Securities and Exchange Commission Adopts Final Fund of Funds Rule

The Securities and Exchange Commission (SEC) adopted on October 7, 2020 Rule 12d1-4 (final rule) and other amendments under the Investment Company Act of 1940, as amended (1940 Act), which streamline and enhance the regulatory requirements for registered investment companies and business development companies (together, funds) to acquire shares of other funds in excess of the limits in Section 12(d)(1) of the 1940 Act (fund of funds arrangements).

New Rule 12d1-4

Rule 12d1-4 allows funds (acquiring funds) subject to certain conditions to acquire shares of other funds (acquired funds) without obtaining a fund of funds exemptive order from the SEC. In addition to mutual funds and exchange-traded funds (ETFs), exchange-traded managed funds (ETMFs), listed and unlisted closed-end funds, unit investment trusts (UITs), and listed and unlisted business development companies can be acquiring and acquired funds under the final rule. Private funds and unregistered investment companies, such as foreign investment companies, are excluded from the final rule.

The final rule subjects fund of funds arrangements to a tailored set of conditions designed to address the historical abuses associated with fund of funds arrangements. These conditions, which are based on the conditions contained in SEC exemptive orders, address (i) required evaluations and findings by investment advisers and (ii) fund of funds investment agreements. For example, the final rule requires funds that do not have the same investment adviser to enter into a fund of funds investment agreement and requires that the adviser of each fund make certain evaluations and findings related the potential exertion of undue influence over an acquired fund or the potential charging of duplicative fees and expenses. A summary of certain conditions under the final rule can be found here.

Rescission of Rule 12d1-2 and Amendment to Rule 12d1-1 and Form N-CEN; Disclosures

In connection with the final rule, the SEC is rescinding Rule 12d1-2 under the 1940 Act, which permits a fund relying on Section 12(d)(1)(G) of the 1940 Act to (i) acquire securities of other funds that are not part of the same group of investment companies, (ii) invest directly in stocks, bonds and other types of securities and (iii) acquire the securities of money market funds. The SEC noted in the final rule release that as a result of the rescission, funds relying on Section 12(d)(1)(G) would not be able to acquire assets other than funds that are within the same group of investment companies, government securities and short-term paper. Funds currently relying on Section 12(d)(1)(G) will be required to rely on the final rule to make those other direct investments.

The SEC also adopted amendments to Rule 12d1-1 under the 1940 Act to allow funds relying on Section 12(d)(1)(G) to continue to invest in unaffiliated money market funds (i.e., cash sweep arrangements). Additionally, the SEC adopted amendments to Form N-CEN, which require that a fund report if it relied on the final rule or the statutory exception from Section 12(d)(1)(G) to operate as a fund of funds during the reporting period.

Rescission of Exemptive Relief and Withdrawal of Staff No-Action Letters

The SEC is rescinding previously granted exemptive relief permitting fund of funds arrangements that fall within the scope of the final rule. Fund of funds exemptive relief or portions of relief from provisions of the 1940 Act that are outside the scope of the final rule will not be rescinded.

Over the years, the SEC staff has also provided no-action relief with respect to certain fund of funds arrangements. Certain no-action letters that fall within the scope of the final rule will be withdrawn one year from the effective date of the final rule. Information regarding the no-action letters that are withdrawn is posted on the SEC’s website.

Compliance and Transition Dates

The final rule will become effective 60 days after publication in the Federal Register. The rescission of Rule 12d1-2 will become effective one year after the effective date of the final rule. The compliance date for the amendment to Form N-CEN is 425 days after publication in the Federal Register. The SEC also adopted a one-year period after the effective date of the final rule before rescission of the SEC exemptive orders and no-action letters that are within the scope of the final rule.

The article in its original form, which also includes some practice points and tips, can be found here.

Joshua B. Deringer is a partner at Faegre Drinker Biddle & Reath (New York office). He leads the firm’s investment management practice group.

Veena K. Jain is a counsel at Faegre Drinker Biddle & Reath (Chicago office). She is an experienced investment management attorney with a focus on exchange-traded funds (ETFs) and mutual funds, including money market funds and fund of funds.

Catherine A. DiValentino is an associate at Faegre Drinker Biddle & Reath (Philadelphia office). She represents and counsels organizations in the financial services industry, including investment companies and investment advisers.

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