gates provisions, would entail: Srafting relevant procedures;
planning, coding, testing, and installing relevant system
modifications; integrating and implementing relevant procedures; and
preparing training materials and administering training sessions for
staff in affected areas. See id. However, in estimating the one-time
costs associated with proposed rule 22e-4, staff has adjusted the
estimated one-time systems costs associated with implementing the
fees and gates provisions to reflect that the estimated costs
associated with implementing the fees and gates provisions include
costs to be incurred by the fund and others in the distribution
chain (including transfer agents, accountants, custodians, and
intermediaries), whose services would be needed if a fund were to
impose a fee or gate, whereas we anticipate that the proposed rule
22e-4 requirements would be borne primarily by a fund complex and
not by others in the distribution chain.
     We note that the estimated one-time systems costs associated
with implementing the fees and gates provisions of the 2014
amendments to rule 2a-7 are generally similar to the proposed
estimated one-time systems costs associated with implementing the
floating NAV provisions of the 2014 rule 2a-7 amendments. See id. at
section III.B.8.a. However, the proposed estimated one-time systems
costs associated with implementing the floating NAV provisions were
adjusted downward at adoption, to account for certain considerations
specific to the floating NAV reforms. Thus, staff believes that the
one-time costs associated with the fees and gates provisions would
provide a closer analogue to the estimated costs associated with
proposed rule 22e-4 than the one-time costs associated with the
floating NAV provisions.
    \703\ This estimate assumes that each fund would not bear all of
the estimated costs (particularly, the costs of systems
modification) on an individual basis, but instead that these costs
would likely be allocated among the multiple users of the systems,
that is, each of the members of a fund complex. Accordingly, we
expect that, in general, funds within large fund complexes would
incur fewer costs on a per fund basis than funds within smaller fund
complexes, due to economies of scale in allocating costs among a
group of users.
    \704\ Specifically, a fund would be required to establish
policies and procedures relating to: (i) Classification and ongoing
review of the classification of the liquidity of each of the fund's
positions in a portfolio asset (or portions of a position in a
particular asset) (proposed rule 22e-4(b)(2)(i)-(ii)); (ii)
assessment and ongoing review of the fund's liquidity risk (proposed
rule 22e-4(b)(2)(iii)); (iii) determination and periodic review of
the adequacy of the fund's three-day liquid asset minimum (proposed
rule 22e-4(b)(2)(iv)(A)-(B)); (iv) the requirement for the fund not
to acquire any less liquid asset if, immediately after the
acquisition, the fund would have invested less than its three-day
liquid asset minimum in three-day liquid assets (proposed rule 22e-
4(b)(2)(iv)(C)); (v) the requirement for the fund not to acquire any
15% standard asset if, immediately after the acquisition, the fund
would have invested more than 15% of its net assets in 15% standard
assets (proposed rule 22e-4(b)(2)(iv)(D)); and (vi) the requirement
to establish policies and procedures regarding redemptions in kind,
to the extent that the fund engages in or reserves the right to
engage in redemptions in kind (proposed rule 22e-4(b)(2)(iv)(E)).
    \705\ See text accompanying supra note 205 (discussing proposed
Commission guidance on a fund's use of third-party service providers
to obtain data to inform or supplement its consideration of the
proposed liquidity classification factors).
     We understand, based on staff outreach, that annual costs to
subscribe to the liquidity classification services provided by
third-party data and analytics providers currently range from
$50,000-$500,000.
    \706\ See supra section III.C.4.a.
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    We anticipate that, depending on the personnel (and/or third party
service providers) involved with respect to the activities associated
with establishing and implementing a liquidity risk management program,
certain of the estimated one-time costs could be borne by the fund, and
others could be borne by the fund's adviser. This cost allocation would
be dependent on the facts and circumstances of a particular fund's
liquidity risk management program, and thus we cannot specify the
extent to which the estimated costs would typically be allocated to the
fund as opposed to the adviser. Estimated costs that are allocated to
the fund would be borne by fund shareholders in the form of fund
operating expenses.
    Staff estimates that each fund complex would incur ongoing program-
related costs, as a result of proposed rule 22e-4, that range from 10%
to 25% of the one-time costs necessary to establish and implement a
liquidity risk management program.\707\ Thus, staff estimates that a
fund complex would incur ongoing annual costs associated with proposed
rule 22e-4 that would range from $130,000 to $562,500.\708\ These costs
are attributable to the following activities, as applicable to each of
the funds within the complex: (i) Classification and ongoing review of
the classification of the liquidity of each of the fund's positions in
a portfolio asset (or portions of a position in a particular asset)
(proposed rule 22e-4(b)(2)(i)-(ii)); (ii) ongoing review of the fund's
liquidity risk (proposed rule 22e-4(b)(2)(iii)); (iii) periodic review
of the adequacy of the fund's three-day liquid asset minimum (proposed
rule 22e-4(b)(2)(iv)(B)); (iv) systems maintenance; (v) additional
staff training; (vi) approval by the board of any material change to
the fund's liquidity risk management program (including a change to the
fund's three-day liquid asset minimum) (proposed rule 22e-4(b)(3)(i));
(vii) periodic reports to the board of directors reviewing the adequacy
of the fund's three-day liquid asset minimum (proposed rule 22e-
4(b)(3)(ii)); and (viii) recordkeeping relating to the fund's liquidity
risk management program (proposed rule 22e-4(c)).\709\
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    \707\ These cost estimates are based in part on the staff's
recent estimates of the ongoing costs associated with implementing
the fees and gates provisions of the 2014 amendments to rule 2a-7
under the 1940 Act. See supra note 702 (discussing why staff
believes that the costs associated with the fees and gates
provisions could be useful to estimate the costs associated with
proposed rule 22e-4). In estimating the ongoing costs associated
with proposed rule 22e-4, staff has adjusted the ongoing costs
associated with implementing the fees and gates provisions to
reflect that we anticipate that the costs associated with
classifying the liquidity of a fund's portfolio positions would
entail the majority of the ongoing costs associated with proposed
rule 22e-4. Staff estimates that these costs, in conjunction with
other ongoing costs, would exceed the estimated ongoing costs
associated with the fees and gates provisions, and thus staff has
adjusted these estimates upward (based in part on staff knowledge of
costs associated with liquidity analyses prepared by third-party
service providers, as well as knowledge of the costs associated with
board approval to the extent that a fund's board were required to
approve a modified three-day liquid asset minimum).
    \708\ This estimate is based on the following calculations: 0.10
x $1,300,000 = $130,000; 0.25 x $2,250,000 = $562,500.
    \709\ We anticipate that, depending on the personnel (and/or
third party service providers) involved in the activities associated
with administering a liquidity risk management program, certain of
the estimated ongoing costs associated with these activities could
be borne by the fund, and others could be borne by the adviser. See
paragraph following supra note 706.

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    For purposes of this analysis, Commission staff estimates, based on
outreach conducted with a variety of funds regarding funds' current
liquidity risk management practices, that approximately \1/3\ of
currently-operational fund complexes (or 289 complexes \710\) would
incur one-time and ongoing costs on the high end of the range of costs
associated with establishing and implementing a liquidity risk
management program, and \2/3\ of currently-operational fund complexes
(or 578 complexes \711\) would incur one-time and ongoing costs on the
low end of the range. Based on these estimates, staff further estimates
that the total aggregate one-time costs for all funds to establish and
implement a liquidity risk management program would be approximately
$1.4 billion.\712\ In addition, staff estimates that the aggregate
annual costs associated with the liquidity risk management program
requirement would be approximately $240 million.\713\
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    \710\ In developing the estimate that 289 fund complexes would
incur one-time and ongoing costs on the high end of the range of
costs associated with establishing and implementing a liquidity risk
management program, the staff assumed that that fund complexes that
include investment grade bond funds, high yield bond funds, world
bond funds (including emerging market bond funds), multi-sector bond
funds, state municipal funds, alternative strategy funds, and
emerging market equity funds, as well as ETFs with any of these
strategies, would incur costs on the high end of the range, and all
other complexes would incur costs on the low end of the range. The
staff assumed that the percentage of fund complexes that includes
these selected investment strategies, as a fraction of all fund
complexes, is the same as the percentage of all mutual funds
(excluding money market funds) and ETFs that these strategies
represent. The actual number of fund complexes that includes these
selected strategies could be higher or lower than the number
calculated using this assumption.
     605 investment grade bond mutual funds + 241 high yield bond
mutual funds + 347 world bond mutual funds + 139 multi-sector bond
mutual funds + 322 state municipal mutual funds + 376 alternative
strategy funds that are equity funds (alternative strategy funds
that are bond funds are included in our estimates of the number of
bond mutual funds) + 469 emerging market equity mutual funds + 264
bond ETFs + 165 emerging market ETFs = 2,928 funds. 2,928 funds /
8,734 open-end funds (excluding money market funds, and including
ETFs) = approximately 33% = approximately \1/3\. \1/3\ x 867
currently-operational fund complexes = 289 fund complexes. These
estimates are based on figures included in the 2015 ICI Fact Book.
See 2015 ICI Fact Book, supra note 3, at Fig. 1.8.
    \711\ In developing the estimate that 578 fund complexes would
incur one-time and ongoing costs on the high end of the range of
costs associated with establishing and implementing a liquidity risk
management program, the staff assumed that that fund complexes that
include investment grade bond funds, high yield bond funds, world
bond funds (including emerging market bond funds), multi-sector bond
funds, state municipal funds, alternative strategy funds, and
emerging market equity funds, as well as ETFs with any of these
strategies, would incur costs on the high end of the range, and all
other complexes would incur costs on the low end of the range. The
staff assumed that the percentage of fund complexes that includes
these selected investment strategies, as a fraction of all fund
complexes, is the same as the percentage of all mutual funds
(excluding money market funds) and ETFs that these strategies
represent. The actual number of fund complexes that includes these
selected strategies could be higher or lower than the number
calculated using this assumption.
    8,734 open-end funds (excluding money market funds, and
including ETFs) -2,928 funds (see supra note 710) = 5,806 funds.
5,806 funds / 8,734 open-end funds (excluding money market funds,
and including ETFs) = approximately 66% = approximately \2/3\. \2/3\
x 867 currently-operational fund complexes = 578 fund complexes.
These estimates are based on figures included in the 2015 ICI Fact
Book. See 2015 ICI Fact Book, supra note 3, at Fig. 1.8.
    \712\ This estimate is based on the following calculation: (578
fund complexes x $1,300,000 = $751,400,000) + (289 fund complexes x
$2,250,000 = $650,250,000) = $1,401,165,000.
    \713\ This estimate is based on the following calculation: (578
fund complexes x $130,000 = $75,140,000) + (289 fund complexes x
$562,500 = $162,562,500) = $237,702,500.
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    Certain elements of the program requirement may entail marked
variability in related compliance costs, depending on a fund's
particular circumstances and sources of potential liquidity risk. The
process of classifying the liquidity of each of a fund's positions in a
portfolio asset, taking into account the factors specified under
proposed rule 22e-4(b)(2)(ii), could give rise to varying costs
depending on the fund's particular investment strategy. For example, a
U.S. large cap equity fund would likely incur relatively few costs to
obtain the data necessary to consider the required factors. On the
other hand, a fund that invests in assets for which relevant market,
trading, and other liquidity-relevant data is less readily available
would incur relatively greater costs associated with the
classification, and ongoing review of the classification, of the funds'
portfolio positions' liquidity. Certain of the factors that a fund
would be required to consider in assessing its liquidity risk also
could entail relatively greater costs, depending on the fund's
circumstances. For instance, a fund with a relatively short operating
history could incur greater costs in assessing the fund's cash flow
projections than a similarly situated fund with a relatively long
operating history. This is because the newer fund could find it
appropriate to assess redemption activity in similar funds during
normal and stressed periods (to predict its future cash flow patterns),
which could entail additional costs to gather and analyze relevant data
about these comparison funds. Also, a fund whose shares are held
largely through omnibus accounts may wish to periodically request
shareholder information from financial intermediaries in order to
determine how the fund's ownership concentration may affect its cash
flow projections. These data requests, and related analyses, could
cause a fund to incur costs that another fund, whose shares are largely
held directly, would not. A fund that deems it appropriate to establish
and implement additional liquidity risk management policies and
procedures beyond those specifically required under the proposed rule
also would incur additional related costs. While we recognize that, as
described above, the costs to establish and implement a liquidity risk
management program in compliance with proposed rule 22e-4 will depend
to some degree on the level of liquidity risk facing the fund, we are
unable to discuss in detail all of the ways in which a fund's
individual risks and circumstances could affect the costs associated
with establishing a liquidity risk management program.
    A fund may incur costs if it decides to reallocate portfolio assets
to correspond with its initial or subsequently modified three-day
liquid asset minimum. While we are unable to anticipate how many funds
may reallocate portfolio assets in this way, or the extent of such
reallocation by any fund that does so, we anticipate that the
transaction-related costs of any such reallocation will not be
significant for most funds. This is because some funds may not need to
reallocate portfolio assets at all to correspond with their three-day
liquid asset minimum, and those that decide to do so would be able to
gradually adjust their portfolios in order to buy and sell portfolio
positions during times that are financially advantageous. We note that
the three-day liquid asset minimum requirement would limit the
acquisition of less liquid assets when such acquisition would result in
a fund investing less than its three-day liquid asset minimum in three-
day liquid assets, but would not require funds always to maintain a
certain portion of their portfolio assets in three-day liquid
assets.\714\ Thus, while a fund may decide to reallocate its portfolio
to correspond with its three-day liquid asset minimum by the time of
the proposed compliance date or at any time the fund determined to
modify the three-day liquid asset minimum, a fund would not be required
to conduct transactions in portfolio assets in any particular
timeframe, so long as it were to limit its acquisition of less liquid
assets in compliance with its three-day

