Conformed to Federal Register version 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.];1 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. Table of Contents Introduction ............................................................................................................................... 3 A. Regulatory Context ............................................................................................................. 6 B. Rule 12d1-4 Overview ...................................................................................................... 10 Discussion ............................................................................................................................... 12 A. Scope ................................................................................................................................. 12 B. Exemptions from the Act’s Prohibition on Certain Affiliated Transactions .................... 25 C. Conditions ......................................................................................................................... 33 D. Rescission of Rule 12d1-2 and Amendment to Rule 12d1-1 .......................................... 126 E. Disclosures Relating to Fund of Funds Arrangements ................................................... 133 F. Compliance Dates ........................................................................................................... 137 Rescission of Exemptive Relief; Withdrawal of Staff Letters .............................................. 137 Other Matters ........................................................................................................................ 153 Economic Analysis ............................................................................................................... 153 A. Introduction ..................................................................................................................... 153 B. Economic Baseline .......................................................................................................... 154 C. Benefits and Costs and Effects on Efficiency, Competition, and Capital Formation ..... 176 D. Reasonable Alternatives .................................................................................................. 226 Paperwork Reduction Act ..................................................................................................... 239 A. Introduction ..................................................................................................................... 239 B. Rule 12d1-4 ..................................................................................................................... 240 1 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]. 2 C. Rule 0-2 ........................................................................................................................... 251 D. Form N-CEN ................................................................................................................... 252 Final Regulatory Flexibility Analysis ............................................................................. 253 A. Need for and Objectives of the Rule and Form Amendments ........................................ 253 B. Significant Issues Raised by Public Comments .............................................................. 254 C. Small Entities Subject to the Rule .................................................................................. 256 D. Projected Board Reporting, Recordkeeping, and Other Compliance Requirements ...... 257 E. Agency Action to Minimize Effect on Small Entities .................................................... 260 Statutory Authority ......................................................................................................... 262 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.2 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. 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,3 and total net assets in mutual 2 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). 3 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. 3 funds that invest primarily in other mutual funds have grown from $469 billion in 2008 to $2.54 trillion in 2019.4 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.5 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.6 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 4 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. 5 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). 6 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