SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 270
Release No. IC-22597, International Series
Release No. 1071,
File No. S7-30-96
RIN 3235-AH09
Privately Offered Investment Companies
AGENCY:
Securities and Exchange Commission
ACTION:
Final rules
SUMMARY:
The Commission is adopting rules under the Investment
Company Act of 1940 to implement provisions
of the National
Securities Markets Improvement Act of 1996
that apply to
privately offered investment companies. The rules define
certain terms for purposes of the new
exclusion from regulation
under the Investment Company Act for
privately offered
investment companies whose investors are all
highly
sophisticated investors, termed "qualified
purchasers." The
rules also address certain transition issues
relating to
existing privately offered investment
companies that have no
more than 100 investors and other matters
concerning privately
offered investment companies.
EFFECTIVE DATE: The rules become effective on June 9, 1997.
FOR FURTHER INFORMATION CONTACT: David P. Mathews, Senior
Counsel, Nadya B. Roytblat, Assistant Office
Chief, or Kenneth
J. Berman, Assistant Director, at (202)
942-0690, Office of
Regulatory Policy, Division of Investment
Management, Mail Stop
10-2, Securities and Exchange Commission,
450 Fifth Street,
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N.W., Washington, D.C. 20549. Requests for formal
interpretative advice should be directed to
the Office of Chief
Counsel at (202) 942-0659, Division of
Investment Management,
Securities and Exchange Commission, 450
Fifth Street, N.W.,
Mail Stop 10-6, Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Commission today is adopting
rules 2a51-1, 2a51-2, 2a51-3, 3c-1, 3c-5 and
3c-6 [17 CFR
270.2a51-1, .2a51-2, .2a51-3, .3c-1, .3c-5
and .3c-6] under the
Investment Company Act of 1940 [15 USC 80a]
(the "Investment
Company Act" or "Act").
EXECUTIVE SUMMARY
The Commission is adopting rules to
implement certain
provisions of the National Securities
Markets Improvement Act
of 1996 (the "1996 Act"). The 1996 Act, among other things,
added section 3(c)(7) to the Investment
Company Act to create a
new exclusion from regulation under the Act
for privately
offered investment companies that sell their
securities solely
to "qualified purchasers" owning
or investing on a
discretionary basis a specified amount of
"investments"
("Section 3(c)(7) Funds"). The 1996 Act also amended section
3(c)(1) of the Investment Company Act, which
excludes from
regulation under the Act privately offered
investment companies
with 100 or fewer "beneficial
owners" ("Section 3(c)(1)
Funds"). Reflecting a relationship between section 3(c)(1) and
new section 3(c)(7), the 1996 Act contains
provisions that
permit an existing Section 3(c)(1) Fund to
convert into a
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Section 3(c)(7) Fund or invest in a Section
3(c)(7) Fund as a
qualified purchaser, subject to certain
requirements designed
to protect the Section 3(c)(1) Fund's
existing "beneficial
owners."
The 1996 Act requires the Commission to
prescribe rules
defining the terms "investments"
and "beneficial owner"
relevant to the new provisions by April 9,
1997. Other changes
to the provisions of the Investment Company
Act relating to
privately offered investment companies
require Commission
rulemaking as well. The Commission is adopting rules under the
Investment Company Act that:
define the term "investments" for
purposes of the qualified
purchaser definition;
define the term "beneficial owner"
for purposes of the
provisions that permit an existing Section
3(c)(1) Fund to
convert into a Section 3(c)(7) Fund or to be
treated as a
qualified purchaser;
clarify certain interpretative issues under
section 3(c)(7);
permit certain Section 3(c)(1) Funds to rely
on the pre-1996
Act provisions of section 3(c)(1) rather
than restructure their
existing relationships with investors;
permit knowledgeable employees of a Section
3(c)(1) Fund or a
Section 3(c)(7) Fund (referred to
collectively in this Release
as "privately offered funds" or
"funds"), and knowledgeable
employees of certain affiliates of these
Funds, to invest in
the Funds; and
address transfers of securities in a
privately offered fund
when the transfer was a gift or caused by
divorce or death.
The rules reflect modifications suggested by
commenters that
are designed to make the rules less complex
and easier to
apply, consistent with the policies
underlying the Investment
Company Act and the 1996 Act's provisions
relating to privately
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offered funds.
I.
BACKGROUND
A.
Statutory Exclusions for Privately Offered Funds
Section 3(c)(1) of the Investment
Company Act excludes
from regulation under the Act certain
privately offered
investment companies "whose outstanding
securities (other than
short-term paper) are beneficially owned by
not more than one
hundred persons."-[1]- A wide variety of investment
vehicles rely on section 3(c)(1), ranging
from small groups of
individual investors, such as investment
clubs, to venture
capital and other investment pools designed
primarily for
sophisticated investors.-[2]-
The 1996 Act-[3]- added new section
3(c)(7) of the
Investment Company Act to create an
alternative exclusion for
investment companies that sell their
securities solely to
investors who are "qualified
purchasers."-[4]- As is the
-[1]- 15 USC 80a-3(c)(1). In
addition, the Section
3(c)(1) Fund must be an
issuer that "is not
making and does not presently
propose to make a
public offering of its
securities." Id.
-[2]- See DIVISION OF INVESTMENT MANAGEMENT, SEC,
PROTECTING INVESTORS: A HALF
CENTURY OF
INVESTMENT COMPANY REGULATION
(hereinafter
PROTECTING INVESTORS REPORT)
at 104 (1992).
-[3]- The National Securities Markets Improvement Act
of 1996, Pub. L. No. 104-290
(1996) (codified in
scattered sections of the
United States Code).
-[4]- 15 USC 80a-3(c)(7).
For the history of the
development of section
3(c)(7), see Private
Investment Companies,
Investment Company Act
Release No. IC-22405 (Dec.
18, 1996) [61 FR
(continued...)
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case for a Section 3(c)(1) Fund, a Section
3(c)(7) Fund cannot
make, or propose to make, a public offering
of its
securities.-[5]-
New section 2(a)(51)(A) of the
Investment Company Act
defines the term qualified purchaser as (i)
any natural person
who owns not less than $5 million in
investments (as defined by
the Commission),-[6]- (ii) a family-owned
company ("Family
-[4]-(...continued)
68100 (Dec. 26, 1996)]
(hereinafter Proposing
Release) at nn.3-9 and
accompanying text.
-[5]- Section 3(c)(7) of the Act.
While the
legislative history of the
1996 Act does not
explicitly discuss section
3(c)(7)'s limitation
on public offerings by
Section 3(c)(7) Funds,
the limitation appears to
reflect Congress's
concerns that unsophisticated
individuals not be
inadvertently drawn into a
Section 3(c)(7) Fund.
See The Investment Company
Act Amendments of
1995: Hearing on H.R. 1495
before the Subcomm.
on Telecommunications and
Finance of the Comm.
on Commerce, House of
Representatives, 104th
Cong., 1st Sess. 53 (1995)
(hereinafter House
Hearings) (testimony of
Matthew P. Fink,
President, Investment Company
Institute, urging
that section 3(c)(7) include
a public offering
limitation). Section 3(c)(1)'s limitation on
public offerings has been
interpreted to permit
"transactions by an
issuer not involving any
public offering" under
section 4(2) of the
Securities Act of 1933
("Securities Act") [15
USC 77d(2)]. See, e.g.,
Engelberger Partnerships
(Dec. 7, 1981). The Commission believes that
section 3(c)(7)'s public
offering limitation
should be interpreted in the
same manner as the
limitation in section
3(c)(1).
-[6]- Section 2(a)(51)(A)(i) of the Act [15 USC 80a-
2(a)(51)(A)(i)]. The 1996 Act directed the
Commission to prescribe rules
defining the term
"investments" by
April 9, 1997. 15 USC 80a-2
note.
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Company") that owns not less than $5
million in
investments,-[7]- (iii) certain trusts,-[8]-
and (iv)
any other person (e.g., an institutional
investor) that owns
and invests on a discretionary basis not
less than $25 million
in investments.-[9]-
Section 3(c)(7)(B) includes a
"grandfather" provision
("Grandfather Provision") that
permits an existing Section
3(c)(1) Fund to convert into a Section
3(c)(7) Fund
("Grandfathered Fund").-[10]- The outstanding securities
of a Grandfathered Fund may be beneficially
owned by as many as
100 persons that are not qualified
purchasers, provided that
-[7]- A Family Company is a company "that is owned
directly or indirectly by or
for 2 or more
natural persons who are
related as siblings or
spouse (including former
spouses), or direct
lineal descendants by birth
or adoption, spouses
of such persons, the estates
of such persons, or
foundations, charitable
organizations, or trusts
established by or for the
benefit of such
persons . . . ." Section 2(a)(51)(A)(ii) of the
Act [15 USC
80a-2(a)(51)(A)(ii)].
-[8]- A trust may be a qualified purchaser if (i) it
was not formed for the
specific purpose of
acquiring the securities
offered, and (ii) the
trustee or other person
authorized to make
decisions with respect to the
trust, and each
settlor or other person who
has contributed
assets to the trust, are
qualified purchasers.
Section 2(a)(51)(A)(iii) of
the Act [15 USC
80a-2(a)(51)(A)(iii)].
-[9]- A qualified purchaser that meets the $25 million
threshold may act for its own
account or for the
accounts of other qualified
purchasers. See
section 2(a)(51)(A)(iv) of
the Act [15 USC 80a-
2(a)(51)(A)(iv)].
-[10]- 15 USC 80a-3(c)(7)(B).
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these persons acquired the securities of the
Grandfathered Fund
on or before September 1, 1996.-[11]- The Grandfather
Provision is designed to allow an existing
Section 3(c)(1) Fund
wishing to avail itself of section 3(c)(7)
to continue its
existing relationships with investors that
are not qualified
purchasers.-[12]-
The Grandfather Provision requires the
Grandfathered Fund,
prior to the conversion, to provide each
beneficial owner of
its securities (i) notice of the Fund's
intention to become a
Section 3(c)(7) Fund and (ii) an opportunity
to redeem the
owner's interest in the Fund.-[13]- The 1996 Act directs
the Commission to define the term
"beneficial owner" for this
purpose.-[14]- The 1996 Act also requires an existing
privately offered fund that wishes to become
a qualified
purchaser to obtain the consent of certain
beneficial owners of
its securities and certain other persons
(the "Consent
Provision").-[15]-
-[11]- Section 3(c)(7)(B)(i)(I) of the Act [15 USC 80a-
3(c)(7)(B)(i)(I)].
-[12]- See S. REP. NO. 293, 104th Cong., 2d Sess. 23
(1996) (hereinafter Senate
Report); H.R. REP.
NO. 622, 104th Cong., 2d
Sess. 51 (1996)
(hereinafter House
Report). These Reports
relate to bills that were
eventually enacted as
the 1996 Act.
-[13]- Section 3(c)(7)(B)(ii) of the Act [15 USC 80a-
3(c)(7)(B)(ii)].
-[14]- 15 USC 80a-3 note.
-[15]- Section 2(a)(51)(C) of the Act [15 USC 80a-
2(a)(51)(C)].
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B.
Amendments to Section 3(c)(1)
To prevent circumvention of the
100-investor limit,
section 3(c)(1)(A) (the "Look-Through Provision")
requires, in
some instances, that a fund seeking to rely
on section 3(c)(1)
"look through" certain companies
(e.g., corporations,
partnerships and other investors that are
not natural persons)
that hold its voting securities and count
the company's
security holders as beneficial owners of the
fund's
securities.-[16]- Prior to the 1996 Act,-[17]- the Look-
Through Provision applied (i) if a company
owned 10% or more of
a Section 3(c)(1) Fund's voting securities
("First 10% Test")
and (ii) more than 10% of the company's
total assets consisted
of securities of Section 3(c)(1) Funds
generally ("Second 10%
Test").-[18]-
-[16]- 15 USC 80a-3(c)(1)(A).
Section 2(a)(42) of the
Investment Company Act [15
USC 80a-2(a)(42)]
defines a voting security as
any security
"presently entitling the
owner or holder thereof
to vote for the election of a
company." See
Thomas P. Lemke and Gerald T.
Lins, Private
Investment Companies Under
Section 3(c)(1), 44
BUS. LAW. 401, 416-18 (Feb.
1989) (discussing
the types of non-voting
interests that have been
treated as voting
securities).
-[17]- The 1996 Act was signed into law by President
Clinton on October 11,
1996. The provisions
relating to privately offered
funds do not
become effective until the earlier of April 9,
1997 or the date on which the
rule defining the
term investments is published
in the Federal
Register. For purposes of convenience, this
Release assumes that the amendments to section
3(c)(1) are now
effective.
-[18]- To illustrate the operation of the pre-1996 Act
Look-Through Provision,
assume Company A is
seeking to rely on section
(3)(c)(1). If one of
(continued...)
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The 1996 Act's amendments to section
3(c)(1) were
designed, in part, to simplify the way in
which the number of
investors in a fund is calculated for
purposes of the
100-investor limit. The amended Look-Through Provision does
not apply to an investor that is an
operating company. In
other words, a Section 3(c)(1) Fund must
only look through an
investor to count its shareholders if the
investor is an
investment company or a privately offered
fund.-[19]- In
addition, the Second 10% Test has been
eliminated. As a
result, a Section 3(c)(1) Fund must count
all of the
shareholders of an investment company or
fund investor that
-[18]-(...continued)
Company A's security holders,
Company B,
beneficially owned 10% or
more of Company A's
voting securities (the First
10% Test), then the
security holders of Company B
would have been
counted as security holders
of Company A, unless
no more than 10% of Company
B's assets consisted
of securities of Section
3(c)(1) Funds (the
Second 10% Test).
The operation of the pre-1996 Act
Look-Through Provision
also is relevant to determining who is
a beneficial owner
of a Section 3(c)(1) Fund's securities
for purposes of the
Grandfather and Consent
Provisions. See section II.B. of
this Release.
-[19]- This approach recognizes that an investment in a
Section 3(c)(1) Fund by a
company that is not
itself an investment company
generally does not
implicate the concerns that
the Look-Through
Provision was intended to
address -- that the
investor may be a conduit
that was created to
enable a Section 3(c)(1) Fund
to have indirectly
more than 100 investors. See The Securities
Investment Promotion Act of
1996: Hearing on S.
1815 before the Senate Comm. on Banking, Housing
and Urban Affairs, 104th
Cong., 2d Sess. 40
(1995) (testimony of Arthur
Levitt, Chairman,
SEC).
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owns 10% or more of the Section 3(c)(1)
Fund's voting
securities even if the investor does not
have more than 10% of
its assets invested in Section 3(c)(1)
Funds.-[20]-
These revisions, while generally narrowing
the scope of the
Look-Through Provision, have raised
questions regarding the
regulatory status of existing Section
3(c)(1) Funds that have
relied on the Second 10% Test.
C.
The Commission's Rule Proposals
On December 26, 1996, the Commission
published a release
proposing several rules under the Investment
Company Act to
implement the provisions of the 1996 Act
relating to privately
offered funds ("Proposing
Release").-[21]- Proposed rule
2a51-1 would define the term
"investments" for purposes of the
qualified purchaser definition. Proposed rule 2a51-2 would
define the term "beneficial owner"
for purposes of the
Grandfather and Consent Provisions. Proposed rule 2a51-3 would
provide that a company could not be a
qualified purchaser if it
was formed for the specific purpose of
acquiring the securities
of a Section 3(c)(7) Fund unless each
beneficial owner of the
-[20]- This change reflects the view that the private
nature of a Section 3(c)(1)
Fund may be brought
into question when an
investment company has a
substantial investment in the
Section 3(c)(1)
Fund. See, e.g., PROTECTING INVESTORS REPORT,
supra note 2, at 106-09. See section III.A.2 of
this Release for a discussion
of when a Section
3(c)(1) Fund should determine
whether an
investor is subject to the
amended Look-Through
Provision.
-[21]- Proposing Release, supra note 4.
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company's securities is a qualified
purchaser. Proposed rule
3c-7 would address certain issues related to
a Grandfathered
Fund and an affiliated Section 3(c)(1) Fund.
The Commission also proposed two other
rules that the 1996
Act directed the Commission to adopt. The 1996 Act directed
the Commission to prescribe rules permitting
"knowledgeable
employees" of a privately offered fund
(or knowledgeable
employees of the fund's affiliates) to
invest in the fund
without causing the fund to lose its
exclusion from regulation
under the Investment Company Act.-[22]- The Commission
proposed rule 3c-5 to permit knowledgeable
employees to make
such investments.
