Document ID: SEC-2020-1859-0001
Agency: sec
Document Type: Rule
Title: Fund of Funds Arrangements
Posted Date: 2020-11-19T05:00Z

[Federal Register Volume 85, Number 224 (Thursday, November 19, 2020)]
[Rules and Regulations]
[Pages 73924-74007]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-23355]

[[Page 73923]]

Vol. 85

Thursday,

No. 224

November 19, 2020

Part III

Securities and Exchange Commission

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17 CFR Parts 270 and 274

Fund of Funds Arrangements; Final Rule

  Federal Register / Vol. 85, No. 224 / Thursday, November 19, 2020 / 
Rules and Regulations  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 274

[Release Nos. 33-10871; IC-34045; File No. S7-27-18]
RIN 3235-AM29

Fund of Funds Arrangements

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is 
adopting 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 new rule, the 
Commission is rescinding rule 12d1-2 under the Act and certain 
exemptive relief that has been granted from sections 12(d)(1)(A), (B), 
(C), and (G) of the Act permitting certain fund of funds arrangements. 
Finally, the Commission is adopting related amendments to rule 12d1-1 
under the Act and to Form N-CEN.

DATES: Effective Date: This rule is effective January 19, 2021.
    Compliance Dates: The applicable compliance dates are discussed in 
sections II.D, II.F and III of this final rule.

FOR FURTHER INFORMATION CONTACT: Bradley Gude, Terri G. Jordan, John 
Lee, Adam Lovell, Senior Counsels; Jacob D. Krawitz, Branch Chief; 
Melissa Gainor, Brian Johnson, Assistant Directors, 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 adopting 17 CFR 270.12d1-4 
(new rule 12d1-4) under the Investment Company Act [15 U.S.C. 80a-1 et 
seq.]; \1\ 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.
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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. Introduction
    A. Regulatory Context
    B. Rule 12d1-4 Overview
II. Discussion
    A. Scope
    B. Exemptions From the Act's Prohibition on Certain Affiliated 
Transactions
    C. Conditions
    D. Rescission of Rule 12d1-2 and Amendment to Rule 12d1-1
    E. Disclosures Relating to Fund of Funds Arrangements
    F. Compliance Dates
III. Rescission of Exemptive Relief; Withdrawal of Staff Letters
IV. Other Matters
V. Economic Analysis
    A. Introduction
    B. Economic Baseline
    C. Benefits and Costs and Effects on Efficiency, Competition, 
and Capital Formation
    D. Reasonable Alternatives
VI. Paperwork Reduction Act
    A. Introduction
    B. Rule 12d1-4
    C. Rule 0-2
    D. Form N-CEN
VII. Final Regulatory Flexibility Analysis
    A. Need for and Objectives of the Rule and Form Amendments
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Rule
    D. Projected Board Reporting, Recordkeeping, and Other 
Compliance Requirements
    E. Agency Action To Minimize Effect on Small Entities
VIII. Statutory Authority

I. Introduction

    We are adopting new rule 12d1-4 under the Investment Company Act 
and several related amendments to streamline and enhance the regulatory 
framework applicable to fund of funds arrangements. This framework 
reflects the Commission's decades of experience with fund of funds 
arrangements and will create a consistent and efficient rules-based 
regime for the formation, operation, and oversight of fund of funds 
arrangements.\2\ We believe that this framework will provide investors 
with the benefits of fund of funds arrangements, and will provide funds 
with investment flexibility to meet their investment objectives 
efficiently, in a manner consistent with the public interest and the 
protection of investors.
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    \2\ As discussed in more detail below, section 12(d)(1) of the 
Investment Company Act limits the ability of a fund to invest 
substantially in securities issued by another fund. See 15 U.S.C. 
80a-12(d)(1).
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    Funds increasingly invest in other funds as a way to achieve asset 
allocation, diversification, or other investment objectives. According 
to staff estimates, approximately 40% of all registered funds hold an 
investment in at least one fund,\3\ and total net assets in mutual 
funds that invest primarily in other mutual funds have grown from $469 
billion in 2008 to $2.54 trillion in 2019.\4\ Retail 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.\5\
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    \3\ See infra Table 2. Of those funds investing in other funds, 
48% invest at least 5% of their assets in other funds, and 26% hold 
more than 90% of their assets in other funds. See infra Table 4. For 
more data on fund of funds arrangements, see infra section VI.
    \4\ During this period the number of mutual funds utilizing this 
arrangement grew from 838 to 1,469. See Investment Company 
Institute, 2020 Fact Book: A Review of Trends and Activities in the 
Investment Company Industry (``2020 ICI Fact Book''), at 244, 
available at https://www.ici.org/pdf/2020_factbook.pdf.
    \5\ Target-date funds are a common type of fund of funds 
arrangement and 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).
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    In December 2018, we proposed rule 12d1-4, which would permit a 
fund to acquire shares of another fund in excess of the limits of 
section 12(d)(1) without obtaining an exemptive order from the 
Commission, subject to certain conditions.\6\ Because the proposed rule 
would provide a comprehensive exemption for funds of funds to operate, 
the Commission also proposed to rescind rule 12d1-2 under the Act and 
individual exemptive orders permitting certain fund of funds 
arrangements. In connection with the proposed rescission of rule 12d1-
2, we proposed amendments to rule 12d1-1 under the

[[Page 73925]]

Act to allow funds that rely on section 12(d)(1)(G) of the Act to 
invest in money market funds that are not part of the same group of 
investment companies. Finally, the Commission proposed certain 
disclosure amendments to Form N-CEN to provide the Commission 
additional census-type information regarding fund of funds 
arrangements.
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    \6\ See Fund of Funds Arrangements, Investment Company Act 
Release No. 10590 (Dec. 19, 2018) [84 FR 1286 (Feb 1, 2019)] (``2018 
FOF Proposing Release''). For purposes of this release and rule 
12d1-4, 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.
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    We received more than 100 comment letters on the proposal.\7\ Many 
commenters supported the Commission's goal of simplifying the 
regulatory framework for fund of funds arrangements.\8\ However, 
commenters recommended modifications to the proposed rule.\9\ For 
example, several commenters suggested changing the scope of 
arrangements permitted by the rule or expanding the scope of certain 
exemptions.\10\ Many commenters also recommended alternatives to the 
proposed rule's conditions. For instance, commenters strongly opposed 
the proposed redemption limit and recommended instead codifying certain 
conditions in existing exemptive orders or applying the limitation only 
to unaffiliated fund of funds arrangements.\11\ Several commenters 
recommended modifications to the proposed rule's control and voting 
provisions, while some commenters proposed changes to the proposed 
rule's disclosure and board reporting requirements.\12\ Some commenters 
expressed concern about the potential impact of the proposed rule's 
conditions on existing fund of funds arrangements, particularly in 
light of the proposed rescission of rule 12d1-2 and existing exemptive 
orders.\13\
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    \7\ The comment letters on the 2018 FOF Proposing Release (File 
No. S7-27-18) are available at https://www.sec.gov/comments/s7-27-18/s72718.htm.
    \8\ See, e.g., Comment Letter of Managed Funds Association 
(April 30, 2019) (``MFA Comment Letter''); Comment Letter of 
Investment Company Institute (April 30, 2019) (``ICI Comment 
Letter''); Comment Letter of Investment Adviser Association (May 2, 
2019) (``IAA Comment Letter''); Comment Letter of Consumer 
Federation of America (May 2, 2019) (``CFA Comment Letter''); 
Comment Letter of the Asset Management Group of the Securities 
Industry and Financial Markets Association (May 2, 2019) (``SIFMA 
AMG Comment Letter''); Comment Letter of Federal Regulation of 
Securities Committee of the Business Law Section of the American Bar 
Association (June 11, 2019) (``ABA Comment Letter'').
    \9\ See, e.g., ICI Comment Letter; ABA Comment Letter; SIFMA AMG 
Comment Letter; Comment Letter of the Committee on Investment 
Management Regulation of the New York City Bar Association (May 2, 
2019) (``NYC Bar Comment Letter''); Comment Letter of Institute for 
Portfolio Alternatives (May 1, 2019) (``IPA Comment Letter''); 
Comment Letter of Fidelity Investments (May 2, 2019) (``Fidelity 
Comment Letter'').
    \10\ See, e.g., MFA Comment Letter; NYC Bar Comment Letter; CFA 
Comment Letter; Comment Letter of T. Rowe Price (May 2, 2019) (``TRP 
Comment Letter'').
    \11\ See, e.g., Comment Letter of Guggenheim Investments (May 2, 
2019) (``Guggenheim Comment Letter''); Comment Letter of Dimensional 
Funds (May 2, 2019) (``Dimensional Comment Letter''); Comment Letter 
of Wells Fargo Funds Management, LLC (May 2, 2019) (``Wells Fargo 
Comment Letter''); Comment Letter of Federated Investors, Inc. (May 
2, 2019) (``Federated Comment Letter''); SIFMA AMG Comment Letter; 
Fidelity Comment Letter; NYC Bar Comment Letter.
    \12\ See, e.g., MFA Comment Letter; ICI Comment Letter; IPA 
Comment Letter; SIFMA AMG Comment Letter; Fidelity Comment Letter; 
Comment Letter of PGIM Investments LLC (May 2, 2019) (``PGIM Comment 
Letter''); TRP Comment Letter.
    \13\ See, e.g., Comment Letter of Pacific Investment Management 
Company LLC (May 1, 2019) (``PIMCO Comment Letter''); Federated 
Comment Letter; SIFMA AMG Comment Letter; Fidelity Comment Letter; 
NYC Bar Comment Letter.
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    After consideration of the comments we received, we are adopting 
rule 12d1-4 with several modifications designed to increase the 
workability of the rule's requirements, while enhancing protections for 
investors in fund of funds arrangements. We are also rescinding rule 
12d1-2 and exemptive relief that permitted certain fund of funds 
arrangements, amending rule 12d1-1 under the Act, and amending Form N-
CEN.

A. Regulatory Context

    Section 12(d)(1) of the Act limits the ability of a fund to invest 
substantially in securities issued by another fund. Section 12(d)(1)(A) 
of the Act prohibits a registered fund (and companies, including funds, 
it controls) from:
     Acquiring more than 3% of another fund's outstanding 
voting securities;
     investing more than 5% of its total assets in any one 
fund; or
     investing more than 10% of its total assets in funds 
generally.\14\
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    \14\ 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. Sections 3(c)(1) and 3(c)(7) subject private 
funds to the 3% limitation on investments in registered funds. 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 
Act, but for section 3(c)(1) or 3(c)(7) of the 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,\15\ and any 
principal underwriter thereof or broker-dealer registered under the 
Securities Exchange Act of 1934 (the ``Exchange Act''), from knowingly 
selling securities to any other investment company if, after the sale, 
the acquiring fund would:
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    \15\ 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.\16\
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    \16\ See 15 U.S.C. 80a-12(d)(1)(B).
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    These restrictions are designed to prevent fund of funds 
arrangements that allow the acquiring fund to control the assets of the 
acquired fund and use those assets to enrich the acquiring fund at the 
expense of acquired fund shareholders.\17\ Congress also was concerned 
about the potential for duplicative and excessive fees when one fund 
invested in another and the formation of overly complex structures that 
could be confusing to investors.\18\
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    \17\ This practice is described as ``pyramiding.'' See 2018 FOF 
Proposing Release, supra footnote 6, at 1287. 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). See id.
    \18\ Controlling persons profited when acquiring fund 
shareholders paid excessive fees due to duplicative charges at both 
the acquiring and acquired fund levels. See Investment Trusts and 
Investment Companies, Report of the Securities and Exchange 
Commission, H.R. Doc. No. 136, 77th Cong., 1st Sess., at ch. 7, 
2725-39, 2760-75, 2778-93, (1941) (``Investment Trust Study'') and 
Exchange-Traded Funds, Investment Company Act Release No. 28193 
(Mar. 11, 2008) [73 FR 14618 (Mar. 18, 2008)] (``2008 ETF Proposing 
Release''), at n. 195. See also 2018 FOF Proposing Release, supra 
footnote 6, at 9.
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    As discussed in the 2018 FOF Proposing Release, our views and those 
of Congress have evolved over the years as fund of funds structures 
developed that include investor protections and serve purposes that 
benefit investors.\19\ As a result, Congress created three statutory 
exceptions that permit different types of fund of funds arrangements 
subject to certain conditions.\20\ Congress also gave the Commission 
authority in section

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12(d)(1)(J) of the Act to exempt any person, security, or transaction, 
or any class or classes of transactions, from the restrictions of 
section 12(d)(1) if the exemption is consistent with the public 
interest and the protection of investors.\21\
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    \19\ See Fund of Funds Investments, Investment Company Act 
Release No. 27399 (June 20, 2006) [71 FR 36640 (June 27, 2006)] 
(``2006 FOF Adopting Release'') at n.7 and accompanying text; 2008 
ETF Proposing Release, supra footnote 18. See also 2018 FOF 
Proposing Release, supra footnote 6, at 10-13.
    \20\ See 15 U.S.C. 80a-12(d)(1)(E) (permitting master-feeder 
arrangements whereby an acquiring fund invests all of its assets in 
a single fund), 15 U.S.C. 80a-12(d)(1)(F) (permitting a fund to take 
small positions (up to 3% of another fund's securities) in an 
unlimited number of other funds), and 15 U.S.C. 80a-12(d)(1)(G) 
(permitting an 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\ 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 the 
Commission's authority under section 6(c) of the Act.
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    We previously exercised this exemptive authority to adopt three 
rules of general applicability that were based on relief we provided to 
specific market participants in exemptive orders.\22\ 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 would 
otherwise prohibit when we found those arrangements to be consistent 
with the public interest and the protection of investors.\23\ 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).\24\ Relief from sections 
12(d)(1)(A) and (B) was included in exemptive orders permitting 
exchange-traded funds (``ETFs'') and exchange-traded managed funds 
(``ETMFs'') to operate.\25\
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    \22\ See 2006 FOF Adopting Release, supra footnote 19. Rule 
12d1-1 allows funds to invest in shares of money market funds in 
excess of the limits of section 12(d)(1). Rule 12d1-2 provides funds 
relying on section 12(d)(1)(G) with greater flexibility to invest in 
other types of securities. Rule 12d1-3 allows acquiring funds 
relying on section 12(d)(1)(F) to charge sales loads greater than 
1.5%.
    \23\ 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''). 
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.
    \24\ 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. See Schwab, supra footnote 23.
    \25\ We recently adopted rule 6c-11, which permits certain ETFs 
to operate without obtaining an exemptive order. 17 CFR 270.6c-11. 
In adopting rule 6c-11, we did not rescind the portions of existing 
ETF exemptive orders that provided relief from sections 12(d)(1)(A) 
and (B) and stated that ETFs relying on rule 6c-11 that do not have 
exemptive relief from sections 12(d)(1)(A) and (B) may enter into 
fund of funds arrangements as set forth in recent ETF exemptive 
orders, provided that such ETFs satisfy the terms and conditions for 
fund of funds relief in those orders. Exchange-Traded Funds, 
Investment Company Act Release No. 33646 (Sep. 25, 2019) [84 FR 
57162 (Oct. 24, 2019)] (``2019 ETF Adopting Release''), at 57199. 
For purposes of this release, we generally use the term ``ETFs'' to 
refer to exchange-traded funds and exchange-traded managed funds 
unless the context otherwise requires.
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    The combination of statutory exemptions, Commission rules, and 
exemptive orders 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.\26\ Alternatively, the acquiring fund could rely 
on relief provided by an exemptive order, which would allow it to 
invest in substantially the same investments, but could require the 
fund to comply with different conditions. Over time, industry 
participants have experimented with new fund of funds structures, 
relying on combinations of statutory exemptions and Commission 
exemptive orders, and considering staff no-action letters, to create 
novel fund of funds arrangements. For example, some commenters 
described funds that have combined various forms of section 12(d)(1) 
relief to create fund structures that include three or more layers of 
funds.\27\
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    \26\ 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.
    \27\ See, e.g., Fidelity Comment Letter; Federated Comment 
Letter; Comment Letter of Federated Investors, Inc. (June 7, 2019) 
(``Federated 2 Comment Letter'').
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B. Rule 12d1-4 Overview

    In order to create a more consistent and efficient regulatory 
framework for fund of funds arrangements, rule 12d1-4 will permit a 
registered investment company or business development company (``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 the 
following conditions:
     Control. Rule 12d1-4 will prohibit an acquiring fund and 
its ``advisory group'' from controlling an acquired fund, except in 
certain limited circumstances.
     Voting. Rule 12d1-4 will require an acquiring fund and its 
advisory group to use mirror voting if it holds more than 25% of an 
acquired open-end fund or UIT due to a decrease in the outstanding 
securities of the acquired fund and if it holds more than 10% of a 
closed-end fund, with the ability to use pass-through voting when 
acquiring funds are the only shareholders of an acquired fund.\28\
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    \28\ See infra section II.C.1.b.ii.
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     Required Findings. Rule 12d1-4 will require investment 
advisers to acquiring and acquired funds that are management companies 
to make certain findings regarding the fund of funds arrangement, after 
considering specific factors. The final rule also will require certain 
findings with respect to UITs and separate accounts funding variable 
insurance contracts, taking into account the unique structural 
characteristics of such entities.
     Fund of Funds Investment Agreement. Rule 12d1-4 will 
require funds that do not have the same investment adviser to enter 
into an agreement prior to the purchase of acquired fund shares in 
excess of section 12(d)(1)'s limits (a ``fund of funds investment 
agreement'').
     Complex Structures. Rule 12d1-4 will impose a general 
three-tier prohibition with certain enumerated exceptions. However, in 
addition to these exceptions, the rule will allow an acquired fund to 
invest up to 10% of its total assets in other funds (including private 
funds), without regard to the purpose of the investment or types of 
underlying funds.
    As proposed, we are rescinding rule 12d1-2 under the Act, and 
amending 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.\29\ In addition, certain 
staff no-action letters relating to section 12(d)(1) will be 
withdrawn.\30\ The resulting regulatory framework will reduce confusion 
and subject similar fund of funds arrangements to tailored conditions 
that will enhance investor protection, while continuing to provide 
funds with investment flexibility to meet their investment objectives. 
In addition, the rule will allow the Commission, as well as funds and

[[Page 73927]]

advisers seeking exemptions, to focus exemptive order review resources 
on novel products or arrangements.
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    \29\ With the rescission of rule 12d1-2, a fund relying on 
section 12(d)(1)(G) will no longer have 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, except in compliance with rule 12d1-4.
    \30\ The list of no-action letters to be withdrawn will be 
available on the Commission's website.
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II. Discussion

A. Scope

1. Registered Funds and BDCs
    As proposed, rule 12d1-4 will permit registered investment 
companies and BDCs to acquire the securities of other registered 
investment companies or BDCs in excess of the limits in section 
12(d)(1). As a result, open-end funds (including ETFs), UITs (including 
ETFs organized as UITs), and closed-end funds (including BDCs), can 
operate in accordance with rule 12d1-4, as both acquiring and acquired 
funds.\31\ The scope of permissible acquiring and acquired funds under 
rule 12d1-4 is greater than the scope of funds that was permitted by 
the Commission's exemptive orders. For example, the rule will 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).\32\ The rule 
similarly will increase permissible investments for closed-end funds 
beyond ETFs to allow them to invest in open-end funds, UITs, other 
closed-end funds, and BDCs, in excess of the section 12(d)(1) limits. 
BDCs, which currently may invest in ETFs in excess of the section 
12(d)(1) limits, also will be permitted to invest in open-end funds, 
UITs, other BDCs, other closed-end funds and ETMFs. Finally, the rule 
will allow ETMFs to invest in open-end funds, UITs, BDCs and other 
closed-end funds. Rule 12d1-4, therefore, will create a consistent 
framework for all registered funds and BDCs and eliminate unnecessary 
and potentially confusing distinctions among permissible investments 
for different types of acquiring funds.
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    \31\ As proposed, the final rule will not be available to face-
amount certificate companies. Face-amount certificate companies are 
registered investment companies that 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, face-amount certificate companies are not within 
the scope of final rule 12d1-4 as either acquiring funds or acquired 
funds. No commenters addressed this aspect of the proposal.
    \32\ 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'').
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    Several commenters supported including all open-end funds, UITs, 
BDCs and other closed-end funds within the scope of permissible fund of 
funds arrangements under the rule.\33\ The commenters noted that 
proposed rule 12d1-4 would provide funds covered by the rule with 
flexibility to meet their investment objectives and level the playing 
field among registered funds and BDCs operating in accordance with the 
rule. However, one commenter raised concerns with arrangements that the 
Commission has not previously permitted in exemptive orders.\34\ This 
commenter stated that the Commission lacks experience with funds of 
funds arrangements that include unlisted closed-end funds and BDCs and 
suggested that permitting these funds to rely on the rule as acquired 
funds would increase retail investor exposure to higher cost 
investments. The commenter also questioned whether one rule should 
apply to all types of fund of funds arrangements, noting that several 
of the statutory requirements of section 12(d)(1) apply differently to 
open-end funds and closed-end funds, and the Commission's historical 
exemptive relief also treated these types of funds differently. The 
commenter additionally questioned whether the Commission has 
appropriately analyzed the risks of fund of funds arrangements 
involving ETMFs or ``non-transparent'' ETFs.
---------------------------------------------------------------------------

    \33\ See, e.g., ICI Comment Letter; Comment Letter of 
Morningstar, Inc. (May 2, 2019) (``Morningstar Comment Letter'').
    \34\ See CFA Comment Letter.
---------------------------------------------------------------------------

    After considering these comments, we continue to believe that the 
universe of permissible fund of funds arrangements generally should not 
turn on the type of funds in the arrangement. Instead, the rule should 
address differences in fund structures with tailored conditions that 
protect investors in all types of covered investment companies against 
the abuses historically associated with funds of funds. We believe the 
conditions of rule 12d1-4 provide appropriate flexibility for 
innovative fund of funds structures while creating a consistent and 
streamlined regulatory framework that protects investors in all types 
of funds. For example, for a management company to rely on the rule, 
the investment advisers to both the acquiring and acquired fund must 
make certain determinations before entering into the fund of funds 
arrangement.\35\ Similarly, the rule will also require principal 
underwriters or depositors of UITs and insurance companies offering 
certain separate accounts to make findings tailored to their 
characteristics.\36\ The rule also imposes a requirement that certain 
acquiring funds and acquired funds enter into a fund of funds 
investment agreement, and imposes voting requirements on acquiring 
funds' holdings of acquired funds above certain ownership thresholds 
that differ depending on the type of acquired fund, as described more 
fully below.\37\
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    \35\ See infra section II.C.2.b.i.
    \36\ See infra section II.C.2.b.ii. For example, UITs do not 
have a board of directors and do not engage in active management of 
a portfolio. The rule therefore will require different 
determinations for UITs.
    \37\ See infra sections II.C.1 and 2.
---------------------------------------------------------------------------

    With respect to BDCs, we believe that the rule's conditions and 
existing statutory provisions will protect investors from concerns 
related to undue influence, fees that are excessive due to being 
duplicative, or complex structures. For example, as we noted in the 
proposal, an acquiring fund board already has a responsibility to see 
that the fund is not overcharged for advisory services regardless of 
any findings we require.\38\ Additionally, the rule will require fund 
of funds arrangements involving BDCs to satisfy the other conditions of 
rule 12d1-4, including the requirement to make certain findings as 
described in section II.C.2.b. below. One element of these findings is 
a determination that the fees and expenses associated with an 
investment in an acquired fund, including an investment in an acquired 
BDC, do not duplicate the fees and expenses of the acquiring fund. 
Further, a BDC operating in accordance with the rule as an acquiring 
fund is subject to other existing limitations on its ability to invest 
in acquired funds.\39\
---------------------------------------------------------------------------

    \38\ Specifically, section 15(c) of the Act requires the 
acquiring fund's board of directors 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). Section 36(b) of the Act imposes on fund advisers a 
fiduciary duty with respect to their receipt of compensation. 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 only to the services that 
the acquiring fund's adviser is providing, and not to any services 
performed by an adviser to an acquired fund. See 2018 FOF Proposing 
Release, supra footnote 6, at 63-64.
    \39\ 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).

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[[Page 73928]]

    Similarly, we do not believe that including ETMFs or non-
transparent ETFs within the scope of the rule will present unique 
investor protection concerns that we have not already extensively 
considered and addressed with respect to traditional registered open-
end funds and fully transparent ETFs. Along with fully transparent 
ETFs, ETMFs and non-transparent ETFs generally are subject to the 
protections of the Act applicable to all registered open-end funds, 
including governance and other requirements. Accordingly, we believe 
that the conditions of rule 12d1-4, when combined with the protections 
imposed by the Act on all investment companies, appropriately address 
concerns of duplicative fees, undue influence, and complex structures 
with respect to these products.
    Finally, one commenter suggested that the concerns underlying 
section 12(d)(1) of the Act largely do not apply to ETFs as acquired 
funds in a fund of funds structure.\40\ This commenter stated that 
passive investments in ETFs do not implicate Congress' concerns 
regarding duplicative fees and undue influence, particularly when an 
investor holds an ETF to gain exposure to a particular market or asset 
class in an efficient manner, to allocate and diversify investments, or 
efficiently hedge a portion of a portfolio or balance sheet. The 
commenter stated that ETFs have not been subject to influence from 
activist investors despite ETF shares trading in the secondary market, 
perhaps because ETF shares have not historically traded at a 
significant discount to net asset value. Accordingly, the commenter 
urged the Commission to exempt the sale of ETFs as acquired funds from 
the limitations in section 12(d)(1)(B) of the Act.
---------------------------------------------------------------------------

    \40\ Comment Letter of WisdomTree Asset Management, Inc. (Dec. 
12, 2019) (``WisdomTree Comment Letter'').
---------------------------------------------------------------------------

    After considering comments, we continue to believe that investments 
in ETFs should be subject to the limitations set forth in section 
12(d)(1), and that any investments in excess of the 12(d)(1) limits 
should be subject to protective conditions. As a threshold matter, ETFs 
issue redeemable securities and are generally classified as open-end 
funds under the Act.\41\ As we discussed in our 2008 ETF Proposing 
Release, we believe that investments in ETFs, similar to investments in 
traditional open-end funds, raise the same concerns of pyramiding and 
the threat of large-scale redemptions as other types of open-end 
funds.\42\ For example, an acquiring fund might seek to use its 
ownership interest in an ETF to exercise a controlling influence over 
the ETF's management or policies, or to enter into a transaction with 
an affiliate of the acquiring fund. These concerns are most pronounced 
when a fund invests in an ETF in a primary market transaction through 
an authorized participant.\43\
---------------------------------------------------------------------------

    \41\ While most ETFs are classified as open-end funds, some ETFs 
are structured as UITs. Regardless of structure, we do not believe 
that the redemption of ETF shares in creation unit-sized 
aggregations by authorized participants insulates ETFs from the 
abuses that section 12(d)(1) was designed to prevent.
    \42\ See 2008 ETF Proposing Release, supra footnote 18, at 69.
    \43\ See generally 2019 ETF Adopting Release, supra footnote 25, 
at section I.B (explaining that an authorized participant that has a 
contractual arrangement with the ETF (or its distributor) purchases 
and redeems ETF shares directly from the ETF in blocks called 
``creation units'' as a principal for its own account or as agent 
for others, including institutional investors (such as funds)).
---------------------------------------------------------------------------

    ETFs, like other open-end funds, also operate pursuant to the 
prohibition in section 12(d)(1)(B), which provides that it is unlawful 
knowingly to sell or otherwise dispose of any securities of which the 
ETF is an issuer to any other investment company in excess of the 
limits in subsection (i) and (ii). Therefore, ETFs that receive 
inquiries and other communications from persons identifying themselves 
as potential purchasers of the ETF's shares as or through an authorized 
participant may want to consider adopting and implementing policies and 
procedures to determine whether those persons intend to purchase ETF 
shares for investment companies.\44\ Further, principal underwriters 
and broker-dealers that transact in an ETF's shares (including an ETF's 
authorized participants), are subject to the requirements of section 
12(d)(1)(B) of the Act. Accordingly, the final rule will treat ETFs 
consistently with other open-end funds and will permit investments in 
ETFs as acquired funds subject to the rule's conditions designed to 
protect acquired funds and their shareholders.
---------------------------------------------------------------------------

    \44\ For example, an ETF that explains its obligations pursuant 
to section 12(d)(1)(B) to potential purchasers who reach out 
directly to the ETF, and documents that exchange with the potential 
purchaser, generally would satisfy its obligation not to knowingly 
sell or otherwise dispose of any of its securities in excess of 
12(d)(1)(B) limits. Further, if an ETF intends to rely on rule 12d1-
4 to exceed the section 12(d)(1) limits, such ETF would be required 
to comply with the conditions of the rule, including entering into a 
fund of funds investment agreement with the acquiring investment 
company.
---------------------------------------------------------------------------

2. Private Funds and Unregistered Investment Companies
    As proposed, the final rule will not permit private funds and 
unregistered investment companies, such as foreign funds, to rely on 
the rule as acquiring funds.\45\ As a result, private funds and 
unregistered investment companies may acquire no more than 3% of a U.S. 
registered fund under the Act.\46\
---------------------------------------------------------------------------

    \45\ We use the term ``foreign fund'' to refer to an 
``investment company'' as defined in section 3(a)(1)(A) of the 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 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). A foreign 
fund may conduct a private U.S. offering in the United States 
without violating section 7(d) of the Act 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 2018 FOF Proposing Release, 
supra footnote 6, at 18-20.
    \46\ Sections 3(c)(1) and 3(c)(7) of the Act subject private 
funds to the 3% limitation on investments in registered funds. 15 
U.S.C. 80a-3(c)(1) and 3(c)(7)(D).
---------------------------------------------------------------------------

    Several commenters suggested that the Commission broaden the scope 
of rule 12d1-4 to permit investments by private funds or unregistered 
investment companies in acquired funds beyond the limits in section 
12(d)(1).\47\ Some of these commenters highlighted the potential for 
private and unregistered investment companies to invest in registered 
funds for efficient allocation, diversification, and hedging purposes 
and stated that such investments could benefit registered fund 
shareholders by increasing the scale and liquidity of the registered 
fund.\48\ Commenters that supported broadening the scope of the rule to 
include private funds and unregistered investment companies stated that 
such funds do not operate in a materially different manner from 
registered funds and therefore the concerns underlying section 12(d)(1) 
are not any more pronounced for private and unregistered investment 
companies nor are different conditions warranted.\49\
---------------------------------------------------------------------------

    \47\ See, e.g., ICI Comment Letter; Comment Letter of American 
Investment Council (May 2, 2019) (``AIC Comment Letter''); Comment 
Letter of Dechert LLP (May 2, 2019) (``Dechert Comment Letter''); 
Comment Letter of Clifford Chance US LLP (May 2, 2019) (``Clifford 
Chance Comment Letter''); NYC Bar Comment Letter; IAA Comment 
Letter; ABA Comment Letter.
    \48\ See MFA Comment Letter; Comment Letter of BlackRock, Inc. 
(May 3, 2019) (``BlackRock Comment Letter'') (stating ``ETFs are 
also frequently used as an alternative to futures and other market 
beta instruments such as forwards and swaps, especially in markets 
where derivatives may be less liquid or nonexistent, because ETFs 
offer intraday liquidity''); WisdomTree Comment Letter; NYC Bar 
Comment Letter.
    \49\ Comment Letter of Invesco Ltd. (Apr. 30, 2019) (``Invesco 
Comment Letter''); MFA Comment Letter; ICI Comment Letter; Dechert 
Comment Letter; Comment Letter of Parallax Volatility Advisers, L.P. 
(May 1, 2019) (``Parallax Comment Letter''); Comment Letter of 
Gracie Asset Management (May 2, 2019) (``Gracie Comment Letter''); 
AIC Comment Letter; IAA Comment Letter; Comment Letter of Ropes & 
Gray LLP (May 2, 2019) (``Ropes Comment Letter''). One commenter 
stated that fee layering and complex structure concerns are not as 
significant in the private fund context as they are in the 
registered fund context because private fund investors must meet 
sophistication standards and typically perform due diligence on a 
private fund's structure and fees. Comment Letter of Massachusetts 
Mutual Life Insurance Company (May 2, 2019).

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

[[Page 73929]]

    While commenters generally suggested subjecting private funds and 
unregistered investment companies to the same conditions as other 
acquiring funds, some commenters recommended additional conditions that 
could apply to private funds and unregistered investment companies 
under the rule.\50\ For example, commenters suggested that the rule 
could include recordkeeping and reporting requirements tailored to 
private funds and unregistered investment companies or limit the 
availability of the rule to private funds and unregistered investment 
companies with an adviser that is registered with the Commission.\51\ 
Some commenters suggested that the final rule allow private funds and 
unregistered investment companies to invest in only certain types of 
funds, such as ETFs, subject to appropriate conditions.\52\
---------------------------------------------------------------------------

    \50\ Some commenters stated that certain private funds have 
sought to control closed-end funds that trade at a discount to their 
NAV and suggested tailored control and voting conditions if private 
funds could rely on the rule to invest in closed-end funds and BDCs. 
See AIC Comment Letter; SIFMA AMG Comment Letter. See also infra 
section II.C.1.a.ii.
    \51\ Invesco Comment Letter; MFA Comment Letter; ICI Comment 
Letter; Gracie Comment Letter; AIC Comment Letter; BlackRock Comment 
Letter; Clifford Chance Comment Letter; NYC Bar Comment Letter; IAA 
Comment Letter; ABA Comment Letter.
    \52\ See, e.g., BlackRock Comment Letter; Parallax Comment 
Letter; MFA Comment Letter (stating that the Commission has already 
allowed private funds to invest in money market funds beyond the 
limits of section 12(d)(1) of the Investment Company Act in rule 
12d1-1, and that secondary market transactions in ETFs may be less 
likely to raise certain abuses that section 12(d)(1) was designed to 
prevent).
---------------------------------------------------------------------------

    Other commenters recommended that the rule exclude unregistered 
investment companies as acquiring funds because the Commission has not 
yet extended exemptive relief allowing such funds to acquire other 
investment companies in excess of the section 12(d)(1) limits.\53\ 
These commenters stated that the Commission does not have experience 
with this type of fund of funds arrangement, and recommended that the 
Commission first provide relief to unregistered investment companies 
through the exemptive application process. These commenters suggested 
that this process would allow the Commission to weigh the facts and 
circumstances of each particular applicant, and the type of underlying 
fund in the proposed fund of funds arrangement. Two commenters 
recommended that the rule exclude private funds as acquiring funds 
because of concerns of undue influence over closed-end funds.\54\
---------------------------------------------------------------------------

    \53\ See Comment Letter of Kauff Laton Miller LLP (May 13, 2019) 
(``Kauff Comment Letter''); Comment Letter of Law Office of William 
Coudert Rand (May 14, 2019) (``Rand Comment Letter''); Comment 
Letter of Cooper LLC (May 24, 2019) (``Cooper Comment Letter'').
    \54\ Comment Letter of Advent Capital Management, LLC (May 1, 
2019 (``Advent Comment Letter''); Comment Letter of FS Investments 
(May 2, 2019) (``FS Comment Letter'').
---------------------------------------------------------------------------

    After considering comments, we continue to believe that the rule 
should not include private funds and unregistered investment companies 
as acquiring funds. We acknowledge that permitting private funds and 
unregistered investment companies to rely on the rule as acquiring 
funds would provide these funds greater investment flexibility, and 
would increase the scale of U.S. registered funds that were acquired by 
private funds and unregistered investment companies. However, we do not 
have sufficient experience tailoring conditions for private funds' and 
unregistered investment companies' investments in registered funds to 
address in a rule of general applicability the concerns such funds 
present as acquiring funds, as described below. To date, few applicants 
have requested relief to permit private funds or unregistered 
investment companies to invest in registered funds beyond the limits in 
section 12(d)(1) of the Act.\55\
---------------------------------------------------------------------------

    \55\ The exemptive application process provides an opportunity 
to consider tailored conditions and limitations for a specific 
applicant that seeks relief to permit private funds or unregistered 
investment companies to invest in registered funds beyond the limits 
in section 12(d)(1) of the Act. If granted, the Commission and its 
staff could monitor fund of funds arrangements that operate pursuant 
to such exemptive relief, determine whether the conditions and 
limitations of the relief operate as intended, and consider whether 
further rulemaking may be appropriate.
---------------------------------------------------------------------------

    We believe it would be more appropriate to consider designing 
protective conditions through the exemptive application process because 
including private funds and unregistered investment companies as 
acquiring funds raises different concerns. Private funds and 
unregistered investment companies are not registered with the 
Commission, and their investments in registered funds would not be 
subject to the reporting requirements under the Act. In particular, 
private funds and unregistered investment companies are not subject to 
periodic reporting on Form N-PORT or the new reporting requirements 
that we are adopting on Form N-CEN regarding reliance on rule 12d1-
4.\56\
---------------------------------------------------------------------------

    \56\ Form N-PORT requires certain registered funds 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''). Rule 31a-1 under the Act sets forth certain 
other recordkeeping requirements for registered investment 
companies.
---------------------------------------------------------------------------

    Additionally, while several commenters noted that many advisers to 
private funds are required to disclose census-type information about 
their private funds on Form PF, Form PF does not require advisers to 
disclose the position-level information that would allow us to monitor 
compliance with rule 12d1-4 and its impact on the fund industry.\57\ In 
addition, smaller private fund advisers are not required to file Form 
PF. Accordingly, under the existing regulatory framework, the 
Commission does not receive routine reporting on the amount and 
duration of private fund or unregistered investment company investments 
in registered funds. As noted in the 2018 FOF Proposing Release, even 
if private funds and unregistered investment companies provided basic 
reporting on investments in underlying funds, that reporting alone may 
not provide an adequate basis to protect against undue influence and 
monitor compliance with the rule's conditions.\58\
---------------------------------------------------------------------------

    \57\ See AIC Comment Letter (noting that the Commission could 
consider amending Form PF to require an adviser to report if any of 
the private funds they advise relied on the rule during the 
reporting period); Clifford Chance Comment Letter; NYC Bar Comment 
Letter; ABA Comment Letter; Invesco Comment Letter; Parallax Comment 
Letter; Gracie Comment Letter. See also 17 CFR 275.204(b)-1 
(requiring certain registered investment advisers to private funds 
to file Form PF to report information about the private funds they 
manage).
    \58\ 2018 FOF Proposing Release, supra footnote 6, at 20.
---------------------------------------------------------------------------

    Private funds and unregistered investment companies are not subject 
to many of the governance and compliance requirements of the Act that 
are designed to protect investors and reduce conflicts of interest that 
are inherent in a fund structure. Such requirements are integral to the 
oversight and monitoring provisions of rule 12d1-4 for registered 
funds. For example, private funds and unregistered investment companies 
are not subject to the board governance requirements of sections 10 and 
16 of the Act and the chief compliance officer requirements of rule 
38a-1.\59\ We are

[[Page 73930]]

adopting rule 12d1-4 against the background of these existing 
requirements and the protections they provide for shareholders in a 
fund of funds arrangement. Without incorporating additional governance 
and compliance obligations for private funds and unregistered 
investment companies as acquiring funds, we do not believe rule 12d1-4 
would have sufficiently protective conditions to address the undue 
influence concerns that Congress raised with respect to fund of funds 
arrangements.
---------------------------------------------------------------------------

    \59\ To protect shareholders and address conflicts of interest 
that can arise from the management of investment companies, the Act 
requires that a registered management investment company be governed 
by a board of directors that has a general oversight role, with 
certain exceptions. Rule 12d1-4 requires the adviser to an acquiring 
fund or acquired fund to submit reports to such fund's board of 
directors so that the board can review the adviser's analysis of the 
fund of funds arrangement. While UITs are not subject to these 
governance and oversight requirements, a UIT does not engage in 
active management of its investment portfolio. Accordingly, we 
believe that a UIT's investment in an acquired fund presents 
different concerns than an investment by a private fund or 
unregistered fund. Rule 38a-1 requires a fund (including a UIT) to 
adopt and implement written policies and procedures reasonably 
designed to prevent a violation of the federal securities laws by 
the fund and designate one individual responsible for administering 
the fund's policies and procedures as a chief compliance officer. 
See 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''). Under rule 38a-1, a fund would adopt policies and 
procedures reasonably designed to prevent a violation of rule 12d1-
4.
---------------------------------------------------------------------------

    We believe designing such protective conditions through the 
exemptive application process would allow the Commission to weigh the 
policy considerations described above in the context of the facts and 
circumstances of the specific fund of funds arrangement described in 
the application. The exemptive application process would allow the 
Commission to consider appropriate investor protection provisions, 
including governance and reporting requirements, applicable to any such 
arrangement.\60\ The exemptive application process also would provide 
the Commission with an opportunity to analyze the operation and effects 
of these fund of funds arrangements before determining whether and how 
to address such arrangements in a rule of general applicability. We 
encourage interested parties to share their views on such arrangements 
by contacting staff in the Division of Investment Management.
---------------------------------------------------------------------------

    \60\ One commenter pointed to rule 12d1-1 as a model for private 
fund investments in registered funds. Prior to the adoption of that 
rule, the Commission considered specific proposals for exemptive 
relief for certain private funds to invest in affiliated money 
market funds. See, e.g., Scudder Global Fund, Inc., et al., 
Investment Company Act Release Nos. 24276 (Feb. 3, 2000) [65 FR 6420 
(Feb. 9, 2000)] (notice) and 24322 (Feb. 29, 2000) (order) and 
related application; Pioneer America Income Trust, et al., 
Investment Company Act Release Nos. 25607 (Jun. 7, 2002) [97 FR 
40757 (Jun. 13, 2002)] (notice) and 25647 (Jul. 3, 2002) (order) and 
related application. However, the Commission has not yet granted 
relief for private funds to invest in registered funds in excess of 
the limits of section 12(d)(1) of the Act.
---------------------------------------------------------------------------

    In addition to the challenges applicable to unregistered funds 
generally, foreign fund investments in registered funds present 
additional concerns.\61\ Specifically, the Commission understands that 
some foreign laws and regulations may limit or prevent disclosure of 
information to the Commission.\62\ These types of restrictions may 
include privacy laws and so-called ``blocking statutes'' (including 
secrecy laws) that prevent the disclosure of information relating to 
third parties and/or disclosure to the U.S. government.\63\ 
Additionally, abusive practices by unregistered investment companies 
that were associated with such investments were a concern underlying 
Congress's amendments to section 12(d)(1) in 1970.\64\ For example, a 
Commission report stated that unregistered investment companies could 
seek to redeem large holdings in acquired funds due to the instability 
of certain foreign economies, political upheaval, or currency 
reform.\65\ The Commission also noted that an unregistered investment 
company could seek to exert undue influence through the shareholder 
voting process.\66\ For these reasons, we also do not believe it is 
appropriate at this time to include foreign funds in the scope of 
acquiring funds under rule 12d1-4.
---------------------------------------------------------------------------

    \61\ The Commission has stated 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 2018 FOF 
Proposing Release, supra footnote 6, at n.52 (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)).
    \62\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers, Exchange Act Release No. 87005 (Sep. 19, 2019) [84 
FR 68550 (Dec. 16, 2019)], at 68557.
    \63\ Id. Data protection, privacy, confidentiality, bank 
secrecy, state secrecy, and national security laws frequently create 
obstacles to cross-border flows of information between regulators 
and foreign-domiciled registrants. Some of these laws, for example, 
prohibit foreign-domiciled registrants in certain jurisdictions from 
responding directly to SEC requests for information and documents or 
prevent the SEC from being able to conduct any type of examination, 
either onsite or by correspondence. See Statement on the Vital Role 
of Audit Quality and Regulatory Access to Audit and Other 
Information Internationally--Discussion of Current Information 
Access Challenges with Respect to U.S.-listed Companies with 
Significant Operations in China, SEC Chairman Jay Clayton, SEC Chief 
Accountant Wes Bricker, and PCAOB Chairman William D. Duhnke III 
(Dec. 7, 2018) available at https://www.sec.gov/news/public-statement/statement-vital-role-audit-quality-and-regulatory-access-audit-and-other.
    \64\ See 2018 FOF Proposing Release, supra footnote 6, at 21, 
citing 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'') at 318.
    \65\ PPI Report, supra footnote 64, at 315.
    \66\ Id. at 324.
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B. Exemptions From the Act's Prohibition on Certain Affiliated 
Transactions

    As proposed, rule 12d1-4 will provide an exemption from section 
17(a) of the Act.\67\ In addition, the final rule will provide a 
limited exemption from that section for in-kind transactions for 
certain affiliated persons of ETFs. Section 17(a) 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.\68\ 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.\69\
---------------------------------------------------------------------------

    \67\ See rule 12d1-4(a); 15 U.S.C. 80a-17(a). With respect to 
BDCs, the rule provides an exemption from sections 57(a)(1)-(2) and 
57(d)(1)-(2) of the Act for arrangements that comply with rule 12d1-
4. See 15 U.S.C. 80a-56(a)(1)-(2) and 80a-56(d)(1)-(2). The 
Commission proposed rule 12d1-4(a) to provide an exemption from 
section 57 for BDCs complying with the rule, but did not specify the 
relevant subsections in section 57 that are analogous to section 
17(a). See generally proposed rule 12d1-4(a) (providing an exemption 
from section 57 of the Act). We did not receive comments on this 
aspect of the proposal. We are adopting rule 12d1-4(a) with changes 
to clarify and specify the relevant subsections of section 57.
    \68\ 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(a) 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.
    \69\ 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 an exemption, 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, limiting the

[[Page 73931]]

efficacy of rule 12d1-4.\70\ 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, 
though the rule as adopted will not address all of these 
situations.\71\
---------------------------------------------------------------------------

    \70\ If an acquiring fund holds 5% 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, an exemption from 
section 17(a) would not be necessary. But, generally, without an 
exemption from section 17(a), an acquired fund could not sell its 
shares to, or redeem or repurchase those shares from, an affiliated 
acquiring fund, and an acquiring fund could not purchase from, 
redeem, or resell shares from an affiliated acquired fund.
    \71\ As discussed below, the rule will 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. 
However, as discussed further below, the final rule will not exempt 
from section 17(a) ETF in-kind creations and redemptions involving 
certain affiliates.
---------------------------------------------------------------------------

    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 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.\72\ We continue to 
believe, as discussed in the 2018 FOF Proposing Release, that these 
exemptions from section 17(a) meet the standards set forth in sections 
17(b) and 6(c) and the rule's conditions make unlikely the prospect of 
overreaching by an affiliated fund. For example, the rule prohibits the 
acquiring fund and its advisory group from controlling the acquired 
fund, which is designed to prevent a fund of funds arrangement that 
involves overreaching.
---------------------------------------------------------------------------

    \72\ 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. See 15 
U.S.C. 6(c). 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).
---------------------------------------------------------------------------

    An acquired fund that is an open-end fund or UIT also is protected 
from overreaching due to the Act's requirement that all purchasers 
receive the same price.\73\ This ensures that the affiliated person 
pays the same consideration for fund shares as non-affiliated persons, 
consistent with the standards set out in section 17(b). We believe that 
this would be true in the context of closed-end funds because the 
acquired fund's repurchase of its shares would provide little 
opportunity for the acquiring fund to overreach since all holders would 
receive the same price.\74\
---------------------------------------------------------------------------

    \73\ See section 22(c) of the Act and 17 CFR 270.22c-1 (rule 
22c-1). Primary transactions with an ETF would also be done at a 
price based on NAV. 2018 FOF Proposing Release, supra footnote 6, at 
n.67.
    \74\ See 2018 FOF Proposing Release, supra footnote 6, at n.68.
---------------------------------------------------------------------------

    As a result, we believe that this exemption is necessary and 
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.\75\ We also believe that the exemption from 
section 17(a) is necessary in light of the goals of rule 12d1-4, 
subject to the conditions set forth in the rule. Existing orders have 
provided exemptive relief from the affiliated transaction provisions in 
section 17(a) under similar conditions for many years.\76\
---------------------------------------------------------------------------

    \75\ See supra footnote 72.
    \76\ See 2018 FOF Proposing Release, supra footnote 6, at n.70.
---------------------------------------------------------------------------

    Commenters generally supported the proposed exemptions from section 
17(a), agreeing with our view that the utility of the proposed rule 
would be limited if it did not exempt fund of funds arrangements from 
the affiliated transaction prohibitions in that section.\77\ These 
commenters requested, however, that the Commission clarify the 
availability of the exemption from section 17(a) when an acquired ETF 
transacts on an in-kind basis with an affiliated acquiring fund. The 
commenters noted that the 2018 FOF Proposing Release suggests, 
consistent with fund of funds exemptive orders, that the rule would 
provide relief for 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), but the proposed rule 
text referred only to relief to permit the purchase and sale of fund 
shares between the acquiring fund and acquired fund.
---------------------------------------------------------------------------

    \77\ See, e.g., ICI Comment Letter; Comment Letter of Voya 
Investment Management LLC (May 2, 2019) (``Voya Comment Letter'').
---------------------------------------------------------------------------

    After considering comments, we are adopting a modified exemption 
from section 17(a) to clarify the rule provides relief from section 
17(a) for in-kind transactions when an acquiring fund is purchasing and 
redeeming shares of an acquired ETF under certain circumstances. As 
adopted, the rule will provide exemptions from section 17(a) with 
regard to the deposit and receipt of baskets by an acquiring fund that 
is an affiliated person of an ETF (or who is an affiliated person of 
such a person) solely by reason of holding with the power to vote 5% or 
more of the ETF's shares or holding with the power to vote 5% or more 
of any investment company that is an affiliated person of the ETF.\78\ 
Consistent with exemptive orders regarding ETF applicants, the 
exemption will not be available where the ETF is in turn an affiliated 
person of the acquiring fund, or an affiliated person of such person, 
for a reason other than such power to vote.\79\
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    \78\ Rule 12d1-4(a)(3). ``Baskets'' for purposes of rule 12d1-4 
will have the same meaning as in rule 6c-11(a)(1). See rule 12d1-
4(d).
    \79\ See, e.g., AQR Trust and AQR Capital Management, LLC, 
Investment Company Act Release Nos. 33343 (Dec. 21, 2018) [83 FR 
67441 (Dec. 28, 2018)] (notice) and 33346 (Jan. 28, 2019) (order) 
and related application.
---------------------------------------------------------------------------

    We are adopting the rule with this exemption because we agree with 
commenters that this rule text clarification is appropriate to permit 
ETFs to engage in in-kind purchase or redemption transactions with 
certain affiliated acquiring funds on the same basis that they would be 
permitted to engage in a cash purchase or redemption transactions with 
such affiliated acquiring fund under the rule.\80\ The provision is 
similar to rule

[[Page 73932]]

6c-11(b)(3).\81\ Purchases and redemptions of ETF creation units are 
typically effected in kind, and section 17(a) would prohibit these in-
kind purchases and redemptions by a fund affiliated with the ETF. We 
believe that such an exemption is appropriate because all purchases and 
redemptions of creation units with such an affiliated fund are at an 
ETF's next-calculated NAV, and an ETF would value the securities 
deposited or delivered upon redemption in the same manner, using the 
same standards, as the ETF values those securities for purposes of 
calculating the ETF's NAV. We do not believe that these transactions 
will give rise to the policy concerns that section 17(a) is designed to 
prevent.\82\
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    \80\ 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) to permit these transactions. See 
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, rule 6c-11 under the Investment Company Act and our ETF 
exemptive 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, but that relief would 
not be sufficient to allow an ETF's in-kind transaction with another 
fund. See 17 CFR 270.6c-11; 2019 ETF Adopting Release, supra 
footnote 25.
    \81\ Rule 6c-11(b)(3). See supra footnote 73 and accompanying 
text. See also 2019 ETF Adopting Release, supra footnote 25 at 
section II.B.3.
    \82\ See also 2019 ETF Adopting Release, supra footnote 25, at 
nn.130-134 and accompanying text.
---------------------------------------------------------------------------

    Further, similar to other fund of funds arrangements, without an 
exemption from section 17(a), the rule would be limited in its utility. 
In this case, section 17(a) would prohibit the delivery or deposit of 
basket assets on an in-kind basis by certain affiliated funds (that is, 
by exchanging certain assets from the ETF's portfolio, rather than in 
cash). As a result, we also believe that the exemption from section 
17(a) regarding this limited exception for ETF in-kind baskets is 
necessary in light of the goals of rule 12d1-4, subject to the 
conditions set forth in the rule.
    Some commenters also suggested the Commission clarify, or provide 
exemptive relief from, section 17(a) for other affiliated transactions 
that are within the statutory limits of section 12(d)(1) or fund of 
funds arrangements that rely on a statutory exemption.\83\ A few 
commenters stated that it would frustrate Congressional intent if the 
Commission does not extend section 17(a) exemptive relief to these 
types of fund of funds arrangements.\84\
---------------------------------------------------------------------------

    \83\ See Voya Comment Letter; ICI Comment Letter; PIMCO Comment 
Letter; SIFMA AMG Comment Letter. Some commenters focused on 
suggesting relief from sections 12(d)(1)(A) and 12(d)(1)(F). See ICI 
Comment Letter. Other commenters stated relief should include 
sections 12(d)(1)(A), (B), (C), (E), (F), and (G). See SIFMA AMG 
Comment Letter; PIMCO Comment Letter.
    \84\ See SIFMA AMG Comment Letter; PIMCO Comment Letter; ICI 
Comment Letter.
---------------------------------------------------------------------------

    Section 12 and section 17 address different concerns under the Act. 
Section 12 addresses concerns regarding ``pyramiding,'' where 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 by virtue of their stake in the acquired fund. Section 
17(a) addresses self-dealing and other types of overreaching of a fund 
by its affiliates. Although an arrangement may not raise pyramiding 
concerns, it may still give rise to self-dealing concerns. As a result, 
we do not believe it would frustrate congressional intent, as asserted 
by commenters, for some fund of funds arrangements that are within the 
limits of, or exempt from section 12(d)(1) to be subject to the 
prohibitions of section 17(a).
    However, we recognize that certain fund of funds arrangements are 
nearly impossible to utilize absent relief from section 17(a). In the 
past, we have considered relief to be implied in these circumstances. 
We believe that it is appropriate to imply relief under sections 
12(d)(1)(E) and 12(d)(1)(G) because, without this relief, these 
statutory provisions would be inoperable.\85\ Transactions permitted by 
sections 12(d)(1)(E) and 12(d)(1)(G) are typically affiliated 
transactions prohibited by section 17(a).\86\
---------------------------------------------------------------------------

    \85\ See, e.g., 2018 FOF Proposing Release, supra footnote 6, at 
n.70.
    \86\ See, e.g., Section 12(d)(1)(E)(ii) (limiting the exception 
to situations where the acquiring fund only owns the acquired fund) 
and section 12(d)(1)(G)(i)(I) (limiting the exception to situations 
where the two funds are part of the same group of investment 
companies). For fund of funds arrangements relying on section 
12(d)(1)(E), Commission staff has taken the position that 
application of section 17(a) of the Act to a registered feeder 
fund's cash redemption from a registered master fund would not be 
consistent with the basic relationship that section 12(d)(1)(E) is 
intended to permit. See Signature Financial Group, Inc., SEC Staff 
No-Action Letter (Dec. 28, 1999) (``Signature Financial No-Action 
Letter''). Section 12(d)(1)(G) of the Act codified certain exemptive 
orders that the Commission had issued permitting funds to purchase 
other funds in the same group of funds beyond the limits in section 
12(d)(1). The Commission issued those orders generally to funds of 
funds where the acquiring and acquired funds were related because 
they shared a common investment adviser or the advisers were 
affiliated persons within the meaning of section 2(a)(3)(C) of the 
Act. Those orders provided relief from section 17(a) of the Act. 
See, e.g., T. Rowe Price Spectrum Fund, Inc., Investment Company Act 
Release Nos. 21371 (Sept. 22, 1995) [60 FR 50654 (Sep. 22, 1995)] 
(notice) and 21425 (Oct. 18, 1995) (order) (``T. Rowe Spectrum 
Order''); Vanguard Star Fund, Investment Company Act Release Nos. 
21372 (Sept. 22, 1995) (notice) and 21426 (Oct. 18, 1995) (order); 
see also MassMutual Institutional Funds, SEC Staff No-Action Letter 
(Oct. 19, 1998).
---------------------------------------------------------------------------

    We are not issuing an interpretation that there is an implied 
exemption from section 17(a) for fund of funds arrangements that 
involve affiliated persons but do not exceed the limits of sections 
12(d)(1)(A), (B), or (C), or that meet the statutory exemption in 
section (F) of the Act. The section 17(a) exemptions provided in this 
rule are limited in scope to those necessary for a fund of funds 
structure to operate under the rule and are consistent with the 
exemptive relief that we have provided under our exemptive orders. The 
types of arrangements that are otherwise permissible under section 
12(d)(1) could include arrangements where funds are affiliated persons 
for reasons other than holding 5% or more of the acquired fund's 
securities. For example, under section 12(d)(1)(A) of the Act, an 
acquiring fund that acquires only 3% of the total outstanding voting 
stock of an acquired fund generally would not be an affiliated person 
by virtue of its holdings.\87\ Expanding section 17(a) relief to all 
transactions that are permitted by section 12(d)(1), without the 
transaction being subject to protections addressing the relevant 
concerns underlying section 17(a), raises issues that would require a 
careful consideration of whether additional conditions are necessary to 
sufficiently address any risks posed by these transactions.
---------------------------------------------------------------------------

    \87\ An acquiring fund's percentage of outstanding shares of the 
acquired fund owned could increase without further acquisition, such 
as when there is a decrease in the outstanding securities of the 
acquired fund, resulting in the acquiring fund exceeding the 5% 
threshold.
---------------------------------------------------------------------------

    Also, unlike transactions permitted by sections 12(d)(1)(E) and 
12(d)(1)(G), transactions under these other provisions are possible 
without an implied exemption from section 17(a). We have historically 
considered whether an exemption from section 17(a) is appropriate (and 
subject to appropriately protective conditions) separately. Thus, while 
we are not providing the requested interpretation, affiliated 
arrangements within the statutory limits of section 12(d)(1) or that 
rely on section 12(d)(1)(F) may continue to apply separately for an 
exemptive order pursuant to section 17(b).\88\ In addition, funds that 
comply with the conditions in rule 12d1-4 may rely upon the rule's 
exemption from section 17(a) even if they are not relying upon it for 
an exemption from section 12(d)(1).
---------------------------------------------------------------------------

    \88\ For example, some arrangements investing in both affiliated 
and unaffiliated underlying funds in amounts not exceeding the 
limits in section 12(d)(1)(F) have received an exemption from 
section 17(a) for investments in affiliated funds. See, e.g., 
Hennion & Walsh, Inc., et al., Investment Company Act Release Nos. 
26207 (Oct. 14, 2003) [68 FR 59954 (Oct. 20, 2003)] (notice) and 
26251 (Nov. 10, 2003) (order).
---------------------------------------------------------------------------

    Two commenters requested that we provide an exemption from section 
17(d) and rule 17d-1 for affiliated arrangements that rely upon rule 
12d1-4, or otherwise comply with section 12(d).\89\ We decline to do 
so. Section

[[Page 73933]]

17(d) and rule 17d-1 prohibit first- and second-tier affiliates of a 
fund, the fund's principal underwriters, and affiliated persons of the 
fund's principal underwriters, acting as principal, from effecting any 
transaction in which the fund or a company controlled by the fund is a 
joint or a joint and several participant.\90\ They are designed to 
prevent these persons from managing the fund for their own benefit, 
rather than for the benefit of the fund's shareholders. Unlike section 
17(a) relief, our fund of funds orders do not currently include 
exemptions from section 17(d) and rule 17d-1.\91\ Further, given the 
fact-specific nature of many rule 17d-1 applications, and the fact that 
we do not normally provide such relief as part of our fund of funds 
exemptive orders, we believe it is appropriate to address requests for 
relief from section 17(d) and rule 17d-1 separately from rule 12d1-4. 
Fund of funds arrangements within the statutory limits of section 
12(d)(1) may apply separately for relief through an application for an 
order under rule 17d-1 under the Act.
---------------------------------------------------------------------------

    \89\ See SIFMA AMG Comment Letter; PIMCO Comment Letter. Section 
17(d) of the Act makes it unlawful for first- and second-tier 
affiliates of a fund, the fund's principal underwriters, and 
affiliated persons of the fund's principal underwriters, acting as 
principal, to effect any transaction in which the fund or a company 
controlled by the fund is a joint or a joint and several participant 
in contravention of such rules and regulations as the Commission may 
prescribe for the purpose of limiting or preventing participation by 
such registered or controlled company on a basis different from or 
less advantageous than that of such other participant. See 15 U.S.C. 
80a-17(d). Rule 17d-1(a) prohibits first- and second-tier affiliates 
of a fund, the fund's principal underwriter, and affiliated persons 
of the fund's principal underwriter, acting as principal, from 
participating in or effecting any transaction in connection with any 
joint enterprise or other joint arrangement or profit-sharing plan 
in which any such fund or company controlled by a fund is a 
participant ``unless an application regarding such joint enterprise, 
arrangement or profit-sharing plan has been filed with the 
Commission and has been granted.''
    \90\ First-tier affiliates are investment companies and their 
affiliated persons. Second-tier affiliates are affiliated persons of 
their affiliated persons.
    \91\ In the past, some fund of funds exemptive orders included 
relief from section 17(d) and rule 17d-1 for certain service 
arrangements. See, e.g., T. Rowe Spectrum Order, supra footnote 86.
---------------------------------------------------------------------------

C. Conditions

    Consistent with the public interest and the protection of 
investors, 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 the conditions in prior fund of funds exemptive 
orders \92\ and commenters' suggestions. The rule establishes a 
framework that will subject fund of funds arrangements to a tailored 
set of conditions that address differences in fund structures.\93\ The 
following table sets forth a general overview of the differences among 
the conditions under our current exemptive relief, proposed rule 12d1-
4, and the final rule:
---------------------------------------------------------------------------

    \92\ Schwab, supra footnote 23; Innovator ETFs, supra footnote 
32.
    \93\ For example, the conditions regarding layering of fees vary 
based on the structure of acquiring fund. See infra section 
II.C.2.b.i.

