[Federal Register: June 27, 2006 (Volume 71, Number 123)]
[Rules and Regulations]
[Page 36639-36660]
[DOCID:fr27jn06-9]

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Part III

Securities and Exchange Commission

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17 CFR Parts 239, 270, and 274

Fund of Funds Investments; Final Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 270, and 274

[Release Nos. 33-8713; IC-27399; File No. S7-18-03]
RIN 3235-AI30

Fund of Funds Investments

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting three new rules under the Investment Company Act of 1940 that
address the ability of an investment company (``fund'') to acquire
shares of another fund. Section 12(d)(1) of the Act prohibits, subject
to certain exceptions, so-called ``fund of funds'' arrangements, in
which one fund invests in the shares of another. The rules broaden the
ability of a fund to invest in shares of another fund in a manner
consistent with the public interest and the protection of investors.
The Commission also is adopting amendments to forms used by funds to
register under the Investment Company Act and offer their shares under
the Securities Act of 1933. The amendments improve the transparency of
the expenses of funds of funds by requiring that the expenses of the
acquired funds be aggregated and shown as an additional expense in the
fee table of the fund of funds.

DATES: Effective Date: July 31, 2006.
    Compliance Dates: All new registration statements on Forms N-1A, N-
2, N-3, N-4, or N-6, and all post-effective amendments that are annual
updates to effective registration statements on Forms N-1A, N-2, N-3,
N-4, or N-6 filed on or after January 2, 2007, must include the
disclosure required by the amendments.

FOR FURTHER INFORMATION CONTACT: Dalia Osman Blass, Attorney, or
Penelope W. Saltzman, Branch Chief, Office of Regulatory Policy, (202)
551-6792, Division of Investment Management, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission today is adopting new rules
12d1-1, 12d1-2 and 12d1-3 under the Investment Company Act of 1940 (the
``Investment Company Act'' or the ``Act'') that address the ability of
an investment company (``fund'' or ``acquiring fund'') registered under
the Act to invest in shares of another investment company (``fund'' or
``acquired fund'').\1\ We also are adopting amendments to Forms N-1A,
N-2, N-3, N-4, and N-6 to require that prospectuses of funds of funds
disclose the expenses investors in the acquiring fund will bear,
including those of any acquired funds.\2\ Forms N-1A and N-2 are the
registration forms used by open-end management funds and closed-end
management funds, respectively, to register under the Act and to offer
their shares under the Securities Act of 1933 (``Securities Act'').\3\
Forms N-3, N-4 and N-6 are the forms used by insurance company separate
accounts to register under the Act and to offer their variable annuity
and variable life insurance contracts under the Securities Act.
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    \1\ The Investment Company Act is codified at 15 U.S.C. 80a. The
new rules will be found in the Code of Federal Regulations at 17 CFR
270.12d1-1, 17 CFR 270.12d1-2, and 17 CFR 270.12d1-3, respectively.
For convenience, any reference we make in this release to rules
12d1-1, 12d1-2 or 12d1-3, or any paragraph of the rules, will be to
those sections of the Code of Federal Regulations.
    \2\ Rules requiring use of these forms under both the Investment
Company Act and the Securities Act of 1933 may be found in the Code
of Federal Regulations at: 17 CFR 239.15A, 17 CFR 274.11A (Form N-
1A); 17 CFR 239.14, 17 CFR 274.11a-1 (Form N-2); 17 CFR 239.17a, 17
CFR 274.11b (Form N-3); 17 CFR 239.17b, 17 CFR 274.11c (Form N-4);
and 17 CFR 239.17c, 17 CFR 274.11d (Form N-6).
    \3\ The Securities Act is codified at 15 U.S.C. 77a. The terms
``open-end management funds'' and ``closed-end management funds''
are defined in 15 U.S.C. 80a-5(a)(1) and (2), respectively.
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Table of Contents

I. Background
II. Discussion
    A. Rule 12d1-1: Investments in Money Market Funds
    1. Scope of Exemption
    2. Conditions
    B. Rule 12d1-2: Affiliated Funds of Funds
    1. Investments in Unaffiliated Funds
    2. Investments in Other Types of Issuers
    3. Investments in Money Market Funds
    C. Rule 12d1-3: Unaffiliated Funds of Funds
    D. Amendments to Disclosure Forms: Transparency of Fund of Funds
Expenses
III. Paperwork Reduction Act
IV. Cost-Benefit Analysis
V. Consideration of Promotion of Efficiency, Competition, and
Capital Formation
VI. Final Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Rules and Form Amendments

I. Background

    The Federal securities laws restrict substantially the ability of a
fund to invest in shares of other funds. These restrictions are
designed to prevent fund of funds arrangements that have been used in
the past to enable investors in an acquiring fund to control the assets
of an acquired fund and use those assets to enrich themselves at the
expense of acquired fund shareholders.\4\ Under section 12(d)(1) of the
Act, funds are subject to certain prohibitions relating to fund of
funds investments. Section 12(d)(1)(A) prohibits a registered fund (and
companies or funds it controls) from--
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    \4\ For a discussion of these ``pyramiding'' schemes and the
additional problems fund of funds arrangements can create for
shareholders, see Fund of Funds Investments, Investment Company Act
Release No. 26198 (Oct. 1, 2003) [68 FR 58226 (Oct. 8, 2003)]
(``Proposing Release''). See also U.S. Securities and Exchange
Commission, Investment Trusts and Investment Companies, H.R. Doc No.
279, 76th Cong., 1st Sess., pt. 3, at 2721-95 (1939).
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     Acquiring more than three percent of a fund's outstanding
voting securities;
     Investing more than five percent of its total assets in
any one acquired fund; or
     Investing more than ten percent of its total assets in all
acquired funds.\5\
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    \5\ See 15 U.S.C. 80a-12(d)(1)(A). If the acquiring fund is not
registered under the Act, the prohibitions apply only with respect
to its acquisition of securities in funds that are registered under
the Act. Funds (together with companies or funds they control and
funds that have the same adviser) also are limited to acquiring no
more than 10 percent of the outstanding voting stock of a closed-end
fund. 15 U.S.C. 80a-12(d)(1)(C).
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    Section 12(d)(1)(B) prohibits a registered open-end fund from
selling securities to any fund (including unregistered funds) if, after
the sale, the acquiring fund would--
     Together with companies and funds it controls, own more
than three percent of the acquired fund's voting securities; or
     Together with other funds (and companies they control) own
more than ten percent of the acquired fund's voting securities.\6\
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    \6\ See 15 U.S.C. 80a-12(d)(1)(B). By limiting the sale of
registered fund shares to other funds, section 12(d)(1)(B) prevents
the creation of a fund of registered funds regardless of the
limitations of U.S. law to regulate the activities of foreign funds.
For a discussion of the events that led to the adoption of sections
12(d)(1)(A) and 12(d)(1)(B) of the Act, see Proposing Release, supra
note 4, at nn. 7-13 and accompanying text.
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    Although these two provisions of section 12(d)(1) have proven quite
effective in putting a stop to the abusive practices that characterized
previous fund of funds arrangements, Congress has recognized that they
also had the effect of preventing legitimate fund of funds
arrangements. To prevent this, Congress created three statutory
exceptions.\7\ Our rulemaking today relates to two of those exceptions:
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    \7\ See sections 15 U.S.C. 80a-12(d)(1)(E), 15 U.S.C. 80a-
12(d)(1)(F), and 15 U.S.C. 80a-12(d)(1)(G).
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    Unaffiliated Fund of Funds Arrangements. Section 12(d)(1)(F)
permits a registered fund to take small positions in an unlimited
number of other funds (an ``unaffiliated fund of

funds''). A fund taking advantage of the exception provided in section
12(d)(1)(F) of the Act (and its affiliated persons) may acquire no more
than three percent of another fund's outstanding stock; \8\ cannot
charge a sales load greater than 1\1/2\ percent; \9\ and is restricted
in its ability to redeem shares of the acquired fund.\10\ In addition,
the fund's adviser would not be able to influence the outcome of
shareholder votes in the acquired fund.\11\
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    \8\ See 15 U.S.C. 80a-12(d)(1)(F)(i).
    \9\ See 15 U.S.C. 80a-12(d)(1)(F)(ii).
    \10\ A fund whose shares are acquired pursuant to section
12(d)(1)(F) is not obligated to redeem more than 1 percent of its
total outstanding securities during any period of less than 30 days.
15 U.S.C. 80a-12(d)(1)(F).
    \11\ Section 12(d)(1)(F), by reference to section 12(d)(1)(E) of
the Act, requires the acquiring fund to vote shares of an acquired
fund either by seeking instructions from the acquiring fund's
shareholders, or to vote the shares in the same proportion as the
vote of all other shareholders of the acquired fund. See 15 U.S.C.
80a-12(d)(1)(E)(iii)(aa).
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    Affiliated Fund of Funds Arrangements. Section 12(d)(1)(G) permits
a registered open-end fund or unit investment trust (``UIT'')\12\ to
acquire an unlimited amount of shares of other registered open-end
funds and UITs that are part of the same ``group of investment
companies,'' (typically known as a fund complex).\13\ A fund taking
advantage of this exception (an ``affiliated fund of funds'') is
restricted in the types of other securities it can hold in addition to
shares of registered funds in the same group of investment
companies.\14\ The acquired funds must have a policy against investing
in shares of other funds in reliance on section 12(d)(1)(F) or
12(d)(1)(G) (to prevent multi-tiered structures),\15\ and overall
distribution expenses are limited (to prevent excessive sales
loads).\16\ Relying on this provision, several large fund complexes
include a fund of funds, which allocates and periodically reallocates
its assets among funds in the complex.\17\
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    \12\ The Act defines ``unit investment trust'' as a fund that:
(i) Is organized under a trust indenture, contract of custodianship
or agency, or similar instrument; (ii) does not have a board of
directors; and (iii) issues only redeemable securities, each of
which represents an undivided interest in a unit of specified
securities, but does not include a voting trust. 15 U.S.C. 80a-4(2).
    \13\ 15 U.S.C. 80a-12(d)(1)(G). For purposes of the exception,
the term ``group of investment companies'' means ``any 2 or more
registered investment companies that hold themselves out to
investors as related companies for purposes of investment and
investor services.'' 15 U.S.C. 80a-12(d)(1)(G)(ii).
    \14\ In addition to investing in securities of registered funds
in the same group of investment companies, the Act permits these
funds to invest only in government securities and short-term paper.
See 15 U.S.C. 80a-12(d)(1)(G)(i)(II).
    \15\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(IV).
    \16\ See 15 U.S.C. 80a-12(d)(1)(G)(i)(III). The provision
permits a fund to invest in shares of another fund only if either
(i) the acquiring fund does not charge a sales load or distribution-
related fee or does not pay (and is not assessed) sales loads or
distribution-related fees on securities of the acquired fund, or
(ii) the aggregate sales loads or distribution-related fees charged
by the acquiring fund on its securities and paid by the acquiring
fund on acquired fund securities are not excessive under rules
adopted under section 22(b) [15 U.S.C. 80a-22(b)] or 22(c) [15
U.S.C. 80a-22(c)] by a securities association registered under
section 15A of the Securities Exchange Act of 1934 (the ``Exchange
Act'') [15 U.S.C. 78o-3] or the Commission. The NASD has adopted
limits on sales loads and distribution-related fees applicable to
funds as well as to funds of funds. See NASD Rule 2830(d)(3) (``NASD
Sales Charge Rule'').
    Under the NASD Sales Charge Rule for funds of funds, if neither
the acquiring nor acquired fund has an asset-based sales charge
(12b-1 fee), the maximum aggregate sales load that can be charged on
sales of acquiring fund and acquired fund shares cannot exceed 8.5
percent. See NASD Sales Charge Rule 2830(d)(3)(A). Any acquiring or
acquired fund that has an asset-based sales charge must individually
comply with the sales charge limitations on funds with an asset-
based sales charge, provided, among other conditions, that if both
funds have an asset-based sales charge, the maximum aggregate asset-
based sales charge cannot exceed .75 of 1 percent per year of the
average annual net assets of both funds; and the maximum aggregate
sales load may not exceed 7.25 percent of the amount invested, or
6.25 percent if either fund pays a service fee. See NASD Sales
Charge Rule 2830(d)(3)(B). The rule is designed so that cumulative
charges for sales-related expenses, no matter how they are imposed,
are subject to equivalent limitations. See Order Approving Proposed
Rule Change Relating to the Limitation of Asset-Based Sales Charges
as Imposed by Investment Companies, Exchange Act Release No. 30897
(July 7, 1992) [57 FR 30985 (July 13, 1992)], at text accompanying
n. 9.
    \17\ See, e.g., T. Rowe Price Retirement Funds, Prospectus 1-10
(Oct. 1, 2005).
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II. Discussion

