1286 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

1Unless otherwise noted, all references to 

statutory sections are to the Investment Company 

Act, and all references to rules under the 

Investment Company Act are to title 17, part 270 

of the Code of Federal Regulations [17 CFR part 

270]. 

2For purposes of this release, we generally use 

the term ‘‘funds’’ to refer to registered investment 

companies and business development companies 

(‘‘BDCs’’) unless the context otherwise requires. A 

BDC is a closed-end fund that: (i) is organized 

under the laws of, and has its principal place of 

business in, any state or states; (ii) is operated for 

the purpose of investing in securities described in 

section 55(a)(1)–(3) of the Act and makes available 

‘‘significant managerial assistance’’ to the issuers of 

those securities, subject to certain conditions; and 

(iii) has elected under section 54(a) of the Act to 

be subject to the sections addressing activities of 

BDCs under the Act. See 15 U.S.C. 80a–2(a)(48). 

Section 6(f) of the Act exempts BDCs that have 

made the election under section 54 of the Act from 

registration provisions of the Act. 3We also are proposing amendments to Form N– 

CEN, a structured form that requires registered 

funds to provide census-type information to the 

Commission on an annual basis. See infra section 

IV. 

Securities and Exchange Commission 

17 CFR Parts 270 and 274 

[Release Nos. 33–10590; IC–33329; File No. 

S7–27–18] 

RIN 3235–AM29 

Fund of Funds Arrangements 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission (the ‘‘Commission’’) is 

proposing a new rule under the 

Investment Company Act of 1940 

(‘‘Investment Company Act’’ or ‘‘Act’’) 

to streamline and enhance the 

regulatory framework applicable to 

funds that invest in other funds (‘‘fund 

of funds’’ arrangements). In connection 

with the proposed rule, the Commission 

proposes to rescind rule 12d1–2 under 

the Act and most exemptive orders 

granting relief from sections 12(d)(1)(A), 

(B), (C), and (G) of the Act. Finally, the 

Commission is proposing related 

amendments to rule 12d1–1 under the 

Act and Form N–CEN. 

DATES: Comments should be received on 

or before May 2, 2019. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an email to rule-comments@

sec.gov. Please include File Number S7– 

27–18 on the subject line. 

Paper Comments 

• Send paper comments to Brent J. 

Fields, Secretary, Securities and 

Exchange Commission, 100 F Street NE, 

Washington, DC 20549–1090. 

All submissions should refer to File 

Number S7–27–18. This file number 

should be included on the subject line 

if email is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s internet website 

(http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for website viewing and 

printing in the Commission’s Public 

Reference Room, 100 F Street NE, 

Washington, DC 20549, on official 

business days between the hours of 

10:00 a.m. and 3:00 p.m. Persons 

submitting comments are cautioned that 

we do not redact or edit personal 

identifying information from comment 

submissions. You should submit only 

information that you wish to make 

available publicly. Studies, memoranda, or other 

substantive items may be added by the 

Commission or staff to the comment file 

during this rulemaking. A notification of 

the inclusion in the comment file of any 

such materials will be made available 

on the Commission’s website. To ensure 

direct electronic receipt of such 

notifications, sign up through the ‘‘Stay 

Connected’’ option at www.sec.gov to 

receive notifications by email. 

FOR FURTHER INFORMATION CONTACT: Joel 

Cavanaugh, John Foley, Senior 

Counsels; Jacob D. Krawitz, Branch 

Chief; Melissa S. Gainor, Senior Special 

Counsel; Brian McLaughlin Johnson, 

Assistant Director, at (202) 551–6792, 

Investment Company Regulation Office, 

Division of Investment Management, 

Securities and Exchange Commission, 

100 F Street NE, Washington, DC 20549. 

SUPPLEMENTARY INFORMATION: The 

Commission is proposing for public 

comment 17 CFR 270.12d1–4 (new rule 

12d1–4) under the Investment Company 

Act [15 U.S.C. 80a–1 et seq.]; 

amendments to 17 CFR 270.12d1–1 

(rule 12d1–1) under the Investment 

Company Act; amendments to Form N– 

CEN [referenced in 17 CFR 274.101] 

under the Investment Company Act; and 

rescission of 17 CFR 270.12d1–2 (rule 

12d1–2) under the Investment Company 

Act.1

Table of Contents 

I. Background 

A. Funds’ Investments in Other Funds 

B. Overview of Section 12(d)(1) Limits 

II. Proposed Rule 12d1–4 

A. Scope of Proposed Rule 12d1–4 and 

Exemptions From Section 12(d)(1) of the 

Act 

B. Exemptions From the Act’s Prohibition 

on Certain Affiliated Transactions 

C. Conditions 

III. Proposed Rescission of Rule 12d1–2 and 

Proposed Amendments to Rule 12d1–1 

IV. Amendments to Form N–CEN 

V. Proposed Rescission of Exemptive Orders; 

Withdrawal of Staff Letters 

VI. Economic Analysis 

A. Introduction 

B. Economic Baseline 

C. Benefits and Costs and Effects on 

Efficiency, Competition, and Capital 

Formation of Rule Proposal 

D. Reasonable Alternatives 

VII. Paperwork Reduction Act 

A. Introduction 

B. Rule 12d1–4 

C. Rule 0–2 

D. Form N–CEN 

E. Request for Comments 

VIII. Initial Regulatory Flexibility Analysis 

A. Reasons for and Objectives of the 

Proposed Actions 

B. Legal Basis 

C. Small Entities Subject to the Proposed 

Requirements 

D. Projected Board Reporting, 

Recordkeeping, and Other Compliance 

Requirements 

E. Duplicative, Overlapping, or Conflicting 

Federal Rules 

F. Significant Alternatives 

G. General Request for Comment 

IX. Consideration of Impact on the Economy 

X. Statutory Authority 

I. Background 

We are proposing new rule 12d1–4 

under the Investment Company Act to 

streamline and enhance the regulatory 

framework applicable to fund of funds 

arrangements.2 The proposed rule 

would, under specified circumstances, 

permit a fund to acquire shares of 

another fund in excess of the limits of 

section 12(d)(1) of the Act without 

obtaining an exemptive order from the 

Commission.3 The proposed rule 

reflects decades of experience with fund 

of funds arrangements, and would 

subject funds relying on proposed rule 

12d1–4 to a tailored set of conditions 

that we believe would help protect 

investors from the harms Congress 

sought to address by enacting section 

12(d)(1) of the Act. As the proposed rule 

would provide a comprehensive 

exemption for funds of funds to operate, 

we also propose to rescind rule 12d1– 

2 under the Act and individual 

exemptive orders for certain fund of 

funds arrangements in order to create a 

consistent and efficient rules-based 

regime for the formation and oversight 

of funds of funds. Finally, in connection 

with the proposed rescission of rule 

12d1–2, we are proposing amendments 

to rule 12d1–1 under the Act to allow 

funds that rely on section 12(d)(1)(G) of 

the Act to invest in money market funds 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1287 

4See infra section III. 5Total net assets in mutual funds that invest 

primarily in other mutual funds have grown from 

$469 billion in 2008 to $2.22 trillion in 2017. 

During this period the number of mutual funds 

utilizing this arrangement grew from 839 to 1,400. 

See Investment Company Institute, 2018 Investment 

Company Fact Book (2018) (‘‘2018 ICI Fact Book’’), 

at 256, available at https://www.ici.org/pdf/2018_

factbook.pdf. 

6This estimate is derived from an analysis of data 

obtained from Morningstar Direct for the period 

ending August 2018. For more data on fund of 

funds arrangements, see infra section VI. 7Target-date funds are a common type of fund of 

funds arrangement that are designed to make it 

easier for investors to hold a diversified portfolio 

of assets that is rebalanced over time without the 

need for investors to rebalance their own portfolio. 

See Investment Company Advertising: Target Date 

Retirement Fund Names and Marketing, Investment 

Company Act Release No. 29301 (June 16, 2010) [75 

FR 35920 (June 23, 2010)] (proposing disclosure 

requirements for target date retirement funds’ 

marketing materials). 

8A fund of funds may invest, for example, in 

funds or share classes with minimum investment 

amounts that are higher than some retail investors 

could afford. 

9As originally enacted, section 12(d)(1) 

prohibited a registered fund (and any companies it 

controlled) from purchasing more than 5% of the 

outstanding shares of any fund that concentrated its 

investments in a particular industry, or more than 

3% of the shares of any other type of fund. See 

Public Law 76–768, 54 Stat. 789, 809–10 § 12(d)(1) 

(1940) (codified at 15 U.S.C. 80a–12(d)(1) (1940)). 

Congress amended section 12(d)(1) to include the 

current limits in section 12(d)(1)(A) and (B) in 1970. 10See 15 U.S.C. 80a–12(d)(1)(A). Both registered 

and unregistered investment companies are subject 

to these limits with respect to their investments in 

a registered investment company. Registered 

investment companies are also subject to these 

same limits with respect to their investment in an 

unregistered investment company. Pursuant to 

sections 3(c)(1) and 3(c)(7), private funds are subject 

to the 3% limitation on investments in registered 

funds as well. 15 U.S.C. 80a–3(c)(1) and 3(c)(7)(D). 

A ‘‘private fund’’ is an issuer that would be an 

investment company, as defined in section 3 of the 

Investment Company Act, but for section 3(c)(1) or 

3(c)(7) of that Act. 15 U.S.C. 80b–2(a)(29). In 

addition, section 60 of the Act makes section 12(d) 

applicable to a BDC to the same extent as it if were 

a registered closed-end fund. 15 U.S.C. 80a–60. 11A registered open-end fund is a management 

company that is offering for sale or has outstanding 

any redeemable security of which it is the issuer. 

15 U.S.C. 80a–5(a)(1) (defining ‘‘open-end 

company’’). A registered closed-end fund is any 

management company other than an open-end 

fund. 15 U.S.C. 80a–5(a)(2) (defining ‘‘closed-end 

company’’). Section 12(d)(1)(C) of the Act also 

includes specific limitations on investments in 

registered closed-end funds. See 15 U.S.C. 80a– 

12(d)(1)(C). 12See 15 U.S.C. 80a–12(d)(1)(B). This prohibition 

applies to the sale of securities issued by an openend fund to registered funds and unregistered 

investment companies. Pursuant to sections 3(c)(1) 

and 3(c)(7), private funds are subject to the 3% 

limitation with respect to the sale of any security 

by any open-end fund to such private fund. 15 

U.S.C. 80a–3(c)(1) and 3(c)(7)(D). 

13See Hearing on H.R. 10065 before the 

Subcomm. of the House Comm. on Interstate and 

Foreign Commerce, 76th Cong., 3d Sess., 112–14 

(1940) (statement of David Schenker); Investment 

Trusts and Investment Companies, Report of the 

Securities and Exchange Commission, pt. 3, ch. 4, 

H.R. Doc. No. 136, 77th Cong., 1st Sess., 1031–1041, 

nn. 58–59 (1941) (‘‘Investment Trust Study’’); id., at 

ch. 7, 2742–50. See also Exchange-Traded Funds, 

Investment Company Act Release No. 28193 (Mar. 

11, 2008) [73 FR 14618 (Mar. 18, 2008)] (‘‘2008 

Proposing Release’’), at n.195 (discussing the 

legislative history of ‘‘pyramiding schemes’’). In 

some cases, acquired funds directed underwriting 

and brokerage business to entities affiliated with 

acquiring fund investors on terms that were 

unfavorable to acquired fund shareholders. 

14Controlling persons profited when acquiring 

fund shareholders paid excessive fees due to 

duplicative charges at both the acquiring and 

acquired fund levels. See Investment Trust Study, 

supra footnote 13, at ch. 7, 2725–39, 2760–75, 

2778–93. 

15Complicated corporate structures could allow 

acquiring funds to circumvent investment 

restrictions and limitations and make it difficult for 

shareholders of the acquiring fund to understand 

who controlled the fund or the true value of their 

investments. See Investment Trust Study, supra 

footnote 13, at 2776–77. Acquiring fund 

shareholders might believe that they owned shares 

in a fund that invested in equity securities of large 

companies without understanding that the 

acquiring fund actually held funds that provided 

substantial exposure to smaller issuers, foreign 

currencies, or interest rates. See id., at 2721–95. 

16See 2008 Proposing Release, supra footnote 13 

(citing legislative history and Report of the 

Securities and Exchange Commission on the Public 

Policy Implications of Investment Company Growth, 

H. Rep. No. 2337, 89th Cong., 2d Sess. (1966) (‘‘PPI 

Report’’)). See also Fund of Funds Investments, 

Investment Company Act Release No. 26198 (Oct. 

1, 2003) [68 FR 58226 (Oct. 8, 2003)] (‘‘Fund of 

Funds Proposing Release’’) at n.8. 

17See Fund of Funds Investments, Investment 

Company Act Release No. 27399 (June 20, 2006) [71 

FR 36640 (June 27, 2006)] (‘‘Fund of Funds 

Continued 

that are not part of the same group of 

investment companies.4

A. Funds’ Investments in Other Funds 

Funds increasingly invest in other 

funds as a way to achieve asset 

allocation, diversification, or other 

investment objectives. For example, a 

fund may invest in another fund to gain 

exposure to a particular market or asset 

class in an efficient manner.5 A fund 

could, for instance, obtain exposure to 

a foreign market by investing in a 

country-specific fund rather than 

investing in the securities of companies 

listed on an exchange in that country. 

Funds also may invest in other funds to 

equitize cash, engage in hedging 

transactions, or manage risk. According to staff estimates, almost 

one half of all registered funds hold 

investments in other funds.6 Of those 

funds investing in other funds, one half 

invest at least 5% of their assets in other 

funds, and one quarter hold almost all 

of their assets (90%) in other funds. The 

acquired funds most often provide 

exposures to US equity, international 

equity, or fixed income asset classes. Main Street investors similarly use 

fund of funds arrangements as a 

convenient way to allocate and diversify 

their investments through a single, 

professionally managed portfolio. For 

example, a fund of funds may provide 

an investor with the same benefits as 

separate direct investments in several 

underlying funds, without the increased 

monitoring and recordkeeping that 

could accompany investments in each 

underlying fund.7 In addition, a fund of 

funds may provide an investor with 

exposure to an asset class or fund that 

may not otherwise be available to that 

investor.8

B. Overview of Section 12(d)(1) Limits 

Section 12(d)(1) of the Investment 

Company Act limits the ability of a fund 

to invest substantially in shares of 

another fund.9 Section 12(d)(1)(A) of the 

Act prohibits a registered fund (and 

companies, including funds, it controls) 

from: • Acquiring more than 3% of another 

fund’s outstanding voting securities; • investing more than 5% of its total 

assets in any one fund; or • investing more than 10% of its total 

assets in funds generally.10

Section 12(d)(1)(B) of the Act 

addresses the other side of the 

transaction by prohibiting a registered 

open-end fund 11 (and any principal 

underwriter thereof or broker-dealer 

registered under the Exchange Act) from 

knowingly selling securities to any other 

investment company if, after the sale, 

the acquiring fund would: • Together with companies it 

controls, own more than 3% of the 

acquired fund’s outstanding voting 

securities; or • together with other funds (and 

companies they control), own more than 

10% of the acquired fund’s outstanding 

voting securities.12

Congress enacted these restrictions 

because it was concerned about 

‘‘pyramiding,’’ a practice under which 

investors in the acquiring fund could 

control the assets of the acquired fund 

and use those assets to enrich 

themselves at the expense of acquired 

fund shareholders.13 Control could be 

exercised either directly (such as 

through the voting power of a 

controlling interest) or indirectly (such 

as coercion through the threat of largescale redemptions). Congress also was 

concerned about the potential for 

excessive fees when one fund invested 

in another,14 and the formation of overly 

complex structures that could be 

confusing to investors.15 Congress 

imposed these limits, in part, based on 

our conclusions in 1966 that fund of 

funds structures served little or no 

economic purpose.16

Our views and those of Congress 

regarding fund of funds arrangements 

have evolved over the years as fund of 

funds structures have developed to 

include investor protections and serve 

purposes that benefit investors.17 As a 

1288 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

Adopting Release’’) at n.7 and accompanying text; 

2008 Proposing Release, supra footnote 13. 

18See Fund of Funds Proposing Release, supra 

footnote 16, at n.8 and accompanying text. 

19See 15 U.S.C. 80a–12(d)(1)(E). This section is 

relied upon by master-feeder fund arrangements, in 

which one or more funds pool their assets by 

investing in a single fund with the same investment 

objective. 

20See 15 U.S.C. 80a–12(d)(1)(F). A fund relying 

on section 12(d)(1)(F) is restricted in its ability to 

redeem shares of the acquired fund and is unable 

to use its voting power to influence the outcome of 

shareholder votes held by the acquired fund. 

21See 15 U.S.C. 80a–12(d)(1)(G). ‘‘Group of 

investment companies’’ is defined in section 

12(d)(1)(G) as any two or more registered funds that 

hold themselves out to investors as related 

companies for purposes of investment and investor 

services. 15 U.S.C. 80a–12(d)(1)(G)(ii). 

22See National Securities Markets Improvement 

Act of 1996 (‘‘NSMIA’’), Public Law 104–290, 110 

Stat. 3416 (1996), at § 202(4) (codified at 15 U.S.C. 

80a–12(d)(1)(J); Comm. On Commerce, Securities 

Amendments of 1996, H.R. Rep. No. 104–622 

(1996), 104th Cong., 2nd Sess., at 43–44 (‘‘H.R. Rep. 

No. 622’’). Congress added section 12(d)(1)(J) to 

resolve questions regarding the scope of our 

authority under section 6(c) of the Act. See 

Vanguard Special Tax-Advanced Retirement Fund, 

Inc., Investment Company Act Release No. 14361 

(Feb. 7, 1985) (order), dissenting opinion of 

Commissioners Treadway and Peters (concluding 

that applicants failed to establish an adequate 

record on which the Commission could find an 

exemption from section 12(d)(1)(A) to meet the 

standards of section 6(c) of the Act). 

23H.R. Rep. No. 622, supra footnote 22, at 44–45. 

The report specifically noted that many fund 

complexes might not have a sufficient number or 

variety of fund types to permit a workable fund of 

funds arrangement under section 12(d)(1)(G) and 

the Commission should use its exemptive authority 

so ‘‘the benefits of [funds of] funds are not limited 

only to investors in the largest fund complexes, but, 

in appropriate circumstances, are available to 

investors through a variety of different types and 

sizes of investment company complexes.’’ The 

report stated that, in exercising its authority, the 

Commission should consider factors that relate to 

the protection of investors, including the extent to 

which a proposed arrangement is subject to 

conditions that are designed to address conflicts of 

interest and overreaching by a participant in the 

arrangement, so as to avoid the abuses that gave rise 

to the initial adoption of the Investment Company 

Act’s restrictions against funds investing in other 

funds. 

24See Fund of Funds Adopting Release, supra 

footnote 17. Rule 12d1–1 allows funds to invest in 

shares of money market funds in excess of the 

limits of section 12(d)(1). See infra section III 

(discussing the proposed amendment of rule 12d1– 

1). Rule 12d1–2 provides funds relying on section 

12(d)(1)(G) with greater flexibility to invest in other 

types of securities. See infra section III (discussing 

the proposed rescission of rule 12d1–2). Finally, 

rule 12d1–3 allows acquiring funds relying on 

section 12(d)(1)(F) to charge sales loads greater than 

1.5%. We did not rescind the exemptive orders that 

funds had relied upon in connection with these 

arrangements before we adopted rules 12d1–1, 

12d1–2 and 12d1–3. 

25As the orders are subject to terms and 

conditions set forth in the applications requesting 

exemptive relief, references in this release to 

‘‘exemptive relief’’ or ‘‘exemptive orders’’ include 

the terms and conditions described in the related 

applications. See, e.g., Schwab Capital Trust, et al., 

Investment Company Act Release Nos. 24067 (Oct. 

1, 1999) [64 FR 54939 (Oct. 8, 1999)] (notice) and 

24113 (Oct. 27, 1999) (order) and related 

application (‘‘Schwab’’); Franklin Fund Allocator 

Series, et al., Investment Company Act Release Nos. 

32669 (June 5, 2017) [82 FR 26720 (June 8, 2017)] 

(notice) and 32722 (July 3, 2017) (order) and related 

application (‘‘Franklin Fund’’). In addition to our 

section 12(d)(1)(J) authority, we have issued these 

orders pursuant to our exemptive authority under 

sections 17(a) and 6(c) of the Act. 

26See, e.g., Schwab, supra footnote 25. The 

conditions include: (i) Limits on the control and 

influence an acquiring fund can exert on the 

acquired fund; (ii) limits on certain fees charged to 

the acquiring fund and its shareholders; and (iii) 

limits on the acquired fund’s ability to invest in 

other funds. 

27ETFs are organized as either open-end funds or 

UITs and require exemptive relief from certain 

provisions of the Act to operate. ETFs issue shares 

that can be bought or sold throughout the day in 

the secondary market at a market-determined price. 

See, e.g., IndexIQ ETF Trust, et al., Investment 

Company Act Release Nos. 33163 (July 19, 2018) 

[83 FR 35289 (July 25, 2018)] (notice) and 33200 

(Aug. 14, 2018) (order) and related application. 

ETMFs are hybrid structures between mutual funds 

and ETFs and similarly need relief from the Act to 

operate. Unlike ETFs, secondary market 

transactions in ETMFs occur at the next-determined 

net asset value (‘‘NAV’’) plus or minus a marketdetermined premium or discount that may vary 

during the trading day. See, e.g., Eaton Vance 

Management, et al., Investment Company Act 

Release Nos. 31333 (Nov. 6, 2014) [79 FR 67471 

(Nov. 13, 2014)] (notice) and 31361 (Dec. 2, 2014) 

(order) and related application (‘‘Eaton Vance’’). 

28Such a fund would rely on section 12(d)(1)(G) 

to invest in acquired funds within the same group 

of investment companies, government securities, 

and short term paper. In addition, the fund could 

rely on rule 12d1–2 to invest in: (i) Securities of 

funds that are not in the same group of investment 

companies up to the limits in section 12(d)(1)(A) or 

(F); (ii) securities of money market funds in reliance 

on rule 12d1–1; and (iii) stocks, bonds, and other 

securities. 

29We do not propose to rescind exemptive orders 

providing relief from section 12(d)(1)(A) and (B) of 

the Act with respect to certain interfund lending 

arrangements. See infra footnote 201 and 

accompanying text. 

result, Congress created statutory 

exceptions that permit different types of 

fund of funds arrangements subject to 

certain conditions.18 First, section 

12(d)(1)(E) of the Act allows an 

acquiring fund to invest all of its assets 

in a single fund so that the acquiring 

fund is, in effect, a conduit through 

which investors may access the 

acquired fund.19 Second, section 

12(d)(1)(F) of the Investment Company 

Act permits a registered fund to take 

small positions (up to 3% of another 

fund’s securities) in an unlimited 

number of other funds.20 Finally, 

section 12(d)(1)(G) allows a registered 

open-end fund or unit investment trust 

(‘‘UIT’’) to invest in other open-end 

funds and UITs that are in the same 

‘‘group of investment companies.’’ 21

When Congress enacted section 

12(d)(1)(G), it also gave the Commission 

specific authority to permit additional 

types of fund of funds arrangements as 

structures evolved. Section 12(d)(1)(J) of 

the Act allows the Commission to 

exempt any person, security, or 

transaction, or any class or classes of 

transactions, from section 12(d)(1) if the 

exemption is consistent with the public 

interest and the protection of 

investors.22 A House of Representatives 

committee report on the amendments 

urged the Commission to use this 

exemptive authority ‘‘in a progressive 

way as the fund of funds concept 

continues to evolve over time.’’ 23

We exercised this exemptive authority 

in 2006 when we adopted 17 CFR 

270.12d1–1 (rule 12d1–1), 17 CFR 

270.12d1–2 (rule 12d1–2), and 17 CFR 

270.12d1–3 (rule 12d1–3), which were 

based on relief we previously provided 

in a number of exemptive orders.24 We 

also have used our authority under 

section 12(d)(1)(J) to issue exemptive 

orders permitting fund of funds 

arrangements that the Act or our rules 

otherwise restrict when we found those 

arrangements to be consistent with the 

public interest and the protection of 

investors.25 These exemptive orders 

permit fund investments in other funds, 

subject to specified conditions that are 

designed to prevent the abuses that led 

Congress to enact section 12(d)(1).26

Relief from sections 12(d)(1)(A) and (B) 

also is included in our exemptive orders 

that allow exchange-traded funds 

(‘‘ETFs’’) and exchange traded managed 

funds (‘‘ETMFs’’) to operate.27

This combination of statutory 

exemptions, Commission rules, and 

exemptive orders, however, has created 

a regulatory regime where substantially 

similar fund of funds arrangements are 

subject to different conditions. For 

example, an acquiring fund could rely 

on section 12(d)(1)(G) and rule 12d1–2 

when investing in an acquired fund 

within the same group of investment 

companies.28 Alternatively, it could rely 

on relief provided by an exemptive 

order, which would allow it to invest in 

substantially the same investments, but 

would require the fund to comply with 

different conditions. 

In order to create a more consistent 

and efficient regulatory framework for 

fund of funds arrangements, we are 

proposing to rescind rule 12d1–2 and 

many of the exemptive orders we have 

granted giving relief from sections 

12(d)(1)(A), (B), (C), and (G) of the Act.29

We propose to replace that relief with a 

comprehensive fund of funds 

framework under new rule 12d1–4. A 

comprehensive, streamlined framework 

would reduce confusion and subject 

fund of funds arrangements to a tailored 

set of conditions that would enhance 

investor protection, while also 

providing funds with investment 

flexibility to meet their investment 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1289 

30Under the proposal, a fund relying on section 

12(d)(1)(G) would no longer have the flexibility to: 

(i) Acquire the securities of other funds that are not 

part of the same group of investment companies; or 

(ii) invest directly in stocks, bonds, and other 

securities. In order to make these investments, the 

fund would need to comply with proposed rule 

12d1–4 (including its conditions). See infra section 

III. 

31See 2008 Proposing Release, supra footnote 13. 

The 2008 Proposing Release, among other things, 

would have allowed funds to invest in ETFs beyond 

the section 12(d)(1) statutory limits. Proposed rule 

12d1–4 also would allow funds to invest in ETFs, 

and would allow ETFs to act as acquiring funds, in 

excess of the limits in section 12(d)(1). As discussed 

in section V, we propose to rescind the exemptive 

relief relating to investments in ETFs that has been 

included in our ETF exemptive orders. 

32The proposed rule would not be available to 

face-amount certificate companies. Face-amount 

certificate companies are registered investment 

companies which are engaged or propose to engage 

in the business of issuing face-amount certificates 

of the installment type, or which have been engaged 

in such businesses and have any such certificates 

outstanding. See section 4(1) of the Investment 

Company Act. There is only one face-amount 

certificate company currently operating as an 

investment company and making current filings 

pursuant to section 13 [15 U.S.C. 80a–13] or section 

15(d) of the Exchange Act [15 U.S.C. 80a–15]. Given 

the very limited universe of face-amount certificate 

companies and the nature of their investments, we 

do not propose to include face-amount certificate 

companies within the scope of proposed rule 12d1– 

4 as acquiring funds or acquired funds. 

33We use the terms ‘‘listed closed-end funds’’ and 

‘‘listed BDCs’’ to refer to closed-end funds and 

BDCs that are listed and traded on national 

securities exchanges. Our exemptive orders have 

included a representation that acquiring funds will 

not invest in reliance on the order in closed-end 

funds or BDCs that are not listed and traded on a 

national securities exchange. See, e.g., Innovator 

ETFs Trust, et al., Investment Company Act Release 

Nos. 33214 (Aug. 24, 2018) [83 FR 44374 (Aug. 30, 

2018)] (notice) and 33238 (Sept. 19, 2018) (order) 

and related application (‘‘Innovator ETFs’’). 

34We have provided this relief to ETFs that are 

structured as open-end funds and UITs. See 

Exchange-Traded Funds, Investment Company Act 

Release No. 33140 (June 28, 2018) [83 FR 37332 

(July 31, 2018)] (‘‘2018 ETF Proposing Release’’) at 

nn. 344–46 and accompanying text (describing 

relief from section 12(d)(1) for investments in 

ETFs). 

35Under proposed rule 12d1–4, an acquiring fund 

could invest in unlisted closed-end funds and 

BDCs. For example, an acquiring fund could invest 

in interval funds under the proposed rule, which 

are closed-end funds that offer to repurchase their 

shares at periodic intervals pursuant to 17 CFR 

270.23c–3 (rule 23c–3 under the Investment 

Company Act), and are generally unlisted. Based on 

staff analysis, there were 39 interval funds, 

representing approximately $21 billion in assets, in 

2017. 

objectives in an efficient manner. We 

believe that the proposed rule would 

provide investors with the benefits of 

fund of funds arrangements, while 

protecting them from the historical 

abuses described above. We also 

propose to amend rule 12d1–1 under 

the Act to allow funds that rely on 

section 12(d)(1)(G) to invest in money 

market funds that are not part of the 

same group of investment companies in 

reliance on that rule.30

In developing this proposal, the 

Commission considered comments we 

received in response to a package of 

new rules and rule amendments focused 

largely on ETFs proposed in 2008.31

This proposal also takes into account 

Commission staff observations of 

developments in the industry since that 

time. 

II. Proposed Rule 12d1–4 

A. Scope of Proposed Rule 12d1–4 and 

Exemptions From Section 12(d)(1) of the 

Act 

Registered funds and BDCs. Proposed 

rule 12d1–4 would permit a registered 

investment company or BDC 

(collectively, ‘‘acquiring funds’’) to 

acquire the securities of any other 

registered investment company or BDC 

(collectively, ‘‘acquired funds’’) in 

excess of the limits in section 12(d)(1), 

subject to conditions that are designed 

to address historical abuses associated 

with fund of funds arrangements. 

Accordingly, open-end funds, UITs, 

closed-end funds (including BDCs), 

ETFs, and ETMFs could rely on 

proposed rule 12d1–4 as both acquiring 

and acquired funds.32

Today, an acquiring fund’s ability to 

invest in an acquired fund in excess of 

the limits in section 12(d)(1) varies 

significantly based on the type of 

acquiring fund. The following chart 

describes the types of fund of funds 

arrangements that have been permitted 

under our exemptive orders: 

Acquiring fund under exemptive orders Acquired fund under exemptive orders 

Open-end funds ........................................................................................ Open-end funds, UITs, ETFs, ETMFs, Listed closed-end funds,33 Listed BDCs. 

UITs .......................................................................................................... Open-end funds, UITs, ETFs, ETMFs, Listed closed-end funds. 

Closed-end funds (listed and unlisted) ..................................................... ETFs, ETMFs. 

BDCs (listed and unlisted) ........................................................................ ETFs. 

ETFs 34 ..................................................................................................... Open-end funds, UITs, ETFs, Listed closed-end funds, Listed BDCs. 

Proposed rule 12d1–4 would create a 

consistent framework for all registered 

funds and BDCs. The proposed rule 

would subject fund of funds 

arrangements to conditions that are 

tailored to different acquiring fund 

structures, rather than assessing the 

merit of a particular fund of funds 

arrangement on an individual basis. As 

described in more detail below, we 

believe that these tailored conditions 

would serve to protect fund investors at 

both tiers of a fund of funds 

arrangement. 

The following chart describes the 

types of fund of funds arrangements that 

would be permitted under proposed 

rule 12d1–4: 

Acquiring fund under proposed rule 12d1–4 Acquired funds under proposed rule 12d1–4 

Open-end funds ........................................................................................ Open-end funds. 

UITs .......................................................................................................... UITs. 

Closed-end funds (listed and unlisted) ..................................................... Closed-end funds (listed and unlisted).35

BDCs (listed and unlisted) ........................................................................ BDCs (listed and unlisted). 

ETFs ......................................................................................................... ETFs. 

ETMFs ...................................................................................................... ETMFs. 

Thus, in addition to the fund of funds 

arrangements currently allowed by our 

exemptive orders, the proposed rule 

would allow open-end funds, UITs, and 

ETFs to invest in unlisted closed-end 

funds and unlisted BDCs beyond the 

limits in section 12(d)(1). Proposed rule 

12d1–4 would similarly increase 

permissible investments for closed-end 

funds beyond ETFs and ETMFs to allow 

them to invest in open-end funds, UITs, 

other closed-end funds, and BDCs, in 

1290 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

36 In 2008, the proposed relief from section 

12(d)(1) was considered within the context of a 

broader ETF rule proposal and thus was limited to 

sales of shares of ETFs beyond the limits in section 

12(d)(1). That proposal, however, similarly would 

have permitted all registered funds and BDCs to act 

as acquiring funds under the rule. See 2008 

Proposing Release, supra footnote 13. 

37See 15 U.S.C. 80a–54(a) (prohibiting a BDC 

from making any investment unless, at the time of 

the investment, at least 70% of the BDC’s total 

assets are invested in securities of certain specific 

types of companies, which do not include funds). 

38See supra footnote 27. 

39Proposed rule 12d1–4(b)(1) would prohibit the 

acquiring fund and its advisory group from 

controlling (individually or in the aggregate) the 

acquired fund, with certain exceptions. Proposed 

rule 12d1–4(b)(2) would limit the amount of 

acquired fund shares that an acquiring fund may 

redeem directly from the acquired fund during any 

thirty-day period. See infra section II.C.1–2. 

40Proposed rule 12d1–4(b)(3). See infra section 

II.C.3. 

41Proposed rule 12d1–4(b)(4). See also infra 

section II.C.4. 

42Pursuant to sections 3(c)(1) and 3(c)(7), private 

funds are subject to the 3% limitation on 

investments in registered funds in section 

12(d)(1)(A)(i). Accordingly, private funds require 

relief from this section in order to invest in 

registered funds beyond the limits in section 

12(d)(1). See supra footnote 10. Because the 

limitations contained in sections 12(d)(1)(A)(i) and 

12(d)(1)(B)(i) referenced in 3(c)(1) and 3(c)(7) only 

apply to registered funds, private funds can invest 

in other private funds or unregistered investment 

companies without limitation. 

43See, e.g., Comment Letter of Barclays Global 

Fund Advisors (May 16, 2008) (‘‘BGFA Letter’’) (all 

investment companies subject to section 12(d)(1) 

should be included within the rule’s scope); 

Comment Letter of Managed Fund Association (May 

18, 2017) (‘‘MFA Letter’’); Comment Letter of The 

Bar of the City of New York (May 9, 2008) (‘‘NY 

Bar Letter’’); Comment Letter of State Street Global 

Advisors (May 19, 2008) (‘‘SSgA Letter’’). 

44See MFA Letter; SSgA Letter. 

45See MFA Letter; SSgA Letter. 

46See, e.g., MFA Letter; NY Bar Letter. 

47See infra section IV. However, Form PF and 17 

CFR 275.204(b)–1 (rule 204(b)–1 under the 

Investment Advisers Act of 1940 (the ‘‘Advisers 

Act’’)) require certain registered investment 

advisers to private funds to file Form PF to report 

information about the private funds they manage. 

See Reporting by Investment Advisers to Private 

Funds and Certain Commodity Pool Operators and 

Commodity Trading Advisors on Form PF, 

Investment Advisers Act Release No. 3308 (Oct. 31, 

2011) [76 FR 71128 (Nov. 16, 2011)]. 

48Form N–PORT requires certain registered 

investment companies to report information about 

their monthly portfolio holdings to the Commission 

in a structured data format. See Investment 

Company Reporting Modernization, Investment 

Company Act Release No. 32314 (Oct. 13, 2016) [81 

FR 81870 (Nov. 18, 2016)] (‘‘Reporting 

Modernization Adopting Release’’). 

excess of the section 12(d)(1) limits. 

Under the proposed rule, BDCs, which 

currently may only invest in ETFs in 

excess of the section 12(d)(1) limits, 

would additionally be permitted to 

invest in open-end funds, UITs, closedend funds, other BDCs, and ETMFs. 

Finally, the proposed rule would allow 

ETMFs to invest in all registered funds 

and BDCs. 

Expanding permissible fund of funds 

arrangements would provide funds 

covered by the rule with flexibility to 

meet their investment objectives. In 

addition, we believe that the proposed 

rule’s scope would eliminate 

unnecessary and potentially confusing 

distinctions among permissible 

investments for different types of 

acquiring funds. The proposed rule also 

would level the playing field among 

these entities, allowing each to invest in 

the same universe of acquired funds in 

excess of the limits in section 12(d)(1) 

without obtaining individualized 

exemptive relief from the Commission. 

We believe that the universe of 

permissible fund of funds arrangements 

generally should not turn on the type of 

the funds in the arrangement. Instead, 

we believe that the proposed rule 

should address differences in fund 

structures with tailored conditions 

designed to protect against the abuses 

historically associated with funds of 

funds.36 When conditioned 

appropriately, expanding the scope of 

permissible acquiring and acquired 

funds in the manner described above 

would create a consistent and 

streamlined regulatory framework, 

while addressing investor protection 

concerns. 

For example, we do not believe that 

expanding the scope of permissible 

acquiring funds to include BDCs would 

present investor protection concerns 

regarding undue influence, duplicative 

fees, or complex structures that the 

proposed rule’s conditions would not 

address. A BDC relying on the proposed 

rule as an acquiring fund also is subject 

to other limitations on its ability to 

invest in acquired funds.37 Similarly, 

we do not believe that including ETMFs 

within the scope of the proposed rule 

would present investor protection 

concerns that we have not already 

extensively considered with other 

investment products. We believe that 

the proposed rule’s conditions 

appropriately address investor 

protection concerns underlying section 

12(d)(1)(A) with respect to these 

products.38

Further, we believe that the proposed 

rule’s scope of permissible arrangements 

is appropriately calibrated based on our 

understanding of these investment 

products and our experience with 

conditions similar to the proposed rule’s 

conditions. As noted above, Congress 

specifically urged the Commission to 

monitor the evolution of legitimate fund 

of funds arrangements and permit such 

arrangements when investors are 

adequately protected against the abuses 

that led Congress to enact section 

12(d)(1). We believe that the proposed 

rule’s conditions appropriately guard 

against those abuses, serving to protect 

investors. More specifically, the 

proposed rule would limit an acquiring 

fund’s ability to exert undue influence 

over an acquired fund directly through 

ownership or indirectly through the 

threat of large-scale redemptions,39

would require evaluation of the fees 

associated with a fund of funds 

arrangement,40 and would guard against 

unduly complex fund of funds 

structures.41 Accordingly, we believe 

that the proposed exemptions from 

sections 12(d)(1)(A), (B), and (C) are 

consistent with the public interest and 

the protection of investors under section 

12(d)(1)(J) of the Act. 

Private funds. Similar to the 2008 

proposal, private funds would not be 

within the proposed rule’s scope of 

acquiring funds.42 Several commenters 

on the 2008 proposal urged us to 

include private funds within that 

proposed rule’s scope.43 They argued 

that the conditions of the 2008 proposed 

rule would prevent abuses by acquiring 

private funds in the same way that the 

conditions would prevent abuses by 

registered acquiring funds. For example, 

some commenters stated that the rule’s 

prohibition of control by an acquiring 

fund and the restrictions on direct 

redemptions would protect an acquired 

ETF from being unduly influenced by 

an acquiring private fund.44 Some also 

stated that the risks associated with 

duplicative fees and overly complex 

structures are less concerning when the 

acquiring fund is a private fund, 

because private fund investors may be 

better able to understand the complex 

structure and judge the propriety of the 

private fund’s fees than some investors 

in other types of acquiring funds.45

They also argued that private fund 

investment in ETFs would benefit ETFs 

by increasing the liquidity of ETF shares 

and furthering economies of scale, and 

would benefit private funds by 

permitting them to invest in specific 

sectors in an efficient manner.46

The proposed rule would not include 

private funds as acquiring funds 

because private funds are not registered 

with the Commission and would not be 

subject to the reporting requirements 

that we propose below on Form N–CEN 

regarding reliance on the proposed 

rule.47 Private funds also would not 

report information regarding their 

acquired fund holdings on Form N– 

PORT.48 In addition, private funds are 

not subject to recordkeeping 

requirements under the Investment 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1291 

49See, e.g., 17 CFR 270.31a–1 (rule 31a–1) (setting 

forth certain recordkeeping requirements for 

registered investment companies). While the 

records of a private fund to which a registered 

investment adviser provides investment advice are 

deemed to be the records of the investment adviser 

under the Investment Advisers Act of 1940 (the 

‘‘Advisers Act’’), there is no requirement for the 

private fund to create these records under the 

Investment Company Act. See section 204(b)(2) of 

the Investment Advisers Act [15 U.S.C. 80b– 

4(b)(2)]. 

50To date, our exemptive orders have not 

permitted private funds to invest in registered funds 

beyond the limits in section 12(d)(1)(A)(i) of the 

Act. 

51See supra footnote 10 and accompanying text. 

We use the term ‘‘foreign fund’’ to refer to an 

‘‘investment company’’ as defined in section 

3(a)(1)(A) of the Investment Company Act that is 

organized outside the United States and that does 

not offer or sell its securities in the United States 

in connection with a public offering. See section 

7(d) of the Investment Company Act (prohibiting a 

foreign fund from using the U.S. mails or any means 

or instrumentality of interstate commerce to offer or 

sell its securities in connection with a public 

offering unless the Commission issues an order 

permitting the foreign fund to register under the 

Act). An unregistered foreign fund, as discussed in 

this release, may be registered in a foreign 

jurisdiction, such as under the European Union’s 

directive regarding Undertakings for Collective 

Investments in Transferable Securities (‘‘UCITS’’). 

A foreign fund may conduct a private U.S. offering 

in the United States without violating section 7(d) 

of the Act only if the foreign fund conducts its 

activities with respect to U.S. investors in 

compliance with either section 3(c)(1) or 3(c)(7) of 

the Act (or some other available exemption or 

exclusion). See Exemptions for Advisers to Venture 

Capital Funds, Private Fund Advisers With Less 

Than $150 Million in Assets Under Management, 

and Foreign Private Advisers, Investment Advisers 

Act Release No. 3222 (June 22, 2011) [76 FR 39646 

(July 6, 2011)] (‘‘Exemptions Release’’). 

52The Commission has taken the position that a 

foreign fund that uses U.S. jurisdictional means in 

the offering of the securities it issues and that relies 

on section 3(c)(1) or 3(c)(7) of the Investment 

Company Act would be a private fund. See 

Exemptions Release, supra footnote 51 (citing 

Dechert LLP, Staff No-Action Letter (Aug. 24, 2009) 

at n.8 (noting that under certain circumstances, a 

foreign fund may make a private U.S. offer in 

reliance on the exclusion from the definition of 

‘‘investment company’’ in sections 3(c)(1) or 3(c)(7) 

of the Act, and such a foreign fund is subject to 

section 12(d)(1) to the same extent as a U.S. 3(c)(1) 

or 3(c)(7) fund)). 

53The legislative history of the 1970 amendments 

suggests that Congress primarily intended to 

address four abusive practices: pyramiding of 

voting control; undue influence over an acquired 

fund through the threat of large-scale redemptions; 

investor confusion caused by complex fund of 

funds structures; and layering of costs. See PPI 

Report, supra footnote 16. With respect to foreign 

funds as acquiring funds, the PPI Report noted that 

‘‘redemptions could be unduly escalated by the 

instability of certain foreign economies, political 

upheaval, currency reform, or other factors which 

are not really relevant to investment in domestic 

mutual funds.’’ See id at 318. 

54See supra footnote 9. 

55To date, our exemptive orders have not 

permitted unregistered funds to invest in registered 

funds beyond the limits in section 12(d)(1)(A) of the 

Act. 

56 In several staff no-action letters, the staff has 

stated that, based on certain facts and 

circumstances, it would not recommend that the 

Commission take any enforcement action under 

section 12(d)(1)(A) (and other sections of the Act) 

if the sponsor of a UIT deposits units of existing 

series in portfolios of futures series of the UIT. See, 

e.g., Municipal Investment Trust Fund, Staff NoAction Letter (pub. avail. Oct. 25, 1975); The Ohio 

Company, Staff No-Action Letter (pub. avail. March 

14, 1977); First Trust of Insured Municipal Bonds, 

Staff No-Action Letter (pub. avail. Feb. 25, 1979). 

Company Act.49 Even if an acquired 

fund kept records relating to this 

arrangement, that alone may not provide 

an adequate basis for monitoring 

compliance with the proposed rule’s 

conditions. 

Accordingly, we do not propose to 

include private funds as acquiring funds 

under the scope of the rule. Given the 

policy considerations discussed above, 

we believe it is appropriate for private 

funds to request relief from sections 

12(d)(1)(A) and (B) of the Act through 

our exemptive application process, and 

for the Commission to weigh these 

policy considerations in the context of 

the facts and circumstances of each 

particular applicant.50

Unregistered investment companies. 

Unregistered investment companies, 

such as foreign funds, also are excluded 

from the scope of proposed rule 12d1– 

4.51 We have the same concerns 

regarding fund of funds arrangements 

involving unregistered investment 

companies that we discussed above for 

private funds.52 By definition, these 

investment companies are not registered 

with the Commission and would not be 

subject to the reporting requirements 

that we propose below on Form N–CEN 

regarding reliance on the proposed rule. 

Furthermore, unregistered foreign 

funds’ investments in U.S. registered 

funds, and certain abusive practices that 

were associated with such investments, 

were a concern underlying Congress’s 

amendments to section 12(d)(1) in 

1970.53 Those amendments expanded 

the scope of section 12(d)(1) to include 

unregistered investment companies.54

We therefore do not propose to include 

unregistered investment companies as 

acquiring funds under the rule. As with 

private funds, we believe it is 

appropriate for unregistered investment 

companies to request relief from 

sections 12(d)(1)(A) and (B) of the Act 

through our exemptive application 

process, and for the Commission to 

weigh the applicable policy 

considerations in the context of the facts 

and circumstances of each particular 

applicant.55

We request comment on the scope of 

proposed rule 12d1–4: 

• Should the exemptive relief under 

the proposed rule include all registered 

funds and BDCs within the scope of 

‘‘acquired funds’’ and ‘‘acquiring funds’’ 

as proposed? Should we define those 

terms more broadly or more narrowly? 

• Should we limit the scope of the 

proposed rule to track the scope of 

existing fund of funds exemptive relief? 

For example, should we exclude closedend funds and BDCs that are not listed 

on a national securities exchange from 

the scope of ‘‘acquired funds’’ under the 

proposed rule, maintaining the status 

quo for those investments? 

• Are there investor protection 

concerns with including closed-end 

funds and BDCs that are not listed on 

a national securities exchange in the 

scope of the ‘‘acquired funds’’? If so, 

what concerns, and why? 

• Would including these unlisted 

closed-end funds and BDCs in the scope 

of ‘‘acquired funds’’ affect an acquiring 

fund’s liquidity risk management, 

including acquiring funds subject to 

rule 22e–4 under the Act? If so, how? 

• Should closed-end funds and BDCs 

be permitted to rely on the rule as 

acquiring funds only with respect to 

investments in ETFs and ETMFs or with 

respect to some other limited subset of 

acquired funds? 

• Should UITs be permitted to invest 

in BDCs under the proposed rule? 

Would such an arrangement present any 

concerns that are not addressed by the 

proposed rule’s conditions? 

• Should the scope of proposed rule 

12d1–4 include ETMFs as acquiring 

funds, as proposed? Are there any 

special concerns we should consider 

with respect to ETMFs, given that we 

have less experience with fund of fund 

arrangements involving these funds? 

• Should the proposed rule expressly 

allow sponsors of UITs to deposit units 

of existing UITs into portfolios of new 

UIT series beyond the limits of section 

12(d)(1)? 56 If so, why, and should the 

proposed rule include conditions 

specifically related to such relief? For 

example, should the proposed rule 

expressly require that no sales charges 

are charged in connection with the 

deposit of units of the existing UIT in 

the portfolio of the future UIT? Are 

there other conditions we should 

consider? 

• Are there additional conditions we 

should consider for any subset of 

acquiring funds or acquired funds? Are 

there any proposed conditions that 

should apply only to a subset of 

acquiring funds or acquired funds? 

• Should the scope of proposed rule 

12d1–4 include private funds as 

acquiring funds? If so, should private 

funds be permitted to invest in all types 

of acquired funds under the rule? Or 

should they be limited to investments in 

funds that may be bought and sold on 

1292 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

57 Investment advisers register with the 

Commission by completing Form ADV and filing 

Parts 1A and 2A of that form with the Commission. 

Exempt reporting advisers also file reports with the 

Commission on Form ADV. Form ADV generally 

requires advisers to private funds to report certain 

information regarding those funds. See generally, 

Rules Implementing Amendments to Investment 

Advisers Act of 1940, Investment Advisers Act 

Release No. 3221 (June 22, 2011) [76 FR 42950 (July 

19, 2011)]. See also Item 7.B and Section 7.B. of 

Schedule D of Form ADV. 

58See supra footnote 51. 

59Proposed rule 12d1–4(a). 

60An affiliated person of a fund includes: (i) Any 

person directly or indirectly owning, controlling, or 

holding with power to vote, 5% or more of the 

outstanding voting securities of the fund; and (ii) 

any person 5% or more of whose outstanding voting 

securities are directly or indirectly owned, 

controlled, or held with power to vote by the fund. 

See 15 U.S.C. 80a–2(a)(3)(A), (B). Section 17 also 

restricts certain transactions involving funds that 

are affiliated because both funds have a common 

investment adviser or other person exercising a 

controlling influence over the management or 

policies of the funds. See 15 U.S.C. 80a–2(a)(3)(C). 

