At Wednesday's Open Meeting, the SEC voted unanimously to seek public 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.  Based on input from the public, SEC Commissioners will decide whether regulatory initiatives or guidance is needed.  Public comments are requested on or before 10/31/11. FACT SHEET. Investment companies - mutual funds, ETFs, closed-end funds play a significant role in the U.S. economy and world financial markets - e.g., at the end of 2010, RICs held more than $13.1 trillion in assets and more than 40% of all U.S. households owned their shares. The extent to which they use derivatives, has been consider by the SEC and its staff on a case by case basis.  Of course, the use of derivatives was not anticipated when the Codes were written in 1940.  In March 2010, the SEC announced that the staff had initiated a broad review to evaluate the use of derivatives by funds to determine whether and what additional protection might be necessary under the Investment Company Act: http://www.sec.gov/news/press/2010/2010-45.htm. Purpose of the Concept Release. To better inform its review, the staff is recommending that the Commission issue a Concept Release to solicit public comment on funds’ use of derivatives and on the current regulatory regime under the Investment Company Act as it applies to funds’ use of derivatives.  The Commission would use the comments to help determine whether regulatory initiatives or guidance is needed that would continue to protect investors and fulfill the purposes underlying the Investment Company Act. What's Being Asked? It asks for information on how different types of funds use various types of derivatives as well as the benefits, risks and costs of using derivatives, among other things.  Additionally, it asks for comment on several specific issues under the Investment Company Act implicated by funds’ use of derivatives, such as:

• Restrictions on Leverage – The Investment Company Act ("ICA of '40)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 to measure the amount of leverage that a fund incurs when it invests in a derivative.
• Fund Portfolio Diversification – The ICA of '40 requires the portfolios of funds to be diversified, but does require them to disclose in their registration statements whether they are diversified or not.  The Act also 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's invested in a particular company for diversification purposes.

For further details, go to:  [SEC PR 11-175, 8/31/11].