Monday, January 30, 2017

Open-end funds may invest in closed-end funds regardless of relationship

By Amy Leisinger, J.D.

The SEC’s Division of Investment Management agreed with Dechert’s position that a registered open­-end investment company or a registered unit investment trust may rely on Investment Company Act Rule 12d1­-2 to invest in a closed­-end fund regardless of whether the two companies hold themselves out to investors as related organizations. Specifically, the staff noted, for the purposes of the rule, the definition of “group of investment companies” in Section 12(d)(1)(G) of the Act, does not include closed-­end investment companies.

Funds of funds. Section 12(d)(1)(A) prohibits a fund from acquiring securities issued by another investment company if, immediately after the acquisition, the fund: (1) owns more than three percent of the outstanding voting stock of the acquired fund; (2) has more than five percent of its total assets invested in the acquired fund; or (3) has more than ten percent of its total assets invested in the acquired fund and all other investment companies.

Section 12(d)(1)(G) provides an exemption for fund of funds arrangements for open-end funds to invest in other open-end funds that are part of the same “group of investment companies,” defined as two or more funds that hold themselves out to investors as related companies for purposes of investment and investor services.

In 2006, the Commission adopted Rule 12d1-2, which allows open-end funds relying on this exemption also to invest in securities issued by a registered investment company “other than securities issued by another registered investment company that is in the same group of investment companies,” subject to certain limitations.

Relief requested and granted. In its request for relief, Dechert noted that the rule permits investments in closed-end funds within these limits but that the absence of clarifying language suggests a possibility that closed-end funds deemed part of the investing fund’s “group of investment companies” may not qualify as permitted investments. There is no indication that the Commission intended to prevent an open-end fund from investing in closed-end funds that could be deemed to be within the same group, Dechert opined, and no policy reason would justify exclusion.

The staff agreed that the definition of “group of investment companies” refers solely, for the purposes of Rule 12d1-2, to open-end funds that hold themselves out as related companies. As such, the staff would not object to an open-end fund relying on the provisions investing in a closed-end fund regardless of whether the two funds belong to the same group, subject to the limitations set forth in the rule.

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