SEC Rule 10f-3

Section 10(f) of the Investment Company Act prohibits a registered investment company from purchasing, in connection with any offering of securities of which the fund's principal underwriter or any affiliated person of the fund's principal underwriter is a member of the underwriting or selling group, any security in such offering until after a period of time prescribed by Commission rules following the public offering of such security. This prohibition reflects the Investment Company Act's foundational concern about self-dealing in affiliated transactions — in this context, the specific risk that a fund's investment adviser, by directing the fund to purchase securities being underwritten by the adviser's affiliated broker-dealer, could cause the fund to act as a reliable buyer of last resort for the affiliated underwriter's offerings rather than as a discriminating purchaser acting in the fund's shareholders' best interests.

The conflict of interest that Section 10(f) was designed to prevent is direct and structural. An affiliated underwriter that has taken on an underwriting commitment has a strong commercial interest in placing all the securities it has committed to underwrite — including securities that may be overpriced, poorly received by the market, or otherwise unattractive to sophisticated unaffiliated investors. A fund whose investment adviser has an affiliated underwriter could, in the absence of regulatory restrictions, be pressured to purchase securities from that affiliated underwriter's book not because those securities represent the best available investment opportunities for fund shareholders but because the purchase solves a commercial problem for the affiliated underwriter. Rule 10f-3's conditions are specifically designed to prevent this outcome by ensuring that fund purchases in affiliated underwritings occur only for eligible, investment-grade securities, at market prices, within percentage limits that prevent the fund from being used as the underwriter's primary distribution channel, and subject to independent board oversight that provides ongoing governance against the conflicts of interest Section 10(f) was designed to address.

Statutory Authority and Rulemaking History

Rule 10f-3 derives its statutory authority from Section 10(f) of the Investment Company Act, which authorises the Commission to exempt registered investment companies from its affiliated underwriting prohibition by rule in cases consistent with the public interest and investor protection, and from Section 38(a)'s general rulemaking authority. Section 10(f)'s specific grant of exemptive rulemaking authority for the affiliated underwriting context is the direct statutory foundation for Rule 10f-3's standing exemption, which qualifying funds may rely upon without seeking individual Commission approval.

Rule 10f-3 has been in the Investment Company Act rules since the early decades of the Act's administration, with its conditions progressively expanded and refined through multiple amendments to accommodate the growing categories of securities and market structures that modern registered fund investment strategies involve. The most recent substantive amendment was adopted April 19, 2002 — Investment Company Act Release No. IC-25557, published at 67 FR 21527, April 30, 2002 — which expanded the rule to permit purchases of government securities during affiliated underwriting syndicates, a significant addition that enabled registered fund participation in Treasury and agency securities offerings managed by affiliated primary dealers. The fund governance standards condition of Rule 0-1(a)(7) was added to Rule 10f-3 in 2004 as part of the Investment Company Governance rulemaking, conditioning Rule 10f-3 reliance on the enhanced board governance framework applicable across the ten designated Exemptive Rules. No changes have been made to Rule 10f-3's operative provisions up to the present time.

Key Provisions and Operative Requirements

Rule 10f-3 establishes its exemption from Section 10(f) through a comprehensive set of conditions that must simultaneously be satisfied for each purchase transaction.

The first category of conditions addresses eligible securities — the types of securities that may be purchased in reliance on Rule 10f-3. The rule identifies four categories of eligible securities. Debt securities that are rated in the four highest rating categories by at least one nationally recognised statistical rating organisation constitute the primary debt securities category, confining Rule 10f-3 purchases to investment-grade and upper-medium-grade securities whose credit quality reduces the risk that the affiliated underwriter is using the fund as a vehicle for distributing lower-quality securities that the market might not otherwise absorb. Government securities — as defined by Section 2(a)(16) of the Investment Company Act, including Treasury bills, notes, bonds, and agency securities — are eligible without a rating condition, reflecting the absence of credit risk in these instruments. Eligible municipal securities — general obligation securities that are rated in the three highest categories by at least one NRSRO — constitute a specifically defined municipal bond category with a more restrictive rating threshold than the general debt securities category, reflecting the Commission's assessment of the relative risk characteristics of the municipal securities market. Securities issued in reliance on Section 4(a)(2) or Rule 144A — private placement and Rule 144A resale securities — are eligible subject to conditions addressing the qualified institutional buyer status of the purchasing fund, the liquidity of the securities for resale, and the seller's reasonable belief that the securities are eligible for resale to QIBs.

The second category addresses the price condition — ensuring that affiliated underwriting purchases occur at market prices rather than at inflated prices that would benefit the affiliated underwriter at the fund's expense. The securities must be purchased at the public offering price — the price at which the securities are offered to all purchasers in the public offering — or in the case of securities offered in a Rule 144A transaction, at the price at which such securities are offered to qualified institutional buyers. The public offering price condition is both an investor protection measure and an anti-favoritism measure: it ensures that the fund pays no more for securities in an affiliated underwriting than any other purchaser of the same securities pays in the same offering, preventing the affiliated underwriter from extracting a premium from the affiliated fund by treating it as a captive buyer.

