Document ID: SEC-2019-0055-0001
Agency: sec
Document Type: Proposed Rule
Title: Fund of Funds Arrangements
Posted Date: 2019-02-01T05:00Z

[Federal Register Volume 84, Number 22 (Friday, February 1, 2019)]
[Proposed Rules]
[Pages 1286-1341]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27924]

[[Page 1285]]

Vol. 84

Friday,

No. 22

February 1, 2019

Part II

 Securities and Exchange Commission

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17 CFR Parts 270 and 274

 Fund of Funds Arrangements; Proposed Rule

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

[[Page 1286]]

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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.

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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\
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    \1\ Unless 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].
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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

[[Page 1287]]

that are not part of the same group of investment companies.\4\
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    \2\ For 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.
    \3\ We 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.
    \4\ See infra section III.
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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.
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    \5\ Total 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.
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    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.
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    \6\ This 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.
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    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\
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    \7\ Target-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).
    \8\ A 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.
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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:
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    \9\ As 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 Sec.  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.
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     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\
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    \10\ See 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.
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    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:
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    \11\ A 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).
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     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\
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    \12\ See 15 U.S.C. 80a-12(d)(1)(B). This prohibition applies to 
the sale of securities issued by an open-end 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).
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    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 large-scale 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\
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    \13\ See 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.
    \14\ Controlling 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.
    \15\ Complicated 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.
    \16\ See 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.
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    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

[[Page 1288]]

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\
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    \17\ See Fund of Funds Investments, Investment Company Act 
Release No. 27399 (June 20, 2006) [71 FR 36640 (June 27, 2006)] 
(``Fund of Funds Adopting Release'') at n.7 and accompanying text; 
2008 Proposing Release, supra footnote 13.
    \18\ See Fund of Funds Proposing Release, supra footnote 16, at 
n.8 and accompanying text.
    \19\ See 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.
    \20\ See 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.
    \21\ See 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).
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    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\
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    \22\ See National Securities Markets Improvement Act of 1996 
(``NSMIA''), Public Law 104-290, 110 Stat. 3416 (1996), at Sec.  
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).
    \23\ H.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.
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    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\
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    \24\ See 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.
    \25\ As 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.
    \26\ See, 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.
    \27\ ETFs 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 market-determined 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'').
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    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.
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    \28\ Such 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.
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    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

[[Page 1289]]

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\
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    \29\ We 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.
    \30\ Under 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.
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    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.
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    \31\ See 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.
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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\
---------------------------------------------------------------------------

    \32\ The 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.
---------------------------------------------------------------------------

    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:

------------------------------------------------------------------------
                                          Acquired fund under exemptive
 Acquiring fund under exemptive orders                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.
---------------------------------------------------------------------------

    \33\ We 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'').
    \34\ We 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).
---------------------------------------------------------------------------

    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-  Acquired funds under proposed
                   4                               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

[[Page 1290]]

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, closed-end funds, other BDCs, and ETMFs. Finally, the 
proposed rule would allow ETMFs to invest in all registered funds and 
BDCs.
---------------------------------------------------------------------------

    \35\ Under 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \37\ See 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).
    \38\ See supra footnote 27.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \39\ Proposed 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.
    \40\ Proposed rule 12d1-4(b)(3). See infra section II.C.3.
    \41\ Proposed rule 12d1-4(b)(4). See also infra section II.C.4.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \42\ Pursuant 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.
    \43\ See, 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'').
    \44\ See MFA Letter; SSgA Letter.
    \45\ See MFA Letter; SSgA Letter.
    \46\ See, e.g., MFA Letter; NY Bar Letter.
---------------------------------------------------------------------------

    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

[[Page 1291]]

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.
---------------------------------------------------------------------------

    \47\ See 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)].
    \48\ Form 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'').
    \49\ See, 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)].
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \50\ To 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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \51\ See 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'').
    \52\ The 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)).
    \53\ The 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.
    \54\ See supra footnote 9.
    \55\ To 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.
---------------------------------------------------------------------------

    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 closed-end 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?
---------------------------------------------------------------------------

    \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 
No-Action 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).
---------------------------------------------------------------------------

     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

[[Page 1292]]

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?
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

     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?
---------------------------------------------------------------------------

    \58\ See supra footnote 51.
---------------------------------------------------------------------------

     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\
---------------------------------------------------------------------------

    \59\ Proposed rule 12d1-4(a).
    \60\ An 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.
    \61\ See 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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
    \63\ As 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.
    \64\ An 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.
---------------------------------------------------------------------------

    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

[[Page 1293]]

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\
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    \65\ The 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).
    \66\ See infra sections II.C.1 and 2.
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    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\
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    \67\ The 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.
    \68\ Closed-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).
---------------------------------------------------------------------------

    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\
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    \69\ Without 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.
    \70\ See 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.
---------------------------------------------------------------------------

    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\
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    \71\ See 2008 Proposing Release, supra footnote 13.
    \72\ See ICI Letter; Comment Letter of Xshares Advisors, LLC 
(May 20, 2008) (``Xshares Letter'').
    \73\ See ICI Letter.
---------------------------------------------------------------------------

    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:
---------------------------------------------------------------------------

    \74\ See, e.g., Schwab, supra footnote 25; Franklin Fund, supra 
footnote 25; Innovator ETFs, supra footnote 33.
    \75\ For example, the conditions regarding layering of fees vary 
based on the structure of acquiring fund. See infra section II.C.3.

