Investment Company Act of 1940 - Rule 3a-8
RESPONSE OF THE OFFICE OF CHIEF COUNSEL
Our Ref. No. 20045251958
Your letter dated April 15, 2005 requests our concurrence that the Proposed Investments (as described below) are capital preservation investments for purposes of Rule 3a-8(b)(4) under the Investment Company Act of 1940 (the "Act").
Background. You state the following: Ark Therapeutics Group plc ("Ark") is organized as a public limited company under the laws of England and Wales. Ark is a biotechnology holding company with four direct and indirect wholly-owned subsidiaries. The principal activities of Ark's subsidiaries are the research and development of healthcare products to address areas of clinical need in vascular disease and cancer. Healthcare products are subject to lengthy and rigorous pre-clinical testing and clinical trials and other extensive, costly and time-consuming procedures mandated by various regulatory authorities.
Ark incurs most of its expenses in pounds and euros. For the year ended December 31, 2004, more than two-thirds of Ark's expenses were incurred in pounds, nearly one-fourth were incurred in euros, and the remaining expenses were incurred in U.S. dollars. Ark has experienced operating losses in each year since its inception and expects to incur further substantial operating losses in its current and future years as its research and development activities continue. Ark generated limited revenues in 2003 and 2004 attributable to its one marketed product. Ark, however, has incurred net losses since its founding. It is uncertain when Ark will become profitable.
Ark's three unapproved lead products, as identified in your letter, that are in late-stage clinical development will require additional clinical evaluation, regulatory review, significant marketing efforts and substantial investment before providing any significant revenue. Ark expects its research and development expenses to increase significantly over the next two years as Ark pursues the late-stage clinical development of its unapproved lead products. In addition, Ark's lead products are supported by a pipeline of earlier-stage products and technologies, although such products are many years away from gaining regulatory approval. Of Ark's four lead products, one is approved and marketed and another could receive marketing approval under exceptional circumstances during this year or the following year. Otherwise, Ark does not anticipate being able to market any of its other lead products for a number of years.
Ark completed an initial public offering (the "Offering") in connection with the listing of its shares on the London Stock Exchange (the "Shares") on March 3, 2004. The Shares were offered outside the United States to non-U.S. persons in reliance on Regulation S and offers were made in the United States only to qualified institutional buyers in reliance on Rule 144A. Ark is not registered as an investment company under the Act.1
Ark intends to use the proceeds of the Offering, along with Ark's existing available cash resources, to continue the development of Ark's products. Ark currently holds the proceeds of the Offering in interest-bearing demand deposits.
Proposed Investments. The board of directors of Ark has adopted an investment policy ("Investment Policy") that sets forth the eligible investments and investment limits that are applicable to Ark's investment portfolio. Pursuant to the Investment Policy, Ark proposes to transfer the Offering proceeds from the demand deposits to certain investments, including international money market funds ("IMMFs"), certificates of deposit of U.S. and non-U.S. financial institutions ("CDs"), term deposits held with U.S. and non-U.S. financial institutions ("Term Deposits"), investment-grade commercial paper issued by U.S. and non-U.S. financial institutions, corporate or government entities ("CP") and U.S. and U.K. government obligations ("Government Obligations"), as more fully described in your letter (the "Proposed Investments"). Under the Investment Policy, all Proposed Investments must have a maximum maturity, or maximum remaining maturity, of 12 months or less. The Proposed Investments will be subject to certain criteria set forth in the Investment Policy, including:
The Proposed Investments are customarily used in the United Kingdom by R&D companies to conserve capital and liquidity and present limited credit risk while generally having higher returns than the demand deposits held by Ark. Ark intends to use the Proposed Investments, including securities denominated in a currency other than the U.S. dollar ("Non-U.S. Securities"), and any yield therefrom, to support its healthcare business and not for speculative purposes.
As described in more detail in your letter, Ark believes that it may be unable to rely on either of the exceptions to the definition of investment company in section 3(c)(1) or section 3(c)(7) of the Act. Ark is concerned that it may meet the definition of investment company set forth in section 3(a)(1) of the Act if the Proposed Investments are not capital preservation investments for purposes of Rule 3a-8 under the Act.
