Fund of Funds Arrangements

Federal RegisterNov 19, 2020

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 274

[Release Nos. 33-10871; IC-34045; File No. S7-27-18]

RIN 3235-AM29

Fund of Funds Arrangements

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (the “Commission”) is adopting a new rule under the Investment Company Act of 1940 (“Investment Company Act” or “Act”) to streamline and enhance the regulatory framework applicable to funds that invest in other funds (“fund of funds” arrangements). In connection with the new rule, the Commission is rescinding rule 12d1-2 under the Act and certain exemptive relief that has been granted from sections 12(d)(1)(A), (B), (C), and (G) of the Act permitting certain fund of funds arrangements. Finally, the Commission is adopting related amendments to rule 12d1-1 under the Act and to Form N-CEN.

DATES:

Effective Date:

This rule is effective January 19, 2021.

Compliance Dates:

The applicable compliance dates are discussed in sections II.D, II.F and III of this final rule.

FOR FURTHER INFORMATION CONTACT:

Bradley Gude, Terri G. Jordan, John Lee, Adam Lovell, Senior Counsels; Jacob D. Krawitz, Branch Chief; Melissa Gainor, Brian Johnson, Assistant Directors, at (202) 551-6792, Investment Company Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

The Commission is adopting 17 CFR 270.12d1-4 (new rule 12d1-4) under the Investment Company Act [15 U.S.C. 80a-1

et seq.

];

amendments to 17 CFR 270.12d1-1 (rule 12d1-1) under the Investment Company Act; amendments to Form N-CEN [referenced in 17 CFR 274.101] under the Investment Company Act; and rescission of 17 CFR 270.12d1-2 (rule 12d1-2) under the Investment Company Act.

Unless otherwise noted, all references to statutory sections are to the Investment Company Act, and all references to rules under the Investment Company Act are to title 17, part 270 of the Code of Federal Regulations [17 CFR part 270].

Table of Contents

I. Introduction

A. Regulatory Context

B. Rule 12d1-4 Overview

II. Discussion

A. Scope

B. Exemptions From the Act's Prohibition on Certain Affiliated Transactions

C. Conditions

D. Rescission of Rule 12d1-2 and Amendment to Rule 12d1-1

E. Disclosures Relating to Fund of Funds Arrangements

F. Compliance Dates

III. Rescission of Exemptive Relief; Withdrawal of Staff Letters

IV. Other Matters

V. Economic Analysis

A. Introduction

B. Economic Baseline

C. Benefits and Costs and Effects on Efficiency, Competition, and Capital Formation

D. Reasonable Alternatives

VI. Paperwork Reduction Act

A. Introduction

B. Rule 12d1-4

C. Rule 0-2

D. Form N-CEN

VII. Final Regulatory Flexibility Analysis

A. Need for and Objectives of the Rule and Form Amendments

B. Significant Issues Raised by Public Comments

C. Small Entities Subject to the Rule

D. Projected Board Reporting, Recordkeeping, and Other Compliance Requirements

E. Agency Action To Minimize Effect on Small Entities

VIII. Statutory Authority

I. Introduction

We are adopting new rule 12d1-4 under the Investment Company Act and several related amendments to streamline and enhance the regulatory framework applicable to fund of funds arrangements. This framework reflects the Commission's decades of experience with fund of funds arrangements and will create a consistent and efficient rules-based regime for the formation, operation, and oversight of fund of funds arrangements.

We believe that this framework will provide investors with the benefits of fund of funds arrangements, and will provide funds with investment flexibility to meet their investment objectives efficiently, in a manner consistent with the public interest and the protection of investors.

As discussed in more detail below, section 12(d)(1) of the Investment Company Act limits the ability of a fund to invest substantially in securities issued by another fund.

See

15 U.S.C. 80a-12(d)(1).

Funds increasingly invest in other funds as a way to achieve asset allocation, diversification, or other investment objectives. According to staff estimates, approximately 40% of all registered funds hold an investment in at least one fund,

and total net assets in mutual funds that invest primarily in other mutual funds have grown from $469 billion in 2008 to $2.54 trillion in 2019.

Retail investors similarly use fund of funds arrangements as a convenient way to allocate and diversify their investments through a single, professionally managed portfolio. For example, a fund of funds may provide an investor with the same benefits as separate direct investments in several underlying funds, without the increased monitoring and recordkeeping that could accompany investments in each underlying fund.

See infra

Table 2. Of those funds investing in other funds, 48% invest at least 5% of their assets in other funds, and 26% hold more than 90% of their assets in other funds.

See infra

Table 4. For more data on fund of funds arrangements,

see infra

section VI.

During this period the number of mutual funds utilizing this arrangement grew from 838 to 1,469.

See

Investment Company Institute, 2020 Fact Book: A Review of Trends and Activities in the Investment Company Industry (“2020 ICI Fact Book”), at 244,

available at

https://www.ici.org/pdf/2020_factbook.pdf.

Target-date funds are a common type of fund of funds arrangement and are designed to make it easier for investors to hold a diversified portfolio of assets that is rebalanced over time without the need for investors to rebalance their own portfolio.

See

Investment Company Advertising: Target Date Retirement Fund Names and Marketing, Investment Company Act Release No. 29301 (June 16, 2010) [75 FR 35920 (June 23, 2010)] (proposing disclosure requirements for target date retirement funds' marketing materials).

In December 2018, we proposed rule 12d1-4, which would permit a fund to acquire shares of another fund in excess of the limits of section 12(d)(1) without obtaining an exemptive order from the Commission, subject to certain conditions.

Because the proposed rule would provide a comprehensive exemption for funds of funds to operate, the Commission also proposed to rescind rule 12d1-2 under the Act and individual exemptive orders permitting certain fund of funds arrangements. In connection with the proposed rescission of rule 12d1-2, we proposed amendments to rule 12d1-1 under the

Act to allow funds that rely on section 12(d)(1)(G) of the Act to invest in money market funds that are not part of the same group of investment companies. Finally, the Commission proposed certain disclosure amendments to Form N-CEN to provide the Commission additional census-type information regarding fund of funds arrangements.

See

Fund of Funds Arrangements, Investment Company Act Release No. 10590 (Dec. 19, 2018) [84 FR 1286 (Feb 1, 2019)] (“2018 FOF Proposing Release”). For purposes of this release and rule 12d1-4, we generally use the term “funds” to refer to registered investment companies and business development companies (“BDCs”) unless the context otherwise requires. A BDC is a closed-end fund that: (i) Is organized under the laws of, and has its principal place of business in, any state or states; (ii) is operated for the purpose of investing in securities described in section 55(a)(1)-(3) of the Act and makes available “significant managerial assistance” to the issuers of those securities, subject to certain conditions; and (iii) has elected under section 54(a) of the Act to be subject to the sections addressing activities of BDCs under the Act.

See

15 U.S.C. 80a-2(a)(48). Section 6(f) of the Act exempts BDCs that have made the election under section 54 of the Act from registration provisions of the Act.

We received more than 100 comment letters on the proposal.

Many commenters supported the Commission's goal of simplifying the regulatory framework for fund of funds arrangements.

However, commenters recommended modifications to the proposed rule.

For example, several commenters suggested changing the scope of arrangements permitted by the rule or expanding the scope of certain exemptions.

Many commenters also recommended alternatives to the proposed rule's conditions. For instance, commenters strongly opposed the proposed redemption limit and recommended instead codifying certain conditions in existing exemptive orders or applying the limitation only to unaffiliated fund of funds arrangements.

Several commenters recommended modifications to the proposed rule's control and voting provisions, while some commenters proposed changes to the proposed rule's disclosure and board reporting requirements.

Some commenters expressed concern about the potential impact of the proposed rule's conditions on existing fund of funds arrangements, particularly in light of the proposed rescission of rule 12d1-2 and existing exemptive orders.

The comment letters on the 2018 FOF Proposing Release (File No. S7-27-18) are available at

https://www.sec.gov/comments/s7-27-18/s72718.htm.

See, e.g.,

Comment Letter of Managed Funds Association (April 30, 2019) (“MFA Comment Letter”); Comment Letter of Investment Company Institute (April 30, 2019) (“ICI Comment Letter”); Comment Letter of Investment Adviser Association (May 2, 2019) (“IAA Comment Letter”); Comment Letter of Consumer Federation of America (May 2, 2019) (“CFA Comment Letter”); Comment Letter of the Asset Management Group of the Securities Industry and Financial Markets Association (May 2, 2019) (“SIFMA AMG Comment Letter”); Comment Letter of Federal Regulation of Securities Committee of the Business Law Section of the American Bar Association (June 11, 2019) (“ABA Comment Letter”).

See, e.g.,

ICI Comment Letter; ABA Comment Letter; SIFMA AMG Comment Letter; Comment Letter of the Committee on Investment Management Regulation of the New York City Bar Association (May 2, 2019) (“NYC Bar Comment Letter”); Comment Letter of Institute for Portfolio Alternatives (May 1, 2019) (“IPA Comment Letter”); Comment Letter of Fidelity Investments (May 2, 2019) (“Fidelity Comment Letter”).

See, e.g.,

MFA Comment Letter; NYC Bar Comment Letter; CFA Comment Letter; Comment Letter of T. Rowe Price (May 2, 2019) (“TRP Comment Letter”).

See, e.g.,

Comment Letter of Guggenheim Investments (May 2, 2019) (“Guggenheim Comment Letter”); Comment Letter of Dimensional Funds (May 2, 2019) (“Dimensional Comment Letter”); Comment Letter of Wells Fargo Funds Management, LLC (May 2, 2019) (“Wells Fargo Comment Letter”); Comment Letter of Federated Investors, Inc. (May 2, 2019) (“Federated Comment Letter”); SIFMA AMG Comment Letter; Fidelity Comment Letter; NYC Bar Comment Letter.

See, e.g.,

MFA Comment Letter; ICI Comment Letter; IPA Comment Letter; SIFMA AMG Comment Letter; Fidelity Comment Letter; Comment Letter of PGIM Investments LLC (May 2, 2019) (“PGIM Comment Letter”); TRP Comment Letter.

See, e.g.,

Comment Letter of Pacific Investment Management Company LLC (May 1, 2019) (“PIMCO Comment Letter”); Federated Comment Letter; SIFMA AMG Comment Letter; Fidelity Comment Letter; NYC Bar Comment Letter.

After consideration of the comments we received, we are adopting rule 12d1-4 with several modifications designed to increase the workability of the rule's requirements, while enhancing protections for investors in fund of funds arrangements. We are also rescinding rule 12d1-2 and exemptive relief that permitted certain fund of funds arrangements, amending rule 12d1-1 under the Act, and amending Form N-CEN.

A. Regulatory Context

Section 12(d)(1) of the Act limits the ability of a fund to invest substantially in securities issued by another fund. Section 12(d)(1)(A) of the Act prohibits a registered fund (and companies, including funds, it controls) from:

• Acquiring more than 3% of another fund's outstanding voting securities;

• investing more than 5% of its total assets in any one fund; or

• investing more than 10% of its total assets in funds generally.

See

15 U.S.C. 80a-12(d)(1)(A). Both registered and unregistered investment companies are subject to these limits with respect to their investments in a registered investment company. Registered investment companies are also subject to these same limits with respect to their investment in an unregistered investment company. Sections 3(c)(1) and 3(c)(7) subject private funds to the 3% limitation on investments in registered funds. 15 U.S.C. 80a-3(c)(1) and 3(c)(7)(D). A “private fund” is an issuer that would be an investment company, as defined in section 3 of the Act, but for section 3(c)(1) or 3(c)(7) of the Act. 15 U.S.C. 80b-2(a)(29). In addition, section 60 of the Act makes section 12(d) applicable to a BDC to the same extent as it if were a registered closed-end fund. 15 U.S.C. 80a-60.

Section 12(d)(1)(B) of the Act addresses the other side of the transaction by prohibiting a registered open-end fund,

and any principal underwriter thereof or broker-dealer registered under the Securities Exchange Act of 1934 (the “Exchange Act”), from knowingly selling securities to any other investment company if, after the sale, the acquiring fund would:

A registered open-end fund is a management company that is offering for sale or has outstanding any redeemable security of which it is the issuer. 15 U.S.C. 80a-5(a)(1) (defining “open-end company”). A registered closed-end fund is any management company other than an open-end fund. 15 U.S.C. 80a-5(a)(2) (defining “closed-end company”). Section 12(d)(1)(C) of the Act also includes specific limitations on investments in registered closed-end funds.

See

15 U.S.C. 80a-12(d)(1)(C).

• Together with companies it controls, own more than 3% of the acquired fund's outstanding voting securities; or

• together with other funds (and companies they control), own more than 10% of the acquired fund's outstanding voting securities.

See

15 U.S.C. 80a-12(d)(1)(B).

These restrictions are designed to prevent fund of funds arrangements that allow the acquiring fund to control the assets of the acquired fund and use those assets to enrich the acquiring fund at the expense of acquired fund shareholders.

