[Federal Register Volume 68, Number 195 (Wednesday, October 8, 2003)]
[Proposed Rules]
[Pages 58226-58247]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-25336]



[[Page 58225]]

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Part III





Securities and Exchange Commission





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17 CFR Parts 239, 274, and 275



Fund of Funds Investments; Proposed Rule

  Federal Register / Vol. 68, No. 195 / Wednesday, October 8, 2003 / 
Proposed Rules  

[[Page 58226]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 274, and 275

[Release Nos. 33-8297; IC-26198; File No. S7-18-03]
RIN 3235-AI30


Fund of Funds Investments

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rules.

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SUMMARY: The Commission is proposing three new rules under the 
Investment Company Act of 1940 that address the ability of an 
investment company to acquire shares of another investment company. 
Section 12(d)(1) of the Act prohibits, subject to certain exceptions, 
so-called ``fund of funds'' arrangements, in which one investment 
company invests in the shares of another. The proposed rules would 
broaden the ability of an investment company to invest in shares of 
another investment company consistent with the protection of investors 
and the purposes of the Act. The Commission also is proposing 
amendments to forms used by investment companies to register under the 
Investment Company Act and offer their shares under the Securities Act 
of 1933. The proposed amendments would improve the transparency of the 
expenses of funds of funds by requiring that the expenses of the 
acquired funds be aggregated and shown as an additional expense in the 
fee table of the fund of funds.

DATES: Comments must be received by December 3, 2003.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by hard copy or e-mail, but not by 
both methods. Comments sent by hard copy should be submitted in 
triplicate to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 5th Street, NW., Washington, DC 20549-0609. Comments 
also may be submitted electronically to the following E-mail address: 
[email protected]. All comment letters should refer to File No. S7-
18-03; this file number should be included on the subject line if E-
mail is used. Comment letters will be available for public inspection 
and copying in the Commission's Public Reference Room, 450 5th Street, 
NW., Washington, DC 20549. Electronically submitted comment letters 
will be posted on the Commission's Internet Web site (http://www.sec.gov).\1\
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    \1\ We do not edit personal, identifying information, such as 
names or E-mail addresses, from electronic submissions. Submit only 
information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Penelope W. Saltzman, Senior Counsel, 
or C. Hunter Jones, Assistant Director, Office of Regulatory Policy, 
(202) 942-0690, Division of Investment Management, Securities and 
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Exchange Commission, 450 5th Street, NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission (the 
``Commission'') today is proposing for public comment new rules 12d1-1 
[17 CFR 270.12d1-1], 12d1-2 [17 CFR 270.12d1-2], and 12d1-3 [17 CFR 
270.12d1-3] under the Investment Company Act of 1940 [15 U.S.C. 80a] 
(the ``Investment Company Act'' or the ``Act'') that address the 
ability of an investment company (``fund'' or ``acquiring fund'') 
registered under the Act to invest in shares of another investment 
company (``fund'' or ``acquired fund''). We also are proposing 
amendments to Forms N-1A [17 CFR 239.15A; 17 CFR 274.11A], N-2 [17 CFR 
239.14; 17 CFR 274.11a-1], N-3 [17 CFR 239.17a; 17 CFR 274.11b], N-4 
[17 CFR 239.17b; 17 CFR 274.11c], and N-6 [17 CFR 239.17c; 17 CFR 
274.11d] to require that prospectuses of funds of funds disclose all of 
the expenses investors in the fund will bear, including those of any 
acquired funds. Forms N-1A and N-2 are the registration forms used by 
open-end management funds and closed-end management funds, 
respectively, to register under the Act and to offer their shares under 
the Securities Act of 1933 [15 U.S.C. 77a] (``Securities Act''). Form 
N-3 is the registration form used by separate accounts that are 
organized as management investment companies and offer variable annuity 
contracts to register under the Act and to offer their shares under the 
Securities Act. Forms N-4 and N-6 are the forms used by separate 
accounts organized as unit investment trusts (``UITs'') that offer 
variable annuity and variable life insurance contracts, respectively, 
to register under the Act and to offer their shares under the 
Securities Act.

Table of Contents

I. Background
II. Discussion
    A. Rule 12d1-1: Investments in Money Market Funds
    1. Scope of Exemption
    2. Conditions
    B. Rule 12d1-2: Affiliated Funds of Funds
    1. Investments in Unaffiliated Funds
    2. Investments in Other Types of Issuers
    3. Investments in Money Market Funds
    C. Rule 12d1-3: Unaffiliated Funds of Funds
    D. Amendments to Forms N-1A, N-2, N-3, N-4, and N-6
III. General Request for Comments
IV. Cost-Benefit Analysis
    A. Background on Proposed Rules 12d1-1, 12d1-2, and 12d1-3
    1. Benefits
    2. Costs
    B. Proposed Amendments to Forms N-1A, N-2, N-3, N-4, and N-6
    1. Benefits
    2. Costs
    C. Request for Comments
V. Paperwork Reduction Act
    A. Proposed Rule 12d1-1
    B. Forms for Registration Statements
    1. Form N-1A
    2. Form N-2
    3. Form N-3
    4. Form N-4
    5. Form N-6
    C. Request for Comments
VI. Consideration of Promoting of Efficency, Competition, and 
Capital Formation
    A. Proposed Rules 12d1-1, 12d1-2, and 12d1-3
    B. Proposed Amendments to Forms N-1A, N-2, N-3, N-4, and N-6
    C. Request for Comment
VII. Summary of Initial Regulatory Flexibility Analysis
VIII. Statutory Authority
Text of Proposed Rules and Form Amendments

I. Background

    Today, the federal securities laws restrict substantially the 
ability of a fund to invest in shares of other funds. Before the 
enactment of the Investment Company Act in 1940, however, a fund was 
free to purchase an unlimited number of shares of another fund. These 
``fund of funds'' arrangements yielded numerous abuses, which were 
catalogued in the Commission's study of funds that preceded the Act 
(``Investment Trust Study'').\2\
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    \2\ Investment Trusts and Investment Companies, Report of the 
Securities and Exchange Commission, pt. 3, ch. 7, H.R. Doc. No. 136, 
77th Cong., 1st Sess. 2721-95 (1941).
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    Using a relatively small amount of money, individuals could acquire 
control of a fund and use its assets to acquire control of the assets 
of another fund, which, in turn, could use its assets to control a 
third fund.\3\ As a result, a few individuals effectively could control 
millions of dollars in shareholder assets invested in various acquired 
funds. These ``pyramiding'' schemes were used to enrich the individuals 
at the expense of fund shareholders in a number of ways. In some cases, 
controlling individuals caused the acquired funds to purchase 
securities in companies in which the

[[Page 58227]]

individuals had an interest. In other cases, these individuals caused 
funds to direct underwriting and brokerage business to broker-dealers 
they controlled--often on terms favorable to the broker-dealer. 
Controlling persons also profited when fund shareholders paid excessive 
charges due to duplicative fees at the acquiring and acquired fund 
levels.\4\
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    \3\ See Investment Trust Study, supra note 2, pt. 3, ch. 4, at 
1031-39 and 1040-41, nn. 58-59 (discussing how individuals and other 
investors were able to make relatively small investments and gain 
control of funds); ch. 7, at 2742-50.
    \4\ See Investment Trust Study, supra note 2, pt. 3, ch. 7, at 
2725-39, 2760-75.
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    The complex structures that resulted from pyramiding created 
additional problems for shareholders. These structures permitted 
acquiring funds to circumvent investment restrictions and limitations, 
and made it impossible for shareholders to understand who really 
controlled the fund or the true value of their investments.\5\ A fund 
shareholder might know that he owned shares in a fund that invested in 
equity securities of large companies without understanding that the 
large companies were large funds that exposed him to substantial risks 
associated with smaller issuers, foreign currencies, or interest 
rates.\6\
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    \5\ See id. at 2776-77 (discussing examples of fund investment 
policy changes that conformed to management interests), 2781-82 
(discussing examples of management policies that resulted in 
confusing or misleading asset valuations).
    \6\ See id. at 2721-95.
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    In response to these findings in the Investment Trust Study, 
Congress included in the Act a provision designed to restrict fund of 
funds arrangements. As originally enacted, section 12(d)(1) prohibited 
a registered investment company (and any companies it controlled) from 
purchasing more than five percent of the outstanding shares of any fund 
that concentrated its investments in a particular industry, or more 
than three percent of the shares of any other type of fund.\7\
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    \7\ See Pub. L. No. 76-768, 54 Stat. 789, 809-10 Sec.  12(d)(1) 
(1940) (codified at 15 U.S.C. 80a-12(d)(1) (1940)).
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    Section 12(d)(1) proved flawed, however, because it did not prevent 
unregistered investment companies from acquiring the securities of 
registered funds. In the 1960s, Fund of Funds, Ltd., an unregistered 
fund operated in Geneva, Switzerland, began to exploit that flaw by 
marketing to members of the U.S. military stationed overseas shares of 
foreign investment companies that had controlling interests in several 
registered U.S. funds.\8\ Fund of Funds, Ltd. engaged in many of the 
abusive activities identified in the Investment Trust Study. These 
included charging duplicative advisory fees at the acquiring and 
acquired fund levels, providing sales loads to an affiliated broker for 
each investment the acquiring fund made in an acquired fund, and 
directing brokerage business to an affiliate of the fund of funds 
(which then rebated half the commission).\9\ In addition, Fund of 
Funds, Ltd. could exert undue influence on the management of acquired 
funds by threatening advisers to those funds with large 
redemptions.\10\
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    \8\ See H.R. Rep. No. 1382, 91st Cong., 2d Sess., 23 (1970) 
(``H.R. Rep. No. 1382''); Charles Raw, et al., Do You Sincerely Want 
to be Rich? 61-66 (1971). Fund of Funds, Ltd. was incorporated in 
Ontario, Canada. See Public Policy Implications of Investment 
Company Growth, H.R. Rep. No. 2337, 89th Cong., 2d Sess., 312-24 
(1966) (``1966 Study'').
    \9\ See Arthur Lipper Corp. et al. v. SEC, Securities Exchange 
Act Release No. 11773, 46 S.E.C. 78 (Oct. 24, 1975), sanction 
modified, 547 F.2d 171 (2d Cir. 1976).
    \10\ See 1966 Study, supra note 8, at 315-16.
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    In 1970, Congress revisited section 12(d)(1) of the Act. Among 
other things, it tightened the restrictions on funds of funds and 
extended them to unregistered funds that invest in registered 
funds.\11\ Today, funds are subject to two sets of prohibitions. First, 
section 12(d)(1)(A) prohibits a registered fund (and companies or funds 
it controls) from--
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    \11\ See Pub. L. No. 91-547, 84 Stat. 1413, 1417 Sec.  7 (1970) 
(``1970 Amendments'') (codified at 15 U.S.C. 80a-12(d)(1)(A)). See 
also Sen. Rep. No. 184, 91st Cong., 1st Sess., at 31 (1969) (``Sen. 
Rep. No. 184'').
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    [sbull] Acquiring more than three percent of a fund's voting 
securities;
    [sbull] Investing more than five percent of its total assets in any 
one acquired fund; or
    [sbull] Investing more than ten percent of its total assets in all 
acquired funds.\12\
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    \12\ See 15 U.S.C. 80a-12(d)(1)(A). If the acquiring fund is not 
registered under the Act, the prohibitions apply only with respect 
to its acquisition of securities in funds that are registered under 
the Act.
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    Second, section 12(d)(1)(B) prohibits a registered open-end fund 
from selling securities to any fund (including unregistered funds) if, 
after the sale, the acquiring fund would--
    [sbull] Together with companies and funds it controls, own more 
than three percent of the acquired fund's voting securities; or
    [sbull] Together with other funds (and companies they control) own 
more than ten percent of the acquired fund's voting securities.\13\
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    \13\ See 15 U.S.C. 80a-12(d)(1)(B).
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    By limiting the sale of registered fund shares to other funds, 
section 12(d)(1)(B) prevents the creation of a fund of registered funds 
regardless of the limitations of U.S. law to regulate the activities of 
foreign funds, such as Fund of Funds, Ltd. Together, these two 
provisions of section 12(d)(1) have proven quite effective in putting a 
stop to the abusive practices that characterized previous fund of funds 
arrangements.
    Congress recognized that these restrictions would have the effect 
of preventing legitimate fund of funds arrangements and has, over the 
years, created three exceptions under which different types of fund of 
funds arrangements are permitted today:
    Conduit Arrangements. The Act permits arrangements under which a 
registered fund invests all of its assets in shares of one other fund 
so that the acquiring fund is, in effect, a conduit through which 
investors may access the acquired fund.\14\ The exception currently 
provided in section 12(d)(1)(E) was originally designed to preserve the 
arrangements under which periodic payment plan certificates were 
issued.\15\ Today, this section is relied upon by most insurance 
company separate accounts, which are organized as UITs,\16\ and invest 
the proceeds from the sale of interests in variable annuity and 
variable life insurance contracts in shares of a mutual fund.\17\ This 
exemption also is used by ``master-feeder funds''--arrangements in 
which two or more funds with identical investment objectives pool their 
assets by investing in a single fund with the same investment 
objective. Investors purchase securities in the ``feeder''

[[Page 58228]]

fund, which is an open-end fund and a conduit to the ``master'' 
fund.\18\
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    \14\ See 15 U.S.C. 80a-12(d)(1)(E).
    \15\ The exception for periodic payment plan arrangements 
originally was set forth in section 12(d)(1)(B). Section 12(d)(1)(E) 
was added by the 1970 Amendments. See S. Rep. No. 184, supra note 
11, at 31; 1970 Amendments, supra note 11, Sec.  7 (codified at 15 
U.S.C. 80a-12(d)(1)(E)). Section 12(d)(1)(E) permits a fund's 
acquisition of securities issued by another fund provided that (i) 
the acquiring fund's depositor or principal underwriter is a broker 
or dealer registered under the Securities Exchange Act of 1934, (or 
a person the broker-dealer controls), (ii) the security is the only 
investment security the acquiring fund holds (or the securities are 
the only investment securities the acquiring fund holds if it is a 
registered UIT that issues two or more classes or series of 
securities, each of which provides for the accumulation of shares of 
a different fund), and (iii) the acquiring fund is obligated (a) to 
seek instructions from its shareholders with regard to voting the 
acquired fund's securities or to vote the acquired fund's shares in 
the same proportion as the vote of all other acquired fund 
shareholders, and (b) if unregistered, to obtain Commission approval 
before substituting the investment security.
    \16\ The Act defines a ``unit investment trust'' as a fund that 
(i) is organized under a trust indenture, contract of custodianship 
or agency, or similar instrument, (ii) does not have a board of 
directors, and (iii) issues only redeemable securities, each of 
which represents an undivided interest in a unit of specified 
securities, but does not include a voting trust. 15 U.S.C. 80a-4(2).
    \17\ See Securities and Exchange Commission, Protecting 
Investors: A Half Century of Investment Company Regulation 373-74 
(1992) (``1992 Study''); Request for Comments on Issues Arising 
Under the Investment Company Act of 1940 Relating to Flexible 
Premium Variable Life Insurance, Investment Company Act Release No. 
13632 (Nov. 23, 1983) [48 FR 54043 (Nov. 30, 1983)].
    \18\ See H.R. Rep. No. 622, 104th Cong., 2d Sess., at 41 (1996) 
(``H.R. Rep. No. 622''); Exemption for Open-End Management 
Investment Companies Issuing Multiple Classes of Shares; Disclosure 
by Multiple Class and Master Feeder Funds; Voting on Distribution 
Plans; Final Rules and Proposed Rule, Investment Company Act Release 
No. 20915 (Feb. 23, 1995) [60 FR 11876, 11876-77 (Mar. 2, 1995)]; 
Division of Investment Management, Securities and Exchange 
Commission, Hub and Spoke Funds: A Report Prepared by the Division 
of Investment Management, submitted with letter to the Honorable 
John D. Dingell, Chairman, Committee on Energy and Commerce, U.S. 
House of Representatives from Richard C. Breeden, Chairman, 
Securities and Exchange Commission (Apr. 15, 1992), available in 
LEXIS, Fedsec library, Noact File.
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    Unaffiliated Fund of Funds Arrangements. The Act also permits a 
registered fund to take small positions in an unlimited number of other 
funds (an ``unaffiliated fund of funds'').\19\ A fund taking advantage 
of the exception provided in section 12(d)(1)(F) of the Act (and its 
affiliated persons) may acquire no more than three percent of another 
fund's securities; \20\ cannot charge a sales load greater than 1\1/2\ 
percent; \21\ is restricted in its ability to redeem shares of the 
acquired fund; \22\ and is unable to use its voting power to influence 
the outcome of shareholder votes held by the acquired fund.\23\ The 
exception was designed to give limited relief to fund of funds 
arrangements in existence in 1970 when section 12(d)(1) was amended, 
subject to restrictions designed to prevent abuses.\24\
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    \19\ See 15 U.S.C. 80a-12(d)(1)(F).
    \20\ A registered fund relying on section 12(d)(1)(F) may 
acquire securities issued by another fund if, immediately after 
acquiring the securities, not more than three percent of the total 
outstanding stock of the acquired fund is owned by the acquiring 
fund and all its affiliates. See 15 U.S.C. 80a-12(d)(1)(F)(i). 
Section 12(d)(1)(F) does not limit acquiring fund investments in 
securities other than those issued by other funds.
    \21\ A fund relying on section 12(d)(1)(F) may not offer or sell 
(or propose to offer or sell through a principal underwriter) a 
security it issues at a public offering price that includes a sales 
load of more than 1\1/2\ percent. See 15 U.S.C. 80a-12(d)(1)(F)(ii).
    \22\ A fund whose shares are acquired pursuant to section 
12(d)(1)(F) is not obligated to redeem more than 1 percent of those 
securities during any period of less than 30 days. 15 U.S.C. 80a-
12(d)(1)(F).
    \23\ Section 12(d)(1)(F), by reference to section 12(d)(1)(E), 
requires the acquiring fund to vote shares of an acquired fund 
either by seeking instructions from the acquiring fund's 
shareholders, or to vote the shares in the same proportion as the 
vote of all other shareholders of the acquired fund. Id.
    \24\ See H.R. Rep. No. 1382, supra note 8, at 11.
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    Affiliated Fund of Funds Arrangements. The Act also permits a fund 
to invest in one or more funds in the same fund complex. Enacted as 
part of the National Securities Markets Improvement Act of 1996 
(``NSMIA''),\25\ section 12(d)(1)(G) permits a registered open-end fund 
or UIT to acquire an unlimited amount of shares of other registered 
open-end funds and UITs that are part of the same ``group of investment 
companies.'' \26\ A fund taking advantage of this exception (an 
``affiliated fund of funds'') is restricted in the types of other 
securities it can hold in addition to shares of registered funds in the 
same group of investment companies.\27\ The acquired funds must have a 
policy against investing in shares of other funds in reliance on 
section 12(d)(1)(F) or 12(d)(1)(G) (to prevent multi-tiered 
structures),\28\ and overall distribution expenses are limited (to 
prevent excessive sales loads).\29\ Under this provision, which 
codified Commission exemptive orders,\30\ several large fund complexes 
offer a fund of funds, which allocates and periodically reallocates its 
assets among funds in the complex.\31\
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    \25\ Pub. L. No. 104-290, 110 Stat. 3416 (1996).
    \26\ See 15 U.S.C. 12(d)(1)(G). For purposes of the exception, 
the term ``group of investment companies'' means ``any 2 or more 
registered investment companies that hold themselves out to 
investors as related companies for purposes of investment and 
investor services.'' 15 U.S.C. 80a-12(d)(1)(G)(ii).
    \27\ In addition to investing in securities of registered funds 
in the same group of investment companies, the Act permits these 
funds to invest only in government securities and short-term paper. 
See 15 U.S.C. 80a-12(d)(1)(G)(i)(II).
    \28\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(IV).
    \29\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(III). The provision 
permits a fund to invest in shares of another fund only if either 
(i) the acquiring fund does not charge a sales load or distribution-
related fee or does not pay (and is not assessed) sales loads or 
distribution-related fees on securities of the acquired fund, or 
(ii) the aggregate distribution-related fees (or loads) charged by 
the acquiring fund on its securities and paid by the acquiring fund 
on acquired fund securities are not excessive under rules adopted 
under section 22(b) [15 U.S.C. 80a-22(b)] or 22(c) [15 U.S.C. 80a-
22(c)] by a securities association registered under section 15A of 
the Securities Exchange Act of 1934 (the ``Exchange Act'') [15 
U.S.C. 78o-3] or the Commission. The NASD has adopted limits on 
sales loads and distribution-related fees applicable to funds as 
well as to funds of funds. See NASD Rule 2830(d)(2), (3) (``NASD 
Sales Charge Rule'').
    Under the NASD Sales Charge Rule for funds of funds, if neither 
the acquiring nor acquired fund has an asset-based sales charge 
(12b-1 fee), the maximum front-end and deferred sales charge that 
can be charged by the acquiring fund, the acquired fund, and both in 
combination cannot exceed 8.5 percent of the offering price of the 
shares. See NASD Sales Charge Rule 2830(d)(3)(A). Any acquiring or 
acquired fund that has an asset-based sales charge must individually 
comply with the sales charge limitations on funds with an asset-
based sales charge, provided, among other conditions, that if both 
funds have an asset-based sales charge, the maximum aggregate asset-
based sales charge cannot exceed .75 of 1 percent per year of the 
average annual net assets of the fund; and the maximum aggregate 
sales load may not exceed 7.25 percent of the amount invested, or 
6.25 percent if either fund pays a service fee. See NASD Sales 
Charge Rule 2830(d)(2)(A), (B).
    \30\ See Vanguard STAR Fund, Investment Company Act Release No. 
21372 (Sept. 22, 1995) [60 FR 50656 (Sept. 29, 1995)] (notice), 
Investment Company Act Release No. 21426 (Oct. 18, 1995) (order) 
(revising conditions on the 1985 Vanguard Order); T. Rowe Price 
Spectrum Fund, Investment Company Act Release No. 21371 (Sept. 22, 
1995) [60 FR 50654 (Sept. 29, 1995)] (notice), Investment Company 
Act Release No. 21425 (Oct. 18, 1995) (order) (revising conditions 
on the 1989 T. Rowe Price Order); T. Rowe Price Spectrum Fund, 
Investment Company Act Release No. 17198 (Oct. 31, 1989) [54 FR 
47010 (Nov. 8, 1989)] (notice), Investment Company Act Release No. 
17242 (Nov. 29, 1989) (order) (``1989 T. Rowe Price Order''); 
Vanguard Special Tax-Advanced Retirement Fund, Investment Company 
Act Release No. 14153 (Sept. 12, 1984) [49 FR 36582 (Sept. 18, 
1984)] (notice), Investment Company Act Release No. 14361 (Feb. 7, 
1985) (order) (``1985 Vanguard Order'').
    \31\ See, e.g., T. Rowe Price, Retirement Funds, Prospectus 1-4 
(Mar. 14, 2003).
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II. Discussion