[[Page 1294]]

----------------------------------------------------------------------------------------------------------------
                                                  Condition under existing        Condition under proposed rule
             Concern addressed                        exemptive orders                       12d1-4
----------------------------------------------------------------------------------------------------------------
Undue Influence............................  Voting conditions (including the   Voting conditions do not differ
                                              point at which the voting          based on the type of acquired
                                              condition is triggered) differ     fund and would require an
                                              based on the type of acquired      acquiring fund and its advisory
                                              fund.                              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      An acquiring fund's ability to
                                              findings and adopt procedures to   quickly redeem or tender a
                                              prevent overreaching and undue     large volume of acquired fund
                                              influence by the acquiring fund    shares is restricted (replacing
                                              and its affiliates.                the requirements for
                                             Requires an agreement between       participation agreements and
                                              acquiring and acquired funds       board findings/procedures).
                                              agreeing to fulfill their
                                              responsibilities under the
                                              exemptive order (a
                                              ``participation agreement'').
Complex Structures.........................  Limits the ability of an acquired  Limits the ability of funds
                                              fund to invest in underlying       relying on certain exemptions
                                              funds (that is, it limits          to invest in an acquiring fund
                                              structures with three or more      and limits the ability of an
                                              tiers of funds).                   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     Requires an evaluation of the
                                              fees at limits under current       complexity of the fund of funds
                                              FINRA sales rule (rule 2830)       structure and aggregate fees.
                                              even in circumstances where the    Specific considerations vary by
                                              rule would not otherwise apply.    acquiring fund structure.
                                             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.
----------------------------------------------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

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

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\
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    \77\ See 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).
    \78\ See, 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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \82\ We 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)).
---------------------------------------------------------------------------

    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\
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    \83\ Proposed 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 sub-adviser.'' 
Under the proposed rule, an acquiring fund would not combine the 
entities listed in clause (1) with those listed in clause (2).
    \84\ See proposed rule 12d1-4(b)(1)(ii).

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[[Page 1295]]

    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\
---------------------------------------------------------------------------

    \85\ See, e.g., BGFA Letter; Comment Letter of Stradley Ronon 
Stevens & Young LLP (May 19, 2008) (``Stradley Letter''); ICI 
Letter; Xshares Letter.
    \86\ See, e.g., ICI Letter.
    \87\ See, 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \88\ See, 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.
    \89\ See 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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \90\ Proposed 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.
    \91\ See proposed rule 12d1-4(b)(1)(ii).
    \92\ See, 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.'').
---------------------------------------------------------------------------

    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 closed-end 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.
---------------------------------------------------------------------------

    \93\ See Innovator ETFs, supra footnote 33.
    \94\ See, 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 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

[[Page 1296]]

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\
---------------------------------------------------------------------------

    \95\ Since 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).
---------------------------------------------------------------------------

    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 sub-advisory 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.
---------------------------------------------------------------------------

    \96\ See, 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.
    \97\ The 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.
    \98\ See Fund of Funds Proposing Release, supra footnote 16.
---------------------------------------------------------------------------

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 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.\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.
---------------------------------------------------------------------------

    \99\ Proposed rule 12d1-4(b)(1)(iii).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \100\ Proposed rule 12d1-4(d).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \101\ The 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.
    \102\ See 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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

[[Page 1297]]

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 sub-adviser's duties as a fiduciary to both 
the acquiring fund and acquired fund.
---------------------------------------------------------------------------

    \104\ See 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 sub-advisers and that 
``[t]he Commission has previously granted exemptive relief relating 
to this issue on many occasions'').
    \105\ See 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.
    \106\ Fund 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.
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    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.
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    \107\ An 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 self-dealing); 
Compliance Rule Adopting Release, supra footnote 89, at n.68.
    \108\ Accordingly, 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).
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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.
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    \109\ We 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.
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    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 non-fund 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.
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    \110\ Such 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.
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    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.
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    \111\ See supra section II.C.2.
    \112\ For 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.
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    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,

[[Page 1298]]

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\
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    \113\ See supra footnotes 93-94 and accompanying text 
(describing the voting conditions included in our orders).
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     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\
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    \114\ See supra footnote 96.
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     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\
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    \115\ Proposed 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.
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    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\
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    \116\ Certain 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).

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[[Page 1299]]

    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\
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    \117\ Our 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.
    \118\ This 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.
    \119\ See, e.g., USCF Advisers, supra footnote 117.
    \120\ See, e.g., Schwab, supra footnote 25.
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    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\
---------------------------------------------------------------------------

    \121\ We 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.
---------------------------------------------------------------------------

    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.
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    \122\ The 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.
    \124\ We 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.
    \125\ See 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.
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    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

[[Page 1300]]

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\
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    \126\ See 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).
    \127\ Acquiring 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).
    \128\ An 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. 32315 (Oct. 13, 2016) 
[81 FR 82142 (Nov. 18, 2016)] (``Liquidity Release'').
    \129\ An 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.
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    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\
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    \130\ See 2008 Proposing Release, supra footnote 13.
    \131\ See, 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.
    \132\ The 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).
---------------------------------------------------------------------------

    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\
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    \133\ See 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).
    \134\ See 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.
    \135\ See, 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)).
---------------------------------------------------------------------------

    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 large-scale 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

[[Page 1301]]

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 open-end 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)?
---------------------------------------------------------------------------

    \136\ See supra footnote 134.
---------------------------------------------------------------------------

     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?
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    \137\ Funds 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).
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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

[[Page 1302]]

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.
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    \138\ See 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 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.
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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.
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    \139\ Proposed 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.
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    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\
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    \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.
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    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\
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    \141\ See infra section II.C.4.
---------------------------------------------------------------------------

    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.
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    \142\ See, 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \143\ See rule 38a-1; see also 17 CFR 275.206(4)-7 (rule 206(4)-
7 under the Advisers Act).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \144\ Proposed rule 12d1-4(b)(3)(i).
    \145\ Proposed rule 12d1-4(b)(3)(i).
---------------------------------------------------------------------------

    The proposed rule would not require the acquiring fund's board to 
find that advisory fees are based on services

[[Page 1303]]

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.
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    \146\ Our 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).
    \147\ See 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).
    \150\ See Fund of Funds Adopting Release, supra footnote 17, at 
n.52.
    \151\ See 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)].
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    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.
---------------------------------------------------------------------------

    \152\ See 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.
    \153\ See id. See also FINRA rule 2341. The proposal also 
included specific fee conditions for insurance product separate 
accounts, which are discussed below.
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    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\
---------------------------------------------------------------------------

    \154\ FINRA 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).
    \155\ See 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.
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    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.
---------------------------------------------------------------------------

    \156\ Proposed rule 12d1-4(c)(1).
    \157\ See id.
    \158\ The retention period is consistent with the period 
provided in rules 22e-4 and 38a-1(d) under the Act.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \159\ Proposed rule 12d1-4(b)(3)(ii).
---------------------------------------------------------------------------

    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\

[[Page 1304]]

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\
---------------------------------------------------------------------------

    \160\ See 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 redeemable securities, each of which 
represents an undivided interest in a unit of specified securities).
    \161\ Section 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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \162\ See supra section II.C.3.a. (discussing examples of 
factors that could be considered as part of such an evaluation).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \163\ See, 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.
---------------------------------------------------------------------------

    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 broad-based 
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.
---------------------------------------------------------------------------

    \164\ See proposed rule 12d1-4(b)(3)(ii).
    \165\ See proposed rule 12d1-4(b)(3)(iii).
    \166\ According to UIT annual Form N-SAR filings, as of December 
2017, insurance UITs made up 673 of the total 719 registered UITs.
    \167\ There 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.
    \168\ The 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.
    \169\ This estimate is based on staff sampling of equity UIT 
prospectuses.
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    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.
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    \170\ Proposed 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.
    \171\ The retention period is consistent with the period 
provided in rule 38a-1(d) under the Act.
    \172\ See 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.
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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

[[Page 1305]]

reasonable in relation to the services rendered, the expenses expected 
to be incurred, and the risks assumed by the insurance company.
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    \173\ Proposed rule 12d1-4(b)(3)(iii).
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    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.
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    \174\ See 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.
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    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.
---------------------------------------------------------------------------

    \175\ Proposed 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.
---------------------------------------------------------------------------

    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 asset-based 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

[[Page 1306]]

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?
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    \176\ See 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%.
    \177\ See Funds of Funds Adopting Release, supra footnote 17, at 
text accompanying n.67 and nn. 53, 88.
    \178\ See, 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'').
---------------------------------------------------------------------------

     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?
---------------------------------------------------------------------------

    \179\ See 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.
---------------------------------------------------------------------------

     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 multi-tier 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).
---------------------------------------------------------------------------

    \180\ As 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.
---------------------------------------------------------------------------

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.
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    \181\ See 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).
---------------------------------------------------------------------------

    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

[[Page 1307]]

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.
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    \182\ A 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).
---------------------------------------------------------------------------

    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.
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    \183\ See proposed rule 12d1-4(b)(4)(i).
    \184\ As 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \185\ Our 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.
    \186\ See supra footnote 120 and accompanying text.
---------------------------------------------------------------------------

    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\
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    \187\ A 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.
    \188\ For 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.
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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\
---------------------------------------------------------------------------

    \189\ See 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).
    \190\ See proposed rule 12d1-4(b)(4)(iii)(A)-(E).
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    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\
---------------------------------------------------------------------------

    \191\ See, 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'').
    \192\ See proposed rule 12d1-4(b)(4)(iii).
    \193\ See proposed rule 12d1-4(b)(4)(iii)(A)-(E).
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    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

[[Page 1308]]

beyond the statutory limits for short-term 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\
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    \194\ The 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 wholly-
owned subsidiary of the underlying fund subject to certain 
conditions. See, e.g., Brinker Capital, supra footnote 191.
    \195\ Proposed rule 12d1-4(b)(4)(iii)(B) and (E).
    \196\ Proposed rule 12d1-4(b)(4)(iii)(A) and (C).
    \197\ Proposed 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).
---------------------------------------------------------------------------

    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 
wholly-owned 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.
---------------------------------------------------------------------------

    \198\ Master-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 pass-through entity.
    \199\ For 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.
    \201\ See, 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).
    \202\ See 2008 Proposing Release, supra footnote 13, at n.226 
and accompanying and following text.
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    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 wholly-owned 
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

[[Page 1309]]

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., short-term 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?
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    \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 No-Action Letter (pub. avail. April 3, 
2015); Thrivent Financial for Lutherans and Thrivent Asset 
Management LLC, Staff No-Action Letter (pub. avail. Sep. 27, 2016).
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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\
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    \204\ See 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 multi-
tier structures, and overall distribution expenses are limited to 
prevent excessive sales loads.
    \205\ See Fund of Funds Proposing Release, supra footnote 16.
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    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\
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    \206\ See Fund of Funds Adopting Release, supra footnote 17.
    \207\ See rule 12d1-2(a)(1).
    \208\ See 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).
    \210\ Fund of Funds Adopting Release, supra footnote 17.
    \211\ Id.
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    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\
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    \212\ See Janus Investment Fund, supra footnote 94.
    \213\ A fund relying on section 12(d)(1)(G) and rule 12d1-2 
could acquire no more than 3% of a closed-end 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.
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    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

[[Page 1310]]

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.
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    \214\ See, 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 short-term cash management purposes or to 
engage in interfund lending).
    \215\ See supra footnote 117 and accompanying text (regarding 
conditions applicable to unaffiliated acquired funds).
    \216\ See also supra footnote 28.
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    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.
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    \217\ Rule 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).
    \218\ Funds 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.
---------------------------------------------------------------------------

    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\
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    \219\ See Fund of Funds Adopting Release, supra footnote 17, at 
n.60 and accompanying text.
    \220\ An 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).
    \221\ See proposed rule 12d1-4(b)(3)(ii). See also supra section 
II.C.3.a.
    \222\ See proposed rule 12d1-4(b)(2). See also supra section 
II.C.2.
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    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.
---------------------------------------------------------------------------

    \223\ Section 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).
---------------------------------------------------------------------------

    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\
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    \224\ Proposed 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.
    \225\ Funds of Funds Adopting Release, supra footnote 17, at n. 
23 and accompanying text.
    \226\ See id., at section II.A.1(a).
    \227\ See, 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)).
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    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?

[[Page 1311]]

     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\
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    \228\ 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 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).
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     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\
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    \229\ See Reporting Modernization Adopting Release, supra 
footnote 48.
    \230\ Proposed Items C.7.k. and C.7.l. of Form N-CEN.
    \231\ See Item C.3.e of Form N-CEN.
    \232\ We 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)'').
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \233\ Proposed Items F.18 and F.19. of Form N-CEN.
---------------------------------------------------------------------------

    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.
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    \234\ See section 38(a) of the Investment Company Act (15 U.S.C. 
80a-37(a)).
    \235\ See, 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.
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    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\
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    \236\ Some 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.
    \237\ See, e.g., section III.
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    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

[[Page 1312]]

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.
---------------------------------------------------------------------------

    \238\ Section 12(d)(1)(G)(i)(IV).
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    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\
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    \239\ We 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.
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    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.
---------------------------------------------------------------------------

    \240\ Our 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.
    \241\ As of June 2018, there were a total of 95 master funds and 
195 feeder funds based on Morningstar Direct and 10-K filings data.
---------------------------------------------------------------------------

    Table 1 below provides descriptive statistics for acquiring and 
acquired

[[Page 1313]]

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\
---------------------------------------------------------------------------

    \242\ As 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.
    \243\ All 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.
    \244\ We define 12(d)(1)(G) acquiring funds as open-end 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).
---------------------------------------------------------------------------

    As Table 1 shows, there are 2,521 acquired funds with total gross 
assets equal to $6,603 billion. 23% of all open-end 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).
---------------------------------------------------------------------------

    \245\ The 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.

                               Table 1--Descriptive Statistics for Single-Tier Funds, Acquiring Funds, and Acquired Funds
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                            Gross                     Gross         N of         N of
                                                                  Gross         N of      assets of       N of      assets of    acquiring     acquired
                                                   N of funds   assets of    acquiring    acquiring     acquired     acquired     funds in     funds in
                                                                funds (bn      funds      funds (bn      funds      funds (bn    multi-tier   multi-tier
                                                                    $)                        $)                        $)       structures   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 
closed-end 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.
---------------------------------------------------------------------------

    \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.

                               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.

[[Page 1314]]

    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\
---------------------------------------------------------------------------

    \247\ Open-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.
---------------------------------------------------------------------------

    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 front-
end 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 open-end funds do not have significantly different 
deferred charges than single-tier 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.
---------------------------------------------------------------------------

    \248\ The 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.
    \249\ We 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.
    \250\ The closed-end funds with front-end load and deferred 
charges identified in Table 3 are all interval funds.

        Table 3--Expense Ratio, Front-End Load, and Deferred Charges for Single-Tier and Acquiring Funds
----------------------------------------------------------------------------------------------------------------
                                                                          Expense ratio
                                                ----------------------------------------------------------------
           Panel A: Single-tier funds               Equal-       Value-
                                                   weighted     weighted      Median      Standard        N
                                                     mean         mean                   deviation
----------------------------------------------------------------------------------------------------------------
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..........................................  ...........  ...........  ...........  ...........  ...........

[[Page 1315]]

 
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 open-end 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 closed-end funds 
because of limited sample size.
---------------------------------------------------------------------------

    \251\ See supra footnote 249.
---------------------------------------------------------------------------

    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 equal-weighted average 
of the expense ratio for open-end funds and ETFs and an increase in the 
expense ratio for closed-end funds between 2013 and 2017.
---------------------------------------------------------------------------

    \252\ ICI Research Perspective, Trends in the Expenses and Fees 
of Funds, 2017, April 2018, p. 14.

---------------------------------------------------------------------------

[[Page 1316]]

[GRAPHIC] [TIFF OMITTED] TP01FE19.002

[GRAPHIC] [TIFF OMITTED] TP01FE19.003

    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 asset-based 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.

[[Page 1317]]

[GRAPHIC] [TIFF OMITTED] TP01FE19.004

    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
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                Sector    International    Taxable     Municipal
                                U.S. equity     equity        equity         bond         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 US-domiciled 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

[[Page 1318]]

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.
---------------------------------------------------------------------------

    \253\ ETF 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).
---------------------------------------------------------------------------

    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?
---------------------------------------------------------------------------

    \254\ Acquired 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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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 sub-adviser 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.
---------------------------------------------------------------------------

    \256\ See also supra footnotes 79-82.
---------------------------------------------------------------------------

    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

[[Page 1319]]

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 short-term 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.
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    \257\ Concerns 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.
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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 staff-level relief provided in these 
letters. In particular, we understand that: (i) Some funds have created 
three-tier master-feeder 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.
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    \258\ The 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.
---------------------------------------------------------------------------

    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?

[[Page 1320]]

     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.
---------------------------------------------------------------------------

    \259\ See section II.A. for a detailed list of permissible 
acquiring and acquired funds under current exemptive relief.
---------------------------------------------------------------------------

    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.
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    \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.
    \262\ The 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \263\ For 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.
---------------------------------------------------------------------------

    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 top-tier 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

[[Page 1321]]

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.
---------------------------------------------------------------------------

    \264\ The 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \265\ Bhattacharya 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)).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \266\ Existing 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) x $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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \268\ See supra footnote 253 for the source of the exemptive 
order data.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \269\ Academic 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).
---------------------------------------------------------------------------

    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

[[Page 1322]]

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.
---------------------------------------------------------------------------

    \270\ See, 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).
    \271\ For 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-
Verd[uacute] (2009) shows that funds with worse before-fee 
performance charge higher fees (Javier Gil-Bazo & Pablo Ruiz-
Verd[uacute], The Relation between Price and Performance in the 
Mutual Fund Industry, 64 J. of Fin., 2153 (Oct. 2009)).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \272\ Our 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).
    \273\ See supra footnote 267.
---------------------------------------------------------------------------

    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 non-discretionary 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 non-discretionary separate 
accounts.
---------------------------------------------------------------------------

    \274\ See 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 plan-level 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)).
    \275\ See, 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)).
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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.
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    \276\ The 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.
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    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) Pass-through 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\
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    \277\ The current exemptive orders require pass-through 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.
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    The more frequent use of pass-through or mirror voting for 
acquiring

[[Page 1323]]

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.
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    \278\ There 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).
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    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 
value-increasing actions through their voting.\279\
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    \279\ Academic 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 Pension-Related 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).
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    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\
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    \280\ This estimate is based on the following calculation: 
$5,053,014 = ($1,176 one-time internal burden + $5,070 one-time 
external burden) x 809 acquiring funds. See infra footnotes 350 and 
353.
    \281\ This estimate is based on the following calculation: 
$4,499,165 = ($1,176 ongoing annual internal burden + $400 ongoing 
annual external burden) x 793 acquiring funds x 3.6 mirror votes per 
year. See infra footnotes 354, 356, and 358.
    \282\ This estimate is based on the following calculation: 
$907,776 = ($11,760 ongoing annual internal burden + $4,000 ongoing 
annual external burden) x 16 acquiring funds x 3.6 pass-through 
votes per year. See infra footnotes 355, 357, and 359.
    \283\ We 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.
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    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 closed-end 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.
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    \284\ The 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.
---------------------------------------------------------------------------

    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

[[Page 1324]]

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 pass-through 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\
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    \286\ This 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.
    \287\ These estimates are based on the following calculations:
    For internal costs, 4 hours x $317 hourly rate for a senior 
portfolio manager = $1,268; 4 hours x $480 blended hourly rate for 
an assistant general counsel ($449) and a chief compliance officer 
($511) = $1,920; 2 hours x $352 hourly rate for a compliance 
attorney = $704. $1,268 + $1,920 + $704 = $3,892; $3,892 x 3,659 
acquiring funds = $14,240,828 and $3,892 x 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 x $400 hourly rate for outside 
counsel = $400 and 1 hour x $5,070 hourly rate for board of 
directors = $5,070. $400 + $5,070 = $5,470; $5,470 x 3,659 acquiring 
funds = $20,014,730 and $5,470 x 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'').
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    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\
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    \288\ These estimates are based on the following calculations: 3 
new acquired funds x 3,659 acquiring funds x ($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 acquiring-
acquired fund pairs because funds in existing acquiring-acquired 
fund relationships have already incurred the cost of drafting a 
participation agreement.
    \289\ This estimate is based on the following calculation: 3,659 
acquiring funds x 11 acquired funds that an acquiring fund invests 
in on average x ($6,000 + $12,000)/2 average cost of negotiating the 
terms and entering into a participation agreement x 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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \290\ Under 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.
    \291\ See supra footnote 279.

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[[Page 1325]]

    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 one-time 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 one-time 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\
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    \292\ This estimate is based on the following calculation: 115 
hours x $324 hourly rate for a senior portfolio manager + 115 hours 
x blended hourly rate for assistant general counsel ($458) and chief 
compliance officer ($521) + 23 hours x $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 x 253 hours of 
internal burden of redemption limit per fund; $446,948,112 = 4,342 
acquiring funds x $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.
    \293\ These estimates are based on the following calculations: 
219,705 hours = 20% x 1,098,526 initial hour burden of redemption 
limit. $89,389,622 = 20% x $446,948,112 of aggregate one-time 
internal cost of redemption limit.
    \294\ These estimates are based on the following calculations: 
20 hours x $5,070 hourly rate for board of directors = $101,400; 
4,342 acquiring funds x $101,400 = $440,278,800.
    \295\ This estimate is based on the following calculation: 
$88,055,760 = 20% x $440,278,800 of aggregate one-time external cost 
of redemption limit.
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    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\
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    \296\ The 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.
    \297\ The 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.
    \298\ See 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).
    \299\ See supra footnote 265.
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    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\
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    \300\ Any 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.
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    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

[[Page 1326]]

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\
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    \301\ The 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.
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    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.
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    \302\ Literature 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.
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    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\
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    \303\ For 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)).
    \304\ See, 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)).
---------------------------------------------------------------------------

    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?

[[Page 1327]]

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.
---------------------------------------------------------------------------

    \305\ See supra section VI.B.2.b.
---------------------------------------------------------------------------

    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.
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    \306\ See, e.g., supra footnotes 148 and 149.
---------------------------------------------------------------------------

    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\
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    \307\ This estimate is based on the following calculation: 
($11,005 initial internal burden per management company + $17,610 
initial external burden per management company) x 3,373 acquiring 
management companies = $96,518,395. See also infra footnotes 365 and 
368.
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    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\
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    \308\ This 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) x 
3,373 acquiring management companies = $29,537,361. See also infra 
footnote 367 and 369.
    (8 hours x $400 hourly rate for outside counsel + 4 hours x 
$5,070 hourly rate for board of directors) x 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.
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    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

[[Page 1328]]

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\
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    \309\ This estimate is based on the following calculation: 
($11,005 initial internal burden per UIT + $2,400 initial external 
burden per UIT) x 969 acquiring UITs = $12,989,445. See also infra 
footnotes 373 and 376.
    \310\ This estimate is based on the following calculation: $388 
ongoing annual recordkeeping cost per UIT x 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.
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    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.
---------------------------------------------------------------------------

    \311\ This estimate is based on the following calculation: $310 
initial burden per separate account x 663 acquiring separate 
accounts = $205,530. See also infra footnote 380.
    \312\ This estimate is based on the following calculation: $78 
ongoing annual burden per separate account x 663 acquiring separate 
accounts = $51,714. See also infra footnote 380.
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    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\
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    \313\ Proposed 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 wholly-owned subsidiaries; or (iv) as a 
result of receiving fund shares as a dividend distribution or as a 
result of a plan reorganization.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \314\ See 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.
---------------------------------------------------------------------------

    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\
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    \315\ See supra section VI.C.1.a. for a detailed discussion of 
the costs of portfolio changes.
---------------------------------------------------------------------------

    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

[[Page 1329]]

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.
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    \316\ See proposed rule 12d1-4(b)(4).
    \317\ These estimates are based on the following calculations: 
$30,706,624 = 4,342 acquiring funds x ($1,602 one-time internal cost 
+ $5,470 one-time external cost); $13,612,170 = 4,342 acquiring 
funds x ($400 ongoing annual internal cost + $2,735 ongoing annual 
external cost). See infra footnotes 341, 342, and 343.
    \318\ These estimates are based on the following calculations: 2 
hours x $276.5 blended hourly rate for senior portfolio manager 
($324) and intermediate portfolio manager ($229) = $553. $2,401,126 
= 4,342 acquiring funds x $553 ongoing annual burden per acquiring 
fund. See supra footnote 287 for the source of salary data.
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    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\
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    \319\ We 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 x $304 + 5 x $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 x 
$3,315). See supra footnote 287 for the source of salary data.
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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.
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    \320\ The 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.
---------------------------------------------------------------------------

    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

[[Page 1330]]

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 ex-ante. 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.
---------------------------------------------------------------------------

    \321\ See supra footnotes 270 and 271.
    \322\ Any 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 one-time costs.
---------------------------------------------------------------------------

    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\
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    \323\ As 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.
    \324\ See, 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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \325\ See, 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[hyphen]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).
---------------------------------------------------------------------------

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

[[Page 1331]]

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.
---------------------------------------------------------------------------

    \326\ Funds 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).
    \327\ As 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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \328\ Academic 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).
---------------------------------------------------------------------------

    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

[[Page 1332]]

Congress's amendments to section 12(d)(1) in 1970.
---------------------------------------------------------------------------

    \329\ See supra footnote 47.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \330\ As 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.
    \331\ The 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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \332\ For example, a family of target date funds tends to invest 
in different proportional allotments of the same underlying funds.
---------------------------------------------------------------------------

    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

[[Page 1333]]

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 sub-adviser 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.
---------------------------------------------------------------------------

    \333\ Acquiring 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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \334\ As 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.
---------------------------------------------------------------------------

    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 multi-tier 
structures prohibition provide sufficient investment and funding 
flexibility to acquiring and acquired funds.
---------------------------------------------------------------------------

    \335\ Concerns of investor confusion are mitigated by fund 
disclosure requirements, such as prospectus and shareholder reports.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \336\ 44 U.S.C. 3501 through 3521.
    \337\ 17 CFR 270.0-2.
    \338\ Form N-CEN [referenced in 17 CFR 274.101] under the 
Investment Company Act.
---------------------------------------------------------------------------

    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

[[Page 1334]]

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.
---------------------------------------------------------------------------

    \339\ See 2008 Proposing Release, supra footnote 13.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \340\ See proposed rule 12d1-4(b)(4).
    \341\ Monetized, the one-time four-hour internal burden 
translates to $1,602 and the ongoing one-hour internal burden 
translates to $400. These estimates are based on the following 
calculations: 4 hours x 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.
    \342\ This estimate is based on the following calculation: 1 
hour x $400 hourly rate of outside counsel + 1 hour x $5,070 hourly 
rate for board of directors = $5,470. See supra footnote 287 for the 
source of salary data.
    \343\ This estimate is based on the following calculation: 0.5 
hour x $400 hourly rate of outside counsel + 0.5 hour x $5,070 
hourly rate for board of directors = $2,735. See supra footnote 287 
for the source of salary data.
    \344\ This estimate is based on the following calculation: (4 
hours + 1 hour + 1 hour)/3 = 2 hours.
    \345\ This estimate is based on the following calculation: 
($5,470 + $2,735 + $2,735)/3 = $3,647.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \346\ See 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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \347\ This 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.
---------------------------------------------------------------------------

    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 pass-through 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\
---------------------------------------------------------------------------

    \349\ This estimate takes into account the different voting 
frequencies of the types of acquired funds included in these 
calculations. For example, closed-end funds typically hold one vote 
per year, while mutual funds typically seek shareholder votes less 
frequently.
---------------------------------------------------------------------------

    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

[[Page 1335]]

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\
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    \350\ See, 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 
x $392 hourly rate for an in-house attorney. See supra footnote 287 
for the source of salary data. 3 x $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.
    \351\ These estimates are based on the following calculations: 
809 acquiring funds x 3 hours = 2,427 hours; 809 acquiring funds x 
$1,176 = $951,384.
    \352\ These estimates are based on the following calculations: 
2,427 hours/3 = 809 hours; $951,384/3 = $317,128.
    \353\ These estimates are based on the following calculations: 1 
hour x $5,070 hourly rate for board of directors = $5070; 5,070/3 = 
$1,690. See supra footnote 287 for the source of salary data.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \354\ This estimate is based on the following calculations: 3 
hours x $392 hourly rate for in-house attorney = $1,176. See supra 
footnote 287 for the source of salary data.
    \355\ This estimate is based on the following calculations: 30 
hours x $392 hourly rate for in-house attorney = $11,760. See supra 
footnote 287 for further explanation of salary data.
---------------------------------------------------------------------------

    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 pass-through voting, 
we estimate 10 hours of outside professional time, at a cost of 
$4,000.\357\
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    \356\ This estimate is based on the following calculations: 1 
hour x hourly rate for outside counsel of $400 = $400. See supra 
footnote 287 for further explanation of salary data.
    \357\ This estimate is based on the following calculations: 10 
hours x hourly rate for outside counsel of $400 = $4,000. See supra 
footnote 287 for further explanation of salary data.
---------------------------------------------------------------------------

    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\ Pass-through 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\
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    \358\ These estimates are based on the following calculations: 
793 acquiring funds x 3.6 mirror votes per year x 3 hours per mirror 
vote = 8,564.4 hours; 793 acquiring funds x 3.6 mirror votes per 
year x $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.
    \359\ These estimates are based on the following calculations: 
16 acquiring funds x 3.6 pass-through votes per year x 30 hours per 
pass-through vote = 1,728 hours; 16 acquiring funds x 3.6 pass-
through votes per year x $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.
    \360\ These 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.
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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\
---------------------------------------------------------------------------

    \361\ Proposed rule 12d1-4(b)(3)(i).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \362\ Id.
    \363\ Id.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \364\ Proposed rule 12d1-4(c).
---------------------------------------------------------------------------

    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

[[Page 1336]]

$5,870 \369\ per fund on management companies, relating to the need for 
board review and consultation with outside counsel.
---------------------------------------------------------------------------