The 1996 Act also directed the
Commission to prescribe
rules implementing section 3(c)(1)(B) of the
Act.-[23]-
Section 3(c)(1)(B) provides that beneficial
ownership of
securities of a Section 3(c)(1) Fund by any
person who acquires
the securities as a result of "a legal
separation, divorce,
death, or other involuntary event" will
be deemed to be
beneficial ownership by the person from whom
the transfer was
-[22]- 15 USC 80a-3 note. The
purpose of this
provision appears to be to
allow privately
offered funds to offer
persons who participate
in the funds' management the
opportunity to
invest in the fund as a
benefit of employment.
See House Hearings, supra
note 5, at 22-23
(testimony of Barry P.
Barbash, Director,
Division of Investment
Management, SEC).
-[23]- 15 USC 80a-3 note.
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made, pursuant to such rules and regulations
as the Commission
prescribes.-[24]- The Commission proposed rule 3c-6 to
implement section 3(c)(1)(B) of the
Act. The proposed rule
also would address similar transfers of
securities issued by
Section 3(c)(7) Funds.-[25]-
The Commission received letters from 48
commenters
concerning the proposals. While commenters generally supported
the proposed rules, many suggested changes
designed to simplify
the rules, make them more flexible or
resolve technical issues.
The Commission is adopting the proposed
rules with several
modifications that reflect, in part, many of
the commenters'
suggestions.
II.
RULES RELATING TO SECTION 3(c)(7) FUNDS
A.
Investments and Other Matters
Rule 2a51-1 under the Investment
Company Act defines the
term investments for purposes of determining
whether a
prospective investor in a Section 3(c)(7)
Fund ("Prospective
Qualified Purchaser") meets the $5
million/$25 million
thresholds.-[26]- Rule 2a51-1 also contains provisions
-[24]- 15 USC 80a-3(c)(1)(B).
-[25]- See section 3(c)(7)(A) of the Act [15 USC 80a-
3(c)(7)(A)] (permitting
certain transfers by
qualified purchasers).
-[26]- The 1996 Act provides that the term investments
is to be defined by
Commission rule. 15 USC
80a-2 note. Section 2(a)(51)(B) of the Act [15
USC 80a-2(a)(51)(B)] also
gives the Commission
authority to prescribe such
rules and
regulations governing
qualified purchasers as
(continued...)
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designed to clarify how the amount of a
Prospective Qualified
Purchaser's investments should be
determined.
1. Qualified Institutional Buyers as Qualified
Purchasers
Many commenters suggested that the
determination of
qualified purchaser status could be made
significantly easier
if qualified institutional buyers
("QIBs"), as defined in rule
144A under the Securities Act of 1933
("Securities Act"), were
deemed to be qualified purchasers. Rule 144A generally defines
QIBs as certain institutions (including
registered investment
companies) that own and invest on a
discretionary basis $100
million of securities of issuers that are
not affiliated with
the institution ("QIB
Securities"); banks that own and invest
on a discretionary basis $100 million of QIB
Securities and
that have an audited net worth of at least
$25 million; and
certain registered dealers.-[27]- The Commission
believes that it is generally appropriate to
treat QIBs as
qualified purchasers for purposes of section
3(c)(7) in light
of the high threshold of securities
ownership that these
institutions must meet under rule 144A, a
threshold much higher
than
the investment ownership threshold required for qualified
-[26]-(...continued)
the Commission determines are
necessary or
appropriate in the public
interest or for the
protection of investors.
-[27]- 17 CFR 230.144A(a). In
each case, the QIB must
be acting for its own account
or the account of
another QIB.
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purchasers under section 2(a)(51)(A) of the
Act.
Rule 2a51-1 therefore provides that,
with two exceptions,
a QIB is deemed to be a qualified
purchaser.-[28]- The
first exception relates to dealers. Under rule 144A, a dealer
(other than a dealer acting for a QIB in a
riskless principal
transaction) must own and invest on a
discretionary basis $10
million of QIB Securities.-[29]- In order to coordinate
the definition of QIB with the statutory
definition of
qualified purchaser, rule 2a51-1 requires
the dealer to own and
invest on a discretionary basis $25 million
of QIB
Securities.-[30]-
The second exception relates to
employee benefit plans.
Rule 144A includes in its QIB definition
certain employee
benefit plans, as well as certain trusts
that hold assets of
employee benefit plans.-[31]- A self-directed employee
-[28]- Rule 2a51-1(g)(1) [17 CFR 270.2a51-1(g)(1)].
The QIB must be acting for its own account, the
account of another QIB or the
account of a
qualified purchaser. A person's status as a QIB
would be determined based on
QIB Securities, not
investments as defined by rule 2a51-1.
-[29]- Rule 144A(a)(1)(ii) [17 CFR 230.144A(a)(1)(ii)].
-[30]- Rule 2a51-1(g)(1)(i) [17 CFR 270.2a51-
1(g)(1)(i)]. A dealer that does not own and
invest on a discretionary basis $25 million of
QIB Securities could still be
a qualified
purchaser if the dealer owns
and invests on a
discretionary basis $25
million of investments,
determined in accordance with rule 2a51-1.
-[31]- Rule 144A(a)(1)(i)(D) (government employee benefit
plans), (E) (any employee
benefit plan within
the meaning of Title I of the
Employee
(continued...)
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benefit plan (such as a "401(k)"
plan) generally would not be
considered to be a qualified purchaser for
purposes of rule
2a51-1; rather, an employee could invest in
a Section 3(c)(7)
Fund through a self-directed plan only if
the employee is a
qualified purchaser.-[32]- This provision therefore is
not available to a self-directed plan.-[33]-
2. Definition of Investments
Rule 2a51-1, as proposed, would have
defined investments
broadly to include securities (other than
controlling interests
in certain issuers), and real estate,
futures contracts,
physical commodities, and cash and cash
equivalents held for
investment purposes. The Commission believes that this
approach is consistent with the legislative
history of the 1996
Act, which suggests that Congress expected
that the definition
of investments would be broader than
securities, but that not
-[31]-(...continued)
Retirement Income Security
Act of 1974), and (F)
(trust funds whose
participants are exclusively
plans of the types identified
in paragraphs (D)
and (E)) [17 CFR
230.144A(a)(1)(i)(D),(E), and
(F)].
-[32]- See infra section II.A.8 of this Release
(discussing the circumstances
under which
pension and retirement plans can be treated as
qualified purchasers).
-[33]- Rule 2a51-1(g)(1)(ii) [17 CFR 270.2a51-
1(g)(1)(ii)] provides that a
plan will not be
deemed to be acting for its
own account if
investment decisions with
respect to the plan
are made by the beneficiaries
of the plan. In
other words, the investment
decision must be
made by a qualified
purchaser.
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OF PAGE 16======
every asset be treated as an
investment.-[34]- Rather,
the legislative history suggests that the
asset should be held
for investment purposes and that the nature
of the asset should
indicate that its holder has the investment
experience and
sophistication necessary to evaluate the
risks of investing in
unregulated investment pools.-[35]-
Commenters generally supported the
approach of the
proposal, although many commenters suggested
alternative
approaches to addressing particular
issues. The Commission is
adopting the definition of investments
substantially as
proposed, with modifications made in view of
the commenters'
suggestions, as discussed below.
-[34]- See Proposing Release, supra note 4, at nn.29-31
and accompanying text.
-[35]- Id. The legislative
history was confined to
addressing new section 3(c)(7), and should not
be viewed as suggesting how
issues of investor
sophistication should be
analyzed in other
contexts under the federal
securities laws.
Although Section 3(c)(7) Funds are not subject
to regulation under the
Investment Company Act,
these Funds and persons who
sell their
securities are subject to the
antifraud, civil
liability, and other applicable provisions of
the federal securities
laws. Persons who sell
the securities issued by
Section 3(c)(7) Funds
should also consider the
applicability of the
broker-dealer registration provisions of the
Securities Exchange Act of
1934 [15 USC 78a-
78jj] ("Exchange
Act").
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OF PAGE 17======
a. Securities
Rule 2a51-1(b)(1) includes securities
within the
definition of investments.-[36]- This approach should
result in a broad range of assets being
treated as investments
for purposes of the qualified purchaser
definition. Many
investment opportunities, such as limited
partnerships and
limited liability companies, are offered in
the form of
securities.-[37]-
Under the rule, securities that
constitute a "control
interest" in an issuer generally do not
come within the
definition of investments.-[38]- Limiting the definition
in this manner is designed to exclude, among
other things,
controlling ownership interests in
family-owned and other
closely-held businesses. These holdings may not demonstrate
the degree of financial sophistication
necessary to invest in
-[36]- 17 CFR 270.2a51-1(b)(1).
-[37]- See section 2(a)(1) of the Securities Act [15
USC 77b(a)(1)].
-[38]- The rule excludes from the definition of
investments securities of an
issuer that
"controls, is controlled
by, or is under common
control with, the person that
owns the
securities." The
term "control" is defined in
section 2(a)(9) of the Act
[15 USC 80a-2(a)(9)]
as "the power to
exercise a controlling
influence over the management
or policies of a
company, unless such power is solely the result
of an official position with
such company."
Section 2(a)(9) also provides
that a person who
owns beneficially,
"either directly or through
one or more controlled companies, more than 25
per centum of the voting
securities of a company
shall be presumed to control
such company." Id.
==========================================START
OF PAGE 18======
unregulated investment pools.
The Commission proposed certain
exceptions from the
control interest exclusion. The Commission is broadening these
exceptions in certain respects, in light of
the suggestions of
commenters as discussed below.
Investment Vehicles. The rule permits control interests
in "investment vehicles" excluded
or exempted from the
definition of investment company by sections
3(c)(1) through
3(c)(9) of the Act or rule 3a-6 or 3a-7 under
the Act to be
treated as investments.-[39]- Sections 3(c)(1) through
3(c)(9) and rules 3a-6 and 3a-7 except from
the definition of
investment company, in addition to privately
offered funds,
certain types of issuers that engage in significant
investment-
related activities (i.e., brokers and other
financial
intermediaries, banks, insurance companies,
finance companies,
and certain structured finance
vehicles).-[40]-
A control interest in these types of
companies generally
suggests a significant degree of investment
experience. In a
change from the proposal, the rule also
specifies that a
control interest in a commodity pool may be
treated as an
investment.-[41]- As in the case of a control interest
-[39]- Rule 2a51-1(a)(3) [17 CFR 270.2a51-1(a)(3)]
(defining the term
"investment vehicle").
-[40]- 15 USC 80a-3(c)(1) through (9); 17 CFR 270.3a-6
(exemption for foreign banks
and insurance
companies) and .3a-7
(exemption for certain
structured finance vehicles).
-[41]- Rule 2a51-1(a)(3).
==========================================START
OF PAGE 19======
in an investment company, a control interest
in a commodity
pool may suggest a significant degree of
investment experience
on the part of the Prospective Qualified
Purchaser.
Public Companies. The rule, as proposed, would have
included in the definition of investments a
control interest in
a "listed" company that is not a
majority-owned subsidiary of
the Prospective Qualified Purchaser. A listed company would
have been defined as a company whose equity
securities are
listed on a national securities exchange,
traded on the
National Association of Securities Dealers
Automated Quotation
System (NASDAQ), or listed on a designated
offshore securities
market.
Commenters generally supported treating control
interests in listed companies as
investments, but suggested
that the category should be broadened to
include control
interests (including majority ownership
interests) in any
public company.
The Commission agrees, and has revised
the rule to include
in the definition of investments a control
interest in a
company that files periodic reports in
accordance with the
Securities Exchange Act of 1934.-[42]- The Commission
has concluded that a person that holds a
control interest in a
reporting company is likely to have
significant experience in
financial matters and investments. The fact that the control
-[42]- Rule 2a51-1(b)(1)(ii) [17 CFR 270.2a51-
1(b)(1)(ii)]. A
control interest in an issuer
may be treated as an
investment if the issuer
files reports pursuant to
section 13 or 15(d) of
the Exchange Act [15 USC 78m
and 78o(d)].
==========================================START
OF PAGE 20======
interest is a majority interest should not
affect this
analysis.
As proposed, a control interest in an issuer whose
securities are listed on a designated
offshore securities
market (as defined by Regulation S under the
Securities Act)
also may be treated as an investment.-[43]-
Large Private Companies. Many commenters suggested that a
control interest in a large private
operating company should be
treated as an investment. These commenters asserted that the
very size of such a company suggests that a
person who controls
it is sophisticated and has significant
financial
acumen.-[44]- The commenters also pointed out that
sophisticated investors, such as venture
capital investors,
often hold control interests in private
companies, and that not
treating these holdings as investments could
result in these
investors not being treated as qualified
purchasers.
Under the rule as adopted, a control
interest in a company
that has shareholders' equity of $50 million
or more may be
-[43]- Rule 2a51-1(a)(7)(ii) [17 CFR 270.2a51-
1(a)(7)(ii)]; 17 CFR 230.901
through .904.
-[44]- Commenters did not agree, however, on how to
identify such a company. Several commenters
suggested that the definition
be based on the
company's shareholders'
equity (e.g., $25
million or $50 million). Other commenters
suggested that the definition
be based on the
company's revenues, assets or
going concern
value. Still other commenters suggested that a
control interest should be
included if its value
was in excess of a specified
amount.
==========================================START
OF PAGE 21======
treated as an investment.-[45]- The Commission believes
that this change should respond to the
concerns of the
commenters in a manner consistent with the
legislative history
indicating Congress' view that control
interests in family-
owned and other small businesses may not
evidence investment
sophistication.
b. Real Estate
Rule 2a51-1(b)(2) includes real estate
held for investment
purposes within the definition of
investments.-[46]-
Most commenters strongly supported treating
real estate as an
investment.
Consistent with the examples provided
by the legislative
history of the 1996 Act, real estate is not
considered to be
held for investment purposes if the real
estate is used by the
Prospective Qualified Purchaser or a member
of the Prospective
Qualified Purchaser's family ("Related
Person") for personal
purposes (e.g., as a personal
residence).-[47]- The term
-[45]- Rule 2a51-1(b)(1)(iii) [17 CFR 270.2a51-
1(b)(1)(iii)]. The
company must have had $50
million of shareholders'
equity on its most
recent financial statements
(whether annual or
quarterly). Id.
-[46]- 17 CFR 270.2a51-1(b)(2).
-[47]- Rule 2a51-1(c)(1) [17 CFR 270.2a51-1(c)(1)].
Rule 2a51-1(a)(8) [17 CFR
270.2a51-1(a)(8)]
defines "related
person" as a sibling, spouse or
former spouse of the
prospective qualified
purchaser, or a direct lineal
descendant or
ancestor by birth or adoption
of the Prospective
Qualified Purchaser, or a
spouse of the
descendant or ancestor.
==========================================START
OF PAGE 22======
"personal purposes" is derived
from the Internal Revenue Code
provision that addresses circumstances under
which a taxpayer
is allowed deductions with respect to
certain "dwelling
units."-[48]- Thus, residential property may be treated
as an investment if it is not treated as a
residence for tax
purposes.
Many commenters agreed that the reference to the
Internal Revenue Code provisions is
appropriate because it
would allow a Prospective Qualified
Purchaser to determine
whether residential real estate is an
investment based on the
same provisions he or she would apply in
determining whether
certain expenses related to the property are
deductible for
purposes of his or her tax returns.
Property owned by a Prospective
Qualified Purchaser that
has been used by the Prospective Qualified
Purchaser or a
Related Person as a place of business or in
connection with the
conduct of a trade or business
("Business-Related Property")
also is not considered to be held for
investment
-[48]- Internal Revenue Code ("IRC") section 280A(d)
[26 USC 280A(d)]. Rule 2a51-1(c) [17 CFR
270.2a51-1(c)] treats residential real estate as
an investment if it is not
treated as a dwelling
unit used as a residence in
determining whether
deductions for depreciation
and other items are
allowable under the IRC. Section 280A provides,
among other things, that a
taxpayer uses a
dwelling unit during the
taxable year as a
residence if he or she uses
such unit for
personal purposes for a number of days that
exceeds the greater of 14
days or 10 percent of
the number of days during
which the unit is
rented at a fair market
value.
