Document ID: SEC-2006-0822-0001
Agency: sec
Document Type: Rule
Title: Fund of Funds Investments
Posted Date: 2006-06-27T04:00Z

[Federal Register: June 27, 2006 (Volume 71, Number 123)]
[Rules and Regulations]               
[Page 36639-36660]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27jn06-9]                         

[[Page 36639]]

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Part III

Securities and Exchange Commission

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17 CFR Parts 239, 270, and 274

Fund of Funds Investments; Final Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 270, and 274

[Release Nos. 33-8713; IC-27399; File No. S7-18-03]
RIN 3235-AI30

 
Fund of Funds Investments

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting three new rules under the Investment Company Act of 1940 that 
address the ability of an investment company (``fund'') to acquire 
shares of another fund. Section 12(d)(1) of the Act prohibits, subject 
to certain exceptions, so-called ``fund of funds'' arrangements, in 
which one fund invests in the shares of another. The rules broaden the 
ability of a fund to invest in shares of another fund in a manner 
consistent with the public interest and the protection of investors. 
The Commission also is adopting amendments to forms used by funds to 
register under the Investment Company Act and offer their shares under 
the Securities Act of 1933. The amendments improve the transparency of 
the expenses of funds of funds by requiring that the expenses of the 
acquired funds be aggregated and shown as an additional expense in the 
fee table of the fund of funds.

DATES: Effective Date: July 31, 2006.
    Compliance Dates: All new registration statements on Forms N-1A, N-
2, N-3, N-4, or N-6, and all post-effective amendments that are annual 
updates to effective registration statements on Forms N-1A, N-2, N-3, 
N-4, or N-6 filed on or after January 2, 2007, must include the 
disclosure required by the amendments.

FOR FURTHER INFORMATION CONTACT: Dalia Osman Blass, Attorney, or 
Penelope W. Saltzman, Branch Chief, Office of Regulatory Policy, (202) 
551-6792, Division of Investment Management, Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission today is adopting new rules 
12d1-1, 12d1-2 and 12d1-3 under the Investment Company Act of 1940 (the 
``Investment Company Act'' or the ``Act'') that address the ability of 
an investment company (``fund'' or ``acquiring fund'') registered under 
the Act to invest in shares of another investment company (``fund'' or 
``acquired fund'').\1\ We also are adopting amendments to Forms N-1A, 
N-2, N-3, N-4, and N-6 to require that prospectuses of funds of funds 
disclose the expenses investors in the acquiring fund will bear, 
including those of any acquired funds.\2\ Forms N-1A and N-2 are the 
registration forms used by open-end management funds and closed-end 
management funds, respectively, to register under the Act and to offer 
their shares under the Securities Act of 1933 (``Securities Act'').\3\ 
Forms N-3, N-4 and N-6 are the forms used by insurance company separate 
accounts to register under the Act and to offer their variable annuity 
and variable life insurance contracts under the Securities Act.
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    \1\ The Investment Company Act is codified at 15 U.S.C. 80a. The 
new rules will be found in the Code of Federal Regulations at 17 CFR 
270.12d1-1, 17 CFR 270.12d1-2, and 17 CFR 270.12d1-3, respectively. 
For convenience, any reference we make in this release to rules 
12d1-1, 12d1-2 or 12d1-3, or any paragraph of the rules, will be to 
those sections of the Code of Federal Regulations.
    \2\ Rules requiring use of these forms under both the Investment 
Company Act and the Securities Act of 1933 may be found in the Code 
of Federal Regulations at: 17 CFR 239.15A, 17 CFR 274.11A (Form N-
1A); 17 CFR 239.14, 17 CFR 274.11a-1 (Form N-2); 17 CFR 239.17a, 17 
CFR 274.11b (Form N-3); 17 CFR 239.17b, 17 CFR 274.11c (Form N-4); 
and 17 CFR 239.17c, 17 CFR 274.11d (Form N-6).
    \3\ The Securities Act is codified at 15 U.S.C. 77a. The terms 
``open-end management funds'' and ``closed-end management funds'' 
are defined in 15 U.S.C. 80a-5(a)(1) and (2), respectively.
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Table of Contents

I. Background
II. Discussion
    A. Rule 12d1-1: Investments in Money Market Funds
    1. Scope of Exemption
    2. Conditions
    B. Rule 12d1-2: Affiliated Funds of Funds
    1. Investments in Unaffiliated Funds
    2. Investments in Other Types of Issuers
    3. Investments in Money Market Funds
    C. Rule 12d1-3: Unaffiliated Funds of Funds
    D. Amendments to Disclosure Forms: Transparency of Fund of Funds 
Expenses
III. Paperwork Reduction Act
IV. Cost-Benefit Analysis
V. Consideration of Promotion of Efficiency, Competition, and 
Capital Formation
VI. Final Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Rules and Form Amendments

I. Background

    The Federal securities laws restrict substantially the ability of a 
fund to invest in shares of other funds. These restrictions are 
designed to prevent fund of funds arrangements that have been used in 
the past to enable investors in an acquiring fund to control the assets 
of an acquired fund and use those assets to enrich themselves at the 
expense of acquired fund shareholders.\4\ Under section 12(d)(1) of the 
Act, funds are subject to certain prohibitions relating to fund of 
funds investments. Section 12(d)(1)(A) prohibits a registered fund (and 
companies or funds it controls) from--
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    \4\ For a discussion of these ``pyramiding'' schemes and the 
additional problems fund of funds arrangements can create for 
shareholders, see Fund of Funds Investments, Investment Company Act 
Release No. 26198 (Oct. 1, 2003) [68 FR 58226 (Oct. 8, 2003)] 
(``Proposing Release''). See also U.S. Securities and Exchange 
Commission, Investment Trusts and Investment Companies, H.R. Doc No. 
279, 76th Cong., 1st Sess., pt. 3, at 2721-95 (1939).
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     Acquiring more than three percent of a fund's outstanding 
voting securities;
     Investing more than five percent of its total assets in 
any one acquired fund; or
     Investing more than ten percent of its total assets in all 
acquired funds.\5\
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    \5\ See 15 U.S.C. 80a-12(d)(1)(A). If the acquiring fund is not 
registered under the Act, the prohibitions apply only with respect 
to its acquisition of securities in funds that are registered under 
the Act. Funds (together with companies or funds they control and 
funds that have the same adviser) also are limited to acquiring no 
more than 10 percent of the outstanding voting stock of a closed-end 
fund. 15 U.S.C. 80a-12(d)(1)(C).
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    Section 12(d)(1)(B) prohibits a registered open-end fund from 
selling securities to any fund (including unregistered funds) if, after 
the sale, the acquiring fund would--
     Together with companies and funds it controls, own more 
than three percent of the acquired fund's voting securities; or
     Together with other funds (and companies they control) own 
more than ten percent of the acquired fund's voting securities.\6\
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    \6\ See 15 U.S.C. 80a-12(d)(1)(B). By limiting the sale of 
registered fund shares to other funds, section 12(d)(1)(B) prevents 
the creation of a fund of registered funds regardless of the 
limitations of U.S. law to regulate the activities of foreign funds. 
For a discussion of the events that led to the adoption of sections 
12(d)(1)(A) and 12(d)(1)(B) of the Act, see Proposing Release, supra 
note 4, at nn. 7-13 and accompanying text.
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    Although these two provisions of section 12(d)(1) have proven quite 
effective in putting a stop to the abusive practices that characterized 
previous fund of funds arrangements, Congress has recognized that they 
also had the effect of preventing legitimate fund of funds 
arrangements. To prevent this, Congress created three statutory 
exceptions.\7\ Our rulemaking today relates to two of those exceptions:
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    \7\ See sections 15 U.S.C. 80a-12(d)(1)(E), 15 U.S.C. 80a-
12(d)(1)(F), and 15 U.S.C. 80a-12(d)(1)(G).
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    Unaffiliated Fund of Funds Arrangements. Section 12(d)(1)(F) 
permits a registered fund to take small positions in an unlimited 
number of other funds (an ``unaffiliated fund of

[[Page 36641]]

funds''). A fund taking advantage of the exception provided in section 
12(d)(1)(F) of the Act (and its affiliated persons) may acquire no more 
than three percent of another fund's outstanding stock; \8\ cannot 
charge a sales load greater than 1\1/2\ percent; \9\ and is restricted 
in its ability to redeem shares of the acquired fund.\10\ In addition, 
the fund's adviser would not be able to influence the outcome of 
shareholder votes in the acquired fund.\11\
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    \8\ See 15 U.S.C. 80a-12(d)(1)(F)(i).
    \9\ See 15 U.S.C. 80a-12(d)(1)(F)(ii).
    \10\ A fund whose shares are acquired pursuant to section 
12(d)(1)(F) is not obligated to redeem more than 1 percent of its 
total outstanding securities during any period of less than 30 days. 
15 U.S.C. 80a-12(d)(1)(F).
    \11\ Section 12(d)(1)(F), by reference to section 12(d)(1)(E) of 
the Act, requires the acquiring fund to vote shares of an acquired 
fund either by seeking instructions from the acquiring fund's 
shareholders, or to vote the shares in the same proportion as the 
vote of all other shareholders of the acquired fund. See 15 U.S.C. 
80a-12(d)(1)(E)(iii)(aa).
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    Affiliated Fund of Funds Arrangements. Section 12(d)(1)(G) permits 
a registered open-end fund or unit investment trust (``UIT'')\12\ to 
acquire an unlimited amount of shares of other registered open-end 
funds and UITs that are part of the same ``group of investment 
companies,'' (typically known as a fund complex).\13\ A fund taking 
advantage of this exception (an ``affiliated fund of funds'') is 
restricted in the types of other securities it can hold in addition to 
shares of registered funds in the same group of investment 
companies.\14\ The acquired funds 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-tiered structures),\15\ and overall 
distribution expenses are limited (to prevent excessive sales 
loads).\16\ Relying on this provision, several large fund complexes 
include a fund of funds, which allocates and periodically reallocates 
its assets among funds in the complex.\17\
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    \12\ The Act defines ``unit investment trust'' as a fund that: 
(i) Is organized under a trust indenture, contract of custodianship 
or agency, or similar instrument; (ii) does not have a board of 
directors; and (iii) issues only redeemable securities, each of 
which represents an undivided interest in a unit of specified 
securities, but does not include a voting trust. 15 U.S.C. 80a-4(2).
    \13\ 15 U.S.C. 80a-12(d)(1)(G). For purposes of the exception, 
the term ``group of investment companies'' means ``any 2 or more 
registered investment companies that hold themselves out to 
investors as related companies for purposes of investment and 
investor services.'' 15 U.S.C. 80a-12(d)(1)(G)(ii).
    \14\ In addition to investing in securities of registered funds 
in the same group of investment companies, the Act permits these 
funds to invest only in government securities and short-term paper. 
See 15 U.S.C. 80a-12(d)(1)(G)(i)(II).
    \15\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(IV).
    \16\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(III). The provision 
permits a fund to invest in shares of another fund only if either 
(i) the acquiring fund does not charge a sales load or distribution-
related fee or does not pay (and is not assessed) sales loads or 
distribution-related fees on securities of the acquired fund, or 
(ii) the aggregate sales loads or distribution-related fees charged 
by the acquiring fund on its securities and paid by the acquiring 
fund on acquired fund securities are not excessive under rules 
adopted under section 22(b) [15 U.S.C. 80a-22(b)] or 22(c) [15 
U.S.C. 80a-22(c)] by a securities association registered under 
section 15A of the Securities Exchange Act of 1934 (the ``Exchange 
Act'') [15 U.S.C. 78o-3] or the Commission. The NASD has adopted 
limits on sales loads and distribution-related fees applicable to 
funds as well as to funds of funds. See NASD Rule 2830(d)(3) (``NASD 
Sales Charge Rule'').
    Under the NASD Sales Charge Rule for funds of funds, if neither 
the acquiring nor acquired fund has an asset-based sales charge 
(12b-1 fee), the maximum aggregate sales load that can be charged on 
sales of acquiring fund and acquired fund shares cannot exceed 8.5 
percent. See NASD Sales Charge Rule 2830(d)(3)(A). Any acquiring or 
acquired fund that has an asset-based sales charge must individually 
comply with the sales charge limitations on funds with an asset-
based sales charge, provided, among other conditions, that if both 
funds have an asset-based sales charge, the maximum aggregate asset-
based sales charge cannot exceed .75 of 1 percent per year of the 
average annual net assets of both funds; and the maximum aggregate 
sales load may not exceed 7.25 percent of the amount invested, or 
6.25 percent if either fund pays a service fee. See NASD Sales 
Charge Rule 2830(d)(3)(B). The rule is designed so that cumulative 
charges for sales-related expenses, no matter how they are imposed, 
are subject to equivalent limitations. See Order Approving Proposed 
Rule Change Relating to the Limitation of Asset-Based Sales Charges 
as Imposed by Investment Companies, Exchange Act Release No. 30897 
(July 7, 1992) [57 FR 30985 (July 13, 1992)], at text accompanying 
n. 9.
    \17\ See, e.g., T. Rowe Price Retirement Funds, Prospectus 1-10 
(Oct. 1, 2005).
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II. Discussion

    Since 1940 we have provided limited relief for funds to acquire 
shares of other funds when the proposed arrangements did not present 
the risk of abuses that section 12(d)(1) was designed to prevent. We 
issued those orders under our general exemptive authority in section 
6(c) of the Act.\18\ In 1996, when Congress added section 12(d)(1)(G), 
it also gave us specific authority to exempt any person, security or 
transaction, or any class or classes of transactions, from section 
12(d)(1) of the Act if the exemption is consistent with the public 
interest and the protection of investors.\19\
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    \18\ 15 U.S.C. 80a-6(c).
    \19\ National Securities Markets Improvement Act of 1996, Pub. 
L. 104-290, Sec.  202, 110 Stat. 3416, 3427 (1996) (codified at 15 
U.S.C. 80a-12(d)(1)(J)).
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    In October 2003, we proposed three new rules to address the ability 
of a registered fund to invest in shares of another fund without first 
having to seek Commission approval.\20\ The rules were proposed to 
codify and expand upon a number of exemptive orders we have issued that 
permit funds to invest in other funds.\21\ We also proposed amendments 
to Forms N-1A, N-2, N-3, N-4, and N-6 to require funds of funds to 
disclose acquired fund expenses in their prospectuses. We received five 
comments on the proposal.\22\ Commenters supported the proposed rules 
and amendments, but suggested changes. Today, we are adopting rules 
12d1-1, 12d1-2 and 12d1-3, and amendments to Forms N-1A, N-2, N-3, N-4, 
and N-6 substantially as proposed, with changes that respond to issues 
raised by commenters.
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    \20\ Proposing Release, supra note 4.
    \21\ See id, at nn. 36, 72 and 87.
    \22\ See Comment Letter of Fidelity Management & Research 
Company (``FMR'') (Dec. 19, 2003); Comment Letter of the Investment 
Company Institute (``ICI'') (Dec. 3, 2003); Comment Letter of IMRC 
Group (Nov. 18, 2003); Comment Letter of Man Investments, Inc. (Dec. 
1, 2003); Comment Letter of Joel Torrance (June 17, 2004). The 
comment letters are available for public inspection and copying in 
the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549 (File No. S7-18-03). The comment letters are 
also available on the Commission's Internet Web site (http://www.sec.gov/rules/proposed/s71803.shtml
).

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A. Rule 12d1-1: Investments in Money Market Funds

    Rule 12d1-1 allows funds to invest in shares of money market funds 
in excess of the limits of section 12(d)(1). The rule is designed to 
permit ``cash sweep'' arrangements in which a fund invests all or a 
portion of its available cash in a money market fund rather than 
directly in short-term instruments. Commenters agreed with our 
assessment that fund investments in money market funds, which did not 
exist in 1940, do not raise the concerns that underlie section 
12(d)(1).\23\ Some, however, persuaded us to make some modifications to 
the rule, which we describe below.\24\
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    \23\ See Comment Letter of IMRC Group (Nov. 18, 2003); Comment 
Letter of ICI (Dec. 3, 2003). For a more extensive discussion of 
this analysis, see Proposing Release, supra note 4, at nn. 38-39 and 
accompanying text.
    \24\ One commenter recommended amending rule 17d-1 to permit 
joint transactions that would allow funds to take advantage of other 
cash management tools, such as joint repurchase agreements where the 
fund participates on terms not different from those applicable to 
its affiliated participant. See Comment Letter of ICI (Dec. 3, 
2003). The broader relief suggested is outside the scope of our 
proposals. We are, however, adopting a technical amendment to rule 
12d1-1 in response to this commenter's assertion that the proposed 
defined term ``Administrative Fees'' could create confusion because 
the term is used elsewhere in our rules. See, e.g., 17 CFR 270.11a-3 
and Instruction 3 to Item 3 of Form N-1A. We have eliminated the 
term and defined the fees subject to the rule in the applicable 
provision without any substantive changes to the provision. See rule 
12d1-1(b)(1).