Section 3(a)(1) of the Act includes two definitions of "investment company" that may be relevant to research and development companies ("R&D companies") such as Ark.2 Section 3(a)(1)(A) defines an investment company as any issuer that is, holds itself out as, or proposes to be engaged primarily in the business of investing, reinvesting, or trading in securities. Section 3(a)(1)(C) defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40 percent of the value of its total assets on an unconsolidated basis (exclusive of Government securities and cash items).3
Certain R&D companies can avoid meeting the definition of investment company in sections 3(a)(1)(A) and 3(a)(1)(C) of the Act by relying on the nonexclusive safe harbor that is provided by Rule 3a-8 under the Act. Specifically, the rule provides that an R&D company would not be an investment company under sections 3(a)(1)(A) and 3(a)(1)(C) of the Act if the R&D company complies with certain conditions that are designed to demonstrate that it is engaged in a non-investment company business. As relevant here, paragraph (a)(4) of Rule 3a-8 provides that an R&D company that relies on the rule must generally limit its investments in securities to capital preservation investments.4 Paragraph (b)(4) of the rule defines the term "capital preservation investment" to mean "an investment that is made to conserve capital and liquidity until the funds are used in the issuer's primary business or businesses."5
Whether particular investments of an R&D company are capital preservation investments within the meaning of Rule 3a-8(b)(4) is dependant on the particular facts and circumstances relating to the R&D company's business or businesses and the terms of the securities (e.g., maturity, interest rate, identity of the issuer). As explained in the Adopting Release, the Commission would expect the securities portfolio of an R&D company whose products require, on average, an additional eight years to develop to differ from the portfolio of another R&D company whose products are expected, on average, to be ready in two years, even though both companies would be investing with the goal of preserving capital and liquidity.6 Thus, securities that are capital preservation investments for one R&D company would not necessarily be capital preservation investments for another R&D company.
The rule does not indicate whether Non-U.S. Securities could be capital preservation investments. Nor did the Commission so indicate in the Proposing and Adopting Releases.7 We believe that, under certain circumstances, Non-U.S. Securities may be capital preservation investments. For example, if an R&D company organized in a non-U.S. jurisdiction incurs expenses that are payable in a currency other than the U.S. dollar, investments in securities denominated in that currency could be capital preservation investments, subject to the general requirements of the rule that such investments be made to conserve capital and liquidity until the funds are used in the company's primary business or businesses. Similarly, under appropriate facts and circumstances, it may be consistent with Rule 3a-8 for an R&D company organized in the United States to invest in capital preservation investments that are Non-U.S. Securities. We note, however, that an R&D company must carefully evaluate such investments consistent with the requirements and purposes of Rule 3a-8 to ensure that they are not being used in a speculative manner (e.g., using investments in Non-U.S. Securities to arbitrage the U.S. dollar).
You request our concurrence that Ark's Proposed Investments are capital preservation investments within the meaning of Rule 3a-8(b)(4). You contend that the Proposed Investments are capital preservation investments because they will conserve capital and liquidity to support Ark's business activities that are predominantly carried out in a jurisdiction other than the United States. You also contend that the Proposed Investments are capital preservation investments in light of the time periods anticipated for the development of Ark's products and the terms of the Proposed Investments. We agree. Please note that we do not view the Proposed Investments as an exclusive list of capital preservation investments for Ark or R&D companies generally. The Commission, when Rule 3a-8 was adopted, considered but declined to specify objective criteria for defining capital preservation investments in order to give the rule the flexibility to address the variety of circumstances that an R&D company may face.8 Investments in other high quality, liquid securities (for instance, high quality, liquid securities with maturities greater than 12 months) could be capital preservation investments, subject to the general requirements of Rule 3a-8.
Susan M. Olson
Section 2(a)(16) of the Act defines "Government security" to include any security issued or guaranteed as to principal or interest by the United States, or by a person controlled or supervised by and acting as an instrumentality of the Government of the United States pursuant to authority granted by the Congress of the United States or any certificate of deposit for any of the foregoing.
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