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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 Staff Allows More Flexible Fund-of-Funds Structures


The staff of the SEC’s Division of Investment Management has provided no-action relief that allows open-end investment companies to invest in closed-end investment companies that hold themselves out as part of the same investment group.  Without the no-action relief, a narrow reading of Section 12(d)(1)(G) and Rule  12d1-2 of the Investment Company Act would only allow open-end funds to invest in related funds only if such funds were open-end.  In general, Section 12(d)(1) limits fund-of-funds structures, absent specific conditions, because fund-of-funds have the potential to create complex products with layered fees and conflicts of interest.

OUR TAKE: This no-action relief provides practical flexibility to create fund-of-funds structures within the same group of companies, which should save costs and avoid artificial product engineering.