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Is Your Fund Exempt under the Investment Company Act of 1940?

*co-authored by Elizabeth L. Carter, Esq., Managing Attorney

What is an Investment Company?

The Investment Company Act of 1940 (“ Act”) defines an “investment company” as an Issuer that “holds itself out as being engaged primarily or proposes to engage primarily, in the business of investing, reinvesting or trading securities.” In other words, an investment company is a fund or business that invests in other businesses. Even if a company depicts itself as operating businesses rather than primarily passively investing in other businesses, the company may still come within the Act’s coverage.

The Act requires investment companies, funds, or businesses that invest in other businesses, to register with the Securities Exchange Commission (“SEC”) or otherwise qualify for an exemption from registering. In fact, any company with at least 40% of their total assets invested in other businesses may be required to register as an investment company under the Act.

Exemptions from the Act

Registering your company or fund with the SEC will cost you hundreds of thousands of dollars on an annual basis in reporting costs, including legal and accounting costs. To alleviate some of these costs, there are numerous exemptions that your company may qualify for. Some of these exemptions are outlined below.

  1. Venture Capital Firm: A venture capital firm is not required to register with the SEC so long as it follows certain restrictions, including (1) having no more than 250 investors; (2) receiving no more than $10 million in total capital contributions, including no more than 15% as debt contributions, from its own investors; (3) investing no more than 20% of its capital into other businesses as debt investments; (4) representing to its investors that it pursues a venture capital strategy; and (5) having no intent to go public on the stock exchange .

  2. Real Estate Fund: A real estate investment fund that primarily engages in the business of “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate” do not have to register as an investment company under the Act.

  3. Charitable Fund: A charitable fund organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes is exempt from registering as an investment company under the Act.

  4. Private Fund: A private fund that has under 100 investors (both accredited and non-accredited) is exempt from registering under the Act.

  5. Holding Company: A holding company is not required to register as an investment company under the Act because it takes on the business purpose of their wholly-owned or majority-owned subsidiaries instead of being in the business of investing in other companies.

  6. Qualified Purchasers Fund: A fund composed of “qualified purchasers,” as that is defined by the Act, and does not intend to make a public offering of securities, is exempt from registering with SEC as an investment company.

  7. State -based Fund: unregistered funds that operate solely in one-state are not required to register as an investment company under the Act.

  8. Investment Club: An investment club is not required to register as an investment company under the Act because these clubs do not have passive investors and have significant business purpose of providing investment education and training in addition to pooling money together to invest in securities.

Going back to our hypothetical in Does the Investment Advisers Act apply to my business. Let’s say you have a company that educates members, provides socializing activities and offers opportunities to invest together in various investment opportunities. You have about thirty (30) members so far, all of whom may be considered both accredited and non-accredited investors, and are charging them annual membership fees that amount to $100,000. Does that make your company an investment company? It depends.

As a for-profit company, the charitable fund exemption would not apply. In addition, you do not intend to invest in real estate or real-estate type securities, so the real estate fund exemption will not apply to your company. Likewise, your company includes both accredited and non-accredited investors which precludes you from being eligible as a qualified purchasers fund. Furthermore, it is not likely that your company will qualify as an exempt state-based fund since it is not clear that your investors are all coming from one state. You also did not represent to the public or your investors that you intend to pursue a venture. Thus, your company is not likely to qualify as an exempt venture capital firm. That leaves two options on our list: (a) a private fund, and (b) an investment club.

Since your members are actively participating in social and educational activities, as well as engaging in investment opportunities together, it does not seem like the private fund exemption is the best option for you. Rather, your company appears to be operating as an exempt investment club instead. This is great news since this means saving you hundreds of thousands of dollars in reporting fees, and even thousands of dollars in filing fees at the State level. If the company's social and educational activities are significantly greater than its member investment activities, then it is quite possible that you may even be excluded from the definition of an investment club. This means that you have even greater leeway in operations and membership recruitment.

The foregoing are just a few exemptions from registration that investment companies may qualify for under the Investment Company Act of 1940. If you are interested in creating your own investment fund, then contact us to learn which exemption (s) is best for your purposes.

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1 Comment

If this has anything to do with my father's trust and property that iam the vested heir that holds title I can't seem to get help from an attorney this is all a nightmare better do the right thing and prosecute these people stole everything from me left me homeless and burnt my home down arson I sure hope the feds are on this one I am tired of being homeless iam ready to testifyand are trying to get title sneekly I sure hope I receive what's mine you seriously can't let liars and their do this to people that are grieving I believe there'surder involved for the greed TEA

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