the cost of preparing materials for the board's deliberation, the cost
of board members' time, as well as the cost of consultations with
outside counsel.
---------------------------------------------------------------------------

    \1115\ See supra section III.C.4.a.
    \1116\ These figures are based on the same comment letter used
to estimate one-time and ongoing costs for open-ended funds. We
assume the costs associated with launching a UIT under rule 22e-4
are equivalent to 20% of the ongoing costs of a one fund complex.
Under the assumptions above that ongoing costs for open-ended funds
are 5% to 32.5% of their initial costs, fund complexes with one fund
have estimated ongoing costs of approximately $40,000 to $260,000.
Multiplying that range by 20% produces the UIT estimate.
---------------------------------------------------------------------------

    Depending on the personnel (and/or third-party service providers)
involved with respect to the activities associated with establishing
and implementing a liquidity risk management program, certain of the
estimated one-time costs could be borne by the fund, and others could
be borne by the fund's adviser or other service providers. This cost
allocation would be dependent on the facts and circumstances of a
particular fund's liquidity risk management program, and thus we cannot
specify the extent to which the estimated costs would typically be
allocated to the fund as opposed to the adviser. Estimated costs that
are allocated to the fund would likely be borne by fund shareholders in
the form of fund operating expenses.
    Certain elements of the program requirement may entail marked
variability in related compliance costs, depending on a fund's
particular circumstances and sources of potential liquidity risk. The
process of classifying the liquidity of each of a fund's portfolio
investments could give rise to varying costs depending on the fund's
particular investment strategy. For example, a U.S. large cap equity
fund would likely incur relatively few costs to obtain the data
necessary to classify its portfolio positions, specifically given that,
relative to the proposed rule, the final rule allows such a fund to
generally classify its positions based on asset classes (subject to an
exception process). On the other hand, funds that hold investments for
which relevant market,

trading, and other investment-specific data is less readily available,
for which a general asset-class-based classification is more difficult
to apply, or funds that require more exceptions to their asset-class-
based classification would incur relatively greater costs associated
with the classification of their portfolio positions' liquidity. In
addition, funds with multiple sub-advisers may incur relatively more
costs to coordinate the process of classifying position liquidity as
well as monitoring whether the fund is compliant with its highly liquid
investment minimum and the 15% illiquid investment limit.
    Certain factors that the rule's guidance suggests a fund should
consider in assessing its liquidity risk also could entail relatively
greater costs, depending on the fund's circumstances. For instance, a
fund with a relatively short operating history could incur greater
costs in assessing the fund's cash flow projections than a similarly
situated fund with a relatively long operating history. This is because
the newer fund could find it appropriate to assess redemption activity
in similar funds during normal and stressed periods (to predict its
future cash flow patterns), which could entail additional costs to
gather and analyze relevant data about these comparison funds. Also, a
fund whose shares are held largely through omnibus accounts may wish to
periodically request shareholder information from financial
intermediaries in order to determine how the fund's ownership
concentration may affect its cash flow projections. These data
requests, and related analyses, could cause a fund to incur costs that
another fund, whose shares are largely held directly, would not. A fund
that deems it appropriate to establish and implement additional
liquidity risk management policies and procedures beyond those
specifically required under the rule also would incur additional
related costs. While we recognize that, as described above, the costs
to establish and implement a liquidity risk management program in
compliance with rule 22e-4 will depend to some degree on the level of
liquidity risk facing the fund, we are unable to quantify the various
ways in which a fund's individual risks and circumstances could affect
the costs associated with establishing a liquidity risk management
program.
    Commenters suggested that the proposed three-day liquid asset
minimum requirement could have had a number of unintended consequences.
As discussed above, if third-party vendors become de facto ``rating
agencies'' for liquidity, then a liquidity minimum could force many
funds to sell the same investments simultaneously after a liquidity
``downgrade,'' which could have a systemic impact on funds and the
overall market.\1117\ Similarly, if a fund were forced into predictable
trading behavior during a market downturn because of the highly liquid
investment minimum requirement, the liquidity and performance of that
fund would be negatively impacted.\1118\ It is possible that the
proposed three-day liquid asset minimum requirements could have created
these types of unintended consequences by prohibiting a fund from
acquiring less liquid assets if it was below its three-day liquid asset
minimum, but the final rule does not include this prohibition. Instead,
as discussed above, a fund is only required to report to its board and,
possibly, the Commission when it is below its highly liquid investment
minimum. This requirement should provide fund management the
flexibility to avoid forced, predictable trading behavior while
maintaining the emphasis on effective liquidity risk management the
minimum is designed to provide. While fund liquidity may vary more
under this approach, the reporting requirements surrounding any
shortfall, including a requirement to provide the fund's board with an
explanation of how the fund plans to restore its minimum if a shortfall
lasts more than 7 consecutive calendar days, should help provide
oversight to prevent a fund from continually failing to meet its
liquidity minimum. As a whole, this approach should result in lower
costs for funds compared to the proposed three-day liquid asset minimum
and, because we anticipate that lengthy breaches of the minimum will be
relatively rare, it should not significantly decrease the benefits of
having a highly liquid investment minimum.
---------------------------------------------------------------------------

    \1117\ ICI Comment Letter II.
    \1118\ ICI Comment Letter II.
---------------------------------------------------------------------------

    One commenter suggested that investor choice could be negatively
impacted because of the implementation and on-going costs of the
liquidity risk management program.\1119\ The commenter asserted that
the costs could overwhelm small fund complexes and force them to either
cease operations or consolidate with a larger complex.\1120\ Most of
the changes made to the rule since its proposal--exclusions for funds
that primarily hold assets that are highly liquid investments and In-
Kind ETFs, a reduction in the number of investment classification
categories, and the ability to generally classify investments based on
asset classes (subject to an exception process)--should decrease the
estimated implementation and on-going costs compared to the proposal.
Yet it remains possible that some fund complexes will still find the
costs burdensome. While investor choice may be harmed if a fund is
closed because the costs of the rule are burdensome, remaining funds
will be better positioned to avoid the negative consequences of
inadequate liquidity management if that fund exited because it was
unable to provide a minimum acceptable baseline of liquidity. To the
extent that there are funds that are currently able to provide
effective liquidity risk management, but would be forced to cease
operations because of the costs of complying with the rule (even after
changes from the proposal that increase flexibility and decrease
implementation and on-going costs), investor choice may be negatively
affected.
---------------------------------------------------------------------------

    \1119\ Charles Schwab Comment Letter.
    \1120\ Id.
---------------------------------------------------------------------------

    A fund may incur costs if it reallocates its portfolio to
correspond with its initial or subsequently modified highly liquid
investment minimum, or if the rule's definition of an illiquid
investment results in the fund holding more than 15% of its net assets
in assets that are illiquid investments. While we are unable to
anticipate how many funds may reallocate their portfolios for these two
reasons, or the extent of such reallocation by any fund that does so,
we anticipate that the transaction-related costs of any such
reallocation will not be significant for most funds. This is because
some funds may not need to reallocate their portfolios at all to
correspond with their highly liquid investment minimum or the 15%
illiquid investment limit, and those that do so would be able to
gradually adjust their portfolios in order to buy and sell portfolio
positions during times that are financially advantageous given the
delayed compliance date. Thus, while a fund may reallocate its
portfolio to comply with its highly liquid investment minimum and the
15% illiquid investment limit by the time of the compliance date, a
fund would not be required to conduct transactions in portfolio
investments in any particular timeframe prior to the compliance date.
If a fund wishes to reallocate its portfolio by the compliance date, we
anticipate that the compliance date would provide sufficient time to do
so with relatively few associated transaction costs. Along with the
transaction-related costs associated with any portfolio reallocation,
we recognize that this reallocation in turn could affect

the performance and/or risk profiles of funds that modify their
composition, which in turn could result in costs associated with
decreased investment options available to investors and any changes to
the market for relatively less liquid investments; these costs are
discussed below. Finally, it is worth noting that, because the rule
excludes both In-Kind ETFs and funds that primarily hold assets that
are highly liquid investments from the requirement of having a highly
liquid investment minimum, these funds will not incur any of the costs
associated with transactions, reduced fund performance, or altered risk
profiles associated with a minimum, though they will still incur these
costs as they apply to the rule's 15% illiquid investment limit.
Potential for Decreased Investment Options and Adverse Effects
    We recognize that the rule requires a fund to determine the
liquidity profile of its current portfolio and evaluate its potential
liquidity needs, which could result in a fund concluding that its
current portfolio lacks sufficient liquidity. This could lead a fund to
modify its portfolio composition to meet its appropriate highly liquid
investment minimum (e.g., one commenter stated that funds may decrease
their holdings of long-term municipal bonds) or to comply with the more
specific 15% illiquid investment limit.\1121\ The rule could therefore
result in certain funds increasing their investments in relatively more
liquid investments or altering the way in which their portfolios are
managed, which in turn could affect the performance, tracking error,
and/or risk profiles of these funds.\1122\ This is most likely to
affect funds that currently hold investments with relatively lower
liquidity. Such modifications to funds' portfolio compositions could in
turn decrease certain investment options available to investors or
reduce investor returns. However, because these portfolio composition
shifts are most likely to occur if a fund needs to adjust its existing
liquidity level to comply with the rule, we anticipate that the
potential for decreased yield is most likely to affect funds currently
holding portfolios whose liquidity levels have the potential to create
redemption-related liquidity risk for fund investors. Thus, the
potential for decreased investment options for certain investors, and
any related decrease in investment yield, has the potential offsetting
benefit of decreased liquidity risk in the funds in which these
investors hold shares. However, there could be other reasons funds may
choose to invest in more liquid investments as a result of the rule
even if this reallocation is not required, including the possibility
that they do not want to appear less liquid than their peer funds in
their publicly disclosed liquidity profile, or because increased
disclosure requirements regarding the timing of a fund's redemption
payments may result in funds holding more liquid investments.\1123\
---------------------------------------------------------------------------

    \1121\ GFOA Comment Letter.
    \1122\ See, e.g., supra footnote 767 (discussing how index funds
that use full replication strategies might need to move towards
other techniques for tracking an index if full replication requires
them to exceed the 15% illiquid asset limit).
    \1123\ See infra section IV.c.2.a (discussing the effects of the
rule's disclosure requirements).
---------------------------------------------------------------------------

    We cannot quantify the number of funds that would need to
significantly modify their portfolios' risk profile as a result of the
rule because we lack the information necessary to provide a reasonable
estimate. Such an estimate would depend on the number of funds that
might need to modify their current portfolio composition as a result of
the rule, as well as the availability of relatively liquid investments
that can act as adequate substitutes to existing investments for those
affected funds. We are unable to quantify the total potential costs
discussed in this section because: (1) We cannot anticipate the highly
liquid investment minimum that each fund would determine to be
appropriate based on its liquidity risk or the extent to which fund
holdings exceed the rule's more specific 15% illiquid investment limit
relative to the current 15% guideline; (2) we cannot determine what
relatively more liquid investments funds would purchase as substitutes;
(3) we are unable to estimate the resulting changes to funds' yields
and risk profiles, nor how investors would react to these changes. In-
Kind ETFs and funds that primarily hold assets that are highly liquid
investments will not be subject to the highly liquid investment
minimum, so this may reduce the aggregate costs associated with
decreased investment options relative to the proposed rule. Commenters
did not specifically object to our assessment of the rule's impact on
investment options in the proposed rule.
Market for Relatively Less Liquid Investments
    As discussed above, the rule could result in certain funds
increasing their investments in relatively more liquid investments,
which would effectively mean that these funds would decrease their
investments in relatively less liquid investments. If funds decrease
their investments in relatively less liquid investments, the market for
those investments could become even less liquid. This could discourage
new issuances of similar investments and decrease the liquidity of
relatively less liquid investments that are still outstanding. The
impact of decreased investment by funds in relatively less liquid
markets will depend on how much current investment in those markets is
driven by the funds, which varies between markets. Further, these
market effects could be partially offset if other opportunistic
investors with greater capacity to hold less liquid investments are
attracted to the market by any lower prices for these investments that
result if funds decrease their holdings of less liquid
investments.\1124\ In addition, if the rule leads funds to better
assess the liquidity risk associated with certain investments, any
decrease in the prices of these investments could reflect more
efficient pricing of the investments (that is, risk would be better
reflected in asset prices than it is currently). Because funds
currently are not required to report or disclose information concerning
the liquidity of their investments, and because we cannot anticipate
the highly liquid investment minimum that each fund would determine to
be appropriate based on its liquidity risk or the extent to which the
more specific 15% illiquid investment limit will apply to current fund
holdings, it is difficult to predict the extent to which the rule could
lead funds to modify their portfolio holdings, or whether such
modifications would discourage the issuance of certain investment. As a
result, we cannot quantify the potential costs discussed in this
section. Commenters did not specifically object to our assessment of
the costs related to decreased investment in illiquid assets in the
proposed rule.
---------------------------------------------------------------------------

