SEC requires fund of funds investing agreements

The commission, in a rare unanimous vote, has adopted new rules designed to keep the public (and investors) updated on complex investment structures.

Funds of funds will have to publish investment agreements laying out redemption terms and other parts of the deal under new rules adopted by the SEC, as reported by sister title Regulatory Compliance Watch.

In adopting the new rules at its October 7 meeting, the commission repeals Investment Company Act rule 12d1-2 and a mass of exemption letters, which allowed acquiring funds to invest within the same “family” of funds. Now, registered investment companies or business development companies – and including open-end funds, unit investment trusts, closed-end funds, exchange-traded funds and exchange-traded managed funds – will be able to invest in other funds more freely.

“The framework adopted today will provide flexibility to fund managers to allocate and structure investments efficiently, without the costs and delays of seeking individualized exemptive orders, as long as the arrangements satisfy a number of conditions designed to enhance investor protection,” SEC Chairman Jay Clayton said in announcing the new rules.

Undue influence

Under the new rules, acquired funds’ advisers will have to study the potential for undue influence by an acquiring fund.

Factors to be addressed in the undue influence evaluations include: “(1) the scale of contemplated investments by the acquiring fund and any maximum investment limits; (2) the anticipated timing of redemption requests by the acquiring fund; (3) whether, and under what circumstances, the acquiring fund will provide advance notification of investment and redemptions; and (4) the circumstances under which the acquired fund may elect to satisfy redemption requests in kind rather than in cash and the terms of any redemptions in kind,” the rules state.

Meanwhile, acquiring funds’ advisers will have to post their own analyses on a proposed deal’s complexity and – especially – “the relevant fees and expenses,” the rules state. “For both acquiring and acquired funds, the required analysis, and any findings based thereon, will be subject to the adviser’s fiduciary duty to act in the best interest of each fund it advises.”

The evaluations, and the findings that support it, will have to be submitted to an acquiring funds’ board of directors, at the next regularly scheduled meeting, the rules state.

10% bucket

The new rules also clamp down on three-tier fund of funds arrangements. Exceptions include the “10% bucket,” where an acquired fund will be allowed to invest up to 10 percent of its assets in other funds, including private funds.

The required public investment agreement replaces a proposal in the original rulemaking that would’ve capped an acquiring funds’ redemptions at 3 percent per month. Regulators were worried that acquiring funds could use redemptions as leverage to manipulate its subalterns. Nearly every commenter condemned that proposal.

Democratic Commissioners Allison Herren Lee and Stephanie Crenshaw asked that the investment agreements be filed publicly, a source told RCW.