United States: Investment Services Regulatory Update - April 2017

NEW RULES, PROPOSED RULES AND GUIDANCE

SEC Adopts T+2 Settlement Cycle for Securities Transactions, Shortening Timing Mismatch for Mutual Funds

On March 22, 2017, the SEC adopted an amendment to the settlement cycle rule under the Securities Exchange Act to shorten the standard settlement cycle for most broker-dealer securities transactions from three business days after the trade date (i.e., T+3) to two business days after the trade date (i.e., T+2). The SEC's adopting release for the rule amendment cites comments on the T+2 proposing release (published on September 28, 2016), including from the Investment Company Institute (ICI), that noted, in the context of mutual funds, a shortened settlement cycle would reduce the timing mismatch and funding gap between settlement of a mutual fund's portfolio securities (which settle on T+3) and the settlement of shares issued to investors through the mutual fund itself (which generally settle on T+1), improving cash management for funds to meet redemptions. The adopting release notes that such comments support the SEC's belief that "by better aligning the settlement cycle between the underlying portfolio securities and the securities issued to investors through the mutual fund, the risk to the fund, and ultimately investors is reduced." The amendment to the settlement cycle rule will go into effect on September 5, 2017.

The adopting release directs the SEC staff to submit a report to the SEC no later than September 5, 2020, examining the impact of the establishment of the T+2 standard settlement cycle on market participants and the potential impacts associated with moving to an even shorter settlement cycle.

The SEC's adopting release is available at: https://www.sec.gov/rules/final/2017/34-80295.pdf.

SEC Staff Issues No-Action Letter Permitting U.S. Master Fund— Foreign Feeder Fund Arrangements

On March 8, 2017, the staff of the SEC's Division of Investment Management (the Staff) issued a no-action letter (the No-Action Letter) stating that it would not recommend enforcement action to the SEC under Section 12(d)(1)(A) or (B) of the 1940 Act against: (i) a foreign investment company that is not registered under the 1940 Act (a Foreign Feeder Fund), if the Foreign Feeder Fund acquires (1) securities of a single 1940 Act-registered open-end fund (a U.S. Master Fund) in excess of the limits of Section 12(d)(1)(A) of the 1940 Act and, for certain Foreign Feeder Funds, (2) Foreign Currency Instruments (as defined in the No-Action Letter); and ( ii) the U.S. Master Fund and its principal underwriter (the Master Fund Principal Underwriter) and any broker or dealer for selling the U.S. Master Fund's securities in excess of the limits of Section 12(d)(1)(B) of the 1940 Act to a Foreign Feeder Fund (the Proposed Structure). As explained in the letter to the Staff seeking no-action assurance (the Incoming Letter), the Proposed Structure would enable global investment managers to efficiently offer investment products across several foreign jurisdictions. The law firm that submitted the request (the Applicant) asserts in the Incoming Letter that the "Proposed Structure would be beneficial to the U.S. mutual fund industry and could potentially attract significant assets to the U.S. and create significant scale to the benefit of investors in U.S. Master Funds."

Section 12(d)(1)(A) of the 1940 Act, in relevant part, prohibit s a registered or unregistered investment company (an acquiring fund) from investing in the securities of a registered fund (the acquired fund) if immediately after the acquisition the acquiring fund: (i) owns more than 3% of the outstanding voting securities of the acquired fund; (ii) has more than 5% of its total assets invested in the acquired fund; or (iii) has more than 10% of its total assets invested in the acquired fund and all other acquired funds. Section 12( d)(1)(B) of the 1940 Act prohibits an acquired fund, its principal underwriter and any broker or dealer registered under the Exchange Act, from knowingly selling the acquired fund's securities to any acquiring fund and any companies controlled by such acquiring funds if, immediately after the sale: (i) more than 3% of the acquired fund's outstanding voting securities would be owned by the acquiring fund or companies controlled by it; or (ii) more than 10% of the acquired fund's outstanding voting securities would be owned by the acquiring fund and other funds and companies controlled by them.