    \365\ These burden hours translate to a monetized cost of 
$11,005 per fund. This estimate is based on the following 
calculation: 15 hours x $352 hourly rate for compliance attorney + 
10 hours x $317 hourly rate for senior portfolio manager + 5 hours x 
$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.
    \366\ This estimate is based on the following calculation: 30 
hours/3 years = 10 hours per year.
    \367\ These 16 burden hours translate to a monetized annual cost 
of $2,887 per fund. This estimate is based on the following 
calculations: 6 hours x $352 hourly rate for compliance attorney = 
$2,112; 5 hours x $61 hourly rate for general clerk = $305; 5 hours 
x $94 hourly rate for senior computer operator = $470. See supra 
footnote 287 for the source of salary data.
    \368\ This estimate is based on the following calculation: 3 
hours x $5,070 hourly rate for board of directors + 6 hours x $400 
hourly rate for outside counsel = $17,610. See supra footnote 287 
for the source of salary data.
    \369\ This estimate is based on the following calculation: 1 
hour x $5,070 hourly rate for board of directors + 2 hours x $400 
hourly rate for outside counsel = $5,870. See supra footnote 287 for 
the source of salary data.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \370\ Proposed rule 12d1-4(b)(3)(ii).
    \371\ Id.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \372\ Proposed rule 12d1-4(c).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \373\ These burden hours translate to a monetized cost of 
$11,005 per fund. This estimate is based on the following 
calculation: 15 hours x $352 hourly rate for compliance attorney + 
10 hours x $317 hourly rate for senior portfolio manager + 5 hours x 
$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.
    \374\ This estimate is based on the following calculation: 30 
hours/3 years = 10 hours per year.
    \375\ These five burden hours translate to a monetized annual 
cost of $388 per fund. This estimate is based on the following 
calculation: 2.5 hours x $61 hourly rate for general clerk + 2.5 
hours x $94 hourly rate for senior computer operator = $388. See 
supra footnote 287 for the source of salary data.
    \376\ This estimate is based on the following calculation: 6 
hours x $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.
    \377\ Proposed rule 12d1-4(b)(3)(ii).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \378\ Proposed rule 12d1-4(b)(3)(iii).
    \379\ Proposed rule 12d1-4(c).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \380\ This 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 x $61 hourly rate for 
general clerk + 1 hour x $94 hourly rate for senior computer 
operator = $155. See supra footnote 287 for the source of salary 
data.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \381\ See 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.
    \382\ This estimate is based on the last time the rule's 
information collection was submitted for PRA renewal in 2016.
---------------------------------------------------------------------------

    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

[[Page 1337]]

annual time cost of $1,349,418 \385\ and an annual external cost of 
$9,369,850.\386\
---------------------------------------------------------------------------

    \383\ See supra footnote 267 and accompanying text. $5,400,000/
($2,029,200.60 + $14,090,000) = 0.335.
    \384\ This estimate is based on the following calculation: 5,340 
hours-(5,340 hours x 0.335) = 3,551 hours.
    \385\ This estimate is based on the following calculation: 
$2,029,200.60-($2,029,200.60 x 0.335) = $1,349, 418.40.
    \386\ This estimate is based on the following calculation: 
$14,090,000-($14,090,000 x 0.335) = $9,369,850.
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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\
---------------------------------------------------------------------------

    \387\ See 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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \389\ See Reporting Modernization Adopting Release, supra 
footnote 48 at text accompanying n.1524.
    \390\ See Reporting Modernization Adopting Release, supra 
footnote 48 at text accompanying nn.1531-1532.
    \391\ See Reporting Modernization Adopting Release, supra 
footnote 48 at text accompanying nn.1533-1534.
    \392\ See Reporting Modernization Adopting Release, supra 
footnote 48 at text accompanying n.1538.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \393\ This estimate stems from the Commission staff's 
understanding of the time it takes to complete initially complete 
and review items on Form N-CEN.
    \394\ We 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.
    \395\ This estimate is based on the following calculation: 0.1 
hours x 3,038 filers = 303.8 hours.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \396\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

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 rules-based 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)].

[[Page 1338]]

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 closed-end 
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\
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    \397\ See rule 0-10(a) under the Investment Company Act.
    \398\ This 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.
---------------------------------------------------------------------------

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 pass-through 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\
---------------------------------------------------------------------------

    \400\ See supra footnotes 340 through 345 and accompanying text.
    \401\ See 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.
    \402\ See supra footnotes 365 through 369 and accompanying text.
    \403\ See supra footnotes 373 through 377 and accompanying text.
    \404\ See supra footnotes 393 through 394 and accompanying text.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \405\ This estimate is based on the following calculations:
     (2 internal burden hours and $3,647 in external costs) x 8 
total small entities for disclosure requirements + (1 internal 
burden hour and $800 in external costs) x 8 total small entities for 
voting requirements + (26 internal burden hours and $11,740 in 
external costs) x 7 management company small entities for fee-
related requirements + (15 internal burden hours and $800 in 
external costs) x 1 UIT small entity for fee-related requirements = 
221 internal burden hours and $118,556.
    \406\ This estimate is based on the following calculations: 0.1 
hours x 8 small entities = 0.8 hours.

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[[Page 1339]]

    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.
---------------------------------------------------------------------------

    \407\ This includes exempting or establishing any different 
requirements relating to proposed rule 12d1-4's redemption limits. 
See supra section VI.C.1.d.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \408\ Public 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).
---------------------------------------------------------------------------

    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

0
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.
* * * * *
0
2. Amend section 270.12d1-1 by revising paragraph (a) to read as 
follows:

Sec.  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 Sec.  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.
* * * * *

Sec.  270.12d1-2   [Removed and Reserved]

0
3. Remove and reserve section 270.12d1-2.
0
4. Section 270.12d1-4 is added to read as follows:

[[Page 1340]]

Sec.  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 face-amount 
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 Sec.  
270.12d1-1 or exemptive relief from the Commission;
    (C) In a subsidiary that is wholly-owned 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

0
5. The general authority citation for part 274 continues to read as 
follows, and the sectional authorities for Sec. Sec.  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,

[[Page 1341]]

80a-24, 80a-26, 80a-29, and Pub. L. 111-203, sec. 939A, 124 Stat. 
1376 (2010), unless otherwise noted.
* * * * *
0
6. Amend Form N-CEN [(referenced in Sec.  274.101), by:
0
a. In Part C, revising Item C.7. and adding paragraphs k. and l.; and
0
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