Sunday, May 4, 2008

Access to US Market for Foreign Mutual Funds

In 1998, it was estimated that over 14% (or $980 billion) of U.S. mutual fund assets are managed by foreign advisers or their U.S. affiliates. Certainly, foreign advisers have been able to make significant inroads in the U.S. market, but there are certain barriers.

Section 7(d) of the Investment Company Act
Section 7(d) has prevented foreign advisers from directly offering their foreign funds to a large number of U.S. investors. Under Section 7(d), only funds organized under the laws of the United States, or any state, are permitted to offer shares in the United States. However, Section 7(d) authorizes the Commission to issue orders permitting foreign-organized funds to offer shares in the United States if the Commission finds that, by reason of special circumstances or arrangements, it is both legally and practically feasible effectively to enforce the provisions of the Investment Company Act against the foreign fund and that permitting the foreign fund to offer shares in the United States is consistent with the public interest and the protection of investors. Thus, Section 7(d) ensures that U.S. investors receive the same essential investor protection whether they acquire shares in a foreign fund or U.S.-organized fund. Many foreign funds are unwilling to submit to having all provisions of the Investment Company Act imposed on them. In fact, only 19 foreign funds, most of them from Canada, have ever received orders under Section 7(d). The SEC issued the last such order in 1973.
Section 7(d) is statutory rule. Therefore, an amendment to Section 7(d) requires an act of the U.S. Congress.

In practice, however, the requirements of Section 7(d) have not posed a problem for foreign fund managers in penetrating the U.S. market. Many foreign fund managers have responded by acquiring U.S. investment management organizations or by setting up their own U.S. affiliates. A foreign investment manager may organize and register a U.S. mutual fund to be sold in the United States on the same basis as a U.S. investment manager. Moreover, it is relatively easy for a foreign firm to establish funds in the United States to replicate an existing foreign fund, which can be managed and administered outside the United States.
The SEC has shown flexibility in permitting performance information, such as that of a comparable foreign fund, to be included in prospectuses of the U.S. funds, greatly aiding foreign managers in marketing their U.S. funds. Also, the National Securities Markets Improvement Act of 1996 ("NSMIA") facilitated a true national market in the United States, eliminating substantive regulation of mutual funds by states, making it considerably easier for foreign firms to access the U.S. markets.
It should also be noted that Section 7(d), as interpreted by the Division of Investment Management, does not prohibit private offerings of foreign funds to U.S. residents, as long as those offerings comply with the private offering requirements of the U.S. securities laws. Section 3(c)(1) of the Investment Company Act provides an exemption for privately placed funds with fewer than 100 beneficial owners and Section 3(c)(7) provides an exemption for privately placed funds sold exclusively to "qualified purchasers." The SEC staff has been flexible in interpreting these provisions, taking the position that a foreign fund may make a private U.S. offering under these exemptions concurrently with an offshore public offering. (See Goodwin, Procter & Hoar, (pub. avail. Feb. 28 1997); Touche Remnant & Co. (pub. avail. August 27, 1984)). Moreover, we have confirmed that a foreign fund remains eligible for these exclusions so long as it has 100 or fewer U.S. persons as beneficial owners or has U.S. investors who are qualified purchasers, regardless of the number or sophistication of its non-U.S. investors. (Goodwin, Procter & Hoar (pub.avail. Feb. 28, 1997)). I should also note that the SEC staff has permitted foreign funds to exceed the 100 U.S. beneficial owner limit or to have U.S. investors who are not qualified purchasers if this is as a result of independent actions of the fund's security holders. (Investment Funds Institute of Canada (pub. avail. March 4, 1996)).

US law insists on independent director in the mutual fund. But,With respect to independent directors of U.S. mutual funds, that there is no residency requirement for directors. Thus, a foreign fund manager could establish a U.S. fund that has a board of all non-U.S. directors. In addition, there are several other areas where the Investment Company Act does not impose requirements in contrast to other countries. For example, the Investment Company Act does not impose high capital, staffing, residency or U.S. place of business requirements so that a U.S. registered fund can be administered outside of the United States.

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