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.1 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. But 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.
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.” 2
Below, we’ll provide a brief overview outlining some changes and conditions of the new rule.
Rule 12d1-4 includes the following changes3:
The main conditions of Rule 12d1-4 fall into four categories3:
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. But in other cases, these conditions differ considerably. Navigating from old to new frameworks will require thoughtful consideration.
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.