==========================================START
OF PAGE 23======
purposes.-[49]- While Business-Related Property may have
been acquired with an investment goal in
mind, these holdings
may not be indicative of extensive
experience in the financial
or real estate markets and may have been
acquired for reasons
other than the potential investment merits
of the
property.-[50]-
c. Commodity Interests, Commodities and
Financial Contracts
Rule 2a51-1(b)(3) includes contracts
for the purchase or
sale of a commodity for future delivery
("Commodity Interests")
held for investment purposes within the
definition of
investments.-[51]- Most commenters agreed that Commodity
-[49]- Rule 2a51-1(c)(1).
-[50]- Real property held by a Prospective Qualified
Purchaser primarily engaged
in the real estate
investment and development
business as part of
that business may be treated as an investment.
Id.
-[51]- 17 CFR 270.2a51-1(b)(3).
Paragraph (a)(1) of
rule 2a51-1 [17 CFR
270.2a51-1(a)(1)] defines
Commodity Interests to mean
commodity futures
contracts, options on
commodity futures
contracts, and options on
physical commodities
traded on or subject to the
rules of (a) any
contract market designated
for trading such
transactions under the
Commodity Exchange Act
(the "CEA") [7 USC
1] and the rules thereunder;
or (b) any board of trade or
exchange outside
the United States, as
contemplated in Part 30 of
the rules under the CEA. 17 CFR 30.1 through
30.11. Commodity Interests held as part of a
business by a Prospective
Qualified Purchaser
that is primarily engaged in
the business of
investing or trading in
Commodity Interests may
be treated as
investments. Rule 2a51-1(c)(2)
[17 CFR 270.2a51-1(c)(2)].
==========================================START
OF PAGE 24======
Interests should be treated as investments.
The rule also includes in the
definition of investments
commodities that are held in physical form
and for investment
purposes.-[52]- This provision recognizes that many
investors hold gold, silver or other
commodities as part of
their investment portfolios. While some commenters suggested
that the definition include any commodity,
other commenters
stated that the rule's definition would
include most
commodities held as investments.
-[52]- Rule 2a51-1(b)(4) [17 CFR 270.2a51-1(b)(4)].
Physical commodities, for
purposes of the rule,
are defined as any commodity
with respect to
which a Commodity Interest is traded on a
domestic or foreign
commodities exchange. Rule
2a51-1(a)(5) [17 CFR
270.2a51-1(a)(5)].
==========================================START
OF PAGE 25======
The rule has been revised from the
proposal to include
"swaps" and similar financial
contracts in the definition of
investments.-[53]- The Commission agrees with the
commenters that, because these instruments
often are used in
connection with investments, it is
appropriate to treat them as
investments.-[54]-
-[53]- Rule 2a51-1(b)(5) [17 CFR 270.2a51-1(b)(5)]
includes in the definition of
investments
"financial contracts"
as defined by section
3(c)(2) of the Act [15 USC
80a-3(c)(2)]. This
definition was added to
section 3(c)(2) by the
1996 Act in order to expand
the exclusion from
the definition of investment
company applicable
to securities brokers to
include certain other
market intermediaries (e.g.,
"swap" dealers).
Section 3(c)(2) provides, in
pertinent part,
that a financial contract is
any arrangement
that --
(I) takes the form of an individually negotiated
contract, agreement, or option to
buy, sell, lend,
swap, or repurchase, or other
similar individually
negotiated transaction commonly entered into by
participants in the financial
markets;
(II) is in respect of securities,
commodities,
currencies, interest or other
rates, other measures
of value, or any other financial
or economic interest
similar in purpose or function to
any of the
foregoing; and
(III) is entered into in response to a request
from a counter party for a
quotation, or is otherwise
entered into and structured to
accommodate the
objectives of the counter party to
such arrangement.
Some "financial contracts"
are also securities, and thus
investments under rule
2a51-1(b)(1). See In re BT
Securities Corp., Exchange Act Release
No. 35136 (Dec. 22,
1994).
-[54]- As with other investments, a financial contract
can be valued at its fair
market value or cost.
See section II.A.3.a of this
Release. The rule
(continued...)
==========================================START
OF PAGE 26======
d. Cash and Cash Equivalents
Rule 2a51-1(b)(7) includes cash and
cash equivalents held
for investment purposes ("Cash")
in the definition of
investments.-[55]- Most commenters agreed that treating
Cash as an investment was appropriate
because many investors
are likely at any given time to have a
component of their
investment portfolio in Cash.-[56]- In response to a
request for comment in the Proposing Release
whether the
"investment purposes" test for
Cash needed further elaboration,
many commenters responded that the "investment
purposes" test
was an appropriate formulation.
The rule clarifies certain issues
related to Cash that
were addressed in the Proposing Release or
raised by
commenters.
The rule specifies that the net cash surrender
value of an insurance policy may be
considered to be
Cash.-[57]-
The rule also specifies that, for purposes
-[54]-(...continued)
does not permit a financial
contract to be
valued at its notional amount
(e.g., the
principal amount upon which
the interest
payments in a swap
transaction are based).
-[55]- 17 CFR 270.2a51-1(b)(7).
-[56]- For example, an investor may have a significant
amount of Cash as a result of
a recent sale of
an investment or because
market conditions
resulted in the investor
taking a "defensive"
position. Cash also may be integral to certain
sophisticated investment
strategies (such as
hedging).
-[57]- Rule 2a51-1(b)(7). See
also Proposing Release,
supra note 4, at n.48.
==========================================START
OF PAGE 27======
of the rule, bank deposits, certificates of
deposit, bankers
acceptances and similar bank instruments may
be treated as
Cash.-[58]-
The rule also provides that a
Prospective Qualified
Purchaser that is a privately offered fund
or a commodity pool
may treat as investments unfunded capital
commitments (i.e.,
firm agreements by investors to provide
these Prospective
Qualified Purchasers with cash upon
request).-[59]-
Several commenters noted that privately
offered funds often do
not require their investors to provide the
moneys the investors
have committed to invest in the fund until
investment
opportunities become available to the
fund. The fund therefore
has access to cash that will be used for
investment purposes,
through commitments that reflect investors'
assessment of the
fund sponsor's investment expertise. The Commission thus
considers it appropriate to treat these
capital commitments in
a manner similar to Cash.
-[58]- Rule 2a51-1(b)(7). One
commenter suggested that
the rule be specific on this
point because
certain bank instruments with
longer maturities
might not be considered to be either cash
equivalents or
securities. The rule does not
specify that securities of a
money market fund
are Cash because they are
securities and would
be investments under rule 2a51-1(b)(1).
-[59]- Rule 2a51-1(b)(6) [17 CFR 270.2a51-1(b)(6)].
==========================================START
OF PAGE 28======
e. Other Types of Investments
The Commission requested comment
whether certain assets
(such as jewelry, artwork, antiques and
other collectibles)
that may be held by some for investment
purposes should be
treated as investments. While several commenters suggested
that such assets should be included in the
definition of
investments, others agreed that they should
be excluded because
these holdings do not necessarily suggest
any experience in the
financial markets or investing in
unregulated investment
pools.-[60]- The Commission agrees with this analysis
and the rule therefore does not include such
assets in the
definition of investments.
3. Determining the Amount of Investments
Rule 2a51-1 permits the amount of a
Prospective Qualified
Purchaser's investments to be based either
on the market value
of the investments or on their cost. In either case, the rule
requires indebtedness incurred to acquire
investments to be
deducted from the amount of investments owned
as discussed
below.
-[60]- See also AMERICAN BAR ASSOCIATION, SECTION OF
BUSINESS LAW, COMMITTEE ON
FEDERAL REGULATION OF
SECURITIES, TASK FORCE ON
HEDGE FUNDS, REPORT ON
SECTION 3(C)(1) OF THE INVESTMENT COMPANY ACT OF
1940 AND PROPOSALS TO CREATE
AN EXCEPTION FOR
QUALIFIED PURCHASERS, 51 Bus.
Law. 773, 778
(Dec. 5, 1995) (hereinafter
HEDGE FUNDS TASK
FORCE REPORT) (suggesting that automobiles,
jewelry and art be excluded
from investments for
purposes of measuring
financial sophistication).
==========================================START
OF PAGE 29======
a. Value of Investments
Rule 2a51-1(d) specifies that the value
of an investment
may be either its market value on the most
recent practicable
date or its cost.-[61]- Most commenters supported this
approach.
The rule as adopted has been reformulated to state
that the value of an investment may be
either its cost or "fair
market value" on the most recent
practicable date. This change
is designed to clarify that, in the absence
of a recent market
value, an investment's value could be
determined by an
appraisal by an independent third
party.-[62]-
The rule does not specify which
valuation methodology
should be used in a particular
circumstance. A Section 3(c)(7)
Fund
could allow Prospective Qualified Purchasers to provide
the amount of their investments based on
either methodology,
since either methodology is an appropriate
way to measure a
Prospective Qualified Purchaser's investment
experience.
b. Deductions from Amount of Investments
i. Certain Indebtedness
The rule, as proposed, would have
required the deduction
from the amount of a Prospective Qualified
Purchaser's
investments (i) of any indebtedness incurred
to acquire the
investments and (ii) of certain
mortgage-related indebtedness
-[61]- 17 CFR 270.2a51-1(d).
In the case of a
security, market value could
be determined in
the manner described in rule
17a-7(b) under the
Investment Company Act [17
CFR 270.17a-7(b)].
-[62]- See Proposing Release, supra note 4, at n.53.
==========================================START
OF PAGE 30======
incurred during the preceding 12 months
("Mortgage Deduction").
These provisions, (collectively, the
"Indebtedness Deduction
Provision") reflected the Commission's
belief that, in
establishing the $5 million/$25 million
investment thresholds,
Congress intended that qualified purchasers
generally be
limited to persons who own a specified
amount of investments.
This intention would appear to be
inconsistent with permitting
a Prospective Qualified Purchaser to
accumulate the requisite
amount of investments through borrowing or
similar means.
Most commenters objected to the
Indebtedness Deduction
Provision as unnecessary and inconsistent
with Congress's
intent.
Some commenters, however, believed that the provision
was appropriate and consistent with the
policies underlying
section 3(c)(7). Many commenters, whether opposing or
supporting the provision, suggested that it
be revised in
certain respects to make it easier to apply.
After considering all of the comments
received and the
1996 Act's legislative history, the
Commission continues to
believe that the Indebtedness Deduction
Provision appropriately
implements Congress's intent. The Commission is therefore
adopting this provision substantially as
proposed with one
change designed to simplify its
application. The rule, as
adopted, does not include the Mortgage
Deduction. This
deduction was designed to preclude a
personal residence or a
vacation home from, in effect, being
converted into Cash or
another type of investment for purposes of
meeting the $5
==========================================START
OF PAGE 31======
million threshold. Some commenters suggested that this
provision was overly complex and would be
difficult to
administer.
Other commenters suggested generally that the
Indebtedness Deduction Provision, if
included in the rule, be
limited to indebtedness incurred to acquire
investments. These
commenters noted that indebtedness secured
by a mortgage could
be incurred for various reasons other than
to acquire
investments and that the provision was
therefore overbroad.
Upon reflection, the Commission has
concluded that the
Mortgage Deduction is unnecessary. As discussed above, the
rule requires that indebtedness incurred to
acquire an
investment be deducted.-[63]- If a mortgage loan (or any
other type of loan) is incurred to acquire,
or for the purpose
of acquiring, an investment, the outstanding
amount of such
loan would have to be deducted.-[64]-
Consistent with these changes to the
Indebtedness
Deduction Provision, the rule's provision
with respect to
indebtedness deductions by Family Companies
has been
significantly simplified. Certain proposed deductions relating
to indebtedness incurred by a Family Company
or its owners are
-[63]- Rule 2a51-1(e) [17 CFR 270.2a51-1(e)].
-[64]- It also should be noted that Cash held for
investment purposes is an
investment.
Therefore, if the cash
proceeds of a loan are
treated as an investment, the
outstanding amount
of the loan must be deducted.
==========================================START
OF PAGE 32======
not required by the adopted rule.-[65]- The rule, as
adopted, requires a Family Company to deduct
the amount of any
outstanding indebtedness incurred by the
Family Company or any
of the Family Company's owners to acquire
the investments held
by the Family Company.-[66]-
ii. Other Payments
The rule, as proposed, would have
required a Prospective
Qualified Purchaser who is a natural person
to deduct certain
payments that he or she received during the
preceding 12 months
relating to, among other things, lawsuits,
insurance policies,
divorce and separation agreements, and gifts
and bequests.
This provision ("Other Payments
Provision") was designed to
assure that Prospective Qualified Purchasers
who are natural
persons would be required to deduct from the
amount of their
investments certain amounts received during
the preceding 12
months that could inflate the amount of
their investments
-[65]- Under the proposed rule, a Family Company also
would have been required to
deduct (i) the
amount of any real estate
loans that any owner
of the Family Company would
have had to deduct
if the owner were the
Prospective Qualified
Purchaser; (ii) the amount of
any indebtedness
incurred by the Family
Company during the
preceding 12 months to the
extent that the
principal amount of the
indebtedness exceeded
the fair market value of any
assets of the
Family Company other than
investments; and (iii)
the amount of any
indebtedness incurred during
the preceding 12 months by an
owner of the
Family Company or by a
related person of an
owner of the Family Company
and guaranteed by
the Family Company. See Proposing Release,
supra note 4, at nn.59-61 and
accompanying text.
-[66]- Rule 2a51-1(f) [17 CFR 270.2a51-1(f)].
==========================================START
OF PAGE 33======
(particularly Cash) without reflecting any
investment
experience.
As with the Indebtedness Deduction
Provision, most
commenters objected to the Other Payments Provision
as overly
complex and potentially difficult to
administer. One
commenter, however, believed that the Other
Payments Provision
was consistent with the policies underlying
section 3(c)(7) and
suggested that the Commission consider
additional deductions
(such as the proceeds from the sale of a
family-owned
business).
After considering the comments
received, the Commission
has determined not to adopt the Other
Payments Provision at
this time.
Similarly, the provision that would have required
Other Payments received by owners of a
Family Company to be
deducted by the Family Company is not being
adopted. At this
time, the burdens that might be associated
with the Other
Payments Provision appear to outweigh its
benefits to
investors.
The Commission may revisit this issue in the future
if experience with section 3(c)(7) suggests
that a provision
similar to the Other Payments Provision is
necessary or
appropriate in the public interest or for
the protection of
investors.
4. Jointly Held Investments
The rule provides that, in determining
whether a natural
person is a qualified purchaser, the person
may include in the
amount of his or her investments any
investments held jointly
==========================================START
OF PAGE 34======
with the person's spouse ("Joint
Investments").-[67]-
Thus, a person who owns $3 million of
investments individually
and $2 million of Joint Investments would be
a qualified
purchaser.
The spouse also would be a qualified purchaser if
he or she owned, individually, an additional
$3 million of
investments.
A spouse who is not a qualified
purchaser can hold a joint
interest in a Section 3(c)(7) Fund with his
or her qualified
purchaser spouse.-[68]- The Commission requested comment
whether spouses who hold $5 million in
investments in the
aggregate (regardless of whether the
investments are held
jointly) should be treated as qualified
purchasers if they make
a joint investment in a Section 3(c)(7)
Fund. All the
commenters that addressed this issue agreed
that permitting
such investments would be appropriate. The rule as adopted
reflects this approach.-[69]- The Commission believes
-[67]- Rule 2a51-1(g)(2) [17 CFR 270.2a51-1(g)(2)].
Joint Investments also
include investments in
which the person shares with
his or her spouse a
community property or similar
shared ownership
interest. Id.
In determining the amount of
Joint Investments, the
Prospective Qualified
Purchaser must deduct from
the amount of any
Joint Investments any
outstanding indebtedness
incurred by the spouse to
acquire the
investments. Id.
-[68]- Section 2(a)(51)(A)(i) of the Act.
-[69]- Rule
2a51-1(g)(2). Consistent with this
approach, the Commission
believes that, for
purposes of determining the
number of beneficial
owners of voting securities
of a Section 3(c)(1)
Fund, securities of the Section 3(c)(1) Fund
(continued...)
==========================================START
OF PAGE 35======
that this approach will simplify the
determination of whether
spouses making a joint investment are
qualified purchasers.
5. Investments Held by Certain Affiliated Entities
The rule, as proposed, would have
permitted a parent
company that is a Prospective Qualified
Purchaser to aggregate
investments it owns with those owned by its
majority-owned
subsidiaries, provided that the
subsidiaries' investments were
managed under the direction of the parent
company.-[70]-
Most commenters agreed with this approach,
but suggested that
the provision should address a broader range
of corporate and
other inter-company structures. Commenters suggested, for
example, that when a company that is part of
a group of related
companies is making an investment in a
Section 3(c)(7) Fund, it
is not necessary to focus on which of these
companies actually
owns or manages the investments.