    \1124\ Relatively less liquid investments have a higher expected
return compared to relatively more liquid investments, thereby
compensating longer-term investors for holding relatively less
liquid investments. See Yakov Amihud & Haim Mendelson, Asset Pricing
and the Bid-Ask Spread, 17 J. Fin. Econ. 223 (1986), available at
http://pages.stern.nyu.edu/~lpederse/courses/LAP/papers/
TransactionCosts/AmihudMendelson86.pdf.
---------------------------------------------------------------------------

d. Effects on Efficiency, Competition, and Capital Formation
    The liquidity risk management program requirement would require a
fund to assess its liquidity risk and to determine its highly liquid
investment minimum based on this risk assessment. For funds that do not
already engage in liquidity risk management practices that meet the
rule's requirements, the requirements should improve the

alignment between fund portfolio liquidity and fund liquidity needs.
This improved alignment could enhance funds' ability to meet
redemptions in a manner that mitigates potential dilution of
shareholders' interests, and thus this improved alignment could be
viewed as increasing efficiency to the extent that dilution is
perceived as a drag on the ability of a fund's NAV to reflect the
performance of its portfolio. Additionally, the requirement for each
fund to classify the liquidity of its portfolio investments and
publicly report the aggregated percentage of its portfolio assigned to
each of the four classifications categories could increase allocative
efficiency by assisting investors in making investment choices that
better match their risk tolerances. However, this potential efficiency
gain will only hold to the extent that these portfolio-level
classification aggregates, which are based on non-public subjective
assessments of investment liquidity, are comparable across funds.
Furthermore, this potential efficiency gain will only be achieved if
this classification sufficiently contrasts the tradeoff between
portfolio liquidity and performance across funds.
    By enhancing funds' liquidity risk assessment and risk management,
the program requirement also could promote pricing efficiency in the
sense that it could decrease the likelihood that a fund would be forced
to sell portfolio investments under unfavorable circumstances in order
to meet redemptions, potentially creating significant negative price
pressure on those investments. If a fund's asset sales were to cause
temporary changes in market prices unrelated to an investment's
fundamentals, this could create a temporary pricing inefficiency. By
decreasing the likelihood that these types of price movements would
occur, the program requirement could decrease pricing inefficiency.
However, the program requirement could negatively affect the efficient
pricing of investments with lower liquidity if it indirectly
discourages funds from investing in them (for example, if a fund were
to decrease its holdings in investments that have lower liquidity if it
determines, as a result of the fund's liquidity risk assessment, that
its appropriate highly liquid investment minimum or the more specific
15% illiquid investment limit do not correspond with the fund's current
portfolio composition). But as discussed above, this market effect
could be partially offset if other investors are incentivized to buy
relatively less liquid investments on account of any lower prices for
these investments that result if funds decrease their holdings of these
investments.\1125\ Alternatively, any price decreases experienced as a
result of decreased mutual fund investment could be considered
efficient price adjustments given the reduction in liquidity of the
investments.
---------------------------------------------------------------------------

    \1125\ See supra section IV.C.1.c.
---------------------------------------------------------------------------

    If the liquidity risk management program requirement results in a
material decrease in funds' investment in relatively less liquid
investments, competition for these investments would initially be
negatively affected. Under this scenario, the relatively less liquid
investments in which funds formerly would have invested may become less
liquid, since the number of current or potential market participants
would be reduced. However, because this reduction in demand and
liquidity results in larger illiquidity discounts and higher expected
returns, some investors might become willing to invest in these assets,
which in turn would partially offset the initial reduction in
competition. As a corollary, if the liquidity risk management program
requirement results in a material increase in funds' investment in
highly liquid investments, competition for these investments would be
positively affected. However, as funds increase their investments, the
liquidity of those investments should increase and their liquidity
premium decrease, which in turn could lead some investors to reduce
their demand for these investments, partially offsetting the initial
increase in competition. Relative to the proposal, the competitive
effects of fund demand for highly liquid investments relative to lower
liquidity investments should, if anything, be reduced because the rule
only requires a fund to consider stressed conditions that are
reasonably foreseeable in determining its minimum.
    The size of a fund, or the family of funds to which a fund belongs,
could have certain competitive effects with respect to the fund's
implementation of its liquidity risk management program. If there are
economies of scale in creating and administering multiple liquidity
risk management programs, funds in large families would have a
competitive advantage. For a fund in a smaller complex, however, a
greater portion of the fund's (and/or adviser's \1126\) resources may
be needed to create and administer a liquidity risk management program,
which may increase barriers to entry in the fund industry, and lead to
an adverse effect on competition. The size of a fund family also could
produce competitive advantages or disadvantages with respect to a
fund's use of products developed by third parties to assist in
classifying the liquidity of their portfolio investments, or to assess
the fund's liquidity risk. Funds in a large complex also could receive
relatively more favorable pricing for third-party liquidity risk
management tools, if the fund complex were to purchase discounted bulk
services from the developer or receive relationship-based pricing
discounts. To the extent that they choose to use liquidity risk
management tools such as committed lines of credit and interfund
lending,\1127\ funds in larger complexes likewise could receive more
favorable rates on committed lines of credit than funds in smaller
complexes, and could have opportunities to establish interfund lending
arrangements more easily than funds in smaller complexes.
---------------------------------------------------------------------------

    \1126\ See supra footnote 446 and accompanying text.
    \1127\ See supra footnote 258 and accompanying text (discussing
and providing guidance on the use of these tools).
---------------------------------------------------------------------------

    Any changes in certain investments' or asset classes' liquidity
that could indirectly result from the liquidity risk management program
requirement (for example, as discussed above, if the number of buyers
and sellers for certain investments becomes significantly reduced as a
result of the program requirement) could also affect capital formation
among issuers of these investments. Because lower asset liquidity
implies higher illiquidity premiums and larger asset price discounts
some firms and other issuers of securities could be discouraged from
issuing new securities in asset classes that are associated with lower
liquidity. If changes in liquidity are not equal across all asset
classes, firms and other entities may begin to shift their capital
structure (e.g., begin to issue equity instead of debt) or to change
the terms of certain securities that they issue in order to increase
their liquidity (e.g., by standardizing the terms of certain debt
securities, or modifying the securities' terms to promote electronic
trading).\1128\
---------------------------------------------------------------------------

    \1128\ See GFOA Comment Letter (discussing these types of
effects on municipal bond issuers).
---------------------------------------------------------------------------

    Commenters did not specifically object to our assessment of the
proposed rule's effects on efficiency, competition, and capital
formation. With the exception of the potential efficiency changes due
to modifications reflected in the adoption of a highly liquid
investment minimum and the more specific 15% illiquid investment limit
discussed above, our assessment of the

final rule's effects largely corresponds with those of the proposed
rule.
e. Reasonable Alternatives
    The Commission considered various alternatives to the individual
elements of rule 22e-4. Those alternatives are outlined above in the
sections discussing the rule elements.\1129\ The following discussion
addresses economically significant alternatives to rule 22e-4, which
involve broader issues than the more granular alternatives to the
individual rule elements discussed above.
---------------------------------------------------------------------------

    \1129\ See supra sections III.A.3, III.B.1.b, III.B.2.j,
III.B.3.b, III.C.1.c, III.C.1.d, III.C.2.a, III.C.2.b, III.C.3.a,
III.C.3.a, III.C.6.a, III.C.6.b, II.C.5.c, III.D.4, and III.E.
---------------------------------------------------------------------------

Liquidity Risk Management Program and Scope
    The Commission considered, but ultimately decided against,
excluding certain types of funds from rule 22e-4.\1130\ For example,
the rule could have carved out funds with investment strategies that
historically have entailed relatively little liquidity risk, or funds
with relatively low asset levels. We are not excluding any subset of
open-end funds, other than money market funds, from the scope of the
rule, although we have tailored the rule for certain kinds of
investment companies that present different liquidity risks (In-Kind
ETFs, funds that primarily hold assets that are highly liquid
investments, and UITs). Some funds with investment strategies that
historically have involved little liquidity risk invest in assets that
have lower liquidity, or in more liquid assets that can experience
episodes of lower liquidity.\1131\ To the extent that these types of
investments create potential liquidity risk for a fund, excluding funds
with investment strategies that have historically involved little
liquidity risk could expose investors to more potential liquidity risk
than they would face under the rule. Furthermore, investors in small
funds could suffer from insufficient liquidity risk management just as
investors in larger funds could. Indeed, staff analysis suggests that
funds with relatively low total assets can experience greater flow
volatility, including more volatility in unexpected flows, than funds
with higher assets, which could indicate increased liquidity
risk.\1132\ The program requirement permits a fund to customize and
calibrate its liquidity risk management program to reflect the
liquidity risks that it typically faces (and that it could face in
stressed market conditions). This flexibility is meant to result in
programs whose scope, and related costs and burdens beyond the fixed
cost of establishing a minimum liquidity risk management program, are
appropriate to manage the actual liquidity risks facing a particular
fund. For example, funds that primarily hold assets that are highly
liquid investments are not required to adopt a highly liquid investment
minimum because any benefits associated with this requirement as
applied to these funds are less likely to justify the associated
burdens.
---------------------------------------------------------------------------

    \1130\ See section III.A.2 for more detailed discussion of rule
22e-4's scope.
    \1131\ See Proposing Release, supra footnote 9, at n.123-124
(discussing liquidity issues in microcap stocks as well as treasury
bonds during the ``Flash Crash'').
    \1132\ DERA Study, supra footnote 95, at 16-24. See infra
footnote 1159 and accompanying paragraph regarding comments on small
funds.
---------------------------------------------------------------------------

    Instead of adopting rule 22e-4, the Commission could issue guidance
surrounding the assessment and management of liquidity risk, which
would give funds more flexibility in managing liquidity risk and could
reduce costs relative to the requirements of the rule. However, on
account of the significant diversity in liquidity risk management
practices that we have observed in the fund industry, we believe that
the need exists for an enhanced comprehensive baseline requirement
instead of only guidance for fund liquidity risk management.
    Commenters suggested the rule could have also taken a purely
principles-based approach instead of a prescriptive approach.\1133\ The
final rule is not a purely prescriptive rule; while it does specify
certain standards, it provides funds with a substantial degree of
flexibility in implementing those standards. That said, a purely
principles-based approach that specified few or no requirements could
give funds more flexibility in tailoring risk management programs to
their needs and could reduce compliance costs, but it would be less
certain to create a comprehensive baseline for fund liquidity risk
management, which in turn would diminish the comparability (and thus
the value) of information reported to the Commission and to the public
about funds' liquidity. Under a purely principles-based approach, an
investor with investments in multiple funds would be aware that those
funds are all generally required to manage liquidity risk, but may not
have sufficient clarity about how each of the funds may have chosen to
interpret and implement general principles so as to permit the investor
to understand how this variation across funds affects the liquidity
risk to which the investor is exposed. Finally, funds are not
prohibited from developing or maintaining their own, tailored risk
management programs to the extent that they are supplemental to the
baseline that the Commission's program requires.
---------------------------------------------------------------------------

    \1133\ AIMA Comment Letter; CFA Comment Letter; Cohen & Steers
Comment Letter; Dodge & Cox Comment Letter; Eaton Vance Comment
Letter I; FSR Comment Letter; ICI Comment Letter I; ICI Comment
Letter III; LSTA Comment Letter; MFDF Comment Letter; Nuveen Comment
Letter; NYC Bar Comment Letter; Oppenheimer Comment Letter; State
Street Comment Letter; Vanguard Comment Letter; Wellington Comment
Letter; Wells Fargo Comment Letter; Dechert Comment Letter.
---------------------------------------------------------------------------