Section 12(d)(1)(E) of the 1940 Act provides a conditional exemption from the restrictions in Sections 12(d)(1)(A) and (B) of the 1940 Act that is relied upon by, among others, private funds and foreign investment companies to invest in U.S.-registered funds. Absent no-action relief from the Staff, as applied to the Proposed Structure, Section 12(d)(1) (E) would require that: (1) the principal underwriter for the Foreign Feeder Fund must be a broker or dealer registered under the Exchange Act or a person controlled by such broker or dealer; (2) the U.S. Master Fund's securities are the only investment security held by the Foreign Feeder Fund; and (3) the Foreign Feeder Fund purchases or otherwise acquires securities issued by the U.S. Master Fund pursuant to an arrangement with the U.S. Master Fund or its principal underwriter whereby the Foreign Feeder Fund is obligated: (i) either to seek instructions from its shareholders with regard to the voting of all proxies with respect to the U.S. Master Fund's securities and to vote such proxies only in accordance with such instructions, or to vote the shares held by it in the same proportion as the vote of all other shareholders of the U.S. Master Fund's securities; and (ii) to refrain from substituting the U.S. Master Fund's securities unless the SEC shall have approved such substitution in the manner provided in Section 26 of the 1940 Act. However, as the Applicant explains in the Incoming Letter, a Foreign Feeder Fund may not be able to comply with certain provisions of Section 12(d)(1)(E) because of its structure and the laws and/or market practices of the foreign jurisdiction in which it operates. As examples, the Applicant notes that the laws and/or market practices of the foreign jurisdiction in which a Foreign Feeder Fund operates: (i) may prohibit the Foreign Feeder Fund from directly voting the shares of the applicable U.S. Master Fund, which could be viewed as precluding compliance with the "pass through" or "echo" voting requirements under Section 12(d)(1)(E); or (ii) not require the Foreign Feeder Fund to distribute its securities through a principal underwriter or a principal underwriter that is, or that is controlled by, a broker-dealer registered under the Exchange Act.

In granting the no-action relief, the Staff allowed the following deviations from the conditions of Section 12(d)(1)(E):

• a Foreign Feeder Fund: (a) may have a principal underwriter that either controls or is under common control with an Exchange Act-registered broker-dealer (Foreign Principal Underwriter); and (b) will have as its investment adviser an adviser (Feeder Fund Adviser) that (i) controls, is controlled by, or is under common control with (Control Affiliate), the investment adviser to the U.S. Master Fund (Master Fund Adviser) and the Master Fund Principal Underwriter and (ii) may be registered under the Advisers Act;
• a Foreign Feeder Fund may hold certain investment securities other than the securities of the U.S. Master Fund, but will do so solely for purposes of hedging either: (a) the performance of the U.S. Master Fund, measured in the U.S. dollar, against the currency of the foreign jurisdiction in which the Foreign Feeder Fund's securities are primarily offered and sold (Designated Currency); or (b) if the U.S. Master Fund seeks to approximate the return of an index, the U.S. dollar and/or foreign currency exposure of the U.S. Master Fund to the Foreign Feeder Fund's Designated Currency; and
• a Foreign Feeder Fund may either abstain from voting or withhold voting the U.S. Master Fund's shares, rather than pass through such vote to the Foreign Feeder Fund's shareholders or vote proportionately to the vote of the U.S. Master Fund's other shareholders.