----------------------------------------------------------------------------------------------------------------
                                     Condition under existing
         Concern addressed               exemptive orders       Proposed rule condition    Final rule condition
----------------------------------------------------------------------------------------------------------------
Undue Influence....................  Voting conditions         Voting conditions do not  Voting conditions
                                      (including the point at   differ based on the       (including the point
                                      which the voting          type of acquired fund     at which the voting
                                      condition is triggered)   and would require an      condition is
                                      differ based on the       acquiring fund and its    triggered) differ
                                      type of acquired fund.    advisory group to use     based on the type of
                                     Once an acquiring fund     pass-through or mirror    acquired fund. Voting
                                      (and any other funds      voting when they hold     conditions will
                                      within the advisory       more than 3% of the       require an acquiring
                                      group) holds more than    acquired fund's           fund and its advisory
                                      3% of the acquired        outstanding voting        group to use mirror
                                      closed-end fund's         securities.               voting when they hold
                                      outstanding voting                                  more than: (i) 25% of
                                      securities, the                                     the outstanding voting
                                      acquiring fund must                                 securities of an open-
                                      vote shares of acquired                             end fund or UIT due to
                                      closed-end funds in the                             a decrease in the
                                      manner required by                                  outstanding securities
                                      section 12(d)(1)(E)                                 of the acquired fund;
                                      (i.e., either pass-                                 or (ii) 10% of the
                                      through or mirror                                   outstanding voting
                                      voting), while non-fund                             securities of a closed-
                                      entities within the                                 end fund. In
                                      advisory group must use                             circumstances where
                                      mirror voting.                                      acquiring funds are
                                     For acquired open-end                                the only shareholders
                                      funds or UITs, an                                   of an acquired fund,
                                      acquiring fund (and its                             however, pass-through
                                      advisory group) must                                voting may be used.
                                      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.
                                     Fund boards must make     An acquiring fund's       Requires a fund of
                                      certain findings and      ability to quickly        funds investment
                                      adopt procedures to       redeem or tender a        agreement between
                                      prevent overreaching      large volume of           acquiring and acquired
                                      and undue influence by    acquired fund shares is   funds unless they have
                                      the acquiring fund and    restricted (replacing     the same investment
                                      its affiliates.           the requirements for      adviser that includes
                                     Requires an agreement      participation             any material terms
                                      between acquiring and     agreements and board      necessary for each
                                      acquired funds agreeing   findings/procedures).     adviser to make the
                                      to fulfill their                                    appropriate finding
                                      responsibilities under                              under the rule, a
                                      the exemptive order (a                              termination provision,
                                      ``participation                                     and a requirement that
                                      agreement'').                                       the acquired fund
                                                                                          provide fee and
                                                                                          expense information to
                                                                                          the acquiring fund.
Complex Structures.................  Limits the ability of an  Limits the ability of     Adviser(s) of acquiring
                                      acquired fund to invest   funds relying on          and acquired funds
                                      in underlying funds       certain exemptions to     that are management
                                      (that is, it limits       invest in an acquiring    companies must make
                                      structures with three     fund and limits the       certain findings
                                      or more tiers of          ability of an acquired    regarding the fund of
                                      funds), subject to        fund to invest in other   funds structure.
                                      certain enumerated        funds, subject to        The principal
                                      exceptions.               certain enumerated        underwriter or
                                                                exceptions.               depositor of a UIT
                                                               Requires an evaluation     must analyze the fund
                                                                of the complexity of      of funds structure and
                                                                the fund of funds         determine that the
                                                                structure and aggregate   arrangement does not
                                                                fees. Specific            result in duplicative
                                                                considerations vary by    fees.
                                                                acquiring fund           Allows an acquired fund
                                                                structure.                to invest up to an
                                                                                          additional 10% of its
                                                                                          assets in other funds.

[[Page 73934]]

 
Layering of Fees...................  Caps sales charges and    Requires an evaluation    Generally the same as
                                      service fees at limits    of the complexity of      proposed, but the
                                      under current FINRA       the fund of funds         investment adviser to
                                      sales rule (rule 2341)    structure and aggregate   an acquiring
                                      even in circumstances     fees. For management      management company
                                      where the rule would      companies, the adviser    must find that the
                                      not otherwise apply.      must determine that it    aggregate fees and
                                     Requires an acquiring      is in the best interest   expenses are not
                                      fund's adviser to waive   for the acquiring fund    duplicative.
                                      advisory fees in          to invest.
                                      certain circumstances
                                      or requires the
                                      acquiring fund's board
                                      to make certain
                                      findings regarding
                                      advisory fees.
----------------------------------------------------------------------------------------------------------------

    The conditions in rule 12d1-4 as adopted are substantially similar 
to the conditions that have been included in our exemptive orders since 
1999.\94\ We discuss each of the conditions below.
---------------------------------------------------------------------------

    \94\ See, e.g., Schwab, supra footnote 23.
---------------------------------------------------------------------------

1. Control and Voting
a. Control
    In order to address concerns that a fund could exert undue 
influence over another fund, as proposed, rule 12d1-4 will prohibit an 
acquiring fund and its advisory group from controlling, individually or 
in the aggregate, an acquired fund, except in the circumstances 
discussed below.\95\ This condition generally comports with the 
conditions of the exemptive relief the Commission has previously 
issued.\96\
---------------------------------------------------------------------------

    \95\ See rule 12d1-4(b)(1)(i); rule 12d1-4(d) (defining 
``advisory group''). See also infra section II.C.1.b.iii. 
(discussing exceptions to the control condition)].
    \96\ 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).
---------------------------------------------------------------------------

    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.\97\ 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 any 
person who does not own that amount does not control it.\98\ A 
determination of control is not based solely on ownership of voting 
securities of a company and depends on the facts and circumstances of 
the particular situation.\99\ 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.\100\
---------------------------------------------------------------------------

    \97\ 15 U.S.C. 80a-2(a)(9).
    \98\ 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.
    \99\ ``[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.
    \100\ See 2018 FOF Proposing Release, supra footnote 6, at 32-
33, nn.81-82 (discussing facts and circumstances that may constitute 
controlling influence).
---------------------------------------------------------------------------

    We proposed that an acquiring fund and its advisory group could not 
control (individually or in the aggregate) an acquired fund. 
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 not to constitute control over the acquired fund. The 
acquiring fund, 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 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), the acquiring fund and other funds in its advisory 
group would not be able to rely on the rule even if the fund and its 
advisory group owned 25% or less of the acquired fund's voting 
securities.
    Commenters generally supported using the concept of ``control'' as 
defined under the Act to guard against potential coercive behavior by 
an acquiring fund, and agreed that this condition is consistent with 
the conditions of existing exemptive relief.\101\ One commenter stated 
that the proposed control provision protects acquired funds from undue 
influence concerns without disrupting investment strategies or creating 
difficult compliance requirements.\102\ We also received more 
particularized comments relating to control of closed-end funds, as 
discussed below.
---------------------------------------------------------------------------

    \101\ See, e.g., ICI Comment Letter; BlackRock Comment Letter.
    \102\ Invesco Comment Letter.
---------------------------------------------------------------------------

    Reflecting these comments, rule 12d1-4 will prohibit an acquiring 
fund and its advisory group from acquiring, and therefore exercising, 
control over an acquired fund as proposed.\103\ We believe this 
condition will limit a fund's ability to exert undue influence over 
another fund.\104\ As discussed in more detail below, we addressed 
commenters' concerns regarding undue influence of acquired closed-end 
funds by imposing a lower ownership threshold that triggers the rule's 
voting conditions for such funds, and by requiring mirror voting when 
an acquiring fund exceeds the threshold.
---------------------------------------------------------------------------

    \103\ Like the limits under section 12(d)(1) of the Act, rule 
12d1-4's control limitation is an acquisition test. In some 
circumstances, an acquiring fund's holdings may trigger the Act's 
control presumption through no action of its own. For example, 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 net redemptions and a decrease in the outstanding voting 
securities of the acquired fund, the rule does not require the 
acquiring fund to dispose of acquired fund shares. However, the 
acquiring fund and other entities within its advisory group may not 
rely on the rule to acquire additional securities of the acquired 
fund when the acquiring fund and other entities within its advisory 
group, in the aggregate, hold more than 25% of the acquired fund's 
voting securities.
    \104\ If an acquiring fund has a controlling influence over an 
acquired fund's management or policies, the acquiring 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.
---------------------------------------------------------------------------

i. Advisory Group Definition
    The rule will require an acquiring fund to aggregate its investment 
in an acquired fund with the investment of the acquiring fund's 
advisory group to assess control as proposed.\105\ This aggregation 
requirement is consistent with past exemptive orders and is designed to 
prevent a fund or adviser from circumventing the control condition by 
investing in an acquired fund through multiple controlled

[[Page 73935]]

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

    \105\ See rule 12d1-4(d) defining ``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 
rule, an acquiring fund would not combine the entities listed in 
clause (1) with those in clause (2).
---------------------------------------------------------------------------

    Commenters recommended that the Commission alter its definition of 
``advisory group'' or revisit the requirement to aggregate affiliated 
entities for purposes of determining control.\106\ For example, several 
commenters suggested that we adopt a narrower definition of ``advisory 
group,'' stating that an acquiring fund's investment adviser or 
depositor may not direct the investments of the affiliates that fall 
within the proposed definition of ``advisory group,'' and in fact could 
be unaware of investments by such affiliates.\107\ One of these 
commenters stated that this definition of advisory group could be 
particularly problematic for large financial services organizations 
that have many affiliates under common control, but that operate 
independently.\108\ Some commenters recommended that the aggregation 
requirement exclude affiliates that are not subject to actual control 
by the investment adviser or exclude certain control affiliates where 
there are information barriers or other limits.\109\ One commenter 
stated that section 12(d)(1)(A) of the Act does not require an 
investment adviser to aggregate holdings across its private funds for 
purposes of determining control and suggested that rule 12d1-4 follow a 
similar approach.\110\ This commenter suggested that the Commission 
instead prevent an acquiring fund from seeking to exert control over an 
acquired fund by including a general provision in the rule prohibiting 
an entity from doing anything indirectly which, if done directly, would 
violate the rule.
---------------------------------------------------------------------------

    \106\ See, e.g., ICI Comment Letter; BlackRock Comment Letter. 
Another commenter generally supported a requirement that funds 
advised by the same adviser cannot in the aggregate hold in excess 
of 3% of the outstanding voting securities of a given acquired fund. 
Comment Letter of General American Investors Company, Inc. (May 2, 
2019).
    \107\ ICI Comment Letter; ABA Comment Letter; Voya Comment 
Letter.
    \108\ ICI Comment Letter (noting that many affiliates may have 
firewall restrictions that prevent the affiliates from coordinating 
their investments).
    \109\ See, e.g., ABA Comment Letter; SIFMA AMG Comment Letter; 
Dechert Comment Letter. One commenter further suggested that the 
Commission clarify that a feeder fund that invests in an acquired 
fund in reliance on Section 12(d)(1)(E) should not be included in 
the advisory group's ownership calculation, noting that a feeder 
fund is already required to use pass-through or mirror voting 
pursuant to 12(d)(1)(E)(iii)(aa). Comment Letter of Capital Research 
and Management Company (May 2, 2019) (``Capital Group Comment 
Letter'').
    \110\ MFA Comment Letter.
---------------------------------------------------------------------------

    On the other hand, some commenters suggested that the Commission 
should adopt a broader definition of advisory group than proposed.\111\ 
Specifically, these commenters recommended that the Commission expand 
the aggregation requirement to include all accounts managed by the 
acquiring fund's adviser, subadviser or their respective affiliates.
---------------------------------------------------------------------------

    \111\ Advent Comment Letter; Comment Letter of Skadden, Arps, 
Slate, Meagher & Flom LLP (May 2, 2019) (``Skadden Comment 
Letter'').
---------------------------------------------------------------------------

    Upon considering the comments received, we continue to believe 
requiring an acquiring fund to aggregate its holdings with its advisory 
group will help prevent a fund or adviser from circumventing the 
control condition. Because the control condition effectively allows an 
acquiring fund and its advisory group to obtain a significant ownership 
stake in an acquired fund by investing through multiple related 
entities, we believe it is appropriate to subject all of the affiliates 
in an advisory group to this condition. 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 definition of the term 
``advisory group.'' \112\
---------------------------------------------------------------------------

    \112\ See, e.g., Symmetry Panoramic Trust and Symmetry Partners, 
LLC, Investment Company Act Release Nos. 33317 (Dec. 6, 2018) [83 FR 
63918 (Dec. 12, 2018)] (notice) and 33364 (Feb. 1, 2019) (order) and 
related application.
---------------------------------------------------------------------------

    We acknowledge that the definition of ``advisory group'' may 
capture many affiliates of an acquiring fund and its investment adviser 
in a complex financial services firm, and will result in monitoring and 
compliance burdens that are greater than if the definition only looked 
to the holdings of an acquiring fund and its adviser. To the extent 
that a particular advisory group has not already established policies 
and procedures pursuant to an exemptive order, we also acknowledge that 
the advisory group may need to restructure information barriers to 
permit entities within the advisory group to share the necessary 
information to comply with the rule. However, other provisions of the 
Act and our rules also extend to affiliated persons of an investment 
adviser.\113\ These provisions apply to affiliated persons, regardless 
of the complexity that may arise because of the way in which a 
financial services firm has determined to structure itself. Funds (and 
their advisers) have experience developing compliance policies and 
procedures in those circumstances.\114\ We believe that requiring the 
entities that fall within this definition to aggregate their holdings 
in an acquired fund for purposes of the control condition will more 
effectively address the risk of undue influence over an acquired fund.
---------------------------------------------------------------------------

    \113\ 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 68 and accompanying text.
    \114\ 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 Rule Adopting Release, supra footnote 59 (noting that 
funds or their advisers should have policies and procedures in place 
to identify affiliated persons and to prevent unlawful transactions 
with them).
---------------------------------------------------------------------------

    The breadth of entities that are included within an advisory group 
will reduce the risk that an acquiring fund and its advisory group will 
exert undue influence over an acquired fund by accumulating a 
controlling ownership position across the advisory group's accounts. We 
believe that the condition's definition of advisory group strikes an 
appropriate balance between the flexibility for efficient market 
activity and protection of acquired funds and their shareholders.
    Additionally, we continue to believe that the advisory group 
definition should not encompass funds managed by unaffiliated sub-
advisers. Absent common control, there is little risk that an advisory 
group and sub-advisory group would coordinate to exert undue influence 
on an acquired fund.\115\ Consistent with past exemptive orders, 
therefore, rule 12d1-4 will not require an acquiring fund to aggregate 
the ownership of an acquiring fund advisory group with an acquiring 
fund sub-advisory group. Instead, each of these groups will consider 
its ownership percentage separately and will be subject to the voting 
provisions as discussed below.\116\
---------------------------------------------------------------------------

    \115\ However, if the 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, 
then the sub-advisory group and advisory group will be required to 
aggregate their ownership for purposes of determining control 
pursuant to rule 12d1-4(b)(1)(i).
    \116\ See rule 12d1-4(b)(1)(ii).
---------------------------------------------------------------------------

ii. Closed-End Funds
    Rule 12d1-4 will include voting requirements specific to acquired 
closed-end funds in response to concerns raised by commenters with 
respect to undue influence over closed-end funds.\117\ The proposed 
rule included voting requirements, as described in section II.C.1.b 
below, and would have required that an acquiring

[[Page 73936]]

fund and its advisory group not control (individually or in the 
aggregate) any acquired fund, whether open-end or closed-end.\118\ As 
discussed above, the rule 12d1-4 control prohibition also applies if 
facts and circumstances exist that give an acquiring fund and its 
advisory group the power to exercise a controlling influence over an 
acquired closed-end fund's management or policies, even if the 
acquiring fund and its advisory group owned 25% or less of the acquired 
closed-end fund's voting securities.\119\
---------------------------------------------------------------------------

    \117\ These voting conditions will also apply to voting of 
shares of acquired BDCs. See rule 12d1-4(b)(1)(ii).
    \118\ Proposed rule 12d1-4(b)(1).
    \119\ See 2018 FOF Proposing Release, supra footnote 6, at 32-
33.
---------------------------------------------------------------------------

    In the 2018 FOF Proposing Release, we requested comment on whether 
the rule's control and voting requirements should vary depending on the 
type of acquired fund, including whether there should be a lower or 
higher threshold for closed-end funds, and whether the threshold should 
differ for listed and unlisted closed-end funds.\120\ As adopted, the 
rule does not impose a lower investment limit on investments in a 
closed-end fund by an acquiring fund and its advisory group; however, 
the rule will impose a mirror-voting requirement at a lower ownership 
threshold than the voting requirements applicable to open-end funds and 
UITs. Specifically, the rule will require mirror voting if an acquiring 
fund and its advisory group hold more than 10% of the voting securities 
of a closed-end fund. This voting requirement is designed to protect an 
acquired closed-end fund from undue influence through the shareholder 
vote mechanism. In addition, the rule will require an acquiring fund to 
enter into a fund of funds investment agreement with an acquired fund 
prior to exceeding the investment limits set forth in section 12(d)(1). 
Together, these provisions are designed to protect acquired closed-end 
funds from undue influence by acquiring funds and their advisory 
groups.
---------------------------------------------------------------------------

    \120\ Id. at 45. We requested comment on whether the proposed 
control and voting conditions sufficiently protect acquired funds, 
and whether there may be other conditions that would address the 
potential for undue influence by an acquiring fund and its 
controlling persons, including a lower limit on investments by an 
acquiring fund and its advisory group in an acquired fund. Id. at 
43.
---------------------------------------------------------------------------

    Several commenters recommended alternatives to the proposed control 
condition for fund of funds arrangements with acquired closed-end 
funds. For example, commenters recommended that, instead of relying on 
the concept of ``control'' for acquired closed-end funds, rule 12d1-4 
should limit the aggregate ownership by an acquiring fund and its 
advisory group to 10% of an acquired closed-end fund's voting 
securities in order to protect these funds from undue influence.\121\ 
One commenter stated that an acquiring fund that holds approximately 
15% of an acquired closed-end fund could dictate certain actions of the 
acquired closed-end fund.\122\ The commenter also recommended expanding 
the definition of advisory group and requiring an acquiring fund (and 
the expanded advisory group) to reduce its holdings in an acquired fund 
to less than 25% within a defined period of time in order to discourage 
activist investors from increasing their holdings in target funds just 
prior to effectiveness of the rule.\123\
---------------------------------------------------------------------------

    \121\ Advent Comment Letter; Comment Letter of TPG Specialty 
Lending, Inc. (May 2, 2019) (``TPG Comment Letter.'').
    \122\ Advent Comment Letter (stating that holdings below the 25% 
level result in the type of undue influence the Commission is 
seeking to prevent, such as a large holder being able to dictate 
various events including the initiation of a proxy contest). See 
also PIMCO Comment Letter (recommending that, if private funds and 
foreign funds are permitted to rely on the rule, such funds must act 
within the limits of section 12(d)(1)(C) as if they were registered 
funds); Skadden Comment Letter; ICI Comment Letter. Section 
12(d)(1)(C) prohibits funds (together with companies or funds they 
control and funds that have the same adviser) from acquiring more 
than 10% of the outstanding voting stock of a closed-end fund. 15 
U.S.C. 80a-12(d)(1)(C).
    \123\ Advent Comment Letter.
---------------------------------------------------------------------------

    Two commenters encouraged the Commission to allow acquired funds 
and their boards, at their option, to set their own limit for an 
acquiring fund's investments.\124\ These commenters suggested that an 
agreement between an acquiring and acquired fund (similar to a 
participation agreement under current fund of funds exemptive relief) 
could allow the acquired fund and its board to evaluate the effects of 
the acquiring fund's investment, including any risks of undue 
influence, and set an appropriate limit.\125\ Similarly, commenters 
suggested that the rule should provide acquired funds with the ability 
to grant consent to potential investments by acquiring funds, 
effectively permitting acquired funds to screen their investors and 
refuse investments by acquiring funds based on undue influence 
concerns.\126\
---------------------------------------------------------------------------

    \124\ Dimensional Comment Letter (noting that a higher 
discretionary investment limit might be beneficial for a newly 
formed or smaller fund that seeks large investments by acquiring 
funds in order to achieve economies of scale); Advent Comment Letter 
(explaining that an acquired fund might use a participation 
agreement to permit an acquiring fund to purchase more than 10% of 
its voting securities, and the participation agreement can require 
passive investment).
    \125\ Dimensional Comment Letter, Advent Comment Letter.
    \126\ ABA Comment Letter; AIC Comment Letter; Dimensional 
Comment Letter (explaining that the participation agreement 
requirement of existing exemptive relief has been helpful for a 
potential acquired fund to refuse large investments by an acquiring 
fund that may present a risk of undue influence, and recommending 
the preservation of such a control).
---------------------------------------------------------------------------

    Other commenters suggested the Commission adopt a passive investor 
certification and reporting regime similar to that under Section 13 of 
the Securities Exchange Act of 1934 and Schedules 13D and 13G to 
protect acquired closed-end funds against undue influence.\127\ Under 
such a regime, an acquiring fund would certify to the Commission, or 
would only be able to operate in accordance with rule 12d1-4, if it 
holds the acquired fund's securities in the ordinary course of business 
and not for the purpose of or with the effect of changing or 
influencing the management or policies of the acquired fund. Commenters 
representing closed-end funds or their investors also recommended that, 
if rule 12d1-4 were to permit private funds to acquire closed-end 
funds, it should incorporate additional protections specific to closed-
end funds.\128\
---------------------------------------------------------------------------

    \127\ Skadden Comment Letter; BlackRock Comment Letter.
    \128\ See, e.g., Comment Letter of Nuveen, LLC (May 2, 2019) 
(``Nuveen Comment Letter''); SIFMA AMG Comment Letter; PIMCO Comment 
Letter; Skadden Comment Letter; Voya Comment Letter; Guggenheim 
Comment Letter; Advent Comment Letter.
---------------------------------------------------------------------------

    Rule 12d1-4, as adopted, will prohibit an acquiring fund and its 
advisory group from exercising control over an acquired closed-end fund 
and will impose a mirror-voting requirement if an acquiring fund and 
its advisory group hold more than 10% of the voting securities of a 
closed-end fund.\129\ We believe these conditions will more effectively 
address undue influence concerns regarding acquired closed-end funds 
than a reporting or certification requirement on acquiring funds, and 
they will avoid potential duplicative reporting requirements on certain 
acquiring funds.\130\
---------------------------------------------------------------------------

    \129\ See rule 12d1-4(b)(1). This voting requirement applies at 
a 10% ownership threshold, while 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.
    \130\ See, e.g., Part C of Form N-PORT (requiring monthly 
disclosure of certain registered management investment companies' 
portfolio holdings, including disclosure of investments in other 
investment companies).
---------------------------------------------------------------------------

    As an additional protective condition, discussed below in section 
II.C.2, the rule will require an acquiring fund and an acquired closed-
end fund that do not share an investment adviser to enter into a fund 
of funds investment agreement prior to the acquiring fund exceeding the 
investment limits of section 12(d)(1)(A). This agreement will

[[Page 73937]]

enable an acquired closed-end fund to screen potential acquiring fund 
investors and set conditions on investments in the acquired fund, if 
desired. The agreement also will allow an acquired closed-end fund to 
terminate the agreement with an acquiring fund without penalty, which 
would then prohibit the acquiring fund from making additional purchases 
of the acquired fund beyond the section 12(d)(1)(A) limits.
    Rule 12d1-4 also includes voting requirements specific to closed-
end funds that preserve voting discretion for investment advisers below 
a specified threshold of ownership, while seeking to avoid amplifying 
the voting power of any particular investor.\131\ These voting 
requirements are described in the section below. Finally, because 
private funds will not be permitted to rely on the rule as acquiring 
funds, we are not adopting any specific conditions associated with 
private fund investments in closed-end funds under rule 12d1-4.
---------------------------------------------------------------------------

    \131\ See infra section II.C.1.b.
---------------------------------------------------------------------------

    In addition to comments on closed-end fund issues under the rule, 
several commenters raised general concerns about private fund 
investments in closed-end funds that are outside the scope of rule 
12d1-4.\132\ These commenters stated that there have been instances in 
which an investment adviser to several private funds (each with less 
than 3% of the outstanding voting shares of a closed-end fund) acquired 
a significant aggregate interest in an acquired closed-end fund and 
sought to unduly influence the fund to the detriment of long-term 
shareholders through proxy contests or other means.\133\ The commenters 
recommended various ways to address these private fund investments in 
closed-end funds under section 12(d)(1). For example, these commenters 
recommended that the Commission: (i) Recommend legislation to deem any 
private fund an ``investment company'' for purposes of section 
12(d)(1)(C) of the Act; \134\ (ii) extend the 3% limit of section 
12(d)(1)(A)(i) to any separate accounts for which an advisory group has 
sole or shared voting or disposition authority; \135\ (iii) deem 
ownership of more than 3% of a registered fund by a private fund 
advisory group to be a violation of section 12(d)(1)(A)(i) pursuant to 
section 48(a) of the Act; \136\ or (iv) treat affiliated private funds 
that ``are not materially different in investment operations or 
investment policies'' as a single fund for purposes of section 
12(d)(l).\137\
---------------------------------------------------------------------------

    \132\ See, e.g., Comment Letter of Center for Capital Markets 
Competitiveness, U.S. Chamber of Commerce (May 2, 2019) (``Chamber 
of Commerce Comment Letter'') (recommending that the Commission 
review existing rules to address ``regulatory loopholes'' related to 
fund of funds structures and ownership thresholds); Comment Letter 
of Anthony S. Colavita (Apr. 30, 2019); Comment Letter of Anthonie 
van Ekris (Apr. 30, 2019); Comment Letter of Kinchen C. Bizzel (May 
2, 2019); Comment Letter of Salvatore Subblells (May 2, 2019); 
Comment Letter of Peter Baldino (May 2, 2019); Comment Letter of 
Clarence A. Davis (May 2, 2019). See 2018 FOF Proposing Release, 
supra footnote 6, at n. 95 and accompanying text.
    \133\ See, e.g., Advent Comment Letter; Skadden Comment Letter; 
ICI Comment Letter; Comment Letter of Gabelli Funds, LLC (Apr. 30, 
2019) (``Gabelli Comment Letter''); Nuveen Comment Letter. One 
commenter requested that the Commission analyze private funds' 
actual capacity for exercising voting control, as well as indirect 
forms of influence, over an acquired closed-end fund. Great American 
Comment Letter.
    \134\ ICI Comment Letter; Comment Letter of Calamos Investments 
LLC (May 2, 2019) (``Calamos Comment Letter''); Nuveen Comment 
Letter; Dechert Comment Letter; Voya Comment Letter; Guggenheim 
Comment Letter. See also Gabelli Comment Letter (recommending that 
the Commission seek legislative changes to create a private right of 
action to enforce rules relating to activist investment in closed-
end funds).
    \135\ Gabelli Comment Letter.
    \136\ Advent Trustees Comment Letter; Gabelli Comment Letter; 
Advent Comment Letter; Skadden Comment Letter.
    \137\ Skadden Comment Letter.
---------------------------------------------------------------------------

    On the other hand, some commenters opposed restrictions on private 
fund investments in closed-end funds under section 12(d)(1).\138\ These 
commenters stated that private funds invest in closed-end funds in 
accordance with the relevant provisions of the Act. In addition, one 
commenter stated that Congress did not impose more restrictive limits 
on the ability of private funds to acquire equity stakes in regulated 
funds when it amended the Act to subject private funds to the 
restrictions of sections 12(d)(1)(A)(i) and 12(d)(1)(B)(i).\139\
---------------------------------------------------------------------------

    \138\ Comment Letter of Saba Capital Management, L.P. (May 1, 
2019) (``Saba Comment Letter''); Comment Letter of City of London 
Investment Management Co Ltd (May 2, 2019) (``City of London Comment 
Letter''); Comment Letter of Bulldog Investors, LLC (May 6, 2019) 
(``Bulldog Comment Letter''); TPG Comment Letter.
    \139\ Saba Comment Letter, citing NSMIA at sections 209(a)(1) 
and 209(a)(4)(D) (codified at Sections 3(c)(1) and Section 3(c)(7) 
of the Investment Company Act).
---------------------------------------------------------------------------

    After considering comments, we believe commenters' additional 
recommendations with respect to investments in closed-end funds that 
are within the statutory limitations of section 12(d)(1) are beyond the 
scope of this rulemaking.\140\
---------------------------------------------------------------------------

    \140\ See supra footnotes 133-137 and accompanying text.
---------------------------------------------------------------------------

b. Voting Provisions
    The final rule will require an acquiring fund and its advisory 
group to vote their shares of an acquired fund: (i) Using mirror voting 
if the acquiring fund and its advisory group (in the aggregate) hold 
more than 25% of the outstanding voting securities of an acquired open-
end fund or UIT due to a decrease in the outstanding securities of the 
acquired fund; \141\ and (ii) using mirror voting if the acquiring fund 
and its advisory group (in the aggregate) hold more than 10% of the 
outstanding voting securities of an acquired closed-end fund or 
BDC.\142\ Similar to our exemptive orders, the final rule's voting 
conditions will differ based on the type of acquired fund.
---------------------------------------------------------------------------

    \141\ In circumstances where acquiring funds are the only 
shareholders of an acquired fund, however, pass-through voting may 
be used.
    \142\ Mirror voting requires the fund to vote the shares held by 
it (and, under rule 12d1-4, an acquiring fund's advisory group) in 
the same proportion as the vote of all other holders of the acquired 
fund. In mirror voting, the tabulation agent for the shareholder 
meeting will first tabulate the votes for a proposal and then apply 
the resulting ratio (for/against/abstain) to the shares instructing 
that they are to be mirror voted.
---------------------------------------------------------------------------

    Proposed rule 12d1-4 would have required 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.\143\ The proposed rule would 
have applied a uniform condition across all types of acquired funds to 
simplify and streamline the requirement. Commenters generally supported 
the proposed voting conditions, stating that they protect acquired 
funds without disrupting current investment strategies or creating new 
or difficult compliance requirements.\144\ As discussed in more detail 
below, however, some commenters suggested modifications to the 
ownership threshold that would trigger the voting condition or the 
required manner of voting, based on the type of acquired fund.\145\
---------------------------------------------------------------------------

    \143\ Proposed rule 12d1-4(b)(1)(ii). Section 
12(d)(1)(E)(iii)(aa) of the Act requires an acquiring fund to 
either: (i) Seek voting instructions from its security holders and 
vote such proxies in accordance with their instructions (``pass-
through voting''); or (ii) use mirror voting.
    \144\ Invesco Comment Letter; CFA Comment Letter (specifically 
supporting the application of the voting condition to an acquiring 
fund and its advisory group).
    \145\ See Invesco Comment Letter; CFA Comment Letter, WisdomTree 
Comment Letter; IPA Comment Letter; Advent Comment Letter; Skadden 
Comment Letter; FS Comment Letter; ABA Comment Letter.
---------------------------------------------------------------------------

    We believe that the voting conditions of the final rule, which we 
modified to respond to the concerns expressed in these comments, will 
help to facilitate compliance monitoring and are better

[[Page 73938]]

tailored to address the potential for undue influence through voting 
power based on the types of acquired fund.
i. Ownership Threshold
    The final rule will impose voting conditions if an acquiring fund 
and its advisory group hold more than 25% of the voting securities of 
an acquired open-end fund or UIT due to a decrease in the outstanding 
voting securities of the acquired fund.\146\ For acquired BDCs and 
other closed-end funds, the rule will impose voting conditions at a 10% 
ownership threshold. The proposed rule included a 3% ownership 
threshold that would trigger the rule's voting conditions, and we 
requested comment on whether that ownership threshold should be higher 
or lower, and whether it should differ depending on the type of 
acquired fund.\147\
---------------------------------------------------------------------------

    \146\ Rule 12d1-4(b)(1)(ii).
    \147\ 2018 FOF Proposing Release, supra footnote 6, at 45.
---------------------------------------------------------------------------

    A number of commenters recommended raising the 3% ownership 
threshold that would trigger the voting conditions in the proposed 
rule, stating that a 3% threshold would substantially increase the 
administrative burden on an advisory group to monitor and vote 
shares.\148\ For example, some commenters recommended the rule raise 
the ownership threshold from the proposed 3% to 10% to better reflect 
an ownership level at which an acquiring fund would be able to 
influence a shareholder vote.\149\ One commenter argued that the rule 
should allow acquiring funds to hold larger positions in closed-end 
funds without forfeiting the right to exercise their independent 
judgment regarding shareholder proposals to ameliorate certain 
unintended consequences associated with a lower threshold.\150\
---------------------------------------------------------------------------

    \148\ Comment Letter of Charles Schwab Investment Management 
(May 2, 2019) (``Schwab Comment Letter''); Voya Comment Letter. But 
see SIFMA AMG Comment Letter (``[T]he voting and control provisions 
do not create significant operational challenges for funds and . . . 
they may prove to be an unobtrusive means to address some of 
Congress's concerns relating to voting control . . .'').
    \149\ MFA Comment Letter; Nuveen Comment Letter. But see Advent 
Comment Letter (stating that an acquiring fund that holds 
approximately 15% of an acquired fund can dictate certain actions of 
the acquired fund).
    \150\ SIFMA AMG Comment Letter (``AMG has observed that activist 
firms are utilizing multiple private funds to acquire significant 
positions in CEFs, but such private funds would not be subject to 
the Proposed Rule. In contrast, registered funds investing in CEFs 
would be subject to this voting condition. Therefore, such 
registered funds would likely mirror vote shares held in any CEF 
subject to the voting condition. This would have the effect of 
increasing the voting power of activist firms . . . We believe the 
Commission could mitigate this concern by increasing the percentage 
beyond which an acquiring fund and its advisory group are required 
to mirror or pass-through vote.'').
---------------------------------------------------------------------------

    Several commenters recommended that the rule adopt the voting 
triggers set forth in exemptive orders.\151\ These commenters stated 
that current exemptive orders only impose voting requirements when a 
fund and its advisory group hold, in aggregate, more than 25% of the 
outstanding voting securities of an acquired open-end fund or UIT. They 
also noted that open-end funds and UITs may not be particularly 
susceptible to influence by shareholder votes because they do not hold 
routine shareholder meetings. Accordingly, these commenters stated that 
there was little practical or policy justification to impose voting 
requirements at a 3% ownership threshold on shares of acquired open-end 
funds and UITs.\152\ In contrast, these commenters stated that closed-
end funds may be required to hold annual shareholder meetings and can 
be the target of proxy contests, which may make such funds more 
susceptible to influence by shareholder vote. Commenters addressing the 
closed-end fund market segment generally recommended that the 
Commission adopt a lower voting threshold for acquiring funds' holdings 
in closed-end funds than the threshold for acquiring funds' holdings in 
open-end funds and UITs.\153\
---------------------------------------------------------------------------

    \151\ Schwab Comment Letter; SIFMA AMG Comment Letter; ICI 
Comment Letter; ABA Comment Letter.
    \152\ ICI Comment Letter; Voya Comment Letter; Schwab Comment 
Letter.
    \153\ See, e.g., Nuveen Comment Letter, SIFMA AMG Comment 
Letter.
---------------------------------------------------------------------------

    After considering the comments received, we believe that it is 
appropriate that the final rule include voting requirements for 
investments in open-end funds and UITs that are consistent with the 
voting requirements imposed by prior exemptive orders in this area. We 
are persuaded that the 25% ownership threshold is appropriate for open-
end funds and UITs given that these funds hold shareholder meetings 
infrequently, and because commenters did not raise concerns about undue 
influence of these funds through shareholder voting. The rule's voting 
conditions therefore will apply to the same scope of entities in an 
acquiring fund's advisory group as the voting conditions in our 
existing fund of funds exemptive orders. A 25% ownership threshold will 
also minimize the administrative burden associated with the voting 
requirement for these funds.\154\ Accordingly, the final rule will 
require mirror voting if an acquiring fund and its advisory group hold 
more than 25% of the voting securities of an open-end fund or UIT. We 
expect an acquiring fund would only exceed 25% of the securities of an 
open-end fund or UIT due to a decrease in the outstanding voting 
securities of the acquired fund because the rule prohibits an acquiring 
fund from controlling an acquired fund and because of the rebuttable 
presumption regarding control under the Act.\155\
---------------------------------------------------------------------------

    \154\ Since our existing fund of funds exemptive orders 
currently impose voting requirements on an advisory group's holdings 
in an acquired fund, we understand from commenters that some 
advisory groups may already have systems in place to monitor 
holdings at the ``advisory group level'' and engage in mirror voting 
when appropriate or required. See, e.g., Invesco Comment Letter; 
SIFMA AMG Comment Letter. To the extent that an advisory group 
utilizes information barriers and determines to rely on this rule, 
the advisory group may need to update its policies and procedures to 
allow entities across the advisory group to monitor compliance with 
the aggregate ownership thresholds set forth in rule 12d1-4. See, 
e.g., Dechert Comment Letter.
    \155\ 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. The presumption 
of control continues until the Commission makes a final 
determination to the contrary by order either on its own motion or 
on application by an interested person. See 15 U.S.C. 80a-2(a)(9).
---------------------------------------------------------------------------

    However, the rule will impose a 10% ownership threshold on acquired 
closed-end funds. We believe a 10% ownership threshold (an increase 
from the proposed 3% threshold) will permit an acquiring fund and its 
advisory group to gain substantial exposure to such funds with full 
voting discretion, but will reduce undue influence concerns associated 
with shareholder votes, which are greater for acquired closed-end funds 
than for other types of acquired funds given the more frequent 
shareholder meetings.\156\ We are concerned that a higher threshold for 
acquiring fund investments in closed-end funds, such as 15% or 25%, 
could give an acquiring fund's advisory group the ability to dictate 
certain fund actions and unduly influence the acquired closed-end fund.
---------------------------------------------------------------------------

    \156\ See, e.g., Nuveen Comment Letter (stating that a 10% 
threshold is a reasonable ownership threshold to limit undue 
influence concerns while allowing acquiring funds to hold larger 
positions in closed-end funds without forfeiting the right to 
exercise their independent judgment regarding shareholder 
proposals); MFA Comment Letter (stating that a 10% ownership 
threshold would appropriately balance the need to prevent influence 
of shareholder votes with allowing acquiring funds that do not have 
the ability to influence acquired funds to participate in 
shareholder votes).
---------------------------------------------------------------------------

ii. Mirror Voting
    The final rule will require mirror voting if an acquiring fund and 
its advisory group hold more than (i) 25% of the outstanding voting 
securities of an open-end fund or UIT due to a decrease in the 
outstanding voting securities of the acquired fund or (ii)

[[Page 73939]]

10% of the outstanding voting securities of an acquired BDC or other 
closed-end fund. As described above, the proposed rule would have 
required acquiring funds to use either pass-through or mirror voting if 
the acquiring fund and its advisory group exceeded a set ownership 
threshold, regardless of the type of acquired fund. In the 2018 FOF 
Proposing Release, we requested comment on whether we should adopt the 
voting requirements of the proposed rule, or whether the final rule 
should codify the voting provisions set forth in existing exemptive 
orders.\157\
---------------------------------------------------------------------------

    \157\ 2018 FOF Proposing Release, supra footnote 6 at 45-46.
---------------------------------------------------------------------------

    Several commenters suggested modifications to the proposed voting 
requirement. For example, one commenter generally opposed pass-through 
voting for closed-end fund voting securities because an activist 
acquiring fund and its advisory group would likely vote according to 
the recommendations of its activist investment manager.\158\ This 
commenter suggested that the rule permit pass-through voting of 
investments in an acquired closed-end fund only if required by the 
terms of an adviser's investment advisory contract. Another commenter 
recommended that the rule require an acquiring fund to mirror vote its 
shares of an acquired open-end fund if it controls the acquired 
fund.\159\ The commenter explained that, at a beneficial ownership of 
more than 25% of the voting securities of an acquired open-end fund, 
there is a greater risk that an acquiring fund can exert undue 
influence on the acquired fund and thus the burden of mirror voting 
acquired fund shares is a reasonable trade-off.
---------------------------------------------------------------------------

    \158\ Advent Comment Letter.
    \159\ Voya Comment Letter.
---------------------------------------------------------------------------

    Some commenters stated that the rule's proposed voting requirements 
could conflict with an acquiring fund adviser's fiduciary duty to vote 
underlying fund shares in the best interest of the acquiring fund.\160\ 
These commenters stated that large advisory firms may serve many 
clients with different investment strategies and shareholder voting 
interests, and a voting requirement that applies across an advisory 
group could cause an affiliate of an acquiring fund to be in violation 
of its fiduciary duties under Sections 404(a)(1)(A) and (B) of the 
Employee Retirement Income Security Act of 1974 if forced to adhere to 
the rule's voting requirements. Further, commenters stated that a 
mirror-voting requirement may require an adviser to vote fund holdings 
in a manner that is contrary to its proxy voting policies.\161\
---------------------------------------------------------------------------

    \160\ ICI Comment Letter (stating that there may be shareholder 
proposals, such as merger approvals or changes to fundamental 
investment strategy, for which an adviser believes that neither 
mirror voting nor pass-through voting is in the acquiring fund's or 
shareholders' best interest); Voya Comment Letter. The voting 
conditions are similar to those included in our existing exemptive 
orders.
    \161\ Schwab Comment Letter.
---------------------------------------------------------------------------

    Some commenters expressed concern regarding the effect of the 
required voting procedures for acquired closed-end funds. These 
commenters stated that requiring acquiring funds to use mirror voting 
if they hold more than 3% of an acquired closed-end fund may increase 
the relative voting power of private funds or separate account 
structures that would not rely on rule 12d1-4, and therefore would not 
be subject to the voting requirements of the rule.\162\ These 
commenters noted that mirror voting by an acquiring fund and its 
advisory group at a low ownership threshold could effectively amplify 
the voting position of these types of investors.
---------------------------------------------------------------------------

    \162\ SIFMA AMG Comment Letter (noting that activist investors 
have historically accumulated ownership of closed-end funds through 
separate investments by private funds and separately managed 
accounts); Nuveen Comment Letter.
---------------------------------------------------------------------------

    After considering comments, we believe it is appropriate to require 
acquiring funds and their advisory group to use mirror voting. However, 
in circumstances where rule 12d1-4 or section 12(d)(1) requires all of 
the security holders of an acquired fund to engage in mirror voting, 
and it would not be possible for every shareholder to engage in mirror 
voting, such acquiring funds must use pass-through voting. For example, 
if an acquired fund is offered solely to acquiring funds that rely on 
rule 12d1-4, there may be no other investors to vote the acquired fund 
shares; therefore, under these circumstances, the acquiring fund's 
shares must be ``passed-through'' to the acquiring funds' shareholders 
for voting purposes. We believe requiring an acquiring fund and its 
advisory group to use mirror voting in most cases, with an ownership 
threshold set at 25% for open-end funds and UITs and at 10% for closed-
end funds, will help address the commenters' concerns regarding undue 
influence over acquired funds through shareholder voting.\163\ We 
further believe that requiring an acquiring fund and its advisory group 
to use mirror voting in most cases, without generally providing the 
option for pass-through voting, will simplify operational and 
compliance burdens for acquiring funds and their advisory groups. For 
example, this approach will facilitate compliance monitoring for fund 
groups that have multiple types of acquiring funds. As under our 
existing exemptive orders, we believe an adviser would need to consider 
these voting requirements as a component of its fiduciary duty when 
determining whether and how much an acquiring fund should invest in an 
acquired fund under the rule.
---------------------------------------------------------------------------

    \163\ One commenter recommended that the rule prescribe a mirror 
voting procedure whereby the acquiring fund must provide legal proxy 
to the proxy agent for the shareholder vote and request that the 
acquiring fund's shares be voted in the same proportion as the vote 
of all other shareholders. Bulldog Comment Letter. We do not believe 
it is necessary to include such a prescription in this rule because 
we understand that proxy agents are able to tabulate and process 
shareholder votes that are subject to a mirror-voting requirement 
and such agents would not require a legal proxy to be set forth in 
the rule text.
---------------------------------------------------------------------------

iii. Exceptions to the Control and Voting Conditions
    We are adopting, as proposed, 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.\164\ The 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.\165\ We 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.\166\
---------------------------------------------------------------------------

    \164\ Rule 12d1-4(b)(1)(iii). The exception to the control and 
voting conditions for sub-advisory arrangements will cover 
arrangements that may not qualify for the exclusion otherwise 
available to funds within the same group of investment companies if 
the acquiring fund and acquired fund do not hold themselves out as 
related funds for purposes of investment and investor services. See 
2018 FOF Proposing Release, supra footnote 6, at n.106 and 
accompanying text.
    \165\ See 2018 FOF Proposing Release, supra footnote 6, at 
section II.C.1.b.
    \166\ Rule 12d1-4(d).
---------------------------------------------------------------------------

    Commenters supported these exceptions.\167\ Commenters agreed with 
the Commission that, in circumstances where an affiliated investment 
manager manages the acquiring fund, it is unlikely that the investors 
in the acquiring fund would exert undue influence and use their vote to 
pursue initiatives that are inconsistent with the long-term interests 
of investors in the

[[Page 73940]]

acquired fund.\168\ Based on our experience overseeing fund of funds 
arrangements, we believe these exceptions from the control and voting 
conditions 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).
---------------------------------------------------------------------------

    \167\ See, e.g., Invesco Comment Letter; ABA Comment Letter.
    \168\ Commenters suggested excluding funds within the same group 
of investment companies from other conditions of the proposed rule, 
including the proposed redemption limit. While we are not adopting 
the proposed redemption limit, we have tailored the rule's 
conditions to account for the different undue influence concerns of 
funds within the same group of investment companies as compared to 
funds that are not part of the same group of investment companies.
---------------------------------------------------------------------------

    The definition of ``group of investment companies'' 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 BDCs and other closed-end funds are within the scope of 
this exception. The determination of whether advisers are control 
affiliates, however, depends on the relevant facts and 
circumstances.\169\
---------------------------------------------------------------------------

    \169\ 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 rule. 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. See also 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 is not necessary for acquired funds to include 
comparable disclosure in their prospectuses or for acquired funds and 
acquiring funds to market themselves as related companies for all 
purposes and to all potential investors.\170\ Rather, the requirement 
in this definition 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 these funds are holding 
themselves out to their potential investors. 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. As we stated in the 2018 FOF Proposing Release, 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 rule 12d1-4 unless they are related investment companies.
---------------------------------------------------------------------------

    \170\ 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 funds are 
holding themselves out as related companies and potentially render 
the control exception unavailable to the fund of funds arrangement.
---------------------------------------------------------------------------

    As proposed, the rule will subject fund of funds arrangements 
within these exclusions to a more limited set of conditions than other 
fund of funds arrangements. 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.\171\ In addition, 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.\172\ We believe 
that the rule's other conditions, such as the fund of funds investment 
agreement and adviser findings described below, would mitigate the 
risks of undue influence when the arrangement involves funds that have 
advisers that are control affiliates.
---------------------------------------------------------------------------

    \171\ See 2018 FOF Proposing Release, supra footnote 6, at 41 
and associated footnotes.
    \172\ Id.
---------------------------------------------------------------------------

2. Redemption Limits, Fund Findings, and Fund of Funds Investment 
Agreements
    In lieu of the proposed limitation on redemptions by an acquiring 
fund, we are adopting a requirement, expanded from the proposal, for an 
investment adviser to a management company operating in accordance with 
the rule to evaluate and make certain findings regarding the 
arrangement.\173\ The rule will also require tailored findings 
regarding acquiring UITs and a certification regarding separate 
accounts funding variable insurance contracts (these findings and 
certifications, collectively with the management company evaluations 
and findings, ``Fund Findings''). In addition, unless they have the 
same adviser, the acquiring fund and acquired fund will be required to 
enter into a fund of funds investment agreement effective for the 
duration of the funds' reliance on the rule, which must include certain 
specific terms. These provisions are, as discussed below, designed to 
address concerns over the exercise of undue influence through excessive 
redemptions that the proposed redemption limit provision was designed 
to address, while also addressing the duplicative fee and complex 
structure concerns that underlie section 12(d)(1)(A).
---------------------------------------------------------------------------

    \173\ See infra footnotes 259 through 276 and accompanying text.
---------------------------------------------------------------------------

a. Proposed Redemption Limit and Disclosure Requirements
    The proposed rule would have prohibited 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 (the ``redemption 
limit'').\174\ The proposed redemption limit was designed to address 
concerns that an acquiring fund could threaten large-scale redemptions 
as a means of exercising undue influence over an acquired fund and 
would have limited an acquiring fund's ability to quickly redeem or 
tender a large volume of acquired fund shares.\175\ The Commission 
proposed the redemption limit believing it would (along with the 
proposed control and voting conditions) address the same concerns 
regarding undue influence and overreaching that the conditions 
currently found in the exemptive orders sought to address, without 
requiring procedures and related board findings covering particular 
instances where undue influence and overreaching could exist. The 
Commission stated that replacing these conditions with the proposed 
redemption, control, and voting conditions could lower compliance

[[Page 73941]]

costs and burdens and enhance investor protection for acquired funds.
---------------------------------------------------------------------------

    \174\ Proposed rule 12d1-4(b)(2).
    \175\ See 2018 FOF Proposing Release, supra footnote 6, at 
section II.C.2 (explaining that we proposed to permit funds to 
purchase up to 25% of an acquired fund (or more when the funds are 
part of the same group of investment companies) 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).
---------------------------------------------------------------------------

    Many commenters opposed the proposed redemption limit.\176\ These 
commenters raised a number of concerns, including: (1) Operational or 
administrative challenges; (2) the redemption limit's potential effects 
on the acquiring fund's investment objectives and its ability to 
respond timely to changing economic or market conditions; (3) the 
impact on competition and innovation; (4) whether funds in the same 
group of investment companies should be subject to the requirements; 
(5) concerns relating to liquidity; and (6) the cost of the proposed 
limits.\177\ These commenters offered a number of alternatives in lieu 
of the proposed redemption limit.\178\ We also received a number of 
comments on a proposed disclosure requirement relating to the 
redemption limit.\179\
---------------------------------------------------------------------------

    \176\ See, e.g., ICI Comment Letter; Morningstar Comment Letter. 
Some commenters did support specific elements of the proposed limit. 
See, e.g., MFA Comment Letter (supporting the approach that the 
limit not apply to sales of fund shares in secondary market 
transactions).
    \177\ See, e.g., ICI Comment Letter; Fidelity Comment Letter; 
Comment Letter of John Hancock Investments (May 2, 2019) (``John 
Hancock Comment Letter'').
    \178\ See, e.g., Comment Letter of The Vanguard Group, Inc. (May 
2, 2019) (``Vanguard Comment Letter''); Comment Letter of Fidelity 
Rutland Square Trust II (May 2, 2019) (``Fidelity Rutland Comment 
Letter'').
    \179\ See, e.g., SIFMA AMG Comment Letter; Fidelity Comment 
Letter; PGIM Comment Letter.
---------------------------------------------------------------------------

    Operational and administrative challenges. Commenters stated that 
the proposed redemption limit would present a number of operational or 
administrative challenges, including disrupting existing fund of funds 
arrangements.\180\ Many commenters provided evidence that the proposed 
redemption limit would have a large effect on funds.\181\ For example, 
one commenter provided survey results showing that, in the past three 
years, 228 fund of funds arrangements conducted 1,399 redemption 
transactions in excess of 3%.\182\ One commenter stated that, in the 
case of large-scale redemptions, an acquiring fund may have difficulty 
meeting redemption requests from its own shareholders in light of this 
limit, in part because making in-kind distributions to its shareholders 
would be difficult on such a large scale.\183\ Other commenters 
questioned whether this requirement was consistent with the 
requirements of the Act, including section 22(e) which generally 
prohibits registered investment companies from suspending the right of 
redemption of redeemable securities.\184\
---------------------------------------------------------------------------

    \180\ See, e.g., ICI Comment Letter; Guggenheim Comment Letter; 
Capital Group Comment Letter; SIFMA AMG Comment Letter; Fidelity 
Comment Letter; Dechert Comment Letter; Ropes Comment Letter; 
Comment Letter of the Independent Directors Council (May 1, 2019 
(``IDC Comment Letter'').
    \181\ See, e.g., Comment Letter of JP Morgan Asset Management 
(May 2, 2019) (``JP Morgan Comment Letter''); Comment Letter of 
Allianz Investment Management LLC (May 1, 2019) (``Allianz Comment 
Letter''); Vanguard Comment Letter. See 2018 FOF Proposing Release, 
supra footnote 6, at n.125 and accompanying text.
    \182\ See ICI Comment Letter.
    \183\ See Fidelity Comment Letter. See also ABA Comment Letter; 
Ropes Comment Letter.
    \184\ See TRP Comment Letter; Fidelity Comment Letter. See also 
Dimensional Comment Letter; NYC Bar Comment Letter (questioning 
whether the Commission was, in effect, redefining ``redeemable 
security'' under the Act).
---------------------------------------------------------------------------

    Some commenters discussed the challenges associated with tracking 
the outstanding voting securities of numerous third-party funds for 
investment threshold and redemption limit percentages over rolling 30-
day periods, noting that this information is not readily available to 
the investing public.\185\ Another commenter stated that it may be 
challenging to build compliance system enhancements that can account 
for multiple redemptions within any rolling 30-day period and apply 
those calculations to outstanding share balances that change 
daily.\186\ Some commenters stated that these challenges would cause 
portfolio management teams to reduce exposures to acquired funds as 
their holdings approach the 3% limit as a means to mitigate these 
challenges.\187\ Other commenters stated that the proposed redemption 
limit could prevent an acquiring fund from timely participating in 
certain transactions, such as liquidations or mergers of the acquiring 
fund, even where the acquiring fund's board and/or its shareholders 
have approved such transactions.\188\
---------------------------------------------------------------------------

    \185\ See, e.g., Fidelity Comment Letter; Ropes Comment Letter.
    \186\ See TRP Comment Letter.
    \187\ See Dechert Comment Letter; JP Morgan Comment Letter.
    \188\ See Allianz Comment Letter; John Hancock Comment Letter.
---------------------------------------------------------------------------

    Potential impacts on investment strategies. Several commenters 
expressed the view that the proposed redemption limit could impede 
acquiring funds' ability to follow their investment strategy.\189\ 
Commenters stated that portfolio managers routinely change allocations 
among underlying funds in response to economic or market conditions, or 
in keeping with the stated investment strategy of the fund of funds, 
and that redemption limits could prevent portfolio managers from making 
such changes in a timely fashion.\190\ For example, some commenters 
noted that the proposed redemption limit would prevent or limit 
portfolio managers' ability to make investment changes when they 
identify an underlying fund as underperforming or no longer meeting the 
needs of the investment strategy of the fund of funds.\191\ One 
commenter stated that the proposed redemption limit could force 
acquiring funds and their shareholders to hold onto underlying funds 
that underperform, have higher costs than alternatives that become 
available, or no longer achieve the fund's strategy.\192\ Another 
commenter suggested that to comply with the proposed redemption limit, 
some funds may alter an acquiring fund's investment strategy to invest 
in different affiliated or unaffiliated acquired funds to avoid owning 
more than 3% of any acquired fund, which could frustrate the investment 
expectations of shareholders, and may increase the costs and complexity 
of the fund.\193\ Other commenters noted that this restriction would 
force acquiring fund portfolio managers to liquidate other positions to 
meet redemption requests.\194\ Another raised concerns as to whether 
the limit would impair rebalancing and restructuring transactions that 
may involve redemptions beyond the 3% limit.\195\
---------------------------------------------------------------------------

    \189\ See, e.g., SIFMA AMG Comment Letter (providing survey 
results suggesting the proposed rule would have ``a significant 
impact on the fund of funds business''); CFA Comment Letter (stating 
that the proposed redemption limit would inappropriately lock fund 
of funds investors into funds that no longer serve their best 
interests for unreasonable amounts of time).
    \190\ See, e.g., Comment Letter of Nationwide Funds Group (Apr. 
26, 2019) (``Nationwide Comment Letter''); Invesco Comment Letter; 
PIMCO Comment Letter; CFA Comment Letter.
    \191\ See Nationwide Comment Letter; Vanguard Comment Letter; 
Dimensional Comment Letter.
    \192\ See CFA Comment Letter. See also Voya Comment Letter.
    \193\ See Allianz Comment Letter.
    \194\ See TRP Comment Letter; Dechert Comment Letter; Ropes 
Comment Letter.
    \195\ See Vanguard Comment Letter.
---------------------------------------------------------------------------

    Impact on competition and innovation. Several commenters stated 
that requiring acquiring funds to redeem large positions slowly over 
time could place acquiring fund shareholders at a substantial 
competitive disadvantage to investors that are not subject to the same 
restrictions.\196\ One of these commenters also stated that the 
redemption limit

[[Page 73942]]

would encourage consolidation, raise barriers to entry for new fund 
managers, and limit investment options for investors.\197\ Many 
commenters stated that the limitation would have an adverse impact upon 
smaller funds, in part because the 3% limit would be easier to cross 
with such funds.\198\ Others asserted that it would adversely impact 
target-date funds.\199\
---------------------------------------------------------------------------

    \196\ See, e.g., JP Morgan Comment Letter; SIFMA AMG Comment 
Letter (arguing that retail investors may be unfairly disadvantaged 
because their exposure to acquired funds through a fund of funds 
would be subject to the proposed redemption limit, while other 
investors who directly invested in an acquired fund would not be so 
limited and therefore would be able to access liquidity with 
priority over acquiring fund investors); Fidelity Comment Letter.
    \197\ See Dechert Comment Letter.
    \198\ See, e.g., PIMCO Comment Letter; IDC Comment Letter; Voya 
Comment Letter; Chamber of Commerce Comment Letter.
    \199\ See, e.g., Morningstar Comment Letter; IAA Comment Letter; 
Comment Letter of Fidelity Fixed Income and Asset Allocation Funds 
(May 2, 2019) (``Fidelity Fixed Income Trustees Comment Letter''); 
Nuveen Comment Letter; ABA Comment Letter.
---------------------------------------------------------------------------

    Other commenters focused on the proposed redemption limit's impact 
on fund innovation. For example, one commenter stated that the 
redemption limit could inhibit the formation of new investment 
products, such as funds intended to serve as underlying funds for other 
funds in the same group of investment companies, because a sufficient 
number of investors would not hold the new product to avoid triggering 
the 3% limit.\200\ Similarly, a commenter raised concerns that the 
proposed redemption limit could discourage acquiring funds from 
exposure to non-traditional asset classes, which often have more 
volatile in- and out-flows and smaller asset bases, resulting in a less 
desirable mix of assets made available to investors.\201\ This 
commenter stated that if the proposed redemption limit discourages an 
acquiring fund from investing in an acquired fund, this could reduce 
overall economies of scale and operational efficiencies of the acquired 
fund or even challenge its viability.
---------------------------------------------------------------------------

    \200\ See Comment Letter of Russell Investment Management, LLC 
(May 3, 2019) (``Russell Comment Letter''). See also Comment Letter 
of Mutual Fund Directors Form (May 2, 2019) (``MFDF Comment 
Letter'') (stating that the proposed limit may limit the desire of 
acquiring funds to buy large stakes in acquired funds, thus 
disincentivizing innovation).
    \201\ See Voya Comment Letter.
---------------------------------------------------------------------------

    Some commenters predicted that the proposed redemption limit would 
have a chilling effect on acquiring funds using mutual funds in their 
allocations and would effectively codify the limits set forth in 
sections 12(d)(1)(A) and (B) of the Act as the maximum investment in 
unrelated acquired funds.\202\ Other commenters indicated that 
acquiring funds would restructure to avoid the proposed redemption 
limitation, including investing in a larger number of funds in order to 
hold smaller proportions of each acquired fund, or relying more on 
ETFs.\203\
---------------------------------------------------------------------------

    \202\ See Capital Group Comment Letter.
    \203\ See, e.g., ABA Comment Letter; Comment Letter of Chapman 
and Cutler LLP (May 2, 2019) (``Chapman Comment Letter''); 
Morningstar Comment Letter; Capital Group Comment Letter.
---------------------------------------------------------------------------

    Same group of investment companies. Several commenters questioned 
the need for applying the proposed redemption limit to acquiring funds 
investing in acquired funds in the same group of investment companies, 
stating that it would be unnecessary and inappropriate to do so.\204\ 
Some of these commenters highlighted that the proposed rule included 
exceptions from the voting and control provisions for funds in the same 
group of investment companies and stated that a similar exception 
should be included from the redemption limit.\205\ One commenter argued 
that the proposed redemption limit could pose particular challenges for 
common fund of funds arrangements involving funds within the same 
group, such as when an acquired fund is exclusively available to 
acquiring funds managed by the same adviser. As a result, these 
commenters asserted there would be no colorable risk that the acquiring 
fund would threaten redemptions to exert undue influence.\206\ Another 
commenter stated that, for affiliated fund of funds arrangements, the 
common investment adviser's fiduciary duties to both the acquiring and 
acquired funds would adequately address duplicative and excessive fee 
concerns.\207\
---------------------------------------------------------------------------

    \204\ See, e.g., Allianz Comment Letter; Fidelity Fixed Income 
Trustees Comment Letter.
    \205\ See, e.g., PIMCO Comment Letter; Wells Fargo Comment 
Letter; Chapman Comment Letter.
    \206\ See Fidelity Fixed Income Trustees Comment letter (arguing 
that there is no colorable risk of using the threat of redemptions 
to bully third-party investors in, or advisers to, such affiliated 
underlying funds).
    \207\ See SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Liquidity. Commenters also identified a number of concerns 
regarding the proposed redemption limit's impact upon the liquidity of 
the acquiring fund's portfolio. A number of commenters thought that 
this aspect of the proposal would increase the difficulty of complying 
with rule 22e-4 by potentially impacting the liquidity categorization 
of an acquired fund's shares.\208\ Some commenters stated that the 
proposed restriction would impose liquidity constraints on funds, which 
could become more pronounced if a particular acquired fund is under 
redemption pressures.\209\ Other commenters discussed the impact of the 
proposed restriction on fund liquidations.\210\
---------------------------------------------------------------------------

