[Federal Register Volume 61, Number 249 (Thursday, December 26, 1996)]
[Proposed Rules]
[Pages 68100-68115]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32652]
[[Page 68099]]
_______________________________________________________________________
Part II
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Part 270
Private Investment Companies; Proposed Rule
Federal Register / Vol. 61, No. 249 / Thursday, December 26, 1996 /
Proposed Rules
[[Page 68100]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 270
[Release No. IC-22405, International Series Release No. 1037, File No.
S7-30-96]
RIN 3235-AH09
Private Investment Companies
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rules.
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SUMMARY: The Commission is publishing for comment new rules under the
Investment Company Act of 1940 to implement provisions of the National
Securities Markets Improvement Act of 1996 that apply to private
investment companies. The proposed rules would define certain terms for
purposes of the new exception from regulation under the Investment
Company Act for private investment companies whose investors are all
highly sophisticated investors, termed ``qualified purchasers.'' The
proposed rules also would address certain transition issues related to
existing private investment companies that have no more than 100
investors and certain other matters related to private investment
companies.
DATES: Comments must be received on or before February 10, 1997.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Stop 6-9, Washington, D.C. 20549. Comments also may be submitted
electronically at the following E-mail address: rule-comments@sec.gov.
All comment letters should refer to File No. S7-30-96; this file number
should be included on the subject line if E-mail is used. Comment
letters will be available for public inspection and copying in the
Commission's Public Reference Room, 450 Fifth Street, N.W., Washington,
D.C. 20549. Electronically submitted comment letters also will be
posted on the Commission's Internet web site (http://www.sec.gov).
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, Stop 10-2, Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Commission today is requesting public
comment on proposed new rules 2a51-1, 2a51-2, 2a51-3, 3c-1, 3c-5, 3c-6
and 3c-7 under the Investment Company Act of 1940 [15 USC 80a] (the
``Investment Company Act'' or ``Act'').
Table of Contents
Executive Summary
I. Background
A. Qualified Purchaser Funds
B. Amendments to Section 3(c)(1)
C. Other Directed Rulemaking
II. Rules Relating to Qualified Purchaser Funds
A. Investments
1. Definition of Investments
a. Securities
b. Real Estate
c. Commodity Interests
d. Cash and Cash Equivalents
e. Request for Comment
2. Determining the Amount of Investments
a. Value of Investments
b. Deductions from Amount of Investments
i. Certain Indebtedness
ii. Other Payments
iii. Request for Comment
3. Jointly-Held Investments
4. Investments Held by Certain Corporate Affiliates
5. Good Faith Reliance on Certain Documentation
B. Definitions of Beneficial Ownership
1. The Grandfather Provision
2. The Consent Provision
C. Conforming Rule
D. Non-Exclusive Safe Harbor for Certain Section 3(c)(7) Funds
III. Other Rules for Private Investment Companies
A. Transition Rule for Section 3(c)(1) Funds
B. Investments by Fund Employees
C. Certain Transfers
IV. General Request for Comment
V. Cost/Benefit Analysis
VI. Summary of Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Proposed Rules
Executive Summary
The Commission is proposing rules to implement certain provisions
of the National Securities Markets Improvement Act of 1996 (the ``1996
Act''), which was signed into law by President Clinton on October 11,
1996. 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 private investment companies that consist solely of highly
sophisticated ``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
private 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 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 private investment companies require
Commission rulemaking as well. The Commission is proposing for public
comment new rules under the Investment Company Act that would:
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;
Address 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) or a
section 3(c)(7) fund (referred to collectively in this Release as
``private funds''), and knowledgeable employees of affiliates of these
funds, to invest in the fund; and
Address transfers of securities in a private fund when the
transfer was caused by legal separation, divorce, death, and certain
other involuntary events.
I. Background
Section 3(c)(1) of the Investment Company Act excludes from
regulation under the Act certain private 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
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\1\ 15 U.S.C. 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.''
\2\ See Division of Investment Management, SEC, Protecting
Investors: A Half Century of Investment Company Regulation at 104
(1992) (hereinafter Protecting Investors Report).
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[[Page 68101]]
A. Qualified Purchaser Funds
In 1992, the Commission concluded that the 100-investor limit,
while reasonably reflecting the point beyond which federal regulatory
concerns incorporated in the Investment Company Act are raised, may
place unnecessary constraints on investment pools that sell their
securities exclusively to sophisticated purchasers.3 The
Commission recommended that Congress amend the Investment Company Act
to create an alternative exclusion for investment companies whose
securities are owned exclusively by sophisticated investors.
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\3\ 138 Cong. Rec. at S4822 (daily ed. Apr. 2, 1992) (Memorandum
of the Securities and Exchange Commission in Support of the Small
Business Incentive Act of 1992) (hereinafter Commission Memorandum).
Some commenters also suggested that section 3(c)(1)'s 100-investor
limit may have had the effect of providing an incentive for
Americans to invest in unregulated off-shore markets. See S. Rep.
No. 293, 104th Cong., 2d Sess. at 10 (1996) (hereinafter Senate
Report); H.R. Rep. No. 622, 104th Cong., 2d Sess. at 18 (1996)
(hereinafter House Report). These Reports relate to bills that were
eventually enacted as the National Securities Markets Improvement
Act of 1996, Pub. L. No. 104-290 (1996) (the ``1996 Act'') (to be
codified in scattered sections of the United States Code
(``U.S.C.''); U.S.C. references are to the sections in which the
relevant provisions of the 1996 Act will be codified).
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Congress implemented this recommendation in the 1996 Act. New
section 3(c)(7) of the Investment Company Act creates an exclusion for
investment companies whose investors consist solely of ``qualified
purchasers.'' 4 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,5 (ii) a family-owned
company (``Family Company'') that owns not less than $5 million in
investments,6 (iii) certain trusts,7 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.8 The
1996 Act directs the Commission to prescribe rules defining 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.9
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\4\ 1996 Act section 209; 15 U.S.C. 80a-3(c)(7). As is the 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\ 15 U.S.C. 80a-2(a)(51)(A)(i).
\6\ A Family Company is a company ``that is owned directly or
indirectly by or for two 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 for the benefit of such persons . . . .'' 15
U.S.C. 80a-2(a)(51)(A)(ii).
\7\ 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. 15 U.S.C.
80a-2(a)(51)(A)(iii).
\8\ A qualified purchaser that meets the $25 million threshold
may act for its own account or for the accounts of other qualified
purchasers. 15 U.S.C. 80a-2(a)(51)(A)(iv).
\9\ 1996 Act section 209(d)(2). Such rules are required to be
prescribed by April 9, 1997 (180 days after the enactment of the
1996 Act). The provisions of the 1996 Act enacting section 3(c)(7)
take effect on the earlier of April 9, 1997 or the date on which the
rulemaking defining the term investments is completed.
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Section 3(c)(7) includes a ``grandfather'' provision that allows an
existing section 3(c)(1) fund to convert into a section 3(c)(7) fund
(``Grandfathered Fund''). The outstanding securities of a Grandfathered
Fund may be beneficially owned by as many as 100 persons who are not
qualified purchasers, provided that these persons acquired their
investment in the Grandfathered Fund on or before September 1,
1996.10 The grandfather provision is designed to allow an existing
section 3(c)(1) fund wishing to avail itself of the new section 3(c)(7)
exclusion to continue its existing relationships with investors who are
not qualified purchasers.11
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\10\ 15 U.S.C. 80a-3(c)(7)(B).
\11\ See 142 Cong. Rec. at E1938 (Oct. 21, 1996) (Remarks of
Hon. John D. Dingell); 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. (1995) (prepared statement of Marianne
Smythe); 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, 779 (Dec. 5, 1995) (hereinafter Hedge Funds Task
Force Report). The grandfather provision is not intended, however,
to allow a sponsor of a section 3(c)(1) fund to nominally give the
fund section 3(c)(7) status in order to be able to operate another
section 3(c)(1) fund and thereby circumvent the 100-investor limit.
Remarks of Hon. John D. Dingell, supra; see also section II.D of
this Release.
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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 such owner's interest in the fund.12
This provision is designed to enable an investor in an existing section
3(c)(1) fund to dispose of an investment, without penalty, if the
investor does not choose to continue its investment in a private
investment company that no longer will be limited to 100
investors.13 The 1996 Act directs the Commission to define the
term ``beneficial owner'' for this purpose.14 The 1996 Act also
requires an existing section 3(c)(1) fund that wishes to become a
qualified purchaser to obtain the consent of the beneficial owners of
its securities and certain other persons (the ``consent
provision'').15
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\12\ 15 USC 80a-3(c)(7)(B)(ii).
\13\ See 142 Cong. Rec. at E1929 (Oct. 4, 1996) (Remarks of Hon.
Thomas J. Bliley, Jr.).
\14\ 1996 Act section 209(d)(4). Such rules are required to be
prescribed by April 9, 1997. See supra note 9.
\15\ 15 USC 80a-2(a)(51)(C).
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The Commission is proposing a rule under the Investment Company Act
to define the term ``investments'' for purposes of the qualified
purchaser definition. The Commission also is proposing rules to define
the term ``beneficial owner'' for purposes of the grandfather and the
consent provisions, and to address other transitional and
interpretative issues related to section 3(c)(7).