liquid asset minimum. If a fund wishes to reallocate its portfolio by
the proposed compliance date, we anticipate that the proposed
compliance date would provide sufficient time to do so with relatively
few associated transaction costs. We request comment on this point in
section III.H above. Along with the transaction-related costs
associated with any portfolio reallocation, we recognize that this
reallocation in turn could affect the performance and/or risk profiles
of funds that modify their composition, which in turn could result in
costs associated with decreased investment options available to
investors and any changes to the market for relatively less liquid
assets; these costs are discussed below.\715\
---------------------------------------------------------------------------

    \714\ See supra notes 346-348 and accompanying text.
    \715\ See infra paragraphs accompanying notes 716-717.
---------------------------------------------------------------------------

Potential for Decreased Investment Options and Adverse Effects
    Under the proposed rule, a fund would be required to determine its
three-day liquid asset minimum based on a consideration of certain
specified factors relating to the fund's liquidity risk.\716\ Because a
fund is currently not required to consider any particular factors
relating to its portfolio liquidity, we recognize that this requirement
could result in a fund newly determining its existing portfolio
liquidity profile given the fund's liquidity needs. This could lead a
fund to modify its portfolio composition if it determines that the
three-day liquid asset minimum that it should hold, as a result of its
liquidity risk assessment, does not correspond with the fund's current
portfolio composition. The proposed rule thus could result in certain
funds increasing their investments in relatively more liquid assets,
which in turn could affect the performance and/or risk profiles of
funds that modify their portfolio composition in this way. This impact
may be particularly strong for funds that plan to meet redemptions
within seven days after receiving them (rather than a shorter period of
time). Such modifications to funds' portfolio composition consequently
could decrease certain investment options available to investors or
reduce investor returns. However, because these portfolio composition
shifts would occur only if a fund were to determine that it needs to
adjust its existing liquidity level based on consideration of the
factors in the proposed rule, we anticipate that the potential for
decreased yield would likely only affect funds currently holding
portfolios whose liquidity levels have the potential to create
redemption-related liquidity risk for fund investors. Thus, the
potential for decreased investment options for certain investors (and
any related decrease in investment yield) has the corollary benefit of
potential decreased liquidity risk in the funds in which these
investors hold shares. Currently we are not able to quantify the number
of funds that would need to significantly modify their portfolios' risk
profile as a result of the proposed rule because of the lack of
information necessary to provide a reasonable estimate. Such an
estimate would depend on the number of funds that might need to modify
their current portfolio composition as a result of the proposed rule,
as well as the availability of relatively liquid assets that can act as
adequate substitutes to existing assets for those affected funds.
Because funds are not required to report or disclose information
concerning the liquidity of their assets, because we cannot anticipate
the three-day liquid asset minimum that each fund would determine to be
appropriate based on its liquidity risk, and because we cannot
determine what relatively more liquid assets funds would purchase as
substitutes, we are unable to quantify the total potential costs
discussed in this section. However, individual funds would only incur
these costs if their current portfolio construction lacks sufficient
liquidity to allow the offering of daily redemption without creating
significant negative impact on investors.
---------------------------------------------------------------------------

    \716\ Proposed rule 22e-4(b)(2)(iv)(A).
---------------------------------------------------------------------------

Market for Relatively Less Liquid Assets
    As discussed above, the proposed rule could result in certain funds
increasing their investments in relatively more liquid assets, which
would effectively mean that these funds would decrease their
investments in relatively less liquid assets. If funds decrease their
investments in relatively less liquid assets, the market for those
assets could become even less liquid. This could discourage new
issuances of similar assets and decrease the liquidity of relatively
less liquid assets that are still outstanding. The impact of decreased
activity from funds in less liquid markets will depend on how much
current activity in those markets is driven by the funds, which varies
between markets. Further, these market effects could be partially
offset if other opportunistic investors with greater capacity to hold
less liquid assets are attracted to the market by any lower prices for
these assets that result if funds decrease their holdings of less
liquid assets.\717\ In addition, if the proposed rule leads funds to
better assess the liquidity risk associated with certain asset
holdings, any decrease in the prices of these assets could reflect more
efficient pricing of the assets (that is, risk would be better
reflected in asset prices than it is currently). Because funds
currently are not required to report or disclose information concerning
the liquidity of their assets, and because we cannot anticipate the
three-day liquid asset minimum that each fund would determine to be
appropriate based on its liquidity risk, it is difficult to predict the
extent to which the proposed rule could lead funds to modify their
portfolio holdings, or whether such modifications would discourage the
issuance of certain assets. As a result, we cannot quantify the
potential costs discussed in this section. However, these costs will
only exist to the extent that some funds lack sufficient liquidity in
their current portfolio to allow the offering of daily redemption
without creating significant negative impact on investors.
---------------------------------------------------------------------------

    \717\ Relatively less liquid assets have a higher expected
return compared to relatively more liquid assets, thereby
compensating longer-term investors for holding relatively less
liquid assets. See Yakov Amihud & Haim Mendelson, Asset Pricing and
the Bid-Ask Spread, 17 J. Fin. Econ. 223 (1986).
---------------------------------------------------------------------------

d. Effects on Efficiency, Competition, and Capital Formation
    The proposed liquidity risk management program requirement would
require a fund to assess its liquidity risk and to determine its three-
day liquid asset minimum based on this risk assessment. We believe that
the proposed requirements would improve the alignment between fund
portfolio liquidity and fund liquidity needs. This improved alignment
could enhance funds' ability to meet redemptions in a manner that
mitigates potential dilution of shareholders' interests, and thus this
improved alignment could be viewed as increasing efficiency to the
extent that dilution is viewed as a drag on the ability of a fund's NAV
to reflect the performance of its portfolio. Additionally, the
requirement for a fund to classify the liquidity of its portfolio
assets (along with the related reporting and disclosure requirements,
discussed below) also could increase allocative efficiency by assisting
investors in making investment choices that better match their risk
tolerances.
    By enhancing funds' liquidity risk assessment and risk management,
the proposed program requirement also could promote pricing efficiency
in the sense that it would decrease the likelihood that a fund would be
forced

to sell portfolio assets under unfavorable circumstances in order to
meet redemptions (thus creating significant negative price pressure on
those assets) without materially affecting the fund's NAV or risk
profile. If a fund's asset sales were to temporarily move asset prices
away from their market value, this could create a temporary pricing
inefficiency. By decreasing the likelihood that these types of price
movements would occur, the program requirement could decrease pricing
inefficiency. However, the proposed program requirement could
negatively affect the efficient pricing of relatively less liquid
assets if it indirectly discourages funds from investing in them (for
example, if a fund were to decrease its investments in less liquid
assets if it determines that the three-day liquid asset minimum that it
should hold, as a result of its liquidity risk assessment, does not
correspond with the fund's current portfolio composition). But as
discussed above, this market effect could be partially offset if other
investors are incentivized to buy relatively less liquid assets on
account of any lower prices for these assets that result if funds
decrease their holdings of these assets.\718\ Alternatively, any price
decreases experienced as a result of decreased mutual fund investment
could be considered efficient price adjustments given the reduction in
liquidity of the assets.
---------------------------------------------------------------------------

    \718\ See supra section IV.C.1.c.
---------------------------------------------------------------------------

    If the proposed liquidity risk management program requirement
results in a material decrease in funds' investment in relatively less
liquid assets, competition for these assets would be negatively
affected. Under this scenario, the relatively less liquid assets in
which funds formerly would have invested may become even less liquid,
since the number of current or potential market participants would be
reduced. This decrease in competition may be partially offset if some
other investors become willing to invest in relatively less liquid
assets because of the larger illiquidity discount now associated with
the price of those assets. As a corollary, if the proposed liquidity
risk management program requirement results in a material increase in
funds' investment in three-day liquid assets, competition for these
assets would be positively affected. As funds increase their investment
in relatively more liquid assets, the liquidity of those assets should
increase. However, that increase may be partially offset if some other
investors decrease their investment in relatively more liquid assets
because of the larger liquidity premium now associated with the price
of those assets.
    The size of a fund, or the family of funds to which a fund belongs,
could have certain competitive effects with respect to the fund's
implementation of its liquidity risk management program. If there are
economies of scale in creating and administrating multiple liquidity
risk management programs, funds in large families would have a
competitive advantage. For a fund in a smaller complex, however, a
greater portion of the fund's (and/or adviser's \719\) resources may be
needed to create and administer a liquidity risk management program,
which may increase barriers to entry in the fund industry, and lead to
an adverse effect on competition. The size of a fund family also could
produce competitive advantages or disadvantages with respect to a
fund's use of products developed by third parties to classify the
liquidity of their portfolio assets, or to assess the fund's liquidity
risk. Funds in a large complex also could receive relatively more
favorable pricing for third-party liquidity risk management tools, if
the fund complex were to purchase discounted bulk services from the
developer or receive relationship-based pricing discounts. To the
extent that they choose to use liquidity risk management tools such as
committed lines of credit and interfund lending,\720\ funds in larger
complexes likewise could receive more favorable rates on committed
lines of credit than funds in smaller complexes, and could have
opportunities to establish interfund lending agreements that may not be
available to funds in smaller complexes.
---------------------------------------------------------------------------

    \719\ See paragraph following supra note 706.
    \720\ See supra section III.C.5.a (discussing and providing
guidance on the use of these tools).
---------------------------------------------------------------------------

    Any changes in certain assets' or asset classes' liquidity that
could indirectly result from the proposed liquidity risk management
program requirement (for example, as discussed above, if the number of
buyers and sellers for certain assets becomes significantly reduced as
a result of the program requirement) could also affect capital
formation among issuers of these assets. Some firms could be
discouraged from issuing new securities in particular asset classes
because of price discounts associated with lower liquidity. Or if
changes in liquidity are not equal across all asset classes, firms may
begin to shift their capital structure (e.g., begin to issue equity
instead of debt) or to change the terms of certain securities that they
issue in order to increase their liquidity (e.g., by standardizing the
terms of certain debt securities, or modifying the securities' terms to
promote electronic trading).
e. Reasonable Alternatives
    In formulating our proposal, we have considered various
alternatives to the individual elements of proposed rule 22e-4. Those
alternatives are outlined above in the sections discussing the proposed
rule elements, and we have requested comment on these
alternatives.\721\ The following discussion addresses significant
alternatives to proposed rule 22e-4, which involve broader issues than
the more granular alternatives to the individual rule elements
discussed above.
---------------------------------------------------------------------------

    \721\ See supra sections III.A.3, III.B.1.b, III.B.2.j,
III.B.3.b, III.C.1.e, III.C.2.b, III.C.3.d, III.C.4.b, III.C.5.e,
III.D.4, III.E.
---------------------------------------------------------------------------