Congress also was concerned about the potential for duplicative and excessive fees when one fund invested in another and the formation of overly complex structures that could be confusing to investors.

This practice is described as “pyramiding.”

See

2018 FOF Proposing Release,

supra

footnote 6, at 1287. Control could be exercised either directly (such as through the voting power of a controlling interest) or indirectly (such as coercion through the threat of large-scale redemptions).

See id.

Controlling persons profited when acquiring fund shareholders paid excessive fees due to duplicative charges at both the acquiring and acquired fund levels.

See

Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, H.R. Doc. No. 136, 77th Cong., 1st Sess., at ch. 7, 2725-39, 2760-75, 2778-93, (1941) (“Investment Trust Study”) and Exchange-Traded Funds, Investment Company Act Release No. 28193 (Mar. 11, 2008) [73 FR 14618 (Mar. 18, 2008)] (“2008 ETF Proposing Release”), at n. 195.

See also

2018 FOF Proposing Release,

supra

footnote 6, at 9.

As discussed in the 2018 FOF Proposing Release, our views and those of Congress have evolved over the years as fund of funds structures developed that include investor protections and serve purposes that benefit investors.

As a result, Congress created three statutory exceptions that permit different types of fund of funds arrangements subject to certain conditions.

Congress also gave the Commission authority in section

12(d)(1)(J) of the Act to exempt any person, security, or transaction, or any class or classes of transactions, from the restrictions of section 12(d)(1) if the exemption is consistent with the public interest and the protection of investors.

See

Fund of Funds Investments, Investment Company Act Release No. 27399 (June 20, 2006) [71 FR 36640 (June 27, 2006)] (“2006 FOF Adopting Release”) at n.7 and accompanying text; 2008 ETF Proposing Release,

supra

footnote 18.

See also

2018 FOF Proposing Release,

supra

footnote 6, at 10-13.

See

15 U.S.C. 80a-12(d)(1)(E) (permitting master-feeder arrangements whereby an acquiring fund invests all of its assets in a single fund), 15 U.S.C. 80a-12(d)(1)(F) (permitting a fund to take small positions (up to 3% of another fund's securities) in an unlimited number of other funds), and 15 U.S.C. 80a-12(d)(1)(G) (permitting an open-end fund or unit investment trust (“UIT”) to invest in other open-end funds and UITs that are in the “same group of investment companies”).

See

National Securities Markets Improvement Act of 1996 (“NSMIA”), Public Law 104-290, 110 Stat. 3416 (1996), at § 202(4) (codified at 15 U.S.C. 80a-12(d)(1)(J)); Comm. On Commerce, Securities Amendments of 1996, H.R. Rep. No. 104-622 (1996), 104th Cong., 2nd Sess., at 43-44 (“H.R. Rep. No. 622”). Congress added section 12(d)(1)(J) to resolve questions regarding the scope of the Commission's authority under section 6(c) of the Act.

We previously exercised this exemptive authority to adopt three rules of general applicability that were based on relief we provided to specific market participants in exemptive orders.

We also have used our authority under section 12(d)(1)(J) to issue exemptive orders permitting fund of funds arrangements that the Act or our rules would otherwise prohibit when we found those arrangements to be consistent with the public interest and the protection of investors.

These exemptive orders permit fund investments in other funds, subject to specified conditions that are designed to prevent the abuses that led Congress to enact section 12(d)(1).

Relief from sections 12(d)(1)(A) and (B) was included in exemptive orders permitting exchange-traded funds (“ETFs”) and exchange-traded managed funds (“ETMFs”) to operate.

See

2006 FOF Adopting Release,

supra

footnote 19. Rule 12d1-1 allows funds to invest in shares of money market funds in excess of the limits of section 12(d)(1). Rule 12d1-2 provides funds relying on section 12(d)(1)(G) with greater flexibility to invest in other types of securities. Rule 12d1-3 allows acquiring funds relying on section 12(d)(1)(F) to charge sales loads greater than 1.5%.

As the orders are subject to terms and conditions set forth in the applications requesting exemptive relief, references in this release to “exemptive relief” or “exemptive orders” include the terms and conditions described in the related applications.

See, e.g.,

Schwab Capital Trust,

et al.,

Investment Company Act Release Nos. 24067 (Oct. 1, 1999) [64 FR 54939 (Oct. 8, 1999)] (notice) and 24113 (Oct. 27, 1999) (order) and related application (“Schwab”). In addition to our section 12(d)(1)(J) authority, we have issued these orders pursuant to our exemptive authority under sections 17(a) and 6(c) of the Act.

The conditions include: (i) Limits on the control and influence an acquiring fund can exert on the acquired fund; (ii) limits on certain fees charged to the acquiring fund and its shareholders; and (iii) limits on the acquired fund's ability to invest in other funds.

See

Schwab,

supra

footnote 23.

We recently adopted rule 6c-11, which permits certain ETFs to operate without obtaining an exemptive order. 17 CFR 270.6c-11. In adopting rule 6c-11, we did not rescind the portions of existing ETF exemptive orders that provided relief from sections 12(d)(1)(A) and (B) and stated that ETFs relying on rule 6c-11 that do not have exemptive relief from sections 12(d)(1)(A) and (B) may enter into fund of funds arrangements as set forth in recent ETF exemptive orders, provided that such ETFs satisfy the terms and conditions for fund of funds relief in those orders. Exchange-Traded Funds, Investment Company Act Release No. 33646 (Sep. 25, 2019) [84 FR 57162 (Oct. 24, 2019)] (“2019 ETF Adopting Release”), at 57199. For purposes of this release, we generally use the term “ETFs” to refer to exchange-traded funds and exchange-traded managed funds unless the context otherwise requires.

The combination of statutory exemptions, Commission rules, and exemptive orders has created a regulatory regime where substantially similar fund of funds arrangements are subject to different conditions. For example, an acquiring fund could rely on section 12(d)(1)(G) and rule 12d1-2 when investing in an acquired fund within the same group of investment companies.

Alternatively, the acquiring fund could rely on relief provided by an exemptive order, which would allow it to invest in substantially the same investments, but could require the fund to comply with different conditions. Over time, industry participants have experimented with new fund of funds structures, relying on combinations of statutory exemptions and Commission exemptive orders, and considering staff no-action letters, to create novel fund of funds arrangements. For example, some commenters described funds that have combined various forms of section 12(d)(1) relief to create fund structures that include three or more layers of funds.

Such a fund would rely on section 12(d)(1)(G) to invest in acquired funds within the same group of investment companies, government securities, and short term paper. In addition, the fund could rely on rule 12d1-2 to invest in: (i) Securities of funds that are not in the same group of investment companies up to the limits in section 12(d)(1)(A) or (F); (ii) securities of money market funds in reliance on rule 12d1-1; and (iii) stocks, bonds, and other securities.

See, e.g.,

Fidelity Comment Letter; Federated Comment Letter; Comment Letter of Federated Investors, Inc. (June 7, 2019) (“Federated 2 Comment Letter”).

B. Rule 12d1-4 Overview

In order to create a more consistent and efficient regulatory framework for fund of funds arrangements, rule 12d1-4 will permit a registered investment company or business development company (“BDC”) (collectively, “acquiring funds”) to acquire the securities of any other registered investment company or BDC (collectively, “acquired funds”) in excess of the limits in section 12(d)(1), subject to the following conditions:

•

Control.

Rule 12d1-4 will prohibit an acquiring fund and its “advisory group” from controlling an acquired fund, except in certain limited circumstances.

•

Voting.

Rule 12d1-4 will require an acquiring fund and its advisory group to use mirror voting if it holds more than 25% of an acquired open-end fund or UIT due to a decrease in the outstanding securities of the acquired fund and if it holds more than 10% of a closed-end fund, with the ability to use pass-through voting when acquiring funds are the only shareholders of an acquired fund.

See infra

section II.C.1.b.ii.

•

Required Findings.

Rule 12d1-4 will require investment advisers to acquiring and acquired funds that are management companies to make certain findings regarding the fund of funds arrangement, after considering specific factors. The final rule also will require certain findings with respect to UITs and separate accounts funding variable insurance contracts, taking into account the unique structural characteristics of such entities.

•

Fund of Funds Investment Agreement.

Rule 12d1-4 will require funds that do not have the same investment adviser to enter into an agreement prior to the purchase of acquired fund shares in excess of section 12(d)(1)'s limits (a “fund of funds investment agreement”).

•

Complex Structures.

Rule 12d1-4 will impose a general three-tier prohibition with certain enumerated exceptions. However, in addition to these exceptions, the rule 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.

As proposed, we are rescinding rule 12d1-2 under the Act, and amending rule 12d1-1 to allow funds that rely on section 12(d)(1)(G) to invest in money market funds that are not part of the same group of investment companies in reliance on that rule.

In addition, certain staff no-action letters relating to section 12(d)(1) will be withdrawn.

The resulting regulatory framework will reduce confusion and subject similar fund of funds arrangements to tailored conditions that will enhance investor protection, while continuing to provide funds with investment flexibility to meet their investment objectives. In addition, the rule will allow the Commission, as well as funds and

advisers seeking exemptions, to focus exemptive order review resources on novel products or arrangements.

With the rescission of rule 12d1-2, a fund relying on section 12(d)(1)(G) will no longer have flexibility to: (i) Acquire the securities of other funds that are not part of the same group of investment companies; or (ii) invest directly in stocks, bonds, and other securities, except in compliance with rule 12d1-4.

The list of no-action letters to be withdrawn will be available on the Commission's website.

II. Discussion

A. Scope

1. Registered Funds and BDCs

As proposed, rule 12d1-4 will permit registered investment companies and BDCs to acquire the securities of other registered investment companies or BDCs in excess of the limits in section 12(d)(1). As a result, open-end funds (including ETFs), UITs (including ETFs organized as UITs), and closed-end funds (including BDCs), can operate in accordance with rule 12d1-4, as both acquiring and acquired funds.

The scope of permissible acquiring and acquired funds under rule 12d1-4 is greater than the scope of funds that was permitted by the Commission's exemptive orders. For example, the rule will allow open-end funds, UITs, and ETFs to invest in unlisted closed-end funds and unlisted BDCs beyond the limits in section 12(d)(1).

The rule similarly will increase permissible investments for closed-end funds beyond ETFs to allow them to invest in open-end funds, UITs, other closed-end funds, and BDCs, in excess of the section 12(d)(1) limits. BDCs, which currently may invest in ETFs in excess of the section 12(d)(1) limits, also will be permitted to invest in open-end funds, UITs, other BDCs, other closed-end funds and ETMFs. Finally, the rule will allow ETMFs to invest in open-end funds, UITs, BDCs and other closed-end funds. Rule 12d1-4, therefore, will create a consistent framework for all registered funds and BDCs and eliminate unnecessary and potentially confusing distinctions among permissible investments for different types of acquiring funds.

As proposed, the final rule will not be available to face-amount certificate companies. Face-amount certificate companies are registered investment companies that are engaged or propose to engage in the business of issuing face-amount certificates of the installment type, or which have been engaged in such businesses and have any such certificates outstanding.

See

section 4(1) of the Investment Company Act. There is only one face-amount certificate company currently operating as an investment company and making current filings pursuant to section 13 [15 U.S.C. 80a-13] or section 15(d) of the Exchange Act [15 U.S.C. 80a-15]. Given the very limited universe of face-amount certificate companies and the nature of their investments, face-amount certificate companies are not within the scope of final rule 12d1-4 as either acquiring funds or acquired funds. No commenters addressed this aspect of the proposal.

We use the terms “listed closed-end funds” and “listed BDCs” to refer to closed-end funds and BDCs that are listed and traded on national securities exchanges. Our exemptive orders have included a representation that acquiring funds will not invest in reliance on the order in closed-end funds or BDCs that are not listed and traded on a national securities exchange.

See, e.g.,

Innovator ETFs Trust, et al., Investment Company Act Release Nos. 33214 (Aug. 24, 2018) [83 FR 44374 (Aug. 30, 2018)] (notice) and 33238 (Sept. 19, 2018) (order) and related application (“Innovator ETFs”).

Several commenters supported including all open-end funds, UITs, BDCs and other closed-end funds within the scope of permissible fund of funds arrangements under the rule.

The commenters noted that proposed rule 12d1-4 would provide funds covered by the rule with flexibility to meet their investment objectives and level the playing field among registered funds and BDCs operating in accordance with the rule. However, one commenter raised concerns with arrangements that the Commission has not previously permitted in exemptive orders.

This commenter stated that the Commission lacks experience with funds of funds arrangements that include unlisted closed-end funds and BDCs and suggested that permitting these funds to rely on the rule as acquired funds would increase retail investor exposure to higher cost investments. The commenter also questioned whether one rule should apply to all types of fund of funds arrangements, noting that several of the statutory requirements of section 12(d)(1) apply differently to open-end funds and closed-end funds, and the Commission's historical exemptive relief also treated these types of funds differently. The commenter additionally questioned whether the Commission has appropriately analyzed the risks of fund of funds arrangements involving ETMFs or “non-transparent” ETFs.