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 the provision ``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 its
securities.\16\ The look-through provision currently applies (i) if a
company owns 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 are invested in section 3(c)(1) funds generally (``second 10%
test'').\17\
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\16\ 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 holder thereof to vote for election of directors [of
the issuer] thereof.'' 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\ To illustrate the operation of the current look-through
provision, assume Company A is seeking to rely on the provisions of
section (3)(c)(1). If one of Company A's security holders, Company
B, beneficially owns 10% or more of Company A's voting securities,
then the security holders of Company B would be counted as security
holders of Company A (under the first 10% test), unless no more than
10% of Company B's assets consist of securities of section 3(c)(1)
funds (the second 10% test).
The operation of the 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 the consent
provisions. See section II.B. of this Release.
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The 1996 Act's amendments to section 3(c)(1) are designed, in part,
to
[[Page 68102]]
simplify the way in which the number of investors in a fund is
calculated for purposes of the 100-investor limit.\18\ When the
relevant provisions of the 1996 Act become effective,\19\ the amended
look-through provision will no longer apply to a security holder that
is an operating company (i.e., a company that is not an investment
company or a private fund).\20\ 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.\21\
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\18\ These changes also had been recommended by the Commission
in 1992. See Commission Memorandum, supra note 3; see also
Protecting Investors Report, supra note 2, at 108-09.
\19\ The amendments to section 3(c)(1)(A) will become effective
on the earlier of April 9, 1997 or the date on which the rulemaking
defining the term investments is completed. 1996 Act section 209(e).
\20\ 15 USC 80a-3(c)(1)(A).
\21\ See Testimony of Arthur Levitt, Chairman, SEC, Concerning
S. 1815, the Securities Investment Promotion Act of 1996, Before the
Senate Committee on Banking, Housing and Urban Affairs (June 5,
1996).
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The 1996 Act not only limits the scope of the look-through
provision, but also seeks to simplify it by eliminating the second 10%
test. The look-through provision will apply whenever an investment
company, including a private fund, owns 10% or more of a section
3(c)(1) fund, regardless of whether or not the investment company has
more than 10% of its assets invested in section 3(c)(1) funds
generally. 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.\22\
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\22\ See, e.g., Protecting Investors Report, supra note 2, at
106-09.
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These amendments, while attempting to simplify the look-through
provision and make it more consistent with its regulatory purpose, may
create interpretative issues for existing section 3(c)(1) funds that
have investors to which the first, but not the second, 10% test
applies. The Commission is proposing a rule to address these issues.
C. Other Directed Rulemaking
The 1996 Act directs the Commission to prescribe two sets of rules
relating to private funds.\23\ The 1996 Act directs the Commission to
prescribe rules permitting ``knowledgeable employees'' of a private
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.\24\ The purpose of this provision
appears to be to allow private funds to offer persons who participate
in the funds' management the opportunity to invest in the fund as a
benefit of employment.\25\
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\23\ 1996 Act section 209(d).
\24\ 1996 Act section 209(d)(3). These rules are required to be
promulgated no later than October 11, 1997 (1 year after enactment
of the 1996 Act).
\25\ 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. 22-23 (1995) (testimony of Barry P. Barbash, Director,
Division of Management, SEC).
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The Commission is proposing a rule to allow directors, executive
officers, general partners, and other knowledgeable employees of a
section 3(c)(1) fund to invest in the fund without being counted for
purposes of the fund's 100-investor limit. The proposed rule similarly
would allow knowledgeable employees of a section 3(c)(7) fund to invest
in the fund even though they may not meet the definition of qualified
purchaser. The rule also would permit investments by knowledgeable
employees of affiliates that manage the investment activities of these
funds.
In addition to directing the Commission to adopt rules relating to
investments by knowledgeable employees, the 1996 Act directs the
Commission to prescribe rules implementing section 3(c)(1)(B) of the
Act.\26\ 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 made, pursuant to such rules and
regulations as the Commission prescribes.\27\ The Commission is
proposing a rule to permit securities acquired by a person as a result
of certain transfers to be treated as being beneficially owned by the
original beneficial owner. The proposed rule would address similar
transfers of securities issued by section 3(c)(7) funds.\28\
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\26\ 1996 Act section 209(d)(1).
\27\ 15 USC 80a-3(c)(1)(B).
\28\ See 15 USC 80a-3(c)(7)(A) (permitting certain transfers by
qualified purchasers).
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II. Rules Relating to Qualified Purchaser Funds
A. Investments
The 1996 Act provides that the term investments is to be defined by
Commission rule. Section 2(a)(51)(B) of the Act also gives the
Commission authority to prescribe such rules and regulations governing
qualified purchasers as the Commission determines are necessary or
appropriate in the public interest or for the protection of investors.
In explaining why Congress deferred to the Commission's defining
what constitutes an investment for purposes of the $5 million/$25
million thresholds, the legislative history of the 1996 Act indicates
that section 3(c)(7) funds are to be limited to investors with a high
degree of financial sophistication who are in a position to appreciate
the risks associated with investment pools that do not have the
protections afforded by the Investment Company Act.\29\ These investors
are likely to be able to evaluate on their own behalf matters such as
the level of a fund's management fees, governance provisions,
transactions with affiliates, investment risk, leverage and redemption
or withdrawal rights.\30\ Congress appears to have expected that the
definition of investments be broader than securities, but not that
every asset be treated as an investment. Rather, the legislative
history suggests that the asset should be held for investment purposes
and that the nature of the asset should indicate a significant degree
of investment experience and sophistication such that the investor can
be expected to have the knowledge to evaluate the risks of investing in
unregulated investment pools.\31\
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\29\ See Senate Report, supra note , at 10.
\30\ Id.
\31\ The Senate Report gave family-owned businesses and personal
residences as examples of assets that should not be considered to be
investments. See id. at 10.
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Proposed rule 2a51-1 under the Investment Company Act seeks to
define the term investments consistent with the principles set forth in
the legislative history. The proposed rule would define investments
broadly to include securities (other than controlling interests in all
but certain issuers), and real estate, futures contracts, physical
commodities, and cash and cash equivalents held for investment
purposes. Proposed rule 2a51-1 also contains certain provisions
designed to clarify how the amount of a person's investments would be
determined (including investments held jointly with a spouse and
investments held by certain affiliated entities). The proposed rule
would permit a section 3(c)(7) fund to rely, in good faith, on certain
documentation in determining a person's eligibility as a qualified
purchaser.
[[Page 68103]]
1. Definition of Investments
a. Securities
Proposed rule 2a51-1(b)(1) would include securities within the
definition of investments. Defining investments in this way should
result in a broad range of investments being treated as such for
purposes of section 3(c)(7). Many investment opportunities are offered
through entities that issue securities, such as limited partnerships
and limited liability companies.\32\
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\32\ For example, the term security includes any ``fractional
undivided interest in oil, gas or other mineral rights.'' See
section 2(1) of the Securities Act of 1933 (``Securities Act'') [15
USC 70a(1)].
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Under the proposed rule, securities of an issuer with which the
prospective qualified purchaser has a control relationship generally
would not come within the definition of investments for purposes of
section 3(c)(7).\33\ Limiting the definition in this manner is designed
to exclude, among other things, controlling ownership interests in
family-owned and other closely held businesses, and controlled
subsidiaries of operating companies. These holdings would appear not to
demonstrate the degree of financial sophistication necessary to invest
in unregulated investment vehicles or securities generally.
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\33\ The proposed rule would exclude 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 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.'' 15 USC 80a-
2(a)(9). 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.
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The proposed rule would not exclude from the definition of
investments controlling ownership interests in investment companies and
other issuers excepted from the definition of investment company by
sections 3(c)(1) through 3(c)(9) of the Act.\34\ Ownership of a
controlling interest in these types of companies generally suggests a
significant degree of investment experience. The proposed rule also
would not exclude a controlling ownership interest in a ``listed''
company (e.g., 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
an offshore securities exchange) that is not a majority-owned
subsidiary of the prospective qualified purchaser.\35\ A controlling
ownership interest in a company listed on a national securities
exchange or traded on NASDAQ is likely to evidence knowledge of and
experience in dealing with investment risk, securities-related
disclosure, corporate governance, transactions with affiliates,
leverage, and other issues relevant to a person's ability to evaluate
investment in a pooled investment vehicle. The proposed inclusion of
securities traded on a ``designated offshore securities market'' is
intended to include securities of foreign issuers that trade in an
organized market that is not regulated by the Commission.
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\34\ 15 USC 80a-3(c) (1) through (9). In addition to private
investment companies, sections 3(c)(1) through (9) except from the
definition of investment company certain types of issuers that
engage in significant investment-related activities (i.e., brokers
and other financial intermediaries, banks, insurance companies, and
finance companies). A controlling interest in a foreign bank,
foreign insurance company or structured finance vehicle also would
be included as an investment, even if the issuer is not considered
to be an investment company under rules 3a-6 or 3a-7 under the Act
[17 CFR 270.3a-6 and 3a-7].
\35\ A company would be considered to be a ``listed company'' if
it has outstanding a class of equity securities that are (i)
``reporting securities'' under rule 11Aa3-1 of the Securities
Exchange Act of 1934 (``Exchange Act'') [17 CFR 240.11Aa3-1] (i.e.,
securities listed and registered, or admitted to unlisted trading
privileges, on a national securities exchange or for which quotation
information is disseminated in the NASDAQ and for which transaction
reports are required to be made on a real-time basis pursuant to an
effective transaction reporting plan) or (ii) listed on a
``designated offshore securities market'' (as such term is defined
in Regulation S under the Securities Act [17 CFR 230.901 et seq.]).
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Comment is requested on the proposed exclusions from the definition
of investments for certain securities. Should other controlling
interests (such as controlling interests in large, but privately held,
companies) be treated as investments for purposes of section 3(c)(7)?
\36\ In the alternative, should the listed company exception be
applicable if any securities of the issuer have been offered to the
public, even if periodic reports with respect to the issuer's
securities are no longer required to be filed under the Securities
Exchange Act of 1934 (``Exchange Act'')? \37\ Should foreign securities
be considered listed securities based on criteria other than, or in
addition to, whether they trade on a designated offshore securities
market (such as a public float requirement or a requirement that
American Depositary Receipts with respect to these securities be traded
in the U.S.)?
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\36\ For example, a controlling interest in a company that has
shareholders equity in excess of a specified amount (e.g., $50
million or $100 million) could be treated as an investment on the
theory that the size of the company suggests a certain level of
financial sophistication on the part of the control person.
\37\ See sections 12(b), 12(g) and 15(d) of the Exchange Act [15
USC 78l(b), 78l(g) and 78o(d)].
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Comment also is requested whether other types of business holdings
(whether or not characterized as securities) should be treated as
investments. For example, should any passive ownership interest in a
trade or business be considered to be an investment? \38\ Finally,
comment is requested whether other types of securities should be
excluded from the definition of investments because they do not serve
as an appropriate measure of investment experience.
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\38\ A passive ownership interest could be defined for these
purposes as an interest in a trade or business in which such person
does not materially participate. See Internal Revenue Code (``IRC'')
section 469(c)(1) [26 USC 469(c)(1)].
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b. Real Estate
Proposed rule 2a51-1(b)(2) would include real estate held for
investment purposes within the definition of investments. Consistent
with the examples provided by the legislative history of the 1996 Act,
real estate would not be 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).\39\
The term ``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.'' \40\
Thus, residential property could be treated as an investment if it is
not treated as a residence for tax purposes. The Commission believes
that reference to the Internal Revenue Code provisions is appropriate
because it would allow prospective qualified purchasers to determine
whether the residential real estate is an investment based on the same
provisions they would apply in
[[Page 68104]]
determining whether certain expenses related to the property are
deductible for purposes of completing their tax returns. Comment is
requested on the proposed approach. Would alternative approaches (such
as not treating the property as held for investment purposes if it is
used at any time for personal purposes) be easier to apply?
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\39\ Proposed rule 2a51-1(c). Proposed rule 2a51-1(a)(5) would
define ``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 such descendant. See also section
2(a)(51)(A)(ii) of the Act [15 USC 80a-2(a)(51)(A)(ii)] (specifying
who is considered a family member for purposes of the Family Company
definition).
\40\ IRC section 280A(d) [26 USC 280A(d)]. The proposed rule
would treat 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
days during which the unit is rented at a fair market value.
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Property owned by the 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'') would not be considered to be
held for investment purposes.\41\ 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.
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\41\ Proposed rule 2a51-1(c).
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Comment is requested on including real estate as an investment for
purposes of the proposed rule. Does real estate investing sufficiently
reflect the kind of financial sophistication required to understand the
risks of investing in an unregulated investment pool? Should real
estate be included as an investment for purposes of the proposed rule
only if the investment is in the form of a security?
c. Commodity Interests
Proposed rule 2a51-1(b)(3) would include contracts for the purchase
or sale of a commodity for future delivery (``commodity interests'')
held for investment purposes within the definition of
investments.42 Commodity interests are often used by investors to
hedge their portfolios from declines in securities prices, changes in
interest rates, or foreign currency fluctuations. Commodity interests
also may provide a means to invest in the commodities markets.
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\42\ Paragraph (a)(1) of proposed rule 2a51-1 would define
commodity interests to mean commodity futures contracts, options on
a 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 et seq.] 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.
A futures contract generally is a bilateral agreement providing
for the purchase or sale of a specified commodity at a stated time
in the future for a fixed price. Robert E. Fink & Robert B.
Feduniak, Futures Trading at 10 (1988). A commodity option gives its
holder the right, for a specified period of time, to either buy (in
the case of a call option) or sell (in the case of a put option) the
subject of the option at a predetermined price. The writer (seller)
of an option is obligated to sell or buy the specified commodity at
the election of the option holder. 1 Philip M. Johnson & Thomas L.
Hazen, Commodities Regulation at section 1.07 (2d ed. Supp. 1994)
(hereinafter Johnson & Hazen).
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Commodity interests would be included as investments to the extent
of the initial margin and option premium deposited with a futures
commission merchant.43 This approach is similar to that taken by
rule 4.7 under the Commodity Exchange Act, which makes available a
simplified regulatory framework for private commodity pools offered to
certain sophisticated investors.44 Gains and losses on commodity
interests generally would be reflected in changes in the prospective
qualified purchaser's cash position (which also could be treated as an
investment).45 Comment is requested on the proposed approach to
treating commodity interests. Since the value of the commodity interest
generally would be reflected in the investor's cash position (including
initial margin), is it necessary for the rule to include commodity
interests? Would the rule be easier to apply if it explicitly provided
that ``variation margin'' posted to the commodity account of the
prospective qualified purchaser to reflect gains could be treated as an
investment for purposes of the rule? Would another formulation for
determining how to value commodity interests be more appropriate?
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\43\ Proposed rule 2a51-1(d)(1). To enter into a futures
contract or write a commodity option, a customer typically deposits
with a futures commission merchant (``FCM''), as security for
performance of its obligations, a specified amount of assets or cash
as ``initial margin.'' Initial margin is not considered part of the
contract or option price, and is returned upon termination of the
position, unless used to cover a loss. Johnson & Hazen, supra note
42, at section 1.10.
\44\ 17 CFR 4.7. In taking this approach, the Commodity Futures
Trading Commission noted that ``account equity in excess of the
minimum necessary for margin or option premiums is not includable
because it has no necessary correlation with actual commodity
interest transactions.'' See Exemption for Commodity Pool Operators
With Respect to Offerings to Qualified Eligible Participants;
Exemption for Commodity Trading Advisors With Respect to Qualified
Eligible Clients, 57 FR 34853, 34855 n.17 (Aug. 7, 1992). Rule 4.7
under the CEA establishes a different threshold for securities
investments ($2,000,000 market value) and commodity interests
($200,000 initial margin). Since the proposed rule would permit cash
to be treated as an investment (see section II.A.2.d. of this
Release), it would not be appropriate to incorporate this dual
threshold into the proposed rule.
\45\ See section II.A.1.d of this Release. An FCM must, on a
daily basis, reconcile its customers' positions by crediting gains
and debiting losses on a customer-by-customer basis. See CEA rule
1.32 [17 CFR 1.32] (requiring daily computation of customer
accounts); see also Custody of Investment Company Assets with
Futures Commission Merchants and Commodity Clearing Organizations,
Investment Company Act Rel. No. 22389 (Dec. 11, 1996) [61 FR 66207
(Dec. 17, 1996)].
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The proposed rule also would include in the definition of
investments commodities that are held in physical form and for
investment purposes.46 This provision would recognize that many
investors hold gold, silver or other commodities as part of their
investment portfolios. Commodities that are used as part of a trade or
business (such as grain held by a food processor as part of its
inventory or raw materials) would not be considered to be investments.
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\46\ Proposed rule 2a51-1(b)(4). Physical commodities, for
purposes of the proposed rule, would be defined as any commodity
with respect to which a commodity interest is traded on a domestic
or foreign commodities exchange. Proposed rule 2a51-1(a)(4). This
approach is designed to provide certainty on the types of
commodities that would be considered investments.
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Comment is requested on the proposed inclusion of commodity
interests and commodities within the definition of investments. Should
any other types of financial instruments, to the extent they are not
addressed by the proposed rule, be included within the definition of
investments? 47
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\47\ See, e.g., section 3(c)(2) of the Act, as amended by the
1996 Act [15 USC 80a-3(c)(2)] (defining the term ``financial
contract'').
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d. Cash and Cash Equivalents
Proposed rule 2a51-1(b)(5) would include cash and cash equivalents
held for investment purposes (``cash'') in the definition of
investments.48 The Commission is proposing to include cash as an
investment to reflect its views that many investors are likely at any
given time to have a component of their investment portfolio in
cash.49 The rule would specify that the cash would have to be held
by the prospective qualified purchaser for investment purposes. Thus,
cash used by the prospective qualified purchaser to meet its day-to-day
expenses (or, in the case of a prospective qualified purchaser that is
a business, its working capital) would
[[Page 68105]]
not be included for purposes of determining whether the prospective
qualified purchaser has the requisite amount of investments.
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\48\ Cash and cash equivalents would generally be considered to
include cash, bank deposits, certificates of deposit, bankers
acceptances and other bank instruments. See, e.g., Investment
Company Act Rel. No. 10937 (Nov. 13, 1979) [44 FR 66608 (Nov. 20,
1979)]; Statement of Cash Flows, Statement of Financial Accounting
Standards No. 95, at section 95.08 (Fin. Accounting Standards Bd.
