SEC Adopts Changes to Regulatory Framework of Fund of Funds Arrangements

October 08, 2020

On October 7, 2020, the Securities and Exchange Commission voted to adopt Rule 12d1-4 under the Investment Company Act of 1940 and related amendments to the regulatory framework governing funds that invest in other funds (“fund of funds” arrangements).1 The changes initially were proposed on December 19, 2018 (proposed rule).2 In addition, the SEC is rescinding Rule 12d1-2 and most exemptive orders granting relief from Sections 12(d)(1)(A), (B), (C) and (G) of the 1940 Act, as well as making related amendments to Rule 12d1-1 and Form N-CEN.3

Rule 12d1-4 will allow a registered investment company or a business development company (acquiring fund) to acquire shares of any other registered investment company or BDC (acquired fund) in excess of the limitations currently imposed by the 1940 Act without obtaining individual exemptive relief from the SEC, subject to certain conditions.4

Rule 12d1-4 will be effective 60 days after publication in the Federal Register and the compliance date for the amendments to Form N-CEN will be 425 days after publication in the Federal Register. The rescission of Rule 12d1-2 and the existing exemptive orders will be effective one year after the effective date of Rule 12d1-4.

This Dechert Newsflash provides a brief overview of fund of funds arrangements and the components of the SEC’s final rulemaking package. Rule 12d1-4, as adopted, reflects several important modifications from the proposed rule (most notably, Rule 12d1-4 will not include the proposed limitation on redemptions by an acquiring fund).5 These modifications will be addressed in an upcoming Dechert OnPoint.

Fund of Funds Arrangements

Registered investment companies, such as mutual funds, exchange-traded funds, closed-end funds and other types of funds, increasingly have invested in other funds for a variety of reasons (e.g., to achieve asset allocation or diversification, to target exposure to a particular market or to equitize cash).

Section 12(d)(1) of the 1940 Act places limits on the investments that funds may make in other funds. Specifically, Section 12(d)(1)(A) prohibits a registered fund from: (i) acquiring more than 3% of another fund’s outstanding voting securities; (ii) investing more than 5% of its total assets in any one fund; or (iii) investing more than 10% of its total assets in funds generally.6 However, over the years, the SEC has adopted rules and issued many exemptive orders permitting fund of funds arrangements in excess of these limits. The various statutory exemptions, exemptive rules and exemptive orders have resulted in a regulatory regime whereby similarly managed funds of funds operate subject to differing conditions. In adopting Rule 12d1-4, the SEC is seeking to harmonize the conditions under which funds of funds operate.

Rule 12d1-4

Rule 12d1-4 will permit an acquiring fund to acquire the shares of any acquired funds in excess of the limits described above, subject to certain conditions. Rule 12d1-4 will expand the scope of permissible fund investments for all types of registered investment companies and BDCs beyond what is currently allowed under existing exemptive orders (although private funds and foreign funds will not be able to rely on Rule 12d1-4 as acquiring funds).

Rule 12d1-4 includes the following conditions designed to address the concerns that led to the enactment of Section 12(d)(1).

  • Control and Voting. Rule 12d1-4 will prohibit an acquiring fund (and its “advisory group,” individually or in the aggregate)7 from controlling an acquired fund. The 1940 Act defines “control” to mean the power to exert a controlling influence on the management or policies of a company, and creates a rebuttable presumption that any person that beneficially owns (directly or indirectly) more than 25% of the voting securities of a company controls that company.

    Rule 12d1-4 will require an acquiring fund (and its advisory group) to use mirror voting when the acquiring fund (and its advisory group, in the aggregate) holds more than: (i) 25% of the outstanding voting securities of an open-end fund (or UIT) due to a decrease in the outstanding voting securities of the acquired fund; or (ii) 10% of the outstanding voting securities of a closed-end fund (or BDC). Rule 12d1-4 prescribes the use of pass-through voting in certain circumstances (for example, if an acquired fund is offered solely to acquiring funds that rely on Rule 12d1-4).

