Derivatives and Mutual Funds – What Do You Think?

The Securities and Exchange Commission (SEC) wants to know what you think about the use of derivatives by mutual funds.

Last week, the SEC voted unanimously to seek public comment on what it termed “a wide range of issues raised by the use of derivatives by mutual funds and other investment companies regulated under the Investment Company Act.”

The SEC is seeking that input through a concept release, which is a Commission-approved document that poses an idea or ideas to the public to get their views. According to the announcement, the SEC will use the comments received in response to this concept release 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.”

“The derivatives markets have undergone significant changes in recent years, and the Commission is taking this opportunity to seek public comment and ensure that our regulatory approach and interpretations under the Investment Company Act remain current, relevant, and consistent with investor protection,” said SEC Chairman Mary L. Schapiro.

The SEC notes that when the Investment Company Act was enacted in 1940, it did not contemplate funds investing in derivatives as they may do today. “Indeed, the use and complexity of derivatives have grown significantly over the past two decades,” it acknowledged in a fact sheet.


The Concept Release 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.  The SEC fact sheet identified those issues as:

Restrictions on Leverage – The Investment Company 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 to measure the amount of leverage that a fund incurs when it invests in a derivative.

Fund Portfolio Diversification – The Investment Company Act does not require 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.

Fund Investments in Certain Securities-Related Issuers – The Investment Company 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 Investment Company Act does not prohibit funds from concentrating their investments in a particular industry, but does require funds to disclose their industry concentration policies in their registration statements. It also 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 Investment Company Act specifies how funds must determine the value of their assets. The Concept Release asks, among other things, whether the Commission should issue guidance on how funds should value derivatives in their portfolios.

The Concept Release will be published in the Federal Register and commenters will have 60 days from the date of publication to submit their comments.

You can submit comments HERE .