See, e.g.,

ICI Comment Letter; Comment Letter of Morningstar, Inc. (May 2, 2019) (“Morningstar Comment Letter”).

See

CFA Comment Letter.

After considering these comments, we continue to believe that the universe of permissible fund of funds arrangements generally should not turn on the type of funds in the arrangement. Instead, the rule should address differences in fund structures with tailored conditions that protect investors in all types of covered investment companies against the abuses historically associated with funds of funds. We believe the conditions of rule 12d1-4 provide appropriate flexibility for innovative fund of funds structures while creating a consistent and streamlined regulatory framework that protects investors in all types of funds. For example, for a management company to rely on the rule, the investment advisers to both the acquiring and acquired fund must make certain determinations before entering into the fund of funds arrangement.

Similarly, the rule will also require principal underwriters or depositors of UITs and insurance companies offering certain separate accounts to make findings tailored to their characteristics.

The rule also imposes a requirement that certain acquiring funds and acquired funds enter into a fund of funds investment agreement, and imposes voting requirements on acquiring funds' holdings of acquired funds above certain ownership thresholds that differ depending on the type of acquired fund, as described more fully below.

See infra

section II.C.2.b.i.

See infra

section II.C.2.b.ii. For example, UITs do not have a board of directors and do not engage in active management of a portfolio. The rule therefore will require different determinations for UITs.

See infra

sections II.C.1 and 2.

With respect to BDCs, we believe that the rule's conditions and existing statutory provisions will protect investors from concerns related to undue influence, fees that are excessive due to being duplicative, or complex structures. For example, as we noted in the proposal, an acquiring fund board already has a responsibility to see that the fund is not overcharged for advisory services regardless of any findings we require.

Additionally, the rule will require fund of funds arrangements involving BDCs to satisfy the other conditions of rule 12d1-4, including the requirement to make certain findings as described in section II.C.2.b. below. One element of these findings is a determination that the fees and expenses associated with an investment in an acquired fund, including an investment in an acquired BDC, do not duplicate the fees and expenses of the acquiring fund. Further, a BDC operating in accordance with the rule as an acquiring fund is subject to other existing limitations on its ability to invest in acquired funds.

Specifically, section 15(c) of the Act requires the acquiring fund's board of directors to evaluate any information reasonably necessary to evaluate the terms of the acquiring fund's advisory contracts (which information would include fees, or the elimination of fees, for services provided by an acquired fund's adviser). Section 36(b) of the Act imposes on fund advisers a fiduciary duty with respect to their receipt of compensation. We believe that to the extent advisory services are being performed by another person, such as the adviser to an acquired fund, this fiduciary duty would require an acquiring fund's adviser to charge a fee that bears a reasonable relationship only to the services that the acquiring fund's adviser is providing, and not to any services performed by an adviser to an acquired fund.

See

2018 FOF Proposing Release,

supra

footnote 6, at 63-64.

See

15 U.S.C. 80a-54(a) (prohibiting a BDC from making any investment unless, at the time of the investment, at least 70% of the BDC's total assets are invested in securities of certain specific types of companies, which do not include funds).

Similarly, we do not believe that including ETMFs or non-transparent ETFs within the scope of the rule will present unique investor protection concerns that we have not already extensively considered and addressed with respect to traditional registered open-end funds and fully transparent ETFs. Along with fully transparent ETFs, ETMFs and non-transparent ETFs generally are subject to the protections of the Act applicable to all registered open-end funds, including governance and other requirements. Accordingly, we believe that the conditions of rule 12d1-4, when combined with the protections imposed by the Act on all investment companies, appropriately address concerns of duplicative fees, undue influence, and complex structures with respect to these products.

Finally, one commenter suggested that the concerns underlying section 12(d)(1) of the Act largely do not apply to ETFs as acquired funds in a fund of funds structure.

This commenter stated that passive investments in ETFs do not implicate Congress' concerns regarding duplicative fees and undue influence, particularly when an investor holds an ETF to gain exposure to a particular market or asset class in an efficient manner, to allocate and diversify investments, or efficiently hedge a portion of a portfolio or balance sheet. The commenter stated that ETFs have not been subject to influence from activist investors despite ETF shares trading in the secondary market, perhaps because ETF shares have not historically traded at a significant discount to net asset value. Accordingly, the commenter urged the Commission to exempt the sale of ETFs as acquired funds from the limitations in section 12(d)(1)(B) of the Act.

Comment Letter of WisdomTree Asset Management, Inc. (Dec. 12, 2019) (“WisdomTree Comment Letter”).

After considering comments, we continue to believe that investments in ETFs should be subject to the limitations set forth in section 12(d)(1), and that any investments in excess of the 12(d)(1) limits should be subject to protective conditions. As a threshold matter, ETFs issue redeemable securities and are generally classified as open-end funds under the Act.

As we discussed in our 2008 ETF Proposing Release, we believe that investments in ETFs, similar to investments in traditional open-end funds, raise the same concerns of pyramiding and the threat of large-scale redemptions as other types of open-end funds.

For example, an acquiring fund might seek to use its ownership interest in an ETF to exercise a controlling influence over the ETF's management or policies, or to enter into a transaction with an affiliate of the acquiring fund. These concerns are most pronounced when a fund invests in an ETF in a primary market transaction through an authorized participant.

While most ETFs are classified as open-end funds, some ETFs are structured as UITs. Regardless of structure, we do not believe that the redemption of ETF shares in creation unit-sized aggregations by authorized participants insulates ETFs from the abuses that section 12(d)(1) was designed to prevent.

See

2008 ETF Proposing Release,

supra

footnote 18, at 69.

See generally

2019 ETF Adopting Release,

supra

footnote 25, at section I.B (explaining that an authorized participant that has a contractual arrangement with the ETF (or its distributor) purchases and redeems ETF shares directly from the ETF in blocks called “creation units” as a principal for its own account or as agent for others, including institutional investors (such as funds)).

ETFs, like other open-end funds, also operate pursuant to the prohibition in section 12(d)(1)(B), which provides that it is unlawful knowingly to sell or otherwise dispose of any securities of which the ETF is an issuer to any other investment company in excess of the limits in subsection (i) and (ii). Therefore, ETFs that receive inquiries and other communications from persons identifying themselves as potential purchasers of the ETF's shares as or through an authorized participant may want to consider adopting and implementing policies and procedures to determine whether those persons intend to purchase ETF shares for investment companies.

Further, principal underwriters and broker-dealers that transact in an ETF's shares (including an ETF's authorized participants), are subject to the requirements of section 12(d)(1)(B) of the Act. Accordingly, the final rule will treat ETFs consistently with other open-end funds and will permit investments in ETFs as acquired funds subject to the rule's conditions designed to protect acquired funds and their shareholders.

For example, an ETF that explains its obligations pursuant to section 12(d)(1)(B) to potential purchasers who reach out directly to the ETF, and documents that exchange with the potential purchaser, generally would satisfy its obligation not to knowingly sell or otherwise dispose of any of its securities in excess of 12(d)(1)(B) limits. Further, if an ETF intends to rely on rule 12d1-4 to exceed the section 12(d)(1) limits, such ETF would be required to comply with the conditions of the rule, including entering into a fund of funds investment agreement with the acquiring investment company.

2. Private Funds and Unregistered Investment Companies

As proposed, the final rule will not permit private funds and unregistered investment companies, such as foreign funds, to rely on the rule as acquiring funds.

As a result, private funds and unregistered investment companies may acquire no more than 3% of a U.S. registered fund under the Act.

We use the term “foreign fund” to refer to an “investment company” as defined in section 3(a)(1)(A) of the Act that is organized outside the United States and that does not offer or sell its securities in the United States in connection with a public offering.

See

section 7(d) of the Act (prohibiting a foreign fund from using the U.S. mails or any means or instrumentality of interstate commerce to offer or sell its securities in connection with a public offering unless the Commission issues an order permitting the foreign fund to register under the Act). A foreign fund may conduct a private U.S. offering in the United States without violating section 7(d) of the Act if the foreign fund conducts its activities with respect to U.S. investors in compliance with either section 3(c)(1) or 3(c)(7) of the Act (or some other available exemption or exclusion).

See

2018 FOF Proposing Release,

supra

footnote 6, at 18-20.

Sections 3(c)(1) and 3(c)(7) of the Act subject private funds to the 3% limitation on investments in registered funds. 15 U.S.C. 80a-3(c)(1) and 3(c)(7)(D).

Several commenters suggested that the Commission broaden the scope of rule 12d1-4 to permit investments by private funds or unregistered investment companies in acquired funds beyond the limits in section 12(d)(1).

Some of these commenters highlighted the potential for private and unregistered investment companies to invest in registered funds for efficient allocation, diversification, and hedging purposes and stated that such investments could benefit registered fund shareholders by increasing the scale and liquidity of the registered fund.

Commenters that supported broadening the scope of the rule to include private funds and unregistered investment companies stated that such funds do not operate in a materially different manner from registered funds and therefore the concerns underlying section 12(d)(1) are not any more pronounced for private and unregistered investment companies nor are different conditions warranted.

See, e.g.,

ICI Comment Letter; Comment Letter of American Investment Council (May 2, 2019) (“AIC Comment Letter”); Comment Letter of Dechert LLP (May 2, 2019) (“Dechert Comment Letter”); Comment Letter of Clifford Chance US LLP (May 2, 2019) (“Clifford Chance Comment Letter”); NYC Bar Comment Letter; IAA Comment Letter; ABA Comment Letter.

See

MFA Comment Letter; Comment Letter of BlackRock, Inc. (May 3, 2019) (“BlackRock Comment Letter”) (stating “ETFs are also frequently used as an alternative to futures and other market beta instruments such as forwards and swaps, especially in markets where derivatives may be less liquid or nonexistent, because ETFs offer intraday liquidity”); WisdomTree Comment Letter; NYC Bar Comment Letter.

Comment Letter of Invesco Ltd. (Apr. 30, 2019) (“Invesco Comment Letter”); MFA Comment Letter; ICI Comment Letter; Dechert Comment Letter; Comment Letter of Parallax Volatility Advisers, L.P. (May 1, 2019) (“Parallax Comment Letter”);

Comment Letter of Gracie Asset Management (May 2, 2019) (“Gracie Comment Letter”); AIC Comment Letter; IAA Comment Letter; Comment Letter of Ropes & Gray LLP (May 2, 2019) (“Ropes Comment Letter”). One commenter stated that fee layering and complex structure concerns are not as significant in the private fund context as they are in the registered fund context because private fund investors must meet sophistication standards and typically perform due diligence on a private fund's structure and fees. Comment Letter of Massachusetts Mutual Life Insurance Company (May 2, 2019).

While commenters generally suggested subjecting private funds and unregistered investment companies to the same conditions as other acquiring funds, some commenters recommended additional conditions that could apply to private funds and unregistered investment companies under the rule.

For example, commenters suggested that the rule could include recordkeeping and reporting requirements tailored to private funds and unregistered investment companies or limit the availability of the rule to private funds and unregistered investment companies with an adviser that is registered with the Commission.

Some commenters suggested that the final rule allow private funds and unregistered investment companies to invest in only certain types of funds, such as ETFs, subject to appropriate conditions.

Some commenters stated that certain private funds have sought to control closed-end funds that trade at a discount to their NAV and suggested tailored control and voting conditions if private funds could rely on the rule to invest in closed-end funds and BDCs.

See

AIC Comment Letter; SIFMA AMG Comment Letter.

See also

17 CFR 275.204(b)-1 (requiring certain registered investment advisers to private funds to file Form PF to report information about the private funds they manage).

2018 FOF Proposing Release,

supra

footnote 6, at 20.

Private funds and unregistered investment companies are not subject to many of the governance and compliance requirements of the Act that are designed to protect investors and reduce conflicts of interest that are inherent in a fund structure. Such requirements are integral to the oversight and monitoring provisions of rule 12d1-4 for registered funds. For example, private funds and unregistered investment companies are not subject to the board governance requirements of sections 10 and 16 of the Act and the chief compliance officer requirements of rule 38a-1.

We are

adopting rule 12d1-4 against the background of these existing requirements and the protections they provide for shareholders in a fund of funds arrangement. Without incorporating additional governance and compliance obligations for private funds and unregistered investment companies as acquiring funds, we do not believe rule 12d1-4 would have sufficiently protective conditions to address the undue influence concerns that Congress raised with respect to fund of funds arrangements.

To protect shareholders and address conflicts of interest that can arise from the management of investment companies, the Act requires that a

registered management investment company be governed by a board of directors that has a general oversight role, with certain exceptions. Rule 12d1-4 requires the adviser to an acquiring fund or acquired fund to submit reports to such fund's board of directors so that the board can review the adviser's analysis of the fund of funds arrangement. While UITs are not subject to these governance and oversight requirements, a UIT does not engage in active management of its investment portfolio. Accordingly, we believe that a UIT's investment in an acquired fund presents different concerns than an investment by a private fund or unregistered fund. Rule 38a-1 requires a fund (including a UIT) to adopt and implement written policies and procedures reasonably designed to prevent a violation of the federal securities laws by the fund and designate one individual responsible for administering the fund's policies and procedures as a chief compliance officer.

