February 1, 2002
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549
Attn: Jonathan G. Katz, Secretary
Re: Concept Release: Actively Managed Exchange-Traded Funds
Release No. IC-25258; File No. S7-20-01
Ladies and Gentlemen:
We submit this letter in response to a request for comment by the Securities and Exchange Commission (the "Commission") on various issues relating to actively managed exchange-traded funds ("ETFs").1 We commend the Commission for raising the issues posed by actively managed ETFs, and we appreciate the opportunity to comment on the matters raised in the concept release (the "Release").
These comments have been prepared by members of the Subcommittee on Investment Companies and Investment Advisers, Section of Business Law of the American Bar Association (the "Subcommittee"). A draft of this letter was circulated for comment among members of the Subcommittee and the Chairs and Vice-Chairs of the other subcommittees and task forces of the Committee on Federal Regulation of Securities (the "Committee"), the officers of the Committee, the members of the Committee's Advisory Committee and the officers of the Section. This letter generally represents the views of those who have reviewed it but does not necessarily represent the official position of the American Bar Association, the Section or the Committee. References to the Subcommittee include other members who have commented on the Subcommittee's draft. Various members of our Subcommittee represent ETFs and/or their sponsors, investment companies, investment advisers, broker-dealers, and others who might purchase or sell shares of actively managed ETFs, some of whom may have interests in the matters raised in the Release. However, in preparing this comment letter we have endeavored to avoid reflecting the interests of any individual client or any particular group.
The Release raises many issues and asks many questions that are technical or economic in nature and better addressed by those with more operational or economic expertise. We have limited our comments to those legal and policy issues when we believe our views will focus and advance reasoned discussion of actively managed ETFs and their implementation, where appropriate, into practice. Accordingly, we have set forth below our comments on these five issues:
The appropriate process for considering relief for actively managed ETFs;
The appropriate regulation of portfolio transparency;
Potential discrimination between holders of creation units and of shares;
Non-pro rata in-kind redemptions to affiliates; and
Conflicts of interest arising from fund or adviser arbitrage operations.
At the open meeting on November 7, 2001 at which the Commission approved the Release, Chairman Harvey Pitt noted that there are currently pending exemptive applications for actively managed ETFs and instructed the Staff to process these applications independently of the administrative process that the Release was initiating. This two-track process would permit the Commission to address these applications in a timely manner while the Staff considers the comments received in response to the Release and formulates appropriate policies.2
We agree with the Commission's approach. The Release will permit a wide range of constituencies to provide different perspectives that will assist the Commission in making the determinations required to grant any necessary relief, by exemptive order or through rulemaking.3 The issues that actively managed ETFs raise may have far-reaching implications, and any relief granted could have broad effects on investor protections and the investment company industry. The Release affords all interested parties an opportunity for public comment and debate about these issues and, thus, should provide the Commission with further knowledge on which to base its policies. At the same time, by granting exemptive relief to appropriate applicants in limited circumstances, the Commission and the public will gain the experience that derives only from observing and administering actual programs.4 There is tremendous interest in actively managed ETFs,5 and the two-track process will permit the Commission to proceed both expeditiously and with a wide base of information and experience.
In addition to this two-track process, we encourage the Commission to consider formulating a rule to codify the exemptive relief currently granted to passively managed ETFs. We believe that the Commission has grown comfortable with the regulatory issues presented by passively managed ETFs and that exemptive relief for passively managed ETFs has now become routine enough to warrant relief via a rule rather than case-by-case consideration.6 Codification of the relief granted to passively managed ETFs would likely be more efficient and promote further creation and growth of passively managed ETFs by minimizing the costs associated with the uncertainty of proceeding with exemptive relief on a case-by-case basis.7 In addition, the comments elicited through the Release may also assist the Commission in formulating a rule proposal to codify the exemptive relief currently granted to passively managed ETFs.
Transparency of an ETF's Portfolio
As the Release notes, the high degree of transparency of index-based ETFs' portfolios helps minimize the probability that their shares will trade at a large premium or discount to their net asset value ("NAV") by facilitating the arbitrage mechanism: potential arbitrageurs know the contents of an ETF's redemption basket and can calculate with some certainty the extent of any profits from arbitrage operations. As an ETF's portfolio becomes less transparent, the arbitrage mechanism becomes more costly because potential arbitrageurs have greater difficulty in determining potential profits and stepping into the market to purchase or redeem creation units carries greater risks. The result may be a higher likelihood of significant deviations between the market price and the NAV of an ETF's shares.
