An overview of the fund of funds rule: Rule 12d1-4

March 31, 2021

Examine the challenges and opportunities Rule 12d1-4 presents for fund of funds investment structures.

The U.S. Securities and Exchange Commission (SEC) estimates about 40% of all registered funds hold an investment in at least one other registered fund. While some funds are extensively engaged in this fund of funds investment structure, others may shy away because of its complicated regulatory implications. However, with the recent implementation of Rule 12d1-4, more managers may start taking advantage of the fund of funds investment opportunity.

For some fund groups, the rule offers an improvement over the assortment of strategies used in past years to manage a fund of funds because it creates a more organized and comprehensive structure. However, the new rule will not necessarily simplify fund management as it imposes new conditions that may outweigh its benefits. Existing fund of funds investments will likely require a strategic portfolio adjustment in order to comply with the rule’s conditions. 


Regulatory obstacles prior to Rule 12d1-4

Before the adoption of Rule 12d1-4, as explained by the SEC in its adopting release, the regulatory regime that existed created a situation where “substantially similar fund of funds arrangements [were] 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.”

Below, we’ll provide a brief overview outlining some changes and conditions of the new rule. 


Key changes

Rule 12d1-4 includes the following changes:

  • Section 12(d)(1) of the 1940 Act limits the amount an acquiring fund can invest in an acquired fund to 3% of the outstanding voting stock of the acquired fund, 5% of the value of the acquiring fund’s total assets in any one other acquired fund, and 10% of the value of the acquiring fund’s total assets in all other acquired funds in the aggregate. 
  • Some flexibility to invest beyond these limitations has been allowed by statutory exemptions, but where these have been insufficient, rules were added over time to the basic statutory structure. In addition, over time, many funds also received, or relied on, various forms of relief issued by the SEC. In this relief, the SEC imposed various conditions. So, in order to invest beyond the 3/5/10 limits, a fund could have relied on a statutory exemption or rule, no-action letters, various forms of exemptive relief from the SEC, or a combination of these. 
  • The new Rule 12d1-4 is meant to provide a more consistent and equitable structure. It will permit any registered investment company (open-end fund, ETF, UIT or closed-end fund) or BDC to acquire securities of any other registered investment company or BDC in excess of the 3/5/10 limits, without obtaining an exemptive order (subject to certain conditions). 


Key conditions

The main conditions of Rule 12d1-4 fall into four categories:

  1. Limits on control and voting of acquired funds’ shares, generally designed to prevent an acquiring fund from controlling an acquired fund 
  2. A requirement that investment advisers (to both acquiring and acquired funds) undertake certain evaluations and make certain findings prior to the initial acquisition 
  3. A requirement that the acquiring and acquired funds enter into an investment agreement, containing specific provisions, before investing beyond the limitations of Section 12(d)(1) 
  4. Limits on the ability of funds to establish complex (three-tiered) fund of funds structures

There are also conditions related to recordkeeping and disclosure. In some cases, the set of conditions imposed by the new rule are substantively the same as conditions imposed in prior exemptive orders. In other cases, these conditions differ considerably. Navigating from old to new frameworks will require thoughtful consideration. 


Looking ahead

With the introduction of Rule 12d1-4 and its conditions, the SEC is withdrawing existing relief and rescinding Rule 12d1-2 on which many fund of funds previously relied. While the field of rules for fund of funds is now small and defined (i.e.¸ funds can either rely on Section 12(d)(1)(G) or Rule 12d1-4), for some funds, the conditions of Rule 12d1-4 could present more challenges than benefits.

At U.S. Bank Global Fund Services, we’re here to help clients in both categories understand and take advantage of the new fund of funds rule. We’re creating board reporting tools, developing best practice guidelines and identifying frequently asked questions to help our clients navigate the process. We’re also working with our internal teams and external vendors to update our compliance monitoring capabilities and Form N-CEN reporting requirements.


This overview of Rule 12d1-4 serves to highlight its importance, but only hints at its impact and implications. We look forward to deepening and sharing our expertise as the consequences of this change unfold. Visit us at to learn more about how we can help support your funds.

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U.S. Bank Global Fund Services is a wholly owned subsidiary of U.S. Bank, N. A. Custody and lending services are offered by U.S. Bank, N.A. 

U.S. Bank Global Fund Services (Ireland) Limited is registered in Ireland, Company Number 413707. Registered Office at 24 - 26 City Quay, Dublin 2, Ireland. Directors: Linda Gorman, Rose Clear, Brett Meili (USA), Joe Neuberger (USA), Padraic O'Connor, Christine Waldron (USA) U.S. Bank Global Fund Services (Ireland) Limited is regulated by the Central Bank of Ireland.

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