    Since 1940 we have provided limited relief for funds to acquire 
shares of other funds when the proposed arrangements did not present 
the risk of abuses that section 12(d)(1) was designed to prevent. We 
issued those orders under our general exemptive authority in section 
6(c) of the Act.\32\ In 1996, when Congress added section 12(d)(1)(G), 
it gave us specific authority to exempt any person, security, or 
transaction, or any class or classes of transactions, from section 
12(d)(1) if the exemption is consistent with the public interest and 
the protection of investors.\33\ The House Report accompanying NSMIA 
urged the Commission to use the additional exemptive authority under 
section 12(d)(1)(J) ``in a progressive way as the fund of funds concept 
continues to evolve over time.'' \34\
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    \32\ 15 U.S.C. 80a-6(c). Section 6(c) provides that ``[t]he 
Commission, by rules and regulations upon its own motion, or by 
order upon application, may conditionally or unconditionally exempt 
any person, security, or transaction, or any class or classes of 
persons, securities, or transactions, from any provision or 
provisions of this title or of any rule or regulation thereunder, if 
and to the extent that such exemption is necessary or appropriate in 
the public interest and consistent with the protection of investors 
and the purposes fairly intended by the policy and provisions of 
this title.''
    \33\ See NSMIA, supra note 25, Sec.  202 (codified at 15 U.S.C. 
80a-12(d)(1)(J)). Congress added section 12(d)(1)(J) to resolve 
questions regarding the scope of our authority under section 6(c). 
See 1985 Vanguard Order, supra note 30, dissenting opinion of 
Commissioners Treadway and Peters (concluding that applicants failed 
to establish an adequate record on which Commission could find 
exemption from section 12(d)(1)(A) to meet the standards of section 
6(c) of the Act).
    \34\ H.R. Rep. No. 622, supra note 18, at 44-45. The House 
Report explained that, in exercising its exemptive authority, the 
Commission should consider factors that relate to the protection of 
investors, including the extent to which a proposed arrangement is 
subject to conditions that are designed to address conflicts of 
interest and overreaching by a participant in the arrangement, so as 
to avoid the abuses that gave rise to the initial adoption of the 
Act's restrictions against funds investing in other funds. See id. 
at 45.
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    Today we are proposing three new rules. Two of these provide 
exemptions

[[Page 58229]]

in addition to the statutory exceptions to the fund of funds limits. 
The third provides an exemption from a statutory condition for a fund 
of funds arrangement. These rules would codify and expand upon a number 
of exemptive orders we have issued that permit funds to invest in other 
funds. We also are proposing amendments to Forms N-1A, N-2, N-3, N-4, 
and N-6 that will require funds of funds to disclose in their 
prospectuses the expenses of acquired funds, which investors in a fund 
of funds will bear indirectly.

A. Rule 12d1-1: Investments in Money Market Funds

    We are proposing a new rule that would permit funds to invest in 
shares of money market funds. Rule 12d1-1 would permit ``cash sweep'' 
arrangements in which a fund invests all or a portion of its available 
cash in a money market fund rather than directly in short-term 
instruments.\35\ Since 1982, we have issued more than 80 exemptive 
orders permitting these types of arrangements.\36\ Funds have 
represented that use of a money market fund may be expected to achieve 
greater efficiencies, reduce fund management expenses, and increase 
returns.\37\ Moreover, use of a money market fund may permit fund 
portfolio managers to focus on the management of the principal 
investments of the fund.
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    \35\ A fund may have uninvested cash from new purchases of 
shares by investors, receipt of dividends and interest from 
portfolio investments, and matured investments, as well as cash 
collateral from securities lending activities. The proposed rule 
would permit a fund to invest in one or more money market funds.
    \36\ See, e.g., Diamond Hill Funds, Investment Company Act 
Release No. 26058 (May 28, 2003) [68 FR 33213 (June 3, 2003)] 
(notice), Investment Company Act Release No. 26079 (June 24, 2003) 
(order); SEI Index Funds, Investment Company Act Release No. 26008 
(Apr. 22, 2003) [68 FR 22423 (Apr. 28, 2003)] (notice), Investment 
Company Act Release No. 26048 (May 19, 2003) (order). These orders 
contain a number of conditions, including: (i) Shares of the 
acquired money market fund will not be subject to sales loads, 
distribution-related fees, or service fees, or if they are, the 
acquiring fund's adviser will waive its advisory fee in an amount to 
offset the amount of fees incurred by the acquiring fund; (ii) 
before approving any advisory contract for the acquiring fund, its 
board of directors, including a majority of directors who are not 
interested persons under section 2(a)(19) of the Act [15 U.S.C. 80a-
2(a)(19)] (``independent directors''), will consider the extent to 
which (if any) the advisory fees charged by the adviser should be 
reduced to account for reduced services as a result of investing 
cash in the money market fund; (iii) the acquiring fund's investment 
in money market funds will be limited to 25 percent of the acquiring 
fund's total assets; (iv) the acquiring fund's investment in the 
money market fund is consistent with the acquiring fund's policies 
as set forth in its registration statement; (v) the acquiring fund 
and money market fund are advised by the same adviser (or are part 
of the same group of investment companies); and (vi) the acquired 
money market fund will not acquire securities in another fund in 
excess of the limits of section 12(d)(1)(A) of the Act.
    \37\ See, e.g., Pioneer America Income Trust, First Amended and 
Restated Application pursuant to Section 12(d)(1)(J) of the 
Investment Company Act of 1940, section IV (filed June 4, 2002) 
(``Pioneer Application''); Bear Stearns Funds, et al., Amended 
Application for an Order under Section 12(d)(1)(J) of the Investment 
Company Act of 1940, section III.C (filed Jan. 8, 1999).
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    Fund investments in money market funds, which did not exist in 
1940, do not appear to raise the concerns that underlie section 
12(d)(1). Money market funds are designed to accommodate significant 
daily inflows and outflows of cash and therefore their management seems 
unlikely to be influenced by investors who could threaten large 
redemptions.\38\ There is little value to obtaining a control position 
in a money market fund, and money market funds do not control valuable 
brokerage commissions that can be directed to affiliates.\39\ A fund's 
investment in shares of a money market fund does, however, present the 
opportunity for layering of advisory fees and distribution expenses, 
which we propose to address as discussed in section II.D below.
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    \38\ See Revisions to Rules Regulating Money Market Funds, 
Investment Company Act Release No. 21837 (Mar. 21, 1996) [61 FR 
13956, 13957 (Mar. 28, 1996)] (among money market fund objectives is 
preservation of capital and liquidity); Revisions to Rules 
Regulating Money Market Funds, Investment Company Act Release No. 
17589 at text preceding n.7 (July 17, 1990) [55 FR 30239 (July 25, 
1990)] (many investors use money market accounts as alternatives to 
checking accounts).
    \39\ We note that in the context of rule 2a-7, the Commission 
has permitted an exception that allows money market funds to invest 
in other money market funds in excess of the diversification 
requirements for other issuers provided the board of directors of 
the acquiring fund reasonably believes that the acquired fund is in 
compliance with rule 2a-7. See 17 CFR 270.2a-7(c)(4)(ii)(E). Under 
rule 2a-7, shares of money market funds are considered first-tier 
securities that without the exception would be subject to the rule's 
issuer diversification standards for first-tier securities. See 17 
CFR 270.2a-7(a)(12).
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1. Scope of Exemption
    (a) Affiliated Money Market Funds. Funds that intend to invest in 
money market funds in the same fund complex (``affiliated money market 
funds'') also need exemptions from sections 17(a) \40\ and 17(d) of the 
Act, and rule 17d-1 thereunder,\41\ which restrict transactions and 
joint arrangements with affiliated persons. In addition, a fund that 
acquires more than five percent of the securities of a money market 
fund in another fund complex would become an affiliated person of the 
money market fund, and would need relief from these section 17 
prohibitions before making any additional investments in the money 
market fund.\42\ Proposed rule 12d1-1 would provide this relief. An 
acquiring fund's purchase and redemption of

[[Page 58230]]

money market fund shares at the net asset value would seem to provide 
little opportunity for insider self-dealing or overreaching, and thus 
an exemption from these provisions appears to be appropriate. We seek 
comment on this proposal. Does an acquiring fund's investment in an 
affiliated money market fund create other opportunities for self-
dealing or overreaching?
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    \40\ Section 17(a)(1) prohibits an affiliated person of a 
registered fund, a promoter or principal underwriter for a 
registered fund, or an affiliated person of the foregoing, acting as 
principal, from selling securities or other property to the fund, 
unless (A) the buyer is the issuer of the securities, (B) the seller 
is the issuer of the securities and the securities are part of a 
general offering to the holders of a class of the seller's 
securities, or (C) a depositor has deposited the securities with the 
trust of a UIT or periodic payment plan. 15 U.S.C. 80a-17(a)(1). 
Section 17(a)(2) prohibits an affiliated person from knowingly 
buying from a registered fund (or companies it controls) any 
security or other property unless the seller is the issuer of the 
securities. 15 U.S.C. 80a-17(a)(2). Affiliated persons of a fund 
include any person directly or indirectly controlling, controlled 
by, or under common control with the fund. See 15 U.S.C. 80a-
2(a)(3)(C) (definition of ``affiliated person''). Most funds today 
are organized by an investment adviser that advises or provides 
administrative services to a number of other funds in the same fund 
complex. Funds in a fund complex are under the common control of an 
investment adviser or other person when the adviser or other person 
exercises a controlling influence over the management or policies of 
the funds. See 15 U.S.C. 80a-2(a)(9). Not all advisers control funds 
they advise. The determination of whether a fund is under the 
control of its adviser, officers, or directors depends on all the 
relevant facts and circumstances. See Investment Company Mergers, 
Investment Company Act Release No. 25259, n.14 (Nov. 8, 2001) [66 FR 
57602 (Nov. 15, 2001)]. For purposes of this release, we presume 
that funds in a fund complex are under common control because funds 
that are not affiliated persons would not require, and thus not rely 
on, the proposed exemptions from section 17(a) and rule 17d-1.
    \41\ Section 17(d) of the Act makes it unlawful for an 
affiliated person of a registered fund (``first-tier affiliate''), 
an affiliated person of an affiliated person of a registered fund 
(``second-tier affiliate''), the fund's principal underwriters, or 
affiliated persons of the fund's principal underwriters, acting as 
principal, to effect any transaction in which the fund, or a company 
it controls, is a joint or a joint and several participant ``in 
contravention of such rules and regulations as the Commission may 
prescribe for the purpose of limiting or preventing participation by 
such registered or controlled company on a basis different from or 
less advantageous than that of such other participant.'' 15 U.S.C. 
80a-17(d). Rule 17d-1(a) prohibits first- and second-tier affiliates 
of a registered fund, the fund's principal underwriter, and 
affiliated persons of the fund's principal underwriter, acting as 
principal, from participating in or effecting any transaction in 
connection with any joint enterprise or other joint arrangement or 
profit-sharing plan in which the fund (or company it controls) is a 
participant ``unless an application regarding such joint enterprise, 
arrangement or profit-sharing plan has been filed with the 
Commission and has been granted by an order * * *.'' 17 CFR 270.17d-
1. When an acquiring fund purchases securities from an affiliated 
money market fund on the advice of an adviser who also manages the 
money market fund, the arrangement and transactions could be deemed 
to be a joint enterprise in which the two funds and the adviser are 
joint participants.
    \42\ An affiliated person of a fund includes: (i) Any person 
directly or indirectly owning, controlling, or holding with power to 
vote, five percent or more of the outstanding voting securities of 
the fund; and (ii) any person five percent or more of whose assets 
or securities are directly or indirectly owned, controlled, or held 
with power to vote by the fund. See 15 U.S.C. 80a-2(a)(3)(A), (B) 
(definition of ``affiliated person'').
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    (b) Unaffiliated Money Market Funds. Although our exemptive orders 
have permitted funds to invest their cash only in money market funds 
advised by the same adviser, we are proposing to expand that relief to 
funds that do not share the same adviser.\43\ As a result, funds would 
be able to invest cash in money market funds that are members of other 
fund complexes. The exemption would permit funds in smaller complexes 
that do not have a money market fund to engage in a cash sweep 
arrangement.\44\ Because of the nature of money market funds, which we 
discussed above, we do not believe that investments in money market 
funds that do not share the same adviser would create any greater risks 
than investments in money market funds with a common adviser.
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    \43\ Some applicants have sought, and we have granted, broader 
exemptive relief permitting funds to invest in funds that are not 
part of the same group of investment companies in excess of the 
limitations of section 12(d)(1). See infra notes 73, 75. Under those 
orders, funds in which the applicants could invest include money 
market funds.
    \44\ See H.R. Rep. No. 622, supra note 18, at 43 (``The 
Committee intends the rulemaking and exemptive authority in new 
Section 12(d)(1)(J) to be used by the Commission so that the 
benefits of funds [of funds] are not limited only to investors in 
the largest fund complexes, but, in appropriate circumstances, are 
available to investors through a variety of different types and 
sizes of investment company complexes.'').
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    If a fund acquires more than five percent of a money market fund's 
securities, the two funds would become affiliated persons of each 
other.\45\ As a result, principal transactions other than purchases and 
redemptions of fund shares would not be exempt under the proposed rule, 
and thus the two funds would be precluded from entering into certain 
types of transactions with each other.\46\ Moreover, the acquiring fund 
would be restricted with respect to the purchase or sale of securities 
through a broker-dealer affiliated with the money market fund.\47\ We 
seek comment on whether funds would be likely to invest cash in money 
market funds in other fund complexes? If so, would additional exemptive 
relief under the proposed rule be appropriate? \48\
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    \45\ See 15 U.S.C. 80a-2(a)(3)(A), (B).
    \46\ See discussion above in section II.A.1(a). We note that 
rule 17a-7 provides an exemption for purchase and sale transactions 
between registered funds (or series of registered funds) that are 
affiliated and that meet certain conditions regardless of the nature 
of the funds' affiliation. 17 CFR 270.17a-7.
    \47\ Section 17(e) of the Act prohibits a first or second-tier 
affiliate of a registered fund that acts as broker, in connection 
with the sale of securities to or by the fund, from receiving from 
any source a commission, fee, or other remuneration for effecting 
the transaction that exceeds specified limits. See 15 U.S.C. 80a-
17(e)(2).
    \48\ We have provided relief for transactions between a fund and 
another entity that are affiliated as a result of the fund's 
investments in a money market fund that is affiliated with the other 
entity. See, e.g., Credit Suisse Asset Management, LLC, Investment 
Company Act Release No. 25789 (Oct. 29, 2002) [67 FR 67220 (Nov. 4, 
2002)] (notice), Investment Company Act Release No. 25832 (Nov. 22, 
2002) (order) (``Credit Suisse Notice and Order''). This relief 
generally has been provided in connection with applications 
regarding securities lending programs. We are considering separate 
rulemaking in this area that would address those issues.
---------------------------------------------------------------------------

