Investment Company Act of 1940 — Section 3(c)(5)(C)
Great Ajax Funding LLC
February 12, 2018
RESPONSE OF THE CHIEF COUNSEL'S OFFICE
DIVISION OF INVESTMENT MANAGEMENT
In your letter, dated February 1, 2018, you request assurance that the staff of the Division of Investment Management (the “Staff”) will not recommend that the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”) take enforcement action under Section 7 of the Investment Company Act of 1940 (the “1940 Act” or “Act”) against Great Ajax Funding LLC, a Delaware limited liability company that is the depositor for, and sponsor of, multiple securitization trusts that hold whole mortgage loans (“Depositor”), in reliance on Section 3(c)(5)(C) of the 1940 Act, if the Depositor operates in the manner described in your letter and summarized below without registering as an investment company under the 1940 Act.
You state the following:
- Great Ajax Corp. (the “Company”), a Maryland corporation and publicly traded real estate investment trust (“REIT”), is engaged in the business of acquiring, investing in and managing a portfolio of whole mortgage loans and, to a lesser extent, real property. The Company conducts substantially all of its business through its operating partnership, Great Ajax Operating Partnership L.P., a Delaware limited partnership (the “Operating Partnership”) and its wholly-owned subsidiaries.
- As a means of obtaining debt financing for the Company, the Depositor, a wholly-owned subsidiary of the Operating Partnership, was formed to establish and sponsor trusts that securitize pools of whole mortgage loans (each a “Trust”). The officers of the Depositor, which are the same officers as the Operating Partnership, periodically select whole mortgage loans from the Operating Partnership (or one of the Operating Partnership’s wholly-owned subsidiaries) that are then transferred to the Depositor. The Depositor subsequently transfers the mortgage loans to a Trust. Despite being transferred to the Trust, however, the mortgage loans continue to remain on the Company’s consolidated balance sheet and be serviced by Gregory Funding LLC, an affiliated entity.
- The Trust issues Class A notes and one or more series of Class B notes (or similar subordinated notes) which are secured solely by the underlying mortgage loans held by the Trust, and payments on which are dependent on the cash flows from such loans. The Class A notes, which are senior, sequential pay, fixed-rate notes, are sold to institutional investors in private offerings. The Class B notes, which are sequential pay, fixed-rate notes that are subordinate to the Class A notes, are held by the Depositor as consideration for the whole mortgage loans. The proceeds received from the notes issued by the Trust are primarily used by the Operating Partnership to acquire additional mortgages.
- The Depositor also holds the Trust’s equity interests, evidenced by trust certificates representing the residual interests in the Trust’s assets (“Trust Certificates”). As the holder of the Trust Certificates, the Depositor is entitled to receive its share of any remaining amounts held by the Trust after the Class A notes and Class B notes are paid in full. In addition, as the Trust Certificate holder, the Depositor exercises significant control over the operations and management of the Trust. The only assets held by the Depositor are the Class B notes and the Trust Certificates acquired from each Trust, and the Depositor’s income is derived exclusively from its ownership of such assets.
Section 3(c)(5)(C) of the Act
Section 3(a)(1) of the Act, in relevant part, defines an investment company as any issuer that: is, or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities; or is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities, and owns or proposes to acquire "investment securities" having a value exceeding 40% of the value of its total assets (exclusive of Government securities and cash items) on an unconsolidated basis. Section 7(a) of the 1940 Act prohibits an investment company organized or otherwise created under the laws of the United States or of a state and having a board of directors from, among other things, offering or selling any security (or engaging in certain other activities) by use of the mails or any means or instrumentality of interstate commerce unless the company is registered under the 1940 Act.
Section 3(c)(5)(C) of the Act, in relevant part, provides an exclusion from the definition of investment company for any person that is "primarily engaged in …[the business of] purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." We have taken the position that the exclusion in Section 3(c)(5)(C) may be available to an issuer if: at least 55% of its assets consist of "mortgages and other liens on and interests in real estate" ("qualifying interests") and the remaining 45% of its assets consist primarily of real estate-type interests (“55%/45% asset test”); at least 80% of its total assets consist of qualifying interests and real estate-type interests; and no more than 20% of its total assets consist of assets that have no relationship to real estate (“miscellaneous assets”).
We generally have taken the position that qualifying interests are assets that represent an actual interest in real estate or are loans or liens fully secured by real estate. Thus, we have not objected if an issuer treated as qualifying interests, among other assets, mortgage loans fully secured by real estate, fee interests in real estate, second mortgages secured by real property, deeds of trust on real property, installment land contracts and leasehold interests secured solely by real property. In contrast, we generally have taken the position that an asset is not a qualifying interest for purposes of Section 3(c)(5)(C) if it is an interest in the nature of a security in another issuer engaged in the real estate business.
