Earlier this month, the SEC lifted investment restrictions on fund of funds (FOFs) by adopting new Rule 12d1-4 (the “Rule”) under the Investment Company Act of 1940 (the “Act”). The new Rule removes certain investment restrictions (subject to conditions), rescinds an existing rule, and eliminates existing exemptive relief. This is good news for registered investment company fund managers that were hemmed in by existing restrictions when investing in other funds (including private funds) and had to rely on the exemptive relief process. The new regulatory requirement does not apply directly to private funds, but there is some clarification in the Rule for private funds. The Rule is primarily aimed at registered investment companies (RICs) and business development companies (BDCs).
Under new Rule 12d1-4, both RICs and BDCs are allowed new exemptions from the current restrictions under Section 12(d)(1) of the Act.
Rule 12d1-4 Summary
Funds must follow and meet certain conditions if they wish to exceed the existing investment restrictions under Section 12(d)(1). These conditions are:
- Control. An acquiring fund cannot control an acquired fund, except in certain limited circumstances.
- Voting. An acquiring fund must use mirror voting if it holds more than 25% of an acquired open-end fund or UIT due to a decrease in the outstanding securities of the acquired fund, and if it holds more than 10% of a closed-end fund, with the ability to use pass-through voting when acquiring funds are the only shareholders of an acquired fund.
- Required Findings. Both the acquired fund and the acquiring fund must evaluate certain factors such as the possibility of undue influence (acquired fund) and that the fund of fund does not have duplicative fees and expenses (acquiring fund). UITs and separate accounts funding variable insurance contracts have their own specific factors.
- Fund of Funds Investment Agreement. Funds that do not have the same investment adviser are required to enter into an agreement (a “fund of funds investment agreement”) before exceeding existing limits.
- Complex Structures. A general prohibition on three tier structures will exist; however, an acquired fund can invest up to 10% of its total assets in other funds (including private funds).
Private funds and foreign funds are still restricted from acquiring more than 3% of a U.S. registered fund.
The Rule also adds a new reporting requirement on Form N-CEN to show if a management company relied on the new Rule or the existing statutory exception during the reporting period.
View SEC Release Nos. 33-10871; IC-34045, “Fund of Funds Arrangements,” which becomes effective 60 days after publication in the Federal Register (TBD).