    \208\ See, e.g., MFDF Comment Letter; Wells Fargo Comment 
Letter; Capital Group Comment Letter (suggesting alternatives on how 
to consider acquired fund shares under the proposed redemption limit 
for rule 22e-4 purposes); Dechert Comment Letter.
    \209\ See, e.g., ABA Comment Letter; Fidelity Comment Letter 
(noting that the acquiring fund could be required to remain invested 
in an acquired fund facing a crisis such as fraud or bankruptcy 
whereas other investors would be able to redeem).
    \210\ See Invesco Comment Letter; Chapman Comment Letter; Schwab 
Comment Letter.
---------------------------------------------------------------------------

    Cost. Commenters also raised concerns over increased costs and 
expenses because of the proposed limit. Several commenters stated that 
the proposed redemption limit would increase compliance costs because 
of the burden of monitoring the 3% threshold.\211\ One commenter 
thought portfolio management costs would increase if an adviser could 
not effect a particular strategy through a fund due to the redemption 
limit.\212\ Some commenters suggested that acquiring funds with a 
limited number of acquired funds might restructure to a ``sleeved'' 
approach--i.e., funds historically organized as funds of funds, rather 
than investing in acquired funds, would instead hire various sub-
advisers to manage directly specified assets of the fund, thus 
increasing costs.\213\ Some commenters also noted that the proposed 
limit would result in significant transaction costs as the acquiring 
funds restructure their investment strategies and portfolios.\214\
---------------------------------------------------------------------------

    \211\ See, e.g., TRP Comment Letter; NYC Bar Comment Letter; 
Ropes Comment Letter. See 2018 FOF Proposing Release, supra footnote 
6, at section II.C.2.
    \212\ See Guggenheim Comment Letter. See also Fidelity Comment 
Letter (discussing the potential for managed account programs to 
move to direct fund investments, rather than fund of funds).
    \213\ See Allianz Comment Letter; Fidelity Comment Letter 
(stating such an approach could increase costs related to screening, 
due diligence, and ongoing monitoring and oversight, and would 
increase the oversight responsibilities and workload of the funds' 
boards of directors, estimating that the number of sub-advisers 
overseen by the funds' boards would approximately triple).
    \214\ See Wells Fargo Comment Letter; Fidelity Comment Letter.
---------------------------------------------------------------------------

    Alternatives. Some commenters suggested alternatives to the 
proposed redemption limit.\215\ For example, some commenters suggested 
that the proposed redemption limit exclude fund of funds arrangements 
that involve funds in the same group of investment companies or are 
otherwise affiliated, stating that there is minimal risk of undue 
influence by an acquiring fund over an acquired fund within the same 
group of investment companies.\216\ Another

[[Page 73943]]

suggested an exception for fund liquidations,\217\ and another 
suggested an exception for redemptions that merely facilitate 
redemption requests from the acquiring fund's shareholders.\218\ Other 
commenters questioned the need to replace the conditions in the 
existing exemptive orders.\219\ Some suggested that the rule permit 
funds to rely either on existing exemptive relief or the rule, or that 
the Commission codify existing relief in a rule, so that funds with 
existing relief would not have to comply with the proposed redemption 
limit.\220\
---------------------------------------------------------------------------

    \215\ See, e.g., Vanguard Comment Letter; Fidelity Rutland 
Comment Letter; Dimensional Comment Letter.
    \216\ See, e.g., Invesco Comment Letter; Allianz Comment Letter; 
Thrivent Comment Letter. As discussed in more detail below, we are 
not exempting funds within the same group of investment companies 
from the fund of funds investment agreement requirement in the rule 
as adopted because, among other things, these funds can have 
different advisers and different boards. See infra text accompanying 
footnote 364.
    \217\ See Invesco Comment Letter.
    \218\ See NYC Bar Comment Letter.
    \219\ See, e.g., ICI Comment Letter; IDC Comment Letter; MFDF 
Comment Letter.
    \220\ See, e.g., Fidelity Rutland Comment Letter; John Hancock 
Comment Letter (further suggesting that the adviser, rather than the 
fund, be responsible for monitoring and oversight, subject to board 
reporting).
---------------------------------------------------------------------------

    Some commenters suggested making the redemption requirement 
permissive,\221\ letting the funds determine the size of permissible 
redemptions,\222\ increasing the percentage of shares that could be 
redeemed,\223\ or providing a shorter time period to align the 
applicable time period with rule 22e-4.\224\ Others questioned the need 
for redemption limits at all to protect acquiring funds' investment in 
unaffiliated acquired funds, particularly given the existence of other 
protections in rule 12d1-4 and elsewhere (such as other regulations or 
existing fiduciary obligations).\225\ Some commenters suggested that we 
exempt in-kind redemptions from the requirement.\226\
---------------------------------------------------------------------------

    \221\ See, e.g., Invesco Comment Letter; Comment Letter of MFS 
Investment Management (May 2, 2019) (``MFS Comment Letter''); 
BlackRock Comment Letter.
    \222\ See Schwab Comment Letter; see also John Hancock Comment 
Letter (suggesting to exempt situations where the acquiring fund 
goes over 3% as a result of the decrease in the outstanding 
securities of the acquired fund from the proposed limit).
    \223\ See NYC Bar Comment Letter.
    \224\ See BlackRock Comment Letter.
    \225\ See, e.g., PIMCO Comment Letter; BlackRock Comment Letter.
    \226\ See Comment Letter of Thrivent Financial for Lutherans 
(May 1, 2019) (``Thrivent Comment Letter''); Ropes Comment Letter 
(stating that the ability of an acquired fund to satisfy redemption 
requests in-kind mitigates undue influence concerns).
---------------------------------------------------------------------------

    Other commenters stated that participation agreements, either 
consistent with existing Commission orders or altered in various ways, 
could be an alternative to the proposed redemption limit because they 
would provide opportunities for acquired funds to protect their 
interests, while preserving the benefits of fund of funds structures 
for shareholders.\227\ As support for this framework, one commenter 
suggested that the acquiring fund's investment adviser certify to the 
acquired fund's investment adviser that it will not invest in the 
acquired fund as a means to exert undue influence over the acquired 
fund or to influence any services or transactions and notify the 
acquired fund if its investment exceeds the limits in section 
12(d)(1)(A).\228\ This commenter also suggested that the rule require 
periodic reporting to each of the acquiring and acquired funds' board 
of directors.
---------------------------------------------------------------------------

    \227\ See NYC Bar Comment Letter (suggesting a redemption 
management agreement); ICI Comment Letter (suggesting a simplified 
participation agreement); Federated Comment Letter; PIMCO Comment 
Letter; John Hancock Comment Letter (suggesting that, instead of a 
participation agreement, each fund receive reciprocal written 
acknowledgment that the funds would be relying upon, and comply 
with, the rule); Advent Comment Letter (arguing that the rule should 
require funds to enter into a participation agreement if the 
investment is more than 10% of the acquired fund's voting 
securities); IDC Comment Letter; Vanguard Comment Letter (suggesting 
a framework of acquiring fund advisers making a best interest 
finding and then entering into a participation agreement); 
Dimensional Comment Letter; Fidelity Rutland Comment Letter; Wells 
Fargo Comment Letter; Capital Group Comment Letter; Fidelity Comment 
Letter; Dechert Comment Letter; IAA Comment Letter; Nationwide 
Comment Letter. But see BlackRock Comment Letter (arguing against 
the inclusion of participation agreements in the final rule).
    \228\ See Vanguard Comment Letter.
---------------------------------------------------------------------------

    Another commenter suggested that the final rule require 
participation agreements that are approved by each of the acquiring and 
acquired funds' board of directors,\229\ although others stated that 
the board should not be required to be involved in approving fund of 
funds arrangements.\230\ This commenter suggested requiring board 
review, at least annually, of all transactions between the acquired 
fund and affiliates of the acquiring funds to determine whether the 
acquiring funds have influenced the transactions.\231\ The commenter 
also suggested that the rule allow acquired funds and their boards, at 
their option, to set their own limit for an acquiring fund's 
investment. Another commenter stated that participation agreements 
operate efficiently and effectively to prevent undue influence and are 
an effective alternative to the proposed redemption limit.\232\ Other 
commenters stated that one of the key elements of a participation 
agreement is the ability for the acquired fund to refuse to enter into 
the participation agreement, which prevents the acquiring fund from 
investment in the acquired fund beyond the limits set forth in section 
12(d)(1)(A).\233\
---------------------------------------------------------------------------

    \229\ See Dimensional Comment Letter. While we are not requiring 
that fund boards approve fund of funds arrangements, we will require 
reporting to boards to facilitate their oversight function. See 
infra footnotes 314 through 320 and accompanying text.
    \230\ See ICI Comment Letter; Voya Comment Letter; Invesco 
Comment Letter.
    \231\ See Dimensional Comment Letter.
    \232\ See Fidelity Rutland Comment Letter.
    \233\ See Chapman Comment Letter; Dimensional Comment Letter.
---------------------------------------------------------------------------

    Another commenter stated that the proposed limit was unnecessary 
because funds frequently negotiate large-scale redemptions to minimize 
any impacts that would result in undue influence.\234\ One commenter 
stated that funds can manage the threat of undue influence from large-
scale redemptions by delaying payment for up to seven days where 
immediate payment would harm the fund.\235\ Others suggested that the 
Commission require pre-notification of large trades as an alternative 
to the limit.\236\
---------------------------------------------------------------------------

    \234\ See John Hancock Comment Letter. See also JP Morgan 
Comment Letter (stating that, in its experience, large investors are 
amenable to procedures designed to facilitate careful redemptions, 
which typically are in all parties' interests).
    \235\ See Fidelity Comment Letter. This commenter also noted 
that, as a practical matter, two-day settlement requirements under 
17 CFR 240.15c6-1 effectively take most fund investments to a T+2 
settlement timeline.
    \236\ See Schwab Comment Letter; JP Morgan Comment Letter.
---------------------------------------------------------------------------

    Commenters suggested a number of other alternatives to the proposed 
redemption limit. One commenter suggested that we limit the overall 
percentage of acquired fund shares that an acquiring fund could own to 
20%.\237\ Another recommended a policies and procedures-based system to 
ensure that the acquiring fund's adviser acts in the acquiring fund's 
best interest.\238\ Others suggested that, if the Commission retained 
the proposed redemption limit, we also retain rule 12d1-2.\239\ One 
suggested that the Commission replace the real-time tracking that would 
have been required to satisfy the proposed redemption limit with an 
allowance to rely upon the shares listed in the acquired fund's most 
recently published financial statements.\240\
---------------------------------------------------------------------------

    \237\ See John Hancock Comment Letter.
    \238\ See SIFMA AMG Comment Letter.
    \239\ See Nuveen Comment Letter; Vanguard Comment Letter 
(further recommending that rule 12d1-2 be expanded to non-
securities); Russell Comment Letter.
    \240\ See NYC Bar Comment Letter.
---------------------------------------------------------------------------

    Disclosure. In connection with the proposed redemption limit, we 
also proposed that a fund relying on rule 12d1-4 would be required to 
disclose in

[[Page 73944]]

its registration statement that it is (or at times may be) an acquiring 
fund for purposes of the proposed rule.\241\ This disclosure 
requirement was intended 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, and therefore to allow a fund to limit its acquisition 
of the acquiring fund's securities accordingly.
---------------------------------------------------------------------------

    \241\ See proposed rule 12d1-4(b)(4).
---------------------------------------------------------------------------

    Commenters generally opposed the disclosure requirement, predicting 
that funds would prophylactically disclose that they may rely upon the 
rule, and that acquired funds would not be able to monitor continuously 
the disclosure of potential acquired funds.\242\ Further, commenters 
suggested that such an approach could reduce the number of funds 
willing to become acquired funds and create fewer investment 
opportunities for funds of funds.\243\ As an alternative, a commenter 
recommended that acquiring funds disclose a principal investment 
strategy of investing in other funds, or allow funds to rely on a 
representation in a participation agreement.\244\ One commenter 
suggested that the Commission provide for alternative disclosures for 
BDCs and other closed-end funds.\245\
---------------------------------------------------------------------------

    \242\ See, e.g., SIFMA AMG Comment Letter; Fidelity Rutland 
Comment Letter; Skadden Comment Letter. However, a few commenters 
did suggest enhanced disclosure, including an expansion of this 
disclosure requirement, in lieu of other proposed requirements. See 
Comment Letter of Massachusetts Mutual Life Insurance Company (May 
2, 2019) (``MassMutual Comment Letter'') (with regard to private 
funds); Ropes Comment Letter; Nationwide Comment Letter (with regard 
to the proposed redemption limit).
    \243\ Fidelity Comment Letter.
    \244\ Fidelity Comment Letter. One commenter also suggested that 
investor confusion concerns could be mitigated by an acquired fund's 
adviser, including with an assurance regarding its disclosure in its 
report to the acquired fund's board. TRP Comment Letter. See infra 
Section II.C.2.c (discussing the board reporting requirements).
    \245\ See BlackRock Comment Letter.
---------------------------------------------------------------------------

b. Fund Findings and Fund of Funds Investment Agreement
    After considering the comments received, we have determined not to 
adopt the proposed redemption limit or require funds to disclose 
whether they are (or at times may be) an acquiring fund for purposes of 
the rule.\246\ Instead, we are adopting a combination of conditions 
that we believe will protect investors in fund of funds arrangements 
from the concerns the proposed redemption limit sought to address and 
will provide the notice that the proposed disclosure requirements would 
have provided. Specifically, the rule will require: (i) An acquired 
management company's adviser to make certain findings focused on 
addressing undue influence concerns, including through redemptions, by 
considering specific enumerated factors; (ii) an acquiring fund's 
adviser, principal underwriter, or depositor to conduct an evaluation 
of the complexity of the fund of funds structure and its aggregate fees 
and expenses and make a finding that the fees and expenses are not 
duplicative; \247\ and (iii) both the acquiring and acquired funds to 
enter into a fund of funds investment agreement to memorialize the 
terms of the arrangement (including terms that serve as a basis for the 
required findings) when the acquiring and acquired fund do not share an 
investment adviser. The rule's requirements vary based on the 
structural characteristics of the funds involved in the arrangement, 
but seek the same goal of avoiding the historical abuses that section 
12(d)(1) was intended to prevent.\248\
---------------------------------------------------------------------------

    \246\ We are, as proposed, amending N-CEN to require reporting 
when an acquired fund has holdings in other funds. See infra Section 
III.
    \247\ The final rule refers to ``fees and expenses'' in a number 
of places where the proposed rule only referred to ``fees.'' Compare 
rule 12d1-4(b)(2)(i)(A) with proposed rule 12d1-4(b)(3)(i). In the 
2018 FOF Proposing Release, when we discussed fees, we mentioned a 
number of ``fees'' that may more appropriately be characterized as 
``expenses.'' See 2018 FOF Proposing Release, supra footnote 6, at 
61 (discussing fees for recordkeeping, sub-transfer agency services, 
sub-accounting services, or other administrative services). In order 
to avoid confusion, we have revised the relevant provisions to refer 
to both fees and expenses, not just fees.
    \248\ The Fund Findings requirement will apply regardless of the 
form and structure of the other fund acquired by or acquiring the 
fund in question. Thus, an adviser to an acquiring fund that is a 
management company would still need to make its finding with respect 
to the acquiring fund even if the acquired fund is, for example, a 
UIT (which will not need its own Fund Finding under the rule).
---------------------------------------------------------------------------

    The Commission proposed the redemption limit believing that it 
would be more effective and less burdensome than conditions set forth 
in our orders.\249\ Commenters provided additional context and 
information regarding the impact of the proposed limit, suggesting that 
the proposed redemption limit would have a larger impact on fund of 
funds arrangements and would be more burdensome than the Commission 
contemplated in the proposal. We believe that our adopted approach 
expanding the proposed finding requirement will address undue influence 
concerns more effectively and with less disruption to current market 
practices than the proposed redemption limit (or the conditions in our 
existing exemptive orders) and will more effectively put funds on 
notice that a fund they seek to acquire is itself an acquiring 
fund.\250\
---------------------------------------------------------------------------

    \249\ The conditions in our orders generally require fund boards 
to make certain findings and, for investments in unaffiliated funds, 
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) limit. See 
2018 FOF Proposing Release, supra footnote 6, at n.117 and 
accompanying text.
    \250\ For example, the fund of funds investment agreement 
discussed below will allow the acquired fund to screen potential 
acquiring fund investments, thereby addressing the notice concern 
enumerated in the proposal. See 2018 FOF Proposing Release, supra 
footnote 6, at 79.
---------------------------------------------------------------------------

i. Evaluations and Findings for Management Companies \251\
---------------------------------------------------------------------------

    \251\ The term ``management companies'' includes BDCs. See 
generally 15 U.S.C. 80a-4 (defining ``management company'' as an 
investment company other than a face amount certificate company or 
UIT) and 15 U.S.C. 80a-58 (providing that, among other things, 15 
U.S.C. 80a-4 applies to a BDC to the same extent as if it were a 
registered closed-end investment company).
---------------------------------------------------------------------------

    Under the final rule, a fund's investment adviser will be required 
to make certain evaluations and findings that are tailored to the 
specific concerns that underlie section 12(d)(1).\252\ For management 
companies that are acquired funds, rule 12d1-4 will require the 
acquired fund's investment adviser to find that any undue influence 
concerns associated with the acquiring fund's investment in the 
acquired fund are reasonably addressed, after considering certain 
specific factors.\253\ These factors are (1) the scale of contemplated 
investments by the acquiring fund and any maximum investment limits; 
(2) the anticipated timing of redemption requests by the acquiring 
fund; (3) whether, and under what circumstances, the acquiring fund 
will provide advance notification of investment and redemptions; and 
(4) the circumstances under which the acquired fund may elect to 
satisfy redemption requests in kind rather than in cash and the terms 
of any redemptions in kind. These factors are designed to focus the 
analysis of an acquired fund's adviser on potential ways to reduce the 
threat of undue influence, including through redemptions, when an 
acquiring fund invests in the acquired fund beyond the section 12(d)(1) 
limits under the rule. Because concerns regarding undue influence are 
more salient for acquired funds, only the adviser to an acquired fund 
will be required to make this determination.
---------------------------------------------------------------------------

    \252\ See supra footnotes 17 and 18 and accompanying text.
    \253\ Rule 12d1-4(b)(2)(i)(B).
---------------------------------------------------------------------------

    In cases where the acquiring fund is a management company, rule 
12d1-4 will require the management company's adviser to evaluate the 
complexity of the structure associated with the acquiring

[[Page 73945]]

fund's investment in the acquired fund. Also, the acquiring fund's 
adviser must evaluate the relevant fees and expenses and find that the 
acquiring fund's fees and expenses do not duplicate the fees and 
expenses of the acquired fund.\254\ Because concerns regarding 
duplicative fees and complexity of structure are relevant for an 
acquiring fund, only the adviser to an acquiring fund will need to 
evaluate and make findings related to these concerns. For both 
acquiring and acquired funds, the required analysis, and any findings 
based thereon, will be subject to the adviser's fiduciary duty to act 
in the best interest of each fund it advises.\255\
---------------------------------------------------------------------------

    \254\ Rule 12d1-4(b)(2)(i)(A).
    \255\ See supra footnote 38. See also Commission Interpretation 
Regarding Standard of Conduct for Investment Advisers, Investment 
Advisers Act Release No. 5248 (Jun. 5, 2019) [84 FR 33669 (July 12, 
2019)] (``Fiduciary Duty Interpretation'') (``The duty of care 
includes, among other things: (i) The duty to provide advice that is 
in the best interest of the client, (ii) the duty to seek best 
execution of a client's transactions where the adviser has the 
responsibility to select broker-dealers to execute client trades, 
and (iii) the duty to provide advice and monitoring over the course 
of the relationship'').
---------------------------------------------------------------------------

    As discussed in more detail below,\256\ the rule will also require 
the acquiring fund and acquired fund to enter into a fund of funds 
investment agreement for the duration of the funds' reliance upon the 
rule to memorialize the terms of the agreement, unless the funds share 
the same investment adviser. The agreement must include any material 
terms necessary to make the appropriate Fund Finding.\257\ The final 
rule will provide funds with flexibility to consider--and where 
appropriate to negotiate and agree to as part of the fund of funds 
investment agreement--terms designed to protect investors and address 
the concerns underlying section 12(d)(1)(A).
---------------------------------------------------------------------------

    \256\ See infra Section II.C.4.c.
    \257\ Rule 12d1-4(b)(2)(iv)(A).
---------------------------------------------------------------------------

    The Fund Findings must be made, and the fund of funds investment 
agreement entered into, before the acquiring fund invests in the 
acquired fund in reliance on the rule. Consistent with the proposal, 
the rule also will require the adviser to report its evaluation, 
finding, and the basis for its evaluation or finding to the acquiring 
fund's board of directors. This report will not be required until the 
next regularly scheduled board of directors meeting.\258\
---------------------------------------------------------------------------

    \258\ Rule 12d1-4(b)(2)(i)(C).
---------------------------------------------------------------------------

    Changes from the Proposal. The Fund Findings for management 
companies as adopted differ from the finding requirement that we 
proposed in a few respects. First, the proposed finding requirement 
would have required the adviser of an acquiring fund to, after an 
evaluation of the complexity of the structure and aggregate fees and 
expenses associated with the acquiring fund's investment in the 
acquired fund, determine that the investment is in the best interest of 
the acquiring fund.\259\ As adopted, the rule will instead require that 
the acquiring fund's adviser, after a similar evaluation,\260\ 
determine that the acquiring fund's fees and expenses do not duplicate 
the fees and expenses of the acquired fund.\261\ In the 2018 FOF 
Proposing Release, we had sought comment on whether we should require a 
best interest determination and whether we should require the 
determination be made on a basis of the reasonableness of fees.\262\ We 
have made this change in part based upon comments that we received in 
response to this request that the concept of ``best interest'' in this 
context was unclear or overly broad,\263\ and that we should instead 
require advisers to make their determinations based upon specific 
elements including whether the fees are duplicative.\264\ While some 
commenters approved, and even recommended that we expand the use, of 
the best interest standard,\265\ we believe that focusing an adviser's 
analysis under this provision upon an evaluation of the complexity of 
the fund of funds structure and a determination regarding whether fees 
and expenses are duplicative will be more effective in mitigating 
overly complex structures and duplicative fees and expenses.
---------------------------------------------------------------------------

    \259\ Proposed rule 12d1-4(b)(3)(i).
    \260\ Consistent with this change, the final rule will require 
both this evaluation and the finding regarding fees and expenses, as 
well as the basis for these two items, be reported to the board. 
Rule 12d1-4(b)(2)(i)(C).
    \261\ Rule 12d1-4(b)(2)(i)(A).
    \262\ 2018 FOF Proposing Release, supra footnote 6, at Section 
II.C.3.
    \263\ See ICI Comment Letter; CFA Comment Letter; NYC Bar 
Comment Letter.
    \264\ See NYC Bar Comment Letter; ICI Comment Letter. See also 
Fidelity Fixed Income Trustees Comment Letter (noting that, in their 
experience, the adviser to the acquiring fund only charges fees if 
the fees are not duplicative). But see Dechert Comment Letter 
(recommending that the finding requirement not include any factors).
    \265\ See SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Second, the proposed finding requirement for management companies 
would have applied only to acquiring funds, not to acquired funds. As 
adopted, the rule will additionally require a finding by advisers to 
acquired funds with a specific set of factors tailored to the concerns 
of an acquired fund.\266\ The principal goal of the proposed redemption 
limit was to protect acquired funds from the threat of undue influence 
due to large-scale redemptions.\267\ A number of commenters suggested 
that there were more appropriate ways to protect acquired funds from 
this concern.\268\ Among these were suggestions that the adviser to an 
acquired fund make an evaluation similar to that of an acquiring 
fund.\269\ We agree that this analysis, coupled with the fund of funds 
investment agreement as discussed below, is better suited to protect 
against this risk in that it avoids unduly impeding portfolio 
management or liquidity risk management while utilizing the acquired 
fund's adviser to assess the risks of undue influence presented by the 
investment, taking into account the enumerated factors.\270\
---------------------------------------------------------------------------

    \266\ Rule 12d1-4(b)(2)(i)(B).
    \267\ 2018 FOF Proposing Release, supra footnote 6, at section 
II.C.2 (``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'').
    \268\ See supra footnotes 215 to 240 and accompanying text.
    \269\ See ICI Comment Letter; Voya Comment Letter; Vanguard 
Comment Letter. But see Dechert Comment Letter (stating that 
portfolio managers should be given flexibility and not subject to 
specific factors).
    \270\ See also infra footnote 296 and accompanying text.
---------------------------------------------------------------------------

    Third, the proposed rule would have required that the acquiring 
fund's adviser report its finding and the basis thereof to the 
acquiring fund's board of directors. Because the initial finding itself 
would have to be made prior to investing in an acquired fund in 
reliance on the rule, commenters were confused as to whether the 
investment could be made before this initial report to the board was 
made.\271\ One commenter suggested we clarify that the adviser need not 
report until the next regularly scheduled board meeting.\272\ We agree 
with this commenter, and are clarifying in the final rule that, while 
the adviser must complete the applicable Fund Findings (and fund of 
funds investment agreement) prior to initial investment, the adviser 
must report no later than the next regularly scheduled board 
meeting.\273\
---------------------------------------------------------------------------

    \271\ See NYC Bar Comment Letter; ABA Comment Letter; Dechert 
Comment Letter (suggesting that we not require board reporting as it 
will limit the ability of portfolio managers to make timely 
portfolio adjustments).
    \272\ See NYC Bar Comment Letter.
    \273\ Rule 12d-1(b)(2)(i)(C). As this requirement, as adopted, 
includes both evaluations and findings, the rule will also require 
reporting regarding evaluations and the basis for evaluations.
---------------------------------------------------------------------------

    Fourth, the proposed rule would have required the acquiring fund's 
adviser to make a finding both prior to the initial investment and with 
such frequency as the acquiring fund's board deems to be

[[Page 73946]]

reasonable and appropriate thereafter, but in any case no less 
frequently than annually. We requested comment on whether we should 
prescribe the frequency of these determinations, and some commenters 
suggested that we not mandate a specific frequency.\274\ However, some 
commenters suggested the Commission adopt the same or more frequent 
assessment and reporting frequency that we proposed in recommending 
their own alternatives to the proposed redemption limit,\275\ and one 
recommended that we retain ongoing reporting but on a discretionary 
basis.\276\ We agree that mandating ongoing assessments and reporting 
is unnecessary, particularly in light of other reporting and oversight 
mechanisms, such as rule 38a-1 under the Investment Company Act, which 
requires a fund's chief compliance officer to provide an annual written 
report to the board. As a result, the final rule will require an 
adviser to report the applicable Fund Findings to the board once; 
subsequent reporting regarding these Fund Findings will be conducted at 
least annually under the fund's compliance program. In addition, we do 
not believe it is necessary to prescribe additional requirements given 
the board's oversight role over fund operations.\277\
---------------------------------------------------------------------------

    \274\ See ABA Comment Letter; Dechert Comment Letter. See also 
NYC Bar Comment Letter (opining that the CCO's role under rule 38a-1 
obviates the need for advisers to report to fund directors on all 
proposed investments).
    \275\ See ICI Comment Letter; John Hancock Comment Letter.
    \276\ See NYC Bar Comment Letter. See also ABA Comment Letter 
(stating that fund boards should be able to select their desired 
reporting frequency and that the rule should not mandate a minimum 
frequency).
    \277\ See Compliance Rule Adopting Release, supra footnote 59 
(``A fund's board plays an important role in overseeing fund 
activities to ensure that they are being conducted for the benefit 
of the fund and its shareholders'').
---------------------------------------------------------------------------

    Additional Comments Received on Findings Requirement. Commenters 
generally supported a condition that required the investment adviser of 
the acquiring fund to review and consider the appropriateness of the 
fund of funds arrangement.\278\ As noted above however, commenters 
suggested a number of modifications to the proposed condition, 
including changes to or elimination of the proposed best interest 
determination.\279\ Some commenters suggested that we require no 
specific best interest determination.\280\ One commenter stated that 
these determinations are implicit in the investment management duties 
of an investment adviser.\281\ Another commenter stated that the 
Commission should provide guidance, in lieu of a best interest 
determination, that sets forth factors that an investment adviser 
should consider before investing in an acquired fund.\282\
---------------------------------------------------------------------------

    \278\ See, e.g., SIFMA AMG Comment Letter (stating the ``adviser 
to an acquiring fund, rather than the acquiring fund's board, should 
be the party primarily responsible for entering into and monitoring 
fund of funds arrangements''); Invesco Comment Letter.
    \279\ See, e.g., PGIM Comment Letter; ABA Comment Letter; NYC 
Bar Comment Letter.
    \280\ See, e.g., ABA Comment Letter; NYC Bar Comment Letter.
    \281\ See ABA Comment Letter.
    \282\ See NYC Bar Comment Letter.
---------------------------------------------------------------------------

    Commenters disagreed, however, on whether the proposed best 
interest determination would be too flexible or not flexible enough. 
For example, one commenter agreed with the proposed requirements for 
investment advisers, but stated that the proposed requirements would 
not prevent fund of funds arrangements from charging duplicative 
fees.\283\ This commenter suggested that the proposed best interest 
finding and the evaluation standards are too flexible, and that the 
Commission should interpret ``best interest'' to mean ``the best of the 
reasonably available options.'' The commenter also suggested that the 
Commission explicitly require advisers to waive duplicative fees. 
Conversely, another commenter agreed with the proposed best interest 
requirement, but stated that the proposed factors on which the finding 
would be based on were not flexible enough.\284\ This commenter 
suggested that we permit the investment adviser to consider any factors 
that it deems relevant in its best interest finding, including 
subjective factors relating to investment merits.\285\
---------------------------------------------------------------------------

    \283\ See CFA Comment Letter; but see PGIM Comment Letter 
(arguing that the rule should not require fee waivers because a fund 
board of directors is already required to evaluate the terms of 
advisory agreements, which encompass the finding requirements of the 
proposed rule).
    \284\ See Dechert Comment Letter.
    \285\ See id. (``[P]ortfolio managers should be given deference 
and afforded flexibility with respect to their consideration of 
factors that they deem most relevant to the proposed best interest 
finding, including subjective factors relating to investment 
merits.'').
---------------------------------------------------------------------------

    One commenter recommended expanding the proposed best interest 
determination to take into account fees, complexity, investment 
characteristics, fund size, underlying asset liquidity, asset 
volatility, legal structure and other characteristics.\286\ Another 
commenter suggested that instead of the proposed best interest finding, 
the final rule should require the acquiring fund's investment adviser 
to find that the investment in the acquired fund is ``appropriate in 
light of the complexity and aggregate fees.'' \287\ This commenter 
stated that this suggestion would more closely align the requisite 
finding (on complexity and aggregate fees instead of the proposed best 
interest finding) because the information on which advisers rely in 
making these evaluations relates to complexity and fees.
---------------------------------------------------------------------------

    \286\ See SIFMA AMG Comment Letter.
    \287\ See ICI Comment Letter.
---------------------------------------------------------------------------

    In the 2018 FOF Proposing Release, we noted that many of the 
conditions relating to fee limitations required in our exemptive 
orders, such as fee waivers and board findings regarding fees, were 
redundant in light of a fund adviser's and board's fiduciary duties and 
statutory obligations. As a result, we did not propose to require them 
as part of the finding requirement.\288\ A number of commenters agreed 
with this approach,\289\ but one commenter would have required fee 
waivers.\290\ This commenter argued that fiduciary duties are often not 
enough to ensure that investors are not subject to duplicative 
fees.\291\ We are requiring specific evaluations and findings to help 
address this concern.\292\
---------------------------------------------------------------------------

    \288\ See 2018 FOF Proposing Release, supra footnote 6, at n.146 
and accompanying text.
    \289\ See ICI Comment Letter; Voya Comment Letter; PGIM Comment 
Letter; ABA Comment Letter.
    \290\ See CFA Comment Letter.
    \291\ See also Comment Letter of Anonymous, (Dec. 28, 2018) 
(suggesting that, if an underlying fund pays a fee, these payments 
should be made into the assets of the acquiring fund, and that fund 
of funds arrangements should not be used to avoid fee limitations).
    \292\ See also infra footnotes 297 to 299 and accompanying text.
---------------------------------------------------------------------------

    After considering comments, and in conjunction with our 
determination to eliminate the proposed redemption limit, we are 
adopting a modified requirement for management companies regarding Fund 
Findings that is designed to address the complexity and fees associated 
with the fund of funds arrangement, as well as undue influence 
concerns, such as from the threat of large-scale redemption. However, 
we are also providing advisers with flexibility to tailor their 
analysis to these specific concerns.
    This requirement will apply to all management companies, including 
when both funds involved are in the same group of investment companies. 
While we believe it is appropriate to provide an exception from the 
voting and control conditions under the rule for funds in the same 
group of investment companies, such an exception is not appropriate for 
the finding condition. For example, two management companies in the 
same group of investment companies could

[[Page 73947]]

have two different advisers and two different boards satisfying their 
fiduciary duties to their respective shareholders. Requiring these 
advisers to evaluate the fund of funds arrangement separately and make 
the appropriate findings tracks their separate--albeit parallel--
fiduciary duties. Further, this requirement also applies if both the 
acquiring and acquired funds have the same adviser. This approach is 
similar to the proposed redemption limit, which would have applied to 
both unaffiliated and affiliated fund of funds arrangements.
    We also believe that it is appropriate to require each fund's 
investment adviser to make the applicable Fund Findings because whether 
to invest in an acquired fund to achieve a fund's investment objective, 
or accept any investment from an acquiring fund, is generally a 
question of portfolio management.\293\ That said, given the conflicts 
of interest at issue, we believe that the rule as adopted should 
provide a framework for advisers to conduct their analysis. Also, as 
discussed below, the fund's board of directors will be required to 
review these arrangements as part of its oversight responsibilities.
---------------------------------------------------------------------------

    \293\ See 2018 FOF Proposing Release, supra footnote 6, at n.140 
and accompanying text.
---------------------------------------------------------------------------

    Acquired Fund Findings. We are requiring that advisers to acquired 
management companies make a finding that any undue influence concerns 
associated with the acquiring fund's investment in the acquired fund 
are reasonably addressed.\294\ As part of this finding, the acquired 
management company's investment adviser will be required to consider a 
specific list of non-exhaustive factors. We believe these factors will 
help ensure that acquired fund advisers make appropriate determinations 
when assessing whether a fund of funds arrangement has terms that 
reasonably address undue influence by the acquiring fund, including 
through the threat of large-scale redemptions. Additionally, because 
this finding requirement (along with the fund of funds investment 
agreement) is replacing the protections that the proposed redemption 
limit would have provided, requiring consideration of specific factors 
is designed to enable the acquired fund to effectively negotiate 
appropriate terms regarding the acquiring fund's use of redemptions and 
other ways that the acquiring fund could exert undue influence over the 
acquired fund.
---------------------------------------------------------------------------

    \294\ By undue influence concerns, we mean circumstances where 
the acquiring fund will be in a position to control the assets of 
the acquired fund and use those assets to enrich the acquiring fund 
at the expense of acquired fund shareholders. See supra footnote 17 
and accompanying text.
---------------------------------------------------------------------------

    The rule does not dictate the particular terms or how acquired fund 
advisers must evaluate or weigh these factors because we believe that 
the investment adviser is in the best position to make these 
decisions.\295\ We believe that the adviser's familiarity with a fund's 
investment strategies and operations will inform its ability to 
identify and discern the most pertinent factors and concerns related to 
a fund of funds arrangement. This flexibility will allow an acquired 
fund to establish a fund of funds arrangement that appropriately 
protects its own interests and those of its investors.
---------------------------------------------------------------------------

    \295\ As noted above, an investment adviser has a fiduciary duty 
to act in the best interests of a fund it advises. See supra 
footnote 38.
---------------------------------------------------------------------------

    We believe that collectively this list of factors will assist 
acquired fund advisers in determining whether undue influence has been 
reasonably addressed. We devised these factors based upon the issues we 
raised in the 2018 FOF Proposing Release and as informed by comments 
received with regard to the proposed redemption limit.\296\ This list 
of factors is not an exhaustive list, and acquired fund advisers should 
consider anything else relevant under the circumstances when making 
their findings.
---------------------------------------------------------------------------

    \296\ See, e.g., Nationwide Comment Letter (suggesting that 
redeeming in-kind and advance notification of redemptions are common 
practices that funds engage in to protect against harms from 
possible large scale redemptions); ABA Comment Letter (suggesting 
that acquired funds prefer permissive limitations, such as the 
redemption limit in section 12(d)(1)(F)(ii), that they can negotiate 
with an acquiring fund). See also 2018 FOF Proposing Release, supra 
footnote 6, at 54 (requesting comment as to whether there should be 
an exception to the redemption limit for redemptions in-kind), 55 
(requesting comment as to whether the redemption limit should be 
voluntary at the election of an acquired fund and, if so, what other 
safeguards could be added to protect against undue influence), and 
57 (requesting comment, if the proposed redemption limit does not 
appropriately limit the threat of using redemptions to exercise 
undue influence or control, on what other conditions would better do 
so).
---------------------------------------------------------------------------

    One commenter objected to a finding that involves an analysis of 
specific factors, stating that we should afford portfolio managers 
deference and flexibility when making an investment decision.\297\ This 
commenter suggested that the fiduciary duties of the adviser and board 
are sufficient to protect against the undue influence concerns behind 
section 12(d)(1). Another commenter made a similar suggestion, stating 
that the guidance provided regarding the proposed finding requirement 
would add complexity, cost, and additional time to the investment 
process without adding significant value beyond the adviser exercising 
its fiduciary duty alone.\298\ While we agree that an adviser acting 
according to its fiduciary duty helps to protect against these 
concerns, the factors we are adopting should help the acquired fund 
adviser to exercise that duty by focusing upon those issues we believe 
are most important for an acquired fund in assessing this risk.\299\
---------------------------------------------------------------------------

    \297\ See Dechert Comment Letter. But see NYC Bar Comment Letter 
(stating that, while it believes that a best interest determination 
is unnecessary, it is appropriate for the Commission to highlight 
areas that it believes an investment adviser should consider prior 
to entering into a fund of funds arrangement).
    \298\ See Guggenheim Comment Letter.
    \299\ See also supra footnotes 288 to 292 and accompanying text.
---------------------------------------------------------------------------

    We believe each of the following factors is appropriate for an 
investment adviser to a management company to consider before making 
its finding:
     Scale of investment. The final rule will require the 
acquired fund's investment adviser to consider the scale of 
contemplated investments by the acquiring fund and any maximum 
investment limits.\300\ For example, the investment adviser may 
determine that certain levels of investment by an acquiring fund in 
excess of the section 12(d)(1) limits would be appropriate for the 
acquired fund's operations. Conversely, the adviser could determine 
that investments above a certain level would raise undue influence 
concerns because of the adverse effect a large-scale redemption from 
one large investor (e.g., 10% of the acquired fund's outstanding voting 
shares) could have on the fund and its investors. Assuming the funds 
have different advisers, the acquired fund could set the limit in the 
fund of funds investment agreement, or for funds with the same adviser, 
as part of the written record of its Fund Findings.\301\ To the extent 
an acquiring fund exceeded the acquired fund's specified threshold, the 
acquired fund could terminate the fund of funds agreement as an 
additional means of prohibiting additional investments. Alternatively, 
an acquired fund's adviser may determine that such a limitation on its 
investment is not necessary to address reasonably undue influence by 
the acquiring fund through the threat of large-scale redemptions.
---------------------------------------------------------------------------

    \300\ See rule 12d1-4(b)(2)(i)(B)(1).
    \301\ See infra footnote 360 and accompanying text.
---------------------------------------------------------------------------

     Anticipated timing of redemption requests. The final rule 
will require the acquired fund's investment adviser to consider the 
anticipated timing of redemption requests by the acquiring fund.\302\ 
The acquired fund's adviser could, for example, determine that the

[[Page 73948]]

undue influence concerns regarding an acquiring fund's investment would 
be reasonably addressed only if the acquiring fund commits to 
submitting redemption requests over multiple days. Depending on the 
particular investment strategy and liquidity of the acquired fund, such 
an adviser might consider the impact of immediate, large redemption 
requests and determine that the undue influence concerns would be 
reasonably addressed only if such requests are made over multiple 
days.\303\
---------------------------------------------------------------------------

    \302\ See rule 12d1-4(b)(2)(i)(B)(2).
    \303\ 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 
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).
---------------------------------------------------------------------------

     Advance notification of investments or redemptions. The 
final rule will require the acquired fund's investment adviser to 
consider whether and under what circumstances the acquiring fund will 
provide advance notification of investments and redemptions.\304\ For 
example, the adviser may request or require that the acquiring fund 
provide advance notice of a large redemption before entering into a 
fund of funds investment agreement. However, any agreement related to 
this factor would still have to comply with section 22(e) of the Act.
---------------------------------------------------------------------------

    \304\ See rule 12d1-4(b)(2)(i)(B)(3).
---------------------------------------------------------------------------

     In-kind redemptions. The final rule requires the acquired 
fund's investment adviser to consider whether redemptions will be made 
in cash or in kind by the acquired fund.\305\ For example, to 
facilitate redemptions or investments, the adviser may consider as part 
of its arrangement whether redemptions will be in cash or in kind, or 
whether only redemptions above a certain threshold may be made in-
kind.\306\
---------------------------------------------------------------------------

    \305\ See rule 12d1-4(b)(2)(i)(B)(5).
    \306\ Many funds reserve the right to redeem their shares in-
kind instead of with cash. See, e.g., rule 18f-1; rule 22e-4(b)(v); 
Election by Open-End Investment Companies to Make Only Cash 
Redemptions, Investment Company Act Release No. 6561 (June 14, 1971) 
[36 FR 11919 (June 23, 1971)] (stating that the definition of 
``redeemable security'' in section 2(a)(32) of the Investment 
Company Act ``has traditionally been interpreted as giving the 
issuer the option of redeeming its securities in cash or in kind'').
---------------------------------------------------------------------------

    In order to make its finding, an acquired fund's adviser also would 
need to consider any other relevant regulatory requirements. For 
example, an acquired fund's consideration of the threat of undue 
influence through redemptions would depend in part on the fund's 
liquidity risk and how it manages that risk. Accordingly, the adviser 
to an acquired fund may need to consider how it would manage any 
liquidity risk from the acquiring fund's investment under its liquidity 
risk management program required by rule 22e-4. Terms agreed upon 
through assessment of the factors described above may be a part of how 
the acquired fund plans to manage any such liquidity risk. In other 
cases, the acquired fund's adviser may determine that an acquiring 
fund's investment does not raise a threat of undue influence through 
large-scale redemptions--or that any threat is addressed through the 
terms of the fund of funds investment agreement--but that it must take 
other steps through its liquidity risk management program to manage 
liquidity risks under rule 22e-4. In negotiating a fund of funds 
investment agreement, an acquired fund adviser should address all 
matters to the extent necessary to allow the fund to comply with legal 
and regulatory requirements under the Federal securities laws.
    Acquiring Fund Evaluations and Findings. As we discussed in the 
2018 FOF Proposing Release, the evaluations (and related finding) that 
we are requiring of advisers to management companies that are acquiring 
funds are designed 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.\307\
---------------------------------------------------------------------------

    \307\ Id.
---------------------------------------------------------------------------

    In evaluating the complexity of a fund of funds structure, an 
acquiring fund adviser should consider the complexity of the 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 or circumvent 
the acquiring fund's investment restrictions and limitations. The 
adviser also should consider whether an acquired fund invests in other 
funds, which may create additional complexity.\308\
---------------------------------------------------------------------------

    \308\ Id. at n.141 and accompanying text.
---------------------------------------------------------------------------

    In evaluating the fees associated with the fund's investment in 
acquired funds, an adviser should consider the fees of both the 
acquiring and acquired funds within the fund of funds arrangement with 
an eye towards duplication. Specifically, 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 own services to 
the acquiring fund. The adviser also should consider the other fees and 
expenses, such as sales charges, recordkeeping fees, sub-transfer 
agency services, and fees for other administrative services.
    We believe the flexibility provided by the rule will allow an 
acquiring fund to establish a fund of funds investment agreement that 
appropriately protects its own interests and those of its investors. 
However, as with acquired fund advisers, in negotiating a fund of funds 
investment agreement, an acquiring fund adviser should address all 
matters to the extent necessary to allow the fund to comply with legal 
and regulatory requirements under the Federal securities laws.
    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.\309\ 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).\310\ Section 36(b) of the Act also imposes on fund advisers a 
fiduciary duty with respect to their receipt of compensation.\311\ 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 only charge fees or 
expenses for the services that the acquiring fund's adviser is 
providing, and not for any services performed by an adviser to an 
acquired fund.\312\ 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 and must 
act in the best interest of its clients, including eliminating or 
making full and fair disclosure of this conflict.\313\
---------------------------------------------------------------------------

    \309\ See 2006 FOF Adopting Release, supra footnote 19, at n.52 
and accompanying text.
    \310\ 15 U.S.C. 80a-15(c).
    \311\ 15 U.S.C. 80a-36(b).
    \312\ See 2006 FOF Adopting Release, supra footnote 19, at n.52.
    \313\ See Fiduciary Duty Interpretation, supra footnote 255.
---------------------------------------------------------------------------

    Nevertheless, we believe that it is appropriate for the rule to 
require that the acquiring fund's adviser find that the aggregate fees 
and expenses are not duplicative, given the inherent conflict

[[Page 73949]]

of interest the adviser faces in this circumstance. This finding, which 
is reported to the board of directors, gives the fund's board 
information specific to the fund of funds arrangement to review when 
exercising its oversight responsibilities over the adviser.
    Investment Adviser Reporting and Board Oversight. The final rule 
will require the adviser to a management company to report its 
evaluation, finding, and the basis for its evaluation or finding to the 
fund's board of directors no later than the next regularly scheduled 
board meeting.\314\ As discussed above,\315\ the final rule differs 
from the proposed rule in that we will not additionally require the 
fund's board of directors to set the frequency of determination as 
reasonable and appropriate after the initial investment, but in any 
case no less frequently than annually.
---------------------------------------------------------------------------

    \314\ Rule 12d1-4(b)(2)(i)(C).
    \315\ See supra footnotes 271 through 276 and accompanying text.
---------------------------------------------------------------------------

    Some commenters suggested that the Commission eliminate or modify 
the requirement that the investment adviser of the acquiring fund 
report the proposed best interest determination to the acquiring fund's 
board of directors.\316\ One commenter characterized this requirement 
as unduly burdensome, as another mandatory report that may be complex 
and data heavy.\317\ Rather than reporting the finding to the board of 
directors before investing in an acquired fund, a commenter recommended 
that the final rule require such reporting and the basis for the 
adviser's determination to the board of directors at the next regularly 
scheduled meeting.\318\ On the other hand, one commenter stated that 
the board of directors appropriately serves an oversight role, 
supporting the proposal's investment adviser reporting requirements. 
The commenter recommended that the frequency of reporting should be set 
forth in a fund's policies and procedures adopted and approved by the 
board under rule 38a-1 under the Act.\319\
---------------------------------------------------------------------------

    \316\ See, e.g., Dechert Comment Letter; NYC Bar Comment Letter; 
ABA Comment Letter.
    \317\ See ABA Comment Letter (suggesting elimination of the best 
interest determination and board reporting requirements).
    \318\ See NYC Bar Comment Letter.
    \319\ See MFDF Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that the board of directors provides an 
additional layer of protection for acquiring and acquired funds that 
are management companies and their respective investors against the 
abuses historically associated with fund of funds arrangements. We are 
therefore adopting conditions that will require the investment adviser 
to each of the acquiring and acquired funds to report its evaluation, 
finding, and the basis for its evaluation or finding. We are adopting 
this change to the proposed rule to conform to the final rule's 
regulatory framework, which now applies to acquiring and acquired fund 
advisers. As proposed,\320\ the final rule will not require a 
management company's adviser to make the applicable Fund Findings in 
connection with every investment in an acquired fund.
---------------------------------------------------------------------------

    \320\ See 2018 FOF Proposing Release, supra footnote 6, at n.143 
and accompanying text.
---------------------------------------------------------------------------

ii. UIT Findings
    Rule 12d1-4 will include an alternative finding condition when the 
acquiring fund 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 find that the fees of the UIT 
do not duplicate the fees and expenses of the acquired funds that the 
UIT holds or will hold at the date of deposit.\321\ The final rule will 
require the principal underwriter or depositor to base its finding on 
an evaluation of the complexity of the structure and the aggregate fees 
and expenses associated with the UIT's investment in acquired 
funds.\322\ This requirement is essentially the same as proposed.\323\
---------------------------------------------------------------------------

    \321\ Rule 12d1-4(b)(3)(ii).
    \322\ Under rule 12d1-4(b)(3)(iv), fund of funds arrangements 
(including acquiring and acquired funds that are UITs) must enter 
into a fund of funds investment agreement. See infra section 
II.C.2.4II.C.2.b.iv.
    \323\ The only change is that we have revised the final rule to 
make clear that it requires the principal underwriter or depositor 
to consider expenses in addition to fees. See supra footnote 247.
---------------------------------------------------------------------------

    We received limited comments addressing this aspect of the 
proposal, but the comments received provided support or did not 
recommend any UIT-specific changes to the proposal.\324\ For example, 
one commenter supported the rule requiring the principal underwriter or 
depositor of a UIT to make a finding regarding aggregate UIT and 
acquired fund fees.\325\
---------------------------------------------------------------------------

    \324\ See ABA Comment Letter; SIFMA AMG Comment Letter.
    \325\ See ABA Comment Letter.
---------------------------------------------------------------------------

    The condition for acquiring UITs under rule 12d1-4 differs from the 
condition applicable to acquiring management companies in many 
respects, and we believe that this is appropriate for several reasons. 
First, by statute, a UIT is unmanaged and its portfolio fixed.\326\ 
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. Second, acquiring UITs typically raise different fee and 
expense 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.\327\
---------------------------------------------------------------------------

    \326\ 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).
    \327\ 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 Exchange-Traded Funds, Investment Company 
Act Release No. 33140 (July 31, 2018) [83 FR 37332 (July 31, 2018)] 
(``2018 ETF Proposing Release'') at n.52 and accompanying text.
---------------------------------------------------------------------------

    Due to the unmanaged nature of UITs and the fixed nature of their 
portfolios, we continue to believe it would be inconsistent with their 
structure to require a re-evaluation of their acquired fund finding 
over time or other reporting requirements. The requirement only 
applies, therefore, at the time of the UIT's creation. Nevertheless, 
this determination generally should consider 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 the UIT-
specific finding requirement that its fees and expenses do not 
duplicate the fees and expenses 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.
    Unlike acquired management companies, we are not extending this 
finding requirement to acquired funds that are UITs.\328\ We do not 
believe it is necessary to require these UITs to make similar findings 
given their structure. A UIT that is an acquired fund does not have 
similar section 12(d)(1) undue influence concerns as a management 
company because the UIT is unmanaged. This is distinguishable from UITs 
that are acquiring funds where we are only requiring UITs to consider 
the complexity of the structure and the aggregate fees and expenses 
associated with the UIT's investment,

[[Page 73950]]

which is only relevant when the UIT is acquiring other funds.
---------------------------------------------------------------------------

    \328\ However, if the acquiring fund is a management company, it 
would need to make its own finding consistent with the rule. See 
supra footnote 248.
---------------------------------------------------------------------------

    This condition will apply only at the time of initial deposit for 
UITs that are formed after the rule's effective date as proposed. We do 
not believe it is necessary to exclude UITs that are already in 
existence from relying on rule 12d1-4 as acquiring funds. UITs that 
serve as separate account vehicles funding variable annuity and 
variable life insurance contracts will be subject to additional fee 
conditions, as discussed below. The majority of UITs fall into this 
category.\329\ In addition, we believe that existing UIT ETFs are 
unlikely to rely on rule 12d1-4 as acquiring funds because they 
replicate the components of broad-based securities indexes that do not 
currently include funds.\330\ 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.\331\ 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, sometimes 
of approximately 12-18 months.\332\ Given this short term, the number 
of UITs that have not made the finding required by rule 12d1-4 would 
decrease quickly over time. Absent this provision, it is unlikely that 
pre-existing UITs could rely upon the rule given the statutory 
requirement that UITs be organized under a trust indenture, contract of 
custodianship or agency, or similar instrument.
---------------------------------------------------------------------------

    \329\ According to UIT annual Form N-CEN filings, as of April 
2020, insurance UITs made up 674 of the total 716 registered UITs.
    \330\ There are five existing UIT ETFs that had total assets of 
approximately $436.6 billion as of December 31, 2019, representing 
85.7% 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.
    \331\ 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 81, at nn. 46-47 and accompanying text.
    \332\ This estimate is based on staff sampling of equity UIT 
prospectuses.
---------------------------------------------------------------------------

iii. Separate Accounts Funding Variable Insurance Contract 
Certification
    With respect to a separate account funding variable insurance 
contracts that invests in an acquiring fund, the final rule will 
require an acquiring fund to obtain a certification from the insurance 
company issuing the separate account that it has determined that the 
fees and expenses 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.\333\ The standard set forth in 
section 26(f)(2)(A) of the Act provides that the fees must be 
reasonable in relation to the services rendered, the expenses expected 
to be incurred, and the risks assumed by the insurance company. This 
requirement generally is the same as proposed.\334\
---------------------------------------------------------------------------

    \333\ Rule 12d1-4(b)(2)(iii).
    \334\ The only change is that we have revised the final rule to 
make clear that it requires the insurance company to consider 
expenses in addition to fees. See supra footnote 247.
---------------------------------------------------------------------------

    Comments received regarding the insurance company certification 
generally raised concerns with this requirement.\335\ One commenter 
stated that the certification requirement is inappropriate because the 
separate account is a separate and distinct legal entity from the fund 
of funds arrangement.\336\ For example, this commenter stated that 
typical fees associated with separate accounts, such as mortality and 
expense risk fees or account fees and expenses, are the responsibility 
of, and paid by, the insurance contract owners. Some commenters also 
stated that the acquiring fund's investment adviser may have limited 
ability to obtain or compel this type of certification from an 
unrelated insurance company to comply with the rule.\337\
---------------------------------------------------------------------------

    \335\ See, e.g., Nationwide Comment Letter; ICI Comment Letter; 
PGIM Comment Letter; ABA Comment Letter.
    \336\ See Nationwide Comment Letter.
    \337\ See, e.g., Dechert Comment Letter; ICI Comment Letter; 
Comment Letter of Insured Retirement Institute (May 2, 2019) (``IRI 
Comment Letter'').
---------------------------------------------------------------------------

    Some commenters stated that section 26 of the Act already requires 
that the separate account and sponsoring insurance company fees and 
charges deducted under a variable insurance contract, in the aggregate, 
be reasonable in relation to the services rendered, the expenses 
expected to be incurred, and the risks assumed by the insurance 
company.\338\ Commenters argued that, in making this determination, the 
insurance company sponsoring the separate account is entitled to rely 
on the obligations already imposed on the investment adviser and board 
of trustees of any fund in which the separate account invests, to 
ensure that the fees borne by any funds that are available through 
variable insurance contracts are appropriate.\339\ Other commenters 
argued that the requirement was superfluous in light of existing 
requirements for review and approval of acquiring and acquired fund 
advisory agreements under section 15(c) of the Act and a fund adviser's 
fiduciary duty under section 36(b) of the Act with respect to the 
receipt of compensation for services, or of payments of a material 
nature, from an acquiring or acquired fund.\340\
---------------------------------------------------------------------------

    \338\ See ICI Comment Letter; PGIM Comment Letter; ABA Comment 
Letter.
    \339\ See, e.g., Nationwide Comment Letter.
    \340\ See, e.g., PGIM Comment Letter; John Hancock Comment 
Letter; Dechert Comment Letter.
---------------------------------------------------------------------------

    We believe the final rule should include a condition that addresses 
the concerns underlying the limits in section 12(d)(1), particularly 
duplicative fee concerns, in this three-tier arrangement.\341\ We 
disagree with commenters that the finding is unnecessary or duplicative 
of section 15(c) or section 36(b) because we believe it is appropriate 
to address concerns with duplicative fees at each tier of the 
arrangement. In addition, section 15(c) and 36(b) generally will not 
apply in each tier of such an arrangement since the funds involved in 
this arrangement typically include UITs, which do not have boards of 
directors or investment advisers.\342\ In addition, this certification 
requirement will ensure an analysis of the aggregate fee and expense 
structure of all the funds involved.
---------------------------------------------------------------------------

    \341\ Rule 12d1-4 restricts fund of funds arrangements to two 
tiers other than in limited circumstances, such as master-feeder 
arrangements in reliance on section 12(d)(1)(E) of the Act. See 
infra section II.C.3 (discussing complex structure requirements).
    \342\ Section 15(c) of the Act applies to registered open-end 
funds that have a board of directors, whereas section 36(b) of the 
Act applies to certain payments to a registered investment company's 
investment adviser.
---------------------------------------------------------------------------

    The final rule's conditions for separate accounts funding variable 
insurance contracts are based on the current fund of funds exemptive 
orders.\343\ Our exemptive orders include a condition similar to the 
certification requirement.\344\ Under the orders, the

[[Page 73951]]

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

    \343\ See 2018 FOF Proposing Release, supra footnote 6, at 
section II.C.3.c.
    \344\ Specifically, in the orders, each acquiring fund must 
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. Id. at n.173-174 and 
accompanying text.
---------------------------------------------------------------------------

    Under the rule, an insurance company sponsoring a separate account 
must certify that the fees and expenses borne by the separate account, 
acquiring fund, and acquired fund in the aggregate are reasonable and 
consistent with the standard set forth in section 26 of the Act. 
Because the final rule will require most funds to enter into a fund of 
funds investment agreement, we considered whether to codify the 
approach of the exemptive orders and require that the fund of funds 
investment agreement include a representation regarding the insurance 
company's certification.\345\ Rule 12d1-4 will not require that the 
fund of funds investment agreement include this representation, 
although the agreement may do so. This is consistent with our general 
approach not to codify in our rule all the particularized terms that an 
agreement must include to reflect the fund of funds arrangement.
---------------------------------------------------------------------------

    \345\ The Commission proposed the certification requirement, in 
part, because the proposal did not contemplate participation 
agreements. See 2018 FOF Proposing Release, supra footnote 6, at 
section II.C.3.c.
---------------------------------------------------------------------------

iv. Fund of Funds Investment Agreements
    The final rule will require funds to enter into a fund of funds 
investment agreement before the acquiring fund acquires securities of 
the acquired fund in excess of the limits of section 12(d)(1) in 
reliance on rule 12d1-4 unless both funds have the same adviser.\346\ 
This requirement works in tandem with the requirement to make certain 
Fund Findings by providing a method to hold the parties to the 
arrangement to the terms that led each fund's investment adviser to 
agree to the arrangement in the first place. In negotiating the fund of 
funds investment agreement, funds can set the terms of the agreement to 
support the Fund Findings. For example, an acquired fund could require 
the acquiring fund to agree to submit redemptions over a certain amount 
for a given period as a condition to the fund of funds investment 
agreement. This agreement both sets the expectations of the parties at 
the outset of the arrangement and provides a method of enforceability 
should one party not live up to these expectations. Thus, the fund of 
funds investment agreement is designed to address historical abuse 
concerns under section 12(d)(1), including an acquiring fund 
threatening large-scale redemptions as a means of exercising undue 
influence over an acquired fund.\347\ Further, the requirement to enter 
into such agreement puts the acquired fund on notice that an acquiring 
fund is investing in it in reliance on the rule.
---------------------------------------------------------------------------

    \346\ Rule 12d1-4(b)(2)(iv). Unlike the conditions relating to 
voting and control, the rule will require funds that are part of the 
same group of investment companies to enter into a fund of funds 
investment agreement if they do not have the same investment 
adviser.
    \347\ We believe that, due to the flexibility that the final 
rule provides in this regard, no special exceptions for certain 
funds or situations, such as interval funds or acquired fund 
liquidations, are necessary. But see NYC Bar Comment Letter 
(suggesting that these instances should be exempted from its 
proposed alternative approach to the proposed redemption limit). We 
would expect that the relevant parties would negotiate appropriate 
terms into their fund of funds investment agreement.
---------------------------------------------------------------------------

    In the 2018 Proposing Release, we requested comment on alternatives 
to the proposed redemption limit, specifically asking whether we should 
permit acquired funds to set their own redemption limit (and, if so, 
what parameters we should establish) or whether we should require 
participation agreements.\348\ As discussed above, a number of 
commenters recommended a negotiated agreement similar to the 
participation agreements required in our exemptive orders as an 
alternative to the proposed redemption limit.\349\ We agree with these 
commenters that a negotiated agreement, combined with the findings 
requirements discussed above, would be a more effective control against 
the threat of the use of large redemptions to exercise undue influence 
than the proposed redemption limit.
---------------------------------------------------------------------------

    \348\ See 2018 FOF Proposing Release, supra footnote 6, at 57-
58. We also requested comment on: (i) Whether participation 
agreements require the parties to a fund of funds arrangement to 
provide information necessary for compliance with other provisions 
of the Act; and (ii) whether we should codify the conditions of 
existing exemptive orders including the procedural requirements. See 
id.
    \349\ See supra footnotes 221 through 236, 266 through 270, and 
296 through 299 and accompanying text.
---------------------------------------------------------------------------

