Understanding The 3 Exemption
The exemption, found in section three of the act, reads in part:
Section 3 Notwithstanding subsection , none of the following persons is an investment company within the meaning of this title: Any issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers, and which is not making and does not at that time propose to make a public offering of such securities.
To qualify for the 3C7 exemption, the private investment company must show that they have no plans of making an initial public offering and that their investors are qualified purchasers. A qualified purchaser is a higher standard than an accredited investor it requires that the investor owns not less than $5 million in investments. The term qualified purchaser is defined in Section 2 of the Investment Company Act.
3C7 funds are not required to go through Securities and Exchange Commission registration or provide ongoing disclosure. They are also exempt from issuing a prospectus that would outline investment positions publicly. 3C7 funds are also referred to as 3C7 companies or 3 funds.
This frees up these funds to use tools like leverage and derivatives to an extent that most publicly traded funds cannot. The vast majority of new hedge funds, private equity funds, venture capital funds, and other private investment vehicles are organized so as to fall outside the purview of the Investment Company Act of 1940.
Section 3 Of The Investment Company Act Now Allows Small Vc Funds To Have Up To 250 Investors
Economic Growth, Regulatory Relief and Consumer Protection Act Section 3new Section 3Section 2Rule 203-1This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to its author, Arina Shulga. Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law. She is also a member of Wall Street Blockchain Alliance.12:29 PM
Who Is The Sec Accountable To
The SEC is an independent federal agency that is headed by a bipartisan five-member commission, comprised of the Chairman and four Commissioners who are appointed by the President and confirmed by the U.S. Senate. The SEC is accountable to Congress as it operates under the authority of federal laws including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, the Investment Advisers Act of 1940, and the Sarbanes-Oxley Act of 2002 , among others.
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Investment Company Registration And Regulation Package
This Investment Company Registration and Regulation Package contains general information about investment companies and supersedes the Investment Company Registration Package that was previously distributed in a printed format. Due to continuous changes in the federal securities laws, we no longer print the Investment Company Registration Package in hard copy. All of the information that was contained in the prior version, however, is now available through hyperlinks to Internet web sites, which are provided below. Further, SEC publications are available from the SECs Publications Office by calling 551-4040.
Commission And Shareholder Reports
After registering with the Commission, investment companies periodically must file certain reports with the Commission and send certain reports to their shareholders. For example, registered management investment companies must file Form N-CSR within ten days after the transmission to shareholders of any annual or semi-annual report that is required to be transmitted to shareholders pursuant to Rule 30e-1 under the Investment Company Act.
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Exceptions To The Control And Voting Conditions
The Final Rule contains two notable exceptions to the control and voting conditions. These conditions will not be applicable when: an acquiring fund is within the same group of investment companies as an acquired fund or the acquiring funds investment sub-adviser or any person controlling, controlled by or under common control with such investment sub-adviser acts as the acquired funds investment adviser or depositor. While the Final Rule will subject fund of funds arrangements within these exclusions to a more limited set of conditions than other fund of funds arrangements, fund of funds arrangements within these exclusions are still subject to other protections.
How To Avoid Registration Under The Investment Company Act Of 1940
One of the worse situations a company may face to be determined to be an investment company under the Investment Company Act of 1940, as amended . If determined to be an investment company, the company is subject to the full regulation under the act. In addition, a company may inadvertently become an investment company in such a case, all of its contracts are potentially voidable and it cannot engage in any other business. Generally, companies inadvertently become investment companies by virtue of their investments in certain securities which trigger the acts 40 percent test.
Many times a number of companies fall within the definition of an investment company because operating companies have large amounts of assets invested in cash management instruments, government securities and money market funds.
The act is draconian in its regulation and can change the entire business of a company. If a company inadvertently becomes an investment company, it must defend itself from SEC regulation and change its investment policies.
Section 3 of the act defines an investment company as an issuer that is or holds itself out as being engaged primarily in an investment company business Section 3 defines an investment company as an issuer that is a face-amount certificate company and Section 3 defines an investment company as an issuer that holds more than 40 percent of its assets in investment securities.
Inadvertent investment companies
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C1 Funds Vs 3c7 Funds
Private equity funds are usually structured as 3C1 funds or 3C7 funds, the latter being a reference to the 3 exemption. Both 3C1 and 3C7 funds are exempt from SEC registration requirements under the Investment Company Act of 1940, but the nature of the exemption is slightly different. Whereas the 3C1 exemption hinges on not exceeding 100 accredited investors, a 3C7 fund must maintain a total of 2,000 or fewer qualified purchasers. However, qualified purchasers must clear a higher bar and have over $5 million in assets, but a 3C7 fund is permitted to have more of these people or entities participating as investors.
Investor Qualification: A Primer
Investor qualification is an integral component of managing an investment fund. The type and character of each investor affect, among other things, whether an investor qualifies to invest, whether the fund would be required to register with the Securities and Exchange Commission , and the fee that can be charged. The terms “accredited investor,” “qualified purchaser,” and “qualified client” are each defined in separate statutes or regulations and are important for different reasons. This article offers a brief explanation of each term and its relevance to a manager’s fund-raising efforts and its ability to collect fees from its investors.
Securities Act of 1933
Investment Company Act of 1940
Investment Company Act of 1940
Section 3 of the 1940 Act excludes privately held investment companies from falling within the definition of an “investment company” under the 1940 Act if: it is not making or proposing to make a public offering, and the company’s outstanding securities are owned exclusively by “qualified purchasers.” “Qualified Purchaser” is defined in Section 2 of the 1940 Act . An individual generally qualifies as a “qualified purchaser” if it owns not less than $5 million in investments. Accordingly, by selling securities only to qualified purchasers, the fund itself would be excluded from regulation under the 1940 Act.
Investment Advisers Act of 1940
What Is Not Regulated As An Investment Company
Investment pools that do not meet the definition of investment company in Section 3 of the Investment Company Act because, for example, they do not invest in securities are not investment companies and, therefore, are not regulated as investment companies under the Investment Company Act.
The Investment Company Act also specifically excludes certain investment pools from the definition of investment company. The Investment Company Act also exempts from regulation under the Investment Company Act a number of investment pools and entities. If an issuer falls within one of these exclusions or exemptions, it may not register as an investment company with the Commission. For example:
Section 2 of the Investment Company Act exempts certain governments, government agencies, and instrumentalities from the provisions of the Investment Company Act.
Section 3 of the Investment Company Act excludes some issuers from the definition of investment company if they are primarily engaged in a business other than investing, reinvesting, holding or trading securities.
Section 3 of the Investment Company Act excludes certain other issuers from the definition of investment company. These issuers include, for example, broker-dealers, charitable organizations, pension plans, and church plans. Two exceptions under Section 3 of the Investment Company Act are discussed in more detail below under Private Investment Companies.
An Introduction To The Regulation Of Investment Companies
The Securities and Exchange Commission is the primary regulator of investment companies and investment advisers. The Division of Investment Management of the SEC has prepared this Package as a general guide to the principal federal securities laws and regulations governing investment companies.
Generally, persons who manage the portfolios of registered investment companies must register with the Commission as investment advisers under the Investment Advisers Act of 1940 . See General Information on the Regulation of Investment Advisers. The Advisers Act, and regulations adopted by the Commission under the Investment Advisers Act, govern registered investment advisers. The regulations are published in 17 CFR, Part 275.
Investment companies are also subject to other federal securities laws and the Securities Exchange Act of 1934). The SEC has also adopted various regulations generally applicable to investment companies under these laws.
Regulations under the Investment Company Act and the other federal securities laws are amended from time to time. You can find SEC proposed regulations and newly amended or adopted regulations in releases published by the Commission.
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Securities And Exchange Commission
James Chen, CMT is an expert trader, investment adviser, and global market strategist. He has authored books on technical analysis and foreign exchange trading published by John Wiley and Sons and served as a guest expert on CNBC, BloombergTV, Forbes, and Reuters among other financial media.
Investopedia / Julie Bang
C7 Funds Vs 3c1 Funds
Both 3C7 and 3C1 funds are exempted from the requirements imposed on investment companies under the Investment Company Act of 1940 . However, there are important differences between them. 3C7 funds, as noted, take investments from qualified purchasers, whereas 3C1 funds work with accredited investors.
Investors in 3C7 funds are held to a higher wealth measure than those in 3C1 funds, which can limit the investor pool that a fund is hoping to raise money from. That said, 3C1 funds are capped at 100 investors total, limiting the number of investors the fund can take in from the wider pool they are allowed to pull from.
3C7 funds don’t have a set cap. However, 3C7 funds will fall under the regulation that is stipulated in the Securities Exchange Act of 1934 when they reach 2,000 investors. At this point, private funds are subject to increased SEC scrutiny and have more in common with public companies.
U.S. Government Publishing Office. “Investment Act of 1940,” Page 17. Accessed March 9, 2021.
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Investments In Other Investment Companies
Section 12 of the 1940 Act places the following limits on investments by investment funds in any registered investment company. Specifically, a fund is prohibited from:
- acquiring more than 3% of a registered investment companys shares
- investing more than 5% of its assets in a single registered investment company or
- investing more than 10% of its assets in registered investment companies .
