SEC Seeks Public Comment on Use of Derivatives by Mutual Funds and Other Investment Companies

August 31, 2011

The SEC is seeking comment on a wide range of issues raised by the use of derivatives by mutual funds and other investment companies regulated under the Investment Company Act of 1940 (1940 Act).  The SEC staff is considering issuing a “Concept Release” that would solicit public comment on funds’ use of derivatives and on the current regulatory regime under the 1940 Act as it applies to funds’ use of derivatives. The SEC would review the comments to the Concept Release and determine whether regulatory initiatives or guidance is needed in this area.

The Concept Release seeks information about how different types of funds use various types of derivatives, the benefits, risks and costs of using derivatives, and other information. Additionally, it asks for comment on several specific issues under the 1940 Act implicated by funds’ use of derivatives, such as:

  • Restrictions on Leverage – The 1940 Act restricts the manner in which, and the extent to which, funds may incur indebtedness and may leverage their portfolios. The Concept Release discusses the treatment of derivatives under these restrictions. The Concept Release asks, among other things, how best to measure the amount of leverage that a fund incurs when it invests in a derivative.
  • Fund Portfolio Diversification – The 1940 Act requires funds to disclose in their registration statements whether they are diversified or not. The 1940 Act prohibits a fund from changing its classification from diversified to non-diversified without shareholder approval. The Concept Release asks, among other things, how a fund should value a derivative to determine the percentage of the fund's assets that is invested in a particular company for diversification purposes.
  • Fund Investments in Certain Securities-Related Issuers– The 1940 Act generally prohibits funds from acquiring any security issued by, or any other interest in, the business of a broker, dealer, underwriter or investment adviser. However, funds that meet certain conditions may acquire some securities issued by companies engaged in such business. The Concept Release asks, among other things, how investing in a derivative issued by a broker-dealer may be different from, or similar to, investing in the broker-dealer's stock or bond.
  • Fund Portfolio Concentration – The 1940 Act requires funds to disclose their industry concentration policies in their registration statements. It prohibits funds from deviating from those policies without shareholder approval. The Concept Release asks, among other things, how funds determine the industry or industries to which they may be exposed through a derivative investment.
  • Valuation of Fund Assets – The 1940 Act specifies how funds must determine the value of their assets. The Concept Release asks, among other things, whether the SEC should issue guidance on how funds should value derivatives in their portfolios.

Commenters have 60 days to submit their comments in response to the Concept Release.

Please click here to access the Concept Release.


Exchange-Traded Funds (ETFs), Investment Companies, Regulatory