The SEC Relaxed Fund-of-Funds Rules for Certain Investors. Here’s How.

BDCs and registered investment firms, rejoice: The previous 10 percent cap and extra regulatory hurdles on fund-of-funds investments no longer apply.

SEC headquarters in Washington, D.C. (Joshua Roberts/Bloomberg)

SEC headquarters in Washington, D.C.

(Joshua Roberts/Bloomberg)

The Securities and Exchange Commission has relaxed rules for certain funds-of-funds, or investment pools that allocate capital to externally managed funds, lifting limits on how much they can invest.

The move will be beneficial to business development companies and registered investment firms, which can now invest in other funds without being subject to investment caps or extra regulatory hurdles.

On Wednesday, the SEC announced its final rule on the matter, which had been a long time coming. In 2018, the regulator released its proposed rule change. More than 100 comment letters and 29 stakeholder meetings later, the new rule has been codified.

According to a statement from SEC Chairman Jay Clayton, retail investors are increasingly using mutual funds and ETFs, which may have invested in other funds to achieve diversification. The SEC’s staff estimated that around 40 percent of registered fund managers hold an investment in at least one other fund.

“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,” Clayton said in the statement.


Before the rule passed, registered investment companies were not allowed to acquire more than 3 percent of another fund’s outstanding voting securities. They were also not allowed to invest more than 5 percent of their total assets into one fund, or more than 10 percent of their total assets in funds generally, according to the SEC’s final rule. To get around this rule, a fund would have to ask the SEC for an exemption.

That has been repealed, with a few limitations. For instance, the rule will require investors to enter into a fund-of-funds agreement specifying the terms of their arrangement.

The SEC initially proposed that a buyer could not redeem more than 3 percent of the fund it purchased in a 30-day period. This became a point of contention among asset managers who wrote comment letters to the SEC.

“While we understand that the redemption limitation is based on concerns that an acquiring fund may threaten to quickly redeem a large volume of acquired fund shares as a means of exerting undue influence over an acquired fund, we believe the limit could have unintended consequences on an acquiring open-end fund’s ability to achieve its investment strategy and on the liquidity of an acquiring open-end fund’s portfolio,” according to a letter from BlackRock.

Letters from law firm Ropes & Gray, PGIM Investments, Russell Investments, Allianz, and others echoed this sentiment. The pressure worked — the SEC removed that specific rule, satisfying some letter writers.

“The removal of the redemption limit from the final rule will be welcomed by the industry,” said George Raine, an asset management partner at law firm Ropes & Gray, via email Wednesday.

The rule also limits a buyer’s voting power and control over its investment.

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But the SEC did not bend to all of the investment firms’ requests. One major issue that popped up was whether these new rules would apply to private funds.

The American Investment Council, which advocates for private equity firms, along with TPG Specialty Lending (now known as Sixth Street Specialty Lending), submitted letters along with their peers asking the SEC to expand the rule to include private funds.

The SEC did not capitulate, citing concerns that it does not have “sufficient experience” in designing rules for these types of investors, its final rule shows.

As a result, the final rule does not change the prior regulations on private and foreign funds. It also does not extend these changes to “complex structures,” or funds-of-funds-of-funds.