1987); Treas. Reg. section 220.2 (as amended in 1996) [Fed. Sec. L.
Rep. (CCH) para. 22,252]. The cash surrender value of an insurance
policy (net of any loans) would also be considered to be a cash
equivalent. Certain of the instruments that are considered to be
cash equivalents (e.g., shares of money market mutual funds, certain
Government securities) for purposes of these sources are securities
and would be treated as investments for purposes of the proposed
rule.
\49\ 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 or cash equivalents may also be integral to certain
sophisticated investment strategies (such as hedging).
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Comment is requested on the proposed inclusion of cash as an
investment. Should cash only be included if it is in excess of a
certain amount (e.g., $25,000)? Should the rule provide examples of
when cash would be considered to be held for investment purposes (i.e.,
if it represents proceeds from the sale of investments occurring during
the preceding six months)? Should cash be included only if ``investment
securities'' and other types of investments (e.g., real estate)
constitute more than a specified average amount or percentage of the
prospective qualified purchaser's investment portfolio (e.g., 25%, 50%
or 75%) over the prior 12-month period? 50
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\50\ Section 3(a)(3) of the Act [15 USC 80a-3(a)(3)] defines the
term ``investment securities'' as all securities except (A)
Government securities, (B) securities issued by employees'
securities companies, and (C) securities issued by majority-owned
subsidiaries of the owner which are not investment companies. Upon
effectiveness of the 1996 Act's amendments related to section
3(c)(7) funds, the term investment securities also will exclude
majority-owned subsidiaries that are section 3(c)(1) or section
3(c)(7) funds. See section 209(c)(6) of the 1996 Act.
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e. Request For Comment
Comment is generally requested on the proposed definition of
investments. Certain assets (such as jewelry, art work, antiques, and
other collectibles) that may be held by some individuals as investments
are not included because they do not necessarily suggest any experience
in the financial markets or investing in unregulated investment
pools.\51\ Should such assets be included if held for investment
purposes? Should any property that produces income from interest,
dividends, annuities or royalties not derived in the ordinary course of
a trade or business be treated as an investment? \52\ Commenters should
explain how these types of investments can serve as indicia of
sophistication in investment matters. Finally, should any assets that
are proposed to be included within the definition of investments not be
included?
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\51\ See Hedge Funds Task Force Report, supra note 11, at 788
(suggesting that automobiles, jewelry and art be excluded from
investments for purposes of measuring financial sophistication).
\52\ See IRC section 163(d)(5) [26 USC 163(d)(5)] (definition of
``property held for investment'' under tax code provisions allowing
a limited deduction for investment interest).
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2. Determining the Amount of Investments
Proposed rule 2a51-1 would allow the amount of a prospective
qualified purchaser's investments to be based on either the market
value of the investments or their cost. In either case, certain
deductions from the amount of investments owned would have to be made
as discussed below.
a. Value of Investments
Proposed rule 2a51-1(d) would specify that the value of an
investment would be determined based either on its market value on a
recent date or its cost.\53\ A section 3(c)(7) fund could determine
which methodology to use, or could allow prospective qualified
purchasers to provide the amount of their investments based on either
methodology. The Commission believes that this approach is appropriate
because either the cost or market value of the prospective qualified
purchaser's investments may provide an appropriate starting point for
assessing the person's investment experience.
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\53\ 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)]. In the case of other investments,
other reasonable methods to ascertain market value (such as real
estate appraisals by independent third parties) could be used. A
prospective qualified purchaser could not use a ``fair value''
method of valuation such as that contemplated by rule 2a-4 under the
Act [17 CFR 270.2a-4]. In the absence of a readily ascertainable
market value, the value of an investment always would be based on
its cost.
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Comment is requested on the proposed approach to valuing
investments. Should the proposed rule instead take an approach similar
to that taken in rule 144A under the Securities Act, which generally
requires that securities be valued at cost even if a market value is
available? \54\ Would that approach make it easier for a section
3(c)(7) fund to determine the continuing status of an investor as a
qualified purchaser when the investor adds to its investment in the
fund? \55\
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\54\ See 17 CFR 230.144A(a)(3) (requiring securities to be
valued at cost, unless a person reports its securities holdings in
its financial statements on the basis of their fair market value, or
no current information with respect to the cost of those securities
has been published).
\55\ See section 3(c)(7)(A) of the Investment Company Act
(providing 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'').
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b. Deductions From Amount of Investments
(i) Certain Indebtedness
The Commission believes 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 leverage or similar means. As a
result, the proposed rule would require that the amount of any
outstanding indebtedness incurred to acquire investments owned by a
prospective qualified purchaser be deducted from that person's amount
of investments. This requirement would apply to all types of
prospective qualified purchasers.\56\
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\56\ Proposed rule 2a51-1(e). The proposed rule would not
require the deduction to be made with respect to investments that
the person manages on a discretionary basis for others.
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The Commission is concerned that section 3(c)(7) funds may have
difficulty in determining whether certain indebtedness was incurred to
acquire investments. To address this issue, the proposed rule would
require that certain indebtedness, if incurred during the preceding 12
months, be deducted from the amount of the person's investments,
regardless of whether the proceeds of the indebtedness can be directly
traced to the acquisition of investments. These provisions are
generally applicable to natural persons and Family Companies.
The amount of any loan to a natural person secured by a mortgage on
the person's personal residence or other non-investment real estate
would be deducted unless the proceeds of the loan were used solely to
finance the acquisition or improvement of the property or to refinance
an outstanding mortgage (``real estate loans'').\57\ The intent of this
provision is 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 million threshold.\58\
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\57\ Proposed rule 2a51-1(f) (4) and (5). The proceeds of a
refinancing loan would be deducted to the extent that the amount of
the new loan exceeds the lowest principal amount of the refinanced
loan outstanding during the preceding 12 months.
\58\ This deduction would generally apply to real estate that is
not held for investment purposes. Outstanding indebtedness incurred
to acquire investment real estate would already have been deducted
as required by proposed rule 2a51-1(e).
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Under the proposed rule, a Family Company would be required to
deduct the amount of any outstanding indebtedness incurred by any of
the Company's owners to acquire the investments held by the
Company.\59\ In addition, a Family Company would have to deduct the
amount of any real estate loans that any owner of the Family Company
would have had to deduct if the owner were the
[[Page 68106]]
prospective qualified purchaser.\60\ Finally, the proposed rule would
require a Family Company to deduct (i) 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 exceeds the fair
market value of any assets of the Family Company other than investments
and (ii) 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.\61\ These provisions would provide further assurance that
indebtedness incurred by the Family Company or its owners to acquire
investments was appropriately deducted.
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\59\ Proposed rule 2a51-1(g)(1).
\60\ Proposed rule 2a51-1(g)(2).
\61\ Proposed rule 2a51-1(g)(3) and (4).
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Comment is requested whether the rule should contain other
provisions to clarify the extent to which indebtedness should be
treated as incurred to acquire the investment. For example, should any
indebtedness collateralized by the investment (whether directly or
indirectly) be deemed to have been incurred to acquire the investment?
(ii) Other Payments
Prospective qualified purchasers who are natural persons would be
required to deduct from the amount of their investments certain other
amounts received during the preceding 12 months that could inflate the
amount of their investments (particularly cash) without reflecting any
investment experience. These amounts include payments received pursuant
to an insurance policy; the value of any investments received by the
person as a gift or bequest or pursuant to an agreement related to a
legal separation or divorce; and any amount received by the person in
connection with a lawsuit.\62\
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\62\ Proposed rule 2a51-1(f)(1) through (3). A Family Company
would have to deduct any such payments received by the Company or by
any owner of the Company. Proposed rule 2a51-1(g)(2).
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(iii) Request for Comment
Comment is requested concerning the proposed approach for deducting
indebtedness and other payments. Should the rule establish guidelines
or presumptions concerning whether indebtedness was incurred to acquire
an investment? Should other specified types of indebtedness or payments
be deducted from the amount of investments?
Comment also is requested whether the 12-month period is sufficient
to establish, for example, that a person who has received a $5 million
bequest is sufficiently sophisticated to be treated as a qualified
purchaser based on investments that may have been made with that
bequest? Would a longer (e.g., 24 months) or shorter (e.g., six months)
period be more appropriate? In lieu of, or in addition to, the 12-month
period, should the rule reduce the amount of the deductions to the
extent that the prospective qualified purchaser can trace the use of
the proceeds of the loans or other payments to non-investment
activities?
3. Jointly Held Investments
The proposed rule would clarify that, in determining whether a
natural person is a qualified purchaser, there may be included in the
value of such person's investments any investments held jointly with
such person's spouse (``joint investments'').\63\ 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. On the other hand, if each spouse owned,
individually, $3 million of investments, but the spouses did not own
any joint investments, neither spouse would be a qualified
purchaser.\64\ Comment is requested on the proposed approach to joint
investments. Should spouses that hold not less than $5 million in
investments in the aggregate (regardless of whether the investments are
held jointly) be treated as qualified purchasers if they make a joint
investment in a section 3(c)(7) fund?