    (c) Unregistered Money Market Funds. Proposed rule 12d1-1 also 
would codify our exemptive orders that permit funds to invest in money 
market funds that are not registered investment companies 
(``unregistered money market funds'').\49\ Unregistered money market 
funds are typically organized by a fund adviser for the purposes of 
managing the cash of other funds in a fund complex and operate in 
almost all respects as a registered money market fund, except that 
their securities are privately offered and thus not registered under 
the Securities Act of 1933.\50\ Although a fund's investments in 
unregistered money market funds is no longer restricted by section 
12(d)(1),\51\ these investments are subject to the affiliate 
transaction restrictions in the Act and rules thereunder and thus 
require exemptions from sections 17(a) and 17(d), and rule 17d-1.\52\
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    \49\ See, e.g., Pioneer America Income Trust, Investment Company 
Act Release No. 25607 (June 7, 2002) [67 FR 40757 (June 13, 2002)] 
(notice), Investment Company Act Release No. 25647 (July 3, 2002) 
(order) (``Pioneer Notice and Order''); Bear Stearns Funds et al., 
Investment Company Act Release No. 25467 (Mar. 20, 2002) [67 FR 
13809 (Mar. 26, 2002)] (notice), Investment Company Act Release No. 
25527 (Apr. 16, 2002) (order); GE Funds, et al., Investment Company 
Act Release No. 22187 (Aug. 29, 1996) [61 FR 46876 (Sept. 5, 1996)] 
(notice), Investment Company Act Release No. 22247 (Sept. 25, 1996) 
(order). The exemptive relief provided in these orders includes 
conditions requiring that: (i) The unregistered money market fund 
comply with rule 2a-7; (ii) the investment adviser to the 
unregistered money market fund (or the fund with approval of its 
board of directors) adopt and monitor the procedures described in 
rule 2a-7 and take any other actions required to be taken under the 
procedures; (iii) an acquiring fund purchase shares of an 
unregistered money market fund only if the unregistered money market 
fund's adviser determines on an ongoing basis that the unregistered 
money market fund is in compliance with rule 2a-7 and preserves for 
a period not less than six years from the date of determination, the 
first two years in an easily accessible place, a record of the 
determination and the basis on which it was made, and the record is 
subject to examination by Commission staff; (iv) the unregistered 
money market fund comply with the requirements of sections 17(a), 
(d), and (e), 18, and 22(e) of the Act as if it were a registered 
open-end fund; (v) the investment adviser to the unregistered money 
market fund adopt procedures designed to ensure that the fund 
complies with those provisions of the Act, periodically reviews and 
updates as appropriate the procedures, and maintains books and 
records describing the procedures; (vi) the investment adviser to 
the unregistered money market fund maintains the records required by 
rules 31(a)-1(b)(1), 31a-1(b)(ii)(2), and 31a-1(b)(9) under the Act 
for a period of not less than six years from the end of the fiscal 
year in which any transaction occurred, the first two years in an 
easily accessible place and subject to examination by Commission 
staff; (vii) the net asset value per share with respect to 
unregistered money market fund shares is determined by dividing the 
value of the assets belonging to the fund, less the liabilities of 
the fund, by the number of outstanding shares of the fund; (viii) 
the acquiring fund purchase and redeem shares of the unregistered 
money market fund as of the same time and at the same price, and 
receive dividends and bear its proportionate share of expenses on 
the same basis, as other shareholders of the unregistered money 
market fund; and (ix) a separate account is established in the 
shareholder records of the unregistered money market fund for the 
account of the acquiring fund. These orders provide exemptions for 
funds with the same adviser as the unregistered money market funds. 
The proposed rule would permit funds to invest in unregistered money 
market funds with the same or a different adviser.
    \50\ See, e.g., Pioneer Application, supra note 37, conditions 7 
 8. See also 15 U.S.C. 80a-3(c)(1) (excepting from the 
definition of ``investment company'' issuers whose securities are 
owned by no more than 100 persons and which is not making and does 
not presently propose to make a public offering of its securities); 
15 U.S.C. 80a-3(c)(7) (excepting from the definition of ``investment 
company'' issuers whose securities are owned exclusively by 
``qualified purchasers'' and which is not making and does not 
presently propose to make a public offering of its securities).
    \51\ Before 1996, a fund that was excepted from the definition 
of ``investment company'' by section 3(c)(1) of the Act (because its 
shares were held by fewer than 100 beneficial owners and was not 
making and did not propose to make a public offering of its 
securities) was nonetheless deemed to be an ``investment company'' 
for purposes of section 12(d)(1). In 1996, Congress narrowed this 
provision of section 3(c)(1) to make section 12(d)(1) limitations 
inapplicable to an investment by a registered fund in shares of a 
fund that is not registered with us in reliance on section 3(c)(1). 
See NSMIA, supra note 25 Sec.  209(a). A parallel provision was 
incorporated into section 3(c)(7), which excepts from the definition 
of ``investment company'' funds whose outstanding securities are 
owned exclusively by ``qualified purchasers'' and that is not making 
and does not propose to make a public offering of its securities. 
See section 3(c)(7)(D) [15 U.S.C 80a-3(c)(7)(D)]. See also 1992 
Study, supra note 17, at 105-110.
    \52\ See discussion above in section II.A.1(a) of this Release.
---------------------------------------------------------------------------

    Under the proposed rule, the exemption would be available only for 
investments in an unregistered money market fund that operates like a 
money market fund registered under the Act.\53\ To be eligible, an 
unregistered money market fund would be required to (i) limit its 
investments to those in which a money market fund may invest under

[[Page 58231]]

rule 2a-7 under the Act,\54\ and (ii) undertake to comply with all the 
other provisions of rule 2a-7.\55\ 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.\56\ Finally, the unregistered money 
market fund's adviser would be required to register as an investment 
adviser with the Commission.\57\ This final requirement would allow the 
Commission to examine the activities of the unregistered money market 
fund to ensure that it is meeting the requirements of the rule.
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    \53\ Proposed rule 12d1-1(c)(3)(ii).
    \54\ Proposed rule 12d1-1(c)(3)(ii)(A).
    \55\ Proposed rule 12d1-1(c)(3)(ii)(B).
    \56\ Proposed rule 12d1-1(b)(2)(i)(A), (B). The acquiring fund 
would be required to reasonably believe that the unregistered money 
market fund (i) operates in compliance with rule 2a-7, (ii) 
complies, as if it were a registered open-end fund, with provisions 
of the Act that limit affiliate transactions (sections 17(a), (d), 
and (e)), issuance of senior securities (section 18), and suspension 
of redemption rights (section 22(e)), (iii) has adopted, and 
periodically reviews, procedures designed to ensure compliance with 
these requirements, and maintains books and records describing the 
procedures, and (iv) maintains and preserves the books and records 
required under rules 31a-1(b)(1) [17 CFR 31a-1(b)(1)], 31a-
1(b)(2)(ii) [17 CFR 31a-1(b)(2)(ii)], 31a-1(b)(2)(iv) [17 CFR 31a-
1(b)(2)(iv)], and 31a-1(b)(9) [17 CFR 31a-1(b)(9)]. Proposed rule 
12d1-1(b)(2)(i). The proposed rule would require that the acquiring 
fund ``reasonably believe'' that, among other things, the acquired 
money market fund complies with rule 2a-7 in order to avoid the 
acquiring fund's loss of the exemption as the result of a minor or 
inadvertent violation of rule 2a-7 by the acquired money market 
fund.
    \57\ Proposed rule 12d1-1(b)(2)(ii). If an unregistered money 
market fund does not have a board of directors (because, for 
example, it is organized as a limited partnership), the proposed 
rule also would require the fund's investment adviser to perform the 
duties required of a money market fund's board of directors under 
rule 2a-7. Proposed rule 12d1-1(c)(3)(ii)(B).
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    (d) Closed-End Funds of Funds. The restrictions of section 12(d)(1) 
on a fund of funds also apply to closed-end funds and business 
development companies,\58\ which are closed-end funds that are exempted 
from registration under the Act.\59\ We have issued several exemptive 
orders to closed-end funds, subject to similar conditions as open-end 
funds.\60\ Today, we propose to make the new rule available to both 
types of funds so that either can invest available cash in a money 
market fund.\61\ Would business development companies benefit from this 
exemption? Are there reasons not to extend the exemption to business 
development companies?
---------------------------------------------------------------------------

    \58\ A business development company is any closed-end company 
that: (i) Is organized under the laws of, and has its principal 
place in, any state or states; (ii) is operated for the purpose of 
investing in securities described in section 55(a)(1)-(3) of the Act 
[15 U.S.C. 80a-54(a)(1)-(3)] and makes available ``significant 
managerial assistance'' to the issuers of those securities, subject 
to certain conditions; and (iii) has elected under section 54(a) of 
the Act to be subject to the sections addressing activities of 
business development companies under the Act. See 15 U.S.C. 80a-
2(a)(48). Section 60 of the Act [15 U.S.C. 80a-59] extends the 
limits of section 12(d) to a business development company to the 
same extent as if it were a registered closed-end fund.
    \59\ Section 6(f) of the Act [15 U.S.C. 80a-6(f)] exempts 
business development companies that have made the election under 
section 54 [15 U.S.C. 80a-53] from registration and other provisions 
of the Act.
    \60\ See, e.g., Pioneer Notice and Order, supra note 49; Credit 
Suisse Notice and Order, supra note 48.
    \61\ The amount of assets a business development company could 
invest in a money market fund may be limited by Section 55 of the 
Act [15 U.S.C. 80a-54].
---------------------------------------------------------------------------

    (e) Unregistered Funds of Funds. Unregistered funds also are 
subject to the section 12(d)(1) restrictions on the acquisition of 
shares of registered funds.\62\ The proposed rule would permit 
unregistered funds to invest their cash in shares of a registered money 
market fund.\63\ Thus, a hedge fund could sweep its cash into a 
registered money market fund pending investment or distribution of the 
cash to investors. We request comment on whether any special concerns 
arise with respect to unregistered funds' use of registered money 
market funds in cash sweep arrangements.
---------------------------------------------------------------------------

    \62\ See 15 U.S.C. 12(d)(1)(A); 15 U.S.C. 12(d)(1)(B). In the 
case of unregistered investment companies (such as a foreign fund or 
business development company) the full restrictions of sections 
12(d)(1)(A) and (B) apply. Companies that are unregistered because 
they are excepted from the definition of investment company under 
sections 3(c)(1) and 3(c)(7) of the Act are prohibited from 
acquiring more than three percent of a registered fund. Both section 
3(c)(1) and section 3(c)(7) deem issuers that rely on these sections 
to be investment companies for the purposes of sections 
12(d)(1)(A)(i) and 12(d)(1)(B)(i) with respect to their acquisition 
of registered funds. As a result, these companies cannot acquire 
more than three percent of the shares of a registered fund. See 15 
U.S.C. 80a-3(c)(1); 15 U.S.C. 80a-3(c)(7)(D).
    \63\ Proposed rule 12d1-1(a).
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2. Conditions
    We propose to eliminate most of the conditions included in the 
exemptive orders provided to cash sweep arrangements.\64\ We would not, 
for example, 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. 
We also would not require directors to make any special findings that 
investors are not paying multiple advisory fees for the same services. 
A fund could pay duplicative fees if an adviser invests a fund's cash 
in a money market fund (which itself pays an advisory fee) without 
reducing its advisory fee by an amount it was compensated to manage the 
cash.\65\ Fund directors have fiduciary duties,\66\ which obligate them 
to protect funds from being overcharged for services provided to the 
fund, regardless of any special findings we might require.\67\ 
Moreover, and as we describe in more detail below, we would require a 
registered fund of funds to disclose to shareholders expenses paid by 
both the acquiring and acquired funds so that shareholders may better 
evaluate the costs of investing in a fund with a cash sweep 
arrangement.\68\
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    \64\ See supra note 36.
    \65\ Our earlier orders required the acquiring fund's adviser to 
waive that portion of the advisory fee attributable to the 
management service that would be performed by the adviser to the 
acquired fund. See, e.g., The Brinson Funds, Investment Company Act 
Release No. 21814 (Feb. 12, 1996) [61 FR 6398, 6399 (Feb. 20, 1996)] 
(notice), Investment Company Act. Release No. 21741 (Mar. 11, 1996) 
(order); Janus Investment Fund, Investment Company Act Release No. 
21042 (May 4, 1995) [60 F.R. 24955, (May 10, 1995)] (notice), 
Investment Company Act Release No. 21103 (May 31, 1995) (order).
    \66\ See 15 U.S.C. 80a-35(a). See generally, 2 Tamar Frankel, 
The Regulation of Money Managers, Sec.  9.05 (2001). Section 15(c) 
of the Act requires the board of directors to evaluate the terms 
(which would include fees, or the elimination of fees, for services 
provided by an acquired fund's adviser) of any advisory contract. 
See 15 U.S.C. 80a-15(c). Moreover, we believe that, section 36(b) 
[15 U.S.C. 80a-35(b)], which imposes on fund advisers a fiduciary 
duty with respect to their compensation, would require an adviser to 
waive that portion of its fee that represents compensation for 
services being performed by another person, such as the adviser to 
an acquired money market fund. See SEC v. American Birthright Trust 
Management Company, Inc., Litigation Release No. 9266 (Dec. 30, 
1980), available in LEXIS, Fedsec Library, Litrel File (settlement 
of civil injunctive action in which defendant investment adviser was 
permanently enjoined from engaging in acts and practices that would 
constitute violations of sections 36(a) and (b) of the Act, and in 
which the Commission alleged that the compensation paid to fund's 
adviser was excessive in light of the services performed, and that 
most of the advisory services had been provided by a ``sub-adviser'' 
retained by the adviser).
    \67\ We also would eliminate the prohibition on an acquired 
money market fund investing in other funds in excess of the limits 
in section 12(d)(1)(A). This would permit the money market fund 
itself to have a cash sweep arrangement. As discussed above, we do 
not believe that investments in money market funds create the 
concerns that led to the limitations in section 12(d)(1). See supra 
notes 38-39 and accompanying text. We also would omit a condition 
that the acquiring fund's investment in the acquired money market 
fund must be consistent with the policies set forth in the acquiring 
fund's registration statement. We believe that the fund already is 
required to make investments consistent with those policies without 
an additional requirement in the rule. For a discussion of the other 
conditions, see supra notes 43-44 and accompanying text.
    \68\ Although not contained in the text of proposed rule 12d1-1, 
the proposed disclosure requirements are a critical element of the 
relief we are proposing today and of our decision that the proposal 
omit required directors' findings from the rule. We note that when 
it enacted section 12(d)(1)(G) in 1996, Congress did not include any 
provision addressing the duplication of advisory fees, although it 
understood that our previous exemptive orders to permit these 
arrangements included a requirement that acquiring fund directors 
determine that fees for advisory services provided to the acquiring 
fund are in addition to and not duplicative of fees paid for 
advisory services provided to the acquired funds. In his testimony 
before the House Subcommittee considering amendments to section 
12(d)(1), the Director of our Division of Investment Management 
explained that such a condition was unnecessary because ``[t]he 
Commission would be able to use its authority under the Securities 
Act [of 1933] to * * * address the potential for excessive layering 
of advisory fees by requiring an acquiring fund to disclose in the 
prospectus fee table the cumulative advisory fees paid by the 
acquiring and acquired funds.'' Hearing on H.R. 1495 Before the 
Subcomm. On Telecommunications and Finance of the House Comm. on 
Commerce, 104th Cong., 1st Sess. 19 (1995) (statement of Barry P. 
Barbash, Director, Division of Investment Management, Securities & 
Exchange Commission). See also Hearing on S. 1815 Before the Senate 
Comm. on Banking, Housing and Urban Affairs, 104th Cong., 2d Sess. 
38 (1996) (statement of Arthur Levitt, Jr. Chairman, Securities and 
Exchange Commission).

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[[Page 58232]]

    We would, however, retain one of the conditions of our orders 
relating to fees. 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.\69\ Rarely do 
institutional investors (such as an acquiring fund) pay sales loads or 
bear distribution expenses on an investment in a money market fund. 
Thus, a money market fund that charges a sales load or distribution 
fees to the acquiring fund may not be an appropriate investment for 
that fund.
---------------------------------------------------------------------------

    \69\ Proposed rule 12d1-1(b)(1). The proposed rule refers to 
``administrative fees,'' which it would define as ``any sales 
charge, as defined in rule 2830(b)(8) of the Conduct Rules of the 
NASD or service fee, as defined in rule 2830(b)(9) of the Conduct 
Rules of the NASD, charged in connection with the purchase, sale, or 
redemption of securities issued by a Money Market Fund.''
---------------------------------------------------------------------------

    Comment is requested on the proposed rule. Should we retain any of 
the other conditions of the exemptive orders? Should a fund be limited 
in the amount of assets it can invest in one or more money market 
funds? If so, what is the appropriate limit? Should the proposed rule 
require fund directors to make findings regarding duplicative fees? Do 
the sponsors, advisers, or directors of money market funds have any 
concerns about other funds making large investments in their money 
market funds? Should we include any restrictions on the ability of an 
acquiring fund to redeem shares of a money market fund that is not part 
of the same group of investment companies? \70\ Should we restrict the 
ability of an acquiring fund to vote shares of a money market fund that 
is not part of the same group of investment companies? \71\ Are there 
reasons to restrict the ability of an acquired money market fund itself 
to have a cash sweep arrangement?
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    \70\ A fund relying on section 12(d)(1)(F) may not redeem more 
than 1 percent of an acquired fund's shares during any period of 
less than 30 days. 15 U.S.C. 80a-12(d)(1)(F).
    \71\ A fund relying on section 12(d)(1)(F) must vote shares of 
an acquired fund either by seeking instructions from its 
shareholders, or in the same proportion as the vote of all other 
shareholders of the acquired fund. 15 U.S.C. 80a-12(d)(1)(F) 
(referencing 15 U.S.C. 80a-12(d)(1)(E)).
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    Some funds considering a cash sweep arrangement may not have an 
investment policy that specifically addresses such an arrangement. 
Should we require funds to adopt a policy before investing in shares of 
a money market fund? Alternatively, should we interpret fund investment 
policies and restrictions that apply to investments in money market 
instruments as applying to investments in money market funds?

