SEC Staff Issues No-Action Letter Permitting In-Kind Purchases of Fund Shares by Affiliates

The SEC staff recently issued the attached no-action letter, which permitted affiliated persons of a fund (the “Fund”) to purchase Fund shares by contributing securities to the Fund (an “in-kind purchase”). We have summarized the pertinent aspects of the letter below. Please note that, for ease of reading, we have simplified certain facts (e.g., the funds at issue had multiple series and classes with differing investment objectives and strategies). Please refer to the letter for more information.

Certain retirement plans and trusts sponsored and maintained by the parent company of the Fund’s adviser (the “Affiliated Investors”) held shares of another fund (the “Redeeming Fund”). The Fund and the Redeeming Fund had the same adviser, portfolio managers, investment objectives, and investment strategies, and substantially identical portfolio holdings. The Redeeming Fund was designed primarily for retail and smaller institutional investors, such as the Affiliated Investors, that could not invest in the Fund. The Affiliated Investors, however, became eligible to invest in the Fund because the Fund changed its eligibility requirements. The Affiliated Investors were expected to choose to invest in the Fund because of its lower expense ratio, the absence of any sales charges, and its substantially identical investment objectives and policies.

The Redeeming Fund and the Fund proposed to facilitate the Affiliated Investors’ transactions by allowing them to redeem their Redeeming Fund shares in-kind and use the redemption proceeds to acquire shares of the Fund. However, the legality of the in-kind purchase was brought into question because the Affiliated Investors could have been deemed to be affiliated persons of the Fund within the meaning of the Investment Company Act of 1940 and, consequently, the in-kind purchase would have violated Section 17(a) of that Act. An in-kind purchase by a fund affiliate raises affiliated transaction concerns because the affiliate may use its influence to cause the fund to accept unwanted portfolio securities or to issue its shares to the affiliate in exchange for consideration (i.e., securities) that is of lesser value than the shares issued. Similar concerns arise in connection with in-kind redemptions by affiliates. However, the incoming letter noted that the Redeeming Fund would affect the in-kind redemption in reliance on no-action relief previously granted by the staff in Signature Financial Group, Inc. (pub. avail. Dec. 28, 1999) (“Signature Letter”).

The SEC staff permitted the proposed in-kind purchases based on, among other things, the Fund’s representation that the purchases would be affected in a manner consistent with the following:

• An in-kind purchase will not dilute the interests of the shareholders of the Fund;
• The in-kind consideration accepted by a Fund will consist of securities that are appropriate, in type and amount, for investment by the Fund in light of its investment objectives and policies, and current holdings;
• An Affiliated Investor’s in-kind consideration will consist only of the entire redemption proceeds obtained through the redemption of Redeeming Fund shares;
• The Redeeming Fund and the Fund will have the same procedures for determining their net asset values, and will follow those procedures in determining the amount of redemption proceeds to be paid to the Affiliated Investor, and the amount of Fund shares to sell to an Affiliated Investor, respectively. The Redeeming Fund and the Fund will ascribe the same value to the in-kind consideration;
• The redemption in-kind and the purchase in-kind will be effected simultaneously;
• The Fund will effect the purchase in-kind pursuant to procedures adopted by the Fund’s board of directors, including a majority of the independent directors, that are reasonably designed to provide that in-kind purchases are effected in a manner consistent with (1) through (5) above;
• The Fund’s board of directors, including a majority of independent directors, will determine no less frequently than quarterly that all in-kind purchases made by an Affiliated Investor during the preceding quarter:
  • were effected in accordance with these procedures;
  • did not favor the Affiliated Investors to the detriment of any other Fund shareholder; and
  • were in the Fund’s best interests;
• The Fund will maintain and preserve for a period of not less than six years from the end of the fiscal year in which the purchase occurred, the first two years in an easily accessible place, a copy of its in-kind purchase procedures, as well as other records for the purchase in-kind setting forth the identity of the Affiliated Investor, a description of the composition of the Fund’s investment portfolio (including each asset’s value) immediately prior to the purchase in-kind, a description of each security delivered in connection with the purchase in-kind, the terms of the in-kind purchase, the information or materials upon which the asset valuations were made, and a description of the composition of the Fund’s investment portfolio (including each asset’s value) one month after the in-kind purchase; and
• The Fund’s adviser will, consistent with its fiduciary duties, disclose to the independent directors the existence of, and all of the material facts relating to, any conflicts of interest between adviser and the Fund in a proposed in-kind purchase to allow the independent directors to approve the in-kind purchase.

View SEC’s report

Unlike the Signature Letter, in which the staff effectively made the relief available to the entire industry when it stated that exemptive orders no longer would be necessary for in-kind redemptions provided that the conditions of the letter were satisfied, this letter offers no such guidance and, presumably, is limited to its facts.

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