    Instead of proposing rule 22e-4, we could issue guidance
surrounding the classification of portfolio assets' liquidity and the
assessment and management of liquidity risk. However, on account of the
significant diversity in liquidity risk management practices that we
have observed in the fund industry, we believe that the need exists for
an enhanced comprehensive baseline requirement instead of only guidance
for fund liquidity risk management. Also, an approach that involves
rulemaking, as opposed to merely guidance, would permit us to examine
registrants' compliance with the requirements and bring enforcement
actions relating to non-compliance and hence make it more likely that
the benefits discussed above would be realized.
    We considered proposing liquidity requirements similar to those
imposed on money market funds--that is, the requirement to hold a
minimum level of highly liquid asset holdings, and the ability to
impose redemption fees and gates.\722\ The requirements imposed on
money market funds, and the tools available to these funds to manage
heavy redemptions, are specifically tailored to the assets held by
money market funds and the behavior of money market fund
investors.\723\ Imposing similar regulatory requirements on funds that
are not money market funds would ignore significant differences between
money market funds and other funds. We discuss below why we decided not
to propose that funds hold a minimum level of highly liquid asset
holdings (similar to the portfolio liquidity requirements applicable to

money market funds). While funds are currently permitted under rule
22c-2 to impose redemption fees under certain circumstances, we
understand based on fund outreach that funds are generally moving away
from the use of fees to manage short-term trading risk, and we are not
proposing that the use of fees be expanded in light of this, as well as
the potential operational complexity that could accompany the use of
fees.\724\ We are not proposing that funds be permitted to impose
redemption gates because funds that are not money market funds have not
demonstrated the same risk of significant redemptions during times of
market stress that money market funds may face, and which redemption
gates are meant to prevent in money market funds. For example, while
there is some evidence of a first-mover advantage among money market
funds during the financial crisis, there is currently no matching
evidence of first-mover advantage among funds that are not money market
funds.\725\
---------------------------------------------------------------------------

    \722\ See supra notes 154-155 and accompanying text.
    \723\ See 2014 Money Market Fund Reform Adopting Release, supra
note 85, at section II.
    \724\ See infra paragraph accompanying note 777 for a discussion
of why we are proposing swing pricing, instead of a framework
involving purchase fees or redemption fees, to address potential
dilution of existing shareholder interests when a fund encounters
significant net purchases or net redemptions and for a discussion of
the operational differences between swing pricing and purchase and
redemption fees.
    \725\ See 2014 Money Market Fund Reform Adopting Release, supra
note 85, at section III.A.1.
---------------------------------------------------------------------------

    The Commission considered, but ultimately decided against,
proposing to exclude certain types of funds from proposed rule 22e-4.
For example, the proposed rule could have carved out exemptions for
funds with investment strategies that historically have entailed
relatively little liquidity risk, or funds with relatively low assets.
We are not proposing to exclude any subset of open-end funds, other
than money market funds, from the scope of the proposed rule. As
discussed above, even funds with investment strategies that
historically have involved little liquidity risk could experience
liquidity stresses in certain environments.\726\ And investors in small
funds could suffer from insufficient liquidity risk management just as
investors in larger funds could. Indeed, staff analysis suggests that
funds with relatively low total assets can experience greater flow
volatility, including more volatility in unexpected flows, than funds
with higher assets, which could indicate increased liquidity risk.\727\
The proposed program requirement is meant to permit a fund to customize
and calibrate its liquidity risk management program to reflect the
liquidity risks that it typically faces (and that it could face in
stressed market conditions). This flexibility is meant to result in
programs whose scope, and related costs and burdens, are appropriate to
manage the actual liquidity risks facing a particular fund.
---------------------------------------------------------------------------

    \726\ See supra notes 123-125 and accompanying text.
    \727\ DERA Study, supra note 39, at pp. 16-24.
---------------------------------------------------------------------------

    We considered multiple alternatives to the proposed requirements
regarding a fund's classification of the liquidity of its portfolio
assets. Under proposed rule 22e-4, a fund would be required to classify
and review the liquidity of each of the fund's positions in a portfolio
asset (or a portion of a fund's position in a portfolio asset) based on
the number of days within which a fund's position in a particular
portfolio asset could be converted to cash at a price that does not
materially affect the value of that asset assessed immediately prior to
sale, and considering certain specified factors.\728\ Instead of these
proposed requirements, we could have codified a definition of illiquid
asset that reflects the current 15% guideline. Because we believe most
funds generally adhere to the 15% guideline, this approach would have
had the benefit of already being accepted and understood by the
industry, and would have entailed few additional implementation costs
for funds. However, we understand, based on staff outreach, that the
15% guideline has generally caused funds to limit their exposures to
particular types of securities that generally cannot be sold or sold
quickly and that the Commission and staff have indicated are often
illiquid, depending on the facts and circumstances. We also understand
that it is not uncommon for a fund to consider very few (or none) of
its portfolio assets to be 15% guideline assets. Given the parameters
of the 15% guideline, we also do not believe that this approach would
require the typical fund to consider the liquidity characteristics of a
significant percentage of its portfolio.\729\ Thus, this approach alone
would not have provided as comprehensive a view of the relative
liquidity of portfolio assets as our proposed approach, or strengthen
funds' ability to meet redemption obligations and mitigate dilution of
the interests of shareholders.
---------------------------------------------------------------------------

    \728\ See rule 22e-4(b)(2)(i)-(ii).
    \729\ See supra section III.C.4.
---------------------------------------------------------------------------

    Instead of proposing an approach whereby a fund would be required
to assign each portfolio position to one of several liquidity
categories, we could have proposed a classification framework under
which a fund would simply be required to classify a portfolio position
as ``liquid'' or ``illiquid,'' based on a number of specified factors.
As discussed above, Commission staff has found, based on outreach to a
variety of funds, that funds with relatively comprehensive liquidity
classification procedures tend to view the liquidity of their portfolio
positions in terms of a liquidity spectrum rather than simply as wholly
liquid or wholly illiquid. This ``spectrum''-based approach to
liquidity can greatly facilitate a fund's portfolio manager in engaging
in portfolio construction that takes into account potential varying
liquidity needs of the fund over time. Our proposed approach to
liquidity classification reflects our understanding that funds commonly
evaluate assets' liquidity across such a liquidity spectrum, as opposed
to making a binary determination of whether an asset is liquid or
illiquid. It also more accurately conveys to investors that liquidity
tends to be a matter of degree.
    We also considered several alternatives to the proposed requirement
for each fund to determine its three-day liquid asset minimum and limit
its acquisition of less liquid assets in contravention of that minimum.
We instead could have proposed that each fund be required to determine
a minimum buffer level of cash (or cash equivalents) that it would
hold, or alternatively, to determine a minimum level of one-day liquid
asset holdings. The cash buffer alternative would help ensure that a
fund would be able to meet redemptions immediately, without the need to
sell any portfolio assets. Likewise, a one-day liquid asset minimum
requirement would help ensure that a fund would be able to meet
redemptions within a very quick period, and could encourage a fund to
hold a comparatively more liquid portfolio than the proposed three-day
liquid asset minimum. But we believe that these options have a number
of disadvantages. Namely, these options would not necessarily match a
fund's liquidity needs with its redemption obligations, and could
result in a fund being underinvested in assets that reflect the fund's
investment strategy (and concurrent risks and performance
potential).\730\ We considered proposing a ``seven-day liquid asset
minimum'' requirement--that is, requiring a fund to invest in a certain
amount of assets that

could be converted to cash within seven calendar days or less--which
would correspond with a fund's redemption obligations under section
22(e) of the Act. However, we were concerned that a seven-day liquid
asset minimum would not provide sufficient minimum liquidity given the
regulatory requirements and disclosures that require most funds to meet
redemptions obligations in shorter time periods and market practices
that effectively require all funds to meet redemption requests within
time periods shorter than seven calendar days.
---------------------------------------------------------------------------

    \730\ We note above that if a fund's redemption practices
require it to pay redeeming shareholders within a period shorter
than three business days, we expect the fund would consider whether
a specified portion of its three-day liquid asset minimum should
consist of portfolio positions that are convertible to cash within a
period shorter than three business days.
---------------------------------------------------------------------------

    We also considered proposing to require a standard level of three-
day liquid asset minimum holdings for all funds. This alternative
approach would have the advantage of being simple for investors to
understand and our examination staff to verify. However, this
alternative fails to account for notable differences between funds with
respect to investment strategy, fund flow patterns, and other
characteristics that contribute to funds' liquidity risk, which in turn
would make it reasonable for funds' portfolios to have varying
liquidity profiles. We believe that the proposed three-day liquid asset
minimum requirement would promote consistency in funds' consideration
of the factors relevant to their liquidity risk management, while also
permitting flexibility in implementation, which we believe is
appropriate in light of the significant diversity within the fund
industry. This approach includes elements that would help our staff to
ascertain that funds are indeed considering the required factors: Each
fund would be required to maintain a written record of how its three-
day liquid asset minimum was determined, as well as copies of materials
submitted to the fund's board in connection with the board's approval
of the three-day liquid asset minimum and reports provided to the board
that review the adequacy of the fund's three-day liquid asset
minimum.\731\ And as discussed above, although a fund would be
permitted to determine its own three-day liquid asset minimum under the
proposed rule, we believe that the requirement for a fund to consider
certain specified factors in determining its three-day liquid asset
minimum would likely preclude a fund from concluding that zero holdings
of three-day liquid assets would be appropriate.\732\
---------------------------------------------------------------------------

    \731\ See proposed rule 22e-4(c)(2)-(3).
    \732\ See supra section III.C.3.a.
---------------------------------------------------------------------------

    Instead of requiring funds to determine and invest their assets in
compliance with a three-day liquid asset minimum, we could require
funds to conduct stress tests of their own design relating to the
extent the fund has liquid assets to cover possible levels of
redemptions. This would have the benefit of permitting a fund
flexibility in determining whether its portfolio liquidity profile is
appropriate given its liquidity needs. Also, since the three-day liquid
asset minimum requirement implicitly also involves the requirement for
a fund to classify its portfolio assets' liquidity in a particular
manner (since compliance with a fund's three-day liquid asset minimum
would require knowing which assets are three-day liquid assets), not
requiring funds to determine a three-day liquid asset minimum would
permit a fund to not incur the costs associated with the proposed
liquidity classification requirements. As discussed above, some funds
already conduct stress testing incorporating the factors that a fund
would be required to consider in assessing their liquidity risk and
determining their three-day liquid asset minimum based on this
assessment.\733\ But, because the quality and comprehensiveness of
funds' liquidity risk management currently varies significantly, we
believe that requiring a certain set of factors to be considered in
assessing and managing liquidity risk (including determining the fund's
three-day liquid asset minimum) is important in reducing the risk that
funds will be unable to meet their redemption obligations under the
Investment Company Act and elevating the overall quality of liquidity
risk management across the fund industry. Also, we believe that it
would be difficult to determine, depending on the level of discretion a
fund would have in developing stress scenarios, whether these scenarios
would accurately depict liquidity risk and lead funds to determine the
appropriate level of portfolio liquidity they should hold. For example,
if a fund's liquidity needs were generally high during normal periods,
but were not correspondingly extreme during stress events, basing this
fund's portfolio liquidity on the results of stress testing alone could
cause a fund to hold too little liquidity during non-stressed periods.
Therefore we do not believe that a general stress testing requirement
would be an adequate substitute for the three-day liquid asset minimum
requirement.\734\
---------------------------------------------------------------------------

    \733\ See supra note 257 and accompanying text.
    \734\ We do note, however, that section 165(i)(2) of the Dodd-
Frank Act obligates the Commission to specify certain stress testing
requirements for certain large non-bank financial companies we
regulate, including investment companies. See supra note 104 and
accompanying text regarding initiatives to address the impact of
open-end fund investment activities on investors and the financial
markets.
---------------------------------------------------------------------------