    The fund of funds investment agreement differs in certain ways from 
the requirement in our exemptive orders that, prior to investing in 
another fund, acquiring and acquired funds enter into a participation 
agreement. Participation agreements under our orders require both funds 
in a fund of funds arrangement (and their investment advisers) to 
fulfill their responsibilities under the order.\350\ Participation 
agreements also require that the acquiring fund notify the acquired 
fund prior to investing in excess of the limits of section 12(d)(1)(A) 
and provide the acquired fund a list of the names of each of its 
affiliates to help the acquired fund ensure compliance with the 
affiliated transaction provisions of the Act.\351\ Because all funds 
operating in accordance with rule 12d1-4 will be required to comply 
with the rule's conditions, the rule will not require that a fund of 
funds investment agreement include these types of contractual 
provisions.\352\ In contrast to a participation agreement, the fund of 
funds investment agreement will be required to memorialize the terms of 
the arrangement that serve as a basis for the required finding. The 
agreement will empower funds relying on the rule to negotiate and 
tailor appropriate terms to protect their interests in a fund of funds 
arrangement. For example, the fund of funds investment agreement will 
provide a mechanism for an acquired fund to limit an acquiring fund's 
investments in reliance on the rule and arm itself with other tools it 
desires to protect against potential undue influence from an acquiring 
fund.
---------------------------------------------------------------------------

    \350\ Fund of funds exemptive orders require a participation 
agreement to state, without limitation, that the funds' boards and 
their investment advisers understand the terms and conditions of the 
order and agree to fulfill their responsibilities under the order. 
See, e.g., ETF Managers Trust, et al., Investment Company Act 
Release Nos. 33799 (Feb. 19, 2020) [85 FR 10794 (Feb. 25, 2020)] 
(notice) and 33823 (Mar. 24, 2020) (order) and related application 
(``ETF Managers Trust'').
    \351\ While not required by exemptive orders, some funds include 
other provisions in participation agreements to govern the fund of 
funds arrangement, such as provisions related to mirror voting, 
waiver of compensation, and notification upon exceeding certain 
thresholds. We are not requiring that these conditions be included 
in the written agreement.
    \352\ See ICI Comment Letter.
---------------------------------------------------------------------------

    Rule 12d1-4 also will require funds operating in accordance with it 
to enter into a fund of funds investment agreement that includes three 
specific provisions. While some commenters suggested that we did not 
need to outline specific provisions in these agreements,\353\ we 
believe that certain minimum requirements are necessary to ensure that 
the fund of funds agreement is effective at curtailing undue influence. 
These requirements are based on the Fund Findings, as well as elements 
of our exemptive orders and

[[Page 73952]]

commenters' recommendations in response to our requests for 
comment.\354\
---------------------------------------------------------------------------

    \353\ See ICI Comment Letter (stating that because a fund of 
funds arrangement would need to comply with the generally applicable 
provisions of the rule, its proposed alternative to a participation 
agreement would not require negotiation). But see Capital Group 
Comment Letter (suggesting that the Commission should include 
practical conditions in a participation agreement-type regime).
    \354\ See, e.g., ETF Managers Trust, supra footnote 350 
(representing, among other things, that the participation agreement 
permitted an unaffiliated acquired fund to terminate it). See also 
ICI Comment Letter (``[r]equiring the acquired fund to agree to (and 
then terminate, if desired) the investment by an acquiring fund from 
a different group of investment companies would give the acquired 
fund a critical tool for protecting the interests of its 
shareholders''); Wells Fargo Comment Letter (stating that the 
standard representations, compliance polices, and other conditions 
accompanying participation agreements in the exemptive orders 
establish an effective framework of checks and balances that has 
successfully governed unaffiliated fund of funds arrangements); 
Fidelity Comment Letter (suggesting that in a participation 
agreement, an acquired fund could always protect itself by refusing 
to enter into such an agreement); NYC Bar Comment Letter 
(suggesting, among other things, that a participation agreement-type 
regime would permit the acquiring fund to negotiate the glide-path 
of redemptions).
---------------------------------------------------------------------------

    First, the fund of funds investment agreement must include any 
material terms necessary for the adviser, underwriter, or depositor to 
make the Fund Finding where the funds involved include management 
companies or UITs.\355\ This ensures that the adviser or other party 
making the Fund Finding will have memorialized the terms of the 
investment that underpin the Fund Finding, thereby making these terms 
fixed and clearly agreed if a dispute arises in the future. Given the 
importance of the Fund Findings to rule 12d1-4's protections, we 
believe that it is critical for the agreement to identify such terms to 
minimize ambiguity.
---------------------------------------------------------------------------

    \355\ Rule 12d1-4(b)(2)(iv)(A). This is not required of separate 
accounts because the acquiring fund is obtaining a certification 
from the insurance company offering the separate account rather than 
making a finding regarding the separate account.
---------------------------------------------------------------------------

    Second, each fund of funds investment agreement must include a 
termination provision whereby either party can terminate the agreement 
with advance written notice within a period no longer than 60 
days.\356\ This provision will give an acquired fund the ability to 
terminate an acquiring fund's acquisition of additional fund shares and 
provides the acquired fund with the negotiating leverage to address 
undue influence concerns. Termination of the agreement does not, unless 
otherwise agreed to by the parties, require that the acquiring fund 
reduce its position in the acquired fund, but will prevent the 
acquiring fund from purchasing additional shares of the acquired fund 
beyond the limits of section 12(d)(1).\357\
---------------------------------------------------------------------------

    \356\ Rule 12d1-4(b)(2)(iv)(B). The 60-day period is based upon 
a similar provision in section 15(a) of the Act. See 15 U.S.C. 80a-
15(a)(3). We believe that this period is also consistent with the 
termination provision in some existing participation agreements.
    \357\ Termination of the agreement would mean that the funds 
could no longer rely upon the rule to purchase or otherwise acquire, 
or sell or otherwise dispose of, fund securities in excess of the 
limits of section 12(d)(1) because they would not have a fund of 
funds investment agreement effective for the duration of the fund's 
reliance on the rule. See rule 12d1-4(b)(2)(iv).
---------------------------------------------------------------------------

    Lastly, the agreement must include a provision requiring an 
acquired fund to provide the acquiring fund with fee and expense 
information to the extent reasonably requested.\358\ We believe that 
this requirement is appropriate to assist the acquiring fund's adviser 
with assessing the impact of fees and expenses associated with an 
investment in an acquired fund. For example, an acquired fund that 
invests in other funds would more readily have fee and expense 
information associated with the underlying investment than the 
acquiring fund, which may inform the acquiring fund's consideration of 
fees and expenses associated with an investment in the acquired fund. 
We believe that fund of funds investment agreements are material 
contracts not made in the ordinary course of business. As a result, 
they must be filed as an exhibit to each fund's registration 
statement.\359\
---------------------------------------------------------------------------

    \358\ Rule 12d1-4(b)(2)(iv)(C).
    \359\ See, e.g., Item 28(h) of Form N-1A.
---------------------------------------------------------------------------

    In sum, we believe that this requirement provides important 
additional protections beyond those provided by the Fund Findings 
requirement. First, it ensures both parties agree to the significant 
terms of the investment, including those terms on which the adviser or 
other party making the Fund Finding has based its analysis. Second, it 
ensures that an acquiring fund has the information it needs to assess 
the impact of the relevant fees and expenses. Lastly, these agreements 
permit funds to terminate the investment if they so choose, thereby 
ending the funds' ability to rely upon the rule for any additional 
investments in the acquired fund.
    The rule will not require acquired funds and acquiring funds that 
are advised by the same adviser to enter into a fund of funds 
investment agreement. We believe that there are comparatively fewer 
benefits to formalizing a fund of funds arrangement with an executed 
agreement if the funds have the same adviser, assuming that the funds' 
adviser has made the applicable Fund Finding. Given the importance of 
the fund of funds investment agreement to the structure of the rule, we 
think it is important to require it of every fund unless the same 
adviser is the primary adviser to both funds. That is, the exception 
will not be available when an investment adviser acts as an adviser to 
one fund and a sub-adviser to the other fund in a fund of funds 
arrangement relying on the rule or as sub-adviser to both funds. We 
believe that this distinction is appropriate because a sub-adviser may 
not have the same access to information or be negotiating from the same 
position as other advisers. Thus, in situations where an adviser is the 
primary adviser to the acquired fund and serves as the sub-adviser to 
the acquiring fund, a fund of funds investment agreement would be 
required. Similarly, funds that do not have an adviser, such as 
internally managed funds or UITs, always would need to enter into a 
fund of funds investment agreement. Funds that do have the same adviser 
must still memorialize the arrangements that led the relevant adviser 
to make the Fund Finding for each fund under the rule.\360\
---------------------------------------------------------------------------

    \360\ Rule 12d1-4(c)(2). See also supra section II.C.4.
---------------------------------------------------------------------------

    In the 2018 Proposing Release, we noted that an adviser to both an 
acquiring and acquired fund would owe a fiduciary duty to each of these 
funds.\361\ As noted above, some commenters suggested that this was a 
reason to exclude affiliated funds of funds from the proposed 
redemption limit.\362\ However, another commenter questioned whether 
advisers to more than one fund can effectively exercise their fiduciary 
duty to each fund independently of the other fund.\363\ Advisers must 
act in accordance with their fiduciary duties to each respective fund, 
which should address the conflicts of interests advisers face when 
acting as an adviser to both the acquiring and acquired funds. Because 
of this, and the requirement to make the Fund Findings, we believe that 
it is unnecessary to apply the fund of funds investment agreement 
requirement to funds having the same adviser. In cases where an adviser 
believes that it cannot satisfy its fiduciary duty to both funds in a 
fund of funds arrangement, the adviser should not enter into the 
arrangement.
---------------------------------------------------------------------------

    \361\ 2018 FOF Proposing Release, supra footnote 6, at n.107 and 
accompanying text.
    \362\ See Wells Fargo Comment Letter; Thrivent Comment Letter; 
SIFMA AMG Comment Letter; see also John Hancock Comment Letter; MFS 
Comment Letter; Ropes Comment Letter.
    \363\ See CFA Comment Letter.
---------------------------------------------------------------------------

    We also are not exempting all funds within the same group of 
investment companies from the fund of funds investment agreement 
requirement, as suggested by a number of commenters in relation to the 
more-restrictive proposed redemption limit.\364\ While some funds 
within the same group may

[[Page 73953]]

have effective communication and controls such that a fund of funds 
investment agreement may seem duplicative, not all do. As we noted 
above, two funds in the same group of investment companies could have 
two different advisers and two different boards satisfying their 
fiduciary duties to their respective funds and shareholders. In some 
cases, the investment advisers to funds in the same group of investment 
companies are not even affiliated persons.\365\ Further, these funds 
are likely subject to different compliance policies and procedures and, 
as a result, we believe that a fund of funds investment agreement is an 
effective mechanism to memorialize the arrangement in these 
circumstances.
---------------------------------------------------------------------------

    \364\ See supra footnote 216 and accompanying text.
    \365\ See supra footnotes 166 through 170 and accompanying text.
---------------------------------------------------------------------------

    In summary, we believe that the requirement to enter into a fund of 
funds investment agreement, coupled with the expanded Fund Findings, 
are collectively a more effective approach than the proposed redemption 
limit to address undue influence concerns from redemptions. As compared 
to the proposed redemption limit that applied to all fund of funds 
arrangements, the conditions we are adopting provide funds with the 
ability to tailor their limits or protections to specific arrangements 
to better promote protection against potential undue influence and are 
more similar to requirements in orders providing section 12(d)(1) 
relief for fund of funds. As a result, we believe the rule, as adopted, 
will be an effective, less burdensome approach.
3. Complex Structures
    A concern underlying section 12(d)(1) is that complex multi-tier 
fund structures could lead to excessive fees and investor confusion. To 
address this concern rule 12d1-4 will include conditions designed 
generally to restrict fund of funds arrangements to two-tiers, largely 
as proposed. Additionally, as proposed, rule 12d1-4 includes exceptions 
to the two-tier limitation that are limited in scope and designed to 
capture circumstances that do not raise the concerns underlying section 
12(d)(1) of the Act. In response to concerns raised by commenters, 
however, we are adding an additional exception that will permit an 
acquired fund to invest up to 10% of its total assets in other funds 
without restriction on the purpose of the investment or types of 
underlying funds, or the size of the investment in a particular 
underlying fund (the ``10% Bucket''). The final rule's conditions seek 
to permit innovation and efficient portfolio management while limiting 
the potential for confusing structures and duplicative fees.
a. General Prohibition on Three-Tier Structures
    Rule 12d1-4 includes conditions designed to restrict fund of funds 
arrangements to two tiers (other than in limited circumstances), 
generally as proposed. Commenters were mixed with respect to the 
proposed rule's general prohibition on three-tier structures. Some 
commenters agreed with the Commission that multi-tier structures have 
the potential to confuse investors and generate duplicative fees.\366\ 
One commenter, for example, supported a broad restriction that limits 
fund of funds arrangements to two levels.\367\ Some commenters 
generally supported a prohibition on three-tier structures, but also 
advocated for broad-based exceptions for certain acquired fund 
investments in underlying funds that had been permitted under 
historical exemptive relief and included in the proposed rule.\368\
---------------------------------------------------------------------------

    \366\ See, e.g., CFA Comment Letter; Invesco Comment Letter; 
Voya Comment Letter.
    \367\ CFA Comment Letter.
    \368\ See, e.g., Invesco Comment Letter (recommending exceptions 
for securities lending programs and cash sweep arrangements), Voya 
Comment Letter (recommending exceptions for master-feeder 
arrangements, short-term cash management, interfund borrowing and 
lending, and investments in wholly owned subsidiaries).
---------------------------------------------------------------------------

    Other commenters stated that multi-tier structures may be 
beneficial and recommended that the Commission allow such structures by 
relying on other aspects of the rule to enhance investor 
protection.\369\ Some commenters recommended that the rule permit 
certain specific multi-tier structures, stating that such structures 
are beneficial to fund shareholders and do not raise the concerns 
section 12(d)(1) was designed to prevent.\370\ Similarly, one commenter 
wrote that the proposed three-tier condition was too rigid and would 
constrain legitimate three-tier arrangements.\371\ Further, some 
commenters noted that the proposed condition would require 
restructuring of certain fund of funds arrangements, resulting in 
additional costs for investors and limiting the variety of investment 
strategies available in the marketplace.\372\ Some commenters also 
recommended that the three tier limitations should not apply to 
acquired fund investments in private funds, since section 12(d)(1) does 
not restrict a fund from investing in private funds.\373\
---------------------------------------------------------------------------

    \369\ Morningstar Comment Letter (advising against a general 
prohibition on three-tier structures in favor of fee and expense 
disclosure in prospectuses and annual reports); TRP Comment Letter 
(stating that the proposed rule's requirements that an adviser 
evaluate the complexity of the structure and engage in a best 
interest finding are sufficient without a broader prohibition on 
three-tier structures).
    \370\ See, e.g., ICI Comment Letter (recommending that the rule 
include an expanded list of permitted multi-tier fund of fund 
arrangements that could be beneficial to shareholders); Fidelity 
Rutland Comment Letter (recommending that the rule permit the use of 
affiliated funds commonly created by an adviser for the purpose of 
efficiently managing exposure to a specific asset class (commonly 
referred to as ``central funds'')); Ropes Comment Letter 
(recommending that the rule permit three-tier structures where the 
underlying fund is an ETF or where all three funds in the structure 
are in the same group of investment companies); Comment Letter of 
Davis Polk & Wardwell LLP (May 2, 2019) (``DPW Comment Letter'') 
(recommending that the rule permit three-tier structures where the 
underlying fund is a limited life grantor trust).
    \371\ TRP Comment Letter (recommending a principles-based 
approach that would generally permit multi-tier structures subject 
to the other conditions of the rule).
    \372\ See, e.g., PIMCO Comment Letter; Nuveen Comment Letter; 
SIFMA AMG Comment Letter.
    \373\ ICI Comment Letter. See also IPA Comment Letter 
(recommending that the rule exempt BDC investments in private funds 
from the general prohibition on three-tier structures); Guggenheim 
Comment Letter (recommending an exception for structured finance 
vehicles if the rule generally prohibits acquired funds from 
investing in private funds).
---------------------------------------------------------------------------

    As an alternative to the three-tier condition, some commenters 
suggested that the Commission require the acquiring fund adviser to 
engage in a best interest determination and enhanced board reporting on 
the use of complex structures.\374\ Other commenters recommended that 
the Commission require enhanced investor disclosure rather than 
restricting fund structures.\375\
---------------------------------------------------------------------------

    \374\ TRP Comment Letter; SIFMA AMG Comment Letter.
    \375\ See, e.g., Morningstar Comment Letter; TRP Comment Letter 
(suggesting enhancing the proposed report to the board to include a 
statement that the adviser believes the fund of funds structure and 
disclosure documents sufficiently mitigate the risk of the three-
tier structure being overly confusing to investors). But See CFA 
Comment Letter (expressing skepticism about the benefit of enhanced 
disclosures to retail investors) citing Study Regarding Financial 
Literacy Among Investors As Required by Section 917 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act, Staff of the 
U.S. Securities and Exchange Commission (August 2012).
---------------------------------------------------------------------------

    Although we acknowledge that three-tier structures may provide 
efficient and cost-effective exposure to certain market segments in 
certain circumstances, we continue to believe that multi-tier 
structures can obfuscate the fund's investments, fees, and related 
risks.\376\ For example, if an acquiring fund invests in an acquired 
fund that in turn invests in other funds, an acquiring

[[Page 73954]]

fund shareholder could find it difficult to determine the nature and 
value of the holdings ultimately underlying his or her investment. 
Accordingly, we continue to believe that it is appropriate to limit the 
ability of funds to structure multi-tier arrangements in reliance on 
rule 12d1-4. We also believe that enhanced disclosure, without 
additional limitations on multi-tier structures, would be insufficient 
to address potential investor confusion associated with complex 
structures.\377\ As discussed below, we have made certain modifications 
to the final rule, however, that are designed to provide additional 
flexibility for acquired funds to gain exposure to underlying funds in 
order to minimize disruption to existing fund structures and preserve 
some flexibility for efficient multi-tier arrangements.\378\ We believe 
that the final rule's three-tier limitation appropriately provides such 
flexibility and provides protections against complex structures and 
excessive fees.
---------------------------------------------------------------------------

    \376\ See 2018 FOF Proposing Release, supra footnote 6, at 83.
    \377\ See infra footnotes 388-390 and accompanying text.
    \378\ See, e.g., Guggenheim Comment Letter (predicting that many 
debt funds that serve as acquired funds would need to be 
restructured given that such funds hold substantial investments in 
entities that rely on section 3(c)(1) and 3(c)(7) of the act, such 
as structured finance vehicles).
---------------------------------------------------------------------------

b. Limitations on Other Funds' Acquisitions of Acquiring Funds
    Rule 12d1-4 includes 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 rule prohibits a fund that is 
relying on section 12(d)(1)(G) of the Act (15 U.S.C. 80a-12(d)(1)(G)) 
or rule 12d1-4 from acquiring, in excess of the limits in section 
12(d)(1)(A), the outstanding voting securities of an acquiring fund (a 
``second-tier fund''), unless the second-tier fund makes investments 
permitted by rule 12d1-4(b)(3)(ii) as discussed below.\379\ As a 
result, this condition will limit a fund's ability to create multi-tier 
arrangements, subject to certain limited exceptions. This condition is 
generally more comprehensive and, therefore, limiting, than the 
conditions in our orders, and addresses certain multi-tier arrangements 
that have emerged.\380\
---------------------------------------------------------------------------

    \379\ Rule 12d1-4(a)(3)(i). 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).
    \380\ See 2018 FOF Proposing Release, supra footnote 6, at 77 
(noting that our orders 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)).
---------------------------------------------------------------------------

    This provision, however, will not prevent a fund from investing all 
of its assets in an acquiring fund in reliance on section 
12(d)(1)(E).\381\ We do not believe three-tier structures involving a 
master-feeder arrangement present the risk that section 12(d)(1) was 
designed to address. In addition, this condition will not prevent other 
funds from acquiring the voting securities of an acquiring fund in 
amounts of 3% or less, which effectively creates a type of three-tier 
structure that does not raise the concerns that section 12(d)(1) was 
designed to prevent.\382\
---------------------------------------------------------------------------

    \381\ 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.
    \382\ 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).
---------------------------------------------------------------------------

    Rule 12d1-4's limitation on investments in acquiring funds is 
generally consistent with the proposed complex structures provision. 
However, the final rule will not apply the condition only to 
investments in an acquiring fund that discloses in its registration 
statement that it may be an acquiring fund for purposes of rule 12d1-4, 
as proposed.\383\ Because rule 12d1-4 will require most funds to enter 
into a fund of funds investment agreement, and an adviser that manages 
both acquiring and acquired funds should have information regarding an 
acquired fund's investments, the final rule will prohibit a fund from 
investing in an acquiring fund without tying this limitation to 
registration statement disclosures.\384\
---------------------------------------------------------------------------

    \383\ Proposed rule 12d1-4(b)(4)(ii) (prohibiting a fund relying 
on the rule or section 12(d)(1)(G) of the Act from acquiring the 
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).
    \384\ We believe funds investing in reliance on section 
12(d)(1)(G) likely 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. See 2018 
FOF Proposing Release, supra footnote 6, at 79. We do not believe 
that funds within the same group of investment companies will face 
challenges in obtaining this information because of the potential 
for information barriers. See supra section II.C.1.a.i.
---------------------------------------------------------------------------

    While several commenters addressed the proposed limit on multi-tier 
structures generally, no commenters addressed whether the rule should 
prohibit a fund from investing in an acquiring fund. We continue to 
believe that concerns of undue influence, complex structures, and 
excessive fees apply both to three-tier structures where registered 
funds invest in acquiring funds and three-tier structures where an 
acquired fund invests a substantial portion of its assets in other 
registered funds. Accordingly, we continue to believe that it is 
appropriate to limit funds' ability to invest in acquiring funds, 
subject to the exception for funds relying on section 12(d)(1)(E). We 
believe this condition will help limit the construction of complex 
multi-tier structures, while preserving some flexibility for efficient 
multi-tier arrangements. In addition, rule 12d1-4 does not prohibit 
other funds from acquiring the voting securities of an acquiring fund 
in amounts allowed by the Act (i.e., 3% or less). We do not believe 
that multiple registered funds holding 3% or less of the acquiring fund 
implicate the historical abuses, such as undue influence, that section 
12(d)(1) is intended to prevent.\385\
---------------------------------------------------------------------------

    \385\ See 2018 FOF Proposing Release, supra footnote 6, at 78-
79.
---------------------------------------------------------------------------

c. Limitations on Acquired Funds' Acquisition of Other Funds and 
Private Funds; Exceptions to Three-Tier Limitation
    As proposed, rule 12d1-4 will include a condition designed to limit 
fund of funds arrangements where the acquired fund is itself an 
acquiring fund. The rule generally will 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). Specifically, the rule 
states that no acquired fund may purchase or otherwise acquire the 
securities of an investment company or private fund if immediately 
after such purchase or acquisition, the securities of investment 
companies and private funds owned by the acquired fund have an 
aggregate value in excess of 10% of the value of the total assets of 
the acquired fund, subject to certain enumerated exceptions.\386\ We 
continue to believe that the general limitation on acquired fund 
investments in other investment companies or private funds is an 
appropriate means to protect against the creation of overly complex 
structures.\387\ While investments by acquired funds in other 
investment companies or in private funds may provide efficient exposure 
to a specific asset class or offer other portfolio management 
advantages, such investments can be confusing to investors and can 
result in additional

[[Page 73955]]

fees and expenses.\388\ We believe that this potential reduction of 
investment flexibility for acquired funds is appropriate to prevent 
potential increases in duplicative fees and expenses, and to avoid the 
investor confusion, that might occur if the final rule did not impose 
such limits on multi-tier structures.\389\ As explained above with 
respect to complex structures generally, we believe a structural three-
tier prohibition will help to limit the potential for complex 
structures that could be difficult for investors to understand even 
with comprehensive disclosures.\390\
---------------------------------------------------------------------------

    \386\ Rule 12d1-4(b)(3)(ii). This prohibition applies to 
investments in a company that is controlled by an investment 
company, because such a controlled company is also subject to 
section 12(d)(1) when it acquires the securities of other investment 
companies. See section 12(d)(1)(A).
    \387\ See 2018 FOF Proposing Release, supra footnote 6, at 81.
    \388\ See Guggenheim Comment Letter. Although one commenter 
suggested that the rule should not limit an acquired fund's ability 
to invest in private funds because section 12(d)(1) of the Act does 
not limit a fund's ability to invest in private funds, (See ICI 
Comment Letter), the risks of investor confusion and fee layering 
apply both with respect to an acquired fund's investments in other 
investment companies and with respect to an acquired fund's 
investments in private funds in a multi-tier structure. Accordingly, 
we believe it is appropriate that the complex structures limitations 
of rule 12d1-4 apply to an acquired fund's investments in private 
funds. This approach also is consistent with the complex structures 
limitations in our exemptive orders.
    \389\ We believe it would be more appropriate for the Commission 
to consider multi-tier structures that do not fall within the 
confines of rule 12d1-4 through the exemptive application process. 
This will allow the Commission to weigh the policy considerations of 
such structures in the context of the facts and circumstances of the 
specific fund of funds arrangement described in the application. 
While the expenses of a third-tier fund may represent only a small 
proportion of the expenses of a top-tier acquiring fund because a 
third-tier fund would represent only a small proportion of the top 
tier acquiring fund's investment portfolio, the exemptive 
application process would permit the Commission to consider whether 
additional fee- or expense-related conditions would be appropriate 
in connection with a specific multi-tier arrangement or in 
connection with a specific investment strategy undertaken through a 
multi-tier structure.
    \390\ For example, without a general three-tier prohibition, an 
acquired fund could shift a substantial portion of its assets among 
underlying funds with different investment exposures and risks, and 
disclosure at the acquiring fund level may still leave acquiring 
fund investors unaware of substantial changes to their investment 
exposure and risks at the acquired fund and underlying fund levels. 
See CFA Comment Letter (expressing skepticism about the benefit of 
enhanced disclosures to retail investors); but see Morningstar 
Comment Letter (supporting an enhanced disclosure requirement) and 
TRP Comment Letter (suggesting that the adviser report to the fund's 
board that a fund of funds disclosure documents sufficiently 
mitigate the risk of investor confusion).
---------------------------------------------------------------------------

    Largely as proposed, the rule will allow arrangements where an 
acquired fund invests in other funds in certain enumerated 
circumstances. These exceptions are limited in scope and are 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. 
Specifically, these categories include securities of another investment 
company that is: (i) Acquired in reliance on section 12(d)(1)(E) of the 
Act (i.e., master-feeder arrangements); (ii) acquired pursuant to rule 
12d1-1; (iii) a subsidiary wholly-owned and controlled by the acquired 
fund; (iv) received as a dividend or as a result of a plan of 
reorganization of a company; or (v) acquired pursuant to exemptive 
relief from the Commission to engage in interfund borrowing and lending 
transactions.\391\ These categories have been permitted under existing 
exemptive orders and addressed in no-action letters, and do not raise 
the concerns that section 12(d)(1) was designed to address, as 
discussed further below.
---------------------------------------------------------------------------

    \391\ Rule 12d1-4(b)(3)(ii).
---------------------------------------------------------------------------

    We made several modifications to the enumerated exceptions of the 
proposed rule to address many of the concerns identified by commenters. 
Additionally, in a change from the proposal, rule 12d1-4 will include a 
separate exception that will permit an acquired fund to invest up to 
10% of its assets in other investment companies or private funds. As 
discussed below, we do not believe that permitting these arrangements 
will raise concerns identified by Congress when enacting section 
12(d)(1).\392\
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    \392\ See also 2018 FOF Proposing Release, supra footnote 6, pp 
80-83 and associated footnotes (describing the enumerated 
circumstances under which our exemptive orders permitted three tier 
fund of funds structures and the rationale in support of such 
structures).
---------------------------------------------------------------------------

i. Master-Feeder Investments
    The proposed exception for master-feeder arrangements in reliance 
on section 12(d)(1)(E) of the Act did not receive substantial public 
comment and we are adopting as proposed.\393\ Under section 12(d)(1)(E) 
of the Act, the acquired feeder fund in this example is, in effect, a 
conduit through which the acquiring fund can access the master fund. 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 involve concerns regarding undue 
influence or layering of fees.\394\ 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.
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    \393\ Voya Comment Letter (supporting the exceptions for master-
feeder arrangements and investments in wholly-owned and controlled 
subsidiaries).
    \394\ See 2018 FOF Proposing Release, supra footnote 6, at p. 
78.
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ii. Rule 12d1-1 Investments
    The final rule will permit an acquired fund to invest more than 10% 
of its total assets in investment companies and private funds if such 
investments are made pursuant to rule 12d1-1. The proposed rule 
included an exception for short-term cash management purposes pursuant 
to rule 12d1-1 or exemptive relief from the Commission.\395\
---------------------------------------------------------------------------

    \395\ Proposed Rule 12d1-4(b)(3)(ii)(B).
---------------------------------------------------------------------------

    Several commenters requested clarification or expansion of this 
proposed exception.\396\ For instance, two commenters recommended that 
the Commission remove the phrase ``short-term cash management 
purposes'' from the exception because rule 12d1-1 does not include the 
phrase.\397\ These commenters suggested there could be a variety of 
reasons other than short-term cash management that an acquired fund 
would invest in reliance on rule 12d1-1 that do not raise any 
additional fund of funds concerns.\398\ Another commenter requested 
that the Commission clarify the applicable exemptive relief referenced 
in the exception, since the Commission also proposed to rescind 
relevant exemptive relief.\399\
---------------------------------------------------------------------------

    \396\ See, e.g., ICI Comment Letter; NYC Bar Comment Letter; 
PIMCO Comment Letter; PGIM Comment Letter.
    \397\ NYC Bar Comment Letter; ICI Comment Letter.
    \398\ ICI Comment Letter; Dechert Comment Letter (acquiring 
funds may make investments pursuant to rule 12d1-1 for the purpose 
of complying with asset coverage requirements and other legitimate 
portfolio management purposes).
    \399\ ICI Comment Letter (noting it is unclear whether 
investments in short-term bond funds would be permitted under the 
proposed exception given the rescission of exemptive relief, despite 
numerous exemptive orders providing relief for investments in short-
term bond funds).
---------------------------------------------------------------------------

    Some commenters recommended that the final rule eliminate the 
reference to rule 12d1-1 and instead expand the types of investments 
that would be permitted for short-term cash management purposes to 
include short-term bond funds.\400\ Another commenter recommended that 
the Commission expand the relief to permit acquired funds to equitize 
cash by investing in other funds, such as certain ETFs.\401\ One 
commenter recommended that the Commission also consider exceptions for 
securities lending and cash sweep arrangements among affiliates.\402\
---------------------------------------------------------------------------

    \400\ ICI Comment Letter; PIMCO Comment Letter; PGIM Comment 
Letter.
    \401\ ABA Comment Letter.
    \402\ Invesco Comment Letter.
---------------------------------------------------------------------------

    In response to concerns raised by commenters, we have modified this 
exception to permit an acquired fund to

[[Page 73956]]

invest in investment companies and private funds in excess of the 
section 12(d)(1) limits if such investments are made pursuant to rule 
12d1-1.\403\ By removing the phrase ``short-term cash management 
purposes,'' the final rule will provide acquired funds with additional 
flexibility to invest in funds pursuant to rule 12d1-1 for any 
investment purpose. We also removed the reference to the phrase ``or 
exemptive relief from the Commission'' in order to clarify that the 
exception for acquired fund investments pursuant to rule 12d1-1 does 
not incorporate prior exemptive relief that an acquired fund may have 
received for cash management or collateral management purposes. As 
described below, we are rescinding this exemptive relief and removed 
the associated reference from the rule text. Although several 
commenters requested that the Commission not rescind prior exemptive 
relief that allows an acquired fund's investment in short-term bond 
funds for cash management or collateral management purposes, we believe 
rule 12d1-4 provides appropriate flexibility for funds to invest for 
these purposes. Specifically, rule 12d1-4 provides the 10% Bucket, 
which permits an acquired fund to invest up to 10% of its assets in 
other investment companies for any investment purposes.
---------------------------------------------------------------------------

    \403\ Rule 12d1-4(b)(3)(ii)(B).
---------------------------------------------------------------------------

    In response to concerns raised by commenters relating to 
investments to equitize cash, the final rule will permit an acquired 
fund to invest up to 10% of its assets in other funds to equitize cash 
or for other investment purposes, pursuant to the 10% Bucket described 
in section II.C.3.d below.\404\ The exception for investments pursuant 
to rule 12d1-1 is designed to permit acquired funds to invest in money 
market funds, which we do not believe raise the concerns that section 
12(d)(1) was designed to prevent.\405\ Accordingly, we decline to 
broaden the rule to permit additional investments under this exception, 
and clarify that investments are only permissible under this exception 
to the extent they are made pursuant to rule 12d1-1.
---------------------------------------------------------------------------

    \404\ See ICI Comment Letter; PIMCO Comment Letter; PGIM Comment 
Letter; ABA Comment Letter.
    \405\ See 2006 FOF Adopting Release, supra footnote 19, at 9-10.
---------------------------------------------------------------------------

iii. Investments in a Wholly-Owned Subsidiary
    We are adopting an exception from the three-tier limitation for 
investments in funds that are wholly-owned and controlled by the 
acquired fund, as proposed. Wholly-owned subsidiaries are typically 
organized under the laws of a non-U.S. jurisdiction in order to invest 
in commodity-related instruments and certain other instruments for tax 
and other reasons.\406\ We requested comment as to whether the rule 
should include additional limits on acquired funds' use of 
subsidiaries, and requested suggestions on the contours of any such 
limitations.\407\ Commenters did not address this aspect of the 
proposal, and rule 12d1-4 will include an exception to the general 
three-tier limitation for investments through such wholly-owned and 
controlled subsidiaries. Because the wholly-owned subsidiary's 
financial statements are consolidated with the financial statements of 
the acquired fund, we do not believe that this arrangement would be so 
complex that investors could not understand the nature of such 
exposure.\408\
---------------------------------------------------------------------------

    \406\ See 2018 FOF Proposing Release, supra footnote 6, at pp. 
82-83.
    \407\ See id., at pp. 84.
    \408\ In this type of arrangement, the acquired fund controls 
the wholly-owned subsidiary and 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, 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.
---------------------------------------------------------------------------

iv. Investments Received as a Dividend as a Result of a Plan of 
Reorganization and Investments Acquired To Engage in Interfund 
Borrowing and Lending
    We continue to believe that it is appropriate to provide exceptions 
from the three-tier limitation to facilitate certain transactions.\409\ 
The proposed rule included exceptions for arrangements where an 
acquired fund receives fund shares as a dividend or as a result of a 
plan of reorganization. Acquired funds do not acquire such investments 
to create a multi-tier fund structure. Rather, a fund acquires these 
investments from a business restructuring unrelated to a fund's status 
as an acquired fund under the rule.\410\ The proposed rule also 
included an exception for acquired fund investments entered into 
pursuant to exemptive relief from the Commission to engage in interfund 
borrowing and lending transactions. This exception would facilitate 
certain interfund transactions, subject to conditions specifically 
designed to address the concerns that such transactions present under 
the terms of existing interfund lending orders.\411\ A commenter 
supported the proposed rule's exception of these transactions from the 
three-tier limitation, and we continue to believe it is appropriate 
that the rule include these exceptions.\412\ Therefore, we are adopting 
these exceptions as proposed.
---------------------------------------------------------------------------

    \409\ See 2018 FOF Proposing Release, supra footnote 6, at 82.
    \410\ See 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).
    \411\ 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 33117 (June 5, 2018) (order) and 
related application (permitting funds to participate in an interfund 
lending facility).
    \412\ See, e.g., Voya Comment Letter.
---------------------------------------------------------------------------

d. Ten Percent Bucket
    In addition to the enumerated exceptions to the limitation on 
acquired fund investments, the rule will permit an acquired fund to 
invest up to 10% of its total assets in other funds, regardless of the 
size of the investment in any one fund, in order to provide funds with 
additional flexibility, and thereby permit certain structures that 
could benefit investors through greater efficiency. For purposes of 
calculating the 10% Bucket, investments by an acquired fund pursuant to 
the general exceptions in the section above would not be included. 
While the proposed rule did not include the 10% Bucket for acquired 
fund investments in other funds, we requested comment on whether the 
proposed rule's limitations were appropriately calibrated to mitigate 
complex structure concerns, and whether we should adopt different 
investment limits.\413\ We also requested comment on whether the rule 
should permit acquired funds relying on section 12(d)(1)(G) to invest 
in a third-tier fund in order to centralize the portfolio management of 
floating rate or other instruments.\414\
---------------------------------------------------------------------------

    \413\ See 2018 FOF Proposing Release, supra footnote 6, at 84.
    \414\ See id., at 86.
---------------------------------------------------------------------------

    Under rule 12d1-4, an acquired fund might utilize the 10% Bucket 
for cash management purposes outside of investments made in reliance on 
rule 12d1-1, to equitize cash, or for any other portfolio management 
purposes.\415\ The 10% Bucket provides flexibility for fund of funds 
arrangements to evolve, while limiting the complex arrangements that 
section 12(d)(1) was designed to prevent. If an acquired fund wishes to 
acquire other underlying funds in excess of the 10% Bucket, the 
acquired fund may seek exemptive relief. In such circumstances, the 
Commission would have the opportunity to consider the proposed

[[Page 73957]]

structure in the context of rule 12d1-4 and weigh the benefits of the 
proposed structure against the concerns underlying section 12(d)(1).
---------------------------------------------------------------------------

    \415\ As an example, an acquired fund could utilize the 10% 
Bucket to invest in short-term bond funds for cash management 
purposes.
---------------------------------------------------------------------------

    As discussed above, section 12(d)(1)(A)(iii) of the Act limits an 
acquiring fund's total investment in other funds to no more than 10% of 
the acquiring fund's assets. The 10% Bucket effectively applies this 
10% limit to acquired funds' investments in underlying funds.\416\ The 
rule as adopted, however, will not impose the 3% and the 5% limits of 
section 12(d)(1)(A)(i) and (ii), respectively, on investments by an 
acquired fund in third-tier funds. Accordingly, the rule will not 
prohibit an acquired fund from holding more than 3% of the outstanding 
voting securities of any single third-tier fund and will not prohibit 
an acquired fund from investing more than 5% of its assets in any 
single third-tier fund. Rather, the 10% Bucket will allow an acquired 
fund some flexibility to invest up to 10% of its assets in other funds 
in order to meet its investment objectives while minimizing shareholder 
confusion by limiting the extent of those acquired fund investments. 
This limit is intended to prohibit multiple layers of funds, which 
raise greater concerns of duplication of fees and expenses as well as 
investor confusion, and reflects a view that funds that invest in 
another fund beyond the 3% and the 5% limits of section 12(d)(1)(A)(i) 
and (ii), but not the 10% limit of section 12(d)(1)(A)(iii), are not 
primarily designed to invest in other funds and do not implicate the 
concerns that led to the adoption of the 10% limit in 1970.\417\ In 
such a structure, by which an acquired fund relies on the 10% Bucket to 
invest in an underlying fund in excess of the section 12(d)(1) limits, 
the acquired fund and underlying funds must comply with the conditions 
of rule 12d1-4 as acquiring and acquired funds, respectively, or 
operate pursuant to another exemption.\418\
---------------------------------------------------------------------------

    \416\ Like the limits under section 12(d)(1) of the Act, the 10% 
Bucket is an acquisition test. Accordingly, if an acquired fund 
holds more than 10% of its assets in other underlying funds due to 
market movements it could not invest any additional assets in 
underlying funds, but the 10% Bucket would not require the acquired 
fund to dispose of its existing investments in underlying funds to 
under 10% of its assets. Further, if an existing acquired fund holds 
more than 10% of its total assets in other funds pursuant to an 
existing exemptive order, the acquired fund would not be required to 
dispose of those holdings after the rescission of its exemptive 
order and the effective date of the rule. However, the acquired fund 
could invest additional assets in underlying funds only in 
accordance with the terms of the rule.
    \417\ See Reporting Modernization Adopting Release, supra 
footnote 56, at 81936. See also PPI Report supra footnote 64, at 
page 322 (describing concerns about the organization and operation 
of registered fund holding companies whose primary purpose is the 
acquisition of shares of other registered investment companies). The 
House and Senate Reports that accompanied the 1970 amendments to the 
Act describe concerns about ``fundholding companies'' whose 
portfolios consist entirely or largely of the securities of other 
investment companies. See H.R. Rep. No. 1382, 91st Cong., 2d Sess. 
28 (1970) (``1970 Amendments House Report''); S. Rep. No. 184, 91st 
Cong., 1st Sess. 29 (1969) (``1970 Amendments Senate Report''). By 
imposing the 10% limit in section 12(d)(1)(A)(iii) as part of the 
1970 amendments to the Act, Congress distinguished between 
investment companies that invest less than 10% of their assets in 
other investment companies, on the one hand, and fund holding 
companies whose primary purpose is the acquisition of shares of 
other registered investment companies, on the other.
    \418\ For example, if an acquired fund invests 10% of its total 
assets in a third-tier underlying fund, and the investment by the 
acquired fund accounts for 20% of the voting stock of the underlying 
fund, the acquired fund and the underlying fund would be required to 
comply with the conditions of rule 12d1-4 as an acquiring fund and 
acquired fund, respectively.
---------------------------------------------------------------------------

    We proposed a similar provision in 2008 as part of a proposal to 
allow funds to invest in ETFs beyond the section 12(d)(1) statutory 
limits.\419\ In order to prevent the formation of overly complex 
structures, the proposed 2008 rule would have prohibited an acquired 
ETF from investing more than 10% of its assets in other funds and 
private funds. One commenter on proposed rule 12d1-4 recommended that 
rule 12d1-4 include a 10% bucket to provide additional flexibility for 
acquired fund investments in other funds, and noted that the 
Commission's 2008 rule proposal included such a provision.\420\
---------------------------------------------------------------------------

    \419\ 2008 ETF Proposing Release, supra footnote 18, at n.225 
and accompanying text (requiring an acquired ETF 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).
    \420\ ICI Comment Letter (``Allowing for this exception 
generally would permit the structures contemplated by the recent no-
action letters and the 2008 Commission proposal, and permit acquired 
funds to have additional limited ability to invest in other funds 
when such investments would not exceed the basic 10 percent limit 
included in Section 12(d)(1)(A)(iii) to protect against overly 
complex structures.'').
---------------------------------------------------------------------------

    As discussed in the 2018 FOF Proposing Release, our staff has 
previously stated that it would not recommend enforcement action if an 
acquired fund in a fund of funds arrangement invested up to 10% of its 
assets in other funds, including ``central funds,'' which are 
affiliated funds commonly created by an adviser for the purpose of 
efficiently managing exposure to a specific asset class.\421\ However, 
the staff stated its position in light of several considerations, 
including that: (a) An acquired fund would not exceed the 5% limit in 
section 12(d)(1)(A)(ii) with respect to an investment in shares of a 
single central fund or the 10% limit in 12(d)(1)(A)(iii) with respect 
to investments in underlying investment companies generally; (b) 
management fees and other fees that were subject to limits; (c) 
acquisitions by the central fund in other investment companies or 
private funds that were subject to limits; (d) a requirement that 
shares of the central fund be sold solely to the funds within the same 
group of investment companies; and (e) the board of directors of each 
of the funds would consider the reasons for the proposed investments in 
the central fund and the benefits expected to be realized from such 
investments.\422\ In a subsequent letter, the staff stated that it 
would not recommend enforcement action if an acquired fund invested, 
solely for short-term cash management purposes, up to 25% of its assets 
in a central fund that is a fixed-income fund that could have a dollar-
weighted average portfolio maturity of up to 3 years.\423\
---------------------------------------------------------------------------

    \421\ 2018 FOF Proposing Release, supra footnote 6, at 86. See 
Franklin Templeton Investments, Staff No-Action Letter (pub. avail. 
April 3, 2015) (``Franklin Templeton No-Action Letter''). In the 
Franklin Templeton No-Action Letter, the staff stated 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. The Franklin Templeton 
No-Action Letter also included a representation that an acquired 
fund's adviser would waive fees on assets invested in underlying 
central funds.
    \422\ Franklin Templeton No-Action Letter.
    \423\ Thrivent Financial for Lutherans and Thrivent Asset 
Management LLC, Staff No-Action Letter (pub. avail. Sep. 27, 2016) 
(``Thrivent No-Action Letter''). The circumstances of the Thrivent 
No-Action Letter did not involve a limitation on acquired funds 
exceeding the 5% limit in section 12(d)(1)(A)(ii) with respect to an 
investment in shares of a single central fund, and included a 
representation that the central funds would not charge advisory 
fees). See id. Rule 12d1-4(b)(3)(ii)(B) provides cash management 
flexibility by permitting an acquired fund to invest in other 
investment companies or private funds beyond the 10% limit if the 
acquired fund makes such investments in reliance on rule 12d1-1.
---------------------------------------------------------------------------

    Several commenters advocated that the final rule permit acquired 
funds to invest in central funds.\424\ Commenters noted that central 
funds are frequently used for cash management purposes, but

[[Page 73958]]

could also be used to gain exposure to any asset class or sector.\425\ 
Several commenters recommended that the rule permit acquired funds to 
invest in private funds, structured finance vehicles, and other 
entities that rely on sections 3(c)(1) or 3(c)(7) of the Act that are 
not traditionally considered pooled investment vehicles.\426\ Other 
commenters requested an exception for acquired fund investments in 
ETFs.\427\ While the final rule does not incorporate prior staff 
positions regarding acquired fund investments in central funds, the 
rule provides substantial flexibility for fund groups to continue to 
utilize central funds within the 10% Bucket. The 10% Bucket allows 
acquired funds to gain exposure to any asset class or sector through 
investments in affiliated or unaffiliated underlying investment 
companies and private funds without imposing many of the limitations 
that were associated with prior staff positions in this area.
---------------------------------------------------------------------------

    \424\ Comment Letter of MFS Investment Management (May 2, 2019); 
Fidelity Comment Letter; PGIM Comment Letter (cash management); ICI 
Comment Letter (short-term bond funds); Thrivent Comment Letter (25% 
of its total assets in one or more short-term bond funds); 
Guggenheim Comment Letter (short-term bond funds); Dechert Comment 
Letter (short-term bond funds); NYC Bar Comment Letter (money market 
funds); Fidelity Rutland Trust Comment Letter; SIFMA AMG Comment 
Letter; Comment Letter of Capital Research and Management Company 
(Jan. 8, 2019) (``Capital Group (2) Comment Letter'').
    \425\ See, e.g., Capital Group (2) Comment Letter (describing 
central fund investments in investment-grade corporate bonds, 
mortgage-backed securities and high yield securities).
    \426\ ICI Comment Letter; Guggenheim Comment Letter; Dechert 
Comment Letter; Comment Letter of Small Business Investor Alliance, 
et al. (Feb. 28. 2019) (``SBIA Comment Letter''); FS Comment Letter; 
IPA Comment Letter; PIMCO Comment Letter; SIFMA AMG Comment Letter.
    \427\ Ropes Comment Letter; Chapman Comment Letter; ICI Comment 
Letter.
---------------------------------------------------------------------------

    As we discussed in the 2018 FOF Proposing Release, some existing 
multi-tier structures may be required to modify their investments to 
ensure compliance with rule 12d1-4.\428\ For example, as of June 2018, 
we identified 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).\429\ Such multi-tier arrangements may need to restructure 
their holdings over time to continue to maintain the same investment, 
to the extent that the acquired funds in such structures invest more 
than 10% of their assets in underlying funds, exclusive of investments 
in underlying funds made pursuant to the enumerated exceptions 
described above.\430\
---------------------------------------------------------------------------

    \428\ 2018 FOF Proposing Release, supra footnote 6, at 150.
    \429\ Id.
    \430\ As noted above, because the 10% Bucket is an acquisition 
test, if an acquired fund holds more than 10% of its assets in other 
underlying funds pursuant to an existing exemptive order, the 
acquired fund would not be required to dispose of those holdings 
after the rescission of its exemptive order and the effective date 
of the rule. However, the acquired fund could invest additional 
assets in underlying funds only in accordance with the terms of the 
rule.
---------------------------------------------------------------------------

    We agree with commenters that additional flexibility to enter into 
multi-tier arrangements could lead to efficiencies and cost savings for 
fund investors. However, unlimited ability to enter into multi-tier 
arrangements could lead to complex structures in which an acquiring 
fund shareholder finds it difficult to determine the nature and value 
of the holdings ultimately underlying his or her investment. We do not 
believe that a 25% limit would be appropriate for investments in 
underlying funds in pursuit of any investment purpose because such a 
limit is based on considerations related to investments in central 
funds for short-term cash management purposes. In addition, such a 
limit would be far in excess of the 10% limit that Congress enacted in 
1970 in response to its concerns about ``fund holding'' companies.\431\ 
Accordingly, rule 12d1-4 provides flexibility for acquired funds to 
invest in private funds, structured finance vehicles, central funds, 
ETFs, and other investment funds up to a 10% limit, consistent with the 
10% limit set forth in section 12(d)(1). We believe that this 10% 
Bucket, when combined with the enumerated exceptions discussed above, 
will provide flexibility for beneficial multi-tier arrangements while 
limiting the harms that Congress sought to prevent.
---------------------------------------------------------------------------

    \431\ See 1970 Amendments House Report; 1970 Amendments Senate 
Report supra footnote 417 and accompanying text.
---------------------------------------------------------------------------

4. Recordkeeping
    The final rule will require the acquiring and acquired funds that 
participate in fund of funds arrangements in accordance with the rule 
to maintain and preserve certain written records for a period of not 
less than five years, the first two years in an easily accessible 
place. These records include: (i) A copy of each fund of funds 
investment agreement that is in effect, or was in effect in the past 
five years, and any amendments thereto; (ii) a written record of the 
relevant Fund Finding made under the rule and the basis therefor within 
the past five years; and (iii) the certification from each insurance 
company required by the rule.\432\ These requirements are largely as 
proposed, with the addition of fund of funds investment agreement 
records as these agreements were not part of the proposal. Also, to 
match the expansion of the Fund Findings requirement, both acquiring 
and acquired funds will need to keep records of the applicable 
evaluations and findings under the final rule. We also are not adopting 
the proposed requirement to keep the reports provided to the board of 
directors regarding management company findings, as we believe that 
this would be duplicative with the requirements of rule 31a-1, 
particularly the requirements to keep minute books of directors' 
meetings and advisory material received from the investment 
adviser.\433\ We did not receive comments on the recordkeeping 
provisions of the proposed rule.\434\
---------------------------------------------------------------------------

    \432\ Rule 12d1-4(c).
    \433\ Rule 31a-1(b)(4) and (11).
    \434\ We received comments on the substantive elements 
underlying the proposed recordkeeping requirements. See supra 
section II.C.2.b (discussing proposed findings and determinations 
requirements and related comments).
---------------------------------------------------------------------------

    Funds and UITs currently have compliance program-related 
recordkeeping procedures in place that incorporate this type of 
retention period, and consistency with that period minimizes compliance 
burdens to funds related to the preservation of the records.\435\ 
Although the retention period would differ from the required period for 
UIT findings under rule 22e-4 and the general recordkeeping 
requirements in rule 31a-2, we believe it is appropriate to have 
consistent recordkeeping requirements under rule 12d1-4.\436\ We 
believe that these recordkeeping requirements allow for external 
examinations of compliance with this condition without placing an undue 
burden on the funds. Moreover, because the fund of funds investment 
agreement sets forth the relevant material terms of the fund of funds 
arrangement specific to particular acquiring funds and acquired funds, 
we believe it is appropriate to include it as part of a fund's 
recordkeeping requirements.
---------------------------------------------------------------------------

    \435\ The retention period is consistent with the period 
provided in rule 38a-1(d).
    \436\ See rule 22e-4(c) (requiring a UIT to maintain, for the 
life of the UIT and for five years thereafter, 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). 
See also Investment Company Liquidity Risk Management Programs, 
Investment Company Act Release No. 32315 (Oct. 13, 2016) [81 FR 
82142 (Nov. 18, 2016)]; 2018 FOF Proposing Release, supra footnote 
6, at 69.
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D. Rescission of Rule 12d1-2 and Amendment to Rule 12d1-1

1. Rescission of Rule 12d1-2
    We are rescinding rule 12d1-2, as proposed, 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

[[Page 73959]]

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.\437\ 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.\438\
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    \437\ 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.
    \438\ See Fund of Funds Investments, Investment Company Act 
Release No. 26198 (Oct. 1, 2003) [68 FR 58226 (Oct. 8, 2003)].
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    In 2006, the Commission exercised its exemptive authority to adopt 
rule 12d1-2.\439\ 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 permitted 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); \440\ (ii) invest directly in 
stocks, bonds, and other securities; \441\ and (iii) acquire the 
securities of money market funds in reliance on rule 12d1-1.\442\ 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.\443\ 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 limit 
in section 12(d)(1)(A) or 12(d)(1)(F)).\444\
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    \439\ See 2006 FOF Adopting Release, supra footnote 19.
    \440\ See rule 12d1-2(a)(1).
    \441\ 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.'' These orders 
provide 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.
    \442\ 17 CFR 270.12d1-2(a)(3).
    \443\ 2006 FOF Adopting Release, supra footnote 19.
    \444\ Id.
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    We have also granted exemptions that permit funds to invest in 
funds within the same group of investment companies as an alternative 
to the requirements of section 12(d)(1)(G) and rule 12d1-2.\445\ Funds 
relying on these orders could invest in the same group of related 
investment companies and unaffiliated funds without regard to the 
limitations in sections 12(d)(1)(A) or 12(d)(1)(F). 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 and 
in other investments. 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 and could invest in other 
financial instruments that may not be securities within the meaning of 
section 2(a)(36) of the Act, such as derivatives.\446\
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    \445\ See 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'').
    \446\ 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. Further, 
funds are limited to investments in securities if they rely upon 
section 12(d)(1)(G) and rule 12d1-2. See supra footnote 441.
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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.\447\ 
The orders generally 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).\448\ Under this existing framework, 
substantially similar fund of funds arrangements are subject to 
different limitations and conditions.\449\ 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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    \447\ 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).
    \448\ See supra footnote 446 and accompanying text (regarding 
conditions applicable to unaffiliated acquired funds).
    \449\ See supra footnote 26.
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    Commenters generally opposed the proposed rescission of rule 12d1-
2.\450\ Some commenters stated that rescinding rule 12d1-2 would 
disrupt investment strategies, opportunities, and operations, and lead 
to an increase in funds' compliance or investing costs.\451\ Commenters 
also suggested, as discussed in more detail below, that the rescission 
of rule 12d1-2, along with the rescission of exemptive orders and 
withdrawal of staff letters, would impact funds' ability to utilize 
certain fund structures, such as three-tier central fund 
arrangements.\452\ Several commenters suggested a number of changes to 
proposed rule 12d1-4 in response to the Commission's proposed 
rescission of rule 12d1-2.\453\ For example, these commenters 
recommended eliminating or substantially restructuring the proposed 
redemption limit, exempting funds within the same group of investment 
companies from the proposed redemption limit, or permitting continued 
reliance on rule 12d1-2 for funds in the same group of investment 
companies.\454\ In particular, two of these commenters raised specific 
concerns about the proposed redemption limit's impact on fund of funds 
arrangements if the Commission rescinds rule 12d1-2.
---------------------------------------------------------------------------

    \450\ See, e.g., Allianz Comment Letter; Invesco Comment Letter; 
Thrivent Comment Letter, PIMCO Comment Letter; Fidelity Rutland 
Comment Letter; Schwab Comment Letter; NYC Bar Comment Letter; PGIM 
Comment Letter, BlackRock Comment Letter; ABA Comment Letter; SIFMA 
AMG Comment Letter; Capital Group Comment Letter.
    \451\ See, e.g., Allianz Comment Letter; Thrivent Comment 
Letter; PIMCO Comment Letter; ABA Comment Letter; SIFMA AMG Comment 
Letter.
    \452\ See generally PIMCO Comment Letter.
    \453\ See, e.g., Allianz Comment Letter; Thrivent Comment 
Letter; NYC Bar Comment Letter; ABA Comment Letter; BlackRock 
Comment Letter; PIMCO Comment Letter; Fidelity Rutland Comment 
Letter; PGIM Comment Letter; SIFMA AMG Comment Letter.
    \454\ See, e.g., NYC Bar Comment Letter; PIMCO Comment Letter; 
SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Some commenters recommended that the Commission retain rule 12d1-2 
and codify existing exemptive orders permitting funds relying on rule 
12d1-2 to enter into derivatives and financial

[[Page 73960]]

instruments.\455\ As an alternative, some commenters suggested that the 
Commission ``grandfather'' existing fund of funds arrangements that 
rely on rule 12d1-2 if the Commission rescinds the rule.\456\ 
Commenters stated that rescinding rule 12d1-2 would increase costs and 
operational inefficiencies by requiring existing fund of funds 
arrangements to either: (i) Comply with section 12(d)(1)(G) of the Act 
and eliminate any investments other than those permitted under the 
statute; or (ii) operate in accordance with rule 12d1-4 and restructure 
to comply with the proposed redemption limit and complex structure 
limitations.\457\
---------------------------------------------------------------------------

    \455\ See, e.g., PIMCO Comment Letter; Fidelity Rutland Comment 
Letter; PGIM Comment Letter; BlackRock Comment Letter; ABA Comment 
Letter; SIFMA AMG Comment Letter.
    \456\ See, e.g., Allianz Comment Letter; Thrivent Comment 
Letter.
    \457\ See, e.g., PIMCO Comment Letter; ABA Comment Letter; NYC 
Bar Comment Letter; SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that it is necessary to rescind rule 12d1-2 
in order to harmonize the overall regulatory structure and create a 
consistent and efficient regulatory framework for the regulation of 
fund of funds investments. The rescission of rule 12d1-2 will eliminate 
some of 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.\458\ 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, will no longer be able to rely on section 
12(d)(1)(G) and rule 12d1-2.\459\ Instead, acquiring funds will have 
flexibility to invest in different types of funds and other asset 
classes under 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.
---------------------------------------------------------------------------

    \458\ 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).
    \459\ 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 footnote 20 and accompanying text.
---------------------------------------------------------------------------

    We believe that this approach will enhance investor protection by 
subjecting more funds of funds arrangements to the conditions in rule 
12d1-4. As we discussed in the 2018 FOF Proposing Release, the purpose 
of this rule is to streamline and enhance the regulatory framework 
applicable to fund of funds arrangements. As we have exercised our 
statutory authority to exempt fund of funds arrangements, we have 
created a regulatory regime where substantially similar fund of funds 
arrangements are subject to different conditions. The rule reflects 
decades of experience with fund of funds arrangements, and will subject 
funds that operate in accordance with it to a tailored set of 
conditions that we believe will help protect investors from the harms 
Congress sought to address by enacting section 12(d)(1) of the Act. The 
requirements of the rule are designed to provide investors with the 
benefits of fund of funds arrangements while protecting them from the 
historical abuses that section 12(d)(1) is designed to prevent.\460\ We 
therefore believe that it is crucial that fund of funds arrangements 
follow the protections of rule 12d1-4 and are rescinding rule 12d1-2. 
We also are not exempting or providing other relief for existing 
investments for these funds for similar reasons.
---------------------------------------------------------------------------

    \460\ See 2018 FOF Proposing Release, supra footnote 6.
---------------------------------------------------------------------------

    We believe that the tailored conditions in rule 12d1-4 are 
appropriate to protect investors and create a harmonized fund of funds 
regulatory regime. We further believe that for fund of funds 
arrangements currently relying on rule 12d1-2, reliance on rule 12d1-4 
will be less disruptive to their arrangements than suggested by 
commenters because the final rule does not include a redemption limit 
and permits an acquired fund to invest up to 10% of its total assets in 
other funds.\461\ Additionally, rule 12d1-4 includes tailored 
conditions for fund of funds arrangements in the same group of 
investment companies by excepting them from the rule's control and 
voting conditions.
---------------------------------------------------------------------------

    \461\ See NYC Bar Comment Letter (suggesting that eliminating 
the proposed redemption limit would address commenters' 
inflexibility concerns with the proposed rescission of rule 12d1-2); 
see also SIFMA AMG Comment Letter (suggesting that the Commission 
should exempt affiliated fund of funds arrangements from the 
proposed redemption limit). See supra section II.C.3 (discussing 
complex structures including general exceptions to the three-tier 
limitation and the 10% Bucket provision). See infra section V.C.1.a 
(discussing Form N-PORT data related to the proposed redemption 
limit).
---------------------------------------------------------------------------

    As proposed, in order to limit the hardship that the rescission of 
rule 12d1-2 could have on existing fund of funds arrangements, we are 
adopting a one-year period after the effective date before rule 12d1-2 
is rescinded. We did not receive comment on this aspect of the proposed 
rescission of rule 12d1-2. We believe that one year is adequate time 
for funds relying on current rule 12d1-2 to bring their future 
operations into conformity with section 12(d)(1)(G) or rule 12d1-4. We 
also decline to exempt existing funds relying on rule 12d1-2 past this 
one-year period, as suggested by some commenters,\462\ because it would 
add unnecessary complexity to the regulatory framework and potentially 
create an uneven playing field for funds based on differing rule 
conditions, as discussed above.
---------------------------------------------------------------------------

    \462\ See supra footnote 456 and accompanying text.
---------------------------------------------------------------------------

2. Amendment to Rule 12d1-1
    We are adopting an amendment to rule 12d1-1 under the Act, as 
proposed, to allow funds relying on section 12(d)(1)(G) to also rely 
upon the rule. This provides these funds with continued flexibility to 
invest in money market funds outside of the same group of investment 
companies despite the rescission of rule 12d1-2.\463\ Comments received 
on this aspect of the proposal supported it.\464\
---------------------------------------------------------------------------

    \463\ Rule 12d1-1(a) provides 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.
    \464\ See, e.g., BlackRock Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that such investments in money market funds 
do not raise the concerns that underlie section 12(d)(1).\465\ We also 
believe that retaining this flexibility will help funds in smaller 
complexes that do not have a money market fund as part of their fund 
complex invest in an unaffiliated money market fund, subject to the 
conditions of rule 12d1-1.\466\ This limited flexibility may be less 
costly than complying with section 12(d)(1)(G)'s limited 
conditions.\467\ We are therefore amending rule 12d1-1 as proposed, to 
provide an exemption from section 12(d)(1)(G) for an investment company 
to acquire the securities of a money market fund.
---------------------------------------------------------------------------

    \465\ See 2006 FOF Adopting Release, supra footnote 19, at n.23 
and accompanying text.
    \466\ See id., at section II.A.1(a).
    \467\ 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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[[Page 73961]]

E. Disclosures Relating to Fund of Funds Arrangements

1. Amendments to 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.\468\ Form N-CEN provides both the Commission and the public with 
enhanced and updated census-type information on a wide-range of 
compliance, risk assessment, and policy related matters.\469\ We 
proposed to add a requirement to Form N-CEN that would require 
reporting if a management company relied on rule 12d1-4 or the 
statutory exception in section 12(d)(1)(G) during the reporting period. 
While Form N-CEN already requires a management company to report if it 
is a fund of funds, we proposed 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. We also proposed to 
require UITs to report if they relied on proposed rule 12d1-4 or the 
statutory exception in section 12(d)(1)(G) during the reporting period. 
In proposing this requirement, we noted that the UIT section of Form N-
CEN does not currently require a UIT to identify if it is a fund of 
funds.\470\
---------------------------------------------------------------------------

    \468\ See, e.g., Reporting Modernization Adopting Release, supra 
footnote 56.
    \469\ Id.
    \470\ 2018 FOF Proposing Release, supra footnote 6.
---------------------------------------------------------------------------

    Commenters that addressed the proposed amendments to Form N-CEN 
supported them,\471\ and we are adopting these amendments to the form 
as proposed.\472\ We believe the amendments we are adopting to the form 
will help us better assess reliance on rule 12d1-4, or the statutory 
exception in section 12(d)(1)(G). In turn, this will allow the staff to 
evaluate whether additional disclosure is needed. These amendments to 
Form N-CEN will also assist with our accounting, auditing and oversight 
functions, including compliance with the Paperwork Reduction Act.\473\
---------------------------------------------------------------------------

    \471\ See, e.g., Federated Comment Letter; Voya Comment Letter; 
ICI Comment Letter.
    \472\ Items C.7.l. and C.7.m. of Form N-CEN (for management 
companies) and Items F.18 and F.19 of Form N-CEN (for UITs).
    \473\ 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 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)'').
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2. Acquired Fund Fees and Expenses
    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''.\474\ 
Since we adopted the AFFE disclosure requirement, some have expressed 
concerns about the impact of this disclosure on certain acquired funds, 
including BDCs.\475\ The 2018 FOF Proposing Release requested comment 
on fees and expenses, including with respect to AFFE disclosure.
---------------------------------------------------------------------------

    \474\ See Instruction 3(f)(i) to Item 3 of Form N-1A. Other 
forms, including N-2, N-3, N-4 and N-6 similarly require disclosure 
relating to AFFE. See, e.g., 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%
    \475\ 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''); see also Comment Letter of the Coalition for Business 
Development to File No. 812-15065, https://www.sec.gov/comments/s7-27-18/s72718-6668087-203950.pdf (Jan. 16, 2020); Comment Letter of 
Brett Palmer, President, SBIA, et al. to File No. S7-27-18, https://www.sec.gov/comments/s7-27-18/s72718-6892436-211002.pdf (Feb. 28. 
2020) (``SBIA Comment Letter 2''); Comment Letter of Gwen Moore, 
Steve Stivers, Brad Sherman and Bill Huizenga, Members of Congress 
to File No. S7-27-18, https://www.sec.gov/comments/s7-27-18/s72718-6913308-211215.pdf (March 5, 2020).
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    Some commenters similarly expressed certain concerns about current 
AFFE disclosure requirements. For example, several commenters suggested 
that fee table disclosure should focus on a fund's operating expenses 
and should not incorporate AFFE.\476\ Some commenters suggested 
eliminating the inclusion of certain investment-related expenses in fee 
tables in the prospectus for all types of funds, or moving AFFE 
disclosure to the risk factors or narrative description of a 
prospectus.\477\ Several commenters also expressed particular concern 
about treating BDCs as acquired fund investments and recommended 
excluding BDC investments from AFFE.\478\
---------------------------------------------------------------------------

    \476\ See, e.g., ICI Comment Letter; PIMCO Comment Letter; 
Invesco Comment Letter; Chapman Comment Letter; SIFMA AMG Comment 
Letter.
    \477\ See, e.g., PIMCO Comment Letter; Invesco Comment Letter; 
SIFMA AMG Comment Letter.
    \478\ See, e.g., SBIA Comment Letter (stating that AFFE 
disclosure distorts an acquiring fund's expense ratio and has 
disproportionately harmed BDCs because this disclosure requirement 
has led to funds no longer investing in BDCs and several index 
providers dropping BDCs from their indexes); Chapman Comment Letter; 
Nuveen Comment Letter; FS Comment Letter; Chamber of Commerce 
Comment Letter; Comment Letter of Alternative Credit Council (May 2, 
2019) (stating that AFFE disclosure overstates the costs of a fund 
investing in a BDC because it essentially requires double-counting 
of a BDC's operating expenses and that because AFFE disclosure has 
effectively resulted in funds no longer investing in BDCs, it has 
restricted the market for BDCs, limited institutional ownership of 
BDCs, and reduced investor choice); ICI Comment Letter; John Hancock 
Comment Letter.
---------------------------------------------------------------------------

    On the other hand, some commenters expressed general support for 
the current AFFE disclosure requirements in the prospectus fee 
table.\479\ Two commenters credited AFFE disclosure for providing 
investors with the necessary information to understand the potential 
layering of fees in fund of funds arrangements and to compare similar 
funds and expenses.\480\
---------------------------------------------------------------------------

    \479\ Kauff Comment Letter at 2; Rand Comment Letter at 1-2; 
Cooper Comment Letter at 1-2.
    \480\ Kauff Comment Letter; Rand Comment Letter.
---------------------------------------------------------------------------

    We are not addressing AFFE disclosure requirements as part of this 
rulemaking. Instead, we are considering modifications to AFFE 
disclosure as part of a broader review of how funds disclose fees in 
their prospectuses.\481\ In this regard, in the Investor Experience 
Proposal, the Commission requested comment on a proposal to replace the 
current requirement that AFFE be included in the prospectus fee table 
of open-end funds regardless of the scope of investments in acquired 
funds with a more tailored requirement based on the percentage of 
assets invested in acquired funds.\482\ This amendment, which the 
Commission proposed in conjunction with other changes to funds' 
prospectus fee disclosure requirements, would permit open-end funds 
that invest 10% or less of their total assets in acquired funds to omit 
AFFE from the fund's bottom line expenses in the fee table and instead 
disclose the amount of the fund's AFFE in a footnote to the fee table. 
Open-end funds that invest more than 10% of their total assets in 
acquired funds would continue to present AFFE as a line item

[[Page 73962]]

in the prospectus fee table, as they do today. The Commission also 
requested comment on whether to amend AFFE disclosure requirements 
similarly for other types of registered investment companies.
---------------------------------------------------------------------------

    \481\ See Tailored Shareholder Reports, Treatment of Annual 
Prospectus Updates for Existing Investors, and Improved Fee and Risk 
Disclosure for Mutual Funds and Exchange-Traded Funds; Fee 
Information in Investment Company Advertisements, Investment Company 
Act Release No. 33963 (Aug. 5, 2020) (``Investor Experience 
Proposal''). The Commission, in proposing the AFFE disclosure 
modifications in the Investor Experience Proposal, considered 
comments received in connection with the 2018 FOF Proposing Release. 
Id., at paragraph accompanying n. 608. The comment period for the 
Investor Experience Proposal closes 60 days after its publication in 
the Federal Register.
    \482\ Id. at paragraph accompanying n. 615.
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F. Compliance Dates

    The Commission is providing for a transition period for the 
amendments to Form N-CEN. Specifically, we are adopting compliance 
dates for our amendment to Form N-CEN of January 19, 2022, one year 
following the amendment's effective date. All reports on this form 
filed on or after the compliance date must comply with the amendments. 
Based on the staff's experience, we believe that this will provide 
adequate time for affected funds to compile and review the information 
that must be disclosed.