See

Compliance Programs of Investment Companies and Investment Advisers, Investment Company Act Release No. 26299 (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 2003)] (“Compliance Rule Adopting Release”). Under rule 38a-1, a fund would adopt policies and procedures reasonably designed to prevent a violation of rule 12d1-4.

We believe designing such protective conditions through the exemptive application process would allow the Commission to weigh the policy considerations described above in the context of the facts and circumstances of the specific fund of funds arrangement described in the application. The exemptive application process would allow the Commission to consider appropriate investor protection provisions, including governance and reporting requirements, applicable to any such arrangement.

The exemptive application process also would provide the Commission with an opportunity to analyze the operation and effects of these fund of funds arrangements before determining whether and how to address such arrangements in a rule of general applicability. We encourage interested parties to share their views on such arrangements by contacting staff in the Division of Investment Management.

One commenter pointed to rule 12d1-1 as a model for private fund investments in registered funds. Prior to the adoption of that rule, the Commission considered specific proposals for exemptive relief for certain private funds to invest in affiliated money market funds.

See, e.g.,

Scudder Global Fund, Inc.,

et al.,

Investment Company Act Release Nos. 24276 (Feb. 3, 2000) [65 FR 6420 (Feb. 9, 2000)] (notice) and 24322 (Feb. 29, 2000) (order) and related application; Pioneer America Income Trust,

et al.,

Investment Company Act Release Nos. 25607 (Jun. 7, 2002) [97 FR 40757 (Jun. 13, 2002)] (notice) and 25647 (Jul. 3, 2002) (order) and related application. However, the Commission has not yet granted relief for private funds to invest in registered funds in excess of the limits of section 12(d)(1) of the Act.

In addition to the challenges applicable to unregistered funds generally, foreign fund investments in registered funds present additional concerns.

Specifically, the Commission understands that some foreign laws and regulations may limit or prevent disclosure of information to the Commission.

These types of restrictions may include privacy laws and so-called “blocking statutes” (including secrecy laws) that prevent the disclosure of information relating to third parties and/or disclosure to the U.S. government.

Additionally, abusive practices by unregistered investment companies that were associated with such investments were a concern underlying Congress's amendments to section 12(d)(1) in 1970.

For example, a Commission report stated that unregistered investment companies could seek to redeem large holdings in acquired funds due to the instability of certain foreign economies, political upheaval, or currency reform.

The Commission also noted that an unregistered investment company could seek to exert undue influence through the shareholder voting process.

For these reasons, we also do not believe it is appropriate at this time to include foreign funds in the scope of acquiring funds under rule 12d1-4.

The Commission has stated that a foreign fund that uses U.S. jurisdictional means in the offering of the securities it issues and that relies on section 3(c)(1) or 3(c)(7) of the Investment Company Act would be a private fund.

See

2018 FOF Proposing Release,

supra

footnote 6, at n.52 (citing Dechert LLP, Staff No-Action Letter (Aug. 24, 2009) at n.8 (noting that under certain circumstances, a foreign fund may make a private U.S. offer in reliance on the exclusion from the definition of “investment company” in sections 3(c)(1) or 3(c)(7) of the Act, and such a foreign fund is subject to section 12(d)(1) to the same extent as a U.S. 3(c)(1) or 3(c)(7) fund)).

See

Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers, Exchange Act Release No. 87005 (Sep. 19, 2019) [84 FR 68550 (Dec. 16, 2019)], at 68557.

Id.

Data protection, privacy, confidentiality, bank secrecy, state secrecy, and national security laws frequently create obstacles to cross-border flows of information between regulators and foreign-domiciled registrants. Some of these laws, for example, prohibit foreign-domiciled registrants in certain jurisdictions from responding directly to SEC requests for information and documents or prevent the SEC from being able to conduct any type of examination, either onsite or by correspondence.

See

Statement on the Vital Role of Audit Quality and Regulatory Access to Audit and Other Information Internationally—Discussion of Current Information Access Challenges with Respect to U.S.-listed Companies with Significant Operations in China, SEC Chairman Jay Clayton, SEC Chief Accountant Wes Bricker, and PCAOB Chairman William D. Duhnke III (Dec. 7, 2018)

available at https://www.sec.gov/news/public-statement/statement-vital-role-audit-quality-and-regulatory-access-audit-and-other.

See

2018 FOF Proposing Release,

supra

footnote 6, at 21,

citing Report of the Securities and Exchange Commission on the Public Policy Implications of Investment Company Growth,

H. Rep. No. 2337, 89th Cong., 2d Sess. (1966) (“PPI Report”) at 318.

PPI Report,

supra

footnote 64, at 315.

Id.

at 324.

B. Exemptions From the Act's Prohibition on Certain Affiliated Transactions

As proposed, rule 12d1-4 will provide an exemption from section 17(a) of the Act.

In addition, the final rule will provide a limited exemption from that section for in-kind transactions for certain affiliated persons of ETFs. Section 17(a) of the Act generally prohibits an affiliated person of a fund, or any affiliated person of such person, from selling any security or other property to, or purchasing any security or other property from, the fund.

It is designed to prevent affiliated persons from managing the fund's assets for their own benefit, rather than for the benefit of the fund's shareholders.

See

rule 12d1-4(a); 15 U.S.C. 80a-17(a). With respect to BDCs, the rule provides an exemption from sections 57(a)(1)-(2) and 57(d)(1)-(2) of the Act for arrangements that comply with rule 12d1-4.

See

15 U.S.C. 80a-56(a)(1)-(2) and 80a-56(d)(1)-(2). The Commission proposed rule 12d1-4(a) to provide an exemption from section 57 for BDCs complying with the rule, but did not specify the relevant subsections in section 57 that are analogous to section 17(a).

See generally

proposed rule 12d1-4(a) (providing an exemption from section 57 of the Act). We did not receive comments on this aspect of the proposal. We are adopting rule 12d1-4(a) with changes to clarify and specify the relevant subsections of section 57.

An affiliated person of a fund includes: (i) Any person directly or indirectly owning, controlling, or holding with power to vote, 5% or more of the outstanding voting securities of the fund; and (ii) any person 5% or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote by the fund.

See

15 U.S.C. 80a-2(a)(3)(A), (B). Section 17(a) also restricts certain transactions involving funds that are affiliated because both funds have a common investment adviser or other person exercising a controlling influence over the management or policies of the funds.

See

15 U.S.C. 80a-2(a)(3)(C). The determination of whether a fund is under the control of its advisers, officers, or directors depends on all the relevant facts and circumstances.

See infra

section II.C.1.

See

Investment Trusts and Investment Companies: Hearings on S. 3580 Before a Subcomm. of the Senate Comm. On Banking and Currency, 76th Cong., 3rd Sess. 37 (1940) (Statement of Commissioner Healy).

Absent an exemption, section 17(a) would prohibit a fund that holds 5% or more of the acquired fund's securities from making any additional investments in the acquired fund, limiting the

efficacy of rule 12d1-4.

Fund of funds arrangements involving funds that are part of the same group of investment companies or that have the same investment adviser (or affiliated investment advisers) also implicate the Act's protections against affiliated transactions, regardless of whether an acquiring fund exceeds the 5% threshold, though the rule as adopted will not address all of these situations.

If an acquiring fund holds 5% or more of the outstanding voting shares of an acquired fund, the acquiring fund is an affiliated person of the acquired fund and the acquired fund is an affiliated person of the acquiring fund. In general, to the extent that purchases and sales of acquired fund shares occur on the secondary market and not through principal transactions directly between an acquiring fund and an acquired fund, an exemption from section 17(a) would not be necessary. But, generally, without an exemption from section 17(a), an acquired fund could not sell its shares to, or redeem or repurchase those shares from, an affiliated acquiring fund, and an acquiring fund could not purchase from, redeem, or resell shares from an affiliated acquired fund.

As discussed below, the rule will allow fund of funds arrangements when: (i) The acquiring fund is in the same group of investment companies as the acquired fund; or (ii) the acquiring fund's investment sub-adviser or any person controlling, controlled by, or under common control with such investment sub-adviser acts as the acquired fund's investment adviser.

See infra

section II.C.1. However, as discussed further below, the final rule will not exempt from section 17(a) ETF in-kind creations and redemptions involving certain affiliates.

Section 17(b) of the Act authorizes the Commission to exempt a proposed transaction from the provisions of section 17(a) if the terms of the transaction, including the consideration to be paid or received, are fair and reasonable and do not involve overreaching on the part of any person concerned, and the transaction is consistent with the policy of the investment company as recited in the fund's registration statement and the general purposes of the Act.

We continue to believe, as discussed in the 2018 FOF Proposing Release, that these exemptions from section 17(a) meet the standards set forth in sections 17(b) and 6(c) and the rule's conditions make unlikely the prospect of overreaching by an affiliated fund. For example, the rule prohibits the acquiring fund and its advisory group from controlling the acquired fund, which is designed to prevent a fund of funds arrangement that involves overreaching.

Section 6(c) of the Act permits the Commission to exempt any person, security, or transaction or any class or classes of persons, securities or transactions from any provision of the Act if such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act.

See

15 U.S.C. 6(c). The Commission has interpreted its authority under section 17(b) as extending only to a single transaction and not a series of transactions.

See

In re Keystone Custodian Funds, Inc., 21 SEC. 295 (1945) (exempting, under section 6(c) of the Act, a series of transactions that otherwise would be prohibited by section 17(a)). The Commission's exemptive authority under section 6(c), however, is not constrained to a single transaction. The Commission looks to the standards set forth in section 17(b) when issuing exemptions by rule from section 17(a).

An acquired fund that is an open-end fund or UIT also is protected from overreaching due to the Act's requirement that all purchasers receive the same price.

This ensures that the affiliated person pays the same consideration for fund shares as non-affiliated persons, consistent with the standards set out in section 17(b). We believe that this would be true in the context of closed-end funds because the acquired fund's repurchase of its shares would provide little opportunity for the acquiring fund to overreach since all holders would receive the same price.

See

section 22(c) of the Act and 17 CFR 270.22c-1 (rule 22c-1). Primary transactions with an ETF would also be done at a price based on NAV. 2018 FOF Proposing Release,

supra

footnote 6, at n.67.

See

2018 FOF Proposing Release,

supra

footnote 6, at n.68.

As a result, we believe that this exemption is necessary and appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act.

We also believe that the exemption from section 17(a) is necessary in light of the goals of rule 12d1-4, subject to the conditions set forth in the rule. Existing orders have provided exemptive relief from the affiliated transaction provisions in section 17(a) under similar conditions for many years.

See supra

footnote 72.

See

2018 FOF Proposing Release,

supra

footnote 6, at n.70.

Commenters generally supported the proposed exemptions from section 17(a), agreeing with our view that the utility of the proposed rule would be limited if it did not exempt fund of funds arrangements from the affiliated transaction prohibitions in that section.

These commenters requested, however, that the Commission clarify the availability of the exemption from section 17(a) when an acquired ETF transacts on an in-kind basis with an affiliated acquiring fund. The commenters noted that the 2018 FOF Proposing Release suggests, consistent with fund of funds exemptive orders, that the rule would provide relief for the delivery or deposit of basket assets on an in-kind basis by an affiliated fund (that is, by exchanging certain assets from the ETF's portfolio, rather than in cash), but the proposed rule text referred only to relief to permit the purchase and sale of fund shares between the acquiring fund and acquired fund.

See, e.g.,

ICI Comment Letter; Comment Letter of Voya Investment Management LLC (May 2, 2019) (“Voya Comment Letter”).

After considering comments, we are adopting a modified exemption from section 17(a) to clarify the rule provides relief from section 17(a) for in-kind transactions when an acquiring fund is purchasing and redeeming shares of an acquired ETF under certain circumstances. As adopted, the rule will provide exemptions from section 17(a) with regard to the deposit and receipt of baskets by an acquiring fund that is an affiliated person of an ETF (or who is an affiliated person of such a person) solely by reason of holding with the power to vote 5% or more of the ETF's shares or holding with the power to vote 5% or more of any investment company that is an affiliated person of the ETF.

Consistent with exemptive orders regarding ETF applicants, the exemption will not be available where the ETF is in turn an affiliated person of the acquiring fund, or an affiliated person of such person, for a reason other than such power to vote.

Rule 12d1-4(a)(3). “Baskets” for purposes of rule 12d1-4 will have the same meaning as in rule 6c-11(a)(1).

See

rule 12d1-4(d).

See, e.g.,

AQR Trust and AQR Capital Management, LLC, Investment Company Act Release Nos. 33343 (Dec. 21, 2018) [83 FR 67441 (Dec. 28, 2018)] (notice) and 33346 (Jan. 28, 2019) (order) and related application.

We are adopting the rule with this exemption because we agree with commenters that this rule text clarification is appropriate to permit ETFs to engage in in-kind purchase or redemption transactions with certain affiliated acquiring funds on the same basis that they would be permitted to engage in a cash purchase or redemption transactions with such affiliated acquiring fund under the rule.

