After 30 years of piecemeal guidance, the Commission has issued proposed Investment Company Act Rule 18f-4, which represents a comprehensive approach to the regulation of derivatives as "senior securities." After discussing the history and current application of Section 18, the author turns to the proposed rule, addressing in detail its coverage, required asset segregation, portfolio limitations, and risk management. She concludes that the new requirements will further restrict, perhaps unnecessarily, the ability of registered funds to invest in derivatives and increase the oversight burden on fund boards.
On December 11, 2015, the Securities and Exchange Commission proposed Rule 18f-4 under the Investment Company Act of 1940 ("1940 Act") providing for a new, exclusive means by which open-end investment companies ("mutual funds"), exchange-traded funds ("ETFs"), closed-end funds, and business development companies or "BDCs" (collectively, "funds") may enter into derivatives, short sales, or other transactions that create conditional or unconditional future payment obligations on the fund.1 To rely on the proposed rule, funds would be required to comply with leverage restrictions, segregation requirements, substantial board oversight, and, in some cases, the adoption of a formal risk management program. If adopted, Rule 18f-4 stands to rescind and replace over 30 years of (often inconsistent) guidance developed by the Commission and its staff regarding the foregoing transactions and the application of Section 18 of the 1940 Act to those transactions.
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Originally published by The Review of Securities & Commodities Regulation, May 4, 2016
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