    Since 1940 we have provided limited relief for funds to acquire
shares of other funds when the proposed arrangements did not present
the risk of abuses that section 12(d)(1) was designed to prevent. We
issued those orders under our general exemptive authority in section
6(c) of the Act.\18\ In 1996, when Congress added section 12(d)(1)(G),
it also gave us specific authority to exempt any person, security or
transaction, or any class or classes of transactions, from section
12(d)(1) of the Act if the exemption is consistent with the public
interest and the protection of investors.\19\
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    \18\ 15 U.S.C. 80a-6(c).
    \19\ National Securities Markets Improvement Act of 1996, Pub.
L. 104-290, Sec.  202, 110 Stat. 3416, 3427 (1996) (codified at 15
U.S.C. 80a-12(d)(1)(J)).
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    In October 2003, we proposed three new rules to address the ability
of a registered fund to invest in shares of another fund without first
having to seek Commission approval.\20\ The rules were proposed to
codify and expand upon a number of exemptive orders we have issued that
permit funds to invest in other funds.\21\ We also proposed amendments
to Forms N-1A, N-2, N-3, N-4, and N-6 to require funds of funds to
disclose acquired fund expenses in their prospectuses. We received five
comments on the proposal.\22\ Commenters supported the proposed rules
and amendments, but suggested changes. Today, we are adopting rules
12d1-1, 12d1-2 and 12d1-3, and amendments to Forms N-1A, N-2, N-3, N-4,
and N-6 substantially as proposed, with changes that respond to issues
raised by commenters.
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    \20\ Proposing Release, supra note 4.
    \21\ See id, at nn. 36, 72 and 87.
    \22\ See Comment Letter of Fidelity Management & Research
Company (``FMR'') (Dec. 19, 2003); Comment Letter of the Investment
Company Institute (``ICI'') (Dec. 3, 2003); Comment Letter of IMRC
Group (Nov. 18, 2003); Comment Letter of Man Investments, Inc. (Dec.
1, 2003); Comment Letter of Joel Torrance (June 17, 2004). The
comment letters are available for public inspection and copying in
the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549 (File No. S7-18-03). The comment letters are
also available on the Commission's Internet Web site (http://www.sec.gov/rules/proposed/s71803.shtml
).

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A. Rule 12d1-1: Investments in Money Market Funds

    Rule 12d1-1 allows funds to invest in shares of money market funds
in excess of the limits of section 12(d)(1). The rule is designed to
permit ``cash sweep'' arrangements in which a fund invests all or a
portion of its available cash in a money market fund rather than
directly in short-term instruments. Commenters agreed with our
assessment that fund investments in money market funds, which did not
exist in 1940, do not raise the concerns that underlie section
12(d)(1).\23\ Some, however, persuaded us to make some modifications to
the rule, which we describe below.\24\
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    \23\ See Comment Letter of IMRC Group (Nov. 18, 2003); Comment
Letter of ICI (Dec. 3, 2003). For a more extensive discussion of
this analysis, see Proposing Release, supra note 4, at nn. 38-39 and
accompanying text.
    \24\ One commenter recommended amending rule 17d-1 to permit
joint transactions that would allow funds to take advantage of other
cash management tools, such as joint repurchase agreements where the
fund participates on terms not different from those applicable to
its affiliated participant. See Comment Letter of ICI (Dec. 3,
2003). The broader relief suggested is outside the scope of our
proposals. We are, however, adopting a technical amendment to rule
12d1-1 in response to this commenter's assertion that the proposed
defined term ``Administrative Fees'' could create confusion because
the term is used elsewhere in our rules. See, e.g., 17 CFR 270.11a-3
and Instruction 3 to Item 3 of Form N-1A. We have eliminated the
term and defined the fees subject to the rule in the applicable
provision without any substantive changes to the provision. See rule
12d1-1(b)(1).

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1. Scope of Exemption
(a) Registered Money Market Funds
    Rule 12d1-1 permits a fund to invest an unlimited amount of its
uninvested cash in a money market fund rather than directly in short-
term instruments.\25\ Any investment would, of course, have to be
consistent with the fund's investment objectives and policies.\26\ The
acquired fund may be a fund in the same fund complex or in a different
fund complex. Thus, a fund in a small complex that does not have a
money market fund may invest available cash in an unaffiliated money
market fund.
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    \25\ Rule 12d1-1(a). Our exemptive orders had limited cash sweep
investments to 25 percent of the acquiring fund's total assets. See,
e.g., Vanguard Group, Inc., et al., Investment Company Act Release
Nos. 26406 (Mar. 29, 2004) [69 FR 17460 (Apr. 2, 2004)] (notice) and
26436 (Apr. 23, 2004) (order); Putnam American Government Income
Fund, et al., Investment Company Act Release Nos. 26200 (Oct. 1,
2003) [68 FR 57937 (Oct. 7, 2003)] (notice) and 26414 (Apr. 9, 2004)
(order) (``Putnam Order''); Credit Suisse Asset Management, LLC, et
al., Investment Company Act Release Nos. 25789 (Oct. 29, 2002) [67
FR 67220 (Nov. 4, 2002)] (notice) and 25832 (Nov. 22, 2002) (order).
    \26\ See infra note 49.
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    In addition to providing an exemption from section 12(d)(1) of the
Act, the rule provides exemptions from section 17(a) and rule 17d-1,
which restrict a fund's ability to enter into transactions and joint
arrangements with affiliated persons.\27\ These provisions would
otherwise prohibit an acquiring fund from investing in a money market
fund in the same fund complex,\28\ or prohibit a fund that acquires
five percent or more of the securities of a money market fund in
another fund complex from making any additional investments in the
money market fund.\29\
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    \27\ Section 17(a) generally prohibits affiliated persons of a
registered fund (``first-tier affiliates'') or affiliated persons of
the fund's affiliated persons (``second-tier affiliates'') from
selling securities or other property to the fund (or any company the
fund controls). 15 U.S.C. 80a-17(a). Section 17(d) of the Act makes
it unlawful for first- and second-tier affiliates, the fund's
principal underwriters, and affiliated persons of the fund's
principal underwriters, acting as principal, to effect any
transaction in which the fund, or a company it controls, is a joint
or a joint and several participant in contravention of Commission
rules. 15 U.S.C. 80a-17(d). Rule 17d-1(a) prohibits first- and
second-tier affiliates of a registered fund, the fund's principal
underwriters, and affiliated persons of the fund's principal
underwriter, acting as principal, from participating in or effecting
any transaction in connection with any joint enterprise or other
joint arrangement or profit-sharing plan in which the fund (or any
company it controls) is a participant unless an application
regarding the enterprise, arrangement or plan has been filed with
the Commission and has been granted. 17 CFR 270.17d-1.
    \28\ An affiliated person of a fund includes any person directly
or indirectly controlling, controlled by, or under common control
with such other person. See 15 U.S.C. 80a-2(a)(3)(C) (definition of
``affiliated person''). Most funds today are organized by an
investment adviser that advises or provides administrative services
to other funds in the same complex. Funds in a fund complex are
generally under common control of an investment adviser or other
person exercising a controlling influence over the management or
policies of the funds. See 15 U.S.C. 80a-2(a)(9). Not all advisers
control funds they advise. The determination of whether a fund is
under the control of its adviser, officers, or directors depends on
all the relevant facts and circumstances. See Investment Company
Mergers, Investment Company Act Release No. 25259 (Nov. 8, 2001) [66
FR 57602 (Nov. 15, 2001)], at n. 11. For purposes of this release,
we presume that funds in a fund complex are under common control
because funds that are not affiliated persons would not require, and
thus not rely on, the exemptions from section 17(a) and rule 17d-1.
    \29\ An affiliated person of a fund also includes: (i) Any
person directly or indirectly owning, controlling, or holding with
power to vote, five percent or more of the outstanding voting
securities of the fund; and (ii) any person five percent or more of
whose outstanding voting securities are directly or indirectly
owned, controlled, or held with power to vote by the fund. See 15
U.S.C. 80a-2(a)(3)(A), (B). Thus, a fund that acquires five percent
of the securities of another fund would be affiliated with that fund
and any transactions with the fund would be subject to the
limitations of section 17. See supra note 27.
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    Commenters agreed with us that an acquiring fund's purchase and
redemption of money market fund shares at net asset value would provide
little opportunity for the insider self-dealing or overreaching that
section 17 was designed to prevent.\30\ They agreed that these
exemptions would benefit funds and their shareholders, supporting our
conclusion that these provisions are appropriate and in the public
interest.\31\
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    \30\ See Comment Letter of IMRC Group (Nov. 18, 2003).
    \31\ See Comment Letter of ICI (Dec. 3, 2003); Comment Letter of
FMR (Dec. 19, 2003).
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    One commenter expressed concern, however, that without additional
relief from section 17, acquiring funds might not be able to take full
advantage of the proposed exemption.\32\ If a fund in one fund complex
acquired more than five percent of the assets of a money market fund in
another fund complex, any broker-dealer affiliated with that money
market fund would become a (second-tier) affiliated person of the
acquiring fund.\33\ As a result of the affiliation, the broker-dealer's
fee for effecting the sale of securities to the acquiring fund would be
subject to the conditions set forth in rule 17e-1, including the
quarterly board review and recordkeeping requirements with respect to
certain securities transactions involving the affiliated broker-
dealer.\34\ We believe that it is unlikely that a broker-dealer would
be in a position to take advantage of a fund merely because that fund
owned a position in a money market fund affiliated with the broker-
dealer.\35\ Accordingly, the final rule permits an acquiring fund to
pay commissions, fees, or other remuneration to a (second-tier)
affiliated broker-dealer without complying with the quarterly board
review and recordkeeping requirements set forth in rules 17e-1(b)(3)
and 17e-1(d)(2).\36\ This relief is available only if the broker-dealer
and the acquiring fund become affiliated solely because of the
acquiring fund's investment in the money market fund. We believe this
additional relief will enable more funds to take advantage of the
exemption provided by the rule.
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    \32\ See Comment Letter of IMRC Group (Nov. 18, 2003). Although
the commenter requested additional relief from section 17 of the
Act, the commenter did not specify any sections or rules other than
section 17(e) and rule 17e-1 thereunder. The additional section 17
relief we are providing is limited to certain provisions of rule
17e-1 under the Act.
    \33\ See supra note 29.
    \34\ Section 17(e)(2) of the Act prohibits an affiliated person
(or second-tier affiliate) of a fund from receiving compensation for
acting as a broker, in connection with the sale of securities to or
by the fund if the compensation exceeds limits prescribed by the
section unless permitted by rule 17e-1 under the Act. 15 U.S.C. 80a-
17(e)(2). Rule 17e-1 sets forth the conditions under which a
commission, fee or other remuneration shall be deemed as not
exceeding the ``usual and customary broker's commission'' for
purposes of section 17(e)(2)(A) of the Act. Rule 17e-1(b)(3)
requires the fund's board of directors, including a majority of the
directors who are not interested persons under section 2(a)(19) of
the Act, to determine at least quarterly that all transactions
effected in reliance on the rule have complied with procedures which
are reasonably designed to provide that the brokerage compensation
is consistent with the rule's standards. Rule 17e-1(d)(2) specifies
the records that must be maintained by each fund with respect to any
transaction effected pursuant to rule 17e-1.
    \35\ The money market fund's adviser would have no influence
over the decisions made by the acquiring fund's adviser. In
addition, because the interests of the adviser to the money market
fund and the adviser to the acquiring fund are directly aligned with
their respective funds, transactions between the acquiring fund and
a broker-dealer affiliate of the money market fund are likely to be
at arm's length.
    \36\ Rule 12d1-1(c). This exemption also is available for
payments to broker-dealer affiliates of unregistered money market
funds. See infra notes 37-42 and accompanying text. The relief
provided by this exemption is similar to relief provided in a number
of exemptive orders issued by the Commission. See, e.g., SunAmerica
Series Trust, et al., Investment Company Act Release Nos. 21203
(July 14, 1995) [60 FR 37485 (July 20, 1995)] (notice) and 21276
(Aug. 9. 1995) (order); Prudential Investments LLC, et al.,
Investment Company Act Release Nos. 25736 (Sept. 18, 2002) [67 FR
59869 (Sept. 24, 2002)] (notice) and 25771 (Oct. 16, 2002) (order).
An acquiring fund relying on this exemption is required to comply
with all of the provisions of rule 17e-1, except 17e-1(b)(3) and
(d)(2). We do not believe that having to comply with the other
provisions contained in rule 17e-1 would deter acquiring funds from
taking full advantage of the exemption provided by the rule.
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(b) Unregistered Money Market Funds
    Rule 12d1-1 also permits funds to invest in money market funds that
are not registered investment companies

