Interested Person

Regarding the governance of a registered open-end investment company, the Investment Company Act of 1940 requires that:

1. A.The entire board consist of persons who are not interested persons of the fund.A fully independent board is not required; interested directors such as the adviser's principals may serve.
2. B.A majority of the board be officers or employees of the fund's investment adviser.This inverts the requirement, which protects against adviser domination of the board.
3. C.The fund have no board of directors, since the adviser governs the fund directly.It is the unit investment trust that lacks a board; a registered management company has one.
4. D.At least 40% of the board be persons who are not interested persons of the fund.Correct. Forty percent independent directors is the statutory minimum under the 1940 Act.

Why: The Investment Company Act requires that at least 40% of a registered fund's board of directors be persons who are not interested persons of the fund, commonly called independent directors. Many exemptive rules on which funds routinely rely condition their availability on a majority-independent board, so most funds in practice exceed the statutory minimum. The independent directors are central to approving the advisory contract and the fund's fee arrangements.

The directors of the Ellerby Core Bond Fund, a registered open-end investment company, meet to consider continuing the fund contract with its investment adviser for another year. Which statement correctly describes what the Investment Company Act of 1940 requires of that continuation?

1. A.The contract renews automatically each year unless the fund shareholders affirmatively vote to terminate itThere is no automatic renewal. Affirmative annual approval is required.
2. B.The contract may run for an initial five-year term and thereafter be renewed by the board of directors of the ADVISERThe initial term is limited to two years, and it is the FUND board, not the adviser board, that acts.
3. C.Only a vote of a majority of the fund outstanding shares can renew the contract; the fund directors have no role in the decisionThe board may approve the continuation, and the independent directors must approve it in every case.
4. D.After an initial term of up to two years the contract must be approved at least annually by the board or by a majority of outstanding voting securities, and in either case also by a majority of the directors who are not interested personsCorrect. That is the annual continuance requirement, and the adviser must supply the information directors need to evaluate the terms.

Why: An advisory contract with a registered investment company may run for an initial term of up to two years. After that it must be approved at least annually, either by the fund board of directors or by a vote of a majority of the outstanding voting securities, and in EITHER case also by a majority of the directors who are not interested persons of the fund, at a meeting called for that purpose. The adviser must furnish, and the directors must request and evaluate, the information reasonably necessary to judge the terms. The contract must also be terminable without penalty on not more than 60 days notice.