    Finally, we considered proposing a liquidity risk management
program requirement that would not incorporate a three-day liquid asset
minimum requirement (or one of the alternatives to this requirement
discussed in the preceding paragraphs). Under this alternative, a fund
would be required to adopt and implement a liquidity risk management
program, which would include the proposed requirements regarding a
fund's classification of the liquidity of its portfolio assets (and
related reporting and disclosure regarding its portfolio assets'
liquidity) and the proposed requirements limiting investments in 15%
standard assets, but a fund would not be required to establish a
minimum level of three-day liquid assets. This alternative would have
the benefit of permitting funds to have a large amount of flexibility
in managing their liquidity risk. Although a fund would need to ensure
that it is able to meet its redemption obligations and would be subject
to the proposed limitations on investments in 15% standard assets, it
would be subject to no other requirements regarding its portfolio
liquidity. This would provide flexibility, for example, for a fund to
adjust its liquidity profile very quickly in light of changing market
conditions, whereas a fund subject to the three-day liquid asset
minimum requirement might not be able to do so as quickly, to the
extent the fund's board would be required to approve a change in the
fund's three-day liquid asset minimum. It also would permit a fund to
calibrate portfolio liquidity based on the factors the fund or its
adviser considers appropriate, instead of the factors that the proposed
rule would require a fund to consider in determining its three-day
liquid asset minimum. To the extent that a fund's portfolio liquidity
was not in line with investors' risk tolerances, investors could decide
not to invest in the fund, based on information about the fund's
portfolio liquidity reported on Form N-PORT.
    We do not believe, however, that this alternative would adequately
respond to primary goals of this rulemaking, that is, reducing the
risks that funds will be unable to meet their redemption obligations
and reducing potential dilution of non-redeeming shareholders. We
believe that the three-day liquid asset minimum requirement is a
critical element of the proposed liquidity risk management program
requirement that is designed to provide investors with increased
protections regarding how

fund portfolio liquidity is managed. As discussed above, we believe
that the proposed three-day liquid asset minimum requirement would
result in a portfolio liquidity standard that fosters consistency in
funds' consideration of the factors relevant to their liquidity risk
management, while simultaneously permitting flexibility in
implementation.\735\ While the board approval requirement associated
with the three-day liquid asset minimum could add a layer of process if
a fund wished to change its liquidity profile, we believe that this
requirement is necessary because it would add independent oversight
over funds' liquidity risk management.\736\ Although we believe that
reporting and disclosure regarding a fund's portfolio liquidity are
important, we do not believe that they would be sufficient to promote a
high quality of liquidity risk management across the fund industry
because they would not necessarily require a fund to consider its
portfolio liquidity in relation to its liquidity needs.
---------------------------------------------------------------------------

    \735\ See supra section III.C.3.
    \736\ See supra section III.D.1.
---------------------------------------------------------------------------

2. Swing Pricing
a. Requirements of Proposed Rule 22c-1(a)(3)
    Under proposed rule 22c-1(a)(3), a fund (with the exception of a
money market fund or ETF) would be permitted to establish and implement
swing pricing policies and procedures that would, under certain
circumstances, require the fund to use swing pricing to adjust its
current NAV as an additional tool to lessen potential dilution of the
value of outstanding redeemable securities caused by shareholder
purchase or redemption activity. In order to use swing pricing under
the proposed rule, a fund would be required to establish and implement
swing pricing policies and procedures.\737\ These policies and
procedures must: (i) Provide that the fund will adjust its NAV by an
amount designated as the ``swing factor'' once the level of net
purchases or net redemptions from the fund has exceeded a specified
percentage of the fund's net asset value known as the ``swing
threshold''; \738\ (ii) specify the fund's swing threshold, considering
certain specified factors; \739\ (iii) provide for the periodic review
(at least annually) of the fund's swing threshold, considering certain
specified factors; \740\ (iv) specify how a swing factor that would be
used to adjust the fund's NAV when the fund's swing threshold is
breached, which determination must take into account certain specified
factors.\741\
---------------------------------------------------------------------------

    \737\ Proposed rule 22c-1(a)(3)(i).
    \738\ Proposed rule 22c-1(a)(3)(i)(A).
    \739\ Proposed rule 22c-1(a)(3)(i)(B).
    \740\ Proposed rule 22c-1(a)(3)(i)(C).
    \741\ Proposed rule 22c-1(a)(3)(i)(D).
---------------------------------------------------------------------------

    A fund's board, including a majority of the fund's independent
directors, would be required to approve the fund's swing pricing
policies and procedures (including the fund's swing threshold, and any
swing factor upper limit specified under the fund's swing pricing
policies and procedures), and any material change to these policies and
procedures.\742\ However, the board would be required to designate the
fund's investment adviser or officers responsible for administration of
the fund's swing pricing policies and procedures and for determining a
swing factor that would be used to adjust the fund's NAV when the
fund's swing threshold is breached.\743\
---------------------------------------------------------------------------

    \742\ Proposed rule 22c-1(a)(3)(ii)(A).
    \743\ Proposed rule 22c-1(a)(3)(ii)(B).
---------------------------------------------------------------------------

    A fund that adopts swing pricing policies and procedures also would
be required to keep certain records, including a written copy of its
swing pricing policies and procedures,\744\ and records of support for
each computation of an adjustment to the fund's NAV based on these
policies and procedures.\745\ A fund that engages in swing pricing
would be required to make certain disclosures and reflect its use of
swing pricing in its financial statements.\746\
---------------------------------------------------------------------------

    \744\ Proposed rule 22c-1(a)(3)(iii).
    \745\ Proposed amendment to rule 31a-2(a)(2).
    \746\ See proposed amendments to Items 11, 13 and 26 of Form N-
1A and proposed amendments to Regulation S-X.
---------------------------------------------------------------------------

b. Benefits
    We believe proposed rule 22c-1(a)(3) would promote investor
protection by providing funds with a tool to reduce the potentially
dilutive effects of shareholder purchase or redemption activity. Rule
22c-1 under the Investment Company Act, the ``forward pricing'' rule,
requires a fund to price its shares based on the current market prices
of its portfolio assets next computed after receipt of an order to buy
or redeem shares.\747\ When a fund trades portfolio assets in order to
meet purchases or redemptions, the fund's current NAV on the trade date
would reflect any changes to the value of the fund's assets that occurs
as a result of trading on that day. But as discussed above, when a fund
trades portfolio assets in order to satisfy purchase or redemption
requests, certain costs associated with this trading activity currently
may not be taken into account in the price that the purchasing or
redeeming shareholder receives for his or her fund shares.\748\ The NAV
of the fund shares held by existing shareholders, however, will
eventually reflect all of these costs, including those that were not
passed on to the purchasing or redeeming shareholders.\749\ Swing
pricing provides funds with an additional tool--as a supplement to the
pricing conventions required by the forward pricing rule--to pass
estimated near-term costs stemming from shareholder purchase or
redemption activity on to the shareholders associated with that
activity.\750\ Swing pricing thus could lessen dilution of existing
shareholders and limit redemptions motivated by a potential first-mover
advantage.
---------------------------------------------------------------------------

    \747\ See rule 22c-1(a).
    \748\ See supra notes 410-413 and accompanying text.
    \749\ See id.
    \750\ See supra paragraph accompanying note 424.
---------------------------------------------------------------------------

    We recognize that swing pricing may involve potential disadvantages
to funds as well as potential advantages, and the provisions of
proposed rule 22c-1(a)(3) are designed to maximize the relative
advantages and respond to potential concerns associated with swing
pricing. While swing pricing may reduce dilution at the fund level and
could act as a deterrent against redemptions motivated by any first-
mover advantage, the potential disadvantages to swing pricing
(described in more detail below) include increased performance
volatility and the fact that the precise impact of swing pricing on
particular purchase or redemption requests would not be known in
advance and thus may not be fully transparent to investors. In
addition, the swing factor used by a fund on a particular day may not
capture all costs incurred by the fund resulting from purchases or
redemptions that day.
    Commission rules and guidance do not currently address the ability
of a fund to use swing pricing to mitigate potential dilution of fund
shareholders, and the Commission's current valuation guidance could
raise questions about making such NAV adjustment.\751\ The proposed
swing pricing rule would provide the regulatory framework that a fund
would apply to adjust its NAV in order to effectively pass on estimated
trading costs to purchasing or redeeming shareholders. The proposed
rule would require a fund that conducts swing pricing to do so in
accordance with policies and procedures and other restrictions designed
to promote all shareholders' interests.\752\ Because we

cannot prospectively measure the extent to which the swing pricing
policies and procedures that a fund may adopt would mitigate potential
dilution, we are unable to quantify the total potential benefits
discussed in this section.\753\ However, analysis by fund groups of
their funds domiciled in regions that allow swing pricing indicates
that investor dilution is significantly reduced through swing pricing
for some funds.\754\
---------------------------------------------------------------------------

    \751\ See supra note 423 and accompanying text.
    \752\ See supra note 424 and accompanying text.
    \753\ There is no database currently available that identifies
whether a foreign-domiciled fund uses swing pricing or the structure
of a fund's swing pricing program (e.g., full swing pricing versus
partial swing pricing).
    \754\ See BlackRock Swing Pricing Paper, supra note 412.
---------------------------------------------------------------------------

c. Costs
    A primary cost of implementing swing pricing is an increase in fund
return volatility. The implementation of swing pricing also could
increase tracking error relative to a fund's benchmark. However, the
impact of swing pricing on volatility and tracking error would decrease
as a function of time: For example, the impact of swing pricing on
daily return volatility and tracking error would likely be much greater
than the impact on monthly volatility and tracking error. The use of
``partial'' swing pricing also lessens the impact on volatility and
tracking error. When deciding whether or not to implement swing
pricing, a fund would have to weigh the cost of increased volatility
and tracking error (along with the other costs discussed below) against
the previously-discussed benefits of swing pricing.
    In addition, a swing pricing regime that uses a fund's daily net
purchases or net redemptions to determine when the fund will adjust its
NAV could create costs for fund investors. For example, an investor who
purchases fund shares on a day when a fund adjusts its NAV downward
will pay less to enter the fund than if the fund had not adjusted its
NAV on that day. However, investors would not be able to purposefully
take advantage of this lower purchase price without knowledge of
contemporaneous intraday flows, which funds do not publicly disclose.
Further, we believe that investors who purchase shares on a day that a
fund adjusts its NAV downward would not create dilution for non-
redeeming shareholders. Shareholders' purchase activity would provide
liquidity to the fund, which could reduce the fund's liquidity costs
and thereby could also decrease the swing factor. This could
potentially help redeeming shareholders to receive a more favorable
redemption price than they otherwise would have if there had been less
purchase activity on that day, but would not affect the interests of
non-redeeming investors. Similarly, adjusting a fund's NAV when the
fund's daily net redemptions cross a certain threshold, regardless of
the size of the component shareholder redemptions that comprise the
daily net redemptions, could produce costs to individual redeeming
shareholders whose redemptions alone would not result in redemption-
related costs to the fund. For instance, a small investor's redemption
request would not create any significant liquidity costs for the fund
on its own, but if this investor were to redeem on the same day that
the fund's net redemptions are high, his or her redemption proceeds
would be reduced by the NAV adjustment.
    We are not proposing to exempt certain investors from the NAV
adjustments permitted under proposed rule 22c-1(a)(3). We believe that
the costs of exempting certain investors from the NAV adjustment could
be significant, particularly the operational costs that we believe
could result from the relatively complex process of applying the NAV
adjustment only to some investors and not to others. Exempting small
investors from the NAV adjustment also may not be beneficial to a fund
because such exemption could lead to large investors engaging in gaming
behavior--that is, structuring their investments in funds using
multiple small accounts--in order to use the exemption. This could
contravene the purpose of the exemption and be costly for funds to
detect.
    Each fund that chooses to adopt swing pricing policies and
procedures pursuant to proposed rule 22c-1(a)(3) would incur one-time
costs to develop and implement the policies and procedures, as well as
ongoing costs relating to administration of the policies and
procedures. Those costs will directly impact the fund and may
indirectly impact fund investors if the fund passes along its costs to
investors through increased fees. As discussed above, while U.S.
registered funds do not currently use swing pricing to mitigate
potential dilution, certain foreign funds affiliated with U.S. fund
families currently do use swing pricing.\755\ U.S. registered funds in
fund complexes that also include foreign-domiciled funds that use swing
pricing may incur relatively lower costs to implement swing pricing
policies and procedures pursuant to the proposed rule. These funds may
only need to modify current swing pricing policies, procedures, and
systems used for foreign-domiciled funds to comply with proposed rule
22c-1(a)(3), instead of developing them from scratch.
---------------------------------------------------------------------------

    \755\ See supra notes 417-420 and accompanying text.
---------------------------------------------------------------------------