The Commission agrees with this
analysis. The rule as
-[69]-(...continued)
jointly owned by both spouses
should be
considered to be owned by one
beneficial owner.
This approach is a departure
from an earlier
staff position on this
issue. See, e.g., Joseph
H. Moss (Feb. 27, 1984).
-[70]- This approach is designed to recognize, for
example, holding company
structures necessitated
by legal, tax or other
factors that may require
or make advantageous the holding of investments
in separate corporate
entities. See, e.g.,
Resale of Restricted
Securities; Changes To
Method of Determining Holding
Period of
Restricted Securities Under
Rules 144 and 145,
Securities Act Release No.
6862 (Apr. 23, 1990)
[55 FR 17933 (Apr. 30, 1990)]
(describing bank
holding company structures).
==========================================START
OF PAGE 36======
adopted permits the investments of a parent
company and its
majority-owned subsidiaries to be
aggregated, regardless of
which company is the Prospective Qualified
Purchaser.-[71]-
6. Reasonable Belief
The rule, as proposed, would have
permitted a Section
3(c)(7) Fund or a person acting on its
behalf, when determining
whether a Prospective Qualified Purchaser is
a qualified
purchaser, to rely upon audited financial statements,
brokerage
account statements and other appropriate
information and
certifications provided by the Prospective
Qualified Purchaser
or its representatives, as well as upon
publicly available
information as of a recent date.-[72]- The rule would
have required that reliance on this
information be reasonable
and that the Section 3(c)(7) Fund or its
representatives, after
reasonable inquiry, have no basis for
believing that the
information is incorrect in any material
respect.
Commenters generally agreed that the
proposed rule was
consistent with the suggestion in the 1996
Act's legislative
history that the Commission use its
rulemaking authority to
-[71]- Rule 2a51-1(g)(3) [17
CFR 270.2a51-1(g)(3)].
Several commenters noted that
the rule, as
proposed, would not have
extended to non-
corporate structures. The rule as adopted
refers generally to
"companies" rather than
"corporations." Id.
-[72]- Proposed rule 2a51-1(j).
==========================================START
OF PAGE 37======
adopt rules with respect to "reasonable
care
defenses."-[73]- The commenters suggested, however, that
the rule should conform to the provisions of
other Commission
rules under the Securities Act that address
transactions
involving certain categories of
sophisticated investors, such
as rule 506 of Regulation D (offerings to
"accredited
investors" and "sophisticated
investors") and rule 144A (sales
to QIBs).-[74]- These rules focus on whether an issuer
"reasonably believes" that a
purchaser of securities satisfies
certain criteria for investors specified in
the
rules.-[75]- Rule 2a51-1, as adopted, reflects this
approach.-[76]-
The Commission requested comment
whether the rule should
contain a list of the types of documents
(similar to the list
included in rule 144A) that a Section
3(c)(7) Fund could rely
-[73]- The legislative history of the 1996 Act
indicates that the Commission
can use its
rulemaking authority provided
in section
2(a)(51) of the Act [15 USC
80a-2(a)(51)] to
"develop reasonable care
defenses when an issuer
relying on the qualified
purchaser exception in
good faith sells securities
to a purchaser that
does not meet the qualified
purchaser
definition." House Report, supra note 12, at
53.
-[74]- 17 CFR 230.144A, .506.
-[75]- 17 CFR 230.144A(d)(1), .501(a).
-[76]- Rule
2a51-1(h) [17 CFR 270.2a51-1(h)] provides,
in relevant part, that the
term "qualified
purchaser" as used in
section 3(c)(7) of the Act
includes a person who a
Section 3(c)(7) Fund or
its representative
"reasonably believes" is a
qualified purchaser.
==========================================START
OF PAGE 38======
on in determining whether a Prospective
Qualified Purchaser was
a qualified purchaser. Commenters had mixed reactions to this
approach.
Some commenters objected to the inclusion of a list,
while others argued that the types of
documents set forth in
rule 144A were not sufficiently
inclusive. Although the
Commission understands that the list
provided in rule 144A has
been useful in that context, that list
reflects the type of
information that usually is publicly
available concerning
institutional investors (the only type of
investor that can be
a QIB).
Commenters suggested that similar information
typically is not available for individual
investors. Because a
list similar to that included in rule 144A
would be of limited
use, it is not included in rule 2a51-1.
7. Retirement Plans
and Other Forms of Holding
Investments
The Commission requested comment
whether there are other
structures for holding ownership interests
in investments that
should be addressed by the rule. Many commenters requested
clarification on various issues related to
assets held in
individual retirement accounts
("IRAs") and employee benefit
plans.
The rule provides that a Prospective Qualified
Purchaser who is a natural person may
include investments held
in his or her IRA or in other retirement
accounts (such as a
"401(k)" plan) when the
Prospective Qualified Purchaser makes
==========================================START
OF PAGE 39======
all of the investment decisions for the
account.-[77]-
The Commission understands that there
are other forms of
holding investments that may raise
interpretative issues
concerning whether a Prospective Qualified
Purchaser "owns" an
investment.-[78]- For instance, when an entity that
holds investments is the "alter
ego" of a Prospective Qualified
Purchaser (as in the case of an entity that
is wholly owned by
a Prospective Qualified Purchaser who makes
all the decisions
with respect to such investments), it would
be appropriate to
attribute the investments held by such
entity to the
Prospective Qualified Purchaser.
8. Pension and Retirement Plans as Qualified
Purchasers
A number of commenters raised
interpretative questions
concerning the circumstances under which a
pension or other
type of employee benefit plan that holds $25
million of
investments in the aggregate could be
treated as a qualified
-[77]- Rule
2a51-1(g)(4) [17 CFR 270.2a51-1(g)(4)].
A
401(k) plan is established in
accordance with
section 401(k) of the IRC [26
USC 401(k)]. If a
401(k) plan provides several
options in which an
employee can choose to invest
his or her
account, the employee would
be making the
investment decision with
respect to the account
even though the plan's
trustee or sponsor
selects the range of options from which the
employee can choose.
-[78]- Many of the issues raised by commenters have
been addressed by the
provision of the rule
dealing with ownership of
investments by certain
affiliated companies. See rule 2a51-1(g)(3);
supra section II.A.5 of this
Release.
==========================================START
OF PAGE 40======
purchaser.
Most of these questions concerned 401(k) plans that
allow an employee to direct the investment
of his or her
account balance (which may consist of
amounts contributed by
the employee, the employer, or both) to
specified investment
alternatives available through the
plan. Some commenters
suggested that if such a plan holds $25
million of investments
in the aggregate, participants in the plan
should have an
opportunity to invest in a Section 3(c)(7)
Fund offered as an
investment option. Other commenters argued that the Section
3(c)(7) Fund should "look through"
the 401(k) plan to its
participants for purposes of determining
whether each investor
in the Fund is a qualified purchaser.
The latter approach reflects the
Commission's
interpretation of section 3(c)(7). The legislative history of
the 1996 Act indicates that Section 3(c)(7)
Funds are to be
limited to investors who own a specified
amount of
investments.-[79]- The critical issue, therefore, is not
-[79]- See Senate Report, supra note 12, at 10. The
Commission staff has taken a
similar position
under section 3(c)(1) of the
Act, with which the
Commission agrees, with
respect to how to
"count" 401(k)
plans for purposes of determining
whether a Section 3(c)(1)
Fund has 100 or fewer
investors. Thus, each participant in the plan
who chooses to invest in the
Fund, as opposed to
the plan itself, should be
treated as a separate
investor in the Section
3(c)(1) Fund for
purposes of determining the
number of beneficial
owners of the Fund's
securities. See The
PanAgora Group Trust (Apr.
29, 1993).
The Commission is aware that the staff
has taken the
position under section 3(c)(1) that a
self-directed
(continued...)
==========================================START
OF PAGE 41======
whether the employee is directing his or her
investments
through a 401(k) plan or a similar
intermediary, but whether
the employee owns the requisite amount of
investments.
Congress determined generally that the
person making the
investment decision to invest in a Section
3(c)(7) Fund had to
own a requisite amount of investments; the
Act generally does
not permit a person who does not own the
requisite amount of
investments to be treated as a qualified
purchaser even if he
or she received advice from a third party
concerning the
investment.
The approach described above would not
apply to a defined
benefit or other retirement plan that owns
$25 million of
investments and does not permit participants
to decide whether
or how much to invest in particular
investment alternatives.
If the decision to invest in a Section
3(c)(7) Fund is made by
the plan trustee or other plan fiduciary
that makes investment
decisions for the plan, and the plan owns at
least $25 million
-[79]-(...continued)
employee benefit plan can be considered
to be a single
investor under certain
circumstances. In particular, the
staff has indicated that such a plan
would be a single
investor for purposes of section
3(c)(1) if the plan
operates in a manner resembling that of
a defined benefit
plan.
See The Standish Ayer & Wood, Inc. Stable Value
Group Trust (Dec. 28, 1995). In adopting the analysis set
forth in the PanAgora letter, the
Commission is not
endorsing the analysis set forth in the
Standish Ayer
letter for purposes of section
3(c)(7). The Commission
has requested the staff to consider
whether the position
taken in the Standish Ayer letter is
appropriate in the
context of section 3(c)(7) and to
reconsider whether the
position taken in the Standish Ayer
letter is consistent
with that reflected in the PanAgora
letter for purposes of
section 3(c)(1).
==========================================START
OF PAGE 42======
of investments that is not subject to
participant direction,
the plan would be a qualified purchaser with
respect to
investments made by the plan trustee.
9. Other Issues Relating to Qualified Purchasers
Section 3(c)(7)(A) of the Act provides that
the
outstanding securities of a Section 3(c)(7)
Fund must be owned
"exclusively by persons who, at the
time of acquisition of such
securities, are qualified
purchasers." The Commission
believes
that, as a general matter, this provision
requires the
determination whether a person is a
qualified purchaser to be
made or reaffirmed each time the person
acquires securities of
a Section 3(c)(7) Fund.
Commenters noted that privately offered
funds often allow
investors to make their investment in a fund
in installments or
as the fund's manager needs capital to make
investments. These
commenters requested that the Commission
clarify whether
section 3(c)(7) requires the investor to be
a qualified
purchaser at the time each installment is
paid. The Commission
would interpret section 3(c)(7) as not
requiring a Section
3(c)(7) Fund to determine whether the
investor is a qualified
purchaser each time the investor makes
additional investments
in the Fund pursuant to a binding commitment
to make such
payments, provided the investor was a
qualified purchaser at
the time the investor made the
commitment. The Commission
believes that this approach is consistent
with section 3(c)(7).
Commenters also requested guidance
whether affiliates of a
==========================================START
OF PAGE 43======
Section 3(c)(7) Fund's sponsor that hold
interests in the Fund
are required to be qualified purchasers. A privately offered
fund is often organized as a limited
partnership with the
fund's sponsor or investment adviser (or one
of their
affiliates) serving as the general
partner. In these
circumstances, if the general partnership
interest is not a
security-[80]- and is not being used as a
device to evade
the provisions of section 3(c)(7) limiting
security holders of
the Section 3(c)(7) Fund to qualified
purchasers, the general
partner need not be a qualified
purchaser.-[81]-
B.
Definitions of Beneficial Ownership and Other Issues
Relating to the Grandfather and
Consent Provisions
Rule 2a51-2 defines the term
"beneficial owner" for
purposes of the Grandfather Provision governing
Section 3(c)(1)
Funds that wish to convert into Section
3(c)(7) Funds and the
Consent Provision governing Section 3(c)(1)
and Section 3(c)(7)
Funds that wish to become qualified
purchasers. The rule also
addresses what types of ownership constitute
"indirect"
beneficial ownership for purposes of the
Consent Provision.
-[80]- See, e.g., Williamson v. Tucker, 645 F.2d 404
(5th Cir.), cert. denied, 454
U.S. 897 (1981).
-[81]- See, e.g., Shoreline Fund, L.P and Condor Fund
International, Inc. (Nov. 14,
1994) (taking a
similar approach under
section 3(c)(1)).
==========================================START
OF PAGE 44======
1. The Grandfather Provision
a. Background
Under the Grandfather Provision, a
Grandfathered Fund may
convert into a Section 3(c)(7) Fund without
requiring investors
that are not qualified purchasers to dispose
of their interests
in the Fund.-[82]- The Grandfather Provision requires
the Grandfathered Fund, prior to the
conversion, (i) to
disclose to each "beneficial
owner" that future investors will
be limited to qualified purchasers, and that
ownership in the
Grandfathered Fund will no longer be limited
to 100 persons,
and (ii) concurrently with or after the
disclosure, to provide
each beneficial owner with a reasonable
opportunity to redeem
any part or all of its interests in the Fund
for that
beneficial owner's proportionate share of
the Fund's "net
assets."-[83]-
-[82]- See 142 CONG. REC. at E1929 (Oct. 4, 1996)
(Remarks of Hon. Thomas J.
Bliley, Jr.). These
non-qualified purchasers must
have acquired all
or a portion of their
investment in the
Grandfathered Fund on or
before September 1,
1996. The Grandfather Provision was designed to
enable existing Section
3(c)(1) Funds to
preserve their arrangements
with these non-
qualified purchasers, and
does not limit
additional purchases by these
non-qualified
purchasers of the Grandfathered Fund's
securities. Any person owning a security of the
Grandfathered Fund who
acquired the security
after September 1, 1996 must
be, either on the
date of the acquisition or on the date that the
Fund avails itself of section
3(c)(7), a
qualified purchaser.
-[83]- The opportunity must be provided
"notwithstanding any
agreement to the contrary
between the [Grandfathered
Fund] and such
beneficial owner." Section 3(c)(7)(B)(ii)(II)
of the Act [15 USC
80a-3(c)(7)(B)(ii)(II)].
==========================================START
OF PAGE 45======
The 1996 Act directs the Commission to
define the term
"beneficial owner" for purposes of
the Grandfather Provision.
The legislative history of the 1996 Act
suggests that the
Commission was to use this authority to
alleviate any
unnecessary burdens that might arise as a
result of the
application of section 3(c)(1)'s
Look-Through
Provision.-[84]- Specifically, Congress appears not to
have intended to require a Grandfathered
Fund to provide the
notice and redemption opportunity to
security holders of its
institutional investors, even when those
security holders would
be deemed beneficial owners of the
Grandfathered Fund's voting
securities under the Look-Through
Provision.-[85]-
Rather, the notice and redemption
opportunity generally are
intended to be provided only to the
institutional investor,
unless the institutional investor is
controlled by or under
common control with the Grandfathered
Fund.-[86]-
Consistent with the purposes indicated
in the legislative
history of the 1996 Act, the Commission
believes that the
grandfather notice and redemption
opportunity requirements were
intended not only for the purposes described
above, but for the
benefit of certain persons who were deemed
to be beneficial
-[84]- See supra note 18 and accompanying text
(describing section
3(c)(1)(A) of the Investment
Company Act).
-[85]- See Remarks of Hon. Thomas J. Bliley, supra note
82.
-[86]- Id.
==========================================START
OF PAGE 46======
owners prior to the 1996 Act's amendments to
the Look-Through
Provision.-[87]- These persons may have relied on the
then-existing Look-Through Provision as a
way to limit the
Grandfathered Fund's ability to sell its
securities to
additional investors.-[88]- Allowing the Grandfathered Fund to
raise substantial new capital from an
unlimited number of
qualified purchasers could significantly
alter the nature of an
investment in the Grandfathered Fund. Most commenters agreed
that the manner in which the proposed rule
defined beneficial
ownership for purposes of the Grandfather
Provision is
consistent with the 1996 Act's legislative
history and
supported the rule.
-[87]- See supra note 19 and accompanying text
(discussing the elimination
of the Second 10%
Test).
-[88]- This reliance can be illustrated by the
following example. An investor invested in a
Section 3(c)(1) Fund
("Fund A") through another
Section 3(c)(1) Fund
("Fund B") that was subject
to the Look-Through Provision
as then in effect.