There are reasons why the directors and sponsors of an actively managed ETF might want its portfolio to be less transparent than that of an index-based ETF. The ETF or its sponsor might consider the contents of the portfolio to be proprietary information and might not want competitors or other investors to "free ride" on the effort and expense put forth in developing the portfolio. Greater transparency increases the risk that speculators will "front run" the ETF's transactions in relatively less liquid securities, thereby driving up the ETF's transaction costs.
There is also a strong reason why the directors and sponsors of an actively managed ETF would want its portfolio to be transparent: they might be concerned that, in the absence of such transparency, the arbitrage mechanism would be more costly and that the fund's shares might trade at a discount or premium. An ETF with a history of and reputation for discounts or premiums might be at a competitive disadvantage in the financial marketplace, and the sponsors might conclude that the portfolio must be transparent for the sponsors' relationship with the ETF to return a profit. The directors might conclude that it was in the best interest of the ETF or its shareholders to minimize the risks of discounts or premiums. The directors and sponsors also might conclude that market and shareholder protection imperatives outweighed risks of free-riding and front-running, for instance when an ETF did not employ an unconventional management approach or invested primarily in more liquid stocks.
We believe that the Commission should not mandate the level of transparency in ETFs' portfolios, but rather should allow fully informed demand in the financial markets to determine the proper levels.8 Different segments of the market with different needs might demand investment vehicles with different variations. To prevent market demand from determining the structure of investment vehicles would retard efficiency, competition, and capital formation. Without regard to regulatory restrictions, an actively managed ETF's directors and sponsors could consider adopting a number of mechanisms other than daily or real-time portfolio disclosure that would facilitate the arbitrage mechanism and thus help minimize the probability that the ETF's shares would trade at a large premium or discount to their NAV. Such mechanisms, for example, might include frequent dissemination of an ETF's NAV to the market during the day, the identification of the baskets of securities that will be used to satisfy redemptions of creation units, or disclosure of statistical data concerning the correlation of the portfolio to a specified index. They might also include the disclosure of certain characteristics of the underlying securities in the ETF's portfolio, such as average price-to-earnings ratios, position sizes, range of market capitalization, and the weightings in particular industries or sectors. We submit that determination of the most appropriate mechanism is best left to the ETF's directors and sponsors and encourage the Commission to consider granting relief that would allow and enable these alternative mechanisms.9
We note that current law does not require closed-end funds to disclose their portfolios more frequently than semi-annually,10 and the market does not seem to demand more frequent disclosure. Although the shares of many closed-end funds do trade at significant discounts to NAV, many investors seem to have concluded that the risks of such discounts are outweighed by the benefits of investing in the funds (for instance, because of the opportunities they afford to invest in illiquid securities through a diversified, pooled vehicle). Similarly, some ETF investors might conclude that the increased risks of discounts (relative to index-based ETFs) resulting from decreased portfolio transparency are outweighed by the benefits from reduced free-riding or front-running. The appeal of such an ETF might be that its trade-offs represented a middle ground between those of mutual funds - which are redeemable at NAV but invest primarily in liquid securities - and closed-end funds - which can invest more fully in illiquid securities but present the risk of discounts. Because we cannot predict demand for such investment opportunities, we strongly encourage the Commission to let the marketplace decide the matter.
The marketplace will function fairly and efficiently and investors will be properly protected only if ETFs with less transparent portfolios fully and fairly disclose the risks that decreased transparency presents.11 In this area, the Commission may wish to consider taking several steps. First, the Commission might condition relief for less transparent portfolios upon clear and prominent disclosure in an ETF's prospectus, product description and web site setting forth the greater risks of discounts. The Commission might also create a procedure under which such ETFs' product descriptions are filed with, and reviewed by, the Commission or National Association of Securities Dealers, Inc. staff to ensure adequate disclosure of risks and the manager's qualifications and strategies.12
Potential Discrimination Among Shareholders
A form of shareholder discrimination is built into the structure of all ETFs: shareholders with sufficient financial resources can aggregate and redeem creation units and can form portfolio deposits and purchase creation units. Shareholders without these resources do not have direct access to redeem or purchase shares but instead must rely upon the secondary market. This discrimination is, of course, intentional and designed to solve a particular problem - how to reduce redemptions and associated portfolio management costs to the fund while still leaving enough of a redemption mechanism to discipline share prices in the secondary market. In normal markets, the risks posed by this arrangement appear attenuated. However, in volatile markets, shareholders with greater financial resources may be able to gain an advantage over smaller shareholders. During a sharp market downturn, larger shareholders might be able to quickly aggregate a creation unit (perhaps by borrowing shares), redeem it for a redemption basket of portfolio securities, and sell those securities into the declining market, thereby realizing profits or minimizing losses not available to smaller shareholders. Conversely, in a rapidly surging market, a larger shareholder might be able to form a portfolio deposit quickly, use it to purchase a creation unit, and thereby acquire a block of fund shares at cheaper prices than those available to smaller investors in the secondary market. These are issues posed by all ETFs, but it could be argued that active management would accentuate them: actively managed ETFs would likely hold more volatile securities than index-based ETFs.