The third category addresses the 25% aggregate percentage limit on affiliated underwriting purchases — the condition specifically addressing the risk that the fund could be used as the affiliated underwriter's primary distribution vehicle. The aggregate amount of securities purchased by the fund in any single offering from an underwriting syndicate in which an affiliated person of the fund is a member may not exceed 25% of the principal amount of the offering of any particular class being offered in the transaction. This 25% limit reflects the Commission's assessment that a fund purchasing up to one-quarter of an affiliated underwriting is participating on terms consistent with genuine portfolio investment decision-making rather than functioning as the affiliated underwriter's backstop purchaser — a fund purchasing a larger fraction of an affiliated offering would more plausibly be suspected of serving the underwriter's distribution interests rather than the fund's investment interests.

The fourth category — the direct affiliate transaction prohibition — ensures that even within the allowable parameters of Rule 10f-3 purchases, the fund does not purchase securities directly from the most immediate affiliated persons whose conflicts of interest are the greatest: the fund's own officers, directors, advisory board members, investment advisers, and employees, or from persons who are affiliated persons of any of the foregoing. A purchase from the syndicate manager — the lead underwriter who manages the syndication process — is not deemed to be a purchase from a specific affiliated underwriter where the specific underwriter does not benefit directly or indirectly from the transaction, preserving the fund's ability to purchase through normal syndicate mechanics without needing to track the ultimate allocation of each purchasing relationship across the syndicate's membership.

The fifth category is the board governance framework — encompassing both the specific Rule 10f-3 board oversight conditions and the fund governance standards condition of Rule 0-1(a)(7). The board of directors of the fund, including a majority of directors who are not interested persons, must have approved written procedures governing purchases pursuant to Rule 10f-3 and must have reviewed no less frequently than quarterly whether all such purchases during the preceding quarter complied with those procedures. The fund's compliance with the fund governance standards of Rule 0-1(a)(7) — including the 75% independent director requirement, independent chairman, annual self-assessment, quarterly independent director meetings, and independent director hiring authority — is a mandatory prerequisite for Rule 10f-3 reliance. The quarterly review by the board's independent directors parallels the quarterly review requirements applicable under Rules 17a-7 and 17e-1 for other categories of affiliated transaction, ensuring consistent governance oversight across the related affiliated transaction exemptive rules.

The sixth category is the sub-adviser consultation prohibition — the condition most distinctive to Rule 10f-3's specific conflict of interest concern. The fund's advisory contract or sub-advisory contract must contain provisions prohibiting any sub-adviser of the fund from consulting with any other sub-adviser of the fund or of any other fund or portfolio managed by the same investment adviser about securities transactions for the fund when a person affiliated with one sub-adviser is a member of the underwriting or selling group for those securities. This prohibition addresses the information flow dimension of the conflict of interest — preventing the sub-adviser whose affiliate is participating in an underwriting from communicating that participation to other sub-advisers who might then coordinate purchasing decisions in ways that would benefit the affiliated underwriter beyond the legitimate exercise of each sub-adviser's independent portfolio management judgment.

Scope of Application

Rule 10f-3 applies to registered investment companies — mutual funds, ETFs, closed-end funds, and other registered funds — that seek to purchase securities during the existence of an underwriting or selling syndicate in which an affiliated person of the fund participates. The affiliation that triggers Section 10(f)'s prohibition — and therefore Rule 10f-3's exemption — arises most commonly from the advisory relationship between the fund and its investment adviser: where the adviser or an affiliate of the adviser is a member of the underwriting syndicate for a particular offering, the fund is an affiliated person of the underwriting syndicate member and therefore could not purchase those securities during the underwriting period without Rule 10f-3's exemption.

ETFs that invest in bond markets — including investment-grade corporate bond ETFs, government bond ETFs, and municipal bond ETFs — are among the most frequent users of Rule 10f-3, since large fixed income ETFs managed by adviser-affiliated fund families frequently seek to acquire securities in new issue offerings managed by the adviser's affiliated broker-dealer underwriting operations. The rule's investment-grade debt securities and government securities categories of eligible securities directly accommodate the primary fixed income investment categories that bond ETFs and bond mutual funds pursue, making Rule 10f-3 commercially important to the institutional fixed income fund market.

Relationship to Related Rules and Regulations

Rule 10f-3's relationship with Rule 0-1(a)(7)'s fund governance standards definition is the most structurally significant in the rule's current operative framework — fund governance standard compliance is a mandatory prerequisite for Rule 10f-3 reliance, and the enhanced board independence and governance requirements of Rule 0-1(a)(7) provide the structural governance underpinning for the independent board oversight that Rule 10f-3's quarterly compliance review requires. The same board governance standards that condition Rule 10f-3 reliance also condition reliance on Rule 12b-1, Rule 17a-7, Rule 17e-1, and Rule 23c-3 — creating a consistent governance infrastructure requirement across all the major Investment Company Act exemptive rules through which registered funds manage affiliated relationships.

