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SEC Issues Guidance on Director Oversight of Affiliated Transactions

On November 2,  the SEC issued a letter to the Mutual Fund Directors Forum and the Investment Company Institute's Independent Ddirectors Council addressing how boards oversee and review certain transactions between a fund and its advisor (or other affiliates), that have the potential to create a conflict of interest. The three 1940 Act rules addressed in the letter permit funds to enter into transactions with the adviser or other fund affiliates without seeking prior permission from the Commission. These rules permit funds to:

• purchase securities where a fund affiliate is a participant in the underwriting syndicate (Rule 10f-3);
• engage in securities transactions with other funds with which they are affiliated (Rule 17a-7); and
• pay a brokerage commission to an affiliated broker on agency transactions (Rule 17e-1).

As a general matter, the SEC's rules require boards to determine, at least quarterly, that all transactions subject to these rules were effected in compliance with appropriate procedures determined by a fund's board.

The SEC stated in their letter that they had determined that some fund boards delegate their responsibility to make the determinations required under these rules, particularly in light of the adoption by the Commission in 2003 of Rule 38a-1 under the Act  (the compliance rule).   The SEC's letter makes clear that the Commission's staff interprets rules 10f-3, 17a-7 and 17e-1 as not permitting a fund board's determinations under each of these rules to be delegated.

While the Commission's staff is expilicit that boards may not delegate their oversight responsibilities, it does state that fund boards may rely on quarterly summary reports in making this determination and need not review each transaction individually. However, because fund boards retain ultimate responsibility for making the required determinations, the letter urges directors to be "appropriately diligent" when relying on others to be sure they have sufficient information to be alerted to issues raised by these transactions.

This guidance has been issued in connection with outgoing Division Director Andrew Donohue's review of fund director duties, and the letter asks the Forum to share this interpretative guidance with its members.

The full text of the November 2, 2010 letter is available at: