Can Mutual Funds Rely on the Recent T. Rowe Price No-Action Letter to Invest in Hedge Funds?
Hedge Fund Law Report
On October 7, 2009, T. Rowe Price Associates, Inc., a registered investment adviser to, primarily, registered investment companies (i.e., mutual funds), received a no-action letter (NAL) from the SEC. The NAL stated that the SEC would not take enforcement action under Section 17(a) or 17(c) of the Investment Company Act of 1940, as amended (the 1940 Act), or Rule 17d-1 thereunder, against T. Rowe Price, the T. Rowe Price Funds (Price Funds) or certain accounts managed by T. Rowe Price (Accounts) if: (1) T. Rowe Price caused certain mutual funds that it advises to contribute cash or securities to a newly created private fund (that is, a fund excepted from the definition of “investment company” under either Section 3(c)(1) or 3(c)(7) of the 1940 Act); (2) the private fund in turn used the cash or securities as collateral for a loan under the U.S. Treasury Department’s Term Asset-Backed Securities Loan Facility (TALF); and (3) the private fund used its own assets and the TALF loan to purchase eligible securities (including various asset-backed securities). T. Rowe Price sought no-action relief with respect to this arrangement for two reasons. First, it perceived an interesting and comparatively low-risk investment opportunity in asset-backed securities purchased in part with TALF loan proceeds. Second, none of its mutual funds individually had or could acquire eligible securities (as defined by the TALF) with a value sufficient to collateralize a TALF loan (such loans have a minimum denomination of $10 million), but collectively the mutual funds had or could acquire a sufficient value of eligible securities. For hedge fund managers, the T. Rowe Price NAL is potentially quite interesting because, at a certain level of generality, it offers no-action relief to a registered investment adviser seeking to cause its advised mutual funds to invest in a private fund. However, the language of the NAL and the fact pattern with respect to which the SEC granted no-action relief may be too specific to have any viable precedential value for mutual fund managers considering investing in hedge funds. In light of the importance of any authority even suggesting the possibility that mutual funds may surmount the various obstacles traditionally understood to stand in the way of investments in hedge funds, this article examines: the mechanics of the TALF program; the structure of the proposed investment outlined by T. Rowe Price in its incoming letter; the legal issues raised by the proposed structure; the primary obstacles faced by mutual funds contemplating investments in hedge funds, including valuation and affiliated transaction issues; and the likely impact of the NAL on the mutual fund and hedge fund industries, and the interaction between the two industries.