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October 14, 2003
TO: SEC RULES COMMITTEE No. 81-03
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 51-03
UNIT INVESTMENT TRUST COMMITTEE No. 20-03
RE: SEC PROPOSAL RELATING TO FUND OF FUNDS INVESTMENTS
The SEC has proposed three new rules under the Investment Company Act of 1940
(“Act”) that would broaden the ability of an investment company to invest in shares of another
investment company under “fund of funds” arrangements.1 The SEC also is proposing
amendments to several forms used by investment companies that would increase the
transparency of the expenses of funds of funds. The proposed rules would codify and expand
upon a number of exemptive orders the SEC has issued that permit funds to invest in other
funds. The most significant aspects of the proposal are summarized below.
Comments on the proposal must be received by the SEC no later than December 3,
2003. We have scheduled a conference call for October 22 at 1 pm Eastern to discuss the
SEC’s proposal and the Institute’s comment letter on the proposal. The dial-in number for
the call will be 888-730-9143 and the pass code for the call will be Fund of Funds/Burstein. If
you, or someone else from your organization, plans to participate on the conference call,
please contact Monica Carter-Johnson by phone at 202-326-5823 or by e-mail at
mcarter@ici.org.
I. Proposed Rule 12d1-1 – Investments in Money Market Funds
Proposed Rule 12d1-1 would codify SEC exemptive orders to permit funds to enter into
“cash sweep” arrangements in which a fund invests all or a portion of its available cash in a
money market fund. In particular, the proposed rule would provide exemptions from Sections
12(d)(1), 17(a) and 17(b) of the Act, as well as Rule 17d-1 thereunder, to permit funds to invest
in affiliated money market funds. In addition, the proposal would expand upon exemptive
orders to permit funds to invest cash in unaffiliated money market funds and would codify
exemptive orders that permit funds to invest in unregistered money market funds. The
proposed rule’s exemption would be available only for investments in an unregistered money
1 Investment Company Act Release No. 26198 (October 1, 2003), 68 FR 58226 (October 8, 2003) (“Release”). The
Release can be found on the SEC’s website at http://www.sec.gov/rules/proposed/33-8297.htm.
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market fund that operates like a money market fund registered under the Act.2 The proposed
rule also would be available to closed-end funds and business development companies, as well
as unregistered funds, to permit them to invest available cash in a money market fund.
The proposal would eliminate most of the conditions included in exemptive orders
provided to cash sweep arrangements.3 It would retain, however, one of the conditions
contained in exemptive orders relating to fees. In particular, under proposed Rule 12d1-1, the
acquiring fund either would not pay any sales load, distribution fees, or service fees on
acquiring fund shares, or, if it did, the acquiring fund’s investment adviser would have to waive
a sufficient amount of its advisory fee to offset the cost of the loads or distribution fees.4
II. Proposed Rule 12d1-2 – Affiliated Funds of Funds
Section 12(d)(1)(G) of the Act permits a registered fund to acquire an unlimited amount
of shares of registered open-end funds and UITs that are part of the same “group of investment
companies” as the acquiring fund. Proposed Rule 12d1-2 would provide relief from Section
12(d)(1)(G) limitations on investments an affiliated fund of funds can make. In particular,
proposed Rule 12d1-2 would codify, and in some cases expand, relief provided to affiliated
funds of funds relating to investments in unaffiliated funds, investments in other types of
issuers, and investments in money market funds.
Specifically, proposed Rule 12d1-2 would permit an affiliated fund of funds to acquire
up to three percent of the securities of funds that are not part of the same group of investment
companies, subject to the limits in Sections 12(d)(1)(A) or 12(d)(1)(F) of the Act.5 The proposed
2 Specifically, an unregistered money market fund would be required to (i) limit its investments to those in which a
money market fund may invest under Rule 2a-7 under the Act, and (ii) undertake to comply with all the other
provisions of Rule 2a-7. In addition, the acquiring fund would have to “reasonably believe” that the unregistered
money market fund operates like a registered money market fund and that it complies with certain provisions of the
Act. Finally, the unregistered money market fund’s adviser would be required to register as an investment adviser
with the SEC.
3 For example, the proposed rule would not preclude a fund from investing more than 25 percent of its assets in
shares of money market funds and would, instead, rely on a fund's own investment restrictions to provide
appropriate limitations. The proposed rule also would not require directors to make any special findings that
investors are not paying multiple advisory fees for the same services.
4 The SEC requests comment on several aspects of proposed Rule 12d1-1. Among other things, the SEC asks whether
any special concerns arise with respect to unregistered funds’ use of registered money market funds in cash sweep
arrangements; whether the SEC should retain any of the other conditions contained in its exemptive orders; whether
the sponsors, advisers, or directors of money market funds have any concerns about other funds making large
investments in their money market funds; and whether there should be restrictions on the ability of an acquiring
fund to redeem shares or vote shares of a money market fund that is not part of the same group of investment
companies.