    The Commission considered proposing liquidity requirements similar
to those imposed on money market funds--that is, the requirement to
hold a specified minimum level of highly liquid investment holdings,
and the ability to impose redemption fees and gates.\1134\ The
requirements imposed on money market funds, and the tools available to
these funds to manage heavy redemptions, are specifically tailored to
the assets held by money market funds and the behavior of money market
fund investors.\1135\ Imposing similar regulatory requirements on funds
that are not money market funds would ignore significant differences
between money market funds and other funds. We discuss the costs and
benefits of requiring funds to hold a specified minimum level of highly
liquid investments below (similar to the portfolio liquidity
requirements applicable to money market funds). With respect to
redemption fees, funds are already permitted to use them under existing
regulations (up to a maximum fee of two percent), although those fees
are largely used by certain funds to recoup costs incurred as a result
of excessive short-term trading of mutual fund shares, rather than
mitigating dilution arising from shareholder transaction activity
generally, and are viewed as unpopular with investors and
intermediaries. Redemption gates would allow funds to limit the
potential dilution shareholders face in circumstances where they face
extreme redemptions, but they would also impose constraints on
shareholders' access to their assets in those situations, and
commenters were not in favor of extending rule 22e-3 to permit funds to
make broader use of suspensions of redemptions.\1136\ In addition,
funds that are not money market funds have not demonstrated the same
risk of significant redemptions during times of

market stress that money market funds may face and which redemption
gates are meant to prevent, implying that the benefits of gates are
less applicable to funds that are not money market funds.\1137\
---------------------------------------------------------------------------

    \1134\ See supra footnotes 153-155 and accompanying text.
    \1135\ See 2014 Money Market Fund Reform Adopting Release, supra
footnote 43, at section II.
    \1136\ See ICI Comment Letter I.
    \1137\ See 2014 Money Market Fund Reform Adopting Release, supra
footnote 43, at section III.A.1.
---------------------------------------------------------------------------

Classifying Portfolio Investment Liquidity
    The Commission considered multiple alternatives to the rule's
requirement that funds classify the liquidity of their portfolio
investments, which establishes one component of a uniform baseline for
fund liquidity risk management. As discussed above, commenters raised
three primary structural alternatives to the proposed classification
requirement: (i) A ``principles-based'' liquidity classification
approach, where each fund would have to classify the liquidity of its
portfolio assets, but the Commission would not require any specific
classification scheme; \1138\ (ii) a simplified version of the proposed
classification system, with fewer classification categories based on
shorter time projections than the proposal; \1139\ and (iii) an
approach with new classification categories based on qualitative
distinctions in the market- and trading-related characteristics of
different asset classes under different market conditions, which
generally would rely on the Commission mapping different asset classes
to each of these new classification categories.\1140\
---------------------------------------------------------------------------

    \1138\ See, e.g., AIMA Comment Letter; LSTA Comment Letter;
Street Comment Letter; Wellington Comment Letter.
    \1139\ See, e.g., Eaton Vance Comment Letter I; Interactive Data
Comment Letter; Markit Comment Letter; Wells Fargo Comment Letter.
Commenters generally suggested three, four, or five classification
categories.
    \1140\ See, e.g., BlackRock Comment Letter; MFS Comment Letter;
Nuveen Comment Letter; CSRC Comment Letter.
---------------------------------------------------------------------------

    A purely principles-based approach to classifying assets, as
suggested by several commenters, would have the benefit of allowing
each fund to tailor its classification scheme to the liquidity factors
most relevant to the assets it invests in rather than imposing a one-
size-fits-all approach that may be less applicable to some funds.
However, as discussed above, this approach would not provide a uniform
methodology for funds' liquidity assessment procedures and would not
promote reasonably comparable reporting to the Commission and
disclosure to the public about funds' portfolio liquidity.\1141\
Instead, also as discussed above, we are largely adopting commenters'
suggested approach of reducing the number of liquidity classifications
from six to four.\1142\
---------------------------------------------------------------------------

    \1141\ See supra section III.C.6.
    \1142\ The Commission also could have, as described in the
Proposing Release, required funds to classify each portfolio
position as ``liquid'' or ``illiquid,'' but commenters did not
support such an alternative, and we continue to believe that a two-
category approach would be insufficiently nuanced to capture the
full spectrum of portfolio position liquidity. See also supra
section III.C.1.a for a more detailed discussion of commenter
suggestions with respect to the number of liquidity classification
categories.
---------------------------------------------------------------------------

    The Commission considered but is not adopting commenters'
alternative of having the Commission establish a fixed classification
schema to which all funds must adhere--for example, an enumeration of
asset classes and a mapping of those classes to a liquidity
classification.\1143\ This approach would have the benefit of producing
liquidity classifications that are objectively comparable across funds,
but the Commission may not be able to respond as quickly as market
participants to dynamic market conditions that might necessitate
changes to asset class liquidity classifications, and would be unable
to account for determinants of investment liquidity that are fund-
specific.
---------------------------------------------------------------------------

    \1143\ For examples suggesting this approach see, e.g., AFR
Comment Letter; BlackRock Comment Letter; SRC Comment Letter.
---------------------------------------------------------------------------

    Relatedly, some commenters also suggested classification categories
based on alternatives to the ``days-to-cash'' criterion of the proposed
and final rule, including, in whole or in part, on the fraction of
average daily trading volume (``ADTV'') that each position size
corresponds to, the expected behavior of bid-ask spreads in a given
asset, or more qualitative liquidity buckets (e.g., ``converted to cash
quickly under most circumstances'').\1144\ Some of these more specific
criteria may be appropriate for particular assets (e.g., ADTV is a
reasonable measure for exchange-traded securities), but do not apply to
all assets (e.g., bid-ask spreads are not readily available for some
asset classes). Also, more qualitative criteria make it more difficult
to compare classifications across funds relative to the ``days-to-
cash'' approach in the final rule.
---------------------------------------------------------------------------

    \1144\ See Nuveen Comment Letter; BlackRock Comment Letter;
Dodge & Cox Comment Letter; SIFMA Comment Letter I.
---------------------------------------------------------------------------

Highly Liquid Investment Minimum
    The final rules require funds that do not primarily hold assets
that are highly liquid investments to establish a highly liquid
investment minimum as part of their liquidity risk management program
and provides some flexibility by not prohibiting the acquisition of
less liquid investments, but instead requiring a fund to report to the
board and, in some cases, the Commission if it goes below its minimum.
The first type of alternative the Commission considered with respect to
this requirement concerns which investments satisfy a minimum, which
could have varied along a spectrum from more liquid (e.g., only cash
would qualify as a highly liquid investment) to less liquid (e.g.,
investments reasonably expected to convert to cash in the 7-day
timeframe associated with open-ended fund redemption and settlement
requirements would qualify). While there are various marginal benefits
and costs associated with defining investments that satisfy the minimum
at points along that spectrum--for example, cash is more liquid but
does not provide any yield--the final rule aligns the definition of
what investments are subject to the minimum with the definition of the
first (most liquid) category of investments in the liquidity risk
management program's liquidity classification requirement.\1145\ This
consistency in treatment means that fund advisers, investors, and the
Commission can focus on a smaller number of clearly-defined concepts
when broadly evaluating fund liquidity.
---------------------------------------------------------------------------

    \1145\ See the Proposing Release, supra footnote 9 at n.730 and
associated text for a further discussion of cash and ``seven day
liquid assets'' as alternatives for a minimum. We did not receive
explicit comments on the merits of which types of investments should
satisfy a minimum.
---------------------------------------------------------------------------

    The Commission also considered whether to make the highly liquid
investment minimum purely a target instead of a minimum. The proposed
rule would have precluded funds from acquiring less liquid investments
anytime they were below their highly liquid investment minimum.
Commenters suggested this could lead to several potential costs, as
discussed above regarding the rule's costs and benefits, including the
possibility that it could lead to herding behavior among funds.\1146\
Some commenters instead suggested that a target or range be used
instead of a minimum, which could provide funds more flexibility in
returning to their target without incurring unnecessary trading costs,
as well as the ability to trade more opportunistically during periods
of market stress.\1147\ However, a target

might have been interpreted as an ``average'' level of highly liquid
investments funds should hold and, without further requirements such as
board reporting, may not have provided a sufficient incentive to fund
managers to ensure that the percentage of a fund's investments invested
in relatively liquid investments is at (or above) the level deemed
appropriate by the fund. The final rules strike a balance: Funds are
not prohibited from acquiring less liquid investments if they go below
their highly liquid investment minimum, but they must report any
shortfall to their boards (and the Commission where required). This
should reduce concerns regarding herding behavior,\1148\ but does make
it more burdensome for a fund to buy any assets that are not highly
liquid investments opportunistically if the fund is at or below its
highly liquid investment minimum, insofar as funds may not want to
trigger their reporting obligation to their board, the Commission, or
both.
---------------------------------------------------------------------------

    \1146\ For example, any market event that increases the value of
the less liquid portion of many funds' portfolios could place them
below the minimum, and could indirectly result in some funds selling
less liquid investments at the same time to bring their allocations
back in line with their minimums.
    \1147\ For comments discussing the costs and benefits of a
target vs. a minimum, see, e.g., Blackrock Comment Letter; Federated
Comment Letter; Invesco Comment Letter; PIMCO Comment Letter.
    \1148\ For example, if an asset ceased to be a highly liquid
investment, it could indirectly lead funds to sell that asset in
order to meet their minimum. Coordinated selling could produce
further downward pressure on the value of the investment. Some funds
could be interested in purchasing such an investment if they viewed
it to be undervalued and thus good for fund investors--which could
also help counteract the downward pricing pressure caused by funds
exiting their positions--but if such a purchase would cause them to
violate their minimum, it would have been prohibited under the
proposed rule.
---------------------------------------------------------------------------

    Some commenters were generally opposed to a highly liquid
investment minimum,\1149\ and the final rule could have excluded this
requirement altogether. Doing so would still require that funds manage
liquidity risk appropriately but would provide even more flexibility in
how that is achieved. However, the highly liquid investment minimum
requires funds to directly consider the assets they need to have on
hand to meet redemptions in a flexible manner to reduce dilution that
may result from forced sales, and funds have flexibility in setting a
minimum that is appropriate to the needs of their fund as well as
adjusting the minimum dynamically to adapt to changing market
conditions.\1150\ We note that the final rule does not require funds
that primarily hold assets that are highly liquid investments to
establish a minimum.
---------------------------------------------------------------------------

    \1149\ See, e.g., Invesco Comment Letter; Blackrock Comment
Letter.
    \1150\ See supra footnote 638 and accompanying text.
---------------------------------------------------------------------------

    The Commission also considered requiring a uniform highly liquid
investment minimum for all funds. This alternative approach would have
the advantage of being simple for investors to understand, easy for
funds to apply, and simple for our examination staff to verify.
However, this alternative would fail to account for notable differences
between funds with respect to investment strategy, fund flow patterns,
and other characteristics that contribute to funds' liquidity risk,
which in turn would make it reasonable for funds' portfolios to have
varying liquidity profiles. We believe that the fund-specific highly
liquid investment minimum requirement will promote alignment of a
fund's liquidity needs with the liquidity of fund investments, while
still permitting funds reasonable flexibility in implementation. In
light of the significant diversity within the fund industry, we believe
that flexibility is appropriate to help minimize the potential costs to
investors of the requirement. This approach still includes elements
that will help our staff to assess whether funds are holding an
appropriate level of assets that are highly liquid investments. Each
fund will be required to maintain a written record of how its highly
liquid investment minimum was determined, as well as copies of
materials submitted to the fund's board in connection with the highly
liquid investment minimum.\1151\ One benefit of a Commission-determined
uniform highly liquid investment minimum would be to ensure that funds
do not set their minimum at an artificially low level (e.g., 0) that is
divorced from their liquidity risk. We believe that the requirement for
a fund to consider certain specified factors in determining its
minimum, as well as the recordkeeping and board review requirements
discussed above, will help promote funds' establishing realistic
minimums, and discourage inappropriately low or zero minimums.
---------------------------------------------------------------------------

