October 21, 2021

How to Avoid Registration Under the Investment Company Act 

by Steven D. Forbes

An investment company is defined as any issuer which: (a) is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; (b) is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or (c) is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis.

To avoid registration under the Investment Company Act the two most frequently used exemptions are set forth in Section 3(c)(1) and Section 3(c)(7), pursuant to which, the fund must (1) not make, or propose to make, a public offering of its securities and (2) either (a) limit the fund to no more than 100 investors (the 3(c)(1) exemption) or (b) limit the fund to “qualified purchasers” (the 3(c)(7) exemption). The term “qualified purchaser” is defined in Section 2(a)(51) of the Investment Company Act but generally means those persons who own not less than $5,000,000 in investments.

Investment companies that conduct private offerings typically do so by issuing securities pursuant to Rule 506 of Securities Act of 1933 (“Securities Act”). Rule 506 is a safe harbor set of rules for compliance with the private securities exemption found under Section 4(2) of the Securities Act, which means that an offering that complies with the requirements of Rule 506 will be exempt from the public registration requirements of Section 3(5) of the Securities Act. Offerings made pursuant to Rule 506 allow funds to avoid the costly registration and disclosure requirements applicable to public issuers of securities.

Other exclusions to the Investment Company Act include but are not limited to: (1) certain government, government agencies; (2) issuers that are primarily engaged in a business other than investing, reinvesting, holding or trading securities; (3) issuers who are engaged in, among other things, purchasing or otherwise acquiring mortgages and other liens on and interests in real estate; (4) broker-dealers, charitable organizations, pension plans, and church plans; and (5) investment clubs.  Most of our clients directly purchase fee interests in real estate through Tenant in Common Interests or beneficial interest in a Delaware Statutory Trust (which makes the Investment Company Act inapplicable).

A fund that does not meet one of the exemptions to the Investment Company Act must register and maintain its status as an investment company with the SEC. As a result, the fund will have to pay costly registration fees, meet ongoing regulatory compliance requirements with the SEC and send certain reports to its investors. Activities of investment companies are generally not regulated by the states, however, states may require investment companies to file notices with them and pay filing or registration fees.

Establishing and maintaining an investment company status exemption is essential to the proper functioning of a private fund. A private fund that does meet the requirements of one of the exemptions to avoid registration pursuant to the Investment Company Act must stop their current activities and rearrange their investment strategies. Such rearrangement can be costly and may put the private fund at risk to lawsuits by investors. Fund managers who are uncertain about their Investment Company Act status should consult with one of the lawyers at MRC regarding their specific situation.



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