The provision is similar to rule

6c-11(b)(3).

Purchases and redemptions of ETF creation units are typically effected in kind, and section 17(a) would prohibit these in-kind purchases and redemptions by a fund affiliated with the ETF. We believe that such an exemption is appropriate because all purchases and redemptions of creation units with such an affiliated fund are at an ETF's next-calculated NAV, and an ETF would value the securities deposited or delivered upon redemption in the same manner, using the same standards, as the ETF values those securities for purposes of calculating the ETF's NAV. We do not believe that these transactions will give rise to the policy concerns that section 17(a) is designed to prevent.

An ETF would be prohibited under section 17(a)(2) from purchasing securities and other property (

i.e.,

securities and other property in the ETF's basket assets) from the affiliated acquiring fund in exchange for ETF shares. An acquiring fund would be prohibited under section 17(a)(1) from selling any securities and other property (

i.e.,

securities and other property in the ETF's basket assets) to an affiliated ETF in exchange for the ETF's shares. The orders we have granted permitting investments in ETFs provide relief from section 17(a) to permit these transactions.

See

Barclays Global Fund Advisors,

et al.,

Investment Company Act Release Nos. 24394 (Apr. 17, 2000) [65 FR 21215 (Apr. 20, 2000)] (notice) and 24451 (May 12, 2000) (order) and related application. In addition, rule 6c-11 under the Investment Company Act and our ETF exemptive orders provide separate affiliated transaction relief for the acquisition or sale of an ETF's basket assets as part of the creation or redemption of ETF creation units, but that relief would not be sufficient to allow an ETF's in-kind transaction with another fund.

See

CFR 270.6c-11; 2019 ETF Adopting Release,

supra

footnote 25.

Rule 6c-11(b)(3).

See supra

footnote 73 and accompanying text.

See also

2019 ETF Adopting Release,

supra

footnote 25 at section II.B.3.

See also

2019 ETF Adopting Release,

supra

footnote 25, at nn.130-134 and accompanying text.

Further, similar to other fund of funds arrangements, without an exemption from section 17(a), the rule would be limited in its utility. In this case, section 17(a) would prohibit the delivery or deposit of basket assets on an in-kind basis by certain affiliated funds (that is, by exchanging certain assets from the ETF's portfolio, rather than in cash). As a result, we also believe that the exemption from section 17(a) regarding this limited exception for ETF in-kind baskets is necessary in light of the goals of rule 12d1-4, subject to the conditions set forth in the rule.

Some commenters also suggested the Commission clarify, or provide exemptive relief from, section 17(a) for other affiliated transactions that are within the statutory limits of section 12(d)(1) or fund of funds arrangements that rely on a statutory exemption.

A few commenters stated that it would frustrate Congressional intent if the Commission does not extend section 17(a) exemptive relief to these types of fund of funds arrangements.

See

Voya Comment Letter; ICI Comment Letter; PIMCO Comment Letter; SIFMA AMG Comment Letter. Some commenters focused on suggesting relief from sections 12(d)(1)(A) and 12(d)(1)(F).

See

ICI Comment Letter. Other commenters stated relief should include sections 12(d)(1)(A), (B), (C), (E), (F), and (G).

See

SIFMA AMG Comment Letter; PIMCO Comment Letter.

See

SIFMA AMG Comment Letter; PIMCO Comment Letter; ICI Comment Letter.

Section 12 and section 17 address different concerns under the Act. Section 12 addresses concerns regarding “pyramiding,” where investors in the acquiring fund could control the assets of the acquired fund and use those assets to enrich themselves at the expense of acquired fund shareholders by virtue of their stake in the acquired fund. Section 17(a) addresses self-dealing and other types of overreaching of a fund by its affiliates. Although an arrangement may not raise pyramiding concerns, it may still give rise to self-dealing concerns. As a result, we do not believe it would frustrate congressional intent, as asserted by commenters, for some fund of funds arrangements that are within the limits of, or exempt from section 12(d)(1) to be subject to the prohibitions of section 17(a).

However, we recognize that certain fund of funds arrangements are nearly impossible to utilize absent relief from section 17(a). In the past, we have considered relief to be implied in these circumstances. We believe that it is appropriate to imply relief under sections 12(d)(1)(E) and 12(d)(1)(G) because, without this relief, these statutory provisions would be inoperable.

Transactions permitted by sections 12(d)(1)(E) and 12(d)(1)(G) are typically affiliated transactions prohibited by section 17(a).

See, e.g.,

2018 FOF Proposing Release,

supra

footnote 6, at n.70.

See, e.g.,

Section 12(d)(1)(E)(ii) (limiting the exception to situations where the acquiring fund only owns the acquired fund) and section 12(d)(1)(G)(i)(I) (limiting the exception to situations where the two funds are part of the same group of investment companies). For fund of funds arrangements relying on section 12(d)(1)(E), Commission staff has taken the position that application of section 17(a) of the Act to a registered feeder fund's cash redemption from a registered master fund would not be consistent with the basic relationship that section 12(d)(1)(E) is intended to permit.

See

Signature Financial Group, Inc., SEC Staff No-Action Letter (Dec. 28, 1999) (“Signature Financial No-Action Letter”). Section 12(d)(1)(G) of the Act codified certain exemptive orders that the Commission had issued permitting funds to purchase other funds in the same group of funds beyond the limits in section 12(d)(1). The Commission issued those orders generally to funds of funds where the acquiring and acquired funds were related because they shared a common investment adviser or the advisers were affiliated persons within the meaning of section 2(a)(3)(C) of the Act. Those orders provided relief from section 17(a) of the Act.

See, e.g.,

T. Rowe Price Spectrum Fund, Inc., Investment Company Act Release Nos. 21371 (Sept. 22, 1995) [60 FR 50654 (Sep. 22, 1995)] (notice) and 21425 (Oct. 18, 1995) (order) (“T. Rowe Spectrum Order”); Vanguard Star Fund, Investment Company Act Release Nos. 21372 (Sept. 22, 1995) (notice) and 21426 (Oct. 18, 1995) (order);

See also

Compliance Rule Adopting Release,

supra

footnote 59 (noting that funds or their advisers should have policies and procedures in place to identify affiliated persons and to prevent unlawful transactions with them).

The breadth of entities that are included within an advisory group will reduce the risk that an acquiring fund and its advisory group will exert undue influence over an acquired fund by accumulating a controlling ownership position across the advisory group's accounts. We believe that the condition's definition of advisory group strikes an appropriate balance between the flexibility for efficient market activity and protection of acquired funds and their shareholders.

Additionally, we continue to believe that the advisory group definition should not encompass funds managed by unaffiliated sub-advisers. Absent common control, there is little risk that an advisory group and sub-advisory group would coordinate to exert undue influence on an acquired fund.

115

Consistent with past exemptive orders, therefore, rule 12d1-4 will not require an acquiring fund to aggregate the ownership of an acquiring fund advisory group with an acquiring fund sub-advisory group. Instead, each of these groups will consider its ownership percentage separately and will be subject to the voting provisions as discussed below.

116

115

However, if the sub-adviser or any person controlling, controlled by, or under common control with such investment sub-adviser acts as an acquired fund's investment adviser or depositor, then the sub-advisory group and advisory group will be required to aggregate their ownership for purposes of determining control pursuant to rule 12d1-4(b)(1)(i).

116

See

rule 12d1-4(b)(1)(ii).

ii. Closed-End Funds

Rule 12d1-4 will include voting requirements specific to acquired closed-end funds in response to concerns raised by commenters with respect to undue influence over closed-end funds.

117

The proposed rule included voting requirements, as described in section II.C.1.b below, and would have required that an acquiring

fund and its advisory group not control (individually or in the aggregate) any acquired fund, whether open-end or closed-end.

118

As discussed above, the rule 12d1-4 control prohibition also applies if facts and circumstances exist that give an acquiring fund and its advisory group the power to exercise a controlling influence over an acquired closed-end fund's management or policies, even if the acquiring fund and its advisory group owned 25% or less of the acquired closed-end fund's voting securities.

119

117

These voting conditions will also apply to voting of shares of acquired BDCs.

See

rule 12d1-4(b)(1)(ii).

118

Proposed rule 12d1-4(b)(1).

119

See

2018 FOF Proposing Release,

supra

footnote 6, at 32-33.

In the 2018 FOF Proposing Release, we requested comment on whether the rule's control and voting requirements should vary depending on the type of acquired fund, including whether there should be a lower or higher threshold for closed-end funds, and whether the threshold should differ for listed and unlisted closed-end funds.

120

As adopted, the rule does not impose a lower investment limit on investments in a closed-end fund by an acquiring fund and its advisory group; however, the rule will impose a mirror-voting requirement at a lower ownership threshold than the voting requirements applicable to open-end funds and UITs. Specifically, the rule will require mirror voting if an acquiring fund and its advisory group hold more than 10% of the voting securities of a closed-end fund. This voting requirement is designed to protect an acquired closed-end fund from undue influence through the shareholder vote mechanism. In addition, the rule will require an acquiring fund to enter into a fund of funds investment agreement with an acquired fund prior to exceeding the investment limits set forth in section 12(d)(1). Together, these provisions are designed to protect acquired closed-end funds from undue influence by acquiring funds and their advisory groups.

120

Id.

at 45. We requested comment on whether the proposed control and voting conditions sufficiently protect acquired funds, and whether there may be other conditions that would address the potential for undue influence by an acquiring fund and its controlling persons, including a lower limit on investments by an acquiring fund and its advisory group in an acquired fund.

Id.

at 43.

Several commenters recommended alternatives to the proposed control condition for fund of funds arrangements with acquired closed-end funds. For example, commenters recommended that, instead of relying on the concept of “control” for acquired closed-end funds, rule 12d1-4 should limit the aggregate ownership by an acquiring fund and its advisory group to 10% of an acquired closed-end fund's voting securities in order to protect these funds from undue influence.

121

One commenter stated that an acquiring fund that holds approximately 15% of an acquired closed-end fund could dictate certain actions of the acquired closed-end fund.

122

The commenter also recommended expanding the definition of advisory group and requiring an acquiring fund (and the expanded advisory group) to reduce its holdings in an acquired fund to less than 25% within a defined period of time in order to discourage activist investors from increasing their holdings in target funds just prior to effectiveness of the rule.

123

121

Advent Comment Letter; Comment Letter of TPG Specialty Lending, Inc. (May 2, 2019) (“TPG Comment Letter.”).

122

Advent Comment Letter (stating that holdings below the 25% level result in the type of undue influence the Commission is seeking to prevent, such as a large holder being able to dictate various events including the initiation of a proxy contest).

See also

PIMCO Comment Letter (recommending that, if private funds and foreign funds are permitted to rely on the rule, such funds must act within the limits of section 12(d)(1)(C) as if they were registered funds); Skadden Comment Letter; ICI Comment Letter. Section 12(d)(1)(C) prohibits funds (together with companies or funds they control and funds that have the same adviser) from acquiring more than 10% of the outstanding voting stock of a closed-end fund. 15 U.S.C. 80a-12(d)(1)(C).

123

Advent Comment Letter.

Two commenters encouraged the Commission to allow acquired funds and their boards, at their option, to set their own limit for an acquiring fund's investments.

124

These commenters suggested that an agreement between an acquiring and acquired fund (similar to a participation agreement under current fund of funds exemptive relief) could allow the acquired fund and its board to evaluate the effects of the acquiring fund's investment, including any risks of undue influence, and set an appropriate limit.

125

Similarly, commenters suggested that the rule should provide acquired funds with the ability to grant consent to potential investments by acquiring funds, effectively permitting acquired funds to screen their investors and refuse investments by acquiring funds based on undue influence concerns.

126

124

Dimensional Comment Letter (noting that a higher discretionary investment limit might be beneficial for a newly formed or smaller fund that seeks large investments by acquiring funds in order to achieve economies of scale); Advent Comment Letter (explaining that an acquired fund might use a participation agreement to permit an acquiring fund to purchase more than 10% of its voting securities, and the participation agreement can require passive investment).

125

Dimensional Comment Letter, Advent Comment Letter.

126

ABA Comment Letter; AIC Comment Letter; Dimensional Comment Letter (explaining that the participation agreement requirement of existing exemptive relief has been helpful for a potential acquired fund to refuse large investments by an acquiring fund that may present a risk of undue influence, and recommending the preservation of such a control).

Other commenters suggested the Commission adopt a passive investor certification and reporting regime similar to that under Section 13 of the Securities Exchange Act of 1934 and Schedules 13D and 13G to protect acquired closed-end funds against undue influence.

127

Under such a regime, an acquiring fund would certify to the Commission, or would only be able to operate in accordance with rule 12d1-4, if it holds the acquired fund's securities in the ordinary course of business and not for the purpose of or with the effect of changing or influencing the management or policies of the acquired fund. Commenters representing closed-end funds or their investors also recommended that, if rule 12d1-4 were to permit private funds to acquire closed-end funds, it should incorporate additional protections specific to closed-end funds.