The determination of whether a fund is under the 

control of its advisers, officers, or directors depends 

on all the relevant facts and circumstances. See 

infra section II.C.1. 

61See Investment Trusts and Investment 

Companies: Hearings on S. 3580 Before a 

Subcomm. of the Senate Comm. On Banking and 

Currency, 76th Cong., 3rd Sess. 37 (1940) 

(Statement of Commissioner Healy). 

62 If an acquiring fund holds 5% percent or more 

of the outstanding voting shares of an acquired 

fund, the acquiring fund is an affiliated person of 

the acquired fund and the acquired fund is an 

affiliated person of the acquiring fund. In general, 

to the extent that purchases and sales of acquired 

fund shares occur on the secondary market and not 

through principal transactions directly between an 

acquiring fund and an acquired fund, relief from 

section 17(a) would not be necessary. 

63As discussed below, the proposed rule would 

allow fund of funds arrangements when: (i) The 

acquiring fund is in the same group of investment 

companies as the acquired fund; or (ii) the 

acquiring fund’s investment sub-adviser or any 

person controlling, controlled by, or under common 

control with such investment sub-adviser acts as 

the acquired fund’s investment adviser. See infra 

section II.C.1. For purposes of this section, we 

assume that funds in the same group of investment 

companies are under common control because 

funds that are not affiliated persons would not 

require relief from section 17(a). See Fund of Funds 

Adopting Release, supra footnote 17. 

64An ETF would be prohibited under section 

17(a)(2) from purchasing securities and other 

property (i.e., securities and other property in the 

ETF’s basket assets) from the affiliated acquiring 

fund in exchange for ETF shares. An acquiring fund 

would be prohibited under section 17(a)(1) from 

selling any securities and other property (i.e., 

securities and other property in the ETF’s basket 

assets) to an affiliated ETF in exchange for the 

ETF’s shares. The orders we have granted 

permitting investments in ETFs provide relief from 

section 17(a) of the Act to permit these transactions. 

See, e.g., Barclays Global Fund Advisors, et al., 

Investment Company Act Release Nos. 24394 (Apr. 

17, 2000) [65 FR 21215 (Apr. 20, 2000)] (notice) and 

24451 (May 12, 2000) (order) and related 

application. In addition, our orders provide 

separate affiliated transaction relief for the 

acquisition or sale of an ETF’s basket assets as part 

of the creation or redemption of ETF creation units. 

Such relief is subject to its own protections. See 

2018 ETF Proposing Release, supra footnote 34. The 

exemptive orders granted to ETMFs have included 

similar exemptions from section 17(a). See Eaton 

Vance, supra footnote 27. 

an exchange, such as closed-end funds 

and ETFs? 

• If we permit private funds to rely on 

the rule as acquiring funds, should the 

rule include additional conditions 

designed to address private fund 

investments? For example, should the 

rule only be available to a private fund 

with an SEC-registered investment 

adviser? Should we also permit private 

funds with exempt reporting advisers to 

rely on the rule? How should we treat 

private funds that are sub-advised for 

these purposes? Should the rule be 

available only to a private fund for 

which an investment adviser provides 

information on Form ADV? 57 Should 

we require additional reporting on Form 

ADV regarding whether a private fund 

relies on rule 12d1–4? 

• Should we allow unregistered 

investment companies, including 

foreign funds, to rely on the rule as 

acquiring funds? If we permit 

unregistered investment companies to 

rely on the rule, should we include 

additional conditions in rule 12d1–4 

designed to address an unregistered 

investment company’s investments? If 

so, what conditions? 

• Should we continue to take the 

interpretive position that foreign funds 

that make private offerings in the U.S. 

in reliance on section 3(c)(1) or 3(c)(7) 

are private funds for purposes of section 

12(d)(1)? Alternatively, should we only 

treat foreign funds that conduct their 

activities with respect to U.S. investors 

in compliance with section 3(c)(1) or 

3(c)(7) and are privately offered outside 

the United States as private funds for 

purposes of section 12(d)(1)? For 

example, should we take the position 

that a fund that conducts a private U.S. 

offering in compliance with sections 

3(c)(1) or 3(c)(7), but also conducts a 

public offering in a foreign jurisdiction 

(e.g., certain UCITS funds),58 is an 

investment company, rather than a 

private fund, solely for purposes of 

section 12(d)(1)? Should the treatment 

of foreign funds as private funds differ 

when the foreign fund is an acquiring 

fund versus when the foreign fund is an 

acquired fund? Are there different or 

greater concerns, particularly regarding 

duplicative fees and complex structures, 

if registered funds are permitted to 

invest in foreign funds in excess of the 

limits in section 12(d)(1)(A) than there 

are with domestic private funds or 

registered funds? 

• If we permit private funds or 

unregistered investment companies to 

rely on rule 12d1–4, should we require 

those acquiring funds to make certain 

filings with the Commission disclosing 

their reliance on the rule? If so, should 

we promulgate a new form for those 

filings, and what information should be 

required on this form? For example, 

should we consider requiring these 

funds to report information to the 

Commission regarding their amount of 

holdings in an acquired fund? How 

frequently should we require these 

funds to report such information? For 

example, should we require monthly 

filings? Should reports be filed more or 

less frequently? Should those reports be 

public or non-public? Would any 

special concerns arise with respect to 

such a condition? To the extent that a 

foreign fund is registered in a foreign 

jurisdiction, should we consider 

requests for substituted compliance 

when the foreign fund complies with 

comparable non-U.S. rules? 

B. Exemptions From the Act’s 

Prohibition on Certain Affiliated 

Transactions 

Proposed rule 12d1–4 would provide 

exemptive relief from section 17(a) of 

the Act.59 Section 17 of the Act 

generally prohibits an affiliated person 

of a fund, or any affiliated person of 

such person, from selling any security 

or other property to, or purchasing any 

security or other property from, the 

fund.60 It is designed to prevent 

affiliated persons from managing the 

fund’s assets for their own benefit, 

rather than for the benefit of the fund’s 

shareholders.61

Absent exemptive relief, section 17(a) 

would prohibit a fund that holds 5% or 

more of the acquired fund’s securities 

from making any additional investments 

in the acquired fund.62 Fund of funds 

arrangements involving funds that are 

part of the same group of investment 

companies or that have the same 

investment adviser (or affiliated 

investment advisers) also implicate the 

Act’s protections against affiliated 

transactions, regardless of whether an 

acquiring fund exceeds the 5% 

threshold.63 Furthermore, in instances 

where an ETF is an acquired fund, 

section 17(a) would prohibit the 

delivery or deposit of basket assets on 

an in-kind basis by an affiliated fund 

(that is, by exchanging certain assets 

from the ETF’s portfolio, rather than in 

cash).64

Section 17(b) of the Act authorizes the 

Commission to exempt a proposed 

transaction from the provisions of 

section 17(a) if the terms of the 

transaction, including the consideration 

to be paid or received, are fair and 

reasonable and do not involve 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1293 

65The Commission has interpreted its authority 

under section 17(b) as extending only to a single 

transaction and not a series of transactions. See In 

re Keystone Custodian Funds, Inc., 21 SEC. 295 

(1945) (exempting, under section 6(c) of the Act, a 

series of transactions that otherwise would be 

prohibited by section 17(a)). The Commission’s 

exemptive authority under section 6(c), however, is 

not constrained to a single transaction. The 

Commission looks to the standards set forth in 

section 17(b) when issuing exemptions by rule from 

section 17(a). 

66See infra sections II.C.1 and 2. 

67The purchase of open-end fund or UIT shares 

must be at a price based on the current NAV of the 

shares which is next-computed after receipt of a 

tender of an offer to purchase or redeem the shares. 

See section 22(c) of the Act and 17 CFR 270.22c– 

1 (rule 22c–1). Primary market transactions with an 

ETF (or an ETMF) would also be done at a price 

based on NAV. See 2018 ETF Proposing Release, 

supra footnote 34; Eaton Vance, supra footnote 27. 

68Closed-end fund shares typically are bought 

and sold on the secondary market. In cases where 

closed-end funds engage in repurchase transactions, 

such as with interval funds, the pricing of the 

closed-end fund’s shares in those transactions are 

subject to certain rules. See, e.g., rule 23c–3; see 

also section 23(c)(2) of the Act (providing for offers 

to repurchase closed-end funds to be made only 

after all holders of securities are given reasonable 

opportunity to submit tenders); 17 CFR 270.23c– 

1(a)(6) (rule 23c–1(a)(6)) (requiring repurchase of 

closed-end fund shares be made at a price not above 

the market value, if any, or the asset value of such 

security, whichever is lower, at the time of such 

purchase); 17 CFR 270.23c–1(a)(9) (rule 23c–1(a)(9)) 

(requiring that the purchase be made in a manner 

or on a basis that does not unfairly discriminate 

against any holders of the class of securities 

purchased). 

69Without an exemption from section 17(a), an 

acquired fund generally could not sell its shares to, 

or redeem or repurchase those shares from, an 

affiliated acquiring fund. 

70See e.g., Schwab, supra footnote 25; Franklin 

Fund, supra footnote 25; Innovator ETFs, supra 

footnote 33. We believe that section 12(d)(1)(G) of 

the Act also implies relief under section 17(a) of the 

Act with respect to the acquisition or sale of shares 

of an acquired fund within the same group of 

investment companies. 

71See 2008 Proposing Release, supra footnote 13. 

72See ICI Letter; Comment Letter of Xshares 

Advisors, LLC (May 20, 2008) (‘‘Xshares Letter’’). 

73See ICI Letter. 

74See, e.g., Schwab, supra footnote 25; Franklin 

Fund, supra footnote 25; Innovator ETFs, supra 

footnote 33. 

75For example, the conditions regarding layering 

of fees vary based on the structure of acquiring 

fund. See infra section II.C.3. 

overreaching on the part of any person 

concerned, and the transaction is 

consistent with the policy of the 

investment company as recited in the 

fund’s registration statement and the 

general purposes of the Act. In addition, 

section 6(c) of the Act permits the 

Commission to exempt any person, 

security, or transaction or any class or 

classes of persons, securities or 

transactions from any provision of the 

Act if such exemption is necessary or 

appropriate in the public interest and 

consistent with the protection of 

investors and the purposes fairly 

intended by the policy and provisions of 

the Act.65 We believe that the 

exemptions from section 17(a) set forth 

in the proposed rule meet the standards 

set forth in sections 17(b) and 6(c). We 

believe that the proposed rule’s 

conditions make unlikely the prospect 

of overreaching by an affiliated fund. 

For example, the proposed rule’s 

redemption limit would prevent an 

acquiring fund (including an acquiring 

fund that is an affiliate of the acquired 

fund) from threatening to quickly 

redeem or tender a large volume of 

acquired fund shares as a means to exert 

undue influence over an acquired 

fund.66

An acquired fund that is an open-end 

fund or UIT is further protected from 

overreaching due to the requirement 

that all purchasers receive the same 

price.67 In the case of a closed-end 

acquired fund, we similarly believe that 

the acquired fund’s repurchase of its 

shares would provide little opportunity 

for the acquiring fund to overreach 

because all holders would receive the 

same share price.68

In addition, the utility of the proposed 

rule would be limited if we did not 

exempt fund of funds arrangements 

from the affiliated transaction 

prohibitions in section 17(a). As a 

practical matter, without an exemption 

from section 17(a), an acquiring fund 

would be subject to a 5% limit on 

investments in acquired funds under 

proposed rule 12d1–4.69 Similarly, a 

fund of funds arrangement involving 

funds that are part of the same group of 

investment companies or that have the 

same investment adviser (or affiliated 

investment advisers) would not be able 

to rely on proposed rule 12d1–4 without 

such an exemption. We also believe that 

the proposed exemption from section 

17(a) is necessary in light of the goals of 

rule 12d1–4. Existing orders have 

provided similar exemptive relief from 

the affiliated transaction provisions in 

section 17(a) for many years.70

We proposed exemptions from section 

17(a) in connection with our 2008 

proposal, which would have permitted 

an ETF that is an affiliated person of an 

acquiring fund to purchase and sell ETF 

shares to the acquiring fund at NAV.71

We noted there that we did not believe 

providing these exemptions would 

implicate the concerns underlying 

section 17(a). Commenters that 

addressed these provisions in the 2008 

Proposing Release agreed with the 

proposed relief under section 17(a).72

One commenter, in particular, noted 

that the exemption was appropriate in 

light of the proposed protections in the 

rule, which provided little opportunity 

for the acquiring fund to manage an 

acquired fund for its own benefit.73

We request comment on the affiliated 

transaction exemptions in proposed rule 

12d1–4. 

• Do the acquiring funds that 

currently invest in acquired funds on 

the basis of the relief provided in our 

orders typically acquire 5% or more of 

the acquired fund’s outstanding voting 

securities? 

• Is the scope of the proposed 

exemptions from section 17(a) 

sufficiently broad to allow funds to use 

the exemptive relief we propose to grant 

from sections 12(d)(1)(A)–(C)? Should 

the scope of the proposed exemptions 

include transactions on the secondary 

market? If so, why? 

C. Conditions 

Consistent with the public interest 

and the protection of investors, 

proposed rule 12d1–4 includes 

conditions designed to prevent the 

abuses that historically were associated 

with fund of funds arrangements and 

that led Congress to enact section 

12(d)(1). These conditions are based on 

conditions in exemptive orders that the 

Commission has issued permitting fund 

of funds arrangements.74 However, we 

propose to streamline these conditions 

to enhance compliance and strengthen 

investor protections. The proposed rule 

would establish a comprehensive 

framework that would subject fund of 

funds arrangements to a tailored set of 

conditions that address differences in 

fund structures.75 The following table 

sets forth a general overview of the 

differences between the conditions 

under our current exemptive relief and 

the proposed rule: 

1294 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

76See, e.g., Schwab, supra footnote 25. 

77See proposed rule 12d1–4(b)(1)(i); proposed 

rule 12d1–4(d) (defining ‘‘advisory group’’). See 

also infra section II.C.1.b. (discussing exceptions to 

the control condition). 

78See, e.g., Wells Fargo Funds Trust, et al., 

Investment Company Act Release Nos. 30201 (Sept. 

12, 2012) [77 FR 57597 (Sept. 18, 2012)] (notice) 

and 30231 (Oct. 10, 2012) (order) and related 

application (prohibiting an acquiring fund (and its 

advisory group and sub-advisory group) from 

controlling an acquired fund). See also 2008 

Proposing Release, supra footnote 13 (prohibiting 

an acquiring fund, any of its investment advisers or 

depositors, or any company in a control 

relationship with any of those entities from 

controlling an ETF, individually or in the 

aggregate). 

79 15 U.S.C. 80a–2(a)(9). 

80 Id. These presumptions continue until the 

Commission makes a final determination to the 

contrary by order either on its own motion or on 

application by an interested person. 

81 ‘‘[N]o person may rely on the presumption that 

less than 25% ownership is not control when, in 

fact, a control relationship exists under all the facts 

and circumstances.’’ Exemption of Transactions by 

Investment Companies with Certain Affiliated 

Persons, Investment Company Act Release No. 

10698 (May 16, 1979) [44 FR 29908 (May 23, 1979)], 

at n.2. 

82We have long held that ‘‘controlling influence’’ 

includes, in addition to voting power, a dominating 

persuasiveness of one or more persons, the act or 

process that is effective in checking or directing 

action or exercising restraint or preventing free 

action, and the latent existence of power to exert 

a controlling influence. See, e.g., In re Investors 

Mutual, Inc., et al., Investment Company Act 

Release No. 4595 (May 11, 1966) (Commission 

opinion), at text accompanying nn.11–14 (citing 

The Chicago Corporation, Investment Company Act 

Release No. 1203 (Aug. 24, 1948); Transit 

Investment Corporation, Investment Company Act 

Release No. 927 (July 31, 1946); In the Matter of the 

M.A. Hanna Company, Investment Company Act 

Release No. 265 (Nov. 26, 1941)). 

83Proposed rule 12d1–4(d) defines ‘‘advisory 

group,’’ to mean ‘‘either: (1) an acquiring fund’s 

investment adviser or depositor, and any person 

controlling, controlled by, or under common 

control with such investment adviser or depositor; 

or (2) an acquiring fund’s investment sub-adviser 

and any person controlling, controlled by, or under 

common control with such investment subadviser.’’ Under the proposed rule, an acquiring 

fund would not combine the entities listed in clause 

(1) with those listed in clause (2). 

84See proposed rule 12d1–4(b)(1)(ii). 

Concern addressed Condition under existing 

exemptive orders 

Condition under proposed 

rule 12d1–4 

Undue Influence ............. Voting conditions (including the point at which the voting 

condition is triggered) differ based on the type of acquired fund.

Voting conditions do not differ based on the type of acquired fund and would require an acquiring fund and 

its advisory group to use pass-through or mirror voting 

when they hold more than 3% of the acquired fund’s 

outstanding voting securities. 

Fund boards must make certain findings and adopt procedures to prevent overreaching and undue influence 

by the acquiring fund and its affiliates.

Requires an agreement between acquiring and acquired 

funds agreeing to fulfill their responsibilities under the 

exemptive order (a ‘‘participation agreement’’).

An acquiring fund’s ability to quickly redeem or tender a 

large volume of acquired fund shares is restricted (replacing the requirements for participation agreements 

and board findings/procedures). 

Complex Structures ........ Limits the ability of an acquired fund to invest in underlying funds (that is, it limits structures with three or 

more tiers of funds).

Limits the ability of funds relying on certain exemptions 

to invest in an acquiring fund and limits the ability of 

an acquired fund to invest in other funds. 

Requires an evaluation of the complexity of the fund of 

funds structure and aggregate fees. Specific considerations vary by acquiring fund structure. 

Layering of Fees ............. Caps sales charges and service fees at limits under current FINRA sales rule (rule 2830) even in circumstances where the rule would not otherwise apply.

Requires an acquiring fund’s adviser to waive advisory 

fees in certain circumstances or requires the acquiring 

fund’s board to make certain findings regarding advisory fees.

Requires an evaluation of the complexity of the fund of 

funds structure and aggregate fees. Specific considerations vary by acquiring fund structure. 

Other than the differences described 

in this table, the conditions in proposed 

rule 12d1–4 are substantially similar to 

the conditions that have been included 

in our exemptive orders since 1999.76

We discuss each of the proposed 

conditions below. 

1. Control 

In order to address the concern that a 

fund could exert undue influence over 

another fund, proposed rule 12d1–4 

prohibits an acquiring fund and its 

advisory group from controlling, 

individually or in the aggregate, an 

acquired fund, except in the 

circumstances discussed below.77 This 

condition generally comports with the 

conditions of the exemptive relief the 

Commission has previously issued and 

our 2008 proposal.78

The Act defines control to mean the 

power to exercise a controlling 

influence over the management or 

policies of a company, unless such 

power is solely the result of an official 

position with such company.79 The Act 

also creates a rebuttable presumption 

that any person who directly or 

indirectly beneficially owns more than 

25% of the voting securities of a 

company controls the company and that 

one who does not own that amount does 

not control it.80 A determination of 

control depends on the facts and 

circumstances of the particular 

situation.81

Accordingly, an acquiring fund and 

its advisory group’s beneficial 

ownership of up to 25% of the voting 

securities of an acquired fund would be 

presumed to not constitute control over 

the acquired fund. A fund relying on the 

proposed rule, therefore, generally 

could make a substantial investment in 

an acquired fund (i.e., up to 25% of the 

acquired fund’s shares). If, however, 

facts and circumstances existed that 

gave an acquiring fund and its advisory 

group the power to exercise a 

controlling influence over the acquired 

fund’s management or policies other 

than as discussed below, that fund 

would not be able to rely on the 

proposed rule even if the fund and its 

advisory group owned 25% or less of 

the acquired fund’s voting securities.82

In assessing control, an acquiring 

fund’s investment in an acquired fund 

would be aggregated with the 

investment of the acquiring fund’s 

advisory group. Consistent with past 

exemptive orders, the proposed rule 

would not require an acquiring fund to 

aggregate the ownership of an acquiring 

fund advisory group with an acquiring 

fund sub-advisory group.83 Instead, 

each of these groups would consider its 

ownership percentage separately and 

would be subject to the same voting 

provisions as discussed below.84

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1295 

85See, e.g., BGFA Letter; Comment Letter of 

Stradley Ronon Stevens & Young LLP (May 19, 

2008) (‘‘Stradley Letter’’); ICI Letter; Xshares Letter. 

86See, e.g., ICI Letter. 

87See, e.g., Xshares Letter. Section 12(d)(1)(B) 

prohibits an acquired fund from ‘‘knowingly’’ 

selling or otherwise disposing of a security issued 

by the acquired fund to any other investment 

company. Section 12(d)(1)(A) does not include a 

similar ‘‘knowing’’ element. 

88See, e.g., section 17(a) of the Act (prohibiting 

first- and second-tier affiliates of a fund from 

borrowing money or other property, or selling or 

buying securities or other property to or from the 

fund, or any company that the fund controls). See 

also supra footnote 60 and accompanying text. 

89See 17 CFR 270.38a–1 (rule 38a–1 under the 

Act) (requiring registered investment companies to 

adopt, implement and periodically review written 

policies and procedures reasonably designed to 

prevent violations of the federal securities laws). 

See also Compliance Programs of Investment 

Companies and Investment Advisers, Investment 

Company Act Release No. 26299 (Dec. 17, 2003) [68 

FR 74714 (Dec. 24, 2003)] (‘‘Compliance Rule 

Adopting Release’’) (noting that funds or their 

advisers should have policies and procedures in 

place to identify affiliated persons and to prevent 

unlawful transactions with them). 

90Proposed rule 12d–4(b)(1)(ii). The acquiring 

fund would be required to follow the prescribed 

voting procedures only so long as such holdings 

remain above the 3% holdings threshold. This 

threshold would be calculated as of the record date 

for a vote at an annual or special meeting of the 

holders of the acquired fund’s shares. 

91See proposed rule 12d1–4(b)(1)(ii). 

92See, e.g., Fund of Funds Adopting Release, 

supra footnote 17 (funds relying on section 

12(d)(1)(F) of the Act are required to follow the 

section 12(d)(1)(E)(iii) voting procedures so that 

‘‘the [acquiring] fund’s adviser would not be able 

to influence the outcome of shareholder votes in the 

acquired fund.’’). 

93See Innovator ETFs, supra footnote 33. 

94See, e.g., Janus Investment Fund, et al., 

Investment Company Act Release Nos. 31753 (Aug. 

13, 2015) (notice) and 31808 (Sept. 9, 2015) (order) 

and related application (‘‘Janus Investment Fund’’). 

Our 2008 proposal would have included a similar 

condition for investments in ETFs. See 2008 

Proposing Release, supra footnote 13. 

We believe requiring an acquiring 

fund to aggregate its holdings with its 

advisory group would prevent a fund or 

adviser from circumventing the control 

condition by investing in an acquired 

fund through multiple controlled 

entities, e.g., other funds in the fund 

complex. Several commenters on our 

2008 proposal, however, urged us to 

narrow the scope of entities that an 

acquiring fund would be required to 

aggregate when determining whether an 

acquiring fund controls an ETF.85 These 

commenters noted that the scope of the 

2008 Proposing Release’s control 

prohibition was broader than that of 

section 12(d)(1)(A), which prohibits 

only an acquiring fund and companies 

it controls from acquiring in the 

aggregate more than 3% of an ETF’s 

shares.86 They also noted the difficulty 

of complying with the proposed 

aggregation requirement, particularly for 

those funds whose advisers are part of 

large financial organizations where 

information barriers may preclude the 

adviser from knowing positions held, 

for example, by advisers under common 

control.87

Because the control condition 

effectively allows an acquiring fund and 

its advisory group to obtain a significant 

ownership stake in an acquired fund, 

we do not believe it is appropriate to 

limit the affiliates that are subject to this 

condition as suggested by commenters 

in 2008. Our exemptive orders include 

a similar condition and funds relying on 

those orders likely already have 

established policies and procedures to 

monitor compliance with the 

aggregation requirement embedded in 

the proposed definition of the term 

‘‘advisory group.’’ Other provisions of 

the Act and our rules also extend to 

affiliated persons of an investment 

adviser.88 Funds (or the advisers) have 

experience developing compliance 

policies and procedures in those 

circumstances.89 Finally, we also do not 

believe that the breadth of the entities 

that are included within an acquiring 

fund and its advisory group would limit 

the usefulness of proposed rule 12d1–4. 

Instead, the risk of undue influence over 

an acquired fund would be more 

effectively addressed by requiring the 

entities that fall within these definitions 

to aggregate their holdings in an 

acquired fund for purposes of the 

control condition. 

In some circumstances, such as net 

redemptions, an acquiring fund’s 

holdings may trigger the Act’s control 

presumption through no action of its 

own. If the acquiring fund and its 

advisory group become a holder of more 

than 25% of the outstanding voting 

securities of an acquired fund as a result 

of a decrease in the outstanding voting 

securities of the acquired fund, the 

proposed rule would not require an 

acquiring fund to dispose of acquired 

fund shares. An acquiring fund, 

however, would not be able to rely on 

the proposed rule to acquire additional 

securities of the acquired fund when it 

(along with its advisory group) holds 

more than 25% of the acquired fund’s 

voting securities. 

a. Voting Provisions 

The proposed rule would require an 

acquiring fund and its advisory group to 

vote their securities in the manner 

prescribed by section 12(d)(1)(E)(iii)(aa) 

of the Act if the acquiring fund and its 

advisory group (in the aggregate) hold 

more than 3% of the outstanding voting 

securities of an acquired fund.90 In these 

circumstances, the acquiring fund 

would be required to either: (i) Seek 

voting instructions from its security 

holders and vote such proxies in 

accordance with their instructions 

(‘‘pass-through voting’’); or (ii) vote the 

shares held by it in the same proportion 

as the vote of all other holders of the 

acquired fund (‘‘mirror voting’’).91 This 

proposed condition is designed to limit 

the acquiring fund and its advisory 

group’s power to influence the outcome 

of shareholder votes of the acquired 

fund.92

Our exemptive orders have 

historically included conditions 

designed to limit an acquiring fund’s 

ability to influence an acquired fund 

through voting power. The voting 

conditions in our exemptive orders, 

however, have differed based on the 

type of acquired fund. For example, our 

orders require an acquiring fund (and 

any other funds within the advisory 

group) to vote shares of acquired closedend funds in the manner required by 

section 12(d)(1)(E), while non-fund 

entities within the advisory group are 

required to use mirror voting.93 The 

voting condition in our orders applies 

whenever the acquiring fund invests in 

a closed-end fund beyond the limits in 

section 12(d)(1). For acquired open-end 

funds or UITs, our exemptive relief has 

required an acquiring fund (and its 

advisory group) to vote their shares 

using mirror voting only if the acquiring 

fund and its advisory group become 

holders of more than 25% of the 

acquired fund’s outstanding voting 

securities due to a decrease in the 

outstanding securities of the acquired 

fund.94 Our exemptive orders also 

include exceptions to the voting 

conditions when the fund of funds 

arrangement involves funds within the 

same group of investment companies as 

discussed below. 

We propose to subject all acquiring 

funds under proposed rule 12d1–4 that 

do not fall within the control exceptions 

discussed below to the same voting 

condition in order to simplify and 

streamline this requirement. We believe 

that this approach would facilitate 

compliance monitoring for fund groups 

that have multiple types of acquiring 

funds. We also believe that requiring 

acquiring funds to utilize mirror voting 

or pass-through voting whenever their 

holdings exceed the statutory limit in 

section 12(d)(1)(A)(i) is appropriate to 

protect the acquired fund (and 

ultimately its investors) from undue 

influence through shareholder votes. A 

3% threshold for the voting condition is 

particularly important because our 

1296 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

95Since the mid-1990s, closed-end funds that 

have traded at a discount to NAV have been the 

target of proxy contests initiated by large investors 

in those funds, including other funds. See, e.g., 

Tom Lauricella, Proxy Fight at Closed-End Fund 

Opens Can of Worms for Industry, The Wall Street 

Journal (Aug. 9, 2002). 96See, e.g., The Ohio National Life Insurance 

Company, et al., Investment Company Act Release 

Nos. 30895 (Jan. 28, 2014) [79 FR 6238 (Feb. 3, 

2014)] (notice) and 30925 (Feb. 24, 2014) (order) 

and related application (‘‘Ohio Life’’). The 

exemptive relief granted by orders generally is 

conditioned on registered separate accounts seeking 

voting instructions from contract owners and then 

voting their shares in accordance with the 

instruction received (and voting shares for which 

no instruction were received in the same proportion 

as the shares for which instructions were received). 

Relief granted to unregistered separate accounts is 

conditioned on those accounts either mirror voting 

their shares or voting in the same manner as 

registered separate accounts. See id. 

97The Commission has granted exemptions from 

certain rules under the Act to the extent necessary 

to permit certain insurance product structures— 

referred to as ‘‘mixed and shared funding.’’ These 

exemptions are subject to conditions, including 

voting conditions, designed to limit potential 

material conflicts of interest among the different 

contract owners. See, e.g., The RBB Fund, Inc., et 

al., Investment Company Act Release Nos. 31648 

(May 27, 2015) (notice) [80 FR 31420 (June 2, 2015)] 

and 31687 (Jun. 23, 2015) (order) and related 

application; SunAmerica Series Trust, et al., 

Investment Company Act Release Nos. 31281 (Oct. 

10, 2014) (notice) [79 FR 62473 (Oct. 17, 2014)] and 

31331 (Nov. 15, 2014) (order) and related 

application. 

98See Fund of Funds Proposing Release, supra 

footnote 16. 

99Proposed rule 12d1–4(b)(1)(iii). 

100Proposed rule 12d1–4(d). 

101The definition of ‘‘affiliated person’’ includes 

any person directly or indirectly controlling, 

controlled by, or under common control with, such 

other person. See section 2(a)(3)(C) of the Act. 

102See Investment Company Mergers, Investment 

Company Act Release No. 25259 (Nov. 8, 2001) [66 

FR 57602 (Nov. 15, 2001)] (proposing rule 

amendments to permit mergers and other business 

combinations between certain affiliated investment 

companies), at n.11. 

103 If the acquired funds’ marketing materials 

and/or prospectuses include any statements that are 

inconsistent with the representations made in the 

prospectuses for the acquiring funds regarding how 

the acquired fund and acquiring funds are related 

companies because of the affiliation of their 

investment advisers, such statements could call into 

question whether the investment companies are 

holding themselves out as related companies and 

potentially render the control exception unavailable 

to the fund of funds arrangement. 

104See Calamos Advisors LLC, et al., Investment 

Company Act Release Nos. 30628 (July 24, 2013) 

[78 FR 46381 (July 31, 2013)] (notice) and 30653 

(Aug. 20, 2013) (order) and related application. See 

also BGFA Letter (noting that asset allocation funds 

often retain the advisers of acquired ETFs as subadvisers and that ‘‘[t]he Commission has previously 

proposal would allow funds to acquire 

shares of closed-end funds under 

proposed rule 12d1–4. Closed-end funds 

historically have been the target of 

proxy contests.95

Since 1999, our exemptive orders also 

have included specific voting provisions 

when an insurance product separate 

account is part of the acquiring fund 

advisory group or acquiring fund subadvisory group.96 These provisions are 

designed to comport with the conditions 

of exemptions the Commission has 

issued specific to certain insurance 

product structures.97 Most insurance 

product separate accounts, however, are 

organized as UITs and rely on section 

12(d)(1)(E) to invest proceeds from the 

sale of interests in variable annuity and 

variable life insurance contracts in 

shares of a mutual fund.98 Accordingly, 

we believe most insurance product 

separate accounts already comply with 

the voting provisions set forth in section 

12(d)(1)(E)(iii)(aa) of the Act, which we 

propose to incorporate into rule 12d1– 

4. We therefore do not believe separate 

voting conditions are necessary for these 

products. 

b. Exceptions From the Control and 

Voting Conditions 

The proposed rule would include 

exceptions to the control and voting 

conditions when: (i) An acquiring fund 

is within the same group of investment 

companies as an acquired fund; or (ii) 

the acquiring fund’s investment subadviser or any person controlling, 

controlled by, or under common control 

with such investment sub-adviser acts 

as the acquired fund’s investment 

adviser or depositor.99 The proposed 

exceptions are designed to include 

arrangements that are permissible under 

section 12(d)(1)(G) and our exemptive 

orders within the regulatory framework 

of rule 12d1–4. Based on our experience 

overseeing fund of funds arrangements, 

we believe the proposed exceptions are 

appropriately tailored to except only 

those fund of funds arrangements that 

do not raise the concerns of undue 

influence that underlie section 12(d)(1) 

from the control and voting conditions. 

As noted above, open-end funds and 

UITs may rely on section 12(d)(1)(G) to 

invest in an open-end fund or UIT 

within the same group of investment 

companies. Our exemptive orders have 

expanded the relief in section 

12(d)(1)(G) to allow open-end funds to 

invest in open-end funds, UITs, ETFs, 

listed closed-end funds, and listed BDCs 

within the same group of investment 

companies. Proposed rule 12d1–4 

would allow registered funds and BDCs 

to invest in other registered funds and 

BDCs within the same group of 

investment companies. 

For purposes of rule 12d1–4, we 

propose to define the term ‘‘group of 

investment companies’’ as ‘‘any two or 

more registered investment companies 

or business development companies 

that hold themselves out to investors as 

related companies for investment and 

investor services.’’ 100 This is similar to 

the definition used in many of our 

exemptive orders permitting 

investments in listed closed-end funds 

and listed BDCs. It is intended to clarify 

that closed-end funds and BDCs are 

within the scope of the exception. 

We believe that it would be false or 

misleading for a group of investment 

companies to hold themselves out as 

related companies as that term is used 

in proposed rule 12d1–4 unless they 

are, in fact, related investment 

companies. We believe, for example, 

that funds that are advised by the same 

investment adviser, or by advisers that 

are control affiliates of each other, 

would be ‘‘related’’ companies for 

purposes of the proposed rule.101 The 

determination of whether advisers are 

control affiliates, however, depends on 

the relevant facts and circumstances.102

We believe that whether a group of 

funds sharing a common adviser or 

having advisers that are all control 

affiliates could satisfy the ‘‘holding out’’ 

prong of the definition would depend 

on the totality of communications with 

investors by or on behalf of the funds. 

For example, the acquiring fund’s 

prospectus could identify the acquired 

funds in which the acquiring fund 

expects to invest, and disclose the 

control relationship among the advisers 

to the acquiring and acquired funds. In 

our view, it would not be necessary for 

the acquired funds to include 

comparable disclosure in their 

prospectuses or that the acquired funds 

and acquiring funds be marketed as 

related companies for all purposes and 

to all potential investors.103 Rather, the 

requirement in the definition of ‘‘group 

of investment companies’’ that the 

funds must hold themselves out to 

‘‘investors’’ as related companies for 

purposes of investment and investor 

services refers only to potential 

investors in the acquiring fund because 

the relevant inquiry is how the funds 

are holding themselves out to potential 

investors in the acquiring fund. 

Disclosure in the acquiring fund’s 

prospectus of the identity of the 

acquired funds in which the acquiring 

fund expects to invest, and of the 

control relationship among the advisers 

to the acquired and acquiring funds, 

therefore, is one way to satisfy the 

‘‘holding out’’ requirement of the 

definition. 

Our orders also allow an acquiring 

fund to invest in an acquired fund when 

an acquiring fund’s sub-adviser (or a 

control affiliate of the sub-adviser) 

serves as the primary investment 

adviser or sponsor to the acquired 

fund.104 Proposed rule 12d1–4 would 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1297 

granted exemptive relief relating to this issue on 

many occasions’’). 

105See proposed rule 12d1–4(b)(1)(iii)(B). 

Proposed rule 12d1–4(b)(1)(iii)(B) would, however, 

use the term ‘‘depositor’’ instead of ‘‘sponsor’’ to be 

consistent with other rules. 

106Fund of funds arrangements where the 

acquiring fund’s primary adviser served as adviser 

to the acquired fund typically would be able to 

qualify as funds within the ‘‘same group of 

investment companies’’ and would not require a 

separate exception under our orders. 

107An investment adviser has a fiduciary duty to 

act in the best interests of a fund it advises. See 

section 36(a) under the Investment Company Act. 

See also, e.g., SEC v. Capital Gains Research 

Bureau, Inc., 375 U.S. 180 (1963); Rosenfeld v. 

Black, 445 F.2d 1337 (2d Cir. 1971) (describing the 

fiduciary relationship between an investment 

adviser and a mutual fund); Brown v. Bullock, 194 

F. Supp. 207, 229, 234 (S.D.N.Y.), aff’d, 294 F.2d 

415 (2d Cir. 1961) (noting that investment advisers 

are under a fiduciary duty to manage the 

investment companies entrusted to their care with 

a single eye to their best interest, free from any selfdealing); Compliance Rule Adopting Release, supra 

footnote 89, at n.68. 

108Accordingly, we also propose to except these 

arrangements from the voting condition in proposed 

rule 12d1–4(b)(1)(ii). See proposed rule 12d1– 

4(b)(iii). 

109We also considered whether the 10% limit 

should be combined with a condition prohibiting 

an acquiring fund and its advisory group from 

controlling an acquired fund. This approach would 

capture certain control relationships that are not 

based on ownership. As with other questions of 

control discussed in this section, whether a person 

is controlling, controlled by, or under common 

control with the acquiring fund’s investment 

adviser or depositor or the acquiring fund’s 

investment sub-adviser depends on the particular 

facts and circumstances. 

110Such a provision also could include funds 

advised by control affiliates of the adviser to reflect 

the current structure of advisory firms, which may 

include multiple entities serving as investment 

advisers to funds. The proposed exception for funds 

within the same group of investment companies in 

proposed rule 12d1–4(b)(1)(iii)(A) would 

incorporate a similar approach. See supra footnote 

101 and accompanying text. 

111See supra section II.C.2. 

112For example, one way to gain efficient and 

cost effective exposure to a particular index in a 

target-date or life-cycle fund might be to acquire up 

to 25% of a fund tracking the index. This allocation 

may change over the life cycle of the fund. 

similarly except these arrangements 

from the control and voting 

conditions.105 This proposed exception 

would cover arrangements that may not 

qualify for the proposed exclusion 

available to funds within the same 

group of investment companies under 

subparagraph (b)(1)(iii)(A) because the 

acquiring fund and acquired fund do 

not hold themselves out as related funds 

for purposes of investment and investor 

services.106 We believe that these 

arrangements do not raise the same 

concerns regarding undue influence as 

other types of fund of funds 

arrangements because of the subadviser’s duties as a fiduciary to both 

the acquiring fund and acquired fund. 

The proposed rule would subject the 

fund of funds arrangements within these 

exclusions to a more limited set of 

conditions than other fund of funds 

arrangements relying on the rule. In 

circumstances where the acquiring fund 

and acquired fund share the same 

adviser, the adviser would owe a 

fiduciary duty to both funds, serving to 

protect the best interests of each 

fund.107 In addition, in cases where the 

arrangement involves funds that are 

advised by advisers that are control 

affiliates, we do not believe that the 

acquiring fund adviser generally would 

seek to benefit the acquiring fund at the 

expense of the acquired fund (nor do we 

believe that the acquiring fund would 

seek to influence the acquired fund 

through its ownership interest in the 

acquired fund).108 We believe that the 

proposed rule’s other conditions, such 

as the redemption condition described 

below, would mitigate against the risks 

of undue influence when the 

arrangement involves funds that have 

advisers that are control affiliates. 

c. Potential Alternatives to Proposed 

Control Condition 

We considered several alternatives to 

the proposed control condition to 

address concerns regarding undue 

influence over an acquired fund, 

including whether we should set a 

different limit on investments by an 

acquiring fund and its advisory group in 

an acquired fund. For example, we 

considered whether to propose a 

condition prohibiting an acquiring fund 

and its advisory group from acquiring 

more than 10% of the outstanding 

voting stock of an acquired fund. This 

alternative would effectively lower an 

acquiring fund’s potential investment in 

an acquired fund from 25% to 10% 

when control is based on ownership.109

A lower limit could reduce the potential 

for undue influence and could eliminate 

the need for additional conditions 

designed to address these concerns, 

such as the redemption limit described 

below. A 10% limit also is consistent 

with sections 12(d)(1)(B) and 12(d)(1)(C) 

of the Act, which each include a 10% 

limit on fund investments in a single 

acquired fund. 

We also considered whether we 

should narrow the scope of entities that 

should be assessed for purposes of a 

10% limit. For example, the 10% limit 

in section 12(d)(1)(C) applies to the 

acquiring fund and other funds advised 

by the same adviser. If we adopted a 

similar provision, it would have the 

benefit of excluding from the 

calculation members of an advisory 

group that are not funds.110 As noted 

above, non-fund affiliates are not subject 

to the 12(d)(1) limits, and acquiring 

funds are required to consider their nonfund affiliates’ holdings when assessing 

whether they control an acquired fund 

by effect of a condition in our exemptive 

orders. This approach therefore could 

lessen compliance burdens for those 

funds whose advisers are part of large 

financial organizations. 

However, we believe that our 

proposed restrictions on control, which 

incorporate the 25% presumption, are 

appropriate when combined with other 

conditions set forth in proposed rule 

12d1–4. For example, we believe the 

proposed condition requiring specified 

voting procedures when the acquiring 

fund and its advisory group exceed a 

3% ownership threshold, and the 

proposed limit on the acquiring fund’s 

ability to quickly redeem or tender a 

large volume of acquired fund shares 

effectively mitigate the influence that an 

acquiring fund and its advisory group 

may have on an acquired fund, even if 

the acquiring fund and its advisory 

group owns up to 25% of that fund.111

We believe that a higher ownership 

limit provides an acquiring fund with 

the ability to allocate its assets in an 

efficient and cost-effective manner.112

Together, we believe that these 

provisions would limit the ability of the 

members of an acquiring fund’s 

advisory group to exercise undue 

influence over an acquired fund. 

We request comment on the control 

and voting conditions in proposed rule 

12d1–4. 

• Would the proposed control and 

voting conditions sufficiently protect an 

acquired fund from the type of coercive 

behavior on the part of acquiring funds 

that section 12(d)(1) was intended to 

prevent? Are there other conditions that 

we should consider to address the 

potential for undue influence by an 

acquiring fund and its controlling 

persons? Should we consider a lower 

limit (e.g., 10%) or a higher limit (e.g., 

30%) on investments by an acquiring 

fund and its advisory group in an 

acquired fund? Would a lower limit 

unduly restrict fund of funds 

arrangements? 

• Should we require an acquiring 

fund to aggregate its holdings with its 

advisory group when assessing control 

of an acquired fund? Are we correct that 

funds relying on fund of funds 

exemptive orders already have 

established policies and procedures to 

monitor compliance with the 

aggregation requirement embedded in 

the definition of an acquiring fund’s 

‘‘advisory group?’’ 

• Should we define ‘‘advisory group’’ 

as proposed or are there alternatives that 

we should consider? For example, 

1298 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

113See supra footnotes 93–94 and accompanying 

text (describing the voting conditions included in 

our orders). 

114See supra footnote 96. 

115Proposed rule 12d1–4(b)(2). Investors in 

mutual funds can redeem their shares on each 

business day and, by law, must receive 

approximately their pro rata share of the fund’s net 

assets (or its cash value) within seven calendar days 

after receipt of the redemption request. See section 

2(a)(32) of the Act (defining redeemable security); 

section 22(e) of the Act (providing, in part, that no 

registered investment company shall suspend the 

right of redemption, or postpone the date of 

payment upon redemption of any redeemable 

security in accordance with its terms for more than 

seven days after tender of the security absent 

unusual circumstances); and rule 22c–1 (purchases 

and redemptions of fund shares must be at a price 

based on the current NAV next computed after 

receipt of an order to purchase or redeem). Since 

the proposed condition restricts an acquiring fund’s 

ability to redeem or submit a redemption request, 

rather than an acquired fund’s obligation to honor 

such redemptions, we do not propose an exemption 

from section 22(e) of the Act in connection with 

this condition. 

116Certain acquiring funds that could rely on 

proposed rule 12d1–4 could acquire even more than 

25% of an acquired fund’s outstanding voting 

securities. See proposed rule 12d1–4(b)(1)(iii) 

(providing exceptions from the control and voting 

conditions for fund of funds arrangements when: (i) 

The acquiring fund is in the same group of 

investment companies as the acquired fund; or (ii) 

the acquiring fund’s investment sub-adviser or any 

control affiliate of such sub-adviser acts as the 

acquired fund’s investment adviser or depositor). 

See also infra sections III and V (discussing the 

proposed rescission of rule 12d1–2 and exemptive 

orders). 

should we exclude control affiliates of 

an acquiring fund’s investment adviser 

or depositor from this definition and 

only include control affiliates of the 

acquiring fund? 

• Should we permit, as proposed, an 

exception to the control and voting 

conditions when the acquiring fund and 

acquired fund are part of the same group 

of investment companies? Alternatively, 

should the proposed rule only except an 

acquiring fund that is part of the same 

group of investment companies from the 

control condition? Is this proposed 

exception to these conditions 

appropriately tailored? Should we 

define ‘‘group of investment 

companies’’ as proposed or are there 

alternative definitions we should 

consider? Should we include a ‘‘holding 

out’’ requirement as part of the 

exception? Or should we provide 

additional guidance regarding how a 

group of funds sharing a common 

investment adviser or having 

investment advisers that are control 

affiliates could satisfy the ‘‘holding out’’ 

prong of the definition? 

• Should we also permit, as 

proposed, an exception to the control 

and voting conditions when the 

acquiring fund’s investment sub-adviser 

or any person controlling, controlled by, 

or under common control with such 

investment sub-adviser acts as the 

acquired fund’s investment adviser or 

depositor? Alternatively, should the 

proposed rule only except such an 

acquiring fund from the control 

condition? Are we correct that the 

potential for abuse is limited in these 

circumstances due to generally aligned 

interests? Are there other conditions we 

should consider in this circumstance? 

• Are there particular kinds of votes 

to which the proposed voting condition 

should not apply? For example, should 

there be an exception to the voting 

condition for votes on changes in 

control of an acquired fund’s adviser? If 

an acquiring fund has a large enough 

investment that is subject to the 

redemption limits (described below) 

and is unable to redeem its investment 

in an acquired fund, would the timing 

of such a vote allow sufficient time for 

the acquiring fund to seek investor 

instructions? 

• Should the control and voting 

exceptions cover funds with advisers 

that are control affiliates as proposed, or 

only funds that share the same 

investment adviser? Are we correct that 

an adviser to an acquiring fund in these 

circumstances would not seek to benefit 

the acquiring fund at the expense of the 

acquired fund? 

• Should we require an acquiring 

fund to vote in the manner prescribed 

by section 12(d)(1)(E)(iii)(aa) if the 

acquiring fund and its advisory group 

hold more than 3% of an acquired 

fund’s outstanding voting securities? Is 

there a lower or higher threshold that 

we should consider? Should that 

threshold vary depending on the type of 

acquired fund? For example, should 

there be a lower or higher threshold for 

closed-end funds? Should that threshold 

depend on whether a closed-end fund is 

listed or not? Why? Are there alternative 

voting procedures that we should 

consider? Should we eliminate the 

optionality in the proposed rule and 

only allow either pass-through voting or 

mirror voting? 

• Are the voting options in proposed 

rule 12d1–4 workable? Would the 

proposed threshold cause operational 

challenges for voting acquired fund 

shares? How frequently do acquiring 

funds use pass-through voting or mirror 

voting under our exemptive orders? 

How frequently would acquiring funds 

use pass-through voting versus mirror 

voting under the proposed rule? 

• Instead of the proposed voting 

condition, should we codify the voting 

provisions set forth in our existing 

exemptive orders? 113

• Are we correct that insurance 

product separate accounts already have 

experience complying with the voting 

provisions in section 12(d)(1)(E)(iii)(aa)? 

Should we instead include separate 

voting provisions for insurance product 

separate accounts? If so, should we 

codify the voting provisions for 

insurance product separate accounts set 

forth in our exemptive orders? 114

• Is our proposal to calculate the 

holdings of an acquired fund for the 

purposes of the 3% voting threshold as 

of the record date appropriate? 

Alternatively, should our proposal be 

more similar to the requirements of 

section 12(d)(1)(F) of the Act, which 

requires section 12(d)(1)(E) voting 

procedures for ‘‘any security purchased 

or acquired pursuant’’ to that section? 

• Would the proposed voting 

provisions have unintended 

consequences regarding fund 

governance? If so, what would those 

consequences be, and how should we 

address them? 

• To the extent that an acquiring fund 

and its advisory group become a holder 

of more than 25% of the outstanding 

voting securities of an acquired fund as 

a result of a decrease in the outstanding 

voting securities of an acquired fund, 

should we provide relief from section 

17(a) to allow the acquiring fund and its 

advisory group to redeem shares of the 

acquired fund in-kind and thus reduce 

their holdings of the acquired fund? 

2. Redemptions 

To address concerns that an acquiring 

fund could threaten large-scale 

redemptions as a means of exercising 

undue influence over an acquired fund, 

the proposed rule includes a condition 

that would limit an acquiring fund from 

quickly redeeming or tendering a large 

volume of acquired fund shares. 

Specifically, proposed rule 12d1–4(b)(2) 

would prohibit an acquiring fund that 

acquires more than 3% of an acquired 

fund’s outstanding shares (i.e., the 

statutory limit) from redeeming or 

submitting for redemption, or tendering 

for repurchase, more than 3% of an 

acquired fund’s total outstanding shares 

in any 30-day period.115

The proposed redemption limitation 

is designed to provide a check against 

the influence that an acquiring fund can 

have on an acquired fund when it owns 

a significant percentage of the acquired 

fund. As discussed in the context of the 

control condition, we believe it is 

appropriate to permit funds to purchase 

up to 25% of an acquired fund in 

reliance on the rule, in part, because of 

the protections afforded by limiting the 

acquiring fund’s ability to influence the 

fund through the threat of large-scale 

redemptions.116

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1299 

117Our orders generally use the term ‘‘unaffiliated 

funds’’ to refer to acquired funds that are not part 

of the same group of investment companies as the 

acquiring fund. For purposes of this discussion of 

the conditions in our orders that differentiate based 

on whether the acquired fund is part of the same 

group of investment companies, we will use the 

term ‘‘unaffiliated acquired fund’’. See, e.g., USCF 

Advisers, LLC, et al., Investment Company Act 

Release Nos. 32851 (Oct. 4, 2017) [82 FR 47262 

(Oct. 11, 2017) (notice) and 32889 (Oct. 31, 2017) 

(order) and related application (‘‘USCF Advisers’’); 

Franklin Fund, supra footnote 25. 

118This condition also requires the board to 

review these transactions on at least an annual basis 

and to maintain certain records associated with the 

procedures and affiliated underwritings. 

119See, e.g., USCF Advisers, supra footnote 117. 

120See, e.g., Schwab, supra footnote 25. 

121We anticipate that fund of funds involving 

separate accounts will continue to enter into 

participation agreements as a result of the 

requirements in their ‘‘mixed and shared funding’’ 

orders. See supra footnote 97. 

122The acquiring fund could redeem shares in 

multiple transactions within a 30-day period, 

provided that, taken together, they represent less 

than 3% of the acquired fund’s outstanding shares. 

123 If the section 12(d)(1)(A)(i) limits are 

exceeded, the acquiring fund could not redeem any 

shares from the acquired fund beyond the rule’s 

limits until the acquiring fund disposes of shares 

it acquired in excess of the 3% statutory limit. Once 

the acquiring fund does not hold any shares in 

excess of 3%, the acquiring fund could redeem any 

remaining acquired fund shares it held. 

124We understand that most acquiring funds 

purchase ETFs, ETMFs, listed closed-end funds, 

and listed BDCs in secondary market transactions. 

In some cases, UITs also may have secondary 

market trading. Secondary market transactions 

would not involve redemptions from the acquired 

fund. However, an acquiring fund might seek to 

redeem ETF or ETMF shares from an ETF or ETMF 

in a primary market transaction through one or 

more authorized participants. When transacting 

with an ETF or ETMF in the primary market, an 

acquiring fund would be subject to, among other 

things, the redemption restrictions discussed 

herein, which could result in acquiring funds being 

treated differently than other market participants 

seeking to engage in primary market transactions 

with an ETF or ETMF. 

125See infra section VI. From January 2017 to 

June 2018, 0.16% of the monthly redemptions of 

unlisted acquired funds exceeded the proposed 3% 

redemption limit. During that same period, 0.76% 

of the monthly redemptions of listed acquired funds 

exceeded the proposed 3% redemption limit. For 

these purposes, open-end funds and UITs are 

included in the figures for unlisted acquired funds 

and ETFs, ETMFs, listed closed-end funds, and 

listed BDCs are included in the figures for listed 

acquired funds. We estimate the percentage of fund 

redemptions that are above the 3% limit in any 30- 

day period using the quarterly fund holding 

information in Morningstar Investment Company 

Holdings database between January 2017 and June 

2018, and assuming that the changes in quarterly 

portfolio holdings occur evenly across the three 

months in each quarter. Our analysis does not 

distinguish between changes in holdings as a result 

of primary and secondary market transactions. 

126See section 12(d)(1)(F)(ii) (providing that no 

issuer of a security purchased or acquired by a 

registered investment company pursuant to that 

section is obligated to redeem such security in an 

amount exceeding 1% of the issuer’s total 

outstanding securities during any period of less 

than thirty days). 

127Acquiring funds could rely on proposed rule 

12d1–4 to hold more than 25% of an acquired 

fund’s outstanding voting securities when they are 

part of the same group of investment companies or 

when the acquiring fund’s sub-adviser (or a control 

affiliate) acts as the acquired fund’s adviser or 

depositor. Because acquiring funds that fall within 

the exceptions in rule 12d1–4(b)(1)(iii) are not 

constrained in their ability to control a fund and 

could acquire more than 25% of an acquiring fund’s 

outstanding voting securities, we propose to subject 

these types of acquiring funds to the redemption 

limitation in proposed rule 12d1–4(b)(2). 

128An acquiring fund that holds more than 3% 

of an acquired fund’s total outstanding shares 

should take this limitation into account when 

classifying this portfolio investment as part of its 

liquidity risk management program under 17 CFR 

270.22e–4 (rule 22e–4 under the Act). See 

Investment Company Liquidity Risk Management 

Programs, Investment Company Act Release No. 

Continued 

We believe the proposed redemption 

condition, together with the proposed 

control and voting conditions, are more 

protective than certain conditions 

currently found in our orders and may 

be objectively tested as part of a fund’s 

compliance program. The conditions in 

our orders generally require the 

acquired fund board to make certain 

findings and adopt procedures to 

prevent overreaching and undue 

influence by the acquiring fund and its 

affiliates once the investment in an 

unaffiliated acquired fund exceeds the 

section 12(d)(1) limits.117 For example, 

our orders require an unaffiliated 

acquired fund board to adopt 

procedures reasonably designed to 

monitor purchases by the unaffiliated 

acquired fund in an underwriting in 

which an affiliate of the acquiring fund 

is the principal underwriter.118 Our 

orders also require the acquiring fund to 

take measures to prevent the acquiring 

fund from influencing the terms of any 

services or transactions between the 

acquiring fund and an unaffiliated 

acquired fund or causing an unaffiliated 

acquired fund to purchase a security in 

any affiliated underwriting. The 

acquiring fund’s board of directors, 

including a majority of its independent 

directors, is required by our orders to 

adopt procedures reasonably designed 

to assure that the acquiring fund’s 

investment adviser does not take into 

account consideration received from an 

unaffiliated acquired fund (or certain of 

the unaffiliated acquired fund’s 

affiliates).119 In addition, our exemptive 

orders require the acquired fund and 

each unaffiliated acquiring fund to 

execute a participation agreement.120

We believe that the proposed 

redemption, control, and voting 

conditions address the same concerns 

regarding overreaching and undue 

influence that these exemptive order 

conditions sought to address, without 

requiring procedures and related board 

findings covering particular instances 

where undue influence and 

overreaching could exist. Therefore, 

replacing these conditions with the 

proposed redemption, control, and 

voting conditions would lower 

compliance costs and burdens and 

enhance investor protection for acquired 

funds.121

We believe the proposed limit is 

appropriately tailored to reduce the 

threat of large-scale redemptions. Along 

with the other conditions we are 

proposing today, it is designed to 

prevent an acquiring fund from unduly 

influencing the acquired fund without 

the board oversight and monitoring 

conditions imposed by our orders. At 

the same time, the redemption limit 

leaves an acquiring fund the ability to 

redeem a portion of its investment.122

Because the threat of large-scale 

redemptions only exists when an 

acquiring fund holds a significant 

amount of an acquired fund, the 

redemption condition does not apply 

unless the acquiring fund holds shares 

of the acquired fund in excess of the 3% 

limit on the acquisition of an acquired 

fund’s outstanding voting securities 

under section 12(d)(1)(A)(i) of the 

Act.123 It does not apply as a result of 

the fund exceeding the 5% limit on the 

total assets of an acquiring fund that 

may be invested in a single acquired 

fund under section 12(d)(1)(A)(ii) of the 

Act or the 10% limit on the total assets 

of an acquiring fund that may be 

invested in all acquired funds under 

section 12(d)(1)(A)(iii) of the Act. In 

addition, acquiring funds that rely on 

the proposed rule to invest in funds that 

are listed on an exchange would be 

permitted to continue to sell shares in 

the secondary market without regard to 

the volume limit.124 Based on the staff’s 

analysis of redemptions of acquired 

fund shares, we do not believe that our 

proposed redemption limit would have 

a large effect on funds.125 However, we 

acknowledge that this condition could 

have a larger impact during periods of 

market stress or high volatility. 

Section 12(d)(1)(F) of the Act includes 

a redemption provision, but limits 

redemptions to only 1% of the acquired 

fund’s total outstanding securities 

during a 30-day period.126 However, a 

fund relying on section 12(d)(1)(F) of 

the Act only may acquire up to 3% of 

an acquired fund, whereas proposed 

rule 12d1–4 would permit an acquiring 

fund to acquire up to 25% of an 

acquired fund.127 We believe a 3% 

redemption limit, rather than a 1% 

limit, would have a less significant 

impact on an acquiring fund’s liquidity, 

particularly if the acquiring fund is not 

able to trade the acquired fund’s shares 

on the secondary market.128 The 

1300 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

32315 (Oct. 13, 2016) [81 FR 82142 (Nov. 18, 2016)] 

(‘‘Liquidity Release’’). 

129An acquiring fund that relies on the statutory 

exemption to section 12(d)(1)(A) in section 

12(d)(1)(G) of the Act, however, may acquire more 

than 3% of an acquired fund’s shares without being 

subject to any redemption limits if that acquired 

fund is in the same group of investment companies 

and structured as an open-end fund or UIT. 

130See 2008 Proposing Release, supra footnote 

13. 

131See, e.g., Comment Letter of Independent 

Directors Council (May 19, 2008) (‘‘IDC Letter’’) 

(‘‘The proposed conditions, particularly the 

condition limiting the ability of an acquiring fund 

to redeem ETF shares, offer an efficient means to 

address the same policy concerns relating to undue 

influence by an acquiring fund of an ETF that the 

director-related conditions of the exemptive orders 

were designed to address.’’); Comment Letter of 

Mutual Fund Directors Forum (May 21, 2008) 

(‘‘MFDF Letter’’); SSgA Letter. 

132The commenter asserted that it would be 

difficult to implement a tracking method for 

particular shares to abide by the redemption 

prohibition in the 2008 proposal. See MFA Letter 

(suggesting a redemption limit of 1% of an ETF’s 

shares per month during any month the acquiring 

fund holds more than 3% of the ETF’s outstanding 

shares). 

133See 2008 Proposing Release, supra footnote 

13, at n.221 and accompanying text. Section 

12(d)(1)(B) applies to a registered open-end 

investment company (and any principal 

underwriter thereof or broker-dealer). 

134See id. The proposed safe harbor was available 

for each of those entities if it had: (i) Received a 

representation from the acquiring fund that none of 

the ETF’s shares the acquiring fund is redeeming 

includes any shares that it acquired in excess of 3% 

of the ETF’s shares in reliance on the proposed rule; 

and (ii) no reason to believe that the acquiring fund 

is redeeming ETF shares that the acquiring fund 

acquired in excess of 3% of the ETF’s shares in 

reliance on the proposed rule. See id. 

135See, e.g., ICI Letter; Comment Letter of 

Morgan, Lewis & Bockius LLP (July 28, 2008) 

(‘‘Morgan Lewis Letter’’); BGFA Letter (noting that 

section 12(d)(1)(B) of the Act (from which this 

provision would provide an exemption) only 

prohibits acquired funds from knowingly selling 

shares in excess of the 3% limit in section 

12(d)(1)(A)(i)). 

proposed 3% redemption limit would 

provide funds and their advisers with 

greater flexibility to manage a fund’s 

investments, while continuing to protect 

acquired funds from undue influence. In 

addition, we believe a 3% redemption 

limit is appropriate for proposed rule 

12d1–4 because an acquiring fund that 

does not seek an exemption from 

section 12(d)(1)(A) would be able to 

redeem up to 3% of an acquired fund’s 

total outstanding shares.129

We acknowledge that the provision in 

section 12(d)(1)(F)(ii) is permissive (i.e., 

acquired funds have the option to limit 

redemptions in this manner), while the 

proposed condition in rule 12d1–4 is 

mandatory. An acquiring fund, 

however, could influence an acquired 

fund to eliminate (or never establish) a 

limit on redemptions if the redemption 

condition were merely permissive. We 

therefore propose a mandatory limit on 

submitting redemptions as a more 

effective means to mitigate the threat of 

undue influence than an optional limit. 

The Commission proposed stricter 

redemption limits in 2008, in part 

because that proposal related to 

investments in ETFs and we anticipated 

that most acquiring funds would 

transact in ETF shares on the secondary 

market.130 Under that proposal, an 

acquiring fund that acquired more than 

3% of an ETF’s outstanding shares in 

reliance on rule 12d1–4 would have 

been prohibited from redeeming any of 

those shares. Commenters on the 2008 

proposal generally supported the 

proposed condition.131 One commenter, 

however, recommended that we modify 

the redemption condition to provide for 

volume and time limitations on 

redemption, rather than rendering 

particular shares ineligible for 

redemption.132

Under the 2008 proposal, an ETF, its 

principal underwriter, and a broker or a 

dealer that relied on the rule to sell the 

ETF’s shares in excess of section 

12(d)(1)(B) limits also would have been 

prohibited from redeeming those shares 

acquired by another fund that exceeded 

the 3% limit in section 12(d)(1)(A)(i).133

In proposing this limit, the Commission 

acknowledged that it may be difficult 

for these entities to know whether a 

redemption order is submitted by such 

an entity and included a safe harbor for 

each of those entities if certain 

conditions were met.134 Commenters 

agreed such identification would be 

difficult and objected to this 

condition.135

Our proposal would not prohibit an 

acquired fund from redeeming, or its 

principal underwriter or a broker or 

dealer from submitting for redemption, 

shares held by an acquiring fund that 

exceed the 3% limit in section 

12(d)(1)(A)(i). The proposed 30-day 

limit on redemptions for acquiring 

funds would reduce the risk of undue 

influence through the threat of largescale redemptions, without requiring an 

acquired fund to track whether a 

redemption order was submitted by an 

acquiring fund that holds more than 3% 

of the acquired fund’s shares. Instead, 

the acquiring fund would need to track 

its redemptions of acquired fund shares. 

We request comment on the proposed 

redemption condition. 

• Should we prohibit, as proposed, an 

acquiring fund that acquires more than 

3% of an acquired fund’s outstanding 

shares (i.e., the statutory limit) from 

redeeming or submitting for 

redemption, or tendering for repurchase, 

more than 3% of an acquired fund’s 

total outstanding shares in any 30-day 

period? Should either of these proposed 

limits be higher (e.g., 5% or 10%) or 

lower (e.g., 1%)? Should the period be 

longer or shorter than 30 days? Should 

the same limit apply for all types of 

acquired funds under the rule? How 

should the rule handle a situation where 

an acquiring fund initially holds less 

than 3% of an acquired fund, but comes 

to hold more than 3% as a result of a 

decline in assets of the acquired fund? 

Should this provision of the proposed 

rule apply to an acquiring fund that 

‘‘holds’’ more than 3% of an acquired 

fund’s outstanding shares, instead of an 

acquiring fund that ‘‘acquires’’ that 

amount? 

• Should the redemption limit apply 

to funds that are not traded on the 

secondary market? Alternatively, should 

the redemption limit be higher for 

acquired funds that are not traded on 

the secondary market? Would 

eliminating this condition increase the 

risk that acquiring funds could exert 

undue influence over acquired funds 

through the threat of large-scale 

redemptions? Should there be an 

exception to the redemption limit for 

redemptions in kind? 

• Should the redemption limit apply 

to an acquiring fund that is part of the 

same group of investment companies as 

the acquired fund? Should the 

redemption limit apply to an acquiring 

fund when the acquiring fund’s 

investment sub-adviser or any person 

controlling, controlled by, or under 

common control with such investment 

sub-adviser acts as the acquired fund’s 

investment adviser or depositor? 

Alternatively, should we except these 

entities from the redemption condition 

for the same reasons we propose to 

except them from the control and voting 

conditions? 

• Are we correct that acquiring funds 

typically buy and sell ETF shares on the 

secondary market? Are there instances 

where acquiring funds transact with an 

ETF in the primary market through an 

authorized participant? Would the 

proposed redemption condition affect 

the efficiency of the arbitrage 

mechanism for ETFs? If so, how? For 

example, would the proposed limitation 

contribute to premiums or discounts to 

NAV? How would the proposed 

redemption limitation affect ETMFs? 

• How would the proposed 

redemption limitation affect acquiring 

fund’s portfolio management? Where an 

acquiring fund holds more than 3% of 

the shares of an acquired fund, would 

the proposed redemption condition 

unduly impede the ability of acquiring 

funds to dispose of acquired fund 

shares, including during periods of 

market stress or high volatility? Do 

acquiring funds realize significant 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1301 

136See supra footnote 134. 

137Funds are currently permitted to impose 

redemption fees in certain circumstances. See 

Mutual Fund Redemption Fees, Investment 

Company Act Release No. 26782 (Mar. 11, 2005) [70 

FR 13328 (Mar. 18, 2005)] (adopting rule 22c–2 

under the Act). 

138See Investment Trust Study, supra footnote 13 

at ch. 7, 2725–39, 2760–75, 2778–93. The 

Investment Trust Study observed that controlling 

persons profited from duplicative fees at the 

Continued 

benefits from the ability to redeem 

acquired fund shares in these 

circumstances? Would the proposed 

limitation disrupt acquiring funds’ 

ability to change underlying funds from 

time to time? Would the proposed 

limitation contribute to changes in how 

acquiring funds allocate their assets to 

acquired funds? For example, would 

acquiring funds be more likely to invest 

in larger funds, or in ETFs rather than 

mutual funds, in order to avoid the 

redemption limit? Would the proposed 

redemption condition create a 

competitive disadvantage for smaller 

acquired funds or acquired funds that 

are not traded on the secondary market? 

• How would the proposed 

redemption limitation affect an 

acquiring fund’s liquidity risk 

management? 

• Would acquiring funds incur 

significant costs from a mandatory 

prohibition on redemption of acquired 

fund shares once the 3% statutory limit 

has been exceeded? Should the 

proposed redemption limitation, like 

the one in section 12(d)(1)(F) of the Act, 

be voluntary at the election of an 

acquired fund? If so, what other 

safeguards could be added to protect 

against undue influence? 

• If an acquiring fund redeems shares 

in multiple transactions, should the 

acquiring fund calculate the total 

percentage redeemed by adding the 

percentage total of each redemption or 

should we provide alternative guidance 

regarding this calculation? For example, 

should a fund calculate the percentages 

as of the time of the latest redemption? 

• Should the proposed redemption 

limit apply to an acquiring fund’s 

advisory group, rather than each 

acquiring fund individually, in order to 

address the potential for large-scale 

redemptions that could originate from a 

fund group? Alternatively, should the 

proposed redemption limit apply, on an 

aggregate basis, to affiliated acquiring 

funds, or acquiring funds with the same 

exact portfolio managers, or that have in 

common at least one portfolio manager, 

as listed in the registration statement? If 

so, should the redemption limit be 

higher (e.g., no more than 5% of the 

acquired fund’s total outstanding shares 

during any 30-day period)? What are the 

benefits and drawbacks of such an 

approach? How would this condition 

affect fund operations? How would 

funds design compliance policies and 

procedures to comply with this 

condition? Would it be difficult to track 

this type of redemption limit? If so, 

why? Would this better protect against 

undue influence in acquired funds? If 

so, how? 

• Notwithstanding that the proposed 

condition limits the ability of an 

acquiring fund to redeem, rather than 

limiting the ability of an acquired fund 

to honor redemption requests, should 

we provide exemptions from section 

22(e) of the Act in connection with this 

condition? 

• Does the proposed condition 

appropriately limit the threat of 

redemption that an acquiring fund 

could otherwise use to unduly influence 

or control an acquired fund? If not, are 

there other conditions that would better 

address the risks associated with undue 

influence or control? For example, do 

the conditions in our existing orders 

more effectively limit the ability of an 

acquiring fund to unduly influence or 

control an acquired fund? Should we 

codify those conditions (including the 

procedural requirements, board 

findings, and participation agreements) 

instead of or in addition to including a 

redemption condition in the rule? 

• As discussed above, we believe that 

participation agreements would not be 

necessary in light of the proposed 

conditions of rule 12d1–4. Are there 

benefits to participation agreements, 

however, that suggest we should 

include this requirement? For example, 

do participation agreements help funds 

determine who is investing in the funds 

above the statutory limits? Do 

participation agreements require the 

parties to a fund of funds arrangement 

to provide information necessary for 

compliance with other provisions of the 

Act? For example, do participation 

agreements require acquiring funds and 

acquired funds to provide lists of 

affiliates to aid in monitoring 

compliance with section 17(a)? How 

would funds use this information in 

complying with the conditions in 

proposed rule 12d1–4? Without 

participation agreements, would an 

acquired fund have sufficient 

information about the acquiring funds 

that hold its shares? Would funds 

continue to enter into participation 

agreements even if not required under 

the rule? 

• Should an acquired fund, its 

principal underwriter, and a broker or a 

dealer that relies on the rule be 

prohibited from redeeming (or from 

submitting an order to redeem) 

acquiring fund shares that exceed the 

3% limit in section 12(d)(1)(A)(i)? 

Should this prohibition apply only to an 

acquired fund that is a registered openend fund, along with its principal 

underwriter and broker or dealer since 

section 12(d)(1)(B) applies to only those 

entities? Would an acquired fund (along 

with its principal underwriter, and a 

broker or a dealer that relies on the rule) 

have difficulty identifying acquiring 

funds investing in the acquired fund in 

reliance on rule 12d1–4? If we included 

this prohibition, should we also include 

the related safe harbors for an acquired 

fund, its principal underwriter, and a 

broker or dealer that we proposed in 

2008? 136 Alternatively, should we 

consider including a knowledge 

qualifier in the prohibition, similar to 

the one included in section 12(d)(1)(B) 

itself? For example, should we prohibit 

an acquired fund (or its principal 

underwriter, or a broker or a dealer) 

only from knowingly redeeming shares 

acquired by the acquiring fund in excess 

of the 3% limit in section 12(d)(1)(A)(i)? 

• Are there alternative approaches to 

a redemption limitation that we should 

consider? For example, should we 

consider requiring acquired funds 

relying on the rule to set a redemption 

limit based on their evaluation of the 

effect of large redemptions on the 

acquired fund? If so, what parameters 

should we establish for such an 

evaluation? Would this approach raise 

investor protection concerns? For 

example, should we require the 

acquired fund to evaluate historical 

redemptions to determine what limit on 

redemptions is appropriate? Should we 

require acquired funds to disclose the 

redemption limit on Form N–CEN? 

• Alternatively, should we consider 

requiring the acquiring fund to provide 

advance notice to an acquired fund 

prior to a large redemption? If so, what 

threshold should trigger this notice 

requirement (e.g., 3% or higher), and 

how far in advance should the acquiring 

fund provide notice? Similarly, should 

we require an acquiring fund to provide 

notice to an acquired fund before 

investing in the fund in reliance on rule 

12d1–4? Should we consider permitting 

an acquired fund to impose redemption 

fees on acquiring funds that make 

redemptions over a certain limit? 137 If 

so, what should that limit be? 

3. Duplicative and Excessive Fees 

We are proposing conditions in rule 

12d1–4 that are designed to prevent 

duplicative and excessive fees in fund 

of funds arrangements, a key concern 

underlying the enactment of section 

12(d)(1).138 The conditions vary based 

1302 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

acquiring and acquired fund levels. Additionally, 

complex multi-tier fund structures made it difficult 

for shareholders to understand who controlled their 

fund, to assess the true value of their investments, 

or to assess the nature of a fund’s investment risks. 

139Proposed rule 12d1–4(b)(3)(i). This condition 

would apply to open-end funds, ETFs structured as 

open-end funds, ETMFs, closed-end funds, and 

BDCs. 

140 In addition, acquiring funds (other than those 

structured as UITs, discussed below) would be 

subject to our disclosure requirements for fund 

investments in other funds, which require all 

registered funds and BDCs to disclose in their 

prospectus fee tables expenses paid by both the 

acquiring and acquired funds so that shareholders 

can evaluate the costs of investing in a fund that 

invests in other funds. See Instruction 3(f) to Item 

3 of Form N–1A; Instruction 10.a to Item 3 of Form 

N–2. The Commission adopted these disclosure 

requirements when it adopted rules 12d1–1, 12d1– 

2 and 12d1–3. See Fund of Funds Adopting 

Release, supra footnote 17, at n.67 and 

accompanying text. We request comment on these 

disclosure requirements at the end of this section. 

141See infra section II.C.4. 

142See, e.g., Allianz Funds Multi-Strategy Trust, 

et al., Investment Company Act Release Nos. 32533 

(Mar. 15, 2017) [82 FR 14580 (Mar. 21, 2017)] 

(notice) and 32598 (Apr. 11, 2017) (order) and 

related application (providing that the acquiring 

fund adviser (or sub-adviser) will waive fees 

otherwise payable to it by an acquiring fund in an 

amount at least equal to any compensation 

(including fees received pursuant to any plan 

adopted by an acquired fund pursuant to rule 12b– 

1 under the Act) received from certain acquired 

funds by the adviser or sub-adviser, or an affiliated 

person of the adviser or sub-adviser, other than any 

advisory fees paid to the adviser, sub-adviser, or an 

affiliated person by the acquired fund, in 

connection with the investment by the acquiring 

fund in the acquired fund). 

Rule 12b–1 under the Act permits a fund to use 

fund assets to pay broker-dealers and others for 

providing services that are primarily intended to 

result in the sale of the fund’s shares. Among other 

things, rule 12b–1 requires that, before using fund 

assets to pay for distribution expenses, a fund must 

adopt a written plan describing all material aspects 

of the proposed financing of distribution. 17 CFR 

270.12b–1. 

143See rule 38a–1; see also 17 CFR 275.206(4)– 

7 (rule 206(4)–7 under the Advisers Act). 

144Proposed rule 12d1–4(b)(3)(i). 

145Proposed rule 12d1–4(b)(3)(i). 

on the structural characteristics of the 

acquiring fund, but generally hinge on 

a determination that the arrangement’s 

aggregate fees do not implicate the 

historical abuses that section 12(d)(1) 

was intended to prevent. We believe 

that the proposed condition would help 

serve to protect acquiring fund investors 

from duplicative fees. 

a. Management Companies 

In cases where the acquiring fund is 

a management company, proposed rule 

12d1–4 would require the acquiring 

fund’s adviser to determine that it is in 

the best interest of the acquiring fund to 

invest in the acquired fund.139 The 

proposed rule would require the adviser 

to make this determination before 

investing in acquired funds in reliance 

on the rule, and thereafter with such 

frequency as the board of directors of 

the acquiring fund, by resolution, deems 

reasonable and appropriate, but in any 

case, no less frequently than annually. 

The proposed rule also would require 

the adviser to report its finding and the 

basis for the finding to the board. 

Investment Adviser Review and 

Reporting. In finding that it is in the best 

interest of the acquiring fund to invest 

in an acquired fund, the proposed rule 

would require the acquiring fund’s 

investment adviser to evaluate: (i) The 

complexity of the fund of funds 

structure; and (ii) the aggregate fees 

associated with the fund’s investment in 

an acquired fund. We believe it is 

appropriate to require the acquiring 

fund’s investment adviser to make these 

evaluations because whether to invest in 

an acquired fund to achieve a fund’s 

investment objective, rather than other 

types of assets, is a question of portfolio 

management. The acquiring fund’s 

board of directors would be required to 

review these arrangements, and any 

conflicts they may present, as part of its 

oversight responsibilities. The proposed 

evaluations are designed both to help 

guard against the construction of a 

complex structure that could be 

confusing to the acquiring fund’s 

shareholders and to prevent excessive 

layering of fund costs.140

In evaluating the complexity of a fund 

of funds structure, an adviser should 

consider the complexity of an acquiring 

fund’s investment in an acquired fund 

versus direct investment in assets 

similar to the acquired fund’s holdings. 

The adviser should consider whether 

the resulting structure would make it 

difficult for shareholders to appreciate 

the fund’s exposures and risks. The 

adviser should consider whether an 

investment in an acquired fund would 

circumvent the acquiring fund’s 

investment restrictions and limitations. 

The adviser also should consider 

whether an acquired fund invests in 

other funds.141

In evaluating the fees associated with 

the fund’s investment in acquired funds, 

an adviser should consider the fees of 

all tiers in the fund of funds 

arrangement with an eye towards 

duplication. As part of this analysis, an 

adviser should consider whether the 

acquired fund’s advisory fees are for 

services that are in addition to, rather 

than duplicative of, the adviser’s 

services to the acquiring fund. The 

adviser should consider sales charges 

and other fees, including fees for 

recordkeeping, sub-transfer agency 

services, sub-accounting services, or 

other administrative services. In 

particular, the adviser should consider 

whether these fees could be duplicative 

or excessive when evaluating an 

investment in a particular acquired 

fund. While not required under 

proposed rule 12d1–4, fee waivers 

would be one way to mitigate the 

duplicative fee concerns.142

Additionally, the adviser should 

consider reviewing acquired fund share 

classes to ensure that the acquiring fund 

is not holding a more expensive share 

class if a less expensive one is available 

to the acquiring fund. 

The proposed rule does not require an 

acquiring fund’s adviser to make these 

evaluations in connection with every 

investment in an acquired fund. For 

example, in developing policies and 

procedures reasonably designed to 

prevent violations of the federal 

securities laws by the fund, an adviser 

to a fund that invests regularly in 

acquired funds as part of its strategy 

could consider establishing parameters 

for routine investments in acquired 

funds, and review individual 

transactions that are outside of those 

parameters.143 Any such policies and 

procedures should be tailored to the 

investment objectives and strategies of 

an individual fund. For example, an 

adviser to a fund that typically invests 

in fixed income securities of non-U.S. 

issuers, but periodically invests in an 

acquired fund to equitize cash before it 

can invest a large purchase of fund 

shares, may decide to make the 

evaluations in connection with each 

investment in an acquired fund. 

Board Oversight. A management 

company’s board of directors provides 

an additional layer of protection for an 

acquiring fund and its investors against 

the abuses historically associated with 

fund of funds arrangements. To enable 

effective board oversight, the proposed 

rule requires an acquiring fund’s adviser 

to report to the acquiring fund’s board 

of directors its finding that the fund of 

funds arrangement is in the best interest 

of the fund and the basis for the 

finding.144 The proposed rule requires 

this reporting before investing in 

acquired funds in reliance on the rule, 

and with such frequency as the board of 

directors of the acquiring fund deems 

reasonable and appropriate thereafter, 

but in any case, no less frequently than 

annually.145 The frequency of any such 

review and reporting by the adviser 

would be determined by resolution of 

the board, which we believe is in the 

best position to understand when such 

a review would be appropriate and the 

frequency thereof. 

The proposed rule would not require 

the acquiring fund’s board to find that 

advisory fees are based on services 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1303 

146Our exemptive orders require the acquiring 

fund’s adviser to waive fees otherwise payable to 

it by an acquiring fund in an amount at least equal 

to any compensation (including fees received 

pursuant to any plan adopted by an unaffiliated 

fund pursuant to rule 12b–1 under the Act) received 

from an unaffiliated fund by the adviser, or an 

affiliated person of the adviser, other than advisory 

fees paid to the adviser or its affiliated person by 

an unaffiliated fund, in connection with the 

investment by the acquiring fund in the unaffiliated 

fund. See also supra footnote 117 (defining 

‘‘unaffiliated fund’’ for these purposes). 

147See Fund of Funds Adopting Release, supra 

footnote 17, at n.52 and accompanying text. 

148 15 U.S.C. 80a–15(c); see also Fund of Funds 

Adopting Release, supra footnote 17, at n.52 and 

accompanying text. 

149 15 U.S.C. 80a–36(b). 

150See Fund of Funds Adopting Release, supra 

footnote 17, at n.52. 

151See Proposed Commission Interpretation 

Regarding Standard of Conduct for Investment 

Advisers, Request for Comment on Enhancing 

Investment Adviser Regulation, Investment 

Advisers Act Release No. 4889 (Apr. 18, 2018) [83 

FR 21203 (May 9, 2018)]. 

152See 2008 Proposing Release, supra footnote 

13, at n.234 (‘‘As we noted in the proposing and 

adopting releases for rule 12d1–1 explaining our 

exclusion of a similar condition from rule 12d1–1, 

an acquiring fund board is already obligated to 

protect the fund from being overcharged for services 

provided to the fund regardless of any special 

findings we might require.’’). The 2008 proposal 

would have limited fees using an approach based 

on the FINRA sales charge rule. 

153See id. See also FINRA rule 2341. The 

proposal also included specific fee conditions for 

insurance product separate accounts, which are 

discussed below. 

154FINRA rule 2341 does not apply to registered 

closed-end funds (other than interval funds relying 

on rule 23c–3 under the Act), BDCs, or UITs (other 

than ‘‘single payment’’ investment plans that are 

issued by a UIT). See FINRA rule 2341(d). 

155See proposed rule 12d1–4(b)(3)(i) 

(requirement to evaluate aggregate fees of the 

arrangement). See also FINRA Notice to Members 

92–41: SEC Approval of Amendments to Article III, 

Section 26 of the NASD Rules of Fair Practice 

Regarding Limitations on Mutual Fund Asset-Based 

Sales Charges (Aug. 1992) (definitions of ‘‘sales 

charges’’ and ‘‘service fees’’ under FINRA Rule 2341 

do not include fees for recordkeeping, transfer 

agency services, accounting services, or other 

administrative services), available at http://

finra.complinet.com/en/display/display_

main.html?rbid=2403&element_id=1684. 

156Proposed rule 12d1–4(c)(1). 

157See id. 

158The retention period is consistent with the 

period provided in rules 22e–4 and 38a–1(d) under 

the Act. 

159Proposed rule 12d1–4(b)(3)(ii). 

160See 15 U.S.C. 80a–4(2) (defining a UIT, in part, 

to mean an investment company organized under 

a trust indenture or similar instrument that issues 

Continued 

provided that are in addition to, rather 

than duplicative of, the services 

provided by an adviser to an acquired 

fund. Similarly, the proposed rule 

would not require an acquiring fund’s 

adviser to waive fees in connection with 

the receipt of compensation from the 

acquired fund. While these conditions 

are required by our exemptive orders, 

we believe they are redundant in light 

of a fund adviser’s and board’s fiduciary 

duties and statutory obligations.146 As 

we stated in connection with our 

omission of a similar condition in rule 

12d1–1, an acquiring fund board already 

has a responsibility to see that the fund 

is not being overcharged for advisory 

services regardless of any findings we 

require.147 Section 15(c) of the Act 

requires the board of directors of the 

acquiring fund to evaluate any 

information reasonably necessary to 

evaluate the terms of the acquiring 

fund’s advisory contracts (which 

information would include fees, or the 

elimination of fees, for services 

provided by an acquired fund’s 

adviser).148 Section 36(b) of the Act also 

imposes on fund advisers a fiduciary 

duty with respect to their receipt of 

compensation.149 We believe that to the 

extent advisory services are being 

performed by another person, such as 

the adviser to an acquired fund, this 

fiduciary duty would require an 

acquiring fund’s adviser to charge a fee 

that bears a reasonable relationship to 

only the services that the acquiring 

fund’s adviser is providing, not taking 

into account services performed by an 

adviser to an acquired fund.150 In 

addition, when an adviser to an 

acquiring fund (or an affiliate of an 

adviser) receives compensation from, or 

related to, an acquired fund in 

connection with an investment by the 

acquiring fund, the adviser has a 

conflict of interest. The adviser has a 

fiduciary duty to the acquiring fund 

under the Advisers Act with respect to 

this conflict.151 Accordingly, we do not 

believe that the elimination of these 

conditions would lead to an increase in 

the costs ultimately borne by acquiring 

fund investors. 

The 2008 Proposing Release took a 

different approach with respect to the 

fee conditions discussed above. Then, as 

now, we did not propose to require the 

acquiring fund board to find that 

advisory fees are based on services 

provided that are in addition to, rather 

than duplicative of, the services 

provided by an adviser to an acquired 

fund.152 Further, we did not propose to 

require an acquiring fund’s adviser to 

waive fees in connection with the 

receipt of compensation from the 

acquired fund. Instead, our 2008 

proposal limited sales charges and 

service fees charged by the acquiring 

fund to those set forth in Financial 

Industry Regulatory Authority’s 

(‘‘FINRA’’) rule 2341 (‘‘FINRA sales 

charge rule’’) to prevent duplicative 

fees.153 The FINRA sales charge rule 

takes into consideration sales charges 

and certain servicing fees charged at 

both levels of a fund of funds 

arrangement. 

We do not believe it is necessary, 

however, to include a similar condition 

in proposed rule 12d1–4. Fund of funds 

arrangements involving open-end funds 

and certain closed-end funds already are 

subject to the FINRA sales charge 

rule.154 Even in circumstances where 

the arrangement is not subject to the 

sales charge rule, we believe the fee 

conditions in proposed rule 12d1–4 

effectively capture concerns regarding 

duplicative or excessive fees. In 

particular, proposed rule 12d1–4 would 

require acquiring funds to consider fees, 

which could include expenses such as 

fees for recordkeeping, sub-transfer 

agency services, sub-accounting 

services, or other administrative 

services that are not covered by the sales 

charge rule, when finding it is in the 

best interest of the acquiring fund to 

invest in the acquired funds.155

Recordkeeping Requirements. The 

proposed rule would require the 

acquiring fund to maintain and preserve 

a written record of the adviser’s finding, 

the basis for the finding, and the 

adviser’s reports to the board.156 These 

records must be maintained and 

preserved for at least five years, the first 

two in an easily accessible place.157

Funds currently have compliance 

program-related recordkeeping 

procedures in place that incorporate this 

type of retention period, and 

consistency with that period would 

minimize any compliance burden to 

funds related to the preservation of the 

records.158 We believe that these 

recordkeeping requirements would 

allow for external examinations of 

advisers’ determinations without 

placing an undue burden on fund 

advisers or boards of directors. 

b. UITs 

Proposed rule 12d1–4 sets forth an 

alternative fee condition when the 

acquiring fund in a fund of funds 

arrangement is a UIT. Specifically, on or 

before the date of initial deposit of 

portfolio securities into a registered UIT, 

the UIT’s principal underwriter or 

depositor must evaluate the complexity 

of the structure and the aggregate fees 

associated with the UIT’s investment in 

acquired funds, and find that the fees of 

the UIT do not duplicate the fees of the 

acquired funds that the UIT holds or 

will hold at the date of deposit.159

The proposed condition for acquiring 

UITs under rule 12d1–4 differs from the 

condition applicable to acquiring 

management companies for several 

reasons. First, by statute, a UIT is 

unmanaged and its portfolio fixed.160

1304 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

redeemable securities, each of which represents an 

undivided interest in a unit of specified securities). 

161Section 26(a)(2)(C) of the Act requires that the 

trust indenture for a UIT prohibit payments to the 

depositor or to any affiliated person thereof, except 

payments for performing bookkeeping and other 

administrative services of a character normally 

performed by the trustee or custodian itself. 80 

U.S.C. 80a–26(a)(2)(C). UIT ETFs have exemptive 

relief that allow the ETF to pay certain enumerated 

expenses that would be prohibited under section 

26(a)(2)(C). See 2018 ETF Proposing Release, supra 

footnote 34, at n.52 and accompanying text. 

162See supra section II.C.3.a. (discussing 

examples of factors that could be considered as part 

of such an evaluation). 

163See, e.g., Elkhorn Securities, LLC, et al., 

Investment Company Act Release Nos. 31022 (Apr. 

17, 2014) [79 FR 22720 (Apr. 17, 2014)] (notice) and 

31043 (May 13, 2014) (order) and related 

application. UITs also have agreed as a condition 

to their exemptive orders to voluntarily comply 

with the FINRA sales charge rule, even though that 

rule does not apply to UITs. See, e.g., Ausdal UIT, 

et al., Investment Company Act Release Nos. 32922 

(Dec. 14, 2017) [82 FR 60426 (Dec. 20, 2017)] 

(notice) and 32953 (Dec. 26, 2017) (order) and 

related application. As discussed above, we believe 

the conditions in proposed rule 12d1–4 more 

effectively capture concerns regarding complex 

structures and duplicative or excessive fees. 

164See proposed rule 12d1–4(b)(3)(ii). 

165See proposed rule 12d1–4(b)(3)(iii). 

166According to UIT annual Form N–SAR filings, 

as of December 2017, insurance UITs made up 673 

of the total 719 registered UITs. 

167There are eight existing UIT ETFs that had 

total assets of approximately $374 billion as of 

December 31, 2017, representing 80% of UIT assets. 

All existing UIT ETFs seek to track the performance 

of a broad-based securities index by investing in the 

component securities of the index in the same 

approximate portions as the index. 

168The exemptive relief that has been granted to 

UIT ETFs provides that the trustee will make 

adjustments to the ETF’s portfolio only pursuant to 

the specifications set forth in the trust formation 

documents in order to track changes in the ETF’s 

underlying index. The trustee does not have 

discretion when making these portfolio 

adjustments. See 2018 ETF Proposing Release, 

supra footnote 34, at nn. 46–47 and accompanying 

text. 

169This estimate is based on staff sampling of 

equity UIT prospectuses. 

170Proposed rule 12d1–4(c)(2). These records 

must be maintained and preserved for at least five 

years, the first two in an easily accessible place. Id. 

171The retention period is consistent with the 

period provided in rule 38a–1(d) under the Act. 

172See rule 22e–4(c) (requiring a UIT to maintain 

a record of the determination that the portion of the 

illiquid investments that the UIT holds or will hold 

at the date of deposit that are assets is consistent 

with the redeemable nature of the securities it 

issues for the life of the trust and for five years 

thereafter). See also Liquidity Release, supra 

footnote 128. 

173Proposed rule 12d1–4(b)(3)(iii). 

Unlike a management company, a UIT 

does not have a board of directors, 

officers, or an investment adviser to 

render advice during the life of the trust. 

Accordingly, we do not propose to 

apply the best interest determination 

requirement to UITs. Second, acquiring 

UITs typically raise different fee 

concerns than management companies. 

A UIT, for example, does not bear 

investment advisory fees and the 

payments UITs make are limited by 

section 26 of the Act.161

Due to the unmanaged nature of UITs 

and the fixed nature of their portfolios, 

we believe it would be inconsistent with 

their structure and portfolios to require 

UITs to re-evaluate their acquired fund 

finding over time. The requirement only 

applies, therefore, at the time of the 

UIT’s creation. Nevertheless, this 

determination generally should consider 

taking into account the planned 

structure of the UIT’s holdings. In 

particular, if the UIT tracks an index, 

the determination should consider the 

index design and whether the index 

design is likely to lead to the UIT 

holding acquired funds with duplicative 

fees or overly complex structures. We 

believe that requiring a UIT’s principal 

underwriter or depositor to evaluate the 

complexity of the structure and 

aggregate fees associated with the UIT’s 

investment in acquired funds, and to 

make a finding that the UIT’s fees do not 

duplicate the fees of the acquired funds 

that the UIT holds or will hold at the 

date of deposit, is an appropriately 

calibrated means to protect investors, 

given a UIT’s unmanaged structure.162

In making this evaluation, the 

depositor could decide to waive fees 

payable to it by the UIT on account of 

any compensation (including any 

distribution fees) received by the UIT’s 

depositor or any affiliated person from 

the acquired fund. Our exemptive 

orders have required UIT depositors to 

deposit only acquired funds that do not 

assess a sales load or that waive any 

sales loads.163 We believe that fee 

waivers would be one way to mitigate 

the duplicative fee concerns, and would 

allow UIT depositors and affiliates to 

rely on processes that they may already 

have in place as a result of the 

exemptive order conditions. 

The proposed condition would apply 

only at the time of initial deposit for 

UITs that are formed after the proposed 

rule’s effective date.164 We do not 

believe it is necessary to exclude UITs 

that are already in existence from 

relying on proposed rule 12d1–4 as 

acquiring funds. UITs that serve as 

separate account vehicles funding 

variable annuity and variable life 

insurance contracts would be subject to 

additional fee conditions, as discussed 

below.165 The majority of UITs fall into 

this category.166 In addition, we believe 

that existing UIT ETFs are unlikely to 

rely on proposed rule 12d1–4 as 

acquiring funds because they replicate 

the components of broad-based 

securities indexes that do not currently 

include funds.167 Even if funds were to 

become significant components of these 

indexes in the future, we believe that 

acquiring funds that invest in broadbased securities indexes are unlikely to 

raise complex structure concerns 

because the funds replicate the relevant 

index.168 If an index were to include 

funds, the UIT ETF would simply 

acquire those funds as part of 

replicating the broader index. Such an 

arrangement also is unlikely to raise 

duplicative fee concerns because 

existing UIT ETFs do not bear advisory 

fees, sales loads, or other types of 

service fees at the UIT ETF level. 

Finally, UITs that do not serve as 

variable insurance contract separate 

account vehicles or that are not ETFs 

typically have a limited term of 12–18 

months.169 Given this short term, the 

number of UITs that have not made the 

finding required by proposed rule 12d1– 

4 would quickly decrease over time. 

Recordkeeping Requirements. The 

proposed rule would require an 

acquiring fund that is a UIT to maintain 

and preserve a written record of its 

principal underwriter’s or depositor’s 

finding under proposed rule 12d1– 

4(b)(3)(ii) and the basis for the 

finding.170 UITs currently have 

compliance program-related 

recordkeeping procedures in place that 

incorporate this type of retention 

period, and consistency with that period 

would minimize any compliance 

burden to funds related to the 

preservation of the records.171 Although 

the proposed retention period would 

differ from the period required for 

certain UIT findings under rule 22e–4 

and the general recordkeeping 

requirements in rule 31a–2, we believe 

it is appropriate have consistent 

recordkeeping requirements under rule 

12d1–4.172 We also believe that these 

recordkeeping requirements would 

allow for external examinations of the 

principal underwriter’s or depositor’s 

determinations without placing an 

undue burden on those entities. 

c. Separate Accounts Funding Variable 

Insurance Contracts 

With respect to a separate account 

funding variable insurance contracts 

that invests in an acquiring fund, the 

proposed rule would require an 

acquiring fund to obtain a certification 

from the insurance company issuing the 

separate account that it has determined 

that the fees borne by the separate 

account, acquiring fund and acquired 

fund, in the aggregate, are consistent 

with the standard set forth in section 

26(f)(2)(A) of the Act.173 The standard 

set forth in section 26(f)(2)(A) of the Act 

provides that the fees must be 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1305 

174See 2008 Proposing Release, supra footnote 

13. See, also, BGFA Letter; IDC Letter; ICI Letter 

(supporting the proposed reasonableness 

determination, but suggesting that additional fee 

limits for separate accounts were unnecessary). 

Commenters supported our proposed exclusion of 

the two conditions from the exemptive orders that 

address the layering of fees. See ICI Letter; IDC 

Letter; MFDF Letter. 

175Proposed rule 12d1–4(c)(3). These records 

must be maintained and preserved for at least five 

years, the first two in an easily accessible place. Id. 

176See Instruction 3(f)(i) to Item 3 of Form N–1A. 

Form N–2 has a similar disclosure relating to AFFE. 

See Instruction 10.a to Item 3.1 of Form N–2. A 

fund may include AFFE in the line item for ‘‘Other 

Expenses’’ rather than in a separate line item if the 

aggregate expenses attributable to acquired funds 

does not exceed 0.01%. 

reasonable in relation to the services 

rendered, the expenses expected to be 

incurred, and the risks assumed by the 

insurance company. 

The proposed requirement relating to 

separate account fees is based on the 

limits in our fund of funds exemptive 

relief. Our exemptive orders are subject 

to conditions providing that each 

acquiring fund will represent in its 

participation agreements with an 

acquired fund that no insurance 

company sponsoring a registered 

separate account funding variable 

insurance contracts will be permitted to 

invest in the acquiring fund unless the 

insurance company has made a 

certification to the acquiring fund. 

Specifically, the insurance company 

must certify to the acquiring fund that 

the aggregate of all fees and charges 

associated with each variable insurance 

contract that invests in the acquiring 

fund are reasonable in relation to the 

services rendered, the expenses 

expected to be incurred, and the risks 

assumed by the insurance company. 

Because the proposed rule would not 

require participation agreements, 

however, proposed rule 12d1–4 requires 

that the acquiring fund obtain a 

certification from the insurance 

company issuing a separate account that 

the required reasonableness 

determination was made. 

Our 2008 Proposing Release also 

included reasonableness determinations 

for separate accounts, which 

commenters generally supported.174 As 

discussed above, we believe it is 

appropriate to require an acquiring fund 

to obtain a certification from each 

insurance company that issues separate 

accounts that a reasonableness 

determination was made in order to 

better protect investors from duplicative 

or excessive fees. 

Recordkeeping Requirements. The 

proposed rule would require an 

acquiring fund to maintain and preserve 

a written record of each certification 

obtained by the acquiring fund under 

proposed rule 12d1–4(b)(3)(iii).175 As 

noted above for the other proposed 

recordkeeping requirements under 

proposed rule 12d1–4, we believe that 

consistency with the retention period 

that funds have in place for other 

requirements under the Act and our 

rules would minimize any compliance 

burden to funds related to the 

preservation of the records. We also 

believe that these recordkeeping 

requirements would allow for external 

examinations of compliance with this 

condition without placing an undue 

burden on the acquiring funds. 

We request comment on the proposed 

fee conditions. 

• Would the proposed fee conditions 

sufficiently reduce the risk of acquiring 

fund shareholders paying excessive or 

duplicative fees? Should those 

conditions vary for management 

companies, UITs, and insurance product 

separate accounts as proposed? 

Alternatively, should all acquiring 

funds be subject to the same fee 

condition and if so which condition? 

Should closed-end funds and BDCs be 

subject to any special fee conditions 

with respect to the adviser’s 

determination, or generally? 

• Are there other conditions we 

should consider? For example, should 

the rule include a condition requiring 

the waiver of certain fees similar to the 

one included in our orders? Should the 

rule include a condition requiring an 

acquiring fund board to find that the 

advisory fees charged under an advisory 

contract are based on services provided 

that will be in addition to, rather than 

duplicative of, the services provided by 

an adviser to an acquired fund? 

• Should we require, as proposed, an 

acquiring fund’s investment adviser to 

determine that it is in the best interest 

of the acquiring fund to invest in an 

acquired fund? Should we prescribe the 

frequency of these determinations? 

Should we provide additional guidance 

or requirements in the rule regarding the 

considerations that an investment 

adviser should or must take into 

account when making this 

determination? Should we require that 

advisers develop policies and 

procedures related to fund of funds 

arrangements before relying on the rule? 

What parameters, if any, should we 

place on board oversight of an 

investment adviser’s determinations 

under rule 12d1–4? 

• Alternatively or in addition to the 

proposed requirements in rule 12d1– 

4(b)(3)(i), should we require an 

acquiring fund’s investment adviser to 

make a determination regarding the 

reasonableness of fees that more closely 

tracks the determination we propose to 

require for insurance product separate 

accounts? 

• Are we correct in our belief that the 

elimination of the fee waiver conditions 

in our exemptive orders would not lead 

to an increase in the costs ultimately 

borne by acquiring fund investors? If 

not, why not? 

• Are the proposed conditions 

associated with separate accounts 

appropriate to address concerns 

regarding layering fees in the three-tier 

structure typically utilized by insurance 

product separate accounts? Should we 

include the reasonableness 

determinations for separate accounts? 

Alternatively, should we cap the assetbased sales charges and services fees 

that may be charged on an aggregate 

basis by both the acquiring fund and the 

acquired fund in these arrangements? 

• Should we condition proposed rule 

12d1–4 on compliance with the FINRA 

sales charge rule? Should we subject all 

acquiring funds to the limits in the 

FINRA sales charge rule, even if that 

rule does not currently apply to them? 

• Should we require, as proposed, 

that an acquiring fund maintain and 

preserve written records regarding the 

finding made under rule 12d1–4(b)(3) 

for a period of not less than five years 

(the first two years in an easily 

accessible place)? Should we require 

any additional records to be maintained 

or preserved? Should the records be 

required to be maintained and preserved 

for a longer or shorter period of time? 

For example, should we require UITs to 

maintain and preserve written records 

regarding the depositor’s finding under 

proposed rule 12d1–4(b)(3)(ii) for the 

life of the UIT and for five years 

thereafter, consistent with other rules 

under the Act? 

• Should we set forth new expense 

disclosure requirements for acquiring 

funds structured as UITs? Should such 

requirements track the disclosure 

requirements in place for other types of 

acquiring funds? Are there additional 

disclosure requirements we should 

consider? 

• An acquiring fund is currently 

required to disclose the fees and 

expenses it incurs indirectly from 

investing in shares of one or more 

acquired funds. In Form N–1A, for 

example, an open-end fund investing in 

another fund is required to include in 

its prospectus fee table an additional 

line item titled ‘‘Acquired Fund Fees 

and Expenses’’ (‘‘AFFE’’).176 The AFFE 

disclosure was designed to provide 

investors with: (i) A better 

understanding of the actual costs of 

investing in a fund that invests in shares 

of another fund; and (ii) relevant 

1306 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

177See Funds of Funds Adopting Release, supra 

footnote 17, at text accompanying n.67 and nn. 53, 

88. 

178See, e.g., ICI Comment Letter to File No S7– 

12–18, https://www.sec.gov/comments/s7-12-18/ 

s71218-4560073-176206.pdf; House Report to 

[Omnibus Spending Bill/H.R. 3280] (July 17, 2017), 

https://www.congress.gov/congressional-report/ 

115th-congress/house-report/234/ 

1?overview=closed; Fidelity Management & 

Research Company, Petition for Rulemaking (Dec. 

28, 2006), https://www.sec.gov/rules/petitions/ 

2006/petn4-528.pdf (‘‘Fidelity Petition’’). 

179See Fidelity Petition, supra footnote 178. As 

in this release, we previously noted Congressional 

concerns regarding potentially duplicative fees at 

the acquiring and acquired fund levels. See supra 

Funds of Funds Adopting Release, supra footnote 

17, at nn.51–53 and accompanying text; Fund of 

Funds Proposing Release, supra footnote 16, at n.4 

and accompanying text and n.68. 

180As discussed in more detail below, we have 

observed target date funds that invest, in reliance 

on section 12(d)(1)(G) of the Act, in acquired funds 

that then invest in ETFs in reliance on an 

exemptive order. See infra section V. 

181See proposed rule 12d1–4(b)(4)(ii). See also 

section 12(d)(1)(G)(v) (granting the Commission 

authority to prescribe rules or regulations with 

respect to acquisitions under section 12(d)(1)(G) as 

necessary and appropriate for the protection of 

investors). 

information to compare directly the 

costs of investing in alternative funds of 

funds or of investing in a fund that 

invests in one or more other funds to a 

fund that does not.177 Since we adopted 

the AFFE disclosure requirement, 

however, concerns have been expressed 

with respect to disclosure of fees and 

expenses of certain acquired funds, e.g., 

private funds other than hedge funds, 

and BDCs.178 Has the AFFE disclosure 

requirement been effective? Why or why 

not? 

• Do investors understand the AFFE 

disclosure? Has the AFFE disclosure 

requirement helped investors 

understand the fees and expenses 

associated with their investment in an 

acquiring fund? If so, how? For 

example, has the AFFE disclosure 

helped in fund selection or fund 

comparison? Are there ways that we 

could improve the AFFE disclosure 

consistent with our intent in adopting 

the AFFE disclosure requirement? Can 

we make the disclosure easier to 

understand or more comparable across 

pooled vehicles of the same or different 

types? Are there additional disclosures 

(e.g., as words, graphics, or pictures) 

that we should require to clarify how 

AFFE is calculated in order to help 

investors to understand the fees and 

expenses associated with such an 

investment? 

• For purposes of the AFFE 

disclosure, the definition of ‘‘acquired 

funds’’ includes investment companies 

and private funds. Is AFFE disclosure 

appropriate for all types of acquired 

funds or should we exempt certain 

types of acquired funds from the 

definition of acquired fund for purposes 

of AFFE disclosure? If so, which types 

of acquired funds should be exempted 

and why? Alternatively, are there 

pooled investment vehicles or other 

entities with structures similar to 

investment companies and private 

funds that are not included in the 

definition of ‘‘acquired fund’’ but 

should be? If so, which entities and 

why? 

• Is AFFE disclosure appropriate for 

every type of fee and expense of every 

type of acquired fund or should specific 

types of acquired fund fees or expenses 

be excluded from the disclosure? If so, 

which fees and/or expenses and why? 

Some have commented, for example, 

that expenses of certain funds are 

operationally distinct and thus do not 

raise expense duplication concerns.179

For example, closed-end funds, and 

particularly BDCs, finance a portion of 

their portfolios through borrowing, 

which is not typical for open-end funds, 

and the interest paid is included in the 

fund’s expense ratio. Would the 

exclusion of certain fees or expenses 

affect the way that acquired funds 

characterize expenses? Are there 

concerns, other than expense 

duplication, that warrant disclosure of 

acquired fund fees and expenses? 

Should we instead require two 

disclosures: One without such fees and 

expenses and one with such fees and 

expenses? 

• Alternatively, should the AFFE 

disclosure be aligned with the 

restrictions imposed by Congress on the 

acquisition limitations imposed by 

section 12(d)(1)(A)? For example, 

should we require AFFE disclosures 

only for acquiring funds that invest in 

acquired funds in excess of the limits of 

section 12(d)(1)(A)? Would such an 

alternative disclosure allow investors to 

fully understand the acquiring fund’s 

fees and expenses? 

• Has the AFFE disclosure 

requirement affected investment or 

other decisions of acquiring funds? If so, 

in what ways? 

• Are there ways that we can improve 

the calculation of AFFE? If so, how 

should we modify the calculation and 

why? For example, acquiring funds that 

have been in operation for less than a 

year are required to calculate AFFE 

using the number of days in the fund’s 

fiscal year. Should we revise the AFFE 

calculation to reflect the number of days 

the acquiring fund has been in 

operation, which we believe would be 

more accurate? 

• Should AFFE take into account fees 

and expenses of a fund held by an 

acquired fund? 

4. Complex Structures 

As discussed above, one 

Congressional concern underlying 

section 12(d)(1) was that complex multitier fund structures may lead to 

excessive fees and investor confusion. 

As a result, our exemptive orders have 

included conditions designed to address 

complex structure concerns, and 

proposed rule 12d1–4 also would 

include conditions designed to prevent 

the creation of complex structures that 

could cause investor confusion or result 

in duplicative and excessive fees. We 

believe that the proposed complex 

structure conditions would protect 

acquiring fund investors from unduly 

complex structures. 

Proposed rule 12d1–4’s complex 

structure conditions generally are more 

comprehensive than the conditions in 

our orders to address certain multi-tier 

arrangements that have emerged.180 Our 

fund of funds exemptive orders prohibit 

an acquired fund (i.e., the lower tier in 

a traditional fund of funds structure) 

from investing in other funds beyond 

the limits in section 12(d)(1), but they 

do not expressly prohibit a fund from 

investing in an acquiring fund (i.e., the 

top tier in a traditional fund of funds 

structure) beyond the limits in section 

12(d)(1). Proposed rule 12d1–4 contains 

conditions designed to restrict fund of 

funds arrangements to two tiers (other 

than in limited circumstances). 

a. Limitations on Other Funds’ 

Acquisitions of Acquiring Funds 

Proposed rule 12d1–4 would include 

a condition designed to prevent an 

acquiring fund from also being an 

acquired fund under the rule or under 

section 12(d)(1)(G) of the Act. 

Specifically, the proposed rule would 

prohibit a fund that is relying on section 

12(d)(1)(G) of the Act (15 U.S.C. 80a– 

12(d)(1)(G)) or the proposed rule from 

acquiring, in excess of the limits in 

section 12(d)(1)(A), the outstanding 

voting securities of a fund that discloses 

in its most recent registration statement 

that it may be an acquiring fund in 

reliance on proposed rule 12d1–4.181

This proposed provision would limit 

the ability of funds relying on section 

12(d)(1)(G) or rule 12d1–4 to acquire the 

securities of acquiring funds, and, as a 

result, would significantly limit funds’ 

ability to create multi-tier arrangements. 

This condition, however, would not 

prevent another fund from investing all 

of its assets in an acquiring fund in 

reliance on section 12(d)(1)(E). We do 

not believe three-tier structures 

involving a master-feeder arrangement 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1307 

182A fund could acquire the securities of an 

acquiring fund within the limits of section 

12(d)(1)(A). Funds relying on section 12(d)(1)(F) 

could acquire up to 3% of the outstanding voting 

securities in an unlimited number of funds. See 

section 12(d)(1)(F). 

183See proposed rule 12d1–4(b)(4)(i). 

184As discussed above, proposed rule 12d1– 

4(b)(3) also would require an acquiring fund’s 

investment adviser or principal underwriter or 

depositor to evaluate the complexity of the fund of 

funds structure. 

185Our 2008 proposal would have required an 

acquired fund to have a disclosed policy that 

prohibits it from investing more than 10% of its 

assets in other investment companies in reliance on 

section 12(d)(1)(F) and 12(d)(1)(G) of the Act. See 

2008 Proposing Release, supra footnote 13, at n.225 

and accompanying text. Some commenters 

supported this approach. See Comment Letter of 

Katten Muchin Rosenman LLP (May 30, 2008) 

(‘‘Katten Letter’’) (stating that the proposed 

condition was consistent with the Commission’s 

long-held position that a three-tiered fund 

arrangement increases structural complexity as well 

as the likelihood of possible abuses section 12(d)(1) 

was designed to prevent); NY Bar Letter. On the 

other hand, one commenter opposed prohibiting 

three-tiered structures, arguing that they can 

provide more efficient and cost-effective exposure 

to certain market segments. See ICI Letter. 

186See supra footnote 120 and accompanying 

text. 

187A fund may not have information regarding 

beneficial owners whose shares are held in omnibus 

accounts registered in the name of intermediaries 

for the benefit of such investors. 

188For example, including a knowledge qualifier 

in this condition could result in secondary market 

transactions in ETF shares that are outside the 

condition’s scope. Eliminating the knowledge 

qualifier, however, could make this condition 

unworkable in connection with omnibus accounts. 

189See proposed rule 12d1–4(b)(4)(iii) (providing 

that an acquiring fund must not acquire the 

securities of an acquired fund that invests in excess 

of the limits in section 12(d)(1)(A) of the Act (15 

U.S.C. 80a–12(d)(1)(A)) in other funds or private 

funds, unless the acquired fund’s investment falls 

within certain covered exceptions). 

190See proposed rule 12d1–4(b)(4)(iii)(A)–(E). 

191See, e.g., Highland Capital Management, L.P., 

et al., Investment Company Act Release Nos. 29890 

(Dec. 19, 2011) [76 FR 80424 (Dec. 23, 2011)] 

(notice) and 29918 (Jan. 17, 2012) (order) and 

related application (‘‘Highland Capital’’). Brinker 

Capital Destinations Trust, et al., Investment 

Company Act Release Nos. 32478 (Feb. 14, 2017) 

[82 FR 11277 (Feb. 21, 2017)] (notice) and 32534 

(Mar. 16, 2017) (order) and related application 

(‘‘Brinker Capital’’). 

192See proposed rule 12d1–4(b)(4)(iii). 

193See proposed rule 12d1–4(b)(4)(iii)(A)–(E). 

194The enumerated circumstances have differed 

depending on the terms of the order. For example, 

some orders provide that an acquired fund will not 

invest in funds in excess of the limits in section 

12(d)(1)(A)(i)–(iii), except to the extent permitted by 

Commission exemptive relief to purchase shares of 

other investment companies for short-term cash 

management purposes. See, e.g., Highland Capital, 

supra footnote 191. Other orders provide that an 

acquired fund will not invest in funds in excess of 

the limits in section 12(d)(1)(A) except to the extent 

the acquired fund: (i) Acquires securities of another 

investment company in compliance with section 

12(d)(1)(E) and either is an affiliated fund or is in 

the same group of investment companies as the 

corresponding master fund; (ii) receives securities 

as a dividend or as a result of a plan of 

reorganization of a company; (iii) acquires 

securities of another investment company pursuant 

to exemptive relief from the Commission to: (a) 

Purchase shares of one or more investment 

companies for short-term cash management 

purposes, or (b) engage in interfund borrowing and 

lending transactions; or (iv) invests in a whollyowned subsidiary of the underlying fund subject to 

certain conditions. See, e.g., Brinker Capital, supra 

footnote 191. 

present the risk that section 12(d)(1) was 

designed to address. For example, this 

type of three-tier structure would permit 

a target date fund (itself an acquiring 

fund) to simply act as a conduit through 

which an insurance product separate 

account invests. 

This condition also would not prevent 

other funds from acquiring the voting 

securities of an acquiring fund in 

amounts under 3%, effectively creating 

a type of three-tier structure.182 We 

would not, however, expect multiple 

funds holding less than 3% of the 

acquiring fund to implicate the 

historical abuses, such as undue 

influence, that section 12(d)(1) is 

intended to prevent. 

The proposed rule would require a 

fund that relies on rule 12d1–4 (or 

wants to preserve investment flexibility 

to rely on the rule) to disclose in its 

registration statement that it is (or may 

be) an acquiring fund for purposes of 

rule 12d1–4.183 The proposed disclosure 

requirement is designed primarily to put 

other funds seeking to rely on rule 

12d1–4 on notice that a fund they seek 

to acquire is itself an acquiring fund. 

This disclosure would allow a fund to 

limit its acquisition of the acquiring 

fund’s securities accordingly.184 Funds 

investing in reliance on section 

12(d)(1)(G) likely would have less need 

for this disclosure. In such 

arrangements, we believe that the 

acquiring fund would have, or be able 

to obtain, sufficient information to know 

which other funds within the same 

group of investment companies are 

acquiring funds under rule 12d1–4. 

Proposed rule 12d1–4 differs from the 

complex structures provision we 

proposed in 2008, which would have 

required an acquired fund to have a 

‘‘disclosed policy’’ limiting three-tier 

arrangements.185 Instead, the proposed 

rule would both require certain 

disclosure and prohibit the acquisition 

of an acquiring fund’s outstanding 

voting securities by other funds. We 

believe that these conditions would 

help prevent the construction of a 

complex multi-tier structure more 

effectively than the current participation 

agreement requirements in our 

exemptive orders.186 Thus, the proposed 

rule would eliminate the need for 

acquiring funds to negotiate 

participation agreements with each 

acquired fund to ensure that the 

acquired fund’s investments would not 

violate the conditions of the acquiring 

fund’s order. 

We considered other conditions that 

would limit fund investments in 

acquiring funds. For example, we 

considered proposing a condition that 

would prevent an acquiring fund, and 

any principal underwriter, from 

knowingly selling the acquiring fund’s 

securities to another fund in excess of 

the limits in section 12(d)(1)(B) of the 

Act, except in limited circumstances. 

We were concerned, however, that some 

acquiring funds may have limited 

ability to know the identity of their 

investors in order to comply with this 

condition.187 We also were concerned 

that this condition could affect funds 

that are traded on secondary markets 

differently than other funds, causing 

certain inadvertent effects on 

competition.188

b. Limitations on Acquired Funds’ 

Acquisition of Other Funds and Private 

Funds 

Proposed rule 12d1–4 would include 

a condition designed to limit fund of 

funds arrangements where the acquired 

fund is itself an acquiring fund. The 

proposed rule generally would prohibit 

arrangements where an acquired fund 

invests in other investment companies 

or private funds in excess of the limits 

in section 12(d)(1)(A).189 However, the 

proposed condition would allow 

arrangements where the acquired fund 

invests in other funds in certain 

enumerated circumstances.190

Our exemptive orders directly 

prohibit acquired funds from acquiring 

securities of any other investment 

company or private fund, with certain 

limited exceptions.191 Proposed rule 

12d1–4 would limit the acquired fund’s 

ability to invest in certain other funds 

consistent with those orders. For 

example, the proposed condition would 

prohibit an arrangement where an 

acquired fund invests beyond the 

statutory limits in both investment 

companies and private funds.192 We 

believe that the limitation on 

investments in private funds is an 

appropriate means to protect against the 

creation of overly complex structures. 

The proposed condition also would 

allow three-tier structures in 

circumstances that we believe do not 

raise the same concerns for complex 

structures as other fund of funds 

transactions.193

Our exemptive orders generally have 

included the same exceptions.194

Specifically, proposed rule 12d1–4 

would permit arrangements where an 

acquired fund invests in another fund 

1308 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

195Proposed rule 12d1–4(b)(4)(iii)(B) and (E). 

196Proposed rule 12d1–4(b)(4)(iii)(A) and (C). 

197Proposed rule 12d1–4(b)(4)(iii)(D). See also 

section 12(d)(1)(D) (exempting from section 12(d)(1) 

securities received as a dividend, as a result of an 

offer of exchange approved under section 11, or as 

a result of a plan of reorganization). 

198Master-feeder arrangements typically rely on 

section 12(d)(1)(E) of the Act to operate. See supra 

footnote 19 and accompanying text. The acquired 

feeder fund in this example would be a passthrough entity. 

199For example, wholly-owned subsidiaries are 

typically organized under the laws of the Cayman 

Islands as an exempted company or under the laws 

of another non-U.S. jurisdiction in order to invest 

in commodity-related instruments and certain other 

instruments for tax and other reasons. See, e.g., 

Consulting Group Capital Markets Fund, et al., 

Investment Company Act Release Nos. 32940 (Dec. 

15, 2017) [82 FR 60463 (Dec. 20, 2017)] (notice) and 

32966 (Jan. 9, 2018) (order) and related application. 

200 In this type of arrangement, the acquired fund 

controls the wholly-owned subsidiary and the 

investment adviser to the acquired fund is also the 

investment adviser to the wholly-owned subsidiary. 

The acquired fund consolidates its financial 

statements with the wholly-owned subsidiary’s 

financial statements, provided that U.S. GAAP or 

other applicable accounting standards permit 

consolidation and acquired fund’s total annual fund 

operating expenses include the wholly-owned 

subsidiaries’ expenses. See id. 

201See, e.g., Franklin Alternative Strategies 

Funds, et al., Investment Company Act Release Nos. 

33095 (May 10, 2018) [83 FR 22720 (May 16, 2018)] 

(notice) and 22117 (June 5, 2018) (order) and related 

application (permitting funds to participate in an 

interfund lending facility). 

202See 2008 Proposing Release, supra footnote 

13, at n.226 and accompanying and following text. 

beyond the statutory limits for shortterm cash management purposes or in 

connection with interfund lending or 

borrowing transactions.195 The 

proposed rule also would permit 

arrangements where an acquired fund 

invests all of its assets in a master fund 

or invests in a wholly-owned 

subsidiary.196 Finally, the exceptions 

would permit arrangements where an 

acquired fund receives fund shares as a 

dividend or as a result of a plan of 

reorganization.197

These exceptions are limited in scope 

and designed to capture circumstances 

where an acquired fund may invest in 

another fund to efficiently manage 

uninvested cash, to address specific 

regulatory or tax limitations, or to 

facilitate certain transactions. We do not 

believe that permitting these 

arrangements would create an overly 

complex structure that could confuse 

investors, nor do we believe that these 

arrangements raise concerns regarding 

undue influence or layering of fees. For 

example, an acquired feeder fund’s 

investment in its master fund would be 

entirely transparent because the feeder 

fund would disclose the master fund’s 

portfolio holdings in its shareholder 

reports.198 Similarly, permitting an 

acquired fund to invest in a whollyowned subsidiary would allow the 

acquired fund to gain exposure to 

certain asset classes.199 Because the 

wholly-owned subsidiary’s financial 

statements are consolidated with the 

financial statement of the acquired fund, 

we do not believe that this arrangement 

would be so complex that investors 

could not understand the nature of these 

exposures.200 In addition, interfund 

transactions are subject to (and would 

continue to be subject to) conditions 

specifically designed to address the 

concerns that they present under the 

terms of their interfund lending 

orders.201 Although we acknowledge 

that three-tier structures may, in certain 

circumstances, provide efficient and 

cost-effective exposure to certain market 

segments, we continue to believe that 

three-tier structures can obfuscate the 

fund’s investments, fees, and related 

risks.202 We thus believe it is 

appropriate to prohibit three-tier 

structures, except in these limited 

circumstances. 

We request comment on the proposed 

limits on complex structures. 

• Are the proposed conditions on 

complex structures sufficient to prevent 

investor confusion and other abuses that 

may be present in a complex structure? 

If not, what limits should the rule 

include? 

• Should we prohibit other funds 

from acquiring the securities of an 

acquiring fund in reliance on section 

12(d)(1)(G) or rule 12d1–4 as proposed? 

Are there other alternatives we should 

consider? 

• Should we prohibit an acquired 

fund from investing in other investment 

companies or private funds as 

proposed? 

• As proposed, should we permit 

arrangements where an acquired fund 

invests in other investment companies 

and private funds in certain enumerated 

circumstances? Alternatively, should we 

strictly prohibit arrangements where an 

acquired fund invests in other funds in 

excess of the limits in section 

12(d)(1)(A)? Should we eliminate any of 

those circumstances? If so, which ones? 

Should we provide additional guidance 

regarding these types of investments? 

Are the limitations appropriately 

calibrated to mitigate complex structure 

concerns, including concerns related to 

transparency and potential investor 

confusion? Should we adopt different 

limits? For example, should we only 

impose a 10% limit on an acquiring 

fund’s investment in other funds? 

• Should the complex structures 

conditions include limits on 

investments in private funds, given that 

section 12(d)(1) does not limit a 

registered fund’s investments in private 

funds? Should the rule instead limit 

investments in funds only, consistent 

with the statutory cap on investment in 

all funds under section 12(d)(1)(A)? 

Should the overall limit be 10% or 

should that limit be higher or lower? 

Why? 

• As proposed, should the complex 

structures condition allow an exception 

for acquired funds’ investment in 

subsidiaries that are wholly-owned and 

controlled by the acquired fund? Should 

we include additional conditions on 

acquired funds’ investments in whollyowned subsidiaries? For example, 

should we limit the expenses of such 

subsidiaries? Should we limit acquired 

funds’ use of such subsidiaries? If so, 

what limitations should we establish 

and why? 

• Should we include a disclosure 

requirement in the complex structures 

condition as proposed? Should the 

disclosure be in an acquiring fund’s 

registration statement? Are there other 

more appropriate places that the fund 

should make such a disclosure? Should 

we require particular placement of this 

disclosure, and if so, where? Would the 

proposed disclosure help ensure that 

funds are not circumventing the 

limitations on multi-tier structures in 

proposed rule 12d1–4? Should we 

require additional disclosures when a 

fund of funds structure involves more 

than two tiers? For example, should an 

acquiring fund be required to disclose 

certain fees and expenses associated 

with a third-tier fund? 

• Should we condition proposed rule 

12d1–4 on providing additional 

disclosure about an acquiring fund’s 

investment in an acquired fund more 

generally? Should we require the 

additional disclosure only if an 

acquiring fund’s investment in an 

acquired fund is above a certain 

threshold? If so, what threshold and 

why? What types of disclosures should 

we require to ensure consistency of 

disclosure across fund of funds 

structures? For example, how much 

detail should an acquiring fund give 

regarding its investment in an acquired 

fund? Would such disclosures assist 

investors to better understand the fund’s 

structure? 

• To avoid three-tier structures 

including private funds as a third tier, 

should the proposed rule prohibit an 

acquiring fund from relying on the rule 

to invest in a fund that invests in private 

funds in excess of the limits in section 

12(d)(1)? Would a fund’s current 

disclosure of its investments in private 

funds be sufficient to put other funds on 

notice that they should not rely on the 

rule to invest in such a fund? Should we 

instead include a specific disclosure 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1309 

203 In several staff no-action letters, the staff has 

stated that, based on certain facts and 

circumstances, it would not recommend that the 

Commission take any enforcement action under 

sections 12(d)(1)(A) and (B) (and other sections of 

the Act) if an acquiring fund relying on section 

12(d)(1)(G) purchases or otherwise acquires shares 

of an underlying fund that, in turn, purchases or 

otherwise acquires shares of a central fund. See, 

e.g., Franklin Templeton Investments, Staff NoAction Letter (pub. avail. April 3, 2015); Thrivent 

Financial for Lutherans and Thrivent Asset 

Management LLC, Staff No-Action Letter (pub. 

avail. Sep. 27, 2016). 

204See 15 U.S.C. 80a–12(d)(1)(G)(i)(II). The 

acquired fund also must have a policy against 

investing in shares of other funds in reliance on 

section 12(d)(1)(F) or 12(d)(1)(G) to prevent multitier structures, and overall distribution expenses are 

limited to prevent excessive sales loads. 

205See Fund of Funds Proposing Release, supra 

footnote 16. 

206See Fund of Funds Adopting Release, supra 

footnote 17. 

207See rule 12d1–2(a)(1). 

208See rule 12d1–2(a)(2). Rule 12d1–2 limits 

investments to ‘‘securities.’’ The Commission has 

issued a series of exemptive orders that allow a 

fund relying on section 12(d)(1)(G) to invest in 

financial instruments that may not be ‘‘securities.’’ 

This relief provides that the funds will comply with 

rule 12d1–2, but for the ability to invest in a portion 

of their assets in these other investments. See, e.g., 

Van Eck Associates Corp, et al., Investment 

Company Act Release Nos. 31547 (Apr. 6, 2015) [80 

FR 19380 (Apr. 10, 2015)] (notice) and 31596 (May 

6, 2015) (order) and related application. 

209 17 CFR 270.12d1–2(a)(3). 

210Fund of Funds Adopting Release, supra 

footnote 17. 

211 Id. 

212See Janus Investment Fund, supra footnote 94. 

213A fund relying on section 12(d)(1)(G) and rule 

12d1–2 could acquire no more than 3% of a closedend fund’s outstanding voting securities. A fund 

relying on an exemptive order could acquire an 

unlimited amount of the voting securities of a 

closed-end fund in the same group of investment 

companies and up to 25% of the outstanding voting 

securities of other closed-end funds. 

214See, e.g., Northern Lights Fund Trust, et al., 

Investment Company Act Release Nos. 32973 (Jan. 

23, 2018) [83 FR 4081 (Jan. 29, 2018)] (notice) and 

33008 (Feb. 21, 2018) (order) and related 

application (setting forth conditions applicable to 

affiliated fund of funds arrangements, including 

that: (1) Any sales charges or service fees charged 

with respect to shares of acquiring funds would not 

exceed the limits set forth in FINRA Rule 2341; and 

(2) no acquired fund will acquire securities of any 

other investment company in excess of the 

limitations of section 12(d)(1) except to the extent 

that such acquired fund (a) acquires such securities 

in compliance with section 12(d)(1)(E), (b) receives 

such securities as a dividend or as the result of a 

plan of reorganization, or (c) acquires such 

securities pursuant to exemptive relief from the 

Commission permitting the acquired fund to 

acquire the securities of investment companies for 

Continued 

requirement for the fund investing in 

private funds? If so, what should the 

fund be required to disclose and where 

should the disclosure be made? 

• Should the proposed rule include 

additional limits on an acquiring fund’s 

ability to serve as an investment for 

other funds? 

• Should there be an exception that 

allows acquired funds to equitize cash 

by investing in other funds (e.g., shortterm investments in ETFs) beyond the 

statutory limits or other exceptions? 

Should the proposed rule permit other 

types of multi-tier arrangements? 

• Should we include an exception for 

offers of exchange approved under 

section 11 of the Act? 

• Should we prohibit an acquiring 

fund, and any principal underwriter 

thereof, from selling or otherwise 

disposing of any security issued by the 

acquiring fund to any investment 

company or any company or companies 

controlled by such other investment 

company in excess of the limits in 

section 12(d)(1)(B) of the Act? Would 

such an approach have a negative effect 

on competition? How would this 

condition affect acquiring funds that are 

not subject to section 12(d)(1)(B) of the 

Act? Are there other limits that we 

should consider? 

• Should we allow funds relying on 

section 12(d)(1)(G) to create three-tier 

master feeder structures? Should the 

proposed rule permit acquired funds 

relying on section 12(d)(1)(G) to invest 

in a third-tier ‘‘central fund’’ in order to 

centralize the portfolio management of 

floating rate or other instruments? 203

Should the proposed rule include 

conditions specifically related to such 

relief? If so, what conditions? For 

example, should the proposed rule 

require that the acquired funds’ 

investments in the central fund be 

subject to the limits in section 

12(d)(1)(A)(ii) and (iii)? Should the 

proposed rule require the acquired fund 

to waive certain management fees? 

Which fees and why? Should the 

proposed rule prohibit the central fund 

from charging sales loads, redemption 

fees, or distribution fees? Should the 

proposed rule subject the central fund to 

the acquisition limits under section 

12(d)(1)(A)? Should the proposed rule 

require any board findings? If so, what 

findings and why? 

III. Proposed Rescission of Rule 12d1– 

2 and Proposed Amendments to Rule 

12d1–1 

We also are proposing to rescind rule 

12d1–2 in order to create a more 

consistent and efficient regulatory 

framework for the regulation of fund of 

funds arrangements. As discussed 

above, section 12(d)(1)(G) allows a 

registered open-end fund or UIT to 

acquire an unlimited amount of shares 

of other open-end funds and UITs that 

are in the same ‘‘group of investment 

companies.’’ A fund relying on this 

exemption is subject to certain 

conditions, including a condition 

limiting the types of securities an 

acquiring fund can hold in addition to 

the shares of funds in the same group of 

investment companies, to government 

securities and short-term paper.204

Congress designed this limit to restrict 

the use of this exemption to a ‘‘bona 

fide’’ fund of funds, while providing the 

fund with a source of liquidity to 

redeem shares.205

In 2006, the Commission exercised its 

exemptive authority to adopt rule 12d1– 

2.206 Rule 12d1–2 codified, and in some 

cases expanded, three types of relief that 

the Commission provided for fund of 

funds arrangements that did not 

conform to the section 12(d)(1)(G) 

limits. Specifically, rule 12d1–2 permits 

a fund relying on section 12(d)(1)(G) to: 

(i) Acquire the securities of other funds 

that are not part of the same group of 

investment companies, subject to the 

limits in section 12(d)(1)(A) or 

12(d)(1)(F); 207 (ii) invest directly in 

stocks, bonds, and other securities; 208

and (iii) acquire the securities of money 

market funds in reliance on rule 12d1– 

1.209 Rule 12d1–2 was designed to 

provide a fund relying on section 

12(d)(1)(G) with greater flexibility to 

meet its investment objective when the 

risks that lead to the restrictions in 

section 12(d)(1) are minimized.210 The 

Commission stated that the investments 

permitted under rule 12d1–2 did not 

raise additional concerns under section 

12(d)(1)(G) because: (i) They were not 

investments in funds; or (ii) they 

represented fund investments that are 

limited in scope (i.e., cash sweep 

arrangements under rule 12d1–1) or 

amount (i.e., up to the limits in section 

12(d)(1)(A) or 12(d)(1)(F)).211

Our exemptive orders also have 

permitted funds to invest in funds 

within the same group of investment 

companies.212 Funds relying on these 

orders could invest in the same group of 

related investment companies to the 

same extent as funds relying on section 

12(d)(1)(G). In addition, funds relying 

on our exemptive orders could invest to 

a greater extent in funds that were not 

part of the same group of investment 

companies. Funds relying on exemptive 

relief also could invest in closed-end 

funds to a greater extent than funds 

relying on section 12(d)(1)(G) combined 

with rule 12d1–2.213

Our exemptive orders include 

conditions that differ from the 

conditions in section 12(d)(1)(G) and the 

conditions within those orders also 

differ depending on whether the 

investment involves an acquired fund 

that is in the same group of investment 

companies.214 The orders generally 

1310 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

short-term cash management purposes or to engage 

in interfund lending). 

215See supra footnote 117 and accompanying text 

(regarding conditions applicable to unaffiliated 

acquired funds). 

216See also supra footnote 28. 

217Rule 12d1–2(a)(1) and (a)(2). In connection 

with our proposed amendment to rule 12d1–1 

discussed below, funds relying on section 

12(d)(1)(G) could continue to invest in money 

market funds that are not part of the same group 

of investment companies even with the proposed 

rescission of rule 12d1–2(a)(3). 

218Funds also may continue to rely on section 

12(d)(1)(F) to make smaller investments in a 

number of funds and section 12(d)(1)(E) to invest 

all of their assets in a master-feeder arrangement. 

See supra footnotes 19 and 20 and accompanying 

text. 

219See Fund of Funds Adopting Release, supra 

footnote 17, at n.60 and accompanying text. 

220An equity or bond fund that holds securities 

could not rely on section 12(d)(1)(G) if rule 12d1– 

2 is rescinded because section 12(d)(1)(G) is 

available only to funds that invest in other funds 

within the same group of investment companies, 

government securities and short-term paper. See 

also supra footnote 217 (discussing proposed 

amendment to rule 12d1–1). 

221See proposed rule 12d1–4(b)(3)(ii). See also 

supra section II.C.3.a. 

222See proposed rule 12d1–4(b)(2). See also supra 

section II.C.2. 

223Section 12(d)(1)(G)(i) (limiting investments to 

open-end funds and UITs within the same group of 

investment companies, government securities, and 

short-term paper). 

224Proposed rule 12d1–1(a) providing an 

exemption from section 12(d)(1)(G) for an 

investment company to acquire the securities of a 

money market fund. Rule 12d1–2, which we 

propose to rescind, provided the same relief. 225Funds of Funds Adopting Release, supra 

footnote 17, at n. 23 and accompanying text. 226See id., at section II.A.1(a). 227See, e.g., section 12(d)(1)(G)(i)(III)(bb) (limiting 

combined sales charges and service fees to limits 

under current FINRA sales rule); section 

12(d)(1)(G)(i)(IV) (requiring the acquired fund to 

have a policy that prohibits it from acquiring 

securities of registered open-end investment 

companies or registered UITs in reliance on section 

12(d)(1)(G) or (F)). 

subject investments in funds that are not 

part of the same group of investment 

companies to a broader set of conditions 

designed to protect investors from the 

harms Congress sought to address by 

enacting section 12(d)(1).215 Under this 

existing framework, substantially 

similar fund of funds arrangements are 

subject to different limitations and 

conditions.216 This has resulted in an 

inconsistent and inefficient regulatory 

framework where the relief on which a 

fund of funds arrangement is relying is 

not always clear to other funds, 

investors, or regulators. 

In order to harmonize the overall 

regulatory structure, we are proposing to 

rescind existing exemptive orders (as 

discussed below) and rule 12d1–2. The 

rescission of rule 12d1–2 would 

eliminate the flexibility of funds relying 

on section 12(d)(1)(G) to: (i) Acquire the 

securities of other funds that are not 

part of the same group of investment 

companies, subject to the limits in 

section 12(d)(1)(A) or 12(d)(1)(F); and 

(ii) invest directly in stocks, bonds, and 

other securities.217 Accordingly, funds 

that wish to invest in funds within the 

same group of investment companies 

beyond the limits in section 12(d)(1)(A), 

as well as other securities and the 

securities of the other funds, could no 

longer rely on section 12(d)(1)(G) and 

rule 12d1–2.218 Instead, acquiring funds 

would have flexibility to invest in 

different types of funds and other asset 

classes under proposed rule 12d1–4 

under a single set of conditions that are 

tailored to address the concerns that 

underlie section 12(d)(1) of the Act. We 

believe that this approach would 

enhance investor protection by 

subjecting more funds of funds 

arrangements to the conditions in rule 

12d1–4. 

As we noted in the adopting release 

for rule 12d1–2, a significant 

consequence of rule 12d1–2 was that a 

fund investing directly in equities or 

bonds could invest a portion of its assets 

in a fund within the same group of 

investment companies if the acquisition 

was consistent with the investment 

policies of the fund.219 The proposed 

rescission of rule 12d1–2 would require 

such an equity or bond fund to comply 

with the conditions in proposed rule 

12d1–4 for any investment in another 

fund in excess of the limits of section 

12(d)(1)(A)(i).220 For example, as 

proposed, such a fund’s adviser would 

be required to engage in an evaluation 

of the complexity of the fund of funds 

structure and fees relating to its limited 

investments in funds—all of which 

would be subject to board oversight.221

The proposed rule’s redemption limits 

on acquired funds also would apply to 

such a fund.222

We believe these conditions are 

necessary to protect investors from the 

abuses that can arise when a fund’s 

investment in other funds exceeds the 

prescribed limits. We therefore believe 

that it is important to require that funds 

that are investing in other funds in 

excess of the limits in section 

12(d)(1)(A)(i) comply with the 

conditions underlying proposed rule 

12d1–4. As a result, however, proposed 

rule 12d1–4 could require additional 

compliance costs for what would be a 

smaller investment (albeit larger than 

the limits under section 12(d)(1) of the 

Act). 

The holdings limitations in section 

12(d)(1)(G) would apply to those funds 

that do not wish to comply with the 

conditions in proposed rule 12d1–4 and 

instead continue to rely on section 

12(d)(1)(G).223 In order to limit the 

hardship that the rescission of rule 

12d1–2 could have on existing fund of 

funds arrangements, we are proposing a 

one-year period after the effective date 

before rule 12d1–2 is rescinded. We 

believe that one-year is adequate time 

for funds relying on current rule 12d1– 

2 time to bring their future operations 

into conformity with section 12(d)(1)(G) 

or proposed rule 12d1–4. 

In addition, we are proposing an 

amendment to rule 12d1–1 under the 

Act to provide funds relying on section 

12(d)(1)(G) with continued flexibility to 

invest in money market funds outside of 

the same group of investment 

companies if they rely on section 

12(d)(1)(G).224 We continue to believe 

that ‘‘cash sweep’’ arrangements do not 

raise the concerns that underlie section 

12(d)(1).225 We also continue to believe 

that retaining this flexibility will help to 

ensure that funds in smaller complexes 

that do not have a money market fund 

as part of their fund complex may invest 

available cash in an unaffiliated money 

market fund, subject to the conditions of 

rule 12d1–1.226 This limited flexibility 

may come with some reduction in costs 

associated with complying with section 

12(d)(1)(G)’s limited conditions.227

We request comment on the proposed 

rescission of rule 12d1–2 and the 

proposed amendments to rule 12d1–1. 

• Should we rescind rule 12d1–2 as 

proposed? How would the proposed 

rescission affect funds that currently 

rely on section 12(d)(1)(G)? Would any 

funds be required to alter their 

investment strategies or holdings as a 

result of the change? Would funds 

currently relying on rule 12d1–2 have 

any challenges with relying on the 

conditions in proposed rule 12d1–4? If 

so, which conditions and why? For 

example, what effect would the 

rescission of rule 12d1–2 have on a fund 

that invests the majority of its assets in 

non-fund securities, but invests a 

portion of its assets in affiliated funds? 

• Would funds that are currently 

relying on rule 12d1–2 rely on proposed 

rule 12d1–4? Alternatively, would such 

funds change their holdings in order to 

rely on section 12(d)(1)(G)? What factors 

would funds consider in determining 

which exemption to rely on? 

• Should we continue to allow funds 

relying on section 12(d)(1)(G) to acquire 

the securities of money market funds 

that are not in the same group of 

investment companies in reliance on 

rule 12d1–1 as proposed? If not, why 

not? Should we amend rule 12d1–1 as 

proposed or would it be more 

appropriate to amend rule 12d1–2 to 

allow only investment in money market 

funds? 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1311 

228The staff has stated that, based on certain facts 

and circumstances, it would not recommend that 

the Commission take any enforcement action under 

section 12(d)(1)(A) (and other sections of the Act) 

if a fund relying on section 12(d)(1)(G) invests a 

portion of its assets in investments that may not be 

securities. See Northern Lights Fund Trust, Staff 

No-Action Letter (pub. avail. Jun. 29, 2015). 

229See Reporting Modernization Adopting 

Release, supra footnote 48. 

230Proposed Items C.7.k. and C.7.l. of Form N– 

CEN. 

231See Item C.3.e of Form N–CEN. 

232We are also making conforming changes to the 

title of Item C.7. of Form N–CEN to reflect that the 

item includes a statutory exemption. See proposed 

amendment to Item C.7. (‘‘Reliance on certain 

statutory exemption and rules. Did the Fund rely 

on the following statutory exemption or any of the 

rules under the Act during the reporting period? 

(check all that apply)’’). 

233Proposed Items F.18 and F.19. of Form N– 

CEN. 

234See section 38(a) of the Investment Company 

Act (15 U.S.C. 80a–37(a)). 

235See, e.g., Ivy Funds, et al., Investment 

Company Act Release Nos. 31068 (June 2, 2014) [79 

FR 32779 (June 6, 2014)] (notice) and 31138 (June 

30, 2014) (order) and related application. 

236Some of the exemptive orders we have issued 

to ETFs include relief permitting ETFs to use 

certain master-feeder arrangements. We have 

proposed to rescind that master-feeder fund relief, 

while grandfathering ETF master-feeder 

arrangements relying on that relief as of June 28, 

2018, as part of an ETF proposal. See 2018 ETF 

Proposing Release, supra footnote 34. In addition, 

we understand that existing ETMFs currently rely 

on the master-feeder relief in the orders and do not 

propose to rescind that relief here. See Eaton Vance, 

supra footnote 27. 

237See, e.g., section III. 

238Section 12(d)(1)(G)(i)(IV). 

• Alternatively, should we amend 

rule 12d1–2 to include conditions? If so, 

should we consider expanding the types 

of investments that are permissible 

under rule 12d1–2 to include 

investments other than securities, such 

as real estate, futures contracts, and 

other financial instruments that may not 

qualify as securities under the Act? 228

• We are proposing a one-year period 

before rescinding rule 12d1–2. Is the 

one-year period an appropriate amount 

of time to allow funds of funds relying 

on current rule 12d1–2 to come into 

compliance with proposed rule 12d1–4 

or section 12(d)(1)(G)? If not, how long 

should this period last? Why? 

Alternatively, should we grandfather 

funds that are relying on section 

12(d)(1)(G) and rule 12d1–2 as of the 

date of this proposal? 

IV. Amendments to Form N–CEN 

On October 13, 2016, the Commission 

adopted Form N–CEN, a structured form 

that requires registered funds to provide 

census-type information to the 

Commission on an annual basis.229 We 

are proposing amendments to Form N– 

CEN to conform to our proposed fund of 

funds arrangement rulemaking. Item 

C.7. of Form N–CEN requires 

management companies to report 

whether they relied on certain rules 

under the Investment Company Act 

during the reporting period. For 

example, Item C.7.a. currently requires 

management companies to disclose if 

they are relying on rule 12d1–1. We are 

proposing to add a requirement to Form 

N–CEN that would require management 

companies to report if they relied on 

rule 12d1–4 or the statutory exception 

in section 12(d)(1)(G) during the 

reporting period.230 While Form N–CEN 

already requires a management 

company to report if it is a fund of 

funds,231 we are proposing to collect 

this information in order to better assess 

reliance on rule 12d1–4 or the statutory 

exception in section 12(d)(1)(G) by 

management companies and to assist us 

with our accounting, auditing and 

oversight functions, including 

compliance with the Paperwork 

Reduction Act.232

UITs also are required to file reports 

on Form N–CEN. However, the UIT 

specific section of Form N–CEN does 

not require a UIT to identify if it is a 

fund of funds. For the same reasons 

discussed above, we are proposing to 

require UITs to report if they relied on 

proposed 12d1–4 or the statutory 

exception in section 12(d)(1)(G) during 

the reporting period.233

We request comment on our proposed 

amendments to Form N–CEN. 

• Should we require any additional 

information on Form N–CEN concerning 

proposed rule 12d1–4 or section 

12(d)(1)(G)? Should we require 

identification of reliance on any other 

fund of funds exemptive rules? For 

example, should we require UITs to 

report on Form N–CEN if they are funds 

of funds or relied upon rule 12d1–1 

during the relevant period? Should we 

require funds to identify any statutory 

exception to section 12(d)(1)(A) that the 

fund relied upon during the relevant 

period (e.g., section 12(d)(1)(E) or 

12(d)(1)(F))? If we do not rescind rule 

12d1–2, should we require funds to 

report that they relied on rule 12d1–2? 

Should we require funds to report if 

they relied on rule 12d1–3? 

• Should we require BDCs to report 

similar information to management 

companies? If so, since BDCs do no file 

reports on Form N–CEN, in what form 

should we require such information be 

reported? 

V. Proposed Rescission of Exemptive 

Orders; Withdrawal of Staff Letters 

Pursuant to our authority under the 

Act to amend or rescind our orders 

when necessary or appropriate to the 

exercise of the powers conferred 

elsewhere in the Act, we are proposing 

to rescind the orders permitting fund of 

funds arrangements.234 The orders 

covered by this rescission include all 

orders granting relief from sections 

12(d)(1)(A), (B), (C), and (G) of the Act 

with one limited exception. 

Specifically, we do not propose to 

rescind the exemptive orders providing 

relief from section 12(d)(1)(A) and (B) 

granted to allow certain interfund 

lending arrangements.235 Interfund 

lending arrangements allow certain 

funds within the same complex to lend 

money to and borrow money from each 

other for temporary purposes and 

subject to certain conditions. While 

such arrangements require exemptive 

relief from sections 12(d)(1)(A) and (B), 

among other provisions, they do not 

result in the pyramiding of funds or the 

related potential abuses that the 

proposed rule is designed to address, 

and thus are not included within the 

scope of the proposed rule. 

We do, however, propose to rescind 

the exemptive orders providing relief 

from sections 12(d)(1)(A) and (B) that 

has been included in our ETF and 

ETMF orders.236 We believe that 

rescinding this fund of funds relief in 

the ETF and ETMF orders, as well as 

more generally, would establish a 

transparent regulatory framework for 

these arrangements. For the reasons 

discussed above, we expect that the 

operations of most existing fund of 

funds arrangements would not be 

significantly negatively affected by the 

need to comply with the requirements 

of proposed rule 12d1–4, as opposed to 

their orders.237

However, the rescission of exemptive 

orders could have an effect on certain 

funds relying on section 12(d)(1)(G). 

Although section 12(d)(1)(G) requires an 

acquired fund to have a policy that 

prohibits it from acquiring any 

securities of a registered open-end fund 

or UIT in reliance on section 12(d)(1)(G) 

or (F), it does not require the acquired 

fund to have a policy that prohibits it 

from acquiring the securities of a fund 

beyond the limits in section 12(d)(1)(A) 

in reliance on an exemptive order 

issued by the Commission.238 We have 

observed some funds that invest in 

acquired funds in reliance on section 

12(d)(1)(G) of the Act that in turn invest 

in ETFs in reliance on an exemptive 

order. If the existing exemptive orders 

are rescinded, acquired funds could be 

required to reallocate or reduce 

underlying acquired fund investments 

1312 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

239We expect that the proposed amendments to 

Form N–CEN would yield immaterial economic 

effects. In particular, we expect that the proposed 

amendments to Form N–CEN would increase the 

annual estimated burden hours associated with 

preparing and filing Form N–CEN by approximately 

0.1 hours for each fund. In addition, the proposed 

amendments to Form N–CEN would facilitate the 

supervision and regulation of the fund industry, 

which would ultimately benefit fund investors, but 

any such effects are likely small. Hence, the 

economic analysis focuses on the economic effects 

of proposed rule 12d1–4, the proposed rescission of 

rule 12d1–2 and the exemptive orders, and the 

proposed amendment to rule 12d1–1. 

