Registered Investment Company 2020 Regulatory Recap


Erik Olsen

Publish Date


Compliance Alert


  • Compliance

During the course of 2020, the U.S. Securities and Exchange Commission (“SEC”) was active in proposing and adopting new rules under the Investment Company Act of 1940 (“IC Act”). Beyond rulemaking, the SEC also issued exemptive orders and no-action letters of note, including actions related to COVID-19. Here, we highlight some of the SEC’s 2020 regulatory activities for registered investment companies. We especially call out the perceived compliance dates of several adopted rules that will take you through 2022.

Compliance Date Notification

Exchange-Trade Fund (“ETF”) Rule – Adopted on September 25, 2019, with a compliance date of December 23, 2020, new Rule 6c-11 under the IC Act, codifies many of the conditions found in previously relied upon exemptive orders allowing for the creation of ETFs. While not applicable to all (unit investment trusts, leverage and inverse ETFs [just yet], ETFs structured as a share class of an open-end mutual fund are excluded), the rule, through its new definition of an ETF, removes the regulatory distinction between passively-managed and actively-managed ETFs. The rule re-defines what is a creation/redemption basket and will allow for custom basket creation. All ETFs able to rely on the rule are required to have daily portfolio transparency, enhanced web disclosures, and include a series of questions and answers in their prospectuses regarding bid-ask spreads in the ETF’s shares.

In conjunction with adopting new Rule 18f-4 under the IC Act, as discussed below, the SEC is also amending Rule 6c-11 to allow leverage and inverse ETFs that comply with Rule 18f-4 to now rely on Rule 6c-11, and come to market under the rule without obtaining separate exemptive relief. Exemptive orders previously issued to sponsors of leveraged and inverse ETFs permitting their operation as ETFs will be rescinded. The effective date for such amendments will be 60 days from the date Rule 18f-4 is published in the Federal Register.

Adopted Rules

Fair Valuation – On December 3, 2020, the SEC adopted new Rule 2a-5 under the IC Act which will apply to all registered investment companies (“funds”) and business development companies (“BDCs”). The rule requires the performance of certain functions for a fund to determine “fair value in good faith” of its investments in accordance with Section 2(a)(41) of the IC Act and Rule 2a-4 thereunder, including:

  • Periodically assessing and managing material risks associated with fair value determinations, including material conflicts of interest
  • Establishing and applying fair value methodologies
  • Testing fair value methodologies
  • Evaluating any pricing services used

Boards may retain the obligations above, or delegate the fair valuation determination related to any or all fund/BDC investments to a “valuation designee,” who in turn, must also carry out the above obligations. Such designee would act under board oversight and provide the board with (i) quarterly reporting, generally related to material changes of developments affecting fair valuation; (ii) annual reporting, generally related to an overall assessment of the fair value process; and (iii) prompt reporting (generally, within five business days of becoming aware of a material matter), of matters that materially affect fair value of the designated portfolio of investments. The valuation designee must specify the titles of the persons responsible for determining the fair value of the designated investments (including their functions), and reasonably segregate fair value determinations from portfolio management.

The SEC also adopted companion Rule 31a-4 to address recordkeeping obligations of the fund and BDC, and if delegated fair valuation responsibilities, the adviser.

Further, the SEC noted in the release adopting Rule 2a-5 that the “definition of readily available market quotations that we are adopting will apply in all contexts under the Investment Company Act and the rules thereunder, including rule 17a-7,” and that “certain securities that had been previously viewed as having readily available market quotations and being available to cross trade under rule 17a-7 may not meet our new definition and thus would not be available for such trades.” The SEC further went on to note that its current rulemaking agenda includes consideration of potential updates to Rule 17a-7. Given, funds’ and adviser’s use of Rule 17a-7 to manage portfolio transactions, this should be added to the regulatory radar for 2021.

The rule will become effective 60 days after publication in the Federal Register.1 There will be an 18-month transition period to come into compliance with the rule’s requirements. At that time, the SEC will rescind Accounting Series Releases 113 and 118, withdraw SEC staff letters and guidance addressing the board’s role in the fair value process, and certain valuation-related guidance in the 2014 release adopting Money Market Funds Reform will be superseded.