    \1151\ See proposed rule 22e-4(c)(2)-(3).
---------------------------------------------------------------------------

    Instead of requiring funds to determine and invest their assets in
compliance with a highly liquid investment minimum, we could require
funds to conduct stress tests of their own design assessing the extent
to which the fund has a level of highly liquid investments necessary to
cover possible levels of redemptions. This would have the benefit of
granting a fund flexibility in determining whether its portfolio
liquidity profile is appropriate given its liquidity needs. However,
because the quality and comprehensiveness of funds' liquidity risk
management currently varies significantly, we believe that requiring
funds to have a highly liquid investment minimum is important in
reducing the risk that funds will be unable to meet their redemption
obligations, in minimizing dilution, and in elevating the overall
quality of liquidity risk management across the fund industry. Also, we
believe that it would be difficult to determine, depending on the level
of discretion a fund would have in developing stress scenarios, whether
these scenarios would accurately depict liquidity risk and lead funds
to determine the appropriate level of portfolio liquidity they should
hold. For example, if a fund's liquidity needs were generally high
during normal periods, but were not correspondingly extreme during
stress events, basing this fund's portfolio liquidity on the results of
stress testing alone could cause a fund to hold too little liquidity
during non-stressed periods. Therefore, we do not believe that a
general stress testing requirement would be an adequate substitute for
the highly liquid investment minimum requirement.
15% Illiquid Investment Limit
    Instead of the adopted illiquid investment definition, the
Commission could have codified a definition of illiquid investments
that reflects the current 15% guideline. This approach would have had
the benefit of already being accepted and understood by the industry,
and would have entailed few additional implementation costs for funds.
However, it would not have been harmonized with the rule's requirements
with respect to other liquidity classifications, particularly the
requirement that funds review at least monthly whether their
investments are illiquid with respect to relevant market, trading, and
investment-specific factors, and also incorporate market depth
considerations into this process.\1152\ To the extent that the rule's
liquidity classification requirement results in funds more accurately
assessing the amount of illiquid investments in their portfolios, funds
may improve on their liquidity risk management under the rule as
adopted than under a codification of the 15% guideline.
---------------------------------------------------------------------------

    \1152\ See supra sections III.C.1.b and III.C.3.b.
---------------------------------------------------------------------------

f. Comments on the DERA Study
    We received substantial comments on the DERA Study from one
commenter. The Commission has carefully considered these comments and
adjusted our analysis where appropriate. In terms of broader concerns,
the commenter suggested that the analysis in the DERA Study does not
provide a strong basis for the specifics

of the rule.\1153\ For example, the commenter asserts that the DERA
Study's analysis does not provide a justification for funds sorting
their assets into six liquidity categories and does not apply this
classification in the DERA Study. The DERA Study's analysis was not
designed to justify each policy choice made in the rule. Rather, the
analysis in the DERA Study makes certain findings and reports certain
empirical results designed to inform the Commission more generally
about the current state of fund liquidity.
---------------------------------------------------------------------------

    \1153\ ICI Comment Letter II.
---------------------------------------------------------------------------

    With respect to the proposal's interpretation of the DERA Study's
results, the commenter expressed the concern that the results in the
DERA Study provide only indirect evidence on the selling behavior of
funds in response to redemptions. While a direct test would be
preferable, such a test would require data on both daily fund flows and
fund daily transactions, neither of which are available in sufficient
detail for analysis. The commenter states that the DERA Study itself
only shows that fund liquidity tends to decrease following outflows and
that other endogenous factors, such as broad changes in market
conditions due to macroeconomic events, could be causing changes in
both fund liquidity and fund flows.\1154\ To demonstrate its concerns
about endogeneity, the commenter uses a vector autoregression (VAR) to
present evidence that a proxy for market returns causes changes to both
the Amihud liquidity of the S&P 500 and net U.S. equity mutual fund
flows in a manner consistent with its alternative hypothesis that a
fund's average Amihud liquidity may decrease due to an increase in
market volatility rather than because of fund managers' trading
behavior.\1155\ The analysis performed in the DERA Study does control
for broad changes in market liquidity at the fund class-level.\1156\ To
the extent that broad market effects drive variation in fund liquidity
within a fund class in a way that is also correlated with fund flows,
we acknowledge the commenter's concern about endogeneity and have
modified our interpretation in the discussion above, but we also note
that there is anecdotal evidence that supports this
interpretation.\1157\ With respect to the Amihud liquidity measure used
in the study, the commenter states that the DERA Study's conclusion
that a ``10% outflow increases the impact of selling $10 million of the
asset-weighted average equity portfolio holding by 11 basis points'' is
a key result supporting the proposal's hypothesis that funds sell their
more liquid assets first to meet redemptions. We disagree that the
specific economic interpretation of the Amihud measure cited by the
commenter is necessary to support the hypothesis that funds tend to
sell their more liquid assets: To the extent that the Amihud measure
reflects the liquidity of underlying fund assets, a decline in the
average Amihud liquidity of a fund's portfolio is consistent with the
fund disproportionately selling its more liquid assets.
---------------------------------------------------------------------------

    \1154\ ICI Comment Letter II.
    \1155\ ICI Comment Letter II.
    \1156\ DERA Study, supra footnote 95, at 43-44. The model
includes Lipper class fixed effects, year-quarter fixed effects, and
interactions of those fixed effects. The year-quarter and
interaction fixed effects should capture any broad changes in
liquidity within different fund styles over time, which could be
related to macroeconomic events.
    \1157\ See, e.g., supra footnote 71.
---------------------------------------------------------------------------

    The commenter concludes that the analysis in the DERA Study does
not demonstrate that funds are managing portfolios and redemptions in a
manner that harms the interests of non-redeeming shareholders.\1158\ We
acknowledge that the analysis does not establish a direct link between
redemptions and quantifiable harm to non-redeeming shareholders; as
discussed above, it was designed to inform the Commission more
generally about the current state of fund liquidity. The commenter also
states the DERA Study's finding that municipal bond funds hold less
cash following redemptions implies that a 40% outflow would be required
to deplete the average municipal bond fund's cash holdings. We
acknowledge the commenter's interpretation of the analysis, but note
that the results do not imply that all municipal bond funds would
necessarily require outflows of a similar magnitude to deplete a
significant portion of their cash holdings.
---------------------------------------------------------------------------

    \1158\ ICI Comment Letter II.
---------------------------------------------------------------------------

    The commenter makes several statements regarding results related to
the volatility of fund flows. First, the commenter provides evidence
that flow volatility declines with fund size, notes that the DERA
Study's use of simple averages to calculate average flow volatility in
a given fund category overstates the highly volatile flows of small
funds, and shows that asset-weighted flow volatility measures are
significantly smaller for all fund categories.\1159\ We acknowledge
that the simple average will overstate smaller funds relative to an
asset-weighted average, but the opposite view holds too: Asset-weighted
averages will understate flow volatility for small funds, and the rule
is concerned with the potential liquidity risk problems at all funds.
The commenter also states that the relatively higher flow volatility of
alternative funds may simply be attributable to the fact that they are
generally smaller in size (because small funds generally tend to have
more volatile flows as a percentage of their assets) and that, as they
have grown, the volatility of their flows has, if anything, decreased.
We acknowledge that the flow volatility of alternative funds may be a
function of their smaller size, but also note that small funds are also
subject to the rule and that other fund categories, such as foreign
bond funds, exhibit higher flow volatility despite being relatively
larger in size. The commenter also notes that, as the DERA Study
acknowledged, the predictability of fund flows is likely understated.
The purpose of analyzing the predictability of flows in the analysis
was to determine, using a simple model of fund flows, the extent which
flow volatility was predictable and whether, after accounting for
predictability, the unexpected component of flow volatility varied
across fund types in the same way as total flow volatility. While fund
managers may be able to predict a larger fraction of flow volatility,
the evidence in the DERA Study supports the notion that unexpected flow
volatility varies proportionally with total flow volatility, and the
relative ranking of unexpected flow volatility by fund type is not
likely to change with a better model of flows. The commenter also
states that the DERA Study provides evidence that funds already
successfully manage volatile flows.\1160\ The proposal acknowledged
that this evidence supports the view that funds do manage volatile
flows by holding larger amounts of cash and liquid assets, and this
evidence provides support for the rule's inclusion of flow volatility
as a factor for funds to consider when managing risk.\1161\ Finally,
the commenter points out that, while the DERA Study finds smaller funds
have more volatile flows, small funds may find it easier to trade
assets with minimal price effects. We agree that small funds may have
less price impact, but note that any fixed trading costs incurred via
smaller trades will involve larger proportional trading costs.
---------------------------------------------------------------------------

    \1159\ ICI Comment Letter II.
    \1160\ ICI Comment Letter II.
    \1161\ See Proposing Release, supra footnote 9, at n.631 and
accompanying discussion.
---------------------------------------------------------------------------

    The commenter also provides evidence on the relationship between
fund flows and holdings of short-term

assets for alternative strategy and high-yield bond funds. It finds no
relationship between the two, asserting that the lack of a relationship
shows funds are not systematically selling short-term assets to meet
redemptions. However, this result is at the aggregate level, and does
not necessarily preclude a relationship between the two quantities at
the fund level for some funds. It also provides a fund-level analysis
across high-yield bond funds in 5 separate months and also does not
find a relationship between the two in four of the months. In one of
the months, it does find statistically significant evidence that a
decrease in short-term assets is associated with outflows, consistent
with the DERA Study's finding. The commenter's inability to find a
relationship is not evidence that there is no relationship per se: It
is possible the commenter's test simply had low statistical power. To
the extent that the commenter's evidence does support the claim that
funds do not sell short-term assets in response to fund flows, the DERA
Study used a different measure of liquidity and did not claim any
evidence found using another measure, such as the short-term asset
ratio used by the commenter, would produce the same result. More
specifically, while funds may not sell their most liquid investments
(which would be reflected in the short-term asset ratio used by the
commenter), they could still be disproportionately selling their more
liquid investments.
    With respect to the liquidity measure used in the DERA Study, the
commenter points out that it only uses a single measure of market
liquidity (Amihud illiquidity) and claims that the measure is not
sufficient to support the interpretations the proposal draws from the
study.\1162\ We acknowledge that the use of alternative measures could
alter some of the results and interpretations in the DERA Study, but
also emphasize that the DERA Study was intended to generally inform the
Commission about the current state of fund liquidity, not to justify
each policy choice made in the rule.
---------------------------------------------------------------------------

    \1162\ ICI Comment Letter II.
---------------------------------------------------------------------------

    The commenter stated that the academic studies used in support of
the DERA Study and the proposal are either (1) theoretical and ignore
important institutional details or (2) based on empirical fund-level
results which by their design cannot provide any commentary on market-
wide concerns. With respect to the theoretical study cited in the
proposal, it shows one mechanism by which mutual fund shareholders may
have a first-mover incentive using a simplified model of the world for
tractability; it is possible that in a model which captures more
institutional details as proposed by the commenter--taxes, longer
investor horizons, and reinvestment risk--this incentive is reduced or
eliminated, but we are not aware of any other studies that reach such a
conclusion. With respect to any empirical studies, the primary goal of
the rule is to improve the fund-level management of liquidity and
redemptions, which makes the cited fund-level academic studies relevant
for the discussion. The commenter also points out that one of the
empirical studies (Coval and Stafford), which provides evidence of
negative price pressure due to forced selling by mutual funds, also
states that the ex-ante probability of an equity mutual fund being
affected by this risk is small because less than one percent of stocks
are affected in a given quarter. The proposal did not claim that forced
selling by mutual funds was a pervasive phenomenon, but did highlight
that it is a possible risk that funds and their shareholders face.
2. Disclosure and Reporting Requirements Regarding Liquidity Risk and
Liquidity Risk Management
a. Disclosure and Reporting Requirements
    We are adopting amendments to Form N-1A as well as adopting new
items to Form N-PORT, Form N-CEN, and adopting Form N-LIQUID, to
enhance fund disclosure and reporting regarding liquidity and
redemption practices. Specifically, amendments to Form N-1A will
require a fund to disclose: (i) The number of days in which the fund
typically expects to pay redemption proceeds to redeeming shareholders
\1163\ and (ii) the methods the fund typically expects to use to meet
redemption requests in stressed and non-stressed market
conditions.\1164\
---------------------------------------------------------------------------

