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SEC Proposes Fund-of-Funds Rule to Replace All Current Exemptive Orders

 The SEC voted to propose a new rule that would completely overhaul the fund-of-funds rules.  Instead of relying on exemptive orders, the new rule would allow fund-of-funds structures that meet specified conditions including: (i) limitations on voting to avoid control of the underlying fund, (ii) redemption limits within 30 days of purchasing the underlying fund, (iii) evaluations to avoid excessive aggregate fees, and (iv) prohibitions on 3-tier fund-of-funds arrangements.  The SEC would rescind all current fund-of-funds exemptive orders, thereby requiring all fund-of-funds arrangements to comply with the new rule.  Proposed Rule 12d1-4 would provide an exemption from Section 12(d)(1) of the Investment Company Act which limits an acquiring fund from acquiring (a) more than 3% of an underlying fund, (b) an underlying fund that would represent more than 5% of the acquiring company, and (c) underlying funds that in the aggregate exceed 10% of the acquiring company.  The SEC has provided a 90-day comment period.

We love the idea of an exemptive rule to allow plain vanilla fund-of-funds structures to quickly get to market without an SEC exemptive order.  We hate that the SEC will rescind all current orders, which could force many current fund-of-funds into restructuring time-tested products.  Since this is such a significant regulatory change, we expect a vigorous comment period.

SEC Allows Cross-Border Fund-of-Funds Structure

The staff of the Division of Investment Management has granted conditional no-action relief that allows a foreign feeder fund to invest in an affiliated U.S. registered master fund.  The arrangement is intended to allow broader global distribution of U.S. investment products.  Without no-action relief, such a structure would be prohibited by Section 12(d) of the Investment Company Act, which significantly limits fund-of-funds schemes.  The no-action relief allows the foreign feeder fund to engage in limited currency and index hedging.  Conditions include the following: (a) the foreign feeder manager will make its books and records available for SEC examination; (b) the foreign feeder fund must be organized in a jurisdiction that has entered into an SEC cooperation agreement; (c) the feeder fund cannot sell securities to U.S. investors; and (d) the hedging activities will only be permitted for currency and index hedging related to the master fund’s index strategy.

OUR TAKE: This no-action letter offers significant structuring flexibility for global distribution of U.S. based mutual funds.  It also provides a good primer on the limits of cross-border fund-of-funds structures under the Investment Company Act.