III. Rescission of Exemptive Relief; 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 rescinding, as proposed, the 
exemptive relief permitting fund of funds arrangements that fall within 
the scope of rule 12d1-4.\483\ As discussed in more detail below, 
exemptive relief granted to fund of funds arrangements outside the 
scope of the rule is not being rescinded.
---------------------------------------------------------------------------

    \483\ See section 38(a) of the Investment Company Act (15 U.S.C. 
80a-37(a)).
---------------------------------------------------------------------------

    We proposed to rescind all orders granting relief from sections 
12(d)(1)(A), (B), (C), and (G) of the Act with one limited exception. 
We did not propose to rescind the exemptive orders providing relief 
from section 12(d)(1)(A) and (B) granted to allow certain interfund 
lending arrangements.\484\ 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, we stated that they do not 
result in the pyramiding of funds or the related potential abuses that 
the proposed rule was designed to address, and thus they were not 
included within the scope of the proposed rule.
---------------------------------------------------------------------------

    \484\ See 2018 FOF Proposing Release, supra footnote 6, at 95.
---------------------------------------------------------------------------

    We also proposed to rescind the exemptive relief from sections 
12(d)(1)(A) and (B) that has been included in our ETF and ETMF 
orders.\485\ We believed 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. As discussed 
in the 2018 FOF Proposing Release, we expected that the need to comply 
with the requirements of proposed rule 12d1-4, as opposed to their 
orders, would not significantly negatively affect the operations of 
most existing fund of funds arrangements.\486\
---------------------------------------------------------------------------

    \485\ Some of the exemptive orders we have issued to ETFs 
include relief permitting ETFs to use certain master-feeder 
arrangements. We rescinded other master-feeder fund relief 
generally, while continuing to permit ETF master-feeder arrangements 
to rely on that relief as part of the implementation of rule 6c-11. 
See 2019 ETF Adopting Release, supra footnote 25. In addition, we 
understand that existing ETMFs currently rely on the master-feeder 
relief in the orders and did not propose to rescind that relief. 
See, e.g., Eaton Vance Management, et al., Investment Company Act 
Release Nos. 31333 (Nov. 6, 2014) (notice) and 31361 (Dec. 2, 2014) 
(order) (``Eaton Vance Order'').
    \486\ 2018 FOF Proposing Release, supra footnote 6, at 96. See 
also section II.D.
---------------------------------------------------------------------------

    Commenters had mixed reactions to our proposal to rescind existing 
fund of funds exemptive orders. Several commenters supported the 
proposed rescission of exemptive orders in connection with the adoption 
of rule 12d1-4, citing the benefits of a standardized rule.\487\ Many 
other commenters requested that we not rescind existing fund of funds 
exemptive orders, and instead codify and expand on existing prior 
exemptive orders.\488\ These commenters stated that our proposal would 
eliminate a fund's ability to rely on existing fund of funds relief and 
could result in undue costs and burdens, including potential 
restructuring of existing arrangements.
---------------------------------------------------------------------------

    \487\ See, e.g., MFDF Comment Letter; Morningstar Comment 
Letter; TRP Comment Letter.
    \488\ See, e.g., Nationwide Comment Letter; ICI Comment Letter; 
Federated 2 Comment Letter; Allianz Comment Letter; Fidelity Fixed 
Income Trustees Comment Letter; Fidelity Comment Letter.
---------------------------------------------------------------------------

    Other commenters suggested the Commission take a tailored approach 
in order to limit disruption to existing fund of funds 
arrangements.\489\ For example, one commenter requested we rescind only 
the exemptive orders described in the 2018 FOF Proposing Release.\490\ 
Many commenters requested additional specificity as to which exemptive 
orders would be withdrawn, and whether the Commission intended to 
withdraw relief from provisions of the Act other than section 12(d)(1) 
in such exemptive orders.\491\
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    \489\ John Hancock Comment Letter; Federated Comment Letter; TRP 
Comment Letter.
    \490\ NYC Bar Comment Letter.
    \491\ See, e.g., Nationwide Comment Letter; ICI Comment Letter; 
Voya Comment Letter; TRP Comment Letter; Federated Comment Letter; 
NYC Bar Comment Letter; Federated Comment Letter; Dechert Comment 
Letter; Chamber of Commerce Comment Letter.
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    As discussed in more detail below, several commenters requested 
that the Commission expand the rule to incorporate individualized 
relief set forth in certain exemptive orders.\492\ Alternatively, some 
commenters suggested that the Commission preserve existing orders, and 
allow current recipients of exemptive relief to follow the conditions 
of their relief rather than relying on the rule.\493\ One commenter 
suggested that the Commission give the holders of exemptive orders at 
least a one-year period to transition operations or obtain new 
exemptive relief.\494\
---------------------------------------------------------------------------

    \492\ Nationwide Comment Letter; Allianz Comment Letter; DPW 
Comment Letter; Voya Comment Letter; Capital Group Comment Letter; 
Fidelity Comment; NYC Bar Comment Letter; PIMCO Comment Letter; PGIM 
Comment Letter; Federated 2 Comment Letter.
    \493\ See, e.g., Allianz Comment Letter; PGIM Comment Letter; 
ABA Comment Letter; Fidelity Fixed Income Trustees Comment Letter; 
Fidelity Rutland Comment Letter; John Hancock Comment Letter.
    \494\ NYC Bar Comment Letter.
---------------------------------------------------------------------------

    As proposed, and as discussed in more detail below, we are 
rescinding the fund of funds exemptive orders that fall within the 
scope of rule 12d1-4. Specifically, we are rescinding exemptive relief 
that permits investments in funds beyond the limits in 12(d)(1)(A), 
(B), or (C) of the Act, other than in circumstances that we believe are 
outside the scope of rule 12d1-4 as discussed below. We are also 
rescinding exemptive relief under section 12(d)(1)(G) that permits an 
affiliated fund of funds to invest in assets that are beyond the scope 
of that statutory provision. We continue to believe that rescinding 
these orders will help to create a consistent framework for fund of 
funds arrangements, subject to conditions that appropriately address 
the concerns underlying section 12(d)(1), including the prevention of 
overly complex structures for funds of funds. In order to limit the 
hardship that revocation of these orders could have on existing fund of 
funds arrangements, however, we are adopting 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 rule and rule amendments.
    Fund of funds exemptive relief that falls outside the scope of rule 
12d1-4, as well as the relevant portions of fund of funds exemptive 
orders that grant relief for provisions in the Act outside of the scope 
of this rulemaking, will remain in place. For example, we have issued 
several exemptive orders that

[[Page 73963]]

provide relief from sections 17(a) and 17(d) of the Act and rule 17d-1 
under the Act that allow a registered fund to invest in private 
funds.\495\ We are not rescinding the relief from section 17(a) and 
under section 17(d) and rule 17d-1 granted in these orders. Similarly, 
we are not rescinding the portions of certain funds of funds exemptive 
orders that grant relief from section 17(d) of the Act and rule 17d-1 
under the Act to enter into fee sharing agreements to avoid duplicative 
fees.\496\ In addition, to the extent we rescind 12(d)(1) relief, we 
are also rescinding any related 17(a) relief for the acquisition and 
redemption of fund shares by another fund. We are not, however, 
rescinding 17(a) relief permitting sales or redemptions of fund shares 
in-kind or portfolio transactions between two funds.
---------------------------------------------------------------------------

    \495\ See, e.g., Aberdeen Asset Management Inc., et al., 
Investment Company Act Release Nos. 33058 (March 27, 2018) (notice) 
and 33080 (April 24, 2018) (order).
    \496\ See, e.g., Lord Abbett Investment Trust, et al., 
Investment Company Act Release Nos. 23088 (March 27, 1998) (notice) 
and 23122 (April 21, 1998) (order) (granting relief for, among other 
things, a servicing arrangement under which one or more of the 
applicant funds may pay a portion of the administrative expenses of 
another applicant fund).
---------------------------------------------------------------------------

    The major topical areas of fund of funds exemptive relief that are 
within the scope of rule 12d1-4 are as follows:
    Standard Fund of Funds Relief. Our exemptive relief relating to 
standard fund of funds arrangements generally grants exemptions from 
sections 12(d)(1)(A), (B), and (C) of the Act and sections 17(a)(1) and 
(2) of the Act to permit acquiring funds to invest in acquired funds in 
excess of the limits of in section 12(d)(1) of the Act.\497\ This 
relief is rescinded, one year from the effective date of the rule.
---------------------------------------------------------------------------

    \497\ The standard fund of funds orders grant an exemption from 
sections 12(d)(1)(A) and 12(d)(1)(B). See, e.g. Aberdeen Asset 
Management Inc., et al., Investment Company Act Release Nos. 28429 
(Sept. 30, 2008) (notice) and 28475 (Oct. 28, 2008) (order). A 
subcategory of these standard fund of funds exemptive orders also 
grant additional relief under section 12(d)(1)(C) to permit 
investment in closed-end funds beyond the limits imposed by section 
12(d)(1)(C). See, e.g., Ares Credit and Income Trust and Ares 
Capital Management III LLC, Investment Company Act Release Nos. 
33243 (Sept. 21, 2018) (notice) and 33275 (Oct. 17, 2018) (order). 
The rescission of standard fund of funds exemptive orders applies to 
the orders that grant additional relief under section 12(d)(1)(C), 
as well, since that relief is within the scope of rule 12d1-4.
---------------------------------------------------------------------------

    Fund of Funds Relief for ETFs and ETMFs. As proposed, the exemptive 
relief from sections 12(d)(1)(A) and (B) that has been included in our 
ETF and ETMF orders is rescinded, one year from the effective date of 
the rule.
    ETFs Relying on Rule 6c-11. In 2019, we adopted rule 6c-11 under 
the Investment Company Act to permit ETFs that satisfy certain 
conditions to operate without the expense and delay of obtaining an 
exemptive order from the Commission under the Act.\498\ In connection 
with that rulemaking, we rescinded those portions of certain ETF 
exemptive orders that grant relief related to the formation and 
operation of an ETF, but we did not rescind the relief provided to ETFs 
from section 12(d)(1) and sections 17(a)(1) and (a)(2) under the Act 
related to fund of funds arrangements involving ETFs. The fund of funds 
exemptive relief for these ETFs is rescinded as well.\499\
---------------------------------------------------------------------------

    \498\ 2019 ETF Adopting Release, supra footnote 25, at 8.
    \499\ Id. We also stated that ETFs relying on rule 6c-11 that do 
not have exemptive relief from sections 12(d)(1)(A) and (B) may 
enter into fund of funds arrangements as set forth in recent ETF 
exemptive orders, provided that such ETFs satisfy the terms and 
conditions for fund of funds relief in those orders. The 2019 ETF 
Adopting Release noted that this position would be available only 
until the effective date of a rule permitting registered funds to 
acquire the securities of other registered funds in excess of the 
limits in section 12(d)(1), including rule 12d1-4 if adopted. See 
id. at 130-133. In order to give any ETFs relying on this position 
sufficient time to come into compliance with rule 12d1-4, however, 
this position will be available for a one-year period following the 
effective date of rule 12d1-4.
---------------------------------------------------------------------------

    Fund of Funds Relief for Non-Transparent ETFs and ETMFs. We also 
have granted exemptive relief permitting certain actively managed ETFs 
to operate without being subject to the daily portfolio transparency 
condition included in other actively managed ETF orders (``non-
transparent ETFs'').\500\ These orders include relief from sections 
12(d)(1)(A) and (B) of the Act to permit certain fund of funds 
arrangements. We also have granted relief from sections 12(d)(1)(A) and 
(B) permitting ETMFs to be an acquired fund in a fund of funds 
arrangement.\501\ We believe that non-transparent ETFs and ETMFs raise 
the same concerns regarding the pyramiding of funds and the related 
potential abuses that the rule is designed to address. As a result, 
relief under section 12(d)(1)(A) and (B) for non-transparent ETFs and 
ETMFs is rescinded as proposed.\502\
---------------------------------------------------------------------------

    \500\ Because these non-transparent ETFs do not provide daily 
portfolio transparency, they do not meet the conditions of rule 6c-
11. See 2019 ETF Adopting Release, supra footnote 25, at text 
accompanying n. 192.
    \501\ See, e.g., Eaton Vance Order, supra footnote 485.
    \502\ See supra footnote 485 noting that master-feeder relief 
for ETMFs will not be rescinded.
---------------------------------------------------------------------------

    Fund of Funds Direct Investment Relief. We have granted exemptive 
relief to permit fund of funds arrangements that rely on section 
12(d)(1)(G) of the Act to invest in assets other than funds within the 
same group of investment companies, government securities, and short-
term paper. Certain exemptive relief granted prior to the adoption of 
rule 12d1-2 in 2006 permitted funds of funds relying on section 
12(d)(1)(G) to invest in securities and other financial 
instruments.\503\ Some exemptive orders granted after the adoption of 
rule 12d1-2 provide relief from rule 12d1-2(a) to the extent necessary 
to permit an acquiring fund that relies on section 12(d)(1)(G) of the 
Act to invest in financial instruments that may not be ``securities.'' 
\504\ Although some commenters requested we retain the relief for 
direct investments,\505\ we are rescinding this relief, one year from 
the effective date of the rule. As discussed above in section II.D, we 
are rescinding rule 12d1-2 in order to create a more consistent and 
efficient regulatory framework for the regulation of fund of funds 
arrangements. We similarly believe that rescinding the direct 
investment exemptive relief will establish an appropriate, consistent 
framework for the regulation of these fund of funds arrangements by 
subjecting them to the conditions of rule 12d1-4 if they continue to 
invest in assets other than those permitted by section 12(d)(1)(G) of 
the Act.
---------------------------------------------------------------------------

    \503\ See, e.g., Nations Fund Trust, Investment Company Act 
Release Nos. 24781 (Dec. 1, 2000) (notice) and 24804 (Dec. 27, 2000) 
(order) (permitting a fund to invest in funds in the same group of 
investment companies and in other securities (not issued by another 
fund)).
    \504\ See, e.g., Context Capital Advisors, LLC, et al., 
Investment Company Act Release Nos. 31689 (June 24, 2015) and 31720 
(July 21, 2015). As discussed in more detail below, certain staff 
no-action letters in connection with this rulemaking, including 
Northern Lights Fund Trust, SEC Staff No-Action Letter (June 29, 
2015) (``Northern Lights Letter'') will be withdrawn. The Northern 
Lights Letter permits an affiliated fund of funds arrangement 
relying on section 12(d)(1)(G) and rule 12d1-2 to invest a portion 
of its assets in other financial instruments (e.g., derivatives that 
are not securities under the Act), consistent with its investment 
objectives, policies and restrictions.
    \505\ See, e.g., Allianz Comment Letter.
---------------------------------------------------------------------------

    Fund of Funds Affiliated Structures. The Commission granted certain 
exemptive relief to permit an open-end fund or UIT to invest in other 
open-end funds and UITs that are in the ``same group of investment 
companies'' in excess of the limits in section 12(d)(1), subject to 
certain enumerated conditions.\506\ Some exemptive orders

[[Page 73964]]

also permitted funds of funds to invest in an affiliated closed-end 
fund.\507\ As with the standard fund of funds relief, we are rescinding 
the affiliated structure relief. These fund of funds arrangements may 
rely on section 12(d)(1)(G) or rule 12d1-4 to the extent they intend to 
purchase other funds in the same group of funds beyond the limits of 
section 12(d)(1). Additionally, although several commenters requested 
that the Commission not rescind certain exemptive relief that allows an 
acquired fund's investment in short-term bond funds for cash management 
or collateral management purposes,\508\ rule 12d1-4 provides 
appropriate flexibility for funds to invest for these purposes. 
Specifically, rule 12d1-4 permits an acquiring fund to invest in any 
acquired fund in excess of the statutory limits pursuant to the 
conditions of the rule. Further, rule 12d1-4 provides an exception from 
the rule's general prohibition against three tiers to permit an 
acquired fund to invest in an underlying fund pursuant to rule 12d1-1 
in excess of the statutory limits, and provides the 10% Bucket, which 
permits an acquired fund to invest up to 10% of its assets in other 
investment companies for any investment purposes. Rule 12d1-4 limits 
the potential for confusing structures and duplicative fees, while 
providing the flexibility of the 10% Bucket. Accordingly, we believe it 
is appropriate to rescind this relief, one year from the effective date 
of the rule. For similar reasons, we believe it is appropriate to 
rescind the exemptive relief that acquired funds have relied on to 
invest in ``central funds.'' \509\ We believe that the 10% Bucket 
provided in rule 12d1-4, when combined with the enumerated exceptions 
discussed above, will provide appropriate flexibility for beneficial 
multi-tier arrangements while limiting the harms that Congress sought 
to prevent. Accordingly, the central funds exemptive relief falls 
within the scope of rule 12d1-4 and is rescinded, one year from the 
effective date of the rule.\510\ As discussed above, some existing 
multi-tier structures, including ``central funds'' arrangements that 
currently rely on existing exemptive relief, may be required to modify 
their investments to ensure compliance with rule 12d1-4.\511\ However, 
unlimited ability to enter into multi-tier arrangements could lead to 
complex structures in which an acquiring fund shareholder finds it 
difficult to determine the nature and value of the holdings ultimately 
underlying his or her investment.
---------------------------------------------------------------------------

    \506\ Some of these orders pre-date the implementation of 
section 12(d)(1)(G), while other orders also included this relief 
for certain affiliated fund of funds arrangements after the 
implementation of section 12(d)(1)(G). See, e.g., Franklin Templeton 
Fund Manager, et al., Investment Company Act Release Nos. 21964 (May 
20, 1996) (notice) and 22022 (June 17, 1996) (order); Aberdeen Asset 
Management Inc., et al., Investment Company Act Release Nos. 28429 
(Sept. 30, 2008) (notice) and 28475 (Oct. 28, 2008) (order). See 
also supra section II.B for a general discussion of exemptive relief 
related to affiliated structures.
    \507\ See, e.g., Sierra Asset Management Portfolios, et al., 
Investment Company Act Release Nos. 22842 (Oct. 7, 1997) (notice) 
and 22869 (Oct. 31, 1997) (order).
    \508\ See PGIM Comment Letter (referring to its exemptive order 
permitting acquired funds (and acquiring funds) to invest in a 
public or private short-term bond fund for cash management 
purposes).
    \509\ See supra footnote 421 and accompanying text describing 
central funds. See also PIMCO Comment Letter (referring to PIMCO 
Funds, et al., Investment Company Act Release Nos. 25220 (Oct. 22, 
2001) (notice) and 25272 (Nov. 19, 2001) (order)). See also supra 
footnote 424 for commenters addressing central fund arrangements, 
including related to the Thrivent No-Action Letter.
    \510\ As discussed in more detail below, certain staff no-action 
letters in connection with this rulemaking, including Franklin 
Templeton Investments, SEC Staff No-Action Letter (Apr. 3, 2015) 
(``FTI Letter'') will be withdrawn. The FTI Letter permits 
underlying funds to rely on 12(d)(1)(G) to invest in a central fund 
that invests in floating rate securities.
    \511\ See section II.C.3.d, noting that as of June 2018, we 
identified 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) that may need to restructure their holdings over 
time to continue to maintain the same investment, to the extent that 
the acquired funds in such structures invest more than 10% of their 
assets in underlying funds, exclusive of investments in underlying 
funds that are made pursuant to the enumerated exceptions described 
above; see also 2018 FOF Proposing Release, supra footnote 6, at 
150.
---------------------------------------------------------------------------

    Captive Funds. One commenter requested that the Commission retain 
exemptive orders for fund of funds arrangements that are captive to an 
affiliated managed account program.\512\ This commenter stated these 
kinds of captive funds of funds are simply conduits that advisers use 
to deliver a more efficient range of investment strategies and achieve 
a more consistent allocation of investment strategies across these 
accounts. We recognize that rescinding such exemptive relief may cause 
fund of funds arrangements that are captive to an affiliated managed 
account program to restructure to comply with the conditions of rule 
12d1-4.\513\ However, rule 12d1-4 provides appropriate flexibility and 
conditions for affiliated fund of funds structures, including 
structures that are captive to an affiliated managed account program. 
Accordingly, such exemptive relief is rescinded, one year from the 
effective date of the rule.
---------------------------------------------------------------------------

    \512\ Fidelity Comment Letter (referring to Fidelity Rutland 
Square Trust, et al., Investment Company Act Release Nos. 28259 
(Apr. 30, 2008) (notice) and 28287 (May 28, 2008) (order)).
    \513\ See section V.C.1.ii for an analysis of the anticipated 
benefits and costs of rescinding exemptive orders; see also section 
V.D.1 for the economic analysis of retaining existing exemptive 
orders.
---------------------------------------------------------------------------

    We have also given relief from section 12(d)(1) in certain 
circumstances that we believe are outside the scope of rule 12d1-4. The 
major topical areas section 12(d)(1) exemptive relief that we believe 
are outside the scope of rule 12d1-4 are as follows:
    Interfund Lending. As proposed, we are not rescinding the exemptive 
relief from section 12(d)(1)(A) and (B) granted to allow certain 
interfund lending arrangements. Commenters generally agreed with this 
approach.\514\ We continue to believe that these arrangements do not 
result in the pyramiding of funds or the related potential abuses that 
rule 12d1-4 is designed to address.
---------------------------------------------------------------------------

    \514\ See, e.g., Voya Comment Letter.
---------------------------------------------------------------------------

    Affiliated Insurance Fund Relief. Commenters requested more clarity 
with respect to certain orders allowing insurance funds to invest in 
fixed income instruments issued by affiliates. For example, one 
commenter requested clarification regarding the status of its 2002 
exemptive relief, which permits its funds of funds to invest in 
affiliated and unaffiliated underlying funds, other securities, and a 
fixed interest contract issued by its affiliate.\515\ Another commenter 
similarly requested clarification whether we are rescinding its 
exemptive relief, a portion of which allows funds to invest in a 
guaranteed rate investment contract issued by an affiliate.\516\ The 
orders cited by these commenters grant exemptions from 12(d)(1)(A) and 
12(d)(1)(B), as well as from section 17(a) for the purchase of the 
guaranteed rate investment contract issued by an affiliate. As 
described above, we are rescinding only the portion of the exemptive 
orders granting fund of funds relief that falls within the scope of 
rule 12d1-4. We agree with commenters that the relief granted under 
sections 6(c) and 17(b) permitting investment in a fixed income 
instrument issued by an affiliate is distinct from the fund of funds 
relief granted in these orders. As noted above, we are not rescinding 
relief under section 17 when the relief does not implicate fund of 
funds arrangements. Accordingly, we are not rescinding this portion of 
the exemptive relief, which is unrelated to the fund of funds exemptive 
relief.
---------------------------------------------------------------------------

    \515\ Nationwide Comment Letter (referring to Nationwide Life 
Insurance Co., Investment Company Act Release Nos. 25492 (Mar. 21, 
2002) (notice) and 25528 (Apr. 16, 2002) (order)).
    \516\ Voya Comment Letter (referring to ING Partners Inc., et 
al., Investment Company Release Nos. 27116 (Oct. 12, 2005) (notice) 
and 27142 (Nov. 8, 2005) (order).
---------------------------------------------------------------------------

    Transaction-Specific Relief. From time to time, we have granted 
exemptive relief to funds under section 12(d)(1) in order to engage in 
a transaction that might otherwise violate such provision.

[[Page 73965]]

In many cases, this relief relates to fund reorganizations.\517\ This 
transaction-specific relief does not involve ongoing fund of funds 
arrangements where the concerns underlying section 12(d)(1) are most 
pronounced and where the conditions of rule 12d1-4 will serve to 
protect investors against those concerns. As a result, we do not 
believe it is necessary to rescind such relief.
---------------------------------------------------------------------------

    \517\ See, e.g., Allied Capital Corporation, et al., Investment 
Company Act Release Nos. 22902 (Nov. 21, 1997) (notice) and 22941 
(order) (granting relief under sections 12(d)(1)(A) and 12(d)(1)(C), 
among other provisions, to allow for the acquisition of investment 
company subsidiaries in a merger).
---------------------------------------------------------------------------

    Grantor Trusts. One commenter requested we retain an exemptive 
order pertaining to current and future automatic common exchange 
security (``ACES'') trusts.\518\ ACES trusts are limited-life, grantor 
trusts. We have previously granted exemptive relief to funds and 
private funds to invest in a grantor trust (typically structured as a 
closed-end fund) in excess of the section 12(d)(1) limits, along with 
related relief.\519\ The grantor trusts in this line of exemptive 
orders are not marketed to provide investors with either professional 
investment asset management or the benefits of investment in a 
diversified pool of assets. As a result, they do not result in the 
pyramiding of funds or the related potential abuses that the rule is 
designed to address, and therefore we are not rescinding this relief.
---------------------------------------------------------------------------

    \518\ DPW Comment Letter (citing Goldman, Sachs & Co., 
Investment Company Act Release Nos. 32460 (Jan. 31, 2017) (notice) 
and 32514 (Feb. 28, 2017) (order) (``Goldman ACES Order'')).
    \519\ See, e.g., Goldman ACES Order; see also J.P. Morgan 
Securities Inc., Investment Company Act Release Nos. 24060 (Sept. 
29, 1999) (notice) and 24112 (Oct. 26, 1999) (order).
---------------------------------------------------------------------------

    Fund of Funds Arrangements with Managed Risk Provision and other 
Relief Related to Section 12(d)(1)(E). One commenter requested that we 
not rescind a fund of funds exemptive order that permits a ``managed 
risk'' fund structure.\520\ This commenter stated that the relief 
allows an insurance series fund that invests in one underlying fund in 
excess of the limits in section 12(d)(1)(A) also to invest in cash, 
cash equivalents, and certain hedging instruments in connection with a 
risk-management strategy that is specifically designed to reduce the 
volatility of the acquiring fund. Because of the fund's investment in 
certain hedging instruments, the fund cannot rely on section 
12(d)(1)(E) of the Act for purposes of an exception from the general 
prohibition against three tiers. We are not rescinding exemptive relief 
from sections 12(d)(1)(A) and (B) of the Act to the extent that the 
relief effectively allows a feeder fund to rely on section 12(d)(1)(E) 
without complying with certain aspects of section 12(d)(1)(E) of the 
Act. Accordingly, we believe this relief is outside the scope of rule 
12d1-4 with respect to the treatment of a fund for purposes of the 
three-tier prohibition.\521\
---------------------------------------------------------------------------

    \520\ See Capital Group Comment Letter (referring to the 
``managed risk fund provision'' in American Funds Insurance Series, 
et al., Investment Company Act Release Nos. 31677 (June 17, 2015) 
(notice) and 31715 (July 14, 2015) (order)).
    \521\ In addition, we did not proposed to rescind exemptive 
relief related to section 12(d)(1)(F) and are not doing so. See FOF 
Proposing Release supra footnote 6 at 95.
---------------------------------------------------------------------------

    We continue to believe that the one-year period for the termination 
of our fund of funds exemptive relief is sufficient to give adequate 
time for funds relying on impacted exemptive orders to bring their 
future operations into conformity with section 12(d)(1)(G) or rule 
12d1-4.
    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.\522\ This rule is 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. Funds are able to request 
Commission approval to operate as a fund of funds that does not meet 
the requirements of the rule.
---------------------------------------------------------------------------

    \522\ See also id. at 97 (stating that ``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.'').
---------------------------------------------------------------------------

    As discussed in the 2018 FOF Proposing Release, our staff has 
previously stated that it would not recommend that the Commission take 
enforcement action in certain situations relating to section 12(d)(1). 
The 2018 FOF Proposing Release noted that the staff in the Division of 
Investment Management were reviewing staff letters relating to section 
12(d)(1) to determine whether any such letters should be withdrawn in 
connection with any adoption of this rule. As we noted in the 2018 FOF 
Proposing Release, some of the letters may be moot, superseded, or 
otherwise inconsistent with the rule and, therefore, will be withdrawn.
    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 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; \523\ (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.
---------------------------------------------------------------------------

    \523\ 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. See, e.g., 
Northern Lights Letter supra footnote 504.
---------------------------------------------------------------------------

    In the 2018 FOF Proposing Release, we asked that commenters detail 
their concerns with the withdrawal of any of the letters. Commenters 
stated preferences for retaining certain no-action letters, including 
those that relate to three-tier structures, subject to the 
circumstances described in those letters.\524\ Some commenters 
requested that no-action letters relating to a foreign fund that 
invests in a U.S. fund to comply with section 12(d)(l)(A)(i) but not 
sections 12(d)(l)(A)(ii) and (iii) not be withdrawn.\525\ Other 
commenters suggested that certain no-action letters be retained related 
to the status of investment vehicles domiciled outside the U.S., where 
such foreign funds are

[[Page 73966]]

acquired funds in fund of funds arrangements.\526\ Commenters expressed 
views in favor of retaining no-action letters related to investments in 
three tier ``central fund'' structures.\527\ Finally, other commenters 
requested that the staff publicly indicate specifically which no-action 
letters would be withdrawn.\528\
---------------------------------------------------------------------------

    \524\ See, e.g., Thrivent Comment Letter; ICI Comment Letter.
    \525\ Vanguard Comment Letter. The Commission previously stated 
that a foreign fund that uses U.S. jurisdictional means in the 
offering of securities it issues and relies on section 3(c)(1) or 
3(c)(7) of the Act will be treated as a private fund for purposes of 
section 12(d)(1). See 2018 FOF Proposing Release, at footnote 52, 
citing ``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, at note 294 and accompanying text (June 22, 2011) 
[76 FR 39646 (July 6, 2011)]. Staff no-action letters stating that 
the staff would not recommend enforcement action if a foreign fund 
purchases securities of U.S. funds in excess of the limits of 
section 12(d)(1) under certain facts and circumstances will not be 
withdrawn. See, e.g., Dechert LLP, SEC No-Action Letter (pub. avail. 
Aug. 4. 2009).
    \526\ Ropes Comment Letter (citing Touche, Remnant & Co., SEC 
No-Action Letter (pub. avail. Aug. 27, 1984) and Red Rocks Capital, 
LLC, SEC No-Action Letter (pub. avail. Jun. 3, 2011) (``Red 
Rocks'')); Blackrock Comment Letter (citing Red Rocks; The France 
Growth Fund, Inc., SEC Staff No-Action Letter (July 15, 2003); and 
Templeton Vietnam Opportunities Fund, Inc., SEC Staff No-Action 
Letter (Sept. 6, 1996).
    \527\ Capital Group Comment Letter (noting reliance on Northern 
Lights Letter supra footnote 504).
    \528\ See, e.g., Voya Letter.
---------------------------------------------------------------------------

    As a result of these considerations, the no-action letters stating 
that the staff would not recommend an enforcement action under specific 
circumstances related to section 12(d)(1) will be withdrawn one year 
from the effective date of the final rule. Importantly, as recognized 
above, the final rule provides a consistent and rules-based mechanism 
for fund of funds arrangements. As with the rescission of fund of funds 
exemptive orders, the withdrawal of staff no-action letters will 
include only those letters that fall within the scope of rule 12d1-4. 
With respect to comments asking for specificity as to which no-action 
letters will be withdrawn, we refer commenters to the resource provided 
on the Division of Investment Management's website.\529\
---------------------------------------------------------------------------

    \529\ See supra footnote 30.
---------------------------------------------------------------------------

IV. Other Matters

    Pursuant to the Congressional Review Act,\530\ the Office of 
Information and Regulatory Affairs has designated this rule a ``major 
rule,'' as defined by 5 U.S.C. 804(2). If any of the provisions of 
these rules, or the application thereof to any person or circumstance, 
is held to be invalid, such invalidity shall not affect other 
provisions or application of such provisions to other persons or 
circumstances that can be given effect without the invalid provision or 
application.
---------------------------------------------------------------------------

    \530\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

V. Economic Analysis

    We are mindful of the costs imposed by, and the benefits obtained 
from, our rules. Section 2(c) of the Investment Company Act states that 
when the Commission is engaging in rulemaking under the Investment 
Company Act and is required to consider or determine whether the action 
is necessary or consistent with the public interest, the Commission 
shall consider whether the action will promote efficiency, competition, 
and capital formation, in addition to the protection of investors. The 
following analysis considers, in detail, the potential economic effects 
that may result from the final rule,\531\ including the benefits and 
costs to investors and other market participants as well as the broader 
implications of the final rule for efficiency, competition, and capital 
formation.
---------------------------------------------------------------------------

    \531\ For purposes of this section, we use the term ``final 
rule'' to refer collectively to rule 12d1-4, the rescission of rule 
12d1-2 and the exemptive orders, the amendment to rule 12d1-1, and 
the amendments to Form N-CEN.
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A. Introduction

    Rule 12d1-4 will 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. We are also 
rescinding rule 12d1-2 under the Act and certain exemptive relief, and 
amending rule 12d1-1 and Form N-CEN.\532\
---------------------------------------------------------------------------

    \532\ We expect that the amendments to Form N-CEN will have 
immaterial economic effects. In particular, we expect that the 
amendments to Form N-CEN will increase the annual estimated burden 
hours associated with preparing and filing Form N-CEN by 
approximately 0.1 hours for each fund (see infra section VI.D). In 
addition, the amendments to Form N-CEN will facilitate the 
supervision and regulation of the fund industry, which will 
ultimately benefit fund investors, but any such effects are likely 
small. Hence, the economic analysis focuses on the economic effects 
of rule 12d1-4, the rescission of rule 12d1-2 and the exemptive 
relief, and the amendment to rule 12d1-1.
---------------------------------------------------------------------------

    The final rule will affect funds' investment flexibility, increase 
regulatory consistency and efficiency, and eliminate the need for 
acquiring and acquired funds to obtain an exemptive order from the 
Commission and incur the associated costs and delays. At the same time, 
the final rule will impose one-time costs on funds that will need to 
assess whether their operations are consistent with the final rule. In 
addition, the conditions in rule 12d1-4 will impose certain ongoing 
costs on funds, such as compliance, monitoring, and recordkeeping 
costs. Finally, certain funds will be required to restructure 
additional investments in other funds and incur the associated costs, 
such as transaction costs, to ensure compliance with the final rule.

B. Economic Baseline

    The baseline against which the costs, benefits, and the effects on 
efficiency, competition, and capital formation of the final rule are 
measured consists of the current state of the fund market and the 
current regulatory framework for funds of funds.
1. Current State of the Funds Market
    To establish a baseline for the economic analysis of the final 
rule, we provide descriptive statistics on the current state of the 
fund of funds market. In particular, we provide descriptive statistics 
on funds, investment advisers, sponsors, and depositors of funds, and 
fund investors because these are the persons that likely will be 
affected by the final rule.
    First, we provide descriptive statistics on the number and size of 
funds and funds of funds.\533\ We provide these statistics not only for 
funds of funds but also for single-tier funds to provide an 
understanding of the fund market as a whole and because the final rule 
will affect both current funds of funds and single-tier funds that may 
consider a fund of funds structure in the future. Master-feeder funds 
created in reliance on section 12(d)(1)(E) and funds that only acquire 
securities of money market funds in reliance on rule 12d1-1 are 
excluded from our analysis because these fund of funds structures are 
beyond the scope of rule 12d1-4.
---------------------------------------------------------------------------

    \533\ We use Form N-CEN and Form N-PORT filings with the 
Commission as of May 2020 in our analysis. Form N-CEN provides 
census-type information on an annual basis and is filed by all 
registered investment companies, except for face amount certificate 
companies (rule 12d1-4 will not be available to face amount 
certificate companies). Form N-PORT provides portfolio holdings 
information on a monthly basis and is filed by registered management 
investment companies and ETFs organized as UITs. Hence, Form N-CEN 
provides information for the universe of potentially affected funds, 
with the exception of BDCs. Form N-PORT covers a subset of the 
potentially affected funds covered by Form N-CEN but it provides 
relevant portfolio holdings information for those funds, which is 
unavailable in Form N-CEN, and thus data from Form N-PORT yields 
additional insights on the fund market.
    As of the data collection date, all fund groups file Form N-CEN 
but only large fund groups file Form N-PORT. Large fund groups are 
funds that, together with other investment companies in the same 
``group of related investment companies,'' have net assets of $1 
billion or more as of the end of the most recent fiscal year of the 
fund. Filing Form N-PORT began in April 2020 for small fund groups, 
and this information became available to the Commission in July 
2020, which was after the May 2020 cut-off date of our data 
analysis. However, we do not believe that such data would 
qualitatively change the results of our analysis. See Amendments to 
the Timing Requirements for Filing Reports on Form N-PORT, 
Investment Company Act Release No. 33384 (Feb. 27, 2019) [84 FR 7980 
(Mar. 6, 2019)]. Nevertheless, large fund groups represent 84% of 
all fund groups in terms of total assets. See infra sections 
V.C.1.a.ii and V.C.1.b.v for discussion of differential effects of 
the rule on smaller relative to larger fund complexes.
---------------------------------------------------------------------------

    Table 1 below shows the number and size of all funds and acquiring 
funds of funds using data from Form N-CEN filings as of May 2020.\534\ 
A fund of

[[Page 73967]]

funds in Form N-CEN is a fund that acquires securities issued by any 
other investment company in excess of the amounts permitted under 
paragraph (A) of section 12(d)(1) of the Act but does not include a 
fund that acquires securities issued by money market funds solely in 
reliance on rule 12d1-1 under the Act.\535\
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    \534\ Form N-CEN data does not allow us to identify and provide 
statistics on acquired funds. BDCs do not file reports on Forms N-
CEN and so are excluded from Table 1. The UIT section of Form N-CEN 
currently does not require a UIT to identify whether it is a fund of 
funds, and so we lack information on acquiring UITs using Form N-CEN 
data. We use the most recent Form N-CEN filing with the Commission 
for each fund between September 2018 and May 2020 for this analysis 
(i.e., the first and last month with Form N-CEN data available as of 
the data collection date). We use all available Form N-CEN filings 
to also capture delinquent filers in our analysis. Approximately 5% 
of the funds in Table 1 were terminated during our sample period. 
Open-end funds, ETFs organized as open-end funds, and ETMFs are 
registered on Form N-1A. ETFs and ETMFs are identified using Item 
C.3.a.i and C.3.a.ii in Form N-CEN filings. Closed-end funds are 
registered on Form N-2. Variable annuity separate accounts organized 
as UITs are series, or classes of series, of trusts registered on 
Form N-4. Variable life insurance separate accounts organized as 
UITs are series, or classes of series, of trusts registered on Form 
N-6. ETFs registered as UITs are series, or classes of series, of 
trusts registered on Form N-8B-2. Non-ETF UITs are trusts registered 
on Forms N-4 or N-6. Management company separate accounts are trusts 
registered on Form N-3. The statistics in Table 1 are generally 
consistent with statistics on funds of funds provided by commenters. 
See, e.g., ICI Comment Letter. One exception is a commenter that 
stated that as of March 2019, there were 496 closed-end funds with 
236 billion in net assets. See Advent Comment Letter. We lack 
detailed information on commenter's estimation of these statistics 
but we believe that these statistics are lower than the statistics 
in Table 1 likely due to the different data sources and sample 
period used. See Table 4 of the Proposing Release for statistics of 
the number of acquiring funds by investment category.
    \535\ Hence, acquiring funds in Table 1 includes: Funds of funds 
that were structured in reliance on section 12(d)(1)(F); funds of 
funds that were structured in reliance on section 12(d)(1)(G); funds 
of funds that were structured in reliance on section 12(d)(1)(G) and 
rule 12d1-2; funds of funds that were structured in reliance on 
exemptive relief on which rule 12d1-4 is based; and funds of funds 
that were structured considering Commission staff letters.
---------------------------------------------------------------------------

    A trade association representing regulated investment companies 
globally provided the Commission with the results of a survey of its 
U.S. members and found that as of 2018, there were 1,359 funds of funds 
with $2.8 trillion in assets under management.\536\ Of those funds, the 
survey observed that 31% (i.e., 423 out of 1,359) of the funds of 
funds, representing $829 billion in assets, will not be affected by the 
final rule because they are structured solely in reliance on sections 
12(d)(1)(E), 12(d)(1)(F), or 12(d)(1)(G), and the remaining 69% (i.e., 
936 out of 1,359) of the funds of funds, representing $2.0 trillion in 
assets, will need to comply with the rule 12d1-4 conditions or 
restructure their investments.\537\
---------------------------------------------------------------------------

    \536\ See ICI Comment Letter.
    \537\ For the purposes of this survey, a fund of funds is 
defined as a fund that invests in at least one other fund in excess 
of the limits of section 12(d)(1)(A) but does not include funds that 
only invest in money market funds. Hence, our definition of 
acquiring fund in Table 1 is similar to the definition of acquiring 
fund in the ICI survey. The ICI survey sample appears to be a subset 
of the sample of acquiring funds in Table 1. That is, the ICI sample 
represents approximately 79% of the acquiring funds in Table 1 (79% 
= 1,359 funds of funds in the ICI survey/1,719 acquiring funds in 
Table 1). See ICI Comment Letter. Our data does not allow us to 
distinguish whether the acquiring funds in Table 1 have been 
structured in reliance on section 12(d)(1)(F); in reliance on 
section 12(d)(1)(G); in reliance on section 12(d)(1)(G) and rule 
12d1-2; in reliance on an exemptive order; or considering Commission 
staff no-action letters.
---------------------------------------------------------------------------

    Another commenter, representing asset managers, conducted a survey 
of its members and found that all 15 surveyed sponsors, representing 
655 funds of funds and assets of $1.8 trillion, stated that they rely 
on a variety of authorities (often in combination), including sections 
12(d)(1)(F) (i.e., five sponsors), section 12(d)(1)(G) (i.e., 14 
sponsors), rule 12d1-2 (i.e., 14 sponsors), exemptive orders (i.e., 14 
sponsors), and/or structure funds of funds consistent with Commission 
staff no-action letters (i.e., three sponsors).\538\ All 15 sponsors 
indicated that they sponsor funds that invest in affiliated open-end 
funds and UITs; \539\ 13 sponsors indicated that they sponsor funds 
that invest in unaffiliated open-end funds and UITs; four sponsors 
indicated that they sponsor funds that invest in affiliated central 
funds; two sponsors indicated that they sponsor funds that invest in 
affiliated unregistered funds; two sponsors indicated that they sponsor 
funds that invest in unaffiliated closed-end funds; one sponsor 
indicated that it sponsors funds that invest in unaffiliated BDCs; and 
one sponsor indicated that it sponsors funds that invest in 
unaffiliated unregistered funds.
---------------------------------------------------------------------------

    \538\ See SIFMA AMG Comment Letter. For purposes of this survey, 
a fund of funds is a fund that invests substantially all of its 
assets (i.e., > 85% of fund assets) in shares of other investment 
companies. The survey also requested information regarding funds 
that make investments in other investment companies beyond the 
limits of section 12(d)(1)(A) but where those investments, in the 
aggregate, represent less than 85% of fund assets. Fifty-nine of 
those funds hold more than 3% of an acquired fund's shares. Eight 
out of the 15 respondents sponsor funds that invest less than 85% of 
their assets in other funds, and those funds rely on a variety of 
authorities (often in combination), including section 12(d)(1)(F) 
(i.e., three sponsors), section 12(d)(1)(G) (i.e., seven sponsors), 
rule 12d1-1 (i.e., three sponsors), exemptive orders (i.e., eight 
sponsors), and/or rule 12d1-2 (i.e., eight sponsors). All 8 sponsors 
indicated that they sponsor funds that invest in affiliated open-end 
funds and UITs; seven sponsors indicated that they sponsor funds 
that invest in unaffiliated open-end funds and UITs; three sponsors 
indicated that they sponsor funds that invest in affiliated central 
funds; two sponsors indicated that they sponsor funds that invest in 
unaffiliated closed-end funds; two sponsors indicated that they 
sponsor funds that invest in unaffiliated BDCs; one sponsor 
indicated that it sponsors funds that invest in unaffiliated 
unregistered funds; and one sponsor indicated that it sponsors funds 
that invest in affiliated unregistered funds. The data provided by 
the commenter is sponsor-level (rather than fund-level) data and so 
we cannot use this data to estimate how many of the acquiring and 
acquired funds in our sample will be affected by the final rule.
    \539\ According to the survey, the funds of funds that invest in 
affiliated open-end funds in reliance on section 12(d)(1)(G) also 
invest in unaffiliated money market funds, unaffiliated registered 
investment companies, individual securities such as stocks and 
bonds, and non-securities such as certain derivatives or real 
estate.

           Table 1--Descriptive Statistics for all Funds and Acquiring Funds Using Form N-CEN Filings
----------------------------------------------------------------------------------------------------------------
                                                               Funds                      Acquiring funds
                                                 ---------------------------------------------------------------
                                                                  Net assets (bn                  Net assets (bn
                                                      Number            $)            Number            $)
----------------------------------------------------------------------------------------------------------------
Open-end funds..................................          13,135          26,328           1,687           2,180
    ETFs registered as open-end funds \540\.....           2,194           5,689             105              16
    ETMFs registered as open-end funds..........              28              14               2            0.04
Closed-end funds................................             736             320              29              10
UITs............................................             720           2,237  ..............  ..............
    Variable annuity separate accounts                       430           1,561  ..............  ..............
     registered as UITs.........................
    Variable life insurance separate accounts                243             165  ..............  ..............
     registered as UITs.........................
    ETFs registered as UITs.....................              47             509  ..............  ..............
Management company separate accounts............              14             225               3            0.05
                                                 ---------------------------------------------------------------

[[Page 73968]]

 
    Total.......................................          14,605          29,110           1,719           2,190
----------------------------------------------------------------------------------------------------------------

    This table reports descriptive statistics for all funds and 
acquiring funds using data from Form N-CEN filings with the Commission 
as of May 2020. A fund of funds is a fund that acquires securities 
issued by any other investment company in excess of the amounts 
permitted under paragraph (A) of section 12(d)(1) of the Act but does 
not include a fund that acquires securities issued by money market 
funds solely in reliance on rule 12d1-1 under the Act (see Item C.3.e 
in Form N-CEN filings). Master-feeder funds are excluded from this 
analysis (see Item C.3.f in Form N-CEN). The UIT section of Form N-CEN 
currently does not require a UIT to identify if it is a fund of funds 
so information on acquiring UITs is marked as missing in this Table. 
For open-end funds, closed-end funds, and management company separate 
accounts, total net assets is the sum of monthly average net assets 
across all funds in the sample during the reporting period (see Item 
C.19.a in Form N-CEN). For UITs, we use the total assets as of the end 
of the reporting period (see Item F.11 in Form N-CEN), and for UITs 
with missing total assets information, we use the aggregated contract 
value for the reporting period instead (see Item F.14.c in Form N-CEN).
---------------------------------------------------------------------------

    \540\ The reported net assets of ETFs registered as open-end 
funds in Table 1 likely are overstated because reporting on whether 
or not a fund is an ETF on Form N-CEN is at the series level, not 
the class level. Hence, all share classes within an open-end fund 
that has ETF share classes are attributed to the ETF category.
---------------------------------------------------------------------------

    Table 2 below shows the number and size of funds, acquiring funds, 
and acquired funds using data from Form N-PORT filings with the 
Commission as of May 2020.\541\ Form N-PORT is only filed by registered 
management investment companies and ETFs that are organized as UITs. 
Hence, the sample of funds in Table 2 (i.e., registered management 
investment companies and ETFs organized as UITs) is narrower than the 
sample of funds in Table 1 (i.e., all registered investment companies) 
because Form N-CEN and Form N-PORT do not apply to the same scope of 
funds.\542\ Each acquiring fund represented in Table 2 is a registered 
management investment company or ETF organized as a UIT that invests a 
non-zero percentage of its assets in registered investment companies or 
BDCs, while each acquired fund is a registered investment company in 
which a registered management investment company or ETF organized as a 
UIT invests.\543\ Hence, the definition of acquiring funds in Table 1 
is broader than the definition of acquiring funds in Table 2.\544\
---------------------------------------------------------------------------

    \541\ BDCs do not file reports on Form N-PORT and are therefore 
excluded from the definition of acquiring funds in Tables 2 and 3. 
We use the most recent Form N-PORT filing with the Commission for 
each fund filed between May 2019 and May 2020 for this analysis 
(i.e., the first and last month with Form N-PORT data available as 
of the data collection date). See supra footnote 534 for definition 
of fund categories. Total net assets in Form N-CEN may be different 
from total net assets in Form N-PORT because Form N-CEN reports 
average assets estimated over the reporting period while Form N-PORT 
reports point-in-time assets as of the reporting date.
    \542\ See supra footnote 534.
    \543\ Hence, acquiring funds in Table 2 includes funds of funds 
that were structured in reliance on section 12(d)(1)(A), funds of 
funds that were structured in reliance on section 12(d)(1)(F), funds 
of funds that were structured in reliance on section 12(d)(1)(G), 
funds of funds that were structured in reliance on exemptive relief 
on which rule 12d1-4 is based, and funds of funds that were 
structured considering Commission staff letters.
    \544\ The Form N-PORT data allows us to use a broader definition 
of acquiring funds in Table 2 compared to Table 1 (i) to provide a 
more complete picture of the fund of funds market; and (ii) for 
comparability purposes with the acquiring fund statistics in the 
2018 FOF Proposing Release.
---------------------------------------------------------------------------

    Untabulated analysis shows that out of the 4,750 acquiring funds in 
Table 2, 1,435, or 30%, invested in at least one acquired fund beyond 
the limits of section 12(d)(1).\545\ These 1,435 acquiring funds 
invested, on average, in nine unique acquired funds beyond the section 
12(d)(1) limits.
---------------------------------------------------------------------------

    \545\ We define acquiring funds that invest in at least one 
acquired fund beyond the limits of section 12(d)(1) using Form N-CEN 
data as of May 2020.
---------------------------------------------------------------------------

    Also, untabulated analysis shows that 954, or 20%, of all acquiring 
funds in Table 2 appear to be relying on the statutory exemption in 
section 12(d)(1)(G) to structure a fund of funds arrangement.\546\ 
Finally, untabulated analysis shows that from the 16,797 acquiring-
acquired fund pairs in Table 2, for which the acquiring fund invests in 
the acquired fund beyond the limits of section 12(d)(1)(A), 7,400 
acquiring-acquired fund pairs have a different primary investment 
adviser.\547\
---------------------------------------------------------------------------

    \546\ 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 that are in the same group of investment companies. We 
identify funds that are in the same group of investment companies 
using Item B.5 in Form N-CEN filings with the Commission as of May 
2020. On one hand, 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). On the other hand, our methodology may underestimate 
the number of 12(d)(1)(G) acquiring funds because the definition of 
the group of investment companies in Form N-CEN is narrower than the 
definition under 12(d)(1)(G). In particular, ``[f]amily of 
investment companies'' is defined in Item B.5 of Form N-CEN as any 
two or more registered funds that (i) share the same investment 
adviser or principal underwriter; and (ii) hold themselves out to 
investors as related companies for purposes of investment and 
investor services. ``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. See 15 U.S.C. 80a-12(d)(1)(G)(ii).
    \547\ Based on investment adviser data in Item C.9 of Form N-CEN 
as of May 2020.
---------------------------------------------------------------------------

    As Table 2 shows, there were 2,151 unique top-tier acquiring funds 
in multi-tier (i.e., more than two-tier) fund of funds structures and 
986 unique second-tier acquired funds in multi-tier fund of funds 
structures.\548\ Out of the 2,151 unique top-tier acquiring funds in 
multi-tier structures in Table 2, untabulated analysis shows that 721 
are top-tier acquiring funds in structures that are four tiers or more, 
149 are top-tier acquiring funds in structures that are five tiers or 
more, and 78 are top-tier acquiring funds in structures that are six 
tiers.\549\ In the case of four-tier structures, the average investment 
of the top-tier acquiring fund in the fourth-tier acquired funds is 
equal to 0.006% of the top-tier acquiring fund's assets; in the case of 
five-tier structures, the average investment of the top-tier acquiring 
fund in the fifth-tier acquired funds is equal to 0.00006% of the top-
tier acquiring fund's assets; and in the case of six-tier structures, 
the average investment of the top-tier acquiring

[[Page 73969]]

fund in the sixth-tier acquired funds is practically zero.\550\
---------------------------------------------------------------------------

    \548\ The 2,151 top-tier acquiring funds in multi-tier 
structures include funds of funds that are structured both within 
and beyond the limits of section 12(d)(1).
    \549\ We have not identified any multi-tier structures that are 
more than 6 tiers.
    \550\ We estimate the top-tier acquiring fund's investment in 
the bottom-tier acquired funds by accounting for the top-tier 
acquiring fund's investment in the second-tier acquired funds, the 
second-tier acquired funds' investments in the third-tier acquired 
funds, and so on. For example, in the case of three-tier structures, 
if the top-tier acquiring fund invests 5% of its assets in one 
second-tier acquired fund, and the second-tier acquired fund invests 
5% of its assets in one third-tier acquired fund, then the top-tier 
acquiring fund's investment in the bottom-tier acquired fund is 
equal to 0.25% = 5% x 5%.
---------------------------------------------------------------------------

    When looking at only multi-tier structures in which at least one 
acquiring fund in each level invests in at least one acquired fund 
beyond the limits of section 12(d)(1), there are 23 top-tier acquiring 
funds in structures that are three tiers or more and one top-tier 
acquiring fund in a structure that is four tiers.\551\ In the case of 
the 23 top-tier acquiring funds in multi-tier structures that are three 
tiers or more, the average investment of the top-tier acquiring fund in 
the third-tier acquired funds is equal to 2.93% of the top-tier 
acquiring fund's assets, and in the case of the one top-tier acquiring 
fund in a multi-tier structure that is four tiers, the average 
investment of the top-tier acquiring fund in the fourth-tier acquired 
funds is equal to 0.00003% of the top-tier acquiring fund's 
assets.\552\
---------------------------------------------------------------------------

    \551\ We define acquiring funds that invest in at least one 
acquired fund beyond the limits of section 12(d)(1) using Form N-CEN 
data as of May 2020. There are no multi-tier funds of funds beyond 
four tiers that are structured beyond the limits of section 
12(d)(1). Our data does not allow us to distinguish whether the 
identified multi-tier structures were structured in reliance on one 
of the exceptions to the complex structures condition in our 
exemptive orders.
    \552\ See supra footnote 550.
---------------------------------------------------------------------------

    A commenter also observed that as of 2018, out of the 1,359 funds 
of funds representing $2.8 trillion in assets under management, 198 
funds of funds representing $287 billion in assets under management 
utilized a multi-tier structure.\553\
---------------------------------------------------------------------------

    \553\ See ICI Comment Letter. The proportion of acquiring funds 
that are top-tier acquiring funds in multi-tier structures in Table 
2 (i.e., 45% = 2,151/4,750) is different from the proportion of 
acquiring funds that are top-tier acquiring funds in multi-tier 
structures provided by the commenter (i.e., 15% = 198/1,359) 
potentially due to different definitions of acquiring funds and top-
tier acquiring funds in multi-tier structures. In particular, the 
commenter defines acquiring funds as funds that invest in at least 
one other fund in excess of the limits of section 12(d)(1)(A) while 
Table 2 defines acquiring funds as funds that invest a non-zero 
percentage of their assets in other funds. The commenter does not 
provide information on how it defines top-tier acquiring funds in 
multi-tier structures.
---------------------------------------------------------------------------

    Another commenter found that out of the 655 funds of funds \554\ 
that were sponsored by 15 survey respondents, 223, or 34%, hold more 
than 3% of an acquired fund's shares.\555\ The commenter also found 
that out of the 15 surveyed sponsors, eight sponsors, or 53%, indicated 
that they employ multi-tier structures.\556\ Out of the eight sponsors 
that employ multi-tier structures, seven sponsors employ three-tiered 
structures, and one sponsor employs a four-tiered structure. Seven 
sponsors operate these multi-tier structures pursuant to exemptive 
orders; three sponsors rely on section 12(d)(1)(G); three sponsors rely 
on rule 12d1-2; two sponsors rely on section 12(d)(1)(A); two sponsors 
structure funds considering staff no-action letters; one sponsor relies 
on section 12(d)(1)(F); and one sponsor relies on rule 12d1-1.\557\
---------------------------------------------------------------------------

    \554\ See supra footnote 537 for the commenter's definition of 
funds of funds.
    \555\ See SIFMA AMG Comment Letter. The 34% (= 223/655) of 
acquiring funds that invest in other funds beyond the limits in 
section 12(d)(1) provided by the commenter is higher than our 30% (= 
1,435/4,750) estimate using Form N-PORT and Form N-CEN data, and the 
difference may be due to the different samples used for the two 
analyses.
    \556\ See SIFMA AMG Comment Letter. The commenter provided 
statistics on multi-tier structures in terms of sponsors (rather 
than funds), and so we are unable to compare with precision the 
statistics provided by the commenter to our statistics on multi-tier 
structures in Table 2. Nevertheless, the 53% of surveyed sponsors 
employing multi-tier structures is largely consistent with the 45% 
(= 2,151/4,750) of acquiring funds that are top-tier acquiring funds 
in multi-tier structures in Table 2.
    \557\ See SIFMA AMG Comment Letter. The data provided by the 
commenter is sponsor-level (rather than fund-level) data and so we 
cannot use this data to estimate how many of the multi-tier 
structures in our sample will be affected by the final rule or the 
extent to which they will be affected. In addition, our data does 
not allow us to distinguish whether the multi-tier structures in our 
sample were created in reliance on sections 12(d)(1)(A), 
12(d)(1)(F), 12(d)(1)(G), rule 12d1-2, exemptive orders, or 
considering staff no-action letters.