240Our baseline includes acquiring funds that 

invest a non-zero percentage of their assets in 

registered funds, BDCs, and unregistered funds, and 

it includes as acquired funds only registered funds 

and BDCs. 241As of June 2018, there were a total of 95 

master funds and 195 feeder funds based on 

Morningstar Direct and 10–K filings data. 

or the acquired funds would be required 

to reduce their investments in ETFs. As 

discussed in more detail below, there 

could be resulting costs. We believe, 

however, that this condition is 

appropriate in order to prevent the 

creation of overly complex structures for 

affiliated funds of funds and eliminate 

those that currently exist. In order to 

limit the hardship that revocation of 

these orders could have on existing fund 

of funds arrangements, we are proposing 

a one-year period after the effective date 

before rescission to give acquiring and 

acquired funds relying on these 

exemptive orders time to conform their 

operations with the requirements of the 

proposed rule and rule amendments. 

The Commission does not believe that 

it is necessary to give individual 

hearings to the holders of the prior 

orders or to any other person. The 

proposed rule would be prospective in 

effect and is intended to set forth for the 

entire industry the Commission’s 

exemptive standards for these types of 

fund of funds arrangements. Recipients 

of prior orders may make their views 

known in the context of the comment 

process that accompanies this 

rulemaking, and those views will be 

given due consideration. Finally, funds 

would be able to request Commission 

approval to operate as a fund of funds 

that does not meet the requirements of 

the proposed rules. 

We request comment on our proposal 

to revoke existing orders: 

• Should we rescind existing fund of 

funds orders? If not, why not? Should 

we revoke the fund of funds provisions 

of the ETF orders and the ETMF orders 

(with the exceptions described above)? 

• As discussed above, we are 

proposing a one-year period after the 

effective date before rescinding 

exemptive orders. Is the one-year period 

an appropriate amount of time to allow 

funds of funds relying on the orders to 

bring their funds into compliance with 

the rules? If not, how long should this 

period last? Why? 

• Are we correct in our belief that 

existing funds of funds would not face 

significant challenges in complying 

with the conditions of proposed rule 

12d1–4 rather than their exemptive 

orders? 

• Are we correct in our 

understanding that certain funds rely on 

both section 12(d)(1)(G) and ETF 

exemptive orders in order to create 

multi-tier fund of funds arrangements? 

If so, would what challenges would 

such funds face if the fund of funds 

portion of the ETF exemptive orders is 

rescinded? 

• Should we consider other 

approaches? For example, should we 

consider not rescinding any of the 

orders? Under this approach, in which 

our exemptive orders would be left in 

place, funds that are otherwise 

structured in similar ways may end up 

operating under different sets of 

conditions. Would permitting funds to 

operate under different sets of 

conditions have an adverse effect on 

competition? 

In addition, staff in the Division of 

Investment Management is reviewing 

staff no-action and interpretative letters 

relating to section 12(d)(1) to determine 

whether any such letters should be 

withdrawn in connection with any 

adoption of this proposal. If the rule is 

adopted, some of the letters may be 

moot, superseded, or otherwise 

inconsistent with the rule and, 

therefore, would be withdrawn. To the 

extent that there are concerns with the 

withdrawal of any of the letters, 

commenters should provide comments. 

VI. Economic Analysis 

A. Introduction 

Proposed rule 12d1–4 would allow 

funds to acquire the securities of 

another fund in excess of the limits in 

section 12(d)(1) of the Act without 

obtaining an exemptive order from the 

Commission. In connection with the 

proposed rule, we are also proposing to 

rescind rule 12d1–2 under the Act and 

most of our exemptive orders granting 

relief from sections 12(d)(1)(A), (B), (C), 

and (G) of the Act. We are also 

proposing a related amendment to rule 

12d1–1. For purposes of this economic 

analysis, we use the term ‘‘rule 

proposal’’ to refer collectively to 

proposed rule 12d1–4, the proposed 

rescission of rule 12d1–2 and the 

exemptive orders, and the proposed 

amendment to rule 12d1–1. 

The rule proposal would affect funds’ 

investment flexibility, increase 

regulatory consistency and efficiency, 

and eliminate the need for funds to 

obtain an exemptive order from the 

Commission and incur the associated 

costs and delays. At the same time, the 

rule proposal would impose one-time 

costs to funds that would need to assess 

whether their operations are consistent 

with the rule proposal, particularly to 

those funds relying on an order being 

withdrawn in connection with the 

rulemaking. In addition, the conditions 

in proposed rule 12d1–4 would impose 

certain one-time and ongoing costs to 

funds, such as compliance, monitoring, 

and recordkeeping costs.239

We are sensitive to the economic 

effects that may result from the rule 

proposal, including the benefits, costs, 

and the effects on efficiency, 

competition, and capital formation. 

These potential effects, as well as 

possible alternatives to the rule proposal 

are discussed in detail below. 

B. Economic Baseline 

The baseline against which the costs, 

benefits, and the effects on efficiency, 

competition, and capital formation of 

the rule proposal are measured consists 

of the current state of the market and the 

current regulatory framework for funds 

of funds. 

1. Current State of the Fund of Funds 

Market 

To establish a baseline for the 

economic analysis of the rule proposal 

we provide descriptive statistics on the 

current state of the fund of funds market 

as of June 2018. For purposes of this 

analysis, we define a fund of funds as 

a fund that invests a non-zero 

percentage of its assets in other 

funds.240 Funds whose only 

investments in other funds are in money 

market funds and master-feeder funds 

(i.e., funds of funds created in reliance 

on section 12(d)(1)(E)) are excluded 

from our definition of a fund of funds 

for the purpose of the baseline.241

Hence, our definition of funds of funds 

includes: (i) Funds of funds whose 

investments are within the limits of 

sections 12(d)(1)(A) and (B); (ii) funds of 

funds that were structured in reliance 

on sections 12(d)(1)(F) or (G); and (iii) 

funds of funds that were formed in 

reliance on exemptive relief on which 

proposed rule 12d1–4 is based. We 

provide descriptive statistics for these 

three categories of funds of funds and 

also for single-tier funds to provide an 

understanding of the funds market as a 

whole and because the rule proposal 

would affect both current and 

prospective funds of funds. 

Table 1 below provides descriptive 

statistics for acquiring and acquired 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1313 

242As of December 2017, there were 663 separate 

accounts with $1,774 bn total assets. 99.2%, or 658, 

of these separate accounts are structured as UITs 

and the remainder 0.8%, or 5, are structured as 

open-end funds. All of the UIT separate accounts 

are master-feeder structures. Data for separate 

accounts is retrieved from Form N–SAR. Separate 

accounts are not included in the Tables 1–4 and 

Figure 1 of the economic analysis because of 

limited structured data for separate accounts. 

243All percentages in this and the next paragraph 

are based on funds’ total gross assets. Percentages 

occasionally do not sum up to 100 due to rounding 

error. 

244We define 12(d)(1)(G) acquiring funds as openend funds or UITs that invest at least 10% of their 

assets in other open-end funds or UITs with the 

same investment adviser. Our methodology may 

underestimate the number of 12(d)(1)(G) acquiring 

funds to the extent that the acquiring fund and 

acquired fund have advisers that are control 

affiliates. Our methodology may overestimate the 

number of 12(d)(1)(G) acquiring funds to the extent 

that certain funds rely on exemptive orders rather 

than 12(d)(1)(G) to invest in funds within the same 

group of investment companies beyond the limits 

of section 12(d)(1)(A). 

245The number of acquiring funds in multi-tier 

structures captures the top-tier fund in three-tier 

structures and the number of acquired funds in 

multi-tier structures captures the mid-tier fund in 

three-tier structures. 

246 In addition to other funds, acquiring funds 

may invest in private funds, cash and cash 

equivalents, derivatives, individual equity and debt 

securities, asset-backed securities, etc. 

funds as of June 2018.242 As Table 1 

shows, there are 4,342 acquiring funds 

with total gross assets equal to $5,761 

billion. 31% of all open-end funds, 28% 

of all UITs, 20% of all ETFs, none of the 

ETMFs, 31% of all closed-end funds, 

and none of the BDCs are acquiring 

funds.243 Further, 89.5% of the 

acquiring funds are open-end funds, 

0.1% are UITs, 9.1% are ETFs, none are 

ETMFs, 1.4% are closed-end funds, and 

none are BDCs. Untabulated analysis 

shows that 63% of all acquiring funds 

are funds that invest in other funds 

beyond the limits in section 12(d)(1)(A), 

and 24% of all acquiring funds appear 

to be relying on the statutory exemption 

in section 12(d)(1)(G) to structure a fund 

of funds arrangement.244

As Table 1 shows, there are 2,521 

acquired funds with total gross assets 

equal to $6,603 billion. 23% of all openend funds, none of the UITs, 93% of all 

ETFs, none of the ETMFs, all of the 

closed-end funds, and 35% of all BDCs 

are acquired funds. In addition, 59% of 

the acquired funds are open-end funds, 

none are UITs, 37% are ETFs, none are 

ETMFs, 4% are closed-end funds, and 

1% are BDCs. Untabulated analysis 

shows that 41% of all acquired funds 

are funds listed on a national securities 

exchange (i.e., listed closed-end funds, 

ETFs, ETMFs, and listed BDCs). 

As Table 1 shows, there are 2,033 

acquiring funds in multi-tier structures 

and 783 acquired funds in multi-tier 

structures as of June 2018.245 Multi-tier 

fund structures are funds of funds that 

comprise more than two tiers. 

Untabulated analysis shows that there 

are 129 multi-tier structures for which 

the investments in both the second and 

third tier are within the statutory limits 

of section 12(d)(1)(A). 

TABLE 1—DESCRIPTIVE STATISTICS FOR SINGLE-TIER FUNDS, ACQUIRING FUNDS, AND ACQUIRED FUNDS

N of funds 

Gross 

assets of 

funds 

(bn $) 

N of 

acquiring 

funds 

Gross 

assets of 

acquiring 

funds 

(bn $) 

N of 

acquired 

funds 

Gross assets of acquired funds 

(bn $) 

N of 

acquiring 

funds in 

multi-tier 

structures 

N of 

acquired 

funds in 

multi-tier 

structures 

Open-end .......................................................... 7,602 16,783 2,841 5,154 1,085 3,880 1,159 447 

UITs ................................................................... 4,706 18 969 5 0 0 767 0 

ETFs .................................................................. 1,885 2,622 424 522 923 2,433 83 220 

ETMFs ............................................................... 9 0.10 0 0 0 0 0 0 

Closed-end ........................................................ 469 258 108 80 469 258 24 116 

BDCs ................................................................. 88 94 0 0 44 33 0 0 

Total ........................................................... 14,759 19,775 4,342 5,761 2,521 6,603 2,033 783 

This table reports descriptive statistics for single-tier funds, acquiring funds, and acquired funds as of June 2018. A fund of funds is a fund that invests a non-zero 

percentage of its assets in other funds. Funds, whose sole fund investments are in money market funds and master-feeder funds are excluded from the definition of 

fund of funds. Data is retrieved from Morningstar Direct, Morningstar Investment Company Holdings, and funds’ 10–K and 10–Q filings. Total gross assets is the sum 

of all fund holdings, and we consider both long and short fund positions in the estimation of total gross assets. 

Table 2 below shows the percentage 

of acquiring funds that invest between 

0 and 5%, 5 and 10%, 10 and 25%, 25 

and 50%, 50 and 75%, 75 and 90%, 90 

and 95%, and 95% and above of their 

assets in other funds as of June 2018.246

The table shows that the majority of 

acquiring funds invest either less than 

10% or more than 90% of their assets 

in other funds. In particular, 31% of the 

acquiring open-end funds, 3% of the 

acquiring UITs, 37% of the acquiring 

ETFs, and 63% of the acquiring closedend funds invest less than 10% of their 

assets in other funds. Moreover, 50% of 

the acquiring open-end funds, 74% of 

the acquiring UITs, 39% of the 

acquiring ETFs, and 20% of the 

acquiring closed-end funds invest more 

than 90% of their assets in other funds. 

The reason for the concentration of 

acquiring funds below the 10% level is 

likely that a 10% investment in other 

funds is within the section 12(d)(1)(A) 

statutory limits. Funds that invest above 

the 90% threshold likely rely either on 

sections 12(d)(1)(G) or (F) or on 

exemptive orders to invest in other 

funds beyond the section 12(d)(1)(A) 

statutory limits. 

TABLE 2—PERCENTAGE OF ACQUIRING FUNDS THAT INVEST CERTAIN % OF THEIR ASSETS IN OTHER FUNDS

(0–5%] (5–10%] (10–25%] (25–50%] (50–75%] (75–90%] (90–95%] (95–100%] 

Open-end .......................................................... 23 8 8 5 4 4 24 26 

UITs ................................................................... 1 2 4 11 7 2 38 36 

ETFs .................................................................. 31 6 7 5 7 4 14 25 

Closed-end ........................................................ 57 6 7 5 3 1 1 19 

This table reports the percentage of acquiring funds by fund type that invest between 0 and 5%, 5 and 10%, 10 and 25%, 25 and 50%, 50 and 75%, 75 and 90%, 

90 and 95%, and above 95% of their assets in other funds as of June 2018. ETMFs and BDCs are excluded from this table because we have not identified any acquiring ETMFs and BDCs. Fund holdings data is retrieved from Morningstar Investment Company Holdings database. Percentages may not sum up to 100 due to 

rounding error. 

1314 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

247Open-end funds of funds are open-end funds 

that invest primarily in other open-end funds. ETF 

funds of funds are ETFs that invest primarily in 

other ETFs. See 2018 ICI Fact Book, supra footnote 

5, at 218 and 256. 

248The number of funds in Table 3 can be 

different than the number of funds in Table 1 due 

to different data requirements to construct the two 

tables. We exclude no-load funds for the estimation 

of descriptive statistics for front-end load and 

deferred charges. 51% of single-tier funds and 45% 

of acquiring funds are no-load funds. 249We use a two-tailed t-test and a 95% 

confidence interval to examine whether the 

differences in the equal-weighted averages of fees 

and expenses for acquiring and single-tier funds are 

statistically significant. A 95% confidence interval 

is frequently used in scientific work (see, e.g., David 

H. Kaye and David A. Freedman, Reference Guide 

on Statistics, in Ref. Man. on Scient. Ev., 2nd ed., 

Washington, DC, Federal Judicial Center, 2000). 

Our comparison of fees and expenses for 

acquiring and single-tier funds does not control for 

differences in the characteristics of single-tier and 

acquiring funds, such as differences in their 

investment strategy, which could potentially affect 

fund fees and expenses. 

250The closed-end funds with front-end load and 

deferred charges identified in Table 3 are all 

interval funds. 

The total net assets of funds of funds 

have increased over time. According to 

the 2018 ICI Fact Book, the total net 

assets of open-end funds of funds 

increased from $638 to $2,216 billion 

between December 2007 and December 

2017, and the total net assets of ETF 

funds of funds increased from $97 

million to $11,944 million between 

December 2008 and December 2017.247

Table 3 below shows the expense 

ratio, front-end load, and deferred 

charges for single-tier funds (excluding 

acquiring funds) in Panel A and for 

acquiring funds in Panel B.248 The 

expense ratio for acquiring funds 

includes the acquired funds’ expense 

ratio. The equal-weighted average 

expense ratio for acquiring funds is 

statistically significantly higher than the 

equal-weighted average expense ratio 

for single-tier funds, with the exception 

of closed-end funds.249 The results of 

the comparison of the equal-weighted 

average front-end load for acquiring and 

single-tier funds are mixed—acquiring 

UITs have statistically significantly 

lower front-end load than single-tier 

UITs but acquiring open-end funds do 

not have significantly different frontend load than single-tier open-end 

funds. The equal-weighted average 

deferred charges for acquiring UITs are 

statistically significantly higher than the 

equal-weighted average deferred charges 

for single-tier UITs but acquiring openend funds do not have significantly 

different deferred charges than singletier open-end funds. We do not compare 

the front-end load and deferred charges 

for single-tier and acquiring closed-end 

funds because of the limited sample size 

for acquiring closed-end funds with 

front-end load and deferred charges. 

TABLE 3—EXPENSE RATIO, FRONT-END LOAD, AND DEFERRED CHARGES FOR SINGLE-TIER AND ACQUIRING FUNDS

Panel A: Single-tier funds 

Expense ratio 

Equalweighted 

mean 

Valueweighted 

mean 

Median Standard 

deviation N 

Open-end ................................................................................................. 0.94 0.52 0.91 0.47 5,191 

UITs ......................................................................................................... 0.30 0.25 0.25 0.26 4,090 

ETFs ........................................................................................................ 0.53 0.23 0.49 0.33 1,738 

ETMFs ..................................................................................................... 0.75 0.78 0.84 0.24 18 

Closed-end ............................................................................................... 1.09 1.04 1.17 1.01 455 

BDCs ........................................................................................................ 8.87 8.89 8.49 3.23 76 

Front-end load 

Open-end ................................................................................................. 1.44 1.75 0.92 1.39 2,479 

UITs ......................................................................................................... 1.90 1.21 1.00 1.86 3,113 

ETFs ........................................................................................................ .................... .................... .................... .................... ....................

ETMFs ..................................................................................................... .................... .................... .................... .................... ....................

Closed-end ............................................................................................... 2.25 1.56 2.25 1.45 16

BDCs ........................................................................................................ 5.70 6.64 5.75 3.51 32 

Deferred charges 

Open-end ................................................................................................. 0.07 0.06 0.03 0.13 2,479 

UITs ......................................................................................................... 2.01 2.11 2.25 0.65 3,113 

ETFs ........................................................................................................ .................... .................... .................... .................... ....................

ETMFs ..................................................................................................... .................... .................... .................... .................... ....................

Closed-end 250 ......................................................................................... 0.10 0.16 0.00 0.16 16 

BDCs ........................................................................................................ .................... .................... .................... .................... ....................

Panel B: Acquiring funds Expense ratio 

Open-end ................................................................................................. 1.04 0.63 0.96 0.60 2,841 

UITs ......................................................................................................... 1.44 1.41 1.49 0.83 969 

ETFs ........................................................................................................ 0.69 0.34 0.58 0.51 424 

ETMFs ..................................................................................................... .................... .................... .................... .................... ....................

Closed-end ............................................................................................... 1.05 0.96 1.10 1.09 108 

BDCs ........................................................................................................ .................... .................... .................... .................... ....................

Front-end load 

Open-end ................................................................................................. 1.38 1.27 0.81 1.42 1,424 

UITs ......................................................................................................... 0.46 0.47 0.00 0.50 952 

ETFs ........................................................................................................ .................... .................... .................... .................... ....................

ETMFs ..................................................................................................... .................... .................... .................... .................... ....................

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1315 

251See supra footnote 249. 

252 ICI Research Perspective, Trends in the 

Expenses and Fees of Funds, 2017, April 2018, p. 

14. 

TABLE 3—EXPENSE RATIO, FRONT-END LOAD, AND DEFERRED CHARGES FOR SINGLE-TIER AND ACQUIRING FUNDS— 

Continued 

Panel A: Single-tier funds 

Expense ratio 

Equalweighted 

mean 

Valueweighted 

mean 

Median Standard 

deviation N 

Closed-end ............................................................................................... 4.07 2.91 4.50 1.24 5 

BDCs ........................................................................................................ .................... .................... .................... .................... ....................

Deferred charges 

Open-end ................................................................................................. 0.08 0.07 0.02 0.13 1,424 

UITs ......................................................................................................... 2.25 2.33 2.25 0.51 952 

ETFs ........................................................................................................ .................... .................... .................... .................... ....................

ETMFs ..................................................................................................... .................... .................... .................... .................... ....................

Closed-end ............................................................................................... 0.11 0.19 0.00 0.15 5 

BDCs ........................................................................................................ .................... .................... .................... .................... ....................

This table reports descriptive statistics for the expense ratio, front-end load, and deferred charges in percentage points for single-tier funds (excluding acquiring funds) in Panel A and for acquiring funds in Panel B as of June 2018. Expense ratio is the percentage of fund assets, net of reimbursements, used to pay for operating expenses and management fees, including 12b–1 fees, administrative fees, and all other asset-based 

costs incurred by the fund, except brokerage costs. Sales charges are not included in the expense ratio. The expense ratio for acquiring funds is 

retrieved from the acquiring fund’s prospectus and it includes the acquired funds’ expense ratio. The front-end load is a one-time deduction from 

an investment made into the fund. Deferred charges are imposed when investors redeem shares. All of the analysis is conducted at the fund 

level using asset-weighted average values for multiple-class portfolios except for UITs. Assets at the share-class level are not available for UITs. 

We exclude no-load funds for the estimation of descriptive statistics for front-end load and deferred charges. ETFs and ETMFs do not charge 

front-end loads or deferred charges. BDCs charge a front-end load, which includes selling commissions and dealer management fees, but they 

do not charge deferred charges. Data for acquiring ETMFs and BDCs is missing because we have not identified any acquiring ETMFs and 

BDCs. Data for open-end funds, UITs, ETFs, ETMFs, and closed-end funds is retrieved from Morningstar Direct, and data for BDCs is retrieved 

from Forms N–2, N–2/A, and 497. Data is winsorized at the 1% and 99% levels. 

Table 2 shows that the majority of 

acquiring funds either invest less than 

10% or more than 90% of their assets 

in other funds. We compare the expense 

ratio, front-end load, and deferred 

charges for funds that invest less than 

10% and funds that invest more than 

90% of their assets in other funds, and 

find mixed evidence.251 In particular, 

the expense ratio for acquiring open-end 

funds that invest more than 90% of their 

assets in other funds is lower than the 

expense ratio for acquiring open-end 

funds that invest less than 10% of their 

assets in other funds. For acquiring UITs 

and ETFs, the expense ratio is higher for 

those funds that invest more than 90% 

of their assets in other funds than those 

that invest less than 10% of their assets 

in other funds. There is no difference in 

the expense ratio of the two types of 

acquiring closed-end funds. Further, 

front-end load and deferred charges are, 

on average, higher for acquiring openend funds that invest more than 90% of 

their assets in other funds. We find no 

difference in the front-end load and 

deferred charges between the two types 

of acquiring UITs. We do not compare 

the front-end load and deferred charges 

for the two types of acquiring closedend funds because of limited sample 

size. 

There is some evidence of a decrease 

in the fund of funds expense ratio over 

time. According to an ICI report, the 

equal-weighted (value-weighted) 

average of the expense ratio of target 

date open-end funds has decreased from 

1.23% (0.67%) in 2008 to 0.85% 

(0.44%) in 2017.252 Figure 1 Panels A– 

C below show a decrease in the equalweighted average of the expense ratio 

for open-end funds and ETFs and an 

increase in the expense ratio for closedend funds between 2013 and 2017. 

1316 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

This figure reports the equal-weighted 

average of the expense ratio for 

acquiring funds by fund type between 

2013 and 2017. Panel A shows the 

average expense ratio for open-end 

funds, Panel B for ETFs, and Panel C for 

closed-end funds. Expense ratio is the 

percentage of fund assets, net of 

reimbursements, used to pay for 

operating expenses and management 

fees, including 12b–1 fees, 

administrative fees, and all other assetbased costs incurred by the fund, except 

brokerage costs. The expense ratio for 

acquiring funds is retrieved from the 

acquiring fund’s annual report and it 

does not include the acquired funds’ 

expense ratio. ETMFs and BDCs are 

excluded from this figure because we 

have not identified any acquiring 

ETMFs and BDCs. There is no historical 

structured data for the expense ratio of 

UITs. Data is retrieved from Morningstar 

Direct and is winsorized at the 1 and 

99% levels. 


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Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1317 

Table 4 provides descriptive statistics 

on acquiring funds’ investment strategy 

by fund category as of June 2018. The 

table shows that the most frequent 

investment category for acquiring funds 

is the ‘‘Allocation’’ category, which 

includes target dates funds—42% of the 

acquiring funds belong to the 

‘‘Allocation’’ investment category. 

TABLE 4—NUMBER OF ACQUIRING FUNDS BY INVESTMENT CATEGORY

U.S. 

equity 

Sector 

equity 

International 

equity 

Taxable 

bond 

Municipal 

bond Allocation Alternative Commodities Total 

Open-end .............................. 438 97 412 290 23 1,316 248 17 2,841 

UITs ....................................... 90 74 18 146 185 423 33 0 969 

ETFs ...................................... 39 28 192 24 2 41 83 15 424 

Closed-end ............................ 10 11 7 31 11 25 13 0 108 

Total ............................... 577 210 629 491 221 1,805 377 32 4,342 

This table presents the number of acquiring funds by investment category as of June 2018. ETMFs and BDCs are excluded from this table because we have not 

identified any acquiring ETMFs and BDCs. ‘‘U.S. Equity’’ funds are those that maintain at least 85% exposure to equity and investing at least 70% of assets in USdomiciled securities. ‘‘Sector Equity’’ funds are usually equity funds, in that they maintain at least 85% exposure to equity. ‘‘International Equity’’ funds include stocks 

domiciled in diverse countries outside the U.S. though most invest primarily in developed markets. ‘‘Taxable Bond’’ funds invest at least 80% of assets in securities 

that provide bond or cash exposure. ‘‘Municipal Bond’’ funds are generally defined by state or national focus and duration exposure. Funds in the ‘‘Allocation’’ category seek to provide income and capital appreciation by investing in multiple asset classes. This category is comprised of target date funds, convertibles, world, and 

tactical allocation funds. ‘‘Alternative’’ funds employ a unique investment approach designed to offer returns different from those of the long-only investments in the 

stock, bond, or commodity markets. ‘‘Commodities’’ funds invest in direct holdings or derivative securities that provide exposure to changes in price of commodities. 

We request comment on the 

following: 

• Do you agree with our estimate of 

acquiring funds that rely on section 

12(d)(1)(G)? Do you agree with the 

methodology we use to identify 

acquiring funds that rely on section 

12(d)(1)(G) as described in footnote 244 

above? If not, please provide an 

alternative methodology to identify 

acquiring funds that rely on section 

12(d)(1)(G) to invest in other funds. 

• Our analysis identified no acquiring 

BDCs, no acquiring ETMFs, no acquired 

UITs, and no acquired ETMFs as of June 

2018. Have commenters identified 

acquiring BDCs, acquiring ETMFs, 

acquired UITs, or acquired ETMFs? If 

so, how prevalent are arrangements 

involving these fund types? 

2. Current Regulatory Framework 

The existing regulatory framework for 

funds of funds comprises the current set 

of statutory provisions and rules 

governing funds of funds, the exemptive 

orders we have granted to allow certain 

funds of funds, and relevant no-action 

and interpretive letters. Section I.B. 

above describes in detail the current set 

of statutory provisions governing funds 

of funds. Below we discuss in more 

detail the fund of funds exemptive order 

process and we provide a summary of 

the existing regulatory framework. 

a. Exemptive Order Process 

Certain funds rely on individual 

exemptive orders granted by the 

Commission to invest in other funds 

beyond the limits of section 12(d)(1). 

The process of obtaining an exemptive 


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1318 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

253ETF fund of funds exemptive order 

applications are typically submitted together with 

applications related to the formation and operation 

of ETFs, and these unrelated aspects of the 

applications could bias the cited statistics on the 

duration and the number of revisions of the fund 

of funds exemptive order process. For this reason, 

statistics for non-ETF and ETF applications for 

exemptive order are discussed separately. 

There is variation in the duration of the 

exemptive order process from the date of the initial 

filing to the date the order is issued. In 2017, for 

non-ETF (ETF) exemptive order applications, the 

duration of the exemptive order process varied from 

98 (43) to 1,205 (2,318) days from the date of the 

first filing to the date the order was issued, and the 

number of the revisions varied from 2 (1) to 6 (6). 

Data is retrieved from the Investment Company Act 

Notices and Orders Category Listing, available at 

https://www.sec.gov/rules/icreleases.shtml 

(accessed on June 11, 2018). 

254Acquired funds may apply for exemptive relief 

to be able to sell their shares to acquiring funds 

beyond the limits of section 12(d)(1)(B) of the Act. 

255 In addition to the exemptive order conditions, 

fund investors are protected from potential abusive 

practices that section 12(d)(1) was designed to 

prevent as a result of the fiduciary obligations of 

acquiring and acquired funds’ boards of directors 

and investment advisers. 

256See also supra footnotes 79–82. 

order imposes direct administrative 

costs on acquiring funds associated with 

the preparation and revision of an 

application and consultations with 

Commission staff. We estimate that the 

administrative cost associated with 

obtaining an exemptive order permitting 

an acquiring fund to invest in an 

acquired fund beyond the limits of 

section 12(d)(1) is approximately 

$100,000. Once a fund adviser/sponsor 

obtains exemptive relief to structure a 

fund of funds, the adviser/sponsor may 

apply this relief to multiple funds of 

funds. The administrative cost 

associated with the exemptive order 

process may be borne both by the fund 

adviser/sponsor and by the fund. 

Nevertheless, we lack data to estimate 

how the administrative cost associated 

with the exemptive order process is 

split between the fund adviser/sponsor 

and the fund. 

The exemptive order process also 

imposes indirect costs on funds and 

their advisers/sponsors because it 

introduces delays and uncertainty to 

fund investments. In 2017, for non-ETF 

(ETF) fund of funds exemptive orders, 

the average time from the date a fund 

filed its initial application for exemptive 

relief to the date the Commission issued 

the related exemptive order was 377 

(321) days and the average number of 

application revisions was 3 (2.4).253

Until the Commission grants exemptive 

relief, fund advisers/sponsors are not 

permitted to create certain fund of funds 

and so acquiring funds must forgo 

certain investments in other funds. In 

addition, the exemptive order process 

may lead to uncertainty regarding 

whether the fund will be able to obtain 

exemptive relief and regarding the exact 

terms of the exemptive relief. 

As a result of the direct and indirect 

costs of the exemptive order process, 

acquiring funds might forego certain 

investments or funds of funds might not 

be launched in the first place because 

they have concluded that the costs of 

seeking an exemptive order would 

exceed the anticipated benefits of the 

investment. Nevertheless, the direct and 

indirect costs of the exemptive order 

process are partially moderated by the 

fact that each exemptive order can be 

used by multiple funds within the same 

fund complex and the costs of the 

exemptive order application process are 

one-time costs. 

We request comment on the 

following: 

• Do you agree with our $100,000 

administrative cost estimate for a fund 

to apply for exemptive relief? If not, 

please provide an estimate of how much 

it would cost a fund to apply for 

exemptive relief. Is the cost different for 

acquiring and acquired funds? 254 Does 

the cost vary with fund size? How is this 

cost split between the fund adviser/ 

sponsor and the fund? 

b. Exemptive Order Conditions 

Funds relying on exemptive orders to 

develop funds of funds also must 

comply with the terms and conditions 

of the exemptive relief. These terms and 

conditions are designed to prevent the 

historical abuses that led Congress to 

enact section 12(d)(1). Existing orders 

include conditions designed to mitigate 

the risks of undue influence, duplicative 

and excessive fees, and overly complex 

structures.255

Undue Influence. To prevent an 

acquiring fund from exercising undue 

influence over the acquired fund, 

existing exemptive orders include the 

following conditions. First, existing 

orders mandate that an acquiring fund 

and its advisory group cannot control an 

acquired fund unless the acquired fund 

is part of the same group of investment 

companies or the acquiring fund’s subadviser serves as the acquired fund’s 

primary adviser. The Act creates a 

rebuttable presumption that any person 

who directly or indirectly beneficially 

owns more than 25% of the voting 

securities of a company controls the 

company.256 Second, existing orders 

include a set of voting provisions that 

differ depending on the type of acquired 

fund. Third, existing exemptive orders 

require acquired fund boards to make 

certain findings and adopt procedures to 

prevent overreaching and undue 

influence by the acquiring fund and its 

affiliates once the investment in an 

acquired fund that is not part of the 

same group of investment companies 

exceeds the section 12(d)(1) limits. 

Fourth, exemptive orders require that 

acquiring and acquired funds enter into 

participation agreements that state that 

the funds understand and agree to 

comply with the terms and conditions 

of the order. This requirement allows 

acquired funds to block the acquisition 

of their shares by acquiring funds that 

could exercise undue influence over 

them by refusing to enter into a 

participation agreement with those 

funds. 

Duplicative and Excessive Fees. 

Current orders contain conditions 

designed to prevent duplicative and 

excessive fees. For management 

companies, our exemptive orders: (i) 

Limit sales charges and service fees 

charged by the acquiring fund to those 

set forth in the FINRA’s sales charge 

rule; (ii) require an acquiring fund’s 

adviser to waive fees otherwise payable 

to it by the acquiring fund in an amount 

at least equal to any compensation 

received from an acquired fund that is 

not part of the same group of investment 

companies by the adviser, or an 

affiliated person of the adviser, other 

than advisory fees paid to the adviser or 

its affiliated person by such an acquired 

fund, in connection with the investment 

by the acquiring fund in such acquired 

fund; and (iii) require the acquiring 

fund board to find that advisory fees are 

based on services provided that are in 

addition to, rather than duplicative of, 

the services provided by an adviser to 

an acquired fund. For UITs, our 

exemptive orders: (i) Limit sales charges 

and service fees charged by the 

acquiring fund to those set forth in the 

FINRA’s sales charge rule and (ii) 

require UIT depositors to deposit only 

acquired funds that do not assess a sales 

load or that waive any sales loads. For 

separate accounts funding variable 

insurance contracts, our exemptive 

orders require that each acquiring fund 

should represent in its participation 

agreement with an acquired fund that 

no insurance company sponsoring a 

registered separate account funding 

variable insurance contracts will be 

permitted to invest in the acquiring 

fund unless the insurance company has 

made a certification to the acquiring 

fund. 

Complex Structures. Current orders 

contain conditions designed to limit 

complex fund structures because 

complex structures historically have 

been associated with excessive fees and 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1319 

257Concerns about complex structures are 

partially mitigated by funds’ disclosures. For 

example, funds are required to report their portfolio 

holdings on a semi-annual basis in the shareholder 

reports. Acquiring funds are required to report the 

aggregate expenses of the acquired and acquiring 

funds in their prospectuses. Further, feeder funds 

must disclose in their registration statements that 

they invest in master funds. These disclosure 

requirements complement the complex structure 

conditions in the current exemptive orders. 

258The Commission has previously issued 

exemptive orders to funds that rely on section 

12(d)(1)(G) to allow those funds to invest in futures 

contracts and other financial instruments. See, e.g., 

KP Funds, et al., Investment Company Act Release 

Nos. 30545 (June 3, 2013) [78 FR 34413 (June 7, 

2013)] (notice) and 30586 (July 1, 2013) (order); 

Financial Investors Trust and Hanson McClain 

Strategic Advisors, Inc., Release Nos. 30521 (May 

15, 2013) [78 FR 30346 (May 22, 2013)] (notice) and 

30554 (order). Following those orders, the staff of 

the Division of Investment Management issued a 

no-action letter stating that it would not 

recommend enforcement action to the Commission 

under section 12(d)(1)(A) or (B) of the Act against 

a fund of funds that meets all of the provisions of 

section 12(d)(1)(G) and rule 12d1–2, except to the 

extent that it invests in assets that might not be 

securities under the Act. 

investor confusion.257 Specifically, our 

current orders prohibit an acquired fund 

from investing in other funds beyond 

the limits in section 12(d)(1). The 

exemptive order conditions contain a 

number of exceptions to the complex 

structures prohibition. In particular, 

acquired funds are permitted to buy 

shares of lower-tier funds in reliance on 

section 12(d)(1)(E) of the Act, for shortterm cash management purposes, in a 

subsidiary that is wholly-owned and 

controlled by the acquired fund, or as 

part of the receipt of securities as a 

dividend or as a result of a plan of 

reorganization of a company. 

c. Relevant Statutory Provisions 

As an alternative to obtaining an 

exemptive order, open-end funds and 

UITs could rely on section 12(d)(1)(G) to 

invest in other funds that are in the 

same group of investment companies 

beyond the limits of section 12(d)(1). 

Section 12(d)(1)(G) limits funds’ 

investment flexibility by only 

permitting investments in government 

securities and short-term paper in 

addition to unlimited investments in 

funds that belong in the same group of 

investment companies. Rule 12d1–2 

relaxes the investment restrictions of 

section 12(d)(1)(G) by providing funds 

relying on section 12(d)(1)(G) with the 

ability to invest in: (i) Securities of 

funds that are not in the same group of 

investment companies up to the limits 

in section 12(d)(1)(A) or (F); (ii) 

securities of money market funds in 

reliance on rule 12d1–1; and (iii) stocks, 

bonds, and other securities. The 

Commission also has issued exemptive 

orders granting funds relief from rule 

12d1–2(a) to the extent necessary to 

permit an acquiring fund that invests in 

acquired funds in reliance on section 

12(d)(1)(G) of the Act to invest in 

financial instruments that may not be 

‘‘securities.’’ 

Funds also can structure fund of 

funds arrangements in reliance on 

12(d)(1)(E), which allows an acquiring 

fund to invest all of its assets in a single 

fund so that the acquiring fund is, in 

effect, a conduit through which 

investors may access the acquired fund. 

Lastly, funds can structure funds of 

funds in reliance on 12(d)(1)(F), which 

permits funds to take small positions 

(up to 3% of another fund’s securities) 

in an unlimited number of other funds. 

A fund relying on section 12(d)(1)(F) 

may be restricted in its ability to redeem 

shares of the acquired fund and is 

prohibited by the Act from using its 

voting power to influence the outcome 

of shareholder votes held by the 

acquired fund. 

d. Relevant No-Action and Interpretive 

Letters 

The staff of the Division of Investment 

Management has issued a line of letters 

stating that the staff would not 

recommend enforcement action to the 

Commission under sections 12(d)(1)(A) 

or (B) of the Act if a fund acquires the 

securities of other funds in certain 

circumstances. We understand that 

certain industry practices have 

developed in connection with the stafflevel relief provided in these letters. In 

particular, we understand that: (i) Some 

funds have created three-tier masterfeeder structures for tax management, 

cash management, or portfolio 

management purposes; (ii) other funds 

have invested in assets that may not be 

securities, but have otherwise complied 

with the restrictions in rule 12d1–2; 258

(iii) sponsors of UITs have deposited 

units of existing trusts into portfolios of 

future UIT series; (iv) foreign pension 

funds and profit sharing funds, and 

foreign subsidiaries and feeder funds 

have invested in other funds beyond the 

limits of section 12(d)(1); and (v) foreign 

funds have invested in other funds 

under section 12(d)(1) to the same 

extent as private funds. 

The staff letters also state that, for 

purposes of rule 12d1–2(a)(1) under the 

Act, the term ‘‘group of investment 

companies,’’ as defined in section 

12(d)(1)(G)(ii) of the Act, does not 

include closed-end funds. Under this 

staff position, open-end funds, or UITs 

may invest in a closed-end fund under 

rule 12d1–2(a)(1) even if the closed-end 

fund is part of the same group of 

investment companies. 

C. Benefits and Costs and Effects on 

Efficiency, Competition, and Capital 

Formation of Rule Proposal 

Where possible, we have sought to 

quantify the benefits, costs, and effects 

on efficiency, competition, and capital 

formation expected to result from the 

rule proposal. However, we are unable 

to reliably quantify many of the 

economic effects in light of the 

uncertainty about how market 

participants would react to the changes 

in regulatory structure under the rule 

proposal. For example, we are unable to 

estimate the number of new funds of 

funds that potentially would be created 

as a result of the adoption of the rule 

proposal, because we do not have 

information about the extent to which 

the exemptive order application process 

and the conditions associated with 

exemptive relief limit the creation of 

funds of funds. Further, we do not have 

information needed to estimate likely 

changes in investor demand for funds of 

funds following the potential adoption 

of the rule proposal. Therefore, much of 

the discussion below is qualitative in 

nature, although we try to describe, 

where possible, the direction of the 

economic effects. 

We request comment on the 

following. In providing comment on the 

questions below, please describe your 

methodology and, where possible, 

identify sources of data. 

• Would the rule proposal result in a 

change in the number of funds of funds? 

Please estimate the potential change in 

the number of funds of funds as a result 

of the rule proposal. 

• Our analysis shows no acquiring 

BDCs and ETMFs as of June 2018. 

Would the rule proposal result in an 

increase in the number of acquiring 

BDCs and ETMFs? If not, why not? 

• Would the rule proposal affect the 

diversity of available funds of funds? If 

yes, how and why would the rule 

proposal affect the diversity of available 

funds of funds? 

• Would the rule proposal affect 

investor demand for funds of funds? If 

yes, in which direction and through 

which mechanisms would the rule 

proposal affect investor demand for 

funds of funds? Please estimate the 

potential change in investor demand for 

funds of funds as a result of the rule 

proposal. 

• Would existing acquiring funds 

change their investments as a result of 

the rule proposal, if adopted? Why and 

in which ways? Relatedly, would funds 

that invest in acquiring funds be 

required to change their investments as 

a result of the rule proposal? If yes, in 

which ways? 

1320 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

259See section II.A. for a detailed list of 

permissible acquiring and acquired funds under 

current exemptive relief. 

260 In particular, as proposed, we estimate that it 

could take up to 10 months for an acquiring fund 

that fully unwinds its investment in an acquired 

fund, if that fund holds 25% of the outstanding 

shares of the acquired fund (i.e., up to the control 

limit), and must comply with the proposed rule’s 

3% redemption limit. Acquiring funds that meet the 

control exceptions in proposed rule 12d1– 

4(b)(1)(iii) could hold more than 25% of an 

acquired fund’s outstanding securities and would 

require additional time to unwind their investment 

in an acquired fund. 

261 In this and subsequent analysis, we assume 

that all 4,342 acquiring funds identified in Table 1 

above would rely on proposed rule 12d1–4 to invest 

in other registered funds or BDCs beyond the limits 

of section 12(d)(1), and thus would be subject to the 

proposed rule’s conditions. To the extent that our 

analysis overestimates the number of acquiring 

funds that would rely on proposed rule 12d1–4, our 

analysis potentially overestimates the economic 

impacts of the proposed rule. We are unable to 

estimate the number of acquiring funds that would 

rely on proposed rule 12d1–4 because of data 

limitations and because we are unable to anticipate 

how acquiring funds may change their investment 

strategies in response to the proposed rule. 

262The percentage of fund redemptions that are 

above the 3% limit in any 30-day period is expected 

to be different than the reported statistics during 

periods of high volatility or decreasing asset prices. 

As a robustness test, we examine fund redemptions 

between October 2007 and March 2009 (i.e., a 

period with high volatility and decreasing asset 

prices), and find that 1.36% (0.4%) of the 

redemptions of listed (unlisted) acquired fund 

shares exceeded the 3% redemption limit. See 

supra footnote 125 for a description of the 

methodology used to estimate fund redemptions. 

263For example, a fund could rely on section 

12(d)(1)(G) to invest in an acquiring fund and that 

fund, in turn, could invest in another fund in 

reliance on an exemptive order. 

264The rescission of rule 12d1–2 would not affect 

the investment flexibility of funds that currently 

rely on section 12(d)(1)(G) and rule 12d1–2 to 

structure two-tier funds of funds because funds 

could rely on proposed rule 12d1–4 to structure the 

same two-tier funds of funds. Funds that would 

continue to rely on section 12(d)(1)(G) would no 

longer be able to acquire securities of other funds 

that are not part of the same group of investment 

companies or invest directly in stocks, bonds, and 

other securities. 

We estimate that there are 1,055 acquiring funds 

that rely on section 12(d)(1)(G) and rule 12d1–2 to 

invest in funds that are part of the same group of 

investment companies beyond the limits of section 

12(d)(1) as of June 2018. See supra footnote 244 for 

identification methodology of 12(d)(1)(G) funds. 

Our methodology may overestimate the number of 

acquiring funds that rely on section 12(d)(1)(G) 

because our data does not allow us to differentiate 

between funds that rely on section 12(d)(1)(G) and 

funds that rely on an exemptive order to invest in 

funds that are part of the same group of investment 

companies beyond the limits of section 12(d)(1). 

Under the rule proposal, a fund relying on section 

12(d)(1)(G) would still have flexibility to invest in 

money market funds that are not part of the same 

group of investment companies in reliance on the 

proposed amendments to rule 12d1–1. 

• What is the net effect of the 

proposed conditions in rule 12d1–4 and 

the elimination of certain conditions 

that are included in our exemptive 

orders on administrative costs for both 

acquiring and acquired funds? 

1. Benefits and Costs 

a. Funds’ Investment Flexibility 

It is unclear ex-ante how the rule 

proposal would affect funds’ investment 

flexibility. On one hand, proposed rule 

12d1–4 would expand funds’ 

investment flexibility by expanding the 

scope of permissible acquiring and 

acquired funds relative to the current 

exemptive orders. On the other hand, 

the conditions in proposed rule 12d1– 

4 and the proposed rescission of rule 

12d1–2 and the exemptive orders would 

restrict certain funds’ investment 

flexibility and would require certain 

acquiring funds to change their 

investments in acquired funds 

compared to the baseline. 

Our current exemptive orders permit 

only certain funds to invest in other 

funds beyond the limits of section 

12(d)(1).259 Proposed rule 12d1–4 

would expand the scope of permissible 

acquiring and acquired funds by 

permitting all open-end funds, UITs, 

ETFs, ETMFs, listed and unlisted 

closed-end funds, and listed and 

unlisted BDCs to invest in open-end 

funds, UITs, ETFs, ETMFs, listed and 

unlisted closed-end funds, and listed 

and unlisted BDCs beyond the limits of 

section 12(d)(1). By expanding the scope 

of permissible acquiring and acquired 

funds, proposed rule 12d1–4 would 

enhance acquiring funds’ investment 

flexibility and would increase acquired 

funds’ access to financing. 

At the same time, the rule proposal 

would limit funds’ investment 

flexibility in order to protect fund 

investors from undue influence, 

duplicative and excessive fees, and 

complex structures. First, proposed rule 

12d1–4 would prohibit an acquiring 

fund that acquires more than 3% of an 

acquired fund’s outstanding shares from 

redeeming or submitting for redemption 

or tendering for repurchase more than 

3% of the acquired fund’s total 

outstanding shares in any 30-day 

period. This condition would limit 

funds’ investment flexibility because it 

would reduce a fund’s ability to quickly 

change its portfolio.260 Untabulated 

analysis shows that as of June 2018, out 

of the 4,342 acquiring funds, 809 hold 

more than 3% of an acquired fund’s 

outstanding shares and would thus be 

affected by the proposed limit on fund 

redemptions.261 In addition, between 

January 2017 and June 2018, 0.76% 

(0.16%) of the redemptions of listed 

(unlisted) acquired fund shares 

exceeded the 3% redemption limit.262

Hence, we expect that the impact of the 

redemption limit on funds’ investment 

flexibility would likely be small. 

Second, proposed rule 12d1–4 and 

the rescission of the exemptive orders 

would limit funds’ investment 

flexibility by limiting certain multi-tier 

structures. Our current exemptive 

orders prohibit an acquired fund from 

investing in other funds beyond the 

limits in section 12(d)(1), but they do 

not prohibit a fund from investing in an 

acquiring fund beyond the limits of 

section 12(d)(1).263 Proposed rule 12d1– 

4 would provide that a fund relying on 

section 12(d)(1)(G) of the Act or on rule 

12d1–4 may not acquire the outstanding 

voting securities of a fund that discloses 

in its registration that it may be an 

acquiring fund under the rule 12d1–4 in 

excess of the limits in section 

12(d)(1)(A). Hence, proposed rule 12d1– 

4 would limit funds’ investment 

flexibility by limiting multi-tier 

structures that are formed when a fund 

invests in an acquiring fund. 

Third, section 12(d)(1)(G) requires an 

acquired fund to have a policy that 

prohibits it from acquiring any 

securities of a registered open-end fund 

or UIT in reliance on section 12(d)(1)(G) 

or (F), but section 12(d)(1)(G) does not 

require the acquired fund to have a 

policy that prohibits it from acquiring 

the securities of a fund in excess of the 

limits in section 12(d)(1)(A) in reliance 

on an exemptive order issued by the 

Commission. The rescission of the 

current exemptive orders could limit 

funds’ investment flexibility in two 

possible ways. To the extent that a fund 

relying on section 12(d)(1)(G) invests in 

an acquired fund that then invests in 

underlying funds in reliance on an 

exemptive order, the rule proposal 

could require the section 12(d)(1(G) 

acquiring fund to change its investment. 

Alternatively, funds relying on section 

12(d)(1)(G) could invest in the same 

acquired funds, but those acquired 

funds would be required to reduce their 

investments in other funds up to the 

limits of sections 12(d)(1)(A) of the Act. 

Our analysis shows no three-tier 

structures created in reliance on 

12(d)(1)(G) and our exemptive orders 

that would be affected by the rescission 

of our exemptive orders. Nevertheless, 

our analysis is limited by data 

availability and hence potentially could 

underestimate the number of affected 

parties. 