You argue that the Depositor should be able to rely on Section 3(c)(5)(C) because the Depositor is primarily engaged in the mortgage loan business, and thus is an issuer that is primarily engaged in a type of business that Section 3(c)(5)(C) intended to exclude from regulation under the Act. You state that the Depositor’s assets consist solely of, and its income is derived exclusively from, the Class B Notes and the Trust Certificates issued by Trusts. You further state that the Depositor acquired these assets as a direct result of the Depositor being in the business of acquiring and securitizing whole mortgage loans. You explain that the Depositor acquires whole mortgage loans from the Operating Partnership and then transfers these mortgage loans into a Trust which the Depositor establishes and for which it acts as sponsor. You further state that proceeds from the sale of the Class A notes are used by the Operating Partnership to acquire additional whole mortgage loans, some of which are eventually transferred to the Depositor which, in turn, transfers them to a Trust. You conclude that the Class B notes and the Trust Certificates retained by the Depositor are indicative of the Depositor’s engagement in the mortgage loan business for purposes of Section 3(c)(5)(C) because the Depositor acquires these assets as a direct result of being in the business of acquiring and securitizing whole mortgage loans.
The Real Estate Finance Business
Section 3(c)(5)(C) generally was intended to exclude from regulation under the Act issuers that were primarily engaged in the mortgage banking and real estate businesses and that did not resemble, or were not considered to be, issuers that were in the investment company business (together, “real estate finance business”). Section 3(c)(5)(C) refers to an issuer in this business, in relevant part, as being in the business of purchasing or otherwise acquiring “mortgages and other liens on and interests in real estate.” As discussed above, and with some exceptions, we have generally interpreted the assets listed in Section 3(c)(5)(C) as assets that represent an actual interest in real estate or are loans or liens fully secured by real estate.
The real estate finance business, however, has evolved substantially since the enactment of the Act, with the creation and use of new debt financing techniques and mortgage-related products. Thus, an issuer that is engaged in the real estate finance business might hold assets, acquired in the course of engaging in the operation of its business, that are not the assets specified in Section 3(c)(5)(C). Nevertheless, the issuer’s assets, sources of income, historical development, public representations of its policy, and the activities of its officers, directors and employees (and other relevant factors) may indicate that the issuer is primarily engaged in the real estate finance business, and therefore should be able to rely on the Section 3(c)(5)(C) exclusion.
The Issuer’s Business Activities
We believe that, consistent with the plain wording of Section 3(c)(5)(C), an issuer that purchases or otherwise acquires whole mortgage loans is engaged in an activity consistent with being in the real estate finance business. We also recognize that such an issuer may also acquire certain other assets as a direct result of being engaged in the business of purchasing or otherwise acquiring whole mortgage loans and, under certain facts and circumstances, those assets might also be indicative of the issuer being in the business of acquiring whole mortgage loans. In these instances, such assets could potentially be treated as qualifying interests for purposes of Section 3(c)(5)(C).
Thus, we agree that an issuer, such as the Depositor, that acquires whole mortgage loans, which it then transfers into a securitization trust which it sponsors for the purpose of obtaining financing to acquire additional whole mortgage loans, may treat as qualifying interests for purposes of Section 3(c)(5)(C) any securities issued by that trust that it retains because such securities are acquired as a direct result of the issuer being engaged in the business of purchasing or otherwise acquiring whole mortgage loans. We note, however, that our position focuses on the business activities of the issuer and not on the assets themselves; thus, our position does not encompass securities issued by a securitization trust that are acquired in a different manner (e.g., from an unaffiliated third party) because acquiring such assets in this manner could be more consistent with the issuer being engaged in an investment activity rather than a financing activity.
Based on the facts and representations in your letter, we would not recommend enforcement action to the Commission under Section 7 of the 1940 Act against the Depositor if the Depositor relies on Section 3(c)(5)(C) of the 1940 Act. Any different facts or representations may require a different conclusion.
Rochelle Kauffman Plesset
 You state that the Depositor has no employees.
 You state that as the Trust Certificate holder, the Depositor has the right to: (i) redeem the Trust’s outstanding notes without the consent of the noteholders following a specified period; (ii) direct the owner trustee in the operation of the Trust, including the removal and /or substitution of mortgage loans; (iii) acquire defaulted mortgage loans from the Trust and foreclose on the real estate underlying such loans; and (iv) dissolve and wind up the Trust following a specified period.
Section 3(a)(2) defines "investment securities" to include all securities except (A) Government securities, (B) securities issued by employees' securities companies, and (C) securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company under Section 3(c)(1) or Section 3(c)(7) of the Act.
 See, e.g., Salomon Brothers, Inc., SEC Staff No-Action Letter (June 17, 1985); Citytrust, SEC Staff No-Action Letter (Dec. 19, 1990); Greenwich Capital Acceptance Inc., SEC Staff No-Action Letter (Aug. 8, 1991).
 See, e.g., United States Property Investment N.V., SEC Staff No-Action Letter (May 1, 1989) (mortgage loan secured exclusively by real estate in which the value of the real estate was equal or greater than the note evidencing the loan); Division of Investment Management, SEC, The Treatment of Structured Finance Under the Investment Company Act, Protecting Investors: A Half Century of Investment Company Regulation (1992) Ch. 1 (“Protecting Investors Report”) at n. 345 and accompanying text (mortgage loan in which 100% of the principal amount of each loan was fully secured by real estate at the time of origination and 100% of the market value of the loan was fully secured by real estate at the time of acquisition); United Bankers, SEC Staff No-Action Letter (Mar. 23, 1988) (fee interests in real estate); The State Street Mortgage Co., SEC Staff No-Action Letter (July 17, 1986) (second mortgages); First National Bank of Fremont, SEC Staff No-Action Letter (Nov. 18, 1985) (deeds of trust on real property); American Housing Trust I, SEC Staff No-Action Letter (May 21, 1988) (installment land contracts); Health Facility Credit Corp., SEC Staff No-Action Letter (Feb. 6, 1985) (leasehold interests).
 See Urban Land Investments Inc., SEC Staff No-Action Letter (Nov. 4, 1971); The Realex Capital, SEC Staff No-Action Letter (Mar. 19, 1984); M.D.C. Holdings, SEC Staff No-Action Letter (May 5, 1987). This position is consistent with the position taken by the Commission in a 1960 release that discussed the applicability of the federal securities laws to the then newly enacted Internal Revenue Code REIT provisions. In that release, the Commission stated that a REIT might not be able to rely on Section 3(c)(5)(C) if it invests “to a substantial extent in other [REITs] . . . or in companies engaged in the real estate business or in other securities.” See Real Estate Investment Trusts, Investment Company Act Release No. 3140 (Nov. 18, 1960).
We have, however, made exceptions to these two positions. See, e.g., Capital Trust Inc., SEC Staff No-Action Letter (May 24, 2007) (certain Tier 1 mezzanine loans); Capital Trust Inc., SEC Staff No-Action Letter (Feb. 3, 2009) (certain “B Notes”); American Home Finance Corp., SEC Staff No-Action Letter (Apr. 9, 1981) (agency whole pool certificates).
 We note that the exclusion in Section 3(c)(5)(C) is not available to an issuer that is in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates. You represent that the Depositor does not engage in such a business.
 You note that a possible alternative basis for the Depositor’s exclusion from investment company status may exist if the Depositor is not an investment company under Section 3(a)(1). In particular, you note that the Depositor would not meet the third prong of the investment company definition, in Section 3(a)(1)(C), if it does not own or propose to acquire “investment securities,” as defined in Section 3(a)(2), that have a value exceeding 40% of the value of its total assets. As noted above, the definition of “investment securities” excludes securities issued by majority-owned subsidiaries that are not themselves investment companies and that do not rely on the exclusions in Section 3(c)(1) or Section 3(c)(7). See supra note 3 and accompanying text. Section 2(a)(24) generally defines a majority-owned subsidiary of a person as a company 50% or more of the outstanding voting securities of which are owned by such person, or by another company which is a majority-owned subsidiary of such person; and Section 2(a)(42) defines “voting security” as any security presently entitling the owner to vote for the election of directors of a company. You state that although the Trusts are passive entities that do not have boards of directors, the Trust Certificates are the functional equivalent of voting securities under the 1940 Act. If that is the case, the Trusts arguably would be majority-owned subsidiaries of the Depositor under Section 2(a)(24), such that the Trust Certificates held by the Depositor would be excluded from the definition of “investment security.” However, because of the availability of relief for the Depositor under Section 3(c)(5)(C) you do not ask for our views on this possible alternative basis for exclusion, nor do we opine on your analysis.
 See, e.g., H.R. Rep. No. 2639, 76th Cong., 3d Sess. 12 (1940); H.R. Rep. No. 1382, 91st Cong., 2d Sess. 17 (1970). See also SEC, Report on the Public Policy Implications of Investment Company Growth, H.R. Rep. No. 2337, 89th Cong. 2d Sess. 328 (1966); Exclusion from the Definition of Investment Company for Certain Structured Financings, Investment Company Act Release No. 18736 (May 29, 1992) at text following n.5.
 See supra notes 5-6 and accompanying text.
 These or similar factors have been considered when determining an issuer’s primary business engagement in various contexts under the Act. See, e.g., Tonopah Mining Company of Nevada, 26 SEC 426, 427 (1947) (Section 3(b)(2)); Dan River Inc. v. Ichan, 701 F.2d. 278, 291 n.14 (4th Cir. 1983) (Section 3(a)(1)(A)); Moses v. Black, Fed. Sec. L. Rep. (CCH) P97,866 (S.D.N.Y. 1981) (Section 3(b)(1)); Rule 3a-1 under the 1940 Act; Rule 3a-8 under the 1940 Act.
 We would be willing to entertain other no-action requests to treat as qualifying interests certain other mortgage-related assets if they are acquired by an issuer as a direct result of the issuer being engaged in the business of purchasing or otherwise acquiring whole mortgage loans (e.g., certain “A-Notes” and servicing rights).
 Similarly, rather than focusing solely on an issuer’s assets when determining whether the issuer is primarily engaged in the real estate finance business and thus can rely on Section 3(c)(5)(C), we would be willing to entertain no-action requests that would broaden the “primarily engagement” test to include other factors that would indicate whether the issuer is primarily engaged in the real estate finance business. See, e.g., supra, note 11 and accompanying text.
The Incoming Letter is in Acrobat format.