    Just as the costs associated with proposed rule 22e-4 could depend
largely on the level of liquidity risk facing the fund, as well as the
sources of the fund's liquidity risk, the costs of implementing swing
pricing policies and procedures likewise could vary depending on these
factors. As discussed above, there are multiple ways in which the costs
associated with classifying portfolio positions' liquidity and
assessing a fund's liquidity risk could vary based on a fund's
individual risks and circumstances.\756\ To determine a fund's swing
threshold, proposed rule 22c-1(a)(3) would require a fund to consider
certain of the factors required to be considered as part of the
liquidity risk assessment required under proposed rule 22e-4.\757\
Therefore, the costs associated with developing policies and procedures
for determining the swing threshold could also vary according to
similar factors that could cause differences in the costs to funds
associated with proposed rule 22e-4.\758\
---------------------------------------------------------------------------

    \756\ See supra section IV.C.1.c.
    \757\ See proposed rule 22c-1(a)(3)(i)(B). Specifically, the
requirement for a fund to consider: (i) The size, frequency, and
volatility of historical purchases and redemptions of fund shares
during normal and stressed periods, (ii) the fund's investment
strategy and the liquidity of the fund's portfolio assets, and (ii)
the fund's holdings of cash and cash equivalents, as well as
borrowing arrangements and other funding sources overlap with
certain of the proposed liquidity risk assessment factors. See
proposed rule 22e-4(b)(iii)(A), (B), and (D).
    \758\ See supra section IV.C.1.c.
---------------------------------------------------------------------------

    Our staff estimates that the one-time costs necessary to establish
and implement swing pricing policies and procedures pursuant to
proposed rule 22c-1(a)(3) would range from $1.3 million to $2.25
million \759\ per fund

complex, depending on the particular facts and circumstances applicable
to the funds comprising the fund complex.\760\ These estimated costs
are attributable to the following activities, as applicable to each of
the funds within the complex that adopts swing pricing policies and
procedures: (i) Developing swing pricing policies and procedures that
include all of the elements required under the proposed rule,\761\ as
well as policies and procedures relating to the recordkeeping
requirements associated with swing pricing; \762\ (ii) planning,
coding, testing, and installing any system modifications for adjusting
the fund's NAV pursuant to the fund's swing pricing policies and
procedures; (iii) integrating and implementing the fund's swing pricing
policies and procedures, as well as policies and procedures relating to
the financial reporting and recordkeeping requirements associated with
swing pricing; (iv) preparing training materials and administering
training sessions for staff in affected areas; and (v) board approval
of the fund's swing pricing policies and procedures.
---------------------------------------------------------------------------

    \759\ These cost estimates are based in part on the staff's
recent estimates of the one-time systems costs associated with
implementing the fees and gates provisions of the 2014 amendments to
rule 2a-7 under the 1940 Act. See 2014 Money Market Fund Reform
Adopting Release, supra note 85, at section III.A.5.b. Although the
substance and content of systems associated with establishing and
implementing swing pricing policies and procedures would be
different from the substance and content of systems associated with
implementing the rule 2a-7 fees and gates provisions, the one-time
costs associated with establishing and implementing swing pricing
policies and procedures, like the one-time costs associated with the
fees and gates provisions, would entail: Drafting relevant
procedures; planning, coding, testing, and installing relevant
system modifications; integrating and implementing relevant
procedures; and preparing training materials and administering
training sessions for staff in affected areas. See id. However, in
estimating the one-time costs associated with establishing and
implementing swing pricing policies and procedures, staff has
adjusted the estimated one-time systems costs associated with
implementing the fees and gates provisions to reflect that the
estimated costs associated with implementing the fees and gates
provisions include costs to be incurred by the fund and others in
the distribution chain (including transfer agents, accountants,
custodians, and intermediaries), whose services would be needed if a
fund were to impose a fee or gate, whereas we anticipate that the
requirements associated with establishing and implementing swing
pricing policies and procedures would be borne primarily by a fund
complex and not by others in the distribution chain.
    We note that the estimated one-time systems costs associated
with implementing the fees and gates provisions of the 2014
amendments to rule 2a-7 are generally similar to the proposed
estimated one-time systems costs associated with implementing the
floating NAV provisions of the 2014 rule 2a-7 amendments. See id. at
section III.B.8.a. However, the proposed estimated one-time systems
costs associated with implementing the floating NAV provisions were
adjusted downward at adoption, to account for certain tax
considerations specific to the floating NAV reforms. Thus, staff
believes that the one-time costs associated with the fees and gates
provisions would provide a closer analogue to the estimated costs
associated with establishing and implementing swing pricing policies
and procedures than the one-time costs associated with the floating
NAV provisions.
    \760\ This estimate assumes that each fund would not bear all of
the estimated costs (particularly, the costs of systems
modification) on an individual basis, but instead that these costs
would likely be allocated among the multiple users of the systems,
that is, each of the members of a fund complex that adopts swing
pricing policies and procedures.
    \761\ Proposed rule 22c-1(a)(3)(i).
    \762\ Proposed rule 22c-1(a)(3)(iii); proposed amendment to rule
31a-2(a)(2).
---------------------------------------------------------------------------

    We anticipate that, depending on the personnel (and/or third party
service providers) involved in the activities associated with
establishing and implementing swing pricing policies and procedures,
certain of the estimated one-time costs associated with these
activities could be borne by the fund, and others could be borne by the
adviser. This cost allocation would depend on the facts and
circumstances of a particular fund's swing pricing policies and
procedures, and thus we cannot specify the extent to which the
estimated costs would typically be allocated to the fund as opposed to
the adviser. Estimated costs that are allocated to the fund would be
borne by fund shareholders in the form of fund operating expenses.
    Staff estimates that, on average, a fund complex that includes
funds that adopt swing pricing policies and procedures pursuant to
proposed rule 22c-1(a)(3) would incur ongoing annual costs that range
from 5% to 15% of the one-time costs necessary to establish and
implement swing pricing policies and procedures pursuant to proposed
rule 22c-1(a)(3).\763\ Thus, staff estimates that a fund complex that
includes funds that adopt swing pricing policies and procedures would
incur ongoing annual costs associated with proposed rule 22c-1(a)(3)
that would range from $65,000 to $337,500.\764\ These estimated costs
are attributable to the following activities, as applicable to each of
the funds within the complex that adopts swing pricing policies and
procedures: (i) Costs associated with monitoring whether the fund's net
purchases or net redemptions cross the swing threshold (which could
include, to the extent a fund determines appropriate, costs associated
with obtaining interim feeds of flows from its transfer agent or
distributor in order to reasonably estimate its daily net flows)
(implicated by proposed rule 22c-1(a)(3)(i)(A)); (ii) adjusting the
fund's NAV when the fund's net purchases or net redemptions cross the
swing threshold, including costs associated with determining a swing
factor that would be used to adjust the fund's NAV when the fund's
swing threshold is breached (proposed rule 22c-1(a)(3)(i)(A), proposed
rule 22c-1(a)(3)(i)(D)); (iii) periodic review of the fund's swing
threshold (proposed rule 22c-1(a)(3)(i)(C)); (iv) systems maintenance;
(iv) additional staff training; (v) board approval of any material
changes to the program (proposed rule 22c-1(a)(3)(ii)(A)); and (vi)
recordkeeping (proposed rule 22c-1(a)(3)(iii), proposed amendments to
rule 31a-2(a)(2)).\765\
---------------------------------------------------------------------------

    \763\ These cost estimates are based in part on the staff's
recent estimates of the ongoing costs associated with implementing
the fees and gates provisions of the 2014 amendments to rule 2a-7
under the 1940 Act. See supra note 759 (discussing why staff
believes that the costs associated with the fees and gates
provisions could be useful to estimate the costs associated with
establishing and implementing swing pricing policies and
procedures).
    \764\ This estimate is based on the following calculations: 0.05
x $1,300,000 = $65,000; 0.15 x $2,250,000 = $337,500.
    \765\ We anticipate that, depending on the personnel (and/or
third party service providers) involved in the activities associated
with administering a fund's swing pricing policies and procedures,
certain of the estimated ongoing costs associated with these
activities could be borne by the fund, and others could be borne by
the adviser. See paragraph following supra note 762.
---------------------------------------------------------------------------

    A fund would be permitted, but not required, to establish and
implement swing pricing policies and procedures under proposed rule
22c-1(a)(3), and for purposes of this cost analysis, staff estimates
that 167 fund complexes would adopt swing pricing policies and
procedures. In developing this estimate, staff assumed that complexes
including certain mutual fund strategies (high-yield bond funds, world
bond funds (including emerging market debt funds), multi-sector bond
funds, state municipal funds, alternative strategy funds, and emerging
market equity funds) would be relatively more likely to adopt swing
pricing policies and procedures, and of complexes with funds following
these strategies, 75% would actually adopt swing pricing policies and
procedures.\766\ Staff estimates that the aggregate one-time costs for
fund complexes to establish and implement swing pricing policies

and procedures, and to comply with the recordkeeping requirements of
the proposed amendments to rule 31a-2(a)(2) and the financial reporting
requirements in Form N-1A and Regulation S-X, would be approximately
$296 million.\767\ In addition, staff estimates that the annual
aggregate costs associated with the proposed regulations relating to
swing pricing would be approximately $34 million.\768\
---------------------------------------------------------------------------

    \766\ In developing the estimate that 167 fund complexes would
adopt swing pricing policies and procedures, the staff assumed that
the percentage of fund complexes that includes high-yield bond
funds, world bond funds (including emerging market debt funds),
multi-sector bond funds, state municipal funds, alternative strategy
funds, and emerging market equity funds, as a fraction of all fund
complexes, is the same as the percentage of all mutual funds
(excluding money market funds) that these strategies represent. The
actual number of fund complexes that includes these selected
strategies could be higher or lower than the number calculated using
this assumption. 241 high yield bond mutual funds + 347 world bond
mutual funds (estimate includes emerging market bond funds) + 139
multi-sector bond mutual funds + 322 state municipal mutual funds +
376 alternative strategy funds that are equity funds (alternative
strategy funds that are bond funds are included in our estimates of
the number of bond mutual funds) + 469 emerging market equity mutual
funds = 1,894 funds with strategies that staff assumed would be
relatively more likely to adopt swing pricing policies and
procedures. 1,894 funds with selected strategies / 7,395 mutual
funds (excluding money market funds) = approximately 25.6%. 0.256 x
867 fund complexes = approximately 222 fund complexes. Assuming that
75% of these fund complexes would actually adopt swing pricing
policies and procedures, 0.75 x 222 fund complexes = approximately
167 fund complexes. These estimates are based on figures included in
the 2015 ICI Fact Book. See 2015 ICI Fact Book, supra note 3.
    \767\ Because staff is unable to estimate how many fund
complexes would incur one-time costs on the low end of the estimated
range versus the high end of the estimated range, this estimate is
based on the assumption that each fund complex would incur one-time
costs of $1,775,000, which represents the middle of the range of
estimated one-time costs ($1,300,000 + $2,250,000 = $3,550,000;
$3,550,000 / 2 = $1,775,000). 167 fund complexes x $1,775,000 =
$296,425,000.
    \768\ Because staff is unable to estimate how many fund
complexes would incur ongoing costs on the low end of the estimated
range versus the high end of the estimated range, this estimate is
based on the assumption that each fund complex would incur ongoing
costs of $201,250, which represents the middle of the range of
estimated ongoing costs ($65,000 + $337,500 = $402,500; $402,500 / 2
= $201,250). 167 fund complexes x $201,250 = $33,608,750.
---------------------------------------------------------------------------

d. Effects on Efficiency, Competition, and Capital Formation
    Proposed rule 22c-1(a)(3) would permit a fund, under certain
circumstances, to adjust its NAV to effectively pass on costs stemming
from shareholder purchase or redemption activity to the shareholders
associated with that activity. Adjusting a fund's NAV in this way could
reduce dilution to existing shareholders arising from trading costs. We
therefore believe that the proposed rule could increase the efficiency
of cost allocation among shareholders of funds that adopt swing pricing
policies and procedures, provided that a fund's swing threshold and
swing factor are appropriately calculated.\769\ If investors believe
swing pricing to be valuable, funds that decide to implement swing
pricing will be at a competitive advantage. Fund complexes currently
using swing pricing in other domiciles may be able to implement swing
pricing more quickly and more effectively.
---------------------------------------------------------------------------

