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U.S. Securities and Exchange Commission

Securities Lending
by
U.S. Open-End and Closed-End Investment Companies

Securities lending is a well-established practice by institutional investors such as U.S. open-end and closed-end investment companies (“funds”), insurance companies, pension plans, and college endowments. A fund whose investment objectives, policies, and restrictions permit it to engage in securities lending may lend out a portion of its portfolio securities to generate additional income.

Funds that engage in securities lending typically lend their portfolio securities to broker-dealers which, in turn, generally relend the securities to hedge funds and other market participants looking to implement various investment strategies. The securities loan is evidenced by a written agreement between the fund and the borrower, terminable by either party at will. To protect the fund from the risk of borrower default, the borrower posts collateral with the fund — typically cash, but U.S. Government securities and letters of credit are also possible — in an amount at least equal to the value of the borrowed securities, marked to market daily. When a fund lends its portfolio securities, the voting rights and the right to dividends and other distributions on the loaned securities transfer to the borrower until the loan is terminated and the securities are returned to the fund. While the loan is open, however, the borrower will remit back to the fund payments equal to such distributions. In addition, if fund management has knowledge of a material vote with respect to the loaned securities, fund directors should recall the loan in time to vote the proxies. When a loan is terminated, the fund must return the collateral to the borrower and the borrower must return the borrowed securities to the fund. The fund’s income from securities lending may come from fees paid to the fund by the borrowers and/or from the reinvestment of the cash collateral. Generally speaking, cash collateral reinvestment is limited to short-term, highly liquid instruments.

A fund that lends its securities typically employs a securities lending agent, which may be the fund’s custodian bank, to administer the lending program. The lending agent’s services, and the compensation that the fund pays to the lending agent, are subject to oversight by the fund’s investment adviser and directors. Funds typically compensate their lending agents with a share of the revenue generated by the lending program, and may pay lending agents an additional fee for managing the cash collateral reinvestment. Lending agents often indemnify funds against the risk that the borrower will fail to return the borrowed securities (to the extent that the value of the collateral is insufficient to replace the unreturned securities). Lending agents, however, typically do not indemnify funds for losses incurred in connection with cash collateral reinvestment.

Securities lending by funds implicates a number of provisions of the Investment Company Act of 1940 (the "1940 Act"). For example, the transfer of a fund’s portfolio securities to a borrower implicates section 17(f) of the 1940 Act, which generally requires that a fund’s portfolio securities be held by an eligible custodian. A fund’s obligation to return collateral at the termination of a loan implicates section 18 of the 1940 Act, which governs the extent to which a fund may incur indebtedness.

Notwithstanding these (and other) 1940 Act provisions, funds engage in securities lending, in large part in reliance on the following staff no-action letters,1 addressing the following areas:

Letters Areas Addressed
State Street Bank and Trust Company (pub. avail. Jan. 29, 1972)
  • Loan collateralization
  • Loan termination
  • Receipt of reasonable interest on loans
  • Receipt of dividends, interest, or other distributions on lent securities, and any increase in the market value on the lent securities
State Street Bank and Trust Company (pub. avail. Sept. 29, 1972)
  • Time within which borrowers must return securities upon loan termination
  • What satisfies the “reasonable interest” condition in the Jan. 29, 1972 State Street letter (immediately above), and cash collateral reinvestment
  • Investment segregation
  • Approval of fees paid
  • Proxy voting
  • Securities lending and a fund’s fundamental policies
Salomon Brothers (pub. avail. Sept. 29, 1972)
  • Staff repeated the “reasonable interest/cash collateral reinvestment” and “proxy voting” conditions contained in the Sept. 29, 1972 State Street letter (immediately above)
Norman F. Swanton Associates (pub. avail. Oct. 13, 1973)
  • Board’s fiduciary duty to invest the fund's assets in accordance with fund’s investment goals
  • Benefits must be commensurate with the risks
  • Approval of fees paid
Bernard S. Kanton (pub. avail. Oct. 13, 1973)
  • Same as Norman F. Swanton no-action letter (immediately above)
Standard Shares Inc. (pub. avail. Aug. 28, 1974)
  • Approval of fees paid
  • Directors’ fiduciary duty to act in the best interests of fund shareholders
Adams Express Company (pub. avail. Oct. 9, 1974)
  • Approval of fees paid
Mutual of Omaha Interest Shares (pub. avail. Oct. 9, 1974)
  • Same as 1974 Adams Express Company no-action letter (immediately above)
Salomon Brothers (pub. avail. May 4, 1975)
  • Loan collateralization
  • Compensation to the lending fund
  • Time within which borrowers must return securities upon loan termination
  • Delegation of authority to negotiate loans
  • Proxy voting
  • Obligation to return collateral may create a senior security, and limitation on amount that may be lent
Lionel D. Edie Capital Fund (pub. avail. May 15, 1975)
  • Loan collateralization
  • Compensation to the lending fund
Merrill Lynch Capital Fund (pub. avail. Mar. 9, 1978)
  • Loan collateralization
Adams Express Company (pub. avail. Oct. 20, 1979)
  • Loan collateralization
SIFE Trust Fund (pub. avail. Feb. 17, 1982)
  • Loan collateralization
  • Commingling of collateral
  • Compensation to the lending fund, including: receipt of dividends, interest, or other distributions on the lent securities; any increase in the market value of the lent securities; and earnings from reinvestment of cash collateral and limitations on any such reinvestment
  • Approval of fees paid
  • Board obligations in connection with the approval of the lending arrangement and any limitations thereon, and delegation of loan negotiation
  • Proxy voting
  • Limitation on amount that may be lent
The Adams Company (pub. avail. Nov. 26, 1982)
  • Loan collateralization
United States & Foreign Securities Corp. (pub. avail. Nov. 26, 1982)
  • Loan collateralization
  • Loan termination
  • Dividends and interest on loaned securities
  • Board approval and responsibility with respect to the loan agreement
Twentieth Century Investors (pub. avail. Nov. 26, 1982)
  • Loan collateralization
The Adams Express Company (pub. avail. Oct. 8, 1984)
  • Board obligation to determine who may borrow the fund’s securities and the propriety of any loan
  • Loan collateralization
  • Fund’s retention of power to prevent any loan from being made and to terminate loans
  • Receipt of dividends, interest, or other distributions on lent securities
  • Valuation of lent securities for purposes of loan collateralization
Norwest Bank Minnesota NA; Society National Bank (pub. avail. May 25, 1995)
  • Use of an affiliated lending agent under section 17(e)(1) and section 17(d) of the Investment Company Act
  • Limitation on discretion of lending agent (even if not affiliated) with respect to cash collateral investment, selection of borrowers, and negotiation of loan terms, and implication of section 15 of the Investment Company Act
  • Section 36 of the Investment Company Act and fiduciary duty of advisers with respect to any compensation paid to affiliated persons of the adviser
  • Approval of fees paid
Morgan Guaranty Trust Company of New York (pub. avail. Apr. 17, 1996)
  • Loan collateralization and return of securities that have been lent through the Euroclear Program
  • Proxy voting
Bear Stearns & Co. (pub. avail. Sept. 16, 1997)
  • Treatment of collateral received and securities lent for accounting and financial statement purposes
"Dear Chief Financial Officer" letter from Lawrence A. Friend, Chief Accountant, Division of Investment Management (pub. avail. Nov. 7, 1997) (staff guidance, but not a no-action letter)
  • Treatment of collateral received, and investments made with cash collateral, for accounting and financial statement purposes
  • Responsibility for losses incurred in connection with cash collateral reinvestment
The Brinson Funds (pub. avail. Nov. 25, 1997)
  • Limitation on amount that may be lent
The Chase Manhattan Bank (pub. avail. July 24, 2001)
  • Conditions applicable if affiliated funds co-invest cash collateral
Investment Company Institute (pub. avail. Dec. 14, 2005)
  • Clarification that the Chase Manhattan Bank no-action letter (immediately above) could apply if the lending agent was affiliated with the co-investing funds provided that the other conditions of the Chase letter are satisfied
Nuveen Investment Funds (pub. avail. Feb. 14, 2014)
  • Update to 1995 Norwest Bank no-action letter (described above) concerning the negotiation of the rebate rate as one of the loan terms and the use of an affiliated lending agent under section 17(e)(1) of the Investment Company Act.

1 To the extent that a fund seeks to lend its portfolio securities to affiliated borrowers, or to compensate an affiliated lending agent with a share of the lending program's revenues, exemptive relief from the Commission may be required. Also, certain cash reinvestment arrangements may need to comply with rule 12d1-1 under the Act.

This document has been prepared by the staff of the Division of Investment Management, and has not been subject to Commission review or approval. Funds should consult the actual authority set out herein, as well as any other applicable legal authority not included herein (both under the 1940 Act and under other laws).

 

http://www.sec.gov/divisions/investment/securities-lending-open-closed-end-investment-companies.htm


Modified: 02/27/2014