Rule 10f-3's affiliated underwriting purchase framework connects to Rule 17e-1's affiliated brokerage commission standards in the context of fund portfolio transactions with affiliated broker-dealers. Where Rule 17e-1 governs the commissions paid to affiliated broker-dealers acting as brokers in secondary market transactions, Rule 10f-3 governs the fund's direct purchases from affiliated underwriting syndicates in primary market transactions — the two rules together address the primary and secondary market dimensions of the affiliated broker-dealer conflict of interest from complementary regulatory angles.

Rule 38a-1's compliance programme framework requires that registered fund compliance programmes specifically address Rule 10f-3 compliance — including the adequacy of the procedures for identifying securities subject to Rule 10f-3 when purchase orders are placed during underwriting periods, the processes for ensuring the rule's price, percentage, and affiliate transaction conditions are satisfied, the sub-adviser consultation prohibition monitoring, and the quarterly board review processes that the rule requires.

Amendment History and Regulatory Evolution

Rule 10f-3 has been amended multiple times since its original adoption to expand the categories of eligible securities and to add governance conditions consistent with the Commission's evolving approach to affiliated transaction management. The April 2002 expansion to include government securities — the most recent substantive amendment to the rule's operative conditions — reflected the Commission's recognition that Treasury and agency securities offerings managed by affiliated primary dealers presented the same structural conflict of interest as other affiliated underwritings but that the absence of credit risk in government securities made the investor protection rationale for restricting fund participation in those offerings substantially weaker than in the corporate debt and municipal securities contexts.

The addition of the fund governance standards condition in 2004 as a condition for Rule 10f-3 reliance represented the most significant governance enhancement to the rule since its adoption, placing Rule 10f-3 within the comprehensive governance framework that the Investment Company Governance rulemaking established across all ten designated Exemptive Rules. No changes have been made to Rule 10f-3's operative provisions up to the present time since those 2004 governance amendments became effective in 2006.

Enforcement Context and SEC Action Patterns

Rule 10f-3 enforcement has concentrated on failures of the rule's specific protective conditions — particularly the price condition, the affiliate transaction prohibition, and the board governance framework. The Commission's examination programme reviews Rule 10f-3 compliance as part of its assessment of affiliated transaction management for fund complexes with affiliated underwriting operations, with specific attention to whether purchases in affiliated underwritings were made at the public offering price rather than at prices that might benefit the affiliated underwriter, whether the 25% aggregate limit was maintained across all affiliated underwriting purchases within a single offering, and whether the quarterly board review process was genuinely substantive rather than perfunctory.

The sub-adviser consultation prohibition has been a specific examination focus for multi-adviser fund complexes, where the practical challenge of maintaining information barriers between affiliated underwriting operations and the various sub-advisers managing different portions of a fund's portfolio creates ongoing compliance monitoring demands.

Examination Relevance and Key Takeaways

Rule 10f-3 is examined at the Series 65 level as the exemptive framework enabling registered fund purchases in affiliated underwritings — addressing the specific conflict of interest that arises when the fund's investment adviser has an affiliated broker-dealer participating in a securities offering that the fund wishes to purchase. The Section 10(f) prohibition that Rule 10f-3 exempts from, the four categories of eligible securities, the public offering price condition, the 25% aggregate percentage limit, the direct affiliate transaction prohibition, and the board governance and quarterly review requirements are the primary examination content.

The fund governance standards condition cross-referencing Rule 0-1(a)(7) — requiring 75% independent directors, independent chairman, annual self-assessment, quarterly independent director meetings, and independent director hiring authority — is examined in the context of understanding the shared governance infrastructure that connects Rule 10f-3 to the nine other Exemptive Rules that impose the same prerequisite.

The key points to retain are these. Rule 10f-3 exempts registered investment companies from Section 10(f)'s prohibition on purchasing securities during affiliated underwritings — where the fund's principal underwriter or an affiliated person is a member of the underwriting syndicate — provided the following conditions are met: the securities are eligible under the rule's four categories including investment-grade debt, government securities, eligible municipal securities, and qualifying Rule 144A securities; the purchase price equals the public offering price; aggregate purchases of any class do not exceed 25% of the principal amount offered; the fund does not purchase from specified directly affiliated persons except through the syndicate manager exception; the board including a majority of non-interested directors has approved procedures and conducts quarterly compliance reviews; the fund satisfies the fund governance standards of Rule 0-1(a)(7); and the fund's advisory or sub-advisory contracts prohibit sub-advisers from consulting with other sub-advisers about transactions in securities for which an affiliate participates in an underwriting syndicate. Rule 10f-3 was last substantively amended April 19, 2002 with the addition of government securities as eligible securities. No changes have been made to its operative provisions up to the present time.