    \1163\ Item 11(c)(7) of Form N-1A.
    \1164\ Item 11(c)(8) of Form N-1A.
---------------------------------------------------------------------------

    New items on Form N-PORT will require a fund to confidentially
disclose monthly: (i) The fund's highly liquid investment minimum and
the number of days a fund's holdings in assets that are highly liquid
investments fell below that minimum during a given reporting period;
\1165\ (ii) the liquidity classification of each investment as
determined pursuant to rule 22e-4(b)(2)(i) including the determination
of whether the investment qualifies as an illiquid investment, and
(iii) the percentage of the fund's highly liquid investments that the
fund has segregated to cover, or pledged to satisfy margin requirements
in connection with, derivatives transactions in each of the other
liquidity classification categories.\1166\ Once per quarter, funds will
be required to publicly disclose (with a 60-day delay): (i) The
aggregated percentage of their portfolios invested in each of the four
liquidity classification categories, but funds will not be required to
publicly disclose the liquidity classification of each individual
position; \1167\ and (ii) the percentage of the fund's highly liquid
investments that it has segregated to cover, or pledged to satisfy
margin requirements in connection with, derivatives transactions in
each of other liquidity classification categories.\1168\
---------------------------------------------------------------------------

    \1165\ Item B.7 of Form N-PORT.
    \1166\ Item C.7 of Form N-PORT.
    \1167\ Item B.8 of Form N-PORT.
    \1168\ Item B.8.b of Form N-PORT.
---------------------------------------------------------------------------

    New items on Form N-CEN will require a fund to disclose certain
information regarding the use of committed lines of credit and
interfund borrowing and lending.\1169\ We have also adopted a new item
on Form N-CEN that will require an ETF to report whether it qualifies
as an In-Kind ETF.\1170\
---------------------------------------------------------------------------

    \1169\ Item C.20 of Form N-CEN.
    \1170\ Item E.5 of Form N-CEN.
---------------------------------------------------------------------------

    The final form amendments differ from the proposal in several ways
that may have potential economic consequences. In response to
commenters' suggestions, the rule does not require funds to file credit
agreements as part of Form N-1A. While Form N-PORT requires funds to
report position-level liquidity classifications to the Commission,
these classifications will not be publicly released. Instead, a fund
will only be required to publicly disclose the aggregate percentage of
the fund's holdings invested in each of the four liquidity
classification categories and the percentage in each of the four
liquidity classification categories of the fund's highly liquid
investments that are segregated to cover derivatives transactions. The
adopted rule also incorporates commenters' suggestions that the
Commission be notified more quickly if a fund's assets that are
illiquid investments exceed 15% of its net assets by requiring funds to
file Form N-LIQUID indicating such a breach immediately after it
occurs. With respect to the highly liquid investment minimum, a fund is
required to report any decline below the minimum that lasts more than 7
consecutive calendar days to the Commission by filing Form N-LIQUID,
whereas the proposal would have required that a fund not purchase

less liquid investments while below its minimum. Any significant
economic effects of these changes are discussed below.
b. Benefits
    The disclosure and reporting requirements will promote investor
protection by improving the availability of information regarding
funds' liquidity risks and risk management practices, as well as funds'
redemption practices. As discussed above, funds' disclosures to
shareholders regarding their redemption practices are currently varied
in content and comprehensiveness.\1171\ To the extent that the
requirement for funds to disclose the number of days in which the fund
will pay redemption proceeds to redeeming shareholders fosters
competition among funds to minimize the timing of redemptions, and
assuming funds are able to meet redemptions in the time advertised,
such competition could potentially be to the benefit of investors.
Relative to the proposal, final Form N-1A requires that funds disclose
estimated payment times for each payment method, which should reduce
any potential investor confusion associated with the complexity of
estimates based on funds' distribution channels under the
proposal.\1172\
---------------------------------------------------------------------------

    \1171\ See supra section III.G.1.a.
    \1172\ See Fidelity Comment Letter.
---------------------------------------------------------------------------

    While some funds voluntarily include disclosure regarding fund
limitations on illiquid asset holdings that track the 15% guideline, a
fund is not currently required to disclose information about the
liquidity of its portfolio investments. In light of the relatively few
disclosure requirements regarding funds' liquidity risks, liquidity
risk management practices, and redemption practices, as well as the
current inconsistency in funds' liquidity-related disclosures, we
believe that the disclosure and reporting requirements would increase
shareholders' and the Commission's understanding of particular funds'
liquidity-related risks and redemption policies. This in turn should
assist investors in making investment choices that better match their
risk tolerances.
    We note that, while Form N-PORT and Form N-CEN are designed
primarily to assist the Commission and its staff, we believe that the
information in these forms (including the liquidity-related information
to be included in these forms) also will be valuable to investors and
other potential users.\1173\ In particular, we believe that both
sophisticated institutional investors and third-party users that
provide services to retail investors may find the publically disclosed
liquidity-related information to be useful. And we believe that
individual investors could benefit indirectly from the information
collected on reports on Form N-PORT through analyses prepared by third-
party service providers.
---------------------------------------------------------------------------

    \1173\ See Investment Company Reporting Modernization Adopting
Release, supra footnote 120.
---------------------------------------------------------------------------

    The liquidity-related information that funds will be required to
provide on Form N-PORT and Form N-CEN will enhance investor protection
by improving the Commission's ability to monitor funds' liquidity using
relevant and targeted data. This monitoring will permit us to analyze
liquidity trends in individual funds, and, to the extent that liquidity
profiles are comparable across funds, among certain types of funds and
the fund industry as a whole, as well as to better understand funds'
liquidity risk management practices. As discussed in our release
adopting rules and forms to modernize investment company reporting, the
information we receive on these reports will facilitate the oversight
of funds and will assist the Commission, as the primary regulator of
such funds, to better effectuate its mission to protect investors,
maintain fair, orderly, and efficient markets, and facilitate capital
formation.\1174\ Some commenters supported the reporting of asset-level
liquidity classifications if such information was only provided to the
Commission (i.e., made non-public),\1175\ although some did object to
the disclosure regardless of whether or not it was made public.\1176\
---------------------------------------------------------------------------

    \1174\ See id.
    \1175\ See CFA Comment Letter; Dechert Comment Letter; State
Street Comment Letter; Interactive Data Comment Letter; Nuveen
Comment Letter; Oppenheimer Comment Letter; Charles Schwab Comment
Letter; T. Rowe Comment Letter; Voya Comment Letter; Wellington
Comment Letter.
    \1176\ See Federated Comment Letter; Fidelity Comment Letter;
Invesco Comment Letter; SIFMA Comment Letter I.
---------------------------------------------------------------------------

    Form N-LIQUID will complement rule 22e-4's enhanced focus on the
limits on illiquid investments and the highly liquid investment minimum
discussed above by requiring reporting to the SEC every time: (1) A
fund's assets that are illiquid investments exceed 15% of its net
assets (as well as additional reporting when the fund's assets that are
illiquid investments fall back to or below 15% of its net assets); and
(2) a fund's investments in highly liquid investments that are assets
fall below its highly liquid investment minimum for more than 7
consecutive calendar days. This enhanced reporting could produce
significant benefits. For example, the SEC's market monitoring capacity
could be enhanced, in that multiple close-in-time filings by similar
types of funds may be an indication of market stress in a market
segment. Similarly, multiple close-in-time filings by the same fund may
be an indication that the fund is failing to adequately manage its
liquidity.
    Form N-PORT as adopted does not require that the asset-level
liquidity classifications be publicly disclosed in order to address
commenter concerns about the potential costs of such disclosure (which
are discussed in the costs section below). This change reduces some of
the proposal's potential public disclosure benefits. Under the
proposal, investors--by their own efforts or via third-party products--
could have compared how assets were classified according to different
funds' subjective approaches and resolved discrepancies across funds to
arrive at more directly comparable fund liquidity profiles. Under the
form as adopted, a fund will publicly disclose a new aggregate
liquidity profile by reporting the percentage of its portfolio assigned
to each of the four liquidity classification categories on Form N-PORT.
This will provide a useful snapshot of fund liquidity to investors and
will increase the amount of information available to investors about
fund liquidity, but this snapshot may not be as informative as
liquidity profiles under the proposed rule. The final form requires
funds to confidentially report their investment liquidity
classifications to the Commission via Form N-PORT. This maintains a
major benefit of the proposal, allowing the Commission to monitor
funds' liquidity levels and take action when significant aberrations
are discovered.
    Similarly, the final form amendments do not require the public
disclosure of a fund's highly liquid investment minimum in order to
address commenter concerns, but it is not likely that this change will
significantly reduce the benefits of reporting this minimum: The
primary investor protection benefit of reporting the minimum via Form
N-PORT is to encourage funds' holding of highly liquid investments that
correspond to the liquidity risks of their strategies. By
confidentially reporting the minimum, a fund will give the Commission
the capability to monitor whether the minimum is an outlier relative to
other funds with similar investment strategies. The oversight role of
the fund's board under rule 22e-4 is yet another safeguard in this
respect.
    Finally, Form N-PORT's requirement that funds disclose the
percentage of the fund's highly liquid investments that it

has segregated to cover or pledged to satisfy margin requirements in
connection with derivatives transactions that are classified as
moderately liquid investments, less liquid investments, and illiquid
investments, should more accurately reflect the amount of highly liquid
investments that are available to manage a fund's liquidity risk. For
example, without such a disclosure, investors might assume a fund whose
highly liquid investments are all segregated to cover derivatives
positions that are not highly liquid is better prepared to handle
redemption requests than it actually is.
    Because we cannot predict the extent to which the requirements will
enhance investors' awareness of funds' portfolio liquidity and
liquidity risk, influence investors' investments in certain funds, or
increase the Commission's ability to protect investors, we are unable
to quantify the potential benefits discussed in this section.
c. Costs
    Funds will incur one-time and ongoing annual costs to comply with
the disclosure and reporting requirements regarding liquidity and
shareholder redemption practices. Commenters' responses to the
estimates of these costs are discussed in the PRA discussion below, and
we have updated all estimates in this section to reflect changes in the
PRA.\1177\
---------------------------------------------------------------------------

    \1177\ See infra section V.
---------------------------------------------------------------------------

    We estimate that the one-time costs to comply with the amendments
to Form N-1A will be approximately $324 per fund (plus printing
costs).\1178\ We estimate that each fund will incur an ongoing cost
associated with compliance with the amendments to Form N-1A of
approximately $81 each year to review and update the disclosure
regarding redemptions.
---------------------------------------------------------------------------

    \1178\ This estimate is based on the following calculation: 1 (1
hour to update registration statement disclosure about redemption
procedures) x $324 (blended rate for a compliance attorney ($340)
and a senior programmer ($308)) = $324. This figure incorporates the
costs we estimated for each fund to update its registration
statement to include the required disclosure about: (i) The number
of days in which the fund will pay redemption proceeds to redeeming
shareholders; and (ii) the methods the fund uses to meet redemption
requests in stressed and non-stressed market conditions. The costs
associated with these activities are all paperwork-related costs and
are discussed in more detail infra at section V.F.
---------------------------------------------------------------------------

    The amendments to Form N-PORT will require funds to report on Form
N-PORT the liquidity classification of each portfolio investment, and
we estimate that the average one-time compliance costs associated with
this reporting will be $15,576 per fund.\1179\ Furthermore, we estimate
that 9,347 funds will be required to file, on a monthly basis,
additional information on Form N-PORT as a result of the
amendments.\1180\ Assuming that 35% of funds (3,271 funds) will choose
to license a software solution to file reports on Form N-PORT in
house,\1181\ we estimate an upper bound on the initial annual costs to
file the additional information associated with the amendments for
funds choosing this option of $783 per fund \1182\ with annual ongoing
costs of $261 per fund.\1183\ We further assume that 65% of funds
(6,076 funds) will choose to retain a third-party service provider to
provide data aggregation and validation services as part of the
preparation and filing of reports on Form N-PORT,\1184\ and we estimate
an upper bound on the initial costs to file the additional information
associated with the amendments for funds choosing this option of $1,044
per fund \1185\ with annual ongoing costs of $131 per fund.\1186\
---------------------------------------------------------------------------