The investor may have made
its investment in
Fund B (or Fund B may have
made its investment
in Fund A) recognizing that
under section
3(c)(1)(A) as then in effect,
each security
holder of Fund B was deemed
to be a beneficial
owner of Fund A's voting
securities. In this
way, the Look-Through
Provision would have
limited the number of
additional persons that
could invest in Fund A. As noted above,
however, even in these
circumstances, Congress
appears to have intended that
investors in Fund
B not be deemed beneficial
owners of Fund A's
securities for purposes of
the Grandfather
Provision unless there is a
control relationship
between Fund A and Fund
B.
==========================================START
OF PAGE 47======
b. Operation of the Rule
Paragraph (a) of rule 2a51-2 provides
generally that
beneficial ownership is to be determined in
accordance with
section 3(c)(1) of the Act.-[89]- Paragraph (b) of the
rule provides a special rule for determining
beneficial
ownership of securities held by a
company.-[90]-
Paragraph (b) provides that securities of a
Grandfathered Fund
beneficially owned by a company (without
giving effect to the
Look-Through Provision) are deemed to be
beneficially owned by
one person (the "Owning Company")
unless (i) on October 11,
1996, under section 3(c)(1)(A) of the Act as
then in effect,
the voting securities of the Grandfathered
Fund were deemed to
be beneficially owned by the holders of the
Owning Company's
outstanding securities,-[91]- (ii) the
Owning Company has
a control relationship with the
Grandfathered Fund,-[92]-
and (iii) the Owning Company is itself an
investment company or
-[89]- 17 CFR 270.2a51-2(a).
-[90]- 17 CFR 270.2a51-2(b).
-[91]- The applicability of the Look-Though Provision
is determined as of October
11, 1996 to assure
that the Grandfathered Fund
did not engage in
transactions subsequent to
the enactment of the
1996 Act designed to limit
the applicability of
the Look-Through Provision
(such as the issuance
of additional voting
securities so that the
percentage of voting
securities owned by an
Owning Company falls below
10%).
-[92]- See supra note 38 (describing the Act's
definition of control).
==========================================START
OF PAGE 48======
a privately offered fund.-[93]- If these conditions do
not apply, the grandfather notice and
redemption opportunity
should be provided to the Owning
Company. If the conditions do
apply, the grandfather notice and redemption
opportunity should
be provided to the Owning Company's security
holders as the
beneficial owners of the Grandfathered
Fund's securities.
The application of the rule can best be
illustrated by the
following example. Assume Company A is a Grandfathered Fund
and that Company B, a Section 3(c)(1) Fund, owned
more than 10%
of the voting securities of Company A on
October 11, 1996. If
Company B does not have a control
relationship with Company A,
the grandfather notice and redemption
opportunity can be
provided directly to Company B. If a control relationship does
exist, and on October 11, 1996, the security
holders of Company
B were deemed to be the beneficial owners of
Company A's voting
securities (because of the Second 10%
Test),-[94]-
Company A must provide the grandfather
notice and redemption
opportunity to each of Company B's security
holders.
-[93]- Limiting the application of the Look-Through
Provision in this context to
Owning Companies
that are investment companies or privately
offered funds is consistent
with amended section
3(c)(1)(A). If the Owning Company is not an
investment company or a
privately offered fund,
its security holders are unlikely to have a
sufficient interest in its
investment in the
Grandfathered Fund to justify
providing them
with the grandfather notice
and redemption
opportunity. See supra
note 19 and accompanying
text.
-[94]- See supra section I.B. of this Release.
==========================================START
OF PAGE 49======
c. Interpretative Issues Relating to the
Grandfather Provision
i. Scope of the Grandfather Provision
The Commission believes that the notice
and redemption
opportunity requirements of the Grandfather
Provision were
intended for the benefit of all persons who
are beneficial
owners of the securities of a Grandfathered
Fund. The
Commission noted in the Proposing Release
that, consistent with
this legislative intent, it believed that
the conditions in the
Grandfather Provision must be complied with
by any Section
3(c)(1) Fund that wishes to rely on the
Grandfather Provision,
even if each beneficial owner of the Fund
meets the definition
of qualified purchaser. While several commenters objected to
this interpretation, the Commission believes
that it clearly
reflects the legislative history of the
Grandfather Provision.
If the notice and redemption opportunity
requirements had been
intended only for the benefit of beneficial
owners who are not
qualified purchasers, Congress could have
limited the
Grandfather Provision accordingly.-[95]-
-[95]- Compare House Report, supra note 12, at 51
(describing original
provision in H.R. 3005, as
reported by the Committee on
Commerce, which
limited the notice and
redemption opportunity to
investors that were not
qualified purchasers)
and Senate Report, supra note
12, at 23 ("The
issuer must allow section
3(c)(1) fund owners
`of record' to redeem their
interests in the
fund in either cash or a
proportionate share of
the fund's assets.");
see also supra note 82.
==========================================START
OF PAGE 50======
ii. "Net Assets"
The Grandfather Provision states that a
redeeming
beneficial owner of a Grandfathered Fund is entitled
to receive
its proportionate share of the Fund's
"net assets."-[96]-
The Act does not define the term "net
assets." In the
Proposing Release, the Commission noted that
the term "current
net assets" is used in the Investment Company
Act and defined
by Commission rule.-[97]- The Commission requested
comment whether "net assets," for
purposes of the Grandfather
Provision, should be determined based upon
the methods used to
determine "current net assets," or
the methods that would have
been used to determine the amount that the
beneficial owner
would have received in accordance with
existing withdrawal
provisions in the Grandfathered Fund's
governing documents.
Most commenters suggested that "net
assets" be determined in
-[96]- Section 3(c)(7)(B)(ii)(II) of the Act. Each
person electing to redeem
must receive its
proportionate share of the
Grandfathered Fund's
net assets in cash, unless the person agrees to
accept such amount in kind
(i.e., in assets of
the Grandfathered Fund). If the Grandfathered
Fund elects to provide
investors with an
opportunity to receive an in-kind distribution,
this election must be
disclosed in the
grandfather disclosure.
-[97]- See, e.g., section 2(a)(32) of the Investment
Company Act [15 USC
80a-2(a)(32)] (defining the
term redeemable security as a
"security . . .
under the terms of which the
holder . . . is
entitled (whether absolutely
or only out of
surplus) to receive
approximately his
proportionate share of the
issuer's current net
assets, or the cash
equivalent thereof") and
rule 2a-4 [17 CFR 270.2a-4]
(definition of
current net asset value for
certain purposes).
==========================================START
OF PAGE 51======
accordance with the latter approach.
The Commission does not believe that
the term "net assets"
as used in the Grandfather Provision was
intended to be
identical to the term "current net
assets" as used in the Act.
The Commission believes that the term
"net assets" should be
interpreted in a manner consistent with the
legislative
purposes of the notice and redemption
opportunity requirements
of the Grandfather Provision. The Grandfather Provision was
designed to afford investors in the
Grandfathered Fund an
opportunity to redeem their investment,
without penalty, before
the Grandfathered Fund raises substantial new
capital by
increasing the number of the Fund's security
holders above the
limit in section 3(c)(1), thereby possibly
altering the nature
of an investment in the Grandfathered
Fund.-[98]-
It would be consistent with the
Grandfather Provision for
a Grandfathered Fund to conclude that it
could redeem a
beneficial owner's pro rata share of the net
asset value of the
Fund in accordance with the methods
specified in the Fund's
governing documents. Valuation methods that "hold back"
certain amounts (e.g., reserves for
contingent liabilities) may
be consistent with the Grandfather Provision
to the extent that
they do not act as a penalty for exercising
the redemption
right afforded by section 3(c)(7). If a fund is unable to
conclude that the hold back is not a
penalty, the fund could
-[98]- See Proposing Release, supra note 4, at n.76 and
accompanying text.
==========================================START
OF PAGE 52======
continue to comply with section 3(c)(1)
until all amounts due
to redeeming beneficial owners have been
paid.
Commenters requested guidance
concerning how to determine
the pro rata share of net assets to which
debt and senior
securities redeemed in accordance with the
Grandfather
Provision would be entitled. The Commission believes that the
"net assets" attributable to these
securities would generally
be determined by the repayment or redemption
provisions
governing such instruments. In most cases, this amount could
be the principal amount of the securities
(or, in the case of
preferred stock, the liquidation preference
or other amount
payable upon redemption), any accrued and
unpaid interest or
dividends, and any premium due upon
prepayment or redemption.
The Commission also notes that the
Grandfather Provision
does not override provisions in fund
documents, other
agreements or applicable law that could have
the effect of
preventing a fund from converting into a
Section 3(c)(7)
Fund.-[99]-
For example, if a fund's partnership
agreement prohibits the fund from having
more than 100
-[99]- The Grandfather Provision requires that a
Grandfathered Fund afford its
beneficial owners
a redemption opportunity
"notwithstanding any
agreement to the contrary
between" the Fund and
its investors.
Section 3(c)(7)(B)(ii)(II) of
the Act. This provision is designed to assure
that the Grandfathered Fund
affords the
redemption opportunity prior
to admitting
qualified purchasers in
accordance with section
3(c)(7), notwithstanding
contractual provisions
that only require redemption
opportunities to be
provided periodically.
==========================================START
OF PAGE 53======
investors, the fund may have to seek to
amend the agreement
before selling its securities to qualified
purchasers (if the
fund already has 100 investors).-[100]-
Many commenters observed that in the case
of certain
privately offered funds, providing the
redemption opportunity
required by the Grandfather Provision could
have significant
adverse effects on a fund's investment
strategy.-[101]-
The Grandfather Provision does not override
the fiduciary
duties that a sponsor of a Grandfathered
Fund may have to the
beneficial owners of the Fund's securities
under the Fund's
governing documents or applicable law. Thus, the general
partner or other fiduciary of a privately
offered fund may have
to consider whether effecting the notice and
redemption
required by the Grandfather Provision in
order to be able to
open the fund to new investors (and increase
the amount of
assets in the fund and the general partner's
fee) is in the
best interests of the fund's security
holders.
2. The Consent Provision
Section 2(a)(51)(C) of the Act requires
that a privately
-[100]- Similarly, if a Grandfathered Fund has issued
debt securities pursuant to
an indenture that
requires a prepayment premium
if the debt
securities are repaid before
a specified date
(or precludes prepayment), the
Grandfather
Provision does not override
these provisions.
-[101]- For example, commenters suggested that in order
to meet redemption requests,
a fund might be
required to sell illiquid portfolio
positions at
a loss or when it would not
otherwise be in the
best interests of the fund's
investors to do so.
==========================================START
OF PAGE 54======
offered fund that wishes to become a
qualified purchaser
("Purchasing Fund") obtain the
consent of all of its beneficial
owners that had invested in the Purchasing
Fund on or before
April 30, 1996.-[102]- The beneficial owners of the
securities of any privately offered fund
that is a direct or
indirect beneficial owner of the securities
of the Purchasing
Fund also must consent to the treatment of
the Purchasing Fund
as a qualified purchaser.-[103]-
a. Definition of Beneficial Owner
Paragraph (c) of rule 2a51-2 clarifies
the meaning of the
term "beneficial owner" for
purposes of the Consent
Provision.-[104]- The rule provides that securities of
a Purchasing Fund beneficially owned by a
company ("Owning
Company"), without giving effect to the
Look-Through Provision,
are deemed to be beneficially owned by one
person unless (i) on
April 30, 1996, under section 3(c)(1)(A) of
the Act as then in
effect, the voting securities of the
Purchasing Fund were
deemed to be beneficially owned by the
holders of the Owning
Company's outstanding securities, (ii) the
Owning Company has a
-[102]- The legislative history of the 1996 Act does not
explain the purpose of the Consent Provision.
Section 2(a)(51)(C) uses the term
"excepted company" to
refer to Section 3(c)(1) and Section
3(c)(7) Funds. The
inclusion of Section 3(c)(7) Funds in
this provision was
presumably designed to require the
consent to be obtained
by any Grandfathered Fund that wished
to be a qualified
purchaser.
-[103]- Id.
-[104]- 17 CFR 270.2a51-2(c).
==========================================START
OF PAGE 55======
control relationship with either the
Purchasing Fund or the
Section 3(c)(7) Fund with respect to which
the Purchasing Fund
will be a qualified purchaser ("Target
Fund"), and (iii) the
Owning Company itself is a privately offered
fund. If these
conditions do not apply, the consent must be
obtained from the
Owning Company. If the conditions do apply, the consent must
be obtained from the Owning Company's
security holders as the
beneficial owners of the Purchasing Fund's
securities under the
rule.
As in the case of the definition of
beneficial owner for
purposes of the Grandfather Provision, the
rule relating to the
Consent Provision is intended to allow an
institutional
investor to provide the required consent
even if, under the
Look-Through Provision, the security holders
of the
institutional investor are deemed to be
beneficial owners of
the Purchasing Fund's securities. If there is a control
relationship between the Purchasing Fund and
either the Owning
Company or the Target Fund, and the Owning
Company is a
privately offered fund whose security
holders were deemed
beneficial owners of the Purchasing Fund on
April 30, 1996,
then the consent must be obtained from those
security holders.
b. Required Consent
As proposed, paragraph (d) of the rule
clarifies what
constitutes "indirect" ownership
with regard to the requirement
in section 2(a)(51)(C) of the Act that the
consent be obtained
from the security holders of a privately
offered fund that is
==========================================START
OF PAGE 56======
an indirect beneficial owner of the
Purchasing
Fund.-[105]- The rule provides that the privately
offered fund would not be considered to own
the securities of
the Purchasing Fund indirectly unless the
privately offered
fund has a control relationship with either
the Purchasing Fund
or the Target Fund. Commenters generally supported this
approach.
Several commenters also suggested that
the rule generally
should limit the circumstances under which a
Purchasing Fund
must obtain the consent of the beneficial
owners of the
securities of a privately offered fund that
directly owns the
securities of the Purchasing Fund
("Owning
Fund").-[106]- These commenters stated that if the rule
did not contain such a limitation, consent
would have to be
obtained from security holders who would not
be entitled to
receive the notice and redemption
opportunity required by the
Grandfather Provision.
As noted in the Proposing Release, the
Consent Provision
appears to be designed to prohibit an existing
Section 3(c)(1)
Fund from avoiding the notice and redemption
opportunity
requirements of the Grandfather Provision by
investing its
assets in a Section 3(c)(7) Fund, either
directly or indirectly
-[105]- 17 CFR 270.2a51-2(d).
-[106]- Many of these commenters believed that such
consent was not required
under the provision of
the proposed rule defining
indirect beneficial
ownership.
==========================================START
OF PAGE 57======
through another privately offered
fund.-[107]- This
purpose is served if the scope of the
Consent Provision is the
same as that of the Grandfather
Provision.-[108]-
Paragraph (e) of the rule, as adopted,
clarifies that the
consent of the beneficial owners of the
Owning Fund is not
required unless the Owning Fund directly or
indirectly
controls, is controlled by, or is under
common control with,
the Purchasing Fund or the Target
Fund.-[109]-
-[107]- Such conduct also may raise issues under section
48(a) of the Investment
Company Act [15 USC 80a-
47(a)] (prohibiting
violations of the Act's
provisions by indirect
means).
-[108]- The Consent Provision also may have been
designed to give investors in
an existing
privately offered fund the
opportunity to review
what could be a significant change in the manner
in which the fund makes
investments as a result
of the regulatory changes
effected by the 1996
Act. In the absence of a control relationship,
however, it is unlikely that the investors in
the Owning Fund would have a
significant
interest in the Purchasing
Fund's decision to
invest in a Section 3(c)(7)
Fund.
-[109]- 17 CFR 270.2a51-2(e).
The following example
illustrates the operation of
the rule. Assume
Company A is a Purchasing
Fund that wishes to
invest in Company B as a
qualified purchaser,
and that Companies C and D
are beneficial owners
of Company A's voting
securities. Company C is
an operating company that
does not have a
control relationship with
Company A, but whose
security holders were deemed
to be beneficial
owners of Company A's voting
securities on April
30, 1996. Company D is a privately offered fund
that was deemed to own
beneficially Company A's
voting securities on April 30, 1996 (in other
words, the Look-Through
Provision did not
apply). Each of Company D's investors
(Companies E through G) are
themselves privately
offered funds, but none has a
control
(continued...)
==========================================START
OF PAGE 58======
Under the rule, the Purchasing Fund
could obtain a general
consent with respect to most transactions in
which it will be a
qualified purchaser. Whether a specific consent would be
required when there is a control
relationship between the
Purchasing Fund or certain of its beneficial
owners and the
Target Fund would depend upon whether the
general consent
provided sufficient information to elicit an
informed consent
from the appropriate investors.
