SEC Rescinds Staff Position Limiting Registered Closed-End Funds’ Investments in Private Funds

Key Takeaways

• When reviewing CE-FOPF registration statements, Division staff will no longer request that the registrant either (i) include accredited investor status and $25,000 minimum investment requirements or (ii) limit its private fund investments to 15% of its assets.
• CE-FOPF registration statements must include robust disclosures regarding costs, risks, strategies, and underlying private fund characteristics.
• In light of the new guidance, registrants should carefully consider whether it is necessary file a post-effective amendment pursuant to Rule 486(a) or Rule 486(b) or a prospectus supplement pursuant to Rule 424 and engage with Division staff as needed.

Background

Historically, Division staff comments led many CE-FOPFs investing 15% or more in private funds to restrict their offerings to “accredited investors”[1] as defined under Regulation D of the Securities Act of 1933 (the “1933 Act”) and require minimum initial investments of at least $25,000. This staff position was not reflected in any statute or formal rule.  

ADI Summary

The ADI clarifies that Division staff will no longer issue comments suggesting that CE-FOPFs restrict their offerings to accredited investors or limit private fund investments to 15% of their assets. The ADI notes that existing regulatory protections under federal securities laws provide adequate protection of investors in CE-FOPFs that indirectly invest in private funds. These include requirements that the CE-FOPF: (i) be managed by a registered investment adviser that owes fiduciary duties to the fund; (ii) be overseen by a board of directors, that also has fiduciary duties to the fund; and (iii) make certain periodic disclosures and bear liability for material omissions and misstatements. CF-FOPFs are also subject to the Investment Company Act of 1940 (the “1940 Act”) and the rules promulgated thereunder, which impose high governance standards, require written compliance programs reasonably designed to ensure that the CE-FOPF does not violate federal securities laws, and impose leverage and capital structure limits, and restrictions on conflicted affiliate transactions.

The ADI also emphasizes areas that the Division staff will remain focused on when reviewing CE-FOPF registration statements, including:

• Plain English and Material Information: Registration statements must be clear, concise, and comply with the “plain English” rule.[2] All material information required by Form N-2 must be disclosed.
• Costs, Strategies, and Risks: CE-FOPFs should fully disclose costs, strategies, risks, and due diligence practices when evaluating private fund investment opportunities. Liquidity terms must be clearly and prominently disclosed. 
• Fee Structures and Netting Risk: Disclosures should describe the fee structures imposed by the underlying private funds, including performance-related fees, and discuss how multiple fee layers affect investor returns. The possibility that certain of the underlying private funds may receive performance fees, despite negative overall performance (i.e., “netting risk”), should be disclosed.
• Underlying Private Fund Characteristics: CE-FOPFs should provide a full discussion of the types of private funds in which they can invest and associated material risks and considerations (e.g., speculative investments, conflicts of interest, and liquidity). CE-FOPFs should also disclose that shareholders may have limited information about the underlying private funds in which a CE-FOPF is investing, including with respect to the underlying private funds’ holdings, liquidity, and valuation.
• Regulatory Differences: CE-FOPFs should clarify that the underlying private funds in which they invest are not subject to protections under the 1940 Act, which may impact the CE-FOPF’s strategies, risks, and costs.
• Additional Material Risks: CE-FOPFs should consider disclosing risks related to legal jurisdictions of the underlying private funds, liquidity terms (e.g., redemption limitations, payments in kind) for its private fund investments, and tax considerations when investing in private funds that could impact the CE-FOPF’s pass-through status as a Regulated Investment Company (RIC) under Subchapter M of the Internal Revenue Code.

Next Steps: Updates to Registration Statements

The ADI states that CE-FOPFs that are currently operating and that have invested or seek to invest more than 15% of their assets in private funds and that have removed or plan to remove accredited investor and/or investment minimum limitations should file (i) amendments to their registration statements pursuant to Rule 486(a) or Rule 486(b) of the 1933 Act or (ii) prospectus supplement updates under Rule 424 of the 1933 Act, as appropriate. CE-FOPFs should consider whether these cumulative changes are material, which would require Division staff review of a post-effective amendment to the CE-FOPF’s registration statement under Rule 486(a). 

Registrants that currently limit private fund exposure to 15% of assets and never imposed accredited investor and/or investment minimum shareholder limitations on their registration statements and now seek to remove the 15% limitation should file a post‑effective amendment filing pursuant to Rule 486(a), subject to Division staff review.

The ADI encourages registrants to consult with Division staff regarding appropriate filings and disclosures for CE-FOPFs.

[1] See Rule 501(a) of Regulation D under the 1933 Act for the definition of “accredited investor.”

[2] See, e.g., Rule 421(d) under the 1933 Act; see also, e.g., Rule 481 under the 1933 Act.