Tuesday, June 07, 2011

SEC Staff Would Not Object to Fund Acquisition of Shares of Foreign Funds in Excess of 1940 Act Limits

The SEC staff would not object if a mutual fund acquired shares of certain foreign investment companies in excess of the limits in Section 12(d)(1)(A) of the Investment Company Act. Section 12(d)(1(A) prohibits a fund from acquiring securities issued by another fund if immediately after the acquisition the fund owns more than three percent of the outstanding voting stock of the acquired fund; has more than five percent of its total assets invested in the acquired fund; or has more than ten percent of its total assets invested in the acquired fund and all other investment companies. Red Rocks Capital, LLC, June 3. 2011.

Section 12(d)(1)(A) is designed to address certain abuses associated with the pyramiding of investment companies, such as undue influence over the acquired investment company, the layering of fees, and complex fund structures. In the incoming letter, the fund’s investment adviser asserts that the abuses that Section 12(d)(1)(A) was intended to prevent are not implicated if the fund invests in the foreign funds as proposed. Specifically, it is asserted that, to the extent that the 3 percent limit in Section 12(d)(1)(A) was designed to protect the acquired fund from undue influence by the acquiring fund, the Commission has no significant regulatory interest in protecting the foreign funds.

The incoming letter also asserts that, to the extent that the 5 percent and 10 percent limits in Section 12(d)(1)(A) were designed to protect shareholders of the acquiring fund excessive layering of fees and a complex fund structure, Congress also has permitted certain types of funds of funds, such as those that invest in accordance with Section 12(d)(1)(F) of the 1940 Act, or invest in private investment companies that are excluded from the definition of investment company by Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.

It was also pointed out that each fund's board of trustees oversees the fund’s fee structure, and that each fund provides disclosure of the fees and expenses related to its investments in foreign funds in the prospectus fee table