SEC Staff Issues Guidance Regarding Open-End Fund Investments in Closed-End Funds

February 16, 2017

The staff of the U.S. Securities and Exchange Commission’s (SEC) Division of Investment Management (Staff) recently issued guidance regarding open-end fund investments in closed-end funds. The Staff’s interpretive letter (Interpretive Letter), in response to a request letter from our firm (Incoming Letter), agreed with the position that registered open-end investment companies and registered unit investment trusts (collectively, open-end funds) may invest in closed-end funds in reliance on Rule 12d1-2 under the Investment Company Act of 1940 (1940 Act), regardless of whether the investing and underlying funds are in “the same group of investment companies.”

By way of background, Section 12(d)(1)(G) permits open-end funds to invest in other open-end funds that are part of the same group of investment companies as the investing fund, above certain limits otherwise prescribed by Section 12(d)(1)(A).2 Reliance on Section 12(d)(1)(G) is conditioned upon the investing open-end fund limiting its investments to: (1) other open-ends funds that are part of the same group of investment companies; (2) Government securities; and (3) short-term paper. 

In 2006, the SEC adopted Rule 12d1-2 to widely broaden the types of securities in which an open-end fund relying on Section 12(d)(1)(G) may invest (including securities issued by other investment companies), subject to certain limits. Rule 12d1-2 provides, in relevant part, that open-end funds also may invest in: 

  1. Securities issued by an investment company, other than securities issued by another registered investment company that is in the same group of investment companies, when the acquisition is in reliance on Section 12(d)(1)(A) or 12(d)(1)(F)3 of the [1940 Act] (emphasis added); 
  2. Securities (other than securities issued by an investment company); and 
  3. Securities issued by a money market fund, when the acquisition is in reliance on Rule 12d1-1.4 

The Incoming Letter indicated that a carve-out from the above categories exists for securities issued by a registered investment company in the same group of investment companies as the investing fund. The Incoming Letter further pointed out that Section 12(d)(1)(G) defines “same group of investment companies” as “any 2 or more registered investment companies that hold themselves out to investors as related companies for purposes of investment and investor services.” The Incoming Letter noted that, because the Section 12(d)(1)(G) definition does not distinguish between open-end and closed-end investment companies, a strict reading of Section 12(d)(1)(G) and Rule 12d1-2 could suggest that “closed-end funds could also be deemed to be part of the investing open-end fund’s ‘group of investment companies,’ as defined in Section 12(d)(1)(G), and thus be excluded from the investments permitted under Rule 12d1-2(a)(1).” 

The Incoming Letter further indicated that excluding closed-end funds from investments permitted under Rule 12d1-2 “is inconsistent with the purpose of the exemptions to expand the scope of Section 12(d)(1)(G) to allow legitimate fund of funds arrangements.” 

The Staff agreed with the analysis in the Incoming Letter, stating that “for the purposes of Rule 12d1-2 … the term ‘group of investment companies,’ as defined in section 12(d)(1)(G)(ii) of the Act, does not include closed-end investment companies.” Accordingly, the Staff stated that an open-end fund “may rely on rule 12d1-2(a)(1) to invest in a closed-end [fund] regardless of whether the two companies hold themselves out to investors as related companies for purposes of investment and investor services.” 


1) The Staff’s response and the Incoming Letter are available here.
2) Those limits are often referred to as the “3/5/10 Limits” and prohibit a registered investment company from acquiring the securities of any other registered investment company if, immediately after the acquisition: (a) the investing fund owns more than 3% of the total outstanding voting stock of the underlying fund; (b) the value of the securities of any fund exceeds 5% of the total assets of the investing fund; or (c) the aggregate value of the securities of all investment companies owned by the investing fund exceeds 10% of its total assets.
3) Section 12(d)(1)(F) of the 1940 Act permits a registered fund to acquire no more than 3% of another fund’s outstanding stock, subject to certain conditions.
4) Rule 12d1-1 permits investment companies to invest in underlying money market funds above the 3/5/10 Limits, provided certain conditions are met.

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