SEC Staff Grants No-Action Relief from Section 17(f) of the 1940 Act and Rule 17f-2 Thereunder with Respect to Self-Custody of Loan Interests

On January 13, 2021, the SEC staff (Staff) granted no-action relief pursuant to Section 17(f) of the 1940 Act and Rule 17f-2 thereunder with respect to certain funds (Funds) or their directors or officers if the Funds, each acting as self-custodian of its assets, maintain custody of loan interests pursuant to Rule 17f-2 in a certain manner and subject to certain conditions.

The no-action request (Request) indicated that the Funds invest in term or delayed draw corporate loans (Loans) that are originated, negotiated and structured by one or more financial institutions serving as primary lenders (Primary Lenders), and that the Primary Lenders may sell interests in the Loans (Loan Interests) to third parties, such as the Funds.  The Request further indicated that the Funds do not receive any securities certificate or other tangible evidence of ownership of the Loan Interest that could be custodied with their custodian or that, if endorsed and delivered to a subsequent purchaser, could be used by such purchaser to evidence its right to the Loan Interest; rather, the Loan Interests are reflected on records that are maintained on behalf of the borrower, typically by an administrative agent that administers Loans on behalf of the lending syndicate.  The Request also stated that the Funds’ practice has been to maintain the Loan Documents with the Funds’ custodian for safekeeping under a “sealed envelope safekeeping letter agreement,” but that in light of the volume of Loan transactions and the frequency of refinancings and paydowns, it has become highly burdensome to maintain copies of the Loan Documents with the Funds’ custodian, adding that custodians have become reluctant to safekeep paper documents like the Loan Documents, which may be subject to loss during natural disasters like Hurricane Sandy.

The Request proposed that the Funds cease providing the Loan Documents to their custodian for safekeeping and instead proposed compliance with a modified version of Rule 17f-2 under the 1940 Act (rule governing fund “self-custody”), under the theory that, by holding the documentation of Loan Interests on the Funds’ records, the Funds would effectively be engaging in self-custody of the Funds’ Loan Interests.  Rule 17f-2 contains vaulting, access, notification, and verification requirements, including a requirement that each Fund’s securities and similar investments deemed to be in the custody of the Fund be verified by an independent public accountant at least three times annually.  The Request stated that the requirements of Rule 17f-2 present obstacles to, and impose unnecessary burdens on, self-custody of assets that are truly uncertificated or that are not represented by traditional securities, such as Loan Interests. The Request further proposed that the Funds would be subject to certain representations and conditions described in the Request as a means of complying with the conditions of Rule 17f-2, including the implementation of certain internal controls and verification procedures consistent with prior SEC no-action relief involving uncertificated investments with respect to fund-of-fund investments.  The Request noted, among other things, that each Fund represents it is subject to an annual audit during which an independent public accountant confirms all of the Fund’s investments, including its investments in Loan Interests, and reconciles the Loan Interests to the Fund’s account records.

The Staff granted the requested relief, based on the facts and representations in the Request, particularly the representations that the Funds were complying with audit requirements.

The Staff no-action letter is available at https://www.sec.gov/investment/klgates-011321-rule17f.