128

127

Skadden Comment Letter; BlackRock Comment Letter.

128

See, e.g.,

Comment Letter of Nuveen, LLC (May 2, 2019) (“Nuveen Comment Letter”); SIFMA AMG Comment Letter; PIMCO Comment Letter; Skadden Comment Letter; Voya Comment Letter; Guggenheim Comment Letter; Advent Comment Letter.

Rule 12d1-4, as adopted, will prohibit an acquiring fund and its advisory group from exercising control over an acquired closed-end fund and will impose a mirror-voting requirement if an acquiring fund and its advisory group hold more than 10% of the voting securities of a closed-end fund.

129

We believe these conditions will more effectively address undue influence concerns regarding acquired closed-end funds than a reporting or certification requirement on acquiring funds, and they will avoid potential duplicative reporting requirements on certain acquiring funds.

130

129

See

rule 12d1-4(b)(1). This voting requirement applies at a 10% ownership threshold, while the Act creates a rebuttable presumption that any person who directly or indirectly beneficially owns more than 25% of the voting securities of a company controls the company.

130

See, e.g.,

Part C of Form N-PORT (requiring monthly disclosure of certain registered management investment companies' portfolio holdings, including disclosure of investments in other investment companies).

As an additional protective condition, discussed below in section II.C.2, the rule will require an acquiring fund and an acquired closed-end fund that do not share an investment adviser to enter into a fund of funds investment agreement prior to the acquiring fund exceeding the investment limits of section 12(d)(1)(A). This agreement will

enable an acquired closed-end fund to screen potential acquiring fund investors and set conditions on investments in the acquired fund, if desired. The agreement also will allow an acquired closed-end fund to terminate the agreement with an acquiring fund without penalty, which would then prohibit the acquiring fund from making additional purchases of the acquired fund beyond the section 12(d)(1)(A) limits.

Rule 12d1-4 also includes voting requirements specific to closed-end funds that preserve voting discretion for investment advisers below a specified threshold of ownership, while seeking to avoid amplifying the voting power of any particular investor.

131

These voting requirements are described in the section below. Finally, because private funds will not be permitted to rely on the rule as acquiring funds, we are not adopting any specific conditions associated with private fund investments in closed-end funds under rule 12d1-4.

131

See infra

section II.C.1.b.

In addition to comments on closed-end fund issues under the rule, several commenters raised general concerns about private fund investments in closed-end funds that are outside the scope of rule 12d1-4.

132

These commenters stated that there have been instances in which an investment adviser to several private funds (each with less than 3% of the outstanding voting shares of a closed-end fund) acquired a significant aggregate interest in an acquired closed-end fund and sought to unduly influence the fund to the detriment of long-term shareholders through proxy contests or other means.

133

The commenters recommended various ways to address these private fund investments in closed-end funds under section 12(d)(1). For example, these commenters recommended that the Commission: (i) Recommend legislation to deem any private fund an “investment company” for purposes of section 12(d)(1)(C) of the Act;

134

(ii) extend the 3% limit of section 12(d)(1)(A)(i) to any separate accounts for which an advisory group has sole or shared voting or disposition authority;

135

(iii) deem ownership of more than 3% of a registered fund by a private fund advisory group to be a violation of section 12(d)(1)(A)(i) pursuant to section 48(a) of the Act;

136

or (iv) treat affiliated private funds that “are not materially different in investment operations or investment policies” as a single fund for purposes of section 12(d)(l).

137

132

See, e.g.,

Comment Letter of Center for Capital Markets Competitiveness, U.S. Chamber of Commerce (May 2, 2019) (“Chamber of Commerce Comment Letter”) (recommending that the Commission review existing rules to address “regulatory loopholes” related to fund of funds structures and ownership thresholds); Comment Letter of Anthony S. Colavita (Apr. 30, 2019); Comment Letter of Anthonie van Ekris (Apr. 30, 2019); Comment Letter of Kinchen C. Bizzel (May 2, 2019); Comment Letter of Salvatore Subblells (May 2, 2019); Comment Letter of Peter Baldino (May 2, 2019); Comment Letter of Clarence A. Davis (May 2, 2019).

See

2018 FOF Proposing Release,

supra

footnote 6, at n. 95 and accompanying text.

133

See, e.g.,

Advent Comment Letter; Skadden Comment Letter; ICI Comment Letter; Comment Letter of Gabelli Funds, LLC (Apr. 30, 2019) (“Gabelli Comment Letter”); Nuveen Comment Letter. One commenter requested that the Commission analyze private funds' actual capacity for exercising voting control, as well as indirect forms of influence, over an acquired closed-end fund. Great American Comment Letter.

134

ICI Comment Letter; Comment Letter of Calamos Investments LLC (May 2, 2019) (“Calamos Comment Letter”); Nuveen Comment Letter; Dechert Comment Letter; Voya Comment Letter; Guggenheim Comment Letter.

See also

Gabelli Comment Letter (recommending that the Commission seek legislative changes to create a private right of action to enforce rules relating to activist investment in closed-end funds).

135

Gabelli Comment Letter.

136

Advent Trustees Comment Letter; Gabelli Comment Letter; Advent Comment Letter; Skadden Comment Letter.

137

Skadden Comment Letter.

On the other hand, some commenters opposed restrictions on private fund investments in closed-end funds under section 12(d)(1).

138

These commenters stated that private funds invest in closed-end funds in accordance with the relevant provisions of the Act. In addition, one commenter stated that Congress did not impose more restrictive limits on the ability of private funds to acquire equity stakes in regulated funds when it amended the Act to subject private funds to the restrictions of sections 12(d)(1)(A)(i) and 12(d)(1)(B)(i).

139

138

Comment Letter of Saba Capital Management, L.P. (May 1, 2019) (“Saba Comment Letter”); Comment Letter of City of London Investment Management Co Ltd (May 2, 2019) (“City of London Comment Letter”); Comment Letter of Bulldog Investors, LLC (May 6, 2019) (“Bulldog Comment Letter”); TPG Comment Letter.

139

Saba Comment Letter, citing NSMIA at sections 209(a)(1) and 209(a)(4)(D) (codified at Sections 3(c)(1) and Section 3(c)(7) of the Investment Company Act).

After considering comments, we believe commenters' additional recommendations with respect to investments in closed-end funds that are within the statutory limitations of section 12(d)(1) are beyond the scope of this rulemaking.

140

See supra

footnotes 133-137 and accompanying text.

b. Voting Provisions

The final rule will require an acquiring fund and its advisory group to vote their shares of an acquired fund: (i) Using mirror voting if the acquiring fund and its advisory group (in the aggregate) hold more than 25% of the outstanding voting securities of an acquired open-end fund or UIT due to a decrease in the outstanding securities of the acquired fund;

141

and (ii) using mirror voting if the acquiring fund and its advisory group (in the aggregate) hold more than 10% of the outstanding voting securities of an acquired closed-end fund or BDC.

142

Similar to our exemptive orders, the final rule's voting conditions will differ based on the type of acquired fund.

141

In circumstances where acquiring funds are the only shareholders of an acquired fund, however, pass-through voting may be used.

142

Mirror voting requires the fund to vote the shares held by it (and, under rule 12d1-4, an acquiring fund's advisory group) in the same proportion as the vote of all other holders of the acquired fund. In mirror voting, the tabulation agent for the shareholder meeting will first tabulate the votes for a proposal and then apply the resulting ratio (for/against/abstain) to the shares instructing that they are to be mirror voted.

Proposed rule 12d1-4 would have required an acquiring fund and its advisory group to vote their securities in the manner prescribed by section 12(d)(1)(E)(iii)(aa) of the Act if the acquiring fund and its advisory group (in the aggregate) hold more than 3% of the outstanding voting securities of an acquired fund.

143

The proposed rule would have applied a uniform condition across all types of acquired funds to simplify and streamline the requirement. Commenters generally supported the proposed voting conditions, stating that they protect acquired funds without disrupting current investment strategies or creating new or difficult compliance requirements.

144

As discussed in more detail below, however, some commenters suggested modifications to the ownership threshold that would trigger the voting condition or the required manner of voting, based on the type of acquired fund.

145

143

Proposed rule 12d1-4(b)(1)(ii). Section 12(d)(1)(E)(iii)(aa) of the Act requires an acquiring fund to either: (i) Seek voting instructions from its security holders and vote such proxies in accordance with their instructions (“pass-through voting”); or (ii) use mirror voting.

144

Invesco Comment Letter; CFA Comment Letter (specifically supporting the application of the voting condition to an acquiring fund and its advisory group).

145

See

Invesco Comment Letter; CFA Comment Letter, WisdomTree Comment Letter; IPA Comment Letter; Advent Comment Letter; Skadden Comment Letter; FS Comment Letter; ABA Comment Letter.

We believe that the voting conditions of the final rule, which we modified to respond to the concerns expressed in these comments, will help to facilitate compliance monitoring and are better

tailored to address the potential for undue influence through voting power based on the types of acquired fund.

i. Ownership Threshold

The final rule will impose voting conditions if an acquiring fund and its advisory group hold more than 25% of the voting securities of an acquired open-end fund or UIT due to a decrease in the outstanding voting securities of the acquired fund.

146

For acquired BDCs and other closed-end funds, the rule will impose voting conditions at a 10% ownership threshold. The proposed rule included a 3% ownership threshold that would trigger the rule's voting conditions, and we requested comment on whether that ownership threshold should be higher or lower, and whether it should differ depending on the type of acquired fund.

147

146

Rule 12d1-4(b)(1)(ii).

147

2018 FOF Proposing Release,

supra

footnote 6, at 45.

A number of commenters recommended raising the 3% ownership threshold that would trigger the voting conditions in the proposed rule, stating that a 3% threshold would substantially increase the administrative burden on an advisory group to monitor and vote shares.

148

For example, some commenters recommended the rule raise the ownership threshold from the proposed 3% to 10% to better reflect an ownership level at which an acquiring fund would be able to influence a shareholder vote.

149

One commenter argued that the rule should allow acquiring funds to hold larger positions in closed-end funds without forfeiting the right to exercise their independent judgment regarding shareholder proposals to ameliorate certain unintended consequences associated with a lower threshold.

150

148

Comment Letter of Charles Schwab Investment Management (May 2, 2019) (“Schwab Comment Letter”); Voya Comment Letter.

But see

SIFMA AMG Comment Letter (“[T]he voting and control provisions do not create significant operational challenges for funds and . . . they may prove to be an unobtrusive means to address some of Congress's concerns relating to voting control . . .”).

149

MFA Comment Letter; Nuveen Comment Letter.

But see

Advent Comment Letter (stating that an acquiring fund that holds approximately 15% of an acquired fund can dictate certain actions of the acquired fund).

150

SIFMA AMG Comment Letter (“AMG has observed that activist firms are utilizing multiple private funds to acquire significant positions in CEFs, but such private funds would not be subject to the Proposed Rule. In contrast, registered funds investing in CEFs would be subject to this voting condition. Therefore, such registered funds would likely mirror vote shares held in any CEF subject to the voting condition. This would have the effect of increasing the voting power of activist firms . . . We believe the Commission could mitigate this concern by increasing the percentage beyond which an acquiring fund and its advisory group are required to mirror or pass-through vote.”).

Several commenters recommended that the rule adopt the voting triggers set forth in exemptive orders.

151

These commenters stated that current exemptive orders only impose voting requirements when a fund and its advisory group hold, in aggregate, more than 25% of the outstanding voting securities of an acquired open-end fund or UIT. They also noted that open-end funds and UITs may not be particularly susceptible to influence by shareholder votes because they do not hold routine shareholder meetings. Accordingly, these commenters stated that there was little practical or policy justification to impose voting requirements at a 3% ownership threshold on shares of acquired open-end funds and UITs.

152

In contrast, these commenters stated that closed-end funds may be required to hold annual shareholder meetings and can be the target of proxy contests, which may make such funds more susceptible to influence by shareholder vote. Commenters addressing the closed-end fund market segment generally recommended that the Commission adopt a lower voting threshold for acquiring funds' holdings in closed-end funds than the threshold for acquiring funds' holdings in open-end funds and UITs.

153

151

Schwab Comment Letter; SIFMA AMG Comment Letter; ICI Comment Letter; ABA Comment Letter.

152

ICI Comment Letter; Voya Comment Letter; Schwab Comment Letter.

153

See, e.g.,

Nuveen Comment Letter, SIFMA AMG Comment Letter.

After considering the comments received, we believe that it is appropriate that the final rule include voting requirements for investments in open-end funds and UITs that are consistent with the voting requirements imposed by prior exemptive orders in this area. We are persuaded that the 25% ownership threshold is appropriate for open-end funds and UITs given that these funds hold shareholder meetings infrequently, and because commenters did not raise concerns about undue influence of these funds through shareholder voting. The rule's voting conditions therefore will apply to the same scope of entities in an acquiring fund's advisory group as the voting conditions in our existing fund of funds exemptive orders. A 25% ownership threshold will also minimize the administrative burden associated with the voting requirement for these funds.