(``unregistered money market funds''). Unregistered money market funds
are typically organized by a fund adviser for the purpose of managing
the cash of other funds in a fund complex and operate in almost all
respects as a registered money market fund, except that their
securities are privately offered and thus not registered under the
Securities Act.\37\ Although a fund's investments in unregistered money
market funds are not restricted by section 12(d)(1), these investments
are subject to the affiliate transaction restrictions in the Act and
rules thereunder and thus require exemptions from section 17(a) and
rule 17d-1.\38\
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    \37\ See 15 U.S.C. 80a-3(c)(1) (excepting from the definition of
``investment company'' an issuer whose securities are owned by no
more than 100 persons and which is not making and does not presently
propose to make a public offering of its securities); 15 U.S.C. 80a-
3(c)(7) (excepting from the definition of ``investment company'' an
issuer whose securities are owned exclusively by ``qualified
purchasers'' and which is not making and does not presently propose
to make a public offering of its securities).
    \38\ See supra notes 27-29 and accompanying text.
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    Commenters had no specific comments on this provision of the
proposal, and we have adopted it substantially as proposed.\39\ The
exemption is available only for investments in an unregistered money
market fund that operates like a money market fund registered under the
Act. To be eligible, an unregistered money market fund is required to
(i) limit its investments to those in which a money market fund may
invest under rule 2a-7 under the Act,\40\ and (ii) undertake to comply
with all the other provisions of rule 2a-7.\41\ In addition, the
unregistered money market fund's adviser must be registered as an
investment adviser with the Commission.\42\ Finally, the acquiring fund
is required to reasonably believe that the unregistered money market
fund operates like a registered money market fund and that it complies
with certain provisions of the Act.\43\ A fund would reasonably believe
that an acquired fund was in compliance with these provisions if, for
example, it received a representation from the acquired fund (or the
adviser to the acquired fund) that the fund would comply with the
relevant provisions in all material respects and if the acquiring fund
had no reason to believe that the acquired fund was not, in fact,
complying with the relevant provisions in all material respects. Thus,
an acquired fund's failure to comply will not automatically result in
the loss of the acquiring fund's exemption.
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    \39\ We have made a technical change to conform the wording in
paragraphs 12d1-1(b)(2)(i)(A) through (E) by adding to paragraph
12d1-1(b)(2)(i) the words ``satisfies the following conditions as if
it were a registered open-end investment company.''
    \40\ See 17 CFR 270.2a-7.
    \41\ Rule 12d1-1(d)(2)(ii).
    \42\ Rule 12d1-1(b)(2)(ii). In order for a registered fund to
invest in reliance on rule 12d1-1 in an unregistered money market
fund that does not have a board of directors (because, for example,
it is organized as a limited partnership), the unregistered money
market fund's investment adviser must perform the duties required of
a money market fund's board of directors under rule 2a-7. Rule 12d1-
1(d)(2)(ii)(B).
    \43\ Rule 12d1-1(b)(2)(i). To rely on the rule, an acquiring
fund must reasonably believe that the unregistered money market fund
complies, as if it were a registered open-end fund, with provisions
of the Act that limit affiliate transactions (sections 17(a), (d),
and (e)), issuance of senior securities (section 18), and suspension
of redemption rights (section 22(e)). Rule 12d1-1(b)(2)(i)(B). The
fund also must reasonably believe that the unregistered money market
fund (i) has adopted and periodically reviews procedures designed to
ensure compliance with these requirements, and maintains books and
records describing the procedures, and (ii) maintains and preserves
the books and records required under rules 31a-1(b)(1) [17 CFR
270.31a-1(b)(1)], 31a-1(b)(2)(ii) [17 CFR 270.31a-1(b)(2)(ii)], 31a-
1(b)(2)(iv) [17 CFR 270.31a-1(b)(2)(iv)], and 31a-1(b)(9) [17 CFR
270.31a-1(b)(9)]. Rule 12d1-1(b)(2)(i)(C), (D).
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(c) Closed-End Funds of Funds
    The exemptions we are adopting are also available for closed-end
funds, including business development companies,\44\ which are closed-
end funds that are exempted from registration under the Act.\45\ In
response to comments, the final rule provides an additional exemption
from section 57 of the Act, which restricts certain transactions
between business development companies and certain of their
affiliates.\46\ This relief is consistent with the relief we are
granting from section 17(a) and rule 17d-1 with respect to affiliated
money market funds. We agree with the commenter that the possibility of
self-dealing or overreaching in the case of business development
companies that invest in money market funds does not appear to be any
greater than investments in money market funds by registered closed-end
funds.
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    \44\ A business development company is any closed-end fund that:
(i) Is organized under the laws of, and has its principal place of
business in, any state or states; (ii) is operated for the purpose
of investing in securities described in section 55(a)(1)-(3) of the
Act [15 U.S.C. 80a-54(a)(1)-(3)] and makes available ``significant
managerial assistance'' to the issuers of those securities, subject
to certain conditions; and (iii) has elected under section 54(a) of
the Act to be subject to the sections addressing activities of
business development companies under the Act. See 15 U.S.C. 80a-
2(a)(48). Section 60 of the Act [15 U.S.C. 80a-59] extends the
limits of section 12(d) to a business development company to the
same extent as if it were a registered closed-end fund.
    \45\ Section 6(f) of the Act [15 U.S.C. 80a-6(f)] exempts from
registration and other provisions of the Act companies that have
elected to be regulated as business development companies under
section 54 [15 U.S.C. 80a-53].
    \46\ 15 U.S.C. 80a-56. See Comment Letter of IMRC Group (Nov.
18, 2003).
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(d) Unregistered Funds of Funds
    Unregistered funds also are subject to the section 12(d)(1)
restrictions on the acquisition of shares of registered funds.\47\ As
proposed, the final rule permits unregistered funds to invest their
cash in shares of a registered money market fund. This allows a hedge
fund, for example, to sweep its cash into a registered money market
fund pending investment or distribution of the cash to investors. In
the Proposing Release, we asked whether any special concerns arise with
respect to unregistered funds' use of money market funds in cash sweep
arrangements, and we received no comment on the question.
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    \47\ See 15 U.S.C. 80a-12(d)(1)(A); 15 U.S.C. 80a-12(d)(1)(B).
In the case of unregistered investment companies (such as most
foreign funds) the full restrictions of sections 12(d)(1)(A) and (B)
apply. Companies that are unregistered because they are excepted
from the definition of investment company by sections 3(c)(1) and
3(c)(7) of the Act are prohibited from acquiring more than three
percent of the outstanding voting securities of a registered fund.
Both section 3(c)(1) and section 3(c)(7) deem issuers that rely on
these sections to be investment companies for the purposes of
sections 12(d)(1)(A)(i) and 12(d)(1)(B)(i) with respect to their
acquisition of registered funds. See 15 U.S.C. 80a-3(c)(1); 15
U.S.C. 80a-3(c)(7)(D).
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2. Conditions
    As proposed, we are eliminating most of the conditions that have
been included in our exemptive orders.\48\ One condition we have
retained precludes the acquiring fund from paying a sales load,
distribution fee, or service fee on acquired fund shares, or if it
does, the acquiring fund's investment adviser must waive a sufficient
amount of its advisory fee to offset the cost of the loads or
distribution fees.\49\ Rarely do institutional investors (such as an
acquiring fund) pay sales loads or bear distribution expenses on an
investment in a money market fund. Thus, a money market fund that
charges a sales load or

distribution fees to the acquiring fund may not be an appropriate
investment for that fund. Commenters who addressed the issue generally
supported this condition.\50\
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    \48\ See Proposing Release, supra note 4, at n. 36.
    \49\ See Rule 12d1-1(b)(1). As discussed in the Proposing
Release, we did not propose to limit the amount an acquiring fund
could invest in a money market fund because a fund's own investment
restrictions should provide appropriate investment limitations. See
Proposing Release, supra note 25, at text following n. 64. With
respect to cash sweeps into unregistered money market funds, we have
also retained the requirement in our prior exemptive orders that the
money market funds operate as if they were money market funds
registered under the Act. As proposed (unlike our exemptive orders),
the final rule requires the acquiring fund to ``reasonably
believe,'' rather than ``determine,'' that the unregistered money
market funds operate in this manner. See supra notes 40-43 and
accompanying text; see, e.g., Putnam Order, supra note 25.
    \50\ See Comment Letter of IMRC Group (Nov. 18, 2003). One
commenter recommended we impose another condition to allow a money
market fund to limit the percentage of fund assets that another fund
complex can redeem during a business day as long as the limits are
disclosed in the money market fund's registration statement. Id. We
do not believe this is necessary in the context of money market
funds, which are designed to easily accommodate large redemptions.
Money market funds with large investors, such as a fund of funds,
may need to pay particularly close attention to their obligations
under rule 2a-7, however, because a large redemption may result in a
growth in any deviation between the fund's net asset value per
share, as computed using available market quotations, and the money
market fund's amortized cost per share.
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    Unlike our prior exemptive orders, the rule does not limit advisory
fees or require directors to make any special findings that investors
are not paying multiple advisory fees for the same service.\51\ A fund
could pay duplicative fees if an adviser invests a fund's cash in a
money market fund (which itself pays an advisory fee) without reducing
its advisory fee by an amount it was compensated to manage the cash. As
we noted in the Proposing Release, fund directors have fiduciary
duties,\52\ which obligate them to protect funds from being overcharged
for services provided to the fund, regardless of any special findings
we might require. Moreover, and as we describe in more detail below, we
have adopted amendments to the disclosure rules that require a
registered fund of funds to disclose to shareholders expenses paid by
both the acquiring and acquired funds so that shareholders may better
evaluate the costs of investing in a fund with a cash sweep
arrangement.\53\
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    \51\ See Proposing Release, supra note 4, at n. 65 and
accompanying text.
    \52\ See id, at n. 66 and accompanying text; see also 15 U.S.C.
80a-35(a). See generally 2 T. Frankel, The Regulation of Money
Managers, Sec.  9.05 (2001). Section 15(c) of the Act requires the
board of directors to evaluate the terms (which would include fees,
or the elimination of fees, for services provided by an acquired
fund's adviser) of any advisory contract. See 15 U.S.C. 80a-15(c).
Section 36(b) of the Act [15 U.S.C. 80a-35(b)] imposes on fund
advisers a fiduciary duty with respect to their compensation. We
believe that to the extent advisory services are being performed by
another person, such as the adviser to an acquired money market
fund, this fiduciary duty would require an acquiring fund's adviser
to reduce its fee by the amount that represents compensation for the
services performed by the other person. See Proposing Release, supra
note 4, at n.66.
    \53\ Of course, disclosure of the cumulative amount of fees does
not absolve the directors of their obligations to evaluate fund
expenses. See supra note 52; Investment Company Governance,
Investment Company Act Release No. 26520 (July 27, 2004) [69 FR
46378 (Aug. 2, 2004)], at text accompanying n.17. Nevertheless, we
believe that the disclosure requirements are essential because they
provide investors with the relevant information to compare directly
the costs of investing in alternative funds of funds, or the costs
of investing in a fund of funds to a more traditional fund.
---------------------------------------------------------------------------

B. Rule 12d1-2: Affiliated Funds of Funds

    As discussed above, section 12(d)(1)(G) permits a registered open-
end fund to acquire an unlimited amount of shares of registered open-
end funds and UITs that are part of the same ``group of investment
companies'' as the acquiring fund.\54\ We proposed to codify, and in
some cases expand, three types of relief we have provided for these
fund of funds arrangements that we concluded were consistent with the
public interest and the protection of investors, but that did not
conform to section 12(d)(1)(G) limits. We proposed to permit an
affiliated fund of funds to make investments in addition to shares of
funds in the same group of investment companies. Commenters supported
the proposal, and we are adopting rule 12d1-2 substantially as
proposed.\55\
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    \54\ See supra notes 12-17 and accompanying text.
    \55\ See, e.g., Comment Letter of IMRC Group (Nov. 18, 2003);
Comment Letter of ICI (Dec. 3, 2003); Comment Letter of Man
Investments, Inc. (Dec. 1, 2003). The other limitations in section
12(d)(1)(G) will continue to apply to a fund of funds relying on
that provision. One commenter requested expanding relief under rule
12d1-2 to permit funds to obtain shares of an acquired fund using
in-kind transfers and exempt such transactions from the ``for cash''
requirement of rule 17a-7 under the Act. See Comment Letter of ICI
(Dec. 3, 2003). That relief is outside the scope of our proposal.
---------------------------------------------------------------------------