Use of Derivatives – On November 2, 2020, the SEC adopted new Rule 18f-4 under the IC Act to address the use of derivatives by funds and BDCs. The rule will allow funds and BDCs to enter into derivatives transactions and certain other transactions notwithstanding the restrictions of Section 18 of the IC Act, and without the need for asset segregation. The rule introduces new conditions for implementation (as follows):

  • Implementation of a principles-based written derivatives risk management program addressing risk identification and assessment, risk guidelines, stress testing, backtesting, and reporting (annual, and more frequent as requested by the board) and escalation
  • Board approved derivatives risk manager, an officer of the adviser who has “relevant experience regarding management of derivatives,” to administer the program
  • Limit on leverage based on a daily outer limit value-at-risk calculation not to exceed 200% of the VaR of the fund’s/BDC’s “designated reference portfolio (Relative VaR Test), or if determined appropriate by the program administrator, 20% of the fund’s/BDC’s net assets (Absolute VaR Test)
  • No need to have program if fund/BDC limits derivative exposure to 10% of net assets, excluding certain currency and interest rate hedging transactions
  • Leverage or inverse funds are subject to Rule 18f-4, with the exception of such funds in operation as of October 28, 2020 that seek an investment return above 200% of the return (or inverse return) of the fund’s underlying index and satisfy certain conditions

The rule also addresses reverse repurchase agreements; unfunded commitments; and when-issued, forward-settling and non-standard settlement cycle securities. A fund/BDC will be permitted to engage in reverse repurchase agreements and similar financing transactions so long as (i) it meets the asset coverage requirements of Section 18, or (ii) it treats such investments as derivatives under the rule. A fund/BDC is permitted to enter into unfunded commitment agreements notwithstanding the requirements of Sections 18(a), 18(c), 18(f)(1), and 61 if the fund/BDC reasonably believes, at the time it enters into such agreement, that it will have sufficient cash and cash equivalents to meet its obligations with respect to such agreements.

The rule will become effective 60 days after publication in the Federal Register.2 There will be an 18-month transition period to come into compliance with the rule’s requirements. At that time, the SEC will rescind Release Number 10666, and withdraw SEC staff letters and guidance addressing funds’ use of derivatives and other transactions covered by Rule 18f-4.

Fund of Funds – On October 7, 2020, the SEC adopted new Rule 12d1-4 under the IC Act permitting funds and BDCs3 to invest in affiliated and unaffiliated investment companies in excess of Section 12 limitations4, subject to certain conditions including:

  • An acquiring fund and its advisory group5 are prohibited from controlling an acquired fund.
  • An acquiring fund and its advisory group will generally be required to mirror vote (or cast votes in the same proportion as the other holders of the acquired fund) when, in the aggregate, the fund and its advisory group hold more than (i) 25% of the outstanding voting securities of an acquired open-end fund or unit investment trust, due to a decrease in the outstanding voting securities of the acquired fund, or (ii) 10% of the outstanding voting securities of an acquired closed-end fund or BDC.
  • Both the acquired fund’s and acquiring fund’s advisers need to make certain findings regarding the investment under the rule. This burden of findings is shifted from the fund board (under current exemptive orders) to the adviser.
  • When the acquired fund and acquiring fund do not share the same adviser, the funds will need to enter into an investment agreement that includes (i) any material terms necessary to make the required fund findings, (ii) a termination provision that allows either the acquiring fund or acquired fund to terminate the agreement, subject to advance written notice no longer than 60 days, and (iii) provision requiring the acquired fund to provide the acquiring fund with information regarding the fees and expenses of the acquired fund reasonably requested by the acquiring fund. The investment agreement replaces participation agreements commonly agreed upon when relying on current exemptive relief.
  • Acquired funds may invest up to 10% of its total assets in other investment companies, subject to certain exceptions such as investment in a subsidiary that is wholly-owned and controlled by the acquired fund, and investment in money market funds in reliance on Rule 12d1-1.6

The rule will become effective on January 19, 2021, with a compliance date set for one year thereon, or January 19, 2022. At that time, the SEC will also rescind Rule 12d1-2 along with most exemptive orders granting relief from Sections 12(d)(1)(A), (B), (C), and (G).