-[109]-(...continued)
relationship with Company D
or Company A.
Company C would have to consent to
Company A being a
qualified purchaser. Because Company C is not a privately
offered fund, Company C's shareholders
would not be
treated as beneficial owners of Company
A's voting
securities, and their consent would not
be required. (The
consent of Company C's shareholders
would not be required
even if Company C had a control
relationship with Company
A.)
Company D would have to consent to
Company A being a
qualified purchaser. Even though Company D is a privately
offered fund, the beneficial owners of
its outstanding
securities (i.e., Companies E through
G) would not have to
consent to Company A being a qualified
purchaser unless
there was a control relationship
between Company D and
either Company A or Company B. Security holders of
Companies E through G would not be
required to consent
even if they are considered to be
beneficial owners of
Company D's securities under the
Look-Through Provision
because there is no control
relationship. Similarly,
Companies E through G would not be
deemed to indirectly
own voting securities of Company A.
==========================================START
OF PAGE 59======
C.
Conforming Rule
Rule 2a51-3(a) under the Investment
Company Act clarifies
an interpretative issue concerning companies
that are qualified
purchasers.-[110]- The statutory definition of
qualified purchaser specifies that a trust
that is a qualified
purchaser must not have been formed
"for the specific purpose
of acquiring the securities
offered."-[111]- The rule
makes the same condition applicable to any
other company that
is a Prospective Qualified Purchaser
(whether a Family Company
or another type of company) unless each
beneficial owner of the
company's securities is a qualified
purchaser. The rule thus
limits the possibility that a company will
be able to do
indirectly what it is prohibited from doing
directly (i.e.,
organize a "qualified purchaser"
entity for the purpose of
making an investment in a particular Section
3(c)(7) Fund
available to investors that themselves did
not meet the
definition of qualified purchaser).-[112]-
-[110]- 17 CFR 270.2a51-3(a).
-[111]- Section 2(a)(51)(A)(iii) of the Act.
-[112]- See supra note 107 and accompanying text
(discussing section 48(a) of
the Act). The
rule, as proposed, would have
required all
interests in the company to
be owned by
qualified purchasers. The rule, as adopted,
recognizes that such a
company may be organized
as a limited partnership,
with a person or
company serving as the
general partner. In
these circumstances, if the
general partnership
interest is not being used as
a device to evade
the provisions of section
3(c)(7) limiting
security holders of the
Section 3(c)(7) Fund to
(continued...)
==========================================START
OF PAGE 60======
As suggested by several commenters, the
scope of the rule
has been expanded to permit a company to be
a qualified
purchaser (even if the company did not own
$5 million of
investments, in the case of a Family
Company, or $25 million of
investments in the case of any other type of
company) if each
beneficial owner of the company's securities
is a qualified
purchaser.-[113]-
D. Non-Exclusive Safe Harbor for Certain Section 3(c)(7)
Funds
The legislative history of the 1996 Act
indicates that a
sponsor of an existing Section 3(c)(1) Fund
could establish a
new Section 3(c)(7) Fund.-[114]- Section 3(c)(7)(E) of
the Act (the "Non-Integration
Provision) provides that the
Commission may not "integrate" the
two Funds -- that is, treat
the two Funds as a single issuer for
purposes of determining
the number of beneficial owners of the
Section 3(c)(1) Fund or
whether the outstanding securities of the
Section 3(c)(7) Fund
-[112]-(...continued)
qualified purchasers, the
general partner need
not be a qualified purchaser. See supra notes
78-79 and accompanying text.
-[113]- Rule 2a51-3(b) [17 CFR 270.2a51-3(b)]; see supra
note 112.
-[114]- See 142 CONG. REC. at E1938 (Oct. 21, 1996)
(Remarks of Hon. John D.
Dingell); House
Hearings, supra note 5, at 71
(prepared
statement of Marianne
Smythe); see also HEDGE
FUNDS TASK FORCE REPORT,
supra note 60, at 779.
==========================================START
OF PAGE 61======
are owned by anyone who is not a qualified
purchaser.-[115]- The Non-Integration Provision,
however, is not intended to allow a sponsor
of an existing
Section 3(c)(1) Fund nominally to convert that
fund into a
Section 3(c)(7) Fund, and then to create
another Section
3(c)(1) Fund ("Related Section 3(c)(1)
Fund") thereby avoiding
the 100-investor limit.-[116]- The Non-Integration
Provision, thus, was not designed to
preclude the Commission
from treating a nominally converted Section
3(c)(1) Fund and a
Section 3(c)(1) Fund organized by the same
sponsor as a single
issuer for certain purposes.
Prior to the publication of the
Proposing Release,
representatives of hedge funds and other
investment pools
-[115]- The Non-Integration Provision states, in part,
that an issuer that is
otherwise excepted under
section 3(c)(7) and an issuer
that is otherwise
excepted under section
3(c)(1) are not to be
treated by the Commission as
being a single
issuer for purposes of
determining the number of
beneficial owners of the Section
3(c)(1) Fund or
whether the outstanding
securities of the
Section 3(c)(7) Fund are
owned by anyone who is
not a qualified
purchaser. The Commission staff
has addressed the possibility
of integrating
Section 3(c)(1) Funds
established by the same
sponsor for purposes of
determining whether they
constitute the same issuer
and have exceeded the
100-investor limit of section
3(c)(1). See,
e.g., Shoreline Fund (Apr.
11, 1994) (the staff
considers several factors in
determining whether
funds should be integrated
and generally will
require integration if
"a reasonable purchaser
would view an interest in an
offering as not
materially different from
another").
-[116]- See Remarks of Hon. John D. Dingell, supra note
114.
==========================================START
OF PAGE 62======
raised concerns regarding the ability of a
sponsor of a Section
3(c)(1) Fund that undergoes a bona fide
conversion into a
Section 3(c)(7) Fund (i.e., provides the
grandfather notice and
redemption opportunity and sells its
securities to new
investors that are qualified purchasers) to
then create a new
Section 3(c)(1) Fund. The Commission proposed rule 3c-7 to
respond to these concerns. The rule would have provided that a
Grandfathered Fund will be treated as an
issuer excluded under
section 3(c)(7) of the Act if, at the time
the new Section
3(c)(1) Fund offers its securities, 25% or
more of the value of
all securities of the Grandfathered Fund is
held by qualified
purchasers that acquired these securities
after October 11,
1996.
Commenters had mixed reactions to the
proposed rule.
Several commenters supported the rule as
proposed or with
modifications that would base availability
of the safe harbor
on securities held by qualified purchasers
regardless of when
acquired.
Other commenters believed that the proposed rule was
unnecessary, that the percentage threshold
for qualified
purchasers investing in the fund would
preclude bona fide
conversions, and that the Commission could
rely on its anti-
fraud authority to address "sham"
grandfathering transactions.
Upon further consideration of the
issue, and after
considering the views of the commenters, the
Commission does
not believe that a safe harbor rule is
necessary. In the
Commission's view, the Non-Integration
Provision was not
==========================================START
OF PAGE 63======
designed to permit a fund to rely on section
3(c)(7) if the
fund's compliance with the Grandfather
Provision was designed
to evade the 100-investor limitation of
section 3(c)(1). A
fund that purports to rely on section
3(c)(7) based on the
Grandfather Provision must have the bona
fide purpose of
selling its securities to qualified
purchasers. At this time,
the Commission does not believe that it is
necessary to set
forth a test based on the percentage of
securities owned by
qualified purchasers to establish the bona
fides of a
conversion for purposes of determining
compliance with the Act.
Whether a conversion to a Grandfathered Fund
is bona fide and
undertaken in good faith would depend upon
the facts and
circumstances. The relevant facts would include, among others,
whether the fund has taken steps to sell its
securities to
qualified purchasers, and whether the fund
is subject to legal
or other impediments that would preclude it
from selling its
securities to qualified purchasers.
III. OTHER RULES RELATING TO PRIVATELY
OFFERED FUNDS
A.
Section 3(c)(1) Funds
1. Transition Rule
The 1996 Act amended section 3(c)(1)(A)
of the Investment
Company Act, the Look-Through Provision,
which governs the way
in which a Section 3(c)(1) Fund calculates
the number of its
beneficial owners for purposes of complying
with the 100-
investor limit. Under amended section 3(c)(1)(A), a Section
3(c)(1) Fund must include among its
beneficial owners the
==========================================START
OF PAGE 64======
underlying security holders of any
investment company or
privately offered fund that owns 10% or more
of the Section
3(c)(1) Fund (collectively, "10%+
Security Holders"). The pre-
1996 Act Look-Through Provision did not
apply unless the 10%+
Security Holder also had more than 10% of
its assets invested
in Section 3(c)(1) Fund securities
generally. The amendment,
in effect, limits the ability of certain
types of investors to
own more than 10% of a Section 3(c)(1)
Fund.-[117]-
Some existing Section 3(c)(1) Funds
have 10%+ Security
Holders in reliance on the pre-amendment
application of the
Look-Through Provision. As a result of the 1996 Act, such a
fund may be required to treat a 10% Security
Holder as more
than one beneficial owner for purposes of
the 100-investor
limit.
The Commission believes that the amendment to the Look-
Through Provision was designed primarily to
simplify the
application of the Provision and was not
intended to disrupt
existing investment arrangements. The Commission, therefore,
proposed rule 3c-1 under the Investment Company
Act to provide
that the amended Look-Through Provision will
not apply in the
case of a pre-1996 Act 10%+ Security Holder,
provided that the
-[117]- The amended Look-Through Provision applies only
when an investment company or a privately
offered fund invests in a
Section 3(c)(1) Fund.
The 1996 Act expands the
ability of corporate,
non-investment company
investors to participate
in Section 3(c)(1) Funds by no longer requiring
Section 3(c)(1) Funds to
count the underlying
shareholders of these
investors under any
circumstances.
==========================================START
OF PAGE 65======
10%+ Security Holder continues to satisfy
the Second 10%
Test.-[118]-
The rule is adopted with one
change. The rule, as
proposed, would have applied only to a 10%+
Security Holder
that acquired its interest in the fund
before the 1996 Act was
signed by the President. Several commenters suggested that the
rule should apply to any 10%+ Security
Holder that acquired its
securities prior to the effective date of
the amendments to the
Look-Through Provision.
These commenters noted that Section
3(c)(1) Funds that admitted new investors
near the end of 1996
may not have known, or appreciated the
significance, of the
1996 Act's amendments. In view of the commenters' suggestions,
the rule as adopted applies to 10%+ Security
Holders that
acquired their securities on or before April
1, 1997.
-[118]- The rule does not limit additional acquisitions
of securities by a 10%+
Security Holder, as long
as it satisfies the Second
10% Test on the date
of acquisition. For the purpose of the rule,
securities of Section 3(c)(7)
Funds would be
included in applying the
Second 10% Test, since
a Section 3(c)(7) Fund
probably would have been
a Section 3(c)(1) Fund but
for the new exclusion
created by the 1996 Act. The rule also applies
to ownership interests of 10%
or more that are
acquired as a result of a
conversion of
convertible non-voting
securities.
==========================================START
OF PAGE 66======
2. Applicability of the Amended Look-Through
Provision
The Commission believes that, as a
general matter, the
determination of whether an investor is
subject to the amended
Look-Through Provision must be made each
time the investor
acquires a voting security of a Section
3(c)(1) Fund. Thus, an
investor would not become subject to the
Look-Through Provision
if its proportionate ownership of the Fund's
voting securities
increased solely because another investor
redeemed its
securities in the Fund. This analysis would not apply if the
redemption (or other transaction) were part
of a series of
transactions designed to avoid the
Look-Through
Provision.-[119]-
B.
Investments by Knowledgeable Employees
As directed by Congress, the Commission
is adopting rule
3c-5 under the Investment Company Act to
permit "knowledgeable
employees" of a fund and certain of its
affiliates to acquire
securities issued by the fund without being
counted for
purposes of section 3(c)(1)'s 100-investor
limit.-[120]-
In addition, as directed by Congress, the
rule permits
-[119]- See supra note 107 (discussing section 48(a) of
the Act).
-[120]- The rule specifies that these persons must be
knowledgeable employees at
the time they acquire
the fund's securities. They do not have to
dispose of these securities
(or be counted as
security holders for purposes
of section
3(c)(1)'s 100-investor limit)
upon termination
of employment.
==========================================START
OF PAGE 67======
knowledgeable employees to invest in a
Section 3(c)(7) Fund
even though they do not meet the definition
of qualified
purchaser.-[121]- Commenters generally supported the
rule, although several commenters suggested
that the scope of
the rule's definition of knowledgeable
employees be expanded.
Rule 3c-5 defines knowledgeable
employees as the
directors, executive officers, and general
partners of the fund
or an affiliated person of the fund that
oversees the fund's
investments ("Management
Affiliate").-[122]- The rule
also encompasses persons who serve in
capacities similar to
directors, such as trustees and advisory
board
members.-[123]-
The rule as proposed also would have
included as
knowledgeable employees other employees of
the fund or its
Management Affiliate who, in connection with
their regular
functions or duties, participate in, or
obtain information
regarding, the investment activities of the
fund or other
investment companies managed by the
Management Affiliate. One
-[121]- The fund will have to determine whether a
knowledgeable employee's
acquisition of the
securities is a transaction
exempt from the
registration requirements of
the Securities Act.
See, e.g., Regulation D under
the Securities Act
[17 CFR 230.501 through
.508].
-[122]- Rule 3c-5(a)(4) [17 CFR 270.3c-5(a)(4)]. The
rule specifies that a fund's
investment adviser
is considered to be an
affiliated person of the
fund for purposes of the
rule. Rule 3c-5(a)(1)
[17 CFR 270.3c-5(a)(1)].
-[123]- Rule
3c-5(a)(4)(i) [17 CFR 270.3c-5(a)(4)(i)].
==========================================START
OF PAGE 68======
commenter suggested that including employees
who "obtain
information" regarding the investment
activities could include
employees, such as compliance personnel, who
may not have any
investment experience. The Commission agrees, and the rule as
adopted includes only employees who
"participate in" the
investment activities of the fund or other
investment companies
managed by the fund's Management
Affiliate.-[124]-
The rule, as proposed, would have
required employees who
are knowledgeable employees by virtue of
their participation in
investment activities to have been engaged
in these activities
on behalf of the fund or the Management
Affiliate for a period
of at least 12 months. Several commenters suggested that the
12 month period would unnecessarily limit
the ability of new
employees who had equivalent experience with
their previous
employer to invest in the fund. The Commission has concluded
that it is not necessary to require that an
employee work for
the particular fund or Management Affiliate
for the entire 12-
month period as long as the employee has the
requisite
experience to appreciate the risks of
investing in the fund.
The rule, as adopted, therefore includes as
knowledgeable
employees those employees who performed
substantially similar
functions or duties for or on behalf of
another person during
the preceding 12 months.-[125]-
The rule permits the acquisition of
privately offered fund
-[124]- Rule 3c-5(a)(4)(ii) [17 CFR 270.3c-5(a)(4)(ii)].
-[125]- Id.
==========================================START
OF PAGE 69======
securities by a company all of whose owners
are knowledgeable
employees.-[126]- This change is consistent with rule
2a51-3, which permits a company all of whose
securities are
owned by qualified purchasers to itself be
treated as a
qualified purchaser. In addition, the rule permits
knowledgeable employees to transfer their
securities of a
privately offered fund on the same terms as
those governing
transfers by other owners of fund securities
in rule 3c-6
discussed below.-[127]-
Several commenters suggested that the
rule permit
purchases by broader categories of
employees. The provision in
the 1996 Act directing Commission rulemaking
with regard to
investments in privately offered funds by
knowledgeable
employees appears to be intended to
encompass persons who
actively participate in the management of a
fund's investments.
At this time, the Commission believes that
the rule as adopted
is consistent with this legislative purpose.
C.
Involuntary Transfers
Section 3(c)(1)(B) of the Act provides
that beneficial
ownership of securities of a Section 3(c)(1)
Fund by any person
who acquires the securities as a result of a
"legal separation,
divorce, death, or other involuntary
event" will be deemed to
be beneficial ownership by the person from
whom the transfer
was made, pursuant to such rules and
regulations as the
-[126]- Rule 3c-5(b)(2) [17 CFR 270.3c-5(b)(2)].
-[127]- Rule 3c-5(b)(3) [17 CFR 270.3c-5(b)(3)].