Fourth, the rescission of rule 12d1–2 

would have a similar effect as the 

rescission of the exemptive orders on 

multi-tier structures for which the toptier fund relies on section 12(d)(1)(G).264

In particular, the rescission of rule 

12d1–2 would force certain acquiring 

funds that currently rely on section 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1321 

265Bhattacharya et al. 2013 shows that affiliated 

funds of funds ‘‘provide an insurance pool against 

liquidity shocks to other funds in the family’’ (Utpal 

Bhattacharya, Jung H. Lee, & Veronika K. Pool, 

Conflicting Family Values in Mutual Fund Families, 

68 J. of Fin., 173 (Feb. 2013)). 

266Existing funds of funds that currently rely on 

exemptive orders that provide relief similar to 

proposed rule 12d1–4 have already incurred the 

cost of the exemptive order process. Hence, these 

funds would not benefit from eliminating the need 

to apply for an exemptive order under proposed 

rule 12d1–4. 

267 In 2017, the Commission granted 14 non-ETF 

fund of funds orders and 40 ETF fund of funds 

orders (see, supra footnote 253 for the source of the 

exemptive order data). Hence, the proposed rule 

could result in annual aggregate administrative cost 

savings to funds of funds equal to $5,400,000, i.e., 

$5,400,000 = (14 non-ETF fund of funds orders + 

40 ETF fund of funds orders) × $100,000 

administrative cost per exemptive order. The cost 

savings associated with removing the need to apply 

for exemptive relief for ETF fund of funds as 

discussed here are separate from the cost savings 

associated with removing the need to apply for 

exemptive relief for ETFs as discussed in the ETF 

proposing release. See 2018 ETF Proposing Release, 

supra footnote 34, at n. 206. 

268See supra footnote 253 for the source of the 

exemptive order data. 

269Academic literature provides evidence 

consistent with the idea that uncertainty has 

negative effects on investment and growth. See, e.g., 

Nick Bloom, Stephen Bond, & John Van Reenen, 

Uncertainty and Investment Dynamics, 74 Rev. of 

Econ. Stud., 391 (Apr. 2007); Nicholas Bloom, The 

Impact of Uncertainty Shocks, 77 Econometrica, 

623 (May 2009); Scott R. Baker, Nicholas Bloom, & 

Steven J. Davis, Measuring Economic Policy 

Uncertainty, 131 The Q. J. of Econ., 1593 (Nov. 

2016). 

12(d)(1)(G) to instead rely on proposed 

rule 12d1–4, and thus comply with the 

complex structures condition of the 

proposed rule. As a result, either the 

top-tier or the middle-tier acquiring 

funds could be required to change their 

portfolio to ensure compliance with the 

proposed rule. As mentioned above, our 

analysis shows no three-tier structures— 

where the top-tier fund relies on section 

12(d)(1)(G) and the middle-tier fund 

relies on exemptive orders to invest in 

other funds beyond the limits of section 

12(d)(1)—that would be required to 

modify their investments. 

To the extent that the rule proposal 

would require some existing funds of 

funds to change their portfolios to 

ensure compliance with the rule 

proposal, portfolio changes could: (i) 

Impose transaction costs on acquiring 

funds; (ii) force acquiring funds to sell 

the shares of acquired funds at 

potentially depressed prices; (iii) 

disrupt the acquiring funds’ investment 

strategy; (iv) impose liquidity demands 

on acquired funds as a result of the 

acquiring fund redemptions; and (v) 

have tax implications, which would 

depend on whether the acquiring fund 

would sell appreciated or depreciated 

shares of acquired funds. Any negative 

effects on acquired funds’ liquidity or 

investment strategy as a result of the 

proposed rule’s conditions potentially 

may be more pronounced for acquired 

funds that are not part of a group of 

investment companies. Academic 

literature suggests that funds tend to 

provide liquidity to affiliated funds that 

face liquidity shocks.265 Any costs of 

portfolio changes would be mitigated by 

the fact that funds would be granted one 

year to bring their operations in 

compliance with the rule proposal. 

We request comment on the 

following: 

• Are there any three-tier structures 

created in reliance on 12(d)(1)(G) and 

our exemptive orders that would be 

affected by the rescission of our 

exemptive orders and the proposed 

conditions in rule 12d1–4? 

• Are there any three-tier structures 

created in reliance on 12(d)(1)(G) and 

our exemptive orders that would be 

affected by the rescission of rule 12d1– 

2 and the proposed conditions in rule 

12d1–4? 

b. Eliminate Need To Apply for 

Exemptive Order 

In return for meeting certain 

conditions, proposed rule 12d1–4 

would permit prospective acquiring 

funds to acquire the securities of other 

funds beyond the limits of section 

12(d)(1)(A) of the Act without the 

expense and delay of obtaining an 

exemptive order.266 Assuming that the 

number of exemptive orders granted by 

the Commission would stay the same 

absent the proposed rule, we estimate 

that by removing the need to obtain an 

exemptive order, the proposed rule 

would eliminate annual aggregate 

administrative costs to prospective 

acquiring and acquired funds of 

approximately $5,400,000 relative to the 

baseline.267 Any direct administrative 

cost savings arising from removing the 

need to apply for an exemptive order are 

likely limited by the fact that each 

exemptive order can be used by 

multiple funds within the same fund 

complex and the costs of the exemptive 

order application process are one-time 

costs. Any cost savings to prospective 

acquiring and acquired funds derived 

from eliminating the need to apply for 

an exemptive order likely would be 

more pronounced for smaller funds 

because the administrative cost of the 

exemptive order application process 

likely does not vary with fund size, and 

thus may constitute a higher percentage 

of a smaller fund’s assets. 

The proposed rule also would remove 

the delay incurred by funds and their 

sponsors when applying for an 

exemptive order. As mentioned above, 

the average time it took a non-ETF (ETF) 

fund to obtain exemptive relief in 2017 

was 377 (321) days.268 If funds were not 

required to apply for an exemptive 

order, prospective acquiring funds 

would not be required to forgo 

investments in other funds while 

awaiting exemptive relief, which 

ultimately would increase the efficient 

allocation of fund assets because funds 

would be able to better determine the 

timing of their investments in other 

funds. Further, if the delay associated 

with the exemptive order process were 

removed, prospective acquiring funds 

would be able to bring new products to 

the market faster, which would expand 

investors’ investment opportunities. 

Prospective acquired funds also would 

benefit because the acquiring funds’ 

investments in them would increase 

their assets more quickly, and as a result 

the acquired funds could achieve 

economies of scale more quickly, 

ultimately benefitting the existing 

shareholders of the acquired funds. 

The proposed rule also would remove 

the uncertainty associated with the 

exemptive order process. The exemptive 

order process presents uncertainties for 

funds because both the probability of 

obtaining an exemptive order and the 

exact terms of the exemptive order are 

uncertain. Uncertainty related to the 

exemptive order process may make 

funds more cautious when investing, 

thus potentially suppressing fund 

investment and growth.269 Nevertheless, 

the effects of the proposed rule on 

uncertainty likely would be limited by 

the fact that the terms of exemptive 

relief for funds of funds have become to 

a large extent standardized and the 

approval of applications for exemptive 

relief has become somewhat routine. 

Investors may benefit from these 

direct and indirect cost reductions if 

prospective funds pass these savings 

through to investors by lowering fees 

and expenses. The degree of potential 

reduction of fund fees and expenses 

depends on the level of competition in 

the fund industry. To the extent that the 

fund industry is competitive, we believe 

that funds would pass to investors a 

higher percentage of cost savings arising 

from the proposed rule. Conversely, if 

the level of competition is low, fund 

advisers, sponsors, and other service 

providers would retain a higher 

percentage of cost savings arising from 

the proposed rule rather than passing 

these cost savings to investors. 

Academic literature provides conflicting 

evidence regarding the level of 

1322 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

270See, e.g., John C. Coates, IV & R. Glenn 

Hubbard, Competition in the Mutual Fund Industry: 

Evidence and Implications for Policy, Harvard L. & 

Econ. Discussion Paper No. 592 (Aug. 2007); Sunil 

Wahal & Albert (Yan) Wang, Competition among 

Mutual Funds, 99 J. of Fin. Econ., 40 (Jan. 2011); 

Ajay Khorana & Henri Servaes, What Drives Market 

Share in the Mutual Fund Industry, 16 Rev. of Fin., 

81 (Oct. 2011); Burton G. Malkiel, Asset 

Management Fees and the Growth of Finance, 27 J. 

of Econ. Persp., 97 (Spring 2013). Further, an ICI 

April 2018 study suggests that the fund of funds 

industry is competitive: ‘‘Strong asset growth and 

competitive pressures, fueled by individuals saving 

for retirement and new target date mutual fund 

entrants, continue to put downward pressure on 

target date mutual fund expense ratios.’’ (See supra 

footnote 252, p. 28). 

271For example, Freeman and Brown (2001) argue 

that there is lack of price competition in the fund 

industry (John P. Freeman & Steward L. Brown, 

Mutual Fund Advisory Fees: The Cost of Conflicts 

of Interest, 26 The J. of Corp. L., 609 (Spring 2001)). 

Further, Barber et al. (2005) find no relation 

between fund operating expenses and fund flows 

(Brad M. Barber, Terrance Odean, & Lu Zheng, Out 

of Sight, Out of Mind: The Effects of Expenses on 

Mutual Fund Flows, 78 J. of Bus., 2095 (Nov. 2005)). 

Gil-Bazo and Ruiz-Verdu ́ (2009) shows that funds 

with worse before-fee performance charge higher 

fees (Javier Gil-Bazo & Pablo Ruiz-Verdu ́, The 

Relation between Price and Performance in the 

Mutual Fund Industry, 64 J. of Fin., 2153 (Oct. 

2009)). 

272Our analysis identified no acquiring BDCs as 

of June 2018. We expect that the effect of the rule 

proposal on the number of acquiring BDCs will be 

limited because BDCs are prohibited from making 

any investment unless, at the time of the 

investment, at least 70% of the BDC’s total assets 

are invested in securities of certain specific types 

of companies, which do not include funds (see 

supra footnote 37). 

273See supra footnote 267. 

274See Benartzi and Thaler (2001) presenting 

survey evidence and plan-level statistics that 

support the idea that retirement plan investors 

practice ‘‘1/n’’ diversification across all available 

investment alternatives (Shlomo Benartzi & Richard 

H. Thaler, Naive Diversification Strategies in 

Defined Contribution Saving Plans, 91 a.m. Econ. 

Rev., 79 (Mar. 2001)). But, Huberman and Jiang 

(2006) demonstrate that individual-level analysis of 

401(k) plan data yields different results from planlevel analysis, showing that individuals are less 

sensitive to the overall number of investment 

alternatives, but may practice ‘‘1/n’’ within a 

smaller subset of alternative investments (Gur 

Huberman & Wei Jiang, Offering versus Choice in 

401(k) Plans: Equity Exposure and Number of 

Funds, 61 J. of Fin., 763 (Apr. 2006)). 

275See, e.g., Elton et al. (2015), which shows that 

‘‘additional expenses charged by TDFs are largely 

offset by the low-cost share classes they hold, not 

normally open to their investors’’ (Edwin J. Elton, 

Martin J. Gruber, Andre de Souza, & Christopher R. 

Blake, Target Date Funds: Characteristics and 

Performance, 5 Rev. of Ass. Pric. Stud., 254 (May 

2015)). 

276The voting provisions for separate accounts in 

the proposed rule would be the same as the voting 

provisions in section 12(d)(1)(E)(iii)(aa) of the Act, 

which we believe most insurance product separate 

accounts already comply with. Thus, we do not 

believe the voting provisions for separate accounts 

would have an economic impact. 277The current exemptive orders require passthrough or mirror voting if an acquiring fund and 

its advisory group, in the aggregate, hold more than 

25% of the acquired fund’s outstanding voting 

securities as a result of a decrease in the 

outstanding voting securities of an acquired fund, 

but the proposed rule would require pass-through 

or mirror voting whenever the acquiring fund and 

its advisory group own more than 3% of the 

acquired fund’s outstanding voting securities. 

competition in the fund industry. On 

one hand, a number of papers provide 

some evidence that the U.S. fund 

industry is competitive and that higher 

competition in the fund industry is 

associated with lower fund fees and 

expenses.270 On the other hand, a 

number of papers suggest that price 

competition is not prevalent in the fund 

industry.271 We believe there are two 

potential explanations as to why prior 

literature provides conflicting evidence 

on the level of competition in the fund 

industry. First, prior literature uses 

different sample periods, focuses on 

different market segments, and uses 

different units of observation (i.e., 

individual funds versus fund families). 

Second, it is possible that funds do not 

compete on fees, but instead compete on 

performance and services. 

Further, the cost savings to 

prospective funds of avoiding the 

exemptive order process under 

proposed rule 12d1–4 could potentially 

increase the number of funds of funds 

available to investors.272 The 

Commission granted 14 non-ETF fund 

of funds orders and 40 ETF fund of 

funds orders in 2017.273 We are unable 

to estimate the number of new funds of 

funds that would be created following 

the potential adoption of the proposed 

rule, but we believe that the number of 

new funds of funds would be higher 

than the number of funds of funds that 

were created as a result of the exemptive 

orders granted in 2017. 

Academic research suggests that 

investment decisions are sensitive to the 

number of available investment 

opportunities.274 Hence, investor 

demand for funds of funds could 

increase as a result of the increased 

number of funds of funds under the 

proposed rule. As an alternative to 

investing in funds of funds, investors 

could meet their investment objectives 

by assembling a portfolio of funds 

through discretionary or nondiscretionary separate accounts with a 

broker/dealer or investment adviser or 

by investing directly in funds without 

the intermediation of broker/dealers or 

investment advisers. Nevertheless, 

funds of funds could represent an 

efficient alternative to such a strategy 

because fund of funds investors can 

avoid minimum investment 

requirements, can invest in funds that 

have been closed to new investors, can 

invest in funds that are restricted to a 

particular investor type, can avoid 

certain transaction costs, and can enjoy 

lower recordkeeping and monitoring 

costs relative to investors that directly 

invest in multiple funds.275 As a result, 

the entry of new funds of funds could 

increase investor demand for funds of 

funds because it would provide 

investors the opportunity to obtain 

diversified exposure to different asset 

classes through a single, professionally 

managed portfolio at a potentially lower 

cost compared to investing in a portfolio 

of funds through discretionary or nondiscretionary separate accounts. 

c. New and Omitted Conditions 

Proposed rule 12d1–4 would include 

new conditions relative to the 

conditions in our current exemptive 

orders, and would omit certain 

conditions contained in our exemptive 

orders that are no longer necessary in 

light of the new conditions of proposed 

rule 12d1–4. The new conditions of 

proposed rule 12d1–4 are designed to 

limit the acquiring funds’ undue 

influence over the acquired funds, limit 

the creation of complex fund structures, 

and limit duplicative and excessive fees 

for acquiring fund investors. We discuss 

the benefits and costs of each of the new 

and omitted conditions of proposed rule 

12d1–4 in detail below. 

Undue Influence—Voting condition. 

Proposed rule 12d1–4 allows both 

investment companies and all other 

members of the acquiring fund advisory 

group to either use pass-through or 

mirror voting for acquired funds that are 

closed-end funds.276 In contrast, the 

exemptive orders only allow investment 

companies to either use pass-through or 

mirror voting, but require any other 

member of the acquiring fund advisory 

group to use mirror voting for acquired 

funds that are closed-end funds. The 

economic effects of proposed rule 12d1– 

4 for acquired funds that are closed-end 

funds are likely immaterial because both 

investment companies and all other 

members of the acquiring fund advisory 

group are already restricted in their 

ability to vote under our current 

exemptive orders by being required to 

use pass-through or mirror voting. 

Acquiring funds that hold shares of 

funds that are not closed-end funds 

would be required to use pass-through 

or mirror voting more frequently under 

proposed rule 12d1–4 relative to the 

exemptive orders because: (i) Passthrough or mirror voting is required at 

a lower ownership level under proposed 

rule 12d1–4 and (ii) the requirement for 

pass-through or mirror voting is 

unconditional under proposed rule 

12d1–4.277

The more frequent use of passthrough or mirror voting for acquiring 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1323 

278There are large differences in voting 

involvement by institutional investors compared to 

retail investors (see, e.g., Broadridge and PwC, 

2018, ProxyPulse: 2018 Proxy Season Review, 

available at https://www.broadridge.com/_assets/ 

pdf/broadridge-2018-proxy-season-review.pdf). 

279Academic literature provides some evidence 

that shareholder activism has a positive effect on 

target funds (see, e.g., Martin Cherkes, Jacob S. Sagi, 

& Z. Jay Wang, Managed Distribution Policies in 

Closed-End Funds and Shareholder Activism, 49 J. 

of Fin. and Quant. An., 1311 (Oct./Dec. 2014); 

Michael Bradley, Alon Brav, Itay Goldstein, & Wei 

Jiang, Activist Arbitrage: A Study of Open-Ending 

Attempts of Closed-End Funds, 95 J. of Fin. Econ., 

1 (Jan. 2010)). Academic literature provides mixed 

evidence on whether funds are activist investors, 

i.e., tend to vote with or against the management 

of the target companies (see, e.g., Dragana 

Cvijanovic, Amil Dasgupta, & Konstantinos E. 

Zachariadis, Ties that Bind: How Business 

Connections Affect Mutual Fund Activism, 71 J. of 

Fin., 2933 (Dec. 2006); Rasha Ashraf, Narayanan 

Jayaraman, & Harley E. Ryan, Jr., Do PensionRelated Business Ties Influence Mutual Fund Proxy 

Voting? Evidence from Shareholder Proposals on 

Executive Compensation, 47 J. of Fin. and Quant. 

An., 567 (Jun. 2012); Gerald F. Davis, & E. Han Kim, 

Business Ties and Proxy Voting by Mutual Funds, 

85 J. of Fin. Econ., 552 (Aug. 2007)). There is some 

evidence, however, of increased activism by funds, 

other than hedge funds, over time (see, e.g., J.P. 

Morgan, The 2017 Proxy Season: Globalization and 

a New Normal for Shareholder Activism, available 

at https://www.jpmorgan.com/jpmpdf/ 

1320739681811.pdf). 

280This estimate is based on the following 

calculation: $5,053,014 = ($1,176 one-time internal 

burden + $5,070 one-time external burden) × 809 

acquiring funds. See infra footnotes 350 and 353. 

281This estimate is based on the following 

calculation: $4,499,165 = ($1,176 ongoing annual 

internal burden + $400 ongoing annual external 

burden) × 793 acquiring funds × 3.6 mirror votes per 

year. See infra footnotes 354, 356, and 358. 

282This estimate is based on the following 

calculation: $907,776 = ($11,760 ongoing annual 

internal burden + $4,000 ongoing annual external 

burden) × 16 acquiring funds × 3.6 pass-through 

votes per year. See infra footnotes 355, 357, and 

359. 

283We expect that certain funds that currently 

rely on section 12(d)(1)(G) and rule 12d1–2 to 

invest in funds that are part of the same group of 

investment companies beyond the limits of section 

12(d)(1) would rely on proposed rule 12d1–4 

following the potential adoption of the rule 

proposal. Those funds would incur the 

administrative costs to set up policies and 

procedures to implement pass-through and mirror 

voting because they currently do not have in place 

these policies and procedures. We estimate that 

there are 1,055 acquiring funds that rely on section 

12(d)(1)(G) and rule 12d1–2 to invest in funds that 

are part of the same group of investment companies 

beyond the limits of section 12(d)(1) as of June 2018 

(see supra footnote 264). We are unable to estimate 

how many of those funds would decide to rely on 

proposed rule 12d1–4 to invest in funds that are 

part of the same group of investment companies 

beyond the limits of section 12(d)(1) because of data 

limitations and complexity and uncertainty of such 

an estimate. We are also unable to estimate the 

extent to which the costs of developing policies and 

procedures to implement pass-through and mirror 

voting would reduce fund incentives to rely on 

proposed rule 12d1–4 instead of section 12(d)(1)(G) 

and amended rule 12d1–1. 

284The voting provisions of proposed rule 12d1– 

4 are not applicable when an acquiring fund is 

within the same group of investment companies as 

an acquired fund or the acquiring fund’s investment 

sub-adviser or any person controlling, controlled 

by, or under common control with such investment 

sub-adviser acts as the acquired fund’s investment 

adviser or depositor (see supra section II.C.1.b). 

285 Due to data limitations we use total rather 

than voting shares outstanding for this analysis. 

Data is retrieved from Morningstar Direct and 

Morningstar Investment Company Holdings 

databases. 

funds that hold shares of funds that are 

not closed-end funds under proposed 

rule 12d1–4 could limit the ability of 

acquiring funds to exercise undue 

influence over the acquired funds. 

At the same time, the more frequent 

use of pass-through or mirror voting for 

acquiring funds that hold shares of 

funds that are not closed-end funds 

could increase distortions in the voting 

process. In particular, pass-through and 

mirror voting requirements can decrease 

the voting power of acquiring funds and 

consequently increase the voting power 

of the remaining acquired fund 

shareholders, potentially introducing 

distortions in the voting process. We 

expect that the distortive effect of mirror 

voting could be more pronounced than 

the distortive effect of pass-through 

voting because pass-through voting 

allows the acquiring fund to vote in 

accordance with the instructions of its 

shareholders while mirror voting 

requires the acquiring fund to vote in 

the same proportion as the vote of all 

other holders of the acquired fund 

shares, which effectively nullifies the 

voting power of the acquiring fund. The 

economic effect of any distortions in the 

voting process is unclear ex-ante and 

would depend on: (i) The percentage of 

acquired fund shares that are held by 

non-fund shareholders and funds that 

are not subject to the voting conditions; 

(ii) the composition of the shareholders 

(e.g., retail versus institutional 

investors); 278 and (iii) how frequently 

votes are close and so the acquiring 

fund’s voting could determine the 

outcome of the vote. 

At the same time, the more frequent 

use of pass-through or mirror voting 

under proposed rule 12d1–4 relative to 

the exemptive orders for acquired funds 

that are not closed-end funds would 

impose voting restrictions on acquiring 

funds, and thus could reduce funds’ 

incentives to acquire large blocks of 

shares and potentially support valueincreasing actions through their 

voting.279

An additional cost of the voting 

provision of proposed rule 12d1–4 for 

acquired funds that are not closed-end 

funds is that acquiring funds would be 

required to more frequently engage in 

pass-through or mirror-voting and incur 

the associated costs. We estimate that all 

funds subject to the voting provision of 

proposed rule 12d1–4 would incur a 

one-time burden to update their proxy 

voting policies and related voting 

disclosures to reflect that the fund is 

subject to the voting provisions of the 

proposed rule. This one-time burden 

would be equal to $6,246 per fund and 

would result in an aggregate one-time 

burden equal to $5,053,014.280 We 

estimate that each year after the 

adoption of the proposed rule, mirror 

voting by acquiring funds subject to the 

voting condition would impose an 

aggregate annual ongoing burden of 

$4,499,165.281 Pass-through voting by 

acquiring funds would impose an 

aggregate annual ongoing burden equal 

to $907,776.282 Funds potentially could 

pass any higher administrative costs 

associated with the new voting 

provisions to their shareholders in the 

form of higher operating expenses. Any 

such additional administrative costs 

would be partially mitigated by the fact 

that funds currently relying on 

exemptive orders already have in place 

policies and procedures to implement 

pass-through and mirror voting.283

The voting provisions of proposed 

rule 12d1–4 are more streamlined than 

the voting provisions under our current 

exemptive orders because the same 

voting provisions apply for both closedend and other types of acquired funds, 

and the same voting provisions apply 

regardless of whether the voting party is 

an investment company or not.284

Untabulated analysis shows that as of 

June 2018, out of the 4,342 acquiring 

funds, 809 hold more than 3% of an 

acquired fund’s outstanding shares.285

Hence, we expect that the proposed 

rule’s pass-through and mirror voting 

provisions could be binding in certain 

circumstances. 

We request comment on the 

following: 

• How do funds currently cast their 

votes in shareholder meetings? What is 

the cost of the current voting 

procedures? What are the determinants 

of the costs of the current voting 

procedures? Please provide a 

breakdown of the costs of the current 

voting procedures by type of cost. 

• What is the initial and ongoing cost 

of a mirror voting procedure? What are 

the determinants of the costs of mirror 

voting? Do funds currently have in place 

procedures for mirror voting? How 

frequently is mirror voting currently 

used by funds? Please provide a 

breakdown of the costs for mirror voting 

by type of cost. 

• What is the initial and ongoing cost 

of a pass-through voting procedure? 

What are the determinants of the costs 

of pass-through voting? Do funds 

currently have in place procedures for 

1324 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

286This 10 hour estimate is based on our analysis, 

which shows that each acquiring fund invests, on 

average, in 12 acquired funds and each acquired 

fund has sold its shares, on average, to 17 acquiring 

funds. To estimate the average number of acquired 

and acquiring funds, we use the investments of 

3,659 acquiring funds (i.e., 4,342 acquiring funds 

from Table 1 above less 683 acquiring funds that 

solely invest in unregistered acquired funds) in 

2,521 acquired funds (i.e., 2,521 acquired funds 

from Table 1 above) because only registered 

investment companies and BDCs that invest in 

other registered investment companies and BDCs 

beyond the limits of section 12(d)(1) are currently 

required to enter into participation agreements 

under our exemptive orders. See also supra section 

II.A. for an overview of the types of arrangements 

that have been permitted by our exemptive orders. 

287These estimates are based on the following 

calculations: 

For internal costs, 4 hours × $317 hourly rate for 

a senior portfolio manager = $1,268; 4 hours × $480 

blended hourly rate for an assistant general counsel 

($449) and a chief compliance officer ($511) = 

$1,920; 2 hours × $352 hourly rate for a compliance 

attorney = $704. $1,268 + $1,920 + $704 = $3,892; 

$3,892 × 3,659 acquiring funds = $14,240,828 and 

$3,892 × 2,521 acquired funds = $9,811,732. See 

supra footnote 286 (describing the estimate of 3,659 

affected acquiring funds). 

For external costs, 1 hour × $400 hourly rate for 

outside counsel = $400 and 1 hour × $5,070 hourly 

rate for board of directors = $5,070. $400 + $5,070 

= $5,470; $5,470 × 3,659 acquiring funds = 

$20,014,730 and $5,470 × 2,521 acquired funds = 

$13,789,870. 

In this and subsequent analysis, our estimates 

may overestimate cost savings because we assume 

that all existing acquiring funds that invest in at 

least one registered fund or BDC and all acquired 

registered funds and BDCs currently rely on 

exemptive orders, and would rely on proposed rule 

12d1–4. 

Our estimates of the relevant wage rates are based 

on salary information for the securities industry 

compiled by the Securities Industry and Financial 

Markets Association’s Office Salaries in the 

Securities Industry 2013. The estimated wage 

figures are modified by Commission staff to account 

for an 1800-hour work-year and multiplied by 5.35 

(professionals) or 2.93 (office) to account for 

bonuses, firm size, employee benefits, overhead, 

and adjusted to account for the effects of inflation. 

See Securities Industry and Financial Markets 

Association, Report on Management & Professional 

Earnings in the Securities Industry 2013 (‘‘SIFMA 

Report’’). 

288These estimates are based on the following 

calculations: 3 new acquired funds × 3,659 

acquiring funds × ($6,000 + $12,000)/2 average cost 

of negotiating the terms and entering into a 

participation agreement = $98,793,000. See supra 

footnote 286 (describing the estimate of 3,659 

affected acquiring funds). The cost savings brought 

by eliminating the need to draft a participation 

agreement only accrue to prospective acquiringacquired fund pairs because funds in existing 

acquiring-acquired fund relationships have already 

incurred the cost of drafting a participation 

agreement. 

289This estimate is based on the following 

calculation: 3,659 acquiring funds × 11 acquired 

funds that an acquiring fund invests in on average 

× ($6,000 + $12,000)/2 average cost of negotiating 

the terms and entering into a participation 

agreement × 0.5 of the cost of negotiating the terms 

and entering into a participation agreement = 

$181,120,500. See supra footnote 286 (describing 

the estimate of 3,659 acquiring funds). 

290Under proposed rule 12d1–4, acquiring funds 

could still block the acquisition of their shares by 

all other funds by disclosing in their registration 

statements that they may be acquiring funds. 

291See supra footnote 279. 

pass-through voting? How frequently is 

pass-through voting currently used by 

funds? Please provide a breakdown of 

the costs for pass-through voting by type 

of cost. 

• What are the initial and ongoing 

costs of mirror voting procedures for 

funds that rely on sections 12(d)(1)(E) 

and (F)? What are the initial and 

ongoing costs of pass-through voting 

procedures for funds that rely on 

sections 12(d)(1)(E) and (F)? Are there 

any funds other than those that rely on 

exemptive orders and sections 

12(d)(1)(E) and (F) that implement passthrough or mirror voting procedures? 

• Are there any economic effects 

associated with the voting provisions of 

proposed rule 12d1–4 that are not 

discussed in this section? What are 

these effects? Is there any data available 

to estimate the magnitude of these 

effects? For example, is there any data 

on the extent to which pass-through 

votes are actually voted? 

• Would funds choose to use mirror 

voting over pass-through voting or the 

other way around under proposed rule 

12d1–4? What would determine this 

decision? 

• How many of the funds that 

currently rely on section 12(d)(1)(G) and 

rule 12d1–2 to invest in funds that are 

part of the same group of investment 

companies beyond the limits of section 

12(d)(1) would rely on proposed rule 

12d1–4 following the potential adoption 

of the rule proposal? 

Undue Influence—Redemption limit. 

To prevent overreaching and undue 

influence, current exemptive orders 

typically require that: (i) Fund boards 

make certain findings and adopt 

procedures and (ii) acquiring and 

acquired funds enter into participation 

agreements. Proposed rule 12d1–4 

would replace these conditions with the 

requirement that acquiring funds cannot 

redeem or tender for repurchase more 

than 3% of the acquired fund’s voting 

shares in any 30-day period. 

Omitting the board and participation 

agreement requirements contained in 

our current exemptive orders would 

result in cost savings for funds. We 

estimate that implementing and 

monitoring compliance with the 

conditions associated with acquiring 

and acquired funds’ findings and 

procedures takes 10 internal burden 

hours of acquiring and acquired funds’ 

staff time each year, monetized to an 

annual burden of $3,892, and imposes 

an external annual cost of $5,470 per 

acquiring or acquired fund.286

Accordingly, by eliminating these 

conditions, we estimate aggregate 

annual internal cost savings of 

$14,240,828 for existing acquiring funds 

and $9,811,732 for existing acquired 

funds under the proposed rule, as well 

as aggregate external cost savings of 

$20,014,730 for existing acquiring funds 

and $13,789,870 for existing acquired 

funds.287

Additionally, we estimate that 

negotiating the terms and entering into 

a participation agreement would 

initially cost each fund between $6,000 

and $12,000. We also estimate that, on 

average, each acquiring fund enters into 

participation agreements with 3 new 

acquired funds each year. Accordingly, 

we estimate that existing acquiring and 

acquired funds would realize an 

aggregate initial annual cost savings of 

$98,793,000 as a result of the proposed 

rule’s elimination of the need to draft 

participation agreements.288 In addition, 

funds would no longer incur the costs 

associated with implementing the terms 

and monitoring compliance with 

participation agreements. We estimate 

that for each fund the ongoing costs are 

half of the initial one-time cost of 

negotiating the terms and entering into 

a participation agreement. Hence, the 

annual cost savings for acquiring and 

acquired funds as a result of eliminating 

the need to implement the terms and 

monitor compliance with the 

participation agreements would be 

approximately $181,120,500.289

By omitting the participation 

agreement requirement, proposed rule 

12d1–4 also could limit acquired funds’ 

ability to block the acquisition of their 

shares by certain acquiring funds by 

refusing to enter into participation 

agreements with those funds.290

Restricting the ability of funds to decide 

on who invests in them could have a 

negative effect on acquired funds’ 

performance, assuming that acquired 

funds would no longer be able to block 

the acquisition of their shares by certain 

acquiring funds that they believe may 

exercise undue influence over them. 

Nevertheless, other provisions of 

proposed rule 12d1–4, such as the 

redemption limit, would mitigate the 

risk that acquiring funds could exercise 

undue influence over acquired funds 

under proposed rule 12d1–4. At the 

same time, restricting the ability of 

funds to determine which acquiring 

funds may invest in them could have a 

positive effect on acquired funds’ 

performance, assuming that acquired 

funds otherwise would block activist 

investors, who could have a positive 

effect on acquired funds’ governance 

and operations, and thus have a positive 

effect on fund performance.291

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1325 

292This estimate is based on the following 

calculation: 115 hours × $324 hourly rate for a 

senior portfolio manager + 115 hours × blended 

hourly rate for assistant general counsel ($458) and 

chief compliance officer ($521) + 23 hours × $408 

hourly rate for fund attorney time = $102,936 of 

one-time cost of redemption limit per fund; 

1,098,526 hours = 4,342 acquiring funds × 253 

hours of internal burden of redemption limit per 

fund; $446,948,112 = 4,342 acquiring funds × 

$102,936 of one-time cost of redemption limit per 

fund. See supra footnote 287 for the source of salary 

data. 

This figure overestimates the total one-time cost 

associated with the redemption limit because it 

assumes each acquiring fund would incur these 

costs on an individual basis. These costs, however, 

likely would be allocated among multiple acquiring 

funds within a fund complex. In addition, this 

figure overestimates the total one-time cost 

associated with the redemption limit because it 

includes acquiring funds that rely on proposed rule 

12d1–4 solely to purchase and sell acquired fund 

shares in secondary market transactions. The 

redemption limit would not apply to secondary 

market transactions in acquired fund shares. 

293These estimates are based on the following 

calculations: 219,705 hours = 20% × 1,098,526 

initial hour burden of redemption limit. 

$89,389,622 = 20% × $446,948,112 of aggregate onetime internal cost of redemption limit. 

294These estimates are based on the following 

calculations: 20 hours × $5,070 hourly rate for 

board of directors = $101,400; 4,342 acquiring funds 

× $101,400 = $440,278,800. 

295This estimate is based on the following 

calculation: $88,055,760 = 20% × $440,278,800 of 

aggregate one-time external cost of redemption 

limit. 

296The impact of the redemption limit on 

acquiring funds’ ability to redeem their investments 

in other funds could be exacerbated during periods 

of large fund outflows. In particular, large fund 

redemptions would decrease the acquired funds’ 

shares outstanding. This decrease in the acquired 

funds’ shares outstanding would further restrict 

acquiring funds’ ability to redeem their investments 

in acquired funds because the redemption limit is 

expressed in terms of the acquired funds’ shares 

outstanding. At the same time, the redemption limit 

could have a positive effect on acquired funds’ 

liquidity because it would slow fund outflows. This 

positive effect of the redemption limit on acquired 

funds could be particularly important during 

periods of poor performance when fund outflows 

are more pronounced and the risk that acquiring 

funds exercise undue influence over the acquired 

fund through the threat of large scale redemptions 

is also more pronounced. 

297The frequency for acquiring funds that redeem 

more than 0.5%, 1%, and 5% of the shares of 

acquired funds that are listed (are not listed) on an 

exchange is 4.11%, 2.18%, and 0.40% (0.61%, 

0.37%, and 0.07%), respectively. 

298See supra footnote 262 for descriptive 

statistics on fund redemptions between October 

2007 and March 2009 (i.e., a period with high 

volatility and decreasing asset prices). 

299See supra footnote 265. 

300Any decrease in the attractiveness of open-end 

funds as acquired funds because they are unlisted 

would be mitigated at least partially by an increase 

in the attractiveness of open-end funds as acquired 

funds because open-end funds are larger than most 

registered funds and thus acquiring funds’ holdings 

in open-end funds are less likely to violate the 3% 

limit of the redemption condition. 

The redemption limit would protect 

acquired funds from the undue 

influence that acquiring funds could 

exercise over them through the threat of 

large-scale redemptions. However, the 

redemption limit would impose several 

costs on acquiring funds. First, the 

redemption limit would impose onetime and ongoing costs on acquiring 

funds because the funds would be 

required to monitor their fund 

redemptions to ensure that they do not 

violate the 3% redemption limit. The 

one-time costs could include: (i) 

Developing policies and procedures to 

ensure compliance with the redemption 

limit; (ii) planning, coding, testing, and 

installing system modifications to 

ensure compliance with the limit; (iii) 

integrating and implementing policies 

and procedures related to the 

redemption limit; and (iv) preparing 

training materials and administering 

training sessions for staff in affected 

areas. The ongoing costs include: (i) 

Continuous monitoring of fund 

redemptions and the percentage of 

acquired fund shares that the acquiring 

fund owns; (ii) periodic review of the 

policies and procedures put in place to 

monitor the redemption limit; (iii) 

system maintenance; and (iv) additional 

staff training. We estimate that the onetime internal hour burden of the 

redemption limit would be equal to 253 

hours for each fund, monetized at 

$102,936, which would result in an 

aggregate internal burden of 1,098,526 

hours, monetized at $446,948,112 for all 

acquiring funds.292 We also estimate 

that the ongoing internal burden of the 

redemption limit would be equal to 

20% of the initial burden of the 

redemption limit and thus would result 

in an aggregate ongoing annual internal 

burden of 219,705 hours, monetized at 

$89,389,622.293 Further, we estimate 

that the one-time external cost of the 

redemption limit would be equal to 

$101,400 for each fund, which would 

result in an aggregate external cost of 

$440,278,800 for all acquiring funds.294

We also estimate that the ongoing 

annual external cost of the redemption 

limit would be equal to 20% of the 

initial external cost of the redemption 

limit, and thus would result in an 

aggregate ongoing annual external cost 

of $88,055,760.295

Second, the proposed rule’s 

redemption limit could impose liquidity 

constraints on current and prospective 

acquiring funds because acquiring funds 

would be unable to quickly liquidate 

their investments in other funds.296 In 

particular, assuming that an acquiring 

fund would hold up to 25% of the 

outstanding shares of an acquired fund 

(i.e., control limit) and assuming it 

would only be allowed to redeem 3% of 

the acquired fund shares in every 30- 

day period (i.e., redemption limit), it 

would take the acquiring fund 10 

months to fully unwind its investment 

in the acquired fund, assuming no other 

concurrent changes in the number of 

acquired fund shares that are unrelated 

to the acquiring fund’s redemptions. 

Between January 2017 and June 2018, 

0.76% (0.16%) of the redemptions of 

listed (unlisted) acquired fund shares 

exceeded the 3% redemption limit.297

Hence, fund redemptions in excess of 

3% in any 30-day period during this 18- 

month sample period are not frequent. 

However, we acknowledge that this 

condition could have a larger impact 

during periods of decreasing prices or 

high volatility.298 In addition, as of June 

2018, 809 of the 4,342 acquiring funds 

hold over 3% of the outstanding shares 

of at least one acquired fund, and thus 

would be affected by the proposed rule’s 

redemption limit. Any negative effects 

on acquiring funds’ liquidity as a result 

of the proposed rule’s redemption limit 

would potentially be more pronounced 

for acquiring funds that do not belong 

to a fund complex. The reason is that 

academic literature shows that funds 

tend to provide liquidity to affiliated 

funds in the event of adverse liquidity 

shocks.299

Third, the redemption limit could 

affect funds’ investments for the 

following reasons. The proposed 

redemption limit would be more 

binding for acquiring funds that hold 

unlisted versus listed funds because 

acquiring funds can dispose of their 

investments in listed acquired funds in 

the secondary market without regard for 

the redemption limit. Hence, as a result 

of the proposed rule, acquiring funds 

would likely favor investments in listed 

over unlisted acquired funds. 41% of 

the acquired funds (in terms of total 

gross assets) are currently listed on 

national securities exchanges. In 

addition, acquiring funds may favor 

investments in larger acquired funds 

because it would be easier to stay below 

3% of the acquired fund’s outstanding 

securities and thus not trigger the 3% 

redemption limit when investing in 

larger rather than smaller acquired 

funds.300

Lastly, the redemption limit could 

affect acquiring funds’ investments in 

affiliated funds. Currently, acquiring 

funds can rely on section 12(d)(1)(G) 

and rule 12d1–2 to invest in affiliated 

funds beyond the limits of section 

12(d)(1) without a limit on fund 

redemptions. Following the proposed 

rescission of rule 12d1–2, some of these 

acquiring funds could decide to rely on 

proposed rule 12d1–4 to preserve their 

investment flexibility. These acquiring 

funds would be required to comply with 

1326 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

301The cost of the redemption limit increases 

with the acquiring fund’s ownership of the acquired 

fund. Under proposed rule 12d1–4, acquiring funds 

are prohibited from acquiring unaffiliated funds 

beyond the control limit, but they may acquire an 

unlimited amount of shares of affiliated funds. 

Hence, to the extent that acquiring funds would 

acquire the maximum permissible amount in 

affiliated and unaffiliated funds, the potential cost 

of the redemption limit would be higher for fund 

investments in affiliated funds than in unaffiliated 

funds. 

302Literature provides evidence that short selling 

constraints can harm price discovery (see, e.g., 

Alessandro Beber & Marco Pagano, Short-Selling 

Bans Around the World: Evidence from the 2007– 

09 Crisis, 68 J. of Fin., 343 (Feb. 2013); Charles M. 

Jones & Owen A. Lamont, Short-Sale Constraints 

and Stock Returns, 66 J. of Fin. Econ., 207 (Nov./ 

Dec. 2002)). Redemption limits could affect price 

discovery similar to short selling constraints 

because both redemption limits and short selling 

constraints impose limits on sales. 

303For example, Chordia et al. (2002) show that 

asset prices are temporarily affected by buying and 

selling pressures (Tarun Chordia, Richard Roll, & 

Avanidar Subrahmanyam, Order Imbalance, 

Liquidity, and Market Returns, 65 J. of Fin. Econ., 

111 (Jul. 2002)). Literature also shows that demand 

and supply shocks can result in price reactions that 

reverse slowly. For example, Duffie (2010) shows 

that price reversals following price responses to 

demand and supply shocks can be slow due to 

impediments to capital movement, such as search 

costs (Darrell Duffie, Presidential address: Asset 

Price Dynamics with Slow Moving Capital, 65 J. of 

Fin., 1237 (Aug. 2010)). 

304See, e.g., Engle and Sarkar (2006), Buetow and 

Henderson (2012), Madhavan and Sobczyk (2016), 

and Petajisto (2017) for empirical evidence on 

premiums and discounts for ETFs (Robert Engle & 

Debojyoti Sarkar, Premiums-Discounts and 

Exchange Traded Funds, 13 J. of Der., 27 (Summer 

2006); Gerald W. Buetow & Brian J. Henderson, An 

Empirical Analysis of Exchange-Traded Funds, 38 

J. of Port. Manag., 112 (Summer 2012); Ananth 

Madhavan & Aleksander Sobczyk, Price Dynamics 

and Liquidity of Exchange-Traded Funds, 14 J. of 

Inv. Manag., 1 (2016); Antti Petajisto, Inefficiencies 

in the Pricing of Exchange-Traded Funds, 73 Fin. 

Anal. J., 24 (1st Quarter 2017)). 

the proposed rule’s redemption limit, 

which would apply to their investments 

in both affiliated and unaffiliated 

acquired funds. As a result, these 

acquiring funds may decide to reduce 

the proportion of their assets invested in 

affiliated acquired funds to mitigate the 

cost of the redemption limit.301

Fourth, the redemption limit could 

distort the prices of the underlying 

securities of the acquired funds by 

limiting the acquiring funds’ ability to 

sell shares.302 In particular, the 

redemption limit could moderate the 

trading activity of informed traders with 

negative information, slowing the flow 

of negative new information to the 

market, and thus reducing the speed of 

price discovery and creating temporary 

deviations of prices from their 

fundamental values. 

Fifth, the control, voting, and 

redemption conditions in proposed rule 

12d1–4 are designed to prevent an 

acquiring fund from being able to 

unduly influence an acquired fund, 

while the provisions in our exemptive 

orders target certain instances where an 

acquiring fund may seek to influence an 

acquired fund (e.g., purchase shares in 

underwritings in which an affiliate of 

the acquiring fund is the principal 

underwriter). We believe that the 

conditions in the proposed rule provide 

protection against a broader set of 

circumstances than the targeted and 

prescriptive provisions in our 

exemptive orders and therefore would 

enhance investor protection. On the 

other hand, to the extent that the 

provisions of the proposed rule would 

not provide protection against all sets of 

circumstances that the provisions in our 

exemptive orders explicitly provide 

protection against, the proposed rule 

could weaken investor protection. 

In addition, the fact that the 

redemption limit only applies to 

primary but not secondary market 

trading could limit the extent to which 

the redemption limit protects listed 

acquired funds from acquiring funds’ 

undue influence because selling 

pressure in the secondary market could 

depress the prices of listed acquired 

funds.303 As a result, acquiring funds 

could use the threat of large scale 

secondary market sales that could 

depress asset prices to exert undue 

influence over the acquired funds. 

Acquired funds could be interested in 

the price of their shares in the 

secondary market because, among other 

things, they potentially could be 

interested in raising additional capital. 

We believe that the risk of fund asset 

prices deviating from their fundamental 

values is mitigated by the likelihood 

that arbitrageurs would trade and 

correct such deviations in the long run. 

Nevertheless, literature provides some 

evidence of persistent deviations of 

fund asset prices from their 

fundamental values.304

We request comment on the 

following: 

• Do you agree with our cost savings 

estimate that would arise from omitting 

the requirements associated with 

acquiring and acquired fund boards’ 

findings and procedures? If not, please 

provide a cost savings estimate that 

would arise from omitting the 

requirements associated with acquiring 

and acquired fund boards’ findings and 

procedures. How many hours do funds 

spend annually, on average, to 

implement and monitor compliance 

with the board findings and procedures 

required by our orders? What is the job 

description of each party involved in 

this process? What is the average hourly 

wage for each party involved? Do costs 

differ for acquiring and acquired funds? 

If yes, in which ways? 

• Are there any economic effects that 

would arise from omitting the board 

requirements under our exemptive 

orders that are not discussed in the 

economic analysis? 

• Do you agree with our cost savings 

estimate that would arise from omitting 

the requirements to negotiate the terms 

and enter into a participation 

agreement? If not, please provide a cost 

savings estimate for each fund that 

would arise from omitting the 

requirement to negotiate the terms and 

enter into a participation agreement. 

What is the job description of each party 

involved in negotiating the terms and 

entering into the participation 

agreements? What is the average hourly 

wage for each party involved? Into how 

many participation agreements does 

each acquiring fund enter each year on 

average? 

• Do you agree with our cost savings 

estimate that would arise from omitting 

the requirement to implement and 

monitor compliance with participation 

agreements? If not, please provide a cost 

savings estimate that would arise from 

omitting the requirement to implement 

and monitor compliance with the 

participation agreements. What is the 

job description of each party involved in 

implementing and monitoring 

compliance with the participation 

agreements? What is the average hourly 

wage for each party involved? 

• Are there any economic effects that 

would arise from omitting the 

requirement for acquiring and acquired 

funds to enter into participation 

agreements beyond those discussed in 

the economic analysis? For example, 

would omitting the requirement for a 

participation agreement change the way 

in which acquiring funds acquire other 

funds? Would acquiring funds change 

the frequency with which they acquire 

funds through intermediaries? Would 

such a change have any economic 

effects? Would acquired funds change 

their agreements with intermediaries? 

• Are our cost estimates for the 

redemption limit accurate? If not, what 

types of one-time costs would the 

redemption limit impose to acquiring 

funds? What types of ongoing costs 

would the redemption limit impose to 

acquiring funds? Please provide an 

estimate for the one-time and ongoing 

costs of the redemption limit. What is 

the job description of each party 

involved in implementing and 

monitoring compliance with the 

redemption limit? What is the average 

hourly wage for each party involved? 

• Is our description of the economic 

effects of the redemption limit accurate? 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1327 

305See supra section VI.B.2.b. 306See, e.g., supra footnotes 148 and 149. 

307This estimate is based on the following 

calculation: ($11,005 initial internal burden per 

management company + $17,610 initial external 

burden per management company) × 3,373 

acquiring management companies = $96,518,395. 

See also infra footnotes 365 and 368. 

308This estimate is based on the following 

calculation: 

($2,887 ongoing internal annual burden per 

management company + $5,870 ongoing annual 

external burden per management company) × 3,373 

acquiring management companies = $29,537,361. 

See also infra footnote 367 and 369. 

(8 hours × $400 hourly rate for outside counsel 

+ 4 hours × $5,070 hourly rate for board of 

directors) × 3,373 acquiring management companies 

= $79,198,040. See supra footnote 287 for the 

source of salary data. 

$29,537,361 + $79,198,040 = $108,735,401. 

Are there any economic effects of the 

redemption limit that are not discussed 

in the economic analysis? For example, 

could the redemption limit increase 

acquiring funds’ costs to monitor their 

investments by forcing them to invest in 

multiple funds in lieu of investing in a 

single fund to avoid the limit on fund 

redemptions? Other than the parties 

identified in the economic analysis, 

please identify any other parties that 

could be differentially affected by the 

redemption limit. 

• Would the redemption limit 

together with the control and voting 

provisions of proposed rule 12d1–4 

appropriately protect acquired funds 

from acquiring funds’ undue influence? 

Duplicative and excessive fees. As 

discussed above, the current exemptive 

orders contain certain conditions 

designed to prevent duplicative and 

excessive fees for acquiring fund 

shareholders.305 Proposed rule 12d1–4 

would replace these conditions with the 

following conditions. For management 

companies, proposed rule 12d1–4 

would require the acquiring fund’s 

adviser to evaluate the complexity of the 

structure and the aggregate fees 

associated with the acquiring fund’s 

investment in acquired funds and find 

that it is in the best interest of the 

acquiring fund to invest in acquired 

funds. The acquiring fund’s adviser 

must make this finding before investing 

in acquired funds in reliance on the 

proposed rule and with such frequency 

as the acquiring fund’s board deems 

reasonable and appropriate, but in any 

case, no less frequently than annually. 