As the Release indicates, Section 1(b)(3) of the 1940 Act states that the public interest and the interest of investors are adversely affected when investment companies issue securities containing inequitable or discriminatory provisions. We note that the Commission, in granting exemptive relief to existing ETFs, has evidently already concluded that, at least in some circumstances, the potentially discriminatory structure of ETFs is warranted by the potential benefits that they provide investors. Accordingly, the question posed by Section 1(b)(3) to actively managed ETFs should focus on a similar benefit-cost test.
Although there are clearly differences between creation units and individual shares traded in the secondary market, we believe that those differences do not present the type of discrimination to which Section 1(b)(3) refers. The only differences are the purchase and redemption rights of creation units, which would, absent regulatory relief, be prohibited by Section 22 of the 1940 Act and rules thereunder. We encourage the Commission to interpret Section 1(b)(3) in light of the purposes of Sections 22 and 23, which (along with the rules thereunder) were designed to prevent "riskless trading by insiders and the resulting dilution of fund assets."13 Board oversight could assure that creation unit holders would not be advantaged over individual shareholders through their knowledge of the composition of the basket of portfolio securities. In any event, the purchases and redemptions of creation unit holders are effected at NAV based on "forward pricing," thereby avoiding the abuses of "backward pricing" that led to the enactment of Section 22 and the adoption of Rule 22c-1. In the absence of evidence that insiders gain an advantage at the expense of other shareholders because of the purchase and redemption rights of holders of creation units, we do not believe that ETFs raise any Section 1(b)(3) discrimination issues. Nonetheless, we encourage the Commission to study closely the behavior of arbitrageurs and other large investors purchasing or redeeming creation units of existing ETFs during recent periods of market volatility to determine whether these investors were able to take advantage of their prior access to ETF assets and whether any such advantage came at the expense (through dilution or otherwise) of other ETF shareholders.
Similarly, some have pointed out that the structure of ETFs, actively managed or otherwise, implicates Section 18(f) of the 1940 Act. One can argue that the differences between creation units and individual shares create a senior security under Section 18(g), because a class of shareholders will have priority as to distribution of the assets of the fund. Section 18(f) would prohibit the fund from issuing such a senior security.14 As a preliminary matter, we note that creation units do not form a separate class of securities because they are simply aggregations of the individual shares which can be unbundled and re-aggregated. Rather, they are analogous to a "round lot" of shares. More importantly, we do not believe that ETFs implicate either Section 18(f) or its underlying policy purposes - preventing investment companies from creating unfair and/or opaque capital structures. Indeed, the creation unit structure is designed to be fair to all investors by helping to minimize deviations from NAV and by preventing possible dilution resulting from the transaction costs incurred when purchasers or redeemers of creation units enter or exit an ETF. The fees15 are imposed on such investors to defray the costs associated with underlying portfolio transactions, thereby shifting such costs from the ETF (hence all ongoing shareholders) to those investors actually responsible for causing the portfolio to expand or contract. Any opacity in the structure can be explained, as it currently is, through adequate disclosure. If the Commission nevertheless concludes that actively managed ETFs implicate Section 18(f), we encourage the Commission to take the approach it took in Rule 18f-3 - reliance on the fund's board of directors to assure that the structure does not result in one class of shares subsidizing the others.