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\63\ Proposed rule 2a51-1(h). Joint investments also would
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 would have to deduct from the amount of any
joint investments any amounts that the spouse would have had to
deduct (e.g., indebtedness incurred to acquire the investments or
bequests received by the spouse). Id.
\64\ This rule would not affect whether a spouse that is not a
qualified purchaser can hold a joint interest in a section 3(c)(7)
fund with his or her qualified purchaser spouse. Section
2(a)(51)(A)(i) of the Act provides that such a joint interest can be
held.
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4. Investments Held by Certain Corporate Affiliates
The proposed rule generally would permit a parent company in a
corporate structure that is a prospective qualified purchaser to
aggregate investments it owns with those owned by its wholly-owned and
majority-owned subsidiaries. The investments of these affiliated
entities would have to be managed under the direction of the parent
company.65 This approach appears to be an appropriate way to
address, 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.66 Comment is
requested whether there are other structures for holding ownership
interests in investments that should be addressed by the proposed rule.
Should the rule also require the subsidiary to be consolidated with the
parent company under Generally Accepted Accounting Principles? 67
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\65\ Proposed rule 2a51-1(i).
\66\ See, e.g., Resale of Restricted Securities; Changes To
Method of Determining Holding Period of Restricted Securities Under
Rules 144 and 145, Securities Act Rel. No. 6862 (Apr. 23, 1990) [55
FR 17933 (Apr. 30, 1990)] (describing bank holding company
structures).
\67\ See rule 144A(a)(4) under the Securities Act [17 CFR
230.144A(a)(4)].
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5. Good Faith Reliance on Certain Documentation
The proposed rule would permit a section 3(c)(7) fund or a person
acting on its behalf, when determining whether a prospective investor
is a qualified purchaser, to rely upon audited financial statements,
brokerage account statements and other appropriate information and
certifications provided by the prospective purchaser or its
representatives, as well as upon publicly available information as of a
recent date.68 Reliance on this information must be reasonable and
the section 3(c)(7) fund or its representatives, after reasonable
inquiry, must have no basis for believing that the information is
incorrect in any material respect. Comment is requested whether rule
2a51-1 should include a list of documentation similar to that included
in rule 144A under the Securities Act.69
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\68\ Proposed rule 2a51-1(j). 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 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 3, at 53.
\69\ 17 CFR 230.144A(d)(1). Rule 144A includes several non-
exclusive methods for purposes of determining whether a person is a
``qualified institutional buyer.'' These methods include most recent
publicly available financial statements, information filed with
Federal and State regulatory authorities, and information appearing
in recognized securities manuals, as well as certifications by a
company's executive officers. Id.
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B. Definitions of Beneficial Ownership
Proposed rule 2a51-2 would define the term ``beneficial owner'' for
[[Page 68107]]
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) funds that wish to become qualified
purchasers. The proposed rule also would address what types of
ownership constitute ``indirect'' beneficial ownership for purposes of
the consent provision.
1. The Grandfather Provision
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.70
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.71
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\70\ These non-qualified purchasers must have acquired all or a
portion of their investment in the Grandfathered Fund prior to
September 1, 1996. Any person acquiring an interest in the
Grandfathered Fund after that date must, either on the date of the
acquisition or on the date that the fund avails itself of the
section 3(c)(7) exception, be a qualified purchaser. These persons
are required to be given the notice and redemption opportunity
described below.
\71\ The opportunity must be provided ``notwithstanding any
agreement to the contrary between the [Grandfathered Fund] and such
beneficial owner.'' 15 USC 80a-3(c)(7)(B)(ii)(II). 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.
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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 address any unnecessary burdens that might arise as a
result of the application of section 3(c)(1)'s look-through
provision.72 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 section 3(c)(1)(A).73
Rather, the notice and redemption opportunity are generally intended to
be provided only to the institutional investor, unless the
institutional investor is controlled by or under common control with
the Grandfathered Fund.74
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\72\ See supra note 17 and accompanying text (describing section
3(c)(1)(A) of the Investment Company Act).
\73\ See Remarks of Hon. Thomas J. Bliley, supra note 13.
\74\ Id.
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Consistent with the purposes indicated in the legislative history
of the 1996 Act, the Commission believes that the grandfather notice
and redemption opportunity provisions were intended not only for the
purposes described above, but for the benefit of certain persons who
were deemed to be beneficial owners prior to the 1996 Act's amendments
to the look-through provision.75 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.76 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.
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\75\ See supra notes 18, 22 and accompanying text (discussing
the elimination of the second 10% test). Consistent with this
legislative intent, the Commission believes that the conditions in
the grandfather provision must be complied with by any section
3(c)(1) fund organized before the enactment of the 1996 Act that
wishes to avail itself of section 3(c)(7). Thus, the notice and
redemption opportunity must be provided to the beneficial owners of
a Grandfathered Fund's securities, even if each beneficial owner
meets the definition of qualified purchaser. If the notice and
redemption opportunity provision had been intended only for the
benefit of beneficial owners who are not qualified purchasers,
Congress could have limited the provision accordingly. Compare House
Report, supra note 3, 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 3, 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 70 .
\76\ 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.
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Paragraph (a) of proposed rule 2a51-2 would provide generally that
beneficial ownership is to be determined in accordance with section
3(c)(1) of the Act. Paragraph (b) of the proposed rule would provide a
special rule for determining beneficial ownership of securities held by
a company. Paragraph (b) would provide 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,77 (ii) the owning company has a control relationship
with the Grandfathered Fund,78 and (iii) the owning company is
itself an investment company or a private fund.79 If these
conditions do not apply, the grandfather notice and redemption
opportunity would be provided to the owning company. If the conditions
do apply, the grandfather notice and redemption opportunity would be
provided to the owning company's security holders as the beneficial
owners of the Grandfathered Fund's securities.
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\77\ The applicability of the look-though provision would be
determined as of October 11, 1996 to assure that the Grandfathered
Fund does not engage in transactions subsequent to the enactment of
the 1996 Act (which was signed by the President on that date)
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%).
\78\ See supra note (describing the Act's definition of
control).
\79\ Limiting the application of the look-through provision in
this context to owning companies that are investment companies or
private funds is consistent with amended section 3(c)(1)(A). If the
owning company is not an investment company or a private 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 21
and accompanying text.
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The intended application of the proposed 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
[[Page 68108]]
10% test),80 Company A must provide the grandfather notice and
redemption opportunity to each of Company B's security holders.
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\80\ See section I.B. of this Release.
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Comment is requested on the proposed approach for determining
beneficial ownership in the absence of a control relationship. Should
Company B's security holders receive the grandfather notice and
redemption opportunity if Company B owns more than 10% of Company A's
voting securities? That is, should Company B's security holders receive
the grandfather notice and redemption opportunity regardless of (i)
Company B's status as an investment company or a private fund; (ii) the
existence of a control relationship, or (iii) the applicability of the
second 10% test?
Comment also is requested whether any other rules may be necessary
to clarify the operation of the grandfather provision. For example, a
redeeming shareholder of a Grandfathered Fund is entitled to receive
its proportionate share of the Fund's ``net assets.'' The term
``current net assets'' is used in the Investment Company Act and
defined by Commission rule.81 Should the same definition apply to
Grandfathered Funds, or should net assets, for purposes of the
grandfather provision, be determined based upon the methods that would
have been used to determine the amount that the investor would have
received in accordance with existing withdrawal provisions in the
Grandfathered Fund's governing documents? Are these withdrawal
provisions typically subject to conditions (e.g., a ``hold-back'') that
would undercut the purpose of the redemption requirements of section
3(c)(7) and, if so, how could the existence of such provisions be
addressed? 82
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\81\ 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).
\82\ For example, if a section 3(c)(1) fund's withdrawal
provision provides for a hold-back to assure that sufficient assets
are available to satisfy contingent liabilities, the rule could
provide that the Grandfathered Fund could not avail itself of
section 3(c)(7) until the hold-backs are released or the liabilities
extinguished.
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2. The Consent Provision
The consent provision requires that a private 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 prior to April 30, 1996.83 The beneficial owners of the
securities of any private fund that is a direct or indirect beneficial
owner of the securities of the purchasing fund must also consent to the
treatment of the purchasing fund as a qualified purchaser.84
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\83\ 15 USC 2(a)(51)(C). Section 2(a)(51)(C) and the proposed
rule use 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.
\84\ Id.
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The consent provision appears to be designed to give investors in
an existing private fund with 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.85 The
consent provision also may serve 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 through another
private fund.86
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\85\ The legislative history of the 1996 Act does not address
the purpose of the consent provision.
\86\ Such conduct may also raise issues under section 48(a) of
the Investment Company Act [15 U.S.C. 80a-47(a)] (precluding
indirect circumvention of the Act's provisions).
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Paragraph (c) of proposed rule 2a51-2 would clarify the meaning of
the term ``beneficial owner'' for purposes of the consent provision.
The proposed rule would provide that securities of a purchasing fund
beneficially owned by a company (without giving effect to the look-
through provision) are deemed to be beneficially owned by one person
unless the company has a 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''). If a
control relationship exists, and the company is a private fund whose
security holders were deemed to be beneficial owners of the purchasing
fund on October 11, 1996, then these security holders would be deemed
to be beneficial owners under the proposed rule.
