By Matt Baskir
Included within the frenetic activity of new rulemaking last year, in October 2020, the SEC announced changes to Section 12(d)(1) of the Investment Company Act of 1940, as amended, and related rules, commonly referred to as the “Fund of Funds Rule.” The stated purpose of the regulatory changes was to
“create a more consistent and efficient rules-based regime for the formation and oversight of funds of funds.” The compliance date for the new regulatory framework is January 19, 2022.
The newly-implemented Rule 12d1-4 allows the acquisition of underlying funds in excess of the prescribed statutory limits of Section 12(d)(1) (3/5/10 limits) without obtaining an exemptive order. It rescinds prior exemptive orders for transactions that fall within the scope of the Rule and rescinds Rule 12d1-2 (investments in affiliated group of funds). Complex, multi-tier structures are generally restricted to two tiers with certain exceptions and limitations. The Rule also squarely focuses on preventing any undue influence and/or excessive fees or expenses in such arrangements and requires certain Board reporting.
It also mandates mirror (or other permissible) proxy voting arrangements above certain control/ownership limits (25% for open-end funds and 10% for closed-end funds) as well as certain reporting on Form N-CEN.
The requirements of Rule 12d1-4 generally include:
- Fund of Funds Investment Agreements between acquiring and acquired funds;
- Board submission of evaluations and findings by investment advisers to such funds regarding the arrangements, including fees, undue influence and other elements;
- Voting requirements for open-end and closed-end funds;
- Limitations on control by an acquiring fund and its “advisory group;”
- Complex structure limitations, generally prohibiting three-tier structures and limiting acquired funds’ investment in other RICs and private funds to 10% of the acquired fund’s total assets; and
- Certain recordkeeping obligations.
Along with the rescission of Rule 12d1-2 and most existing exemptive orders under Sections 12(d)(1)(A), (B), (C) and (G), Rule 12d1-1 was amended to allow funds that primarily invest in funds in the same fund group to continue to invest in unaffiliated money market funds.
There are alternatives to Rule 12d1-4 and its requirements, including managing a fund of funds under the statutory exemption in Section 12(d)(1)(F) or simply not breaching the Section 12(d)(1) limits.
The information contained herein is made available only for your assistance and convenience and for informational purposes. Nothing herein is designed to provide, and does not constitute, legal advice on any matter and should not be relied upon for that purpose. Any opinions included herein are those of the author and not attributable to the Nottingham Company, its management or affiliates.
If you have any questions about the new Fund of Funds Rule, recent SEC rulemaking, 40 Act or Advisers Act compliance, starting a fund or other compliance or consulting solutions, please don’t hesitate to reach out.