==========================================START
OF PAGE 70======
Commission prescribes. This provision was designed to address
situations in which section 3(c)(1)'s
100-investor limit is
exceeded "because of transfers which
are neither within the
issuer's control nor are voluntary on the
part of the present
beneficial owner."-[128]-
The 1996 Act directed the Commission to
prescribe rules to
implement section 3(c)(1)(B).-[129]- The Commission is
adopting rule 3c-6 under the Investment
Company Act to provide
that beneficial ownership by a person
("Transferee") who
acquired securities of a Section 3(c)(1)
Fund pursuant to a
gift, bequest, or an agreement relating to a
legal separation
or divorce will be deemed to be beneficial
ownership by the
person from whom the transfer was made
("Transferor").-[130]- Rule 3c-6, as proposed, would
have permitted such transfers of fund
securities only to
certain persons, generally family
members. Commenters
suggested that the categories of Transferees
were unnecessarily
limited.
These commenters also noted that, as long as the
transfer is in the form of a gift, the
relationship of the
Transferee to the Transferor was not
particularly important for
purposes of the policies underlying section
3(c)(1). The rule
-[128]- H.R. REP. NO. 1341, 96th Cong., 2d Sess. at 36
(1980).
-[129]- 15 USC 80a-3 note.
-[130]- Transferees are not limited to natural persons.
Donative transfers to
charitable organizations
are therefore permitted by
the rule.
==========================================START
OF PAGE 71======
as adopted reflects this approach.-[131]-
Unlike the proposed rule, the rule as
adopted does not
limit subsequent transfers by Transferees
that are in the form
of a gift or bequest. Several commenters suggested that this
limitation would be unnecessarily
restrictive. As noted by
commenters, it is not necessary for the rule
to contain
restrictions on non-donative transfers since
the effect of the
transfer may be to cause the Section 3(c)(1)
Fund to lose its
exclusion from Investment Company Act
regulation.-[132]-
Rule 3c-6 also deals with transfers of
securities by
qualified purchasers under section
3(c)(7)(A) of the Act. That
section provides that securities of a
Section 3(c)(7) Fund that
are owned by persons who received them from
a qualified
purchaser as a gift or bequest, or when the
transfer was caused
by legal separation, divorce, death or other
involuntary event,
will be deemed to be owned by a qualified
purchaser, subject to
such rules as the Commission may
prescribe. Rule 3c-6 permits
-[131]- The rule, as proposed, would have permitted
transfers to the specified
categories of
Transferees pursuant to
"other involuntary
events." Given the breadth of the rule and the
elimination of restrictions
on the classes of
Transferees, the Commission
does not believe
that it is necessary at this
time to address
other involuntary transfers
of Section 3(c)(1)
Fund securities.
-[132]- A person that acquires securities from a
Transferee for consideration
or from the Section
3(c)(1) Fund would have to be
counted toward the
100-investor limitation as a
beneficial owner
(or more than one beneficial
owner, if the
amended Look-Through
Provision is applicable).
==========================================START
OF PAGE 72======
transfers of securities of a Section 3(c)(7)
Fund under
essentially the same conditions as those
governing transfers
under section 3(c)(1)(B).-[133]- The rule treats a
person who acquires securities of a Section
3(c)(7) Fund in
accordance with the rule as qualified
purchasers only for
purposes of those securities. If the person acquires
additional securities of the Fund other than
in accordance with
the rule, the person would have to meet the
definition of
qualified purchaser (without regard to the
rule) at that time.
IV.
COST/BENEFIT ANALYSIS AND EFFECTS ON COMPETITION,
EFFICIENCY AND CAPITAL FORMATION
Consistent with legislative intent and
the protection of
investors, the rules benefit privately
offered funds and their
investors in a number of ways. The rules define certain terms
necessary to effectuate the new exclusion
from regulation under
the Investment Company Act for Section
3(c)(7) Funds; enable
Section 3(c)(1) Funds that wish to convert
into Section 3(c)(7)
Funds or become qualified purchasers to do
so without being
subject to unduly burdensome notice and
consent requirements;
-[133]- Other involuntary transfers of Section 3(c)(7)
Fund securities may occur
even if they are not
covered by rule 3c-6. See section 3(c)(7)(A) of
the Act ("securities
that are owned by persons
who received the securities
from a qualified
purchaser . . . in a case in
which the transfer
was caused by . . . other
involuntary event,
shall be deemed to be owned
by a qualified
purchaser, subject to such
rules, regulations
and orders as the Commission
may prescribe . .
."). The Commission does not contemplate
adopting additional rules
concerning involuntary
transfers under section
3(c)(7) at the present
time.
==========================================START
OF PAGE 73======
enable knowledgeable employees of a
privately offered fund to
invest in the fund without causing the fund
to relinquish its
exclusion from regulation under the Act;
permit certain
transfers of privately offered fund
securities; and clarify
certain interpretative issues for privately
offered funds. The
Commission believes that the rules would not
impose any
additional costs on privately offered
funds. Rather, the rules
would clarify the statutory requirements for
privately offered
funds in order to reduce any unnecessary
burdens without
jeopardizing investor protection.
Section 2(c) of the Investment Company
Act provides that
whenever the Commission is engaged in
rulemaking and is
required to consider or determine whether an
action is
necessary or appropriate in the public
interest, the Commission
also shall consider, in addition to the
protection of
investors, whether the action will promote
efficiency,
competition, and capital
formation.-[134]- The
Commission believes that the rules will
promote efficiency,
competition and capital formation. The rules define terms and
clarify certain provisions of the new
statutory exclusion for
Section 3(c)(7) Funds and clarify other
statutory requirements
applicable to privately offered funds. The Commission believes
that the rules do so in a way that will reduce
unnecessary
burdens and provide greater flexibility,
consistent with
investor protection.
-[134]- 15 USC 80a-2(c).
==========================================START
OF PAGE 74======
V.
SUMMARY OF REGULATORY FLEXIBILITY ANALYSIS
A summary of the Initial Regulatory
Flexibility Act
Analysis ("IRFA"), which was
prepared in accordance with 5 USC
603, was published in Investment Company Act
Release No. 22405.
No comments were received on the IRFA.
The Commission has prepared a Final
Regulatory Flexibility
Analysis ("FRFA") in accordance
with 5 USC 604 regarding rules
2a51-1, 2a51-2, 2a51-3, 3c-1, 3c-5 and 3c-6
under the
Investment Company Act. The FRFA indicates that the rules
comply with the provisions of the 1996 Act
directing the
Commission to prescribe certain rules
concerning privately
offered funds, and address certain
interpretive issues raised
by the 1996 Act's amendments relating to
privately offered
funds.
The FRFA states that the rules, among other things, are
designed to assure that investors in Section
3(c)(7) Funds are
the types of investors that Congress
determined do not need the
protections of the Investment Company
Act. The FRFA further
states that the rules give privately offered
funds greater
flexibility as well as minimize certain
compliance burdens
imposed by the applicable provisions of the
Investment Company
Act.
The FRFA also discusses the effect of
the rules on small
entities that are Section 3(c)(7) or Section
3(c)(1) Funds.
For purposes of the rules, small entities
are those with assets
of $50 million or less at the end of their
most recent fiscal
year.
The FRFA states that the rules make possible the
==========================================START
OF PAGE 75======
creation of small entities that are Section
3(c)(7) Funds, and
provide greater flexibility and minimize
certain compliance
burdens imposed by the provisions of the
Investment Company Act
on small entities that are Section 3(c)(1)
Funds. It is
estimated that there are approximately 600
U.S. venture capital
pools that are Section 3(c)(1) Funds, of which
about 50% may be
considered small entities. The number of U.S. hedge funds has
been estimated as being between 800 and
3,000. Based on a
sample of 250 hedge funds, it is estimated
that approximately
75% may be small entities.
The FRFA states that the rules do not impose any new
reporting, recordkeeping or compliance
requirements, and that
the Commission believes that there are no
rules that duplicate,
overlap or conflict with the adopted rules.
The FRFA discusses the various
alternatives considered by
the Commission in connection with the rules
that might minimize
the effect on small entities, including: (a)
the establishment
of differing compliance or reporting
requirements or timetables
that take into account the resources of
small entities; (b) the
clarification, consolidation or
simplification of compliance
and reporting requirements under the rule
for small entities;
(c) the use of performance rather than design
standards; and
(d) an exemption from coverage of the rule
or any part of the
rule, for small entities. The Commission believes that it
would be inconsistent with the purposes of
the Act to exempt
small entities from the rules or to use
performance standards
==========================================START
OF PAGE 76======
to specify different requirements for small
entities.
Different compliance or reporting
requirements for small
entities are not necessary because the rules
do not establish
any new reporting, recordkeeping or
compliance requirements.
The Commission has determined that it is not
feasible to
further clarify, consolidate or simplify the
rules for small
entities.
Cost-benefit information reflected in
the "Cost/Benefit
Analysis" section of this Release also
is reflected in the
FRFA.
A copy of the FRFA may be obtained by contacting David
P. Mathews, Securities and Exchange
Commission, 450 5th Street,
N.W., Mail Stop 10-2, Washington, D.C.
20549.
VI.
STATUTORY AUTHORITY
The Commission is adopting rules
2a51-1, 2a51-2 and 2a51-3
pursuant to the authority set forth in
sections 2(a)(51)(B),
6(c) and 38(a) of the Investment Company Act
[15 USC
80a-2(a)(51)(B), -6(c) and -37(a)] and
sections 209(d)(2) and
(4) of the 1996 Act [15 USC 80a-2 note and
-3 note). The
Commission is adopting rule 3c-1 pursuant to
the authority set
forth in sections 6(c) and 38(a) of the
Investment Company Act
[15 USC 80a-6(c) and -37(a)]. The Commission is adopting rule
3c-5 pursuant to the authority set forth in
sections 6(c) and
38(a) of the Investment Company Act [15 USC
80a-6(c) and -
37(a)] and section 209(d)(3) of the 1996 Act
[15 USC 80a-3
note].
The Commission is adopting rule 3c-6 pursuant to the
authority set forth in sections 3(c)(1),
3(c)(7), 6(c) and
==========================================START
OF PAGE 77======
38(a) of the Investment Company Act [15 USC
80a-3(c)(1),
-3(c)(7), -6(c) and -37(a)] and section
209(d)(1) of the 1996
Act [15 USC 80a-3 note].
TEXT OF RULES
List of subjects in 17 CFR Part 270
Investment companies, Securities
For the reasons set out in the
preamble, Title 17, Chapter
II of the Code of Federal Regulations is
amended as follows:
PART 270 - RULES AND REGULATIONS, INVESTMENT
COMPANY ACT OF
1940
1.
The authority citation for Part 270 continues to read
as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-39 unless
otherwise noted;
*
* * * *
2.
Section 270.2a51-1 is added to read as follows:
270.2a51-1. Definition of investments for purposes of
section 2(a)(51) (definition of
"qualified purchaser"); certain
calculations.
(a)
Definitions. As used in this
section:
(1)
The term Commodity Interests means commodity futures
contracts, options on commodity futures
contracts, and options
on physical commodities traded on or subject
to the rules of:
(i)
Any contract market designated for trading such
transactions under the Commodity Exchange
Act and the rules
thereunder; or
==========================================START
OF PAGE 78======
(ii) Any board of trade or exchange
outside the United
States, as contemplated in Part 30 of the
rules under the
Commodity Exchange Act [17 CFR 30.1 through
.11].
(2)
The term Family Company means a company described in
paragraph (A)(ii) of section 2(a)(51) of the
Act [15 U.S.C.
80a-2(a)(51)].
(3)
The term Investment Vehicle means an investment
company, a company that would be an
investment company but for
the exclusions provided by sections 3(c)(1)
through 3(c)(9) of
the Act [15 U.S.C. 80a-3(c)(1) through
3(c)(9)] or the
exemptions provided by 270.3a-6
or 270.3a-7, or a commodity
pool.
(4)
The term Investments has the meaning set forth in
paragraph (b) of this section.
(5)
The term Physical Commodity means any physical
commodity with respect to which a Commodity
Interest is traded
on a market specified in paragraph (a)(1) of
this section.
(6)
The term Prospective Qualified Purchaser means a
person seeking to purchase a security of a
Section 3(c)(7)
Company.
(7)
The term Public Company means a company that:
(i)
Files reports pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934 [15 U.S.C.
78m or 78o(d)]; or
(ii) Has a class of securities that are
listed on a
"designated offshore securities
market" as such term is defined
by Regulation S under the Securities Act of
1933 [17 CFR
==========================================START
OF PAGE 79======
230.901 through 230.904].
(8)
The term Related Person means a person who is related
to a Prospective Qualified Purchaser as a
sibling, spouse or
former spouse, or is a direct lineal
descendant or ancestor by
birth or adoption of the Prospective
Qualified Purchaser, or is
a spouse of such descendant or ancestor,
provided that, in the
case of a Family Company, a Related Person
includes any owner
of the Family Company and any person who is
a Related Person of
such owner.
(9)
The term Relying Person means a Section 3(c)(7)
Company or a person acting on its behalf.
(10)
The term Section 3(c)(7) Company means a company
that would be an investment company but for
the exclusion
provided by section 3(c)(7) of the Act [15
U.S.C. 80a-3(c)(7)].
(b)
Types of Investments. For
purposes of section
2(a)(51) of the Act [15 U.S.C.
80a-2(a)(51)], the term
Investments means:
(1)
Securities (as defined by section 2(a)(1) of the
Securities Act of 1933 [15 U.S.C.
77b(a)(1)]), other than
securities of an issuer that controls, is
controlled by, or is
under common control with, the Prospective
Qualified Purchaser
that owns such securities, unless the issuer
of such securities
is:
(i)
An Investment Vehicle;
(ii) A Public Company; or
(iii) A company with shareholders' equity of not less
==========================================START
OF PAGE 80======
than $50 million (determined in accordance
with generally
accepted accounting principles) as reflected
on the company's
most recent financial statements, provided
that such financial
statements present the information as of a
date within 16
months preceding the date on which the
Prospective Qualified
Purchaser acquires the securities of a
Section 3(c)(7) Company;
(2)
Real estate held for investment purposes;
(3)
Commodity Interests held for investment purposes;
(4)
Physical Commodities held for investment purposes;
(5)
To the extent not securities, financial contracts (as
such term is defined in section 3(c)(2)(B)(ii)
of the Act [15
U.S.C. 80a-3(c)(2)(B)(ii)] entered into for
investment
purposes;
(6)
In the case of a Prospective Qualified Purchaser that
is a Section 3(c)(7) Company, a company that
would be an
investment company but for the exclusion
provided by section
3(c)(1) of the Act [15 U.S.C. 80a-3(c)(1)],
or a commodity
pool, any amounts payable to such
Prospective Qualified
Purchaser pursuant to a firm agreement or
similar binding
commitment pursuant to which a person has
agreed to acquire an
interest in, or make capital contributions
to, the Prospective
Qualified Purchaser upon the demand of the
Prospective
Qualified Purchaser; and
==========================================START
OF PAGE 81======
(7)
Cash and cash equivalents (including foreign
currencies) held for investment
purposes. For purposes of this
section, cash and cash equivalents include:
(i)
Bank deposits, certificates of deposit, bankers
acceptances and similar bank instruments
held for investment
purposes; and
(ii) The net cash surrender value of an
insurance policy.
(c)
Investment Purposes. For
purposes of this section:
(1)
Real estate shall not be considered to be held for
investment purposes by a Prospective
Qualified Purchaser if it
is used by the Prospective Qualified
Purchaser or a Related
Person for personal purposes or as a place
of business, or in
connection with the conduct of the trade or
business of the
Prospective Qualified Purchaser or a Related
Person, provided
that real estate owned by a Prospective
Qualified Purchaser who
is engaged primarily in the business of
investing, trading or
developing real estate in connection with
such business may de
deemed to be held for investment
purposes. Residential real
estate shall not be deemed to be used for
personal purposes if
deductions with respect to such real estate
are not disallowed
by section 280A of the Internal Revenue Code
[26 U.S.C. 280A].
(2)
A Commodity Interest or Physical Commodity owned, or
a financial contract entered into, by the
Prospective Qualified
Purchaser who is engaged primarily in the
business of
investing, reinvesting, or trading in
Commodity Interests,
==========================================START
OF PAGE 82======
Physical Commodities or financial contracts
in connection with
such business may be deemed to be held for
investment purposes.