As in the case of the proposed definition of beneficial owner for
purposes of the grandfather provision, the proposed 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
institutional investor or the target fund, and the institutional
investor is a private fund whose security holders were deemed
beneficial owners of the purchasing fund prior to the enactment of the
1996 Act, then the consent must be obtained from those security
holders.
The proposed rule also would clarify what constitutes ``indirect''
ownership with regard to the requirement that the consent be obtained
from the security holders of a private fund that is an indirect
beneficial owner of the purchasing fund. Paragraph (d) of the proposed
rule would provide that the private fund would not be considered to own
the securities of the purchasing fund indirectly unless the private
fund has a control relationship with either the purchasing fund or the
target fund.87
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\87\ The following example illustrates the intended operation of
the proposed rule. Assume Company A is a purchasing fund and that
Companies B and C are beneficial owners of Company A's voting
securities. Company B 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
October 11, 1996. Company C is a private fund that was deemed to own
beneficially Company A's voting securities on October 11, 1996 (in
other words, the look-through provision did not apply). Each of
Company C's investors (Companies D through F) are themselves private
funds, but none has a control relationship with Company C or Company
A.
Company B would have to consent to Company A being a qualified
purchaser. Because Company B is not a private fund, Company B'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 B's shareholders would not be required even if
Company B had a control relationship with Company A.)
Company C would have to consent to Company A being a qualified
purchaser. Additionally, because Company C is a private fund, all
beneficial owners of its outstanding securities also would have to
consent to Company A being a qualified purchaser. Because there is
no control relationship, however, security holders of Companies D
through F would not be required to consent even if they are
considered to be beneficial owners of Company C's securities under
the look-through provision. Similarly, Companies D through F would
not be deemed to indirectly own voting securities of Company A.
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Under the proposed rule, the purchasing fund could obtain a general
consent with respect to most transactions in which it will be a
qualified purchaser. Consent for specific transactions would be
required only when there is a control relationship between the
purchasing fund or certain of its beneficial owners and the target
fund.
Comment is requested on proposed rule 2a51-2. Comment specifically
is requested on the proposed approach of
[[Page 68109]]
defining indirect beneficial ownership in the purchasing fund on the
basis of whether the investor has a control relationship with the
purchasing fund or the target fund.
C. Conforming Rule
The Commission is proposing a rule to clarify an interpretative
issue concerning companies that are qualified purchasers.88 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.'' 89 The proposed
rule would make 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 or other interest in the company is a qualified purchaser.
The proposed rule would limit 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).90
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\88\ Proposed rule 2a51-3.
\89\ 15 U.S.C. 80a-2(a)(51)(A)(iii).
\90\ See supra note 86 and accompanying text.
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D. Non-Exclusive Safe Harbor for Certain Section 3(c)(7) Funds
The legislative history of the 1996 Act indicates that the
grandfather provision 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 in order to create another section 3(c)(1) fund and
thereby avoid the 100-investor limit.91 While the 1996 Act
includes a provision allowing a sponsor to operate both a section
3(c)(1) and a section 3(c)(7) fund (the ``non-integration
provision''),92 this provision was not designed to address whether
a nominally converted section 3(c)(1) fund should be treated as a
section 3(c)(7) fund for purposes of the integration and other
applicable provisions.93
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\91\ See Remarks of Hon. John D. Dingell, supra note 11.
\92\ Section 3(c)(7)(E) of the Investment Company Act [15 U.S.C.
80a-3(c)(7)(E)]. 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) is 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.
\93\ See Remarks of Hon. John D. Dingell, supra note 11. The
bona fides of a conversion to a section 3(c)(7) fund also would
affect the ability of the fund to use the new exemption from the
prohibition in the Investment Advisers Act of 1940 (``Advisers
Act'') on performance fees available to section 3(c)(7) funds. See
new section 205(b)(4) of the Advisers Act [15 U.S.C. 80b-5(b)(4)].
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Since the passage of the 1996 Act, representatives of hedge funds
and other investment pools have 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., sells its securities to
new investors that are qualified purchasers) to then create a new
section 3(c)(1) fund. These representatives have requested that the
Commission clarify the application of the non-integration provision to
sponsors of Grandfathered Funds who form new section 3(c)(1) funds. To
respond to these concerns, the Commission is proposing rule 3c-7 under
the Investment Company Act to provide that a Grandfathered Fund will be
treated as an issuer excepted 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. The proposed rule is designed to provide a non-exclusive safe
harbor for Grandfathered Funds. Comment is requested whether the
percentage threshold should be higher (e.g., 50%). Comment also is
requested whether existing investors that are qualified purchasers on
the date that the Grandfathered Fund avails itself of section 3(c)(7)
should also be counted for purposes of the proposed threshold.
III. Other Rules for Private Investment Companies
A. Transition Rule for Section 3(c)(1) Funds
As noted above, the 1996 Act amended section 3(c)(1)(A) of the
Investment Company Act, which governs the way 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 underlying security holders of any investment company and
any private fund that owns 10% or more of the section 3(c)(1) fund
(collectively, ``10%+ investors''). Until the amendment becomes
effective, the look-through provision does not apply unless the 10%+
investor also has more than 10% of its assets invested in section
3(c)(1) funds generally. The amendment, in effect, will limit the
ability of certain types of investors to own more than 10% of a section
3(c)(1) fund.94
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\94\ The limitation will exist only when an investment company
or a private 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.
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The Commission is aware that some existing section 3(c)(1) funds
may have 10%+ investors in reliance on the pre-amendment application of
the look-through provision. The Commission believes that the amendment
to the look-through provision was primarily designed to simplify the
application of the provision and was not intended to disrupt existing
investment relationships. The Commission, therefore, is proposing a
rule under the Investment Company Act to provide that the amended look-
through provision will not apply in the case of an investor that held
more than 10% of the outstanding voting securities of a section 3(c)(1)
fund on October 11, 1996, provided that the investor continues to
satisfy the second 10% test.95
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\95\ Proposed rule 3c-1. For the purpose of the proposed rule,
investment in 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 exception created
by the 1996 Act. The proposed rule also would address 10%+ ownership
interests that result from voting securities acquired as a result of
the conversion of convertible non-voting securities acquired prior
to October 11, 1996.
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The Commission requests comment on the approach of the proposed
rule. For example, the proposed rule would not limit additional
investments by the 10%+ investors in the section 3(c)(1) fund as long
as the second 10% test continues to be inapplicable. Should the rule
prohibit additional investments? Should the rule only permit additional
investments that do not increase the percentage of the section 3(c)(1)
fund's voting securities that the 10%+ investor owns? Are there other
circumstances when similar relief would be appropriate?
Comment also is requested on rule 3c-2 under the Investment Company
Act, which was adopted in 1958 to facilitate capital investments by
operating companies in small business investment companies (``SBICs'')
that were section 3(c)(1) funds.96 Rule 3c-2
[[Page 68110]]
provides that beneficial ownership of 10% or more of an SBIC's voting
securities by a company is deemed to be ownership by one person if and
so long as that company's total investment interest in all SBICs does
not exceed 5% of the value of the company's assets. The amendments to
the look-through provision made by the 1996 Act will make it
unnecessary for an investor in an SBIC that is itself not an investment
company or a private fund to rely on rule 3c-2.97 Comment is
requested whether rule 3c-2 is still necessary.98 To what extent
do SBICs rely on registered or private investment companies as a source
of capital? To assure that the flow of capital to small businesses is
not inhibited, should the rule be amended to incorporate the second 10%
test? Should the rule be rescinded to reflect Congress' decision to
eliminate the second 10% test?
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\96\ Rule 3c-2 [17 CFR 270.3c-2]. At that time, the look-through
provision did not include the second 10% test and, therefore,
inhibited SBICs' capital raising efforts because SBICs frequently
depended upon corporate investors to make investments that resulted
in their owning more than 10% of the SBICs voting securities.
\97\ The need for SBICs to rely on rule 3c-2 may have diminished
when the second 10% test was added to the look-through provision in
1980.
\98\ Rule 3c-2 also provides that the look-through provision
does not apply to 10%+ investors that are ``state development
corporations,'' subject to certain conditions.
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B. Investments by Fund Employees
The Commission is proposing rule 3c-5 under the Investment Company
Act to permit directors, executive officers, general partners and
certain knowledgeable employees of a section 3(c)(1) fund or of an
affiliated person of the fund (collectively, ``fund personnel'') to
acquire securities issued by the fund without being counted for
purposes of section 3(c)(1)'s 100-investor limit. The rule also would
permit fund personnel to invest in a section 3(c)(7) fund even though
they did not meet the definition of qualified purchaser.
The provision in the 1996 Act directing Commission rulemaking with
regard to investments in private funds by knowledgeable employees
appears to be intended to encompass all natural persons who actively
participate in the management of a fund's investments. The proposed
rule, therefore, would extend to directors, executive officers, and
general partners of a fund or of an affiliate of the fund that oversees
the fund's investments. The proposed rule also would extend to other
employees who, in connection with their regular functions or duties,
participated in, or obtained information regarding, the investment
activities of the fund or other investment companies managed by the
affiliate for a period of at least 12 months.99 Comment is
requested whether the proposed rule should contain any other criteria
for identifying knowledgeable employees (i.e., the employee's salary
level or the amount of investments owned).
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\99\ The term ``employee'' as used in the proposed rule is
intended also to encompass individuals who may be deemed independent
contractors for tax purposes. See, e.g., Cornish & Carey Commercial,
Inc. (pub. avail. June 21, 1996).
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The proposed rule would allow transfers of fund securities held by
fund personnel to family members as a gift, bequest or pursuant to an
agreement relating to legal separation or divorce, as well as to family
trusts and similar family vehicles established by fund personnel for
the exclusive benefit of family members and charitable organizations,
provided fund securities had been acquired by fund personnel pursuant
to, or are otherwise subject to, an arrangement prohibiting any other
transfers of such shares.100 The Commission believes that this
approach would afford adequate flexibility for employees' estate
planning and other financial goals, while assuring that the securities
of the issuer were not transferred in a manner inconsistent with the
rationale underlying sections 3(c)(1) and 3(c)(7).
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\100\ The securities could be sold back to the issuing fund or,
in the case of securities issued by a section 3(c)(7) fund, other
qualified purchasers.
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The Commission recognizes that the proposed rule would not extend
to employees performing certain other functions with respect to a fund,
such as clerical, secretarial and other administrative personnel.
Should the rule be extended to these employees (or employees of firms
that provide such services) if, for example, the employees are assisted
by an independent purchaser representative? 101 The Commission
also requests comment whether the proposed rule should contain any
other requirements, particularly with respect to investments that are
made by fund personnel through plans that are subject to the Employee
Retirement Income Security Act of 1974, as amended.
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\101\ A similar concept of ``purchaser representative'' is found
in Regulation D under the Securities Act that governs securities
transactions exempted from registration under section 5 of that Act.
See rule 501(h) under the Securities Act [17 CFR 230.501(h)].
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C. Certain 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 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.'' 102
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\102\ H.R. Rep. No. 1341, 96th Cong., 2d Sess. at 36 (1980).
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The 1996 Act directed the Commission to prescribe rules to
implement section 3(c)(1)(B). The Commission is proposing 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 or other involuntary event will be deemed
to be beneficial ownership by the person from whom the transfer was
made (``transferor''). The proposed rule would limit transferees to
family members of the transferor, trusts or similar vehicles
established by the transferor for the exclusive benefit of family
members, and charitable organizations. The proposed rule also would
provide that the securities of the section 3(c)(1) fund must have been
acquired by the transferor pursuant to, or are otherwise subject to, an
arrangement prohibiting any other transfers, except transfers back to
the fund. The Commission believes that the proposed rule would afford
sufficient flexibility to section 3(c)(1) funds and their investors
consistent with the intent behind section 3(c)(1)(B).
Proposed rule 3c-6 also would address 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. Proposed rule 3c-6 would permit transfers of securities of a
section 3(c)(7) fund under essentially the same conditions as those
proposed for transfers under section 3(c)(1)(B).
Comment is requested on the proposed rule governing transfers of
private funds' securities. Should transfers of a section 3(c)(7) fund's
securities be governed by different conditions than transfers of a
section 3(c)(1) fund's securities, or be permitted in other types of
situations as well?
[[Page 68111]]
Should the rule provide other examples of ``involuntary events''?
IV. General Request for Comment
Any interested persons wishing to submit written comments on the
rules that are the subject of this Release, to suggest additional rules
to address interpretative and other issues relating to private funds
resulting from the 1996 Act, or to submit comments on other matters
that might have an effect on the proposals contained in this Release,
are requested to do so. In accordance with section 2(c) of the
Investment Company Act, comment is requested regarding the effects of
the proposed rules on efficiency, competition and capital formation.
V. Cost/Benefit Analysis
Consistent with legislative intent and the protection of investors,
the proposed rules would benefit private funds and their investors in a
number of ways. The proposed rules would: 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; enable knowledgeable
employees of a private fund to invest in the fund without causing the
fund to relinquish its exclusion from regulation under the Act; permit
certain transfers of private fund securities; and address certain
interpretative issues for private funds.
The Commission believes that the proposed rules would not impose
any additional costs on private funds. Rather, the proposed rules would
clarify the statutory requirements for private funds in order to reduce
any unnecessary burdens without jeopardizing investor protection.
Comment is requested on this cost/benefit analysis. Commenters are
requested to provide views and empirical data relating to any costs and
benefits associated with the proposed rules.
For purposes of making determinations required by the Small
Business Regulatory Enforcement Fairness Act of 1996, the Commission is
requesting information regarding the potential impact of the proposed
rules on the economy on an annual basis. Commenters should provide
empirical data to support their views.
VI. Summary of Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis (``IRFA'') in accordance with 5 USC 603 regarding proposed
rules 2a51-1, 2a51-2, 2a51-3, 3c-1, 3c-5, 3c-6 and 3c-7 under the
Investment Company Act. The IRFA indicates that the proposed rules
would comply with the provisions of the 1996 Act directing the
Commission to prescribe certain rules concerning private funds, and
would address certain interpretive issues raised by the 1996 Act's
amendments relating to private funds. The IRFA states that the proposed
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 IRFA further states that the proposed rules would give private
funds greater flexibility as well as minimize certain compliance
burdens imposed by the applicable provisions of the Investment Company
Act.
The IRFA sets forth the statutory authority for the proposed rules.
The IRFA also discusses the effect of the proposed rules on small
entities that are section 3(c)(7) or section 3(c)(1) funds. For
purposes of the proposed rules, small entities are those with assets of
$50 million or less at the end of their most recent fiscal year. The
IRFA states that the proposed rules would make possible the creation of
small entities that are section 3(c)(7) funds, and would 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 IRFA states that the proposed rules would 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 proposed rules.
The IRFA discusses the various alternatives considered by the
Commission in connection with the proposed 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 thereof, for small entities. The
Commission believes that it would be inconsistent with the purposes of
the Act to exempt small entities from the proposed rules or to use
performance standards to specify different requirements for small
entities. Different compliance or reporting requirements for small
entities are not necessary because the proposed 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 proposed rules for small entities.
The IRFA includes information concerning the solicitation of
comments with respect to the IRFA generally, and in particular, the
number of small entities that would be affected by the proposed rules.
Cost-benefit information reflected in the ``Cost/Benefit Analysis''
section of this Release also is reflected in the IRFA. A copy of the
IRFA 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.
VII. Statutory Authority
The Commission is proposing rules 2a51-1, 2a51-2, 2a51-3 and 3c-7
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. The Commission
is proposing 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 proposing 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. The
Commission is proposing rule 3c-6 pursuant to the authority set forth
in sections 3(c)(1), 3(c)(7), 6(c) and 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.
Text of Proposed 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
[[Page 68112]]
Code of Federal Regulations is proposed to be amended as follows:
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
1. The authority citation for Part 270 is amended by adding the
following citations to read as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-39 unless
otherwise noted;
* * * * *
Section 270.2a51-1 is also issued under 15 U.S.C. 80a-
2(a)(51)(B) and 80a-6(c), and secs. 209(d) (2) and (4), National
Securities Markets Improvement Act of 1996;
Section 270.2a51-2 is also issued under 15 U.S.C. 80a-
2(a)(51)(B) and 80a-6(c), and secs. 209(d) (2) and (4), National
Securities Markets Improvement Act of 1996;
Section 270.2a51-3 is also issued under 15 U.S.C. 80a-
2(a)(51)(B) and 80a-6(c), and secs. 209(d) (2) and (4), National
Securities Markets Improvement Act of 1996;
Section 270.3c-1 is also issued under 15 U.S.C. 80a-6(c);
Section 270.3c-5 is also issued under 15 U.S.C. 80a-6(c), and
sec. 209(d)(3), National Securities Markets Improvement Act of 1996;
Section 270.3c-6 is also issued under 15 U.S.C. 80a-3(c)(1),
80a-3(c)(7), 80a-6(c) and 80a-37(a) and sec. 209(d)(1), National
Securities Markets Improvement Act of 1996;
Section 270.3c-7 is also issued under 15 U.S.C. 80a-2(a)(51)(B)
and 80a-6(c);
* * * * *
2. Section 270.2a51-1 is added to read as follows:
Sec. 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 shall mean 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
(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];
(2) The term Family Company shall mean 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 Listed Company shall mean a company that has
outstanding a class of equity securities that are:
(i) Reported securities as such term is defined by Sec. 240.11Aa3-1
of this Chapter; or
(ii) Listed on a ``designated offshore securities market'' as such
term is defined by Regulation S under the Securities Act of 1933 [17
CFR 230.901 through 230.904];
(4) The term Physical Commodities shall mean any physical commodity
with respect to which a Commodity Interest is traded on a market
specified in paragraphs (a)(1) of this section; and
(5) The term Related Person shall mean a person who is related to
another person as a sibling, spouse or former spouse, or is a direct
lineal descendant or ancestor by birth or adoption of such person, or
is a spouse of such descendant, 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.
(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 shall mean:
(1) Securities (as defined by section 2(1) of the Securities Act of
1933 [15 U.S.C. 70a(1)]), other than securities of an issuer that
controls, is controlled by, or is under common control with, the person
that owns such securities, unless the issuer is:
(i) An investment company or 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 Secs. 270.3a-6 or 270.3a-7; or
(ii) A Listed Company that is not a majority-owned subsidiary of
such person or a person that controls, is controlled by, or is under
common control with such person;
(2) Real estate held for investment purposes;
(3) Commodity Interests held for investment purposes;
(4) Physical Commodities held for investment purposes; and
(5) Cash and cash equivalents held for investment purposes.