    \1179\ This estimate is based on the following calculation: (i)
Project planning and systems design (24 hours x $264 (hourly rate
for a senior systems analyst) = $6,336) and (ii) systems
modification integration, testing, installation and deployment (30
hours x $308 (hourly rate for a senior programmer) = $9,240). $6,336
+ $9,240 = $15,576. Estimates for drafting, integrating,
implementing policies and procedures are addressed in the discussion
of rule 22e-4. This figure incorporates the costs that we estimated
associated with preparing the section of the fund's report on Form
N-PORT that will incorporate the information that will be required
under Item C.7. The costs associated with these activities are all
paperwork-related costs and are discussed in more detail infra at
section V.E. As discussed in section V.E infra, we believe that any
external annual costs associated with filing Form N-PORT will be
only incrementally affected by compliance with Item C.7 of Form N-
PORT, and thus Item C.7 does not affect our previous estimates of
these costs.
    \1180\ There were 10,633 open-end funds (excluding money market
funds, and including ETFs) as of the end of 2015. See 2016 ICI Fact
Book, supra footnote 11, at 22, 176, 183. As discussed in note 1253,
infra, we assume that 75% of ETFs, or 1,196 ETFs, will identify as
In-Kind ETFs, which are exempt from the classification requirement,
thereby reducing the total number of funds filing classification
information to 9,347.
    \1181\ This assumption tracks the assumption made in the
Investment Company Reporting Modernization Adopting Release that 35%
of funds will choose to license a software solution to file reports
on Form N-PORT. See Investment Company Reporting Modernization
Adopting Release, supra footnote 120.
    \1182\ This estimate is based upon the following calculations:
$783 in internal costs = ($783 = 3 hours x $261 (blended hourly rate
for senior programmer ($308), senior database administrator ($312),
financial reporting manager ($266), senior accountant ($192),
intermediate accountant ($157), senior portfolio manager ($306), and
compliance manager ($283)). We do not anticipate any change to
external annual costs as a result of the amendments. See infra at
section V.E. The hourly wage figures in this and subsequent
footnotes are from SIFMA's Management & Professional Earnings in the
Securities Industry 2013, modified by Commission staff to account
for an 1800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits, and overhead.
    \1183\ This estimate is based upon the following calculations:
$261 in internal costs ($261 = 1 hour x $261 (blended hourly rate
for senior programmer ($308), senior database administrator ($312),
financial reporting manager ($266), senior accountant ($192),
intermediate accountant ($157), senior portfolio manager ($306), and
compliance manager ($283)). We do not anticipate any change to
external annual costs as a result of the amendments. See infra at
section V.E.
    \1184\ This assumption tracks the assumptions made in the
Investment Company Reporting Modernization Adopting Release that 65%
of funds will choose to retain a third-party service provider to
provide data aggregation and validation services as part of the
preparation and filing of reports on Form N-PORT. See Investment
Company Reporting Modernization Adopting Release, supra footnote
120.
    \1185\ This estimate is based upon the following calculations:
$1,044 in internal costs ($1,044 = 4 hours x $261 (blended hourly
rate for senior programmer ($308), senior database administrator
($312), financial reporting manager ($266), senior accountant
($192), intermediate accountant ($157), senior portfolio manager
($306), and compliance manager ($283)). We do not anticipate any
change to external annual costs as a result of the amendments.
    \1186\ This estimate is based upon the following calculations:
$130.5 in internal costs ($130.5 = (0.5 hours x $261 (blended hourly
rate for senior programmer ($308), senior database administrator
($312), financial reporting manager ($266), senior accountant
($192), intermediate accountant ($157), senior portfolio manager
($306), and compliance manager ($283)). We do not anticipate any
change to external annual costs as a result of the amendments.
---------------------------------------------------------------------------

    Likewise, compliance with the amendments to Form N-CEN will involve
ongoing costs as well as one-time costs. We estimate that 10,633 funds
will be required to file responses on Form N-CEN as a result of the
amendments to the form. We estimate that the one-time and ongoing
annual compliance costs associated with providing additional responses
to Form N-CEN as a result of the amendments will be approximately $162
per fund.\1187\
---------------------------------------------------------------------------

    \1187\ This estimate is based on the following calculation: 0.5
hour x $324 (blended hourly rate for a compliance attorney ($340)
and a senior programmer ($308)) = $162. This figure incorporates the
costs that we estimated associated with preparing the section of the
fund's report on Form N-CEN that will incorporate the information
that will be required under Item C.20. We do not estimate any
additional costs in connection with proposed Item E.5 of Form N-CEN
because the new item only requires a yes or no response. We do not
estimate any change to the external costs associated with Form N-
CEN. The costs associated with these activities are all paperwork-
related costs and are discussed in more detail infra at section V.E.
---------------------------------------------------------------------------

    Based on these estimates, staff further estimates that the total
one-time costs to comply with the disclosure and reporting requirements
will be approximately $55 million for all funds that would file reports
on Form N-PORT in house \1188\ and approximately

$103 million for all funds that will use a third-party service provider
to prepare and file reports on Form N-PORT.\1189\ In addition, staff
estimates that the total ongoing annual costs associated with the
disclosure and reporting requirements would be approximately $1.6
million for all funds that file reports on Form N-PORT in house \1190\
and approximately $2.3 million for all funds that use a third-party
service provider to prepare and file reports on Form N-PORT.\1191\
---------------------------------------------------------------------------

    \1188\ This estimate assumes that 35% of funds (3,271 funds)
would choose to file reports on proposed Form N-PORT in house (see
infra section V.D) and is based on the following calculation: 3,271
funds x $16,845 ($324 + $15,576 + $783 + $162) = $55,099,995.
    \1189\ This estimate assumes that 65% of funds (6,076) would
choose to file reports on proposed Form N-PORT with the assistance
of third-party service providers (see infra section V.D) and is
based on the following calculation: 6,076 funds x $17,106 ($324 +
$15,576 + $1,044 + $ 162) = $103,850,526.
    \1190\ This estimate is based on the following calculation:
3,271 funds x $502.63 ($79.63 + $261 + $162) = $1,644,102.73.
    \1191\ This estimate is based on the following calculation:
6,071 funds x $372.63 ($79.63 + $131 + $162) = $2,262,236.73
---------------------------------------------------------------------------

    Commenters expressed concern that it was not appropriate to require
public disclosure of liquidity classifications by position via Form N-
PORT, arguing that reporting position-level liquidity classifications
creates significant costs which outweigh the potential benefits. For
example, they suggested this disclosure could create potential
litigation exposures, create investor confusion surrounding the
perceived precision of the classifications, stifle innovation in
liquidity risk management, or facilitate predatory trading and/or
first-mover incentives, particularly during times of stress.\1192\ We
agree that funds could have encountered costs related to the above
concerns if they were required to follow the disclosure regime
contemplated in the original proposal. While investors already have
access to fund portfolio positions, to the extent that position-level
liquidity classifications could have been valuable to professional
traders, predatory trading opportunities could have increased under the
proposal. The final form mitigates these costs by requiring that a
fund's most competitively-sensitive information--its individual
position liquidity classifications--be filed confidentially with the
Commission.
---------------------------------------------------------------------------

    \1192\ See, e.g., Federated Comment Letter; Dodge & Cox Comment
Letter; PIMCO Comment Letter; Invesco Comment Letter.
---------------------------------------------------------------------------

    The costs of the adopted form amendments differ from the proposal
in several ways. First, as discussed above, the Form N-PORT only
requires that funds publicly disclose an aggregate liquidity profile,
which should significantly mitigate many of the potential costs
associated with the potential front running of mutual funds by
sophisticated investors. Second, Form N-PORT requires a fund to
disclose the percentage of the fund's highly liquid investments that it
has segregated to cover or pledged to satisfy margin requirements in
connection with derivatives transactions that are classified as
moderately liquid investments, less liquid investments, and illiquid
investments. By contrast, the proposed rules required a fund to pair
each segregated asset with the derivative it was covering. The final
rule's approach should lower costs relative to the proposal. We also
are not requiring funds to file credit agreements as exhibits to Form
N-1A. Many commenters objected to the proposed requirement to file line
of credit agreements \1193\ with some arguing that such filings would
be unnecessary because lines of credit are often already disclosed
under existing requirements of Form N-1A, in a fund's statement of
additional information, in footnotes to fund financial statements, and
potentially in Form N-CEN.\1194\ In addition, commenters stated that
public disclosure of line of credit agreements could (1) weaken their
ability to negotiate credit terms; \1195\ (2) make public proprietary
and competitive information; \1196\ and (3) discourage lending banks
from granting certain lending terms to funds (out of a concern that
terms granted would become standard in other lending agreements).\1197\
Removing the requirement to file credit agreements as exhibits to Form
N-1A should, if anything, lead to a reduction in the costs associated
with filing that form, vis-[agrave]-vis the proposed rule.
---------------------------------------------------------------------------

    \1193\ Fidelity Comment Letter; CRMC Comment Letter; Invesco
Comment Letter; Oppenheimer Comment Letter; T. Rowe Comment Letter;
Voya Comment Letter.
    \1194\ Oppenheimer Comment Letter; T. Rowe Comment Letter; Voya
Comment Letter.
    \1195\ Oppenheimer Comment Letter; Fidelity Comment Letter.
    \1196\ CRMC Comment Letter; Invesco Comment Letter; Oppenheimer
Comment Letter; Voya Comment Letter.
    \1197\ Fidelity Comment Letter.
---------------------------------------------------------------------------

    The requirement to file Form N-LIQUID in three circumstances--if
more than 15% of a fund's net assets are, or become, illiquid
investments that are assets; if the fund's illiquid investments that
are assets previously exceeded 15% of net assets and the fund
determines that its illiquid investments that are assets have changed
to be less than or equal to 15% of net assets; or if a fund's holdings
in highly liquid investments that are assets fall below the fund's
highly liquid investment minimum for more than 7 consecutive calendar
days--may impose small incremental costs on funds. The adopted rule's
liquidity risk management framework should help encourage funds to
avoid exceeding the 15% illiquid investment limit, but in cases where
they must file Form N-LIQUID, there will be incidental costs associated
with filing the form itself. There will be similar incidental costs
associated with filing Form N-LIQUID should a fund breach its highly
liquid investment minimum for more than 7 consecutive calendar days. We
estimate these costs as $1,745 per filing, and estimate the total
number of filings to be roughly 90 per year, for an aggregate cost of
$157,050.\1198\ Finally, any potential indirect costs associated with
filing the form, such as spillover effects or investor flight due to a
breach, should be limited because Form N-LIQUID filings will not be
publicly disclosed. Because Form N-LIQUID filings will be triggered by
events that are part of a fund's periodic review of its investment
classifications under rule 22e-4, the monitoring costs associated with
Form N-LIQUID are included in our estimates of the compliance costs for
rule 22e-4 above.
---------------------------------------------------------------------------

