SEC Proposes New Comprehensive Registered Fund of Funds Rule

January 03, 2019

The new rule would permit registered funds to invest in other registered funds beyond the limits of Section 12(d)(1) of the Investment Company Act of 1940 without the need to obtain individual exemptive orders from the US Securities and Exchange Commission.

At an open meeting[1] on Wednesday, December 19, the US Securities and Exchange Commission (SEC) voted unanimously to propose Rule 12d1-4 (Rule) under the Investment Company Act of 1940 (Act), amendments to Rule 12d1-1 and Form N-CEN, and to rescind Rule 12d1-2 (collectively, the Proposal).

Applicability of the Rule

The Rule would be available to registered funds and business development companies (BDCs) seeking to invest in other registered funds and BDCs beyond the limits of Section 12(d)(1) of the Act. Unregistered funds, such as private funds and foreign investment companies, would not be permitted to rely on the Rule. The intent of the Rule is to create a consistent framework for all registered funds and BDCs that seek to operate in a fund of funds arrangement, irrespective of the type of fund in the arrangement.

Form N-CEN

The Proposal would amend Form N-CEN to require a fund of funds to report if they relied on the Rule or relied on the statutory exemption in Section 12(d)(1)(G) during the reporting period.

Existing Exemptive Orders

The Proposal would rescind exemptive relief previously granted to permit fund of funds arrangements. The orders covered by the rescission would include all orders granting relief from Sections 12(d)(1)(A), (B), (C), and (G) of the Act with one exception – the exemptive orders permitting certain interfund lending arrangements would not be rescinded. In addition, the Staff of the Division of Investment Management will review Staff no-action and interpretive letters related to Section 12(d)(1) to determine if any such letters should be withdrawn.

Rule 12d1-2

The Proposal would also rescind Rule 12d1-2, which permits a fund of funds relying on Section 12(d)(1)(G) of the Act to (i) invest in securities of funds that are not part of the same group of funds; (ii) invest directly in stocks, bonds, and other securities, and (iii) acquire shares of money market funds in reliance on 12d1-1. By rescinding Rule 12d1-2 and the existing 12(d)(1) exemptive orders, all fund of funds arrangements that currently rely on Section 12(d)(1)(G) and Rule 12d1-2 and/or exemptive relief, will now have to comply with the Rule or discontinue certain investments.

Rule 12d1-1

Because of the proposed rescission of Rule 12d1-2, the SEC is proposing to amend Rule 12d1-1 to specifically permit fund of funds arrangements that rely on Section 12(d)(1)(G) to invest in shares money market funds.

Fund of Funds Arrangements

The SEC believes that the current mix of exemptive rules and exemptive relief has led to a wide variety of different fund of funds arrangements, subject to a wide variety of conditions. The Proposal would have the effect of limiting fund of funds arrangements to three types:

  • Funds that rely on the Rule
  • Funds that rely on, and comply with the restrictions of Section 12(d)(1)(G) of the Act and Rule 12d1-1 thereunder, as it would be amended
  • Funds that rely on, and comply with the restrictions of, Section 12(d)(1)(F) of the Act and Rule 12d1-3 thereunder

Conditions of the Rule

To rely on the Rule, fund of funds would have to satisfy, among others, the following conditions:


  • Similar to existing exemptive relief, an acquiring fund and its advisory group would be prohibited from controlling an acquired fund. Accordingly, an acquiring fund and its advisory group could own up to 25% of the outstanding shares of an acquired fund. If, due to redemptions, the acquiring fund’s position in an acquired fund becomes more than 25% of the outstanding shares, the acquiring fund would be prohibited from making additional purchases of the acquired fund.
  • An acquiring fund and its advisory group would be required to use pass through or mirror voting when the acquiring fund and its advisory group, in the aggregate, hold more than 3% of an acquired fund’s shares. This requirement would uniformly apply to any type of acquired fund (closed-end, open-end, UIT, etc.).
  • Similar to Section 12(d)(1)(G), the voting requirement above would not apply if the acquiring fund is in the same group of investment companies as the acquired fund. It would also not apply if the sub-adviser of the acquiring fund, or any person controlling, controlled by, or under common control with the sub-adviser is the acquired fund’s investment adviser or depositor.

Limited Redemptions

  • An acquiring fund that holds more than 3% of the outstanding shares of an acquired fund may only redeem, or tender for repurchase, up to 3% of the outstanding shares of the acquired fund in any thirty-day period. Acquiring funds that rely on the Rule to invest in funds that are listed on an exchange would be permitted to continue to sell shares in the secondary market without regards to the volume limit.


  • The investment adviser of any acquiring fund, before the initial investment in reliance on the Rule and at least annually thereafter, must consider the complexity and overall cost of the fund of funds structure, and determine that the investment in the acquired fund is in the best interest of the acquiring fund. This determination, and the basis for the determination, must be reported to the board of the acquiring fund.
  • The principal underwriter or depositor of an acquiring fund that is a UIT must make a similar determination about the complexity and cost of the fund of funds structure, and determine that the UIT’s fees do not duplicate the fees of an acquired fund, on or before the initial deposit into the UIT.
  • If a separate account funding variable insurance products invests in an acquiring fund, the insurance company offering the separate account must certify to the acquiring fund that the fees borne by the separate account, acquiring fund, and acquired funds, in the aggregate, are consistent with the reasonableness standard in Section 26(f)(2)(A) of the Act.

Complex Fund Structures

  • A fund that intends to rely on the Rule must disclose in its registration statement that it is, or at times may be, an acquiring fund.
  • No fund may rely on Section 12(d)(1)(G) of the Act or the Rule to invest beyond the 12(d)(1)(A) limits in any fund that has disclosed in its most recent registration statement that it is or may be acquiring fund under the Rule.
  • An acquired fund may not acquire shares of another investment company, or private fund excluded from the definition of investment company pursuant to Sections 3(c)(1) or 3(c)(7) of the Act, unless the investment is (i) in reliance on Section 12(d)(1)(E) of the Act; (ii) for short-term cash management purposes pursuant to Rule 12d1-1 or other exemptive relief; (iii) in a subsidiary that is wholly-owned and controlled by the acquired fund; (iv) securities received as a dividend as the result of a plan of reorganization; or (v) securities of another investment company pursuant to exemptive relief to engage in interfund borrowing and lending transactions.

Comment Period

Comments on the Proposal will be due 90 days after the Rule is published in the Federal Register. If you would like assistance with submitting comments to the SEC, please contact us.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Lea Anne Copenhefer
Barry N. Hurwitz
Roger P. Joseph
Jeremy Kantrowitz
Paul B. Raymond
Toby R. Serkin
Mari Wilson
Kyle T. Sullivan 

New York
Elizabeth Belanger

Orange County
Laurie A. Dee
Jonathan J. Nowakowski

Sean Graber
Timothy Levin
John J. O’Brien
David W. Freese
Brian T. London

Washington, DC
Laura E. Flores
Thomas S. Harman
W. John McGuire
Christopher D. Menconi
Mana Behbin
K. Michael Carlton
Magda El Guindi-Rosenbaum
Joseph (Beau) Yanoshik
Erica L. Zong Evenson

[1] When available, a recording of the open meeting will be available here.