A. Overview

The Securities and Exchange Commission recently approved new, and amended existing, rules and forms[1] that (i) are intended to enhance liquidity risk management by registered open-end management investment companies (open-end funds); (ii) make changes to reporting and disclosure of information by such companies; and (iii) permit, but do not require, open-end funds, other than money market funds and exchange-traded funds (ETFs), to utilize “swing pricing.” Money market funds are exempt from most requirements and exchange-traded funds that redeem “in-kind” are exempt from certain requirements.[2] As used herein, the term “funds” refers to both open-end investment companies (mutual funds) and ETFs, but not money market funds, unless otherwise specified. This alert summarizes the new rules and forms especially with respect to new Rule 22e-4, Form N-CEN, Form N-PORT and amended Rule 22c-1. Readers should be aware that the Releases (as defined in footnote 1 below) contain additional and substantive information and therefore should be read in conjunction with interpreting the new requirements.

The Releases were issued in response to two key concerns of the Investment Company Act of 1940, as amended (1940 Act): fund liquidity and shareholder dilution. The SEC believes that these changes will help to strengthen a fund’s ability to maintain liquidity to meet shareholder redemptions while minimizing the effect of such redemptions on such fund’s remaining shareholders.[3] These changes also will update the existing reporting protocols for funds under the 1940 Act, and provide additional information and data to the SEC and fund shareholders. As written, the new rules and other changes require funds and their advisers to make many judgments and decisions in implementing the new mandated policies and procedures, as well as to review them in light of current market conditions during the life of such funds. Further, the SEC relies on increased board oversight as a key element of implementation, as discussed below.[4]

B. New Rule 22e-4: Liquidity Risk Management Programs

New Rule 22e-4 requires each fund to adopt and implement a written liquidity risk management program (Program) that is both “reasonably designed to assess and manage its liquidity risk,”[5] and suitably tailored to take into account the liquidity risks specifically applicable to each such fund.[6] Rule 22e-4 contains a definition of “liquidity risk” that is centered on the key concept that a fund should be able to meet its redemption requests without significant dilution of remaining investors’ interests. [7]

1.Program Design

Under Rule 22e-4, a fund must design its Program to (i) assess, manage and periodically review its portfolio’s liquidity risk;, (ii) classify each of its portfolio investments into one of the four liquidity types discussed below and file a report with the SEC showing such classifications on new Form N-PORT (Form N-PORT, as discussed in more detail below); and (iii) establish a “highly liquid investment minimum” (Liquidity Minimum). The Liquidity Minimum is the minimum percentage of portfolio assets that the fund must hold in “highly liquid investments” which can be exchanged for cash within three business days without significantly changing such investments’ market value.[8] Note that an “In-Kind ETF”[9] is not required to classify its portfolio investments nor report to the SEC on Form N-PORT, and therefore is not required to determine a Liquidity Minimum.

2.Consideration of Required Program Elements

When designing and reviewing its Program, each fund (including In-Kind ETFs) must consider the following elements, as applicable: (i) the fund’s investment strategy and liquidity of its portfolio investments during both normal and reasonably foreseeable stressed conditions, including the appropriateness of such investments for an open-end fund structure, the concentration of its portfolio assets or the holding of large positions in certain issuers, and the use of borrowing for derivatives and investment purposes; (ii) the fund’s short-term and long-term cash flow projections during both normal and reasonably foreseeable stressed conditions; and (iii) the fund’s holdings of cash and cash equivalents as well as the Program’s use of borrowing arrangements for investment purposes and other funding sources.[10] Additionally, each ETF must consider the following two elements when establishing a Program: (i) the relationship between such ETF’s portfolio liquidity and the way in which its shares trade, taking into account both prices and spreads, the efficiency of the arbitrage function and the level of active participation by market participants (including authorized participants), and (ii) the effect of the composition of creation and redemption baskets on the overall liquidity of such ETF’s portfolio.[11]

