SEC Adopts Final Rule Amendments for Fund-of-Funds Arrangements

October 22, 2020

The Securities and Exchange Commission (SEC) recently adopted a new rule, Rule 12d1-4 (FoF Rule), and related amendments designed to implement a regulatory framework for investments by registered investment companies and business development companies (BDCs) (collectively, funds) in underlying funds.1 The SEC also rescinded Rule 12d1-2 under the Investment Company Act of 1940 (1940 Act) and certain prior fund-of-funds exemptive relief (the substance of which is covered by the new rule) and amended other previously adopted exemptive rules under the 1940 Act relating to fund-of-funds investments.

Section 12(d)(1) and the FoF Rule

Section 12(d)(1)(A) of the 1940 Act2 generally limits a fund (acquiring fund), including a pooled investment vehicle relying on Sections 3(c)(1) or 3(c)(7) of the 1940 Act (private fund), from acquiring more than 3% of an underlying fund’s (acquired fund) outstanding voting securities.3 For funds that are acquiring funds, this section also limits the fund’s exposure to a particular acquired fund to 5% of the fund’s total assets and limits the fund from acquiring shares of acquired funds in an amount exceeding 10% of the fund’s total assets.4

The FoF Rule exempts funds from these limitations, subject to the conditions described below. These conditions are modified versions of conditions included in prior exemptive relief and reflect revisions made by the SEC in response to public comments on the proposed FoF Rule.5

  • Control and voting limitations. The FoF Rule restricts an acquiring fund and its “advisory group” from controlling, individually or in the aggregate, an acquired fund. “Advisory group” for this purpose includes the acquiring fund’s adviser or sub-adviser, and any person controlling, controlled by, or under common control with such adviser or sub-adviser. This effectively prohibits an acquiring fund from acquiring more than 25% of an acquired fund’s outstanding voting securities. Under the FoF Rule, if this 25% ownership level is passively breached (e.g., the acquiring fund’s ownership of shares remains the same but the acquired fund has redeemed more shares than it has sold and therefore has less shares outstanding), the acquiring fund is required to vote its shares in the same proportion as the vote of all other shareholders of the acquired fund (mirror voting) or seek instructions from the acquiring fund’s shareholders as to how to vote its acquired fund shares (pass-through voting). The FoF Rule also requires mirror or pass-through voting when the acquiring fund and its advisory group acquire or hold more than 10% of a CEF or BDC’s outstanding voting securities. These conditions do not apply when the acquiring fund is in the same fund complex as the acquired fund, or when the acquiring fund’s subadviser (or certain of its control affiliates) acts as the acquired fund’s adviser.
  • Required findings and investment agreements. Before an acquiring fund that is a “managed fund” (i.e., a mutual fund, ETF, CEF or BDC) relies on the FoF Rule to acquire more than 3% of an acquired fund’s outstanding voting securities, the advisers to the acquiring fund and the acquired fund are required to make certain findings that relate to certain policy concerns underlying the Section 12(d)(1) fund-of-funds restrictions.
    • The adviser to an acquiring fund must document its evaluations of the complexity of the fund-of-funds structure, the fees and expenses associated with the acquiring fund’s investment in the acquired fund and the extent to which such fees and expenses are duplicative of the acquiring fund’s fees and expenses.
    • The adviser to the acquired fund is required to find that any undue influence concerns are reasonably addressed according to certain factors specified in the FoF Rule itself and other relevant circumstances regarding the acquiring fund’s potential exit from its investment in the acquired fund.
    • The acquiring fund and acquired fund are required to report their respective findings to the applicable board at the next regular meeting.
    • If the acquiring fund and the acquired fund have different advisers, the funds are required to enter into an agreement that contains the basis for the findings noted above and certain termination and disclosure provisions (FoF agreement). The FoF agreement can also include other material terms that are negotiated (e.g., advance notice requirements for redemptions).6
  • Limitations on complex structures. Similar to existing exemptive orders under Section 12(d)(1), the FoF Rule contains provisions designed to limit the creation of multi-tier fund-of-funds structures. The FoF Rule restricts: (i) an acquired fund from investing in other funds or private funds in excess of 10% of the acquired fund’s total assets, subject to limited exceptions for certain types of investments (permitted acquired fund investments);7 and (ii) an acquiring fund from investing in an acquired fund that relies on the FoF Rule (acquired underlying fund) above the limitations of Section 12(d)(1)(A), where the acquiring fund relies on the FoF Rule or Section 12(d)(1)(G), unless the acquired underlying fund’s investments are limited to permitted acquired fund investments.
  • Recordkeeping requirements. Consistent with other exemptive rules and prior exemptive relief, the FoF Rule requires records regarding compliance with the rule’s conditions, including records of FoF agreements and the acquiring fund and acquired fund findings noted above and the bases for such findings.