    \1198\ See infra footnotes 1280-1287 and surrounding discussion
for more details on these estimates.
---------------------------------------------------------------------------

d. Effects on Efficiency, Competition, and Capital Formation
    We believe the final rules' disclosure requirements could increase
informational efficiency by providing additional information about the
aggregate liquidity profile of funds' portfolios to investors and
third-party service providers. To the extent that aggregate liquidity
profiles--the percentages a fund holds in each of the four liquidity
classification categories--are comparable across funds, this could
assist investors in evaluating the risks associated with certain funds,
which could increase allocative efficiency by assisting investors in
making more informed investment choices that better match their risk
tolerances. However, because each fund has discretion in how it defines
both the asset type and liquidity classification of its portfolio
positions, the publicly disclosed aggregation of these classifications
may not be directly comparable across funds; in this case, allocative
efficiency may not be enhanced, and, if fund liquidity profiles are
misinterpreted as being comparable, efficiency could be reduced.
Enhanced disclosure regarding funds' liquidity and liquidity risk

management practices could positively affect competition by permitting
investors to choose whether to invest in certain funds based on this
information. However, if investors were to move their assets among
funds as a result of the disclosure requirements (for example, if the
disclosure made clear that a certain fund was able to generate higher
returns than its peers only because of high exposures to relatively
less liquid positions, which then led investors with limited risk
tolerance to move assets out of this fund), this could negatively
affect the competitive stance of certain funds.
    Increased investor awareness of funds' portfolio liquidity and
liquidity risk management practices also could promote capital
formation if investors find certain funds' liquidity profiles or risk
management practices, or both, attractive, and this awareness promotes
increased investment in these funds (assuming these investments consist
of assets that were not otherwise invested in the capital markets) and
in turn in the assets in which the funds invest. On the other hand,
disclosure which reveals liquidity risk could negatively impact capital
formation if the disclosure causes investors to perceive that some
funds pose too great an investment risk. Investors could consequently
decide not to invest in these funds or to decrease their investment in
these funds. If these foregone investments are not reinvested elsewhere
in capital markets, capital formation would be negatively affected.
Conversely, to the extent that investors assume that funds investing in
relatively less liquid investments could obtain a liquidity risk
premium in the form of higher returns over some period of time, the
potential for higher returns could draw certain investors to funds
investing in relatively less liquid asset classes, which could
positively affect capital formation. If investors shift their invested
investments between funds based on liquidity, there could be capital
formation effects stemming from increased (or decreased) investment in
the funds' portfolio investments, even if the total capital invested in
funds remains constant. For example, if fund investors move assets from
an investment strategy that entails relatively high liquidity risk to
one whose investment strategy involves relatively low liquidity risk,
less liquid portfolio asset classes could experience an adverse impact
on capital formation while the more liquid portfolio asset classes
could experience a positive impact on capital formation, although the
total capital invested in funds would remain constant.
    Relative to the proposal, the final disclosure and reporting
requirements do not significantly alter our assessment of the
requirements' impact on efficiency, competition, and capital formation.
The exclusion of individual portfolio position classification from
public disclosure requirements reduces the potential efficiency and
capital formation gains that might accrue from better informed
investors: position-level data could have been used (directly or via
third-party vendor applications) to construct a detailed breakdown of a
fund's liquidity profile, but any public analysis is now limited to an
aggregate liquidity profile for each fund to address the concerns of
commenters regarding the potential costs of disclosing position-level
liquidity data publicly. At the same time, to the extent position-level
liquidity classifications could be valuable to professional traders,
requiring less public disclosure may reduce any potential
inefficiencies that could have resulted from predatory trading or front
running associated with the disclosure of individual investment
classifications.
    In addition, while we are also imposing a new filing requirement
via Form N-LIQUID, this form will be filed confidentially with the
Commission and will only be necessary when a fund breaches the 15%
illiquid investment limit, returns to compliance with the 15% illiquid
investment limit, or breaches its highly liquid investment minimum for
longer than 7 consecutive calendar days. Requiring notice to the
Commission of these events may itself provide an incentive for funds to
manage their liquidity in such a way as to avoid triggering the
reporting obligation; where a reporting obligation is triggered, Form
N-LIQUID will provide the Commission with timely information that may
prompt the Commission to inquire further into the circumstances that
gave rise to the requirement to file Form N-LIQUID. As discussed above,
for example, if a number of similarly-situated funds each file a report
in close temporal proximity to one another, or if a single fund files a
series of reports, such information is likely to be of value to the
Commission in taking appropriate action to protect investors, if
required. If Form N-LIQUID provides an early warning of potential fund
liquidity issues that is sufficiently timely and clear to permit
Commission involvement when needed to respond to the potential for
disruptive fund closures and associated negative consequences,
including fund shareholder dilution and any spillover effects, Form N-
LIQUID could enhance efficiency to the extent that negative price
pressure on investments due to fire sales is avoided and, to the extent
mutual fund investors associate this with lower liquidity risk in the
mutual fund industry, Form N-LIQUID may promote capital formation.
e. Reasonable Alternatives
    The following discussion addresses significant alternatives to the
disclosure and reporting requirements. More detailed alternatives to
the individual elements of the requirements are discussed in detail
above.\1199\
---------------------------------------------------------------------------

    \1199\ See supra sections III.G.1.a, III.G.1.b, III.G.2.d, and
III.G.3.c.
---------------------------------------------------------------------------

    The Commission considered requiring each fund to disclose
information about the liquidity of its portfolio positions in the
fund's prospectus or on the fund's Web site, in addition to in reports
filed on Form N-PORT. For example, we could have required a fund to
disclose its highly liquid investment minimum, or the percentage of the
fund's portfolio invested in each of the liquidity categories specified
under rule 22e-4(b)(2)(i), in its prospectus or on its Web site. This
additional disclosure could further increase transparency with respect
to funds' portfolio liquidity and liquidity-related risks. But this
additional disclosure could inappropriately emphasize risks relating to
a fund's portfolio liquidity over other significant risks associated
with an investment in the fund. In addition, funds are not precluded
from voluntarily disclosing any of the information contained in the
rule's required disclosure forms on their Web sites, so it is likely
more efficient to allow investor demand for this information to drive
whether or not funds publicly disclose this information of their own
volition.
    Conversely, the Commission also considered both limiting and
expanding the enhancements to funds' liquidity-related disclosures on
Form N-PORT. As discussed above, we are sensitive to the possibility
that any amendments to the form could facilitate front-running,
predatory trading, and other activities that could be detrimental to a
fund and its investors. We likewise carefully considered costs and
benefits with respect to the new liquidity-related disclosures required
under Form N-PORT and concluded that these disclosures appropriately
balance related costs with the benefits that could arise from the
ability of the Commission, and members of the public, to monitor and
analyze the liquidity of individual funds, as well as liquidity trends
within the fund industry.

    In response to the proposal, which would have required that certain
position-level data be reported publicly (albeit with a 60 day delay)
commenters suggested that the Commission require (1) no reporting of
any kind, or (2) no public disclosure, in light of potential negative
competitive effects of public reporting and the limited benefits of
stale data in understanding current fund liquidity levels.\1200\ The
Commission considered these alternatives, but rejected the first
alternative because it would have provided no useful information to
investors to permit them to better understand their funds' liquidity
profiles, and no useful information to the Commission to enable the
Commission to better monitor funds' liquidity. With regard to the
second alternative, providing no information to investors would have
the same defect of not permitting investors the opportunity to assess
and make investment decisions based on better information about funds'
liquidity. However, recognizing commenters' concern about voluminous,
stale data, the final form provides investors with aggregated
information--the percentage of the funds' portfolio falling into each
of the four liquidity categories--and reserves the more detailed data
for confidential submission to the Commission. We believe the approach
in the final form strikes an appropriate balance, by mitigating many of
the concerns expressed by commenters while preserving significant
benefits for investors (both directly, and through the Commission's
improved ability to monitor funds).
---------------------------------------------------------------------------

    \1200\ See supra section III.C.6.
---------------------------------------------------------------------------

V. Paperwork Reduction Act Analysis

A. Introduction

    New rule 22e-4 contains ``collections of information'' within the
meaning of the Paperwork Reduction Act of 1995 (``PRA'').\1201\ In
addition, the amendments to Form N-1A will impact the collections of
information burden under those rules and form. The new reporting
requirements on Form N-CEN and Form N-PORT will impact the collections
of information burdens associated with these forms described in the
Investment Company Reporting Modernization Adopting Release.\1202\ New
rule 30b1-10 and new Form N-LIQUID also contain a collection of
information within the meaning of the PRA.\1203\
---------------------------------------------------------------------------

    \1201\ 44 U.S.C. 3501 through 3521.
    \1202\ See Investment Company Reporting Modernization Adopting
Release, supra footnote 120.
    \1203\ See rule 30b1-10 requiring certain funds to file Form N-
LIQUID.
---------------------------------------------------------------------------

    The titles for the existing collections of information are: ``Form
N-1A under the Securities Act of 1933 and under the Investment Company
Act of 1940, Registration Statement of Open-End Management Investment
Companies'' (OMB Control No. 3235-0307). In the Investment Company
Reporting Modernization Adopting Release, we submitted new collections
of information for Form N-CEN and Form N-PORT.\1204\ The titles for
these new collections of information are: ``Form N-CEN Under the
Investment Company Act, Annual Report for Registered Investment
Companies'' and ``Form N-PORT Under the Investment Company Act, Monthly
Portfolio Investments Report.''
---------------------------------------------------------------------------

    \1204\ See Investment Company Reporting Modernization Adopting
Release, supra footnote 120.
---------------------------------------------------------------------------

    We are submitting new collections of information for new rule 22e-
4, new rule 30b1-10, and new Form N-LIQUID under the Investment Company
Act of 1940. The titles for these new collections of information will
be: ``Rule 22e-4 Under the Investment Company Act of 1940, Liquidity
risk management programs,'' ``Rule 30b1-10 Under the Investment Company
Act of 1940, Current report for open-end management investment
companies,'' and ``Form N-LIQUID, Current Report, Open-end Management
Investment Company Liquidity.'' The Commission is submitting these
collections of information to the OMB for review in accordance with 44
U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not conduct or sponsor,
and a person is not required to respond to, a collection of information
unless it displays a currently valid control number.
    The Commission is adopting new rule 22e-4, new rule 30b1-10, new
Form N-LIQUID, and amendments to Form N-1A. The Commission also is
adopting new items to Form N-CEN and Form N-PORT. The new rules and
amendments are designed to promote effective liquidity risk management
throughout the open-end fund industry and enhance disclosure and
Commission oversight of fund liquidity and shareholder redemption
practices. We discuss below the collection of information burdens
associated with these reforms. In the Proposing Release, the Commission
solicited comment on the collection of information requirements and the
accuracy of the Commission's statements in the Proposing Release.

B. Rule 22e-4

    Rule 22e-4 requires a ``fund'' and an In-Kind ETF, each within the
meaning of rule 22e-4,\1205\ to establish a written liquidity risk
management program that is reasonably designed to assess and manage the
fund's or In-Kind ETF's liquidity risk. This program includes policies
and procedures that incorporate certain program elements, including:
(i) For funds, the classification of the liquidity of a fund's
portfolio positions; (ii) for funds and In-Kind ETFs, the assessment,
management, and periodic review of liquidity risk (with such review
occurring no less frequently than annually); (iii) for funds that do
not primarily hold assets that are highly liquid investments, the
determination of and periodic review of the fund's highly liquid
investment minimum and establishment of policies and procedures for
responding to a shortfall of the fund's highly liquid investment
minimum, which includes reporting to the fund's board of directors; and
(iv) for funds and In-Kind ETFs, the establishment of policies and
procedures regarding redemptions in kind, to the extent that the fund
engages in or reserves the right to engage in redemptions in kind. The
rule also requires board approval and oversight of a fund's or In-Kind
ETF's liquidity risk management program and recordkeeping. Rule 22e-4
also requires a limited liquidity review, under which a UIT's principal
underwriter or depositor determines, on or before the date of the
initial deposit of portfolio securities into the UIT, that the portion
of the illiquid investments that the UIT holds or will hold at the date
of deposit that are assets is consistent with the redeemable nature of
the securities it issues and retains a record of such determination for
the life of the UIT and for five years thereafter.
---------------------------------------------------------------------------

    \1205\ The term ``funds'' is defined under rule 22e-4(a)(4) to
mean an open-end management investment company that is registered or
required to be registered under section 8 of the Act and includes a
separate series of such an investment company, but does not include
a registered open-end management investment company that is
regulated as a money market fund under Sec.  270.2a-7 or an In-Kind
ETF, as defined under rule 22e-4(a)(9).
---------------------------------------------------------------------------

