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November 26, 2001
TO: CLOSED-END INVESTMENT COMPANY COMMITTEE No. 22-01
COMPLIANCE ADVISORY COMMITTEE No. 60-01
SEC RULES COMMITTEE No. 95-01
TRANSFER AGENT ADVISORY COMMITTEE No. 95-01
UNIT INVESTMENT TRUST COMMITTEE No. 27-01
RE: SEC PROPOSES RULE AMENDMENTS RELATING TO SECURITIES DEPOSITORIES
The Securities and Exchange Commission (the “Commission”) recently proposed
amendments to Rule 17f-4 of the Investment Company Act of 1940, the rule that governs
investment companies’ use of securities depositories.* According to the Proposing Release, the
amendments would update and simplify the rule to reflect the developments in securities
depository practices and commercial law that have occurred over the years. Specifically, they
would expand the types of investment companies that can maintain assets with a depository,
expand the types of depositories they can use, and update the conditions they must follow to
use a depository. The amendments also would eliminate unnecessary custodial compliance
requirements, including the requirements that fund directors approve the fund’s custody
arrangements and fund approval of its custodian’s depository arrangements. A copy of the
Proposing Release is attached, and it is summarized below.
Comments are due to the Commission by January 31, 2002. A conference call to
discuss the proposal has been scheduled for December 11, 2001 at 2:00 p.m. (EST). If you
would like to participate on the call, please notify Deborah Washington by sending an email
to deborah@ici.org that includes your name, firm, telephone number, and email address. If
you are unable to participate on the call, please provide any comments you may have to
Marguerite Bateman at 202/326-5813 (phone), 202/326-5827 (fax), or bateman@ici.org (email),
no later than December 10, 2001.
Expansion of the Rule to Include Transfer Agents
Currently, Rule 17f-4 permits funds to maintain assets with a depository established by
a registered clearing agency, such as DTC, and the book-entry system of the Federal Reserve.
The amendments would expand the scope of the rule to permit funds to maintain assets with a
registered transfer agent for the purpose of holding shares of an open-end management
* Investment Company Act Release No. 25266 (Nov. 15, 2001) (“Proposing Release”). The Proposing Release also is
available from the SEC’s website at www.sec.gov/rules/proposed/ic-25266.htm.
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investment company. This change recognizes that transfer agents may serve as the functional
equivalent of a depository, and responds to the growth in “fund of funds,” the use of cash
sweep accounts and other arrangements in which a registered investment company invests in
mutual fund shares.
The Commission requests comment on the expanded scope of the rule. Comment also is requested on
whether the rule should be expanded to include other organizations that serve as depositories for funds.
Expansion of the Rule to Include Non-Management Companies
At present, only registered management investment companies, i.e., open-end funds and
closed-end funds, may rely on Rule 17f-4. The proposed amendments would expand the rule to
permit unit investment trusts and face-amount certificate companies to use securities
depositories. The SEC staff has previously granted no-action relief to non-management
companies seeking to maintain assets in a depository to supplement custody arrangements with
a trustee. Accordingly, the Commission’s proposal would require the trustee of such non-
management entities to approve these arrangements and establish an internal control system
reasonably designed to prevent unauthorized officer’s instructions.
The Commission requests comment on the proposed use of depositories by non-management
companies. The Commission also requests comment on the proposed conditions, and whether any
additional conditions should apply.
Proposed Amendments to the Compliance Requirements
The Proposing Release notes that recent revisions to Article 8 of the Uniform
Commercial Code have rendered certain requirements of Rule 17f-4 unnecessary for the
protection of fund assets. As a result, the proposed amendments would replace the segregation
and earmarking, confirmation and successor custodian requirements with more general
compliance requirements for custodians and depositories designed to provide reasonable
protection for fund assets under modern commercial law. First, the fund’s contract with its
custodian would be required to provide that the custodian will take all actions reasonably
necessary or appropriate under applicable commercial and regulatory law to safeguard assets
held by the custodian, or assets maintained elsewhere for the benefit of the fund. If a fund deals
directly with a depository, the contract or rules for participants must provide the depository
will meet similar obligations. Second, the custody contract (or depository rules) must state that
the custodian (or depository) will promptly provide the fund with periodic reports on its
internal accounting controls and financial strength, and any available reports on the controls of
any depository or intermediary custodian it uses.
The Commission requests comment on these proposed contractual requirements. Specifically, the
Commission requests comment on whether the rule should specify the duties applicable under particular
circumstances, or whether it should clarify that custody contracts should not generally waive duties
under commercial law. In addition, the Commission questions whether it is appropriate to require reports
about the custodian’s financial strength, whether reports on the subcustodian’s internal controls are
necessary and whether other requirements should apply to custodians or depositories. Finally, comment
is sought on whether the amendments should provide a transition provision that would apply the current
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requirements of the rule to any custody arrangement that remains subject to Article 8 before it was
revised.
Proposed Elimination of Board Approval Requirements
The Proposing Release notes that, since custody arrangements involving depositories
have become largely routine, approval of such arrangements by directors appears unnecessary.
The proposed amendments, therefore, would permit the fund itself (through an officer) to
approve arrangements with depositories and with custodians that use depositories. The
Proposing Release clarifies, however, that directors should continue to monitor the fund’s
dealings with its own custodian.
The Commission requests comment on these proposals. Specifically, the Commission seeks
comment on whether the fund or its directors should approve any arrangement in which the custodian
maintains certificates in the fund’s name with a centralized processing facility or maintains fund shares
with a transfer agent that acts as a depository. The Commission also seeks comment on whether a fund’s
board should approve any direct dealings with a depository.
Proposed Inclusion of Note on Applicability of Rule 17f-4 to Foreign Custodial
Arrangements
The proposed amendments would add a note to Rule 17f-4 to clarify the rule’s
relationship to Rule 17f-5, which governs the maintenance of fund assets with a foreign
custodian. The Proposing Release states that, if fund assets are held with a U.S. depository
through a foreign custodian, this custody arrangement would be governed by both rules.
General Request for Comment
In addition to comments on the rule amendments in the Proposing Release, the Commission
requests suggestions for additional changes to existing rules or forms and comments on other matters that
may impact these proposals. The Commission specifically requests comment on whether the failure to
apply Rules 17f-5 and 17f-7 to domestic depositories would create an unfair burden on competition
between domestic depositories and global custodians of funds.
Marguerite C. Bateman
Associate Counsel
Attachment (in .pdf format)