154

Accordingly, the final rule will require mirror voting if an acquiring fund and its advisory group hold more than 25% of the voting securities of an open-end fund or UIT. We expect an acquiring fund would only exceed 25% of the securities of an open-end fund or UIT due to a decrease in the outstanding voting securities of the acquired fund because the rule prohibits an acquiring fund from controlling an acquired fund and because of the rebuttable presumption regarding control under the Act.

155

154

Since our existing fund of funds exemptive orders currently impose voting requirements on an advisory group's holdings in an acquired fund, we understand from commenters that some advisory groups may already have systems in place to monitor holdings at the “advisory group level” and engage in mirror voting when appropriate or required.

See, e.g.,

Invesco Comment Letter; SIFMA AMG Comment Letter. To the extent that an advisory group utilizes information barriers and determines to rely on this rule, the advisory group may need to update its policies and procedures to allow entities across the advisory group to monitor compliance with the aggregate ownership thresholds set forth in rule 12d1-4.

See, e.g.,

Dechert Comment Letter.

155

The Act creates a rebuttable presumption that any person who directly or indirectly beneficially owns more than 25% of the voting securities of a company controls the company. The presumption of control continues until the Commission makes a final determination to the contrary by order either on its own motion or on application by an interested person.

See

15 U.S.C. 80a-2(a)(9).

However, the rule will impose a 10% ownership threshold on acquired closed-end funds. We believe a 10% ownership threshold (an increase from the proposed 3% threshold) will permit an acquiring fund and its advisory group to gain substantial exposure to such funds with full voting discretion, but will reduce undue influence concerns associated with shareholder votes, which are greater for acquired closed-end funds than for other types of acquired funds given the more frequent shareholder meetings.

156

We are concerned that a higher threshold for acquiring fund investments in closed-end funds, such as 15% or 25%, could give an acquiring fund's advisory group the ability to dictate certain fund actions and unduly influence the acquired closed-end fund.

156

See, e.g.,

Nuveen Comment Letter (stating that a 10% threshold is a reasonable ownership threshold to limit undue influence concerns while allowing acquiring funds to hold larger positions in closed-end funds without forfeiting the right to exercise their independent judgment regarding shareholder proposals); MFA Comment Letter (stating that a 10% ownership threshold would appropriately balance the need to prevent influence of shareholder votes with allowing acquiring funds that do not have the ability to influence acquired funds to participate in shareholder votes).

ii. Mirror Voting

The final rule will require mirror voting if an acquiring fund and its advisory group hold 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 an acquired BDC or other closed-end fund. As described above, the proposed rule would have required acquiring funds to use either pass-through or mirror voting if the acquiring fund and its advisory group exceeded a set ownership threshold, regardless of the type of acquired fund. In the 2018 FOF Proposing Release, we requested comment on whether we should adopt the voting requirements of the proposed rule, or whether the final rule should codify the voting provisions set forth in existing exemptive orders.

157

2018 FOF Proposing Release,

supra

footnote 6 at 45-46.

Several commenters suggested modifications to the proposed voting requirement. For example, one commenter generally opposed pass-through voting for closed-end fund voting securities because an activist acquiring fund and its advisory group would likely vote according to the recommendations of its activist investment manager.

158

This commenter suggested that the rule permit pass-through voting of investments in an acquired closed-end fund only if required by the terms of an adviser's investment advisory contract. Another commenter recommended that the rule require an acquiring fund to mirror vote its shares of an acquired open-end fund if it controls the acquired fund.

159

The commenter explained that, at a beneficial ownership of more than 25% of the voting securities of an acquired open-end fund, there is a greater risk that an acquiring fund can exert undue influence on the acquired fund and thus the burden of mirror voting acquired fund shares is a reasonable trade-off.

158

Advent Comment Letter.

159

Voya Comment Letter.

Some commenters stated that the rule's proposed voting requirements could conflict with an acquiring fund adviser's fiduciary duty to vote underlying fund shares in the best interest of the acquiring fund.

160

These commenters stated that large advisory firms may serve many clients with different investment strategies and shareholder voting interests, and a voting requirement that applies across an advisory group could cause an affiliate of an acquiring fund to be in violation of its fiduciary duties under Sections 404(a)(1)(A) and (B) of the Employee Retirement Income Security Act of 1974 if forced to adhere to the rule's voting requirements. Further, commenters stated that a mirror-voting requirement may require an adviser to vote fund holdings in a manner that is contrary to its proxy voting policies.

161

160

ICI Comment Letter (stating that there may be shareholder proposals, such as merger approvals or changes to fundamental investment strategy, for which an adviser believes that neither mirror voting nor pass-through voting is in the acquiring fund's or shareholders' best interest); Voya Comment Letter. The voting conditions are similar to those included in our existing exemptive orders.

161

Schwab Comment Letter.

Some commenters expressed concern regarding the effect of the required voting procedures for acquired closed-end funds. These commenters stated that requiring acquiring funds to use mirror voting if they hold more than 3% of an acquired closed-end fund may increase the relative voting power of private funds or separate account structures that would not rely on rule 12d1-4, and therefore would not be subject to the voting requirements of the rule.

162

These commenters noted that mirror voting by an acquiring fund and its advisory group at a low ownership threshold could effectively amplify the voting position of these types of investors.

162

SIFMA AMG Comment Letter (noting that activist investors have historically accumulated ownership of closed-end funds through separate investments by private funds and separately managed accounts); Nuveen Comment Letter.

After considering comments, we believe it is appropriate to require acquiring funds and their advisory group to use mirror voting. However, in circumstances where rule 12d1-4 or section 12(d)(1) requires all of the security holders of an acquired fund to engage in mirror voting, and it would not be possible for every shareholder to engage in mirror voting, such acquiring funds must use pass-through voting. For example, if an acquired fund is offered solely to acquiring funds that rely on rule 12d1-4, there may be no other investors to vote the acquired fund shares; therefore, under these circumstances, the acquiring fund's shares must be “passed-through” to the acquiring funds' shareholders for voting purposes. We believe requiring an acquiring fund and its advisory group to use mirror voting in most cases, with an ownership threshold set at 25% for open-end funds and UITs and at 10% for closed-end funds, will help address the commenters' concerns regarding undue influence over acquired funds through shareholder voting.

163

We further believe that requiring an acquiring fund and its advisory group to use mirror voting in most cases, without generally providing the option for pass-through voting, will simplify operational and compliance burdens for acquiring funds and their advisory groups. For example, this approach will facilitate compliance monitoring for fund groups that have multiple types of acquiring funds. As under our existing exemptive orders, we believe an adviser would need to consider these voting requirements as a component of its fiduciary duty when determining whether and how much an acquiring fund should invest in an acquired fund under the rule.

163

One commenter recommended that the rule prescribe a mirror voting procedure whereby the acquiring fund must provide legal proxy to the proxy agent for the shareholder vote and request that the acquiring fund's shares be voted in the same proportion as the vote of all other shareholders. Bulldog Comment Letter. We do not believe it is necessary to include such a prescription in this rule because we understand that proxy agents are able to tabulate and process shareholder votes that are subject to a mirror-voting requirement and such agents would not require a legal proxy to be set forth in the rule text.

iii. Exceptions to the Control and Voting Conditions

We are adopting, as proposed, exceptions to the control and voting conditions when: (i) An acquiring fund is within the same group of investment companies as an acquired fund; or (ii) the acquiring fund's investment sub-adviser or any person controlling, controlled by, or under common control with such investment sub-adviser acts as the acquired fund's investment adviser or depositor.

164

The exceptions are designed to include arrangements that are permissible under section 12(d)(1)(G) and our exemptive orders within the regulatory framework of rule 12d1-4.

165

We define the term “group of investment companies” as any two or more registered investment companies or business development companies that hold themselves out to investors as related companies for investment and investor services.

166

164

Rule 12d1-4(b)(1)(iii). The exception to the control and voting conditions for sub-advisory arrangements will cover arrangements that may not qualify for the exclusion otherwise available to funds within the same group of investment companies if the acquiring fund and acquired fund do not hold themselves out as related funds for purposes of investment and investor services.

See

2018 FOF Proposing Release,

supra

footnote 6, at n.106 and accompanying text.

165

See

2018 FOF Proposing Release,

supra

footnote 6, at section II.C.1.b.

166

Rule 12d1-4(d).

Commenters supported these exceptions.

167

Commenters agreed with the Commission that, in circumstances where an affiliated investment manager manages the acquiring fund, it is unlikely that the investors in the acquiring fund would exert undue influence and use their vote to pursue initiatives that are inconsistent with the long-term interests of investors in the

acquired fund.

168

Based on our experience overseeing fund of funds arrangements, we believe these exceptions from the control and voting conditions are appropriately tailored to except only those fund of funds arrangements that do not raise the concerns of undue influence that underlie section 12(d)(1).

167

See, e.g.,

Invesco Comment Letter; ABA Comment Letter.

168

Commenters suggested excluding funds within the same group of investment companies from other conditions of the proposed rule, including the proposed redemption limit. While we are not adopting the proposed redemption limit, we have tailored the rule's conditions to account for the different undue influence concerns of funds within the same group of investment companies as compared to funds that are not part of the same group of investment companies.

The definition of “group of investment companies” is similar to the definition used in many of our exemptive orders permitting investments in listed closed-end funds and listed BDCs. It is intended to clarify that BDCs and other closed-end funds are within the scope of this exception. The determination of whether advisers are control affiliates, however, depends on the relevant facts and circumstances.

169

We believe, for example, that funds that are advised by the same investment adviser, or by advisers that are control affiliates of each other, would be “related” companies for purposes of the rule. The definition of “affiliated person” includes any person directly or indirectly controlling, controlled by, or under common control with, such other person.

See

section 2(a)(3)(C) of the Act.

See also

Investment Company Mergers, Investment Company Act Release No. 25259 (Nov. 8, 2001) [66 FR 57602 (Nov. 15, 2001)] (proposing rule amendments to permit mergers and other business combinations between certain affiliated investment companies), at n.11.

We believe that whether a group of funds sharing a common adviser or having advisers that are all control affiliates could satisfy the “holding out” prong of the definition would depend on the totality of communications with investors by or on behalf of the funds. For example, the acquiring fund's prospectus could identify the acquired funds in which the acquiring fund expects to invest, and disclose the control relationship among the advisers to the acquiring and acquired funds. In our view, it is not necessary for acquired funds to include comparable disclosure in their prospectuses or for acquired funds and acquiring funds to market themselves as related companies for all purposes and to all potential investors.

170

Rather, the requirement in this definition that the funds must hold themselves out to “investors” as related companies for purposes of investment and investor services refers only to potential investors in the acquiring fund because the relevant inquiry is how these funds are holding themselves out to their potential investors. Disclosure in the acquiring fund's prospectus of the identity of the acquired funds in which the acquiring fund expects to invest, and of the control relationship among the advisers to the acquired and acquiring funds, therefore, is one way to satisfy the “holding out” requirement of the definition. As we stated in the 2018 FOF Proposing Release, we believe that it would be false or misleading for a group of investment companies to hold themselves out as related companies as that term is used in rule 12d1-4 unless they are related investment companies.

170

If the acquired funds' marketing materials and/or prospectuses include any statements that are inconsistent with the representations made in the prospectuses for the acquiring funds regarding how the acquired fund and acquiring funds are related companies because of the affiliation of their investment advisers, such statements could call into question whether the funds are holding themselves out as related companies and potentially render the control exception unavailable to the fund of funds arrangement.

As proposed, the rule will subject fund of funds arrangements within these exclusions to a more limited set of conditions than other fund of funds arrangements. In circumstances where the acquiring fund and acquired fund share the same adviser, the adviser would owe a fiduciary duty to both funds, serving to protect the best interests of each fund.

171

In addition, where the arrangement involves funds that are advised by advisers that are control affiliates, we do not believe that the acquiring fund adviser generally would seek to benefit the acquiring fund at the expense of the acquired fund. Nor do we believe that the acquiring fund would seek to influence the acquired fund through its ownership interest in the acquired fund.

172

We believe that the rule's other conditions, such as the fund of funds investment agreement and adviser findings described below, would mitigate the risks of undue influence when the arrangement involves funds that have advisers that are control affiliates.

171

See

2018 FOF Proposing Release,

supra

footnote 6, at 41 and associated footnotes.

172

Id.

2. Redemption Limits, Fund Findings, and Fund of Funds Investment Agreements

In lieu of the proposed limitation on redemptions by an acquiring fund, we are adopting a requirement, expanded from the proposal, for an investment adviser to a management company operating in accordance with the rule to evaluate and make certain findings regarding the arrangement.