Registration Reform for Closed-End Funds and Business Development Companies – On April 8, 2020, the SEC adopted rule and form amendments to modify the registration, communications, and offering processes under the Securities Act of 1933 for exchange listed BDCs and exchange listed closed-end funds that seek to raise capital. The amendments would, among other things, allow certain closed-end funds and BDCs to utilize securities offering reforms previously made available to operating companies. In part, so-called “Seasoned Funds” will be permitted to file on Form N-2 a “short form” registration statement similar to the Form S-3 used by operating companies allowing funds to incorporate by reference information from reports previously filed under the Securities Exchange Act of 1934. Further, non-interval closed-end funds and BDCs that conduct continuous offerings will be permitted to rely on Rule 486 under the Securities Act in order to file post-effective amendments that either become effective immediately upon filing under Rule 486(b) or automatically effective after 60 days under Rule 486(a).

For interval funds, they may now register an indefinite number of shares and pay registration fees based on net issuance of shares by filing Form 24F-2, similar to open-end funds. This becomes effective on August 1, 2021.

Proposed Rules

Disclosure Reform – On Aug 5, 2020, the SEC proposed “rule and form amendments that would modernize the disclosure framework for mutual funds and ETFs,” which “would feature concise and visually engaging shareholder reports that would highlight key information that is particularly important for retail investors to assess and monitor their fund investments.” Mutual funds and ETFs would not be required to deliver annual prospectus updates to existing shareholders, instead relying on use of the new streamlined, abbreviated, shareholder report along with timely notifications to shareholders about material changes as they occur. “Traditional” annual report items such as the fund’s financial statements and financial highlights would be moved to Form N-CSR.

The SEC also proposed amendments to mutual fund and ETF prospectus disclosure requirements regarding fees, expenses, and principal risks to be summarized in a concise format. The proposal would also look to narrow Rule 30e-3 under the IC Act (which allows funds to rely on a “notice and access” model for shareholder report delivery beginning in January 2021) to exclude mutual funds and ETFs given their potential new reliance on the streamlined shareholder reports.

Finally, the SEC proposed amendments to the advertising rules for funds and BDCs to present fees consistently with the new streamlined shareholder reports. Comments on the proposal are due January 4, 2021.

Exemptive Relief, SEC Staff Letters, and SEC Staff Guidance Statements

“In-Person” Board Relief – On June 19, 2020, the SEC extended its exemptive relief allowing fund and BDC boards’ ability to not adhere to certain in-person voting requirements in the event of unforeseen or emergency circumstances affecting some or all of the directors as a result of COVID-19.7 During this time, boards are able to make certain approvals that normally require in-person meetings via telephone or video conferencing with respect to the engagement of an independent public accountant, and approval of investment advisory agreements and a 12b-1 plan.

The relief will terminate on a date specified in a public notice, which date will be at least two weeks from the date of the notice and no earlier than December 31, 2020. According to the Joint Statement, the Division of Investment Management “recognizes that restrictions and concerns relating to travel are likely to continue for some time, and because directors and meeting participants will need significant lead time to make appropriate travel plans, the Division anticipates providing sufficient advance notice before setting any termination date for this relief.”

Participation in TALF – On May 27, 2020, the SEC staff issued a no-action letter concerning fund participation in the Federal Reserve Board’s 2020 term asset-backed securities loan (“TALF”) facility. The staff noted that given similarities in the terms and conditions of TALF 2020 and similar Federal Reserve Board action taken in 2008, the staff was reaffirming its prior positions taken in staff letters issued in 2009. In one of the letters, the SEC staff also extended its no-action position to third-parties and also stated a no-action position with respect to section 57(a) of the IC Act that the staff will not recommend enforcement action against a BDC if the facts and circumstances of a transaction are substantially similar to those described in the letter.

BDC Relief – On April 8, 2020, the SEC announced temporary, conditional relief until December 31, 2020 allowing BDCs flexibility to issue and sell senior securities and invest alongside certain affiliates that would otherwise be prohibited by Section 57(a)(4) of the IC Act and Rule 17d-1 thereunder. The SEC recognized that certain BDCs may face challenges in continuing to provide credit support to portfolio companies impacted by COVID-19 if (i) it is unable to satisfy the asset coverage requirements under Section 18 due to temporary mark-downs in the value of the loans to such portfolio companies, or (ii) certain of its affiliates are prohibited from participating in additional investments in the BDC’s portfolio companies due to restrictions in its current exemptive order permitting co-investments.