B. Rule 12d1-2: Affiliated Funds of Funds

    As discussed above, section 12(d)(1)(G) 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. Since 1996, when the section was added to the Act, 
we have issued exemptive orders for a variety of fund of funds 
arrangements that we concluded were consistent with the public interest 
and the protection of investors, but that did not conform to section 
12(d)(1)(G) limits.\72\
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    \72\ See, e.g., Scudder Kemper Investments, Inc., Investment 
Company Act Release No. 23691 (Feb. 11, 1999) [64 FR 8153 (Feb. 18, 
1999)] (notice), Investment Company Act Release No. 23731 (Mar. 8, 
1999) (order) (permitting a fund to invest in funds in the same 
group of investment companies and in limited amounts of funds in 
different fund companies); Nations Fund Trust, Investment Company 
Act Release No. 24781 (Dec. 1, 2000) [65 FR 77050 (Dec. 8, 2000)] 
(notice), Investment Company Act Release No. 24804 (Dec. 27, 2000) 
(order) (permitting a fund to invest in funds in the same group of 
investment companies and in other securities (not issued by another 
fund)).
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    Proposed rule 12d1-2 would codify, and in some cases expand, three 
types of relief provided to affiliated funds of funds.\73\ In each 
case, the proposed rule provides relief from section 12(d)(1)(G) 
limitations on investments an affiliated fund of funds can make in 
addition to shares of funds in the same group of investment companies. 
The other limitations in section 12(d)(1)(G) would continue to apply to 
a fund of funds relying on that provision.\74\
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    \73\ We are not at this time proposing to codify the broader 
relief we have granted to permit an affiliated fund of funds to 
acquire shares of funds in different groups of investment companies 
in excess of the limits of section 12(d)(1)(F). See Nationwide Life 
Insurance Co., Investment Company Act Release No. 25492 (Mar. 21, 
2002) [67 FR 14735 (Mar. 27, 2002)] (notice), Investment Company Act 
Release No. 25528 (Apr. 16, 2002) (order); Schwab Capital Trust, 
Investment Company Act Release No. 24067 (Oct. 1, 1999) [64 FR 54939 
(Oct. 8, 1999)] (notice), Investment Company Act Release No. 24113 
(Oct. 27, 1999) (order).
    \74\ See supra notes 28-29, and accompanying text.
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1. Investments in Unaffiliated Funds
    Section 12(d)(1)(G) permits a fund to acquire only funds that are 
part of the same group of investment companies. We propose to permit an 
affiliated fund of funds also 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 section 12(d)(1)(A) or 
12(d)(1)(F).\75\ This exemption would, in effect, permit funds to 
combine the relief provided by the statutory exceptions.\76\ There do 
not appear to be any greater risks to an acquired fund or its 
shareholders if three percent of its shares are acquired by an 
affiliated fund of funds as opposed to being acquired by other types of 
mutual funds specifically permitted to purchase the shares by section 
12(d)(1)(A) or 12(d)(1)(F). We seek comment on the proposed exemption. 
Are there greater risks to an acquired fund if the investor in these 
circumstances is an affiliated fund of funds?
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    \75\ Proposed rule 12d1-2(a)(1). 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. See 15 U.S.C. 80a-12(d)(1)(A)(i)-
(iii). 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 vote of all other shareholders 
of the acquired fund. See 15 U.S.C. 80a-12(d)(1)(F) (referencing 15 
U.S.C. 80a-12(d)(1)(E)). In addition, the acquiring fund would be 
limited to charging a sales load of 1\1/2\ 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. Id.
    \76\ We have issued a number of exemptive orders granting 
similar relief. See, e.g., Sage Life Assurance of America, Inc., 
Investment Company Act Release No. 25098 (Aug. 1, 2001) [66 FR 41272 
(Aug. 7, 2001)] (notice), Investment Company Act Release No. 25142 
(Aug. 28, 2001) (order); Scudder Kemper Investments, Inc., 
Investment Company Act Release No. 23691 (Feb. 11, 1999) [64 FR 8153 
(Feb. 18, 1999)] (notice), Investment Company Act Release No. 23731 
(Mar. 8, 1999) (order).
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2. Investments in Other Types of Issuers
    To restrict the use of the exemption provided by section 
12(d)(1)(G) to a ``bona fide'' fund of funds, Congress

[[Page 58233]]

required a fund relying on the exemption to invest all of its assets in 
shares of funds in the same group of investment companies, and 
permitted other investments to include only government securities and 
short-term paper, which would provide the fund with a source of 
liquidity to redeem shares.\77\ Congress encouraged us, however, to 
provide exemptions from these limitations ``in a progressive way,'' 
taking into account factors that related to the protection of 
investors.\78\
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    \77\ See H.R. Rep. No. 622, supra note 18, at 42.
    \78\ Id. at 43-44.
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    We propose to permit an affiliated fund of funds to invest in any 
other securities (i.e., securities not issued by a fund).\79\ 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. These investments would 
allow an acquiring fund greater flexibility to meet investment 
objectives that may not be met as well by investments in other funds in 
the same fund group, while the investments would not seem to present 
any additional concerns that section 12(d)(1)(G) was intended to 
address.\80\
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    \79\ Proposed rule 12d1-2(a)(2).
    \80\ Unlike section 12(d)(1)(G), section 12(d)(1)(F) does not 
restrict the other types of securities in which an unaffiliated fund 
of funds may invest.
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    A potentially significant consequence of the proposed rule would be 
that an equity fund or bond fund could invest any portion of its assets 
in an affiliated fund if such an acquisition is consistent with the 
investment policies of the fund and the restrictions of the rule. Our 
exemptive orders have permitted arrangements under which fund complexes 
have, for example, established a fund investing in foreign securities 
and made that fund available exclusively to other funds in the fund 
complex. The other funds used an investment in the international fund 
to obtain exposure to foreign securities consistent with their 
investment objectives.\81\ Investments in an affiliated fund by a fund 
investing in other types of securities would not seem to raise any 
greater concerns than would an investment by a fund investing entirely 
in shares of affiliated funds. We note that section 12(d)(1)(G) already 
addresses concerns regarding excessive distribution-related fees in its 
fee limitations.\82\ In addition, as noted above, we would address the 
concerns regarding excessive advisory fees through the proposed 
amendments to Forms N-1A and N-2 requiring disclosure of acquired fund 
expenses.\83\ We seek comment on this proposal. Would any concerns 
arise if an affiliated fund of funds could invest directly in stocks, 
bonds, or other types of securities?
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    \81\ See Van Kampen American Capital Comstock Fund, Inc., 
Investment Company Act Release No. 21977 (May 23, 1996) [61 FR 27118 
(May 30, 1996)] (notice), Investment Company Act Release No. 22025 
(June 18, 1996) (order). See also Smith Breeden Trust, Investment 
Company Act Release No. 23918 (July 21, 1999) [64 FR 40923 (July 28, 
1999)] (notice), Investment Company Act Release No. 23947 (Aug. 17, 
1999) (order) (permitting funds to acquire shares of another fund in 
the same group of investment companies that invests primarily in 
mortgage-backed securities issued by the U.S. government, its 
agencies, and instrumentalities).
    \82\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(III). See also supra note 
29.
    \83\ As noted above, we would expect directors to address the 
issue of duplicative fees in the exercise of their fiduciary duties. 
See supra notes 66-68, and accompanying text.
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3. Investments in Money Market Funds
    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, which, as discussed above, is designed to permit 
cash sweep arrangements involving money market funds.\84\ An affiliated 
fund of funds currently is permitted to invest in money market funds in 
the same fund complex. The proposed rule would permit an affiliated 
fund of funds to invest in money market funds in a different fund 
complex. This will allow affiliated funds of funds the same 
opportunities as any other fund to invest in a cash sweep arrangement 
that will provide the greatest benefit to the acquiring fund. We are 
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.
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    \84\ Proposed rule 12d1-2(a)(3). See supra notes 35-57, 64-71 
and accompanying text. A collateral effect of our rule proposals 
would be to permit an affiliated fund of funds to invest in an 
acquired fund that itself had a cash sweep arrangement. As discussed 
above, section 12(d)(1)(G) prohibits a fund from acquiring shares of 
another fund that does not have an investment policy prohibiting it 
from investing in shares of funds in reliance on section 12(d)(1)(F) 
or (G). An acquired fund investing in a money market fund under a 
cash sweep arrangement permitted under proposed rule 12d1-1 would 
not be relying on either of those sections. The fees and expenses of 
acquired funds would be aggregated and shown in the fee table in the 
acquiring fund's prospectus. See discussion below at section II.D of 
this Release.
---------------------------------------------------------------------------

    We request comment on proposed rule 12d1-2. Are there 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? If so, are there conditions we should include in the 
proposed rule to protect against the risks that underlie the section 
12(d)(1)(G)(i)(III) limitations?

C. Rule 12d1-3: Unaffiliated Funds of Funds

    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 1\1/2\ percent.\85\
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    \85\ See 15 U.S.C. 80a-12(d)(1)(F)(i)-(ii). Section 12(d)(1)(F) 
also provides that the acquired fund is not obligated to redeem more 
than 1 percent of its outstanding securities held by the acquiring 
fund in any period of less than 30 days, and requires the acquiring 
fund to vote shares of an acquired fund either by seeking 
instructions from the acquired fund's shareholders or by voting in 
the same proportion as the other shareholders of the acquired fund. 
15 U.S.C. 80a-12(d)(1)(F).
---------------------------------------------------------------------------

    Proposed rule 12d1-3 would permit funds relying on section 
12(d)(1)(F) to charge sales loads greater than 1\1/2\ percent provided 
that the aggregate sales load any investor pays (i.e., the combined 
distribution expenses of both the acquiring and acquired funds) does 
not exceed the limits on sales loads established by NASD for funds of 
funds.\86\ The rule would codify a number of our exemptive orders.\87\ 
Moreover, the limitations on distribution expenses reflect Congress's 
intent under NSMIA that the NASD regulate duplicative and excessive 
sales charges, as provided in section 12(d)(1)(G).\88\ Our proposal 
would

[[Page 58234]]

provide funds greater flexibility in structuring sales loads, 
consistent with the approach Congress took in section 12(d)(1)(G) to 
prevent excessive sales loads in affiliated funds of funds, while 
providing shareholders greater protection by requiring that funds 
relying on the rule limit overall distribution fees (rather than only 
sales loads). We seek comment on the proposed rule. Are there reasons 
to retain the 1\1/2\ percent sales load limit under an unaffiliated 
fund of funds arrangement rather than limit sales loads and 
distribution fees in conformance with section 12(d)(1)(G)(i)(III) 
limits for affiliated funds of funds?
---------------------------------------------------------------------------

    \86\ See NASD Sales Charge Rule 2830(d)(3), supra note 29.
    \87\ The conditions in these orders limit aggregate sales 
charges to the limits imposed under the NASD Sales Charge Rule. See, 
e.g., Investec Ernst Company, Investment Company Act Release No. 
25507 (Apr. 3, 2002) [67 FR 16775 (Apr. 8, 2002)] (notice), 
Investment Company Act Release No. 25552 (Apr. 24, 2002) (order); 
Lifetime Achievement Fund, Inc., Investment Company Act Release No. 
24453 (May 12, 2000) [65 FR 31948 (May 19, 2000)] (notice), 
Investment Company Act Release No. 24489 (June 7, 2000) (order).
    \88\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(III)(bb) (a fund relying 
on section 12(d)(1)(G) is limited from imposing sales loads and 
other distribution-related fees that, when aggregated with sales 
loads and distribution fees paid on acquired fund shares, are 
excessive under rules adopted under section 22(b) or 22(c) of the 
Act by a securities association registered under section 15A of the 
Securities Exchange Act or the Commission). In 1970, sales loads 
commonly were 8\1/2\ percent of the total payment, see Sen. Rep. No. 
184, supra note 11, at 7, which would have resulted in an aggregate 
load of 10 percent of the total payment under the sales load 
limitation in section 12(d)(1)(F). The NASD Sales Charge Rule limits 
the aggregate sales loads on a fund of funds to 8\1/2\ percent if 
neither the acquiring fund nor the acquired fund in a fund of funds 
charges an asset-based sales charge, and to less than 8\1/2\ percent 
if they do. In addition, the NASD Sales Charge Rule limits aggregate 
asset-based sales charges the funds may impose. See supra note 29.
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D. Amendments to Forms N-1A, N-2, N-3, N-4, and N-6

    We also are 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 better disclosure of the costs of investing in these 
arrangements. The proposed disclosure is designed to help investors 
understand the full costs of investing in a fund of funds, both to 
assist them in comparing the costs of investing in alternative funds of 
funds and in comparing the cost of an investment in a fund of funds 
with the cost of a more traditional fund.\89\
---------------------------------------------------------------------------

    \89\ A fund of funds may have higher fees and expenses than a 
fund that invests directly in debt and equity securities. See John 
Shipman, Diversifying Through Funds of Funds--Small Investors Get 
Exposure to a Variety of Categories, But Fees, Overlap Are Issues, 
Wall St. J., Nov. 7, 2002, at D11 (``[a]t least half of the funds of 
funds available to investors charge fees--amounting to more than 2% 
of assets in some cases--on the overlying portfolio, in addition to 
the costs of the underlying portfolios.''); Yuka Hayashi, Schwab 
Abandons ``Fund of Funds''--High Fees Were Obstacle to Drawing 
Investors; New Managers to Step In, Wall St. J., June 17, 2002, at 
C17 (``[t]he biggest problem was the high fees that Schwab had to 
charge in order to cover its own asset-management costs, as well as 
those of underlying funds.* * *'').
---------------------------------------------------------------------------

    Our current disclosure rules do not require funds (other than 
feeder funds) to provide information about the cost associated with 
investments in acquired funds.\90\ Some funds of funds disclose 
expenses of acquired funds as an item of the acquired fund's annual 
operating expenses.\91\ Other funds list the operating expense ratios 
of each acquired fund, without relating those costs to the acquiring 
fund's expenses.\92\ Still other funds merely note that the shareholder 
will indirectly bear a proportionate share of fees and expenses charged 
by acquired funds. In some cases, funds of funds provide no information 
regarding acquired funds' expenses. As a result, investors cannot 
always appreciate the total costs of investing in a fund of funds. 
Currently they have no direct means to determine whether the indirect 
costs of acquired funds will result in a higher overall cost of 
investing in a fund of funds when compared with another fund of funds, 
or a more traditional fund.
---------------------------------------------------------------------------

    \90\ A feeder fund must disclose in its fee table the aggregate 
expenses of the feeder fund and master fund. See Instruction 1(d)(i) 
to Item 3, Form N-1A. For a description of feeder funds, see text 
accompanying note 18, supra.
    \91\ See, e.g., GE Lifestyle Funds, Prospectus 10 (January 27, 
2003), available at http://www.sec.gov/Archives/edgar/data/1018218/000091205702002852/0000912057-02-002852-index.htm.
    \92\ Some of these funds note that expenses will differ 
depending on the acquiring fund's asset allocation in the acquired 
funds.
---------------------------------------------------------------------------

    Under the 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.\93\ 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. Those 
costs would be included in the acquiring funds' total annual operating 
expenses, which would be reflected in the ``Example'' portion of the 
fee table.\94\ We seek comment on the proposed disclosure. Will the 
additional disclosure provide helpful information to investors? Is 
there a more informative means of providing investors information about 
the costs of acquired funds? Should the subcaption be included in Form 
N-1A with an instruction that it may be omitted for funds that do not 
invest in other funds?
---------------------------------------------------------------------------

    \93\ The item would appear directly above the line item titled 
``Total Annual Fund Operating Expenses.''
    \94\ The fee table example requires the fund to disclose the 
cumulative amount of fund expenses of 1, 3, 5, and 10 years based on 
a hypothetical investment of $10,000 and an annual 5% return. See 
Item 3, Form N-1A.
---------------------------------------------------------------------------

    We also are 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 instructions would reflect expenses associated 
with the historical holdings in each acquired fund. The calculation 
would require the acquiring fund to aggregate the operating expenses of 
acquired funds and transaction costs and express them as a percentage 
of average net assets of the acquiring fund.\95\ Under this approach, 
the acquiring fund would calculate the average invested balance and 
number of actual days invested in each acquired fund.\96\ We ask for 
comment on these instructions. Are they consistent with the current fee 
table? Is there another way to determine acquired funds' fees and 
expenses that would provide better disclosure of these costs? \97\ The 
instructions require the calculation of an average invested balance, 
which is based on a monthly average.\98\ Should the average be 
calculated on a more frequent basis?
---------------------------------------------------------------------------

    \95\ This approach is consistent with the current requirement 
that a feeder fund disclose the aggregate expenses of the feeder 
fund and master fund. See supra note 90.
    \96\ See proposed instruction 3(f)(ii) to Item 3, Form N-1A (to 
calculate the pro rata share of total operating expenses for each 
acquired fund, an acquiring fund would divide the acquired fund's 
total operating expense ratio by 365 days, and multiply the result 
by the average daily balance invested in the acquired fund and the 
number of days invested in the acquired fund).
    \97\ For example, the instructions could require an acquiring 
fund to take the amounts invested in each acquired fund as of a 
current measurement date and multiply those amounts by the 
corresponding total annual fund operating expense ratio for the 
acquired fund. This would require a fairly simple calculation based 
on investments on a single day that would reflect the acquired 
fund's asset size on the measurement date, rather than the actual 
results that are indirectly included in the acquiring fund's 
operations. Because it would be based on the most recent allocation 
of fund assets, this method may also disclose the expenses an 
investor is more likely to pay. The proposed instructions, however, 
are less likely to result in an understatement or overstatement of 
actual expenses paid by the acquiring fund.
    \98\ See proposed instruction 3(f) to Item 3, Form N-1A.
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    Expenses of the acquiring fund would be based on actual expenses or 
those reported in the most recent communication from the acquired 
fund.\99\ Expenses of an acquired fund that is part of the same group 
of investment companies should 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.\100\ If the acquiring fund paid any sales load to acquire shares 
of a fund during the past fiscal year, it must include that amount in 
its

[[Page 58235]]

fee table (even if it no longer holds shares of that fund).\101\
---------------------------------------------------------------------------

    \99\ The operating expenses for acquired funds are likely to be 
for a different period than that of the acquiring fund's fiscal 
year. If the acquiring and acquired funds are not part of the same 
fund complex, the acquiring fund would rely on operating expenses 
the acquired fund has disclosed in its most recent semi-annual 
report. Those expenses would be for a period that ended before 
publication of the report, and thus was before the acquiring fund's 
most recent fiscal year. If the acquiring and acquired funds are 
part of the same fund complex, the two funds may still have 
different fiscal years.
    \100\ See proposed instruction 3(f)(iv) to Item 3, Form N-1A.
    \101\ See proposed instruction 3(f)(ii) to Item 3 (``transaction 
fees'' included in the calculation for acquired funds' fees and 
expenses include the total amount of sales loads, redemption fees, 
or other transaction fees paid by the acquiring fund in connection 
with acquiring shares in acquired funds during the year).
---------------------------------------------------------------------------

    The proposed disclosure requirements also would apply with respect 
to investments in any unregistered fund that would be an investment 
company under section 3(a) of the Act but for the exceptions provided 
in sections 3(c)(1) and 3(c)(7) of the Act.\102\ We do not see any 
reason to treat fund investments in these unregistered funds 
differently from investments in registered funds. Thus, a fund with a 
cash sweep arrangement could not avoid reporting the unregistered money 
market fund's expenses merely because the fund was not registered under 
the Act. Is there a basis for treating disclosure of unregistered and 
registered fund expenses differently?
---------------------------------------------------------------------------

    \102\ See proposed instruction 3(f)(1) to Item 3. See also 15 
U.S.C. 80a-3(c)(1), 80a-3(c)(7), and supra note 50. High fees also 
are a concern with funds of hedge funds. See NASD Investor Alert, 
Funds of Hedge Funds--Higher Costs and Risks for Higher Potential 
Returns (Aug. 23, 2002) (available at: http://www.nasd.com/Investor/alerts/alert_hedgefunds.htm) (``Expenses in funds of hedge funds 
are significantly higher than most mutual funds.''); Stephen J. 
Brown, William N. Goetzmann, and Bing Lang, Fees on Fees in Funds of 
Funds 18 (National Bureau of Econ. Research Working Paper No. 9464, 
2003) (``The chief disadvantage of [funds of hedge funds] is the 
high fees that are typically charged * * *.''). See also Daniel 
Kadlac, Affordable Hedge Funds, Time.com, http://www.time.com/globalbusiness/html (``The big drawback [of a fund of hedge funds] 
is that you pay two layers of fees: one to the fund-of-funds 
manager, who in turn gets charged by each fund in the portfolio.'').
---------------------------------------------------------------------------