(d)
Valuation. For purposes of
determining whether a
Prospective Qualified Purchaser is a
qualified purchaser, the
aggregate amount of Investments owned and
invested on a
discretionary basis by the Prospective Qualified
Purchaser
shall be the Investments' fair market value
on the most recent
practicable date or their cost, provided
that:
(1)
In the case of Commodity Interests, the amount of
Investments shall be the value of the
initial margin or option
premium deposited in connection with such
Commodity Interests;
and
(2)
In each case, there shall be deducted from the amount
of Investments owned by the Prospective
Qualified Purchaser the
amounts specified in paragraphs (e) and (f)
of this section, as
applicable.
(e)
Deductions. In determining
whether any person is a
qualified purchaser there shall be deducted
from the amount of
such person's Investments the amount of any
outstanding
indebtedness incurred to acquire or for the
purpose of
acquiring the Investments owned by such
person.
(f)
Deductions: Family Companies. In
determining whether
a Family Company is a qualified purchaser,
in addition to the
amounts specified in paragraph (e) of this
section, there shall
be deducted from the value of such Family
Company's Investments
any outstanding indebtedness incurred by an
owner of the Family
==========================================START
OF PAGE 83======
Company to acquire such Investments.
(g)
Special Rules for Certain Prospective Qualified
Purchasers.
(1)
Qualified Institutional Buyers.
Any Prospective
Qualified Purchaser who is, or who a Relying
Person reasonably
believes is, a qualified institutional buyer
as defined in
paragraph (a) of 230.144A of this
chapter, acting for its
own account, the account of another
qualified institutional
buyer, or the account of a qualified
purchaser, shall be deemed
to be a qualified purchaser provided:
(i)
That a dealer described in paragraph (a)(1)(ii) of
230.144A of this chapter shall own and
invest on a
discretionary basis at least $25 million in
securities of
issuers that are not affiliated persons of
the dealer; and
(ii) That a plan referred to in
paragraph (a)(1)(i)(D) or
(a)(1)(i)(E) of 230.144A of this
chapter, or a trust fund
referred to in paragraph (a)(1)(i)(F) of
230.144A of this
chapter that holds the assets of such a
plan, will not be
deemed to be acting for its own account if
investment decisions
with respect to the plan are made by the
beneficiaries of the
plan, except with respect to investment
decisions made solely
by the fiduciary, trustee or sponsor of such
plan.
(2)
Joint Investments. In
determining whether a natural
person is a qualified purchaser, there may
be included in the
amount of such person's Investments any
Investments held
jointly with such person's spouse, or
Investments in which such
==========================================START
OF PAGE 84======
person shares with such person's spouse a
community property or
similar shared ownership interest. In determining whether
spouses who are making a joint investment in
a Section 3(c)(7)
Company are qualified purchasers, there may
be included in the
amount of each spouse's Investments any
Investments owned by
the other spouse (whether or not such
Investments are held
jointly).
In each case, there shall be deducted from the
amount of any such Investments the amounts
specified in
paragraph (e) of this section incurred by
each spouse.
(3)
Investments by Subsidiaries. For
purposes of
determining the amount of Investments owned
by a company under
section 2(a)(51)(A)(iv) of the Act [15
U.S.C.
80a-2(a)(51)(A)(iv)], there may be included
Investments owned
by majority-owned subsidiaries of the
company and Investments
owned by a company ("Parent
Company") of which the company is a
majority-owned subsidiary, or by a
majority-owned subsidiary of
the company and other majority-owned
subsidiaries of the Parent
Company.
(4)
Certain Retirement Plans and Trusts.
In determining
whether a natural person is a qualified
purchaser, there may be
included in the amount of such person's
Investments any
Investments held in an individual retirement
account or similar
account the Investments of which are
directed by and held for
the benefit of such person.
==========================================START
OF PAGE 85======
(h)
Reasonable Belief. The term
"qualified purchaser" as
used in section 3(c)(7) of the Act [15
U.S.C. 80a-3(c)(7)]
means any person that meets the definition
of qualified
purchaser in section 2(a)(51)(A) of the Act
[15 U.S.C. 80a-
2(a)(51)(A)]) and the rules thereunder, or
that a Relying
Person reasonably believes meets such
definition.
3.
Section 270.2a51-2 is added to read as follows:
270.2a51-2. Definitions of beneficial owner for certain
purposes under sections 2(a)(51) and 3(c)(7)
and determining
indirect ownership interests.
(a)
Beneficial Ownership: General.
Except as set forth
in this section, for purposes of sections
2(a)(51)(C) and 3(c)(7)(B)(ii)
of the Act [15 U.S.C. 80a-2(a)(51)(C) and
-3(c)(7)(B)(ii)], the
beneficial owners of securities of an
excepted investment
company (as defined in section 2(a)(51)(C)
of the Act [15
U.S.C. 80a-2(a)(51)(C)]) shall be determined
in accordance with
section 3(c)(1) of the Act [15 U.S.C.
80a-3(c)(1)].
(b)
Beneficial Ownership: Grandfather Provision. For
purposes of section 3(c)(7)(B)(ii) of the
Act [15 U.S.C. 80a-
3(c)(7)(B)(ii)], securities of an issuer
beneficially owned by
a company (without giving effect to section
3(c)(1)(A) of the
Act [15 U.S.C. 80a-3(c)(1)(A)])
("owning company") shall be
deemed to be beneficially owned by one
person unless:
(1)
The owning company is an investment company or an
excepted investment company;
(2)
The owning company, directly or indirectly, controls,
is controlled by, or is under common control
with, the issuer;
==========================================START
OF PAGE 86======
and
(3)
On October 11, 1996, under section 3(c)(1)(A) of the
Act as then in effect, the voting securities
of the issuer were
deemed to be beneficially owned by the
holders of the owning
company's outstanding securities (other than
short-term paper),
in which case, such holders shall be deemed
to be beneficial
owners of the issuer's outstanding voting
securities.
(c)
Beneficial Ownership: Consent Provision. For
purposes of section 2(a)(51)(C) of the Act
[15 U.S.C. 80a-
2(a)(51)(C)], securities of an excepted
investment company
beneficially owned by a company (without
giving effect to
section 3(c)(1)(A) of the Act [15 U.S.C.
80a-3(c)(1)(A)])
("owning company") shall be deemed
to be beneficially owned by
one person unless:
(1)
The owning company is an excepted investment company;
(2)
The owning company directly or indirectly controls,
is controlled by, or is under common control
with, the excepted
investment company or the company with
respect to which the
excepted investment company is, or will be,
a qualified
purchaser; and
(3)
On April 30, 1996, under section 3(c)(1)(A) of the
Act as then in effect, the voting securities
of the excepted
investment company were deemed to be
beneficially owned by the
holders of the owning company's outstanding securities
(other
than short-term paper), in which case the
holders of such
excepted company's securities shall be
deemed to be beneficial
==========================================START
OF PAGE 87======
owners of the excepted investment company's
outstanding voting
securities.
(d)
Indirect Ownership: Consent Provision.
For purposes
of section 2(a)(51)(C) of the Act [15 U.S.C.
80a-2(a)(51)(C)],
an excepted investment company shall not be
deemed to
indirectly own the securities of an excepted
investment company
seeking a consent to be treated as a
qualified purchaser
("qualified purchaser company")
unless such excepted investment
company, directly or indirectly, controls,
is controlled by, or
is under common control with, the qualified
purchaser company
or a company with respect to which the
qualified purchaser
company is or will be a qualified purchaser.
(e)
Required Consent: Consent Provision.
For purposes of
section 2(a)(51)(C) of the Act [15 U.S.C.
80a-2(a)(51)(C)], the
consent of the beneficial owners of an
excepted investment
company ("owning company") that
beneficially owns securities of
an excepted investment company that is
seeking the consents
required by section 2(a)(51)(C)
("consent company") shall not
be required unless the owning company
directly or indirectly
controls, is controlled by, or is under
common control with,
the consent company or the company with
respect to which the
consent company is, or will be, a qualified
purchaser.
==========================================START
OF PAGE 88======
NOTES to 270.2a51-2:
1.
On both April 30, 1996 and October 11, 1996, section
3(c)(1)(A) of the Act as then in effect
provided that: (A)
Beneficial ownership by a company shall be
deemed to
be beneficial ownership by one person,
except that, if the
company owns 10 per centum or more of the
outstanding voting
securities of the issuer, the beneficial
ownership shall be
deemed to be that of the holders of such
company's outstanding
securities (other than short-term paper)
unless, as of the date
of the most recent acquisition by such
company of securities of
that issuer, the value of all securities
owned by such company
of all issuers which are or would, but for
the exception set
forth in this subparagraph, be excluded from
the definition of
investment company solely by this paragraph,
does not exceed 10
per centum of the value of the company's
total assets. Such
issuer nonetheless is deemed to be an
investment company for
purposes of section 12(d)(1).
2.
Issuers seeking the consent required by section
2(a)(51)(C) of the Act should note that
section 2(a)(51)(C)
requires an issuer to obtain the consent of
the beneficial
owners of its securities and the beneficial
owners of
securities of any "excepted investment
company" that directly
or indirectly owns the securities of the
issuer. Except as set
forth in paragraphs (d) (with respect to
indirect owners) and
(e) (with respect to direct owners) of this
section, nothing in
this section is designed to limit this
consent requirement.
==========================================START
OF PAGE 89======
4.
Section 270.2a51-3 is added to read as follows:
270.2a51-3. Certain companies as qualified purchasers.
(a)
For purposes of section 2(a)(51)(A)(ii) and (iv) of
the Act [15 U.S.C. 80a-2(a)(51)(A)(ii) and
(iv)], a company
shall not be deemed to be a qualified
purchaser if it was
formed for the specific purpose of acquiring
the securities
offered by a company excluded from the
definition of investment
company by section 3(c)(7) of the Act [15
U.S.C. 80a-3(c)(7)]
unless each beneficial owner of the
company's securities is a
qualified purchaser.
(b)
For purposes of section 2(a)(51) of the Act [15
U.S.C. 80a-2(a)(51)], a company may be
deemed to be a qualified
purchaser if each beneficial owner of the
company's securities
is a qualified purchaser.
5.
Section 270.3c-1 is added to read as follows:
270.3c-1. Definition of beneficial ownership for certain
section 3(c)(1) funds.
(a)
As used in this section:
(1)
The term Covered Company means a company that is an
investment company, a Section 3(c)(1)
Company or a Section
3(c)(7) Company.
(2)
The term Section 3(c)(1) Company means a company that
would be an investment company but for the
exclusion provided
by section 3(c)(1) of the Act [15 U.S.C.
80a-3(c)(1)].
(3)
The term Section 3(c)(7) Company means a company that
would be an investment company but for the
exclusion provided
by section 3(c)(7) of the Act [15 U.S.C.
80a-3(c)(7)].
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(b)
For purposes of section 3(c)(1)(A) of the Act [15
U.S.C. 80a-3(c)(1)(A)], beneficial ownership
by a Covered
Company owning 10 percent or more of the
outstanding voting
securities of a Section 3(c)(1) Company
shall be deemed to be
beneficial ownership by one person, provided
that:
(1)
On April 1, 1997, the Covered Company owned 10
percent or more of the outstanding voting
securities of the
Section 3(c)(1) Company or non-voting
securities that, on such
date and in accordance with the terms of
such securities, were
convertible into or exchangeable for voting
securities that, if
converted or exchanged on or after such
date, would have
constituted 10 percent or more of the
outstanding voting
securities of the Section 3(c)(1) Company;
and
(2)
On the date of any acquisition of securities of the
Section 3(c)(1) Company by the Covered
Company, the value of
all securities owned by the Covered Company
of all issuers that
are Section 3(c)(1) or Section 3(c)(7)
Companies does not
exceed 10 percent of the value of the
Covered Company's total
assets.
6.
Section 270.3c-5 is added to read as follows:
270.3c-5. Beneficial ownership by knowledgeable employees
and certain other persons.
(a)
As used in this section:
(1)
The term Affiliated Management Person means an
affiliated person, as such term is defined
in section 2(a)(3)
of the Act [15 U.S.C. 80a-2(a)(3)], that
manages the investment
activities of a Covered Company. For purposes of this
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definition, the term "investment
company" as used in section
2(a)(3) of the Act includes a Covered
Company.
(2)
The term Covered Company means a Section 3(c)(1)
Company or a Section 3(c)(7) Company.
(3)
The term Executive Officer means the president, any
vice president in charge of a principal
business unit, division
or function (such as sales, administration
or finance), any
other officer who performs a policy-making
function, or any
other person who performs similar
policy-making functions, for
a Covered Company or for an Affiliated
Management Person of the
Covered Company.
(4)
The term Knowledgeable Employee with respect to any
Covered Company means any natural person who
is:
(i)
An Executive Officer, director, trustee, general
partner, advisory board member, or person
serving in a similar
capacity, of the Covered Company or an Affiliated
Management
Person of the Covered Company; or
(ii) An employee of the Covered Company
or an Affiliated
Management Person of the Covered Company
(other than an
employee performing solely clerical,
secretarial or
administrative functions with regard to such
company or its
investments) who, in connection with his or
her regular
functions or duties, participates in the
investment activities
of such Covered Company, other Covered
Companies, or investment
companies the investment activities of which
are managed by
such Affiliated Management Person of the
Covered Company,
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provided that such employee has been
performing such functions
and duties for or on behalf of the Covered
Company or the
Affiliated Management Person of the Covered
Company, or
substantially similar functions or duties
for or on behalf of
another company for at least 12 months.
(5)
The term Section 3(c)(1) Company means a company that
would be an investment company but for the
exclusion provided
by section 3(c)(1) of the Act [15 U.S.C.
80a-3(c)(1)].
(6)
The term Section 3(c)(7) Company means a company that
would be an investment company but for the
exclusion provided
by section 3(c)(7) of the Act [15 U.S.C.
80a-3(c)(7)].
(b)
For purposes of determining the number of beneficial
owners of a Section 3(c)(1) Company, and
whether the
outstanding securities of a Section 3(c)(7)
Company are owned
exclusively by qualified purchasers, there
shall be excluded
securities beneficially owned by:
(1)
A person who at the time such securities were
acquired was a Knowledgeable Employee of
such Company;
(2)
A company owned exclusively by Knowledgeable
Employees;
(3)
Any person who acquires securities originally
acquired by a Knowledgeable Employee in
accordance with this
section, provided that such securities were
acquired by such
person in accordance with 270.3c-6.
7.
Section 270.3c-6 is added to read as follows:
270.3c-6. Certain transfers of interests in section 3(c)(1)
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and section 3(c)(7) funds.
(a)
As used in this section:
(1)
The term Donee means a person who acquires a security
of a Covered Company (or a security or other
interest in a
company referred to in paragraph (b)(3) of
this section) as a
gift or bequest or pursuant to an agreement
relating to a legal
separation or divorce.
(2)
The term Section 3(c)(1) Company means a company that
would be an investment company but for the
exclusion provided
by section 3(c)(1) of the Act [15 U.S.C.
80a-3(c)(1)].
(3)
The term Section 3(c)(7) Company means a company that
would be an investment company but for the
exclusion provided
by section 3(c)(7) of the Act [15 U.S.C. 80a-3(c)(7)].
(4)
The term Transferee means a Section 3(c)(1)
Transferee or a Qualified Purchaser
Transferee, in each case as
defined in paragraph (b) of this section.
(5)
The term Transferor means a Section 3(c)(1)
Transferor or a Qualified Purchaser
Transferor, in each case as
defined in paragraph (b) of this section.
(b)
Beneficial ownership by any person ("Section 3(c)(1)
Transferee") who acquires securities or
interests in securities
of a Section 3(c)(1) Company from a person
other than the
Section 3(c)(1) Company shall be deemed to
be beneficial
ownership by the person from whom such
transfer was made
("Section 3(c)(1) Transferor"),
and securities of a Section
3(c)(7) Company that are owned by persons
who received the
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securities from a qualified purchaser other
than the Section
3(c)(7) Company ("Qualified Purchaser
Transferor") or a person
deemed to be a qualified purchaser by this
section shall be
deemed to be acquired by a qualified
purchaser ("Qualified
Purchaser Transferee"), provided that
the Transferee is:
(1)
The estate of the Transferor;
(2)
A Donee; or
(3)
A company established by the Transferor exclusively
for the benefit of (or owned exclusively by)
the Transferor and
the persons specified in paragraphs (b)(1)
and (b)(2) of this
section.
By the Commission.
Jonathan G. Katz
Secretary
April 3, 1997