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[[Page 36642]]

1. Scope of Exemption
(a) Registered Money Market Funds
    Rule 12d1-1 permits a fund to invest an unlimited amount of its 
uninvested cash in a money market fund rather than directly in short-
term instruments.\25\ Any investment would, of course, have to be 
consistent with the fund's investment objectives and policies.\26\ The 
acquired fund may be a fund in the same fund complex or in a different 
fund complex. Thus, a fund in a small complex that does not have a 
money market fund may invest available cash in an unaffiliated money 
market fund.
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    \25\ Rule 12d1-1(a). Our exemptive orders had limited cash sweep 
investments to 25 percent of the acquiring fund's total assets. See, 
e.g., Vanguard Group, Inc., et al., Investment Company Act Release 
Nos. 26406 (Mar. 29, 2004) [69 FR 17460 (Apr. 2, 2004)] (notice) and 
26436 (Apr. 23, 2004) (order); Putnam American Government Income 
Fund, et al., Investment Company Act Release Nos. 26200 (Oct. 1, 
2003) [68 FR 57937 (Oct. 7, 2003)] (notice) and 26414 (Apr. 9, 2004) 
(order) (``Putnam Order''); Credit Suisse Asset Management, LLC, et 
al., Investment Company Act Release Nos. 25789 (Oct. 29, 2002) [67 
FR 67220 (Nov. 4, 2002)] (notice) and 25832 (Nov. 22, 2002) (order).
    \26\ See infra note 49.
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    In addition to providing an exemption from section 12(d)(1) of the 
Act, the rule provides exemptions from section 17(a) and rule 17d-1, 
which restrict a fund's ability to enter into transactions and joint 
arrangements with affiliated persons.\27\ These provisions would 
otherwise prohibit an acquiring fund from investing in a money market 
fund in the same fund complex,\28\ or prohibit a fund that acquires 
five percent or more of the securities of a money market fund in 
another fund complex from making any additional investments in the 
money market fund.\29\
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    \27\ Section 17(a) generally prohibits affiliated persons of a 
registered fund (``first-tier affiliates'') or affiliated persons of 
the fund's affiliated persons (``second-tier affiliates'') from 
selling securities or other property to the fund (or any company the 
fund controls). 15 U.S.C. 80a-17(a). Section 17(d) of the Act makes 
it unlawful for first- and second-tier affiliates, 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 it controls, is a joint 
or a joint and several participant in contravention of Commission 
rules. 15 U.S.C. 80a-17(d). Rule 17d-1(a) prohibits first- and 
second-tier affiliates of a registered fund, the fund's principal 
underwriters, 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 the fund (or any 
company it controls) is a participant unless an application 
regarding the enterprise, arrangement or plan has been filed with 
the Commission and has been granted. 17 CFR 270.17d-1.
    \28\ An affiliated person of a fund includes any person directly 
or indirectly controlling, controlled by, or under common control 
with such other person. See 15 U.S.C. 80a-2(a)(3)(C) (definition of 
``affiliated person''). Most funds today are organized by an 
investment adviser that advises or provides administrative services 
to other funds in the same complex. Funds in a fund complex are 
generally under common control of an 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)(9). Not all advisers 
control funds they advise. The determination of whether a fund is 
under the control of its adviser, officers, or directors depends on 
all the relevant facts and circumstances. See Investment Company 
Mergers, Investment Company Act Release No. 25259 (Nov. 8, 2001) [66 
FR 57602 (Nov. 15, 2001)], at n. 11. For purposes of this release, 
we presume that funds in a fund complex are under common control 
because funds that are not affiliated persons would not require, and 
thus not rely on, the exemptions from section 17(a) and rule 17d-1.
    \29\ An affiliated person of a fund also includes: (i) Any 
person directly or indirectly owning, controlling, or holding with 
power to vote, five percent or more of the outstanding voting 
securities of the fund; and (ii) any person five percent 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). Thus, a fund that acquires five percent 
of the securities of another fund would be affiliated with that fund 
and any transactions with the fund would be subject to the 
limitations of section 17. See supra note 27.
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    Commenters agreed with us that an acquiring fund's purchase and 
redemption of money market fund shares at net asset value would provide 
little opportunity for the insider self-dealing or overreaching that 
section 17 was designed to prevent.\30\ They agreed that these 
exemptions would benefit funds and their shareholders, supporting our 
conclusion that these provisions are appropriate and in the public 
interest.\31\
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    \30\ See Comment Letter of IMRC Group (Nov. 18, 2003).
    \31\ See Comment Letter of ICI (Dec. 3, 2003); Comment Letter of 
FMR (Dec. 19, 2003).
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    One commenter expressed concern, however, that without additional 
relief from section 17, acquiring funds might not be able to take full 
advantage of the proposed exemption.\32\ If a fund in one fund complex 
acquired more than five percent of the assets of a money market fund in 
another fund complex, any broker-dealer affiliated with that money 
market fund would become a (second-tier) affiliated person of the 
acquiring fund.\33\ As a result of the affiliation, the broker-dealer's 
fee for effecting the sale of securities to the acquiring fund would be 
subject to the conditions set forth in rule 17e-1, including the 
quarterly board review and recordkeeping requirements with respect to 
certain securities transactions involving the affiliated broker-
dealer.\34\ We believe that it is unlikely that a broker-dealer would 
be in a position to take advantage of a fund merely because that fund 
owned a position in a money market fund affiliated with the broker-
dealer.\35\ Accordingly, the final rule permits an acquiring fund to 
pay commissions, fees, or other remuneration to a (second-tier) 
affiliated broker-dealer without complying with the quarterly board 
review and recordkeeping requirements set forth in rules 17e-1(b)(3) 
and 17e-1(d)(2).\36\ This relief is available only if the broker-dealer 
and the acquiring fund become affiliated solely because of the 
acquiring fund's investment in the money market fund. We believe this 
additional relief will enable more funds to take advantage of the 
exemption provided by the rule.
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    \32\ See Comment Letter of IMRC Group (Nov. 18, 2003). Although 
the commenter requested additional relief from section 17 of the 
Act, the commenter did not specify any sections or rules other than 
section 17(e) and rule 17e-1 thereunder. The additional section 17 
relief we are providing is limited to certain provisions of rule 
17e-1 under the Act.
    \33\ See supra note 29.
    \34\ Section 17(e)(2) of the Act prohibits an affiliated person 
(or second-tier affiliate) of a fund from receiving compensation for 
acting as a broker, in connection with the sale of securities to or 
by the fund if the compensation exceeds limits prescribed by the 
section unless permitted by rule 17e-1 under the Act. 15 U.S.C. 80a-
17(e)(2). Rule 17e-1 sets forth the conditions under which a 
commission, fee or other remuneration shall be deemed as not 
exceeding the ``usual and customary broker's commission'' for 
purposes of section 17(e)(2)(A) of the Act. Rule 17e-1(b)(3) 
requires the fund's board of directors, including a majority of the 
directors who are not interested persons under section 2(a)(19) of 
the Act, to determine at least quarterly that all transactions 
effected in reliance on the rule have complied with procedures which 
are reasonably designed to provide that the brokerage compensation 
is consistent with the rule's standards. Rule 17e-1(d)(2) specifies 
the records that must be maintained by each fund with respect to any 
transaction effected pursuant to rule 17e-1.
    \35\ The money market fund's adviser would have no influence 
over the decisions made by the acquiring fund's adviser. In 
addition, because the interests of the adviser to the money market 
fund and the adviser to the acquiring fund are directly aligned with 
their respective funds, transactions between the acquiring fund and 
a broker-dealer affiliate of the money market fund are likely to be 
at arm's length.
    \36\ Rule 12d1-1(c). This exemption also is available for 
payments to broker-dealer affiliates of unregistered money market 
funds. See infra notes 37-42 and accompanying text. The relief 
provided by this exemption is similar to relief provided in a number 
of exemptive orders issued by the Commission. See, e.g., SunAmerica 
Series Trust, et al., Investment Company Act Release Nos. 21203 
(July 14, 1995) [60 FR 37485 (July 20, 1995)] (notice) and 21276 
(Aug. 9. 1995) (order); Prudential Investments LLC, et al., 
Investment Company Act Release Nos. 25736 (Sept. 18, 2002) [67 FR 
59869 (Sept. 24, 2002)] (notice) and 25771 (Oct. 16, 2002) (order). 
An acquiring fund relying on this exemption is required to comply 
with all of the provisions of rule 17e-1, except 17e-1(b)(3) and 
(d)(2). We do not believe that having to comply with the other 
provisions contained in rule 17e-1 would deter acquiring funds from 
taking full advantage of the exemption provided by the rule.
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(b) Unregistered Money Market Funds
    Rule 12d1-1 also permits funds to invest in money market funds that 
are not registered investment companies

[[Page 36643]]

(``unregistered money market funds''). Unregistered money market funds 
are typically organized by a fund adviser for the purpose of managing 
the cash of other funds in a fund complex and operate in almost all 
respects as a registered money market fund, except that their 
securities are privately offered and thus not registered under the 
Securities Act.\37\ Although a fund's investments in unregistered money 
market funds are not restricted by section 12(d)(1), these investments 
are subject to the affiliate transaction restrictions in the Act and 
rules thereunder and thus require exemptions from section 17(a) and 
rule 17d-1.\38\
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    \37\ See 15 U.S.C. 80a-3(c)(1) (excepting from the definition of 
``investment company'' an issuer whose securities are owned by no 
more than 100 persons and which is not making and does not presently 
propose to make a public offering of its securities); 15 U.S.C. 80a-
3(c)(7) (excepting from the definition of ``investment company'' an 
issuer whose securities are owned exclusively by ``qualified 
purchasers'' and which is not making and does not presently propose 
to make a public offering of its securities).
    \38\ See supra notes 27-29 and accompanying text.
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    Commenters had no specific comments on this provision of the 
proposal, and we have adopted it substantially as proposed.\39\ The 
exemption is available only for investments in an unregistered money 
market fund that operates like a money market fund registered under the 
Act. To be eligible, an unregistered money market fund is required to 
(i) limit its investments to those in which a money market fund may 
invest under rule 2a-7 under the Act,\40\ and (ii) undertake to comply 
with all the other provisions of rule 2a-7.\41\ In addition, the 
unregistered money market fund's adviser must be registered as an 
investment adviser with the Commission.\42\ Finally, the acquiring fund 
is required to reasonably believe that the unregistered money market 
fund operates like a registered money market fund and that it complies 
with certain provisions of the Act.\43\ A fund would reasonably believe 
that an acquired fund was in compliance with these provisions if, for 
example, it received a representation from the acquired fund (or the 
adviser to the acquired fund) that the fund would comply with the 
relevant provisions in all material respects and if the acquiring fund 
had no reason to believe that the acquired fund was not, in fact, 
complying with the relevant provisions in all material respects. Thus, 
an acquired fund's failure to comply will not automatically result in 
the loss of the acquiring fund's exemption.
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    \39\ We have made a technical change to conform the wording in 
paragraphs 12d1-1(b)(2)(i)(A) through (E) by adding to paragraph 
12d1-1(b)(2)(i) the words ``satisfies the following conditions as if 
it were a registered open-end investment company.''
    \40\ See 17 CFR 270.2a-7.
    \41\ Rule 12d1-1(d)(2)(ii).
    \42\ Rule 12d1-1(b)(2)(ii). In order for a registered fund to 
invest in reliance on rule 12d1-1 in an unregistered money market 
fund that does not have a board of directors (because, for example, 
it is organized as a limited partnership), the unregistered money 
market fund's investment adviser must perform the duties required of 
a money market fund's board of directors under rule 2a-7. Rule 12d1-
1(d)(2)(ii)(B).
    \43\ Rule 12d1-1(b)(2)(i). To rely on the rule, an acquiring 
fund must reasonably believe that the unregistered money market fund 
complies, as if it were a registered open-end fund, with provisions 
of the Act that limit affiliate transactions (sections 17(a), (d), 
and (e)), issuance of senior securities (section 18), and suspension 
of redemption rights (section 22(e)). Rule 12d1-1(b)(2)(i)(B). The 
fund also must reasonably believe that the unregistered money market 
fund (i) has adopted and periodically reviews procedures designed to 
ensure compliance with these requirements, and maintains books and 
records describing the procedures, and (ii) maintains and preserves 
the books and records required under rules 31a-1(b)(1) [17 CFR 
270.31a-1(b)(1)], 31a-1(b)(2)(ii) [17 CFR 270.31a-1(b)(2)(ii)], 31a-
1(b)(2)(iv) [17 CFR 270.31a-1(b)(2)(iv)], and 31a-1(b)(9) [17 CFR 
270.31a-1(b)(9)]. Rule 12d1-1(b)(2)(i)(C), (D).
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(c) Closed-End Funds of Funds
    The exemptions we are adopting are also available for closed-end 
funds, including business development companies,\44\ which are closed-
end funds that are exempted from registration under the Act.\45\ In 
response to comments, the final rule provides an additional exemption 
from section 57 of the Act, which restricts certain transactions 
between business development companies and certain of their 
affiliates.\46\ This relief is consistent with the relief we are 
granting from section 17(a) and rule 17d-1 with respect to affiliated 
money market funds. We agree with the commenter that the possibility of 
self-dealing or overreaching in the case of business development 
companies that invest in money market funds does not appear to be any 
greater than investments in money market funds by registered closed-end 
funds.
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    \44\ A business development company is any 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 [15 U.S.C. 80a-54(a)(1)-(3)] 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 
business development companies under the Act. See 15 U.S.C. 80a-
2(a)(48). Section 60 of the Act [15 U.S.C. 80a-59] extends the 
limits of section 12(d) to a business development company to the 
same extent as if it were a registered closed-end fund.
    \45\ Section 6(f) of the Act [15 U.S.C. 80a-6(f)] exempts from 
registration and other provisions of the Act companies that have 
elected to be regulated as business development companies under 
section 54 [15 U.S.C. 80a-53].
    \46\ 15 U.S.C. 80a-56. See Comment Letter of IMRC Group (Nov. 
18, 2003).
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(d) Unregistered Funds of Funds
    Unregistered funds also are subject to the section 12(d)(1) 
restrictions on the acquisition of shares of registered funds.\47\ As 
proposed, the final rule permits unregistered funds to invest their 
cash in shares of a registered money market fund. This allows a hedge 
fund, for example, to sweep its cash into a registered money market 
fund pending investment or distribution of the cash to investors. In 
the Proposing Release, we asked whether any special concerns arise with 
respect to unregistered funds' use of money market funds in cash sweep 
arrangements, and we received no comment on the question.
---------------------------------------------------------------------------

    \47\ See 15 U.S.C. 80a-12(d)(1)(A); 15 U.S.C. 80a-12(d)(1)(B). 
In the case of unregistered investment companies (such as most 
foreign funds) the full restrictions of sections 12(d)(1)(A) and (B) 
apply. Companies that are unregistered because they are excepted 
from the definition of investment company by sections 3(c)(1) and 
3(c)(7) of the Act are prohibited from acquiring more than three 
percent of the outstanding voting securities of a registered fund. 
Both section 3(c)(1) and section 3(c)(7) deem issuers that rely on 
these sections to be investment companies for the purposes of 
sections 12(d)(1)(A)(i) and 12(d)(1)(B)(i) with respect to their 
acquisition of registered funds. See 15 U.S.C. 80a-3(c)(1); 15 
U.S.C. 80a-3(c)(7)(D).
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2. Conditions
    As proposed, we are eliminating most of the conditions that have 
been included in our exemptive orders.\48\ One condition we have 
retained precludes the acquiring fund from paying a sales load, 
distribution fee, or service fee on acquired fund shares, or if it 
does, the acquiring fund's investment adviser must waive a sufficient 
amount of its advisory fee to offset the cost of the loads or 
distribution fees.\49\ Rarely do institutional investors (such as an 
acquiring fund) pay sales loads or bear distribution expenses on an 
investment in a money market fund. Thus, a money market fund that 
charges a sales load or

[[Page 36644]]

distribution fees to the acquiring fund may not be an appropriate 
investment for that fund. Commenters who addressed the issue generally 
supported this condition.\50\
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    \48\ See Proposing Release, supra note 4, at n. 36.
    \49\ See Rule 12d1-1(b)(1). As discussed in the Proposing 
Release, we did not propose to limit the amount an acquiring fund 
could invest in a money market fund because a fund's own investment 
restrictions should provide appropriate investment limitations. See 
Proposing Release, supra note 25, at text following n. 64. With 
respect to cash sweeps into unregistered money market funds, we have 
also retained the requirement in our prior exemptive orders that the 
money market funds operate as if they were money market funds 
registered under the Act. As proposed (unlike our exemptive orders), 
the final rule requires the acquiring fund to ``reasonably 
believe,'' rather than ``determine,'' that the unregistered money 
market funds operate in this manner. See supra notes 40-43 and 
accompanying text; see, e.g., Putnam Order, supra note 25.
    \50\ See Comment Letter of IMRC Group (Nov. 18, 2003). One 
commenter recommended we impose another condition to allow a money 
market fund to limit the percentage of fund assets that another fund 
complex can redeem during a business day as long as the limits are 
disclosed in the money market fund's registration statement. Id. We 
do not believe this is necessary in the context of money market 
funds, which are designed to easily accommodate large redemptions. 
Money market funds with large investors, such as a fund of funds, 
may need to pay particularly close attention to their obligations 
under rule 2a-7, however, because a large redemption may result in a 
growth in any deviation between the fund's net asset value per 
share, as computed using available market quotations, and the money 
market fund's amortized cost per share.
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    Unlike our prior exemptive orders, the rule does not limit advisory 
fees or require directors to make any special findings that investors 
are not paying multiple advisory fees for the same service.\51\ A fund 
could pay duplicative fees if an adviser invests a fund's cash in a 
money market fund (which itself pays an advisory fee) without reducing 
its advisory fee by an amount it was compensated to manage the cash. As 
we noted in the Proposing Release, fund directors have fiduciary 
duties,\52\ which obligate them to protect funds from being overcharged 
for services provided to the fund, regardless of any special findings 
we might require. Moreover, and as we describe in more detail below, we 
have adopted amendments to the disclosure rules that require a 
registered fund of funds to disclose to shareholders expenses paid by 
both the acquiring and acquired funds so that shareholders may better 
evaluate the costs of investing in a fund with a cash sweep 
arrangement.\53\
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    \51\ See Proposing Release, supra note 4, at n. 65 and 
accompanying text.
    \52\ See id, at n. 66 and accompanying text; see also 15 U.S.C. 
80a-35(a). See generally 2 T. Frankel, The Regulation of Money 
Managers, Sec.  9.05 (2001). Section 15(c) of the Act requires the 
board of directors to evaluate the terms (which would include fees, 
or the elimination of fees, for services provided by an acquired 
fund's adviser) of any advisory contract. See 15 U.S.C. 80a-15(c). 
Section 36(b) of the Act [15 U.S.C. 80a-35(b)] imposes on fund 
advisers a fiduciary duty with respect to their compensation. We 
believe that to the extent advisory services are being performed by 
another person, such as the adviser to an acquired money market 
fund, this fiduciary duty would require an acquiring fund's adviser 
to reduce its fee by the amount that represents compensation for the 
services performed by the other person. See Proposing Release, supra 
note 4, at n.66.
    \53\ Of course, disclosure of the cumulative amount of fees does 
not absolve the directors of their obligations to evaluate fund 
expenses. See supra note 52; Investment Company Governance, 
Investment Company Act Release No. 26520 (July 27, 2004) [69 FR 
46378 (Aug. 2, 2004)], at text accompanying n.17. Nevertheless, we 
believe that the disclosure requirements are essential because they 
provide investors with the relevant information to compare directly 
the costs of investing in alternative funds of funds, or the costs 
of investing in a fund of funds to a more traditional fund.
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B. Rule 12d1-2: Affiliated Funds of Funds

    As discussed above, section 12(d)(1)(G) permits a registered open-
end fund to acquire an unlimited amount of shares of registered open-
end funds and UITs that are part of the same ``group of investment 
companies'' as the acquiring fund.\54\ We proposed to codify, and in 
some cases expand, three types of relief we have provided for these 
fund of funds arrangements that we concluded were consistent with the 
public interest and the protection of investors, but that did not 
conform to section 12(d)(1)(G) limits. We proposed to permit an 
affiliated fund of funds to make investments in addition to shares of 
funds in the same group of investment companies. Commenters supported 
the proposal, and we are adopting rule 12d1-2 substantially as 
proposed.\55\
---------------------------------------------------------------------------