3.Classification of Portfolio Holdings into Liquidity Categories

Rule 22e-4 also imposes a new liquidity classification system for each fund’s portfolio (although this does not apply to In-Kind ETFs). On at least a monthly basis,[12] each fund must individually classify its portfolio investments into one of four specified liquidity categories listed below, which categories are based on a “days to cash” calculation; that is, the number of days in which the fund reasonably expects an investment would be convertible to cash in current market conditions without significantly changing the market value of the investment. In addition, this determination must be made after assessing information that has been obtained after reasonable inquiry and taking into account “the relevant market, trading and investment-specific considerations” for portfolio holding.[13] A fund may, but is not required to, utilize third party service providers to provide data and analysis relevant to investment liquidity, or to help assess the liquidity of a specific holding or an asset class, and should consider reviewing the quality of such data and information, as well as the methodologies used and metrics analyzed by such parties.[14]

The four liquidity categories are:

  • “highly liquid investments”[15] —cash and any investments reasonably expected to be convertible to cash in current market conditions in three business days or less without significantly changing the market value of the investment (Category 1);
  • “moderately liquid investments”[16] —those investments reasonably expected to be convertible to cash in current market conditions in more than three but less than seven calendar days without significantly changing the market value of the investment (Category 2);
  • “less liquid investments”[17] —those investments reasonably expected to be convertible to cash in current market conditions in less than seven calendar days but which will settle in more than seven calendar days (Category 3); and
  • “illiquid investments”[18] —those investments reasonably expected not to be convertible to cash in current market conditions in less than seven calendar days without significantly changing the market value of the investment (Category 4).

Under Rule 22e-4, funds are permitted to classify their portfolio investments by asset class, unless market, trading, or investment-specific considerations with respect to a particular investment are expected to significantly affect the liquidity characteristics of that investment as compared to the fund’s other portfolio holdings within that asset class.[19] Funds are required to review the classifications of their portfolio investment at least once a month and report such classifications for each portfolio investment to the SEC on new Form N-PORT.[20]

4.Establishment and Review of Highly Liquid Investment Minimum

Rule 22e-4 requires each fund, other than In-Kind ETFs and funds “primarily holding highly liquid investments,”[21] to determine a minimum percentage of its net assets that must be invested in Category 1 highly liquid investments as its Liquidity Minimum. Rule 22e-4 does not specify a minimum amount or otherwise state any numerical thresholds but rather expects each fund to make an individual determination of its Liquidity Minimum based on the fund’s analysis of the liquidity elements discussed above under the heading “Consideration of Required Program Elements.”[22] Each fund is required to report confidentially to the SEC its Liquidity Minimum on new Form N-PORT on a monthly basis,[23] and must maintain a written record of how its Liquidity Minimum was derived, including an assessment of each of the liquidity elements used to determine such amount.[24]

Although a fund is not prevented from acquiring securities that are not highly liquid investments if the fund falls below its Liquidity Minimum, Rule 22e-4 requires such fund to report the shortfall to its board at the next scheduled meeting.[25] Further, if a fund falls below its Liquidity Minimum for more than seven calendar days, it must (i) report such occurrence to the board within one business day, (ii) confidentially notify the SEC on new Form N-LIQUID[26] within one business day, and (iii) create and submit to the board a plan for restoring the threshold amount within a reasonable period of time.[27] A fund’s board is not required to approve the amount or level of the Liquidity Minimum, nor approve changes to it, except in those cases where a fund seeks to change the Liquidity Minimum during the period in which the fund falls below its pre-existing threshold.[28]