(c) Real Estate Not Held for Investment Purposes. For purposes of
this section, real estate shall not be considered to be held for
investment purposes by its owner if it is used by the owner or a
Related Person of the owner for personal purposes or as a place of
business, or in connection with the conduct of the trade or business of
such owner or a Related Person of the owner. 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 USC 280A].
(d) Valuation. For purposes of determining whether a person is a
qualified purchaser, the aggregate amount of investments owned and
invested on a discretionary basis by such person shall be their readily
ascertainable 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 such person the amounts specified in paragraphs
(e), (f) and (g) of this section, as applicable.
(e) Deductions: General. In determining whether any person is a
qualified purchaser there shall be deducted from the value of such
person's investments the amount of any outstanding indebtedness
incurred to acquire the investments owned by such person.
(f) Deductions: Natural Persons. In determining whether any natural
person is a qualified purchaser, in addition to the amounts specified
in paragraph (e) of this section there shall also be deducted from the
value of such person's investments the following amounts:
(1) Any payments received by such person pursuant to an insurance
policy during the preceding 12 months;
(2) The value of any investments received by such person during the
preceding 12 months as a gift or bequest or pursuant to an agreement
related to a legal separation or divorce;
(3) Any amount received by such person during the preceding 12
months in connection with a lawsuit (whether pursuant to a judgment or
settlement agreement);
(4) The proceeds of any loan incurred during the preceding 12
months secured by a mortgage or deed of trust on such person's personal
residence or other property that is not held for investment (``mortgage
loan'') unless the proceeds of such loan were used solely to finance
the acquisition or improvement of such residence or property; and
(5) The proceeds of any loan (``refinancing loan'') incurred during
the preceding 12 months secured by a mortgage or deed of trust on such
person's personal residence or other property that is not held for
investment used to refinance a mortgage loan (``refinanced loan'') to
the extent that the proceeds of the refinancing loan exceed the lowest
principal amount of the refinanced loan outstanding during the prior 12
months.
(g) Deductions: Family Companies. In determining whether a Family
Company is a qualified purchaser, in addition to
[[Page 68113]]
the amounts specified in paragraph (e) of this section, there shall
also be deducted from the value of such Family Company's investments
the following amounts for purposes of this section:
(1) Any outstanding indebtedness incurred by an owner of the Family
Company to acquire such investments;
(2) The amounts described in paragraph (f) of this section received
by the Family Company or any owner of the Family Company;
(3) The amount of any indebtedness incurred by the Family Company
to the extent that the principal amount of such indebtedness exceeds
the fair market value of any assets of the Family Company other than
investments; and
(4) The amount of any indebtedness incurred 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.
(h) Joint Investments. In determining whether a natural person is a
qualified purchaser, there may be included in the value of such
person's investments any investments held jointly with such person's
spouse, or investments in which such person shares with such person's
spouse a community property or similar shared ownership interest. There
shall be deducted from the amount of any such investments any amounts
specified by paragraphs (e) and (f) of this section incurred or
received by such spouse.
(i) Corporate Investments. For purposes of determining the amount
of investments owned by a corporation (``Corporation'') 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
Corporation (``Subsidiaries''), provided that the investments of the
Subsidiary are managed under the direction of the Corporation.
(j) Good Faith Reliance. In determining whether a prospective
purchaser is a qualified purchaser, an issuer or a person acting on the
issuer's behalf (collectively, ``relying person'') shall be entitled to
rely upon audited financial statements, brokerage account statements
and other appropriate information and certifications provided by the
prospective purchaser or its representatives and dated as of a recent
date, or publicly available information as of a recent date, provided
that such reliance is reasonable and the relying person, after
reasonable inquiry, does not have any basis for believing that such
information is incorrect in any material respect.
3. Section 270.2a51-2 is added to read as follows:
Sec. 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) Except as set forth below, 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) 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; 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) 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 owners of the excepted investment company's
outstanding voting securities.
(d) 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.
Note to Sec. 270.2a51-2. On October 11, 1996, the National
Securities Markets Improvement Act of 1996 [P.L. 104-290] was signed
into law. Prior to that date, section 3(c)(1)(A) of the Act 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).
4. Section 270.2a51-3 is added to read as follows:
Sec. 270.2a51-3 Certain companies not qualified purchasers.
For purposes of section 2(a)(51)(A) (ii) and (iv) of the Act [15
U.S.C. 80a-2(a)(51)(A)] 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 or
other interest in the company is a qualified purchaser.
5. Section 270.3c-1 is added to read as follows:
Sec. 270.3c-1 Definition of beneficial ownership for certain private
investment companies.
(a) As used in this section:
(1) The term Covered Company shall mean 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 shall mean a company that
would be an
[[Page 68114]]
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 shall mean 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 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 October 11, 1996, 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:
Sec. 270.3c-5 Beneficial ownership by knowledgeable employees and
certain other persons.
(a) As used in this section:
(1) The term Covered Company shall mean a company that is an
investment company, a Section 3(c)(1) Company or a Section 3(c)(7)
Company.
(2) The term Executive Officer shall mean 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.
(3) The term Knowledgeable Employee with respect to any Covered
Company shall mean any natural person who is:
(i) An Executive Officer, director, or general partner of the
Covered Company or of an affiliated person of such Covered Company that
manages the investment activities of such Covered Company; or
(ii) An employee of the Covered Company or of an affiliated person
of such Covered Company that manages the investment activities of such
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, or obtains information regarding, the
investment activities of such Covered Company or other investment
companies the investment activities of which are managed by such
affiliated person, provided that such employee has been performing such
functions and duties for or on behalf of the Covered Company or the
affiliated person of the Covered Company for at least 12 months.
(4) The term Related Person shall mean a person who:
(i) Is related to another person as a sibling, spouse or former
spouse; or
(ii) Is a direct lineal descendant or ancestor by birth or adoption
of such person, or is a spouse of such descendant.
(5) The term Section 3(c)(7) Company shall mean 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)].
(6) The term Section 3(c)(1) Company shall mean 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)].
(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 a
Knowledgeable Employee of such Company; an estate of such Knowledgeable
Employee; a Related Person of such Knowledgeable Employee who acquired
such securities as a gift, bequest or pursuant to an agreement relating
to a legal separation or divorce; or a company established by the
Knowledgeable Employee exclusively for the benefit of (or owned
exclusively by) the Knowledgeable Employee, his or her estate, and his
or her Related Persons or charitable organizations, provided, however,
that in each case such securities shall have been acquired by the
Knowledgeable Employee pursuant to, or shall otherwise be subject to,
an arrangement that prohibits the transfer, pledge or hypothecation of
such securities, or any interest in such securities, to any person
other than the Covered Company, such estate, such Related Persons, such
companies or, if the Covered Company is a Section 3(c)(7) Company,
qualified purchasers.
7. Section 270.3c-6 is added to read as follows:
Sec. 270.3c-6 Certain transfers of interests in section 3(c)(1) and
section 3(c)(7) funds.
(a) As used in this section:
(1) The term Related Person shall mean a person who is:
(i) Related to another person as a sibling, spouse or former
spouse; or
(ii) A direct lineal descendant or ancestor by birth or adoption of
such person, or is a spouse of such descendant.
(2) The term Section 3(c)(7) Company shall mean 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)].
(3) The term Section 3(c)(1) Company shall mean 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)].
(4) The term Transferee shall mean 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 shall mean 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 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 securities from a qualified purchaser
(``Qualified Purchaser Transferor'') shall be deemed to be owned by a
qualified purchaser (``Qualified Purchaser Transferee''), provided
that:
(1) The transfer was made as a gift or bequest, or pursuant to an
agreement relating to a legal separation or divorce or as a result of
another involuntary event;
(2) The Transferee is:
(i) The estate of the Transferor;
(ii) A Related Person of the Transferor; or
(iii) A company established by the Transferor exclusively for the
benefit of (or owned exclusively by) his or her estate, Related Persons
or charitable organizations; and
(3) The securities shall have been acquired by the Transferor
pursuant to, or shall otherwise be subject to, an arrangement that
prohibits the transfer, pledge or hypothecation of such securities, or
any interest in such
[[Page 68115]]
securities, to any person other than the Company that issued the
securities, the Transferor's estate, such Related Persons or such
companies or, in the case of a Qualified Purchaser Transferor,
qualified purchasers.
8. Section 270.3c-7 is added to read as follows:
Sec. 270.3c-7 Non-exclusive safe harbor for certain section 3(c)(7)
funds.
An issuer relying on section 3(c)(7)(B) of the Act [15 U.S.C. 80a-
3(c)(7)(B)] shall be deemed to be excluded under section 3(c)(7) of the
Act [15 U.S.C. 80a-3(c)(7)] if 25% or more of the value of the issuer's
securities is held by qualified purchasers that acquired these
securities after October 11, 1996.
Dated: December 18, 1996.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-32652 Filed 12-24-96; 8:45 am]
BILLING CODE 8010-01-P
