c) of the 1940 Act provides the SEC with the power

to conditionally or unconditionally exempt “any person, security, transaction, or any class or classes of persons, securities, or transactions from any provision or provisions of this [the 1940 Act] or of any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this title.”

The 1940 Act provides the Commission with a variety of more specific exemptive authority as well.

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Exemptive Relief – An Overview

An exemptive order permits its recipient, as a matter of law, to act in a manner that is contrary to the explicit provisions of the 1940 Act or its rules, provided that the recipient complies with the conditions of the order.

Unlike no-action letters, which are discussed later, an exemptive order – unless rescinded – protects its recipient from actions by private litigants.

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Exemptive Relief – Process for Obtaining Relief

In order to obtain exemptive relief an applicant must submit a formal, written application to the SEC.

This application will typically: Discuss the problem(s) at issue, Provide an analysis of the legal problems caused by the issue(s)

under the 1940 Act Provide the proposed conditions under which the order would

be granted, Discuss why the conditions are sufficient to address the policy

concerns underlying the provisions of the 1940 Act at issue, and Request formal exemptive relief.

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Exemptive Relief – Process for Obtaining Relief (cont.)

Once prepared, the application is filed with the SEC electronically on EDGAR

Upon filing the application is assigned to staff members in the Division of Investment Management’s Office of Investment Company Regulation, who will review the application.

Once the staff has reviewed the application, they will provide written comments on the contents and structure of the application.

The applicant will then revise its application and file the amended application with the SEC. Often the revisions will be further informed by oral discussions with the staff.

Depending on the complexity of the issues, the comment process may be repeated multiple times

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Exemptive Relief – Process for Obtaining Relief (cont.)

Once the SEC staff has reviewed the application and has resolved its comments, a notice containing a summary of the application is posted in the Federal Register giving interested parties the opportunity to request a hearing on the proposed relief.

The notice period typically runs from between 25-28 days from the date of the notice.

Once the notice period has run, and assuming that no hearing has been requested by an interested party or by the Commission acting on its own motion, the order will typically be granted within two days after the notice period expired.

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Exemptive Relief – Delegated Authority

Most orders are typically granted by the SEC staff pursuant to authority delegated by the SEC itself.

Delegated authority is available if the order involves issues that the SEC has previously addressed.

If the SEC has not previously addressed an issue, delegated authority is not available, and the SEC acting as a body must approve the publication of the notice and the issuance of the order.

If delegated authority is not available, the process of obtaining an order can extend over a much greater period of time.

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Exemptive Relief: The Staff’s Role in Supporting Relief

As part of the exemptive process, the staff may determine that the requested relief is not justified.

In such a case, the staff will typically recommend that the exemptive application be withdrawn.

If the exemptive application is not withdrawn, the staff will send the application to the SEC for with a recommendation that it be subject to hearing at which the Division can present its views on denial of the requested order.

The staff does not have the power under delegated authority to deny an application or to order a hearing; this requires the full action of the Commission.

Pursuing an order without staff support is somewhat quixotic, and is unlikely to succeed.

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No-Action Letters

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What is a no-action letter?

The term “no-action letter” is a generic reference to the staff’s written views regarding its enforcement position related to a particular pattern of facts.

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No-Action Letters Take Three Forms

Interpretive letters: opinions on the application of the law to contemplated factual situations.

Enforcement-only letters: statements by an authorized officer of the Commission’s staff to the effect that the staff will not recommend to the Commission that it take enforcement action if the transaction is consummated exactly as it has been described in the incoming letter.

Hybrid Letters: a combination of interpretive and enforcement only relief.

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No-action letters are informal relief.

The no-action process is designed to aid the public and facilitate the execution of the Commission’s functions by providing advice and assistance to members of the public dealing with the Commission. (17 C.F.R. §202.1(d) (2009)). No-action letters “represent the views of persons who are continuously working with the provisions of the [federal securities law] statues….” Id.

The Commission’s informal procedures – which govern no-action letters – are designed to supplement the federal securities statutes, and the rules, regulations, and forms that are adopted under them. (17 C.F.R. §202.1(c) (2006)).

The staff has set forth a variety of informal guidelines for applying for relief. See Procedures Utilized by the Division of Corporation Finance for Rendering Informal Advice, Rel. No. 33-6253 (Oct. 28, 1980). Some of these procedures, such as multiple copies, are no longer required as a practical matter.

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What are the precedential value of no-action letters? Short Answer: None. No-action letters “do not bind the SEC, the parties, or

the courts. In effect, they bind no one.” New York City Employee’s Retirement System v. S.E.C., 45 F.3d 7, 12 (2d Cir., 1995).

No-action letters do not bind private litigants.

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What is the use of the letter then?

No-action letters provide a certain amount of comfort to recipients (and possibly others).

They provide the public with interpretive guidance issued by the SEC’s staff, and they provide a good-faith promise by the staff not to recommend enforcement action to the Commission.

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Staff authority to issue NALs.

There is no statutory basis. The practice is informal. The practice, although recognized by rule, is not

authorized by rule.

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What can the SEC staff do in a no-action letter?

The authority to issue no-action letters is not based upon statute or rule, and consequently is not bound by statute or rule, although interpretive letters are essentially bound by the text of the provisions being interpreted.

The staff will not go beyond its perceived authority, however. There is a line of demarcation between no-action relief and

exemptive relief, although this line can be fuzzy at times.

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The Staff will not go beyond its perceived authority.

The staff takes positions that are consistent with the policies underlying the federal securities laws.

NALs do not bind the Commission; the staff tries very hard, however, not to take a position that is contrary to the Commission’s views (even submitting letters to the Commission on occasion for their review).

NALs ultimately are persuasive; the authority of a NAL is only as strong as the reasoning upon which it is based.

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The Staff also has other self-imposed limits.

No hypotheticals. No anonymous inquiries (usually). No pending litigation. No retroactive relief (usually). No inherently factual determinations. Will not usurp the exemptive function (usually). Will not substitute its business judgment (usually). No positions on evolving law or new rules (usually).

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Who can rely on a no action letter? It depends. Generally, the Division of Investment Management

takes a broad view: An interpretive letter interprets a statute or rule. To the

extent a statute or a rule applies to a person, the interpretation should be universally available.

An enforcement-only letter gives the greatest level of comfort to the recipient and strong comfort to those who are similarly situated. A deviation from the facts yields less comfort depending on the magnitude of the deviation.

Recently, however, the Division of Investment Management has started to explicitly limit enforcement only no-action relief to the person writing in for the relief. This is a significant departure from past practice.

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Options for appealing the staff’s position. Options for appeal are limited. Generally the staff’s position stems from the Associate Director

level. You can appeal to the Division Director, or failing that, you can

attempt to get the full Commission to take up the issue, although this is rare, and rarely successful.

There is no right to review beyond this. Staff no-action letters are not “final rules” of the Commission that are reviewable by courts under the Administrative Procedures Act (“APA”). Commission determinations related to no-action letters are also not reviewable by the courts because they are viewed either as “decisions committed to agency discretion,” or are viewed as not being “final orders,” and therefore are not subject to APA review.

Questions?