    \769\ See supra notes 748-749 (discussing cost allocation among
shareholders with respect to funds that do not use swing pricing).
---------------------------------------------------------------------------

    We anticipate that proposed rule 22c-1-1(a)(3) could indirectly
foster capital formation by bolstering investor confidence. Investors
may be more inclined to invest in funds if they understand that funds
will be able to use swing pricing to prevent the purchase or redemption
activity of certain investors from diluting the interests of other
investors (particularly long-term investors, who represent the majority
of fund shareholders). To the extent that swing pricing preserves
investment returns to investors, particularly long-term investors,\770\
this could incentivize investment in funds that use swing pricing. If
proposed rule 22c-1(a)(3) enhances investor confidence in funds,
investors are more likely to invest in funds, thus making additional
assets available for investment in the capital markets. On the other
hand, investors could be discouraged from investing in funds that use
swing pricing if swing pricing produces increased performance
volatility, which could increase tracking error, and could make a
fund's short-term performance appear relatively poor compared to other
funds and the fund's benchmark. Because we do not have the information
necessary to determine how investors will perceive swing pricing, or
how they will evaluate the relative benefits or detriments of investing
in funds that use swing pricing, we are unable to draw conclusions
about the precise effects of proposed rule 22c-1(a)(3) on capital
formation. However, to the extent that investors perceive swing pricing
improves fund performance by decreasing investor dilution, capital
formation could be encouraged.
---------------------------------------------------------------------------

    \770\ See supra notes 440-441 and accompanying text.
---------------------------------------------------------------------------

e. Reasonable Alternatives
    The following discussion addresses significant alternatives to
proposed rule 22c-1(a)(3). More detailed alternatives to the individual
elements of the proposed rule are discussed in detail above, and we
have requested comment on these alternatives.\771\
---------------------------------------------------------------------------

    \771\ See supra Requests for Comment in sections III.F.1.a,
III.F.1.b, III.F.1.c, III.F.1.d, III.F.1.e, III.F.1.f, III.F.1.g,
III.F.2.d, and III.F.3.
---------------------------------------------------------------------------

    Instead of permitting, but not requiring, funds to adopt swing
pricing policies and procedures under proposed rule 22c-1(a)(3), we
could have proposed a rule that would require all funds to adopt swing
pricing policies and procedures. This alternative approach would have
the benefit of establishing a uniform regulatory framework to prevent
potential shareholder dilution. But because funds differ notably in
terms of their particular circumstances and risks, as well as with
respect to the tools funds use to manage risks relating to liquidity
and shareholder purchases and redemptions, we decided to propose a rule
that would permit swing pricing as a voluntary tool for funds. Our
chosen approach would allow funds to weigh the advantages of swing
pricing (e.g., improved allocation of trading costs \772\) against
potential disadvantages (e.g., the potential for swing pricing to
increase the volatility of a fund's NAV in the short term \773\).
---------------------------------------------------------------------------

    \772\ See supra sections III.F.1.a, III.F.1.c, III.F.1.e.
    \773\ See supra paragraphs accompanying note 446.
---------------------------------------------------------------------------

    While proposed rule 22c-1(a)(3) envisions partial swing pricing
(that is, a NAV adjustment would not be permitted unless net purchases
or redemptions exceed a threshold set by the fund), the Commission
instead could have proposed a rule that would permit full swing pricing
(that is, a NAV adjustment would be permitted any time the fund
experiences net purchases or net redemptions). Full swing pricing would
result in any costs associated with purchases or redemptions being
passed along to the shareholders whose actions created those costs,
whereas the partial swing pricing contemplated by the proposed rule
would only allocate trading costs to purchasing or redeeming
shareholders when net purchases or net redemptions exceed the fund's
swing threshold. Nevertheless, we believe that the partial swing
pricing alternative is, on balance, preferable to the full swing
pricing option. We expect that partial swing pricing, as opposed to
full swing pricing, would reduce any performance volatility potentially
associated with swing pricing.\774\ Also, the use of partial swing
pricing recognizes that purchases or redemptions below a certain
threshold might not require a fund to trade portfolio assets, and
therefore a NAV adjustment might not be appropriate if purchases or
redemptions would not result in costs associated with asset purchases
or sales (in which case, a NAV adjustment could unfairly penalize
purchasing or redeeming shareholders).\775\
---------------------------------------------------------------------------

    \774\ See supra paragraph accompanying notes 447-449.
    \775\ See supra note 449 and accompanying text.
---------------------------------------------------------------------------

    We considered permitting funds to use swing pricing only to adjust
their NAV downward in the event that net redemptions exceeded a
particular threshold, as there may be more significant issues regarding
potential dilution for non-redeeming shareholders in connection with
shareholder redemptions, because funds are obligated to satisfy
redemption requests pursuant to section 22(e) of the Act. In this
regard, we note that unlike redemptions, funds may reserve the right to
decline purchase requests. For example, a fund may decline purchase
requests from shareholders who engaged in frequent trading, and it also
may decline large purchase requests that would negatively impact the
fund.

However, we are proposing to permit funds to use swing pricing to
adjust their NAV upward or downward because we believe that swing
pricing could be a useful tool in mitigating dilution associated with
shareholder purchase activity as well.
    We also considered limiting the swing factor, but we recognize that
there could be circumstances in which limiting the swing factor would
prevent a fund from capturing the costs associated with purchase or
redemption activity in a fund.\776\ We believe it is appropriate to
provide flexibility to funds to determine the appropriate swing factor
that takes into account estimated trading costs. As part of their swing
pricing policies and procedures, funds may decide to limit the swing
factor.
---------------------------------------------------------------------------

    \776\ See supra paragraph accompanying notes 502-504.
---------------------------------------------------------------------------

    Lastly, instead of proposing to permit funds to use swing pricing,
we considered clarifying that a fund (other than a money market fund)
could impose a purchase fee or redemption fee to address potential
dilution.\777\ Swing pricing and purchase and redemption fees could
pass on transaction-related costs to transacting shareholders. Purchase
fees and redemption fees, as opposed to swing pricing, would have the
benefit of being simple for investors to understand, and they would not
produce the same volatility and tracking error concerns as swing
pricing. However, on balance we believe that the operational costs and
difficulty of imposing a fee would be significantly higher than those
associated with swing pricing. Implementing a fee requires coordination
with the fund's service providers, which could entail operational
complexity. On the other hand, we anticipate that swing pricing would
be simpler to implement than a fee because the NAV adjustment would
occur pursuant to the fund's own procedures and would be factored into
the process by which a fund strikes its NAV.
---------------------------------------------------------------------------

    \777\ As discussed above, funds are currently permitted under
rule 22c-2 to impose redemption fees under certain circumstances.
See supra notes 421-422 and accompanying text; see also Rule 22c-2
Adopting Release, supra note 421 (noting that the redemption fee
permitted under rule 22c-2 ``is intended to allow funds to recoup
some of the direct and indirect costs incurred as a result of short-
term trading strategies, such as market timing'').
---------------------------------------------------------------------------

3. Disclosure and Reporting Requirements Regarding Liquidity Risk and
Liquidity Risk Management
a. Proposed Disclosure and Reporting Requirements
    We are proposing amendments to Form N-1A, Regulation S-X, proposed
Form N-PORT, and proposed Form N-CEN to enhance fund disclosure and
reporting regarding liquidity and redemption practices. Specifically,
proposed amendments to Form N-1A would require a fund to disclose: (i)
The number of days in which the fund will pay redemption proceeds to
redeeming shareholders \778\ and (ii) the methods the fund uses to meet
redemption requests in stressed and non-stressed market
conditions.\779\ A fund also would be required to file as an exhibit to
its registration statement any credit agreements for the benefit of the
fund.\780\ Regarding swing pricing, a fund would be required to
disclose in Form N-1A a statement as to whether the fund uses swing
pricing, and an explanation of the circumstances under which it will
use swing pricing and the effects of using swing pricing.\781\ The NAV
reported on a fund's financial statements would reflect swing pricing,
if applicable. Proposed amendments to proposed Form N-PORT would
require a fund to disclose: (i) For each portfolio asset, whether that
security is a 15% standard asset; \782\ (ii) the fund's three-day
liquid asset minimum; \783\ and (iii) for each of the fund's positions
in a portfolio asset, the liquidity classification of that position as
determined pursuant to proposed rule 22e-4(b)(2)(i).\784\ Finally,
proposed amendments to proposed Form N-CEN would require a fund to
disclose certain information regarding the use of lines of credit,
interfund borrowing and lending, and swing pricing.\785\ We have also
proposed amendments to Form N-CEN that would require an ETF to report
whether it required that an authorized participant post collateral to
the ETF or any of its designated service providers in connection with
the purchase or redemption of ETF shares.\786\
---------------------------------------------------------------------------

    \778\ Proposed Item 11(c)(7) of Form N-1A.
    \779\ Proposed Item 11(c)(8) of Form N-1A.
    \780\ Proposed Item 28(h) of Form N-1A.
    \781\ Proposed Item 6(d) of Form N-1A.
    \782\ Proposed Item C.7 of proposed Form N-PORT.
    \783\ Proposed Item B.7 of proposed Form N-PORT.
    \784\ Proposed Item C.13 of proposed Form N-PORT. If a fund were
to determine that different portions of a position in a particular
asset would receive different liquidity classifications pursuant to
proposed rule 22e-4(b)(2)(i) (see supra paragraph accompanying note
172), the fund would be required to indicate the dollar amount of
that position attributable to each classification.
    \785\ Proposed Item 44 of proposed Form N-CEN.
    \786\ Proposed Item 60g of proposed Form N-CEN.
---------------------------------------------------------------------------

b. Benefits
    The proposed disclosure and reporting requirements would promote
investor protection by improving the availability of information
regarding funds' liquidity risks and risk management practices, as well
as funds' redemption practices. As discussed above, funds' disclosures
to shareholders regarding their redemption practices are currently
quite varied in content and comprehensiveness.\787\ While some funds
voluntarily include disclosure regarding fund limitations on illiquid
asset holdings that track the 15% guideline, a fund is not currently
required to disclose information about the liquidity of its portfolio
assets. A fund is also not currently required to disclose information
about liquidity risk management practices such as the use of lines of
credit. In light of the relatively few disclosure requirements
regarding funds' liquidity risks, liquidity risk management practices,
and redemption practices, as well as the current inconsistency in
funds' liquidity-related disclosures, we believe that the proposed
disclosure and reporting requirements would increase shareholder
understanding of particular funds' liquidity-related risks and
redemption policies. This in turn would assist investors in making
investment choices that better match their risk tolerances.
---------------------------------------------------------------------------

    \787\ See supra section III.G.1.a.
---------------------------------------------------------------------------

    We note that, while proposed Form N-PORT and proposed Form N-CEN
are designed primarily to assist the Commission and its staff, we
believe that the information in these proposed forms (including the
liquidity-related information proposed to be included in these forms)
also would be valuable to investors.\788\ In particular, we believe
that both sophisticated institutional investors and third-party users
that provide services to investors may find the proposed liquidity-
related information to be useful. And we believe that individual
investors would benefit indirectly from the information collected on
reports on Form N-PORT, through analyses prepared by third-party
service providers, and through enhanced Commission monitoring and
oversight of the fund industry.
---------------------------------------------------------------------------

    \788\ See Investment Company Reporting Modernization Release,
supra note 104, at sections IV.B.b, IV.E.b.
---------------------------------------------------------------------------

    The liquidity-related information that funds would be required to
provide on proposed Form N-PORT and proposed Form N-CEN would enhance
investor protection by improving the Commission's ability to monitor
funds' liquidity using relevant and targeted data. This monitoring
would permit us to analyze liquidity trends in individual funds, and
among certain types of funds and the fund industry as a whole, as well
as to better understand funds' liquidity risk management practices. As

discussed in our recent proposal to modernize investment company
reporting, the information we receive on these reports would facilitate
the oversight of funds and would assist the Commission, as the primary
regulatory of such funds, to better effectuate its mission to protect
investors, maintain fair, orderly, and efficient markets, and
facilitate capital formation.\789\
---------------------------------------------------------------------------

    \789\ See id.
---------------------------------------------------------------------------