1. Investments in Unaffiliated Funds
    Rule 12d1-2 permits an affiliated fund of funds to acquire
securities of funds that are not part of the same group of investment
companies, subject to the limits in section 12(d)(1)(A) or
12(d)(1)(F).\56\ This exemption, in effect, permits funds to combine
the relief provided by the statutory exceptions. There do not appear to
be any greater risks to an acquired fund or its shareholders if three
percent of its shares are acquired by an affiliated fund of funds as
opposed to being acquired by other types of funds specifically
permitted to purchase shares by section 12(d)(1)(A) or 12(d)(1)(F).\57\
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    \56\ Rule 12d1-2(a)(1). A fund relying on section 12(d)(1)(A)
(together with any companies or funds it controls) could not acquire
more than 3 percent of the outstanding voting securities of any
other fund in a different fund group. In addition, the acquiring
fund would be limited to investing no more than 5 percent of its own
assets (together with assets of any companies it controls) in the
securities of any one fund in a different fund group, and no more
than 10 percent of its assets (together with assets of any companies
it controls) in securities of other funds in one or more different
fund groups, in the aggregate. See 15 U.S.C. 80a-12(d)(1)(A)(i)-
(iii). A fund relying on section 12(d)(1)(F) (together with its
affiliates) could not acquire more than 3 percent of the outstanding
stock of any other fund in a different fund group. The acquiring
fund also would be required either to seek instructions from its
shareholders as to how to vote shares of those acquired funds, or to
vote the shares in the same proportion as the vote of all other
shareholders of the acquired fund. See 15 U.S.C. 80a-12(d)(1)(F)
(referencing 15 U.S.C. 80a-12(d)(1)(E)). In addition, the acquiring
fund would be limited to charging a sales load of 1\1/2\ percent on
its shares and could be prevented from redeeming more than 1 percent
of the shares of any acquired fund during any period of less than 30
days. Id.
    \57\ A commenter also suggested that we clarify the scope of
rule 12d1-2(a)(1) because it could be read to subject investments in
registered funds in the same complex as the acquiring fund to the
limits of sections 12(d)(1)(A) or 12(d)(1)(F). See Comment Letter of
ICI (Dec. 3, 2003). We agree, and the final rule clarifies that the
limits apply only to investments in securities of unaffiliated funds
rather than registered funds in the same complex. See rule 12d1-
2(a)(1).
---------------------------------------------------------------------------

2. Investments in Other Types of Issuers
    Rule 12d1-2 also provides an exemption from section 12(d)(1)(G) of
the Act to permit an affiliated fund of funds to invest directly in
stocks, bonds, and other types of securities (i.e., securities not
issued by a fund).\58\ Those investments would, of course, have to be
consistent with the fund's investment policies.\59\ A significant
consequence of the rule is that an equity or bond fund can invest any
portion of its assets in an affiliated fund if the acquisition is
consistent with the investment policies of the fund and the
restrictions of the rule.\60\ Commenters agreed that these investments
would allow an acquiring fund greater flexibility in meeting investment
objectives that may not be met as well by investments in other funds in
the same fund group, while not presenting any additional concerns that
section 12(d)(1)(G) was intended to address.\61\
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    \58\ Rule 12d1-2(a)(2). Under this exemption, a fund may invest
in any security as that term is defined under the Act. See 15 U.S.C.
80a-2(a)(36).
    \59\ See Item 4 of Form N-1A (requiring disclosure of fund's
investment objectives and principal investment strategies).
    \60\ See Proposing Release, supra note 4, at nn. 81-82 and
accompanying text. To the extent that a fund that normally invests
directly in securities begins to make investments in affiliated
funds in reliance on the rule, we would expect the fund's directors
to be aware of the investments, particularly in the context of their
consideration of potentially duplicative fees. See supra notes 52-53
and accompanying text.
    \61\ See Comment Letter of ICI (Dec. 3, 2003); Comment Letter of
IMRC Group (Nov. 18, 2003).
---------------------------------------------------------------------------

3. Investments in Money Market Funds
    Rule 12d1-2 permits an affiliated fund of funds to invest in
affiliated or unaffiliated money market funds in reliance on rule 12d1-
1, which, as discussed above, is designed to permit cash sweep
arrangements involving money market funds.\62\ This provision

allows the affiliated fund of funds the same opportunities as any other
fund to invest in a cash sweep arrangement that will provide the
greatest benefit to the acquiring fund. As proposed, we are
conditioning the investment on compliance with rule 12d1-1 in order to
ensure that the same limitations on sales loads and distribution
expenses apply to any fund's investment in a money market fund. Thus,
any fund that invests in a money market fund in reliance on rule 12d1-2
must comply with the conditions in rule 12d1-1.
---------------------------------------------------------------------------

    \62\ Rule 12d1-2(a)(3). See supra notes 23-50 and accompanying
text. A collateral effect of our rule is to permit an affiliated
fund of funds to invest in an acquired fund that itself has a cash
sweep arrangement. As discussed above, section 12(d)(1)(G) prohibits
a fund from acquiring shares of another fund that does not have an
investment policy prohibiting it from investing in shares of funds
in reliance on section 12(d)(1)(F) or (G). An acquired fund
investing in a money market fund under a cash sweep arrangement
permitted under rule 12d1-1 would not be relying on either of those
sections. The fees and expenses of acquired funds would be
aggregated and shown in the fee table in the acquiring fund's
prospectus. See discussion below at Section II.D of this release.
    We are not, as one commenter suggested, providing expanded
section 17 relief under rule 12d1-2. See Comment Letter of IMRC
Group (Nov. 18, 2003). Affiliated funds of funds' investments in
money market funds will be made in reliance upon rule 12d1-1, and we
are including additional relief from certain provisions of rule 17e-
1 in rule 12d1-1. We do not believe it is necessary to provide a
duplicative exemption under rule 12d1-2. See supra notes 32-35 and
accompanying text.
---------------------------------------------------------------------------

C. Rule 12d1-3: Unaffiliated Funds of Funds

    Section 12(d)(1)(F) of the Act provides an exemption from section
12(d)(1) that allows a registered fund to invest all its assets in
other registered funds if: (i) The acquiring fund (together with its
affiliates) acquires no more than 3 percent of the outstanding stock of
any acquired fund; and (ii) the sales load charged on the acquiring
fund's shares is no greater than 1\1/2\ percent.\63\
---------------------------------------------------------------------------

    \63\ See 15 U.S.C. 80a-12(d)(1)(F)(i)-(ii). Section 12(d)(1)(F)
also provides that the acquired fund is not obligated to redeem more
than 1 percent of its outstanding securities held by the acquiring
fund in any period of less than 30 days, and requires the acquiring
fund to vote shares of an acquired fund either by seeking
instructions from the acquiring fund's shareholders or by voting in
the same proportion as the other shareholders of the acquired fund.
---------------------------------------------------------------------------

    Rule 12d1-3 allows funds relying on section 12(d)(1)(F) to charge
sales loads greater than 1\1/2\ percent provided that the aggregate
sales load any investor pays (i.e., the combined distribution expenses
of both the acquiring and acquired funds) does not exceed the limits on
sales loads established by the NASD for funds of funds.\64\ The rule is
intended to provide funds greater flexibility in structuring sales
loads, consistent with the approach Congress took in section
12(d)(1)(G) to prevent excessive sales loads in affiliated funds of
funds, while providing shareholders greater protection by requiring
that funds relying on the rule limit overall distribution fees (rather
than only sales loads).\65\ We are adopting this rule substantially as
proposed.\66\
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    \64\ See NASD Sales Charge Rule 2830(d)(3), supra note 16. We
note that any fund relying on the exemption provided in rule 12d1-3
must comply with the limitations set forth in NASD Sales Charge Rule
2830(d)(3), regardless of whether sales of the fund's shares by
broker-dealers are otherwise subject to the rule according to its
terms. See NASD Sales Charge Rule 2830(d) (NASD Sales Charge Rule
limits apply to sales of open-end funds, any closed-end funds that
make periodic repurchase offers under rule 23c-3(b) under the Act
and offer their shares on a continuous basis, or single payment
plans issued by UITs). Unlike the proposal, the final rule text
limits sales charges and service fees charged with respect to the
acquiring fund, but the rule does not specifically limit those fees
when aggregated with sales charges and service fees charged with
respect to acquired funds. The additional language on aggregation is
not necessary in the rule because limits in NASD Sales Charge Rule
2830(d)(3) specifically apply to fees imposed by the acquiring fund,
the acquired fund and those funds in combination.
    \65\ See Proposing Release, supra note 4, at n. 88 and
accompanying text. An affiliated fund of funds may rely on rule
12d1-2 to invest in funds in a different fund complex subject to the
limits of section 12(d)(1)(A) or 12(d)(1)(F). If the acquiring
fund's investment is subject to the limits of section 12(d)(1)(F),
the acquiring fund may also rely on the exemption provided under
rule 12d1-3 to charge sales loads greater than 1\1/2\ percent
provided it complies with the conditions of rule 12d1-3.
    \66\ Commenters generally supported this provision. See Comment
Letter of ICI (Dec. 3, 2003); Comment Letter of FMR (Dec. 19, 2003).
---------------------------------------------------------------------------

D. Amendments to Disclosure Forms: Transparency of Fund of Funds
Expenses

    We are also adopting amendments to our disclosure requirements to
require each fund that invests in shares of other funds to disclose in
its prospectus fee table the expenses of funds in which it invests. The
amendments are designed to provide investors with a better
understanding of the actual costs of investing in a fund that invests
in other funds, which have their own expenses that may be as high or
higher than the acquiring fund's expenses.\67\ Investors may not be
aware of these potentially higher expenses. Most commenters supported
these amendments, which we are adopting substantially as proposed.\68\
---------------------------------------------------------------------------

    \67\ A fund of funds may have higher fees and expenses than a
fund that invests directly in debt and equity securities.
    \68\ See Comment Letter of ICI (Dec. 3, 2003); Comment Letter of
FMR (Dec. 19, 2003) (supporting position taken in the ICI comment
letter); Comment Letter of IMRC Group (Nov. 18, 2003); Comment
Letter of Joel Torrance (June 17, 2004).
---------------------------------------------------------------------------

    Open-End Funds. Form N-1A is used by open-end management funds to
register under the Act and to offer their securities under the
Securities Act. Form N-1A sets forth the disclosure requirements for
fund prospectuses. Our amendments to Form N-1A require any registered
open-end fund investing in shares of another fund to include in its
prospectus fee table an additional line item titled ``Acquired Fund
Fees and Expenses'' under the section that discloses total annual fund
operating expenses.\69\ The line item will set forth the acquiring
fund's pro rata portion of the cumulative expenses charged by funds in
which the acquiring fund invests. Those costs will be included in the
acquiring funds' total annual fund operating expenses, which will be
reflected in the ``Example'' portion of the fee table.\70\ One
commenter suggested that we add an instruction to permit a fund to omit
the new separate line item if the aggregate expenses attributable to
acquired funds do not exceed 0.01 percent (one basis point) of average
net assets of the acquiring fund. We agree with the commenter that the
disclosure of this de minimis amount in a separate line item would not
be important to investors. Therefore, the instructions to the amended
fee table allow these expenses to be included in ``Other Expenses.''
\71\
---------------------------------------------------------------------------

    \69\ The item will appear directly above the line item titled
``Total Annual Fund Operating Expenses.'' The proposed instructions
to Form N-1A would have permitted funds to use terms in the fee
table other than the term ``Acquired Fund.'' We received no comment
in response to our question whether the proposed instructions were
consistent with the current fee table. We have decided not to permit
funds to use other terms, however, because no variation is permitted
for other line items in the fee table (except for the subcaptions
that may be used under ``Other Expenses'' in order to identify the
largest expenses comprising ``Other Expenses''). Accordingly, the
instruction, as adopted, is consistent with the other line items in
the expense table, and allows investors to more easily compare
disclosure among funds. In the event a fund uses another defined
term to describe acquired funds in its prospectus, it may include
this term in a parenthetical following the title of the new line
item. See Instruction 3(f)(i) to Item 3 of Form N-1A. We are
adopting conforming amendments to Forms N-2 and N-3. See Instruction
10.a to Item 3.1 of Form N-2; Instruction 19(a) to Item 3(a) of Form
N-3.
    \70\ The fee table example requires the fund to disclose the
cumulative amount of fund expenses of 1, 3, 5, and 10 years based on
a hypothetical investment of $10,000 and an annual 5 percent return.
See Item 3 of Form N-1A.
    \71\ See Comment Letter of ICI (Dec. 3, 2003). See Instruction
3(f)(i) to Item 3 of Form N-1A. Inclusion of the de minimis amount
under ``Other Expenses,'' however, ensures that the acquired funds'
expenses will be included in the acquiring fund's total annual
operating expense ratio. Form N-2 and Form N-3 filers may also rely
on this exception and we have amended the relevant instructions
accordingly. See Instruction 10.a to Item 3.1 of Form N-2;
Instruction 19(a) to Item 3(a) of Form N-3.
---------------------------------------------------------------------------