The acquiring fund’s adviser must 

report its finding and the basis for the 

finding to the acquiring fund’s board of 

directors to enable the board to exercise 

effective oversight. Additionally, the 

proposed rule would require the 

acquiring fund to maintain and preserve 

a written record of the adviser’s finding, 

the basis for the finding, and the 

adviser’s reports to the board. 

For UITs, on or before the date of 

initial deposit of portfolio securities into 

a registered UIT, the UIT’s principal 

underwriter or depositor must evaluate 

the complexity of the structure and the 

aggregate fees associated with the UIT’s 

investment in acquired funds, and find 

that the fees of the UIT do not duplicate 

the fees of the acquired funds that the 

UIT holds or will hold at the date of 

deposit. The proposed rule would 

require the acquiring fund to maintain 

and preserve a written record of the 

finding of the principal underwriter or 

depositor. 

For separate accounts, the proposed 

rule would require an acquiring fund to 

obtain a certification from the insurance 

company issuing the separate account 

that it has determined that the fees 

borne by the separate account, acquiring 

fund and acquired fund, in the 

aggregate, are consistent with the 

standard set forth in section 26(f)(2)(A) 

of the Act. The proposed rule would 

also require the acquiring fund to 

maintain and preserve a written record 

of each certification obtained by the 

acquiring fund. 

We believe that omitting the 

requirements contained in our current 

exemptive orders likely would not have 

an economic effect. First, the FINRA 

sales charge rule remains applicable to 

certain funds of funds regardless of the 

proposed rule’s requirements. Second, 

current exemptive orders require that 

the acquiring fund’s adviser should 

waive advisory fees and the acquiring 

fund’s board should make certain 

findings regarding advisory fees. These 

requirements also are part of the 

advisers’ and boards’ fiduciary 

duties.306 Consequently, advisers and 

boards would fulfill these requirements 

regardless of the proposed rule’s 

conditions. 

We also believe that the fee 

conditions of the proposed rule might 

better protect acquiring fund 

shareholders from duplicative and 

excessive fees because they are broader 

than the requirements included in the 

exemptive orders. For example, the 

requirement in the exemptive orders 

that the acquiring fund board should 

find that advisory fees are based on 

services provided that are in addition to, 

rather than duplicative of, the services 

provided by an adviser to an acquired 

fund is redundant in light of a fund 

board’s fiduciary duties and statutory 

obligations. Under proposed rule 12d1– 

4, the adviser should evaluate the 

complexity of the fund of funds 

structure and also evaluate aggregate 

fees of all tiers in the fund of funds 

arrangement with an eye towards 

duplication. Further, the proposed rule 

includes a number of additional 

requirements that are not included in 

the exemptive orders and are tailored to 

the characteristics of certain categories 

of acquiring funds. For example, the 

proposed rule would impose different 

fee conditions for management 

companies and UITs to account for the 

unique characteristics of UITs. 

At the same time, the fee conditions 

of the proposed rule would result in 

one-time and ongoing implementation 

and monitoring costs. A management 

company’s adviser would bear one-time 

costs to evaluate the complexity of the 

structure and aggregate fees associated 

with the acquiring fund’s investment in 

acquired funds. The proposed rule does 

not require an acquiring fund’s adviser 

to evaluate the complexity of the 

structure and aggregate fees in 

connection with every investment in an 

acquired fund, and advisers may 

consider developing policies and 

procedures to evaluate the complexity 

of the fund of funds’ structure and the 

aggregate fees associated with the 

acquiring fund’s investment in acquired 

funds. The Commission staff estimates 

that the evaluations would impose an 

initial cost of $28,615 per fund resulting 

in an aggregate initial cost of 

$96,518,395.307

The ongoing costs for management 

companies include: (i) Advisers’ initial 

and periodic evaluation, as frequently as 

required by the board, of the complexity 

of the structure and aggregate fees and 

expenses associated with their 

investments in acquired funds; (ii) 

advisers’ preparation and reporting of 

their finding and the basis for the 

finding to the acquiring fund’s board of 

directors; and (iii) the recordkeeping 

costs associated with maintaining and 

preserving a written record of the 

adviser’s finding, the basis for the 

finding, and the adviser’s reports to the 

board. The Commission staff estimates 

that the evaluations—including board 

oversight responsibilities, recordkeeping 

obligations, and the board engaging 

outside counsel to review the 

evaluations—would impose ongoing 

annual costs of $32,237 per fund 

resulting in an aggregate ongoing annual 

cost of $108,735,401.308

UITs’ principal underwriters or 

depositors would bear one-time costs to 

evaluate the fund of funds’ complexity 

and the aggregate fees associated with 

the UIT’s investment in acquired funds. 

The one-time cost to evaluate the fund 

of funds’ complexity and the aggregate 

fees would be equal to $13,405 per UIT 

1328 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

309This estimate is based on the following 

calculation: ($11,005 initial internal burden per UIT 

+ $2,400 initial external burden per UIT) × 969 

acquiring UITs = $12,989,445. See also infra 

footnotes 373 and 376. 

310This estimate is based on the following 

calculation: $388 ongoing annual recordkeeping 

cost per UIT × 969 acquiring UITs = $375,972. See 

also infra footnote 375. In contrast to management 

companies, UITs do not charge management fees, 

but they charge sales charges. To the extent that the 

proposed rule would increase operating costs for 

UITs, UITs could pass through to investors any 

such cost increases in the form of higher sales 

charges. 

311This estimate is based on the following 

calculation: $310 initial burden per separate 

account × 663 acquiring separate accounts = 

$205,530. See also infra footnote 380. 

312This estimate is based on the following 

calculation: $78 ongoing annual burden per 

separate account × 663 acquiring separate accounts 

= $51,714. See also infra footnote 380. 

313Proposed rule 12d1–4 wound permit an 

acquired fund to invest in other funds beyond the 

statutory limits (i) for short-term cash management 

purposes; (ii) in connection with inter-fund lending 

or borrowing transactions; (iii) in connection with 

master-feeder structures or investments in whollyowned subsidiaries; or (iv) as a result of receiving 

fund shares as a dividend distribution or as a result 

of a plan reorganization. 

314See proposed rule 12d1–4(b)(4)(i) and (ii). 

Proposed rule 12d1–4 would, however, permit an 

acquiring fund to be an acquired fund in connection 

with master-feeder arrangements and interfund 

borrowing and lending transactions. 

315See supra section VI.C.1.a. for a detailed 

discussion of the costs of portfolio changes. 

316See proposed rule 12d1–4(b)(4). 

resulting in an aggregate initial cost of 

$12,989,445.309 Further, UITs would 

bear ongoing annual recordkeeping 

costs equal to $388 per UIT resulting in 

an aggregate ongoing annual 

recordkeeping cost of $375,972, and 

they would not bear any other ongoing 

implementation or monitoring costs 

because they are only required to 

evaluate the complexity of the structure 

and the aggregate fees associated with 

the UIT’s investment in an acquired 

fund at the time of initial deposit.310

Lastly, separate accounts would bear 

initial recordkeeping costs equal to $310 

per separate account resulting in an 

aggregate initial recordkeeping cost of 

$205,530.311 Separate accounts also 

would bear ongoing recordkeeping costs 

equal to $78 per separate account 

resulting in an aggregate ongoing annual 

recordkeeping cost of $51,714.312 The 

rest of the fee conditions in the 

proposed rule are the same as the 

requirements in the current exemptive 

orders, and thus they would not impose 

additional costs to separate accounts 

funding variable insurance products. 

We request comment on the 

following: 

• Do you agree with our assessment 

that omitting the requirements in our 

exemptive orders that relate to 

duplicative and excessive fees would 

not have an economic effect? If not, 

what economic effect do you expect this 

omission would have? 

• Do you agree with our assessment 

that the duplicative and excessive fee 

conditions of proposed rule 12d1–4 

would better protect acquiring fund 

shareholders from duplicative and 

excessive fees than the conditions in our 

exemptive orders? If not, why not? 

• Do you agree with our cost 

estimates for implementation and 

monitoring of compliance with the 

duplicative and excessive fee conditions 

of proposed rule 12d1–4? If not, please 

provide a cost estimate to implement 

and monitor compliance with the 

duplicative and excessive fee conditions 

of proposed rule 12d1–4. What types of 

one-time costs would the fee conditions 

involve? What types of ongoing costs 

would the fee conditions involve (e.g., 

recordkeeping costs)? What is the job 

description of each party involved in 

the implementation and monitoring of 

compliance with each fee condition of 

proposed rule 12d1–4? What is the 

average hourly wage for each party 

involved in the implementation and 

monitoring of compliance with each fee 

condition of proposed rule 12d1–4? 

Complex structures. The current 

exemptive orders prohibit an acquired 

fund from investing in other investment 

companies beyond the limits in section 

12(d)(1), but they do not prohibit a fund 

from investing in an acquiring fund 

beyond the limits in section 12(d)(1). In 

line with the current exemptive orders, 

proposed rule 12d1–4 would prohibit an 

acquired fund from investing beyond 

the statutory limits in both registered 

funds and private funds subject to 

limited exceptions.313

The rule proposal also would expand 

the complex structures prohibitions 

included in the exemptive orders in the 

following ways. First, proposed rule 

12d1–4 would prohibit an investment 

company that is relying on section 

12(d)(1)(G) of the Act or proposed rule 

12d1–4 from acquiring, in excess of the 

limits in section 12(d)(1)(A) of the Act, 

the outstanding voting securities of a 

fund that discloses in its most recent 

registration statement that it may be an 

acquiring fund in reliance on rule 12d1– 

4, thereby limiting fund of funds 

arrangements in which the acquired 

fund is itself an acquiring fund.314

Second, the rescission of the current 

exemptive orders would result in the 

prohibition of multi-tier structures 

formed in reliance on section 

12(d)(1)(G) and the exemptive orders. 

As discussed above, an acquiring fund 

relying on section 12(d)(1)(G) currently 

could invest in an acquired fund that 

invests in another fund in reliance on an 

exemptive order. 

The rule proposal would enhance 

investor protection because the 

additional complex structures 

conditions included in the rule proposal 

would limit the creation of multi-tier 

structures that historically have been 

associated with duplicative and 

excessive fees and investor confusion. 

At the same time, the rule proposal 

would impose costs on funds that could 

be required to change their portfolio to 

ensure compliance with the rule 

proposal. In particular, multi-tier 

structures that were formed in reliance 

on section 12(d)(1)(G) and on exemptive 

orders would need to be restructured. 

Funds relying on section 12(d)(1)(G) 

would be required to reallocate their 

investments to acquired funds that do 

not invest in underlying funds beyond 

the limits of section 12(d)(1) in reliance 

on an exemptive order. Alternatively, 

acquiring funds relying on section 

12(d)(1)(G) could invest in the same 

acquired funds, but those acquired 

funds would incur costs to reduce their 

investments in other funds to comply 

with the limits of section 12(d)(1) of the 

Act.315

As of June 2018, there were 2,033 

multi-tier structures. Some of these 

structures are within the statutory limits 

or are in compliance with the 

exceptions to the complex structures 

conditions contained in the proposed 

rule, and thus would not be affected by 

the proposed rule and the rescission of 

the exemptive orders. The remaining 

multi-tier structures would be required 

to modify their investments to ensure 

compliance with proposed rule 12d1–4 

and the rescission of the exemptive 

orders. As of June 2018, there were: (i) 

231 three-tier structures for which both 

the first- and second-tier funds invested 

in other funds beyond the limits in 

section 12(d)(1); and (ii) no three-tier 

structures for which the first-tier fund 

relies on 12(d)(1)(G) to invest in the 

middle-tier fund and the middle-tier 

fund relies on exemptive orders to 

invest in the bottom-tier fund beyond 

the limits of section 12(d)(1). 

Proposed rule 12d1–4 would prohibit 

an investment company that is relying 

on section 12(d)(1)(G) of the Act or 

proposed rule 12d1–4 from acquiring, in 

excess of the limits of section 

12(d)(1)(A) of the Act, the outstanding 

voting securities of a fund that discloses 

in its most recent registration statement 

that it may be an acquiring fund in 

reliance on rule 12d1–4.316 We estimate 

that complying with this disclosure 

requirement would impose a one-time 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1329 

317These estimates are based on the following 

calculations: $30,706,624 = 4,342 acquiring funds × 

($1,602 one-time internal cost + $5,470 one-time 

external cost); $13,612,170 = 4,342 acquiring funds 

× ($400 ongoing annual internal cost + $2,735 

ongoing annual external cost). See infra footnotes 

341, 342, and 343. 

318These estimates are based on the following 

calculations: 2 hours × $276.5 blended hourly rate 

for senior portfolio manager ($324) and 

intermediate portfolio manager ($229) = $553. 

$2,401,126 = 4,342 acquiring funds × $553 ongoing 

annual burden per acquiring fund. See supra 

footnote 287 for the source of salary data. 

319We estimate that assessing the requirements of 

the proposed rule would require 5 hours of a 

compliance manager ($304 per hour) and 5 hours 

of a compliance attorney ($359 per hour), resulting 

in a cost of $3,315 (5 × $304 + 5 × $359) per fund. 

The total cost for the 6,863 acquiring and acquired 

funds that would rely on the proposed rule would 

thus be $22,750,845 (6,863 × $3,315). See supra 

footnote 287 for the source of salary data. 

320The new and omitted conditions of proposed 

rule 12d1–4 would also affect the cost of operations 

of funds of funds. See section VI.C.1.c for a detailed 

discussion of the costs and benefits of the new and 

omitted conditions. Nevertheless, the net effect of 

the new and omitted conditions on the funds’ cost 

of operations is unclear because we are unable to 

quantify the effect of many of these conditions. To 

the extent that the net effect of the new and omitted 

conditions would be to increase (decrease) the cost 

of operations for funds of funds, the new and 

omitted conditions (i) could result in higher (lower) 

fees and expenses for fund investors and (ii) could 

decrease (increase) the number of available funds of 

funds, which would ultimately harm (improve) the 

efficient allocation of the assets of the acquiring 

fund investors. 

aggregate cost equal to $30,706,624 and 

an ongoing annual aggregate cost of 

$13,612,170.317 Acquiring funds also 

would incur annual ongoing costs to 

review the disclosures of potential 

acquired funds equal to $553 per fund 

resulting in an aggregate annual ongoing 

cost of $2,401,126.318 Lastly, funds that 

are acquired by 12(d)(1)(G) funds and 

currently rely on exemptive orders to 

invest in other funds beyond the limits 

of section 12(d)(1) would need to 

implement policies and procedures to 

monitor their investments in other 

funds beyond the limits of section 

12(d)(1). We believe that any such 

additional costs are likely minimal 

because acquired funds already have 

policies and procedures to monitor their 

investments in other funds for 

compliance with the terms of the 

exemptive orders that could be 

leveraged to monitor compliance with 

the limits of the proposed rule. 

Finally, as discussed in detail in 

section VI.C.1.c. above, the proposed 

restrictions on multi-tier structures 

would affect both current and 

prospective funds by restricting their 

investment flexibility. Proposed rule 

12d1–4 would restrict funds’ investment 

flexibility because: (i) It would limit 

funds’ ability to acquire shares of 

acquiring funds beyond the limits of 

section 12(d)(1) and (ii) it would 

prohibit funds acquired by 12(d)(1)(G) 

funds from relying on exemptive orders 

to invest in other funds beyond the 

limits of section 12(d)(1). 

We request comment on the impact of 

the complex structures conditions of 

proposed rule 12d1–4 on funds that 

would be required to modify their 

investments to comply with the 

condition. Please provide any available 

data or estimates in responding to these 

requests for comment. 

• Would acquiring funds or acquired 

funds be required to change their 

portfolios to ensure compliance with the 

proposed complex structures conditions 

in the proposed rule? Would the 

complex structures conditions and the 

rescission of exemptive orders impose 

transaction costs on these funds? 

• Would the complex structures 

conditions and the rescission of 

exemptive orders require funds to sell 

listed fund shares at potentially 

depressed prices? Would the fact that 

funds would be granted one year to 

bring their operations in compliance 

with the proposed rule mitigate any 

negative effects associated with the 

complex structures conditions? 

• Would the complex structures 

conditions and the rescission of 

exemptive orders disrupt acquiring or 

acquired funds’ investment strategies? 

In which ways? 

• Would the complex structures 

conditions and the rescission of 

exemptive orders impose liquidity 

demands on acquired funds as a result 

of any potential fund redemptions? 

• Would the complex structures 

conditions and the rescission of 

exemptive orders have tax implications 

for funds? If yes, in which ways? 

• Are there any economic effects of 

the complex structure conditions that 

we have not identified? To the extent 

possible, please quantify any economic 

effects the economic analysis does not 

account for. 

d. Assessment of Rule Proposal 

Finally, existing acquired and 

acquiring funds relying on exemptive 

orders on which proposed rule 12d1–4 

is based would incur a one-time 

administrative cost to assess whether 

their operations are consistent with the 

rule proposal. Further, existing 

acquiring funds would be required to 

decide whether to continue to rely on 

section 12(d)(1)(G) and amended rule 

12d1–1 or instead rely on proposed rule 

12d1–4 and comply with the associated 

conditions. We preliminarily believe 

this assessment would result in an 

aggregate cost of $22,750,845.319

2. Effects on Efficiency, Competition, 

and Capital Formation 

a. Efficiency 

Efficiency of current and prospective 

acquiring funds’ asset allocation. The 

impact of the rule proposal on the 

efficiency of current and prospective 

acquiring funds’ asset allocation is 

unclear ex-ante. On one hand, the rule 

proposal could promote the efficiency of 

funds’ asset allocation. First, the 

proposed rule would eliminate the need 

for funds to apply for an exemptive 

order to structure certain funds of funds, 

and thus would eliminate the costs 

associated with the exemptive order 

process.320 By eliminating the costs 

associated with the exemptive order 

process, the proposed rule would 

reduce frictions in funds’ asset 

allocation and thus could promote the 

efficient allocation of funds’ assets. 

Second, the rule proposal would 

create a more consistent and efficient 

regulatory framework for funds of funds 

than the existing regulatory framework 

for the following reasons. First, 

proposed rule 12d1–4 would create a 

consistent framework for all registered 

funds and BDCs by providing the same 

investment flexibility to all registered 

funds and BDCs. Second, under the 

existing regulatory framework, 

substantially similar funds of funds are 

subject to different conditions. For 

example, an acquiring fund currently 

can rely on section 12(d)(1)(G) and rule 

12d1–2 to invest in an acquired fund 

within the same group of investment 

companies or, alternatively, can rely on 

relief provided by the Commission to 

achieve the same investment objectives. 

The rule proposal would eliminate the 

existing overlapping and potentially 

inconsistent conditions for funds of 

funds and harmonize conditions across 

different fund arrangements. Regulatory 

consistency and efficiency could 

remove obstacles to funds’ investments 

and operations because regulatory 

consistency and efficiency would 

decrease compliance and operating 

costs. By reducing compliance and 

operating costs, the rule proposal would 

further reduce frictions in asset 

allocation and could promote the 

efficient allocation of funds’ assets. 

Third, assuming that the proposed 

rule would increase funds’ investment 

flexibility, it could increase the 

efficiency of funds’ asset allocation 

because funds would be better able to 

diversify their investment portfolio. The 

proposed rule could increase funds’ 

investment flexibility by expanding the 

scope of permissible acquiring and 

1330 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

321See supra footnotes 270 and 271. 

322Any effects of eliminating the need to apply 

for an exemptive order are limited by the fact that 

each exemptive order can be used by multiple 

funds within the same fund complex and the costs 

of the exemptive order application process are onetime costs. 

323As discussed in section VI.C.1.a above, the net 

effect of the proposed rule on funds’ investment 

flexibility is unclear. To the extent that the 

proposed rule would decrease funds’ investment 

flexibility, it could decrease the diversity of 

available funds of funds. 

324See, e.g., Anat R. Admati & Paul Pfleiderer, A 

Theory of Intraday Patterns: Volume and Price 

Variability, 1 Rev. of Fin. Stud., 3 (Spring 1988); 

Tarun Chordia, Richard Roll & Avanidhar 

Subrahmanyam, Liquidity and Market Efficiency, 87 

J. of Fin. Econ., 249 (Feb. 2008). 

325See, e.g., Eli Bartov, Suresh Radhakrishnan, & 

Itzhak Krinsky, Investor Sophistication and Patterns 

in Stock Returns after Earnings Announcements, 75 

The Acc. Rev., 43 (Jan. 2000); Joseph D. Piotroski 

& Darren T. Roulstone, The Influence of Analysts, 

Institutional Investors, and Insiders on the 

Incorporation of Market, Industry, and 

Firm-Specific Information into Stock Prices, 79 The 

Acc. Rev., 1119 (Oct. 2004); Ekkehart Boehmer & 

Eric K. Kelley, Institutional Investors and the 

Informational Efficiency of Prices, 22 Rev. of Fin. 

Stud., 3563 (Sept. 2009). 

326Funds can choose to compete through prices 

or through product differentiation. See, e.g., Avner 

Shaked & John Sutton, Relaxing Price Competition 

Through Product Differentiation, 49 Rev. of Econ. 

Stud., 3 (Jan. 1982). 

acquired funds relative to the current 

exemptive orders. Fourth, the limit on 

fund redemptions under proposed rule 

12d1–4 would incentivize acquiring 

funds to hold smaller percentages of the 

acquired fund shares to mitigate any 

negative effects of the limits on fund 

redemptions, which could ultimately 

result in a more diversified fund 

portfolio. 

On the other hand, the rule proposal 

could reduce the efficiency of funds’ 

asset allocation for two reasons. First, 

proposed rule 12d1–4 could affect 

funds’ investment objectives due to the 

differential effects of the redemption 

limit on listed versus unlisted acquired 

funds and large versus small acquired 

funds, which ultimately could harm the 

efficient allocation of funds’ assets. 

Second, assuming that the rule proposal 

would reduce funds’ investment 

flexibility by prohibiting certain 

currently permissible funds of funds, it 

could decrease the efficiency of funds’ 

asset allocation because funds would be 

less able to diversify their investment 

portfolio. 

Efficiency of the asset allocation of 

current and prospective acquiring fund 

investors. The impact of the rule 

proposal on the efficiency of the asset 

allocation of current and prospective 

acquiring fund investors is unclear exante. On one hand, the rule proposal 

could promote the efficiency of 

investors’ asset allocation. First, 

proposed rule 12d1–4 would reduce the 

cost of setting up a fund of funds by 

eliminating the need to apply for an 

exemptive order. To the extent that the 

fund industry is competitive,321 fund 

advisers/sponsors could pass through to 

investors the cost savings associated 

with eliminating the need to apply for 

an exemptive order, which could result 

in lower fees and expenses for acquiring 

fund investors.322 Lower fees and 

expenses, in turn, could translate into 

improved efficiency of investors’ asset 

allocation because investors could 

achieve the same investment objectives 

at a potentially lower cost. Similarly, 

the rule proposal would create a more 

consistent and more efficient regulatory 

framework. Fund advisers/sponsors 

could also pass through to investors any 

cost savings associated with a more 

consistent and efficient regulatory 

framework, which could result in lower 

fees and expenses, and more efficient 

allocation of acquiring fund investors’ 

assets. Second, assuming that proposed 

rule 12d1–4 would increase funds’ 

investment flexibility, the proposed rule 

would increase the diversity of available 

funds of funds, which could promote 

the efficient allocation of acquiring fund 

investors’ assets because investors 

would be better able to diversity their 

investment portfolio. 

On the other hand, the rule proposal 

could reduce the efficiency of investors’ 

asset allocation. In particular, proposed 

rule 12d1–4 could decrease the diversity 

of available funds of funds because (i) 

it could reduce acquiring funds’ 

investment flexibility and (ii) it could 

affect funds’ investment objectives due 

to the differential effects of the 

redemption limit on listed versus 

unlisted acquired funds and large versus 

small acquired funds, which could 

decrease acquiring fund incentives to 

invest in small and unlisted acquired 

funds. A decrease in the diversity of 

available funds of funds would harm the 

efficient allocation of investors’ assets 

because investors would be less able to 

diversify their investment portfolio. 

Efficiency of prices of acquired funds 

and their underlying assets. The impact 

of the rule proposal on the efficiency of 

prices is unclear ex-ante. On one hand, 

the rule proposal could harm the 

efficiency of prices of the underlying 

assets of acquired funds because, as 

described above, the redemption limit 

could slow down the incorporation of 

negative information about the 

underlying assets of the acquired funds. 

On the other hand, the rule proposal 

could have a positive impact on the 

efficiency of the prices of acquired 

funds and their underlying assets. 

Proposed rule 12d1–4 could (i) increase 

the diversity of funds of funds by 

increasing funds’ investment 

flexibility; 323 (ii) increase the number of 

available funds of funds by eliminating 

the need to apply for an exemptive 

order, by creating a more consistent and 

more efficient regulatory framework, 

and by reducing the cost of setting up 

a fund of funds; and (iii) enhance 

investor protection against undue 

influence, duplicative and excessive 

fees, and complex structures. The 

potential increase in the diversity and 

number of funds of funds and the 

enhancement of investor protection 

could increase the attractiveness of 

funds of funds, and thus could increase 

investors’ demand for funds of funds. 

The increased investor demand for 

funds of funds could increase 

investment rates, increase investments 

in acquiring funds, and thus increase 

investments in the acquired funds and 

the acquired funds’ underlying assets 

(i.e., stocks, bonds, etc.). An increased 

investment in the acquired funds and 

the acquired funds’ underlying assets 

could increase trading interest for those 

assets. Higher trading interest could 

lead to higher liquidity, lower trading 

costs, improved information production, 

and thus more efficient prices for those 

assets.324

In addition, the rule proposal could 

increase the price efficiency of listed 

acquired funds (i.e., ETFs, ETMFs, 

listed closed-end funds, and listed 

BDCs) because investors could increase 

their investments in those funds 

through investments in funds of funds 

rather than investing directly in those 

funds. Consequently, the funds’ investor 

base could shift from individual 

investors to acquiring funds. The 

investment advisers of acquiring funds 

are arguably more sophisticated than 

individual investors. A shift of certain 

funds’ investor base to more 

sophisticated investors could in turn 

result in more efficient prices for listed 

acquired funds, because noise trading 

would decrease.325

b. Competition 

The impact of the rule proposal on 

fund competition is unclear ex-ante. On 

one hand, the rule proposal could 

promote competition in the fund 

industry for the following reasons. First, 

to the extent that proposed rule 12d1– 

4 would increase acquiring funds’ 

investment flexibility, the proposed rule 

could promote competition in the fund 

industry because it would increase the 

diversity of available funds of funds.326

Second, the rule proposal would level 

the playing field for funds by expanding 

the scope of permissible acquiring and 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1331 

327As discussed in supra section I, the 

combination of statutory exemptions, Commission 

rules, and the exemptive orders has created a 

regime where substantially similar funds of funds 

are subject to different conditions. The rule 

proposal would level the playing field for funds 

because it would create a regime where similar 

funds of funds are subject to the same conditions. 

At the same time, any effects of leveling the playing 

field would be limited by the fact that different 

funds face different levels of restrictions on their 

investments that are unrelated to proposed rule 

12d1–4 (see, e.g., supra footnote 37 for restrictions 

on BDC investments). 

328Academic literature provides evidence 

consistent with the idea that higher demand for a 

firm’s securities could lead to lower cost of capital. 

See, e.g., Douglas W. Diamond & Robert E. 

Verrecchia, Disclosure, Liquidity, and the Cost of 

Capital, 46 J. of Fin., 1325 (Sept. 1991). 329See supra footnote 47. 

acquired funds and mandating the same 

conditions for similar funds of funds.327

A more level playing field could 

increase competition in the fund 

industry because it would allow various 

funds to operate under similar 

conditions. Third, the rule proposal 

would contribute towards leveling the 

playing field for affiliated and 

unaffiliated acquired funds by imposing 

a limit on fund redemptions for both 

affiliated and unaffiliated acquired 

funds. Fourth, the rule proposal would 

create a more consistent and efficient 

regulatory framework than the current 

regulatory framework for funds of funds. 

To the extent that regulatory 

inefficiencies and inconsistencies could 

hamper funds’ investment and growth, 

an increase in regulatory consistency 

and efficiency could result in the 

creation of more funds of funds, which 

could increase competition in the fund 

industry. Fifth, proposed rule 12d1–4 

would remove the need to apply for an 

exemptive order and thus would 

decrease the cost of setting up a fund of 

funds. A decrease in the cost of setting 

up a fund of funds would lower the 

barriers to entry for new funds of funds, 

and thus could increase competition in 

the fund industry. 

On the other hand, to the extent that 

the rule proposal would decrease funds’ 

investment flexibility, it could harm 

competition among funds of funds 

because it would decrease the diversity 

of available funds of funds. In addition, 

proposed rule 12d1–4 would have a 

differential impact on publicly listed 

versus unlisted and large versus small 

funds, and this differential impact could 

harm competition in the fund industry. 

Specifically, the redemption limit under 

proposed rule 12d1–4 could provide an 

advantage to listed and large acquired 

funds because the redemption limit 

would be less binding for listed and 

large acquired funds. By providing a 

potential advantage to listed and large 

acquired funds and to the extent that 

there are economies of scale in fund 

operations, the proposed rule could 

have a negative effect on fund 

competition. 

c. Capital Formation 

The impact of the rule proposal on 

capital formation is unclear ex-ante. On 

one hand, the rule proposal could have 

a positive effect on capital formation. 

Specifically, the potential increase in 

fund investment flexibility, the 

potential leveling of the playing field as 

a result of the rule proposal, the 

increase in regulatory consistency and 

efficiency, and the decrease in the 

operating costs of prospective funds of 

funds as a result of removing the need 

to apply for an exemptive order could 

increase the number and diversity of 

funds of funds. An increase in the 

number and diversity of funds of funds 

could increase the demand for funds of 

funds, increase investor saving rates, 

increase investments in funds of funds, 

and ultimately increase demand for the 

funds of funds’ underlying securities. 

Investor demand for funds of funds also 

could increase as a result of the new 

conditions of the proposed rule, which 

would enhance investor protection. As 

a result of the increased demand for the 

firms’ equity and debt securities, 

companies would be able to issue new 

debt and equity at higher prices, which 

could lead to a decrease in the cost of 

capital of firms, and thus facilitate 

capital formation.328 Nevertheless, we 

expect that any positive effects of the 

proposed rule on capital formation 

would be small. 

On the other hand, assuming that 

single-tier funds and funds of funds are 

purely substitute investments, an 

increase in investors’ demand for funds 

of funds could decrease the demand for 

single-tier fund structures. 

Consequently, under that assumption, 

there would be no change in the amount 

of money that flows to corporations and 

there would be no impact on capital 

formation as a result of the rule 

proposal. 

D. Reasonable Alternatives 

1. Retention of Existing Exemptive 

Relief 

As discussed in section V above, we 

are proposing to rescind rule 12d1–2 

and certain exemptive orders in 

connection with proposed rule 12d1–4 

and amended rule 12d1–1. 

Alternatively, we could allow existing 

funds of funds to choose whether to 

operate under the existing regulatory 

framework or the new regulatory 

framework, and require only new funds 

of funds to comply with the new 

regulatory framework. The benefit of 

such an alternative would be that 

existing funds of funds would not incur 

the one-time switching costs from the 

existing regulatory framework to the 

new framework. At the same time, 

however, this alternative would subject 

existing funds of funds and new funds 

of funds to different sets of conditions. 

For example, existing funds of funds 

would be exempt from the proposal’s 

new requirements relating to 

redemption limits, multi-tier structures, 

and duplicative and excessive fees. 

Consequently, unlike the proposal, this 

alternative would establish a less 

uniform regulatory framework 

governing fund of funds arrangements. 

2. Allow Private and Unregistered 

Investment Companies To Rely on 

Proposed Rule 12d1–4 

As discussed above, proposed rule 

12d1–4 is based in part on previously 

granted exemptive relief and would 

permit registered funds and BDCs to 

invest in registered funds and BDCs 

beyond the limits in section 12(d)(1). 

Alternatively, we could expand the 

scope of the proposed rule to allow 

private funds and unregistered 

investment companies to rely on the 

rule as acquiring funds. Expanding the 

proposed rule in this manner would 

increase investment flexibility for those 

funds, would level the playing field for 

those funds, and would broaden the 

funding opportunities for acquired 

funds because private funds and 

unregistered investment companies 

could increase their investments in 

them. 

Nevertheless, we preliminarily 

believe that there are risks associated 

with expanding proposed rule 12d1–4 

to acquiring private funds and 

unregistered investment companies. 

First, private funds and unregistered 

investment companies are not registered 

with the Commission and would not be 

subject to the same reporting 

requirements (i.e., Forms N–CEN and 

N–PORT) as the proposed acquiring 

funds.329 Second, private funds and 

unregistered investment companies are 

not subject to recordkeeping 

requirements under the Investment 

Company Act, and therefore, may not 

maintain the same records as a 

registered investment company. Third, 

unregistered foreign funds’ investments 

in U.S. registered funds have raised 

concerns of abuse and undue influence 

in the past, which gave raise to 

1332 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

330As discussed in section II.B. above, section 17 

of the Act generally restricts a fund’s ability to enter 

into transactions with affiliated persons and thus 

provides some protection to acquired funds from 

acquiring funds’ undue influence. Proposed rule 

12d1–4 also contains a number of conditions aimed 

at protecting acquired funds from acquiring funds’ 

undue influence. 

331The control condition could, for example, 

limit an acquiring fund from obtaining the optimal 

level of risk exposure to another fund. Acquiring 

funds potentially could obtain similar levels of risk 

exposure at a higher cost by investing in multiple 

funds. 

332For example, a family of target date funds 

tends to invest in different proportional allotments 

of the same underlying funds. 

Congress’s amendments to section 

12(d)(1) in 1970. 

3. Codify Current Conditions in Existing 

Exemptive Orders 

As discussed above, proposed rule 

12d1–4 would omit certain conditions 

contained in current exemptive orders 

that we believe are no longer necessary 

to prevent the abuses that section 

12(d)(1) seeks to curtail in light of the 

new conditions being proposed. 

Proposed rule 12d1–4 also would 

include new conditions to address the 

potential for undue influence, complex 

structures, or duplicative and excessive 

fees. Alternatively, we could codify the 

conditions contained in existing 

exemptive orders rather than replacing 

certain conditions with alternative 

conditions as contained in the proposal. 

This alternative approach would not 

impose the costs associated with the 

new conditions in the proposed rule, 

but it might impose costs to the extent 

that the conditions in the orders on 

which some funds of funds rely might 

not be identical to the conditions in this 

alternative proposed rule because of 

cross-sectional variation in the 

conditions of the exemptive orders. For 

example, this alternative would not 

limit an acquiring fund’s ability to 

quickly redeem or tender a large volume 

of acquired fund shares to mitigate 

undue influence, which could impose 

liquidity constraints and restrict funds’ 

investment flexibility. At the same time, 

this alternative would not result in cost 

savings associated with removing 

certain conditions that are no longer 

necessary in light of the new conditions, 

such as removing the need to enter into 

participation agreements. Nevertheless, 

we believe that this alternative approach 

would not be as effective at preventing 

the abuses that section 12(d)(1) seeks to 

curtail while eliminating conditions that 

are no longer necessary in light of the 

new conditions of proposed rule 12d1– 

4. 

4. Restrict the Ability of an Acquiring 

Fund and Its Advisory Group To Invest 

in an Acquired Fund Above a Lower or 

Higher Limit Than the Proposed Control 

Limit 

As discussed in section II.C.1 above, 

to address concerns about one fund 

exerting undue influence over another 

fund, proposed rule 12d1–4 is not 

available when an acquiring fund 

together with its advisory group controls 

the acquired fund. The proposed rule 

relies on the definition of ‘‘control’’ in 

the Act, including the rebuttable 

presumption that any person who 

directly or indirectly beneficially owns 

more than 25% of the voting securities 

of a company controls that company. 

The proposed rule includes an 

exception for funds that are in the same 

group of investment companies. The 

proposed rule also includes an 

exception when the acquiring fund’s 

investment sub-adviser or any person 

controlling, controlled by, or under 

common control with such investment 

sub-adviser acts as the acquired fund’s 

investment adviser or depositor. 

As an alternative means of preventing 

undue influence, we could instead 

restrict the ability of an acquiring fund 

and its advisory group to invest in an 

acquired fund above a lower limit than 

the 25% limit used to define ‘‘control’’ 

in the Act. A lower limit could provide 

additional assurance that the proposed 

rule would protect investors from the 

abusive practices that section 12(d)(1) 

was designed to prevent because a lower 

percentage of ownership would reduce 

the risk that the acquiring fund could 

exercise undue influence over the 

acquired fund’s strategy, management, 

or governance.330 However, we expect 

that a lower limit could hamper the 

acquiring fund’s ability to allocate its 

assets in an efficient and cost effective 

manner.331

We also could impose a lower limit 

while narrowing the scope of entities 

that would be assessed for the purposes 

of the ownership threshold. In 

particular, the ownership limit could 

apply only to the acquiring fund and 

other funds advised by the same adviser 

or by the adviser’s control affiliates. As 

a result, acquiring funds would not be 

required to consider their non-fund 

affiliates’ holdings when assessing 

whether they control an acquired fund, 

which would lessen compliance 

burdens for the acquiring funds. 

Nevertheless, our exemptive orders 

define control in terms of a fund and its 

advisory group. Consequently, funds 

likely have established already policies 

and procedures to monitor compliance 

with the aggregation requirement 

embedded in the proposed rule’s 

definition of an acquiring fund’s 

‘‘advisory group.’’ In addition, other 

provisions of the Act and our rules also 

extend to affiliated persons of an 

investment adviser, and so funds (or 

their advisers) have experience 

developing compliance policies and 

procedures in those circumstances. 

Lastly, the risk of undue influence over 

an acquired fund would be more 

effectively addressed by requiring all 

entities within an advisory group to 

aggregate their holdings for purposes of 

the control condition because entities in 

the same advisory group could 

potentially coordinate to exercise undue 

influence over the acquired funds.332

Further, as an alternative, we could 

impose a limit lower than 25%, while 

imposing no limits on fund 

redemptions. The lower limit 

potentially would protect acquired 

funds from acquiring funds undue 

influence while allowing acquiring 

funds greater flexibility to liquidate 

their investments in acquired funds. As 

proposed, however, rule 12d1–4 

balances these concerns by allowing 

acquiring funds to invest to a greater 

extent in acquired funds, subject to the 

proposed redemption limit. 

Similarly, we could impose a limit 

higher than 25%, which would provide 

acquiring funds with greater investment 

flexibility. This alternative, however, 

would diverge from how control has 

been defined in the past under the Act. 

Moreover, we believe that a limit higher 

than 25% would be more likely to give 

rise to the abuses that section 12(d)(1) 

was designed to prevent because it 

would make it more likely that the 

acquiring fund could control the 

acquired fund and thus potentially 

could influence the acquired fund for 

the benefit of the acquiring fund’s 

shareholders, advisers, or sponsors. 

Lastly, given the proposed rule’s 3% 

redemption limit, acquiring funds likely 

would not take advantage of a higher 

limit because it would take an acquiring 

fund longer to unwind a larger position 

in an acquired fund. 

5. Alternative Approaches to the 

Redemption Limit 

a. Do Not Impose Redemption Limit 

As discussed above, proposed rule 

12d1–4 would prohibit an acquiring 

fund that acquires more than 3% of an 

acquired fund’s outstanding shares from 

redeeming, submitting for redemption, 

or tendering for repurchase more than 

3% of an acquired fund’s total 

outstanding shares in any 30-day 

period. The purpose of this prohibition 

is to address concerns that an acquiring 

fund could threaten large-scale 

redemptions to unduly influence an 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1333 

333Acquiring funds that invest in acquired funds 

beyond the limits of section 12(d)(1) when: (i) The 

acquiring fund is within the same group of 

investment companies as the acquired fund or (ii) 

the acquiring fund’s investment sub-adviser or any 

person controlling, controlled by, or under common 

control with such investment sub-adviser acts as 

the acquired fund’s investment adviser or depositor 

currently are not subject to redemption limits under 

section 12(d)(1)(G) and the exemptive orders. 

334As discussed above, the control conditions in 

proposed rule 12d1–4 would apply to an acquiring 

fund’s advisory group. See supra section II.C.1. 

335Concerns of investor confusion are mitigated 

by fund disclosure requirements, such as 

prospectus and shareholder reports. 

336 44 U.S.C. 3501 through 3521. 

337 17 CFR 270.0–2. 

338Form N–CEN [referenced in 17 CFR 274.101] 

under the Investment Company Act. 

acquired fund. The proposed rule’s 3% 

limit on fund redemptions in any 30- 

day period, however, could impose 

liquidity and investment flexibility 

constraints on current and prospective 

acquiring funds because acquiring funds 

would be unable to quickly liquidate 

their investments in funds if they hold 

more than 3% of the acquired fund’s 

outstanding shares. 

Alternatively, we could impose no 

limits on the redemptions of an 

acquired fund’s shares. Instead, we 

could adopt conditions that generally 

require the acquired and acquiring fund 

boards to make certain findings and 

adopt procedures to prevent 

overreaching and undue influence by 

the acquiring fund and its affiliates once 

the acquired fund’s investment exceeds 

the section 12(d)(1) limits, and also 

require the acquiring and acquired 

funds to enter into participation 

agreements. Similar, to section 

12(d)(1)(F), we also could make rule 

12d1–4’s redemption provision 

permissive, by giving the acquired fund 

or its board the option to limit 

redemptions. 

We believe that a redemption limit, 

together with the proposed control and 

voting conditions, are more protective of 

acquired funds because they provide 

protection against a broader set of 

circumstances than the targeted and 

prescriptive provisions in our 

exemptive orders. In addition, the 

redemption limit, together with the 

proposed control and voting conditions, 

may be more objectively tested as part 

of a fund’s compliance program than the 

conditions currently found in our orders 

because they are based on numerical 

thresholds that are easily observable and 

verifiable. 

b. Do Not Impose Redemption Limit for 

Funds Within the Same Group of 

Investment Companies 

Proposed rule 12d1–4 imposes a 

redemption limit on all acquiring funds 

relying on the rule if they hold more 

than 3% of an acquired fund’s 

outstanding voting securities. 

Alternatively, we could impose the 

redemption limit only on acquiring 

funds when: (i) The acquiring fund is 

not in the same group of investment 

companies as the acquired fund and (ii) 

the acquiring fund’s investment subadviser is different from, and not in a 

control relationship with, the acquired 

fund’s investment adviser or depositor. 

Such an approach would be similar to 

the exceptions to the control and voting 

conditions under proposed rule 12d1–4. 

The benefit of such an alternative is 

that it would limit any costs associated 

with the redemption limit because any 

costs would be borne by only a subset 

of the acquiring funds.333 In addition, 

such an alternative potentially would 

maintain investor protection because 

fund of funds arrangements involving 

control affiliates do not raise the same 

concerns regarding undue influence as 

other types of fund of funds 

arrangements. In circumstances where 

the acquiring fund and acquired fund 

share the same adviser or subadviser, 

the adviser or subadviser would owe a 

fiduciary duty to both funds, serving to 

protect the best interests of each fund. 

In addition, in cases where the 

arrangement involves funds that are 

advised by advisers that are control 

affiliates, the acquiring fund adviser is 

less likely to seek to benefit the 

acquiring fund at the expense of the 

acquired fund, nor do we believe that 

the acquiring fund would seek to 

influence the acquiring fund through its 

ownership interest in the acquired fund. 

Nevertheless, acquiring funds that fall 

within the exceptions in rule 12d1– 

4(b)(1)(iii) are not constrained in their 

ability to control a fund and could 

acquire more than 25% of an acquiring 

fund’s outstanding voting securities. As 

a result, we propose to subject these 

types of acquiring funds to the 

redemption limitation in proposed rule 

12d1–4(b)(2). 

c. Impose Aggregate Redemption Limit 

on Acquiring Fund and Its Advisory 

Group 

As discussed above, the proposed 3% 

redemption limit in proposed rule 

12d1–4 only would apply to individual 

acquiring funds and thus would not 

apply to entities within an acquiring 

fund’s advisory group.334 Hence, the 

proposed redemption limit would 

provide limited protection to acquired 

funds when the shares of the acquired 

funds are held by multiple acquiring 

funds within the acquiring fund’s 

advisory group. 

Alternatively, we could impose a 3% 

or higher aggregate redemption limit 

applicable to an acquiring fund and its 

advisory group. To the extent that these 

entities could coordinate their 

redemptions to exercise undue 

influence on acquired funds through the 

threat of large scale redemptions, this 

proposed alternative would better 

protect acquired funds from acquiring 

funds’ undue influence. Nevertheless, 

we believe that imposing a 3% aggregate 

redemption limit on an acquiring fund 

and its advisory group could 

significantly harm the liquidity and 

investment flexibility of acquiring 

funds, and could impose a higher 

monitoring burden on acquiring funds. 

Hence, we are not proposing to impose 

a 3% aggregate redemption limit on 

acquiring funds and their advisory 

group. 

6. Permit Multi-Tier Fund Structures 

As discussed above, proposed rule 

12d1–4 would limit the creation of 

multi-tier structures. As an alternative, 

we could allow certain multi-tier fund 

structures by allowing funds to invest in 

an acquiring fund or by allowing 

acquired funds to invest in other funds 

beyond the limits in section 12(d)(1)(A). 

While this alternative would provide 

additional flexibility to funds to meet 

their investment objectives, it could 

potentially lead to duplicative and 

excessive fees and investor 

confusion.335 In particular, the 

organizational complexity of multi-tier 

fund structures could make it difficult 

for acquired fund investors to 

understand who really controls the 

fund. Additionally, we believe that the 

proposed rule’s exceptions to the multitier structures prohibition provide 

sufficient investment and funding 

flexibility to acquiring and acquired 

funds. 

VII. Paperwork Reduction Act 

A. Introduction 

Proposed new rule 12d1–4 contains a 

‘‘collection of information’’ within the 

meaning of the Paperwork Reduction 

Act of 1995 (‘‘PRA’’).336 In addition, 

proposed rule 12d1–4 would affect the 

current collection of information burden 

of rule 0–2 under the Act.337 The 

proposed amendments to Form N–CEN 

also would affect the collection of 

information burden under that form.338

The title for the new collection of 

information for rule 12d1–4 would be: 

‘‘Rule 12d1–4 Under the Investment 

Company Act of 1940, Fund of Funds 

Arrangements.’’ The titles for the 

existing collections of information are: 

‘‘Rule 0–2 under the Investment 

1334 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

339See 2008 Proposing Release, supra footnote 

13. 

340See proposed rule 12d1–4(b)(4). 

341Monetized, the one-time four-hour internal 

burden translates to $1,602 and the ongoing onehour internal burden translates to $400. These 

estimates are based on the following calculations: 

4 hours × blended hourly rate of assistant general 

counsel (2 hours at $449/hour) and compliance 

attorney (2 hours at $352/hour) = $1,602; $400 = 

$1,602/4. See supra footnote 287 for the source of 

salary data. 

342This estimate is based on the following 

calculation: 1 hour × $400 hourly rate of outside 

counsel + 1 hour × $5,070 hourly rate for board of 

directors = $5,470. See supra footnote 287 for the 

source of salary data. 

343This estimate is based on the following 

calculation: 0.5 hour × $400 hourly rate of outside 

counsel + 0.5 hour × $5,070 hourly rate for board 

of directors = $2,735. See supra footnote 287 for the 

source of salary data. 

344This estimate is based on the following 

calculation: (4 hours + 1 hour + 1 hour)/3 = 2 hours. 

345This estimate is based on the following 

calculation: ($5,470 + $2,735 + $2,735)/3 = $3,647. 

346See proposed rule 12d1–2(b)(1)(ii). As 

described above, in pass-through voting, the 

acquiring fund seeks voting instructions from its 

security holders and votes such proxies in 

accordance with their instructions. In mirror voting, 

the acquiring fund votes the shares it holds in the 

same proportion as the vote of all other holders. 

347This estimate is based on data from the 

Morningstar Investment Company Holdings 

database. 

348 Id. This estimate of the average number of 

acquired funds per acquiring fund is based on the 

investments of the 4,342 acquiring funds 

summarized in Table 1, supra section VI.B.1. For 

purposes of this analysis, we assume that all 

existing acquiring funds would rely on proposed 

rule 12d1–4. 

349This estimate takes into account the different 

voting frequencies of the types of acquired funds 

included in these calculations. For example, closedend funds typically hold one vote per year, while 

mutual funds typically seek shareholder votes less 

frequently. 

Company Act of 1940, General 

Requirements of Papers and 

Applications’’ (OMB Control No. 3235– 

0636); and ‘‘Form N–CEN’’ (OMB 

Control No. 3235–0730). The 

Commission is submitting these 

collections of information to the Office 

of Management and Budget (‘‘OMB’’) for 

review in accordance with 44 U.S.C. 

3507(d) and 5 CFR 1320.11. An agency 

may not conduct or sponsor, and a 

person is not required to respond to, a 

collection of information unless it 

displays a currently valid control 

number. 

We published notice soliciting 

comments on the collection of 

information requirements in the 2008 

Proposing Release and submitted the 

proposed collections of information to 

OMB for review and approval in 

accordance with 44 U.S.C. 3507(d) and 

5 CFR 1320.11.339 We received no 

comments on the collection of 

information requirements. 

We discuss below the collection of 

information burdens associated with 

proposed rule 12d1–4 and its impact on 

rule 0–2, as well as proposed 

amendments to Form N–CEN. 