    Because we cannot predict the extent to which the proposed
requirements would enhance investors' awareness of funds' portfolio
liquidity and liquidity risk, or that this enhanced awareness would
influence investors' investments in certain funds, we are unable to
quantify the potential benefits discussed in this section.
c. Costs
    Funds would incur one-time and ongoing annual costs to comply with
the proposed disclosure and reporting requirements regarding liquidity
and shareholder redemption practices.
    We estimate that the one-time costs to comply with the proposed
amendments to Form N-1A would be approximately $637 per fund (plus
printing costs).\790\ We estimate that each fund would incur an ongoing
cost associated with compliance with the proposed amendments to Form N-
1A of approximately $80 \791\ each year to review and update the
proposed disclosure regarding swing pricing and redemptions.
---------------------------------------------------------------------------

    \790\ This estimate is based on the following calculation: 2
hours (1 hour to update registration statement to include swing
pricing-related disclosure statements + 1 hour to update
registration statement disclosure about redemption procedures and
file credit agreements as exhibits, if applicable) x $318.50
(blended rate for a compliance attorney ($334) and a senior
programmer ($303)) = $637. This figure incorporates the costs we
estimated for each fund to update its registration statement to
include the required disclosure about: (i) The number of days in
which the fund will pay redemption proceeds to redeeming
shareholders; (ii) the methods the fund uses to meet redemption
requests in stressed and non-stressed market conditions; and (iii)
if the fund uses swing pricing, an explanation of the circumstances
under which it will use swing pricing and the effects of using swing
pricing. This figure also includes the costs we estimate for each
fund to file any applicable credit agreements as exhibits to the
fund's registration statement. The costs associated with these
activities are all paperwork-related costs and are discussed in more
detail infra at section V.G.
    \791\ This estimate is based on the following calculations: 0.25
hours (\1/8\ hour to update swing pricing-related disclosure
statements + \1/8\ hour to update disclosures about redemption
procedures) x $318.50 (blended hourly rate for a compliance attorney
($334) and a senior programmer ($303)) = $79.63.
---------------------------------------------------------------------------

    The proposed amendments to proposed Form N-PORT would require funds
to report on Form N-PORT the liquidity classification of each portfolio
asset position (or portion of a position in a particular asset), and we
estimate that the average one-time compliance costs associated with
this reporting would be $15,330 per fund.\792\ Furthermore, we estimate
that 8,734 funds would be required to file, on a monthly basis,
additional information on Form N-PORT as a result of the proposed
amendments.\793\ Assuming that 35% of funds (3,057 funds) would choose
to license a software solution to file reports on Form N-PORT in
house,\794\ we estimate an upper bound on the initial annual costs to
file the additional information associated with the proposed amendments
for funds choosing this option of $780 per fund \795\ with annual
ongoing costs of $260 per fund.\796\ We further assume that 65% of
funds (5,677 funds) would choose to retain a third-party service
provider to provide data aggregation and validation services as part of
the preparation and filing of reports on Form N-PORT,\797\ and we
estimate an upper bound on the initial costs to file the additional
information associated with the proposed amendments for funds choosing
this option of $1,040 per fund \798\ with annual ongoing costs of $130
per fund.\799\
---------------------------------------------------------------------------

    \792\ This estimate is based on the following calculation: (i)
Project planning and systems design (24 hours x $260 (hourly rate
for a senior systems analyst) = $6,240) and (ii) systems
modification integration, testing, installation and deployment (30
hours x $303 (hourly rate for a senior programmer) = $9,090). $6,240
+ $9,090 = $15,330. Estimates for drafting, integrating,
implementing policies and procedures are addressed in the discussion
of proposed rule 22e-4. This figure incorporates the costs that we
estimated associated with preparing the section of the fund's report
on Form N-PORT that would incorporate the information that would be
required under proposed Item C.13. The costs associated with these
activities are all paperwork-related costs and are discussed in more
detail infra at section V.E. As discussed in section V.E infra, we
believe that any external annual costs associated with filing Form
N-PORT would be only incrementally affected by compliance with
proposed Item C.13 to proposed Form N-PORT, and thus proposed Item
C.13 does not affect our previous estimates of these costs.
    \793\ There were 8,734 open-end funds (excluding money market
funds, and including ETFs) as of the end of 2014. See 2015 ICI Fact
Book, supra note 3, at 177, 184.
    \794\ This assumption tracks the assumption made in the
Investment Company Reporting Modernization Release that 35% of funds
would choose to license a software solution to file reports on Form
N-PORT. See Investment Company Reporting Modernization Release,
supra note 104, at nn.658-659 and accompanying text.
    \795\ This estimate is based upon the following calculations:
$780 in internal costs = ($780 = 3 hours x $260 (blended hourly rate
for senior programmer ($303), senior database administrator ($312),
financial reporting manager ($266), senior accountant ($198),
intermediate accountant ($157), senior portfolio manager ($301), and
compliance manager ($283)). We do not anticipate any change to
external annual costs as a result of the proposed amendments. See
infra at section V.E. The hourly wage figures in this and subsequent
footnotes are from SIFMA's Management & Professional Earnings in the
Securities Industry 2013, modified by Commission staff to account
for an 1800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits, and overhead.
    \796\ This estimate is based upon the following calculations:
$260 in internal costs ($260 = 1 hour x $260 (blended hourly rate
for senior programmer ($303), senior database administrator ($312),
financial reporting manager ($266), senior accountant ($198),
intermediate accountant ($157), senior portfolio manager ($301), and
compliance manager ($283)). We do not anticipate any change to
external annual costs as a result of the proposed amendments. See
infra at section V.E.
    \797\ This assumption tracks the assumptions made in the
Investment Company Reporting Modernization Release that 65% of funds
would choose to retain a third-party service provider to provide
data aggregation and validation services as part of the preparation
and filing of reports on Form N-PORT. See Investment Company
Reporting Modernization Release, supra note 104, at nn.660-661 and
accompanying text.
    \798\ This estimate is based upon the following calculations:
$1,040 in internal costs ($1,040 = 4 hours x $260 (blended hourly
rate for senior programmer ($303), senior database administrator
($312), financial reporting manager ($266), senior accountant
($198), intermediate accountant ($157), senior portfolio manager
($301), and compliance manager ($283)). We do not anticipate any
change to external annual costs as a result of the proposed
amendments.
    \799\ This estimate is based upon the following calculations:
$130 in internal costs ($130 = (0.5 hours x $260 (blended hourly
rate for senior programmer ($303), senior database administrator
($312), financial reporting manager ($266), senior accountant
($198), intermediate accountant ($157), senior portfolio manager
($301), and compliance manager ($283)). We do not anticipate any
change to external annual costs as a result of the proposed
amendments.
---------------------------------------------------------------------------

    Likewise, compliance with the proposed amendments to proposed Form
N-CEN would involve ongoing costs as well as one-time costs. We
estimate that 8,734 funds would be required to file responses on Form
N-CEN as a result of the proposed amendments to the form. We estimate
that the one-time and ongoing annual compliance costs associated with
providing additional responses to Form N-CEN as a result of the
proposed amendments would be approximately $160 per fund.\800\
---------------------------------------------------------------------------

    \800\ This estimate is based on the following calculation: 0.5
hour x $318.50 (blended hourly rate for a compliance attorney ($334)
and a senior programmer ($303)) = $159.25. This figure incorporates
the costs that we estimated associated with preparing the section of
the fund's report on Form N-CEN that would incorporate the
information that would be required under proposed Item 44. We do not
estimate any additional costs in connection with proposed Item 60(g)
of Form N-CEN because the proposed new item only requires a yes or
no response. We do not estimate any change to the external costs
associated with Form N-CEN. The costs associated with these
activities are all paperwork-related costs and are discussed in more
detail infra at section V.F.
---------------------------------------------------------------------------

    Based on these estimates, staff further estimates that the total
one-time costs to comply with the proposed disclosure and reporting
requirements would be

approximately $51 million for all funds that would file reports on
proposed Form N-PORT in house \801\ and approximately $96 million for
all funds that would use a third-party service provider to prepare and
file reports on proposed Form N-PORT.\802\ In addition, staff estimates
that the total ongoing annual costs associated with the proposed
disclosure and reporting requirements would be approximately $1.5
million for all funds that would file reports on proposed Form N-PORT
in house \803\ and approximately $2.1 million for all funds that would
use a third-party service provider to prepare and file reports on
proposed Form N-PORT.\804\
---------------------------------------------------------------------------

    \801\ This estimate assumes that 35% of funds (3,057 funds)
would choose to file reports on proposed Form N-PORT in house (see
infra section V.E) and is based on the following calculation: 3,057
funds x $16,587.75 ($318.50 + $15,330 + $780 + $159.25) =
$50,708,751.75.
    \802\ This estimate assumes that 65% of funds (5,677) would
choose to file reports on proposed Form N-PORT with the assistance
of third-party service providers (see infra section V.E) and is
based on the following calculation: 5,677 funds x $16,847.75
($318.50 + $15,330 + $1,040 + $159.25) = $95,644,676.75.
    \803\ This estimate is based on the following calculation: 3,057
funds x $498.88 ($79.63 + $260 + $159.25) = $1,525,076.16.
    \804\ This estimate is based on the following calculation: 5,677
funds x $368.88 ($79.63 + $130 + $159.25) = $2,094,131.76.
---------------------------------------------------------------------------

    We appreciate that the proposed amendments to proposed Form N-PORT
would increase the amount and availability of public information about
investment companies' portfolio positions and that more frequent
portfolio disclosure could potentially harm fund shareholders by
expanding the opportunities for professional traders to exploit this
information by engaging in predatory trading practices, such as
``front-running'' and ``copycatting.'' \805\ Both front-running and
copycatting can reduce the returns of shareholders who invest in
actively managed funds.\806\ Thus, the proposed amendments to proposed
Form N-PORT could entail costs to funds and market participants
associated with any reduced profitability of funds that could result
from the increase in publicly available information.\807\ We believe
that these costs cannot be separated from the overall costs to funds
and market participants that could result from the increased disclosure
of currently non-public information associated with Form N-PORT in its
entirety.\808\ The effects of the proposed liquidity-related
disclosures are intertwined with the effects of the other proposed Form
N-PORT disclosures. For example, any analyses of the liquidity-related
disclosure proposed to be required could be affected by the enhanced
reporting of information concerning the pricing of funds' investments,
information on fund flows, and disclosure of additional information
that could more clearly reveal the investment strategy and risk
exposures of reporting funds (e.g., information pertaining to
derivatives and securities lending activities). The potential costs
associated with the increased disclosure of currently non-public
information on Form N-PORT are discussed in detail in our recent
proposal to modernize investment company reporting.\809\ This proposal
also discusses the ways in which we have endeavored to mitigate these
costs, including by proposing to maintain the status quo for the
frequency and timing of disclosure of publicly available portfolio
information.\810\ While proposed Form N-PORT would be required to be
filed monthly, it would be required to be disclosed quarterly and would
not be made public until 60 days after the close of the period at
issue. Because funds are currently required to disclose their portfolio
investments quarterly (and this disclosure is made public with a 60-day
lag), we believe that maintaining the status quo with regard to the
frequency and the time lag of publicly available portfolio reporting
would permit the Commission (as well as the fund industry generally) to
assess the impact of the Form N-PORT filing requirement on the mix of
information available to the public, and the extent to which these
changes might affect the potential for predatory trading, before
determining whether more frequent or more timely public disclosure
would be beneficial to investors in funds.\811\ We cannot currently
predict the extent to which the proposed enhancements to funds'
disclosures on Form N-PORT would give rise to front-running, predatory
trading, and other activities that could be detrimental to a fund and
its investors, and thus we are unable to quantify potential costs
related to these activities.
---------------------------------------------------------------------------

