Investment Companies and the SEC

Updated: Nov 17


Generally, investment companies or funds are defined as companies that are primarily in the business of investing and trading securities. The US Securities Act of 1933, and applicable case law, generally defines securities as any note, are defined as any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest, investment contract, or participation in any profit-sharing agreement. In other words, whenever investors or members of a company are not actively engaged in running the company but instead have only passively invested in the company through the purchase of a share, stock, or membership interest, then it is safe to conclude that the company made an offer of securities.


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.” A company that invests in other businesses are required by the Investment company Act to either register with the Securities Exchange Commission (SEC) or qualify for an exemption from registering. Even companies that claim to be operating businesses can still be categorized as investment companies under the Investment Company Act of 1940 if they primarily invest in other businesses and do not qualify for an exemption.


Some exemptions, under the Investment Company Act of 1940 may include Venture Capital Firms, Real Estate Funds, Charitable Funds, Private Funds, Holding Companies, Qualified Purchasers Fund, State-based Funds, and Investment clubs. Learn more about these exemptions here.



Investment clubs


An investment club is a group of people who pool their money to invest together. Investment club members generally study different investments and then make investment decisions together. Therefore, there is usually an educational component of an investment club. In addition to the educational component, each member usually actively helps make investment decisions. The type of investments varies depending on what the members desire to achieve. For example, in a self-directed investment club, a type of investment club where members research and select investments together but each member invests separately rather than together through the pooling of money. While the SEC does not usually regulate investment clubs, it is possible for an investment club to fall under their oversight. For instance, a member’s interest in an investment club can amount to a security, as that is defined under the Securities Act of 1933.

A security in an investment club may be an investment contract. An investment contract is defined by the U.S. Supreme Court’s Howey Test. In SEC v. W.J. Howey Co., the Court found an offering of small parcels of land was security whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party. Therefore an investment contract involves members passively investing in an investment club or expecting other members to make it a profit through the other members’ efforts rather than actively participating in the investment decisions themselves. The SEC will consider a membership interest in an investment club a security even if the club has only one passive member and the rest are active.

Likewise, an investment club may be considered an investment company under the Investment Company Act of 1940 if the club invests in other companies or securities. As such, the investment club will need to register with the SEC unless there is an exemption as previously mentioned. Moreover, a person who is paid to provide members of an investment club advice may be required to register as an investment adviser under the Investment advisers act of 1940 or a State’s equivalent. It is necessary to review your state’s security law to ensure that your investment club complies with the state’s rules.

Investment clubs have gained popularity in the last decade due to their ability to bring people together to learn how to invest. However, before starting an investment club, it is important that one consults with an attorney to make sure that the investment club does not become an investment company in need of SEC registration or that its membership interests do not need to be registered with the SEC as securities.


If you are thinking of starting an investment club or advising people on investments as part of a business venture, please consult with a securities lawyer to ensure that you are compliant. We can help.

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





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