5.Codification of 15% Limitation on Illiquid Assets

Rule 22e-4 also prohibits a fund from acquiring illiquid investments if such activity will cause the fund’s Category 4 illiquid investments to exceed 15% of its net assets.[29] This rule codifies the SEC’s long established guidance with respect to holding illiquid securities.[30] A fund is required to make this calculation monthly using the same process as it does for its other portfolio liquidity classifications, and also must review its illiquid investments at least monthly. If a fund exceeds its 15% limit, it must report the occurrence to its board within one business day, and present an explanation of the method by which the fund plans to bring its illiquid investments back to its 15% limit within a reasonable period of time.[31] If the amount of the fund’s illiquid investments exceeds its 15% limit after thirty days from the occurrence, and again for each consecutive thirty day period thereafter, the fund’s board, including a majority of its independent directors, must assess whether the fund’s remedial plan (as presented to the board) continues to be in the best interest of the fund and its shareholders.[32]

6.Redemptions In-Kind

An In-Kind ETF, as well as any fund providing, or reserving the right to provide, redemptions in-kind, must establish and state its policies and procedures with respect to how and when it will engage in such redemptions.[33] Any In-Kind ETF is expected to include in its description of its policies and procedures for its Program, to the extent applicable, (i) how such ETF analyzes its ability to redeem in-kind in both normal and stressed market conditions, (ii) the circumstances in which such In-Kind ETF may use a de minimis amount of cash to meet a redemption, and (iii) the amount of cash it would characterize as a de minimis amount. In making these determinations, an In-Kind ETF should consider, to the extent applicable, the amount and frequency with which cash is used to meet redemptions; as well as the circumstances and rationale for using cash to meet redemptions.[34]

7.Board Oversight of the Program

Rule 22e-4 also imposes board oversight over the Program, and requires board approvals in certain circumstances. A fund’s board, including a majority of the fund’s independent directors, must approve the fund’s Program and the designation of the fund’s adviser or officer(s) to administer the Program.[35] The board, however, is not required to approve the level or amount of the Liquidity Minimum, which is determined solely by the fund. The fund’s board must also review, at least annually, a written report on the adequacy of the Program and the effectiveness of its implementation including, if applicable, the operation of its Liquidity Minimum, as well as any material changes to the Program.[36] Note, however, that a fund cannot change the level or amount of its Liquidity Minimum during any time period in which its highly liquid investments are below the established Liquidity Minimum without receiving approval from its board, including a majority of disinterested directors.[37]

C. Reporting Requirements and New Forms to File with the SEC


The SEC also amended rules relating to reporting requirements that are intended to enhance fund disclosure and reporting regarding a fund’s redemption practices, its portfolio liquidity, and certain of its liquidity risk management practices. The amended rules require additional data reporting using a new annual reporting form (Form N-CEN) for mutual funds, ETFs and other registered investment companies.[38] Form N-CEN, which replaces the current semiannual reporting on Form N-SAR requires census-type information reported in a structured data format. All registered funds (including ETFs but excluding money market funds and small business investment companies) must also file a Form N-PORT on a monthly basis, which report provides information about a fund’s complete portfolio.[39] Every third month, a fund’s Form N-PORT will be made available to the public sixty (60) days after the end of the quarter.[40] Funds must report the information about their portfolio holdings required by Form N-PORT and Form N-CEN in an XML format. [41]

New Form N-CEN requires a fund to provide the SEC with a wide variety of specific information about the fund’s structure, reliance on rules and exemption orders, third party service providers and the like. In addition, ETFs must report substantial information about certain activities, such as the fund’s creation and redemption activities, each of the fund’s authorized participants (APs) and report the dollar value of creation units that each AP purchased and redeemed from the ETF during the reporting period.[42] Each ETF must also report on Form N-CEN whether its APs were required to post collateral to such fund or any of its designated service providers in connection with the acquisition or redemption of its shares during the reporting period.[43] In addition, ETFs are obliged to report the average transaction fee (i) charged in dollars per creation unit, (ii) charged for one or more creation units on the same business day and (iii) charged as a percentage of the value of a creation unit.[44] Also, ETFs are required to report, with respect to those creation units purchased by APs that were fully or partially comprised of cash, the average transaction fee (i) charged in dollars per creation unit, (ii) charged for one or more creation units on the same business day and (iii) charged as a percentage of the value of the cash in the creation unit.[45]