173

The rule will also require tailored findings regarding acquiring UITs and a certification regarding separate accounts funding variable insurance contracts (these findings and certifications, collectively with the management company evaluations and findings, “Fund Findings”). In addition, unless they have the same adviser, the acquiring fund and acquired fund will be required to enter into a fund of funds investment agreement effective for the duration of the funds' reliance on the rule, which must include certain specific terms. These provisions are, as discussed below, designed to address concerns over the exercise of undue influence through excessive redemptions that the proposed redemption limit provision was designed to address, while also addressing the duplicative fee and complex structure concerns that underlie section 12(d)(1)(A).

173

See infra

footnotes 259 through 276 and accompanying text.

a. Proposed Redemption Limit and Disclosure Requirements

The proposed rule would have prohibited an acquiring fund that acquires more than 3% of an acquired fund's outstanding shares (

i.e.,

the statutory limit) 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 (the “redemption limit”).

174

The proposed redemption limit was designed to address concerns that an acquiring fund could threaten large-scale redemptions as a means of exercising undue influence over an acquired fund and would have limited an acquiring fund's ability to quickly redeem or tender a large volume of acquired fund shares.

175

The Commission proposed the redemption limit believing it would (along with the proposed control and voting conditions) address the same concerns regarding undue influence and overreaching that the conditions currently found in the exemptive orders sought to address, without requiring procedures and related board findings covering particular instances where undue influence and overreaching could exist. The Commission stated that replacing these conditions with the proposed redemption, control, and voting conditions could lower compliance

costs and burdens and enhance investor protection for acquired funds.

174

Proposed rule 12d1-4(b)(2).

175

See

2018 FOF Proposing Release,

supra

footnote 6, at section II.C.2 (explaining that we proposed to permit funds to purchase up to 25% of an acquired fund (or more when the funds are part of the same group of investment companies) in reliance on the rule, in part, because of the protections afforded by limiting the acquiring fund's ability to influence the fund through the threat of large-scale redemptions).

Many commenters opposed the proposed redemption limit.

176

These commenters raised a number of concerns, including: (1) Operational or administrative challenges; (2) the redemption limit's potential effects on the acquiring fund's investment objectives and its ability to respond timely to changing economic or market conditions; (3) the impact on competition and innovation; (4) whether funds in the same group of investment companies should be subject to the requirements; (5) concerns relating to liquidity; and (6) the cost of the proposed limits.

177

These commenters offered a number of alternatives in lieu of the proposed redemption limit.

178

We also received a number of comments on a proposed disclosure requirement relating to the redemption limit.

179

176

See, e.g.,

ICI Comment Letter; Morningstar Comment Letter. Some commenters did support specific elements of the proposed limit.

See, e.g.,

MFA Comment Letter (supporting the approach that the limit not apply to sales of fund shares in secondary market transactions).

177

See, e.g.,

ICI Comment Letter; Fidelity Comment Letter; Comment Letter of John Hancock Investments (May 2, 2019) (“John Hancock Comment Letter”).

178

See, e.g.,

Comment Letter of The Vanguard Group, Inc. (May 2, 2019) (“Vanguard Comment Letter”); Comment Letter of Fidelity Rutland Square Trust II (May 2, 2019) (“Fidelity Rutland Comment Letter”).

179

See, e.g.,

SIFMA AMG Comment Letter; Fidelity Comment Letter; PGIM Comment Letter.

Operational and administrative challenges.

Commenters stated that the proposed redemption limit would present a number of operational or administrative challenges, including disrupting existing fund of funds arrangements.

180

Many commenters provided evidence that the proposed redemption limit would have a large effect on funds.

181

For example, one commenter provided survey results showing that, in the past three years, 228 fund of funds arrangements conducted 1,399 redemption transactions in excess of 3%.

182

One commenter stated that, in the case of large-scale redemptions, an acquiring fund may have difficulty meeting redemption requests from its own shareholders in light of this limit, in part because making in-kind distributions to its shareholders would be difficult on such a large scale.

183

Other commenters questioned whether this requirement was consistent with the requirements of the Act, including section 22(e) which generally prohibits registered investment companies from suspending the right of redemption of redeemable securities.

184

180

See, e.g.,

ICI Comment Letter; Guggenheim Comment Letter; Capital Group Comment Letter; SIFMA AMG Comment Letter; Fidelity Comment Letter; Dechert Comment Letter; Ropes Comment Letter; Comment Letter of the Independent Directors Council (May 1, 2019 (“IDC Comment Letter”).

181

See, e.g.,

Comment Letter of JP Morgan Asset Management (May 2, 2019) (“JP Morgan Comment Letter”); Comment Letter of Allianz Investment Management LLC (May 1, 2019) (“Allianz Comment Letter”); Vanguard Comment Letter.

See

2018 FOF Proposing Release,

supra

footnote 6, at n.125 and accompanying text.

182

See

ICI Comment Letter.

183

See

Fidelity Comment Letter.

See also

ABA Comment Letter; Ropes Comment Letter.

184

See

TRP Comment Letter; Fidelity Comment Letter.

See also

Dimensional Comment Letter; NYC Bar Comment Letter (questioning whether the Commission was, in effect, redefining “redeemable security” under the Act).

Some commenters discussed the challenges associated with tracking the outstanding voting securities of numerous third-party funds for investment threshold and redemption limit percentages over rolling 30-day periods, noting that this information is not readily available to the investing public.

185

Another commenter stated that it may be challenging to build compliance system enhancements that can account for multiple redemptions within any rolling 30-day period and apply those calculations to outstanding share balances that change daily.

186

Some commenters stated that these challenges would cause portfolio management teams to reduce exposures to acquired funds as their holdings approach the 3% limit as a means to mitigate these challenges.

187

Other commenters stated that the proposed redemption limit could prevent an acquiring fund from timely participating in certain transactions, such as liquidations or mergers of the acquiring fund, even where the acquiring fund's board and/or its shareholders have approved such transactions.

188

185

See, e.g.,

Fidelity Comment Letter; Ropes Comment Letter.

186

See

TRP Comment Letter.

187

See

Dechert Comment Letter; JP Morgan Comment Letter.

188

See

Allianz Comment Letter; John Hancock Comment Letter.

Potential impacts on investment strategies.

Several commenters expressed the view that the proposed redemption limit could impede acquiring funds' ability to follow their investment strategy.

189

Commenters stated that portfolio managers routinely change allocations among underlying funds in response to economic or market conditions, or in keeping with the stated investment strategy of the fund of funds, and that redemption limits could prevent portfolio managers from making such changes in a timely fashion.

190

For example, some commenters noted that the proposed redemption limit would prevent or limit portfolio managers' ability to make investment changes when they identify an underlying fund as underperforming or no longer meeting the needs of the investment strategy of the fund of funds.

191

One commenter stated that the proposed redemption limit could force acquiring funds and their shareholders to hold onto underlying funds that underperform, have higher costs than alternatives that become available, or no longer achieve the fund's strategy.

192

Another commenter suggested that to comply with the proposed redemption limit, some funds may alter an acquiring fund's investment strategy to invest in different affiliated or unaffiliated acquired funds to avoid owning more than 3% of any acquired fund, which could frustrate the investment expectations of shareholders, and may increase the costs and complexity of the fund.

193

Other commenters noted that this restriction would force acquiring fund portfolio managers to liquidate other positions to meet redemption requests.

194

Another raised concerns as to whether the limit would impair rebalancing and restructuring transactions that may involve redemptions beyond the 3% limit.

195

189

See, e.g.,

SIFMA AMG Comment Letter (providing survey results suggesting the proposed rule would have “a significant impact on the fund of funds business”); CFA Comment Letter (stating that the proposed redemption limit would inappropriately lock fund of funds investors into funds that no longer serve their best interests for unreasonable amounts of time).

190

See, e.g.,

Comment Letter of Nationwide Funds Group (Apr. 26, 2019) (“Nationwide Comment Letter”); Invesco Comment Letter; PIMCO Comment Letter; CFA Comment Letter.

191

See

Nationwide Comment Letter; Vanguard Comment Letter; Dimensional Comment Letter.

192

See

CFA Comment Letter.

See also

Voya Comment Letter.

193

See

Allianz Comment Letter.

194

See

TRP Comment Letter; Dechert Comment Letter; Ropes Comment Letter.

195

See

Vanguard Comment Letter.

Impact on competition and innovation.

Several commenters stated that requiring acquiring funds to redeem large positions slowly over time could place acquiring fund shareholders at a substantial competitive disadvantage to investors that are not subject to the same restrictions.

196

One of these commenters also stated that the redemption limit

would encourage consolidation, raise barriers to entry for new fund managers, and limit investment options for investors.

197

Many commenters stated that the limitation would have an adverse impact upon smaller funds, in part because the 3% limit would be easier to cross with such funds.

198

Others asserted that it would adversely impact target-date funds.

199

196

See, e.g.,

JP Morgan Comment Letter; SIFMA AMG Comment Letter (arguing that retail investors may be unfairly disadvantaged because their exposure to acquired funds through a fund of funds would be subject to the proposed redemption limit, while other investors who directly invested in an acquired fund would not be so limited and therefore would be able to access liquidity with priority over acquiring fund investors); Fidelity Comment Letter.

197

See

Dechert Comment Letter.

198

See, e.g.,

PIMCO Comment Letter; IDC Comment Letter; Voya Comment Letter; Chamber of Commerce Comment Letter.

199

See, e.g.,

Morningstar Comment Letter; IAA Comment Letter; Comment Letter of Fidelity Fixed Income and Asset Allocation Funds (May 2, 2019) (“Fidelity Fixed Income Trustees Comment Letter”); Nuveen Comment Letter; ABA Comment Letter.

Other commenters focused on the proposed redemption limit's impact on fund innovation. For example, one commenter stated that the redemption limit could inhibit the formation of new investment products, such as funds intended to serve as underlying funds for other funds in the same group of investment companies, because a sufficient number of investors would not hold the new product to avoid triggering the 3% limit.

200

Similarly, a commenter raised concerns that the proposed redemption limit could discourage acquiring funds from exposure to non-traditional asset classes, which often have more volatile in- and out-flows and smaller asset bases, resulting in a less desirable mix of assets made available to investors.

201

This commenter stated that if the proposed redemption limit discourages an acquiring fund from investing in an acquired fund, this could reduce overall economies of scale and operational efficiencies of the acquired fund or even challenge its viability.

200

See

Comment Letter of Russell Investment Management, LLC (May 3, 2019) (“Russell Comment Letter”).

See also

Comment Letter of Mutual Fund Directors Form (May 2, 2019) (“MFDF Comment Letter”) (stating that the proposed limit may limit the desire of acquiring funds to buy large stakes in acquired funds, thus disincentivizing innovation).

201

See

Voya Comment Letter.

Some commenters predicted that the proposed redemption limit would have a chilling effect on acquiring funds using mutual funds in their allocations and would effectively codify the limits set forth in sections 12(d)(1)(A) and (B) of the Act as the maximum investment in unrelated acquired funds.

202

Other commenters indicated that acquiring funds would restructure to avoid the proposed redemption limitation, including investing in a larger number of funds in order to hold smaller proportions of each acquired fund, or relying more on ETFs.

203

202

See

Capital Group Comment Letter.

203

See, e.g.,

ABA Comment Letter; Comment Letter of Chapman and Cutler LLP (May 2, 2019) (“Chapman Comment Letter”); Morningstar Comment Letter; Capital Group Comment Letter.

Same group of investment companies.

Several commenters questioned the need for applying the proposed redemption limit to acquiring funds investing in acquired funds in the same group of investment companies, stating that it would be unnecessary and inappropriate to do so.

204

Some of these commenters highlighted that the proposed rule included exceptions from the voting and control provisions for funds in the same group of investment companies and stated that a similar exception should be included from the redemption limit.

205

One commenter argued that the proposed redemption limit could pose particular challenges for common fund of funds arrangements involving funds within the same group, such as when an acquired fund is exclusively available to acquiring funds managed by the same adviser. As a result, these commenters asserted there would be no colorable risk that the acquiring fund would threaten redemptions to exert undue influence.

206

Another commenter stated that, for affiliated fund of funds arrangements, the common investment adviser's fiduciary duties to both the acquiring and acquired funds would adequately address duplicative and excessive fee concerns.

207

204

See, e.g.,

Allianz Comment Letter; Fidelity Fixed Income Trustees Comment Letter.

205

See, e.g.,

PIMCO Comment Letter; Wells Fargo Comment Letter; Chapman Comment Letter.

206

See

Fidelity Fixed Income Trustees Comment letter (arguing that there is no colorable risk of using the threat of redemptions to bully third-party investors in, or advisers to, such affiliated underlying funds).

207

See

SIFMA AMG Comment Letter.

Liquidity.

Commenters also identified a number of concerns regarding the proposed redemption limit's impact upon the liquidity of the acquiring fund's portfolio. A number of commenters thought that this aspect of the proposal would increase the difficulty of complying with rule 22e-4 by potentially impacting the liquidity categorization of an acquired fund's shares.

208

Some commenters stated that the proposed restriction would impose liquidity constraints on funds, which could become more pronounced if a particular acquired fund is under redemption pressures.

209

Other commenters discussed the impact of the proposed restriction on fund liquidations.

210

208

See, e.g.,

MFDF Comment Le

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