SEC No-Action Letter Addresses Adviser Duties and Use of Nasdaq Official Closing Price in Rule 17a-7 Transactions
[20796]
January 22, 2007
TO: COMPLIANCE MEMBERS No. 3-07FIXED-INCOME ADVISORY COMMITTEE No. 1-07
SEC RULES MEMBERS No. 8-07 RE: SEC NO-ACTION LETTER ADDRESSES ADVISER DUTIES AND USE OF NASDAQ OFFICIAL CLOSING PRICE IN RULE 17A-7 TRANSACTIONS
The staff of the SEC’s Division of Investment Management recently issued no-action assurances to a fund group regarding the use of independent pricing service prices in transactions under Rule 17a-7 under the Investment Company Act of 1940. [1] The staff also provided “general guidance” concerning best execution and the duty of loyalty, as well as the use of the Nasdaq Official Closing Price, in the context of Rule 17a-7 transactions. The staff’s letter is summarized below.
Independent Pricing Services
Section 17(a) of the Investment Company Act prohibits an affiliated person of a registered investment company (“fund”), or any affiliated person of such person, from selling securities to, or purchasing securities from, the fund. Rule 17a-7 provides a conditional exemption from this prohibition for purchases and sales of securities between funds that are affiliated solely because they share a common adviser. Among the conditions are: (1) the transaction must involve securities for which market quotations are readily available; and (2) the transaction must be effected at the “independent current market price” of the security (defined as the average of the highest current independent bid and lowest independent offer determined on the basis of reasonable inquiry).
In an earlier letter, the staff provided no-action relief to allow certain affiliated funds to engage in Rule 17a-7 transactions involving municipal securities for which market quotations were not readily available. [2] Those funds proposed to use prices provided by an independent pricing service (Muller Data Corporation, now operating as FT Interactive Data, or FTID) that were the same as the prices to be used to determine the funds’ net asset values per share.
In the more recent letter, the staff clarified that its earlier no-action position would extend to the use of prices provided by independent pricing services other than FTID. The relief is conditioned on the requesting funds’ compliance with all of the representations in two earlier letters, [3] other than the identity of the pricing service.
Best Execution and the Duty of Loyalty
With respect to best execution, the letter advises that in a Rule 17a-7 transaction, an investment adviser should ensure that the selling fund’s total proceeds are the most favorable under the circumstances and that the buying fund’s total cost is the most favorable under the circumstances. If the adviser can obtain greater proceeds for the selling fund or more favorable total cost for the buying fund through a transaction in the market, it should do so instead of having the fund(s) engage in a Rule 17a-7 transaction.
The letter further states that consistent with the duty of loyalty, an adviser should not cause funds to enter into a Rule 17a-7 transaction unless doing so would be in the best interests of each participating fund.
Nasdaq Official Closing Price
The staff also expressed its view that use of the Nasdaq Official Closing Price (“NOCP”) “would be consistent with the policies underlying” Section 17(a) and Rule 17a-7 “because of the manner in which the NOCP is independently determined.” Therefore, the staff would not recommend enforcement action to the Commission if funds engaging in Rule 17a-7 transactions determine the current market price for an “NMS stock” (as defined in 17 CFR 242.600) by using the NOCP, rather than by using one of the methodologies listed in Rule 17a-7.
Frances M. Stadler
Deputy Senior Counsel
endnotes
[1] Federated Municipal Funds (pub. avail. November 20, 2006). The staff’s response and the incoming letter are available at http://www.sec.gov/divisions/investment/noaction/2006/fmf112006.htm.
[2] United Municipal Bond Fund (pub. avail. January 27, 1995). The relief in this letter was based on representations contained in the letter, as well as representations in United Municipal Bond Fund (pub. avail. July 30, 1992).
[3] See supra note 2.