    \54\ See supra notes 12-17 and accompanying text.
    \55\ See, e.g., Comment Letter of IMRC Group (Nov. 18, 2003); 
Comment Letter of ICI (Dec. 3, 2003); Comment Letter of Man 
Investments, Inc. (Dec. 1, 2003). The other limitations in section 
12(d)(1)(G) will continue to apply to a fund of funds relying on 
that provision. One commenter requested expanding relief under rule 
12d1-2 to permit funds to obtain shares of an acquired fund using 
in-kind transfers and exempt such transactions from the ``for cash'' 
requirement of rule 17a-7 under the Act. See Comment Letter of ICI 
(Dec. 3, 2003). That relief is outside the scope of our proposal.
---------------------------------------------------------------------------

1. Investments in Unaffiliated Funds
    Rule 12d1-2 permits an affiliated fund of funds to acquire 
securities of 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).\56\ This exemption, in effect, permits funds to combine 
the relief provided by the statutory exceptions. There do not appear to 
be any greater risks to an acquired fund or its shareholders if three 
percent of its shares are acquired by an affiliated fund of funds as 
opposed to being acquired by other types of funds specifically 
permitted to purchase shares by section 12(d)(1)(A) or 12(d)(1)(F).\57\
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    \56\ Rule 12d1-2(a)(1). A fund relying on section 12(d)(1)(A) 
(together with any companies or funds it controls) could not acquire 
more than 3 percent of the outstanding voting securities of any 
other fund in a different fund group. In addition, the acquiring 
fund would be limited to investing no more than 5 percent of its own 
assets (together with assets of any companies it controls) in the 
securities of any one fund in a different fund group, and no more 
than 10 percent of its assets (together with assets of any companies 
it controls) in securities of other funds in one or more different 
fund groups, in the aggregate. See 15 U.S.C. 80a-12(d)(1)(A)(i)-
(iii). A fund relying on section 12(d)(1)(F) (together with its 
affiliates) could not acquire more than 3 percent of the outstanding 
stock of any other fund in a different fund group. The acquiring 
fund also would be required either to seek instructions from its 
shareholders as to how to vote shares of those acquired funds, or to 
vote the shares in the same proportion as the vote of all other 
shareholders of the acquired fund. See 15 U.S.C. 80a-12(d)(1)(F) 
(referencing 15 U.S.C. 80a-12(d)(1)(E)). In addition, the acquiring 
fund would be limited to charging a sales load of 1\1/2\ percent on 
its shares and could be prevented from redeeming more than 1 percent 
of the shares of any acquired fund during any period of less than 30 
days. Id.
    \57\ A commenter also suggested that we clarify the scope of 
rule 12d1-2(a)(1) because it could be read to subject investments in 
registered funds in the same complex as the acquiring fund to the 
limits of sections 12(d)(1)(A) or 12(d)(1)(F). See Comment Letter of 
ICI (Dec. 3, 2003). We agree, and the final rule clarifies that the 
limits apply only to investments in securities of unaffiliated funds 
rather than registered funds in the same complex. See rule 12d1-
2(a)(1).
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2. Investments in Other Types of Issuers
    Rule 12d1-2 also provides an exemption from section 12(d)(1)(G) of 
the Act to permit an affiliated fund of funds to invest directly in 
stocks, bonds, and other types of securities (i.e., securities not 
issued by a fund).\58\ Those investments would, of course, have to be 
consistent with the fund's investment policies.\59\ A significant 
consequence of the rule is that an equity or bond fund can invest any 
portion of its assets in an affiliated fund if the acquisition is 
consistent with the investment policies of the fund and the 
restrictions of the rule.\60\ Commenters agreed that these investments 
would allow an acquiring fund greater flexibility in meeting investment 
objectives that may not be met as well by investments in other funds in 
the same fund group, while not presenting any additional concerns that 
section 12(d)(1)(G) was intended to address.\61\
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    \58\ Rule 12d1-2(a)(2). Under this exemption, a fund may invest 
in any security as that term is defined under the Act. See 15 U.S.C. 
80a-2(a)(36).
    \59\ See Item 4 of Form N-1A (requiring disclosure of fund's 
investment objectives and principal investment strategies).
    \60\ See Proposing Release, supra note 4, at nn. 81-82 and 
accompanying text. To the extent that a fund that normally invests 
directly in securities begins to make investments in affiliated 
funds in reliance on the rule, we would expect the fund's directors 
to be aware of the investments, particularly in the context of their 
consideration of potentially duplicative fees. See supra notes 52-53 
and accompanying text.
    \61\ See Comment Letter of ICI (Dec. 3, 2003); Comment Letter of 
IMRC Group (Nov. 18, 2003).
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3. Investments in Money Market Funds
    Rule 12d1-2 permits an affiliated fund of funds to invest in 
affiliated or unaffiliated money market funds in reliance on rule 12d1-
1, which, as discussed above, is designed to permit cash sweep 
arrangements involving money market funds.\62\ This provision

[[Page 36645]]

allows the affiliated fund of funds the same opportunities as any other 
fund to invest in a cash sweep arrangement that will provide the 
greatest benefit to the acquiring fund. As proposed, we are 
conditioning the investment on compliance with rule 12d1-1 in order to 
ensure that the same limitations on sales loads and distribution 
expenses apply to any fund's investment in a money market fund. Thus, 
any fund that invests in a money market fund in reliance on rule 12d1-2 
must comply with the conditions in rule 12d1-1.
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    \62\ Rule 12d1-2(a)(3). See supra notes 23-50 and accompanying 
text. A collateral effect of our rule is to permit an affiliated 
fund of funds to invest in an acquired fund that itself has a cash 
sweep arrangement. As discussed above, section 12(d)(1)(G) prohibits 
a fund from acquiring shares of another fund that does not have an 
investment policy prohibiting it from investing in shares of funds 
in reliance on section 12(d)(1)(F) or (G). An acquired fund 
investing in a money market fund under a cash sweep arrangement 
permitted under rule 12d1-1 would not be relying on either of those 
sections. The fees and expenses of acquired funds would be 
aggregated and shown in the fee table in the acquiring fund's 
prospectus. See discussion below at Section II.D of this release.
    We are not, as one commenter suggested, providing expanded 
section 17 relief under rule 12d1-2. See Comment Letter of IMRC 
Group (Nov. 18, 2003). Affiliated funds of funds' investments in 
money market funds will be made in reliance upon rule 12d1-1, and we 
are including additional relief from certain provisions of rule 17e-
1 in rule 12d1-1. We do not believe it is necessary to provide a 
duplicative exemption under rule 12d1-2. See supra notes 32-35 and 
accompanying text.
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C. Rule 12d1-3: Unaffiliated Funds of Funds

    Section 12(d)(1)(F) of the Act provides an exemption from section 
12(d)(1) that allows a registered fund to invest all its assets in 
other registered funds if: (i) The acquiring fund (together with its 
affiliates) acquires no more than 3 percent of the outstanding stock of 
any acquired fund; and (ii) the sales load charged on the acquiring 
fund's shares is no greater than 1\1/2\ percent.\63\
---------------------------------------------------------------------------

    \63\ See 15 U.S.C. 80a-12(d)(1)(F)(i)-(ii). Section 12(d)(1)(F) 
also provides that the acquired fund is not obligated to redeem more 
than 1 percent of its outstanding securities held by the acquiring 
fund in any period of less than 30 days, and requires the acquiring 
fund to vote shares of an acquired fund either by seeking 
instructions from the acquiring fund's shareholders or by voting in 
the same proportion as the other shareholders of the acquired fund.
---------------------------------------------------------------------------

    Rule 12d1-3 allows funds relying on section 12(d)(1)(F) to charge 
sales loads greater than 1\1/2\ percent provided that the aggregate 
sales load any investor pays (i.e., the combined distribution expenses 
of both the acquiring and acquired funds) does not exceed the limits on 
sales loads established by the NASD for funds of funds.\64\ The rule is 
intended to provide funds greater flexibility in structuring sales 
loads, consistent with the approach Congress took in section 
12(d)(1)(G) to prevent excessive sales loads in affiliated funds of 
funds, while providing shareholders greater protection by requiring 
that funds relying on the rule limit overall distribution fees (rather 
than only sales loads).\65\ We are adopting this rule substantially as 
proposed.\66\
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    \64\ See NASD Sales Charge Rule 2830(d)(3), supra note 16. We 
note that any fund relying on the exemption provided in rule 12d1-3 
must comply with the limitations set forth in NASD Sales Charge Rule 
2830(d)(3), regardless of whether sales of the fund's shares by 
broker-dealers are otherwise subject to the rule according to its 
terms. See NASD Sales Charge Rule 2830(d) (NASD Sales Charge Rule 
limits apply to sales of open-end funds, any closed-end funds that 
make periodic repurchase offers under rule 23c-3(b) under the Act 
and offer their shares on a continuous basis, or single payment 
plans issued by UITs). Unlike the proposal, the final rule text 
limits sales charges and service fees charged with respect to the 
acquiring fund, but the rule does not specifically limit those fees 
when aggregated with sales charges and service fees charged with 
respect to acquired funds. The additional language on aggregation is 
not necessary in the rule because limits in NASD Sales Charge Rule 
2830(d)(3) specifically apply to fees imposed by the acquiring fund, 
the acquired fund and those funds in combination.
    \65\ See Proposing Release, supra note 4, at n. 88 and 
accompanying text. An affiliated fund of funds may rely on rule 
12d1-2 to invest in funds in a different fund complex subject to the 
limits of section 12(d)(1)(A) or 12(d)(1)(F). If the acquiring 
fund's investment is subject to the limits of section 12(d)(1)(F), 
the acquiring fund may also rely on the exemption provided under 
rule 12d1-3 to charge sales loads greater than 1\1/2\ percent 
provided it complies with the conditions of rule 12d1-3.
    \66\ Commenters generally supported this provision. See Comment 
Letter of ICI (Dec. 3, 2003); Comment Letter of FMR (Dec. 19, 2003).
---------------------------------------------------------------------------

D. Amendments to Disclosure Forms: Transparency of Fund of Funds 
Expenses

    We are also adopting amendments to our disclosure requirements to 
require each fund that invests in shares of other funds to disclose in 
its prospectus fee table the expenses of funds in which it invests. The 
amendments are designed to provide investors with a better 
understanding of the actual costs of investing in a fund that invests 
in other funds, which have their own expenses that may be as high or 
higher than the acquiring fund's expenses.\67\ Investors may not be 
aware of these potentially higher expenses. Most commenters supported 
these amendments, which we are adopting substantially as proposed.\68\
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    \67\ A fund of funds may have higher fees and expenses than a 
fund that invests directly in debt and equity securities.
    \68\ See Comment Letter of ICI (Dec. 3, 2003); Comment Letter of 
FMR (Dec. 19, 2003) (supporting position taken in the ICI comment 
letter); Comment Letter of IMRC Group (Nov. 18, 2003); Comment 
Letter of Joel Torrance (June 17, 2004).
---------------------------------------------------------------------------

    Open-End Funds. Form N-1A is used by open-end management funds to 
register under the Act and to offer their securities under the 
Securities Act. Form N-1A sets forth the disclosure requirements for 
fund prospectuses. Our amendments to Form N-1A require any registered 
open-end fund investing in shares of another fund to include in its 
prospectus fee table an additional line item titled ``Acquired Fund 
Fees and Expenses'' under the section that discloses total annual fund 
operating expenses.\69\ The line item will set forth the acquiring 
fund's pro rata portion of the cumulative expenses charged by funds in 
which the acquiring fund invests. Those costs will be included in the 
acquiring funds' total annual fund operating expenses, which will be 
reflected in the ``Example'' portion of the fee table.\70\ One 
commenter suggested that we add an instruction to permit a fund to omit 
the new separate line item if the aggregate expenses attributable to 
acquired funds do not exceed 0.01 percent (one basis point) of average 
net assets of the acquiring fund. We agree with the commenter that the 
disclosure of this de minimis amount in a separate line item would not 
be important to investors. Therefore, the instructions to the amended 
fee table allow these expenses to be included in ``Other Expenses.'' 
\71\
---------------------------------------------------------------------------

    \69\ The item will appear directly above the line item titled 
``Total Annual Fund Operating Expenses.'' The proposed instructions 
to Form N-1A would have permitted funds to use terms in the fee 
table other than the term ``Acquired Fund.'' We received no comment 
in response to our question whether the proposed instructions were 
consistent with the current fee table. We have decided not to permit 
funds to use other terms, however, because no variation is permitted 
for other line items in the fee table (except for the subcaptions 
that may be used under ``Other Expenses'' in order to identify the 
largest expenses comprising ``Other Expenses''). Accordingly, the 
instruction, as adopted, is consistent with the other line items in 
the expense table, and allows investors to more easily compare 
disclosure among funds. In the event a fund uses another defined 
term to describe acquired funds in its prospectus, it may include 
this term in a parenthetical following the title of the new line 
item. See Instruction 3(f)(i) to Item 3 of Form N-1A. We are 
adopting conforming amendments to Forms N-2 and N-3. See Instruction 
10.a to Item 3.1 of Form N-2; Instruction 19(a) to Item 3(a) of Form 
N-3.
    \70\ The fee table example requires the fund to disclose the 
cumulative amount of fund expenses of 1, 3, 5, and 10 years based on 
a hypothetical investment of $10,000 and an annual 5 percent return. 
See Item 3 of Form N-1A.
    \71\ See Comment Letter of ICI (Dec. 3, 2003). See Instruction 
3(f)(i) to Item 3 of Form N-1A. Inclusion of the de minimis amount 
under ``Other Expenses,'' however, ensures that the acquired funds' 
expenses will be included in the acquiring fund's total annual 
operating expense ratio. Form N-2 and Form N-3 filers may also rely 
on this exception and we have amended the relevant instructions 
accordingly. See Instruction 10.a to Item 3.1 of Form N-2; 
Instruction 19(a) to Item 3(a) of Form N-3.
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    We also are adopting instructions to assist an acquiring fund in 
determining the amount of acquired funds' fees and expenses that must 
be reflected in its fee

[[Page 36646]]

table. The acquiring fund must aggregate the amount of total annual 
fund operating expenses of acquired funds (which are indirectly paid by 
the acquiring fund) and transaction fees (which are directly paid by 
the acquiring fund over the past year) and express the total amount as 
a percentage of average net assets of the acquiring fund. Under this 
approach, the acquiring fund must determine the average invested 
balance and number of actual days invested in each acquired fund.\72\ 
We also are adopting the proposed instruction that requires the 
acquiring fund to include in the expense calculation any transaction 
fee the acquiring fund paid to acquire or dispose of shares of a fund 
during the past fiscal year (even if it no longer holds shares of that 
fund).\73\
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    \72\ See Instruction 3(f)(ii) to Item 3 of Form N-1A (to 
calculate the pro rata share of total annual fund operating expenses 
for each acquired fund, an acquiring fund will divide the acquired 
fund's expense ratio by the number of days in the relevant calendar 
year, and multiply the result by the average invested balance and 
the number of days invested in the acquired fund). We have revised 
the divisor in the calculation for the daily expense ratio from the 
proposed 365 days to the number of days in the fiscal year to 
reflect that some fiscal years will have 366 days. One commenter 
asserted that our proposed formula in Instruction 3(f)(ii) to Item 3 
of Form N-1A would not correspond to the expense ratio (i.e., the 
Ratio of Expenses to Average Net Assets) currently in Item 8 of Form 
N-1A, ``Financial Highlights Information.'' The commenter stated 
that, as a result, the total annual fund operating expenses 
disclosed in response to Item 3 would be generally higher than those 
reflected in response to Item 8 because the expense ratio in Item 8 
would only reflect expenses paid directly by the acquiring fund. See 
Comment Letter of ICI (Dec. 3, 2003). We agree that this potential 
discrepancy may be confusing to investors, and have revised the 
instruction to permit funds to address this discrepancy in a 
clarifying footnote to the fee table. See Instruction 3(f)(vii) to 
Item 3 of Form N-1A. Because Form N-2 and Form N-3 filers would face 
the same issue, the adopted instructions permit those funds also to 
include a clarifying footnote. See Instruction 10.i to Item 3.1 of 
Form N-2; Instruction 19(g) to Item 3(a) of Form N-3. We also have 
directed the staff to continue monitoring funds of funds' disclosure 
to determine whether additional disclosure of acquired funds' fees 
is needed, such as in the financial highlights section or 
shareholder reports.
    We are also revising Instruction 3(f)(v) to Item 3 of Form N-1A. 
The proposed instructions would have required the acquiring fund to 
calculate an ``average invested balance'' based on month-end 
balances. One commenter recommended that funds be permitted to 
calculate ``average invested balances'' based on the value of 
investment measured no less frequently than monthly to allow funds 
the flexibility of using daily balances. See Comment Letter of ICI 
(Dec. 3, 2003). We believe that the recommendation will allow the 
most accurate disclosure for funds that use the more frequent 
measure and have revised the instruction to allow the acquiring fund 
to calculate ``average invested balance'' based on the value of 
investment measured no less frequently than monthly. See Instruction 
10.e to Item 3.1 of Form N-2; Instruction 19(e) to Item 3 of Form N-
3.
    \73\ See Instruction 3(f)(ii) to Item 3 of Form N-1A 
(``transaction fees'' included in the calculation for acquired 
funds' fees and expenses include the total amount of sales loads, 
redemption fees, or other transaction fees paid by the acquiring 
fund in connection with acquiring or disposing of shares in acquired 
funds during the year). We clarified this instruction to indicate 
that ``transaction fees'' include fees paid in connection with 
acquiring and disposing of shares. If an acquired fund charges a 
performance fee, the fee would be included in the disclosure of 
acquired funds' fees and expenses. The amended instructions to Form 
N-1A would require an acquiring fund to include a performance fee 
that is accounted for as an incentive allocation, in conformance 
with the amended instructions to Form N-2. See infra notes 83, 84.
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    Our proposed instructions would have required an acquiring fund in 
the same fund complex as the acquired fund to calculate the acquired 
fund's actual total annual expense ratio for the period covering the 
acquiring fund's fiscal year.\74\ For funds in a different fund 
complex, our proposal would have required the acquiring funds to use 
the gross expense ratio disclosed in an acquired fund's most recent 
semi-annual report filed with the Commission, or if the fund does not 
file reports with the Commission or the gross expense ratio is not 
provided, to use the expense ratio provided in a recent communication 
from the acquired fund.\75\
---------------------------------------------------------------------------

    \74\ See Proposing Release, supra note 4.
    \75\ Id.
---------------------------------------------------------------------------