Relief for In-Kind Transactions between an ETF and Certain Affiliates
One of the primary advantages to investing in ETFs is that they can be highly tax-efficient investment vehicles. One technique that ETFs use to achieve tax efficiency is that, when redeeming creation units, the fund gives the redeemer the stock with the lowest cost-basis. As a result, the fund holds higher cost-basis stock, reducing the amount of capital gains realized when it sells portfolio stock.16 Because the portfolios of current ETFs mirror or approximate an index, so do their redemption baskets, and this limits the tax advantages that can be achieved from this technique: even when a disproportionate amount of a portfolio's relatively low cost-basis stock is in a particular holding, the ETF cannot distribute a disproportionate amount of this stock to a redeemer in order to minimize the capital gains that might be realized later. However, the investment objectives and policies of an actively managed ETF would not necessarily impose this restriction. There might be circumstances where a distribution that did not represent the fund's portfolio pro rata would be both tax-advantageous and in accord with the fund's investment objectives and policies.
However, when an ETF does not have enough outstanding shares to form more than twenty creation units, any person attempting to redeem a creation unit would be an affiliate. As the Release points out, the orders permitting current ETFs to operate grant relief from Section 17(a) of the 1940 Act to the extent necessary to permit such 5% affiliates to redeem creation units. The rationales for providing exemptive relief are that the redemption basket (1) will be the same in most circumstances regardless of the redeemer's identity and (2) will be valued under the same standards applied in valuing the ETF's portfolio securities. Therefore, in-kind redemptions afford no opportunity for an affiliated person to effect a transaction detrimental to the fund's other shareholders. However, the first rationale would not necessarily apply to an actively managed ETF that sought, for tax or other reasons, to redeem an affiliate with a basket that was not pro rata. The fund's adviser, it could be argued, might tailor the redemption basket so that certain affiliates might receive shares that it believed were undervalued by the market ("cherry picking"). Or, the adviser might include disproportionately in the basket securities in which an affiliate of the adviser had a short position.
Nonetheless, we believe that the Commission should consider granting actively managed ETFs relief from Section 17 to the extent necessary to permit such redemptions. The benefits to shareholders in the form of potentially more tax-efficient management could, for some funds, outweigh the potential risks posed by such redemptions, thus their directors should have the option to permit them where appropriate. The risks discussed above could be addressed through conditions similar to those in the Signature Financial letter, in which the Staff took the position that traditional open-end investment companies seeking to effect in-kind redemptions that are not pro rata to fund affiliates were not required to file exemptive applications under Section 17(b) of the 1940 Act.17 In particular, the Signature Financial letter mandated these conditions: (1) that there be appropriate board oversight, (2) that distributed securities be valued in the same way as for pricing purposes, and (3) that no party with the financial incentive to influence the selection of redeemed securities actually select these securities or influence their selection.18 Board oversight would inhibit overreaching by fund managers. Pricing at NAV and disinterestedness in selection would minimize "cherry picking" and manipulation.
Potential Conflicts of Interest for an ETF's Investment Adviser and Board
To the extent that the portfolios of actively managed ETFs are less transparent than those of currently existing passively managed ETFs, arbitrageurs may be less willing to form and redeem creation units, the arbitrage mechanism becomes more costly, and the fund's shares may trade at greater discounts from NAV. Thus, ETF boards may be faced with the same types of issues that boards of closed-end funds face when confronted with discounts. It is likely that the board of an ETF that is trading at a discount will consider whether discounts are in the best interests of the fund's shareholders.19 The board might conclude that the fund itself, or the fund's adviser, in order to attempt to narrow the discount, should step into the market to purchase fund shares, aggregate them into creation units, and redeem them for a redemption basket of portfolio securities.20 The fund or the adviser (or an affiliate) may be the only parties willing to engage in arbitrage, perhaps because they are the only parties with enough knowledge of the fund's portfolio to conclude that arbitrage would be profitable.
However, such operations could present conflicts of interest and could violate Section 17 of the 1940 Act. If the fund were to conduct arbitrage operations, the board would have to balance the interests of the shareholders selling in the arbitrage operations with those remaining after the operation is complete. These interests might, under some circumstances, conflict. The fund would have to use uninvested cash, borrow funds (to the extent permitted under Section 18), or sell portfolio securities to gain the resources to purchase fund shares, and these choices might have unfavorable tax consequences for, or impose additional costs on, the remaining shareholders.
Arbitrage operations by the adviser may also present conflicts of interest or run afoul of the prohibitions of Section 17 and may raise a variety of other issues. Because of its closer knowledge of the fund's portfolio, the adviser may have better information than shareholders to ground a belief that the market is undervaluing some or all of the fund's portfolio securities, and it could use arbitrage operations as a means to acquire these at prices lower than those available in the market. The adviser might designate a redemption basket that did not represent the fund's portfolio pro rata and use arbitrage operations to obtain some securities that it believed were particularly undervalued. Or, even if the redemption basket were a pro rata representation, it might still find it advantageous to use its better information by forming and redeeming a creation unit under the rationale that it was engaging in arbitrage operations.
