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,
==========================================START OF PAGE 2======
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
==========================================START OF PAGE 4======
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...)
==========================================START OF PAGE 5======
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.
==========================================START OF PAGE 6======
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).
==========================================START OF PAGE 10======
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...)
==========================================START OF PAGE 13======
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.
==========================================START OF PAGE 14======
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...)
==========================================START OF PAGE 15======
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.
==========================================START 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").
==========================================START 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)].
==========================================START OF PAGE 90======
(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
==========================================START OF PAGE 91======
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,
==========================================START OF PAGE 92======
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)
==========================================START OF PAGE 93======
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
==========================================START OF PAGE 94======
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