    Because we also are 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.\103\ 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.\104\ This approach is similar to that required 
of new funds.\105\ We seek comment on the proposed amendments to Form 
N-2. In addition to the proposed instructions, are there additional 
matters our instructions should cover?
---------------------------------------------------------------------------

    \103\ See proposed instruction 10 to Item 3, Form N-2.
    \104\ See proposed instruction 3(f)(vi) to Item 3, Form N-1A. 
See also instruction 6 to Item 3, Form N-2.
    \105\ See Instruction 5(a) to Item 3, Form N-1A (new funds are 
instructed to base percentages to be included in the ``Annual Fund 
Operating Expense'' portion of the fee table on amounts that will be 
incurred (without reduction for expense reimbursement or fee waiver 
arrangements), estimating amounts of ``Other Expenses'').
---------------------------------------------------------------------------

    Our proposal also would require separate accounts to include in 
their registration forms, disclosures regarding the expenses of 
acquired funds. The proposal includes amendments to Forms N-3, N-4, and 
N-6.\106\ We seek comment on the amendments to these forms. Are the 
different instructions appropriate to the respective forms? \107\
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    \106\ The proposed instructions to Form N-3 would require the 
same disclosure and calculation as required in the proposed 
instructions to Forms N-1A and N-2. The proposed instructions for 
Forms N-4 and N-6 are different, however, because those forms 
already require registrants to disclose expenses of funds 
(``portfolio companies'') in which the separate account invests. See 
Item 3, Form N-4, Item 3, Form N-6. Accordingly, the proposed 
instructions to Forms N-4 and N-6 require that if a portfolio 
company invests in other funds, the registrant must include in the 
item disclosing the portfolio company's ``other expenses,'' the 
Acquired Fund's fees and expenses calculated according to the 
proposed instructions to Form N-1A.
    \107\ See supra note 106.
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III. General Request for Comments

    We request comment on the proposed rules and form amendments that 
are the subject of this release, suggestions for additional provisions 
or changes to the rules and form amendments, and comments on other 
matters that might have an effect on the proposals contained in this 
release. We encourage commenters to provide data to support their 
views.
    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,\108\ we also request information regarding the potential 
effect of the proposals on the U.S. economy on an annual basis. 
Commenters are requested to provide empirical data to support their 
views. The Commission strives to draft its rules according to 
principles outlined in its Plain English Handbook.\109\ We invite your 
comments on how to make the proposed rules and form amendments more 
consistent with those principles and easier to understand.
---------------------------------------------------------------------------

    \108\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996).
    \109\ Office of Investor Education and Assistance, U.S. 
Securities and Exchange Commission, A Plain English Handbook (1998) 
(available on the Commission's Web site at <http://www.sec.gov).
---------------------------------------------------------------------------

IV. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules. 
The proposed rules would provide relief to investment companies by 
providing additional exemptions from the limitations on fund of fund 
arrangements without requiring the funds to obtain an exemptive order. 
The proposed amendments to Forms N-1A, N-2, N-3, N-4, and N-6 would 
provide additional information to shareholders regarding the costs of 
acquired funds in a fund of funds arrangement. We have identified costs 
and benefits that may result from the proposed rules and form 
amendments, as described below.

A. Background on Proposed Rules 12d1-1, 12d1-2, and 12d1-3

    Under current law, a fund is limited in the amount of securities it 
can acquire from another fund. In general under the Act, a registered 
fund (and companies it controls) cannot:
    [sbull] Acquire more than three percent of another fund's 
securities;
    [sbull] Invest more than five percent of its own assets in another 
fund; or
    [sbull] Invest more than ten percent of its own assets in other 
funds in the aggregate.\110\
---------------------------------------------------------------------------

    \110\ See 15 U.S.C. 80a-12(d)(1)(A). If an acquiring fund is not 
registered, these limitations apply only with respect to the 
acquiring fund's acquisition of registered funds.
---------------------------------------------------------------------------

    In addition, a registered open-end fund, its principal underwriter, 
and any registered broker or dealer cannot sell the fund's shares to 
another fund if, as a result:
    [sbull] The acquiring fund (and any companies it controls) owns 
more than three percent of the acquired fund's stock; or
    [sbull] All acquiring funds (and companies they control) in the 
aggregate own more than ten percent of the acquired fund's stock.\111\
---------------------------------------------------------------------------

    \111\ See 15 U.S.C. 80a-12(d)(1)(B).
---------------------------------------------------------------------------

    The Act provides three exceptions from these limitations that 
permit certain fund of funds arrangements. First, section 12(d)(1)(E) 
permits a fund to invest all its assets in one other fund, provided 
that (i) the depositor of or principal underwriter for the fund is a 
registered broker or dealer (or a person it controls), and (ii) the 
acquiring fund is subject to certain voting restrictions on the shares 
of acquired funds.\112\ Second, under section 12(d)(1)(F), a registered 
fund may invest any amount of its assets in other funds, provided that 
the acquiring fund (together with its affiliates) acquires no more than 
three percent of the securities of any other fund.\113\ These 
unaffiliated funds of funds are limited to charging a 1\1/2\ percent 
sales load on their shares and are subject to voting restrictions

[[Page 58236]]

regarding shares of acquired funds.\114\ Finally, section 12(d)(1)(G) 
allows a registered open-end fund or UIT to invest any amount of its 
own assets in one or more other registered funds or UITs in the same 
group of investment companies.\115\ These affiliated funds of funds are 
limited to investing in government securities and short-term paper in 
addition to funds in the same fund group.\116\ The exemption also 
limits sales loads and distribution charges on fund shares, and 
requires that the acquired fund have a policy that it cannot acquire 
other fund shares in reliance on section 12(d)(1)(F) or 12(d)(1)(G) of 
the Act.\117\
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    \112\ See 15 U.S.C. 80a-12(d)(1)(E). The acquiring fund must 
either seek instruction from its shareholders with regard to voting 
all proxies with respect to the acquired fund's securities or vote 
the acquired fund shares in the same proportion as the vote of all 
other shareholders. In addition, in the event the acquiring fund is 
not registered, it cannot substitute the acquired fund shares 
without Commission approval.
    \113\ See 15 U.S.C. 80a-12(d)(1)(F)(i).
    \114\ See 15 U.S.C. 80a-12(d)(1)(F). The acquiring fund is 
subject to the voting restrictions imposed under section 
12(d)(1)(E). See supra note 112. In addition, no issuer of 
securities held by the acquiring fund is obligated to redeem more 
than 1 percent of its securities during any period of less than 30 
days.
    \115\ See 15 U.S.C. 80a-12(d)(1)(G).
    \116\ See 15 U.S.C. 80a-12(d)(1)(G)(II).
    \117\ See 15 U.S.C. 80a-12(d)(1)(G)(III), (IV). Section 
12(d)(1)(G)(III) provides that either (i) the acquiring company does 
not pay any distribution-related charges with respect to the 
acquired shares or the acquiring fund does not charge sales loads or 
distribution-related fees itself, or (ii) sales loads and 
distribution-related charges with respect to acquiring fund shares 
and acquired fund shares, when aggregated, are not excessive under 
rules adopted under section 22(b) or 22(c) of the Act by a 
securities association registered under section 15A of the 
Securities Exchange Act or the Commission.
---------------------------------------------------------------------------

    We also have issued a number of exemptive orders that have 
broadened the ability of funds to invest in other funds. Over the past 
decade, we have issued over 80 orders that permit registered funds to 
invest in a money market fund advised by the same adviser.\118\ Many of 
those orders also have permitted funds to invest in an unregistered 
fund operated as a money market fund.\119\ In addition to these orders, 
we have permitted an affiliated fund of funds relying on section 
12(d)(1)(G) to invest in funds outside the same fund group subject to 
the limitations of section 12(d)(1)(F), as well as in other securities 
not issued by a fund.\120\
---------------------------------------------------------------------------

    \118\ See supra note 36. These orders have included the 
following conditions: (i) Shares of the acquired money market fund 
are not subject to sales loads, distribution-related fees, or 
service fees, or if they are, the acquiring fund's adviser will 
waive its advisory fee in an amount to offset the amount of fees 
incurred by the acquiring fund; (ii) before approving any advisory 
contract for the acquiring fund, its board of directors, including a 
majority of independent directors, considers the extent to which (if 
any) the advisory fees charged by the adviser should be reduced to 
account for reduced services as a result of investing cash in the 
money market fund; (iii) the acquiring fund's investment in money 
market funds is limited to 25 percent of the acquiring fund's total 
assets; (iv) the acquiring fund's investment in the money market 
fund is consistent with the acquiring fund's policies as set forth 
in its registration statement; (v) the acquiring fund and money 
market fund are advised by the same adviser; and (vi) the acquired 
money market fund cannot acquire securities in another fund in 
excess of the limits of section 12(d)(1)(A) of the Act.
    \119\ Investments in unregistered funds have been subject to the 
following conditions: (i) The unregistered money market fund 
complies with rule 2a-7; (ii) the investment adviser to the 
unregistered money market fund (or the fund with approval of its 
board of directors) adopts and monitors the procedures described in 
rule 2a-7 and takes the other actions required to be taken under the 
procedures; (iii) an acquiring fund purchases shares of an 
unregistered money market fund only if the unregistered fund's 
adviser determines on an ongoing basis that the unregistered money 
market fund is in compliance with rule 2a-7 and preserves for a 
period of not less than six years from the date of determination, 
the first two years in an easily accessible place, a record of the 
determination and the basis on which it was made, and the record is 
subject to examination by Commission staff; (iv) the unregistered 
money market fund complies with the requirements of sections 17(a), 
(d), and (e), 18, and 22(e) of the Act as if it were a registered 
open-end fund; (v) the investment adviser to the unregistered money 
market fund adopts procedures designed to ensure that the fund 
complies with those provisions of the Act, periodically reviews and 
updates as appropriate the procedures, and maintains books and 
records describing those procedures; (vi) the investment adviser to 
the unregistered money market fund maintains the records required by 
rules 31(a)-1(b)(1), 31a-1(b)(ii)(2), and 31a-1(b)(9) under the Act 
for a period of not less than six years from the end of the fiscal 
year in which any transaction occurred, the first two years in an 
easily accessible place and subject to examination by Commission 
staff; (vii) the net asset value per share with respect to 
unregistered money market fund shares is determined by dividing the 
value of the assets belonging to the fund, less the liabilities of 
the fund, by the number of outstanding shares of the fund; (viii) 
the acquiring fund purchases and redeems shares of the unregistered 
money market fund as of the same time and at the same price, and 
receives dividends and bears its proportionate share of expenses on 
the same basis, as other shareholders of the unregistered money 
market fund; and (ix) a separate account is established in the 
shareholder records of the unregistered money market fund for the 
account of the acquiring fund.
    \120\ The orders permitting affiliated funds of funds to invest 
in funds outside the fund group have required that the acquiring 
fund's board of directors, including the independent directors, must 
find that the fees charged under the acquiring fund's advisory 
contract are based on services that are not duplicative of services 
provided under any acquired fund's advisory contract.
---------------------------------------------------------------------------

    The orders discussed above provide exemptions from statutory 
limitations. A fund that obtains the benefit of the exemption incurs 
costs of applying for an exemptive order as well as costs of satisfying 
any conditions imposed in the order. The application costs are 
primarily legal and include costs of drafting the application and 
analyzing the ways in which the conditions fit the fund's business 
model. By contrast, the costs of satisfying conditions include ongoing 
compliance costs of meeting those conditions. We assume that a fund 
only seeks an exemptive order if the benefits of the additional 
flexibility provided by the exemption outweigh the costs of obtaining 
and satisfying the conditions of an order.
1. Benefits
    Proposed rule 12d1-1 would codify our orders that permit a fund to 
acquire an unlimited number of shares of a registered money market 
fund. The proposed rule would retain only one condition included in the 
orders: no sales load, distribution-related fees, or service fees could 
be imposed on the acquisition of money market fund shares unless the 
adviser waived an equivalent amount of its fee. The proposed rule would 
not limit a fund to investing 25 percent of its assets in a money 
market fund. We believe that any restrictions on an acquiring fund's 
investments in money market funds should be governed by the fund's 
investment policies and limitations. Consequently, the proposed rule 
may provide some additional flexibility to certain funds. We do not 
know whether many funds are likely to invest more than 25 percent of 
their assets in money market funds as a result of this change, and we 
seek comment on the issue.
    Under the proposed rule, funds also would be allowed to invest in 
money market funds advised by a different adviser. We believe that this 
would allow all funds, particularly small funds without a money market 
fund in their fund group, the opportunity currently available to large 
funds to acquire money market fund shares. This might allow smaller 
funds to be more competitive with larger funds. We seek comment on 
whether many funds are likely to invest in money market funds outside 
their fund group.\121\
---------------------------------------------------------------------------

    \121\ The other conditions included in our exemptive orders are 
addressed by requirements under the Act and rules thereunder. Thus, 
we do not believe that any benefits or costs are associated with 
eliminating those conditions in the proposed rule.
---------------------------------------------------------------------------

    Proposed rule 12d1-1 also would codify our orders permitting funds 
to invest cash in unregistered money market funds that comply with rule 
2a-7. The proposed rule would require the acquiring fund to 
``reasonably believe'' that the unregistered money market fund operates 
in compliance with rule 2a-7, complies with certain provisions of the 
Act,\122\ as well as other requirements. This standard is slightly 
different than the condition in our exemptive orders, which requires 
the acquired fund's compliance with rule 2a-7 and certain provisions of 
the Act. An acquiring fund could ``reasonably believe'' that an 
acquired fund is complying with these provisions even if there is a 
minor or inadvertent violation of one by the acquired fund. In those 
circumstances, the violation would not

[[Page 58237]]

cause the acquiring fund to lose its exemption, while a strict standard 
of compliance could result in the acquiring fund's loss of the 
exemption. The proposed rule does not include certain conditions 
imposed in the orders that we believe are addressed by other provisions 
of the Act or rules thereunder, and with which the unregistered fund 
would have to comply.
---------------------------------------------------------------------------

    \122\ See supra note 119.
---------------------------------------------------------------------------

    Proposed rule 12d1-2 would codify our exemptive orders that permit 
an affiliated fund of funds to acquire securities issued by a fund in a 
different fund group under section 12(d)(1)(F) or 12(d)(1)(A). The 
proposed rule also would permit an affiliated fund of funds to acquire 
securities not issued by a fund. An affiliated fund of funds that 
invests in another fund under section 12(d)(1)(A) or (F) could acquire 
no more than 3 percent of the shares of any acquired fund in a 
different fund group. An acquiring fund that invests in securities 
issued by a fund in a different group under section 12(d)(1)(A) could 
invest no more than 5 percent of its assets in any one fund in a 
different group, or 10 percent of its assets in funds in a different 
group (or groups) in the aggregate. A fund that acquires securities 
under section 12(d)(1)(F) would not be limited in the amount of assets 
it could invest in funds in a different fund group. The acquiring fund 
would, however, be limited to charging a 1\1/2\ percent sales load on 
its shares, subject to voting restrictions with respect to acquired 
fund securities, and limited in the amount of an acquired fund's 
securities it could redeem in any period of less than 30 days.\123\ The 
proposed rule would allow funds to choose from one of two sets of 
conditions under which they may invest in funds outside the fund group. 
We believe that there may be benefits to permitting funds the ability 
to invest under either section, whichever may be more beneficial to the 
fund, and we seek comment on this issue.
---------------------------------------------------------------------------

    \123\ See supra note 114.
---------------------------------------------------------------------------

    Proposed rule 12d1-3 codifies the exemptive orders we have issued 
permitting funds relying on section 12(d)(1)(F) to charge a sales load 
in excess of 1\1/2\ percent, provided the aggregate sales load and 
distribution fees 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.\124\ We seek 
comment on the benefits and costs of this proposal.
---------------------------------------------------------------------------

    \124\ See supra note 123 and accompanying text.
---------------------------------------------------------------------------

    We anticipate that funds and their shareholders would benefit from 
the proposed rules. As discussed above, funds increasingly have sought 
exemptive orders (which the Commission has granted) to engage in most 
of the activities the proposed rules would permit. The application 
process involved in obtaining exemptive orders imposes direct costs on 
funds, including preparation and revision of an application, as well as 
consultations with the staff. The proposed rules would benefit funds 
and their shareholders by eliminating the direct costs of applying to 
engage in activities permitted under the rule.\125\ The proposed rules 
would further benefit funds by eliminating the uncertainty that a 
particular applicant might not obtain relief to engage in the 
activities permitted under the proposed rules.
---------------------------------------------------------------------------

    \125\ For example, in calendar years 2001 and 2002, 24 funds 
sought exemptive relief to invest uninvested cash and/or cash 
collateral from securities lending activities in money market funds, 
and 8 of those funds also sought exemptive relief to invest cash 
collateral in unregistered money market funds. In the past 5 years, 
13 funds investing in other funds in the same fund group in reliance 
on section 12(d)(1)(G) have sought exemptive relief to invest in 
securities other than government securities or short-term paper. 
During that time, 11 funds investing in other funds in reliance on 
section 12(d)(1)(F) have sought exemptive relief to charge a sales 
load greater than 1\1/2\ percent, subject to the NASD Sales Charge 
Rule. The cost to a fund for submitting one of these applications 
ranges from approximately $7,000 to $67,000. These figures are based 
on conversations with attorneys and fund employees who have been 
involved in submitting applications to the Commission.
---------------------------------------------------------------------------

    The exemptive application process also involves other indirect 
costs. Funds that apply for an order to permit additional investments 
forego beneficial investments until they receive the order, while other 
funds forego the investment entirely rather than seek an exemptive 
order because the cost would exceed the anticipated benefit of the 
investment. Eliminating direct and indirect costs of the proposed 
activities also eliminates factors that discriminate against smaller 
funds, for which the cost of an exemptive application consistently 
exceeds the potential benefit.
2. Costs
    We do not believe that the proposed rules would impose mandatory 
costs on any fund. As discussed above, the rules are exemptive, and we 
believe that no fund would rely on any of them if the benefits did not 
outweigh the costs of relying on the rule.
    We believe the costs of relying on the proposed rules would be the 
same as or less than the costs to a fund that relies on an existing 
exemptive order because each of the proposed rules includes the same or 
fewer conditions than existing orders that provide equivalent exemptive 
relief.\126\ As noted earlier, we assume a fund would only bear the 
costs of obtaining and complying with an order if the benefits of the 
order outweighed those costs.
---------------------------------------------------------------------------

    \126\ Under the current system, a fund could obtain the proposed 
relief by obtaining an exemptive order and complying with the 
conditions in the order, and a fund incurs costs in obtaining 
exemptive relief under this system. Our analysis compares the costs 
a fund would bear to comply with the proposed rules with the costs a 
fund would bear under the current system to obtain equivalent 
exemptive relief. Because the conditions in the proposed rules are 
the same or less onerous than the conditions in the exemptive 
orders, the costs discussed in this section primarily are costs that 
a fund would bear to obtain an exemptive order and comply with its 
conditions.
---------------------------------------------------------------------------

    The rule will affect different types of funds in different ways. 
For a fund that has not sought and would not seek exemptive relief from 
the statute, the proposed rules would have no effect. For a fund that 
currently relies on an exemptive order there may be one-time ``learning 
costs'' in determining the difference between the order and the rule. 
After making this determination, the costs of relying on any of the 
rules would be the same as or less than the costs of relying on an 
order providing similar exemptive relief. In addition, a fund that 
currently relies on an exemptive order could satisfy all the conditions 
of any of the proposed rules that provide similar exemptive relief 
without changing its operation. In the case of rule 12d1-1, the fund 
would simply be satisfying conditions that are no longer required.
    A fund that has not relied on an exemptive order and that intends 
to rely on one of the proposed rules in the future would have to 
determine how that rule fits into the fund's business model and the 
potential costs associated with complying with the rule. Nevertheless, 
if the Commission never promulgated the rule, those funds would bear 
the same costs if they considered applying for an exemptive order. 
Moreover, in the absence of the proposed rules, if these funds applied 
for exemptive orders and obtained them, their total costs would be the 
same as or greater than the costs associated with the proposed rules.