    We also are adopting instructions to assist an acquiring fund in
determining the amount of acquired funds' fees and expenses that must
be reflected in its fee

table. The acquiring fund must aggregate the amount of total annual
fund operating expenses of acquired funds (which are indirectly paid by
the acquiring fund) and transaction fees (which are directly paid by
the acquiring fund over the past year) and express the total amount as
a percentage of average net assets of the acquiring fund. Under this
approach, the acquiring fund must determine the average invested
balance and number of actual days invested in each acquired fund.\72\
We also are adopting the proposed instruction that requires the
acquiring fund to include in the expense calculation any transaction
fee the acquiring fund paid to acquire or dispose of shares of a fund
during the past fiscal year (even if it no longer holds shares of that
fund).\73\
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    \72\ See Instruction 3(f)(ii) to Item 3 of Form N-1A (to
calculate the pro rata share of total annual fund operating expenses
for each acquired fund, an acquiring fund will divide the acquired
fund's expense ratio by the number of days in the relevant calendar
year, and multiply the result by the average invested balance and
the number of days invested in the acquired fund). We have revised
the divisor in the calculation for the daily expense ratio from the
proposed 365 days to the number of days in the fiscal year to
reflect that some fiscal years will have 366 days. One commenter
asserted that our proposed formula in Instruction 3(f)(ii) to Item 3
of Form N-1A would not correspond to the expense ratio (i.e., the
Ratio of Expenses to Average Net Assets) currently in Item 8 of Form
N-1A, ``Financial Highlights Information.'' The commenter stated
that, as a result, the total annual fund operating expenses
disclosed in response to Item 3 would be generally higher than those
reflected in response to Item 8 because the expense ratio in Item 8
would only reflect expenses paid directly by the acquiring fund. See
Comment Letter of ICI (Dec. 3, 2003). We agree that this potential
discrepancy may be confusing to investors, and have revised the
instruction to permit funds to address this discrepancy in a
clarifying footnote to the fee table. See Instruction 3(f)(vii) to
Item 3 of Form N-1A. Because Form N-2 and Form N-3 filers would face
the same issue, the adopted instructions permit those funds also to
include a clarifying footnote. See Instruction 10.i to Item 3.1 of
Form N-2; Instruction 19(g) to Item 3(a) of Form N-3. We also have
directed the staff to continue monitoring funds of funds' disclosure
to determine whether additional disclosure of acquired funds' fees
is needed, such as in the financial highlights section or
shareholder reports.
    We are also revising Instruction 3(f)(v) to Item 3 of Form N-1A.
The proposed instructions would have required the acquiring fund to
calculate an ``average invested balance'' based on month-end
balances. One commenter recommended that funds be permitted to
calculate ``average invested balances'' based on the value of
investment measured no less frequently than monthly to allow funds
the flexibility of using daily balances. See Comment Letter of ICI
(Dec. 3, 2003). We believe that the recommendation will allow the
most accurate disclosure for funds that use the more frequent
measure and have revised the instruction to allow the acquiring fund
to calculate ``average invested balance'' based on the value of
investment measured no less frequently than monthly. See Instruction
10.e to Item 3.1 of Form N-2; Instruction 19(e) to Item 3 of Form N-
3.
    \73\ See Instruction 3(f)(ii) to Item 3 of Form N-1A
(``transaction fees'' included in the calculation for acquired
funds' fees and expenses include the total amount of sales loads,
redemption fees, or other transaction fees paid by the acquiring
fund in connection with acquiring or disposing of shares in acquired
funds during the year). We clarified this instruction to indicate
that ``transaction fees'' include fees paid in connection with
acquiring and disposing of shares. If an acquired fund charges a
performance fee, the fee would be included in the disclosure of
acquired funds' fees and expenses. The amended instructions to Form
N-1A would require an acquiring fund to include a performance fee
that is accounted for as an incentive allocation, in conformance
with the amended instructions to Form N-2. See infra notes 83, 84.
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    Our proposed instructions would have required an acquiring fund in
the same fund complex as the acquired fund to calculate the acquired
fund's actual total annual expense ratio for the period covering the
acquiring fund's fiscal year.\74\ For funds in a different fund
complex, our proposal would have required the acquiring funds to use
the gross expense ratio disclosed in an acquired fund's most recent
semi-annual report filed with the Commission, or if the fund does not
file reports with the Commission or the gross expense ratio is not
provided, to use the expense ratio provided in a recent communication
from the acquired fund.\75\
---------------------------------------------------------------------------

    \74\ See Proposing Release, supra note 4.
    \75\ Id.
---------------------------------------------------------------------------

    One commenter questioned whether funds in the same fund complex
should have to calculate this special purpose expense ratio and
recommended that an acquiring fund use the acquired fund's annual
expense ratio as disclosed in its most recent semi-annual report filed
with the Commission.\76\ We agree with the commenter that it is
unnecessary to calculate a special purpose expense ratio for funds in
the same fund complex because expense ratios typically do not fluctuate
much from year to year. Therefore, acquired fund expense disclosure
based on a special purpose expense ratio would in most cases be
identical to or negligibly different from the disclosure based on the
expense ratio as disclosed in the most recent shareholder report.
Accordingly, the instructions as adopted require an acquiring fund to
calculate the acquired funds' expenses using the net expense ratios
reported in the acquired funds' most recent shareholder reports.\77\ We
also believe that allowing acquiring funds to use the net expense ratio
disclosed in shareholder reports (which may or may not be filed with
the Commission depending on whether the fund is registered with the
Commission), instead of reports filed with the Commission, will permit
more acquiring funds to rely on a readily available expense ratio and
will eliminate the need for any special communication between the
funds.\78\ If an acquired fund does not provide a net expense ratio in
its most recent shareholder report or is a newly formed fund that has
not prepared a report, the acquiring fund must use the acquired fund's
total annual fund operating expenses over average annual net assets as
reported in its most recent communication to the acquiring fund.\79\
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    \76\ See Comment Letter of ICI (Dec. 3, 2003).
    \77\ See Instruction 3(f)(iv) to Item 3 of Form N-1A. The
proposal would have required acquiring funds to use a gross expense
ratio, which would have excluded the effect of waivers or
reimbursements. Amended instruction 3(f)(iv) requires use of the net
operating expense ratio, which includes the effect of waivers or
reimbursements by the acquired fund's investment adviser or sponsor.
We believe that permitting funds to use the net operating expense
ratio that is disclosed in shareholder reports instead of the gross
expense ratio (which may not be available in shareholder reports
because it is not required disclosure) will significantly reduce the
need for special calculations or communications between the
acquiring and acquired fund because the acquiring fund will not have
to adjust the net expense ratio disclosed in the shareholder report
to exclude the effect of waivers and reimbursements. We have made
conforming amendments to Forms N-2 and N-3. See Instruction 10.d to
Item 3.1 of Form N-2; Instruction 19(d) to Item 3(a) of Form N-3.
    \78\ Funds may use the most recent shareholder report, whether
it is an annual or semi-annual report. If the acquiring fund relies
on a semi-annual report, however, it must use an annualized expense
ratio. See Instruction 3(f)(iv) to Item 3 of Form N-1A; Instruction
10.d to Item 3.1 of Form N-2; Instruction 19(d) to Item 3(a) of Form
N-3.
    \79\ See Instruction 3(f)(iv) to Item 3 of Form N-1A. We also
are conforming the instruction with respect to the expense ratio
used for funds in a different fund complex in order to establish a
uniform instruction. We believe that this revision will provide
greater consistency among funds of funds' expense disclosures. Id.
We have made conforming changes to Forms N-2 and N-3. See
Instruction 10.d to Item 3.1 of Form N-2; Instruction 19(d) to Item
3 of Form N-3.
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    The new disclosure requirements we are adopting today also will
apply with respect to investments in any unregistered fund that would
be an investment company under section 3(a) of the Act but for the
exceptions provided in sections 3(c)(1) and 3(c)(7) of the Act.\80\
Thus, a fund with a cash sweep arrangement will be required to report
the expenses of the unregistered money market fund in which the
acquiring fund invests.
---------------------------------------------------------------------------

    \80\ See Instruction 3(f)(i) to Item 3 of Form N-1A, Instruction
10.a to Item 3.1 of Form N-2, Instruction 19(a) to Item 3 of Form N-
3. See also 15 U.S.C. 80a-3(c)(1), 80a-3(c)(7), and supra note 37.
---------------------------------------------------------------------------

    Closed-End Funds. Form N-2 is used by closed-end management funds
to register under the Act and to offer their securities under the
Securities Act. Closed-end funds sometimes invest in other funds and
unregistered pools of investments, such as hedge funds.\81\ The

amendments to Form N-2 require a registered closed-end fund of funds
(including a closed-end fund of hedge funds) to include its pro rata
portion of the cumulative expenses charged by the acquired funds,
including management fees and expenses, transaction fees and
performance fees (including incentive allocations), as a line item in
its fee table.\82\ As adopted, the instructions provide generally that
any incentive allocations (fees based on a share of income, capital
gains and/or appreciation) must be reflected in the acquired fund's
fees and expenses.\83\
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    \81\ Hedge funds are often ``private funds'' as defined in rule
203(b)(3)-1(d) of the Investment Advisers Act of 1940. 17 CFR
275.203(b)(3)-1(d) (a ``private fund'' is a fund (i) that would be
an investment company under section 3(a) of the Investment Company
Act but for the exceptions to that definition in sections 3(c)(1)
and 3(c)(7) of the Act, (ii) that permits its owners to redeem any
portion of their ownership interests within two years of the
purchase of such interests, and (iii) interests in which are or have
been offered based on the investment advisory skills, ability or
expertise of the investment adviser). See also Registration Under
the Advisers Act of Certain Hedge Fund Advisers, Investment Advisers
Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054 (Dec. 10, 2004)],
at Section II.E. Closed-end funds also may invest in private equity
funds, venture capital funds, or other funds that generally require
capital contributions over the life of the fund and the long-term
commitment of capital. See id. at nn. 224-225.
    \82\ See Instruction 10 to Item 3.1 of Form N-2. Consistent with
the required disclosure of master-feeder funds' expenses under Form
N-1A, the instructions to Form N-2 clarify that in the event a
closed-end fund of funds is a master-feeder fund, the feeder fund
must disclose in its fee table the aggregate expenses of the feeder
fund and master fund. The aggregate expenses of the master fund must
also include fees and expenses incurred indirectly by the feeder
fund as a result of the master fund's investment in shares of one or
more acquired funds. See Instruction 10.h to Item 3.1 of Form N-2.
See also Proposing Release, supra note 4, at n. 90.
    As with a fund of registered funds, investors may not be aware
that a fund of hedge funds may have higher fees and expenses than an
alternate fund of funds or a fund that invests directly in debt and
equity securities. See NASD Investor Alert, Funds of Hedge Funds--
Higher Costs and Risks for Higher Potential Returns (Aug. 23, 2002)
(available at: http://www.nasd.com/Investor/alerts/alert_hedgefunds.htm
); Stephen J. Brown, William N. Goetzmann, and Bing

Liang, Fees on Fees in Funds of Funds, 3 (Yale International Center
for Finance Working Paper No. 02-33, June 14, 2004). See also supra
note 67.
    \83\ See Instruction 10.b to Item 3.1 of Form N-2. The adviser
of an acquired fund may charge its shareholders a fee based on a
share of income, capital gains and/or appreciation of the assets of
the shareholder in the acquired fund. This fee, which is paid to the
adviser or an affiliate, is called either a performance fee or an
incentive allocation depending on the way the acquired fund accounts
for it in its financial statements. Performance fees are reflected
in the acquired fund's statement of operations, but incentive
allocations are reported in the statement of changes of capital. The
effect of this accounting treatment is that performance fees are
included in the acquired fund's expense ratio reported in the
shareholder report but incentive allocations are not.
    Therefore, in order to provide complete disclosure of fees
incurred when funds invest in hedge funds, we are requiring
acquiring funds to include these incentive allocations in the
formula for calculating acquired funds' fees and expenses. We have
made conforming amendments to Form N-1A. See Instruction 3(f)(ii) to
Item 3 of Form N-1A.
---------------------------------------------------------------------------

    Each acquiring closed-end fund must determine expenses attributable
to its investments in acquired funds during the most recent fiscal year
together with, if applicable, any investments it intends to make with
the proceeds of its present offering. The instructions require a fund
to reflect the amount of expenses attributed to the intended
investments assuming those investments had been held by the acquiring
fund during its most recent fiscal year.\84\ Given the extensive due
diligence that we understand fund of hedge fund managers undertake in
order to create an investment strategy for the fund, we believe that
each acquiring fund should be able to provide these estimates of
expenses based on written fee arrangements with acquired funds in which
it invests or intends to invest.\85\
---------------------------------------------------------------------------

    \84\ See Instruction 10.f to Item 3.1 of Form N-2. The
instructions to Item 3.1 clarify that an acquiring fund must use the
expenses (of assumed investments) for the previous fiscal year
rather than predict expenses of the acquired funds in which the
acquiring fund assumes it will invest. The instructions further
clarify that acquiring funds must include anticipated net proceeds
from the offering in the average invested balance in each acquired
fund and the average net assets of the acquiring fund. See
Instructions 10.c and 10.f to Item 3.1 of Form N-2. This treatment
is consistent with the treatment for funds offering shares under
Form N-1A. See Instruction 3(f)(vi) to Item 3 of Form N-1A. The
instructions also clarify that a fund that intends to invest in a
fund that has no operating history should include fees to be paid to
the adviser to that fund (or its affiliate) as disclosed in the
registration statement, offering memorandum or similar document
without giving effect to any performance component. See Instruction
10.d to Item 3.1 of Form N-2. We have made conforming amendments to
Form N-1A. See Instruction 3(f)(iv) to Item 3 of Form N-1A.
    \85\ Typically, funds of hedge funds invest in 15 to 25 hedge
funds. See Rory B. O'Halloran, An Overview and Analysis of Recent
Interest in Increased Hedge Fund Regulation, 79 Tul. L. Rev. 461,
480 (2004). Most hedge fund investors perform extensive due
diligence prior to making initial and subsequent investments.
According to a survey of institutional investors, 60 percent of
institutional investors take between two to six months to complete
due diligence on a single hedge fund. Deutsche Bank, Equity Prime
Services Alternative Investment Survey Results Part 2: Inside the
Mind of the Hedge Fund Investor, Mar. 2003, at 1, 7. One manager of
a fund of hedge funds estimates that initial due diligence on a
single hedge fund manager takes 3 to 4 weeks. See George Van, The
Smartest Way to Invest in Hedge Funds, available at http://www.hedgefund.com/smartest/Smartest_Way_professional.pdf.
 In light

of our understanding that fund of hedge funds managers engage in
this time consuming initial diligence, we believe that a fund is
likely to have an investment allocation strategy prior to filing its
registration statement and, therefore, would be able to make the
necessary assumptions in order to provide the required disclosure.
---------------------------------------------------------------------------

    One commenter opposed our proposed disclosure requirement for a
fund of hedge funds for several reasons.\86\ The commenter questioned
whether disclosure based on historical hedge fund expenses may be
misleading because future expenses could differ materially due to the
impact on performance fees of fund performance and portfolio changes.
The commenter also expressed concern that investors may conclude that
the acquired funds' expenses are fixed costs and not subject to change
over time.\87\ The commenter expressed concern that the potential
fluctuation in acquired fund fees and expenses might require a fund of
hedge funds to continually monitor its disclosure to guard against
material misstatements or omissions in its registration statement.\88\
---------------------------------------------------------------------------

    \86\ See Comment Letter of Man Investments, Inc. (Dec. 1, 2003).
    \87\ The commenter also asserted that the instructions could
inaccurately portray expenses of acquired hedge funds because fees
may vary widely among investors in a hedge fund as a result of
individual rates negotiated through side letters. Id. We share the
commenter's concern. Accordingly, the final instructions require the
acquiring fund to rely on the expense ratio in the shareholder
report or, if applicable, any written fee agreements with acquired
hedge funds to determine acquired fund fees and expenses. See
Instruction 10.d to Item 3.1 of Form N-2.
    \88\ See Comment Letter of Man Investments, Inc. (Dec. 1, 2003).
The commenter also stated its belief that actual returns over time
are the most important factor in comparing funds of hedge funds. We
do not disagree that actual returns over time are a relevant factor
for investors to consider. We believe, however, that the required
disclosure will assist a fund of hedge funds investor in making an
informed investment decision as to whether the benefit of
diversification provided by investing in a fund of hedge funds
outweighs any layering of costs. We also continue to believe that
the disclosure will provide investors with the relevant information
to compare directly the costs of investing in alternative funds of
funds, or the costs of investing in a fund of funds to a more
traditional fund. See supra note 53.
---------------------------------------------------------------------------

    The Commission understands that the presentation of acquired hedge
fund fees and expenses poses particular challenges for funds of hedge
funds because their fees may be more variable than other types of
pooled investment vehicles, such as mutual funds. The commenter's
suggestion to disclose the estimated ranges of fees that hedge funds
could charge in a footnote or in text somewhere other than in the fee
table would not improve transparency of expenses. While the amount of
acquired fund expenses may vary, they are expenses that we believe
should be included in the total annual fund operating expenses
disclosed to investors in order to provide them a more complete
presentation of the aggregate direct and indirect costs of investing in
a fund of funds.
    We believe that we can address the commenter's concerns and still
provide investors in funds of hedge funds with a better understanding
of the multiple

layers of fees that are charged in a fund of hedge funds investment. To
accomplish this, first we have revised the instructions to require a
fund of hedge funds to include in a footnote to the new line item the
typical performance fee charged by acquired hedge funds in which it
invests. The footnote also would alert investors that acquired hedge
fund fees are based on historical expenses and could be substantially
higher or lower due to potential fluctuations in acquired hedge fund
performance.\89\ Second, we have provided an exception that allows
funds to exclude from the expense ratio disclosed in the fee table
acquired fund performance fees that are calculated solely on the
realization and/or distribution of gains or the sum of the realization
and/or distribution of gains and unrealized appreciation of assets
distributed in-kind.\90\ This type of performance fee is typically paid
by a private equity fund upon liquidation of the fund or when a fund
has terminated an investment and distributed the proceeds or the
appreciated assets to investors.\91\ We agree that in these
circumstances, the performance fees associated with a particular period
may be unrelated to the costs of investing in a fund of funds.\92\
---------------------------------------------------------------------------

    \89\ See Instruction 10.g to Item 3.1 of Form N-2. The footnote
could, for example, state:
    [Some/All] Acquired Funds in which the Registrant invests charge
a performance fee based on the Acquired Funds' earnings. The
``Acquired Fund Fees and Expenses'' disclosed above are based on
historic earnings of the Acquired Funds, which may change
substantially over time and, therefore, significantly affect
Acquired Fund Fees and Expenses. The typical performance fee charged
by Acquired Funds in which the Registrant invests is [INSERT
PERCENTAGE].
    \90\ See Instruction 10.d to Item 3.1 of Form N-2. We have made
a conforming change to the instructions for Form N-1A. See
Instruction 3(f)(iv) to Item 3 of Form N-1A.
    \91\ See James M. Schell, Private Equity Funds, Business
Structure and Operations Sec. Sec.  1.03[3][a], 1.04[3][a] (2006).
    \92\ In contrast, hedge funds generally charge performance fees
that are calculated as a percentage of the hedge fund's net
investment income, realized capital gains and unrealized capital
appreciation. See Staff of U.S. Securities and Exchange Commission,
Report to the Commission on Implications of the Growth of Hedge
Funds (2003) at text preceding n. 212.
---------------------------------------------------------------------------

    Insurance Company Separate Accounts. We received no specific
comments on our proposed amendments to Forms N-3, N-4 and N-6, and we
are adopting them substantially as proposed.\93\ These forms will
require separate accounts to include disclosures regarding the expenses
of acquired funds in their prospectuses.\94\
---------------------------------------------------------------------------

    \93\ As with the instructions to Forms N-1A and N-2, the
instructions to Form N-3 require that the line item expense
disclosure be titled: ``Acquired Fund Fees and Expenses.'' See supra
note 69 and accompanying text.
    \94\ The amended instructions to Form N-3 require the same
disclosure and calculation as required in the amended instructions
to Forms N-1A and N-2. The amended instructions for Forms N-4 and N-
6 are different from the instructions in Forms N-1A, N-2, and N-3,
however, because Forms N-4 and N-6 already require registrants
(i.e., separate accounts) to disclose expenses of funds (``portfolio
companies'') in which the separate account invests. See Item 3 of
Form N-4; Item 3 of Form N-6. Accordingly, the amended instructions
to Forms N-4 and N-6 require that if a portfolio company invests in
other (acquired) funds, the separate account must include in the
item disclosing the portfolio company's ``other expenses,'' the
acquired funds' fees and expenses calculated according to the
instructions to Form N-1A. Unlike the proposal, the instructions
refer specifically to portfolio companies instead of using the term
``Acquiring Fund'' in describing the disclosure of acquired funds'
fees and expenses incurred by the portfolio company.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

    Rule 12d1-1 will impose a new ``collection of information''
requirement within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\95\ The title of the new collection is ``Rule 12d1-1.'' Rule
12d1-1 permits a fund to invest in unregistered money market funds
notwithstanding the limitations of section 17 and rule 17d-1, if the
unregistered money market funds meet certain conditions under rule 2a-7
of the Act and preserve records under rule 31 of the Act. Both rules
2a-7 and 31 contain collection of information requirements. Compliance
with the collection of information requirements of rule 12d1-1 is
necessary to obtain a benefit for unregistered money market funds that
seek investments by registered funds that may be made only in reliance
on rule 12d1-1. Responses to the collection of information requirements
of rule 12d1-1 will not be kept confidential.
---------------------------------------------------------------------------

    \95\ 44 U.S.C. 3501.
---------------------------------------------------------------------------

    In the Proposing Release, Commission staff estimated that the
annual hour burden of the proposed rule's collection of information
requirements for unregistered money market fund compliance with rule
2a-7 would be 21,175 hours.\96\ The staff also estimated that the
requirements under rules 31a-1(b)(1), 31a-1(b)(2)(ii), 31a-1(b)(2)(iv),
and 31a-1(b)(9) would not impose any additional burden because the
costs of maintaining records would be incurred by unregistered money
market funds in any case to keep books and records that are necessary
to prepare financial statements for shareholders, to prepare the fund's
annual income tax returns, and as a normal business practice.\97\ We
submitted the collection for rule 12d1-1 to the Office of Management
and Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d)
and 5 CFR 1320.11. No commenters addressed these burden estimates for
the collection of information requirements, and we continue to believe
that they are appropriate. 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. OMB approved the
collection of information under control number 3235-0212 (expiring on
May 31, 2007).\98\
---------------------------------------------------------------------------

    \96\ See Proposing Release, supra note 4, at n. 138 and
accompanying text.
    \97\ Id. at text following n. 138.
    \98\ We are adopting rule 12d1-1 with some modifications, which
are described in Section II of this release. None of the
modifications affects the PRA analysis or collection of information
burden approved by OMB.
---------------------------------------------------------------------------

    In addition, the Commission is adopting amendments to certain forms
that currently contain mandatory ``collection of information''
requirements. The titles for the existing collections are: (i) ``Form
N-1A under the Securities Act of 1933 and the Investment Company Act of
1940, Registration Statement of Open-End Management Investment
Companies;'' (ii) ``Form N-2 under the Securities Act of 1933 and the
Investment Company Act of 1940, Registration Statement of Closed-End
Management Investment Companies;'' (iii) ``Form N-3 under the
Securities Act of 1933 and the Investment Company Act of 1940,
Registration Statement of Separate Accounts Organized as Management
Investment Companies;'' (iv) ``Form N-4 under the Securities Act of
1933 and the Investment Company Act of 1940, Registration Statement of
Separate Accounts Organized as Unit Investment Trusts;'' and (v) ``Form
N-6 under the Securities Act of 1933 and the Investment Company Act of
1940, Registration Statement of Separate Accounts Organized as Unit
Investment Trusts that Offer Variable Life Insurance Policies.'' The
amendments require that investors in a registered fund of funds receive
more transparent disclosure of the costs of investing in these
arrangements. The disclosure is designed to provide investors with a
more complete presentation of the actual costs of investing in a fund
that invests in other funds, which have their own expenses that may be
as high or higher than the acquiring fund's expenses. Compliance with
the disclosure requirements of Forms N-1A, N-2, N-3, N-4 and N-6 is
mandatory. Responses to the disclosure requirements will not be kept
confidential.
    In the Proposing Release, Commission staff estimated that the
amendment to

the disclosure requirement will add up to 7 hours per portfolio to the
existing hour burden associated with completing Forms N-1A, N-2 and N-
3, and 0.5 hours to the existing hour burden associated with completing
Forms N-4 and N-6.\99\ No commenters addressed the burden estimates for
the collection of information requirements associated with Forms N-1A,
N-3, N-4 and N-6, and we continue to believe that they are
appropriate.\100\
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    \99\ See Proposing Release, supra note 4, at nn.139-161 and
accompanying text.
    \100\ We have revised the final instructions for calculating
acquired funds' expenses as described above. See supra notes 77-79
and accompanying text. Although the staff believes that these
modifications may provide funds with some time and cost savings, we
are not changing our hour burden estimates. We will review the
estimates when the collection of information requirements must be
resubmitted for review, and at that time we will be able to consider
funds' actual experience in complying with them.
---------------------------------------------------------------------------

    One commenter, a fund of hedge funds, disagreed with our Form N-2
estimate. The commenter asserted that calculating the costs would
entail vast amounts of time by numerous personnel reviewing a large
number of hedge funds that provide information in varying formats. The
commenter added that it believes a fund of hedge funds would be
required to monitor and recalculate actual performance fees paid on an
ongoing basis to guard against a material misstatement in the fee
table.\101\ The commenter provided cost estimates but did not provide
any specific estimates of burden hours. Funds offering their shares on
a continuous or delayed basis in reliance on Rule 415 under the
Securities Act must update their registration statements under certain
circumstances.\102\ We have revised the PRA estimate to reflect staff
estimates that funds offering their shares on a continuous basis file
updated registration statements on at least an annual basis. The
revised estimated annual burden per fund of hedge fund is 213
hours.\103\
---------------------------------------------------------------------------