    One commenter questioned whether funds in the same fund complex 
should have to calculate this special purpose expense ratio and 
recommended that an acquiring fund use the acquired fund's annual 
expense ratio as disclosed in its most recent semi-annual report filed 
with the Commission.\76\ We agree with the commenter that it is 
unnecessary to calculate a special purpose expense ratio for funds in 
the same fund complex because expense ratios typically do not fluctuate 
much from year to year. Therefore, acquired fund expense disclosure 
based on a special purpose expense ratio would in most cases be 
identical to or negligibly different from the disclosure based on the 
expense ratio as disclosed in the most recent shareholder report. 
Accordingly, the instructions as adopted require an acquiring fund to 
calculate the acquired funds' expenses using the net expense ratios 
reported in the acquired funds' most recent shareholder reports.\77\ We 
also believe that allowing acquiring funds to use the net expense ratio 
disclosed in shareholder reports (which may or may not be filed with 
the Commission depending on whether the fund is registered with the 
Commission), instead of reports filed with the Commission, will permit 
more acquiring funds to rely on a readily available expense ratio and 
will eliminate the need for any special communication between the 
funds.\78\ If an acquired fund does not provide a net expense ratio in 
its most recent shareholder report or is a newly formed fund that has 
not prepared a report, the acquiring fund must use the acquired fund's 
total annual fund operating expenses over average annual net assets as 
reported in its most recent communication to the acquiring fund.\79\
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    \76\ See Comment Letter of ICI (Dec. 3, 2003).
    \77\ See Instruction 3(f)(iv) to Item 3 of Form N-1A. The 
proposal would have required acquiring funds to use a gross expense 
ratio, which would have excluded the effect of waivers or 
reimbursements. Amended instruction 3(f)(iv) requires use of the net 
operating expense ratio, which includes the effect of waivers or 
reimbursements by the acquired fund's investment adviser or sponsor. 
We believe that permitting funds to use the net operating expense 
ratio that is disclosed in shareholder reports instead of the gross 
expense ratio (which may not be available in shareholder reports 
because it is not required disclosure) will significantly reduce the 
need for special calculations or communications between the 
acquiring and acquired fund because the acquiring fund will not have 
to adjust the net expense ratio disclosed in the shareholder report 
to exclude the effect of waivers and reimbursements. We have made 
conforming amendments to Forms N-2 and N-3. See Instruction 10.d to 
Item 3.1 of Form N-2; Instruction 19(d) to Item 3(a) of Form N-3.
    \78\ Funds may use the most recent shareholder report, whether 
it is an annual or semi-annual report. If the acquiring fund relies 
on a semi-annual report, however, it must use an annualized expense 
ratio. See Instruction 3(f)(iv) to Item 3 of Form N-1A; Instruction 
10.d to Item 3.1 of Form N-2; Instruction 19(d) to Item 3(a) of Form 
N-3.
    \79\ See Instruction 3(f)(iv) to Item 3 of Form N-1A. We also 
are conforming the instruction with respect to the expense ratio 
used for funds in a different fund complex in order to establish a 
uniform instruction. We believe that this revision will provide 
greater consistency among funds of funds' expense disclosures. Id. 
We have made conforming changes to Forms N-2 and N-3. See 
Instruction 10.d to Item 3.1 of Form N-2; Instruction 19(d) to Item 
3 of Form N-3.
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    The new disclosure requirements we are adopting today also will 
apply with respect to investments in any unregistered fund that would 
be an investment company under section 3(a) of the Act but for the 
exceptions provided in sections 3(c)(1) and 3(c)(7) of the Act.\80\ 
Thus, a fund with a cash sweep arrangement will be required to report 
the expenses of the unregistered money market fund in which the 
acquiring fund invests.
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    \80\ See Instruction 3(f)(i) to Item 3 of Form N-1A, Instruction 
10.a to Item 3.1 of Form N-2, Instruction 19(a) to Item 3 of Form N-
3. See also 15 U.S.C. 80a-3(c)(1), 80a-3(c)(7), and supra note 37.
---------------------------------------------------------------------------

    Closed-End Funds. Form N-2 is used by closed-end management funds 
to register under the Act and to offer their securities under the 
Securities Act. Closed-end funds sometimes invest in other funds and 
unregistered pools of investments, such as hedge funds.\81\ The

[[Page 36647]]

amendments to Form N-2 require a registered closed-end fund of funds 
(including a closed-end fund of hedge funds) to include its pro rata 
portion of the cumulative expenses charged by the acquired funds, 
including management fees and expenses, transaction fees and 
performance fees (including incentive allocations), as a line item in 
its fee table.\82\ As adopted, the instructions provide generally that 
any incentive allocations (fees based on a share of income, capital 
gains and/or appreciation) must be reflected in the acquired fund's 
fees and expenses.\83\
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    \81\ Hedge funds are often ``private funds'' as defined in rule 
203(b)(3)-1(d) of the Investment Advisers Act of 1940. 17 CFR 
275.203(b)(3)-1(d) (a ``private fund'' is a fund (i) that would be 
an investment company under section 3(a) of the Investment Company 
Act but for the exceptions to that definition in sections 3(c)(1) 
and 3(c)(7) of the Act, (ii) that permits its owners to redeem any 
portion of their ownership interests within two years of the 
purchase of such interests, and (iii) interests in which are or have 
been offered based on the investment advisory skills, ability or 
expertise of the investment adviser). See also Registration Under 
the Advisers Act of Certain Hedge Fund Advisers, Investment Advisers 
Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054 (Dec. 10, 2004)], 
at Section II.E. Closed-end funds also may invest in private equity 
funds, venture capital funds, or other funds that generally require 
capital contributions over the life of the fund and the long-term 
commitment of capital. See id. at nn. 224-225.
    \82\ See Instruction 10 to Item 3.1 of Form N-2. Consistent with 
the required disclosure of master-feeder funds' expenses under Form 
N-1A, the instructions to Form N-2 clarify that in the event a 
closed-end fund of funds is a master-feeder fund, the feeder fund 
must disclose in its fee table the aggregate expenses of the feeder 
fund and master fund. The aggregate expenses of the master fund must 
also include fees and expenses incurred indirectly by the feeder 
fund as a result of the master fund's investment in shares of one or 
more acquired funds. See Instruction 10.h to Item 3.1 of Form N-2. 
See also Proposing Release, supra note 4, at n. 90.
    As with a fund of registered funds, investors may not be aware 
that a fund of hedge funds may have higher fees and expenses than an 
alternate fund of funds or a fund that invests directly in debt and 
equity securities. See NASD Investor Alert, Funds of Hedge Funds--
Higher Costs and Risks for Higher Potential Returns (Aug. 23, 2002) 
(available at: http://www.nasd.com/Investor/alerts/alert_hedgefunds.htm
); Stephen J. Brown, William N. Goetzmann, and Bing 

Liang, Fees on Fees in Funds of Funds, 3 (Yale International Center 
for Finance Working Paper No. 02-33, June 14, 2004). See also supra 
note 67.
    \83\ See Instruction 10.b to Item 3.1 of Form N-2. The adviser 
of an acquired fund may charge its shareholders a fee based on a 
share of income, capital gains and/or appreciation of the assets of 
the shareholder in the acquired fund. This fee, which is paid to the 
adviser or an affiliate, is called either a performance fee or an 
incentive allocation depending on the way the acquired fund accounts 
for it in its financial statements. Performance fees are reflected 
in the acquired fund's statement of operations, but incentive 
allocations are reported in the statement of changes of capital. The 
effect of this accounting treatment is that performance fees are 
included in the acquired fund's expense ratio reported in the 
shareholder report but incentive allocations are not.
    Therefore, in order to provide complete disclosure of fees 
incurred when funds invest in hedge funds, we are requiring 
acquiring funds to include these incentive allocations in the 
formula for calculating acquired funds' fees and expenses. We have 
made conforming amendments to Form N-1A. See Instruction 3(f)(ii) to 
Item 3 of Form N-1A.
---------------------------------------------------------------------------

    Each acquiring closed-end fund must determine expenses attributable 
to its investments in acquired funds during the most recent fiscal year 
together with, if applicable, any investments it intends to make with 
the proceeds of its present offering. The instructions require a fund 
to reflect the amount of expenses attributed to the intended 
investments assuming those investments had been held by the acquiring 
fund during its most recent fiscal year.\84\ Given the extensive due 
diligence that we understand fund of hedge fund managers undertake in 
order to create an investment strategy for the fund, we believe that 
each acquiring fund should be able to provide these estimates of 
expenses based on written fee arrangements with acquired funds in which 
it invests or intends to invest.\85\
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    \84\ See Instruction 10.f to Item 3.1 of Form N-2. The 
instructions to Item 3.1 clarify that an acquiring fund must use the 
expenses (of assumed investments) for the previous fiscal year 
rather than predict expenses of the acquired funds in which the 
acquiring fund assumes it will invest. The instructions further 
clarify that acquiring funds must include anticipated net proceeds 
from the offering in the average invested balance in each acquired 
fund and the average net assets of the acquiring fund. See 
Instructions 10.c and 10.f to Item 3.1 of Form N-2. This treatment 
is consistent with the treatment for funds offering shares under 
Form N-1A. See Instruction 3(f)(vi) to Item 3 of Form N-1A. The 
instructions also clarify that a fund that intends to invest in a 
fund that has no operating history should include fees to be paid to 
the adviser to that fund (or its affiliate) as disclosed in the 
registration statement, offering memorandum or similar document 
without giving effect to any performance component. See Instruction 
10.d to Item 3.1 of Form N-2. We have made conforming amendments to 
Form N-1A. See Instruction 3(f)(iv) to Item 3 of Form N-1A.
    \85\ Typically, funds of hedge funds invest in 15 to 25 hedge 
funds. See Rory B. O'Halloran, An Overview and Analysis of Recent 
Interest in Increased Hedge Fund Regulation, 79 Tul. L. Rev. 461, 
480 (2004). Most hedge fund investors perform extensive due 
diligence prior to making initial and subsequent investments. 
According to a survey of institutional investors, 60 percent of 
institutional investors take between two to six months to complete 
due diligence on a single hedge fund. Deutsche Bank, Equity Prime 
Services Alternative Investment Survey Results Part 2: Inside the 
Mind of the Hedge Fund Investor, Mar. 2003, at 1, 7. One manager of 
a fund of hedge funds estimates that initial due diligence on a 
single hedge fund manager takes 3 to 4 weeks. See George Van, The 
Smartest Way to Invest in Hedge Funds, available at http://www.hedgefund.com/smartest/Smartest_Way_professional.pdf.
 In light 

of our understanding that fund of hedge funds managers engage in 
this time consuming initial diligence, we believe that a fund is 
likely to have an investment allocation strategy prior to filing its 
registration statement and, therefore, would be able to make the 
necessary assumptions in order to provide the required disclosure.
---------------------------------------------------------------------------

    One commenter opposed our proposed disclosure requirement for a 
fund of hedge funds for several reasons.\86\ The commenter questioned 
whether disclosure based on historical hedge fund expenses may be 
misleading because future expenses could differ materially due to the 
impact on performance fees of fund performance and portfolio changes. 
The commenter also expressed concern that investors may conclude that 
the acquired funds' expenses are fixed costs and not subject to change 
over time.\87\ The commenter expressed concern that the potential 
fluctuation in acquired fund fees and expenses might require a fund of 
hedge funds to continually monitor its disclosure to guard against 
material misstatements or omissions in its registration statement.\88\
---------------------------------------------------------------------------

    \86\ See Comment Letter of Man Investments, Inc. (Dec. 1, 2003).
    \87\ The commenter also asserted that the instructions could 
inaccurately portray expenses of acquired hedge funds because fees 
may vary widely among investors in a hedge fund as a result of 
individual rates negotiated through side letters. Id. We share the 
commenter's concern. Accordingly, the final instructions require the 
acquiring fund to rely on the expense ratio in the shareholder 
report or, if applicable, any written fee agreements with acquired 
hedge funds to determine acquired fund fees and expenses. See 
Instruction 10.d to Item 3.1 of Form N-2.
    \88\ See Comment Letter of Man Investments, Inc. (Dec. 1, 2003). 
The commenter also stated its belief that actual returns over time 
are the most important factor in comparing funds of hedge funds. We 
do not disagree that actual returns over time are a relevant factor 
for investors to consider. We believe, however, that the required 
disclosure will assist a fund of hedge funds investor in making an 
informed investment decision as to whether the benefit of 
diversification provided by investing in a fund of hedge funds 
outweighs any layering of costs. We also continue to believe that 
the disclosure will provide investors with the relevant information 
to compare directly the costs of investing in alternative funds of 
funds, or the costs of investing in a fund of funds to a more 
traditional fund. See supra note 53.
---------------------------------------------------------------------------

    The Commission understands that the presentation of acquired hedge 
fund fees and expenses poses particular challenges for funds of hedge 
funds because their fees may be more variable than other types of 
pooled investment vehicles, such as mutual funds. The commenter's 
suggestion to disclose the estimated ranges of fees that hedge funds 
could charge in a footnote or in text somewhere other than in the fee 
table would not improve transparency of expenses. While the amount of 
acquired fund expenses may vary, they are expenses that we believe 
should be included in the total annual fund operating expenses 
disclosed to investors in order to provide them a more complete 
presentation of the aggregate direct and indirect costs of investing in 
a fund of funds.
    We believe that we can address the commenter's concerns and still 
provide investors in funds of hedge funds with a better understanding 
of the multiple

[[Page 36648]]

layers of fees that are charged in a fund of hedge funds investment. To 
accomplish this, first we have revised the instructions to require a 
fund of hedge funds to include in a footnote to the new line item the 
typical performance fee charged by acquired hedge funds in which it 
invests. The footnote also would alert investors that acquired hedge 
fund fees are based on historical expenses and could be substantially 
higher or lower due to potential fluctuations in acquired hedge fund 
performance.\89\ Second, we have provided an exception that allows 
funds to exclude from the expense ratio disclosed in the fee table 
acquired fund performance fees that are calculated solely on the 
realization and/or distribution of gains or the sum of the realization 
and/or distribution of gains and unrealized appreciation of assets 
distributed in-kind.\90\ This type of performance fee is typically paid 
by a private equity fund upon liquidation of the fund or when a fund 
has terminated an investment and distributed the proceeds or the 
appreciated assets to investors.\91\ We agree that in these 
circumstances, the performance fees associated with a particular period 
may be unrelated to the costs of investing in a fund of funds.\92\
---------------------------------------------------------------------------

    \89\ See Instruction 10.g to Item 3.1 of Form N-2. The footnote 
could, for example, state:
    [Some/All] Acquired Funds in which the Registrant invests charge 
a performance fee based on the Acquired Funds' earnings. The 
``Acquired Fund Fees and Expenses'' disclosed above are based on 
historic earnings of the Acquired Funds, which may change 
substantially over time and, therefore, significantly affect 
Acquired Fund Fees and Expenses. The typical performance fee charged 
by Acquired Funds in which the Registrant invests is [INSERT 
PERCENTAGE].
    \90\ See Instruction 10.d to Item 3.1 of Form N-2. We have made 
a conforming change to the instructions for Form N-1A. See 
Instruction 3(f)(iv) to Item 3 of Form N-1A.
    \91\ See James M. Schell, Private Equity Funds, Business 
Structure and Operations Sec. Sec.  1.03[3][a], 1.04[3][a] (2006).
    \92\ In contrast, hedge funds generally charge performance fees 
that are calculated as a percentage of the hedge fund's net 
investment income, realized capital gains and unrealized capital 
appreciation. See Staff of U.S. Securities and Exchange Commission, 
Report to the Commission on Implications of the Growth of Hedge 
Funds (2003) at text preceding n. 212.
---------------------------------------------------------------------------

    Insurance Company Separate Accounts. We received no specific 
comments on our proposed amendments to Forms N-3, N-4 and N-6, and we 
are adopting them substantially as proposed.\93\ These forms will 
require separate accounts to include disclosures regarding the expenses 
of acquired funds in their prospectuses.\94\
---------------------------------------------------------------------------

    \93\ As with the instructions to Forms N-1A and N-2, the 
instructions to Form N-3 require that the line item expense 
disclosure be titled: ``Acquired Fund Fees and Expenses.'' See supra 
note 69 and accompanying text.
    \94\ The amended instructions to Form N-3 require the same 
disclosure and calculation as required in the amended instructions 
to Forms N-1A and N-2. The amended instructions for Forms N-4 and N-
6 are different from the instructions in Forms N-1A, N-2, and N-3, 
however, because Forms N-4 and N-6 already require registrants 
(i.e., separate accounts) to disclose expenses of funds (``portfolio 
companies'') in which the separate account invests. See Item 3 of 
Form N-4; Item 3 of Form N-6. Accordingly, the amended instructions 
to Forms N-4 and N-6 require that if a portfolio company invests in 
other (acquired) funds, the separate account must include in the 
item disclosing the portfolio company's ``other expenses,'' the 
acquired funds' fees and expenses calculated according to the 
instructions to Form N-1A. Unlike the proposal, the instructions 
refer specifically to portfolio companies instead of using the term 
``Acquiring Fund'' in describing the disclosure of acquired funds' 
fees and expenses incurred by the portfolio company.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

    Rule 12d1-1 will impose a new ``collection of information'' 
requirement within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\95\ The title of the new collection is ``Rule 12d1-1.'' Rule 
12d1-1 permits a fund to invest in unregistered money market funds 
notwithstanding the limitations of section 17 and rule 17d-1, if the 
unregistered money market funds meet certain conditions under rule 2a-7 
of the Act and preserve records under rule 31 of the Act. Both rules 
2a-7 and 31 contain collection of information requirements. Compliance 
with the collection of information requirements of rule 12d1-1 is 
necessary to obtain a benefit for unregistered money market funds that 
seek investments by registered funds that may be made only in reliance 
on rule 12d1-1. Responses to the collection of information requirements 
of rule 12d1-1 will not be kept confidential.
---------------------------------------------------------------------------

    \95\ 44 U.S.C. 3501.
---------------------------------------------------------------------------

    In the Proposing Release, Commission staff estimated that the 
annual hour burden of the proposed rule's collection of information 
requirements for unregistered money market fund compliance with rule 
2a-7 would be 21,175 hours.\96\ The staff also estimated that the 
requirements under rules 31a-1(b)(1), 31a-1(b)(2)(ii), 31a-1(b)(2)(iv), 
and 31a-1(b)(9) would not impose any additional burden because the 
costs of maintaining records would be incurred by unregistered money 
market funds in any case to keep books and records that are necessary 
to prepare financial statements for shareholders, to prepare the fund's 
annual income tax returns, and as a normal business practice.\97\ We 
submitted the collection for rule 12d1-1 to the Office of Management 
and Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) 
and 5 CFR 1320.11. No commenters addressed these burden estimates for 
the collection of information requirements, and we continue to believe 
that they are appropriate. 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. OMB approved the 
collection of information under control number 3235-0212 (expiring on 
May 31, 2007).\98\
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    \96\ See Proposing Release, supra note 4, at n. 138 and 
accompanying text.
    \97\ Id. at text following n. 138.
    \98\ We are adopting rule 12d1-1 with some modifications, which 
are described in Section II of this release. None of the 
modifications affects the PRA analysis or collection of information 
burden approved by OMB.
---------------------------------------------------------------------------