In allowing the foregoing deviations from Section 12(d)(1)(E), and in view of, in particular, the potential absence of a principal underwriter or depositor for a Foreign Feeder Fund or participation in the Proposed Structure by a Foreign Principal Underwriter, the Staff required that:

• the Foreign Feeder Fund will have an investment adviser that is a Control Affiliate of the Master Fund Adviser and Master Fund Principal Underwriter;
• to the extent the Feeder Fund Adviser is not registered under the Advisers Act, such Feeder Fund Adviser must make its books and records with respect to the activities of the Foreign Feeder Fund available to the SEC and its Staff, designate the Master Fund Adviser as its agent for service of process in the U.S. with respect to the Foreign Feeder Fund, and consent to the jurisdiction of the U.S. courts and the SEC with respect to its activities in connection with the Foreign Feeder Fund;
• the Foreign Feeder Fund will be organized in, and regulated under the laws of, jurisdictions whose securities regulators have entered into a cooperation agreement with the SEC; and
• no Foreign Feeder Fund will offer or sell its securities in the U.S., either publicly or privately, or sell its securities to any "U.S. person," as defined in Rule 902(k) of Regulation S; each Foreign Feeder Fund's transactions with its shareholders will be consistent with the definition of "offshore transactions" in Rule 902(h) of Regulation S; and no Foreign Feeder Fund, Feeder Fund Adviser, Foreign Principal Underwriter, any of their respective affiliates, or any person acting on be half of any of the foregoing, will engage in any "directed selling efforts, " as defined in Rule 902(c) of Regulation S, with respect to securities of the Foreign Feeder Fund in the U.S.

The No-Action Letter is available at: https://www.sec.gov/divisions/investment/noaction/2017/dechert-030817-12d1.htm.

SEC Issues Proposal Requiring Use of Inline XBRL Format for Mutual Fund Risk/Return Summaries

On March 1, 2017, the SEC issued a proposed rule that would require the use of the "Inline XBRL" format for the submission of mutual fund risk/return summaries. Inline XBRL allows filers to embed XBRL data directly into an HTML document, eliminating the need to tag a copy of the information in a separate XBRL exhibit. In 2009, the SEC required mutual funds to provide risk/return summary information from their prospectuses in eXtensible Business Reporting Language (i.e., XBRL) format by submitting it to the SEC in an "Interactive Data File" exhibit. The Interactive Data File is required to be posted on a mutual fund 's website for as long as the registration statement or post-effective amendment to which the Interactive Data File relates remains current. If a mutual fund does not submit or post interactive data as required, its ability to file post-effective amendments to its registration statement under Rule 485(b) under the Securities Act is automatically suspended until it submits and posts the interactive data required. The 2009 requirements were intended to make mutual fund risk/return summaries easier for investors to analyze and to assist in automating regulatory filings.

To "help facilitate efficiencies in the mutual fund post-effective amendment filing process," the SEC is proposing changes to the General Instructions to Form N-1A that would change the timing requirements for the submission of Interactive Data Files. As noted in the proposing release, the SEC proposes permitting mutual funds to submit Interactive Data Files concurrently with certain post -effective amendments filed pursuant to Rule 485(b) under the Securities Act. The SEC also is proposing to eliminate the current 15 business day filing period accorded to all mutual fund filings containing risk/return summaries, including initial registration statements, post-effective amendments, and forms of prospectuses filed pursuant to Rule 497 . In the case of initial registration statements and post-effective amendments, the Interactive Data File would be required to be submitted no later than the effective date of those filings. In the case of forms of prospectuses file d pursuant to Rule 497, the Interactive Data File would be required to be submitted concurrently with the filing.

The SEC proposes a phase-in for mutual funds based on net asset size. For "larger entities," identified in the proposing release as mutual funds that together with other investment companies in the same "group of related investment companies" have net assets of $1 billion or more as of the end of the most recent fiscal year, the proposed compliance date is one year after the effective date t o comply with the new reporting requirements. For "smaller entities," i.e., mutual funds that together with other investment companies in the same "group of related investment companies" have net assets of less than $1 billion a s of the end of the most recent fiscal year , the SEC proposes to provide for an additional year to comply with the new reporting requirements.

Comments on the proposed rule are due by May 16, 2017. The SEC's proposing release is available at: https://www.sec.gov/rules/proposed/2017/33-10323.pdf.

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