                        Table 2--Descriptive Statistics for Funds, Acquiring Funds, and Acquired Funds Using Form N-PORT Filings
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                       Funds                      Acquiring funds                 Acquired funds
                                                         -----------------------------------------------------------------------------------------------
                                                                          Net assets (bn                  Net assets (bn                  Net assets (bn
                                                              Number            $)            Number            $)            Number            $)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                            Panel A: Statistics on Funds, Acquiring Funds, and Acquired Funds
--------------------------------------------------------------------------------------------------------------------------------------------------------
Open-end funds..........................................          11,170          24,458           4,514           8,349           2,925          14,743
    ETFs................................................           1,898           6,361             649           2,364             729           6,053
    ETMFs...............................................              21              18               4               3               3              17
Closed-end funds........................................             600             310             231             115             458             242
ETFs registered as UITs.................................               5             436  ..............  ..............               4             436
UITs registered as separate accounts....................  ..............  ..............  ..............  ..............               5              50
Management company separate accounts....................              13             208               5             144  ..............  ..............
                                                         -----------------------------------------------------------------------------------------------
        Total...........................................          11,788          25,412           4,750           8,608           3,392          15,471
--------------------------------------------------------------------------------------------------------------------------------------------------------

 
                                               Multi-tier structures
                                         -------------------------------
                                             Number of
                                             acquiring       Number of
                                               funds      acquired funds
------------------------------------------------------------------------
              Panel B: Statistics on Multi-Tier Structures
------------------------------------------------------------------------
Open-end funds..........................           2,074             813
    ETFs................................             148             278
    ETMFs...............................               2               1
Closed-end funds........................              74             173
ETFs registered as UITs.................  ..............  ..............
UITs registered as separate accounts....  ..............  ..............

[[Page 73970]]

 
Management company separate accounts....               3  ..............
                                         -------------------------------
        Total...........................           2,151             986
------------------------------------------------------------------------
This table reports descriptive statistics for all funds, acquiring
  funds, and acquired funds using data from Form N-PORT filings with the
  Commission as of May 2020. Panel A presents statistics on all funds,
  acquiring funds, and acquired funds, and Panel B presents statistics
  on multi-tier structures. A fund of funds is a fund that invests a non-
  zero percentage of its assets in securities issued by other registered
  investment companies but does not include a fund that solely invests
  in money market funds. Master-feeder funds, defined as structures
  where the acquiring fund invests more than 98% of its assets in
  another registered investment company, are excluded from this
  analysis. Multi-tier structures are funds of funds with more than two
  tiers. Acquiring funds in multi-tier structures are the unique top-
  tier acquiring funds in a multi-tier structure, and acquired funds in
  multi-tier structures are the unique second-tier acquired funds in
  multi-tier structures. Total net assets is the sum of total net assets
  across all funds in the sample during the reporting period (see Item
  B.1.c in Form N-PORT).

    Our review of BDC filings show that as of December 2019, there were 
83 BDCs with $123 billion in total gross assets, out of which 45 BDCs 
with 83 billion in total gross assets were listed on a national 
securities exchange.\558\ Approximately 44% of the BDCs were acquiring 
BDCs and 60% were acquired BDCs in fund of funds structures.\559\ We 
have not granted exemptive relief to BDCs as acquiring funds so we 
believe that all acquiring BDCs invest in other funds within the 
12(d)(1) limits.
---------------------------------------------------------------------------

    \558\ Estimates of the number of BDCs and their gross assets are 
based on a staff analysis of Form 10-K and Form 10-Q filings as of 
December 2019, which are the most recent available filings as of the 
data collection date. Our estimates exclude BDCs that may be 
delinquent or have filed extensions for their filings, wholly-owned 
subsidiaries of other BDCs, and BDCs in master-feeder structures. 
These statistics are generally consistent with statistics on BDCs 
provided by commenters. See, e.g., SBIA Comment Letter; IPA Comment 
Letter.
    \559\ We define acquiring BDCs as BDCs that reported non-zero 
AFFEs in Forms 497, N-2, or N-2A filed with the Commission between 
January 2019 and May 2020. 44% = 14 BDCs that reported non-zero 
AFFEs in Forms 497, N-2, or N-2A filed with the Commission between 
January 2019 and May 2020/32 BDCs that filed Forms 497, N-2, or N-2A 
with the Commission between January 2019 and May 2020. Only BDCs 
traded on an exchange file Forms 497, N-2, or N-2A. The remaining 
BDCs file Forms 10-K but BDCs are not required to report their AFFEs 
on Form 10-K. For those BDCs that did not file a Form 497, N-2, or 
N-2A with the Commission between January 2019 and May 2020, our 
review of the schedule of investment companies in Forms 10-K filed 
with the Commission between January 2019 and May 2020 yielded one 
acquiring BDC additional to the 14 acquiring BDCs identified from 
our review of Forms 497, N-2, or N-2A. We estimate the number of 
acquired BDCs using Form N-PORT filings as of May 2020. 60% = 50 
BDCs acquired BDCs identified using Form N-PORT data as of May 2020/
83 BDCs that filed forms 10-K or 10-Q as of December 2019.
---------------------------------------------------------------------------

    Table 3 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 above 95% of their total assets in other funds as 
of May 2020.\560\ The table shows that the majority of acquiring funds 
invest either less than 10% or more than 95% 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 95% 
threshold likely rely either on section 12(d)(1)(G) or (F) or on 
exemptive orders to invest in other funds beyond the section 
12(d)(1)(A) statutory limits.
---------------------------------------------------------------------------

    \560\ 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. We do not 
aggregate fund holdings across advisory groups for the purposes of 
this analysis.

                               Table 3--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%]    above 95%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Open-end funds..................................           47            8            7            8            4            5            3           17
    ETFs........................................           70            2            4            6            4            6            2            6
    ETMFs.......................................           25           25            0           25           25            0            0            0
Closed-end funds................................           82            6            7            1            2            0            0            0
Management company separate accounts............          100            0            0            0            0            0            0            0
--------------------------------------------------------------------------------------------------------------------------------------------------------
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 total assets in other funds using data from Form N-PORT filings with the Commission as of May 2020. UITs,
  except for ETFs registered as UITs, do not file Form N-PORT filings with the Commission and thus are excluded from this table. We have not identified
  any ETFs registered as UITs that are acquiring funds. Fund investments in money market funds and master-feeder structures are excluded from this
  analysis. Percentages may not sum up to 100 due to rounding error.

    The total net assets of funds of funds have generally increased 
over time. According to the 2020 ICI Fact Book, the total net assets of 
open-end funds of funds increased from $680 billion to $2.54 trillion 
between December 2009 and December 2019, and the total net assets of 
exchange-traded funds of funds increased from $824 million to $13,444 
million between December 2009 and December 2019.\561\
---------------------------------------------------------------------------

    \561\ 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 2020 ICI Fact Book, supra 
footnote 4, at 206 and 244.
---------------------------------------------------------------------------

    Table 4 Panel A shows descriptive statistics for the expense ratio, 
front-end load, and deferred charges for single-tier funds (i.e., all 
funds excluding acquiring funds), and Table 4 Panel B shows descriptive 
statistics for the expense ratio, front-end load, and deferred charges 
for acquiring funds as of July 2020.\562\ The expense ratio in Table 4 
includes acquired fund fees and

[[Page 73971]]

expenses. Untabulated analysis based on the expense data in Table 4 
shows that the equal-weighted average expense ratio for acquiring open-
end funds, UITs, and ETFs is statistically significantly higher than 
the equal-weighted average expense ratio for single-tier open-end 
funds, UITs, and ETFs, respectively.\563\ For BDCs and registered 
closed-end funds, there is no statistically significant difference in 
the operating expenses of acquiring and single-tier funds. There are no 
acquiring ETMFs with expense data in our sample. Our results are 
qualitatively similar when we compare the value-weighted (instead of 
the equal-weighted) average of the expense ratio for single-tier and 
acquiring funds. Nevertheless, the results of the statistical 
comparison of the expense ratio for single-tier and acquiring funds 
should be interpreted with caution because our analysis 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.
---------------------------------------------------------------------------

    \562\ In Table 4 and Figure 1 of this release (i.e., fee and 
expense analysis), we identify acquiring funds (excluding BDCs) 
using Morningstar Holdings data instead of Form N-CEN or Form N-PORT 
data, similar to Table 3 and Figure 1 of the Proposing Release. The 
reason is that Form N-CEN and Form N-PORT data only becomes 
available in 2019 but the analysis in Figure 1 requires 
identification of acquiring funds starting from 2015. We use the 
same data to identify acquiring funds in both Table 4 and Figure 1 
to allow for data comparability in the fee and expense analysis. We 
define acquiring BDCs as BDCs that reported non-zero AFFEs in Forms 
497, N-2, or N-2A filed with the Commission between January 2019 and 
May 2020 (see supra footnote 559). The number of observations in 
Table 4 is different than the number of observations in Table 1 
because (i) we lack expense data for some of the funds; and (ii) 
there are differences in the unit of observation in Morningstar and 
Form N-CEN (see infra footnote 564).
    \563\ 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 for hypothesis testing in scientific work (see, e.g., David H. 
Kaye & David A. Freedman, Reference Guide on Statistics, in The 
Reference Manual on Scientific Evidence (2nd ed., 2000), at 83).
    \564\ The difference in the number of UITs reported in Table 1 
compared to Table 4 is likely due to the fact that Form N-CEN data 
(i.e., Table 1) is aggregated at the trust level while Morningstar 
(i.e., Table 4) reports unique UIT series, which we are unable to 
aggregate at the trust level due to data limitations.
    \565\ The BDC expense ratio statistics are higher in Table 4 of 
this release compared to Table 3 of the 2018 FOF Proposing Release. 
In the 2018 FOF Proposing Release we collected BDC expense data from 
the most recent available Forms 497, N-2, or N-2A, while in this 
release we collect BDC expense data only from Forms 497, N-2, or N-
2A that were filed between January 2019 and May 2020 to avoid using 
stale data in our analysis.

        Table 4--Expense Ratio, Front-End Load, and Deferred Charges for Single-Tier and Acquiring Funds
----------------------------------------------------------------------------------------------------------------
                               Equal-weighted    Value-weighted                      Standard
                                    mean              mean            Median         deviation           N
----------------------------------------------------------------------------------------------------------------
                                           Panel A: Single-Tier Funds
----------------------------------------------------------------------------------------------------------------
Expense Ratio:
    Open-end funds..........              0.92              0.47            0.89            0.47           5,124
    UITs \564\..............              0.32              0.30            0.26            0.30           3,316
    ETFs....................              0.52              0.13            0.49            0.32           2,003
    ETMFs...................              0.74              0.77            0.78            0.25              16
    Closed-end funds........              2.29              1.96            1.86            1.90             192
    Management company                    0.33              0.35            0.32            0.03               7
     separate accounts......
    BDCs \565\..............             12.00             11.00           12.20            4.17              18
Front-End Load:
    Open-end funds..........              1.42              1.67            0.83            1.44           2,490
    UITs....................              3.72              3.16            3.90            1.04           1,342
    ETFs....................  ................  ................  ..............  ..............  ..............
    ETMFs...................  ................  ................  ..............  ..............  ..............
    Closed-end funds........              2.13              1.61            1.57            1.97              19
    Management company        ................  ................  ..............  ..............  ..............
     separate accounts......
    BDCs....................              2.98              2.92            2.00            1.87               9
Deferred Charges;
    Open-end funds..........              0.05              0.04            0.03            0.07           2,035
    UITs....................              1.86              1.94            2.18            0.56           1,784
    ETFs....................  ................  ................  ..............  ..............  ..............
    ETMFs...................  ................  ................  ..............  ..............  ..............
    Closed-end funds........              0.12              0.16            0.13            0.08               5
    Management company        ................  ................  ..............  ..............  ..............
     separate accounts......
    BDCs....................  ................  ................  ..............  ..............  ..............
----------------------------------------------------------------------------------------------------------------
                                            Panel B: Acquiring Funds
----------------------------------------------------------------------------------------------------------------
Expense Ratio:
    Open-end funds..........              0.98              0.56            0.91            0.57           2,837
    UITs....................              1.71              1.56            1.79            0.88             874
    ETFs....................              0.63              0.20            0.54            0.40             503
    ETMFs...................  ................  ................  ..............  ..............  ..............
    Closed-end funds........              2.07              1.91            1.91            0.79              79
    Management company        ................  ................  ..............  ..............  ..............
     separate accounts......
    BDCs....................             12.02             10.06           12.98            3.89              14
Front-End Load:
    Open-end funds..........              1.43              1.28            0.86            1.47           1,359
    UITs....................              1.00              1.00            1.00            0.00              19
    ETFs....................  ................  ................  ..............  ..............  ..............
    ETMFs...................  ................  ................  ..............  ..............  ..............
    Closed-end funds........              1.24              1.08            1.13            1.02              11
    Management company        ................  ................  ..............  ..............  ..............
     separate accounts......
    BDCs....................              2.75              2.00            2.00            1.82               5
Deferred Charges:
    Open-end funds..........              0.08              0.05            0.04            0.09           1,066
    UITs....................              2.09              2.14            2.25            0.46             872
    ETFs....................  ................  ................  ..............  ..............  ..............
    ETMFs...................  ................  ................  ..............  ..............  ..............

[[Page 73972]]

 
    Closed-end funds........              0.30              0.16            0.32            0.16               3
    Management company        ................  ................  ..............  ..............  ..............
     separate accounts......
    BDCs....................  ................  ................  ..............  ..............  ..............
----------------------------------------------------------------------------------------------------------------
This table reports descriptive statistics for the expense ratio, front-end load, and deferred charges in
  percentage points for single-tier funds (i.e., all funds excluding acquiring funds) in Panel A, and for
  acquiring funds in Panel B as of July 2020. 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. The analysis is
  conducted at the fund level using asset-weighted average values for multiple-class portfolios. We exclude
  funds with zero expense ratios, front-end loads, and deferred charges for the estimation of the descriptive
  statistics in each respective panel. There are no acquiring ETMFs with expense ratio data in our sample. There
  are also no acquiring management company separate accounts in our sample. ETFs, ETMFs, and management company
  separate accounts 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. We identify
  acquiring open-end funds, UITs, ETFs, ETMFs, and closed-end funds using Morningstar Holdings data and
  acquiring BDCs as BDCs that reported non-zero AFFEs in Forms 497, N-2, or N-2A filed with the Commission
  between January 2019 and May 2020. Expense 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 497, N-2, or N-2A. Data is
  winsorized at the 1% and 99% levels, with the exception of the BDC data, which is not winsorized because there
  are no outliers.

    There is some evidence of a decrease in the expense ratio for 
certain funds of funds over time. In particular, 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 0.78% (0.37%) in 2019.\566\
---------------------------------------------------------------------------

    \566\ Trends in the Expenses and Fees of Funds, 2019, ICI Res. 
Persp., Mar. 2020, at 13.
---------------------------------------------------------------------------

    Figure 1 Panels A-C below show the equal-weighted average of the 
expense ratio for acquiring open-end funds, ETFs, and closed-end funds 
between 2015 and 2019.\567\ Due to data limitations, the expense ratio 
in Figure 1 does not include acquired fund fees and expenses. As Panel 
A shows, the expense ratio for open-end acquiring funds has decreased 
from 0.91 in 2015 to 0.80 in 2019, but this decrease is not 
statistically significant.\568\ As Panel B shows, the expense ratio for 
acquiring ETFs has increased from 0.51 in 2015 to 0.53 in 2019, with a 
peak equal to 0.57 in 2016, but this decrease is not statistically 
significant. Finally, as Panel C shows, the expense ratio of closed-end 
acquiring funds has monotonically increased from 1.39 in 2015 to 2.31 
in 2019 and this increase is statistically significant at the 1% level. 
The time-series trends for the expense ratio of acquiring ETFs and 
closed-end funds are qualitatively similar when we examine the value-
weighted (instead of the equal-weighted) average of the expense ratio 
whereas the trend for the expense ratio of acquiring open-end funds 
exhibits a slight increase although this is not statistically 
significant.
---------------------------------------------------------------------------

    \567\ See supra footnote 552 for definition of acquiring funds.
    \568\ In this and all subsequent analysis, to examine if there 
is a statistically significant time trend in the data, we regress 
the variable of interest to a year trend variable, and we test 
whether the coefficient on the trend variable is statistically 
different from zero. We use a two-tailed t-test and a 95% confidence 
interval. See supra footnote 563.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

[[Page 73973]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.000

[[Page 73974]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.001

BILLING CODE 8011-01-C
    As a baseline for understanding the effects of the voting 
provisions of rule 12d1-4 on acquiring funds, we study how frequently 
funds held shareholder meetings in 2019. Our review of filings with the 
Commission showed that 12% of all open-end funds, no UITs, 68% of all 
closed-end funds, and 86% of BDCs held at least one shareholder meeting 
in 2019.\569\ Further, 12% of the acquired open-end funds, no acquired 
UITs, 92% of the acquired closed-end funds, and 94% of the acquired 
BDCs held at least one shareholder meeting in 2019.\570\
---------------------------------------------------------------------------

    \569\ We identify funds that held a shareholder meeting in 2019 
as funds that filed at least one Form DEF14A with the Commission in 
2019. Our sample of funds is the same as in Table 1 above. Acquired 
funds are defined as in Table 2 above.
    Separate accounts are excluded from this analysis because rule 
12d1-4 will not include specific voting provisions when an insurance 
product separate account is part of the acquiring fund advisory 
group or acquiring fund sub-advisory group.
    \570\ Our sample of acquired funds is the same as in Table 2 
above.
---------------------------------------------------------------------------

    The final rule will also affect investment advisers to funds. As of 
March 2020, there were 1,720 investment advisers that provide portfolio 
management services to registered investment companies and BDCs and 
these investment advisers managed assets equal to $28,629 billion.\571\ 
Approximately 17% of all investment advisers provided portfolio 
management services to acquiring funds and 33% to acquired funds.\572\
---------------------------------------------------------------------------

    \571\ Based on Item 5.D. of Form ADV filed with the Commission 
as of March 2020.
    \572\ Based on Item C.9. of Form N-CEN filed with the Commission 
as of May 2020. Our sample of acquiring funds is the same as in 
Table 1 above and the sample of acquired funds is the same as in 
Table 2 above. BDCs do not file Form N-CEN and thus are excluded 
from this analysis.
---------------------------------------------------------------------------

    The final rule will also affect UIT depositors and sponsors. As of 
May 2020, there are 150 UIT unique depositors and 14 unique UIT 
sponsors.\573\
---------------------------------------------------------------------------

    \573\ Based on Items F.1 and F.4 of Forms N-CEN filed with the 
Commission as of May 2020. We lack data on acquiring UITs and so we 
do not provide counts of depositors and sponsors to acquiring UITs 
(see supra Tables 1 and 2).
---------------------------------------------------------------------------

    Lastly, the final rule will impact current and prospective 
individual investors that invest in funds. As of December 2019, there 
were 59.7 million U.S. households and 103.9 million individuals that 
owned U.S. registered investment companies.\574\
---------------------------------------------------------------------------

    \574\ See 2020 ICI Fact Book, supra footnote 4.
---------------------------------------------------------------------------

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 certain industry practices that have developed in connection with 
staff-level views provided in certain staff no-action letters. Below we 
discuss in more detail the fund of funds exemptive order process \575\ 
and we list the current set of statutory provisions and rules governing 
funds of funds as well as relevant staff no-action letters.\576\
---------------------------------------------------------------------------

    \575\ See supra section II.C and infra section V.C.1.b for 
detailed discussion of the exemptive order conditions.
    \576\ See supra section I.A for detailed discussion of the 
relevant statutory provisions and rules and supra sections II.C.3.d 
and III for detailed discussion of relevant staff no-action and 
interpretive letters.

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

[[Page 73975]]

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 order imposes direct 
administrative costs on 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.\577\ 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 shared between the fund adviser/sponsor 
and the fund, and thus this administrative cost may be passed down to 
investors in the form of management fees or expenses. Nevertheless, we 
lack data and the commenters did not provide any data that would allow 
us to estimate how the administrative cost associated with the 
exemptive order process is split between the fund adviser/sponsor and 
the fund.
---------------------------------------------------------------------------

    \577\ The $100,000 estimate reflects the current administrative 
cost associated with obtaining an exemptive order. This cost may 
decrease following the adoption of amendments to establish an 
expedited review procedure for applications for orders that are 
substantially identical to recent precedent. See infra note 579 and 
associated text.
---------------------------------------------------------------------------

    The exemptive order process also imposes indirect costs on funds 
and their advisers/sponsors because it introduces delays and 
uncertainty to fund investments. For non-ETF (ETF) fund of funds 
applications that received exemptive orders in 2019, 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 127 
(378) days and the average number of total filings (i.e., both initial 
and amended filings) was 1.5 (3).\578\ On July 6, 2020, the Commission 
adopted amendments to establish an expedited review procedure for 
applications for orders that are substantially identical to recent 
precedent as well as a rule to establish an internal timeframe for 
review of applications outside of such expedited procedure. As a 
result, we expect that future delays associated with the application 
process, including for any funds of funds applications, will decrease 
significantly following the effective date of these amendments.\579\
---------------------------------------------------------------------------

    \578\ ETF fund of funds exemptive order applications are 
typically submitted as part of the 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 filings of the fund of funds exemptive order process. In 
addition, the statistics for the processing times and number of 
filings of ETF fund of funds exemptive order applications are skewed 
upwards by applications for non-transparent ETFs, which are 
relatively novel products. When we exclude non-transparent ETF fund 
of funds applications that received exemptive orders in 2019, 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 196 days and the average number of filings was 
2. 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. 
For non-ETF (ETF) fund of funds applications that received exemptive 
orders in 2019, the duration of the exemptive order process varied 
from 84 (58) to 155 (2,269) days from the date of the first filing 
to the date the order was issued, and the number of the filings 
varied from 1 (1) to 2 (12). Data is retrieved from the Investment 
Company Act Notices and Orders: Category Listing, available at 
https://www.sec.gov/rules/icreleases.shtml (accessed on July 29, 
2020).
    \579\ The effective date of this rule will be on June 14, 2021. 
See Amendments to Procedures With Respect to Applications Under the 
Investment Company Act of 1940, Investment Company Act Release No. 
33921 (July 6, 2020) [85 FR 57089 (Sept. 15, 2020)].
---------------------------------------------------------------------------

    Until the Commission grants exemptive relief, fund advisers/
sponsors are not permitted to create certain funds of funds and so 
acquiring funds must forgo certain investments in other funds. In 
addition, the exemptive order process may lead to uncertainty regarding 
whether the fund will be able to obtain exemptive relief and regarding 
the exact terms of the exemptive relief.
    As a result of the direct and indirect costs of the exemptive order 
process, acquiring funds might forgo certain investments in other funds 
or funds of funds might not be launched in the first place because the 
fund may conclude that the costs of seeking an exemptive order exceed 
the anticipated benefits of the investment in another fund beyond the 
limits of section 12(d)(1).
    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.\580\
---------------------------------------------------------------------------

    \580\ See supra section II.C and infra section V.C.1.b for 
detailed discussion of the conditions of the exemptive orders. In 
addition to the exemptive order conditions, fund investors in 
management investment companies 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.
---------------------------------------------------------------------------

b. Summary of Relevant Statutory Provisions, Rules, and Industry 
Practices Associated With Staff No-Action Letters
    As an alternative to obtaining an exemptive order, some funds have 
relied on statutory provisions and rules, and have considered staff-
level views expressed in staff no-action letters to structure fund of 
funds arrangements beyond the limits of section 12(d)(1)(A) and (B). In 
particular, funds of funds can rely on section 12(d)(1)(G) and rule 
12d1-2, section 12(d)(1)(E), and 12(d)(1)(F).\581\ In addition, 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 views provided in these letters.\582\
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    \581\ See supra section I.A for detailed discussion of relevant 
statutory provisions and rules.
    \582\ See supra sections II.C.3.d and III for detailed 
discussion of relevant staff no-action and interpretive letters.
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C. Benefits and Costs and Effects on Efficiency, Competition, and 
Capital Formation

    Where possible, we have attempted to quantify the costs, benefits, 
and effects on efficiency, competition, and capital formation expected 
to result from the final rule. In some cases, however, we are unable to 
quantify the economic effects because we lack the information necessary 
and commenters have not made data available to provide a reasonable 
estimate. For example, we are unable to estimate the number of new 
funds of funds that potentially will be created as a result of the 
adoption of the final rule, 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 adoption of 
the final rule. In those circumstances, in which we do not have the 
requisite data to assess the impact of the final rule quantitatively, 
we have qualitatively analyzed the economic impact of the final rule.

[[Page 73976]]

1. Benefits and Costs
a. General Economic Effects \583\
---------------------------------------------------------------------------

    \583\ See supra footnote 532 for a discussion of the economic 
effects of the N-CEN reporting requirements.
---------------------------------------------------------------------------

i. Change in Funds' Investment Flexibility
    The final rule will have opposing effects on funds' investment 
flexibility. On one hand, rule 12d1-4 will expand funds' investment 
flexibility by expanding the scope of permissible acquiring and 
acquired funds relative to the current exemptive orders.\584\ In 
particular, our current exemptive orders permit registered funds to 
invest only in certain other funds beyond the limits of section 
12(d)(1), but rule 12d1-4 will expand the scope of permissible acquired 
funds by permitting both registered funds and BDCs to invest in all 
other registered funds and BDCs beyond the limits of section 12(d)(1) 
subject to certain conditions. Hence, relative to current exemptive 
orders, rule 12d1-4 will additionally allow (i) open-end funds to 
invest in unlisted BDCs and registered closed-end funds; (ii) UITs to 
invest in unlisted closed-end funds and listed and unlisted BDCs; (iii) 
closed-end funds to invest in open-end funds, UITs, and listed and 
unlisted BDCs and registered closed-end funds; (iv) BDCs to invest in 
open-end funds, UITs, ETMFs, and listed and unlisted BDCs and 
registered closed-end funds; and (v) ETFs to invest in ETMFs and 
unlisted BDCs and registered closed-end funds. By expanding the scope 
of permissible acquiring and acquired funds, rule 12d1-4 will enhance 
acquiring funds' investment flexibility and will increase acquired 
funds' access to financing.\585\
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    \584\ See, e.g., ICI Comment Letter for similar arguments.
    \585\ A commenter argued that by expanding the scope of 
permissible acquiring and acquired funds, rule 12d1-4 will encourage 
the creation of funds of funds that ``expose investors to excessive 
costs and poor performance and other risks associated with overly 
complex structures'' and ``the Commission has proposed this 
expansion without any serious analysis of what would result from 
such a sweeping change or explanation of why it would be in 
investors' best interest.'' See CFA Comment Letter. See supra 
section II.A.1 for discussion of this comment letter, including a 
discussion of why we believe the conditions of rule 12d1-4 will 
address the concerns raised.
---------------------------------------------------------------------------

    In addition, rule 12d1-4 will expand funds' investment flexibility 
and, more specifically, their ability to create multi-tier structures 
in the following way. Our current exemptive orders provide an exception 
from the three-tier limitation for investments in funds that are 
wholly-owned and controlled by the acquired fund as long as the 
investment adviser to the acquired fund is also the investment adviser 
to the wholly-owned subsidiary, while rule 12d1-4 does not include the 
requirement that the acquired fund and the wholly-owned subsidiary 
share the same investment adviser.
    Finally, an existing staff no-action letter considers acquired fund 
investments of up to 10% of its assets in other funds, including 
``central funds,'' subject to certain conditions, including a condition 
that the acquired fund would not exceed the 5% limit in section 
12(d)(1)(A)(ii) with respect to an investment in shares of a single 
central fund.\586\ In contrast, rule 12d1-4 will permit an acquired 
fund to invest up to 10% of its assets in other funds, regardless of 
the size of the investment in any one fund, the affiliation with the 
acquired fund, or the purpose of the investment. Hence, rule 12d1-4 
will expand funds' investment flexibility relative to the baseline by 
(i) permitting acquired funds' investments in both affiliated and 
unaffiliated funds (i.e., compared to the no-action letter, which only 
regards acquired fund investments in affiliated funds); and (ii) not 
imposing the 5% limit on investments in any single fund.
---------------------------------------------------------------------------

    \586\ See Franklin Templeton No-Action Letter, supra footnote 
421. Central funds are affiliated funds commonly created by an 
adviser for the purpose of efficiently managing exposure to a 
specific asset class.
---------------------------------------------------------------------------

    On the other hand, the conditions of rule 12d1-4, the rescission of 
rule 12d1-2, and the withdrawal of certain staff letters \587\ will 
decrease certain funds' investment flexibility by restricting their 
ability to create certain multi-tier structures, and thus may require 
certain acquiring funds to change their investments in acquired funds 
over time compared to the baseline.\588\ In particular, 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 expressly 
prohibit a fund from investing in an acquiring fund beyond the limits 
of section 12(d)(1). In addition, 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.\589\
---------------------------------------------------------------------------

    \587\ See supra section III.
    \588\ See, e.g., SBIA Comment Letter; ICI Comment Letter; DPW 
Comment Letter; PIMCO Comment Letter; Fidelity Comment Letter; 
Guggenheim Comment Letter; TRP Comment Letter; Dechert Comment 
Letter; MFS Comment Letter; PGIM Comment Letter; Ropes Comment 
Letter; SIFMA AMG Comment Letter; ABA Comment Letter; Fidelity Fixed 
Income Trustees Comment Letter for related discussion that rule 
12d1-4, the rescission of rule 12d1-2 and certain exemptive orders, 
and the withdrawal of certain staff no-action letters as proposed 
may limit funds' ability to structure certain multi-tier fund of 
funds arrangements that are currently permissible.
    \589\ Our analysis shows 73 three-tier structures for which the 
top-tier acquiring fund is a 12(d)(1)(G) fund and the second-tier 
acquired fund invests in the third tier beyond the 12(d)(1)(A) 
limits. See supra footnote 545 for methodology used to identify 
12(d)(1)(G) funds. The results of this analysis should be 
interpreted with caution because our data does not allow us to 
distinguish whether the second-tier acquired fund invests in the 
third tier beyond the 12(d)(1)(A) limits in reliance on exemptive 
orders.
---------------------------------------------------------------------------

    Further, our exemptive orders permit acquired funds to invest in 
other funds beyond the statutory limits for short-term cash management 
purposes.\590\ Some of these orders have allowed an acquired fund to 
invest in short-term bond funds for these purposes.\591\ Rule 12d1-4 
will permit acquired funds to invest in funds in reliance on rule 12d1-
1 beyond the statutory limits, regardless of the purpose of the 
investment.\592\ This condition of rule 12d1-4 will increase funds' 
investment flexibility to create multi-tier structures to the extent 
that acquired funds invest in funds in reliance on rule 12d1-1 above 
the statutory limits for purposes other than cash management. An 
acquired fund could also invest up to 10% of its assets in short-term 
bond funds pursuant to the 10% Bucket.\593\ However, this condition of 
rule 12d1-4 will decrease funds' flexibility to create multi-tier 
structures relative to existing exemptive orders to the extent an 
acquired fund may no longer rely on a cash management exception to 
invest in excess of the statutory limits in short-

[[Page 73977]]

term bond funds.\594\ Accordingly, on balance, the rule preserves 
substantial flexibility for acquired funds to invest in underlying 
funds for cash management purposes with an exception for investments in 
underlying funds pursuant to rule 12d1-1 and a separate 10% Bucket for 
investments in underlying funds that do not comply with the terms of 
rule 12d1-1.
---------------------------------------------------------------------------

    \590\ See, e.g., Federated Investment Management Company, 
Investment Company Act Release Nos. 30093 (June 1, 2012) [77 FR 
34095 (June 8, 2012)] (notice) and 30123 (Jun. 26, 2012) (order); 
Diamond Hill Capital Management, Inc., et al., Investment Company 
Act Release Nos. 31433 (Jan. 28, 2015) [80 FR 5825 (Feb. 3, 2015)] 
(notice) and 31472 (Feb. 24, 2015) (order).
    \591\ See supra footnote 590. Relatedly, the staff stated in the 
Thrivent No-Action letter that it would not recommend enforcement 
action if an acquired fund invested, solely for short-term cash 
management purposes, up to 25% of its assets in a central fund that 
is a fixed-income fund that could have a dollar-weighted average 
portfolio maturity of up to 3 years. See supra footnote 423.
    \592\ See rule 12d1-4(b)(3)(ii)(B).
    \593\ An acquired fund may wish to invest in money market funds, 
short-term bond funds, or other cash management funds for various 
portfolio management purposes, including for cash management, 
liquidity management, to seek a higher level of return on 
investments used to collateralize derivatives (or other) positions, 
and to achieve greater diversification and trading efficiency. See 
Guggenheim Comment Letter.
    \594\ As a result of this restriction in funds' investment 
flexibility, acquired funds may (i) invest more in money market 
funds instead of short-term bond funds, which may reduce fund 
returns; (ii) invest in funds that charge separate advisory fees or 
cease to waive their own fees, potentially resulting in higher costs 
for fund investors; and/or (iii) make direct investments in short-
term bonds, which may increase transaction costs and decrease those 
funds' ability to diversify. The remaining enumerated exceptions to 
the complex rule condition of rule 12d1-4 (i.e., rule 12d1-
4(b)(3)(ii)(A)-(E)) are similar to the conditions in our exemptive 
orders and thus likely will not materially affect funds' ability to 
create multi-tier structures.
---------------------------------------------------------------------------

    Our analysis shows 23 multi-tier structures in which at least one 
acquiring fund in each level invests in at least one acquired fund 
beyond the section 12(d)(1) limits, and thus may be affected by the 
final rule.\595\ Nevertheless, our analysis of multi-tier structures 
should be interpreted with caution because we lack data that would 
allow us to identify whether existing multi-tier structures that were 
created under the complex structures conditions in our exemptive orders 
or in consideration of the existing no-action letters will comply with 
the conditions of rule 12d1-4. Further, like the limits under section 
12(d)(1) of the Act, the complex structures investment prohibitions of 
rule 12d1-4 are applicable at acquisition. Accordingly, only funds that 
seek to increase their investments in other funds beyond the statutory 
limits will be limited by the rule's complex structures 
prohibitions.\596\
---------------------------------------------------------------------------

    \595\ See supra footnote 551.
    \596\ See supra footnote 416.
---------------------------------------------------------------------------

    Several commenters argued that the rescission of rule 12d1-2 will 
decrease the investment flexibility of funds that currently rely on 
section 12(d)(1)(G) and rule 12d1-2 to structure affiliated fund of 
funds arrangements.\597\ Funds that currently rely on section 
12(d)(1)(G) and rule 12d1-2 can now rely on rule 12d1-4 to structure 
the same arrangements instead. In particular, rule 12d1-4, unlike 
section 12(d)(1)(G), does not limit acquiring funds' ability to invest 
in securities other than securities issued by affiliated funds. Thus, a 
fund that wishes to invest in affiliated funds beyond the limits of 
section 12(d)(1) can also invest in (i) unaffiliated fund securities 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 subject to the conditions of rule 12d1-4, rather than 
section 12(d)(1)(G) and rule 12d1-2. The funds that will choose to 
operate in accordance with rule 12d1-4, however, will need to comply 
with the rule's conditions and incur the costs associated with these 
conditions.\598\ In addition, we believe that many of the commenter 
concerns related to potential changes in funds' investment flexibility 
as a result of the rescission of rule 12d1-2 will be alleviated because 
we are not adopting the proposed redemption limit.
---------------------------------------------------------------------------

    \597\ See, e.g., Allianz Comment Letter; PIMCO Comment Letter; 
Thrivent Comment Letter; Hancock Comment Letter; Fidelity Comment 
Letter; NYC Bar Comment Letter; Nuveen Comment Letter; Chapman 
Comment Letter; Russell Comment Letter; SIFMA AMG Comment Letter; 
ABA Comment Letter; Fidelity Fixed Income Trustees Comment Letter.
    \598\ See infra section V.C.1.b for detailed discussion of the 
costs and benefits associated with the conditions of rule 12d1-4. 
Funds that currently rely on section 12(d)(1)(G) and rule 12d1-2 
will only be required to restructure their portfolio if they choose 
to continue relying on section 12(d)(1)(G) to avoid compliance with 
the conditions of rule 12d1-4. See, e.g., Allianz Comment Letter 
(stating that funds ``may be compelled to restructure to avoid the 
most challenging aspects of the Proposal.'').
---------------------------------------------------------------------------

    The final rule will require some existing funds of funds to change 
their portfolios to ensure compliance with the final rule, and these 
portfolio changes may impose the following costs on acquiring funds: 
(i) Legal and transaction costs to restructure their portfolios; (ii) 
sale of the shares of acquired funds at potentially depressed prices; 
(iii) tax implications, which will depend on whether the acquiring fund 
will sell shares of acquired funds at a gain or a loss; (iv) disruption 
in the acquiring funds' investment strategy; and (v) disclosure costs 
to the extent that funds will change their investment strategy.\599\ 
The prohibition of certain multi-tier structures may also result in 
less efficient fund of funds structures (i.e., funds of funds with 
fewer investment options, higher administrative costs, higher 
transaction costs, and/or lower returns) to the detriment of acquiring 
fund investors.\600\
---------------------------------------------------------------------------

    \599\ We do not quantify these costs because we lack data that 
would allow us to provide meaningful estimates of the costs and 
commenters did not provide any relevant data. Some additional 
difficulties with quantification are: (i) The magnitude of certain 
costs depends on market conditions and market conditions are 
unpredictable (e.g., sale of shares at depressed prices); (ii) 
certain costs are inherently difficult to quantify because they are 
not well defined (e.g., disruption in the acquiring funds investment 
strategy); and (iii) funds have some discretion as to whether and 
when they will incur the costs associated with the restructuring of 
their portfolios (i.e., the rule imposes an acquisition test) and so 
it is difficult to predict the magnitude of the costs associated 
with restructuring.
    \600\ See, e.g., PIMCO Comment Letter; ABA Comment Letter for 
similar arguments.
---------------------------------------------------------------------------

    The final rule will also impose costs on acquired funds that will 
lose the investments of the acquiring funds in them. As a result, 
acquired funds may be unable to achieve economies of scale in portfolio 
management, resulting in decreased efficiencies and increased operating 
costs for acquired fund shareholders. Acquired funds will also bear 
costs associated with selling assets in their portfolios to meet any 
redemptions by acquiring funds, assuming that acquiring fund 
redemptions are not made in kind. Finally, certain funds may opt for 
more complex, costly, and unregulated structures to avoid the rule 
12d1-4 conditions.\601\ For example, some funds may opt to invest 
directly in multiple securities, rather than investing in other funds 
that hold such securities, which may increase the funds' complexity and 
cost of operations. Nevertheless, we believe that any such costs to 
funds and their investors will be moderated by benefits associated with 
improved investor protection, and a more efficient regulatory framework 
for funds of funds, under the final rule.\602\
---------------------------------------------------------------------------

    \601\ See, e.g., Hancock Comment Letter (noting that ``[S]ome of 
these structures may be unregulated or may be more complex or have 
higher costs. For example, we believe that some investment managers 
may elect to rely more heavily upon unregistered products or may use 
multiple portfolio sleeves within a single registered fund, which 
could potentially introduce additional costs and administrative 
complexities'').
    \602\ For example, rule 12d1-4 will impose the undue influence 
finding requirement on both affiliated and unaffiliated funds, which 
may enhance investor protection. See infra sections V.C.1.b and 
V.C.2.i for detailed discussion of the effects of the final rule on 
regulatory efficiency and investor protection.
---------------------------------------------------------------------------

ii. Eliminate the Need To Apply for an Exemptive Order
    Rule 12d1-4 will permit prospective acquiring funds to acquire the 
securities of other funds beyond the limits of section 12(d)(1)(A) of 
the Act and will permit prospective acquired funds to sell their shares 
to acquiring funds beyond the limits of section 12(d)(1)(B) of the Act 
without the expense and delay of obtaining an exemptive order, subject 
to certain conditions.\603\ Assuming that the number of exemptive 
orders granted by the Commission

[[Page 73978]]

would stay the same absent the final rule, we estimate that by removing 
the need to obtain an exemptive order, the final rule will eliminate 
annual aggregate administrative costs to prospective acquiring and 
acquired funds of approximately $4.2 million relative to the 
baseline.\604\ Any cost savings to prospective acquiring and acquired 
funds derived from eliminating the need to apply for an exemptive order 
likely will be more pronounced for smaller funds or smaller fund 
complexes because (i) 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; and (ii) the 
same exemptive order can be used by multiple funds within a fund 
complex, and there may be fewer funds to benefit from an exemptive 
order within smaller fund complexes.\605\
---------------------------------------------------------------------------

    \603\ Existing funds of funds that currently rely on exemptive 
orders that provide relief similar to rule 12d1-4 have already 
incurred the cost of the exemptive order process. Hence, these funds 
will not benefit from eliminating the need to apply for an exemptive 
order under rule 12d1-4.
    \604\ In 2019, the Commission granted 4 non-ETF fund of funds 
orders and 38 ETF fund of funds orders (see supra footnote 578 for 
the source of the exemptive order data). Hence, the final rule could 
result in annual aggregate administrative cost savings to funds of 
funds equal to $4,200,000, i.e., $4,200,000 = (4 non-ETF fund of 
funds orders + 38 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 arrangements 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 adopting release. See 2019 
ETF Adopting Release, supra footnote 25, at 57207. The direct 
administrative costs associated with the need to apply for an 
exemptive order are one-time costs and each exemptive order can be 
used by multiple funds within the same fund complex.
    \605\ See, e.g., MFDF Comment Letter for a similar argument.
---------------------------------------------------------------------------

    Rule 12d1-4 also will 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 
2019 was 127 (378) days.\606\ If funds are not required to apply for an 
exemptive order, prospective acquiring funds will not be required to 
forgo investments in other funds while awaiting exemptive relief, which 
ultimately will permit these funds to achieve an efficient allocation 
of fund assets sooner and will permit these funds to better time their 
investments in other funds (i.e., potentially purchase shares at more 
favorable prices). Further, by removing the delay associated with the 
exemptive order process, prospective acquiring funds will be able to 
bring new products to the market faster, which will expand investors' 
investment opportunities and may therefore foster capital 
formation.\607\ Prospective acquired funds also will benefit because 
the acquiring funds' investments in them will increase their assets 
more quickly, and as a result the acquired funds may achieve economies 
of scale more quickly, ultimately benefitting the existing and future 
shareholders of the acquired funds, which may also foster capital 
formation.\608\
---------------------------------------------------------------------------

    \606\ See supra footnote 578 for the source of the exemptive 
order data.
    \607\ See infra section V.C.2.iii for detailed discussion of the 
effect of the final rule on capital formation.
    \608\ See supra footnote 607.
---------------------------------------------------------------------------

    Rule 12d1-4 also will remove the uncertainty associated with the 
exemptive order process.\609\ Uncertainty related to the exemptive 
order process may negatively affect fund investment decisions, thus 
potentially suppressing fund investment and growth.\610\ Nevertheless, 
the effects of the final rule on uncertainty likely will 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.
---------------------------------------------------------------------------

    \609\ See supra section V.B.2.a for detailed discussion of costs 
associated with the exemptive order process.
    \610\ Academic literature provides evidence consistent with the 
idea that uncertainty has negative effects on investment and growth. 
See, e.g., Nicholas Bloom, Stephen Bond, & John Van Reenen, 
Uncertainty and Investment Dynamics, 74 Rev. Econ. Stud. 391 (2007); 
Nicholas Bloom, The Impact of Uncertainty Shocks, 77 Econometrica 
623 (2009); Scott R. Baker, Nicholas Bloom, & Steven J. Davis, 
Measuring Economic Policy Uncertainty, 131 Q. J. Econ. 1593 (2016). 
The cited studies examine the effect of uncertainty on the economy 
in general, rather than the effect of uncertainty on funds.
---------------------------------------------------------------------------

    Investors may benefit from these direct and indirect cost 
reductions. For example, prospective fund advisers, sponsors, and other 
service providers may pass cost savings associated with no longer 
having to request exemptive relief 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 fund 
advisers, sponsors, and other service providers will pass on to 
investors a higher percentage of cost savings arising from the final 
rule. Conversely, if the level of competition is low, fund advisers, 
sponsors, and other service providers will retain a higher percentage 
of cost savings arising from the final rule rather than passing these 
cost savings on to investors. Academic literature provides conflicting 
evidence regarding the level of competition in the fund industry. On 
one hand, several papers provide some evidence that the U.S. fund 
industry is competitive and that greater competition in the fund 
industry is associated with lower fund fees and expenses.\611\ On the 
other hand, several papers suggest that price competition is not 
prevalent in the fund industry.\612\ 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 solely on fees, but instead compete on performance and 
services.
---------------------------------------------------------------------------

    \611\ See, e.g., John C. Coates, IV & R. Glenn Hubbard, 
Competition in the Mutual Fund Industry: Evidence and Implications 
for Policy (Harvard John M. Olin Ctr. for L., Econ., and Bus., 
Discussion Paper No. 592, Aug. 2007); Sunil Wahal & Albert (Yan) 
Wang, Competition among Mutual Funds, 99 J. Fin. Econ. 40 (2011); 
Ajay Khorana & Henri Servaes, What Drives Market Share in the Mutual 
Fund Industry, 16 Rev. Fin. 81 (2012); Burton G. Malkiel, Asset 
Management Fees and the Growth of Finance, J. Econ. Persp., Spring 
2013, at 97. Further, an ICI study suggests that the fund of funds 
industry is competitive: ``Mutual fund expense ratios also have 
fallen because of economies of scale and competition.'' See 2020 ICI 
Fact Book, supra footnote 4, at 121.
    \612\ See, e.g., John P. Freeman & Steward L. Brown, Mutual Fund 
Advisory Fees: The Cost of Conflicts of Interest, 26 J. Corp. L. 609 
(2001) (arguing that there is lack of price competition in the fund 
industry). See also Brad M. Barber, Terrance Odean, & Lu Zheng, Out 
of Sight, Out of Mind: The Effects of Expenses on Mutual Fund Flows, 
78 J. Bus. 2095 (2005) (finding no relation between fund operating 
expenses and fund flows); Javier Gil-Bazo & Pablo Ruiz-Verd[uacute], 
The Relation between Price and Performance in the Mutual Fund 
Industry, 64 J. Fin. 2153 (2009) (showing that funds with worse 
before-fee performance charge higher fees).
---------------------------------------------------------------------------

    Further, the cost savings to prospective funds associated with 
avoiding the exemptive order process under rule 12d1-4 may potentially 
increase the rate at which new funds of funds become available to 
investors.\613\ The Commission granted 4 non-ETF fund of funds orders 
and 38 ETF fund of funds orders in 2019.\614\ We are unable to estimate 
the number of new funds of funds that will be created following the 
adoption of the final rule, but we believe that the number of new funds 
of funds will be higher than the number of funds of funds that were 
created as a result of the exemptive orders granted in 2019 because the 
final rule permits the establishment of funds

[[Page 73979]]

of funds without the cost of the exemptive order process.
---------------------------------------------------------------------------

    \613\ We expect that the effect of the final rule 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 39).
    \614\ See supra footnote 604.
---------------------------------------------------------------------------

    Academic research suggests that investment decisions are sensitive 
to the number of available investment opportunities.\615\ Hence, 
investor demand for funds of funds may increase as a result of the 
increased number of funds of funds under the final rule. In particular, 
investors may increase their investments in funds of funds by either 
decreasing their investments in other asset classes or increasing their 
investment rate. More specifically, as an alternative to investing in 
funds of funds, investors may meet their investment objectives by 
assembling a portfolio of funds through non-discretionary or 
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 may 
represent an efficient alternative to such a strategy because fund of 
funds investors can avoid minimum investment requirements, invest in 
funds that have been closed to new investors, invest in funds that are 
restricted to a particular investor type, avoid certain transaction 
costs, and enjoy lower recordkeeping and monitoring costs relative to 
investors that directly invest in multiple funds.\616\ As a result, the 
entry of new funds of funds that do not replicate existing investment 
opportunities may increase investor demand for funds of funds because 
those funds will 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.
---------------------------------------------------------------------------

    \615\ See Shlomo Benartzi & Richard H. Thaler, Naive 
Diversification Strategies in Defined Contribution Saving Plans, Am. 
Econ. Rev., Mar. 2001, at 79 (presenting survey evidence and plan-
level statistics that support the idea that retirement plan 
investors practice ``1/n'' diversification across all available 
investment alternatives). But see Gur Huberman & Wei Jiang, Offering 
versus Choice in 401(k) Plans: Equity Exposure and Number of Funds, 
61 J. Fin. 763 (2006) (demonstrating 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).
    \616\ See, e.g., Edwin J. Elton et al., Target Date Funds: 
Characteristics and Performance, 5 Rev. Asset Pricing Stud. 254 
(2015) (showing that ``additional expenses charged by TDFs are 
largely offset by the low-cost share classes they hold, not normally 
open to their investors.'').
---------------------------------------------------------------------------

iii. Assess Compliance With the Final Rule
    Existing acquired and acquiring funds relying on exemptive orders 
on which rule 12d1-4 is based will incur a one-time administrative cost 
to assess whether their operations are consistent with rule 12d1-4 by 
examining differences between the exemptive order conditions they are 
currently required to meet and the conditions of rule 12d1-4. Further, 
existing acquiring funds currently relying on section 12(d)(1)(G) and 
rule 12d1-2 to structure funds of funds will be required to decide 
whether to continue relying on section 12(d)(1)(G) and amended rule 
12d1-1 or instead operate in accordance with rule 12d1-4 and comply 
with the rule's conditions. We believe this assessment will result in a 
one-time cost equal to $3,315 per fund and an aggregate one-time cost 
of $7.6 million for all affected funds.\617\
---------------------------------------------------------------------------

    \617\ We estimate that assessing the requirements of rule 12d1-4 
will 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 hours x $304 + 5 hours x $359) per fund. The 
Commission's estimates of the relevant wage rates in the tables 
below 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 1,800-hour work-year and inflation, and multiplied by 5.35 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'') for the source of salary data. The total cost for the 
1,211 acquiring and 1,069 acquired funds that will be subject to 
rule 12d1-4 will thus be $7.6 million. $7.6 million = (1,211 
acquiring funds that may be required to assess compliance with the 
rule + 1,069 acquired funds that may be required to assess 
compliance with the rule) x $3,315 one-time costs to assess 
compliance with the final rule per fund. Our estimate is likely an 
upper bound of the cost associated with assessing compliance with 
the final rule because we count separately the cost for acquiring 
and acquired funds but certain acquiring funds may also be acquired 
funds that will be subject to the final rule, and vice versa, and 
there may be synergies to assess compliance with the final rule for 
those funds. 1,211 acquiring funds that will be subject to rule 
12d1-4 = [1,719 acquiring registered investment companies that 
invest in other funds beyond the section 12(d)(1) limits (see Table 
1 in supra section V.B.1) + 37 acquiring BDCs (see supra footnotes 
558 and 559 and associated text)] x 69% of acquiring funds that 
invest in other funds beyond the section 12(d)(1) limits and will be 
subject to rule 12d1-4 as estimated by a commenter (see supra 
footnote 537 and associated text). Our calculation assumes that the 
commenter's sample is representative of the acquiring funds in Table 
1. 1,069 acquired funds that will be subject to rule 12d1-4 = [3,392 
acquired registered investment companies that have a non-zero 
investment from other funds (see Table 2 in supra section V.B.1) + 
50 acquired BDCs (see supra footnotes 558 and 559 and associated 
text)] x 45% of acquired funds for which there is at least one 
acquiring fund that invests in them beyond the 3% limit of section 
12(d)(1) x 69% of acquired funds that have investments from other 
funds in them beyond the 3% limit of section 12(d)(1) and will be 
subject to rule 12d1-4 as estimated by a commenter (see supra 
footnote 537 and associated text). Our calculation assumes that the 
commenter's estimate of acquiring funds that will be subject to rule 
12d1-4 is also applicable to acquired funds.
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b. Effects of New and Omitted Conditions
    Rule 12d1-4 will include new conditions relative to the conditions 
in our current exemptive orders and rule 12d1-2, and will omit certain 
conditions contained in our exemptive orders that are not necessary in 
light of the new conditions of rule 12d1-4. The new conditions of rule 
12d1-4 are designed to limit the acquiring funds' undue influence over 
the acquired funds, limit duplicative fees for acquiring fund 
investors, limit the creation of complex fund structures, and 
ultimately encourage effective oversight of fund of funds structures. 
The rule 12d1-4 conditions augment certain conditions in our exemptive 
orders, which will likely enhance investor protections. We expect, 
however, that the implementation and monitoring of these new conditions 
will impose certain incremental one-time and ongoing costs on funds and 
their investors.\618\ We discuss the benefits and costs of each of the 
new conditions of rule 12d1-4 and the conditions of existing exemptive 
orders that rule 12d1-4 omits in detail below.\619\
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    \618\ See also Guggenheim Comment Letter (noting that the 
conditions of rule 12d1-4 will ``likely result in significant 
additional compliance, investment and practical costs and burdens 
that ultimately may result in increased fund expenses. We note that 
the proposed conditions would necessitate meaningful investments in 
technology, personnel, training and other compliance-related 
resources to monitor holdings of acquired funds, particularly when 
such `advisory groups' involve large diversified financial services 
institutions.''). Some of the costs discussed by the commenter may 
be no longer relevant given the changes in the rule's conditions 
relative to the 2018 FOF Proposing Release.
    \619\ See supra section II.C for discussion of the rule's 
conditions. In this section, we compare the conditions of rule 12d1-
4 to the conditions of our current exemptive orders. Hence, the 
discussion in this section describes the effects of rule 12d1-4 on 
(i) funds that currently rely on our exemptive orders to invest in 
other funds beyond the limits of section 12(d)(1) but will be 
subject to rule 12d1-4 following the rescission of our exemptive 
orders; and (ii) funds that would otherwise choose to rely on our 
exemptive orders in the future to invest in other funds beyond the 
limits of section 12(d)(1) but will be subject to rule 12d1-4 
following the final rule adoption. Any effects discussed in this 
section will be more pronounced for funds that currently rely on 
section 12(d)(1)(G) and rule 12d1-2 to invest in affiliated funds 
beyond the limits of section 12(d)(1) but will be subject to rule 
12d1-4 following the final rule adoption, because the conditions of 
section 12(d)(1)(G) and rule 12d1-2 are less costly than the 
conditions in our current exemptive orders. In particular, in 
contrast to our exemptive orders, funds relying on section 
12(d)(1)(G) and rule 12d1-2 to invest in affiliated funds beyond the 
limits of section 12(d)(1) are not required to enter into a 
participation agreement or make certain findings and adopt 
procedures to prevent overreaching and undue influence by the 
acquiring fund and its affiliates. Further, the conditions aimed at 
mitigating excessive and duplicative fees under section 12(d)(1)(G) 
are more limited in scope than the fee conditions in our exemptive 
orders. See, e.g., Invesco Comment Letter for a discussion of 
compliance burdens associated with the rescission of rule 12d1-2 and 
the potential reliance of affiliated funds of funds on rule 12d1-4 
instead of section 12(d)(1)(G) and rule 12d1-2.