As Sections 3 and 3 of the 1940 Act indicate that companies relying on these exemptions will be considered investment companies for purposes of the 3% Limit but do not mention the 5% Limit or the 10% Limit, it has generally been assumed that only the 3% Limit applies to private funds. This assumption was placed in doubt by the March 2008 proposing release for Rule 12d1-4, which states in footnote 194 that Both registered and unregistered funds are subject to these limits with respect to their investments in a registered fund. The New York City Bars Committee on Private Investment Funds requested clarification of this issue in a comment letter regarding the 2008 proposed rules but, as the rules were never adopted, no such clarification was ever issued by the SEC.
Funds with significant positions in registered investment companies should implement policies to ensure that they regularly determine whether they are in compliance with the above limitations.
Sec Adopts New Rule For Fund Of Fund Arrangements
On October 7, 2020, the Securities and Exchange Commission adopted Rule 12d1-4 under the Investment Company Act of 1940 in an effort to streamline and enhance the regulatory framework for fund of funds arrangements. In connection with the adoption of Rule 12d1-4, the SEC is rescinding Rule 12d1-2 under the 1940 Act and most of the existing exemptive orders granting relief from Sections 12, , and of the 1940 Act. In addition, the SEC also is adopting related amendments to Rule 12d1-1 under the 1940 Act and Form N-CEN.
In response to numerous comment letters, including a letter from Skadden , the Final Rule includes provisions specifically designed to protect closed-end funds from undue influence resulting from acquiring funds use of the Final Rule. The Final Rule provides closed-end funds with a modicum of protection against opportunistic short-term investors that seek to use other registered funds to acquire shares of closed-end funds at a discount and pursue disruptive agendas. However, significant unaddressed issues remain relating to private funds ability to circumvent the protections of Section 12 and Section 12, which we address at the end of this mailing.
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Less Than 100 Investors
Section 3 of the Investment Company Act excludes from being an investment company any issuer whose outstanding securities are beneficially owned by not more than 100 persons and that is not making and does not presently propose to make a public offering of its securities. The benefit of Section 3 is that there is no additional status requirement for the investor, such as net worth, total assets, or total investments owned beyond the accredited investor standard.
There are some catches in trying to count the number of investors. There are several types of investors that result in a look through their ownership.
One Important Math Question In Securities Law: How To Count Investors
Many attorneys choose law so they can be done with math. Unfortunately, attorneys still need to perform some calculations, especially when practicing securities law. For example, counting investors is a legal and mathematical question of great importance. Its outcome decides whether a company will be exempt from investment company regulations. To put it in another way, counting investors decides whether a company needs to spend an additional six figures or more annually to comply with investment company regulations. Thus, it is paramount for attorneys to count a companys investors accurately.
The Investment Company Act of 1940 provides a few exemptions, one of which is Section 3. Section 3 exempts any private issuer whose outstanding securities are beneficially owned by no more than one hundred persons. The 1940 Act defines person as a natural person or a company, and a company is defined broadly to include a corporation, a partnership, an association, a joint-stock company, a trust, a fund, or any organized group of persons whether incorporated or not. This exemption excludes from the 1940 Act private companies for which there are no significant concerns of public interest. Although one hundred was chosen arbitrarily, it has served as a benchmark in deciding whether there is sufficient public interest in a company that warrants federal regulation.
Counting Investors who are Natural Persons
15 U.S.C. § 80a-3.
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How The Securities And Exchange Commission Works
The SEC’s primary function is to oversee organizations and individuals in the securities markets, including securities exchanges, brokerage firms, dealers, investment advisors, and investment funds. Through established securities rules and regulations, the SEC promotes disclosure and sharing of market-related information, fair dealing, and protection against fraud. It provides investors with access to registration statements, periodic financial reports, and other securities forms through its electronic data-gathering, analysis, and retrieval database, known as EDGAR.
The Securities And Exchange Commission was created in 1934 to help restore investor confidence in the wake of the 1929 stock market crash.
The SEC is headed by five commissioners who are appointed by the president, one of whom is designated as chair. Each commissioner’s term lasts five years, but they may serve for an additional 18 months until a replacement is found. The current SEC chair is Gary Gensler, who took office on April 17, 2021. To promote nonpartisanship, the law requires that no more than three of the five commissioners come from the same political party.
The SEC consists of five divisions and 23 offices. Their goals are to interpret and take enforcement actions on securities laws, issue new rules, provide oversight of securities institutions, and coordinate regulation among different levels of government. The five divisions and their respective roles are: