Last December, the Securities and Exchange Commission proposed a new exemptive rule under the Investment Company Act of 1940. The proposed rule would allow mutual funds, exchange-traded funds (“ETFs”), closed-end funds, and companies that have elected to be treated as business development companies (“BDCs”) under the ICA to enter into derivatives transactions and financial commitment transactions notwithstanding the prohibitions and restrictions on the issuance of senior securities under section 18 of the ICA. Of course, the proposed exemption would be conditioned upon satisfying several conditions. The proposed text of the rule suffers from a number of disappointing drafting missteps.
What shall be done?
In numerous posts, I’ve railed against the use of “shall”. I am not alone in abjuring “shall”. The Federal Plain Language Guidelines state:
Besides being outdated, ‘shall’ is imprecise. It can indicate either an obligation or a prediction. Dropping ‘shall’ is a major step in making your document more user- friendly.
The proposed rule virtually invites confusion by using “shall” and “must” interchangeably. For example, proposed Rule 270.18f-4(a)(3)(ii)(C) begins by providing that “The fund shall designate . . .” and ends with “whose designation must . . .”.
Why define a term and then not use it?
The SEC also takes an inconsistent approach to defined terms. Proposed Rule 270.18f-4(c) is captioned “definitions” and it does in fact include a number of definitions. However, the proposed Rule uses “program” as a defined term but does not include the definition with the other definitions in proposed Rule 270.18f-4(c). To make matters more confusing, the proposed Rule sometimes uses the defined term “program” (e.g., in proposed Rule 270.18f-4(a)(3)(i)) while at other times uses “derivatives risk management program” (e.g., in proposed Rule 270.18f-4(a)(5)(iii)). Why create a defined term only to use it erratically?
Who’s the actor – the fund or the board?
At other times, the SEC seems to be make a pointless distinction between action by the fund and action by the fund’s board, as illustrated by the following examples:
Proposed Rule 270.18f-4(a)(3)(ii)(A): The fund shall obtain initial approval of the program, as well as any material change to the program, from the fund’s board of directors, including a majority of directors who are not interested persons of the fund.
Suggested improvement: The fund’s board of directors, including a majority of directors who are not interested persons of the fund, must approve the program and any material change to the program.
Proposed Rule 270.18f-4(a)(3)(ii)(C): The fund shall designate an employee or officer of the fund or the fund’s investment adviser (who may not be a portfolio manager of the fund) responsible for administering the policies and procedures incorporating the elements of paragraphs (a)(3)(i)(A) through (D) of this section, whose designation must be approved by the fund’s board of directors, including a majority of the directors who are not interested persons of the fund.
Suggested improvement: The fund’s board of directors, including a majority of the directors who are not interested persons of the fund, must designate an employee or officer of the fund or the fund’s investment adviser (who may not be a portfolio manager of the fund) as responsible for administering the policies and procedures incorporating the elements of paragraphs (a)(3)(i)(A) through (D) of this section.
Considered relevant by whom?
Finally, the proposed rule at other points appears to be pointlessly verbose and indefinite. For example, proposed Rule 270.18f-4(a)(3)(i)(A) would require a fund to have policies and procedures reasonably designed to assess risks associated with its derivatives transactions. However, the laundry list of specific risks ends with the entirely open-ended “any other risks considered relevant”. Considered relevant by whom – the fund, the fund’s board, the fund’s investment adviser, the SEC’s examination or enforcement staff?
Proposed Rule 270.18f-4(a)(3)(i)(A): Assess the risks associated with the fund’s derivatives transactions, including an evaluation of potential leverage, market, counterparty, liquidity, and operational risks, as applicable, and any other risks considered relevant.
Suggested improvement: Assess the applicable leverage, market, counterparty, liquidity, operational, and other material risks associated with the fund’s derivatives transactions.