B. Rule 12d1–4 

Proposed rule 12d1–4 would permit 

registered funds and BDCs that satisfy 

certain conditions to acquire shares of 

another fund in excess of the limits of 

section 12(d)(1) of the Act without 

obtaining an exemptive order from the 

Commission. The rule is designed to 

create a consistent and streamlined 

regulatory framework applicable to fund 

of funds arrangements while addressing 

investor protection concerns. The 

proposed rule would require an 

acquiring fund to disclose certain 

information in its registration statement, 

require an acquiring fund to follow 

certain procedures for voting an 

acquired fund’s securities if certain 

ownership thresholds are met, require 

an acquiring fund’s adviser (if the fund 

is a management company) or its 

principal underwriter or depositor (if 

the fund is a UIT) to make certain 

findings, require an acquiring fund (if 

the fund is a separate account funding 

a variable insurance contract) to obtain 

a certification from an insurance 

company issuing separate accounts, and 

require an acquiring fund to maintain 

certain records. These requirements are 

collections of information under the 

PRA. 

The respondents to proposed rule 

12d1–4 would be registered funds or 

BDCs. The collection of information 

would be mandatory only for entities 

that wish to rely on the new rule. 

Information provided to the 

Commission in connection with staff 

examinations or investigations would be 

kept confidential subject to the 

provisions of applicable law. 

1. Disclosure Requirements 

Under the proposed rule, a fund that 

relies on rule 12d1–4 (or intends to 

preserve flexibility to rely on rule 12d1– 

4) would be required to disclose in its 

registration statement that it is or may 

be an acquiring fund for purposes of 

rule 12d1–4.340 The Commission staff 

estimates that complying with these 

disclosure requirements would impose a 

one-time internal hour burden of four 

hours, and an ongoing internal hour 

burden of one hour, on each acquiring 

fund to determine the disclosures 

appropriate to the fund and ensure that 

the appropriate disclosures are set forth 

in the fund’s registration statement.341

Additionally, the Commission staff 

estimates that these disclosure 

requirements would impose a one-time 

external cost burden of $5,470 342 and 

an ongoing external cost burden of 

$2,735 on each acquiring fund relating 

to board review and consultation with 

outside counsel.343 Amortized over 

three years, the internal hour burden 

would be two hours per acquiring 

fund 344 and the annual external cost 

burden would be $3,647 per acquiring 

fund.345

2. Voting Provisions 

Under proposed rule 12d1–4, where 

an acquiring fund and its advisory 

group (in the aggregate) hold more than 

3% of the outstanding voting securities 

of an acquired fund, the acquiring fund 

would be required to vote those 

securities using either pass-through 

voting or mirror voting, unless the 

acquiring fund is covered by certain 

exceptions to the requirement.346 This 

provision is designed to minimize the 

influence that an acquiring fund and its 

advisory group may exercise over an 

underlying fund through voting. 

For purposes of this analysis, we 

estimate that approximately 809 funds 

would be acquiring funds holding more 

than 3% of the outstanding voting 

securities of an acquired fund, and 

would not fall within any of the 

proposed exceptions to the voting 

requirement, and thus would be subject 

to the voting requirement.347 We further 

estimate that each of these acquiring 

funds invests in, on average, 

approximately 11 underlying funds.348

As discussed above, acquiring funds 

subject to the proposed voting condition 

would have the option of using either 

pass-through voting or mirror voting to 

vote their shares of the underlying fund. 

We estimate that approximately 98% of 

the funds that become subject to the 

voting condition would choose to 

implement mirror voting. Accordingly, 

we estimate that a total of 

approximately 793 acquiring funds, 

investing in a total of approximately 

7,930 underlying funds, would use 

mirror voting. We further estimate that 

approximately 16 acquiring funds (2% 

of the 809 funds described above), 

investing in a total of approximately 160 

underlying funds, would use passthrough voting. For this analysis, we 

estimate that each acquiring fund 

subject to the voting provision will 

participate in one vote on the securities 

of each acquired fund every three 

years.349

We estimate that all funds subject to 

the voting condition of proposed rule 

12d1–4 would incur a one-time internal 

burden of 3 hours, monetized to $1,176 

and amortized to $392 annually over 3 

years, to update their proxy voting 

policies and related proxy voting 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1335 

350See, e.g., 17 CFR 270.30b1–4 (rule 30b1–4 

under the Act). This estimate of the one-time 

annual hour burden consists of 3 hours × $392 

hourly rate for an in-house attorney. See supra 

footnote 287 for the source of salary data. 3 × $392 

= $1,176 per fund. We do not believe that funds 

subject to the proposed voting provision would 

incur any ongoing time or cost burdens associated 

with proxy voting policies and procedures or 

related disclosures. 

351These estimates are based on the following 

calculations: 809 acquiring funds × 3 hours = 2,427 

hours; 809 acquiring funds × $1,176 = $951,384. 

352These estimates are based on the following 

calculations: 2,427 hours/3 = 809 hours; $951,384/ 

3 = $317,128. 

353These estimates are based on the following 

calculations: 1 hour × $5,070 hourly rate for board 

of directors = $5070; 5,070/3 = $1,690. See supra 

footnote 287 for the source of salary data. 

354This estimate is based on the following 

calculations: 3 hours × $392 hourly rate for inhouse attorney = $1,176. See supra footnote 287 for 

the source of salary data. 

355This estimate is based on the following 

calculations: 30 hours × $392 hourly rate for inhouse attorney = $11,760. See supra footnote 287 

for further explanation of salary data. 

356This estimate is based on the following 

calculations: 1 hour × hourly rate for outside 

counsel of $400 = $400. See supra footnote 287 for 

further explanation of salary data. 

357This estimate is based on the following 

calculations: 10 hours × hourly rate for outside 

counsel of $400 = $4,000. See supra footnote 287 

for further explanation of salary data. 

358These estimates are based on the following 

calculations: 793 acquiring funds × 3.6 mirror votes 

per year × 3 hours per mirror vote = 8,564.4 hours; 

793 acquiring funds × 3.6 mirror votes per year × 

$400 per mirror vote = $1,141,920. (3.6 mirror votes 

per year = 11 (average number of acquired funds in 

which each acquiring fund invests)/3 years.) See 

supra footnote 348. 

359These estimates are based on the following 

calculations: 16 acquiring funds × 3.6 pass-through 

votes per year × 30 hours per pass-through vote = 

1,728 hours; 16 acquiring funds × 3.6 pass-through 

votes per year × $4,000 per pass-through vote = 

$230,400. (3.6 pass-through votes per year = 11 

(average number of acquired funds in which each 

acquiring fund invests)/3 years.) See supra footnote 

348. 

360These estimates are based on the following 

calculations: 8,564.4 hours + 1,728 hours = 10,292.4 

hours; $1,141,920 + $230,400 = $1,372,320. 

361Proposed rule 12d1–4(b)(3)(i). 

362 Id. 

363 Id. 

364Proposed rule 12d1–4(c). 

365These burden hours translate to a monetized 

cost of $11,005 per fund. This estimate is based on 

the following calculation: 15 hours × $352 hourly 

rate for compliance attorney + 10 hours × $317 

hourly rate for senior portfolio manager + 5 hours 

× $511 hourly rate for chief compliance officer = 

$11,005. See supra footnote 287 for the source of 

salary data. Amortized over three years, the 

monetized annual cost of the initial hour burden 

would be $3,590. This estimate is based on the 

following calculation: $11,005/3 = $3,669. 

366This estimate is based on the following 

calculation: 30 hours/3 years = 10 hours per year. 

367These 16 burden hours translate to a 

monetized annual cost of $2,887 per fund. This 

estimate is based on the following calculations: 6 

hours × $352 hourly rate for compliance attorney 

= $2,112; 5 hours × $61 hourly rate for general clerk 

= $305; 5 hours × $94 hourly rate for senior 

computer operator = $470. See supra footnote 287 

for the source of salary data. 

368This estimate is based on the following 

calculation: 3 hours × $5,070 hourly rate for board 

of directors + 6 hours × $400 hourly rate for outside 

counsel = $17,610. See supra footnote 287 for the 

source of salary data. 

disclosures to reflect that the fund is 

subject to the voting procedures 

required under the rule.350 In the 

aggregate, we estimate that funds subject 

to the proposed voting provision would 

incur a one-time internal burden of 

2,427 hours, at a monetized value of 

$951,384.351 Amortized over three 

years, the estimated burdens are one 

hour per fund, at a monetized value of 

$1,951.33. In the aggregate, amortized 

over three years, these estimated 

burdens equate to 809 hours and 

$951,384.352 We further estimate that all 

funds subject to the voting condition of 

proposed rule 12d1–4 would incur a 

one-time external cost of $5,070 

associated with the condition, or $1,690 

amortized over 3 years.353

We estimate that each instance of 

mirror voting under the proposed voting 

condition would impose an annual 

internal burden of 3 hours on the 

acquiring fund to evaluate the votes of 

the other acquired fund’s shareholders 

and submit its own votes, at a 

monetized internal cost of $1,176.354 We 

further estimate that each instance of 

pass-through voting would impose an 

internal burden of 30 hours, which 

would include identifying the 

shareholders of record and their 

holdings, providing proxy statements to 

and otherwise communicating with 

those shareholders regarding the vote, 

compiling shareholder responses, and 

voting accordingly, at a monetized 

internal cost of $11,760.355

We estimate that compliance with the 

proposed voting condition also would 

impose external costs. For each instance 

of mirror voting, we estimate a cost of 

$400.356 For each instance of passthrough voting, we estimate 10 hours of 

outside professional time, at a cost of 

$4,000.357

Accordingly, each year after the 

adoption of the proposed rule, in the 

aggregate, mirror voting by acquiring 

funds subject to the voting condition 

would impose an estimated internal 

annual burden of 8,564.4 hours with an 

external cost of $1,141,920.358 Passthrough voting by acquiring funds 

would impose an estimated annual 

burden of 1,932 hours with an external 

cost of $230,400.359 In the aggregate, the 

voting provision of proposed rule 12d1– 

4 therefore would impose an estimated 

internal annual burden of 10,292.4 

hours with an external cost of 

$1,372,320.360

3. Management Companies—Adviser 

Evaluations and Board Oversight 

In addition, in cases where the 

acquiring fund is a management 

company, proposed rule 12d1–4 would 

require the acquiring fund’s adviser to 

evaluate the complexity of the structure 

and aggregate fees associated with the 

acquiring fund’s investment in acquired 

funds, and find that it is in the best 

interest of the acquiring fund to invest 

in the acquired fund.361

Further, in cases where the acquiring 

fund is a management company, the 

proposed rule requires the acquiring 

fund’s adviser to report to the acquiring 

fund’s board of directors its finding that 

it is in the best interest of the acquiring 

fund to invest in the acquired fund and 

the basis for that finding.362 The 

proposed rule requires this reporting 

before investing in acquired funds in 

reliance on the rule, and with such 

frequency as the board of directors of 

the acquiring fund deems reasonable 

and appropriate thereafter, but in any 

case, no less frequently than 

annually.363

Finally, an acquiring fund that is a 

management company would be 

required to maintain and preserve for a 

period of not less than five years, the 

first two years in an easily accessible 

place: (i) A written record of the 

adviser’s finding that it is in the best 

interest of the acquiring fund to invest 

in the acquired funds; (ii) the basis for 

such finding; and (iii) any related 

reports provided by the adviser to the 

board of directors.364

These evaluations would impose both 

initial and ongoing burdens on 

management companies, related to both 

the evaluations themselves and the 

creation, review and maintenance of the 

aforementioned written materials 

associated with the evaluations. The 

Commission staff estimates the 

evaluations would impose an initial 

internal burden of 30 hours per fund.365

Amortized over three years, this initial 

burden would equate to 10 hours per 

fund.366 Because the rule requires 

ongoing evaluations with such 

frequency as the board of directors of 

the acquiring fund deems reasonable 

and appropriate, but in any case, no less 

frequently than annually, the 

Commission staff estimates that the 

evaluations (including the creation, 

review and maintenance of written 

materials associated with the 

evaluations) would impose an ongoing 

internal burden of 16 hours per fund.367

Additionally, the staff estimates that 

these evaluations would impose an 

initial external cost of $17,610 368 and 

external annual ongoing costs of 

1336 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

369This estimate is based on the following 

calculation: 1 hour × $5,070 hourly rate for board 

of directors + 2 hours × $400 hourly rate for outside 

counsel = $5,870. See supra footnote 287 for the 

source of salary data. 

370Proposed rule 12d1–4(b)(3)(ii). 

371 Id. 

372Proposed rule 12d1–4(c). 

373These burden hours translate to a monetized 

cost of $11,005 per fund. This estimate is based on 

the following calculation: 15 hours × $352 hourly 

rate for compliance attorney + 10 hours × $317 

hourly rate for senior portfolio manager + 5 hours 

× $511 hourly rate for chief compliance officer = 

$11,005. See supra footnote 287 for the source of 

salary data. Amortized over three years, the 

monetized annual cost of the initial hour burden 

would be $3,590. This estimate is based on the 

following calculation: $11,005/3 = $3,669. 

374This estimate is based on the following 

calculation: 30 hours/3 years = 10 hours per year. 

375These five burden hours translate to a 

monetized annual cost of $388 per fund. This 

estimate is based on the following calculation: 2.5 

hours × $61 hourly rate for general clerk + 2.5 hours 

× $94 hourly rate for senior computer operator = 

$388. See supra footnote 287 for the source of salary 

data. 

376This estimate is based on the following 

calculation: 6 hours × $400 hourly rate for outside 

counsel = $2,400. Amortized over three years, this 

initial cost is equal to $800 (based on a calculation 

of $2,400/3). See supra footnote 287 for the source 

of salary data. 

377Proposed rule 12d1–4(b)(3)(ii). 

378Proposed rule 12d1–4(b)(3)(iii). 

379Proposed rule 12d1–4(c). 

380This estimate is based on the following 

calculation: (4 hours + 1 hour + 1 hour)/3 = 2 hours. 

These two burden hours translate to a monetized 

annual cost of $155 per fund. This estimate is based 

on the following calculation: 1 hour × $61 hourly 

rate for general clerk + 1 hour × $94 hourly rate for 

senior computer operator = $155. See supra 

footnote 287 for the source of salary data. 

381See Supporting Statement of Rule 0–2 under 

the Investment Company Act of 1940, General 

Requirements of Paper Applications (Nov. 23, 2016) 

(summarizing how applications are filed with the 

Commission in accordance with the requirements of 

rule 0–2), available at https://www.reginfo.gov/ 

public/do/PRAViewICR?ref_nbr=201602-3235-008. 382This estimate is based on the last time the 

rule’s information collection was submitted for PRA 

renewal in 2016. 383See supra footnote 267 and accompanying 

text. $5,400,000/($2,029,200.60 + $14,090,000) = 

0.335. 

384This estimate is based on the following 

calculation: 5,340 hours¥(5,340 hours × 0.335) = 

3,551 hours. 

$5,870 369 per fund on management 

companies, relating to the need for 

board review and consultation with 

outside counsel. 

4. UITs—Principal Underwriter or 

Depositor Evaluations 

The proposed rule would also require 

that, in cases where the acquiring fund 

is a registered UIT, the UIT’s principal 

underwriter or depositor must evaluate 

the complexity of the structure and the 

aggregate fees associated with the UIT’s 

investment in acquired funds, and find 

that the UIT’s fees do not duplicate the 

fees of the acquired funds that the UIT 

holds or will hold at the date of 

deposit.370 This evaluation must take 

place on or before of the date of initial 

deposit of portfolio securities into the 

UIT.371

An acquiring fund that is a UIT also 

would be required to maintain and 

preserve for a period of not less than 

five years, the first two years in an 

easily accessible place, the UIT’s 

principal underwriter or depositor’s 

finding that the UIT’s fees do not 

duplicate the fees of the acquired funds 

and the basis for such finding.372

These evaluations would impose both 

initial and ongoing burdens on UITs, 

related to both the evaluations 

themselves and the creation, review and 

maintenance of the aforementioned 

written materials associated with the 

evaluations. The Commission staff 

estimates the evaluations would impose 

an initial internal burden of 30 hours 

per fund.373 Amortized over three years, 

this initial burden would equate to 10 

hours per fund.374 Because the rule 

requires ongoing maintenance of written 

materials, the Commission staff 

estimates that the evaluations would 

impose an ongoing burden of five hours 

per fund, due to recordkeeping 

obligations related to the evaluations.375

The Commission staff further estimates 

that these evaluations would impose an 

initial external cost of $2,400 for 

consultation with outside counsel.376 In 

contrast to the external annual ongoing 

costs noted above for management 

companies, the Commission staff 

estimates that these evaluations would 

impose no external annual ongoing 

costs on UITs, because the rule would 

only require each UIT to make a single 

determination on or before of the date 

of initial deposit of portfolio securities 

into the UIT.377

5. Separate Accounts Funding Variable 

Insurance Contracts—Certificates 

Additionally, the proposed rule 

would require that, with respect to a 

separate account funding variable 

insurance contracts that invests in an 

acquiring fund, the acquiring fund must 

obtain a certification from the insurance 

company offering the separate account 

that the insurance company has 

determined that the fees borne by the 

separate account, acquiring fund and 

acquired fund, in the aggregate, are 

consistent with the standard set forth in 

section 26(f)(2)(A) of the Act (15 U.S.C. 

80a–26(f)(2)(A)).378 The acquiring fund 

would also be subject to the proposed 

rule’s recordkeeping provisions.379 An 

insurance company already is required 

to make these fee-related 

determinations, but obtaining the 

aforementioned certifications and 

maintaining the certifications for 

recordkeeping purposes would impose 

new burdens on the acquiring fund. 

The Commission staff estimates that 

obtaining these certifications and 

maintaining them for recordkeeping 

purposes would impose a one-time 

internal hour burden of four hours, then 

an ongoing internal hour burden of one 

hour, on each acquiring fund. 

Amortized over three years, the internal 

hour burden would be two hours per 

acquiring fund.380 The staff estimates 

that obtaining and maintaining the 

certifications would not require board 

review or consultation with outside 

counsel, and would therefore impose no 

additional external costs on these 

acquiring funds. 

C. Rule 0–2 

Section 6(c) of the Act provides the 

Commission with authority to 

conditionally or unconditionally 

exempt persons, securities or 

transactions from any provision of the 

Act if and to the extent that such 

exemption is necessary or appropriate 

in the public interest and consistent 

with the protection of investors and the 

purposes fairly intended by the policy 

and provisions of the Act. Rule 0–2 

under the Act, entitled ‘‘General 

Requirements of Papers and 

Applications,’’ prescribes general 

instructions for filing an application 

seeking exemptive relief with the 

Commission.381 We currently estimate 

for rule 0–2 a total hour burden of 5,340 

hours at an annual time cost of 

$2,029,200.60 and the total annual 

external cost burden is $14,090,000.382

Proposed rule 12d1–4 would permit 

acquiring funds to invest in acquired 

funds beyond the limits in section 

12(d)(1) of the Act subject to several 

conditions that are designed to limit the 

acquiring funds’ control over the 

acquired funds, limit the potential for 

duplicative or excessive fees, and limit 

the construction of complex structures 

that may confuse investors. Many of 

these fund of funds arrangements are 

permitted under current Commission 

exemptive orders. Therefore, proposed 

rule 12d1–4 would alleviate some of the 

burdens associated with rule 0–2 

because it would reduce the number of 

entities that require exemptive relief in 

order to operate. The Commission staff 

estimates that this reduction would 

decrease the annual aggregate burden by 

approximately $5,400,000 

(approximately 33.5%).383 Therefore, in 

the aggregate, we estimate that proposed 

rule 12d1–4 would result in a decrease 

of the annual burden of rule 0–2 to 

approximately 3,551 384 hours at an 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1337 

385This estimate is based on the following 

calculation: $2,029,200.60¥($2,029,200.60 × 0.335) 

= $1,349, 418.40. 386This estimate is based on the following 

calculation: $14,090,000¥($14,090,000 × 0.335) = 

$9,369,850. 387See Reporting Modernization Adopting 

Release, supra footnote 48. The compliance date for 

Form N–CEN is June 1, 2018. 388 Item C.7.a. of Form N–CEN currently requires 

funds to disclose if they are relying on rule 12d1– 

1. The Commission is proposing to add to Form N– 

CEN requirements that funds report if they are 

relying on section 12(d)(1)(G) or rule 12d1–4. See 

Proposed Items C.7.l. and m. of Form N–CEN 

(relating to management companies) and Proposed 

Items F.18 and F.19 (relating to UITs). 

389See Reporting Modernization Adopting 

Release, supra footnote 48 at text accompanying 

n.1524. 

390See Reporting Modernization Adopting 

Release, supra footnote 48 at text accompanying 

nn.1531–1532. 

391See Reporting Modernization Adopting 

Release, supra footnote 48 at text accompanying 

nn.1533–1534. 

392See Reporting Modernization Adopting 

Release, supra footnote 48 at text accompanying 

n.1538. 

393This estimate stems from the Commission 

staff’s understanding of the time it takes to 

complete initially complete and review items on 

Form N–CEN. 

394We also have revised our estimate of the 

number of reports on Form N–CEN per year down 

from 3,113 reports to 3,038 reports to reflect 

updates to the industry data figures that were 

utilized in the Reporting Modernization Release. 

This estimate is based on the number of entities as 

of December 2017 that we expect will be required 

to make filings on Form N–CEN. See Reporting 

Modernization Adopting Release, supra footnote 48 

at text accompanying n.1524. 

395This estimate is based on the following 

calculation: 0.1 hours × 3,038 filers = 303.8 hours. 396 5 U.S.C. 603(a). 

annual time cost of $1,349,418 385 and 

an annual external cost of $9,369,850.386

D. Form N–CEN 

Form N–CEN is a structured form that 

requires registered funds to provide 

census-type information to the 

Commission on an annual basis.387

Today, the Commission is proposing an 

amendment to Form N–CEN to require 

management companies and UITs to 

report whether they relied on section 

12(d)(1)(G) or rule 12d1–4 during the 

reporting period.388

In the Reporting Modernization 

Adopting Release, we estimated that the 

Commission would receive an average 

of 3,113 reports on Form N–CEN.389 We 

estimated that the average annual hour 

burden per response for Form N–CEN 

for the first year to be 32.37 hours and 

12.37 hours in subsequent years.390

Amortizing the burden over three years, 

we estimated the average annual hour 

burden per fund per year to be 19.04 

hours and the total aggregate annual 

hour burden to be 59,272 hours.391

Finally, we estimated that all applicable 

funds will incur, in the aggregate, 

external annual costs of $2,088,176 to 

prepare and file reports on Form N– 

CEN.392

Based on Commission staff 

experience, we believe that our proposal 

to require management companies and 

UITs to report whether they relied on 

section12(d)(1)(G) or rule 12d1–4 during 

the reporting period would increase the 

estimated burden hours associated with 

Form N–CEN by approximately 0.1 

hours,393 both initially and on an 

ongoing basis.394 Therefore, in the 

aggregate, we estimate that management 

companies and UITs will incur an 

annual burden of an additional 303.8 

hours, to comply with the proposed 

amendments to Form N–CEN.395 We 

estimate that there are no additional 

external costs associated with this 

collection of information. 

E. Request for Comments 

We request comment on whether our 

estimates for burden hours and any 

external costs as described above are 

reasonable. Pursuant to 44 U.S.C. 

3506(c)(2)(B), the Commission solicits 

comments in order to: (i) Evaluate 

whether the proposed collections of 

information are necessary for the proper 

performance of the functions of the 

Commission, including whether the 

information will have practical utility; 

(ii) evaluate the accuracy of the 

Commission’s estimate of the burden of 

the proposed collections of information; 

(iii) determine whether there are ways 

to enhance the quality, utility, and 

clarity of the information to be 

collected; and (iv) determine whether 

there are ways to minimize the burden 

of the collections of information on 

those who are to respond, including 

through the use of automated collection 

techniques or other forms of information 

technology. 

The agency is submitting the 

proposed collections of information to 

OMB for approval. Persons wishing to 

submit comments on the collection of 

information requirements of the 

proposed rule should direct them to the 

Office of Management and Budget, 

Attention Desk Officer for the Securities 

and Exchange Commission, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503, and should send 

a copy to Brent J. Fields, Secretary, 

Securities and Exchange Commission, 

100 F Street NE, Washington, DC 

20549–1090, with reference to File No. 

S7–27–18. OMB is required to make a 

decision concerning the collections of 

information between 30 and 60 days 

after publication of this release; 

therefore, a comment to OMB is best 

assured of having its full effect if OMB 

receives it within 30 days after 

publication of this release. Requests for 

materials submitted to OMB by the 

Commission with regard to these 

collections of information should be in 

writing, refer to File No. S7–27–18, and 

be submitted to the Securities and 

Exchange Commission, Office of FOIA 

Services, 100 F Street NE, Washington, 

DC 20549–2736. 

VIII. Initial Regulatory Flexibility 

Analysis 

The Commission has prepared the 

following Initial Regulatory Flexibility 

Analysis (‘‘IRFA’’) in accordance with 

section 3(a) of the Regulatory Flexibility 

Act (‘‘RFA’’).396 It relates to proposed 

rule 12d1–4 and the proposed 

amendments to Form N–CEN under the 

Investment Company Act. 

A. Reasons for and Objectives of the 

Proposed Actions 

Proposed rule 12d1–4 would permit 

registered funds and BDCs that satisfy 

certain conditions to acquire shares of 

another fund in excess of the limits of 

section 12(d)(1) of the Act without 

obtaining an exemptive order from the 

Commission. The rule is designed to 

streamline and enhance the regulatory 

framework applicable to fund of funds 

arrangements. In addition, we propose 

to rescind rule 12d1–2 under the Act 

and individual exemptive orders for 

certain fund of funds arrangements to 

create a consistent and efficient rulesbased regime for the formation and 

oversight of funds of funds. We also 

propose to amend rule 12d1–1 to allow 

funds that rely on section 12(d)(1)(G) to 

invest in money market funds that are 

not part of the same group of investment 

companies in reliance on that rule. 

Finally, our proposed amendments to 

Form N–CEN would allow the 

Commission to better monitor funds’ 

reliance on rule 12d1–4 and section 

12(d)(1)(G), and would assist the 

Commission with its accounting, 

auditing, and oversight functions. 

B. Legal Basis 

The Commission is proposing new 

rule 12d1–4 pursuant to the authority 

set forth in sections 6(c), 12(d)(1)(G) and 

(J), 17(b), and 38(a) of the Investment 

Company Act [15 U.S.C. 80a–6(c), 80a– 

12(d)(1)(G) and (J), 80a–17(b), and 80a– 

37(a)]. The Commission is proposing 

amendments to Form N–CEN under the 

authority set forth sections 8(b), 30(a), 

and 38(a) of the Investment Company 

Act [15 U.S.C. 80a–8(b), 80a–29(a), and 

80a–37(a)]. 

1338 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

397See rule 0–10(a) under the Investment 

Company Act. 

398This estimate is derived an analysis of data 

obtained from Morningstar Direct as well as data 

reported to the Commission for the period ending 

June 30, 2018. There are currently no ETMFs or 

face-amount certificate companies that would be 

considered small entities. We estimate that no BDCs 

that are small entities invest in other funds. 

399 Id. 

400See supra footnotes 340 through 345 and 

accompanying text. 

401See supra footnotes 349 through 356 and 

accompanying text. We expect that small entities 

subject to the voting requirement would choose to 

use mirror voting rather than pass-through voting, 

and thus use our estimates for mirror voting here. 

402See supra footnotes 365 through 369 and 

accompanying text. 

403See supra footnotes 373 through 377 and 

accompanying text. 

404See supra footnotes 393 through 394 and 

accompanying text. 

405This estimate is based on the following 

calculations: 

(2 internal burden hours and $3,647 in external 

costs) × 8 total small entities for disclosure 

requirements + (1 internal burden hour and $800 

in external costs) × 8 total small entities for voting 

requirements + (26 internal burden hours and 

$11,740 in external costs) × 7 management company 

small entities for fee-related requirements + (15 

internal burden hours and $800 in external costs) 

× 1 UIT small entity for fee-related requirements = 

221 internal burden hours and $118,556. 

406This estimate is based on the following 

calculations: 0.1 hours × 8 small entities = 0.8 

hours. 

C. Small Entities Subject to the 

Proposed Requirements 

An investment company is a small 

entity if, together with other investment 

companies in the same group of related 

investment companies, it has net assets 

of $50 million or less as of the end of 

its most recent fiscal year.397

Commission staff estimates that, as of 

June 2018, there were 59 open-end 

funds (including 10 ETFs), 32 closedend funds, 6 UITs, and 19 BDCs that 

would be considered small entities that 

may be subject to proposed rule 12d1– 

4.398 For the purposes of this analysis, 

we estimate that, of those 116 total 

entities, 8 entities (3 open-end funds, 4 

closed-end funds, and 1 UIT) invest in 

other funds and thus may be subject to 

the proposed rule.399

D. Projected Board Reporting, 

Recordkeeping, and Other Compliance 

Requirements 

We are proposing new rule 12d1–4 to 

streamline and enhance the regulatory 

framework applicable to fund of funds 

arrangements, the rescission of rule 

12d1–2 and individual exemptive 

orders for certain fund of funds 

arrangements in order to create a 

consistent and efficient rules-based 

regime for the formation and oversight 

of fund of funds, and amendments to 

Form N–CEN to allow the Commission 

to better monitor funds’ reliance on rule 

12d1–4 and section 12(d)(1)(G) and 

assist the Commission with its 

accounting, auditing, and oversight 

functions. 

A fund that relies on rule 12d1–4 (or 

intends to preserve flexibility to rely on 

rule 12d1–4) would be required to 

disclose in its registration statement that 

it is or at times may be an acquiring 

fund for purposes of rule 12d1–4. In 

addition, under proposed rule 12d1–4, 

where an acquiring fund and its 

advisory group (in the aggregate) hold 

more than 3% of the outstanding voting 

securities of an acquired fund, the 

acquiring fund would be required to 

vote those securities using either passthrough voting or mirror voting, unless 

the acquiring fund is covered by certain 

exceptions to the requirement. In cases 

where the acquiring fund is a 

management company, proposed rule 

12d1–4 would require the acquiring 

fund’s adviser to evaluate the 

complexity of the structure and 

aggregate fees associated with the 

acquiring fund’s investment in acquired 

funds, and find that it is in the best 

interest of the acquiring fund to invest 

in the acquired funds. Proposed rule 

12d1–4 also would require that, in cases 

where the acquiring fund is a registered 

UIT, the UIT’s principal underwriter or 

depositor must evaluate the complexity 

of the structure and the aggregate fees 

associated with the UIT’s investment in 

acquired funds, and find that the UIT’s 

fees do not duplicate the fees of the 

acquired funds that the UIT holds or 

will hold at the date of deposit. 

Additionally, the proposed rule would 

require that, with respect to a separate 

account funding variable insurance 

contracts that invests in an acquiring 

fund, the acquiring fund must obtain a 

certification from the insurance 

company offering the separate account 

that the insurance company has 

determined that the fees borne by the 

separate account, acquiring fund and 

acquired fund, in the aggregate, are 

consistent with the standard set forth in 

section 26(f)(2)(A) of the Act. 

To harmonize the overall regulatory 

structure in view of proposed rule 

12d1–4, we are proposing to rescind 

existing exemptive orders (as discussed 

below) and rule 12d1–2, which would 

eliminate the flexibility of funds relying 

on section 12(d)(1)(G) to: (i) Acquire the 

securities of other funds that are not 

part of the same group of investment 

companies, subject to the limits in 

section 12(d)(1)(A) or 12(d)(1)(F); and 

(ii) invest directly in stocks, bonds and 

other securities. We also propose to 

amend rule 12d1–1 to allow funds 

relying on section 12(d)(1)(G) to invest 

in money market funds that are not part 

of the same group of investment 

companies in reliance on that rule. 

Finally, we are proposing an 

amendment to Form N–CEN to require 

management companies and UITs to 

report whether they relied on section 

12(d)(1)(G) or rule 12d1–4 during the 

reporting period. 

Proposed new rule 12d1–4, the 

rescission of rule 12d1–2, and the 

amendments to rule 12d1–1 and Form 

N–CEN would change current reporting 

requirements for small entities that 

choose to rely on the rule. Entities 

eligible to rely on proposed rule 12d1– 

4 would be required to comply with the 

requirements of the rule only if they 

wish to rely on the rule’s exemptions. 

Additionally, entities that are 

management companies or UITs and are 

relying on rule 12d1–4 would be 

required to report this reliance on Form 

N–CEN. For purposes of this analysis, 

Commission staff estimates, based on 

outreach conducted with a variety of 

funds, that small fund groups will incur 

approximately the same initial and 

ongoing costs as large fund groups. As 

discussed above, we estimate that each 

entity that relies on proposed rule 

12d1–4 (and is subject to rule 12d1–4’s 

voting provision) would incur the 

following annual time and cost burdens 

(with initial burdens amortized over the 

initial three years): (a) Two internal 

burden hours and $3,647 in external 

costs to satisfy new disclosure 

requirements; 400 (b) 1 internal burden 

hour and $800 in external costs to 

satisfy the proposed voting 

requirement; 401 (c) for management 

companies, 26 internal burden hours 

and $11,740 in external costs to satisfy 

the proposed complex structure and 

aggregate fees analysis requirement,402

and for UITs, 15 internal burden hours 

and $800 in external costs to satisfy the 

proposed complex structure and 

aggregate fees analysis.403 Furthermore, 

as discussed above, we estimate that 

each entity that relies on the proposed 

new rule would incur an additional 

annual time burden of 0.1 hours to 

comply with the amendments to Form 

N–CEN.404

Therefore, in the aggregate, we 

estimate that small entities would incur 

an annual internal burden of 221 

additional hours and an annual external 

cost burden of $118,556 to comply with 

the requirements of proposed rule 

12d1–4.405 Furthermore, in the 

aggregate, we estimate that small 

entities would incur an annual burden 

of an additional 0.8 hours to comply 

with the amendments to Form N– 

CEN.406

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1339 

407This includes exempting or establishing any 

different requirements relating to proposed rule 

12d1–4’s redemption limits. See supra section 

VI.C.1.d. 

408Public Law 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 15 

U.S.C. and as a note to 5 U.S.C. 601). 

In addition, the economic effects of 

proposed rule 12d1–4’s redemption 

limit, discussed above in section 

VI.C.1.d, may disproportionately affect 

smaller entities by creating an incentive 

for acquiring funds to invest in larger 

acquired funds rather than smaller 

acquired funds. This may reduce the 

flow of capital to smaller potential 

acquired funds. We do not otherwise 

expect the proposal to generate 

significant economic impacts on smaller 

entities that are disproportionate to the 

general economic impacts, including 

compliance costs and burdens, 

discussed in sections VI and VII above. 

E. Duplicative, Overlapping, or 

Conflicting Federal Rules 

The Commission has not identified 

any federal rules that duplicate, overlap, 

or conflict with the proposed fund of 

funds regulations. 

F. Significant Alternatives 

The RFA directs the Commission to 

consider significant alternatives that 

would accomplish our stated objectives, 

while minimizing any significant 

economic impact on small entities. We 

considered the following alternatives for 

small entities in relation to the proposed 

disclosure, findings, board reporting, 

and recordkeeping requirements: (i) 

Exempting small entities from some or 

all of the proposed requirements to rely 

on proposed rule 12d1–4, or 

establishing different disclosure or 

reporting requirements, or different 

disclosure frequency, for small entities 

to account for different levels of 

resources available to small entities; (ii) 

clarifying, consolidating, or simplifying 

the compliance requirements under 

proposed rule 12d1–4 for small entities; 

and (iii) using performance rather than 

design standards. 

We do not believe that exempting or 

establishing different requirements for 

any subset of funds, including funds 

that are small entities, from proposed 

rule 12d1–4 or the proposed 

amendments to rule 12d1–1 and Form 

N–CEN or the proposed rescission of 

rule 12d1–2 and certain existing 

exemptive relief would permit us to 

achieve our stated objectives.407 Nor do 

we believe that clarifying, consolidating 

or simplifying the various aspects of the 

proposal for small entities would satisfy 

those objectives. In particular, we do not 

believe that the interest of investors 

would be served by these alternatives. 

We believe that all investors, including 

investors in entities that are small 

entities, would benefit from the 

proposed rule and form amendments. 

We believe that our proposal strikes the 

right balance between allowing funds to 

engage in fund of funds arrangements 

while protecting such entities from the 

abuses that Congress sought to curtail in 

adopting section 12(d)(1). We believe 

that our proposed requirements are vital 

to that balance and important to all 

investors, irrespective of the size of the 

entity. We note that the current 

exemptive orders do not distinguish 

between small entities and other funds. 

Finally, we determined to use 

performance rather than design 

standards for all funds, regardless of 

size, because we believe that providing 

funds with the flexibility to determine 

how to implement the requirements of 

the rule allows them the opportunity to 

tailor these obligations to the facts and 

circumstances of the entities 

themselves. 

G. General Request for Comment 

The Commission requests comments 

regarding this analysis. We request 

comment on the number of small 

entities that would be subject to the 

proposed rules and whether the 

proposed rules would have any effects 

on small entities that have not been 

discussed. We request that commenters 

describe the nature of any effects on 

small entities subject to the proposed 

rules and provide empirical data to 

support the nature and extent of such 

effects. We also request comment on the 

estimated compliance burdens of the 

proposed rules and how they would 

affect small entities. 

IX. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 408 we must advise 

OMB whether a proposed regulation 

constitutes a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’ 

where, if adopted, it results in or is 

likely to result in: (1) An annual effect 

on the economy of $100 million or 

more; (2) a major increase in costs or 

prices for consumers or individual 

industries; or (3) significant adverse 

effects on competition, investment or 

innovation. 

We request comment on the potential 

impact of the proposed rule and form 

amendments on the economy on an 

annual basis. Commenters are requested 

to provide empirical data and other 

factual support for their views to the 

extent possible. 

X. Statutory Authority 

The Commission is proposing new 

rule 12d1–4 pursuant to the authority 

set forth in sections 6(c), 12(d)(1)(G) and 

(J), 17(b) and 38(a) of the Investment 

Company Act [15 U.S.C. 80a–6(c), 80a– 

12(d)(1)(G) and (J), 80a–17(b), and 80a– 

37(a)]. The Commission is proposing an 

amendment to Form N–CEN under the 

authority set forth sections 8(b), 30(a), 

and 38(a) of the Investment Company 

Act [15 U.S.C. 80a–8(b), 80a–29(a), and 

80a–37(a)]. 

List of Subjects in 17 CFR Parts 270 and 

274 

Investment companies, Reporting and 

recordkeeping requirements, Securities. 

Text of Proposed Rules and Form 

Amendments 

For the reasons set out in the 

preamble, Title 17, Chapter II of the 

Code of Federal Regulations is proposed 

to be amended as follows: 

PART 270—RULES AND 

REGULATIONS, INVESTMENT 

COMPANY ACT OF 1940 

■ 1. The authority citation for part 270 

continues to read, in part, as follows: 

Authority: 15 U.S.C. 80a–1 et seq., 80a– 

34(d), 80a–37, 80a–39, and Pub. L. 111–203, 

sec. 939A, 124 Stat. 1376 (2010) unless 

otherwise noted. 

* * * * * 

■ 2. Amend section 270.12d1–1 by 

revising paragraph (a) to read as follows: 

§ 270.12d1–1 Exemptions for investments 

in money market funds. 

(a) Exemptions for acquisition of 

money market fund shares. If the 

conditions of paragraph (b) of this 

section are satisfied, notwithstanding 

sections 12(d)(1)(A), 12(d)(1)(B), 

12(d)(1)(G), 17(a), and 57 of the Act (15 

U.S.C. 80a–12(d)(1)(A), 80a–12(d)(1)(B), 

80a–12(d)(1)(G), 80a–17(a), and 80a–56)) 

and § 270.17d–1: 

(1) An investment company 

(‘‘acquiring fund’’) may purchase and 

redeem shares issued by a money 

market fund; and 

(2) A money market fund, any 

principal underwriter thereof, and a 

broker or a dealer may sell or otherwise 

dispose of shares issued by the money 

market fund to any acquiring fund. 

* * * * * 

§ 270.12d1–2 [Removed and Reserved] 

■ 3. Remove and reserve section 

270.12d1–2. 

■ 4. Section 270.12d1–4 is added to 

read as follows: 

1340 Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 

§ 270.12d1–4 Exemptions for investments 

in certain investment companies. 

(a) Exemptions for acquisition and 

sale of acquired fund shares. If the 

conditions of paragraph (b) of this 

section are satisfied, notwithstanding 

sections 12(d)(1)(A), 12(d)(1)(B), 

12(d)(1)(C), 17(a), and 57 of the Act (15 

U.S.C. 80a–12(d)(1)(A), 80a–12(d)(1)(C), 

80a–17(a) and 80a–56): 

(1) A registered investment company 

(other than a face-amount certificate 

company) or business development 

company (an ‘‘acquiring fund’’) may 

purchase or otherwise acquire the 

securities issued by another registered 

investment company (other than a faceamount certificate company) or business 

development company (an ‘‘acquired 

fund’’); and 

(2) An acquired fund, any principal 

underwriter thereof, and any broker or 

dealer registered under the Securities 

Exchange Act of 1934 may sell or 

otherwise dispose of the securities 

issued by the acquired fund to any 

acquiring fund and any acquired fund 

may redeem or repurchase any 

securities issued by the acquired fund 

from any acquiring fund. 

(b) Conditions. 

(1) Control. 

(i) The acquiring fund and its 

advisory group will not control 

(individually or in the aggregate) an 

acquired fund; and 

(ii) If the acquiring fund and its 

advisory group, in the aggregate, hold 

more than 3% of the outstanding voting 

securities of an acquired fund, each of 

those holders will vote its securities in 

the manner prescribed by section 

12(d)(1)(E)(iii)(aa) of the Act (15 U.S.C. 

80a–12(d)(1)(E)(iii)(aa)); 

(iii) The conditions in paragraphs 

(b)(1)(i) and (ii) of this section do not 

apply when: 

(A) The acquiring fund is in the same 

group of investment companies as an 

acquired fund; or 

(B) The acquiring fund’s investment 

sub-adviser or any person controlling, 

controlled by, or under common control 

with such investment sub-adviser acts 

as an acquired fund’s investment 

adviser or depositor. 

(2) Limited redemption. An acquiring 

fund that holds shares of an acquired 

fund in excess of the limits of section 

12(d)(1)(A)(i) of the Act (15 U.S.C. 80a– 

12(d)(1)(A)(i)) does not redeem or 

submit for redemption, or tender for 

repurchase, any of those shares in an 

amount exceeding 3% of the acquired 

fund’s total outstanding shares during 

any thirty-day period in which the 

acquiring fund holds the acquired 

fund’s shares in excess of that limit. 

(3) Fees and other considerations. 

(i) Management companies. If the 

acquiring fund is a management 

company, before investing in an 

acquired fund in reliance on this 

section, and with such frequency as the 

acquiring fund’s board of directors 

deems reasonable and appropriate 

thereafter, but in any case, no less 

frequently than annually, the acquiring 

fund’s investment adviser must evaluate 

the complexity of the structure and 

aggregate fees associated with the 

acquiring fund’s investment in the 

acquired fund, and find that it is in the 

best interest of the acquiring fund to 

invest in the acquired fund. The 

acquiring fund’s investment adviser 

must report its finding and the basis for 

the finding to the acquiring fund’s board 

of directors. 

(ii) Unit investment trusts. If the 

acquiring fund is a unit investment trust 

and the date of initial deposit of 

portfolio securities into a registered UIT 

occurs after the effective date of this 

section, the UIT’s principal underwriter 

or depositor must evaluate the 

complexity of the structure and the 

aggregate fees associated with the UIT’s 

investment in acquired funds and, on or 

before such date of initial deposit, find 

that the UIT’s fees do not duplicate the 

fees of the acquired funds that the UIT 

holds or will hold at the date of deposit. 

(iii) Separate account funding 

variable insurance contracts. With 

respect to a separate account funding 

variable insurance contracts that invests 

in an acquiring fund, the acquiring fund 

must obtain a certification from the 

insurance company offering the separate 

account that the insurance company has 

determined that the fees borne by the 

separate account, acquiring fund and 

acquired fund, in the aggregate, are 

consistent with the standard set forth in 

section 26(f)(2)(A) of the Act (15 U.S.C. 

80a–26(f)(2)(A)). 

(4) Complex fund structures. 

(i) An investment company must 

disclose in its registration statement that 

it is (or at times may be) an acquiring 

fund for purposes of this section; 

(ii) No investment company may rely 

on section 12(d)(1)(G) of the Act (15 

U.S.C. 80a–12(d)(1)(G)) or this section to 

purchase or otherwise acquire, in excess 

of the limits in section 12(d)(1)(A) of the 

Act (15 U.S.C. 80a–12(d)(1)(A)), the 

outstanding voting securities of another 

investment company that discloses in 

its most recent registration statement 

that it may be an acquiring fund under 

this section; and 

(iii) An acquired fund must not 

acquire the securities of another 

investment company (or companies that 

would be investment companies under 

section 3(a) of the Act but for the 

exclusions from that definition provided 

for in section 3(c)(1) or section 3(c)(7) of 

the Act (15 U.S.C. 80a–3(c)(1) or 80a– 

3(c)(7)) in excess of the limits in section 

12(d)(1)(A) of the Act (15 U.S.C. 80a– 

12(d)(1)(A)) unless the acquired fund’s 

investment is: 

(A) In reliance on section 12(d)(1)(E) 

of the Act (15 U.S.C. 80a–12(d)(1)(E)); 

(B) For short-term cash management 

purposes pursuant to § 270.12d1–1 or 

exemptive relief from the Commission; 

(C) In a subsidiary that is whollyowned and controlled by the acquired 

fund; 

(D) The receipt of securities as a 

dividend or as a result of a plan of 

reorganization of a company; or 

(E) The acquisition of securities of 

another investment company pursuant 

to exemptive relief from the 

Commission to engage in interfund 

borrowing and lending transactions. 

(c) Recordkeeping. The acquiring fund 

must maintain and preserve for a period 

of not less than five years, the first two 

years in an easily accessible place, a 

written record of: 

(1) The finding required by paragraph 

(b)(3)(i) of this section and the basis for 

such finding, and the reports provided 

to the board of directors pursuant to 

paragraph (b)(3)(i) of this section; 

(2) The finding required by paragraph 

(b)(3)(ii) of this section and the basis for 

such finding; and 

(3) The certification from each 

insurance company required by 

paragraph (b)(3)(iii) of this section. 

(d) Definitions. For purposes of this 

section: 

Advisory group means either: 

(1) An acquiring fund’s investment 

adviser or depositor, and any person 

controlling, controlled by, or under 

common control with such investment 

adviser or depositor; or 

(2) An acquiring fund’s investment 

sub-adviser and any person controlling, 

controlled by, or under common control 

with such investment sub-adviser. 

Group of investment companies 

means any two or more registered 

investment companies or business 

development companies that hold 

themselves out to investors as related 

companies for purposes of investment 

and investor services. 

* * * * * 

PART 274—FORMS PRESCRIBED 

UNDER THE INVESTMENT COMPANY 

ACT OF 1940 

■ 5. The general authority citation for 

part 274 continues to read as follows, 

and the sectional authorities for 

§§ 274.101 and 274.130 are removed: 

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 

77s, 78c(b), 78l, 78m, 78n, 78o(d), 80a–8, 

Federal Register / Vol. 84, No. 22 / Friday, February 1, 2019 / Proposed Rules 1341 

80a–24, 80a–26, 80a–29, and Pub. L. 111– 

203, sec. 939A, 124 Stat. 1376 (2010), unless 

otherwise noted. 

* * * * * 

■ 6. Amend Form N–CEN [(referenced 

in § 274.101), by: 

■ a. In Part C, revising Item C.7. and 

adding paragraphs k. and l.; and 

■ b. In Part F, adding Item F.18. and 

Item F.19. 

Note: The text of Form N–CEN does not 

and the amendments will not appear in the 

Code of Federal Regulations. 

The revisions and additions read as 

follows: 

FORM N–CEN 

ANNUAL REPORT FOR REGISTERED 

INVESTMENT COMPANIES 

* * * * * 

Part C. Additional Questions for 

Management Investment Companies 

* * * * * 

Item C.7. Reliance on certain statutory 

exemption and rules. Did the Fund rely 

on the following statutory exemption or 

any of the rules under the Act during 

the reporting period? (check all that 

apply) 

* * * * * 

k. Rule 12d1–4 (17 CFR 270.12d1–4): 

___

l. Section 12(d)(1)(G) of the Act (15 

U.S.C. 80a–12(d)(1)(G)): ___

* * * * * 

Part F. Additional Questions for Unit 

Investment Trusts 

* * * * * 

Item F.18. Reliance on rule 12d1–4. 

Did the Registrant rely on rule 12d1–4 

under the Act (17 CFR 270.12d1–2) 

during the reporting period? [Y/N] 

Item F.19. Reliance on section 

12(d)(1)(G). Did the Registrant rely on 

the statutory exception in section 

12(d)(1)(G) of the Act (15 U.S.C. 80a– 

12(d)(1)(G)) during the reporting period? 

[Y/N] 

* * * * * 

By the Commission. 

Dated: December 19, 2018. 

Brent J. Fields, 

Secretary. 

[FR Doc. 2018–27924 Filed 1–31–19; 8:45 am] 

BILLING CODE 8011–01–P