Joseph W. Bartlett, jbartlett@reitlerlaw.com, Counsel, Reitler Kailas & Rosenblatt LLC

The typical `40 Act exemptions for private funds from the necessity of `40 Act registration are found in `40 Act Sections 3(c)(1) and 3(c)(7). That said, funds are moving to exemptions which allow publicly traded securities held by any number of investors and listed on an exchange … maybe a Venture Exchange. In fact, a client of the undersigned is planning to adopt the Business Development Company Act format, carried interest and all the same except as a conglomerate as per the following:

Section 3(a)(1)(C) defines an Investment Company as one which:

“… is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government Securities and cash items, on an unconsolidated basis.”

Section 3(a)(2):

“As used in this section, investment securities” includes 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 (i) are not investment companies; and (ii) are not relying on the exception from the definition of investment company in paragraph (1) or (7) of subsection (c).” (Emphasis added.)

Section 3(b)(2):

“Any issuer which the Commission, upon application by such issuer, finds and by order declares to be primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities either directly or (A) through majority-owned subsidiaries, or (B) through controlled companies conducting similar types of businesses.  The filing of an application under this paragraph in good faith by an issuer other than a registered investment company shall exempt the applicant for a period of 60 days from all provisions of this title applicable to investment companies as such.  For cause shown, the Commission by order may extend such period of exemption for an additional period or periods.  Whenever the Commission, upon its own motion or upon application, finds the circumstances which gave rise to the issuance of an order granting an application under this paragraph no longer exists, the Commission shall by order revoke such order.”  (Emphasis added.)

The magic formula is less than 40% in “investment securities.”  The magic words are in Section 3(b)(2)(B) … “controlled companies” conducting “similar types of businesses.”

Obviously, control can be established by methods (e.g., shareholders agreements, special series or classes of stock) despite the stock held by the parent being less than 51% of the voting stock.

By qualifying under either Sections 3(a)(2) or 3(b)(2), the company is exempt from the definition of “Investment Company” and, therefore, exempt from application of the Investment Company Act. In point of fact, it is useful to examine the online data concerning the prime example, Berkshire Hathaway. When and if an application is filed under Section 3(b)(2) is filed, it is useful to argue that by operating within the boundaries of the prime example, the registrant is as exempt as Berkshire Hathaway.