    In addition, the Commission is adopting amendments to certain forms 
that currently contain mandatory ``collection of information'' 
requirements. The titles for the existing collections are: (i) ``Form 
N-1A under the Securities Act of 1933 and the Investment Company Act of 
1940, Registration Statement of Open-End Management Investment 
Companies;'' (ii) ``Form N-2 under the Securities Act of 1933 and the 
Investment Company Act of 1940, Registration Statement of Closed-End 
Management Investment Companies;'' (iii) ``Form N-3 under the 
Securities Act of 1933 and the Investment Company Act of 1940, 
Registration Statement of Separate Accounts Organized as Management 
Investment Companies;'' (iv) ``Form N-4 under the Securities Act of 
1933 and the Investment Company Act of 1940, Registration Statement of 
Separate Accounts Organized as Unit Investment Trusts;'' and (v) ``Form 
N-6 under the Securities Act of 1933 and the Investment Company Act of 
1940, Registration Statement of Separate Accounts Organized as Unit 
Investment Trusts that Offer Variable Life Insurance Policies.'' The 
amendments require that investors in a registered fund of funds receive 
more transparent disclosure of the costs of investing in these 
arrangements. The disclosure is designed to provide investors with a 
more complete presentation of the actual costs of investing in a fund 
that invests in other funds, which have their own expenses that may be 
as high or higher than the acquiring fund's expenses. Compliance with 
the disclosure requirements of Forms N-1A, N-2, N-3, N-4 and N-6 is 
mandatory. Responses to the disclosure requirements will not be kept 
confidential.
    In the Proposing Release, Commission staff estimated that the 
amendment to

[[Page 36649]]

the disclosure requirement will add up to 7 hours per portfolio to the 
existing hour burden associated with completing Forms N-1A, N-2 and N-
3, and 0.5 hours to the existing hour burden associated with completing 
Forms N-4 and N-6.\99\ No commenters addressed the burden estimates for 
the collection of information requirements associated with Forms N-1A, 
N-3, N-4 and N-6, and we continue to believe that they are 
appropriate.\100\
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    \99\ See Proposing Release, supra note 4, at nn.139-161 and 
accompanying text.
    \100\ We have revised the final instructions for calculating 
acquired funds' expenses as described above. See supra notes 77-79 
and accompanying text. Although the staff believes that these 
modifications may provide funds with some time and cost savings, we 
are not changing our hour burden estimates. We will review the 
estimates when the collection of information requirements must be 
resubmitted for review, and at that time we will be able to consider 
funds' actual experience in complying with them.
---------------------------------------------------------------------------

    One commenter, a fund of hedge funds, disagreed with our Form N-2 
estimate. The commenter asserted that calculating the costs would 
entail vast amounts of time by numerous personnel reviewing a large 
number of hedge funds that provide information in varying formats. The 
commenter added that it believes a fund of hedge funds would be 
required to monitor and recalculate actual performance fees paid on an 
ongoing basis to guard against a material misstatement in the fee 
table.\101\ The commenter provided cost estimates but did not provide 
any specific estimates of burden hours. Funds offering their shares on 
a continuous or delayed basis in reliance on Rule 415 under the 
Securities Act must update their registration statements under certain 
circumstances.\102\ We have revised the PRA estimate to reflect staff 
estimates that funds offering their shares on a continuous basis file 
updated registration statements on at least an annual basis. The 
revised estimated annual burden per fund of hedge fund is 213 
hours.\103\
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    \101\ See Comment Letter of Man Investments, Inc. (Dec. 1, 
2003).
    \102\ See 17 CFR 230.415. Section 10(a)(3) of the Securities Act 
provides that ``when a prospectus is used more than nine months 
after the effective date of the registration statement, the 
information contained therein shall be as of a date not more than 
sixteen months prior to such use so far as such information is known 
to the user of such prospectus or can be furnished by such user 
without unreasonable effort or expense.'' 15 U.S.C. 77j(a)(3). In 
general, funds that are offering their securities on a continuous or 
delayed basis in reliance on Rule 415 file annual post-effective 
amendments to update the prospectus in the registration statement 
pursuant to section 10(a)(3). In addition to the statutory 
provisions of section 10(a)(3), Rule 415 and Form N-2 require that 
the registrant undertake to file a post-effective amendment to 
reflect: (i) any prospectus required by section 10(a)(3) of the 
Securities Act; (ii) facts or events arising after the effective 
date that ``represent a fundamental change in the information set 
forth in the registration statement;'' and (iii) material 
information with respect to the plan of distribution not disclosed 
previously in the registration statement or any material change to 
such information in the registration statement. See 17 CFR 
230.415(a)(3); Item 34.4.a of Form N-2. In the release adopting Rule 
415, the Commission noted that ``the term `fundamental' is intended 
to reflect current staff practice under which post-effective 
amendments are filed when major and substantial changes are made to 
information contained in the registration statement. Material 
changes that can be stated accurately and succinctly in a short 
sticker will continue to be permitted. While many variations in 
matters such as operating results, properties, business, product 
development, backlog, management and litigation ordinarily would not 
be fundamental, major changes in the issuer's operations, such as 
significant acquisitions or dispositions, would require the filing 
of a post-effective amendment. Also, any change in the business or 
operations of the registrant that would necessitate a restatement of 
the financial statements always would be reflected in a post-
effective amendment.'' See Adoption of Integrated Disclosure System, 
Securities Act Release No. 6383 (Mar. 3, 1982) [47 FR 11380 (Mar. 
16, 1982)] at text accompanying nn.79-81. See also Guide 8 to Form 
N-2. In addition, purchasers of an issuer's securities in a 
registered offering have private rights of action for materially 
deficient disclosure in prospectuses and oral communications under 
section 12(a)(2) of the Securities Act. See 15 U.S.C. 77l(a)(2); see 
also Securities Offering Reform, Securities Act Release No. 8591 
(July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] at Section IV.A 
(discussing information conveyed by the time of sale for purposes of 
liability under section 12(a)(2)).
    \103\ The increase in annual hour burden was estimated using an 
average of the range of costs the commenter estimated a fund of 
hedge funds would incur to prepare the disclosure ($16,500) and 
dividing that cost by the estimated hourly cost to prepare the 
disclosure: $16,500 / $77.42 = 213.12. Therefore, the estimated 
total annual burden per fund of hedge funds to prepare the 
disclosure is 213 hours. The estimated hourly cost is the weighted 
average of the cost to prepare the disclosure for other closed-end 
funds ($404 (cost of 6 hours of an accountant's time) + $138 (cost 
of 1 hour of an attorney's time) / 7 = $77.42). See infra note 120. 
This estimate also includes the costs of including the footnote to 
the line item that discloses the typical performance fee charged by 
the hedge funds in which the acquiring fund invests or intends to 
invest.
---------------------------------------------------------------------------

    Based on recent Commission filings, 23 registered funds of hedge 
funds offer their shares on a continuous basis under rule 415 of the 
Securities Act. Therefore, the staff estimates the additional annual 
burden for funds of hedge funds to update the acquired fund expenses in 
their prospectuses pursuant to the requirements of section 10(a)(3) of 
the Securities Act is 2450 hours.\104\
---------------------------------------------------------------------------

    \104\ Any post-effective amendment to a registration statement 
filed to update the information in the prospectus for purposes of 
section 10(a)(3) of the Securities Act or to reflect fundamental 
changes in the information in the prospectus contained in the 
registration statement would also revise the information regarding 
the acquired funds' fees and expenses. Because only a portion of 
acquired funds' fees and expenses may be updated in the annual post-
effective amendment to reflect additional or revised fees and 
expenses, since the date of the last updating, resulting from 
existing, newly acquired or to be acquired funds, the Commission 
estimates that a fund of hedge funds in continuous offering would 
spend approximately 50% of the time it takes to determine the 
initial acquired hedge funds disclosure (213 hours) to review and 
update its calculation of acquired funds' fees and expenses prior to 
filing a post-effective amendment. Therefore, the annual burden for 
funds of hedge funds in continuous registration is an additional 
2450 hours ((213 hours / 2 = 106.5 hours) (106.5 hours x 23 funds = 
2449.5 hours)).
---------------------------------------------------------------------------

    Based on recent filings, Commission staff estimates that, on an 
annual basis, registrants file 234 initial registration statements (of 
which 11 are funds of hedge funds) and 38 post-effective amendments 
(including 23 post-effective amendments for funds of hedge funds in 
continuous registration). The current estimated total annual burden for 
the preparation and filing of Form N-2 is 120,673 hours.\105\ 
Accordingly, we estimate the total annual burden for all funds for the 
preparation and filing of initial registrations statements and post-
effective amendments to Form N-2 would be 125,389 hours.\106\
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    \105\ The Commission made this estimate in connection with its 
submission for approval of recent proposed amendments to Form N-2. 
See Executive Compensation and Related Party Disclosure, Investment 
Company Act Release No. 27218 (Jan. 27, 2006) [71 FR 6542 (Feb. 8, 
2006)].
    \106\ This estimate is based on the following calculation: 
120,673 + 2450 + (11 x 206) = 125,389. The current estimated total 
annual hour burden already incorporates the time estimated in the 
proposing release to prepare the disclosure required by the 
amendments (7 hours for each closed-end fund that invests in other 
funds). The revised estimate includes the additional 206 hours (213 
minus 7 hours included in the approved total annual hour burden) the 
staff estimates it may take a closed-end fund of hedge funds to 
complete the required disclosure, based on the commenter's cost 
estimates.
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    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 submitted the collections of 
information associated with Forms N-1A, N-2, N-3, N-4 and N-6 to OMB to 
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. OMB 
approved the collections of information under control numbers 3235-0307 
(Form N-1A, expiring on December 31, 2007), 3235-0026 (Form N-2, 
expiring on January 31, 2008, revised submission currently under review 
by OMB), 3235-0316 (Form N-3, expiring on July 31, 2007), 3235-0318 
(Form N-4, expiring on March 31, 2007), and 3235-0503 (Form N-6, 
expiring on March 31, 2007).

IV. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules. As 
discussed above in sections II.A--II.C, the new rules provide relief to 
funds by providing additional exemptions from

[[Page 36650]]

the limitations on fund of funds arrangements without requiring the 
funds or their advisers to obtain an exemptive order. As discussed in 
section II.D, the amendments to Forms N-1A, N-2, N-3, N-4, and N-6 
provide additional information to shareholders regarding the costs of 
acquired funds in a fund of funds arrangement.

A. Rules 12d1-1, 12d1-2 and 12d1-3

    We have issued a number of exemptive orders that have broadened the 
ability of funds to invest in other funds and provided certain funds of 
funds greater flexibility in structuring their sales charges. These 
orders have provided exemptions from statutory limitations. A fund that 
has obtained the benefit of an exemption has incurred costs of applying 
for an exemptive order as well as costs of satisfying any conditions 
imposed in the order. Application costs are primarily legal and include 
costs of drafting the application and analyzing the ways in which the 
conditions fit the fund's business model. The costs of satisfying 
conditions include ongoing compliance costs of meeting those 
conditions. We assume that a fund only seeks an exemptive order if the 
benefits of the additional flexibility provided by the exemption 
outweigh the costs of obtaining and satisfying the conditions of an 
order. We solicited but did not receive comments with respect to the 
cost-benefit analysis for rules 12d1-1, 12d1-2 and 12d1-3.
1. Benefits
    Rule 12d1-1 codifies our prior exemptive orders that permit a fund 
to invest all or a portion of its available cash in money market funds 
rather than directly in short-term instruments. The rule retains one 
condition included in our orders that the acquiring fund pays no sales 
load or distribution or service fee on the acquired money market fund 
shares unless the acquiring fund's investment adviser waives a 
sufficient amount of its advisory fee to offset the cost of those 
fees.\107\ We believe that any further restrictions on an acquiring 
fund's investments in money market funds should be governed by the 
fund's investment policies and limitations and the fiduciary 
obligations of its board of directors. Consequently, we believe that 
the rule will provide greater flexibility for certain funds than 
exemptive orders we have issued.
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    \107\ With respect to investments in unregistered money market 
funds, we also have retained the requirement in our prior exemptive 
orders that the money market funds operate as if they were money 
market funds registered under the Act. Unlike our exemptive orders, 
however, and as we proposed, we are requiring the acquiring fund to 
reasonably believe, rather than to determine, that the unregistered 
money market funds operate in this manner. See supra notes 40-43 and 
accompanying text; see, e.g., Putnam Order, supra note 25.
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    Under the rule, funds also may invest in money market funds advised 
by a different adviser. We believe that this will allow all funds, 
particularly small funds without a money market fund in their fund 
group, the opportunity currently available to large funds to engage in 
cash sweep arrangements. In addition, we have provided additional 
relief under section 17 of the Act. If a fund in one fund complex 
acquired more than five percent of the assets of a money market fund in 
another complex, any broker-dealer affiliated with the money market 
fund would become a (second-tier) affiliated person of the acquiring 
fund. As a result of the affiliation, the broker-dealer's fee for 
effecting the sale of securities to the acquiring fund would be subject 
to the conditions set forth in rule 17e-1, including the quarterly 
board review and recordkeeping requirements with respect to certain 
securities transactions involving the affiliated broker-dealer.\108\ 
The final rule permits an acquiring fund to pay commissions, fees, or 
other remuneration to an affiliated broker-dealer without complying 
with the quarterly board review and recordkeeping requirements set 
forth in rules 17e-1(b)(3) and 17e-1(d)(2).\109\ This relief is 
available only if the broker-dealer and the acquiring fund become 
affiliated solely because of the acquiring fund's investment in the 
money market fund. We believe this additional relief will enable more 
funds to take advantage of the exemption provided by the rule.
---------------------------------------------------------------------------

    \108\ See supra note 34.
    \109\ See supra notes 32-36 and accompanying text.
---------------------------------------------------------------------------

    Rule 12d1-1 also codifies our orders permitting funds to invest in 
unregistered money market funds that operate like a money market fund 
registered under the Act. The acquiring fund is required to 
``reasonably believe'' that the unregistered money market fund operates 
in compliance with rule 2a-7 and complies with certain provisions of 
the Act, as well as other requirements.\110\ This standard is slightly 
different than the condition in our exemptive orders, which requires 
the acquiring fund to determine that the acquired fund is in compliance 
with rule 2a-7 and certain provisions of the Act. A fund would 
reasonably believe that an acquired fund was in compliance with these 
provisions if, for example, it received a representation from the 
acquired fund (or the adviser to the acquired fund) that the fund would 
comply with the relevant provisions in all material respects and if the 
acquiring fund had no reason to believe that the acquired fund was not, 
in fact, complying with the relevant provisions in all material 
respects. Thus, an acquired fund's failure to comply will not 
automatically result in the loss of the acquiring fund's exemption. 
Rule 12d1-1 does not include certain conditions imposed in the 
exemptive orders that we believe are already adequately addressed by 
other provisions of the Act or rules thereunder.\111\
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    \110\ See supra notes 40-43 and accompanying text.
    \111\ See Proposing Release, supra note 4, at n. 49.
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    Rule 12d1-2 codifies, and in some cases expands upon, three types 
of relief that we provided to affiliated funds of funds. The rule 
permits affiliated funds of funds to acquire up to three percent of the 
securities of 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) 
of the Act. The rule also permits an affiliated fund of funds to 
acquire securities not issued by a fund. These investments would have 
to be consistent with the fund's investment policies. Finally, the rule 
permits affiliated funds of funds to invest in affiliated or 
unaffiliated money market funds in reliance on rule 12d1-1.
    Rule 12d1-3 codifies the exemptive orders we have issued permitting 
funds relying on section 12(d)(1)(F) to charge a sales load greater 
than 1\1/2\ percent provided that the aggregate sales load any investor 
pays (i.e., the combined distribution expenses of both the acquiring 
and acquired funds) does not exceed the limits on sales loads 
established by the NASD for funds of funds. This exemption also would 
be available to an affiliated fund of funds relying on rule 12d1-2 to 
invest in funds in a different fund group.
    We anticipate that funds and their shareholders will benefit from 
the rules. Funds increasingly have sought exemptive orders (which the 
Commission has granted) to engage in most of the activities the rules 
permit. The application process involved in obtaining exemptive orders 
imposes direct costs on funds, including preparation and revision of an 
application, as well as consultations with the staff. The rules will 
benefit funds and their shareholders by eliminating the direct costs of 
applying to the Commission to engage in activities permitted under the 
rules.\112\

[[Page 36651]]

The rules will further benefit funds by eliminating the uncertainty 
that a particular applicant might not obtain relief to engage in the 
activities permitted under the rules.
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    \112\ For example, in calendar years 2003 and 2004, 11 funds 
sought exemptive relief to invest uninvested cash and/or cash 
collateral from securities lending activities in money market funds, 
and 3 of those funds also sought exemptive relief to invest cash 
collateral in unregistered money market funds. In the past 5 years, 
9 funds investing in other funds in the same fund group in reliance 
on section 12(d)(1)(G) have sought exemptive relief to invest in 
securities other than government securities or short-term paper. 
During that time, 9 funds investing in other funds in reliance on 
section 12(d)(1)(F) have sought exemptive relief to charge a sales 
load greater than 1\1/2\ percent, subject to the NASD Sales Charge 
Rule. In the Proposing Release, we estimated that the cost to a fund 
for submitting one of these applications ranges from $7,000 to 
$67,000. See Proposing Release, supra note 4, at n. 125. We did not 
receive any comments on these estimates and continue to believe that 
they are appropriate.
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    The exemptive application process also involves other indirect 
costs. Funds that apply for an order to permit additional investments 
forgo potentially beneficial investments until they receive the order, 
while other funds forgo the investment entirely rather than seek an 
exemptive order because they have concluded that the cost of seeking an 
exemptive order would exceed the anticipated benefit of the investment. 
Eliminating direct and indirect costs of the proposed activities also 
eliminates factors that discriminate against smaller funds, for which 
the cost of an exemptive application can often exceed the potential 
benefit.
2. Costs
    We do not believe that the rules will impose mandatory costs on any 
fund. As discussed above, the rules are exemptive, and we believe that 
a fund would not rely on any of them if the anticipated benefits did 
not justify the costs. We believe the costs of relying on the rules 
will be the same as or less than the costs to a fund that relies on an 
existing exemptive order because each of the rules includes the same or 
fewer conditions than existing orders that provide equivalent exemptive 
relief.\113\
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    \113\ Our analysis compares the costs a fund would bear to 
comply with the rules with the costs a fund would bear under the 
current system of obtaining equivalent exemptive relief. Because the 
conditions in the rules are the same or less onerous than the 
conditions in the exemptive orders, the costs discussed in this 
section primarily are costs that a fund would bear to obtain an 
exemptive order and comply with its conditions.
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    The rules will affect different types of funds in different ways. A 
fund that has not sought and would not seek exemptive relief from 
section 12(d)(1) of the Act will not be affected by the rules. The cost 
for a fund that currently relies on exemptive relief covered by our 
rules will be the same as or less than the costs of relying on its 
exemptive order because the rules contain the same or fewer conditions 
than existing orders.\114\ In addition, a fund that currently relies on 
an exemptive order can satisfy all the conditions of any of the rules 
that provide similar exemptive relief without changing its operation. 
For example, in the case of rule 12d1-1, the fund will simply be 
satisfying conditions that are no longer required.\115\ Finally, a fund 
that has not relied on an exemptive order and that intends to rely on 
one of the rules will bear the same continuing costs of complying with 
conditions that it would have borne had it obtained an exemptive order. 
In that case, its total costs would have been the same as or greater 
than the costs associated with the rules.
---------------------------------------------------------------------------

