Section 12(d)(1)(A) of the 1940 Act places the following limits on investments by investment funds in any registered investment company. Specifically, a fund is prohibited from:
- acquiring more than 3% of a registered investment company’s shares (the “3% Limit”);
- investing more than 5% of its assets in a single registered investment company (the “5% Limit”); or
- investing more than 10% of its assets in registered investment companies (the “10% Limit”).
As Sections 3(c)(1) and 3(c)(7) of the 1940 Act (the exemptions relied upon by private funds to avoid registration as investment companies) indicate that companies relying on these exemptions will be considered investment companies for purposes of the 3% Limit but do not mention the 5% Limit or the 10% Limit, it has generally been assumed that only the 3% Limit applies to private funds. This assumption was placed in doubt by the March 2008 proposing release for Rule 12d1-4, which states in footnote 194 that “Both registered and unregistered funds are subject to these limits [i.e., the limits of Section 12(d)(1)(A)] with respect to their investments in a registered fund.” The New York City Bar’s Committee on Private Investment Funds requested clarification of this issue in a comment letter regarding the 2008 proposed rules but, as the rules were never adopted, no such clarification was ever issued by the SEC.
The SEC has indicated on an informal basis that only the 3% Limit would apply to private funds because Sections 3(c)(1) and 3(c)(7) provide that companies relying on these exemptions are only “investment companies” for the purposes of 12(d)(1)(A)(i). Private funds are not otherwise considered investment companies and would therefore not be subject to the 5% Limit and 10% Limit.
Funds with significant positions in registered investment companies should implement policies to ensure that they regularly determine whether they are in compliance with the above limitations.
I've got a solid grip on investment regulations and the 1940 Act's stipulations. Sections 12(d)(1)(A), 3(c)(1), and 3(c)(7) of the 1940 Act lay out intricate limits and exemptions governing investment funds' dealings with registered investment companies. Let's unpack this:
Sections of the 1940 Act:
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12(d)(1)(A):
- 3% Limit: Prohibits a fund from acquiring more than 3% of a registered investment company's shares.
- 5% Limit: Caps the investment of more than 5% of a fund's assets in a single registered investment company.
- 10% Limit: Restricts the investment of over 10% of a fund's assets in registered investment companies.
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3(c)(1) and 3(c)(7):
- These exemptions are pivotal for private funds to sidestep registration as investment companies.
- Notably, companies relying on these exemptions are categorized as investment companies solely for the purpose of the 3% Limit. There's no explicit mention of the 5% or 10% Limits.
Interpretation and Ambiguity:
- The March 2008 proposing release for Rule 12d1-4 introduced uncertainty. Footnote 194 implied that both registered and unregistered funds are subject to the limits of Section 12(d)(1)(A) concerning their investments in registered funds.
- The New York City Bar's Committee on Private Investment Funds sought clarification on this via a comment letter but, as the proposed rules were never enacted, the SEC didn't offer any official clarification.
SEC's Informal Position:
- The SEC informally indicated that private funds should adhere only to the 3% Limit. Their rationale rests on Sections 3(c)(1) and 3(c)(7), stipulating that these exemptions deem companies as "investment companies" solely for the purpose of 12(d)(1)(A)(i). Hence, private funds, not being classified otherwise as investment companies, aren't subject to the 5% and 10% Limits.
Compliance Measures:
- Firms heavily invested in registered investment companies need stringent policies to ensure continual compliance with these limitations. Regular assessments are crucial to avoid breaching the prescribed thresholds.
Understanding the nuances and implications of these regulations is vital for fund managers and stakeholders to navigate investment strategies within the legal framework set by the 1940 Act.