B. Proposed Amendments to Forms N-1A, N-2, N-3, N-4, and N-6

    Forms N-1A, N-2, and N-3 currently do not require registered funds 
to disclose information regarding the expenses associated with acquired 
funds. The proposed amendments to Form N-1A would require a registered

[[Page 58238]]

open-end fund that invests in other funds to include a line item in its 
fee table, under the fund's annual operating expenses, that lists the 
aggregate fees and costs of acquired funds. The proposed amendment to 
Form N-2 would require registered closed-end funds that invest in other 
funds to provide the same disclosure. 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. 
The proposal includes instructions on calculating the fees and 
operating costs of acquired funds. The calculation would aggregate 
indirect operating expenses of acquired funds and transaction costs and 
express them as a percentage of average net assets of the acquiring 
fund.
    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.
1. Benefits
    Under current disclosure requirements, a fund's shareholders may 
not understand the fees and operating costs of a fund's investment in 
acquired funds, costs that investors bear indirectly. We believe that 
the proposed amendments to Forms N-1A, N-2, N-3, N-4, and N-6 would 
enable shareholders to better understand the expenses that relate to 
acquired funds, and provide investors the means to compare directly the 
costs of investing in alternative funds of funds, or the costs of 
investing in a fund of funds to a more traditional fund. The increased 
transparency may provide further benefits by allowing investors to 
choose funds that more closely reflect their preferences for fees and 
performance. We have no means by which to quantify these benefits, 
however. We seek comment on the benefits of the proposed amendments 
(and any alternatives suggested by commenters) as well as any data 
quantifying those benefits.
2. Costs
    The proposed amendments to Forms N-1A, N-2, N-3, N-4, and N-6 would 
result in costs to registered open-end and closed-end funds, and to 
separate accounts that offer variable annuity and variable life 
contracts, which may be passed on to those funds' shareholders. The 
proposal would require a new disclosure to the annual operating expense 
item in the fee table for funds that invest in other funds. It also 
would require separate accounts organized as UITs that offer variable 
annuity and variable life contracts to include an additional expense in 
its calculation of annual portfolio company operating expenses. The 
costs of the proposed disclosures would include both internal costs 
(for attorneys and accountants) to prepare and review the disclosure, 
and external costs (for printing and typesetting the disclosure).
    First, with respect to Forms N-1A, N-2, and N-3, the proposed 
disclosures would add a single line item to the fee table for funds 
that invest in other funds. In the context of the prospectus, we 
believe that the external costs of including this additional line of 
disclosure per registered fund would be minimal. With respect to Forms 
N-4 and N-6, the proposal would require registrants to include in the 
item for annual portfolio company operating expenses, any fees and 
expenses of acquired companies, as disclosed in the portfolio company's 
most recent prospectus.
    Second, for purposes of the Paperwork Reduction Act, Commission 
staff has estimated that the disclosure requirement for calculating the 
line item according to the proposed instructions would add up to 7 
hours to the burden of completing Forms N-1A, N-2, and N-3. Thus, we 
estimate that the additional annual cost of including the line item per 
portfolio would equal $410.\127\ Commission staff also has estimated 
that including the additional item in the disclosure of portfolio 
company expenses on Forms N-4 and N-6 would add approximately 0.5 hours 
per portfolio, for an annual cost per portfolio of $15.\128\ Commission 
staff estimates that there are 224 fund of funds portfolios.\129\ 
Accordingly, we estimate that, at a minimum, the total annual internal 
costs of complying with the proposed form amendments would equal 
$92,000.\130\ In addition, Commission staff estimates that half the 
funds registered under Forms N-1A and N-2 invest in other funds, and 5 
separate accounts (with 7 portfolios) registered under Form N-3 invest 
in other funds and would be required to make the proposed disclosure on 
an annual basis.\131\ For purposes of the Paperwork Reduction Act 
analysis, Commission staff has estimated that on an annual basis, 
registrants file (i) initial registration statements covering 483 
portfolios and post effective amendments covering 6,542 portfolios on 
Form N-1A, (ii) 234 initial registration statements and 38 post-
effective amendments on Form N-2, and (iii) initial registration 
statements covering 12 portfolios and post-effective amendments 
covering 152 portfolios on Form N-3. In addition, Commission staff also 
estimates that each year, 157 separate accounts file initial 
registrations and 1,242 separate accounts file post-effective 
amendments on Form N-4, and 50 separate accounts file initial 
registrations and 500 separate accounts file post-effective amendments 
on Form N-6.\132\ Of the filings on Forms N-4 and N-6, Commission staff 
estimates that half the separate accounts invest in portfolio companies 
that themselves invest in other funds. Thus, Commission staff estimates 
that the cost of the proposed amendments to Forms N-1A, N-2, N-3, N-4, 
and N-6 using the calculation in the proposed instructions would be 
$1.5 million.\133\
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    \127\ Commission staff estimated the cost to equal six hours for 
an intermediate-level accountant at $30 per hour to perform the 
calculation and one hour for a deputy general counsel at $230 per 
hour to review the calculation ((6 x $30) + (1 x $230) = $410).
    \128\ Commission staff estimated the cost to equal one-half hour 
for an intermediate level accountant to include the expense item in 
the calculation. The estimated cost is based on the following 
calculation: 0.5 x $30 = $15.
    \129\ The estimate of fund of funds portfolios is based on 
information gathered from Morningstar, Inc.
    \130\ The estimate is based on the following calculation: 224 
portfolios x $410 = $91,840.
    \131\ See infra notes 139, 145, 151, and accompanying text.
    \132\ Of these post-effective amendments, 150 are updates and 
350 are additional post-effective amendments. Separate accounts file 
initial post-effective amendments to update their financial 
statements and provide any other material updates. The additional 
post-effective amendments generally are filed pursuant to Securities 
Act rule 485(b) to make non-material changes to the registration 
statement and are generally more limited and much simpler to prepare 
than post-effective amendments filed as annual updates. We assume 
that registered funds would include the proposed disclosure only in 
a post-effective amendment for the annual update.
    \133\ The estimate is based on the following calculation: ((483 
+ 6,542/2) x $410) + ((234 + 38/2 x $410) + (7 separate account 
portfolios x $410) + ((157 + 1,242/2) x $15) + (200 separate 
accounts/2 x $15) = $1,510,747.5.
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    We do not know the number of funds that would be likely to begin 
investing in other funds under the proposed rules.

[[Page 58239]]

Accordingly, we seek comment as to how many funds that do not now 
invest in other funds, would invest in funds under the proposed rules 
and be required to report the expenses of acquired funds under the 
proposed form amendments.

C. Request for Comments

    The Commission requests comment on the potential costs and benefits 
identified in the proposal and any other costs or benefits that may 
result from the proposal. For purposes of the Small Business Regulatory 
Enforcement Fairness Act of 1996,\134\ we also request comment 
regarding the potential impact of the proposed rule on the economy on 
an annual basis. Commenters are requested to provide data to support 
their views.
---------------------------------------------------------------------------

    \134\ Pub. L. No. 104-113, Title II, 109 Stat. 163 (1995).
---------------------------------------------------------------------------

V. Paperwork Reduction Act

    Proposed rule 12d1-1 would impose a new ``collection of 
information'' requirement within the meaning of the Paperwork Reduction 
Act of 1995.\135\ If adopted, this collection of information would not 
be mandatory. In addition, the Commission is proposing amendments to 
certain forms that currently contain ``collection of information'' 
requirements. The title of the new collection is ``Rule 12d1-1.'' The 
titles for the existing collections are: (i) ``Form N-1A under the 
Investment Company Act of 1940 and Securities Act of 1933, Registration 
Statement of Open-End Management Companies;'' (ii) ``Form N-2--
Registration Statement of Closed-End Management Investment Companies;'' 
(iii) ``Form N-3--Registration Statement of Separate Accounts Organized 
as Management Investment Companies;'' (iv) ``Form N-4--Registration 
Statement of Separate Accounts Organized as Unit Investment Trusts;'' 
and (v) ``Form N-6--Registration Statement of Separate Accounts 
Organized as Unit Investment Trusts that Offer Variable Life Insurance 
Policies.'' An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.
---------------------------------------------------------------------------

    \135\ 44 U.S.C. 3501 to 3520.
---------------------------------------------------------------------------

    The Commission has submitted these proposals to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. OMB has not yet assigned a control number to 
the new collection for proposed rule 12d1-1.

A. Proposed Rule 12d1-1

    Proposed rule 12d1-1 would permit a fund to invest in registered 
money market funds and in unregistered money market funds that meet 
certain conditions in excess of the limits of section 12(d)(1). A 
registered fund may invest in an unregistered money market fund as long 
as the unregistered money market fund (i) is limited to investing in 
the types of securities and other investments in which a money market 
fund may invest under rule 2a-7; and (ii) undertakes to comply with all 
other requirements of rule 2a-7. In addition, the acquiring fund must 
reasonably believe that the unregistered money market fund (i) operates 
in compliance with rule 2a-7; (ii) complies with sections 17(a), (d), 
(e), 18, and 22(c) of the Act; (iii) has adopted procedures to ensure 
that it complies with these statutory provisions; and maintains records 
to describe those procedures; (iv) maintains the records required under 
rules 31a-1(b)(1), 31a-1-1(b)(2)(ii), 31a-1(b)(2)(iv), and 31a-1(b)(9) 
under the Act; and (v) preserves those records permanently, the first 
two years in an easily accessible place. Rule 2a-7 contains certain 
collection of information requirements. In addition, the recordkeeping 
requirements under rule 31 are collections of information. We believe 
that this exemptive rule will provide funds greater options for cash 
management. We believe that unregistered money market funds must comply 
with certain collection of information requirements for registered 
money market funds to ensure that unregistered money market funds have 
established procedures for collecting the information necessary to make 
adequate credit reviews of securities in their portfolios, as well as 
other recordkeeping requirements that will assist the acquiring fund 
(and Commission staff in its examination of the unregistered money 
market fund's adviser) in overseeing the unregistered money market 
fund.
    Based on exemptive orders issued by the Commission, Commission 
staff estimates that registered funds currently invest in 35 
unregistered money market funds in excess of the limits imposed by 
section 12(d)(1).\136\ Under the terms of the exemptive orders, those 
unregistered money market funds must comply with the requirements of 
rule 2a-7. Commission staff also estimates that 4 new unregistered 
money market funds would be established each year that would have to 
meet the requirements of the proposed rule. We seek comments on these 
estimates. For purposes of the Paperwork Reduction Act requirements, 
Commission staff has estimated that a registered money market fund each 
year spends an average of approximately 539 hours of professional time 
to record credit risk analyses and determinations regarding adjustable 
rate securities, asset-backed securities and securities subject to a 
demand feature or guarantee. Commission staff also estimated that in 
the first year of operation the board of directors, counsel, and staff 
of a new registered money market fund spend 38.5 hours to formulate and 
establish written procedures for stabilizing the fund's NAV and 
guidelines for delegating certain of the board's responsibilities to 
the fund's adviser.\137\ Based on this estimate, Commission staff 
estimates the annual hour burden of the proposed rule's paperwork 
requirements for unregistered money market fund compliance with rule 
2a-7 would be 21,175 hours.\138\
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    \136\ This estimate may be understated because applicants 
generally do not identify the unregistered money market funds in 
which registered funds will invest, and exemptive orders provide 
relief for unregistered money market funds that may be organized in 
the future.
    \137\ These estimates were included in the Commission's most 
recent Paperwork Reduction Act submission for approval of the 
collection of information burden for rule 2a-7. The estimates are 
based on discussions with individuals at money market funds and 
their advisers who responded to a random survey of 9 money market 
funds. The actual number of burden hours for credit risk analyses 
and determinations regarding adjustable rate securities, asset 
backed securities, and securities subject to a demand feature or 
guarantee may vary significantly depending on the type and number of 
portfolio securities held by the individual fund.
    In addition, in its Paperwork Reduction Act submission, 
Commission staff estimated that in a year, only 0.3% of registered 
money market funds spends 0.5 hours to record board determinations 
and actions in response to certain events of default or insolvency, 
and to notify the Commission of the event. We have not included this 
burden estimate in our estimate for unregistered funds because 0.3 
percent of 35 unregistered money market funds is less than 1.
    \138\ This estimate is based on the following calculation: (35 
unregistered money market funds x 539 hours) + (4 new unregistered 
money market funds x (539 + 38.5 hours) = 21,175. To the extent that 
unregistered money market funds would keep these records in any case 
as a matter of good business practice, this estimate may be greater 
than the actual annual burden.
---------------------------------------------------------------------------

    Rules 31a-1(b)(1), 31a-1(b)(2)(ii), 31a-1(b)(2)(iv), and 31a-
1(b)(9) require registered funds to keep certain records, which include 
journals and general and auxiliary ledgers, including ledgers for each 
portfolio security and each shareholder of record of the fund. Most of 
the records required to be maintained by the rule are the type that 
generally would be maintained as a matter of good business practice and 
to prepare the unregistered money market fund's

[[Page 58240]]

financial statements. Accordingly, Commission staff estimates that the 
requirements under rules 31a-1(b)(1), 31a-1(b)(2)(ii), 31a-1(b)(2)(iv), 
and 31a-1(b)(9) would not impose any additional burden because the 
costs of maintaining these records would be incurred by unregistered 
money market funds in any case to keep books and records that are 
necessary to prepare financial statements for shareholders, to prepare 
the fund's annual income tax returns, and as a normal business custom.

B. Forms for Registration Statements

    We are proposing amendments to require registered open-end and 
closed-end funds, and separate accounts organized as management 
investment companies that invest in other funds to disclose aggregate 
fees of acquired funds. The disclosure would be a line item appearing 
under the item for annual operating expenses of the fund. We also are 
proposing that separate accounts organized as UITs that invest in 
portfolio companies that themselves invest in other funds, include the 
costs of investing in those other funds in the disclosure on portfolio 
companies' operating expenses. We believe that the proposed amendments 
will enable shareholders to understand better the expenses of acquired 
funds and to compare overall costs of investing in a fund of funds with 
the costs of an alternative fund of funds, and with the costs of a more 
traditional fund.
1. Form N-1A
    Form N-1A (OMB Control No. 3235-0307), including the proposed 
amendment, contains collection of information requirements. The likely 
respondents to this information collection are open-end funds 
registering with the Commission on Form N-1A. Compliance with the 
disclosure requirements of Form N-1A is mandatory. Responses to the 
disclosure requirements are not confidential.
    The current burden for preparing an initial Form N-1A filing is 809 
hours per portfolio. The current annual hour burden for preparing post-
effective amendments on Form N-1A is 101 hours per portfolio. The 
Commission estimates that, on an annual basis, registrants file initial 
registration statements covering 483 portfolios, and post-effective 
amendments covering 6,542 portfolios on Form N-1A.\139\ Thus, the 
Commission estimates that the current total annual hour burden for the 
preparation and filing of Form N-1A is 1,051,489.\140\
---------------------------------------------------------------------------

    \139\ These estimates are based on information in the 
Commission's filing database and from Morningstar databases. They 
assume that of the 3,075 registered open-end funds, 179 registrants 
will file an initial registration statement and 2,423 registrants 
will file one post-effective amendment with material differences 
each year with an average of 2.7 portfolios per registrant.
    \40\ This estimate is based on the following calculation: ((483 
x 809) + (6,542 x 101) = 1,051,489). The total annual hour burden 
approved for N-1A is 916,162. The increase over the approved annual 
burden is due to an increase in the number of registrants filing 
initial registration statements on Form N-1A.
---------------------------------------------------------------------------

    We estimate that a line item prepared according to the proposed 
instructions would increase the hour burden per portfolio per filing of 
an initial registration or a post-effective amendment to a registration 
statement by 7 hours.\141\ Commission staff estimates that \1/2\ of 
funds registered under Form N-1A invest in another fund, and would be 
required to make the proposed disclosure.\142\ We seek comment on these 
estimates. Thus, if the proposed amendments to Form N-1A instructions 
were adopted, the total annual hour burden for all funds for 
preparation and filing of initial registration statements and post-
effective amendments to Form N-1A would be 1,076,080.\143\
---------------------------------------------------------------------------

    \141\ See supra note 119.
    \142\ This is based on information in the Commission's database 
of Form N-SAR filings.
    \143\ This estimate is based on the following calculation: 
(1,051,489 + (483/2 x 7) + (6,542/2 x 7)) = 1,076,080).
---------------------------------------------------------------------------

2. Form N-2
    Form N-2 (OMB Control No. 3235-0026), including the proposed 
amendment, contains collection of information requirements. The likely 
respondents to this information collection are closed-end funds 
registering with the Commission on Form N-2. Compliance with the 
disclosure requirements of Form N-2 is mandatory. Responses to the 
disclosure requirements are not confidential.
    The current burden for preparing an initial Form N-2 filing is 
544.7 hours per fund.\144\ The current burden for preparing a post-
effective amendment on Form N-2 is 103.7 hours. Commission staff 
estimates that an average of 234 closed-end funds file an initial 
registration statement and 38 file a post-effective amendment on Form 
N-2 each year.\145\ Thus, the Commission estimates that the current 
annual hour burden for preparing an N-2 is 131,400.\146\
---------------------------------------------------------------------------

    \144\ Initial registration statements and post-effective 
amendments filed on Form N-2 generally cover only one portfolio.
    \145\ This estimate is based on information in the Commission's 
database.
    \146\ This estimate is based on the following calculation: ((234 
x 544.7) + (38 x 103.7) = 131,400.4). The total annual hour burden 
approved for Form N-2 is 80,198.6. The increase is due to an 
increase in the number of initial registration statements filed on 
Form N-2.
---------------------------------------------------------------------------

    Commission staff estimates that it would take the same amount of 
time to prepare the line item disclosure in Form N-2 as it would to 
prepare the disclosure in Form N-1A (see previous discussion). As with 
funds registered under Form N-1A, we are assuming that \1/2\ of funds 
registered under Form N-2 invest in another fund, and would be required 
to make the proposed disclosure. We seek comment on those numbers. 
Accordingly, if the proposed amendments to Form N-2 were adopted, we 
estimate the total annual hour burden for all funds for preparation and 
filing of initial registration statements and post-effective amendments 
to Form N-2 would be 132,352.\147\
---------------------------------------------------------------------------

