SEC broadens fund of funds arrangement landscape

The Securities and Exchanges Commission adopted a new and related amendments Wednesday to allow fund managers to acquire the shares of another fund without obtaining an individual exemptive order.

The rule and amendments tare aimed at modernizing the current fund of funds regulatory framework, SEC Chairman Jay Clayton said in a news release. “Main Street investors have increasingly used mutual funds, exchange-traded funds and other types of funds to access our markets and invest for their future,” Mr. Clayton said. “To achieve asset allocation, diversification and other objectives, many funds have also invested in other funds. Today’s action will enhance and modernize the regulatory framework for these arrangements.”

The SEC estimates that about 40% of all registered funds hold an investment in at least one other fund and total net assets in mutual funds that invest primarily in other mutual funds have grown to $2.5 trillion in 2019, up from $469 billion in 2008.

Under the rule, a registered investment company or business development company are permitted to acquire the securities of any other registered investment company or BDC in excess of the limits outlined in the Investment Company Act if certain conditions are met. The act prohibits funds from acquiring more than 3% of another fund’s outstanding voting securities; investing more than 5% of its total assets in any one fund; or investing more than 10% of its total assets in funds generally.

The rule’s conditions include limits on control and voting; required evaluations and findings; and an obligation for funds that do not share the same investment adviser to enter into a fund of funds investment agreement memorializing the terms of the arrangement.

Open-end funds, unit investment trusts, closed-end funds (including BDCs), exchange-traded funds and exchange-traded managed funds will all be able to rely on the rule as both acquiring and acquired funds, the SEC said.

The rule will be effective 60 days after publication in the Federal Register, but the compliance dates for certain amendments will take place in a year or more.