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[[Page 73980]]

i. Undue Influence--Control
    Rule 12d1-4 mandates that the acquiring fund and its advisory group 
will not control (individually or in the aggregate) an acquired fund. 
Control is presumed when a fund owns more than 25% of the voting 
securities of another fund. The control condition does not apply to 
affiliated fund of funds structures. The control condition of rule 
12d1-4 is consistent with the conditions of our current exemptive 
orders and thus will not have an economic effect relative to the 
baseline.\620\
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    \620\ Commenters agreed with the assertion that the control 
condition of rule 12d1-4 is consistent with the conditions of the 
existing orders. See, e.g., ICI Comment Letter. A commenter argued 
that ``many advisers already have systems in place to monitor 
holdings at the `advisory group level,' '' which would decrease any 
potential compliance costs associated with this aspect of the final 
rule. See Invesco Comment Letter.
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ii. Undue Influence--Voting Conditions
    Rule 12d1-4 will require an acquiring fund and its advisory group 
to vote their shares of an acquired fund using mirror voting if the 
acquiring fund and its advisory group (in the aggregate): (i) Hold more 
than 25% of the outstanding voting securities of an acquired open-end 
fund or UIT due to a decrease in the outstanding securities of the 
acquired fund; or (ii) hold more than 10% of the outstanding voting 
securities of an acquired closed-end fund or BDC.\621\
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    \621\ The voting condition of rule 12d1-4 is 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 rule 12d1-4(b)(1)(iii). In 
circumstances where all holders of the outstanding voting securities 
of the acquired fund are required by rule 12d1-4 or otherwise under 
section 12(d)(1) to mirror vote the securities of the acquired fund, 
the acquiring fund may use pass-through instead of mirror voting. 
See rule 12d1-4(b)(1)(ii). Our exemptive orders do not include such 
a condition. Our analysis shows no existing acquired funds that will 
be subject to this rule condition (i.e., acquired funds that are 
only held by acquiring funds that are subject to the voting 
conditions of rule 12d1-4). Hence, we expect that the economic 
effects of this aspect of the rule will be immaterial.
---------------------------------------------------------------------------

    Acquired open-end funds and UITs. Our current exemptive orders 
require an acquiring fund and its advisory group to vote their shares 
of an acquired open-end fund or UIT using mirror voting only if the 
acquiring fund and its advisory group hold more than 25% of the 
acquired fund's outstanding voting securities due to a decrease in the 
outstanding securities of the acquired fund. Hence, for acquiring funds 
that hold shares of open-end funds or UITs beyond the section 12(d)(1) 
limits, the voting condition of rule 12d1-4 is the same as the voting 
condition in our exemptive orders, and so we expect that this aspect of 
the rule will not impose additional costs on funds relative to the 
exemptive orders.
    Acquired BDCs and registered closed-end funds. Rule 12d1-4 differs 
from our current exemptive orders for acquiring funds that invest in 
acquired registered closed-end funds or BDCs beyond the limits of 
section 12(d)(1) because (i) it imposes a 10% (instead of 3% in the 
exemptive orders) voting threshold; and (ii) it only allows mirror 
voting (instead of either mirror or pass-through voting in the 
exemptive orders) for all funds within the acquiring funds' advisory 
group.\622\ Hence, rule 12d1-4 is less restrictive than our current 
exemptive orders in terms of the voting threshold but more restrictive 
than our current exemptive orders in terms of permissible voting 
methods for acquiring funds that invest in acquired BDCs and registered 
closed-end funds.
---------------------------------------------------------------------------

    \622\ Similar to the rule's voting condition, our current 
exemptive orders require non-fund entities within the advisory group 
to use mirror voting.
---------------------------------------------------------------------------

    The voting conditions of rule 12d1-4 with respect to acquired BDCs 
and registered closed-end funds may have the following costs. First, we 
estimate that all acquiring funds that invest in registered closed-end 
funds or BDCs in reliance on rule 12d1-4 will incur a one-time cost to 
update their proxy voting policies to reflect that the fund is 
potentially subject to the voting provisions of the rule. Our analysis 
shows that only one of the existing acquiring funds invests in at least 
one registered closed-end fund beyond the 10% voting threshold.\623\ 
Hence, for funds that invest in registered closed-end funds or BDCs in 
reliance on rule 12d1-4, we expect that the one-time cost to update 
their proxy voting policies will be immaterial. Nevertheless, we 
estimate that the one-time cost for acquiring funds that invest in BDCs 
and registered closed-end funds beyond the 10% voting threshold to 
update their proxy voting policies will be equal to $1,257 per 
fund.\624\
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    \623\ Results are the same when aggregating fund holdings across 
funds sharing the same adviser or sub-adviser. We lack structured 
data on BDCs' outstanding shares and so BDCs are excluded from this 
analysis. Our data does not allow us to identify whether acquiring 
funds hold voting or non-voting securities of the acquired funds, 
which may result in misestimation of the number of acquiring funds 
that hold an investment in at least one closed-end fund or BDC 
beyond the 10% voting threshold. This data limitation applies to all 
analysis in section V that uses voting share information.
    \624\ See Table 5 in infra section VI.B.1.
---------------------------------------------------------------------------

    Second, the cost of the more restrictive voting methods (i.e., the 
rule generally permits only mirror voting) of rule 12d1-4 relative to 
our current exemptive orders is that the rule may increase economic 
distortions in the voting process since mirror voting requires the 
acquiring fund to vote in the same proportion as the vote of all other 
holders of the acquired fund shares.\625\ The economic effect of any 
distortions in the voting process is unclear and will 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 acquiring fund shareholders (e.g., retail 
versus institutional investors); \626\ and (iii) how frequently votes 
are close and so the acquiring fund's voting may determine the outcome 
of the vote.
---------------------------------------------------------------------------

    \625\ See, e.g., ICI Comment Letter; Nuveen Comment Letter; 
Schwab Comment Letter; TPG Comment Letter; SIFMA AMG Comment Letter 
noting that both pass-through and mirror voting can introduce 
distortions in the shareholder voting process, but those distortions 
are more pronounced in the case of mirror voting.
    \626\ There are significant differences in voting involvement by 
institutional investors compared to retail investors (see, e.g., 
Broadridge & PwC, 2019 Proxy Season Review, available at https://www.broadridge.com/_assets/pdf/broadridge-proxypulse-2019-review.pdf).
---------------------------------------------------------------------------

    Relatedly, the mirror voting requirement applicable to acquiring 
fund holdings in excess of 10% of an acquired BDC or registered closed-
end fund may require advisers to revise existing proxy voting policies 
and procedures, including those of other members of the advisory group 
and their respective clients.\627\ Additionally, a more restrictive 
voting method may require an acquiring fund and its advisory group to 
follow a less flexible proxy voting policy, subject to the other legal 
requirements that are applicable to an investment adviser's proxy 
voting responsibilities.\628\ However, this effect

[[Page 73981]]

would be mitigated by the fact that, as discussed below, we believe 
that the majority of acquiring funds that invest in registered closed-
end funds or BDCs beyond the limits of section 12(d)(1) in reliance on 
our exemptive orders already use mirror voting.
---------------------------------------------------------------------------

    \627\ See supra footnote 161 and associated text for related 
discussion.
    \628\ See generally Commission Guidance Regarding Proxy Voting 
Responsibilities of Investment Advisers, Investment Advisers Act 
Release No. 5325 (Aug. 21, 2019), at 5-6 [84 FR 47420, 42421 (Sept. 
10, 2019)]; id. at 12, Question No. 2 [84 FR 47423]; Supplement to 
Commission Guidance Regarding Voting Responsibilities of Investment 
Advisers, Investment Advisers Act Release No. 5547 (July 22, 2020) 
[85 FR 55155 (September 3, 2020)]. See also Exemptions from the 
Proxy Rules for Proxy Voting Advice, Securities Exchange Act Release 
No. 89372 (Jul. 22, 2020) [85 FR 55082 (September 3, 2020)] 
(reaffirming an investment adviser's fiduciary duty to vote in the 
best interest of its client).
---------------------------------------------------------------------------

    Third, the more restrictive voting methods will impose more voting 
restrictions on acquiring funds, and thus may decrease funds' 
incentives to acquire larger blocks of shares (i.e., blocks of shares 
in excess of the section 12(d)(1) limits but below the 10% threshold of 
the rule) and thereby potentially support value-increasing actions 
through their voting.\629\
---------------------------------------------------------------------------

    \629\ 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. Fin. & Quantitative Analysis 1311 (2014); Michael Bradley et 
al., Activist Arbitrage: A Study of Open-Ending Attempts of Closed-
End Funds, 95 J. Fin. Econ. 1 (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. Fin. 2933 (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. Fin. & Quantitative 
Analysis 567 (2012); Gerald F. Davis & E. Han Kim, Business Ties and 
Proxy Voting by Mutual Funds, 85 J. Fin. Econ. 552 (2007)). There is 
some evidence, however, of increased activism by funds, other than 
hedge funds, over time (see, e.g., J.P. Morgan, 2019 Proxy Season 
Review (Aug. 2019), available at https://www.jpmorgan.com/jpmpdf/1320747618625.pdf). The abovementioned studies are not solely 
focused on acquiring fund activism targeted at acquired funds but 
also study fund activism targeted at non-funds and non-fund activism 
targeted at funds.
---------------------------------------------------------------------------

    The voting conditions of rule 12d1-4 for acquired BDCs and 
registered closed-end funds may have the following benefits. First, the 
less restrictive voting threshold of rule 12d1-4 relative to the 
exemptive orders (i.e., 10% instead of 3%) may decrease economic 
distortions in the voting process since the voting provision will not 
apply until an acquiring fund holds a greater percentage of the voting 
securities of an acquired fund.
    Second, the less restrictive voting threshold of rule 12d1-4 
relative to the exemptive orders will impose fewer voting restrictions 
on acquiring funds, and thus may increase funds' incentives to acquire 
larger blocks of shares and thereby potentially support value-
increasing actions through their voting.\630\
---------------------------------------------------------------------------

    \630\ See supra footnote 629 and associated text.
---------------------------------------------------------------------------

    Third, assuming no difference between the permissible voting 
methods under the rule and the exemptive orders, the voting threshold 
of the rule may decrease ongoing costs associated with voting because 
it is less restrictive than the voting threshold in existing exemptive 
orders (i.e., 10% under the rule versus 3% under the exemptive orders). 
Similarly, holding the voting threshold constant, the more restrictive 
voting methods of the rule may decrease ongoing costs for funds 
associated with voting because pass-through voting is more costly to 
implement than mirror voting.\631\ Nevertheless, we expect any such 
cost decreases to be small because we believe that the majority of 
acquiring funds that invest in registered closed-end funds or BDCs 
beyond the limits of section 12(d)(1) in reliance on our exemptive 
orders already use mirror voting, and we expect those funds to continue 
using mirror voting following the final rule adoption.\632\
---------------------------------------------------------------------------

    \631\ See Table 5 in infra section VI.B.1. Under pass-through 
voting, acquiring funds must seek voting instructions from their 
security holders and vote such proxies in accordance with their 
instructions. Under mirror voting, acquiring funds must vote the 
acquired fund shares in the same proportion as the vote of all other 
holders of the acquired fund.
    \632\ Two commenters noted that mirror voting is generally 
preferable to pass-through voting, and other commenters noted that 
the expense and logistical challenges associated with pass-through 
voting make pass-through voting impractical. See Invesco Comment 
Letter (noting that mirror voting is ``typically preferable to pass-
through voting''); SIFMA AMG Comment Letter (noting that 
``registered funds would likely mirror vote shares held in any 
[closed-end funds] subject to the voting condition''). See also ICI 
Comment Letter (noting that ``[i]n some situations, the expense and 
logistical challenges of pass though voting also may be 
undesirable.''); Voya Comment Letter (noting that ``the use of pass-
through voting would increase the costs and logistical challenges of 
proxy solicitations. . . . If these acquiring funds determine to 
implement pass-through voting, the costs of obtaining approvals of 
shareholder proposals could increase significantly, without 
corresponding benefit to [the acquiring] fund's shareholders.''); 
Charles Schwab Comment Letter (noting that ``[g]enerally speaking, 
the expense and logistical challenges make pass-through voting 
impractical'').
---------------------------------------------------------------------------

    Fourth, the additional restriction on voting methods (i.e., only 
allow mirror voting) may enhance the protection of the acquired fund 
investors from the acquiring funds' undue influence. Pass-through 
voting may not provide the same level of protection from acquiring 
funds' undue influence as mirror voting because acquiring fund 
investors may vote in line with the recommendations of the acquiring 
fund investment adviser and board when the acquiring fund uses pass-
through voting.\633\
---------------------------------------------------------------------------

    \633\ See, e.g., Advent Comment Letter; Comment Letter of 
Franklin Square Holdings (May 2, 2019) (``Franklin Comment 
Letter''); Skadden Comment Letter; ABA Comment Letter (arguing that 
pass-through voting does not provide the same level of protection 
from undue influence as mirror voting).
---------------------------------------------------------------------------

iii. Undue Influence--Findings \634\
---------------------------------------------------------------------------

    \634\ See infra section V.C.1.b.iv for discussion of the 
condition of rule 12d1-4 related to layering of fees and expenses 
and complex structures for management companies, UITs, and separate 
accounts (i.e., rule 12d1-4(b)(2)(i), (ii), and (iii)).
---------------------------------------------------------------------------

    To prevent overreaching and undue influence, current exemptive 
orders typically require (i) acquired fund boards to make certain 
findings and adopt procedures at least annually to prevent overreaching 
and undue influence by the acquiring fund and its affiliates; (ii) 
acquiring funds 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; and (iii) acquiring fund boards 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. These requirements in the exemptive orders 
are only applicable to unaffiliated funds of funds and they are only 
applicable to acquiring and acquired funds that are management 
companies.
    To mitigate concerns of overreaching and undue influence, if an 
acquired fund is a management company, rule 12d1-4 will require the 
acquired fund's investment adviser, prior to the initial acquisition of 
the acquired fund's shares in excess of the limits in section 
12(d)(1)(A)(i) of the Act, to find that any undue influence concerns 
associated with the acquiring fund's investment in the acquired fund 
are reasonably addressed. As part of this consideration, the acquired 
fund's investment adviser must consider, at a minimum, the following 
factors: (i) The scale of contemplated investments by the acquiring 
fund and any maximum investment limits; (ii) the anticipated timing of 
redemption requests by the acquiring fund; (iii) whether and under what 
circumstances the acquiring fund will provide advance notification of 
investments and redemptions; and (iv) the circumstances under which the 
acquired fund may elect to satisfy redemption requests in kind rather 
than in cash and the terms of any such redemptions in kind. The 
acquired fund's investment adviser must report its findings and the 
basis for those findings to the fund's board of directors no later than 
the next regularly scheduled board of directors meeting

[[Page 73982]]

following the acquiring fund's initial investment in the acquired 
fund.\635\
---------------------------------------------------------------------------

    \635\ Under our exemptive orders, in cases when the investment 
adviser to the fund assists the board with the findings and 
procedures to prevent overreaching and undue influence by the 
acquiring fund and its affiliates, the investment adviser 
periodically reports its findings to the fund's board of directors. 
Hence, the reporting requirement in rule 12d1-4 likely is no more 
burdensome than reporting practices under our exemptive orders.
---------------------------------------------------------------------------

    Hence, rule 12d1-4 will differ from the undue influence conditions 
in our exemptive orders in the following main ways. First, the undue 
influence requirement of rule 12d1-4 will only apply to acquired funds, 
while the policies and procedures requirement in our exemptive orders 
is applicable to both acquiring and acquired funds.\636\ Second, the 
undue influence requirement of rule 12d1-4 will apply to both 
affiliated and unaffiliated funds of funds, while the policies and 
procedures requirement in our exemptive orders only applies to 
unaffiliated funds of funds. Third, the undue influence requirement of 
rule 12d1-4 will only apply prior to the initial acquisition of the 
acquired fund shares, while the policies and procedures requirement for 
acquired funds in our exemptive orders applies periodically (i.e., at 
least annually). Fourth, the undue influence requirement of rule 12d1-4 
will apply to funds' investment advisers, while the policies and 
procedures requirement in our exemptive orders applies to funds' boards 
of directors.
---------------------------------------------------------------------------

    \636\ See rule 12d1-4(b)(2)(i)(B). Acquiring funds are 
nevertheless subject to other rule conditions, such as the 
requirement to enter into a fund of funds investment agreement and 
the evaluation of the complexity of the structure and findings 
regarding the aggregate fees and expenses associated with the 
acquiring fund's investment in the acquired fund.
---------------------------------------------------------------------------

    Rule 12d1-4 imposes the undue influence requirement only on 
acquired funds. The benefit of such an approach is that it will reduce 
ongoing costs to acquiring funds relative to our exemptive orders 
because acquiring funds will not be required to adopt policies and 
procedures to prevent undue influence over the acquired fund. Such an 
approach, however, may be weaker from an investor protection standpoint 
to the extent that acquiring funds are no longer required to make 
findings to prevent undue influence over the acquired fund. We believe 
that these concerns are mitigated by the rule's additional conditions 
related to undue influence, including voting requirements, the fund of 
funds investment agreement requirement, and the fact that the rule will 
prohibit an acquiring fund and its advisory group from controlling an 
acquired fund.
    Rule 12d1-4 will impose the undue influence requirement on both 
affiliated and unaffiliated funds of funds, which may enhance investor 
protection.\637\ At the same time, by imposing the undue influence 
requirement to both affiliated and unaffiliated funds of funds, the 
undue influence requirement of rule 12d1-4 will be more costly to 
implement than the policies and procedures in our exemptive orders 
because a larger number of acquired funds (i.e., both affiliated and 
unaffiliated funds) will be required to incur the costs associated with 
the undue influence requirement.\638\
---------------------------------------------------------------------------

    \637\ Several commenters stated that affiliated funds of funds 
do not raise the concerns that section 12(d)(1) was enacted to 
address. See, e.g., PIMCO Comment Letter; Allianz Comment Letter; 
Thrivent Comment Letter. Academic literature, however, provides 
results of empirical analysis consistent with the idea that 
affiliated funds of funds suffer from conflicts of interest. See, 
e.g., Utpal Bhattacharya, Jung H. Lee, & Veronika K. Pool, 
Conflicting Family Values in Mutual Fund Families, 68 J. Fin. 173 
(2013); Jung Hoon Lee, Information Flows in Mutual Fund Families 
(Working Paper, Sept. 2014), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2148075. See also, e.g., Diane Del 
Guercio, Egemen Genc, & Hai Tran, Playing Favorites: Conflicts of 
Interest in Mutual Fund Management, 128 J. Fin. Econ. 535 (2018); 
Jose-Miguel Gaspar, Massimo Massa, & Pedro Matos, Favoritism in 
Mutual Fund Families?Evidence on Strategic Cross-Fund Subsidization, 
61 J. Fin. 73 (2006); Luis Goncalves-Pinto, Juan Sotes-Paladino, & 
Jing Xu, The Invisible Hand of Internal Markets in Mutual Fund 
Families, 89 J. Banking & Fin. 105 (2018) for evidence consistent 
with the idea of conflicts of interest in affiliated fund complexes 
in general (i.e., not necessarily affiliated funds of funds). See 
also CFA Comment Letter for similar arguments. Any such conflicts of 
interest are, at least partially, mitigated to the extent that the 
investment adviser owes a fiduciary duty both to the acquiring and 
acquired funds and the acquiring and acquired funds share the same 
board of directors that exercise oversight over both funds.
    \638\ See also Guggenheim Comment Letter (noting that the 
finding requirement of rule 12d1-4 will ``give rise to the need to 
incorporate attorneys and accounting staff to assist in documenting 
the cost of the fund investment and the complexity of the structure 
prior to making the investment and in preparing a document for 
review by the board.'').
---------------------------------------------------------------------------

    In contrast, by requiring an undue influence finding only at 
initial acquisition, rule 12d1-4 will reduce costs for acquired funds 
relative to our exemptive orders because acquired funds will no longer 
be required to periodically make findings and adopt procedures related 
to undue influence. While this rule condition does not require periodic 
evaluation of acquiring funds' investments in acquired funds, the board 
may require more frequent subsequent reporting under the fund's 
compliance program.
    Rule 12d1-4 also allocates the responsibility of making undue 
influence findings to the acquired fund's investment adviser, subject 
to the board's oversight.\639\ As discussed above, our current 
exemptive orders require the board to approve certain procedures to 
prevent overreaching and undue influence by the acquiring fund and its 
affiliates.\640\ While rule 12d1-4 does not require the adoption of 
specific procedures, rule 38a-1 requires funds to adopt written 
compliance policies and procedures reasonably designed to prevent a 
violation of the federal securities laws by the fund.\641\ Accordingly, 
we believe that the economic effect of this difference between our 
exemptive orders and rule 12d1-4 will be limited because funds will be 
required to maintain similar policies and procedures, and compliance 
with the exemptive orders is generally facilitated by the fund's 
investment adviser at the direction of the board.\642\ We believe 
investor protection concerns that had been addressed by the conditions 
in our exemptive orders will be more effectively addressed by the 
protective conditions of the final rule, such as the requirement that 
an acquiring fund investment adviser evaluate the complexity of the 
structure and find that the acquiring fund's fees and expenses do not 
duplicate the fees and expenses of the acquired fund and that certain 
funds enter into a fund of funds investment agreement.\643\
---------------------------------------------------------------------------

    \639\ Rule 12d1-4(b)(2).
    \640\ 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. In addition, 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).
    \641\ See supra footnote 59 and associated text.
    \642\ Some commenters argued that allocating more 
responsibilities to the fund's investment adviser subject to the 
board's oversight will be beneficial to fund investors because this 
approach is consistent with the board's current oversight 
responsibilities. See IDC Comment Letter; Hancock Comment Letter; 
MFDF Comment Letter; ABA Comment Letter.
    \643\ In addition, the acquired fund's board and adviser are 
subject to ongoing fiduciary obligations and the acquired fund's 
board must determine an appropriate level of subsequent reporting 
under the acquired fund's compliance program.
---------------------------------------------------------------------------

    The undue influence finding requirement of rule 12d1-4 will impose 
one-time costs on acquired funds to review the rule's requirement and 
modify, as necessary, their policies and procedures to comply with the 
rule, and these costs may be borne by investors in acquired funds.\644\ 
These estimated

[[Page 73983]]

costs are attributable to the following activities: (i) Reviewing the 
rule's finding requirement; (ii) developing new (or modifying existing) 
policies and procedures to align with the finding requirement of rule 
12d1-4; (iii) integrating and implementing those policies and 
procedures into the rest of the funds' activities; and (iv) preparing 
new training materials and administering training sessions for staff in 
affected areas.
---------------------------------------------------------------------------

    \644\ Acquired funds will bear the costs associated with rule 
12d1-4 only if they permit acquiring fund investments in excess of 
the section 12(d)(1) limits in reliance on rule 12d1-4 and therefore 
must comply with the rule's conditions. Acquired funds may be able 
to pass through some of the costs associated with the rule's 
conditions to acquiring funds through higher operating expenses. The 
ability of acquired funds to pass through some of the costs depends 
on the market power of acquired funds, which ultimately depends on 
the availability of investment options for acquiring funds.
---------------------------------------------------------------------------

    The undue influence requirement of rule 12d1-4 also will impose 
ongoing costs on an acquired fund's investment adviser each time a new 
acquiring fund invests in the acquired fund. Our current exemptive 
orders require fund boards to make certain findings and adopt 
procedures to prevent overreaching and undue influence by the acquiring 
fund and its affiliates, and some of those processes and procedures may 
be similar to the rule's requirements. Consequently, to the extent that 
investment advisers can leverage some of the existing board processes 
and procedures to comply with the rule's requirements, any ongoing 
costs will be mitigated. We generally believe that the undue influence 
finding of rule 12d1-4 is as comprehensive as the policies and 
procedures in our exemptive orders because both rule 12d1-4 and our 
exemptive orders allow funds flexibility to determine the undue 
influence concerns, and to consider factors applicable to those 
concerns, that may be relevant to each fund of funds structure.\645\
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    \645\ In particular, rule 12d1-4 requires acquired funds to 
consider (i) the scale of the acquiring fund's investment in the 
acquired fund; and (ii) the timing and circumstances of the 
acquiring fund's redemptions of the acquired fund shares. Our 
exemptive orders require acquiring funds to consider (i) any 
services or transactions between the acquiring fund and an 
unaffiliated acquired fund; (ii) any purchases by the acquired fund 
of securities in affiliated underwritings; and (iii) any 
compensation that the acquiring fund investment adviser received 
from an unaffiliated acquired fund. Rule 12d1-4 requires advisers to 
consider certain factors at a minimum but does not dictate the 
particular terms or how advisers must evaluate or weigh the various 
factors. See also Dechert Comment Letter (recommending that the 
Commission should not set forth specific factors that an adviser 
should consider when making such a finding).
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    Our staff estimates that the annual costs necessary to comply with 
the undue influence finding requirement of rule 12d1-4 for acquired 
management companies will be equal to $45,193 per acquired management 
company and will result in an aggregate ongoing burden equal to $131 
million for all affected acquired management companies.\646\
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    \646\ This estimate is based on the following calculation: $131 
million = $45,193 initial and annual internal and external burden 
per fund x 2,900 acquired management companies that will be subject 
to rule 12d1-4. $45,193 = [$14,994 initial and annual internal 
burden per fund + $35,220 initial external burden per fund (see 
Table 7 in infra section VI.B.3.)] x (1--10% of the total burden 
that is associated with the recordkeeping requirements of rule 12d1-
4). This and all subsequent cost estimates in this section that rely 
on per fund dollar cost estimates from section VI below are an upper 
bound of the costs imposed by the final rule because they capture 
the total rather than the incremental cost of the rule's 
requirements. 2,900 acquired management companies that will be 
subject to rule 12d1-4 = 4,203 acquired management companies x 69% 
of acquired management companies that will be subject to rule 12d1-4 
as estimated by a commenter (see supra footnote 537 and associated 
text). Our calculation assumes that the commenter's estimate of 
acquiring funds that will be subject to rule 12d1-4 is also 
applicable to acquired funds. 4,203 acquired management companies = 
3,392 acquired registered investment companies (see supra Table 2) x 
14,605 registered investment companies (see Table 1 in supra section 
V.B.1)/11,788 management companies (see Table 2 in supra section 
V.B.1). This estimate assumes that acquired management companies 
with investments from acquiring funds beyond the limits of section 
12(d)(1) will be subject to rule 12d1-4 at the same rate as the 
acquired management companies with investments from acquiring funds 
within the limits of section 12(d)(1) following the rule adoption.
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    We expect that the costs associated with the finding requirement of 
rule 12d1-4 will be incurred by the acquired fund's investment adviser 
and the acquired fund's board of directors but, depending on market 
competition and other factors, may partially or fully be borne by the 
acquired fund shareholders in the form of higher management fees and/or 
operating expenses.
iv. Layering of Fees and Expenses
    Our current exemptive orders contain a set of conditions designed 
to prevent duplicative and excessive fees and expenses in fund of funds 
structures. In particular, 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 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. The conditions 
in our exemptive orders apply to both investments in affiliated and 
unaffiliated funds of funds.
    Rule 12d1-4 will replace the above-mentioned conditions with the 
following requirements that will also apply to both affiliated and 
unaffiliated funds of funds. For management companies, rule 12d1-4 will 
require the acquiring fund's adviser to evaluate the complexity of the 
structure and the aggregate fees and expenses associated with the 
acquiring fund's investment in acquired funds and find that the 
acquiring fund's fees and expenses do not duplicate the fees and 
expenses of the acquired fund. As part of this evaluation, the 
acquiring fund's adviser should consider, among others, whether such 
fees incurred by the acquiring fund are based on services that are in 
addition to, rather than duplicative of, services provided by the 
acquiring fund's investment adviser. For UITs, rule 12d1-4 will require 
the principal underwriter or depositor of a UIT to analyze the 
complexity of the structure associated with the UIT's investment in 
acquired funds, and find that the arrangement does not result in 
duplicative fees and expenses. For all acquiring funds, similar to the 
finding requirement related to undue influence,\647\ rule 12d1-4 will 
require the evaluation of aggregate fees and expenses prior to the 
initial acquisition of an acquired fund in excess of the limits in 
section 12(d)(1).
---------------------------------------------------------------------------

    \647\ See supra section V.C.1.b.iii.
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    Management companies. In the case of management companies, rule 
12d1-4 will replace the specific conditions in our exemptive orders 
with a broader requirement that the investment adviser to the acquiring 
fund consider both the complexity and the aggregate fees and expenses 
of the fund of funds arrangement. We believe that the omission of the 
specific conditions in our exemptive orders will not compromise 
investor protection for the following reasons.
    First, the omission of the FINRA sales charge limitation from rule 
12d1-4

[[Page 73984]]

likely will not have an economic effect because the FINRA sales charge 
rule remains applicable to certain funds (i.e., open-end funds and 
certain closed-end funds) regardless of the rule's requirements.\648\ 
Second, rule 12d1-4 will replace the requirements in our exemptive 
orders that (i) the acquiring fund's adviser should waive advisory fees 
under certain circumstances; and (ii) the acquiring fund's board should 
make certain findings regarding advisory fees, with a broader 
requirement that the investment adviser should consider whether fees 
and expenses are duplicative. We believe that the fee waiver condition 
of the existing orders is unnecessary in light of the existing duties 
and obligations of the fund boards of directors.\649\ In addition, the 
requirement in the exemptive orders that the acquiring fund board 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 covered by a fund board's fiduciary duties and 
statutory obligations.
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    \648\ See FINRA rule 2341. 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).
    \649\ See supra footnotes 309-313 and accompanying text; see 
also 2018 FOF Proposing Release, supra footnote 6, at nn.146-147 and 
accompanying text.
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    The benefit of the broader fee and expense conditions of rule 12d1-
4 relative to the more specific conditions of the exemptive orders is 
that the acquiring fund's investment adviser will be able to tailor the 
evaluation of the complexity and the findings regarding aggregate fees 
and expenses of the fund of funds structure to the needs of each 
structure, including the consideration of any additional factors that 
may be appropriate under the circumstances. As a result, the fee 
conditions of rule 12d1-4 may better protect acquiring fund 
shareholders from duplicative fees than the conditions in the exemptive 
orders.\650\
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    \650\ A commenter argued that an additional benefit of the fee 
and expense conditions of rule 12d1-4 relative to the baseline is 
that rule 12d1-4 will ``lower administrative burden, and 
appropriately shift the decision-making to the party (the adviser) 
in the best position to make the assessment'' whether the fees and 
expenses of the fund of funds are reasonable. See Invesco Comment 
Letter.
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    At the same time, the broader fee and expense conditions of rule 
12d1-4 relative to the exemptive orders may be more costly to implement 
and monitor relative to the conditions in the exemptive orders. In 
particular, rule 12d1-4 will impose one-time costs on funds to review 
the rule's requirement and modify, as necessary, their policies and 
procedures to comply with this aspect of rule 12d1-4.
    The incremental initial and ongoing costs that management companies 
will incur whenever they invest for the first time in an acquired fund 
under rule 12d1-4 include: (i) Advisers' initial evaluation of the 
complexity of the structure and analysis supporting the finding 
regarding aggregate fees and expenses associated with their investments 
in acquired funds; (ii) advisers' preparation and reporting of their 
evaluations, findings, and the basis for their evaluations or findings 
to the acquiring funds' board of directors; (iii) board time to review 
the reports prepared by the investment advisers; and (iv) costs of 
counsel to the independent directors to review the reports prepared by 
the investment advisers.
    The Commission staff estimates that the one-time and ongoing annual 
costs necessary to comply with the fee and expense conditions of rule 
12d1-4 for acquiring management companies will be equal to $45,193 per 
acquiring management company and will result in an aggregate ongoing 
burden equal to $148.1 million for all affected acquiring management 
companies.\651\
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    \651\ This estimate is based on the following calculation: 
$148.1 million = [$14,994 initial and annual internal burden per 
fund + $35,220 initial external burden per fund (see Table 7 in 
infra section VI.B.3.)] x (1--10% of the total burden that is 
associated with the recordkeeping requirements of rule 12d1-4) x 
3,278 acquiring management companies that will be subject to rule 
12d1-4. 3,278 acquiring management companies that will be subject to 
rule 12d1-4 = 4,750 acquiring management companies (see Table 2 in 
supra section V.B.1) x 69% of acquiring management companies that 
will be subject to rule 12d1-4 as estimated by a commenter (see 
supra footnote 537 and associated text). This estimate assumes that 
acquiring management companies with current investments in other 
funds beyond the limits of section 12(d)(1) will be subject to rule 
12d1-4 at the same rate as the acquiring management companies with 
current investments in other funds within the limits of section 
12(d)(1) following the rule adoption.
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    UITs. With respect to acquiring UITs, rule 12d1-4 will replace the 
specific conditions related to sales charges in the exemptive orders 
with a broader requirement that on or before the date of initial 
deposit of portfolio securities, the UIT's principal underwriter or 
depositor evaluate the complexity of the structure and find that the 
UIT's fees and expenses do not duplicate the fees and expenses of the 
acquired funds that the UIT holds or will hold at the date of deposit. 
Similar to the fee and expense conditions of rule 12d1-4 for management 
companies, the benefit of the broader requirement of rule 12d1-4 for 
UITs relative to the more specific conditions of the exemptive orders 
is that the acquiring UIT's depositor or underwriter will be able to 
tailor the evaluation of the complexity and finding regarding the 
aggregate fees and expenses of the fund of funds structure to the needs 
of each structure and augment, whenever appropriate, the exemptive 
order conditions with additional appropriate factors. As a result, the 
UIT fee and expense conditions of rule 12d1-4 may better protect 
acquiring fund shareholders from duplicative fees than the conditions 
in the exemptive orders.
    At the same time, the broader UIT fee and expense conditions of 
rule 12d1-4 relative to the exemptive orders may be more costly to 
implement and monitor relative to the conditions in the exemptive 
orders. In particular, rule 12d1-4 will impose one-time costs on funds 
to review the rule's requirement and modify, as necessary, their 
policies and procedures to comply with the rule. Our staff estimates 
that the one-time costs necessary to comply with the finding 
requirement related to fees and expenses of rule 12d1-4 will be equal 
to $13,187 per acquiring UIT and will result in an aggregate ongoing 
burden equal to $2.6 million for all affected acquiring UITs.\652\ UITs 
will not bear any ongoing implementation or monitoring costs because 
they are only required to evaluate the complexity of the structure and 
make a finding regarding the aggregate fees and expenses associated 
with the UIT's investment in an acquired fund at the time of initial 
deposit.
---------------------------------------------------------------------------

    \652\ This estimate is based on the following calculation: $2.6 
million = $13,187 initial internal and external burden per fund x 
200 acquiring UITs that will be subject to rule 12d1-4. $13,187 
initial internal and external burden per fund = [$12,253 initial 
internal burden per fund + $2,400 initial external burden per fund 
(see Table 8 in infra section VI.B.4.)] x (1--10% of the total 
burden associated with the recordkeeping requirements of rule 12d1-
4). 200 acquiring UITs that will be subject to rule 12d1-4 = 720 
UITs (see Table 1 in supra section V.B.1) x 40% of funds that are 
acquiring funds x 69% of acquiring UITs that will be subject to rule 
12d1-4 as estimated by a commenter (see supra footnote 534 and 
associated text). 40% of funds that are acquiring funds = 4,750 
acquiring funds (see Table 2 in supra section V.B.1)/11,788 funds 
(see Table 2 in supra section V.B.1). This estimate assumes that 
acquiring UITs with current investments in other funds beyond the 
limits of section 12(d)(1) will be subject to rule 12d1-4 at the 
same rate as the acquiring UITs with current investments in other 
funds within the limits of section 12(d)(1) following the rule 
adoption. This estimate also assumes that the percentage of 
management companies that are acquiring funds is the same as the 
percentage of UITs that are acquiring funds.
---------------------------------------------------------------------------

    To the extent that the fee and expense conditions of rule 12d1-4 
will increase operating costs for management

[[Page 73985]]

companies and UITs, management companies and UITs could pass through to 
investors any such cost increases in the form of higher operating 
expenses.
    Variable Annuity Separate Accounts. With respect to separate 
accounts funding variable insurance contracts,\653\ the rule's fees and 
expenses requirement is the same as the requirement in our current 
exemptive orders, and thus will not have a significant economic effect. 
However, to the extent that some insurance companies currently do not 
provide the same certification to acquiring funds (e.g., because the 
acquiring funds are able to rely upon section 12(d)(1)(G) and rule 
12d1-2 or their orders permit certifications with a different scope), 
acquiring funds will incur costs to request and insurance companies 
will incur costs to provide this certification.\654\ We lack data that 
would allow us to estimate how many insurance companies currently do 
not provide this certification. Relatedly, a commenter stated that its 
exemptive order requires that the insurance company make a 
representation to the Commission, rather than the acquiring fund, that 
the aggregate fees and expenses of the structure are reasonable.\655\ 
We believe that providing a certification to the acquiring fund rather 
than the Commission will impose minimal additional costs on insurance 
companies.\656\
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    \653\ See rule 12d1-4(b)(2)(iii).
    \654\ See PGIM Comment Letter.
    \655\ See Nationwide Comment Letter.
    \656\ See Table 9, infra section VI.B.5, for relevant cost 
estimates.
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v. Fund of Funds Investment Agreement
    Our current exemptive orders require a participation agreement 
between unaffiliated acquiring and acquired funds under which the funds 
agree to fulfill their responsibilities under the exemptive order. 
Unless the acquiring and acquired funds have the same investment 
adviser, rule 12d1-4 will require the acquiring and acquired funds to 
enter into a fund of funds investment agreement before the acquiring 
fund acquires securities of the acquired fund in excess of the limits 
of section 12(d)(1). The investment agreement must include: (i) Any 
material terms necessary for the adviser, underwriter, or depositor to 
have made the finding regarding the acquiring fund's investment in the 
acquired fund; (ii) a termination provision whereby either party can 
terminate the agreement with advance written notice within a period no 
longer than 60 days; \657\ and (iii) a provision whereby the acquired 
fund must provide the acquiring fund with fee and expense information 
to the extent reasonably requested. Hence, the fund of funds investment 
agreement in rule 12d1-4 is more comprehensive than the participation 
agreement in our exemptive orders because it (i) applies to both 
affiliated and unaffiliated fund of funds structures (unless the 
acquiring and acquired funds share the same primary investment adviser) 
while the participation agreement in our exemptive orders only applies 
to unaffiliated funds; and (ii) encompasses a broader set of 
conditions.\658\
---------------------------------------------------------------------------

    \657\ Our exemptive orders do not mandate a specific termination 
right in the participation agreement. However, the exemptive orders 
allow acquired funds to terminate the participation agreement 
subject solely to the giving of notice to a Fund of Funds and the 
passage of a reasonable notice period and some of the current 
participation agreements contain a 60-day termination provision. See 
supra footnote 356.
    \658\ Similar to the participation agreement in our exemptive 
orders, the fund of funds investment agreement in rule 12d1-4 will 
allow acquired funds to block the acquisition of their shares by 
certain acquiring funds beyond the limits of section 12(d)(1) by 
refusing to enter into a fund of funds investment agreement with the 
acquiring fund.
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    The benefit of a more comprehensive fund of funds investment 
agreement relative to the participation agreement is that it will 
enhance investor protection. First, the fund of funds investment 
agreement will protect investors in both certain affiliated and 
unaffiliated fund of funds structures from acquiring funds' undue 
influence, duplicative fees, and complex fund of funds structures. 
Second, it will allow acquiring and acquired fund boards to monitor 
better investment advisers' conflicts of interest and the findings of 
the acquiring and acquired fund investment advisers in the context of 
the fund of funds arrangement.\659\ Third, the fund of funds investment 
agreements will provide a mechanism for acquiring and acquired funds to 
terminate the arrangement if it is no longer in their respective best 
interest. Finally, the fund of funds investment agreement will require 
acquired funds to provide fee and expense information to the acquiring 
fund, which will assist the acquiring fund's adviser with assessing the 
impact of fees and expenses associated with an investment in an 
acquired fund.
---------------------------------------------------------------------------

    \659\ See rule 12d1-4(c)(1) recordkeeping requirements.
---------------------------------------------------------------------------

    By requiring fund of funds investment agreements for both 
affiliated and unaffiliated funds of funds, rule 12d1-4 will level the 
playing field for small and large fund complexes relative to the 
exemptive orders. Funds in smaller complexes are less likely to have 
sufficient investment opportunities within the fund complex than funds 
in larger complexes, and thus are more likely to structure unaffiliated 
funds of funds and bear the costs associated with a participation 
agreement. Under our current exemptive orders, participation agreements 
are only required in the case of unaffiliated funds of funds, which may 
impose a relatively higher burden on funds in smaller complexes. Rule 
12d1-4 will require funds to enter into a fund of funds investment 
agreement both in the case of unaffiliated and affiliated funds of 
funds (except when the acquiring and acquired funds share the same 
primary adviser), which will level the playing field for funds that are 
more likely to structure unaffiliated funds of funds, that is, smaller 
fund complexes.
    The disadvantage of a more comprehensive set of conditions in the 
fund of funds investment agreements relative to the participation 
agreements is that fund of funds investment agreements will be more 
costly to implement and monitor than the participation agreements.\660\ 
In addition, funds of funds will bear incremental ongoing costs to 
implement the terms of and monitor compliance with the fund of funds 
investment agreements. Hence, the one-time and ongoing annual costs 
borne by acquiring and acquired funds as a result of the requirement to 
enter into fund of funds investment agreements will be $12,142 for each 
fund that enters into a fund of funds investment agreement and will 
result in an aggregate burden equal to $112.2 million for all funds 
that enter into a fund of funds investment agreement.\661\
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    \660\ As noted above, fund of funds investment agreements 
entered into under the rule will be considered material contracts 
and thus must be filed as exhibits to each fund's registration 
statement. See supra footnote 359 and accompanying text. While we 
believe currently that some funds may similarly file participation 
agreements that are entered into under our exemptive orders as 
exhibits, this certainty regarding fund of funds investment 
agreements could result in increased costs to ensure that they are 
filed. Several commenters argued that the cost of entering into a 
participation agreement is small, especially because of the 
standardization of terms and the broad use of participation 
agreements in the industry. See, e.g., Fidelity Comment Letter; 
Hancock Comment Letter. We expect that the costs associated with 
preparing and monitoring the fund of funds investment agreements may 
decrease over time as the fund of funds investment agreements become 
more standardized.
    \661\ This estimate is based on the following calculation: 
$112.2 million = [$9,364 internal burden per fund + $2,778 external 
burden per fund (see infra Table 6 in section VI.B.2.)] x 9,240 
acquiring-acquired fund pairs that that do not share the same 
investment adviser and will be subject to rule 12d1-4. 9,240 
acquiring-acquired fund pairs that that do not share the same 
investment adviser and will be subject to rule 12d1-4 = 13,391 
acquiring-acquired fund pairs that do not share the same investment 
adviser x 69% of acquiring-acquired fund pairs that will be subject 
to rule 12d1-4 as estimated by a commenter (see supra footnote 534 
and associated text). 13,391 acquiring-acquired fund pairs that do 
not share the same investment adviser = 30,548 acquiring-acquired 
fund pairs x 44% of the acquiring-acquired fund pairs that do not 
share the same investment adviser. We use data from Item C.9 of Form 
N-CEN to identify a fund's investment adviser. 30,548 acquiring-
acquired fund pairs = 24,689 acquiring-acquired fund pairs 
identified using Form N-PORT data x [14,605 registered investment 
companies (see Table 1 in supra section V.B.1) + 83 BDCs (see supra 
footnotes 558 and 559 and associated text)]/[11,788 management 
companies (see Table 2 in supra section V.B.1) + 83 BDCs (see supra 
footnotes 558 and 559 and associated text)]. We lack data that would 
allow us to identify acquiring-acquired fund pairs, for which the 
acquiring fund is a BDC or a registered investment company that is 
not a management company. Hence, we assume that acquiring BDCs and 
acquiring registered investment companies that are not management 
companies invest in the same number of unique acquired funds as the 
management companies. Our estimate also assumes that acquiring-
acquired fund pairs that are structured beyond the limits of section 
12(d)(1) will be subject to rule 12d1-4 at the same rate as 
acquiring-acquired fund pairs that are structured within the limits 
of section 12(d)(1) following the rule adoption. Our estimate is 
likely an upper bound of the cost associated with fund of funds 
investment agreements because funds of funds that currently have 
participation agreements in place will only be required to enter 
into a fund of funds investment agreement if the acquiring fund 
purchases additional shares of the acquired fund in reliance on the 
rule.

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[[Page 73986]]

vi. 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 our 
current exemptive orders, rule 12d1-4 will prohibit an acquired fund 
from investing beyond the statutory limits in both registered funds and 
private funds subject to limited exceptions.\662\ Nevertheless, the 
final rule will also expand the complex structures prohibitions 
included in the exemptive orders in the following ways. First, rule 
12d1-4 will prohibit a fund from acquiring in excess of the limits in 
section 12(d)(1)(A) of the Act (either in reliance on section 
12(d)(1)(G) or rule 12d1-4) the outstanding voting securities of an 
acquiring fund.\663\ Second, the rescission of the current exemptive 
orders will result in the prohibition of multi-tier structures formed 
in reliance on section 12(d)(1)(G) and those exemptive orders.\664\
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    \662\ See rule 12d1-4(b)(3)(ii).
    \663\ See rule 12d1-4(b)(3)(i).
    \664\ As discussed above, an acquiring fund relying on section 
12(d)(1)(G) currently can invest in an acquired fund that invests in 
another fund beyond the limits of section 12(d)(1) in reliance on an 
exemptive order.
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    The additional complex structures prohibitions of the final rule 
will limit the creation of multi-tier structures that historically were 
associated with investor confusion and duplicative and excessive fees 
before the enactment of section 12(d)(1).\665\ Hence, the complex 
structures conditions of the final rule will enhance investor 
protection.
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    \665\ As discussed above in section II.C.3.b, multi-tier 
structures may be difficult for investors to understand even with 
comprehensive disclosures. Accordingly, the rule includes a general 
prohibition on three-tier structures, subject to enumerated 
exceptions and the 10% Bucket for acquired fund investments in other 
investment companies. See rule 12d1-4(b)(3).
---------------------------------------------------------------------------

    At the same time, the final rule will impose costs on funds that 
may be required to reallocate their portfolio to ensure compliance with 
the rule. In particular, multi-tier structures that have been formed in 
reliance on exemptive orders or a combination of exemptive orders and 
section 12(d)(1)(G) will need to be restructured to the extent that the 
acquiring fund chooses to invest additional amounts in the existing 
acquired funds in reliance on this rule. In particular, the top-tier 
acquiring funds will be required to reallocate their investments to 
funds that do not invest in underlying funds beyond the 10% limit of 
rule 12d1-4. Alternatively, the top-tier acquiring funds can invest in 
the same acquired funds, but those acquired funds will incur costs to 
reduce their investments in other funds to comply with the limits of 
rule 12d1-4. Our analysis shows 23 multi-tier structures that are at 
least three tiers and one multi-tier structure that is four-tiers, for 
which there is at least one acquiring fund in each level that invests 
beyond the limits of section 12(d)(1) in at least one acquired 
fund.\666\ For those 23 top-tier acquiring funds, 3.56% of their assets 
are invested in the second-tier acquired funds that invest in a third-
tier acquired fund, and 2.93% of their assets are invested in the 
third-tier acquired funds, on average. Our analysis, however, should be 
interpreted with caution because our data does not allow us to 
distinguish how many of these 23 multi-tier structures are consistent 
with the exceptions to the complex structures prohibitions of rule 
12d1-4.
---------------------------------------------------------------------------

    \666\ See supra footnote 551 and associated text.
---------------------------------------------------------------------------

    Section VI.C.1.a above provides a detailed discussion of the costs 
associated with portfolio reallocations. Any costs that funds will 
incur to restructure their investments will be moderated by the fact 
that funds will have a period to bring their operations into compliance 
with the final rule.\667\
---------------------------------------------------------------------------

    \667\ See supra section III.
---------------------------------------------------------------------------

    In addition, funds that will operate in accordance with rule 12d1-4 
to create fund of funds structures will need to implement policies and 
procedures to monitor their investments in other funds beyond the 
limits of section 12(d)(1) to ensure compliance with the complex 
structures conditions of rule 12d1-4. We believe that any such 
additional costs may be mitigated to the extent that many of the 
complex structures conditions of rule 12d1-4 are similar to the complex 
structures conditions in our exemptive orders and funds already have 
policies and procedures to monitor their investments in other funds for 
compliance with the terms of the exemptive orders. Those policies and 
procedures may be leveraged to monitor compliance with the complex 
structures conditions of rule 12d1-4.
    Finally, as discussed in detail in Section V.C.1.i above, the 
restrictions on multi-tier structures will affect both current and 
prospective funds by restricting their investment flexibility, thus 
reducing investment options available to fund investors.
vii. Recordkeeping
    Our exemptive orders generally require the unaffiliated acquiring 
and acquired funds to maintain (i) records of the exemptive order; (ii) 
records of the participation agreement; and (iii) a list of the names 
of each fund of funds affiliate and underwriting affiliate. Further, 
our exemptive orders require the unaffiliated acquired funds to 
maintain a written copy of the policies and procedures (and any 
modifications to such policies and procedures) that the acquired funds 
put in place to monitor any purchases of securities from the acquiring 
fund or its affiliates. The recordkeeping requirements in our exemptive 
orders are for a period of not less than six years, and the records 
must be maintained in an easily accessible place in the first two 
years.
    Rule 12d1-4 will require both affiliated and unaffiliated acquiring 
and acquired funds to maintain (i) a copy of each fund of funds 
investment agreement; (ii) for management companies and UITs, a written 
record of the acquiring and acquired funds' evaluations and findings, 
and the basis for such evaluations and findings; and (iii) for separate 
accounts funding variable insurance contracts, the certification 
provided by the insurance company. Rule 12d1-4 will require 5 years of 
recordkeeping and, similar to the orders, it will require records to be 
maintained in an easily accessible place in the first two years.
    The recordkeeping requirements of rule 12d1-4 are more extensive 
than the recordkeeping requirements in our

[[Page 73987]]

exemptive orders because (i) they apply to both affiliated and 
unaffiliated funds of funds while the recordkeeping requirements in our 
exemptive orders only apply to unaffiliated funds of funds; and (ii) 
they apply to both acquiring and acquired funds while only certain of 
the recordkeeping requirements in our exemptive orders apply to both 
acquiring and acquired funds.\668\ At the same time, the recordkeeping 
requirements of rule 12d1-4 have a shorter duration than the 
recordkeeping requirements of our exemptive orders (i.e., five years 
under the rule instead of six years under the orders). Further, the 
undue influence findings of rule 12d1-4 are only required prior to the 
initial acquisition of the acquired fund shares while the 
determinations in our exemptive orders apply periodically (i.e., at 
least annually). Consequently, the associated recordkeeping of rule 
12d1-4 will be less burdensome than the associated recordkeeping in our 
exemptive orders.
---------------------------------------------------------------------------

    \668\ The recordkeeping requirements in our exemptive orders 
related to purchases in affiliated underwritings only apply to 
acquired funds.
---------------------------------------------------------------------------

    The benefit of any more extensive recordkeeping requirements is 
that they will allow for Commission examinations of investment 
advisers' investing decisions, which may ultimately benefit fund 
investors. The disadvantage of any more extensive recordkeeping 
requirements of rule 12d1-4 relative to our exemptive orders is that it 
will impose higher costs on funds and their investors. We estimate that 
each acquiring and acquired management company will bear annual 
recordkeeping costs equal to $5,021, each acquiring UIT will bear 
annual recordkeeping costs equal to $1,465, each separate account will 
bear annual recordkeeping costs equal to $65, and each fund that enters 
into a fund of funds investment agreement will bear annual 
recordkeeping costs equal to $954, which will result in aggregate 
ongoing annual recordkeeping costs equal to $40.1 million.\669\
---------------------------------------------------------------------------

    \669\ This estimate is based on the following calculation: $40.1 
million = $14.6 million recordkeeping cost associated with the undue 
influence finding of rule 12d1-4 for acquired management companies + 
$16.5 million recordkeeping cost associated with the fee and expense 
finding of rule 12d1-4 for acquiring management companies + $0.3 
million recordkeeping cost associated with the fee and expense 
finding for acquiring UITs + $0.01 million recordkeeping cost 
associated with the recordkeeping requirement for separate accounts 
+ $8.8 million recordkeeping cost associated with the fund of funds 
investment agreement. $14.6 million recordkeeping cost associated 
with the undue influence finding of rule 12d1-4 for acquired 
management companies = [$14,994 initial and annual internal burden 
per fund + $35,220 initial external burden per fund (see Table 7 in 
infra section VI.B.3.)] x 10% of the total burden that is associated 
with the recordkeeping requirements of rule 12d1-4 x 2,900 acquired 
management companies that will be subject to rule 12d1-4 (see supra 
footnote 646). $16.5 million recordkeeping cost associated with the 
fee and expense finding of rule 12d1-4 for acquiring management 
companies = [$14,994 initial and annual internal burden per fund + 
$35,220 initial external burden per fund (see Table 7 in infra 
section VI.B.3.)] x 10% of the total burden that is associated with 
the recordkeeping requirements of rule 12d1-4 x 3,278 acquiring 
management companies that will be subject to rule 12d1-4 (see supra 
footnote 651). $0.3 million recordkeeping cost associated with the 
fee and expense finding for acquiring UITs = [$12,253 initial 
internal burden per fund + $2,400 initial external burden per fund 
(see Table 8 in infra section VI.B.4.)] x 10% of the total burden 
that is associated with the recordkeeping requirements of rule 12d1-
4 x 200 acquiring UITs that will be subject to rule 12d1-4 (see 
supra footnote 652). $0.01 million recordkeeping cost associated 
with the recordkeeping requirement for separate accounts = $649 
internal burden per fund (see Table 9 in infra section VI.B.5) x 10% 
of the total burden that is associated with the recordkeeping 
requirements of rule 12d1-4 x 191 acquiring separate accounts that 
will be subject to rule 12d1-4. 191 acquiring separate accounts that 
will be subject to rule 12d1-4 = [430 variable annuity separate 
accounts registered as UITs (see Table 1 in supra section V.B.1) + 
243 variable life insurance separate accounts registered as UITs 
(see Table 1 in supra section V.B.1) + 14 management company 
separate accounts (see Table 1 in supra section V.B.1)] x 40% of 
funds that are acquiring funds (see supra footnote 652) x 69% of 
acquiring separate accounts that will be subject to rule 12d1-4 as 
estimated by a commenter (see supra footnote 534 and associated 
text). This estimate assumes that acquiring separate accounts with 
current investments in other funds beyond the limits of section 
12(d)(1) will be subject to rule 12d1-4 at the same rate as the 
acquiring separate accounts with current investments in other funds 
within the limits of section 12(d)(1) following the rule adoption. 
This estimate also assumes that the percentage of management 
companies that are acquiring funds is the same as the percentage of 
separate accounts that are acquiring funds. $8.8 million 
recordkeeping cost associated with the fund of funds investment 
agreement = $954 recordkeeping cost associated with the fund of 
funds investment agreements (see Table 6 in infra section VI.B.2.) x 
9,240 acquiring-acquired funds pairs that that do not share the same 
investment adviser and will be subject to rule 12d1-4 (see supra 
footnote 661).
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2. Effects on Efficiency, Competition, and Capital Formation
i. Efficiency
    Efficiency of current and prospective acquiring funds' asset 
allocation. The final rule will have opposing effects on the efficiency 
of current and prospective acquiring funds' asset allocation. More 
specifically, the final rule may promote the efficiency of funds' asset 
allocation for the following reasons. First, the final rule will 
eliminate the need for funds to apply for an exemptive order to 
structure certain funds of funds.\670\ By eliminating the need for 
funds of funds to apply for an exemptive order, the final rule will 
reduce certain frictions in funds' asset allocation that are caused by 
the expense and delays associated with the exemptive order process, and 
thus may promote the efficient allocation of funds' assets.\671\
---------------------------------------------------------------------------

    \670\ See supra section V.B.2.a for discussion of the costs 
associated with the exemptive orders.
    \671\ See, e.g., Morningstar Comment Letter.
     See supra section V.B.2.a for discussion of costs associated 
with the exemptive order process.
---------------------------------------------------------------------------

    Second, rule 12d1-4 may increase the efficiency of certain funds' 
asset allocation. This is because rule 12d1-4 may increase funds' 
investment flexibility by expanding the scope of permissible acquiring 
and acquired funds relative to the current exemptive orders and 
broadening some of the exemptions to the complex structures 
prohibitions relative to the current exemptive orders and staff no-
action letters, and thus may make it easier for funds to create an 
investment portfolio that better meets their investors' risk-return 
preferences.
    Third, the final rule will create a more consistent and efficient 
regulatory framework for funds of funds than the existing regulatory 
framework for the following reasons.\672\ First, rule 12d1-4 provides 
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 final rule 
will eliminate the existing overlapping and potentially inconsistent 
conditions for funds of funds and harmonize conditions across different 
fund arrangements.\673\ This may remove obstacles to funds' investments 
and operations to the extent that regulatory consistency and efficiency 
decreases compliance and operating costs. By reducing compliance and 
operating costs, the final rule will further reduce frictions in asset 
allocation and may

[[Page 73988]]

promote the efficient allocation of funds' assets.
---------------------------------------------------------------------------

    \672\ See, e.g., Nationwide Comment Letter; Invesco Comment 
Letter; ICI Comment Letter; Advent Comment Letter; Hancock Comment 
Letter; Clifford Chance Comment Letter; Schwab Comment Letter; 
Blackrock Comment Letter; Morningstar Comment Letter for commenters 
agreeing with our assessment that rule 12d1-4 will create a more 
efficient regulatory framework for funds of funds.
    \673\ In particular, affiliated funds of funds currently can be 
structured either under section 12(d)(1)(G) and rule 12d1-2 or under 
exemptive orders, and each alternative subjects affiliated funds of 
funds to different conditions. In addition, funds that are 
structured under different exemptive orders may be subject to 
somewhat different conditions. Finally, unlike rule 12d1-4, our 
exemptive orders provide relief from section 12(d)(1) to a subset of 
registered investment companies and BDCs, and thus provide different 
levels of flexibility depending on the fund type.
---------------------------------------------------------------------------

    At the same time, the final rule may decrease the efficiency of 
certain funds' asset allocation by prohibiting certain existing funds 
of funds and requiring the restructuring of additional investments in 
other funds to ensure compliance with the rule. The new prohibition on 
certain fund structures may leave certain funds less able to diversify 
their investment portfolio or efficiently determine the funds in which 
they invest or their allocation of assets.
    In addition, the new conditions of rule 12d1-4, and the rule's 
omission of certain conditions contained in our exemptive orders, will 
also affect the cost of operations of funds of funds.\674\ 
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 will be to increase the cost 
of operations for funds of funds,\675\ those conditions may ultimately 
reduce the efficient allocation of acquiring fund assets.
---------------------------------------------------------------------------

    \674\ See supra section V.C.1.b for a detailed discussion of the 
costs and benefits of the new and omitted conditions.
    \675\ We believe that the new and omitted conditions of rule 
12d1-4 may increase certain funds' cost of operations but at the 
same time will enhance investor protection.
---------------------------------------------------------------------------

    Efficiency of the asset allocation of current and prospective 
acquiring fund investors. The final rule may promote the efficiency of 
investors' asset allocation. First, rule 12d1-4 will 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,\676\ fund advisers/sponsors might pass through to 
investors the cost savings associated with eliminating the need to 
apply for an exemptive order, which might result in lower fees and 
expenses for acquiring fund investors. Lower fees and expenses, in 
turn, might result in improved efficiency of investors' asset 
allocation because investors can achieve the same investment objectives 
at a potentially lower cost. Similarly, the final rule will create a 
more consistent and more efficient regulatory framework. Fund advisers/
sponsors might also pass through to investors any cost savings 
associated with a more consistent and efficient regulatory framework, 
which might result in lower fees and expenses, and more efficient 
allocation of acquiring fund investors' assets.
---------------------------------------------------------------------------

    \676\ See supra footnotes 611 and 612.
---------------------------------------------------------------------------

    Second, rule 12d1-4 may increase funds' investment flexibility by 
expanding the scope of permissible acquiring and acquired funds 
relative to the current exemptive orders and broadening some of the 
exemptions to the complex structures prohibitions relative to the 
current exemptive orders and staff no-action letters. The rule will 
therefore increase the diversity of available funds of funds and may 
promote the efficient allocation of acquiring fund investors' assets 
because investors will be better able to achieve their investment 
objectives.\677\
---------------------------------------------------------------------------

    \677\ Rule 12d1-4 may also increase innovation in the fund 
industry by allowing funds and advisers seeking exemptions to focus 
resources on novel products or arrangements rather than preparing 
and reviewing exemptive orders.
---------------------------------------------------------------------------

    Third, having one uniform rule that applies to registered 
investment companies and BDCs may improve acquiring fund investors' 
ability to efficiently allocate their assets because it will be easier 
for these investors to understand fund of funds operations and it will 
simplify across-fund comparisons of various fund characteristics (e.g., 
liquidity) because investors will no longer be required to adjust for 
differences in regulatory requirements across funds when making cross-
fund comparisons for investment decision-making purposes.\678\
---------------------------------------------------------------------------

    \678\ See, e.g., Morningstar Comment Letter.
---------------------------------------------------------------------------

    On the other hand, there are ways in which the final rule might 
reduce the efficiency of investors' asset allocation. In particular, 
the final rule may increase the costs of operations for acquiring and 
acquired funds because the cost of implementation and monitoring of the 
rule's conditions may be higher than the cost of implementation and 
monitoring of the conditions in our current exemptive orders. To the 
extent that any increased costs are passed through to investors, the 
fees and expenses for acquiring and acquired fund investors may 
increase. Higher fees and expenses, in turn, might negatively affect 
the efficiency of investors' asset allocation. In addition, rule 12d1-4 
might decrease the diversity of funds of funds' investment strategies 
because it might reduce acquiring funds' investment flexibility by 
decreasing their ability to create certain multi-tier structures. A 
decrease in the diversity of available funds of funds may reduce the 
efficient allocation of investors' assets because investors may be less 
able to achieve their investment objectives.
    Efficiency of prices of acquired funds and their underlying assets. 
The final rule may have opposing effects on the efficiency of prices of 
acquired funds and their underlying assets. In particular, the final 
rule may have a positive impact on the efficiency of the prices of 
acquired funds and their underlying assets. More specifically, rule 
12d1-4 may (i) increase the diversity of certain funds of funds by 
expanding the scope of permissible acquiring and acquired funds; \679\ 
(ii) increase the number of available funds of funds by eliminating the 
need to apply for an exemptive order and by creating a more consistent 
and more efficient regulatory framework; and (iii) enhance investor 
protection against acquiring funds' undue influence, duplicative fees, 
and complex structures. The potential increase in the diversity and 
number of funds of funds and the enhancement of investor protection may 
increase the attractiveness of funds of funds, and thus might increase 
investors' demand for funds of funds. The increased investor demand for 
funds of funds may 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 may increase trading interest for those assets. 
Higher trading interest might lead to higher liquidity, lower trading 
costs, improved information production, and thus more efficient prices 
for those assets.\680\
---------------------------------------------------------------------------

    \679\ As discussed in section V.C.1.a.i. above, the net effect 
of the final rule on funds' investment flexibility is unclear. To 
the extent that the final rule will decrease funds' investment 
flexibility, it could decrease the diversity of available funds of 
funds.
    \680\ See, e.g., Anat R. Admati & Paul Pfleiderer, A Theory of 
Intraday Patterns: Volume and Price Variability, 1 Rev. Fin. Stud. 3 
(1988); Tarun Chordia, Richard Roll, & Avanidhar Subrahmanyam, 
Liquidity and Market Efficiency, 87 J. Fin. Econ. 249 (2008). For 
ETFs, there is mixed evidence on the effects of ETF ownership on the 
liquidity and price efficiency of underlying assets. See 2019 ETF 
Adopting Release, supra footnote 25, at 57219 for a more detailed 
discussion.
---------------------------------------------------------------------------

    In addition, the final rule may increase the price efficiency of 
listed acquired funds (i.e., ETFs, ETMFs, listed closed-end funds, and 
listed BDCs) because investors may increase their investments in those 
funds through investments in funds of funds rather than investing 
directly in those funds. Consequently, the funds' investor base may 
shift from individual investors to acquiring funds. A shift of certain 
funds' investor base to more financially sophisticated investors may in 
turn result in more efficient prices for listed acquired funds.\681\ 
Financially

[[Page 73989]]

sophisticated investors may improve price efficiency through both 
aggressive and passive trading.\682\ For example, financially 
sophisticated investors may tend more frequently to trade based on 
information obtained through their research and analysis (i.e., 
aggressive trading). To the extent they perceive a potentially 
profitable trading opportunity, they must execute their trades while 
the security remains potentially mispriced before their information 
gets impounded into prices. Hence, financially sophisticated investors 
that trade on information may tend to place aggressive orders that move 
prices closer to fundamentals. Financially sophisticated investors may 
also improve price efficiency by providing liquidity to uninformed 
traders (i.e., passive trading). More specifically, to the extent 
financially sophisticated investors may be able to distinguish between 
informed and uninformed investors, financially sophisticated investors 
may be more willing to provide liquidity to uninformed investors, and 
thus improve price efficiency by enhancing market liquidity.
---------------------------------------------------------------------------

    \681\ See, e.g., Eli Bartov, Suresh Radhakrishnan, & Itzhak 
Krinsky, Investor Sophistication and Patterns in Stock Returns after 
Earnings Announcements, 75 Acc. Rev. 43 (2000); Joseph D. Piotroski 
& Darren T. Roulstone, The Influence of Analysts, Institutional 
Investors, and Insiders on the Incorporation of Market, Industry, 
and Firm-Specific Information into Stock Prices, 79 Acc. Rev. 1119 
(2004); Ekkehart Boehmer & Eric K. Kelley, Institutional Investors 
and the Informational Efficiency of Prices, 22 Rev. Fin. Stud. 3563 
(2009) (``Boehmer & Kelley (2009)''). See also Franklin Comment 
Letter (arguing that the final rule will increase institutional 
ownership for BDCs, which ``would support BDC share prices, trading 
volume and the depth and liquidity of the BDC market . . . promote 
better corporate governance and management oversight as well as more 
insightful analysis of the BDC market through increased third-party 
analyst coverage and research reports . . . [and] support capital 
formation while decreasing BDCs' cost of capital, meaning that BDCs 
could invest more, and on better terms, in the portfolio companies 
that rely on them.'').
    \682\ Boehmer & Kelley (2009), supra footnote 681.
---------------------------------------------------------------------------

    On the other hand, any potential increase in acquiring and acquired 
funds' cost of operations as a result of the more comprehensive 
conditions of rule 12d1-4 relative to the conditions in the exemptive 
orders and rule 12d1-2, and any potential decrease in available fund of 
funds structures due to additional prohibitions on multi-tier 
structures, will have the opposite effect on the efficiency of prices 
of acquired funds and their underlying assets.
ii. Competition
    Certain aspects of the final rule may have opposing effects on fund 
competition. On one hand, the final rule might promote competition in 
the fund industry for the following reasons. First, to the extent that 
rule 12d1-4 increases acquiring funds' investment flexibility, the 
final rule might promote competition in the fund industry because it 
will increase the diversity of available funds of funds.\683\ Second, 
the final rule will level the playing field for funds by expanding the 
scope of permissible acquiring and acquired funds, mandating the same 
conditions for similar funds of funds, and imposing more similar 
conditions on affiliated and unaffiliated fund of funds 
structures.\684\ A more level playing field might increase competition 
in the fund industry because it will allow various funds to operate 
under similar regulatory restrictions and thus funds will bear similar 
costs associated with regulatory restrictions. To the extent that 
regulatory inefficiencies and inconsistencies might hamper funds' 
investment and growth, an increase in regulatory consistency and 
efficiency might result in the creation of more funds of funds, which 
might increase competition in the fund industry. Fourth, rule 12d1-4 
will remove the need to apply for an exemptive order and thus will 
decrease the cost of setting up a fund of funds. To the extent that a 
decrease in the cost of setting up a fund of funds may lower the 
barriers to entry for new funds of funds, it thus might increase 
competition in the fund industry.\685\
---------------------------------------------------------------------------

    \683\ 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. 
Econ. Stud. 3 (1982).
    \684\ See, e.g., Morningstar Comment Letter. 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 final rule will level the playing field for funds 
because it will 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 will be limited by the fact that 
different funds face different levels of restrictions on their 
investments that are unrelated to rule 12d1-4 (see, e.g., supra 
footnote 39 for restrictions on BDC investments).
    \685\ Any beneficial effects of the rule on competition may be 
muted to the extent that existing funds of funds may incur costs to 
comply with the rule conditions (e.g., costs associated with 
portfolio restructuring).
---------------------------------------------------------------------------

    At the same time, to the extent that the final rule will decrease 
certain funds' investment flexibility or increase the cost of 
operations for certain funds that will operate in accordance with rule 
12d1-4, it might reduce competition among funds of funds because it 
will decrease the diversity of available funds of funds.
iii. Capital Formation
    The impact of the final rule on capital formation is unclear. On 
one hand, the final rule might have a positive effect on capital 
formation if it causes investors to commit more of their financial 
resources to investments in securities in aggregate. Specifically, the 
potential increase in fund investment flexibility, the potential 
leveling of the playing field as a result of the final rule, the 
increase in regulatory consistency and efficiency, and the potential 
decrease in the operating costs of prospective funds of funds as a 
result of removing the need to apply for an exemptive order may 
increase the number and diversity of funds of funds. An increase in the 
number and diversity of funds of funds may attract additional 
investment in funds of funds, and ultimately increase demand for the 
funds of funds' underlying securities. Investor demand for funds of 
funds also may increase as a result of the new conditions of rule 12d1-
4, which will enhance investor protection. As a result of the increased 
demand for the firms' equity and debt securities, companies might be 
able to issue new debt and equity at higher prices, and therefore 
decrease the cost of capital of firms, thus facilitating capital 
formation.\686\
---------------------------------------------------------------------------

    \686\ 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. 
Fin. 1325 (1991).
---------------------------------------------------------------------------

    On the other hand, to the extent that single-tier funds and funds 
of funds are purely substitute investments, an increase in investors' 
demand for funds of funds may decrease the demand for single-tier fund 
structures, leaving aggregate demand for the underlying securities 
unchanged. Consequently, under this scenario, there will be no change 
in the amount of money that flows to issuers and there will be no 
impact on capital formation as a result of the final rule. In addition, 
a potential increase in the operating costs of acquiring and acquired 
funds as a result of the rule's conditions may reduce capital formation 
to the extent that there is a decrease in the amount of money available 
to be employed in value-generating activities.
    At the same time, the potential decrease in fund investment 
flexibility and the potential increase in the funds' cost of operations 
as a result of the final rule may have the opposite effect on capital 
formation. In particular, the potential decrease in fund investment 
flexibility and the potential increase in the funds' cost of operations 
may decrease the number and diversity of funds of funds. A decrease in 
the number and diversity of funds of funds may discourage investments 
in funds of

[[Page 73990]]

funds, and ultimately decrease demand for the funds of funds' 
underlying securities. As a result of the decreased demand for the 
firms' equity and debt securities, companies may be forced to issue new 
debt and equity at lower prices, and therefore increase the cost of 
capital of firms, thus impeding capital formation.
    Nevertheless, we do not expect that the final rule will have 
significant effects on investors' investment rates.