    \101\ See Comment Letter of Man Investments, Inc. (Dec. 1,
2003).
    \102\ See 17 CFR 230.415. Section 10(a)(3) of the Securities Act
provides that ``when a prospectus is used more than nine months
after the effective date of the registration statement, the
information contained therein shall be as of a date not more than
sixteen months prior to such use so far as such information is known
to the user of such prospectus or can be furnished by such user
without unreasonable effort or expense.'' 15 U.S.C. 77j(a)(3). In
general, funds that are offering their securities on a continuous or
delayed basis in reliance on Rule 415 file annual post-effective
amendments to update the prospectus in the registration statement
pursuant to section 10(a)(3). In addition to the statutory
provisions of section 10(a)(3), Rule 415 and Form N-2 require that
the registrant undertake to file a post-effective amendment to
reflect: (i) any prospectus required by section 10(a)(3) of the
Securities Act; (ii) facts or events arising after the effective
date that ``represent a fundamental change in the information set
forth in the registration statement;'' and (iii) material
information with respect to the plan of distribution not disclosed
previously in the registration statement or any material change to
such information in the registration statement. See 17 CFR
230.415(a)(3); Item 34.4.a of Form N-2. In the release adopting Rule
415, the Commission noted that ``the term `fundamental' is intended
to reflect current staff practice under which post-effective
amendments are filed when major and substantial changes are made to
information contained in the registration statement. Material
changes that can be stated accurately and succinctly in a short
sticker will continue to be permitted. While many variations in
matters such as operating results, properties, business, product
development, backlog, management and litigation ordinarily would not
be fundamental, major changes in the issuer's operations, such as
significant acquisitions or dispositions, would require the filing
of a post-effective amendment. Also, any change in the business or
operations of the registrant that would necessitate a restatement of
the financial statements always would be reflected in a post-
effective amendment.'' See Adoption of Integrated Disclosure System,
Securities Act Release No. 6383 (Mar. 3, 1982) [47 FR 11380 (Mar.
16, 1982)] at text accompanying nn.79-81. See also Guide 8 to Form
N-2. In addition, purchasers of an issuer's securities in a
registered offering have private rights of action for materially
deficient disclosure in prospectuses and oral communications under
section 12(a)(2) of the Securities Act. See 15 U.S.C. 77l(a)(2); see
also Securities Offering Reform, Securities Act Release No. 8591
(July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] at Section IV.A
(discussing information conveyed by the time of sale for purposes of
liability under section 12(a)(2)).
    \103\ The increase in annual hour burden was estimated using an
average of the range of costs the commenter estimated a fund of
hedge funds would incur to prepare the disclosure ($16,500) and
dividing that cost by the estimated hourly cost to prepare the
disclosure: $16,500 / $77.42 = 213.12. Therefore, the estimated
total annual burden per fund of hedge funds to prepare the
disclosure is 213 hours. The estimated hourly cost is the weighted
average of the cost to prepare the disclosure for other closed-end
funds ($404 (cost of 6 hours of an accountant's time) + $138 (cost
of 1 hour of an attorney's time) / 7 = $77.42). See infra note 120.
This estimate also includes the costs of including the footnote to
the line item that discloses the typical performance fee charged by
the hedge funds in which the acquiring fund invests or intends to
invest.
---------------------------------------------------------------------------

    Based on recent Commission filings, 23 registered funds of hedge
funds offer their shares on a continuous basis under rule 415 of the
Securities Act. Therefore, the staff estimates the additional annual
burden for funds of hedge funds to update the acquired fund expenses in
their prospectuses pursuant to the requirements of section 10(a)(3) of
the Securities Act is 2450 hours.\104\
---------------------------------------------------------------------------

    \104\ Any post-effective amendment to a registration statement
filed to update the information in the prospectus for purposes of
section 10(a)(3) of the Securities Act or to reflect fundamental
changes in the information in the prospectus contained in the
registration statement would also revise the information regarding
the acquired funds' fees and expenses. Because only a portion of
acquired funds' fees and expenses may be updated in the annual post-
effective amendment to reflect additional or revised fees and
expenses, since the date of the last updating, resulting from
existing, newly acquired or to be acquired funds, the Commission
estimates that a fund of hedge funds in continuous offering would
spend approximately 50% of the time it takes to determine the
initial acquired hedge funds disclosure (213 hours) to review and
update its calculation of acquired funds' fees and expenses prior to
filing a post-effective amendment. Therefore, the annual burden for
funds of hedge funds in continuous registration is an additional
2450 hours ((213 hours / 2 = 106.5 hours) (106.5 hours x 23 funds =
2449.5 hours)).
---------------------------------------------------------------------------

    Based on recent filings, Commission staff estimates that, on an
annual basis, registrants file 234 initial registration statements (of
which 11 are funds of hedge funds) and 38 post-effective amendments
(including 23 post-effective amendments for funds of hedge funds in
continuous registration). The current estimated total annual burden for
the preparation and filing of Form N-2 is 120,673 hours.\105\
Accordingly, we estimate the total annual burden for all funds for the
preparation and filing of initial registrations statements and post-
effective amendments to Form N-2 would be 125,389 hours.\106\
---------------------------------------------------------------------------

    \105\ The Commission made this estimate in connection with its
submission for approval of recent proposed amendments to Form N-2.
See Executive Compensation and Related Party Disclosure, Investment
Company Act Release No. 27218 (Jan. 27, 2006) [71 FR 6542 (Feb. 8,
2006)].
    \106\ This estimate is based on the following calculation:
120,673 + 2450 + (11 x 206) = 125,389. The current estimated total
annual hour burden already incorporates the time estimated in the
proposing release to prepare the disclosure required by the
amendments (7 hours for each closed-end fund that invests in other
funds). The revised estimate includes the additional 206 hours (213
minus 7 hours included in the approved total annual hour burden) the
staff estimates it may take a closed-end fund of hedge funds to
complete the required disclosure, based on the commenter's cost
estimates.
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    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. We submitted the collections of
information associated with Forms N-1A, N-2, N-3, N-4 and N-6 to OMB to
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. OMB
approved the collections of information under control numbers 3235-0307
(Form N-1A, expiring on December 31, 2007), 3235-0026 (Form N-2,
expiring on January 31, 2008, revised submission currently under review
by OMB), 3235-0316 (Form N-3, expiring on July 31, 2007), 3235-0318
(Form N-4, expiring on March 31, 2007), and 3235-0503 (Form N-6,
expiring on March 31, 2007).

IV. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules. As
discussed above in sections II.A--II.C, the new rules provide relief to
funds by providing additional exemptions from

the limitations on fund of funds arrangements without requiring the
funds or their advisers to obtain an exemptive order. As discussed in
section II.D, the amendments to Forms N-1A, N-2, N-3, N-4, and N-6
provide additional information to shareholders regarding the costs of
acquired funds in a fund of funds arrangement.

A. Rules 12d1-1, 12d1-2 and 12d1-3

    We have issued a number of exemptive orders that have broadened the
ability of funds to invest in other funds and provided certain funds of
funds greater flexibility in structuring their sales charges. These
orders have provided exemptions from statutory limitations. A fund that
has obtained the benefit of an exemption has incurred costs of applying
for an exemptive order as well as costs of satisfying any conditions
imposed in the order. Application costs are primarily legal and include
costs of drafting the application and analyzing the ways in which the
conditions fit the fund's business model. The costs of satisfying
conditions include ongoing compliance costs of meeting those
conditions. We assume that a fund only seeks an exemptive order if the
benefits of the additional flexibility provided by the exemption
outweigh the costs of obtaining and satisfying the conditions of an
order. We solicited but did not receive comments with respect to the
cost-benefit analysis for rules 12d1-1, 12d1-2 and 12d1-3.
1. Benefits
    Rule 12d1-1 codifies our prior exemptive orders that permit a fund
to invest all or a portion of its available cash in money market funds
rather than directly in short-term instruments. The rule retains one
condition included in our orders that the acquiring fund pays no sales
load or distribution or service fee on the acquired money market fund
shares unless the acquiring fund's investment adviser waives a
sufficient amount of its advisory fee to offset the cost of those
fees.\107\ We believe that any further restrictions on an acquiring
fund's investments in money market funds should be governed by the
fund's investment policies and limitations and the fiduciary
obligations of its board of directors. Consequently, we believe that
the rule will provide greater flexibility for certain funds than
exemptive orders we have issued.
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    \107\ With respect to investments in unregistered money market
funds, we also have retained the requirement in our prior exemptive
orders that the money market funds operate as if they were money
market funds registered under the Act. Unlike our exemptive orders,
however, and as we proposed, we are requiring the acquiring fund to
reasonably believe, rather than to determine, that the unregistered
money market funds operate in this manner. See supra notes 40-43 and
accompanying text; see, e.g., Putnam Order, supra note 25.
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    Under the rule, funds also may invest in money market funds advised
by a different adviser. We believe that this will allow all funds,
particularly small funds without a money market fund in their fund
group, the opportunity currently available to large funds to engage in
cash sweep arrangements. In addition, we have provided additional
relief under section 17 of the Act. If a fund in one fund complex
acquired more than five percent of the assets of a money market fund in
another complex, any broker-dealer affiliated with the money market
fund would become a (second-tier) affiliated person of the acquiring
fund. As a result of the affiliation, the broker-dealer's fee for
effecting the sale of securities to the acquiring fund would be subject
to the conditions set forth in rule 17e-1, including the quarterly
board review and recordkeeping requirements with respect to certain
securities transactions involving the affiliated broker-dealer.\108\
The final rule permits an acquiring fund to pay commissions, fees, or
other remuneration to an affiliated broker-dealer without complying
with the quarterly board review and recordkeeping requirements set
forth in rules 17e-1(b)(3) and 17e-1(d)(2).\109\ This relief is
available only if the broker-dealer and the acquiring fund become
affiliated solely because of the acquiring fund's investment in the
money market fund. We believe this additional relief will enable more
funds to take advantage of the exemption provided by the rule.
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    \108\ See supra note 34.
    \109\ See supra notes 32-36 and accompanying text.
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    Rule 12d1-1 also codifies our orders permitting funds to invest in
unregistered money market funds that operate like a money market fund
registered under the Act. The acquiring fund is required to
``reasonably believe'' that the unregistered money market fund operates
in compliance with rule 2a-7 and complies with certain provisions of
the Act, as well as other requirements.\110\ This standard is slightly
different than the condition in our exemptive orders, which requires
the acquiring fund to determine that the acquired fund is in compliance
with rule 2a-7 and certain provisions of the Act. A fund would
reasonably believe that an acquired fund was in compliance with these
provisions if, for example, it received a representation from the
acquired fund (or the adviser to the acquired fund) that the fund would
comply with the relevant provisions in all material respects and if the
acquiring fund had no reason to believe that the acquired fund was not,
in fact, complying with the relevant provisions in all material
respects. Thus, an acquired fund's failure to comply will not
automatically result in the loss of the acquiring fund's exemption.
Rule 12d1-1 does not include certain conditions imposed in the
exemptive orders that we believe are already adequately addressed by
other provisions of the Act or rules thereunder.\111\
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    \110\ See supra notes 40-43 and accompanying text.
    \111\ See Proposing Release, supra note 4, at n. 49.
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    Rule 12d1-2 codifies, and in some cases expands upon, three types
of relief that we provided to affiliated funds of funds. The rule
permits affiliated funds of funds to acquire up to three percent of the
securities of funds that are not part of the same group of investment
companies, subject to the limits in section 12(d)(1)(A) or 12(d)(1)(F)
of the Act. The rule also permits an affiliated fund of funds to
acquire securities not issued by a fund. These investments would have
to be consistent with the fund's investment policies. Finally, the rule
permits affiliated funds of funds to invest in affiliated or
unaffiliated money market funds in reliance on rule 12d1-1.
    Rule 12d1-3 codifies the exemptive orders we have issued permitting
funds relying on section 12(d)(1)(F) to charge a sales load greater
than 1\1/2\ percent provided that the aggregate sales load any investor
pays (i.e., the combined distribution expenses of both the acquiring
and acquired funds) does not exceed the limits on sales loads
established by the NASD for funds of funds. This exemption also would
be available to an affiliated fund of funds relying on rule 12d1-2 to
invest in funds in a different fund group.
    We anticipate that funds and their shareholders will benefit from
the rules. Funds increasingly have sought exemptive orders (which the
Commission has granted) to engage in most of the activities the rules
permit. The application process involved in obtaining exemptive orders
imposes direct costs on funds, including preparation and revision of an
application, as well as consultations with the staff. The rules will
benefit funds and their shareholders by eliminating the direct costs of
applying to the Commission to engage in activities permitted under the
rules.\112\