5 A fund relying on section 12(d)(1)(A) (together with any companies or funds it controls) could not acquire more
than 3 percent of the securities of any other fund in a different fund group. In addition, the acquiring fund would be
limited to investing no more than 5 percent of its own assets (together with assets of any companies it controls) in the
securities of any one fund in a different fund group, and no more than 10 percent of its assets (together with assets of
any companies it controls) in securities of other funds in one or more different fund groups, in the aggregate. A fund
relying on Section 12(d)(1)(F) (together with its affiliates), could not acquire more than 3 percent of the securities of
any other fund in a different fund group. The acquiring fund also would be required either to seek instructions from
its shareholders as to how to vote shares of those acquired funds, or to vote the shares in the same proportion as the
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rule also would permit an affiliated fund of funds to invest in any other securities (i.e., securities
not issued by a fund).6 This exemption would permit an affiliated fund of funds to invest
directly in stocks, bonds, and other types of securities if such investments are consistent with
the fund’s investment policies. Finally, proposed Rule 12d1-2 would permit an affiliated fund
of funds to invest in affiliated or unaffiliated money market funds in reliance on proposed Rule
12d1-1. The Release states that the SEC is conditioning the investment on compliance with
proposed Rule 12d1-1 in order to ensure that the same limitations on sales loads and
distribution expenses apply to any fund’s investment in a money market fund.7
III. Proposed Rule 12d1-3 – Unaffiliated Funds of Funds
Proposed Rule 12d1-3 would codify SEC exemptive orders permitting funds relying on
Section 12(d)(1)(F) of the Act8 to charge a sales load in excess of 1½ percent, provided the
aggregate sales loads on acquiring and acquired fund shares are not excessive under the NASD
Sales Charge Rule. This exemption also would be available to an affiliated fund of funds
relying on proposed Rule 12d1-2 to invest in funds in a different fund group.
IV. Amendments to Investment Company Act Forms
The SEC is proposing amendments to Forms N-1A, N-2, N-3, N-4, and N-6 that would
require that investors in a registered fund of funds receive increased disclosure of the costs of
investing in these arrangements.
Under proposed amendments to Form N-1A, any registered open-end fund investing in
shares of another fund would be required to include in the fee table in its prospectus an
additional line item under the section that discloses annual operating expenses. The line item
would set forth the acquiring fund’s pro rata portion of the cumulative expenses charged by
funds in which the acquiring fund invests.
The SEC also is proposing instructions to the fee table to assist an acquiring fund in
determining the amount of fees and expenses associated with acquired funds that must be
reflected in the acquiring fund’s fee table. The calculation would require the acquiring fund to
vote of all other shareholders of the acquired fund. In addition, the acquiring fund would be limited to charging a
sales load of 1½ percent on its shares and would be prevented from redeeming more than 1 percent of the shares of
any acquired fund during any period of less than 30 days.
6 Currently, in order to rely on the exemption provided by Section 12(d)(1)(G), investments other than shares of funds
in the same group of investment companies are only permitted to include government securities and short-term
paper.
7 The SEC requests comment on several aspects of the proposed rule, including whether there are greater risks to an
acquired fund if the investor in these circumstances is an affiliated fund of funds; and whether there are reasons not
to permit an affiliated fund of funds to invest its assets in any securities other than affiliated funds, government
securities, or short-term paper.
8 As discussed above, Section 12(d)(1)(F) of the Act provides an exemption from Section 12(d)(1)(A) that allows a
registered fund to invest all its assets in other registered funds if: (i) the acquiring fund (together with its affiliates)
acquires no more than 3 percent of any acquired fund; and (ii) the sales load charged on the acquiring fund’s shares is
no greater than 1½ percent.
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aggregate the operating expenses of acquired funds and transaction costs and express them as a
percentage of average net assets of the acquiring fund. Under this approach, the acquiring fund
would calculate the average invested balance and number of actual days invested in each
acquired fund. Expenses of an acquired fund that is part of the same group of investment
companies would reflect actual expenses of the fund. Expenses of other funds may be based on
annual expenses reported in the most recent report or other communication received by the
fund of funds.
The proposed amendment to Form N-2 would require registered closed-end funds that
invest in other funds to provide the same disclosure.9 The proposed amendment to Form N-3
would require the same disclosure for separate accounts organized as management investment
companies that offer variable annuity contracts. Finally, Forms N-4 and N-6 currently require
separate accounts organized as UITs that offer variable annuity and variable life contracts,
respectively, to disclose the range of minimum and maximum operating expenses of the
portfolio companies in which they invest. The proposed amendment to each of these forms
would require a separate account organized as a UIT that invests in a portfolio company that
itself invests in other funds, to include the portfolio company’s costs of investing in other funds
in the portfolio company's operating expenses disclosed in the N-4 or N-6 fee table.10
Ari Burstein
Associate Counsel
9 The Release states that because the SEC also is proposing to amend Form N-2, a registered closed-end fund of hedge
funds would be required to include a pro rata portion of the hedge funds’ expenses in its fee table. In the case of a
newly offered fund, including a newly offered fund of hedge funds, the fee table would reflect expenses the fund
expects to incur based on its initial investments.
10 The SEC requests comment on several aspects of the proposed disclosure. Among other things, the SEC asks
whether the instructions are consistent with the current fee table; whether there is another way to determine acquired
funds’ fees and expenses that would provide better disclosure of these costs; whether the average invested balance
should be calculated on a more frequent basis than monthly; and whether there is a basis for treating disclosure of
unregistered and registered fund expenses differently.