[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.
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(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.
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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?
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\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].
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(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.
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\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.
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\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.''
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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.
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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).
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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?
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\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\
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\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.* * *'').
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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.
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\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.
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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?
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\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.
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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?
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\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\
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\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).
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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?
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\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.'').
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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?
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\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'').
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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.
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\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).
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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\
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\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.
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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\
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\111\ See 15 U.S.C. 80a-12(d)(1)(B).
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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.
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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\
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\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.
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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\
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\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.
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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.
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\122\ See supra note 119.
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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.
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\123\ See supra note 114.
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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.
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\124\ See supra note 123 and accompanying text.
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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.
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\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.
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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.
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\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.
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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.
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\134\ Pub. L. No. 104-113, Title II, 109 Stat. 163 (1995).
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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.
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\135\ 44 U.S.C. 3501 to 3520.
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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.
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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\
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\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.
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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\
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\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).
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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\
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\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.
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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).
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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\
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\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.
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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\
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\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.
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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\
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\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\
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\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).
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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\
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\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.
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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\
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\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).
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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.
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\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\
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\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.
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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