The rules will further benefit funds by eliminating the uncertainty
that a particular applicant might not obtain relief to engage in the
activities permitted under the rules.
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    \112\ For example, in calendar years 2003 and 2004, 11 funds
sought exemptive relief to invest uninvested cash and/or cash
collateral from securities lending activities in money market funds,
and 3 of those funds also sought exemptive relief to invest cash
collateral in unregistered money market funds. In the past 5 years,
9 funds investing in other funds in the same fund group in reliance
on section 12(d)(1)(G) have sought exemptive relief to invest in
securities other than government securities or short-term paper.
During that time, 9 funds investing in other funds in reliance on
section 12(d)(1)(F) have sought exemptive relief to charge a sales
load greater than 1\1/2\ percent, subject to the NASD Sales Charge
Rule. In the Proposing Release, we estimated that the cost to a fund
for submitting one of these applications ranges from $7,000 to
$67,000. See Proposing Release, supra note 4, at n. 125. We did not
receive any comments on these estimates and continue to believe that
they are appropriate.
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    The exemptive application process also involves other indirect
costs. Funds that apply for an order to permit additional investments
forgo potentially beneficial investments until they receive the order,
while other funds forgo the investment entirely rather than seek an
exemptive order because they have concluded that the cost of seeking an
exemptive order would exceed the anticipated benefit of the investment.
Eliminating direct and indirect costs of the proposed activities also
eliminates factors that discriminate against smaller funds, for which
the cost of an exemptive application can often exceed the potential
benefit.
2. Costs
    We do not believe that the rules will impose mandatory costs on any
fund. As discussed above, the rules are exemptive, and we believe that
a fund would not rely on any of them if the anticipated benefits did
not justify the costs. We believe the costs of relying on the rules
will be the same as or less than the costs to a fund that relies on an
existing exemptive order because each of the rules includes the same or
fewer conditions than existing orders that provide equivalent exemptive
relief.\113\
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    \113\ Our analysis compares the costs a fund would bear to
comply with the rules with the costs a fund would bear under the
current system of obtaining equivalent exemptive relief. Because the
conditions in the rules are the same or less onerous than the
conditions in the exemptive orders, the costs discussed in this
section primarily are costs that a fund would bear to obtain an
exemptive order and comply with its conditions.
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    The rules will affect different types of funds in different ways. A
fund that has not sought and would not seek exemptive relief from
section 12(d)(1) of the Act will not be affected by the rules. The cost
for a fund that currently relies on exemptive relief covered by our
rules will be the same as or less than the costs of relying on its
exemptive order because the rules contain the same or fewer conditions
than existing orders.\114\ In addition, a fund that currently relies on
an exemptive order can satisfy all the conditions of any of the rules
that provide similar exemptive relief without changing its operation.
For example, in the case of rule 12d1-1, the fund will simply be
satisfying conditions that are no longer required.\115\ Finally, a fund
that has not relied on an exemptive order and that intends to rely on
one of the rules will bear the same continuing costs of complying with
conditions that it would have borne had it obtained an exemptive order.
In that case, its total costs would have been the same as or greater
than the costs associated with the rules.
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    \114\ Such a fund may face a one-time ``learning cost'' to
determine the difference between the fund's exemptive order and the
rule. We do not believe this cost would be significant given the
similarity of conditions in our rules and existing exemptive orders.
    \115\ We note that a fund may choose to rely on an existing
exemptive order and comply with the conditions of that order. A fund
might conclude that continued reliance on an existing order is
appropriate, for example, because the existing order was tailored to
circumstances specific to a fund complex and may provide additional
exemptive relief that is not covered under the rules we are adopting
today.
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B. Amendments to Forms N-1A, N-2, N-3, N-4, and N-6

    Forms N-1A, N-2 and N-3 currently do not require registered funds
to disclose information regarding the expenses associated with acquired
funds. The amendment to Form N-1A requires a registered open-end fund
that invests in other funds to include a line item in its fee table,
under the total annual fund operating expenses, that lists the
aggregate fees and costs of acquired funds. The amendment to Form N-2
requires registered closed-end funds that invest in other funds to
provide the same disclosure.\116\ The amendment to Form N-3 requires
the same disclosure for separate accounts organized as management
investment companies that offer variable annuity contracts. The new
disclosure requirements include instructions on calculating the fees
and operating costs of acquired funds. The calculation will aggregate
the annual fund operating expenses of acquired funds, transaction costs
and, as applicable, incentive allocations incurred by the acquiring
fund, and express the aggregate fees as a percentage of average net
assets of the acquiring fund.
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    \116\ In addition, closed-end funds of hedge funds must add a
footnote to the line item that discloses the typical performance fee
charged by acquired hedge funds in which the acquiring fund invests.
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    Forms N-4 and N-6 currently require separate accounts organized as
UITs that offer variable annuity and variable life contracts,
respectively, to disclose the range of minimum and maximum operating
expenses of the portfolio companies in which they invest. The amendment
to each of these forms requires a separate account organized as a UIT
that invests in a portfolio company that itself invests in other funds,
to include the portfolio company's costs of investing in other funds in
the portfolio company's operating expenses disclosed in the Form N-4 or
Form N-6 fee table.
1. Benefits
    Under current disclosure requirements, a fund's shareholders may
not understand the fees and operating costs of a fund's investment in
acquired funds, costs that investors bear indirectly. We believe that
the amendments to Forms N-1A, N-2, N-3, N-4, and N-6 will enable
shareholders to better understand the expenses that relate to acquired
funds, and provide investors the means to compare directly the costs of
investing in alternative funds of funds, or the costs of investing in a
fund of funds to a more traditional fund. The increased transparency
may provide further benefits by allowing investors to choose funds that
more closely reflect their preferences for fees and performance.\117\
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    \117\ We requested comments as well as any quantifying data in
the Proposing Release, but did not receive any.
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2. Costs
    The amendments to Forms N-1A, N-2, N-3, N-4, and N-6 will result in
costs to registered open-end and closed-end funds, and to separate
accounts that offer variable annuity and variable life contracts, which
may be passed on to those funds' shareholders. The amendments will
require a new disclosure to the annual operating expense item in the
fee table for funds that invest in other funds. It also will require
separate accounts organized as UITs that offer variable annuity and
variable life contracts to include an additional expense in their
calculations of annual portfolio company operating expenses. The costs
of the disclosures will include both internal costs (for attorneys and
accountants) to prepare and review the disclosure, and external costs
(for printing and typesetting the disclosure).
    First, with respect to Forms N-1A, N-2 and N-3, the disclosures
will add a single line item to the fee table for funds

that invest in other funds.\118\ In the context of the prospectus for
Forms N-1A, N-2 and N-3, we believe that the external costs of
including this additional line of disclosure per registered fund will
be minimal.\119\ With respect to Forms N-4 and N-6, the disclosure will
require registrants to include in the item for annual portfolio company
operating expenses, any fees and expenses of acquired companies, as
disclosed in the portfolio company's most recent prospectus.
Accordingly, we believe there will be no additional external costs for
Forms N-4 and N-6 as a result of the amendments.
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    \118\ We are permitting acquiring funds to omit a separate line
item if the amount of expenses attributable to acquired funds does
not exceed 0.01 percent (one basis point) of average net assets, and
to include these expenses in ``Other Expenses.'' See Instruction
3(f)(i) to Item 3 of Form N-1A; Instruction 10.a to Item 3.1 of Form
N-2; Instruction 19(a) to Item 3(a) of Form N-3.
    \119\ We also believe the costs to the acquiring fund of
preparing the footnote to the line item that discloses the typical
performance fee charged by hedge funds in which the acquiring fund
invests will be minimal.
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    Second, for purposes of the PRA, Commission staff estimated in the
proposal that the disclosure requirement for calculating the line item
according to the instructions will add up to 7 hours per portfolio to
the burden of completing Forms N-1A, N-2 and N-3. Commission staff
further estimated that the additional annual cost of including the line
item per portfolio would equal $542.\120\
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    \120\ In the Proposing Release, Commission staff estimated the
additional burden would equal 6 hours for an intermediate level
accountant and 1 hour for a deputy general counsel to review the
calculation per portfolio. See Proposing Release, supra note 4, at
n.127. We did not receive any comments on these hourly estimates and
continue to believe that they are appropriate. We have, however,
updated our wage estimates based on current wage data for
professionals in the financial services industry available at http://www.careerjournal.com/salaryhiring
 (last visited July 28, 2005).

    In order to determine who would be an intermediate level
accountant in the new source, we looked at years of experience. We
believe that accountants with 6 to 15 years of experience would fall
within that category. The national average salary for these
accountants is $89,749 (($85,483 (6-10 years of experience) +
$94,015 (11-15 years of experience)) / 2 = $89,749). Adjusting this
salary upwards by 35% to reflect possible overhead costs and
employee benefits, the staff estimates that the annual adjusted
salary would be $121,161, and the cost for 6 hours of an
intermediate level accountant's time would be $404 ($121,161 / 1,800
hours x 6 = $403.87). The staff estimates the national average
salary for a deputy general counsel is $183,675. Adjusting this
salary upwards by 35% to reflect possible overhead costs and
employee benefits, the staff estimates that the annual adjusted
salary would be $247,961, and the cost for 1 hour of a deputy
general counsel's time would be $138 ($247,961 / 1,800 hours =
$137.76). Accordingly, the staff estimates the total cost for each
portfolio to calculate the amended disclosure would equal $542 ($404
+ $138 = $542). We have revised the final instructions for
calculating acquired funds' expenses as described above. See supra
notes 77-79 and accompanying text. Although the staff believes that
these modifications may provide funds with some cost savings, we
have not adjusted the hour burden estimates but will review them
when the collection of information requirements must be resubmitted
for review and funds will have had actual experience in complying
with them.
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    One commenter, a fund of hedge funds, disagreed with our estimates
and asserted that the cost to a single fund of hedge funds to make an
initial calculation each year would be between $8,000 and $25,000
depending on the number of personnel involved and the need for auditor
review.\121\ The commenter did not specify the number or functions of
the personnel involved. We agree with the commenter that a fund of
hedge funds may have additional costs. We estimate that the cost of
adding the new line item for a fund of hedge funds is $16,500.\122\
Based on recent Commission filings, approximately 11 funds of hedge
funds file initial registration statements on Form N-2 each year and
their aggregate assets under management are $958.2 million. The
estimated aggregate costs for these funds of hedge funds to calculate
the new line item is $181,500.\123\ We do not believe that the
additional cost is significant given the funds of hedge funds'
aggregate assets under management.\124\
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    \121\ See Comment Letter of Man Investments, Inc. (Dec. 1,
2003).
    \122\ Because the commenter did not explain the underlying
calculations for its range of costs, the estimate is based on the
average of the $8,000 to $25,000 range provided by the commenter.
The cost to each fund of hedge funds may be higher or lower
depending on a variety of factors, including the number of hedge
funds in which the fund of hedge funds invests.
    \123\ This calculation is based on the following: (11 x $16,500)
= $181,500).
    \124\ The estimated cost of preparing the line item is 0.0189%
of assets under management for funds of hedge funds in the aggregate
($181,500 / $958.2 million).
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    On the assumption that funds of hedge funds would have to monitor
current fees in order to guard against material misrepresentations in
the fee table, the commenter estimated that these funds of hedge funds
would face an additional monitoring cost of $15,000 or more annually.
As discussed in Section III above, staff estimates that the 23 funds of
hedge funds registered under Form N-2 and offering their shares on a
continuous basis file updated registration statements on at least an
annual basis. We estimate the additional cost to review the disclosure
will be $8245 per fund of hedge funds and the total annual costs for
funds of funds to update the acquired fund expenses in their
prospectuses pursuant to the requirements of section 10(a)(3) of the
Securities Act will be $189,635.\125\
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    \125\ See supra notes 102-104 and accompanying text. These
estimates are based on the following calculations: 106.5 (hours per
fund) x $77.42 (estimated hourly cost to prepare the disclosure) =
$8245; $8245 x 23 (funds) = $189,635.
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    Despite this additional cost, we continue to believe that the costs
of the required disclosure are justified because the disclosure will
assist a fund of hedge funds investor in making an informed investment
decision as to whether the benefit of diversification provided by
investing in a fund of hedge funds outweighs any layering of costs. We
do not believe that other alternatives suggested by the commenter, such
as simply disclosing a range of fees, would be a meaningful substitute.
These alternatives would not meet our objective of improving
transparency of expenses. Nor would they meet our objective to include
acquired fund expenses in the total annual fund operating expenses
disclosed to investors in order to provide them a more complete
presentation of the aggregate direct and indirect costs of investing in
a fund of funds. We continue to believe that our estimate is
appropriate for Form N-2 registrants that are not funds of hedge funds.
    In the Proposing Release, we also estimated that including the
additional item in the disclosure of portfolio company expenses on
Forms N-4 and N-6 would add approximately 0.5 hours per portfolio,
which based on the updated wage estimates would be an annual cost per
portfolio of $34.\126\ We did not receive any comments on this estimate
and continue to believe that it is appropriate.
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