US Regulatory Brief: SEC adopts new rules and amendments for fund of funds investments and disclosure

The US SEC has adopted three new rules and amendments to several forms under the Investment Company Act that address "fund of funds arrangements."

The new rules, adopted on 20 June 2006, will codify several exemptions from the Act that the Securities and Exchange Commission has issued over the years, and will provide greater transparency of expenses investors in these arrangements pay.

Fund of funds arrangements are created when a mutual fund or other type of investment company invests in shares of another investment company. The Investment Company Act imposes restrictions on these arrangements to prevent abusive "pyramiding" schemes.

The Commission is adopting two types of regulatory changes:

1. Three new rules codify exemptions the Commission has issued by order over the past decade in circumstances that do not create risks for the fund or investors.

  • Rule 12d-1-1 permits "cash sweep arrangements," under which a stock or bond fund may invest its available cash in a money market fund.
  • Rule 12d-2 permits greater flexibility to a fund of funds arrangement that invests exclusively or primarily in funds in the same fund group.
  • Rule 12d-3 permits greater flexibility for a fund that invests small amounts in many unaffiliated funds to structure the sales load it charges (but does not increase the overall amount charged).

Funds and their advisers will no longer have to file routine exemptive applications in these circumstances, eliminating the need for SEC staff review of the applications and allowing staff more time to focus on exemptive applications that present new issues.

2. Amendments to Forms N-1A, N-2, N-3, N-4, and N-6 require a registered fund that invests any of its assets in another fund, including an unregistered fund such as a hedge fund, to disclose in its fee table the cumulative amount of expenses charged by the fund and any fund in which it invests. Currently, the fee table information does not generally include information about fees and expenses charged by the funds in which the fund of funds invests. The increased transparency of fund of funds expenses is intended to allow investors to understand and more easily to compare the relative costs of different fund of funds arrangements.

New rules 12d1-1, 12d1-2, and 12d1 3 will become effective on 31 July 2006. All new registration statements on Forms N-1A, N-2, N-3, N-4, and N-6, and all post-effective amendments that are annual updates to effective registration statements on any of those forms filed on or after 2 January 2007, must include the disclosure required by the form amendments.

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