On March 5, 2026, the staff of the SEC’s Division of Investment Management issued updated frequently asked questions (FAQs) related to fund of funds arrangements under Rule 12d1-4 under the Investment Company Act of 1940 (Fund of Funds Rule). The staff originally issued three FAQs in April 2021, and the update provides a fourth FAQ related to an acquired fund’s investments in debt securities issued by collateralized loan obligations (CLOs).
The Fund of Funds Rule generally prohibits acquired funds (as defined in the Rule) from acquiring the securities of an investment company or private fund if, immediately after the acquisition, the securities of investment companies and private funds owned by the acquired fund would exceed 10% of the acquired fund’s total assets, with certain limited exceptions (the 10% bucket). This limitation is intended to avoid duplicative fees and expenses and investor confusion that can result from multi-tier fund of funds structures. Many CLO issuers are private funds for purposes of the Fund of Funds Rule because they rely on an exclusion from the definition of “investment company” provided under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act, and therefore their securities count towards the 10% bucket. This restriction generally limits the ability of funds to invest in an underlying fund that holds securities issued by CLOs.
The new FAQ guidance provides that the SEC staff would not recommend an enforcement action under applicable sections of the Investment Company Act if an acquired fund does not count debt securities issued by CLOs towards the 10% bucket. The guidance does not apply to equity securities issued by CLOs. The staff explained that because CLO debt securities earn principal and interest on the financing costs of the underlying collateral, rather than provide economic exposure to the underlying collateral like CLO equity securities, CLO debt securities do not implicate the policy concerns regarding multi-tier fund of funds structures that the 10% bucket restriction is intended to address.
This guidance provides greater flexibility for funds of funds, including target-date funds, to invest in funds that hold CLO debt securities, enhancing access to those strategies and leveling the playing field with other funds that invest in similar structured credit assets, such as mortgage-backed securities.
The updated FAQs are available here. The Investment Company Institute (ICI) also released a statement in support of the guidance, which is available here.