2.Books and Records

Rule 22e-4 requires funds to keep specific records, including those relating to the establishment of a fund’s initial Program and associated policies and procedures, the determination of the fund’s Liquidity Minimum and related policies and procedures, including those pertaining to the fund’s plan to respond to a shortfall below its Liquidity Minimum, any adjustments thereto, responses to one or more actual shortfall(s), and any materials provided to the board in connection with all of the foregoing.[46] Further, funds must provide comprehensive information about many transactions, including their use of derivatives, securities lending activities, liquidity and pricing of portfolio instruments.[47]


Certain elements of a fund’s Program must be disclosed to the public on the new forms N-PORT and N-CEN mentioned above, including whether the fund qualifies as an In-Kind ETF under the definition contained in Rule 22e-4, as well as its use of lines of credit and other borrowing sources.[48]

In addition, Form N-1A has been amended to require all open-end funds, including ETFs and money market funds, to disclose their redemption procedures, including the typical number of days a fund expects to pay proceeds to a shareholder following receipt of its redemption request.[49] Further, each fund must describe the methods by which it usually plans to meet redemption requests, both in normal and stressed market conditions (for example by holding cash reserves, paying redemptions in–kind or selling portfolio assets).[50]

D. Amended Rule 22c-1: Swing Pricing


In order to mitigate potential shareholder dilution and manage liquidity risk, the SEC’s amended Rule 22c-1 permits funds (other than money market funds and ETFs) to engage in “swing pricing.” “Swing pricing” is the process of adjusting a fund’s NAV per share to pass on to purchasing or redeeming shareholders certain costs associated with their trading activity. Open-end funds may adopt “swing pricing” on a voluntary basis; that is, they are permitted but not required to use “swing pricing.”

Rule 22c-1(a)(3) provides that a fund using “swing pricing” must adjust its NAV by a specified amount—the “swing factor”—once the level of net purchases into, or net redemptions from, the fund has exceeded a preset specified percentage or percentages of the fund’s NAV known as the “swing threshold.” A fund’s swing pricing policies and procedures must specify the process for how such fund’s swing factor and swing threshold was determined (taking into account certain considerations) as well as establish and disclose an upper limit on the swing factor used, which may not exceed 2% of NAV per share.[51]

2.Board Oversight

The board of each fund electing to use swing pricing must approve the funds’ related policies and procedures, as well as periodically review the fund’s written report that, among other things, assessing the adequacy of the funds’ swing pricing policies and procedures as well as the efficacy of their implementation.[52] The board is also required to approve the funds’ swing factor upper limit, swing pricing threshold, and any changes thereto,[53] as well as designate the fund’s officer(s) responsible for administering the swing pricing policies and procedures.[54]

3.Reporting and Disclosure

In addition, the SEC adopted amendments to Rule 31a-2 to require funds using swing pricing to maintain records evidencing and supporting each computation of an adjustment to the fund’s NAV based on its current “swing pricing” policies and procedures. Also, the SEC adopted amendments to Form N-1A and Regulation S-X, and adopted an item in Form N-CEN, to require a fund to publicly disclose certain information regarding its use of “swing pricing,” including a fund’s “swing factor” upper limit.[55]

E. Compliance Dates

The compliance date for the implementation of the Program under Rule 22e-4 and reporting on Form N-LIQUID under Rule 30b1-10 is December 1, 2018 for entities with net assets equal to $1 billion dollars or more, and June 1, 2019 for entities with net assets equal to less than $1 billion dollars.

The compliance date for reporting on Forms N-PORT and N-CEN is June 1, 2018 for entities with net assets equal to $1 billion or more, and June 1, 2019 for entities with net assets equal to less than $1 billion.

The SEC has delayed the effective date of amendments that would permit funds to use swing pricing to a date that will be twenty-four months following publication in the Federal Register.