Nonetheless, we believe that the benefits to be gained from fund and/or adviser arbitrage operations in the form of narrowed discounts will, under some circumstances, outweigh the potential costs from these conflicts of interest. We also believe that an ETF's board of directors is in the best position to conduct the benefit-cost analysis on a contextual basis and to address and resolve the risks posed by the potential conflicts noted above. An actively managed ETF's portfolio and the relevant market conditions would be too complex and difficult to predict in advance for the Commission to construct a suitable rule-based regulatory regime. Narrowly circumscribed rules or conditions, such as a requirement that in-kind redemptions represent a pro rata basket of portfolio securities, could limit the operational flexibility of the board unnecessarily. For instance, there may be circumstances under which a non-pro rata redemption basket was in fund shareholders' best interests (perhaps for tax reasons, as set forth above).
Accordingly, we believe that the Commission should consider granting relief from Section 17 to the extent necessary for actively managed ETFs and for their advisers to engage in arbitrage operations, on the condition that such operations be approved and reviewed by the board and conducted under procedures adopted by the board.21 We also believe that it would be useful to clarify that the board of directors has wide latitude to consider measures to address discounts. This approach would be consistent with the Staff's no-action position in the Signature Financial letter.22 The primary conditions to the relief in this letter entail board oversight and notably do not include any requirement that the redemption basket be a pro rata representation of the fund's portfolio securities.23 We believe that appropriate board oversight would be sufficient to address and resolve the resulting conflicts of interest.
The Subcommittee respectfully requests that the Commission consider the recommendations set forth above. We are prepared to meet and discuss these matters with the Commission and the Staff and to respond to any questions.
Chair, Committee on Federal Regulation of Securities
Diane E. Ambler
Chair, Subcommittee on Investment Companies
and Investment Advisers
Jay G. Baris
Vice-Chair, Subcommittee on Investment Companies and Investment Advisers
Diane E. Ambler
Jay G. Baris
Kenneth J. Berman
Martin E. Lybecker
Kathleen M. Moriarty
Mark D. Perlow
Francine J. Rosenberger
cc: The Honorable Chairman Harvey L. Pitt
Commissioner Cynthia A. Glassman
Commissioner Isaac C. Hunt, Jr.
Paul F. Roye, Director, Division of Investment Management
|1||Release No. IC-25258 (Nov. 8, 2001).|
|2||We note that the Commission has adopted a similar two-track process in another context. The Commission recently, in considering issues raised by the registration of non-U.S. public-utility holding companies, solicited comments on certain novel issues while addressing relevant applications seeking approval of acquisitions by such companies of U.S. public utility companies on a case-by-case basis. Registered Public-Utility Holding Companies and Internationalization, Release No. 35-27110 (Dec. 14, 1999).|
|3||Section 6(c) of the Investment Company Act of 1940 (the "1940 Act") grants the Commission the authority to exempt persons, securities or transactions from any or all provisions of the 1940 Act. The Commission can grant exemptions on a case-by-case basis upon application by the parties involved or they can be promulgated in rules of general application. In each instance, the Commission can grant relief "if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions" of the Act. Section 2(c) of the Act mandates that, in connection with proposed rulemaking, the Commission must consider not only the public interest and the protection of investors, but also "whether the action will promote efficiency, competition and capital formation."|
|4||Certain of our members have noted the benefits and experience to be gained by the Commission and the industry in conducting a pilot program for actively managed ETFs.|
|5||The concept of ETFs, both actively managed and index based, is attracting much attention. The Staff has stated that trading in index-based ETF shares reportedly has accounted for as much as two-thirds of the daily volume on the American Stock Exchange. The director of the Division of Investment Management has noted that "during the 4th quarter of 2000, the $26.8 billion that flowed into ETFs nearly equaled the $29.6 billion that went into mutual funds." Paul F. Roye, Director, Division of Investment Management, SEC, Remarks before the American Law Institute/American Bar Association Investment Company Regulation and Compliance Conference (June 14, 2001).|
|6||Mr. Roye has stated that the exemptive relief provided to passively managed ETFs is now standard. In fact, he noted that the Commission has even granted prospective relief to the iShares Trust, permitting the Trust to list new ETFs without having to seek further exemptive relief from the Commission. Paul F. Roye, Director, Division of Investment Management, SEC, Remarks before the American Stock Exchange Symposium on Exchange-Traded Funds (Jan. 14, 2002).|