    \147\ This estimate is based on the following calculation: 
(131,400 + (234/2 x 7) + (38/2 x 7) = 132,352).
---------------------------------------------------------------------------

3. Form N-3
    Form N-3 (OMB Control No. 3235-0316), including the proposed 
amendment, contains collection of information requirements. The likely 
respondents to this information collection are separate accounts 
organized as management investment companies registering with the 
Commission on Form N-3. Compliance with the disclosure requirements of 
Form N-3 is mandatory. Responses to the disclosure requirements are not 
confidential.
    The current burden for preparing an initial Form N-3 filing is 
915.2 hours per portfolio. The current burden for preparing a post-
effective amendment on Form N-3 is 150.4 hours per portfolio. 
Commission staff estimates that 3 initial registrations and 38 post 
effective amendments are filed annually with an average of 4 portfolios 
per filing, for a total of 12 portfolios covered by initial 
registrations and 152 portfolios covered by post-effective amendments 
annually.\148\ Thus, the Commission estimates that the current annual 
hour burden for preparing an N-3 is 33,843.\149\
---------------------------------------------------------------------------

    \148\ This estimate is based on information in the Commission's 
database.
    \149\ This estimate is based on the following calculation: (12 
portfolios x 915.2) + (152 portfolios x 150.4 hours) = 33,843.2. The 
total annual hour burden approved for Form N-3 is 36,096. The 
decrease is due to a decrease in the number of post-effective 
amendments filed on Form N-3.
---------------------------------------------------------------------------

    We estimate that it would take the same amount of time to prepare a 
line item according to the proposed instructions in Form N-3, as in 
Forms N-1A and N-2. Thus we estimate the

[[Page 58241]]

proposed line item would increase the hour burden per portfolio per 
filing of an initial registration or a post-effective amendment to a 
registration statement by 7 hours.\150\ Commission staff estimates that 
5 registrants with 7 portfolios registered on Form N-3 invest in 
another fund, and would be required to make the proposed 
disclosure.\151\ We seek comment on these numbers. Thus, if the 
proposed amendments to Form N-3 instructions were adopted, the 
Commission estimates that the total annual hour burden for all funds 
for preparation and filing of initial registration statements and post-
effective amendments to Form N-3 would be 33,934.\152\
---------------------------------------------------------------------------

    \150\ See supra note 127.
    \151\ This estimate is based on information in the Commission's 
database of Form N-SAR filings.
    \152\ This estimate is based on the following calculation: 
33,843 + (7 x 7) + (12/2 x 7) = 33,934.
---------------------------------------------------------------------------

4. Form N-4
    Form N-4 (OMB Control No. 3235-0318), including the proposed 
amendments, contains collection of information requirements. The likely 
respondents to this information collection are separate accounts 
organized as UITs that offer variable annuity contracts registering 
with the Commission on Form N-4. Compliance with the disclosure 
requirements of Form N-4 is mandatory. Responses to the disclosure 
requirements are not confidential.
    The current burden for preparing an initial registration on Form N-
4 is 273.2 hours per separate account. The current annual burden for 
preparing a post-effective amendment on Form N-4 is 195 hours per 
separate account. Commission staff estimates that an average of 157 
separate accounts organized as UITs that offer variable annuity 
contracts file an initial registration statement and 1,242 file a post-
effective amendment on Form N-4 each year.\153\ Thus, the Commission 
estimates that the current annual hour burden for preparing an N-4 is 
285,082.\154\
---------------------------------------------------------------------------

    \153\ This estimate is based on information in the Commission's 
database.
    \154\ This estimate is based on the following calculation: (157 
x 273.2) + (1242 x 195) = 285,082.4. The total annual hour burden 
approved for Form N-4 is 300,292. The decrease is due to a decrease 
in the number of registrants filing post-effective amendments on 
Form N-4.
---------------------------------------------------------------------------

    Commission staff estimates that it would take \1/2\ hour to include 
in the disclosure of total annual portfolio company operating expenses, 
the line item from the portfolio company's prospectus disclosing 
acquired fund fees and expenses. We estimate that \1/2\ of separate 
accounts registering on Form N-4 invest in portfolio companies that 
invest in other funds, and would be required to make the proposed 
disclosure.\155\ We seek comment on those numbers. Accordingly, if the 
proposed amendments to Form N-4 were adopted, the total annual hour 
burden for all funds for preparation and filing of initial registration 
statements and post-effective amendments to Form N-4 would be 
285,432.\156\
---------------------------------------------------------------------------

    \155\ Commission staff estimates that each portfolio would be 
required to include the disclosure either in one initial 
registration or post-effective amendment each year.
    \156\ This estimate is based on the following calculation: 
(285,082.4 + (157/2 x 0.5) + (1,242/2 x 0.5) = 285,432.2).
---------------------------------------------------------------------------

5. Form N-6
    Form N-6 (OMB Control No. 3235-0503), including the proposed 
amendments, contains collection of information requirements. The likely 
respondents to this information collection are separate accounts 
organized as UITs that offer variable life insurance contracts 
registering with the Commission on Form N-6. Compliance with the 
disclosure requirements of Form N-6 is mandatory. Responses to the 
disclosure requirements are not confidential.
    The current burden for preparing an initial registration on Form N-
6 is 765 hours. The current annual burdens for preparing a post-
effective amendment for an annual update and an additional post-
effective amendment on Form N-6 are 65 hours and 10 hours, 
respectively.\157\ Commission staff estimates that an average of 50 
initial registration statements, 150 post-effective amendments for an 
annual update, and 350 additional post-effective amendments will be 
filed by variable life insurance policies issued by separate accounts 
on Form N-6 each year.\158\ Thus, the Commission estimates that the 
current annual hour burden for preparing Form N-6 is 51,500.\159\
---------------------------------------------------------------------------

    \157\ The hour burden for filing additional post-effective 
amendments is significantly less than that for the post-effective 
amendment for the annual update. See supra note 132.
    \158\ This estimate is based on information in the Commission's 
database.
    \159\ This estimate is based on the following calculation: (50 x 
765) + (150 x 65) + (350 x 10) = 51,500). The total annual hour 
burden approved for Form N-6 is 61,135. The approved burden was 
based on estimates of filings at the time Form N-6 was proposed, and 
was not based on actual form filings.
---------------------------------------------------------------------------

    Commission staff estimates that it would take \1/2\ hour to include 
in the disclosure of total annual portfolio company operating expenses, 
the line item from the portfolio company's prospectus disclosing 
acquired fund fees and expenses. We estimate that \1/2\ of separate 
accounts registering on Form N-6 invest in portfolio companies that 
invest in other funds, and would be required to make the proposed 
disclosure.\160\ We seek comment on those numbers. Accordingly, if the 
proposed amendments to Form N-6 were adopted, the total annual hour 
burden for all funds for preparation and filing of initial registration 
statements and post-effective amendments to Form N-6 would be 
51,550.\161\
---------------------------------------------------------------------------

    \160\ Commission staff estimates that each portfolio would be 
required to include the disclosure either in an initial registration 
or post-effective amendment each year.
    \161\ This estimate is based on the following calculation: 
(51,500 + (50/2 x 0.5) + (150/2 x 0.5) = 51,550).
---------------------------------------------------------------------------

C. Request for Comments

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to: (i) Evaluate whether the proposed collections of 
information are necessary for the proper performance of the functions 
of the agency, including whether the information will have practical 
utility; (ii) evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collections of information; (iii) determine 
whether there are ways to enhance the quality, utility, and clarity of 
the information to be collected; and (iv) evaluate whether there are 
ways to minimize the burden of the collections of information on those 
who are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements of the proposed rules and form amendments should direct 
them to the Office of Management and Budget, Attention Desk Officer for 
the Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10102, New Executive Office Building, 
Washington, DC 20503, and should send a copy to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-18-03. OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication of this Release; therefore a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release. Requests 
for materials submitted to OMB by the Commission with regard to these 
collections of information should be in writing, refer to File No. S7-
18-03, and be submitted to the Securities and Exchange Commission, 
Records

[[Page 58242]]

Management, Office of Filings and Information Services, 450 Fifth 
Street, NW., Washington, DC 20549.

VI. Consideration of Promotion of Efficiency, Competition and Capital 
Formation

    Section 2(c) of the Investment Company Act requires the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider whether the action will promote efficiency, competition, 
and capital formation.\162\
---------------------------------------------------------------------------

    \162\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

A. Proposed Rules 12d1-1, 12d1-2, and 12d1-3

    Proposed rules 12d1-1, 12d1-2, and 12d1-3 will expand the 
circumstances in which funds can invest in other funds without first 
obtaining an exemptive order from the Commission, which can be costly 
and time-consuming. We anticipate that the proposed rules will promote 
efficiency and competition. Proposed rule 12d1-1 would permit funds to 
acquire shares of money market funds in the same or in a different fund 
group in excess of the limitations in section 12(d)(1). This exemption 
should allow funds, particularly small funds without a money market 
fund in their complex, to allocate their uninvested cash more 
efficiently and thereby increase competition among funds. Proposed rule 
12d1-2 would permit an affiliated fund of funds to acquire limited 
amounts of securities issued by funds outside the same fund group and 
securities not issued by a fund, as well as permit a traditional equity 
or bond fund to invest in funds within the same fund complex. We 
believe that this expansion of investment opportunities also will 
permit funds to allocate their investments more efficiently. The 
effects of the proposed rules on capital formation are unclear.

B. Proposed Amendments to Forms N-1A, N-2, N-3, N-4, and N-6

    The proposed form amendments are intended to provide better 
transparency for fund shareholders with respect to the costs of 
investing in funds of funds. The enhanced disclosure requirements would 
provide shareholders with greater access to information regarding the 
indirect costs they bear when a fund in which they invest purchases 
shares of other funds. This information should promote more efficient 
allocation of investments by investors and more efficient allocation of 
assets among competing funds because investors may compare and choose 
funds based on their preferences for cost more easily. The proposed 
amendments may also improve competition, as enhanced disclosure may 
prompt funds to provide improved products and services that may have a 
greater appeal to better-informed investors. Enhanced disclosure also 
may prompt acquiring funds to invest in acquired funds with lower 
costs. Finally, the effects of the proposed amendments on capital 
formation are unclear. Although, as noted above, we believe that the 
proposed amendments would benefit investors, the magnitude of the 
effect of the proposed amendments on efficiency, competition, and 
capital formation is difficult to quantify, particularly given that 
most funds do not currently provide the type of disclosure contemplated 
by the proposed amendments.

C. Request for Comment

    We request comment on whether the proposed rules and form 
amendments, if adopted, would promote efficiency, competition, and 
capital formation. We also request comment on whether the proposed 
rules and form amendments, if adopted, would impose a burden on 
competition. Commenters are requested to provide empirical data and 
other factual support for their views, if possible.

VII. Summary of Initial Regulatory Flexibility Analysis

    We have prepared an Initial Regulatory Flexibility Analysis 
(``IRFA'') under 5 U.S.C. 603 regarding proposed rules 12d1-1, 12d1-2, 
and 12d1-3, and proposed amendments to Forms N-1A, N-2, N-3, N-4, and 
N-6 under the Investment Company Act. The following summarizes the 
IRFA. The IRFA summarizes the reasons, objectives, and legal basis for 
the proposed rules and form amendments. The IRFA also discusses the 
effect of the proposed rules and form amendments on small entities. The 
staff estimates, based upon Commission filings, that there are 
approximately 5,025 active registered funds and 48 business development 
companies, of which approximately 209 and 28 are small entities, 
respectively.\163\ The staff estimates that few, if any, registered 
separate accounts are small entities. Funds that are small entities, 
like other funds, may rely on the proposed rules if they satisfy the 
conditions. Under the proposed form amendments, a fund that invests in 
another fund would be required to disclose the aggregate expenses of 
acquired funds.
---------------------------------------------------------------------------

    \163\ For purposes of the Regulatory Flexibility Act, a fund is 
a small entity if the fund, together with other funds in the same 
group of related funds, has net assets of $50 million or less as of 
the end of its most recent fiscal year. Rule 0-10 [17 CFR 270.0-10]. 
The number of small entities is derived from analyzing information 
from databases such as Morningstar, Inc. and Lipper. Some or all of 
these entities may contain multiple series or portfolios, which are 
also small entities.
---------------------------------------------------------------------------

    We believe that the proposed rules would have little impact on 
small entities. Like other funds, small entities would be affected by 
the proposed rules only if they determined to use the exemptions 
provided under the proposed rules. Few small entities have applied for 
relief to engage in the activities that would be permitted under the 
proposed rules.\164\ The proposed amendments to Forms N-1A and N-2 
would likely have a greater impact on small entities.
---------------------------------------------------------------------------

    \164\ If the rules were adopted more small entities may use the 
relief provided, but the number of small entities engaging in these 
activities would probably remain small.
---------------------------------------------------------------------------

    As noted above, compliance with the proposed rules is voluntary, 
and therefore the proposed rules would not impose mandatory reporting 
or recordkeeping requirements and would not materially increase other 
compliance requirements. No federal rules duplicate or conflict with 
the proposed rules. The Commission is seeking comment on the proposed 
amendments to Forms N-1A, N-2, N-3, N-4, and N-6. Commission staff has 
estimated that the burden per small fund portfolio would be up to 7 
hours, at a cost of $410.\165\ Assuming half of small funds invest in 
other funds and were required to comply with the form amendments, we 
estimate the annual disclosure cost for small entities would be 
$93,685.\166\
---------------------------------------------------------------------------

    \165\ If each portfolio of a registered fund includes the 
proposed disclosure, staff estimates the disclosure required by the 
proposed instructions would take up to 6 hours for an intermediate 
accountant at a rate of $30 per hour plus one hour for a deputy 
general counsel at a rate of $230 per hour to perform ((6 x $30) + 
(1 x $230) = $410). See Securities Industry Association, Report on 
Management and Professional Earnings in the Securities Industry 
(2002).
    \166\ There are 157 small funds registered under Form N-1A, with 
an average of 2.7 portfolios per registrant. There are 33 small 
funds registered under Form N-2, with an average of 1 portfolio per 
registrant. Thus, Commission staff estimates there are a total of 
457 portfolios ((157 x 2.7) + 33 = (423.9 + 33) = 456.9) reporting 
under Forms N-1A and N-2. The estimate of annual disclosure cost is 
based on the following calculation: 457/2 portfolios x $410 = 
$93,685.
---------------------------------------------------------------------------

    We have considered significant alternatives that would accomplish 
the stated objective, while minimizing any significant adverse impact 
on small entities. We considered: (a) Differing compliance or reporting 
requirements or

[[Page 58243]]

timetables that take into account the resources available to small 
entities; (b) clarification, consolidation, or simplification of 
compliance and reporting requirements under the rule for small 
entities; (c) performance rather than design standards; and (d) an 
exemption from coverage of the rule, or any part thereof, for small 
entities. The rule requirements, as explained above, are designed to 
protect the interests of all fund investors, and an exemption from the 
conditions in the proposed rules for small entities would not be 
consistent with the protection of investors. Further clarification, 
consolidation, or simplification of the requirements is not necessary. 
The conditions of the rules are design rather than performance 
standards.
    We encourage comment on the IRFA, especially with regard to the 
number of small entities that are likely to rely on the proposed rules 
and the impact of the proposed form amendments on small entities. A 
copy of the IRFA is available from Penelope W. Saltzman, Securities and 
Exchange Commission, 450 5th Street, NW., Washington, DC 20549-0506.

VIII. Statutory Authority

    The Commission is proposing rules 12d1-1, 12d1-2, and 12d1-3 under 
the authority set forth in sections 6(c), 12(d)(1)(J), and 38(a) of the 
Investment Company Act [15 U.S.C. 80a-6(c), 80a-12(d)(1)(J), 80a-
37(a)]. The Commission is proposing amendments to registration forms 
under the authority set forth in sections 6, 7(a), 10 and 19(a) of the 
Securities Act of 1933 [15 U.S.C. 77f, 77g(a), 77j, 77s(a)], and 
sections 8(b), 24(a), and 30 of the Act [15 U.S.C. 80a-8(b), 80a-24(a), 
and 80a-29].

List of Subjects

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rules and Form Amendments

    For the reasons set out in the preamble, the Commission proposes to 
amend Title 17, Chapter II of the Code of Federal Regulations to read 
as follows:

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. The authority citation for part 270 is amended by revising the 
subauthority for Sec.  270.12d1-1 to read as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted;
* * * * *
    Sections 270.12d1-1, 270.12d1-2, and 270.12d1-3 are also issued 
under 15 U.S.C. 80a-6(c), 80a-12(d)(1)(J), and 80a-37(a).
* * * * *

    2. Sections 270.12d1-1, 270.12d1-2, and 270.12d1-3 are added to 
read as follows:


Sec.  270.12d1-1  Exemptions for investments in money market funds.

    (a) Exemptions. If the conditions of paragraph (b) of this section 
are satisfied, notwithstanding sections 12(d)(1)(A), 12(d)(1)(B), and 
17(a) of the Act (15 U.S.C. 80a-12(d)(1)(A), 80a-12(d)(1)(B), and 80a-
17(a)), and Sec.  270.17d-1:
    (1) An investment company (``Acquiring Fund'') may purchase and 
redeem shares issued by a Money Market Fund; and
    (2) A Money Market Fund, any principal underwriter therefor, and a 
broker or a dealer may sell or otherwise dispose of shares issued by 
the Money Market Fund to an Acquiring Fund.
    (b) Conditions.
    (1) Administrative fees. The Acquiring Fund pays no Administrative 
Fees, or the Acquiring Fund's investment adviser waives its advisory 
fee in an amount necessary to offset any Administrative Fees.
    (2) Unregistered money market funds. If the Money Market Fund is 
not an investment company registered under the Act:
    (i) The Acquiring Fund reasonably believes that the Money Market 
Fund:
    (A) Operates in compliance with Sec.  270.2a-7;
    (B) Complies with sections 17(a), (d), (e), 18, and 22(e) of the 
Act (15 U.S.C. 80a-17(a), (d), (e), 80a-18, and 80a-22(e)) as if it 
were a registered open-end investment company; and
    (C) Has adopted procedures designed to ensure that it complies with 
sections 17(a), (d), (e), 18, and 22(e) of the Act (15 U.S.C. 80a-
17(a), (d), (e), 80a-18, and 80a-22(e)) as if it were a registered 
open-end investment company, periodically reviews and updates those 
procedures, and maintains books and records describing those 
procedures;
    (D) Maintains the records required by Sec. Sec.  270.31a-1(b)(1), 
270.31a-1(b)(2)(ii), 270.31a-1(b)(2)(iv), and 270.31a-1(b)(9); and
    (E) Preserves permanently, the first two years in an easily 
accessible place, all books and records required to be made under 
paragraphs (b)(2)(i)(C) and (D) of this section, and makes those 
records available for examination on request by the Commission or its 
staff; and
    (ii) The adviser to the Money Market Fund is registered with the 
Commission as an investment adviser under section 203 of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-3).
    (c) Definitions.
    (1) Administrative Fees means any sales charge, as defined in rule 
2830(b)(8) of the Conduct Rules of the NASD, or service fee, as defined 
in rule 2830(b)(9) of the Conduct Rules of the NASD, charged in 
connection with the purchase, sale, or redemption of securities issued 
by a Money Market Fund.
    (2) Investment company includes a company that would be an 
investment company under section 3(a) of the Act (15 U.S.C. 80a-3(a)) 
but for the exceptions to that definition provided for in sections 
3(c)(1) and 3(c)(7) of the Act (15 U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).
    (3) Money Market Fund means:
    (i) An open-end management investment company registered under the 
Act that is regulated as a money market fund under Sec.  270.2a-7; or
    (ii) A company that would be an investment company under section 
3(a) of the Act (15 U.S.C. 80a-3(a)) but for the exceptions to that 
definition provided for in sections 3(c)(1) and 3(c)(7) of the Act (15 
U.S.C. 80a-3(c)(1) and 80a-3(c)(7)) and that:
    (A) Is limited to investing in the types of securities and other 
investments in which a money market fund may invest under Sec.  270.2a-
7; and
    (B) Undertakes to comply with all the other requirements of Sec.  
270.2a-7, except that, if the company has no board of directors, the 
company's investment adviser performs the duties of the board of 
directors.