    \114\ Such a fund may face a one-time ``learning cost'' to 
determine the difference between the fund's exemptive order and the 
rule. We do not believe this cost would be significant given the 
similarity of conditions in our rules and existing exemptive orders.
    \115\ We note that a fund may choose to rely on an existing 
exemptive order and comply with the conditions of that order. A fund 
might conclude that continued reliance on an existing order is 
appropriate, for example, because the existing order was tailored to 
circumstances specific to a fund complex and may provide additional 
exemptive relief that is not covered under the rules we are adopting 
today.
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B. Amendments to Forms N-1A, N-2, N-3, N-4, and N-6

    Forms N-1A, N-2 and N-3 currently do not require registered funds 
to disclose information regarding the expenses associated with acquired 
funds. The amendment to Form N-1A requires a registered open-end fund 
that invests in other funds to include a line item in its fee table, 
under the total annual fund operating expenses, that lists the 
aggregate fees and costs of acquired funds. The amendment to Form N-2 
requires registered closed-end funds that invest in other funds to 
provide the same disclosure.\116\ The amendment to Form N-3 requires 
the same disclosure for separate accounts organized as management 
investment companies that offer variable annuity contracts. The new 
disclosure requirements include instructions on calculating the fees 
and operating costs of acquired funds. The calculation will aggregate 
the annual fund operating expenses of acquired funds, transaction costs 
and, as applicable, incentive allocations incurred by the acquiring 
fund, and express the aggregate fees as a percentage of average net 
assets of the acquiring fund.
---------------------------------------------------------------------------

    \116\ In addition, closed-end funds of hedge funds must add a 
footnote to the line item that discloses the typical performance fee 
charged by acquired hedge funds in which the acquiring fund invests.
---------------------------------------------------------------------------

    Forms N-4 and N-6 currently require separate accounts organized as 
UITs that offer variable annuity and variable life contracts, 
respectively, to disclose the range of minimum and maximum operating 
expenses of the portfolio companies in which they invest. The amendment 
to each of these forms requires a separate account organized as a UIT 
that invests in a portfolio company that itself invests in other funds, 
to include the portfolio company's costs of investing in other funds in 
the portfolio company's operating expenses disclosed in the Form N-4 or 
Form N-6 fee table.
1. Benefits
    Under current disclosure requirements, a fund's shareholders may 
not understand the fees and operating costs of a fund's investment in 
acquired funds, costs that investors bear indirectly. We believe that 
the amendments to Forms N-1A, N-2, N-3, N-4, and N-6 will enable 
shareholders to better understand the expenses that relate to acquired 
funds, and provide investors the means to compare directly the costs of 
investing in alternative funds of funds, or the costs of investing in a 
fund of funds to a more traditional fund. The increased transparency 
may provide further benefits by allowing investors to choose funds that 
more closely reflect their preferences for fees and performance.\117\
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    \117\ We requested comments as well as any quantifying data in 
the Proposing Release, but did not receive any.
---------------------------------------------------------------------------

2. Costs
    The amendments to Forms N-1A, N-2, N-3, N-4, and N-6 will result in 
costs to registered open-end and closed-end funds, and to separate 
accounts that offer variable annuity and variable life contracts, which 
may be passed on to those funds' shareholders. The amendments will 
require a new disclosure to the annual operating expense item in the 
fee table for funds that invest in other funds. It also will require 
separate accounts organized as UITs that offer variable annuity and 
variable life contracts to include an additional expense in their 
calculations of annual portfolio company operating expenses. The costs 
of the disclosures will include both internal costs (for attorneys and 
accountants) to prepare and review the disclosure, and external costs 
(for printing and typesetting the disclosure).
    First, with respect to Forms N-1A, N-2 and N-3, the disclosures 
will add a single line item to the fee table for funds

[[Page 36652]]

that invest in other funds.\118\ In the context of the prospectus for 
Forms N-1A, N-2 and N-3, we believe that the external costs of 
including this additional line of disclosure per registered fund will 
be minimal.\119\ With respect to Forms N-4 and N-6, the disclosure will 
require registrants to include in the item for annual portfolio company 
operating expenses, any fees and expenses of acquired companies, as 
disclosed in the portfolio company's most recent prospectus. 
Accordingly, we believe there will be no additional external costs for 
Forms N-4 and N-6 as a result of the amendments.
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    \118\ We are permitting acquiring funds to omit a separate line 
item if the amount of expenses attributable to acquired funds does 
not exceed 0.01 percent (one basis point) of average net assets, and 
to include these expenses in ``Other Expenses.'' See Instruction 
3(f)(i) to Item 3 of Form N-1A; Instruction 10.a to Item 3.1 of Form 
N-2; Instruction 19(a) to Item 3(a) of Form N-3.
    \119\ We also believe the costs to the acquiring fund of 
preparing the footnote to the line item that discloses the typical 
performance fee charged by hedge funds in which the acquiring fund 
invests will be minimal.
---------------------------------------------------------------------------

    Second, for purposes of the PRA, Commission staff estimated in the 
proposal that the disclosure requirement for calculating the line item 
according to the instructions will add up to 7 hours per portfolio to 
the burden of completing Forms N-1A, N-2 and N-3. Commission staff 
further estimated that the additional annual cost of including the line 
item per portfolio would equal $542.\120\
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    \120\ In the Proposing Release, Commission staff estimated the 
additional burden would equal 6 hours for an intermediate level 
accountant and 1 hour for a deputy general counsel to review the 
calculation per portfolio. See Proposing Release, supra note 4, at 
n.127. We did not receive any comments on these hourly estimates and 
continue to believe that they are appropriate. We have, however, 
updated our wage estimates based on current wage data for 
professionals in the financial services industry available at http://www.careerjournal.com/salaryhiring
 (last visited July 28, 2005).

    In order to determine who would be an intermediate level 
accountant in the new source, we looked at years of experience. We 
believe that accountants with 6 to 15 years of experience would fall 
within that category. The national average salary for these 
accountants is $89,749 (($85,483 (6-10 years of experience) + 
$94,015 (11-15 years of experience)) / 2 = $89,749). Adjusting this 
salary upwards by 35% to reflect possible overhead costs and 
employee benefits, the staff estimates that the annual adjusted 
salary would be $121,161, and the cost for 6 hours of an 
intermediate level accountant's time would be $404 ($121,161 / 1,800 
hours x 6 = $403.87). The staff estimates the national average 
salary for a deputy general counsel is $183,675. Adjusting this 
salary upwards by 35% to reflect possible overhead costs and 
employee benefits, the staff estimates that the annual adjusted 
salary would be $247,961, and the cost for 1 hour of a deputy 
general counsel's time would be $138 ($247,961 / 1,800 hours = 
$137.76). Accordingly, the staff estimates the total cost for each 
portfolio to calculate the amended disclosure would equal $542 ($404 
+ $138 = $542). We have revised the final instructions for 
calculating acquired funds' expenses as described above. See supra 
notes 77-79 and accompanying text. Although the staff believes that 
these modifications may provide funds with some cost savings, we 
have not adjusted the hour burden estimates but will review them 
when the collection of information requirements must be resubmitted 
for review and funds will have had actual experience in complying 
with them.
---------------------------------------------------------------------------

    One commenter, a fund of hedge funds, disagreed with our estimates 
and asserted that the cost to a single fund of hedge funds to make an 
initial calculation each year would be between $8,000 and $25,000 
depending on the number of personnel involved and the need for auditor 
review.\121\ The commenter did not specify the number or functions of 
the personnel involved. We agree with the commenter that a fund of 
hedge funds may have additional costs. We estimate that the cost of 
adding the new line item for a fund of hedge funds is $16,500.\122\ 
Based on recent Commission filings, approximately 11 funds of hedge 
funds file initial registration statements on Form N-2 each year and 
their aggregate assets under management are $958.2 million. The 
estimated aggregate costs for these funds of hedge funds to calculate 
the new line item is $181,500.\123\ We do not believe that the 
additional cost is significant given the funds of hedge funds' 
aggregate assets under management.\124\
---------------------------------------------------------------------------

    \121\ See Comment Letter of Man Investments, Inc. (Dec. 1, 
2003).
    \122\ Because the commenter did not explain the underlying 
calculations for its range of costs, the estimate is based on the 
average of the $8,000 to $25,000 range provided by the commenter. 
The cost to each fund of hedge funds may be higher or lower 
depending on a variety of factors, including the number of hedge 
funds in which the fund of hedge funds invests.
    \123\ This calculation is based on the following: (11 x $16,500) 
= $181,500).
    \124\ The estimated cost of preparing the line item is 0.0189% 
of assets under management for funds of hedge funds in the aggregate 
($181,500 / $958.2 million).
---------------------------------------------------------------------------

    On the assumption that funds of hedge funds would have to monitor 
current fees in order to guard against material misrepresentations in 
the fee table, the commenter estimated that these funds of hedge funds 
would face an additional monitoring cost of $15,000 or more annually. 
As discussed in Section III above, staff estimates that the 23 funds of 
hedge funds registered under Form N-2 and offering their shares on a 
continuous basis file updated registration statements on at least an 
annual basis. We estimate the additional cost to review the disclosure 
will be $8245 per fund of hedge funds and the total annual costs for 
funds of funds to update the acquired fund expenses in their 
prospectuses pursuant to the requirements of section 10(a)(3) of the 
Securities Act will be $189,635.\125\
---------------------------------------------------------------------------

    \125\ See supra notes 102-104 and accompanying text. These 
estimates are based on the following calculations: 106.5 (hours per 
fund) x $77.42 (estimated hourly cost to prepare the disclosure) = 
$8245; $8245 x 23 (funds) = $189,635.
---------------------------------------------------------------------------

    Despite this additional cost, we continue to believe that the costs 
of the required disclosure are justified because the disclosure will 
assist a fund of hedge funds investor in making an informed investment 
decision as to whether the benefit of diversification provided by 
investing in a fund of hedge funds outweighs any layering of costs. We 
do not believe that other alternatives suggested by the commenter, such 
as simply disclosing a range of fees, would be a meaningful substitute. 
These alternatives would not meet our objective of improving 
transparency of expenses. Nor would they meet our objective to include 
acquired fund expenses in the total annual fund operating expenses 
disclosed to investors in order to provide them a more complete 
presentation of the aggregate direct and indirect costs of investing in 
a fund of funds. We continue to believe that our estimate is 
appropriate for Form N-2 registrants that are not funds of hedge funds.
    In the Proposing Release, we also estimated that including the 
additional item in the disclosure of portfolio company expenses on 
Forms N-4 and N-6 would add approximately 0.5 hours per portfolio, 
which based on the updated wage estimates would be an annual cost per 
portfolio of $34.\126\ We did not receive any comments on this estimate 
and continue to believe that it is appropriate.
---------------------------------------------------------------------------

    \126\ Commission staff estimates the cost would equal 0.5 hours 
for an intermediate level accountant to include the expense item in 
the calculation. The estimated cost is based on the following 
calculation: 0.5 x $67.3 = $33.7. The estimated hourly cost for an 
intermediate level accountant is $67 ($121,161.15 (annual cost) / 
1,800 hours = $67.31/hour). See supra note 120.
---------------------------------------------------------------------------

    Based on Commission filings, the staff estimates that half the 
funds registered under Forms N-1A and N-2 (excluding funds of hedge 
funds) invest in other funds, all funds of hedge funds registered on 
Form N-2 invest in other funds, and 5 separate accounts (with 7 
portfolios) registered under Form N-3 invest in other funds and will be 
required to make the proposed disclosure on an annual basis. For 
purposes of the PRA analysis, Commission staff has estimated that on an 
annual basis, registrants file (i) initial registration statements 
covering 483 portfolios and post effective amendments covering 6542 
portfolios on Form N-1A, (ii) 234 initial

[[Page 36653]]

registration statements (of which 11 are funds of hedge funds) and 38 
post-effective amendments on Form N-2, and (iii) initial registration 
statements covering 3 portfolios and post-effective amendments covering 
35 portfolios on Form N-3. In addition, Commission staff also estimates 
that each year, 157 separate accounts file initial registrations and 
1242 separate accounts file post-effective amendments on Form N-4, and 
50 separate accounts file initial registrations and 500 separate 
accounts file post-effective amendments on Form N-6.\127\ Of the 
filings on Forms N-4 and N-6, Commission staff estimates that half the 
separate accounts invest in portfolio companies that themselves invest 
in other funds. Thus, Commission staff estimates that the cost of the 
amendments to Forms N-1A, N-2, N-3, N-4, and N-6 to funds registering 
under these forms will be $2.4 million.\128\
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    \127\ Changes in estimates from the Proposing Release are due to 
updated PRA analyses for the relevant forms. Of the Form N-6 post-
effective amendments, 150 are annual updates and 350 are additional 
post-effective amendments. As we said in the Proposing Release, we 
assume that registered funds would include the disclosure only in a 
post-effective amendment to the annual update. See Proposing 
Release, supra note 4, at n.132.
    \128\ The estimate is based on the following calculation: (((483 
+ 6542)) / 2) x $542) + (((223 + 38) / 2) x $542 + (11 x $16,500) + 
(23 x $8,245) + (7 separate account portfolios x $542) + (((157 + 
1,242) / 2) x $34) + (((50 + 150) / 2) x $34) = $2,376,618. The 
increase in costs from the Proposing Release is due to adjustments 
for salary and overhead costs during the intervening period and the 
additional cost for funds of hedge funds to comply with the 
disclosure requirement.
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V. Consideration of Promotion of Efficiency, Competition, and Capital 
Formation

    Section 2(c) of the Investment Company Act requires the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider whether the action will promote efficiency, competition, 
and capital formation.\129\ We sought, but did not receive any comment 
with respect to this section.
---------------------------------------------------------------------------

    \129\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

A. Rules 12d1-1, 12d1-2 and 12d1-3

    Rules 12d1-1, 12d1-2 and 12d1-3 will expand the circumstances in 
which funds can invest in other funds without first obtaining an 
exemptive order from the Commission, which can be costly and time-
consuming. We anticipate that the rules will promote efficiency and 
competition. Rule 12d1-1 permits funds to acquire shares of money 
market funds in the same or in a different fund group in excess of the 
limitations in section 12(d)(1) of the Act. This exemption allows 
funds, particularly small funds without a money market fund in their 
complex, to allocate their uninvested cash more efficiently and thereby 
increase competition among funds. In addition, the final rule provides 
additional section 17 relief for funds that execute transactions with 
broker-dealers affiliated with money market funds in which the 
acquiring funds invest. This additional relief, we believe, will allow 
more funds to take full advantage of the exemption provided by the 
rule.\130\ Rule 12d1-2 permits an affiliated fund of funds to acquire 
limited amounts of securities issued by funds outside the same fund 
group and securities not issued by a fund. The rule also permits a 
traditional equity or bond fund to invest in funds within the same fund 
complex. We believe that this expansion of investment opportunities 
will permit funds to allocate their investments more efficiently. Rule 
12d1-3 allows funds relying on section 12(d)(1)(F) of the Act to charge 
sales loads greater than 1\1/2\ percent provided that the aggregate 
sales load any investor pays does not exceed the limits established by 
the NASD for funds of funds. We believe this will increase competition 
among funds as it will provide funds with greater flexibility in 
structuring their sales charges. We do not believe that these exemptive 
rules, which provide funds with greater flexibility in their 
investments and provide certain funds of funds greater flexibility in 
structuring their sales charges, will have an adverse impact on capital 
formation.
---------------------------------------------------------------------------

    \130\ See supra notes 32-36 and accompanying text.
---------------------------------------------------------------------------

B. Amendments to Forms N-1A, N-2, N-3, N-4, and N-6

    The form amendments are designed to provide better transparency for 
fund shareholders with respect to the costs of investing in funds of 
funds. The enhanced disclosure requirements will provide shareholders 
with greater access to information regarding the indirect costs they 
bear when a fund in which they invest purchases shares of other funds. 
This information should promote more efficient allocation of 
investments by investors and more efficient allocation of assets among 
competing funds because investors may compare and choose funds based on 
their preferences for cost more easily. The amendments may also improve 
competition, as enhanced disclosure may prompt funds to provide 
improved products and services that may have a greater appeal to 
investors. Enhanced disclosure also may prompt acquiring funds to 
invest in acquired funds with lower costs. Finally, we do not believe 
that the amendments will have an adverse impact on capital formation. 
As discussed above, we believe that the amendments will benefit 
investors.

VI. Final Regulatory Flexibility Analysis

    We have prepared this Final Regulatory Flexibility Analysis 
(``FRFA'') in accordance with 5 U.S.C. 604. It relates to new rules 
12d1-1, 12d1-2 and 12d1-3 under the Investment Company Act, and 
amendments to Forms N-1A, N-2, N-3, N-4, and N-6. The Commission 
prepared an Initial Regulatory Flexibility Analysis (``IRFA'') in 
accordance with 5 U.S.C. 603, a summary of which was published in the 
Proposing Release.\131\
---------------------------------------------------------------------------

    \131\ See Proposing Release, supra note 4, at Section VII.
---------------------------------------------------------------------------

A. Need for the New Rules and Form Amendments

    As described more fully in Section II of this release, we are 
adopting rules 12d1-1, 12d1-2 and 12d1-3 to address the ability of a 
registered fund to invest in shares of another fund without first 
having to seek Commission approval. The rules codify and expand upon a 
number of exemptive orders we have issued that permit funds to invest 
in other funds. The form amendments are a critical element of the 
relief we are adopting today and are designed to improve the 
transparency of the expenses of funds of funds by requiring that the 
expenses of the acquired funds be aggregated and shown as an additional 
expense in the fee table of the fund of funds.

B. Significant Issues Raised by Public Comment

    In the IRFA for the proposed rules and form amendments, we 
requested comment on any aspect of the IRFA, including the number of 
small entities that are likely to rely on the proposed rules and 
amendments and the likely impact of the proposal on small entities. We 
received no comments on the IRFA.