Other Amendments, Withdrawal of Prior No-Action Letters and Rescission of Prior Exemptive Relief

The SEC rescinded Rule 12d1-2 and amended Rule 12d1-1. With the rescission of Rule 12d1-2, a fund relying on Section 12(d)(1)(G) will no longer have the 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. Rule 12d1-1 was amended to permit an affiliated fund-of-funds relying on Section 12(d)(1)(G) to also rely on that rule to invest in unaffiliated money market funds.

Form N-CEN was revised to require disclosure when an acquiring fund has relied on the FoF Rule or Section 12(d)(1)(G) to invest in acquired funds in excess of Section 12(d)(1) limits during the reporting period.

Prior no-action letters providing relief under specific circumstances related to Section 12(d)(1) and previous exemptive relief providing relief within the scope of relief provided by the FoF Rule will be rescinded one year after the effective date of the FoF Rule.8 Exemptive relief that is within the scope of relief provided by the FoF Rule includes relief granted to ETFs and other fund complexes that permit unaffiliated funds to invest in such funds. The SEC will still consider applications for exemptive relief from Section 12(d)(1) limitations that is outside of the scope of the FoF Rule.

Compliance Dates

The FoF Rule will be effective 60 days after it is published in the Federal Register. Amendments to Form N-CEN will be effective one year following the FoF Rule’s effective date, which means reports filed on that form after the Form N-CEN compliance date will need to comply with the amendments. ETFs that rely on Rule 6c-11 under the 1940 Act and funds that invest in such ETFs will have one year from the FoF Rule’s effective date to come into compliance with the rule. The release adopting rule 6c-11 permitted such funds to rely on the Section 12(d)(1) relief contained in recent exemptive orders previously issued to ETFs, pending the adoption of the FoF Rule or a similar rule.

S&K Observations

The FoF Rule generally provides the same relief as exemptive relief from Section 12(d)(1) previously issued by the SEC and largely incorporates the conditions of those orders, which should be beneficial for fund complexes that previously have not received such relief. By including BDCs and CEFs within the FoF Rule’s scope, the new rule presents opportunities for fund-of-funds strategies that may not previously have been considered by fund sponsors.

The SEC revised the conditions in the final FoF Rule to be less burdensome than those initially proposed. In contrast to the proposed FoF Rule, the FoF Rule does not mandate that an acquired fund impose redemption limitations on acquiring funds that rely on the FoF Rule. In lieu of this limitation, however, the SEC has required an acquiring fund and an acquired fund to make certain findings regarding the concerns underlying Section 12(d)(1) and, in circumstances where the funds do not share the same adviser, enter into an FoF agreement, which will likely result in variations across fund sponsors regarding approaches to document compliance with this condition. These factors may be the subject of future guidance as they are largely tailored to open-end fund fund-of-funds structures, but also apply to other types of funds such as CEFs and BDCs.


1 Final Rule: Fund of Funds Arrangements, SEC Rel. No. IC-34045 (Oct. 7, 2020) (Adopting Release), available at

2 Section 60 of the 1940 Act applies the provisions of Section 12 of the 1940 Act to BDCs to the same extent that they apply to closed-end funds (CEFs).

3 Section 12(d)(1)(B) of the 1940 Act generally prohibits an acquired fund that is a mutual fund or ETF, its principal underwriter and any broker-dealer from knowingly selling the acquired fund’s voting securities to a fund in excess of the 3% limit contained in Section 12(d)(1)(A). The FoF Rule contains an exemption from this limitation.

4 Section 12(d)(1) contains certain statutory exemptions, such as exemptions for affiliated fund-of-funds arrangements and master-feeder arrangements in Section 12(d)(1)(G). An acquiring fund investing in an acquired fund that is an exchange-traded fund (ETF) is also limited by the affiliated transaction limitations under the 1940 Act from creating and redeeming in-kind with the ETF through an authorized participant in certain instances, such as where the acquiring fund holds more than 5% of the ETF’s shares.

5 Adopting Release at 33.

6 The Adopting Release indicates that a FoF agreement will be considered a material contract and therefore must be filed as an exhibit to each fund’s registration statement. Adopting Release at 102.

7 Permitted underlying fund investments are: (i) a master fund in certain types of master-feeder fund structures; (ii) a money market fund in reliance on Rule 12d1-1; (iii) a subsidiary that is wholly-owned and controlled by the acquired underlying fund; (iv) securities received as a dividend or as a result of a plan of reorganization; or (v) fund shares received pursuant to interfund lending exemptive relief.

8 The specific no-action letters that will be withdrawn will appear on the SEC’s website at As of the date of this memorandum, the specific no-action letters that are being withdrawn have not been listed on that website.