SEC Issues No-Action Relief in Connection with the Purchase of an Investment Adviser

September 7, 2016

In a recent no-action letter, the staff of the Division of Investment Management of the Securities and Exchange Commission (the “Staff”) indicated that it would not recommend enforcement under Section 12(d)(3) of the Investment Company Act of 1940 (the “1940 Act”) against the AFL-CIO Housing Investment Trust (“HIT”), an open-end management investment company registered under the 1940 Act, if HIT organizes and acquires securities issued by a wholly owned and controlled subsidiary, organized as a limited liability company, that will operate as an investment adviser (the “Adviser Sub”), and will be registered under the Investment Advisers Act of 1940 (the “Advisers Act”).

HIT argued that the Staff should permit the proposed arrangement because it would not raise any of the concerns underlying Section 12(d)(3) of the 1940 Act, which generally prohibits registered investment companies from purchasing or acquiring securities issued by an investment adviser of an investment company or an investment adviser registered under the Advisers Act. HIT stated that, by enacting Section 12(d)(3), Congress intended to prevent investment companies from exposing their assets to the entrepreneurial risks of securities-related businesses and prevent potential conflicts of interest and situations in which financial intermediaries were in a position to dominate investment companies.

In turn, HIT proposed to organize the Adviser Sub as a limited liability company, which, it argued, would insulate HIT shareholders from exposure to any entrepreneurial risks. HIT also argued that its arrangement would mitigate the potential for conflicts of interest because HIT: (i) will remain internally managed and will not have an investment adviser within the meaning of section 2(a)(20) of the 1940 Act; (ii) will wholly own and control the Adviser Sub; and (iii) will only have persons acting in their capacities as directors, officers or employees of HIT provide advisory services to HIT.

Additional ongoing representations will require HIT to discuss the existence of the Adviser Sub and the provision by the Adviser Sub of outside advisory services as well as include an assessment of whatever risks, if any, are associated with the existence of the Adviser Sub and its provision of such services in each of its annual reports to shareholders; and to deem the assets, liabilities and indebtedness of the Adviser Sub as its own when assessing compliance with the asset coverage requirements under Section 18 of the 1940 Act. Further, the Adviser Sub may not make any proprietary investment that HIT would be prohibited from making directly under its investment objectives, policies and restrictions or under any applicable law. Lastly, the Board must review at least annually the investment advisory business of the Adviser Sub to determine whether such business should be continued and whether the benefits derived by HIT from the Adviser Sub’s business warrant the continued ownership of the Adviser Sub and, if appropriate, approve (by a vote of at least a majority of its directors who are not “interested persons” as defined in the 1940 Act) at least annually such continuation.

Click here to read the No-Action letter.


Investment Advisers