C. Small Entities Subject to the New Rules and Form Amendments

    For purposes of the Regulatory Flexibility Act, a fund is a small 
entity if the fund, together with other funds in the same group of 
related funds, has net assets of $50 million or less as of the end of 
its most recent fiscal year.\132\ The staff estimates, based upon 
recent Commission filings, that there are

[[Page 36654]]

approximately 4083 active registered funds and 88 business development 
companies, of which approximately 175 and 65 are small entities, 
respectively.\133\ The staff estimates that no separate account is a 
small entity. A fund that is a small entity, like other funds, may rely 
on any of the exemptive rules if the fund satisfies the rule's 
conditions.
---------------------------------------------------------------------------

    \132\ 17 CFR 270.0-10.
    \133\ Some or all of the funds may contain multiple series or 
portfolios. If a registered investment company is a small entity, 
the portfolios or series it contains are also small entities. The 
estimated number of small entities in the IRFA was based on filings 
with the Commission current at that time.
---------------------------------------------------------------------------

    The Commission expects the new rules to have little impact on small 
entities. Like other funds, small entities will be affected by new 
rules 12d1-1, 12d1-2 and 12d1-3 only if they determine to use any of 
the exemptions provided by the rules. Few small entities have applied 
for relief to engage in the activities that will be permitted under the 
rules. The staff anticipates that the number of funds, including small 
funds, that will engage in the activities permitted under the rules, 
will increase. Nevertheless, the staff believes that the proportion of 
small entities compared to the total number of funds that engage in 
these activities will remain small.
    The Commission expects that the amendments to Forms N-1A and N-2 
will have a greater impact on small entities. The amendments require 
each registered fund, including each fund that is a small entity, that 
invests in any other fund to disclose the aggregate costs of investing 
in acquired funds. The staff estimates, based upon Commission filings, 
that 140 funds that file on Form N-1A, and 32 funds (of which 4 are 
funds of hedge funds)\134\ that file on Form N-2 are small 
entities.\135\ Commission staff also estimates that half of the funds 
registered under Forms N-1A and N-2 (excluding funds of hedge funds) 
invest in other funds, and all funds of hedge funds would be required 
to make the new disclosure.\136\ Accordingly, we estimate that 70 funds 
that are small entities file on Form N-1A and 18 funds (including the 4 
funds of hedge funds) that are small entities file on Form N-2 and 
would be required to make the new disclosure.
---------------------------------------------------------------------------

    \134\ The 4 funds of hedge funds that are small entities do not 
offer their shares continuously in reliance on rule 415 of the 
Securities Act.
    \135\ Amendments to Forms N-3, N-4, and N-6 are not expected to 
impact small entities because the staff estimates that no registered 
separate account is a small entity.
    \136\ This estimate is based on information in the Commission's 
database of Form N-SAR filings.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The new rules will not impose any mandatory reporting or 
recordkeeping requirements on any person and will not materially 
increase other compliance requirements. Rule 12d1-1 allows funds to 
invest in money market funds in excess of section 12(d)(1)(A) limits. 
The rule requires that either (i) the acquiring fund does not pay any 
sales charge, distribution fee or service fee (as defined by NASD Sales 
Charge Rule 2830(d)) on the purchase of money market fund shares, or 
(ii) the fund's adviser waives its fee in an amount necessary to offset 
any administrative fees of the money market fund.\137\ This condition 
may reduce the cost of cash management (by reducing advisory or 
custodial fees relating to money market instruments) for large and 
small funds. In addition, under the rule, a fund that invests in an 
unregistered money market fund will have to ``reasonably believe'' that 
the unregistered fund (i) operates in compliance with rule 2a-7, and 
(ii) complies with certain provisions of the Act. With respect to these 
conditions, we believe that if the cost of investing in a money market 
fund (registered or unregistered) exceeds the costs of other forms of 
cash management, acquiring funds, including funds that are small 
entities, will not take advantage of the exemption. Finally, we believe 
the additional section 17 relief for acquiring funds that execute 
transactions with broker-dealers that are affiliated solely as a result 
of the acquiring fund's investment in a money market fund, will allow 
more funds to take full advantage of the exemption provided by the 
rule. We believe this additional relief will be important if a small 
fund without a money market fund in its complex invests, in reliance 
upon rule 12d1-1, in a money market fund in another complex and thereby 
becomes affiliated with a broker-dealer affiliated with the money 
market fund. Without the relief from certain recordkeeping and 
monitoring requirements, small funds may find it potentially costly or 
onerous to monitor transactions with affiliated broker-dealers.\138\
---------------------------------------------------------------------------

    \137\ Rule 12d1-1(b)(1).
    \138\ See supra notes 32-36 and accompanying text.
---------------------------------------------------------------------------

    Rule 12d1-2 also has no mandatory reporting, recordkeeping or other 
compliance requirements.\139\ Rule 12d1-3 requires an unaffiliated fund 
of funds relying on the rule to limit aggregate distribution-related 
costs under the NASD Sales Charge Rule.\140\ The rule provides funds 
greater flexibility in structuring sales loads, consistent with the 
approach Congress took in section 12(d)(1)(G) to prevent excessive 
sales loads in affiliated funds of funds, while providing shareholders 
greater protection by requiring that funds relying on the rule limit 
overall distribution fees (rather than only sales loads).
---------------------------------------------------------------------------

    \139\ Funds that invest in a money market fund in reliance on 
rule 12d1-2, however, must comply with the conditions of rule 12d1-
1. See supra note 62 and accompanying text.
    \140\ See rule 12d1-3(a); See also supra note 64 and 
accompanying text.
---------------------------------------------------------------------------

    Funds that intend to rely on the rules will no longer incur the 
expense associated with filing applications for comparable exemptive 
relief from sections 12(d)(1)(A), (B), (F), and (G), 17(a), 
17(e)(2)(A), and 57, and rules 17d-1, 17e-1(b)(3) and 17e-1(d)(2) in 
connection with the fund of funds arrangement permitted by the rules. 
The exemptive rules may be of greater benefit to small funds for which 
the benefits of obtaining an order for the relief described above may 
not sufficiently offset the costs of filing an exemptive application.
    The amendments to Forms N-1A and N-2 require registered funds to 
include a line item in the fee table disclosing the acquiring fund's 
pro rata portion of the cumulative expenses charged by funds in which 
the acquiring fund invests. The amendments include instructions for 
calculating the line item''Acquired Fund Fees and Expenses.'' For 
purposes of the PRA, Commission staff estimated that the disclosure 
requirement for calculating the line item according to the instructions 
will add up to 7 hours per portfolio to the burden of completing Forms 
N-1A and N-2.\141\ Commission staff also estimated that the additional 
cost of including the line item per portfolio would equal $542 for 
Forms N-1A and Form N-2 (excluding funds of hedge funds).\142\ The 
Commission staff has further estimated, based on comments received, 
that a fund of hedge funds would incur $16,500 to calculate the new 
line item.\143\ Assuming that half of all small funds and all small 
funds of hedge funds invest in other funds and will be required to 
include the additional disclosure, the Commission staff estimates that 
the maximum total annual cost for small entities to comply with the 
form amendments will be $176,026.\144\
---------------------------------------------------------------------------

    \141\ See supra notes 99-100 and accompanying text.
    \142\ See supra note 120 and accompanying text.
    \143\ See supra note 103 and accompanying text.
    \144\ Based on recent Commission filings, the staff estimates 
that 140 funds that are small entities are registered under Form N-
1A, with an average of 2.7 portfolios per registrant. Commission 
staff further estimates that 28 funds registered with an average of 
1.0 portfolio per registrant and 4 funds of hedge funds registered 
under Form N-2 are small entities. The staff's estimate assumes that 
all funds of hedge funds and half of all other portfolios would 
include the proposed disclosure. The maximum cost estimate is based 
on the following calculation: ((140 x 2.7) + (28 x 1.00)) 2 
portfolios x $542 = $110,026) + (4 x $16,500 = $66,000) = $176,026. 
The increase from the Proposing Release is due to adjustments for 
salary and overhead costs during the intervening period and the 
additional cost for funds of hedge funds to comply with the 
disclosure requirement. Amendments to Forms N-3, N-4 and N-6 are not 
expected to impact small entities because the staff estimates that 
no registered separate account is a small entity.

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

[[Page 36655]]

E. Commission Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objective, 
while minimizing any significant adverse impact on small entities. In 
connection with the new rules, the Commission considered the following 
alternatives: (i) The establishment of differing compliance or 
reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the rule for small entities; (iii) the use of 
performance rather than design standards; and (iv) an exemption from 
coverage of the rule, or any part thereof, for small entities.
    The new rules are exemptive, and compliance with them is voluntary. 
We therefore do not believe that special compliance, timetable, or 
reporting requirements or an exemption from coverage of the rules for 
small entities would be appropriate.
    The rules do not require any reporting requirements that could be 
further clarified, consolidated, or simplified. Rule 12d1-1 uses 
performance rather than design standards to the extent it requires that 
acquiring funds ``reasonably believe'' that underlying funds are 
operating in compliance with rule 2a-7 and certain provisions of the 
Act. This standard is designed to ensure that a violation on the part 
of the acquired fund would not cause the acquiring fund to lose its 
exemption under the rule if it can demonstrate that it reasonably 
believed that the acquired fund was in compliance. In addition, rule 
12d1-3 does not specify the sales load and distribution-related charges 
an acquiring or acquired fund must impose, but permits funds to 
determine the combined charges within the overall limit set by the NASD 
Sales Charge Rule.
    With respect to the form amendments, we believe that any further 
clarification, consolidation, or simplification of the requirements to 
report expenses of acquired funds for small funds would not be 
consistent with the protection of investors. A different requirement, 
including differing compliance or reporting requirements or timetables, 
could compromise the intent to provide investors with cost information 
that will allow them to make direct comparisons to the costs of 
alternative fund of funds arrangements and to the costs of a more 
traditional fund. Performance standards also would not provide this 
important benefit to investors. An exemption for small entities would 
defeat the purposes of the amendments for the same reasons.

VII. Statutory Authority

    The Commission is adopting rules 12d1-1, 12d1-2 and 12d1-3 under 
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 
also adopting amendments to Forms N-1A, N-2, N-3, N-4, and N-6 under 
the authority set forth in sections 6, 7(a), 10 and 19(a) of the 
Securities Act (15 U.S.C. 77f, 77g(a), 77j, 77s(a)), and sections 8(b), 
24(a), 30, and 38(a) of the Act (15 U.S.C. 80a-8(b), 80a-24(a), 80a-29, 
and 80a-37(a)).

List of Subjects

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Rules and Form Amendments

0
For the reasons set out in the preamble, the Commission is amending 
Title 17, Chapter II of the Code of Federal Regulations as follows:

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
1. The authority citation for part 239 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77x-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 
79g, 79j, 79l, 79m, 79n, 79q, 79t, 80a-9, 80a-10, 10a-13, 80a-8, 
80a-24, 80a-26, 80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
2. The authority citation for part 270 is amended by revising the 
subauthority for Sec.  270.12d1-1 to read as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted;
* * * * *
    Sections 270.12d1-1, 270.12d1-2, and 270.12d1-3 are also issued 
under 15 U.S.C. 80a-6(c), 80a-12(d)(1)(J), and 80a-37(a).
* * * * *

0
3. Sections 270.12d1-1, 270.12d1-2, and 270.12d1-3 are added 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), 17(a), and 57 of the 
Act (15 U.S.C. 80a-12(d)(1)(A), 80a-12(d)(1)(B), 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 an acquiring fund.
    (b) Conditions--(1) Fees. The acquiring fund pays no sales charge, 
as defined in rule 2830(b)(8) of the Conduct Rules of the NASD (``sales 
charge''), or service fee, as defined in rule 2830(b)(9) of the Conduct 
Rules of the NASD, charged in connection with the purchase, sale, or 
redemption of securities issued by a money market fund (``service 
fee''); or the acquiring fund's investment adviser waives its advisory 
fee in an amount necessary to offset any sales charge or service fee.
    (2) Unregistered money market funds. If the money market fund is 
not an investment company registered under the Act:
    (i) The acquiring fund reasonably believes that the money market 
fund satisfies the following conditions as if it were a registered 
open-end investment company:
    (A) Operates in compliance with Sec.  270.2a-7;
    (B) Complies with sections 17(a), (d), (e), 18, and 22(e) of the 
Act (15 U.S.C. 80a-17(a), (d), (e), 80a-18, and 80a-22(e));
    (C) Has adopted procedures designed to ensure that it complies with 
sections 17(a), (d), (e), 18, and 22(e) of the Act (15 U.S.C. 80a-
17(a), (d), (e), 80a-18, and 80a-22(e)), periodically reviews and 
updates those procedures, and maintains books and records describing 
those procedures;
    (D) Maintains the records required by Sec. Sec.  270.31a-1(b)(1), 
270.31a-1(b)(2)(ii),

[[Page 36656]]

270.31a-1(b)(2)(iv), and 270.31a-1(b)(9); and
    (E) Preserves permanently, the first two years in an easily 
accessible place, all books and records required to be made under 
paragraphs (b)(2)(i)(C) and (D) of this section, and makes those 
records available for examination on request by the Commission or its 
staff; and
    (ii) The adviser to the money market fund is registered with the 
Commission as an investment adviser under section 203 of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-3).
    (c) Exemption from certain monitoring and recordkeeping 
requirements under Sec.  270.17e-1. Notwithstanding the requirements of 
Sec. Sec.  270.17e-1(b)(3) and 270.17e-1(d)(2), the payment of a 
commission, fee, or other remuneration to a broker shall be deemed as 
not exceeding the usual and customary broker's commission for purposes 
of section 17(e)(2)(A) of the Act if:
    (1) The commission, fee, or other remuneration is paid in 
connection with the sale of securities to or by an acquiring fund;
    (2) The broker and the acquiring fund are affiliated persons 
because each is an affiliated person of the same money market fund; and
    (3) The acquiring fund is an affiliated person of the money market 
fund solely because the acquiring fund owns, controls, or holds with 
power to vote five percent or more of the outstanding securities of the 
money market fund.
    (d) Definitions. (1) Investment company includes a company that 
would be an investment company under section 3(a) of the Act (15 U.S.C. 
80a-3(a)) but for the exceptions to that definition provided for in 
sections 3(c)(1) and 3(c)(7) of the Act (15 U.S.C. 80a-3(c)(1) and 80a-
3(c)(7)).
    (2) Money market fund means:
    (i) An open-end management investment company registered under the 
Act that is regulated as a money market fund under Sec.  270.2a-7; or
    (ii) A company that would be an investment company under section 
3(a) of the Act (15 U.S.C. 80a-3(a)) but for the exceptions to that 
definition provided for in sections 3(c)(1) and 3(c)(7) of the Act (15 
U.S.C. 80a-3(c)(1) and 80a-3(c)(7)) and that:
    (A) Is limited to investing in the types of securities and other 
investments in which a money market fund may invest under Sec.  270.2a-
7; and
    (B) Undertakes to comply with all the other requirements of Sec.  
270.2a-7, except that, if the company has no board of directors, the 
company's investment adviser performs the duties of the board of 
directors.

Sec.  270.12d1-2  Exemptions for investment companies relying on 
section 12(d)(1)(G) of the Act.

    (a) Exemption to acquire other securities. Notwithstanding section 
12(d)(1)(G)(i)(II) of the Act (15 U.S.C. 80a-12(d)(1)(G)(i)(II)), a 
registered open-end investment company or a registered unit investment 
trust that relies on section 12(d)(1)(G) of the Act (15 U.S.C. 80a-
12(d)(1)(G)) to acquire securities issued by another registered 
investment company that is in the same group of investment companies 
may acquire, in addition to Government securities and short-term paper:
    (1) Securities issued by an investment company, other than 
securities issued by another registered investment company that is in 
the same group of investment companies, when the acquisition is in 
reliance on section 12(d)(1)(A) or 12(d)(1)(F) of the Act (15 U.S.C. 
80a-12(d)(1)(A) or 80a-12(d)(1)(F));
    (2) Securities (other than securities issued by an investment 
company); and
    (3) Securities issued by a money market fund, when the acquisition 
is in reliance on Sec.  270.12d1-1.
    (b) Definitions. For purposes of this section, money market fund 
has the same meaning as in Sec.  270.12d1-1(d)(2).

Sec.  270.12d1-3  Exemptions for investment companies relying on 
section 12(d)(1)(F) of the Act.

    (a) Exemption from sales charge limits. A registered investment 
company (``acquiring fund'') that relies on section 12(d)(1)(F) of the 
Act (15 U.S.C. 80a-12(d)(1)(F)) to acquire securities issued by an 
investment company (``acquired fund'') may offer or sell any security 
it issues through a principal underwriter or otherwise at a public 
offering price that includes a sales load of more than 1\1/2\ percent 
if any sales charges and service fees charged with respect to the 
acquiring fund's securities do not exceed the limits set forth in rule 
2830 of the Conduct Rules of the NASD applicable to a fund of funds.
    (b) Definitions. For purposes of this section, the terms fund of 
funds, sales charge, and service fee have the same meanings as in rule 
2830(b) of the Conduct Rules of the NASD.

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

0
4. The authority citation for part 274 continues to read in part 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, and 80a-29, unless otherwise 
noted.
* * * * *
    5. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A), Item 
3, is amended by adding paragraph (f) to Instruction 3 to read as 
follows:

    Note: The text of Form N-1A does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-1A

* * * * *
Item 3. Risk/Return Summary: Fee Table
* * * * *

Instructions

* * * * *
    3. Annual Fund Operating Expenses.
* * * * *
    (f)(i) If the Fund (unless it is a Feeder Fund) invests in shares 
of one or more Acquired Funds, add a subcaption to the ``Annual Fund 
Operating Expenses'' portion of the table directly above the subcaption 
titled ``Total Annual Fund Operating Expenses.'' Title the additional 
subcaption: ``Acquired Fund Fees and Expenses.'' Disclose in the 
subcaption fees and expenses incurred indirectly by the Fund as a 
result of investment in shares of one or more Acquired Funds. For 
purposes of this item, an ``Acquired Fund'' means any company in which 
the Fund invests or has invested during the relevant fiscal period that 
(A) is an investment company or (B) would be an investment company 
under section 3(a) of the Investment Company Act (15 U.S.C. 80a-3(a)) 
but for the exceptions to that definition provided for in sections 
3(c)(1) and 3(c)(7) of the Investment Company Act (15 U.S.C. 80a-
3(c)(1) and 80a-3(c)(7)). If a Fund uses another term in response to 
other requirements of this Form to refer to Acquired Funds, it may 
include that term in parentheses following the subcaption title. In the 
event the fees and expenses incurred indirectly by the Fund as a result 
of investment in shares of one or more Acquired Funds do not exceed 
0.01 percent (one basis point) of average net assets of the Fund, the 
Fund may include these fees and expenses under the subcaption ``Other 
Expenses'' in lieu of this disclosure requirement.
    (ii) Determine the ``Acquired Fund Fees and Expenses'' according to 
the following formula:

[[Page 36657]]

[GRAPHIC] [TIFF OMITTED] TR27JN06.000

Where:

AFFE = Acquired Fund fees and expenses;
F1, F2, F3, . . . = Total annual 
operating expense ratio for each Acquired Fund;
FY = Number of days in the relevant fiscal year.
AI1, AI2, AI3, . . = Average invested 
balance in each Acquired Fund;
D1, D2, D3, . . . = Number of days 
invested in each Acquired Fund; and
``Transaction Fees'' = The total amount of sales loads, redemption 
fees, or other transaction fees paid by the Fund in connection with 
acquiring or disposing of shares in any Acquired Funds during the most 
recent fiscal year.
``Incentive Allocations'' = Any allocation of capital from the 
Acquiring Fund to the adviser of the Acquired Fund (or its affiliate) 
based on a percentage of the Acquiring Fund's income, capital gains 
and/or appreciation in the Acquired Fund.