Sec.  270.12d1-2  Exemptions for investment companies relying on 
section 12(d)(1)(G) of the Act.

    (a) Exemption to acquire other securities. Notwithstanding section 
12(d)(1)(G)(i)(II) of the Act (15 U.S.C. 80a-12(d)(1)(G)(i)(II)), a 
registered open-end investment company or a registered unit investment 
trust that relies on section 12(d)(1)(G) of the Act (15 U.S.C. 80a-
12(d)(1)(G)) to acquire securities issued by another registered 
investment company that is in the same group of

[[Page 58244]]

investment companies may acquire, in addition to Government securities 
and short-term paper:
    (1) Securities issued by an investment company, when the 
acquisition is in reliance on section 12(d)(1)(A) or 12(d)(1)(F) of the 
Act (15 U.S.C. 80a-12(d)(1)(A) or 80a-12(d)(1)(F));
    (2) Securities (other than securities issued by an investment 
company); and
    (3) Securities issued by a Money Market Fund, when the acquisition 
is in reliance on Sec.  270.12d1-1.
    (b) Definitions. For purposes of this section, Money Market Fund 
has the same meaning as in Sec.  270.12d1-1(c)(3).


Sec.  270.12d1-3  Exemptions for investment companies relying on 
section 12(d)(1)(F) of the Act.

    (a) Exemption from sales charge limits. A registered investment 
company (``Acquiring Company'') that relies on section 12(d)(1)(F) of 
the Act (15 U.S.C. 80a-12(d)(1)(F)) to acquire securities issued by an 
investment company (``Acquired Company'') may offer or sell any 
security it issues through a principal underwriter or otherwise at a 
public offering price that includes a sales load of more than 1\1/2\ 
percent if any sales charges and service fees charged with respect to 
the Acquiring Company's securities, when aggregated with the sales 
charges and service fees charged with respect to the Acquired Company's 
securities, do not exceed the limits set forth in rule 2830 of the 
Conduct Rules of the National Association of Securities Dealers, Inc. 
applicable to a fund of funds.
    (b) Definitions. For purposes of this section, the terms fund of 
funds, sales charge, and service fee have the same meanings as is 
attributed to those terms in rule 2830(b) of the National Association 
of Securities Dealers, Inc. Rules.

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    3. The authority citation for Part 239 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77sss, 78c, 
78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 
79l, 79m, 79n, 79q, 79t, 80a-8, 80a-24, 80a-26, 80a-29, 80a-30, and 
80a-37, unless otherwise noted.
* * * * *

    4. The authority citation for part 274 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, 80a-26, and 80a-29, unless otherwise 
noted.
* * * * *

    5. Item 3 of Form N-1A (referenced in Sec. Sec.  239.15A and 
274.11A) is amended by adding paragraph (f) to Instruction 3 to read as 
follows:

    Note: The text of Form N-1A does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-1A

* * * * *

Item 3. Risk/Return Summary: Fee Table

* * * * *

Instructions.

* * * * *
3. Annual Fund Operating Expenses.
* * * * *
    (f)(i) If the Fund (unless it is a Feeder Fund) invests in shares 
of one or more ``Acquired Funds,'' add a subcaption to the ``Annual 
Fund Operating Expenses'' portion of the table directly above the 
subcaption titled ``Total Annual Fund Operating Expenses.'' Title the 
additional subcaption: ``[Acquired Fund] Fees and Expenses.'' Disclose 
in the subcaption fees and expenses incurred indirectly by the Fund as 
a result of investment in shares of one or more ``Acquired Funds.'' For 
purposes of this item, an ``Acquired Fund'' means any company in which 
the Fund invests that (A) is an investment company or (B) would be an 
investment company under section 3(a) of the Investment Company Act (15 
U.S.C. 80a-3(a)) but for the exceptions to that definition provided for 
in sections 3(c)(1) and 3(c)(7) of the Investment Company Act (15 
U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).
    (ii) Determine the ``[Acquired Fund] Fees and Expenses'' according 
to the following formula:
[GRAPHIC] [TIFF OMITTED] TP08OC03.006

Where:

AFFE = Acquired Fund fee expense;
F1, F2, F3, . . . = Total annual fund 
operating expense ratio (gross) for each Acquired Fund;
AI1, AI2, AI3, . . . = Average 
invested balance in each Acquired Fund;
D1, D2, D3, . . . = Number of days 
invested in each Acquired Fund; and
``Transaction Fees'' = The total amount of sales loads, redemption 
fees, or other transaction fees paid by the Fund in connection with 
acquiring shares in any Acquired Funds during the most recent fiscal 
year.

    (iii) Calculate the average net assets of the Fund for the most 
recent fiscal year, as provided in Item 9(a) (see Instruction 4 to Item 
9(a)).
    (iv) If the Acquired Fund and the Fund are part of the same ``group 
of investment companies'' (as defined in section 12(d)(1)(G)(ii) of the 
Investment Company Act (15 U.S.C. 80a-12(d)(1)(G)(ii))), the total 
annual expense ratio used for purposes of this calculation 
(F1) is the actual total annual expense ratio of the 
Acquired Fund for the Acquiring Fund's most recent fiscal year. If the 
Acquired Fund and the Fund are not part of the same ``group of 
investment companies,'' the total annual expense ratio used for 
purposes of this calculation (F1) is: (A) the gross total 
annual fund operating expense ratio for the Acquired Fund's most recent 
fiscal year disclosed in the financial highlights table of the Acquired 
Fund's most recent semi-annual report filed with the Commission; or (B) 
in the case of an Acquired Fund that does not provide a gross total 
annual expense ratio in its semi-annual report or does not file semi-
annual reports with the Commission, the ratio of total annual operating 
expenses of the Acquired Fund to average total annual net assets of the 
Acquired Fund for its most recent fiscal year, as disclosed in the most 
recent communication from the Acquired Fund to the Fund. In each case, 
the total annual expense ratio used should not include the effect of 
waivers or reimbursements by the Acquired Funds' investment advisers or 
sponsors. The Fund may disclose the AFFE determined based on the net 
expenses of the Acquired Funds in a footnote to the fee table.
    (v) To determine the average invested balance (AI1), the 
numerator is the sum of the amount initially invested in an Acquired 
Fund during the most recent fiscal year (if the investment was held at 
the end of the previous fiscal year,

[[Page 58245]]

use the amount invested as of the end of the previous fiscal year) and 
the amounts invested in the Acquired Fund as of each month end during 
the period the investment is held by the Fund (if the investment was 
held through the end of the fiscal year, use each month-end through and 
including the fiscal year-end). Divide the numerator by the number of 
measurement points included in the calculation of the numerator (i.e., 
if an investment is made during the fiscal year and held for 3 
succeeding months, the denominator would be 4).
    (vi) A New Fund should base the ``[Acquired Fund] Fees and 
Expenses'' on assumptions as to the specific Acquired Funds in which 
the New Fund expects to invest. Disclose in a footnote to the table 
that [Acquired Fund] Fees and Expenses are based on estimated amounts 
for the current fiscal year.
    (vii) The Fund may substitute the term used in the prospectus to 
refer to the Acquired Funds for the bracketed portion of the caption 
provided.
* * * * *
    6. Item 3 of Form N-2 [referenced in Sec. Sec.  239.14 and 274.11a-
1] is amended by:
    a. Redesignating paragraph 10 under the Instructions titled 
``Example'' as paragraph 11; and
    b. Adding new paragraph 10 before the heading ``Example'' to read 
as follows:

    Note: The text of Form N-2 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-2

* * * * *

Item 3. Fee Table and Synopsis

* * * * *

Instructions

* * * * *

Annual Expenses

* * * * *
    10. a. If the Registrant invests in shares of one or more 
``Acquired Funds,'' add a subcaption to the ``Annual Expenses'' portion 
of the table directly above the subcaption titled ``Total Annual 
Expenses.'' Title the additional subcaption: ``[Acquired Fund] Fees and 
Expenses.'' Disclose in the subcaption fees and expenses incurred 
indirectly by the Registrant as a result of investment in shares of one 
or more ``Acquired Funds.'' For purposes of this item, an ``Acquired 
Fund'' means any company in which the Registrant invests (A) that is an 
investment company or (B) that would be an investment company under 
section 3(a) of the 1940 Act (15 U.S.C. 80a-3(a)) but for the 
exceptions to that definition provided for in sections 3(c)(1) and 
3(c)(7) of the 1940 Act (15 U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).
    b. Determine the ``[Acquired Fund] Fee and Expenses'' according to 
the following formula:
[GRAPHIC] [TIFF OMITTED] TP08OC03.007

Where:

AFFE = Acquired Fund fee expense;
F1, F2, F3, . . . = Total annual fund 
operating expense ratio for each Acquired Fund;
AI1, AI2, AI3, . . . = Average 
invested balance in each Acquired Fund;
D1, D2, D3, . . . = Number of days 
invested in each Acquired Fund; and
``Transaction Fees'' = The total amount of sales loads, redemption 
fees, or other transaction fees paid by the Registrant in connection 
with acquiring shares in any Acquired Funds during the most recent 
fiscal year.

    c. Calculate the average net assets of the Registrant for the most 
recent fiscal year, as provided in Item 4.1 (see Instruction 15 to Item 
4).
    d. If the Acquired Fund and the Registrant are part of the same 
``group of investment companies'' (as defined in section 
12(d)(1)(G)(ii) of the 1940 Act (15 U.S.C. 80a-12(d)(1)(G)(ii))), the 
total annual expense ratio used for purposes of this calculation 
(F1) is the actual total annual expense ratio of the 
Acquired Fund for the Acquiring Fund's most recent fiscal year. If the 
Acquired Fund and the Registrant are not part of the same ``group of 
investment companies,'' the total annual expense ratio used for 
purposes of this calculation (F1) is: (A) the total annual 
fund operating expense ratio for the Acquired Fund's most recent fiscal 
year disclosed in the financial highlights table of the Acquired Fund's 
most semi-annual report filed with the Commission; or (B) in the case 
of an Acquired Fund that does not provide a total annual expense ratio 
in its semi-annual report or does not file semi-annual reports with the 
Commission, the ratio of total annual operating expenses of the 
Acquired Fund to average total annual net assets of the Acquired Fund 
for its most recent fiscal year, as disclosed in the most recent 
communication from the Acquired Fund to the Registrant.
    e. To determine the average invested balance (AI1), the 
numerator is the sum of the amount initially invested in an Acquired 
Fund during the most recent fiscal year (if the investment was held at 
the end of the previous fiscal year, use the amount invested as of the 
end of the previous fiscal year) and the amounts invested in the 
Acquired Fund as of each month end during the period the investment is 
held by the Registrant (if the investment was held through the end of 
the fiscal year, use each month-end through and including the fiscal 
year-end). Divide the numerator by the number of measurement points 
included in the calculation of the numerator (i.e., if an investment is 
made during the fiscal year and held for 3 succeeding months, the 
denominator would be 4).
    f. Base the ``[Acquired Fund] Fees and Expenses'' on (i) 
assumptions about specific funds in which the Registrant expects to 
invest, and (ii) estimates of the amount of assets the Registrant 
expects to invest in each of those Acquired Funds with the proceeds of 
the offering.
    g. The Registrant may substitute the term used in the prospectus to 
refer to the Acquired Funds for the bracketed portion of the caption 
provided.
* * * * *
    7. Item 3 of Form N-3 (referenced in Sec. Sec.  239.17a and 
274.11b) is amended by:
    a. Redesignating paragraph 19 under the Instructions titled 
``Example'' as paragraph 20; and
    b. Adding new paragraph 19 before the heading ``Example'' to read 
as follows:

    Note: The text of Form N-3 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-3

* * * * *

Item 3. Synopsis

* * * * *

[[Page 58246]]

Instructions

* * * * *

Annual Expenses

* * * * *
    19. (a) If the Registrant invests in shares of one or more 
``Acquired Funds,'' add a subcaption to the ``Annual Expenses'' portion 
of the table directly above the subcaption titled ``Total Annual 
Expenses.'' Title the additional subcaption: ``[Acquired Fund] Fees and 
Expenses.'' Disclose in the subcaption fees and expenses incurred 
indirectly by the Registrant as a result of investment in shares of one 
or more ``Acquired Funds.'' For purposes of this Item, an ``Acquired 
Fund'' means any company in which the Fund invests that (i) is an 
investment company or (ii) would be an investment company under section 
3(a) of the 1940 Act (15 U.S.C. 80a-3(a)) but for the exceptions to 
that definition provided for in sections 3(c)(1) and 3(c)(7) of the 
1940 Act (15 U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).
    (b) Determine the ``[Acquired Fund] Fees and Expenses'' according 
to the following formula:
[GRAPHIC] [TIFF OMITTED] TP08OC03.008

Where:

AFFE = Acquired Fund fee expense;
F1, F2, F3, . . . = Total annual fund 
operating expense ratio for each Acquired Fund;
AI1, AI2, AI3, . . . = Average 
invested balance in each Acquired Fund;
D1, D2, D3, . . . = Number of days 
invested in each Acquired Fund; and
``Transaction Fees'' = The total amount of sales loads, redemption 
fees, or other transaction fees paid by the Registrant in connection 
with acquiring shares in any Acquired Funds during the most recent 
fiscal year.

    (c) Calculate the average net assets of the Registrant for the most 
recent fiscal year, as provided in Item 4(a) (see Instruction 10 to 
Item 4(a)).
    (d) If the Acquired Fund and the Registrant are part of the same 
``group of investment companies'' (as defined in section 
12(d)(1)(G)(ii) of the 1940 Act (15 U.S.C. 80a-12(d)(1)(G)(ii))), the 
total annual expense ratio used for purposes of this calculation (F1) 
is the actual total annual expense ratio of the Acquired Fund for the 
Acquiring Fund's most recent fiscal year. If the Acquired Fund and the 
Registrant are not part of the same ``group of investment companies,'' 
the total annual expense ratio used for purposes of this calculation 
(F1) is: (i) the total annual fund operating expense ratio for the 
Acquired Fund's most recent fiscal year disclosed in the financial 
highlights table of the Acquired Fund's most recent semi-annual report 
filed with the Commission; or (ii) in the case of an Acquired Fund that 
does not provide a total annual expense ratio in its semi-annual report 
or does not file a semi-annual report with the Commission, the ratio of 
total annual operating expenses of the Acquired Fund to average total 
annual net assets of the Acquired Fund for its most recent fiscal year, 
as disclosed in the most recent communication from the Acquired Fund to 
the Registrant.
    (e) To determine the average invested balance (AI1), the 
numerator is the sum of the amount initially invested in an Acquired 
Fund during the most recent fiscal year (if the investment was held at 
the end of the previous fiscal year, use the amount invested as of the 
end of the previous fiscal year) and the amounts invested in the 
Acquired Fund as of each month end during the period the investment is 
held by the Registrant (if the investment was held through the end of 
the fiscal year, use each month-end through and including the fiscal 
year-end). Divide the numerator by the number of measurement points 
included in the calculation of the numerator (i.e., if an investment is 
made during the fiscal year and held for 3 succeeding months, the 
denominator would be 4).
    (f) A New Registrant should base the ``[Acquired Fund] Fees and 
Expenses'' on assumptions as to the specific funds in which the New 
Registrant assumes it will invest. Disclose in a footnote to the table 
that ``[Acquired Fund] Fees and Expenses'' are based on estimated 
amounts for the current fiscal year.
    (g) The Registrant may substitute the term used in the prospectus 
to refer to the Acquired Funds for the bracketed portion of the caption 
provided.
* * * * *
    8. Item 3 of Form N-4 (referenced in Sec. Sec.  239.17b and 
274.11c) is amended by adding a sentence at the end of paragraph 17(a) 
under the Instructions to read as follows:

    Note: The text of Form N-4 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-4

* * * * *

Item 3. Synopsis

* * * * *

Instructions

* * * * *

Total Annual [Portfolio Company] Operating Expenses

* * * * *
    17. (a) * * * If any portfolio company invests in shares of one or 
more ``Acquired Funds,'' ``Total Annual [Portfolio Company] Operating 
Expenses'' for the portfolio company must also include fees and 
expenses of the Acquiring Funds, calculated in accordance with 
instruction 3(f) of Item 3 of Form N-1A (17 CFR 239.15A; 17 CFR 
274.11A). For purposes of this paragraph, an ``Acquired Fund'' means 
any company in which the portfolio company invests that (i) is an 
investment company or (ii) would be an investment company under section 
3(a) of the 1940 Act (15 U.S.C. 80a-3(a)) but for the exceptions to 
that definition provided for in sections 3(c)(1) and 3(c)(7) of the 
1940 Act (15 U.S.C. 80a-3(c)(1) and 80a-3(c)(7)).
    9. Item 3 of Form N-6 (referenced in Sec. Sec.  239.17c and 
274.11d) is amended by adding a sentence at the end of paragraph 4(b) 
under the Instructions to read as follows:

    Note: The text of Form N-6 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-6

* * * * *

Item 3. Risk/Benefit Summary: Fee Table

* * * * *

Instructions

* * * * *

4. Total Annual [Portfolio Company] Operating Expenses

* * * * *
    (b) * * * If any Portfolio Company invests in shares of one or more 
``Acquired Funds,'' ``Total Annual

[[Page 58247]]

[Portfolio Company] Operating Expenses'' for the Portfolio Company must 
also include fees and expenses of the Acquiring Funds, calculated in 
accordance with instruction 3(f) of Item 3 of Form N-1A (17 CFR 
239.15A; 17 CFR 274.11A). For purposes of this section, an ``Acquired 
Fund'' means any company in which the Portfolio Company invests that 
(i) is an investment company or (ii) would be an investment company 
under section 3(a) of the Investment Company Act (15 U.S.C. 80a-3(a)) 
but for the exceptions to that definition provided for in sections 
3(c)(1) and 3(c)(7) of the Investment Company Act (15 U.S.C. 80a-
3(c)(1) and 80a-3(c)(7)).
* * * * *

    Dated: October 1, 2003.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-25336 Filed 10-7-03; 8:45 am]
BILLING CODE 8010-01-P