The relief is available until the earlier of December 31, 2020, or the date by which the BDC ceases to rely on the order. According to the Joint Statement, the Division of Investment Management “is continuing to monitor the situation and may recommend extension of any or all of this relief as necessary.”

Annual Shareholder Meetings – On March 13, 2020, the SEC’s Division of Corporate Finance and Division of Investment Management staff published guidance regarding shareholder meetings held by public companies and funds. The SEC staff provided companies flexibility to change the date and location of in-person meetings and allow virtual shareholder meetings, provided the companies announce changes in the meeting date or location, or the use of virtual meetings in filings made with the SEC. In addition, companies are encouraged to provide shareholders alternative means to present their proposals at the annual meetings.

Affiliated Purchases of Debt Securities – On March 19 and 26, 2020, the SEC staff issued two staff letters pertaining to securities purchases by affiliated entities. The first permitted affiliated persons of a money market fund regulated under Rule 2a-7 under the IC Act, and who are subject to Section 23A and 23B of the Federal Reserve Act, to purchase securities from the fund in reliance of Rule 17a-9 under the IC Act, provided: (i) the purchase price of the security would be the fair market value price as determined by a reliable third-party pricing service; (ii) the purchase transaction satisfies the conditions of Rule 17a-9, except if the terms would otherwise conflict with applicable banking regulations or the exemption issued by the Board of Governors of the Federal Reserve System on March 17, 2020 that clarified a “covered transaction” does not include the purchase of assets from an affiliated money market fund; and (iii) the fund files Form N-CR, reports the transactions under Part C, and discloses in Part H that the transactions were conducted in reliance of this no-action letter in a timely manner.

The second, permits affiliated persons of an open-end fund, that is not an exchange-traded fund and that does not hold itself out as a money market fund, to purchase debt securities from the fund, provided the following:

  • The purchase price is paid in cash.
  • The price of the purchased debt security is its fair market value, provided that this price is not materially different from the fair market value of the security indicated by a reliable third-party pricing service.
  • In the event that the affiliated person subsequently sells the purchased security for a higher price than the purchase price paid to the fund, the affiliated person shall promptly pay to the fund the amount by which the subsequent sale price exceeds the purchase price paid to the fund. If the affiliated person is subject to Sections 23A and 23B of the Federal Reserve Act, this condition does not apply to the extent that it would otherwise conflict with applicable banking regulations or any applicable exemption from such regulations issued by the Board of Governors of the Federal Reserve System.
  • Within one business day of the purchase of the security, the fund publicly posts on its website and informs the SEC staff via email of the name of the fund, the name of the affiliated person, the security(ies) purchased (including a legal identifier if available), the amount purchased, and the total price paid.

Both staff letters grant temporary relief, but remain in effect as of the writing of this publication.

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1 At the time of drafting, such publication has not occurred.


BDCs, pursuant to Section 54(a) of the IC Act, are prohibited from making any investment unless, at the time of the investment, at least 70% of the BDC’s total assets are invested in securities of certain types of companies (of which funds are not included).

Private funds will still need to comply with the conditions of Section 12(d)(1)(A) of the IC Act and not exceed owning 3% of the outstanding voting shares of a fund or BDC absent exemptive relief.

An “advisory group” is defined as: (i) an acquiring fund’s investment adviser or depositor, and any person controlling, controlled by, or under common control with such investment adviser or depositor; or (ii) an acquiring fund’s investment sub-adviser and any person controlling, controlled by, or under common control with such investment sub-adviser.

The SEC is also amending Rule 12d1-1 to allow funds relying on Section 12(d)(1)(G) of the IC Act to invest in unaffiliate money market funds.

Please note that the SEC took additional actions in March related to certain fund filings, prospectus delivery, and short-term funding that have since expired. For this reason, they are not recounted here. See a related ACA summary available here as well as a joint statement by SEC Chairman Jay Clayton and Division Directors William Hinman, Dalia Blass, and Brett Redfearn on June 26, as updated December 7 (the “Joint Statement”).