|7||It is our understanding that pending exemptive applications request relief for "enhanced-index" ETFs. We believe that relief for enhanced-index funds should also be included in any proposed rule. Enhanced-index fund management represents an incremental step along the spectrum from passive to active management, and the issues posed by enhanced-index ETFs can be resolved largely in reliance on the precedents set by current index-based ETFs.|
|8||We note that the rationale for greater transparency of ETF portfolios does not carry over to the portfolios of other types of investment companies.|
|9||Certain of our members have stated the view that, on balance, there are no compelling policy reasons to permit actively managed ETFs to be less transparent than passively managed ETFs.|
|10||See Section 30(e) of the 1940 Act and Rule 30e-1 thereunder.|
|11||There are certain of our members who believe that mere disclosure of the potential for an opaque fund to trade at a substantial discount or premium to NAV is not sufficient for investors to assess such risks appropriately.|
|12||Current ETFs operate under relief from the prospectus delivery requirements of Securities Act Section 5 on the condition that a purchaser's broker provide them with a brief sponsor-authored product description.|
|13||See Protecting Investors: A Half Century of Investment Company Regulation, Division of Investment Management, SEC, 300 (discussing Section 22), 425 (discussing Section 23(b)) (1992).|
|14||See David Silver, The Investment Company Act of 1940: At the Frontiers (Nov. 2001) (unpublished manuscript presented at SEC Historical Society Major Issues Conference: Securities Regulation in the Global Internet Economy, on file with Kirkpatrick & Lockhart LLP).|
|15||See, e.g., the brief description of the "Transaction Fees" charged to investors purchasing or redeeming iShares in creation units. In the Matter of Barclays Global Fund Advisors, Release No. IC-24393 (Apr. 17, 2000).|
|16||See Jim Wiandt, How ETFs Manage a Tax-Efficiency Edge over Traditional Mutual Funds, at http://www.indexfunds.com/articles/20010928_etftax_adv_etf_JW.htm (last visited Nov. 12, 2001).|
|17||Signature Financial Group, Inc. (pub. avail. Dec. 28, 1999). (Staff would not recommend enforcement action under Section 17(a) of the 1940 Act if, under certain conditions, a registered open-end investment company satisfies a redemption request from an affiliated person by means of an in-kind distribution of portfolio securities.) The Staff declined to confirm that an in-kind distribution of portfolio securities to an affiliated person does not constitute a "purchase" or "sale" for purposes of Section 17(a) of the 1940 Act. Indeed, the Staff stated that Section 17(a) is triggered by redemptions in kind to affiliated shareholders because such transactions involve both fund shares and fund portfolio securities. We encourage the Staff to reconsider this position. We assert that such transactions are not impermissible "purchases" or "sales" under Section 17(a). In addition, we believe that Section 22 and the provisions of the 1940 Act that govern valuation provide ample protections against potential abuses involved in the satisfaction of a redemption request by an affiliated persons, e.g., "cherry picking."|
|18||The other conditions are that (i) the redemption be at approximately the affiliated shareholder's proportionate share of net assets, (ii) the redemption be consistent with the fund's disclosed policies, and (iii) the fund maintain records of the redemption in accordance with recordkeeping requirements of the 1940 Act.|
|19||We note that there is little case law to suggest that fund directors have a fiduciary duty under applicable state law to address such discounts. See, e.g., Weiner & Hanks, Directors' Duties and the Discount, The Investment Lawyer (May 2001).|
|20||See Silver, above n.14.|
|21||Such procedures might, for example, include a regime of escalating board involvement as the discount reached certain thresholds, such as those adopted by many money market funds under Rule 2a-7.|
|22||See above n.17.|
|23||As noted above, the other conditions are that (i) the redemption be at approximately the affiliated shareholder's proportionate share of net assets, (ii) the distributed securities be valued in the same way as for pricing purposes, (iii) the redemption be consistent with the fund's disclosed policies, (iv) no party with the financial incentive to influence the selection of redeemed securities shall select these securities or influence their selection, and (v) the fund maintain records of the redemption in accordance with recordkeeping requirements of the 1940 Act. Condition (iv), to the extent that it would prohibit the adviser from participating in arbitrage operations, would be inconsistent with the relief we advocate here, and thus we believe that it should not be imposed where there is adequate board oversight to resolve any potential conflicts of interest.|