    The requirements under rule 22e-4 that a fund and In-Kind ETF adopt
a written liquidity risk management program, report to the board,
maintain a written record of how the highly liquid investment minimum
was determined and written policies and procedures for responding to a
shortfall of the fund's highly liquid investment

minimum, which includes reporting to the fund's board of directors (for
funds that do not primarily hold highly liquid investments), establish
written policies and procedures regarding how the fund will engage in
redemptions in kind, and retain certain other records are all
collections of information under the PRA. In addition, the requirement
under rule 22e-4 that the principal underwriter or depositor of a UIT
assess the liquidity of the UIT on or before the date of the initial
deposit of portfolio securities into the UIT and retain a record of
such determination for the life of the UIT, and for five years
thereafter, is also a collection of information under the PRA. The
respondents to rule 22e-4 will be open-end management investment
companies (including, under certain circumstances, In-Kind ETFs but
excluding money market funds), and the principal underwriters or
depositors of UITs under certain circumstances.
1. Preparation of Written Liquidity Risk Management Program
    We believe that some open-end funds regularly monitor the liquidity
of their portfolios as part of the portfolio management function, but
they may not have written policies and procedures regarding liquidity
management. Rule 22e-4 requires funds and In-Kind ETFs to have a
written liquidity risk management program. We believe such a program
will minimize dilution of shareholder interests by promoting stronger
and more effective liquidity risk management across open-end funds and
will reduce the risk that a fund or In-Kind ETF will be unable to meet
redemption obligations.
    In the Proposing Release, we estimated that funds within 867 fund
complexes would be subject to rule 22e-4.\1206\ Compliance with rule
22e-4 would have been mandatory for all such funds. We further
estimated that a fund complex would incur a one-time average burden of
40 hours associated with documenting the liquidity risk management
programs adopted by each fund within the complex. Under the proposal,
rule 22e-4 would have required fund boards to approve the liquidity
risk management program and any material changes to the program, and we
estimated a one-time burden of nine hours per fund complex associated
with fund boards' review and approval of the funds' liquidity risk
management programs and preparation of board materials. Amortized over
a 3-year period, we estimated this would be an annual burden per fund
complex of about 16 hours. Accordingly, we estimated that the total
burden for initial documentation and review of funds' written liquidity
risk management program would be 42,483 hours.\1207\ We also estimated
that it would cost a fund complex approximately $38,791 to document,
review and initially approve these policies and procedures, for a total
cost of approximately $33,631,797.\1208\
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    \1206\ See Proposing Release, supra footnote 9, at n.819 and
accompanying text. This estimate excluded ETFs and UITs. See also
2016 ICI Fact Book, supra footnote 11, at Fig. 1.8.
    \1207\ This estimate was based on the following calculation: (40
+ 9) hours x 867 fund complexes = 42,483 hours.
    \1208\ These estimates were based on the following calculations:
20 hours x $301 (hourly rate for a senior portfolio manager) =
$6,020; 20 hours x $455.5 (blended hourly rate for assistant general
counsel ($426) and chief compliance officer ($485)) = $9,110; 5
hours x $4,465 (hourly rate for a board of 8 directors) = $22,325; 4
hours (for a fund attorney's time to prepare materials for the
board's determinations) x $334 (hourly rate for a compliance
attorney) = $1,336. $6,020 + $9,110 + $22,325 + $1,336 = $38,791;
$38,791 x 867 fund complexes = $33,631,797. The hourly wages used
are from SIFMA's Management & Professional Earnings in the
Securities Industry 2013, modified to account for an 1800-hour work-
year and multiplied by 5.35 to account for bonuses, firm size,
employee benefits, and overhead. The staff previously estimated in
2009 that the average cost of board of director time was $4,000 per
hour for the board as a whole, based on information received from
funds and their counsel. Adjusting for inflation, the staff
estimates that the current average cost of board of director time is
approximately $4,465.
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    We did not receive any comments on the estimated hour and costs
burdens associated with the overall preparation of written liquidity
risk management programs under rule 22e-4 discussed above. We did,
however, receive comments on the costs associated with the
classification of the liquidity of a fund's portfolio positions, which
we address below in connection with Form N-PORT. The Commission has
modified the estimated increase in annual burden hours and total time
costs that will result from the new written liquidity risk management
requirements of rule 22e-4 based on certain modifications made to rule
22e-4 and updates to the industry data figures that were utilized in
the Proposing Release. Based upon our review of industry data, we
estimate that funds within 873 fund complexes would be subject to rule
22e-4,\1209\ updated from 867 in our proposal. Compliance with rule
22e-4 will be mandatory for all such funds and In-Kind ETFs, with
certain program elements applicable to certain funds within a fund
complex based upon whether the fund is an In-Kind ETF or does not
primarily hold assets that are highly liquid investments, as noted
above. We discuss mandatory compliance with rule 22e-4 with respect to
principal underwriters and depositors of UITs in section V.B.5. below.
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    \1209\ See 2016 ICI Fact Book, supra footnote 11, at Fig. 1.8.
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    The Commission continues to estimate that a fund complex will incur
a one-time average burden of 40 hours associated with documenting the
liquidity risk management programs adopted by each fund within a fund
complex. In light of the requirement that a fund subject to the highly
liquid investment minimum requirement adopt and implement policies and
procedures for responding to a shortfall of the fund's highly liquid
investment minimum, and responding to any potential excesses of the 15%
illiquid asset limit, both of which include reporting to the fund's
board of directors, we estimate a one-time burden of 10 hours, rather
than 9 hours, per fund complex associated with fund boards' review and
approval of the funds' liquidity risk management programs and
preparation of board materials. Amortized over a 3-year period, we
estimate this will be an annual burden per fund complex of about 16.67
hours. Accordingly, we estimate that the total burden for initial
documentation and review of funds' written liquidity risk management
program will be 43,650 hours.\1210\ We also estimate that it will cost
a fund complex approximately $41,467.5 to document, review, and
initially approve these policies and procedures, for a total cost of
approximately $36,201,127.5.\1211\
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    \1210\ This estimate is based on the following calculation: (40
+10) hours x 873 fund complexes = 43,650 hours.
    \1211\ These estimates are based on the following calculations:
20 hours x $306 (hourly rate for a senior portfolio manager) =
$6,120; 20 hours x $463 (blended hourly rate for assistant general
counsel ($433) and chief compliance officer ($493)) = $9,260; 5.5
hours x $4,465 (hourly rate for a board of 8 directors) = $24,557.5;
4.5 hours (for a fund attorney's time to prepare materials for the
board's determinations) x $340 (hourly rate for a compliance
attorney) = $1,530. $6,120 + $9,260 + $24,557.5 + $1,530 =
$41,467.5; $41,467.5 x 873 fund complexes = $36,201,127.5. The
hourly wages used are from SIFMA's Management & Professional
Earnings in the Securities Industry 2013, modified by Commission
staff to account for an 1800-hour work-year and inflation, and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. The staff previously estimated in 2009 that
the average cost of board of director time was $4,000 per hour for
the board as a whole, based on information received from funds and
their counsel. Adjusting for inflation, the staff estimates that the
current average cost of board of director time is approximately
$4,465.
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2. Reporting Regarding the Highly Liquid Investment Minimum
    Rule 22e-4 requires any fund that does not primarily hold assets
that are highly liquid investments to determine

a highly liquid investment minimum for the fund, which must be reviewed
at least annually, and may not be changed during any period of time
that a fund's assets that are highly liquid investments are below the
determined minimum without approval from the fund's board of
directors.\1212\ The fund's investment adviser or officers designated
to administer the liquidity risk management program must provide a
written report to the fund's board at least annually that describes a
review of the adequacy and effectiveness of the fund's liquidity risk
management program, including, if applicable, the operation of the
highly liquid investment minimum.\1213\ In addition, the fund must
adopt and implement policies and procedures for responding to a
shortfall of the fund's assets that are highly liquid investments below
its highly liquid investment minimum, which must include reporting to
the fund's board of directors with a brief explanation of the causes of
the shortfall, the extent of the shortfall, and any actions taken in
response, and, if the shortfall lasts more than 7 consecutive calendar
days, an explanation of how the fund plans to come back into compliance
with its minimum within a reasonable period of time.\1214\
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    \1212\ See rule 22e-4(b)(1)(iii)(A).
    \1213\ See rule 22e-4(b)(3)(iii).
    \1214\ See rule 22e-4(b)(1)(iii)(A)(3).
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    Similar to the highly liquid investment minimum, in the Proposing
Release, we proposed that funds be required to establish a three-day
liquid asset minimum as part of a fund's liquidity risk management
program, subject to board review, and we estimated that, for each fund
complex, compliance with this reporting requirement would entail: (i)
Five hours of portfolio management time, (ii) five hours of compliance
time, (iii) five hours of professional legal time and (iv) 2.5 hours of
support staff time, requiring an additional 17.5 burden hours at a time
cost of approximately $5,193 per fund complex to draft the required
report to the board.\1215\ We estimated that the total burden for
preparation of the board report would be 15,173 hours, at an aggregate
cost of $4,502,331.\1216\
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    \1215\ This estimate was based on the following calculation: 5
hours x $301 (hourly rate for a senior portfolio manager) = $1,505;
5 hours x $283 (hourly rate for compliance manager) = $1,415; 5
hours x $426 (hourly rate for assistant general counsel) = $2,130;
and 2.5 hours x $57 (hourly rate for general clerk) = $143. $1,505 +
$1,415 + $2,130 + $143 = $5,193. The hourly wages used were from
SIFMA's Management & Professional Earnings in the Securities
Industry 2013, modified to account for an 1800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. The hourly wage used for the general clerk
was from SIFMA's Office Salaries in the Securities Industry 2013,
modified to account for an 1800-hour work-year and multiplied by
2.93 to account for bonuses, firm size, employee benefits, and
overhead.
    Because, under the proposal, each fund within a fund complex
would be required to determine its own three-day liquid asset
minimum, this estimate assumed that the report at issue would
incorporate an assessment of the three-day liquid asset minimum for
each fund within the fund complex.
    \1216\ These estimates were based on the following calculations:
867 fund complexes x 17.5 hours = 15,173 hours; and $5,193 x 867
fund complexes = $4,502,331.
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    We received several comments addressing, in general, the potential
costs associated with a fund establishing and implementing a liquid
asset minimum. To minimize the costs of implementing a liquid asset
minimum, one commenter recommended that funds that have demonstrated a
history of investing in only three-day liquid assets be excluded from
the proposed three-day liquid asset minimum requirements and thus not
incur the costs of related board reporting requirements.\1217\ Other
commenters characterized the program requirements under the proposal as
a one-size-fits-all approach to liquidity risk management and expressed
the belief that such requirements were expensive and unsuitable for
many funds.\1218\
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    \1217\ See CFA Comment Letter.
    \1218\ See, e.g., Dechert Comment Letter; Federated Comment
Letter.
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    As discussed above, the Commission has modified the proposed three-
day liquid asset minimum requirement to a highly liquid investment
minimum requirement that is tailored to apply only to funds that do not
primarily hold highly liquid investments, thereby potentially reducing
the number of funds required to establish, maintain, and report a
highly liquid investment minimum. In addition, the final rule retains a
role for the board in overseeing the fund's liquidity risk management
program, but eliminates certain of the more specific and detailed
approval requirements originally proposed.\1219\ Unlike the proposal,
however, rule 22e-4 requires a fund that is subject to the highly
liquid investment minimum requirement to also adopt and implement
policies and procedures to respond to a shortfall of assets that are
highly liquid investments below the fund's highly liquid investment
minimum, which includes reporting to the fund's board of directors.
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    \1219\ See supra section III.H.3.
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    In light of these modifications, we estimate that the burdens
associated with board reporting will decrease overall in comparison to
the proposal due to the elimination of certain board oversight
requirements originally proposed and the potential reduction in the
number of funds that would require board oversight of a highly liquid
investment minimum. Therefore, we have modified the estimated annual
burden hours and total costs that will result from the highly liquid
investment minimum requirement under rule 22e-4.\1220\ We estimate
that, for each fund complex, compliance with the reporting requirement
would entail: (i) 4 Hours, rather than five hours, of portfolio
management time; (ii) 4 hours, rather than five hours, of compliance
time; (iii) 4 hours, rather than five hours, of professional legal
time; and (iv) 2 hours, rather than 2.5 hours, of support staff time,
requiring an additional 14 burden hours at a time cost of approximately
$4,224 per fund complex to draft the required report to the