    As proposed, the control and voting conditions will not apply to: (i) an acquiring fund that is part of the same “group of investment companies” as the acquired fund; or (ii) an acquiring fund that has a sub-adviser that acts (or whose control affiliate acts) as adviser (or depositor) to the acquired fund.
  • Evaluations and Findings Requirement. Rule 12d1-4 will require that the investment adviser to an acquiring fund or an acquired fund undertake certain evaluations and make certain findings prior to the initial acquisition by the acquiring fund of the acquired fund’s shares in reliance on Rule 12d1-4 (whether or not both funds involved are in the same group of investment companies). The investment adviser to an acquiring fund must evaluate the complexity of the arrangement and associated fees and expenses and find that the acquiring fund’s fees and expenses do not duplicate the fees and expenses of the acquired fund.8 In addition, the investment adviser to an acquired fund must find that any concerns of undue influence associated with the acquiring fund’s investment in the acquired fund are reasonably addressed after considering certain specified factors. These findings will be subject to certain board reporting requirements.
  • Required Investment Agreements. Rule 12d1-4 will require funds that do not share the same investment adviser to enter into a fund of funds investment agreement before relying on Rule 12d1-4. These agreements must include certain provisions required by Rule 12d1-4, such as any material terms necessary to make the required findings and evaluations summarized above. These investment agreements will be similar to the participation agreements currently used by many mutual funds and ETFs in connection with fund of funds arrangements utilized pursuant to exemptive orders issued by the SEC.
  • Complex Structure Limits. Rule 12d1-4 will restrict the ability to establish three-tier fund of funds structures, by limiting: (i) the ability of other funds to acquire shares of an acquiring fund that relies on Rule 12d1-4; and (ii) the ability of an acquired fund to itself invest in other funds, except in certain circumstances (e.g., investments in money market funds in reliance on Rule 12d1-1, certain interfund lending or borrowing transactions, or investments in funds that are wholly owned and controlled subsidiaries). In addition to these exceptions, Rule 12d1-4 will allow an acquired fund to invest up to 10% of its total assets in other funds (including private funds), without regard to the purpose of the investment or types of underlying funds, and regardless of the size of the investment in any one fund.

Other Amendments to Existing Regulatory Regime

The SEC also is modifying its current rules with respect to fund of funds arrangements in order to facilitate a more cohesive regulatory framework for such arrangements.

Specifically, the SEC is rescinding Rule 12d1-2, which permits funds that primarily invest in other funds within the same group of investment companies in reliance on Section 12(d)(1)(G) to invest in: (i) unaffiliated funds (up to the limits in Section 12(d)(1)(A) or (F)); and (ii) non-fund assets. The SEC also is rescinding the exemptive relief under Section 12(d)(1) it has granted with respect to fund of funds arrangements (other than exemptive relief related to interfund lending arrangements and certain other limited exceptions).

In addition, the SEC is amending Rule 12d1-1 to allow funds that invest primarily in affiliated funds in reliance on Section 12(d)(1)(G) to continue to invest in unaffiliated money market funds.

Amendments to Form N-CEN

Form N-CEN requires registered investment companies to annually report to the SEC certain census-type information in a structured data format. The SEC is amending Form N-CEN to require funds to report whether they relied on Rule 12d1-4 or Section 12(d)(1)(G) during the applicable reporting period.

This comprehensive Dechert OnPoint provides further analysis of Rule 12d1-4, as well as related matters for fund sponsors to consider with respect to fund of funds arrangements.


  1. Fund of Funds Arrangements, Release No. IC-34045 (Oct. 7, 2020).
  2. Fund of Funds Arrangements, Release No. IC-33329 (Dec. 19, 2018). 
  3. The SEC also is withdrawing certain staff no-action letters relating to Section 12(d)(1) one year after the effective date of Rule 12d1-4. The list of letters to be withdrawn will be available on the SEC’s website.
  4. Certain conditions of Rule 12d1-4 are designed specifically for unit investment trusts (UIT) and separate accounts funding variable insurance contracts.
  5. The proposed limitation would have prohibited an acquiring fund from redeeming (or submitting for redemption or tendering for repurchase) more than 3% of an acquired fund’s total outstanding shares in any 30-day period, if the acquiring fund holds more than 3% of the acquired fund’s outstanding voting shares.
  6. Section 60 of the 1940 Act makes these limits applicable to a BDC to the same extent as it if were a registered closed-end fund.
  7. “Advisory group” means either: (1) an acquiring fund’s investment adviser or depositor, and any person controlling, controlled by, or under common control with such investment adviser or depositor; or (2) an acquiring fund’s investment sub-adviser, and any person controlling, controlled by, or under common control with such investment sub-adviser.
  8. The SEC has indicated that it is not addressing “acquired fund fees and expenses” (AFFE) disclosure requirements as part of this rulemaking, but instead is considering modifications to AFFE disclosure as part of a broader review of how funds disclose fees in their prospectuses.

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