    \805\ See Investment Company Reporting Modernization Release,
supra note 104, at n.170 and accompanying and following text.
    \806\ See Russ Wermers, The Potential Effects of More Frequent
Portfolio Disclosure on Mutual Fund Performance, 7 Investment
Company Institute Perspective No. 3 (June 2001), available at http://www.ici.org/pdf/per07-03.pdf.
    \807\ See Investment Company Reporting Modernization Release,
supra note 104, at nn.663-667 and accompanying text.
    \808\ See id. at paragraphs accompanying nn.663-673.
    \809\ See id.
    \810\ See id. at section II.A.4 and paragraph accompanying n.
670.
    \811\ See id.
---------------------------------------------------------------------------

d. Effects on Efficiency, Competition, and Capital Formation
    We believe the proposed requirements could increase informational
efficiency by providing additional information about the liquidity of
funds' portfolio positions to investors, third-party service providers,
and the Commission. This in turn could assist investors in evaluating
the risks associated with certain funds, which could increase
allocative efficiency by assisting investors in making investment
choices that better match their risk tolerances. Enhanced disclosure
regarding funds' liquidity and liquidity risk management practices
could positively affect competition by permitting investors to choose
whether to invest in certain funds based on this information. However,
if investors were to move their assets among funds as a result of the
disclosure requirements (for example, if the disclosure made clear that
a certain fund was able to generate higher returns than its peers
through high exposure to relatively less liquid positions, which then
led investors with limited risk tolerance to move assets out of this
fund), this could negatively affect the competitive stance of certain
funds.
    Increased investor awareness of funds' portfolio liquidity and
liquidity risk management practices also could promote capital
formation if investors find certain funds' liquidity profiles and/or
risk management practices attractive, and this awareness promotes
increased investment in these funds and in turn in the assets in which
the funds invest. For example, disclosure that reveals liquidity risk
in funds' portfolios could negatively impact capital formation if this
disclosure leads investors to decide that such funds pose too great of
an investment risk, and consequently decide not to invest in these
funds or to decrease their investment in these funds. Conversely, to
the extent that investors assume that funds investing in relatively
less liquid assets could obtain a liquidity risk premium in the form of
higher returns over some period of time, the potential for higher
returns could draw certain investors to funds investing in relatively
less liquid asset classes, which could positively affect capital
formation for these funds. If investors shift their invested assets
between funds based on liquidity, there could be capital formation
effects stemming from increased (or decreased) investment in the funds'
portfolio assets, even if the total capital invested in funds remains
constant. For example, if fund investors move assets from an investment
strategy that entails relatively high liquidity risk

to one whose investment strategy involves relatively low liquidity
risk, less liquid portfolio asset classes could experience an adverse
impact on capital formation while the more liquid portfolio asset
classes could experience a positive impact on capital formation,
although the total capital invested in funds would remain constant.
e. Reasonable Alternatives
    The following discussion addresses significant alternatives to
proposed disclosure and reporting requirements. More detailed
alternatives to the individual elements of the proposed requirements
are discussed in detail above, and we have requested comment on these
alternatives.\812\
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    \812\ See supra sections III.G.1.a, III.G.1.b, III.G.2.d, and
III.G.3.c.
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    The Commission considered proposing to require each fund to
disclose information about the liquidity of its portfolio positions in
the fund's prospectus or on the fund's Web site, in addition to in
reports filed on Form N-PORT. For example, we could have proposed to
require a fund to disclose its three-day liquid asset minimum, or the
percentage of the fund's portfolio invested in each of the liquidity
categories specified under proposed rule 22e-4(b)(2)(i), in its
prospectus or on its Web site. This additional disclosure could further
increase transparency with respect to funds' portfolio liquidity and
liquidity-related risks. But we had concerns that this additional
disclosure could create investor confusion; for example, an investor
could mistakenly understand statements about the liquidity of the
fund's portfolio to implicate the redeemability of the fund's shares.
We also had concerns that this additional disclosure could
inappropriately emphasize risks relating to a fund's portfolio
liquidity over other significant risks associated with an investment in
the fund. We therefore determined that this alternative could lead to
poor investor allocation and that its costs would likely outweigh its
potential benefits.
    Conversely, the Commission also considered limiting the proposed
enhancements to funds' liquidity-related disclosures on proposed Form
N-PORT. As discussed above, we are sensitive to the possibility that
the proposed amendments to the proposed form could facilitate front-
running, predatory trading, and other activities that could be
detrimental to a fund and its investors. Limiting the required
disclosure about information concerning the liquidity of funds'
portfolio positions could allow funds to shelter certain information
that they may consider a source of competitive advantage. As discussed
in our recent proposal to modernize investment company reporting, the
items included on proposed Form N-PORT reflect our careful
consideration of what information we believe to be important for our
oversight activities and to the public, and the costs to investment
companies to provide the information.\813\ We likewise carefully
weighed costs and benefits with respect to the new liquidity-related
disclosures proposed to be required under proposed Form N-PORT and
concluded that these disclosures appropriately balance related costs
with the benefits that could arise from the ability of the Commission,
and members of the public, to monitor and analyze the liquidity of
individual funds, as well as liquidity trends within the fund industry.
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    \813\ See Investment Company Reporting Modernization Release,
supra note 104, at section IV.B.
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D. Request for Comment

    The Commission requests comment on all aspects of this initial
economic analysis, including whether the analysis has: (i) Identified
all benefits and costs, including all effects on efficiency,
competition, and capital formation; (ii) given due consideration to
each benefit and cost, including each effect on efficiency,
competition, and capital formation; and (iii) identified and considered
reasonable alternatives to the proposed new rule and rule amendments.
We request and encourage any interested person to submit comments
regarding the proposed rule and proposed amendments, our analysis of
the potential effects of the proposed rule and proposed amendments, and
other matters that may have an effect on the proposed rule and proposed
amendments. We request that commenters identify sources of data and
information as well as provide data and information to assist us in
analyzing the economic consequences of the proposed rule and proposed
amendments. We also are interested in comments on the qualitative
benefits and costs we have identified and any benefits and costs we may
have overlooked. We also request comments on all data and empirical
analyses used in support of the proposed rule and proposed amendments.
    In addition to our general request for comment on the economic
analysis associated with the proposed rule and proposed amendments, we
request specific comment on certain aspects of the proposal:
     To what extent do funds' current practices regarding
portfolio asset liquidity classification and liquidity risk assessment
and management currently align with the proposed liquidity risk
management program requirements, and what operational and other costs
would funds incur in modifying their current practices to comply with
the proposed requirements?
     What factors, with respect to a fund's particular risks
and circumstances, would cause particular variance in funds' compliance
costs related to the liquidity risk management program requirement?
     We note that rule 22e-4 as proposed is meant to provide
flexibility in permitting a fund to customize its liquidity risk
management program, and thus we anticipate that the costs and burdens
relating to the program requirement will vary based on the fund's risks
and circumstances. Does this flexibility (and the attendant requirement
for each fund to adopt liquidity risk management policies and
procedures based on an assessment of the fund's individual liquidity
risk) affect the extent to which a fund family could lower costs by
developing procedures, or implementing systems modifications, that
could be used by all funds within the fund family? Does this
flexibility enhance the potential effectiveness of the proposed
liquidity risk management program?
     We request comment on our estimates of the one-time and
ongoing costs associated with the proposed program requirement. Do
commenters agree with our cost estimates? If not, how should our
estimates be revised, and what changes, if any, should be made to the
assumptions forming the basis for our estimates? Are there any
significant costs that have not been identified within our estimates
that warrant consideration? To what degree would economies of scale
affect compliance costs for larger entities, and is the longer proposed
compliance period for small entities \814\ appropriate in light of any
relatively larger burden that would be borne by smaller entities that
are not able to take advantage of economies of scale? How do commenters
anticipate that these estimated costs might be allocated between a fund
and its adviser?
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    \814\ See supra section III.H.1.
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     To what extent do commenters anticipate that the proposed
liquidity risk management program requirement could lead funds to
modify their investment strategies or increase their

investments in relatively more liquid assets? Do commenters believe
that the proposed program requirement could significantly affect the
market for relatively more liquid assets (or, conversely, the market
for relatively less liquid assets) and if so, to what extent would
these markets be affected?
     We request comment on our estimate of the number of funds
that would adopt swing pricing policies and procedures under proposed
rule 22c-1(a)(3). For what reasons would a fund decide not to adopt
swing pricing policies and procedures, and would funds with certain
investment strategies be relatively more likely to adopt swing pricing
policies and procedures?
     What operational and other costs would a fund incur in
adopting swing pricing policies and procedures, and would these costs
be significantly lower if a fund is a member of a fund complex that
also includes foreign-domiciled funds that currently use swing pricing?
Do commenters agree with our cost estimates associated with proposed
rule 22c-1(a)(3)? If not, how should our estimates be revised, and what
changes, if any, should be made to the assumptions forming the basis
for our estimates? Are there any significant costs that have not been
identified within our estimates that warrant consideration? How do
commenters anticipate that these estimated costs might be allocated
between a fund and its adviser?
     Would fund shareholders be more inclined or less inclined
to invest in a fund that has adopted swing pricing policies and
procedures as contemplated by proposed rule 22c-1(a)(3)? Do commenters
believe that swing pricing could preserve investment returns to fund
investors? If so, please provide any available data regarding the
relationship between the use of swing pricing and the preservation of
investment returns.
     Do commenters agree with our statement that swing pricing
would be simpler and less costly to implement than purchase fees or
redemption fees?
     Do the proposed disclosure and reporting requirements
raise any concerns about confidentiality relating to a fund's portfolio
holdings, investor confusion, the potential misallocation of invested
funds, or other concerns? To what extent would the proposed portfolio
liquidity-related enhancements to funds' disclosures on Form N-PORT
give rise to front-running, predatory trading, and other activities
that could be detrimental to a fund and its investors?
     Would additional prospectus disclosure about funds'
portfolio liquidity, beyond that which would be required under the
proposed Form N-1A amendments, be useful to investors? If so, what
additional disclosure would be most useful, and what disclosure methods
would permit funds to appropriately balance disclosure about liquidity-
related risks with disclosure regarding other risks facing the fund?

V. Paperwork Reduction Act Analysis

A. Introduction

    Proposed rule 22e-4 and the proposed amendments to rule 22c-1
contain ``collections of information'' within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\815\ In addition, the
proposed amendments to rule 31a-2, Form N-1A and Regulation S-X would
impact the collections of information burden under those rules and
form.\816\ The proposed amendments to proposed Form N-CEN and proposed
Form N-PORT would impact the collections of information burdens
associated with these proposed forms described in the Investment
Company Reporting Modernization Release.\817\
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    \815\ 44 U.S.C. 3501 through 3521.
    \816\ The paperwork burden from Regulation S-X is imposed by the
rules and forms that relate to Regulation S-X and, thus, is
reflected in the analysis of those rules and forms. To avoid a PRA
inventory reflecting duplicative burdens and for administrative
convenience, we have previously assigned a one-hour burden to
Regulation S-X.
    \817\ See Investment Company Reporting Modernization Release,
supra note 104, at section V.
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    The title for the existing collections of information are: ``Rule
31a-2 Records to be preserved by registered investment companies,
certain majority-owned subsidiaries thereof, and other persons having
transactions with registered investment companies'' (OMB Control No.
3235-0179); and ``Form N-1A under the Securities Act of 1933 and under
the Investment Company Act of 1940, Registration Statement of Open-End
Management Investment Companies'' (OMB Control No. 3235-0307). In the
Investment Company Reporting Modernization Release, we submitted new
collections of information for proposed Form N-CEN and proposed Form N-
PORT.\818\ The titles for these new collections of information are:
``Form N-CEN Under the Investment Company Act, Annual Report for
Registered Investment Companies'' and ``Form N-PORT Under the
Investment Company Act, Monthly Portfolio Investments Report.'' We are
submitting new collections of information for proposed new rule 22e-4
and the proposed amendments to rule 22c-1 under the Investment Company
Act of 1940. The titles for these new collections of information would
be: ``Rule 22e-4 Under the Investment Company Act of 1940, Liquidity
risk management programs,'' and ``Rule 22c-1 Under the Investment
Company Act of 1940, Pricing of redeemable securities for distribution,
redemption and repurchase.'' The Commission is submitting these
collections of information to the OMB for review in accordance with 44
U.S.C. 3507(d) and 5 CFR 1320.11. 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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    \818\ See id.
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    The Commission is proposing new rule 22e-4 and amendments to rule
22c-1, rule 31a-2, Regulation S-X and Form N-1A. The Commission also is
proposing to amend proposed Form N-CEN and proposed Form N-PORT. The
new rule and proposed amendments are designed to promote effective
liquidity risk management throughout the open-end fund industry,
prevent potential dilution of interests of fund shareholders in light