    (iii) Calculate the average net assets of the Fund for the most 
recent fiscal year, as provided in Item 8(a) (see Instruction 4 to Item 
8(a)).
    (iv) The total annual operating expense ratio used for purposes of 
this calculation (F1) is the annualized ratio of operating expenses to 
average net assets for the Acquired Fund's most recent fiscal period as 
disclosed in the Acquired Fund's most recent shareholder report. If the 
ratio of expenses to average net assets is not included in the most 
recent shareholder report or the Acquired Fund is a newly formed fund 
that has not provided a shareholder report, then the ratio of expenses 
to average net assets of the Acquired Fund is the ratio of total annual 
operating expenses to average annual net assets of the Acquired Fund 
for its most recent fiscal period as disclosed in the most recent 
communication from the Acquired Fund to the Fund. For purposes of this 
instruction: (i) Acquired Fund expenses include increases resulting 
from brokerage service and expense offset arrangements and reductions 
resulting from fee waivers or reimbursements by the Acquired Funds' 
investment advisers or sponsors; and (ii) Acquired Fund expenses do not 
include expenses (i.e., performance fees) that are incurred solely upon 
the realization and/or distribution of a gain. If an Acquired Fund has 
no operating history, include in the Acquired Funds' expenses any fees 
payable to the Acquired Fund's investment adviser or its affiliates 
stated in the Acquired Fund's registration statement, offering 
memorandum or other similar communication without giving effect to any 
performance.
    (v) To determine the average invested balance (AI1), the numerator 
is the sum of the amount initially invested in an Acquired Fund during 
the most recent fiscal year (if the investment was held at the end of 
the previous fiscal year, use the amount invested as of the end of the 
previous fiscal year) and the amounts invested in the Acquired Fund no 
less frequently than monthly during the period the investment is held 
by the Fund (if the investment was held through the end of the fiscal 
year, use each month-end through and including the fiscal year-end). 
Divide the numerator by the number of measurement points included in 
the calculation of the numerator (i.e., if an investment is made during 
the fiscal year and held for 3 succeeding months, the denominator would 
be 4).
    (vi) A New Fund should base the Acquired Fund fees and expenses on 
assumptions as to the specific Acquired Funds in which the New Fund 
expects to invest. Disclose in a footnote to the table that Acquired 
Fund fees and expenses are based on estimated amounts for the current 
fiscal year.
    (vii) The Fund may clarify in a footnote to the fee table that the 
total annual fund operating expenses under Item 3 do not correlate to 
the ratio of expenses to average net assets given in response to Item 
8, which reflects the operating expenses of the Fund and does not 
include Acquired Fund fees and expenses.
* * * * *
    6. Form N-2 (referenced in Sec. Sec.  239.14 and 274.11a-1), Item 
3, paragraph 1, is amended by:
    a. Redesignating Instruction 10 titled ``Example'' as Instruction 
11; and
    b. Adding new Instruction 10. The addition reads as follows:

    Note: The text of Form N-2 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM N-2

* * * * *
Item 3. Fee Table and Synopsis
    1. * * *
    Instructions:
* * * * *
    10. a. If the Registrant invests, or intends to invest based upon 
the anticipated net proceeds of the present offering, in shares of one 
or more ``Acquired Funds,'' add a subcaption to the ``Annual Expenses'' 
portion of the table directly above the subcaption titled ``Total 
Annual Expenses.'' Title the additional subcaption: ``Acquired Fund 
Fees and Expenses.'' Disclose in the subcaption fees and expenses 
incurred indirectly by the Registrant as a result of investment in 
shares of one or more Acquired Funds. For purposes of this item, an 
``Acquired Fund'' means any company in which the Registrant invests or 
intends to invest (A) that is an investment company or (B) that would 
be an investment company under section 3(a) of the 1940 Act (15 U.S.C. 
80a-3(a)) but for the exceptions to that definition provided for in 
sections 3(c)(1) and 3(c)(7) of the 1940 Act (15 U.S.C. 80a-3(c)(1) and 
80a-3(c)(7)). If a Registrant uses another term in response to other 
requirements of this Form to refer to Acquired Funds, it may include 
that term in parentheses following the subcaption title. In the event 
the fees and expenses incurred indirectly by the Registrant as a result 
of investment in shares of one or more Acquired Funds do not exceed 
0.01 percent (one basis point) of average net assets of the Registrant, 
the Registrant may include these fees and expenses under the subcaption 
``Other Expenses'' in lieu of this disclosure requirement.
    b. Determine the ``Acquired Fund Fees and Expenses'' according to 
the following formula:
[GRAPHIC] [TIFF OMITTED] TR27JN06.001

[[Page 36658]]

Where:

AFFE = Acquired Fund fees and expenses;
F1, F2, F3, . . . = Total annual operating expense ratio for each 
Acquired Fund;
FY = Number of days in the relevant fiscal year.
AI1, AI2, AI3, . . . =Average invested 
balance in each Acquired Fund;
D1, D2, D3, . . . = Number of days invested in each Acquired Fund;
``Transaction Fees''= The total amount of sales loads, redemption fees, 
or other transaction fees paid by the Registrant in connection with 
acquiring or disposing of shares in any Acquired Funds during the most 
recent fiscal year; and
``Incentive Allocations''= Any allocation of capital from the Acquiring 
Fund to the adviser of the Acquired Fund (or its affiliate) based on a 
percentage of the Acquiring Fund's income, capital gains and/or 
appreciation in the Acquired Fund.

    c. Calculate the average net assets of the Registrant for the most 
recent fiscal year, as provided in Item 4.1 (see Instruction 15 to Item 
4.1) and include the anticipated net proceeds of the present offering.
    d. The total annual operating expense ratio used for purposes of 
this calculation (F1) is the annualized ratio of operating expenses to 
average net assets for the Acquired Fund's most recent fiscal period as 
disclosed in the Acquired Fund's most recent shareholder report. If the 
ratio of expenses to average net assets is not included in the most 
recent shareholder report or the Acquired Fund is a newly formed fund 
that has not provided a shareholder report, then the ratio of expenses 
to average net assets of the Acquired Fund is the ratio of total annual 
operating expenses to average annual net assets of the Acquired Fund 
for its most recent fiscal period as disclosed in the most recent 
communication from the Acquired Fund to the Registrant. If the 
Registrant has a written fee agreement with the Acquired Fund that 
would affect the ratio of expenses to average net assets as disclosed 
in the Acquired Fund's most recent shareholder report, the Registrant 
should determine the ratio of expenses to average net assets for the 
Acquired Fund's most recent fiscal period using the written fee 
agreement. For purposes of this instruction: (i) Acquired Fund expenses 
include increases resulting from brokerage service and expense offset 
arrangements and reductions resulting from fee waivers or 
reimbursements by the Acquired Funds' investment advisers or sponsors; 
and (ii) Acquired Fund expenses do not include any expenses (i.e., 
performance fees) that are calculated solely upon the realization and/
or distribution of gains, or the sum of the realization and/or 
distribution of gains and unrealized appreciation of assets distributed 
in-kind. If an Acquired Fund has no operating history, include in the 
Acquired Funds' expenses any fees payable to the Acquired Fund's 
investment adviser or its affiliates stated in the Acquired Fund's 
registration statement, offering memorandum or other similar 
communication without giving effect to any performance.
    e. If a Registrant has made investments in the most recent fiscal 
year, to determine the average invested balance (AI1), the 
numerator is the sum of the amount initially invested in an Acquired 
Fund during the most recent fiscal year (if the investment was held at 
the end of the previous fiscal year, use the amount invested as of the 
end of the previous fiscal year) and the amounts invested in the 
Acquired Fund no less frequently than monthly during the period the 
investment is held by the Registrant (if the investment was held 
through the end of the fiscal year, use each month-end through and 
including the fiscal year-end). Divide the numerator by the number of 
measurement points included in the calculation of the numerator (i.e., 
if an investment is made during the fiscal year and held for 3 
succeeding months, the denominator would be 4).
    f. For investments based upon the anticipated net proceeds from the 
present offering, base the ``Acquired Fund Fees and Expenses'' on: (i) 
Assumptions about specific funds in which the Registrant expects to 
invest, (ii) estimates of the amount of assets the Registrant expects 
to invest in each of those Acquired Funds, and (iii) an assumption that 
the investment was held for all of the Registrant's most recent fiscal 
year and was subject to the Acquired Funds' fees and expenses for that 
year. Disclose in a footnote to the table that Acquired Fund fees and 
expenses are based on estimated amounts for the current fiscal year.
    g. If an Acquired Fund charges an Incentive Allocation or any other 
fee based on income, capital gains and/or appreciation (i.e., 
performance fee), the Registrant must include a footnote to the 
``Acquired Fund Fees and Expenses'' subcaption that: (i) Discloses the 
typical Incentive Allocation or such other fee (expressed as a 
percentage) to be paid to the investment advisers of the Acquired Funds 
(or an affiliate); (ii) discloses that Acquired Funds' fees and 
expenses are based on historic fees and expenses; and (iii) states that 
future Acquired Funds' fees and expenses may be substantially higher or 
lower because certain fees are based on the performance of the Acquired 
Funds, which may fluctuate over time.
    h. If the Registrant is a Feeder Fund, reflect the aggregate 
expenses of the Feeder Fund and the Master Fund in the ``Acquired Fund 
Fees and Expenses.'' The aggregate expenses of the Master-Feeder Fund 
must include the fees and expenses incurred indirectly by the Feeder 
Fund as a result of the Master Fund's investment in shares of one or 
more companies (A) that are investment companies or (B) that would be 
investment companies under section 3(a) of the 1940 Act (15 U.S.C. 80a-
3(a)) but for the exceptions to that definition provided for in 
sections 3(c)(1) and 3(c)(7) of the 1940 Act (15 U.S.C. 80a-3(c)(1) and 
80a-3(c)(7)). For purposes of this instruction, a ``Master-Feeder 
Fund'' means a two-tiered arrangement in which one or more investment 
companies registered under the 1940 Act (each a ``Feeder Fund'') holds 
shares of a single management investment company registered under the 
1940 Act (the ``Master Fund'') in accordance with section 12(d)(1)(E) 
of the 1940 Act [15 U.S.C. 80a-12(d)(1)(E)].
    i. The Registrant may clarify in a footnote to the fee table that 
the total annual expenses item under Item 3.1 is different from the 
ratio of expenses to average net assets given in response to Item 4.1, 
which reflects the operating expenses of the Registrant and does not 
include Acquired Fund fees and expenses.
* * * * *
    7. Form N-3 (referenced in Sec. Sec.  239.17a and 274.11b), Item 
3(a), is amended by:
    a. In Instruction 16(a), revising the phrase in the third sentence 
``Instructions 18(b), 19(e) and 19(f)'' to read ``Instructions 18(b), 
19(f), 20(e), and 20(f)''';
    b. Redesignating Instruction 19 titled ``Example'' as Instruction 
20; and
    c. Adding new Instruction 19.
    The addition reads as follows:

    Note: The text of Form N-3 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM N-3

* * * * *
Item 3. Synopsis or Highlights
    (a) * * *
    Instructions:
* * * * *
    19. (a) If the Registrant invests in shares of one or more Acquired 
Funds,

[[Page 36659]]

add a subcaption to the ``Annual Expenses'' portion of the table 
directly above the subcaption titled ``Total Annual Expenses.'' Title 
the additional subcaption: ``Acquired Fund Fees and Expenses.'' 
Disclose in the subcaption fees and expenses incurred indirectly by the 
Registrant as a result of investment in shares of one or more Acquired 
Funds. For purposes of this Item, an ``Acquired Fund'' means any 
company in which the Fund invests that (i) is an investment company or 
(ii) would be an investment company under section 3(a) of the 1940 Act 
(15 U.S.C. 80a-3(a)) but for the exceptions to that definition provided 
for in sections 3(c)(1) and 3(c)(7) of the 1940 Act (15 U.S.C. 80a-
3(c)(1) and 80a-3(c)(7)). If a Registrant uses another term in response 
to other requirements of this Form to refer to Acquired Funds, it may 
include that term in parentheses following the subcaption title. In the 
event the fees and expenses incurred indirectly by the Registrant as a 
result of investment in shares of one or more Acquired Funds do not 
exceed 0.01 percent (one basis point) of average net assets of the 
Registrant, the Registrant may include these fees and expenses under 
the subcaption ``Other Expenses'' in lieu of this disclosure 
requirement.
    (b) Determine the ``Acquired Fund Fees and Expenses'' according to 
the following formula:
[GRAPHIC] [TIFF OMITTED] TR27JN06.002

Where:

AFFE = Acquired Fund fees and expenses;
F1, F2, F3, ... = Total annual 
operating expense ratio for each Acquired Fund;

FY = Number of days in the relevant fiscal year.
AI1, AI2, AI3, ... = Average invested 
balance in each Acquired Fund;
D1, D2, D3, ... = Number of days 
invested in each Acquired Fund; and
``Transaction Fees'' = The total amount of sales loads, redemption 
fees, or other transaction fees paid by the Registrant in connection 
with acquiring or disposing of shares in any Acquired Funds during the 
most recent fiscal year.

    (c) Calculate the average net assets of the Registrant for the most 
recent fiscal year, as provided in Item 4(a) (see Instruction 10 to 
Item 4(a)).
    (d) The total annual operating expense ratio used for purposes of 
this calculation (F1) is the annualized ratio of operating expenses to 
average net assets for the Acquired Fund's most recent fiscal period as 
disclosed in the Acquired Fund's most recent shareholder report. If the 
ratio of expenses to average net assets is not included in the most 
recent shareholder report or the Acquired Fund is a newly formed fund 
that has not provided a shareholder report, then the ratio of expenses 
to average net assets of the Acquired Fund is the ratio of total annual 
operating expenses to average annual net assets of the Acquired Fund 
for its most recent fiscal period as disclosed in the most recent 
communication from the Acquired Fund to the Registrant. For purposes of 
this instruction, Acquired Fund expenses include increases resulting 
from brokerage service and expense offset arrangements and reductions 
resulting from fee waivers or reimbursements by the Acquired Funds' 
investment advisers or sponsors.
    (e) To determine the average invested balance (AI1), the 
numerator is the sum of the amount initially invested in an Acquired 
Fund during the most recent fiscal year (if the investment was held at 
the end of the previous fiscal year, use the amount invested as of the 
end of the previous fiscal year) and the amounts invested in the 
Acquired Fund no less frequently than monthly during the period the 
investment is held by the Registrant (if the investment was held 
through the end of the fiscal year, use each month-end through and 
including the fiscal year-end). Divide the numerator by the number of 
measurement points included in the calculation of the numerator (i.e., 
if an investment is made during the fiscal year and held for 3 
succeeding months, the denominator would be 4).
    (f) A New Registrant should base the ``Acquired Fund Fees and 
Expenses'' on assumptions as to the specific Acquired Funds in which 
the New Registrant expects to invest. Disclose in a footnote to the 
table that Acquired Fund fees and expenses are based on estimated 
amounts for the current fiscal year.
    (g) The Registrant may clarify in a footnote to the fee table that 
the total annual expenses under Item 3 are different from the ratio of 
expenses to average net assets given in response to Item 4, which 
reflects the operating expenses of the Registrant and does not include 
Acquired Fund fees and expenses.
* * * * *
    8. Form N-4 (referenced in Sec. Sec.  239.17b and 274.11c), Item 3, 
is amended by adding a sentence at the end of Instruction 17(a) to read 
as follows:

    Note: The text of Form N-4 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-4

* * * * *
Item 3. Synopsis
* * * * *
    Instructions:
* * * * *
    17. (a) * * * If any Portfolio Company invests in shares of one or 
more Acquired Funds, ``Total Annual [Portfolio Company] Operating 
Expenses'' for the Portfolio Company must also include fees and 
expenses incurred indirectly by the Portfolio Company as a result of 
investment in shares of one or more Acquired Funds, calculated in 
accordance with Instruction 3(f) to Item 3 of Form N-1A (17 CFR 
239.15A; 17 CFR 274.11A). For purposes of this paragraph, an Acquired 
Fund means any company in which the Portfolio Company invests that (i) 
is an investment company or (ii) would be an investment company under 
section 3(a) of the 1940 Act (15 U.S.C. 80a-3(a)) but for the 
exceptions to that definition provided for in sections 3(c)(1) and 
3(c)(7) of the 1940 Act (15 U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).
* * * * *
    9. Form N-6 (referenced in Sec. Sec.  239.17c and 274.11d), Item 3, 
is amended by adding a sentence at the end of Instruction 4(b) to read 
as follows:

    Note: The text of Form N-6 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-6

* * * * *
Item 3. Risk/Benefit Summary: Fee Table
* * * * *
    Instructions:
* * * * *

[[Page 36660]]

    4. Total Annual [Portfolio Company] Operating Expenses.
* * * * *
    (b) * * * If any Portfolio Company invests in shares of one or more 
Acquired Funds, ``Total Annual [Portfolio Company] Operating Expenses'' 
for the Portfolio Company must also include fees and expenses incurred 
indirectly by the Portfolio Company as a result of investment in shares 
of one or more Acquired Funds, calculated in accordance with 
Instruction 3(f) to Item 3 of Form N-1A (17 CFR 239.15A; 17 CFR 
274.11A). For purposes of this paragraph, an Acquired Fund means any 
company in which the Portfolio Company invests that (i) is an 
investment company or (ii) would be an investment company under section 
3(a) of the Investment Company Act (15 U.S.C. 80a-3(a)) but for the 
exceptions to that definition provided for in sections 3(c)(1) and 
3(c)(7) of the Investment Company Act (15 U.S.C. 80a-3(c)(1) and 80a-
3(c)(7)).
* * * * *

    By the Commission.

    Dated: June 20, 2006.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 06-5650 Filed 6-26-06; 8:45 am]

BILLING CODE 8010-01-P