D. Reasonable Alternatives

1. Retain Existing Exemptive Relief
    As discussed in section III above, we are rescinding, as proposed, 
the exemptive relief permitting fund of funds arrangements that fall 
within the scope of rule 12d1-4. Alternatively, we could allow existing 
funds of funds to choose whether to operate indefinitely under the 
existing exemptive relief or rule 12d1-4, and require only new funds of 
funds to comply with rule 12d1-4.\687\ The benefit of such an 
alternative would be that existing funds of funds would not incur the 
one-time switching costs from the exemptive order conditions to the 
conditions of rule 12d1-4 and will not incur costs associated with 
reduced investment flexibility as a result of the complex structure 
conditions of the rule relative to the exemptive orders,\688\ which 
could ultimately benefit those funds' investors. 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 rule's new requirements 
relating to fund of funds investment agreements, findings, and multi-
tier structures. Consequently, unlike the final rule, this alternative 
would establish a less uniform regulatory framework governing fund of 
funds arrangements and would not include the benefit of enhanced 
investor protection that is afforded by the rule's conditions.
---------------------------------------------------------------------------

    \687\ See supra footnote 493.
    \688\ See supra section V.C.1.a.i for a comparison of the 
complex structure conditions of rule 12d1-4 relative to the 
exemptive orders.
---------------------------------------------------------------------------

2. Retain Rule 12d1-2
    We considered not rescinding rule 12d1-2 but instead allowing funds 
to operate under either rule 12d1-4 or section 12(d)(1)(G) and rule 
12d1-2.\689\ The advantage of such an approach would be that funds that 
choose to operate in accordance with section 12(d)(1)(G) and rule 12d1-
2 will not be required to modify their operations to comply with the 
conditions of rule 12d1-4 and incur the associated costs or potentially 
restructure their investments to comply with the amended regulatory 
framework.\690\ The main disadvantages of such an alternative would be 
that (i) various funds would not operate under a consistent and 
efficient regulatory framework because similar funds of funds would 
operate under different conditions; and (ii) investors in affiliated 
funds of funds would not enjoy the enhanced investor protection 
afforded by the conditions of rule 12d1-4.
---------------------------------------------------------------------------

    \689\ See supra footnote 450. Our analysis shows that there are 
954, or 20%, of all acquiring funds that currently rely on section 
12(d)(1)(G) and rule 12d1-2 to structure affiliated funds of funds. 
See supra section V.B.1.
    \690\ Many commenters opposed the rescission of rule 12d1-2. 
See, e.g., Allianz Comment Letter; Invesco Comment Letter; Thrivent 
Comment Letter, PIMCO Comment Letter; Fidelity Rutland Comment 
Letter; Schwab Comment Letter; NYC Bar Comment Letter; PGIM Comment 
Letter, BlackRock Comment Letter; ABA Comment Letter; SIFMA AMG 
Comment Letter; Capital Group Comment Letter. See supra section 
II.D.1 for detailed discussion of arguments raised by commenters. 
Some of the commenter concerns may have been addressed given that 
the rule will not include a redemption limit and the rule will 
permit acquired funds to invest up to 10% of their assets in other 
funds.
---------------------------------------------------------------------------

3. Allow Private and Unregistered Investment Companies To Rely on Rule 
12d1-4
    As discussed above, rule 12d1-4 will permit certain registered 
investment companies and BDCs to invest in certain registered 
investment companies and BDCs beyond the limits in section 12(d)(1). 
Alternatively, we could expand the scope of rule 12d1-4 to allow 
private funds and unregistered investment companies to rely on the rule 
as acquiring funds.\691\ Expanding rule 12d1-4 in this manner would (i) 
increase investment flexibility for private and unregistered acquiring 
funds and their investors; (ii) level the playing field across 
registered and private and unregistered acquiring funds because they 
would enjoy the same investment flexibility and be subject to the same 
conditions; and (iii) benefit acquired registered investment companies 
and BDCs by increasing private and unregistered funds' investments in 
them, thus enhancing their liquidity and increasing their scale, which 
would result in efficiency gains for those acquired funds.\692\
---------------------------------------------------------------------------

    \691\ See supra footnote 47 for commenters supporting this 
alternative.
    \692\ See, e.g., MFA Comment Letter; Parallax Comment Letter; 
NYC Bar Comment Letter; Dechert Comment Letter; Blackrock Comment 
Letter discussing the benefits of expanding the scope of rule 12d1-4 
to private funds and unregistered investment companies.
---------------------------------------------------------------------------

    Nevertheless, we continue to believe that there are risks 
associated with expanding 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 registered investment companies.\693\ 
Accordingly, the Commission does not receive routine reporting on the 
amount and duration of private fund or unregistered investment company 
investments in registered funds. Without imposing reporting 
requirements on private funds and unregistered investment companies, it 
would be difficult for the Commission to monitor potential undue 
influence by such funds, or to monitor their compliance with rule 12d1-
4. Second, private funds and unregistered investment companies are not 
subject to the governance and compliance requirements under the 
Investment Company Act, which are designed to protect investors and 
reduce conflicts of interest that are inherent in a fund structure and 
are integral to the oversight and monitoring provisions of rule 12d1-4 
for registered funds. Third, unregistered foreign funds' investments in 
U.S. registered funds have raised concerns of abuse and undue influence 
in the past, which gave rise to Congress's amendments to section 
12(d)(1) in 1970. Finally, as commenters noted, the Commission does not 
have experience with this type of fund of funds arrangement because it 
has not yet extended exemptive relief allowing such funds to acquire 
other investment companies in excess of the section 12(d)(1) 
limits.\694\ Without that experience, the Commission is not able to 
determine at this time that the rule's conditions and protections would 
apply as appropriately to private funds and unregistered investment 
companies or be properly tailored to prevent the abuses that led 
Congress to enact section 12(d)(1).
---------------------------------------------------------------------------

    \693\ See supra section II.A.2.
    \694\ See supra footnote 53.
---------------------------------------------------------------------------

4. Codify Current Conditions in Existing Exemptive Orders
    As discussed above, rule 12d1-4 will not include certain conditions 
contained in current exemptive orders that we believe are not necessary 
to prevent the abuses that section 12(d)(1) seeks to curtail in light 
of the new conditions being adopted. Rule 12d1-4 also will include new 
conditions to address the potential for undue influence, complex 
structures, or duplicative fees. Alternatively, we could

[[Page 73991]]

codify the conditions contained in existing exemptive orders rather 
than replacing certain conditions with alternative conditions as 
contained in rule 12d1-4.\695\
---------------------------------------------------------------------------

    \695\ See supra footnote 488.
---------------------------------------------------------------------------

    This alternative approach would not impose the costs associated 
with the new conditions in rule 12d1-4, 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 
rule because of cross-sectional variation in the conditions of the 
exemptive orders. We also 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 not necessary in 
light of the new conditions of rule 12d1-4. In particular, we believe 
that the conditions in rule 12d1-4 may enhance investor protection 
relative to the exemptive orders by imposing certain requirements 
(i.e., findings and fund of funds investment agreement) on both 
affiliated and unaffiliated funds of funds and by prohibiting certain 
multi-tier structures.
5. 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 
Adopted Control Limit
    As discussed in section II.C.1.a above, to address concerns about 
one fund exerting undue influence over another fund, rule 12d1-4 is not 
available when an acquiring fund together with its advisory group 
controls the acquired fund. Rule 12d1-4 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. Rule 12d1-4 
includes an exception for funds that are in the same group of 
investment companies. Rule 12d1-4 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.\696\ A lower limit could 
provide additional assurance that rule 12d1-4 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.\697\ However, a 
lower limit could hamper the acquiring fund's ability to achieve its 
investment strategy in an efficient and cost effective manner.\698\
---------------------------------------------------------------------------

    \696\ Some commenters argued that the control condition should 
be lower than 25% for acquired closed-end funds because closed-end 
funds are frequently subject to investor activism. See, e.g., 
Gabelli Comment Letter; Comment Letter of John Birch (April 22, 
2019); Comment Letter of Kuni Nakamura (April 25, 2020); Advent 
Comment Letter. See also supra footnotes 121 and 122. Other 
commenters, however, argued that the 25% threshold is appropriate 
because investor activism can be beneficial to fund investors. See, 
e.g., Saba Comment Letter; City of London Comment Letter. As a 
response to commenters that argued that investor activism for 
closed-end funds is harmful, we note that academic literature 
provides evidence consistent with the idea that investor activism 
can be beneficial for closed-end fund investors because it has the 
potential to increase the market value of closed-end funds and 
mitigate managerial entrenchment. See, e.g., Matthew E. Souther, The 
Effects of Takeover Defenses: Evidence from Closed-End Funds, 119 J. 
Fin. Econ. 420 (2016); Michael Bradley et al., Activist Arbitrage: A 
Study of Open-Ending Attempts of Closed-End Funds, 95 J. Fin. Econ. 
1 (2010).
    \697\ 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. Rule 12d1-4 also 
contains a number of conditions aimed at protecting acquired funds 
from acquiring funds' undue influence.
    \698\ 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.\699\ 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 already have established policies and 
procedures to monitor compliance with the aggregation requirement 
embedded in the 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 will 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.\700\
---------------------------------------------------------------------------

    \699\ See supra footnotes 106-110.
    \700\ For example, a family of target date funds tends to invest 
in different proportional allotments of the same underlying funds.
---------------------------------------------------------------------------

    Similarly, we could impose a limit higher than 25%, which would 
provide acquiring funds with greater investment flexibility. However, 
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 influence the acquired 
fund for the benefit of the acquiring fund's shareholders, advisers, or 
sponsors to the detriment of acquired fund investors.
6. Permit Multi-Tier Fund Structures
    As discussed above, rule 12d1-4 will limit the creation of certain 
multi-tier structures. As an alternative, we could allow all multi-tier 
fund structures that are currently permissible.\701\ While this 
alternative would provide greater flexibility to funds to meet their 
investment objectives, the organizational complexity of multi-tier fund 
structures could make it difficult for acquired fund investors to 
understand who controls the fund and acquiring fund investors may find 
it difficult to understand the true asset exposure of the acquiring 
fund.\702\ It could also raise concerns associated with duplicative and 
excessive fees. Additionally, we believe that the rule's exceptions to 
the multi-tier structures prohibition and 10% Bucket provide sufficient 
investment and funding flexibility to acquiring and acquired funds.
---------------------------------------------------------------------------

    \701\ See supra footnotes 369, 370, 371, and 373.
    \702\ Alternatively, concerns of investor confusion could be 
addressed by increasing disclosure requirements regarding multi-tier 
structures. However, we believe that enhanced disclosure 
requirements may not be sufficient to mitigate concerns of investor 
confusion.
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7. Alternative Control Conditions
a. Redemption Limit
    We proposed a redemption limit that would prohibit an acquiring 
fund that acquires more than 3% of an acquired fund's outstanding 
shares from

[[Page 73992]]

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 was to address concerns that an 
acquiring fund could threaten large-scale redemptions to unduly 
influence an acquired fund. Using data from Form N-PORT filings that 
were filed with the Commission between May 2019 and July 2020, we find 
that 1,304 funds out of a total of 3,654 held more than 3% of any 
acquired fund's shares at the end of a reporting period, and thus could 
have been affected by the proposed redemption limit. Our analysis also 
shows that the average (median) 30-day redemption was 0.32% (0.011%): 
The average (median) 30-day redemption for listed acquired funds was 
0.13% (0.003%) and for unlisted acquired funds was 0.45% (0.027%). 
Finally, there were 1,961 instances in which an acquiring fund redeemed 
more than 3% of an acquired fund's shares in any 30-day period, 
representing 578 unique funds.\703\ When looking at fund redemptions in 
March 2020, a presumed period of market stress, the average (median) 
30-day redemption was 0.69% (0.033%).
---------------------------------------------------------------------------

    \703\ Our analysis is limited by data availability. In 
particular, we only have monthly data on acquiring funds' holdings 
and our sample period is primarily a stable period of rising market 
prices (with the exception of the March to July 2020 period of 
market stress). Any effects of the redemption limit would be more 
pronounced during periods of market stress. See also 2018 FOF 
Proposing Release, supra footnote 6, at n.125 and accompanying text 
for similar statistics using data from Morningstar Holdings. Some 
commenters argued that the low frequency of large-scale redemptions 
suggests that the redemption limit is unnecessary because funds do 
not engage frequently in large-scale redemptions that would raise 
undue influence concerns. See, e.g., Dechert Comment Letter.
---------------------------------------------------------------------------

    An acquiring fund that holds 25% of the outstanding shares of an 
acquired fund (i.e., up to the control limit) and can only redeem 3% of 
the acquired fund shares in every 30-day period (i.e., up to the 
redemption limit) would take 10 months to fully unwind its investment 
in the acquired fund, assuming no other concurrent changes in the 
number of acquired fund shares outstanding that are unrelated to the 
acquiring fund's redemptions. It would take longer than 10 months for 
an acquiring fund to redeem the acquired fund shares if other investors 
were concurrently redeeming the shares of the acquired fund due to, for 
example, changes in market conditions or if the acquiring fund held 
more than 25% of the shares of an affiliated acquired fund.\704\
---------------------------------------------------------------------------

    \704\ See, e.g., Vanguard Comment Letter (stating that ``by way 
of example, Vanguard offers an acquiring fund that would be subject 
to the Proposed Rule, but not subject to the control condition, that 
holds approximately 60% of an underlying Vanguard fund. We estimate 
that it would take approximately 2.5 years for this acquiring fund 
to fully unwind its investment in the underlying fund, assuming 
there was no other shareholder activity during the period.'').
---------------------------------------------------------------------------

    Various commenters provided statistics showing that the redemption 
limit would be frequently binding.\705\ We summarize those statistics 
in the table below.
---------------------------------------------------------------------------

    \705\ A commenter stated that ``[f]or three of the five [funds 
of funds in its group], a majority of each such Fund's investments 
in Underlying Funds represent more than three-percent of the 
Underlying Fund's outstanding shares.'' See Russell Comment Letter.

----------------------------------------------------------------------------------------------------------------
                                                               Number of acquiring
                                        Sample period for     funds holding > 3% of   Number of acquiring funds
             Commenter                 number of funds or     at least one acquired  or instances of redemptions
                                       instances exceeding     fund's outstanding     > 3% limit within a 30-day
                                        redemption limit             shares                     period
----------------------------------------------------------------------------------------------------------------
Nationwide \706\...................  January 1, 2016-        32 acquiring funds....  all 32 acquiring funds in
                                      December 31, 2018.                              at least one instance and
                                                                                      some on as many as four
                                                                                      separate instances.
ICI \707\..........................  2016-2018.............  516 acquiring funds     228 acquiring funds in
                                                              with $1.8 trillion in   1,399 instances \708\.
                                                              assets under
                                                              management.
John Hancock \709\.................  January 1, 2016-        ......................  among all funds sponsored
                                      December 31, 2018.                              by commenter, 350
                                                                                      instances.
JP Morgan \710\....................  past 3 years..........  ......................  among all commenter funds,
                                                                                      more than 100 instances.
TRP \711\..........................  2016-2018.............  ......................  for a subset of commenter's
                                                                                      funds, 6 acquiring funds
                                                                                      in 17 instances \712\.
MFS \713\..........................  January 1, 2016-March   ......................  for one surveyed commenter
                                      31, 2019.                                       fund, in 25% of the months
                                                                                      surveyed.
Voya \714\.........................  2016-2018.............  ......................  among all commenter funds,
                                                                                      13 acquiring funds in 64
                                                                                      instances.
Fidelity \715\.....................  2016-2018.............  ......................  for one of the commenter
                                                                                      fund of funds categories
                                                                                      consisting 14 acquiring
                                                                                      funds, in 149 instances
                                                                                      \716\.
Allianz \717\......................  since December 2016...  ......................  at least 7 out of the 13
                                                                                      acquiring funds in the
                                                                                      commenter's fund complex
                                                                                      at least once, and most on
                                                                                      a number of occasions.
SIFMA \718\........................  January 1, 2018-March   223 out of 655          over 500 of the acquiring
                                      1, 2019.                surveyed acquiring      funds sponsored by the
                                                              funds \719\.            survey respondents \720\.
Morningstar \721\..................  ......................  1,591 acquiring funds
                                                              with $1 billion in
                                                              assets.
----------------------------------------------------------------------------------------------------------------

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

    \706\ See Nationwide Comment Letter.
    \707\ The survey sample included 1,359 funds of funds with $2.8 
trillion in assets under management, out of which 936 funds of funds 
with $2 trillion in assets under management would be subject to rule 
12d1-4 and be required to comply with the rule's conditions. The 
reported survey statistics excluded holdings and redemptions of 
money market funds. See ICI Comment Letter.
    \708\ Out of all survey respondents, 394 funds of funds with 
$1.7 trillion in assets under management were able to provide 
complete or partial information on their fund redemptions for the 
period 2016-2018. 122 funds of funds with $147 billion in assets 
under management were unable to provide any information on their 
redemptions. Further, some complexes were able to analyze only some 
of their funds (e.g., larger or affiliated) or were able to analyze 
a shorter time frame (e.g., a quarter rather than three years).
    \709\ See John Hancock Comment Letter.
    \710\ See JP Morgan Comment Letter.
    \711\ See TRP Comment Letter.
    \712\ Statistics exclude redemptions from affiliated money 
market funds.
    \713\ See MFS Comment Letter.
    \714\ See Voya Comment Letter.
    \715\ See Fidelity Comment Letter.
    \716\ Approximately one third of the 149 redemptions were out of 
unaffiliated acquired funds (non-ETFs). During the same period, 
another of the commenter's fund of funds categories redeemed more 
than 3% of an affiliated fund's total outstanding shares in a 
rolling 30-day period a total of 172 times. All redemptions were out 
of affiliated open-end funds.
    \717\ See Allianz Comment Letter.
    \718\ See SIFMA AMG Comment Letter.
    \719\ For purposes of this survey, a fund of funds is a fund 
that invests substantially all of its assets (i.e., > 85% of fund 
assets) in shares of other investment companies. In the same survey, 
there are 59 funds that invest less than 85% of their assets in 
other funds, and for these funds of funds there have been ``dozens 
of redemptions of more than 3% of an acquired fund's shares during 
the period from January 1, 2018 through March 1, 2019.''
    \720\ The survey included both affiliated and unaffiliated funds 
of funds arrangements and 90% of the redemptions occurred in 
affiliated funds of funds.
    \721\ See Morningstar Comment Letter.

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

[[Page 73993]]

    Most of the commenters' statistics do not distinguish between fund 
redemptions in the secondary market, which would not have been subject 
to the redemption limit, and fund redemptions directly with the 
acquired fund. We are unable to reconcile our statistics with the 
statistics provided by commenters because we only have monthly data on 
fund holdings while commenters' holdings information likely is more 
granular, and we lack complete information regarding commenters' 
research design choices (e.g., whether the statistics include money 
market funds).
    Commenters raised a number of issues associated with the proposed 
redemption limit, some of which we discussed in the 2018 FOF Proposing 
Release.\722\ These concerns included (1) operational or administrative 
challenges; (2) the redemption limit's potential effects on the 
acquiring fund's investment objectives and its ability to respond 
timely to changing economic or market conditions; (3) the impact on 
competition and innovation; (4) whether funds in the same group of 
investment companies should be subject to the requirements; (5) 
concerns relating to liquidity; and (6) the cost of the proposed 
limits.
---------------------------------------------------------------------------

    \722\ See supra section II.C.2.a for detailed discussion of 
issues raised by commenters regarding the proposed redemption limit. 
See also 2018 FOF Proposing Release, supra footnote 6, at 1325-26 
for discussion of costs of the proposed redemption limit.
---------------------------------------------------------------------------

    We have addressed the issues raised by commenters by not adopting 
the redemption limit and instead imposing alternative conditions to 
guard against undue influence.
b. Uniform Voting Conditions for all Funds
    We proposed to impose the same voting conditions on all funds. In 
particular, proposed rule 12d1-4 would have required the same ownership 
threshold that would trigger the voting condition (i.e., 3% of 
outstanding voting securities of the acquired fund) and the same manner 
of voting (i.e., pass-through or mirror voting) for all funds that 
would be subject to rule 12d1-4. One advantage of uniform voting 
conditions would be a less complex rule, which would facilitate rule 
compliance. Another advantage would be imposing the same conditions on 
all acquired funds, which would level the playing field across acquired 
funds because all acquired funds would enjoy the same levels of 
protection from acquiring funds' undue influence. The disadvantage of 
such an approach would be that it would not consider the unique 
characteristics of each fund category.\723\ In particular, open end 
funds and UITs hold shareholder meetings infrequently and are rarely 
the subject of investor activism, while closed-end funds may be 
required to hold shareholder meetings annually and historically have 
been the target of activist investors. Hence, concerns of undue 
influence may differ across fund categories. For this reason, rule 
12d1-4 will impose different voting thresholds with respect to acquired 
funds that are open-end funds and UITs versus BDCs and registered 
closed-end funds.\724\
---------------------------------------------------------------------------

    \723\ See supra footnote 145.
    \724\ See supra section II.C.1.b.
---------------------------------------------------------------------------

c. Disclosure Requirement
    We proposed to require a fund that operates in accordance with rule 
12d1-4 to disclose in its registration statement that it is (or at 
times may be) an acquiring fund for purposes of the rule. The advantage 
of such a disclosure would be that it would put other funds seeking to 
operate in accordance with rule 12d1-4 on notice that a fund they seek 
to acquire is itself an acquiring fund, and thus prevent the creation 
of complex fund of funds structures. This requirement would impose some 
ongoing costs on funds to prepare and provide those disclosures. 
Commenters generally opposed the proposed disclosure requirement, 
predicting that (i) funds would prophylactically disclose that they may 
rely upon rule 12d1-4, which would reduce the number of available 
potential acquired funds; (ii) it would be costly for acquiring funds 
to monitor continuously the disclosure of potential acquired funds; and 
(iii) time lags between when an acquired fund decides to operate in 
accordance with the rule and become an acquiring fund and when it 
updates its registration statement could cause violations of the 
rule.\725\ Further, commenters suggested that such an approach could 
reduce the number of funds willing to become acquired funds and create 
fewer investment opportunities for funds of funds.\726\
---------------------------------------------------------------------------

    \725\ See supra footnotes 242 and 243.
    \726\ See supra footnote 244.
---------------------------------------------------------------------------

    As mentioned above, the proposed disclosure requirement was 
designed to put funds on notice that a fund would be subject to rule 
12d1-4 as an acquiring fund. Under rule 12d1-4, this function will be 
filled by the fund of funds investment agreement, which an acquiring 
fund and acquired fund must execute before the acquiring fund may 
invest in the acquired fund in excess of the limits imposed by section 
12(d)(1). Since rule 12d1-4 imposes the fund of funds investment 
agreement condition, it does not include such a disclosure requirement.

VI. Paperwork Reduction Act

A. Introduction

    Rule 12d1-4 will result in a new ``collection of information'' 
within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\727\ In addition, the adoption of rule 12d1-4 will affect 
the current collection of information burden of rule 0-2 under the 
Act.\728\ The amendments to Form N-CEN also will affect the collection 
of information burden under that form.\729\
---------------------------------------------------------------------------

    \727\ 44 U.S.C. 3501 through 3521.
    \728\ 17 CFR 270.0-2.
    \729\ 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 
will 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 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 2018 FOF 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.\730\ 
We received one comment on the collection of information 
requirements.\731\
---------------------------------------------------------------------------

    \730\ See 2018 FOF Proposing Release, supra footnote 6. We also 
published a notice soliciting comments on the collection of 
information requirements in the 2008 ETF Proposing Release. We 
similarly did not receive comments on the collection of information 
requirements. See id. at n.339 and accompanying text.
    \731\ See Guggenheim Comment Letter (stating that lawyers and 
accounting personnel would need to be involved with the proposed 
findings requirement).

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

[[Page 73994]]

B. Rule 12d1-4

    Rule 12d1-4 will permit certain 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. These conditions include (1) 
adherence to certain voting provisions, (2) for most funds, entering 
into a fund of funds investment agreement, (3) for management 
companies, certain evaluations and findings that are reported to a 
fund's board, (4) for UITs, an evaluation by the principal underwriter 
or depositor, and (5) for separate accounts funding variable insurance 
contracts, the acquiring fund obtaining a certification by the 
insurance company offering the separate account. These requirements are 
collections of information for purposes of the PRA. These are the same 
collections we identified in the 2018 FOF Proposing Release, with two 
exceptions based upon changes to the rule from the proposal. We have 
removed the disclosure requirements that were included in the proposed 
estimate and added the fund of funds investment agreement element of 
the collection.
    The respondents to rule 12d1-4 will be registered funds or 
BDCs.\732\ The collection of information will be mandatory only for 
entities that wish to operate in accordance with the new rule. 
Information provided to the Commission in connection with staff 
examinations or investigations will be kept confidential subject to the 
provisions of applicable law.
---------------------------------------------------------------------------

    \732\ See supra footnote 617 for the source of salary data.
---------------------------------------------------------------------------

1. Voting Provisions
    Under rule 12d1-4, where an acquiring fund and its advisory group 
(in the aggregate) hold more than 25% of the outstanding voting 
securities of an acquired fund that is a registered open-end investment 
company or registered UIT, the acquiring fund will be required to vote 
those securities using mirror voting, unless certain exceptions 
apply.\733\ If the acquired fund is a closed-end fund, the acquiring 
fund and its advisory group must vote its securities using mirror 
voting if they, in the aggregate, hold more than 10% of the outstanding 
voting securities, unless certain exceptions apply.\734\ We estimate 
that 450 acquiring funds will be subject to these requirements, 440 of 
which will be utilizing mirror voting and 10 of which will be utilizing 
pass-through voting in limited circumstances.\735\
---------------------------------------------------------------------------

    \733\ See rule 12d1-4(b)(1)(ii) and (iv). As described above, in 
mirror voting, the acquiring fund votes the shares it holds in the 
same proportion as the vote of all other holders. In circumstances 
where acquiring funds are the only shareholders of an acquired fund, 
however, pass-through voting may be used.
    \734\ See rule 12d1-4(b)(1)(iii) and (iv).
    \735\ 450 acquiring funds that will invest in open-end funds or 
UITs in reliance on rule 12d1-4 and beyond the 25% voting threshold 
= 4,086 acquiring funds that will invest in other funds in reliance 
on rule 12d1-4 x 11% of acquiring funds that invest in at least one 
open-end fund or UIT beyond the 25% voting threshold of the rule. 
4,086 acquiring funds that will invest in other funds in reliance on 
rule 12d1-4 = 5,922 acquiring registered investment companies and 
BDCs x 69% of acquiring funds that will be subject to rule 12d1-4 as 
estimated by a commenter (see supra footnote 533 and associated 
text). This estimate assumes that acquiring funds with current 
investments in other funds beyond the limits of section 12(d)(1) 
will be subject to rule 12d1-4 at the same rate as the acquiring 
funds with current investments in other funds within the limits of 
section 12(d)(1) following the rule adoption. 5,922 acquiring 
registered investment companies and BDCs = [4,750 acquiring 
management companies (see supra Table 2 in section V.B.1) + 37 
acquiring BDCs (see supra footnotes 558 and 559 and accompanying 
text)] x [14,605 registered investment companies (see supra Table 1 
in section V.B.1) + 83 BDCs (see supra footnotes 554 and 555 and 
associated text)]/[11,788 management companies (see supra Table 2) + 
83 BDCs (see supra footnotes 558 and 559 and accompanying text)]. We 
lack structured data that would allow us to estimate the percentage 
of acquiring funds that are within the same group of investment 
companies as the 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, and thus will be subject to 
the rule's voting condition. To avoid underestimating the costs 
associated with this aspect of rule 12d1-4, we assume that all 450 
acquiring funds will be subject to this rule's conditions. Further, 
the circumstances of an acquiring fund utilizing pass-through voting 
in the final rule are limited and may be only for certain 
investments. See supra footnote 621 and accompanying text.
---------------------------------------------------------------------------

    Table 5 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. This estimate is as 
proposed, except that we (1) lowered the relative amount of funds that 
are expected to use pass-through voting given the changes to that 
requirement, (2) lowered the amount of funds estimated to be subject to 
these provisions due to the raised threshold of when pass-through or 
mirror voting will be required and (3) also lowered the expected number 
of votes per year based upon updated analysis.\736\
---------------------------------------------------------------------------

    \736\ The 2018 FOF Proposing Release contemplated that 809 funds 
would be subject to this requirement based upon a 3% threshold, 
rather than the 25% and 10% threshold we are adopting. See 2018 FOF 
Proposing Release, supra footnote 6, at n.349 and accompanying text. 
See also supra footnotes 735 and 621 and footnotes 569 through 570 
and accompanying text (outlining updated voting analysis).

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

[[Page 73995]]

BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TR19NO20.002

[[Page 73996]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.003

2. Fund of Funds Investment Agreements
    As discussed in section II.C.2.4 above, unless the acquiring fund's 
adviser acts as the acquired fund's investment adviser, the rule will 
require that the acquiring fund enter into an agreement containing 
certain provisions with the acquired fund effective for the duration of 
the funds' reliance on the rule. Funds subject to this requirement must 
maintain a copy of these agreements.\737\ We estimate that 9,240 fund 
pairs will be subject to this requirement.\738\
---------------------------------------------------------------------------

    \737\ Rule 12d1-4(b)(2)(iv) and (c).
    \738\ See supra footnote 661 and accompanying text.
---------------------------------------------------------------------------

    Table 6 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. This element of the 
rule was not included in the proposal.
[GRAPHIC] [TIFF OMITTED] TR19NO20.004

3. Management Companies--Fund Findings
    In cases where the acquiring fund is a management company, rule 
12d1-4 will require, prior to the initial acquisition of an acquired 
fund in reliance on the rule, the acquiring fund's investment adviser 
to evaluate the complexity of the structure and fees and expenses 
associated with the acquiring fund's investment in the acquired fund, 
and find that the acquiring fund's fees and expenses do not duplicate 
the fees and expenses of the acquired fund. In cases where the acquired 
fund is a management company, rule 12d1-4 will require, prior to the 
initial acquisition of the acquired fund in reliance on the rule, the 
acquired fund's investment adviser to find that any undue influence 
concerns associated with the acquiring fund's investment in the 
acquired fund are reasonably addressed and, as part of this finding, 
the investment adviser must consider at a minimum certain enumerated 
factors. The rule will

[[Page 73997]]

further require that each investment adviser report its evaluation, 
finding, and the basis for its evaluation or finding to the fund's 
board of directors no later than the next regularly scheduled meeting 
of the board of directors. The rule also will require the acquiring and 
acquired funds participating in fund of funds arrangements in 
accordance with the rule to maintain and preserve a copy of each fund 
of funds investment agreement that is in effect, or was in effect in 
the past five years, and a written record of the relevant Fund Findings 
(and the basis for the Fund Findings) made under the rule.\739\ We 
estimate 6,178 funds will be subject to this requirement.\740\
---------------------------------------------------------------------------

    \739\ Rule 12d1-4(b)(2)(i) and (c).
    \740\ See supra footnotes 651 and 646.
---------------------------------------------------------------------------

    Table 7 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. We have made some 
changes to the estimate from the proposal based upon changes to the 
rule as adopted.\741\ We increased the number of funds responding to 
this collection since the final rule will require both the acquiring 
and acquired funds to make certain findings under the rule. We have 
also increased our estimated burdens regarding initial hour and cost 
burdens due to the increased amount of factors that advisers would need 
to consider as part of this collection. In response to a 
commenter,\742\ we adjusted our estimates regarding the hours and wage 
rates to conduct evaluations and the creation, review, and maintenance 
of written materials. Lastly, we reduced the estimates regarding annual 
hour burdens, and eliminated the estimate of external annual costs, due 
to the elimination of the requirement to conduct on-going evaluations.
---------------------------------------------------------------------------

    \741\ See 2018 FOF Proposing Release, supra footnote 6, at 
nn.365-369 and accompanying text.
    \742\ See Guggenheim Comment Letter.
    [GRAPHIC] [TIFF OMITTED] TR19NO20.005
    

[[Page 73998]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.006

4. UITs--Principal Underwriter or Depositor Evaluations
    The rule will require that, in cases where the acquiring fund is a 
UIT, the UIT's principal underwriter or depositor must evaluate the 
complexity of the structure associated with the UIT's investment in 
acquired funds, and find that the UIT's fees and expenses do not 
duplicate the fees and expenses of the acquired funds that the UIT 
holds or will hold at the date of deposit. The UIT is also required to 
keep records of the finding, and any basis for the finding.\743\ We 
estimate 200 funds will be subject to this requirement.\744\
---------------------------------------------------------------------------

    \743\ Rule 12d1-4(b)(2)(ii) and (c).
    \744\ See supra footnote 652.
---------------------------------------------------------------------------

    Table 8 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. We decreased the 
total number of respondents to this item based upon updated analysis as 
described above. Also, in response to a commenter,\745\ we adjusted our 
estimates regarding the hours and wage rates to conduct evaluations and 
the creation, review, and maintenance of written materials.\746\
---------------------------------------------------------------------------

    \745\ See Guggenheim Comment Letter.
    \746\ See 2018 FOF Proposing Release, supra footnote 6, at 
nn.373-377 and accompanying text.

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

[[Page 73999]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.007

[[Page 74000]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.008

5. Separate Accounts Funding Variable Insurance Contracts--
Certification
    Lastly, the rule will 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. The certification must 
state that the insurance company has determined that the fees and 
expenses 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 acquiring fund will be required to 
keep a record of this certification.\747\ We estimate 191 funds will be 
subject to this requirement.\748\
---------------------------------------------------------------------------

    \747\ Rule 12d1-4(b)(2)(iii) and (c).
    \748\ See supra footnote 669.
---------------------------------------------------------------------------

    Table 9 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. We decreased the 
total number of respondents to this item based upon updated analysis as 
described above. Also, we increased the proposed internal hour burden 
and time costs to account for likely attorney and compliance review of 
the required certification.\749\
---------------------------------------------------------------------------

    \749\ See 2018 FOF Proposing Release, supra footnote 6, at 
nn.373-377 and accompanying text. The rule will not subject an 
insurance company to a collection of information as section 
26(f)(2)(A) of the Act already requires insurance companies to 
collect this information. 
[GRAPHIC] [TIFF OMITTED] TR19NO20.009

[[Page 74001]]

6. Rule 12d1-4 Total Estimated Burden
    As summarized in Table 10 below, we estimate that the total hour 
burdens and time costs associated with rule 12d1-4, amortized over 
three years, would result in an average aggregate annual burden of 
578,084 hours and an average aggregate annual monetized time cost of 
$191,773,875. We also estimate that, amortized over three years, there 
would be external costs of $243,953,880 associated with this collection 
of information. Therefore, each fund operating in accordance with the 
rule will incur an average annual burden of approximately 35.55 hours, 
at an average annual monetized time cost of approximately $11,794.94, 
and an external cost of $15,004.24 to comply with it. 
[GRAPHIC] [TIFF OMITTED] TR19NO20.011

C. Rule 0-2

    Rule 0-2 under the Act, entitled ``General Requirements of Papers 
and Applications,'' prescribes general instructions for filing an 
application seeking an order from the Commission under any provision of 
the Act.\750\ Rule 12d1-4 will alleviate some of the burdens associated 
with rule 0-2 because it will reduce the number of entities that 
require exemptive relief in order to operate.
---------------------------------------------------------------------------

    \750\ See Supporting Statement of Rule 0-2 under the Investment 
Company Act of 1940, General Requirements of Paper Applications 
(Mar. 3, 2020) (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=201912-3235-002.
---------------------------------------------------------------------------

    Table 11 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. We reduced our 
estimated burdens from what we proposed because of the intervening 
adoption of rule 6c-11, which also reduced the number of entities that 
require exemptive relief in order to operate.\751\
---------------------------------------------------------------------------

    \751\ We proposed an approximate reduction of one-third from the 
2016 approved burdens. See 2018 FOF Proposing Release, supra 
footnote 6, at nn.381-386 and accompanying text. In the 2019 ETF 
Adopting Release, we reduced the 2016 approved burdens by 30%. See 
2019 ETF Adopting Release, supra footnote 25, at nn.691-692 and 
accompanying text. We are reducing the estimates from the 2019 ETF 
Adopting Release a further 30% as rule 12d1-4 will reduce a 
different type of application than those addressed by rule 6c-11.
[GRAPHIC] [TIFF OMITTED] TR19NO20.012

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.\752\ We are amending 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.\753\
---------------------------------------------------------------------------

    \752\ See Reporting Modernization Adopting Release, supra 
footnote 56.
    \753\ See supra Section III.1.
---------------------------------------------------------------------------

    Table 12 summarizes the final PRA estimates for internal and 
external burdens associated with this requirement. We have adjusted 
these estimates due to the intervening adoption of rule 6c-11, which 
also added items to Form N-CEN.\754\
---------------------------------------------------------------------------

    \754\ We proposed an increase of 0.1 hours per response. See 
2018 FOF Proposing Release, supra footnote 6, at nn.387-395 and 
accompanying text. The 2019 ETF Adopting Release also added 0.1 
hours, but per ETF, to the estimated burden. See 2019 ETF Adopting 
Release, supra footnote 25, at nn.691-692 and accompanying text.

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

[[Page 74002]]

[GRAPHIC] [TIFF OMITTED] TR19NO20.013

BILLING CODE 8011-01-C

VII. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis (``FRFA'') has been 
prepared in accordance with section 4(a) of the Regulatory Flexibility 
Act (``RFA'').\755\ It relates to final rule 12d1-4 and the amendments 
to Form N-CEN under the Investment Company Act. In connection with the 
new rule, the Commission is rescinding rule 12d1-2 under the Act and 
certain exemptive relief that has been granted from sections 
12(d)(1)(A), (B), (C), and (G) of the Act. Finally, the Commission is 
adopting related amendments to rule 12d1-1 under the Act. An Initial 
Regulatory Flexibility Analysis (``IRFA'') was prepared in accordance 
with the RFA and is included in the 2018 FOF Proposing Release.\756\
---------------------------------------------------------------------------

    \755\ 5 U.S.C. 603(a).
    \756\ See 2018 FOF Proposing Release, at section VIII.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule and Form Amendments

    As described more fully above, rule 12d1-4 will 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 are rescinding rule 
12d1-2 under the Act and certain exemptive relief that has been granted 
from sections 12(d)(1)(A), (B), (C), and (G) of the Act to create a 
more consistent and efficient rules-based regime for the formation and 
oversight of funds of funds. We also are amending 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 amendments to Form N-CEN will allow the 
Commission to better monitor funds' reliance on rule 12d1-4 and section 
12(d)(1)(G), and will assist the Commission with its accounting, 
auditing, and oversight functions.
    All of these requirements are discussed in detail above. The costs 
and burdens of these requirements on small entities are discussed below 
as well as above in our Economic Analysis and Paperwork Reduction Act 
Analysis, which discusses the costs and burdens on all funds.

B. Significant Issues Raised by Public Comments

    In the 2018 FOF Proposing Release, we requested comment on every 
aspect of the IRFA, including the number of small entities that would 
be affected by the proposed rule and amendments, the existence or 
nature of the potential impact of the proposals on small entities 
discussed in the analysis and how to quantify the impact of the 
proposed rule and amendments. We also requested comment on the broader 
impact of the proposed rule and amendments on all relevant entities, 
regardless of size.
    We proposed adopting a redemption limit that 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.\757\ Among the comments 
received on this topic, one commenter stated that the redemption limit 
could discourage acquiring funds from gaining exposure to non-
traditional asset classes with more volatile in- and out-flows and 
smaller asset bases, resulting in a less desirable mix of assets being 
made available to investors.\758\ Commenters also stated that this 
would negatively impact newly launched or small acquired mutual 
funds.\759\ For example, these commenters noted that novel and emerging 
fund strategies, which would

[[Page 74003]]

likely exist primarily in smaller funds, would not be as attractive to 
an acquiring fund as they otherwise would be because of liquidity 
concerns accompanying the redemption condition.\760\ Commenters noted 
the potential that this provision would affect smaller funds 
disproportionately since funds of funds would likely migrate out of 
smaller funds into larger funds in order to dilute their position.\761\ 
Further, commenters noted the possible impact of this provision on 
smaller funds achieving scalable asset sizes.\762\ Finally, some 
commenters raised administrative and compliance challenges associated 
with tracking the outstanding voting securities of numerous acquired 
funds.\763\ As discussed in more detail above, we are not adopting the 
proposed redemption limit.
---------------------------------------------------------------------------

    \757\ See supra Section II.C.2.
    \758\ Voya Comment Letter.
    \759\ See, e.g., ICI Comment Letter; Invesco Comment Letter; IDC 
Comment Letter; Voya Comment Letter; Chamber of Commerce Comment 
Letter; Guggenheim Comment Letter; Dimensional Comment Letter; Wells 
Fargo Comment Letter; Capital Group Comment Letter; Schwab Comment 
Letter; John Hancock Comment Letter; Fidelity Comment Letter; 
Dechert Comment Letter; MFS Comment Letter; Ropes Comment Letter; 
IAA Comment Letter; BlackRock Comment Letter; Nationwide Comment 
Letter.
    \760\ See, e.g., Invesco Comment Letter; Chamber of Commerce 
Comment Letter.
    \761\ Id.
    \762\ See, e.g., Nationwide Comment Letter.
    \763\ See, e.g., Fidelity Comment Letter; Ropes Comment Letter.
---------------------------------------------------------------------------

    Commenters also noted that codifying certain categories of existing 
exemptive relief would benefit smaller and midsize fund complexes by 
relieving them of the cost burden of obtaining an exemptive order.\764\
---------------------------------------------------------------------------

    \764\ See, e.g., MFDF Comment Letter.
---------------------------------------------------------------------------

    In addition to not adopting the proposed redemption limit, after 
consideration of the comments we received on the proposed rule and 
amendments, we are adopting the rule and amendments with several 
modifications that are designed to reduce certain operational 
challenges that commenters identified, while maintaining protections 
for investors and providing useful disclosures regarding fund of funds 
arrangements. Revisions to the estimates below also are based on 
updated figures regarding the number of small entities impacted by the 
rule and amendments and updated estimated wage rates.

C. Small Entities Subject to the Rule

    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.\765\ Commission staff estimates that, as of 
December 2019, there were 46 open-end funds (including 8 ETFs), 30 
closed-end funds, 2 UITs, and 14 BDCs that would be considered small 
entities that may be subject to rule 12d1-4.\766\ For the purposes of 
this analysis, we estimate that, of those 92 total entities, 8 entities 
(1 open-end fund, 5 closed-end funds, and 2 UITs) invest in other funds 
and thus may be subject to the rule.\767\
---------------------------------------------------------------------------

    \765\ See rule 0-10(a) under the Investment Company Act.
    \766\ This estimate is derived an analysis of data obtained from 
Morningstar Direct as well as data reported to the Commission for 
the period ending December 31, 2019. There are currently no ETMFs or 
face-amount certificate companies that would be considered small 
entities. We believe that no BDCs that are small entities invest in 
other funds outside the limits of 12(d)(1). See supra section V.B.1.
    \767\ Id.
---------------------------------------------------------------------------

D. Projected Board Reporting, Recordkeeping, and Other Compliance 
Requirements

    We are adopting new rule 12d1-4 to streamline and enhance the 
regulatory framework applicable to fund of funds arrangements, the 
rescission of rule 12d1-2 and certain exemptive relief, and an 
amendment to rule 12d1-1 to create a more consistent and efficient 
rules-based regime for the formation and oversight of fund of funds 
arrangements. We are also adopting 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.
    Rule 12d1-4 will 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. These conditions include (1) adherence to 
certain voting provisions, (2) for some funds, entering into a fund of 
funds investment agreement, (3) for management companies, the adviser 
making certain evaluations and findings that are reported to the fund's 
board, (4) for UITs, a finding by the principal underwriter or 
depositor, and (5) for separate accounts funding variable insurance 
contracts, the acquiring fund obtaining a certification by the 
insurance company offering the separate account.\768\
---------------------------------------------------------------------------

    \768\ We estimate that no separate accounts funding variable 
insurance contracts would be treated as small entities for purposes 
of this analysis. See also Updated Disclosure Requirements and 
Summary Prospectus for Variable Annuity and Variable Life Insurance 
Contracts, Investment Company Act Release No. 33814 (May 1, 2020) 
[FR 24964 (May 1, 2020)] (noting that the Commission expects that 
few, if any, separate accounts would be treated as small entities).
---------------------------------------------------------------------------

    To harmonize the overall regulatory structure in view of rule 12d1-
4, we are rescinding 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. 
Similarly we are rescinding certain exemptive relief that has been 
granted from sections 12(d)(1)(A), (B), (C), and (G) of the Act for the 
same reasons. In addition, we are amending 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 amending 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.
    New rule 12d1-4, the rescission of rule 12d1-2 and certain 
exemptive relief that has been granted from sections 12(d)(1)(A), (B), 
(C), and (G) of the Act, 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 rule 12d1-4 
are 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 are 
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 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) 6 internal burden hours and $400 in external 
costs to satisfy the new voting provisions related to mirror voting and 
33 internal burden hours and $4,000 in external costs to satisfy the 
new voting provisions related to pass-through voting; \769\ (b) 38 
internal burden hours and $2,778 in external costs to satisfy the 
requirement that acquiring fund enter into an agreement containing 
certain provisions with the acquired fund effective for the duration of 
the funds' reliance on the rule, if the acquiring fund and the acquired 
fund do not share the same

[[Page 74004]]

investment adviser; \770\ (c) for management companies, 35 internal 
burden hours and $35,220 in external costs initially,\771\ and in cases 
where the acquired fund is a management company, 13 internal burden 
hours and $0 in external costs per year on an on-going basis to satisfy 
the considerations associated with their Fund Findings; \772\ and (d) 
for UITs, 35 internal burden hours and $2,400 in external costs to 
satisfy the proposed complex structure and aggregate fees 
analysis.\773\ Furthermore, as discussed above, we estimate that each 
entity that relies on the new rule would incur an additional annual 
time burden of 0.1 hours to comply with the amendments to Form N-
CEN.\774\
---------------------------------------------------------------------------

    \769\ See supra Section VI.B.1. For purposes of this analysis, 
we assume that all small entities will utilize mirror voting. See 
also supra footnote 735 and footnotes 569 through 570 and 
accompanying text (outlining updated voting analysis).
    \770\ See supra Section VI.B.2.
    \771\ See supra Section VI.B.3.
    \772\ Id.
    \773\ See supra Section VI.B.4.
    \774\ See supra Section VI.D.
---------------------------------------------------------------------------

    Therefore, in the aggregate, we estimate that small entities would 
incur an annual internal burden of 570 additional hours and an annual 
external cost burden of $100,664 to comply with the requirements of 
rule 12d1-4. This estimate is based on the following calculations:
[GRAPHIC] [TIFF OMITTED] TR19NO20.010

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.\775\
---------------------------------------------------------------------------

    \775\ This estimate is based on the following calculations: 0.1 
hours x 8 small entities = 0.8 hours.
---------------------------------------------------------------------------

    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. Agency Action To Minimize Effect on Small Entities

    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 
disclosure, findings, board reporting, and recordkeeping requirements: 
(i) Exempting small entities from some or all of the requirements to 
rely on 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 rule 12d1-4 for small entities; and (iii) using 
performance rather than design standards.
    In addition, as discussed above, we proposed a redemption 
limitation applicable to fund of funds investments in an acquired fund 
to address concerns that an acquiring fund could threaten large-scale 
redemptions to unduly influence an acquired fund. In response to 
concerns raised by comments received on this redemption limit, 
including comments regarding the significant impact the proposed 
requirement would have on small entities, we are not adopting the 
redemption limit as part of rule 12d1-4.
    Further, as discussed above, any cost savings to prospective 
acquiring and acquired funds derived from eliminating the need to apply 
for an exemptive order likely will be more pronounced for smaller funds 
because (i) 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; and (ii) the same 
exemptive order can be used by multiple funds within a fund complex, 
and there may be fewer funds to benefit

[[Page 74005]]

from an exemptive order within smaller fund complexes.\776\
---------------------------------------------------------------------------

    \776\ See supra section V.C.1.ii (citing MFDF Comment Letter for 
a similar argument).
---------------------------------------------------------------------------

    We do not believe that exempting or establishing different 
requirements for any subset of funds, including funds that are small 
entities, from rule 12d1-4, the amendments to rule 12d1-1 and Form N-
CEN, or the rescission of rule 12d1-2 would permit us to achieve our 
stated objectives. Nor do we believe that clarifying, consolidating or 
simplifying the various aspects of the final rule 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, will benefit from the rule and form amendments. We 
believe that this rulemaking 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 the new requirements are vital to 
that balance and important to all investors, irrespective of the size 
of the entity. Existing fund of funds 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.

VIII. Statutory Authority

    The Commission is adopting 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 
adopting amendments to rule 12d1-1 pursuant to the authority set forth 
in sections 6(c), 12(d)(1)(J), and 38(a) of the Act [15 U.S.C. 80a-
6(c), 80a-12(d)(1)(J), 80a-37(a)]. The Commission is adopting 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 Rules and Form Amendments

    For the reasons set out in the preamble, we are amending Title 17, 
Chapter II of the Code of Federal Regulations 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:

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), 
57(a)(1)-(2), and 57(d)(1)-(2) of the Act (15 U.S.C. 80a 12(d)(1)(A), 
80a-12(d)(1)(C), 80a 17(a), 80a-56(a)(1)-(2), and 80a-56(d)(1)-(2)):
    (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);
    (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; and
    (3) An acquiring fund that is an affiliated person of an exchange-
traded fund (or who is an affiliated person of such a fund) solely by 
reason of the circumstances described in Sec.  270.6c-11(b)(3)(i) and 
(ii), may deposit and receive the exchange-traded fund's baskets, 
provided that the acquired exchange-traded fund is not otherwise an 
affiliated person (or affiliated person of an affiliated person) of the 
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;
    (ii) If the acquiring fund and its advisory group, in the 
aggregate,
    (A) Hold more than 25% of the outstanding voting securities of an 
acquired fund that is a registered open-end management investment 
company or registered unit investment trust as a result of a decrease 
in the outstanding voting securities of the acquired fund, or
    (B) Hold more than 10% of the outstanding voting securities of an 
acquired fund that is a registered closed-end management investment 
company or business development company, each of those holders will 
vote its securities in the same proportion as the vote of all other 
holders of such securities; provided, however, that in circumstances 
where all holders of the outstanding voting securities of the acquired 
fund are required by this section or otherwise under section 12(d)(1) 
to vote securities of the acquired fund in the same proportion as the 
vote of all other holders of such securities, the acquiring fund will 
seek instructions from its security holders with regard to the voting 
of all proxies with respect to such acquired fund securities and vote 
such proxies only in accordance with such instructions; and
    (iii) The conditions in paragraphs (b)(1)(i) through (ii) of this 
section do not apply if:
    (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.

[[Page 74006]]

    (2) Findings and agreements. (i) Management companies.
    (A) If the acquiring fund is a management company, prior to the 
initial acquisition of an acquired fund in excess of the limits in 
section 12(d)(1)(A)(i) of the Act (15 U.S.C. 80a-12(d)(1)(A)(i)), the 
acquiring fund's investment adviser must evaluate the complexity of the 
structure and fees and expenses associated with the acquiring fund's 
investment in the acquired fund, and find that the acquiring fund's 
fees and expenses do not duplicate the fees and expenses of the 
acquired fund;
    (B) If the acquired fund is a management company, prior to the 
initial acquisition of an acquired fund in excess of the limits in 
section 12(d)(1)(A)(i) of the Act (15 U.S.C. 80a-12(d)(1)(A)(i)), the 
acquired fund's investment adviser must find that any undue influence 
concerns associated with the acquiring fund's investment in the 
acquired fund are reasonably addressed and, as part of this finding, 
the investment adviser must consider at a minimum the following items:
    (1) The scale of contemplated investments by the acquiring fund and 
any maximum investment limits;
    (2) The anticipated timing of redemption requests by the acquiring 
fund;
    (3) Whether and under what circumstances the acquiring fund will 
provide advance notification of investments and redemptions; and
    (4) The circumstances under which the acquired fund may elect to 
satisfy redemption requests in kind rather than in cash and the terms 
of any such redemptions in kind; and
    (C) The investment adviser to each acquiring or acquired management 
company must report its evaluation, finding, and the basis for its 
evaluations or findings required by paragraphs (b)(2)(i)(A) or (B) of 
this section, as applicable, to the fund's board of directors, no later 
than the next regularly scheduled board of directors meeting.
    (ii) Unit investment trusts. If the acquiring fund is a unit 
investment trust (UIT) and the date of initial deposit of portfolio 
securities into the UIT occurs after the effective date of this 
section, the UIT's principal underwriter or depositor must evaluate the 
complexity of the structure associated with the UIT's investment in 
acquired funds and, on or before such date of initial deposit, find 
that the UIT's fees and expenses do not duplicate the fees and expenses 
of the acquired funds that the UIT holds or will hold at the date of 
deposit.
    (iii) Separate accounts 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 and expenses 
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)).
    (iv) Fund of funds investment agreement. Unless the acquiring 
fund's investment adviser acts as the acquired fund's investment 
adviser and such adviser is not acting as the sub-adviser to either 
fund, the acquiring fund must enter into an agreement with the acquired 
fund effective for the duration of the funds' reliance on this section, 
which must include the following:
    (A) Any material terms regarding the acquiring fund's investment in 
the acquired fund necessary to make the finding required under 
paragraph (b)(2)(i) through (ii) of this section;
    (B) A termination provision whereby either the acquiring fund or 
acquired fund may terminate the agreement subject to advance written 
notice no longer than 60 days; and
    (C) A requirement that the acquired fund provide the acquiring fund 
with information on the fees and expenses of the acquired fund 
reasonably requested by the acquiring fund.
    (3) Complex fund structures. (i) 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 an investment company (a second-tier 
fund) that relies on this section to acquire the securities of an 
acquired fund, unless the second-tier fund makes investments permitted 
by paragraph (b)(3)(ii) of this section; and
    (ii) No acquired fund may purchase or otherwise acquire the 
securities of an investment company or private fund if immediately 
after such purchase or acquisition, the securities of investment 
companies and private funds owned by the acquired fund have an 
aggregate value in excess of 10 percent of the value of the total 
assets of the acquired fund; provided, however, that the 10 percent 
limitation of this paragraph shall not apply to investments by the 
acquired fund in:
    (A) Reliance on section 12(d)(1)(E) of the Act (15 U.S.C. 80a-
12(d)(1)(E));
    (B) Reliance on Sec.  270.12d1-1;
    (C) A subsidiary that is wholly-owned and controlled by the 
acquired fund;
    (D) Securities received as a dividend or as a result of a plan of 
reorganization of a company; or
    (E) Securities of another investment company received pursuant to 
exemptive relief from the Commission to engage in interfund borrowing 
and lending transactions.
    (c) Recordkeeping. The acquiring and acquired funds relying upon 
this section must maintain and preserve for a period of not less than 
five years, the first two years in an easily accessible place, as 
applicable:
    (1) A copy of each fund of funds investment agreement that is in 
effect, or at any time within the past five years was in effect, and 
any amendments thereto;
    (2) A written record of the evaluations and findings required by 
paragraph (b)(2)(i) of this section, and the basis therefor within the 
past five years;
    (3) A written record of the finding required by paragraph 
(b)(2)(ii) of this section and the basis for such finding; and
    (4) The certification from each insurance company required by 
paragraph (b)(2)(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.
    Baskets has the same meaning as in 17 CFR 270.6c-11(a)(1).
    Exchange-traded fund means a fund or class, the shares of which are 
listed and traded on a national securities exchange, and that has 
formed and operates in reliance on Sec.  6c-11 or under an exemptive 
order granted by the Commission.
    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.
    Private fund means an issuer that would be an investment company 
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)).

[[Page 74007]]

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:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 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 l. and m.; and
0
b. In Part F, adding Item F.18. and Item F.19.
    The revisions and additions read as follows:

    Note:  The text of Form N-CEN does not and the amendments will 
not appear in the Code of Federal Regulations.

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)
* * * * *
    l. Rule 12d1-4 (17 CFR 270.12d1-4): __
    m. 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: October 7, 2020.
Vanessa A. Countryman
Secretary.
[FR Doc. 2020-23355 Filed 11-18-20; 8:45 am]
BILLING CODE 8011-01-P