Regulation

Section 3(c)(1)

Quick Definition

Section 3(c)(1) is an exemption under the Investment Company Act of 1940 (commonly referred to simply as the "Investment Company Act") that allows a private investment company to be exempt from certain regulations that otherwise apply to Investment companies. Perhaps most notably, 3(c)(1) companies do not have register with the SEC. 3(c)(1) is arguably one of two most-common private investment company structures utilized by hedge funds, with the other being 3(c)(7).


What you need to know about Section 3(c)(1)

Context:

Entities that meet the definition of being an “investment company” – which hedge funds that engage in securities do – are generally regulated by and required to register with the SEC under the Investment Company Act of 1940 (the “Act“).  Registration under the Act subjects investment companies to a wide variety of regulatory and reporting requirements that hedge funds typically seek to avoid.  The SEC provides for certain exemption frameworks from registration for qualifying entities, and as such, hedge funds generally seek to qualify under one of those exemption frameworks.  Section 3(c)(1) is generally the most common exemption, alongside its less common sibling, Section 3(c)(7).  An even rarer exemption framework, Section 3(c)(5), also exists, but only applies to certain types of real estate funds.

Exemption via Section 3(c)(1):

Exemption under Section 3(c)(1) is relatively straightforward to understand, although restrictive, with only one single requirement for the investment company:

  1. No more than 100 investors*
    • An investor may be a natural person or an entity
    • Entity considerations: an investing entity, if it itself is an investment company, may trigger “look-through” that could cause the number of investors in the entity investing to be counted individually towards the threshold.  This article shall not delve into the nuances on that front, but notably, an company formed with the primary purposes of investing into another company will generally trigger look-through; in other words, there is no simple way to put a stack of investors into one company and then invest to effectively avoid the 100 investor limit.
    • Spinning up multiple funds: unless funds have materially different investment objectives and strategies, multiple funds will be considered by regulators to constitute a single fund for purposes of the Act and exemption frameworks.  Therefore, simply making a second fund once the 100 investor limit is reached is not an effective solution.  Regulation is not so easily sidestepped.

A common misconception is that there are other requirements associated with 3(c)(1) beyond the 100 investor limit.  There are not; such misconceptions typically are misattributing requirements from other acts, which may apply to most hedge funds, but which are technically distinct.  Understanding which act governs what and why is important for investment company owners and creators.

*Certain venture funds may have up to 250 investors while still qualifying for 3(c)(1) in certain circumstances, although the cap on such a venture fund is $10 million in assets under management.  Generally, this is not relevant to non-venture funds.

Final thoughts:

The 100 investor limit is a key threshold that most hedge funds must pay attention to.  3(c)(1)’s sibling, 3(c)(7), does allow for a higher investor count, but has an additional requirement that each and every investor be a Qualified Purchaser, which is a very challenging requirement for funds to meet and take advantage of.

Lastly, note that as a reminder, the Act only applies to funds that invest in securities.  Funds that do not invest at all in securities, such as commodities funds or non-security digital asset funds, fall outside of the regulatory purview of the Act and registration requirements with the SEC.  However, other similar acts from other regulators may apply, and naturally, the regulation landscape associated with digital assets and their categorization as securities, commodites, or neither securities nor commodites is ongoing.



Want to gain access to new and diverse fund managers?

Become an investor

Interested in launching your fund quickly and easily?

Disclaimer

Repool, Inc. (“Repool”) serves as an administrator to various pooled investment vehicles.  The content on this site, or any associated distribution platforms and public Repool online social media accounts, platforms, and site (collectively, “Distribution Channels”), is provided for information and discussion purposes only, and should not be construed as or relied upon in any manner as legal, business, tax, investment, or other advice. Repool’s services and information available on Distribution Channels are not a substitute for third-party professionals (including properly licensed and/or registered lawyers, brokers and tax professionals), and you should seek your own professional advisers, including legal counsel. Repool is not licensed to provide legal advice and is not registered as a broker-dealer or investment adviser, and Repool is not otherwise licensed or registered.

Any views expressed in posted content, such as articles, blogposts, commentary, videos, or social media, are those of individual Repool personnel or third-party authors and are not the views of Repool or our affiliates, unless explicitly stated otherwise. Additionally, with respect to any content or views available on Distribution Channels, Repool makes no representations that the information has been validated by independent, licensed third-parties, nor that such information has any enduring accuracy or appropriateness for any given individual or situation.

Laws and regulations applicable to the sale of securities, forming pooled investment vehicles (including private funds), and investment management (including serving as an investment adviser or commodity trading advisor) are complicated and occasionally ambiguous. Relevant law may come from the state, federal, or international level, and you may be under the regulatory oversight of one or many regulatory bodies such as, but not limited to, the Securities and Exchange Commission and the Commodity Futures Trading Commission. It is your responsibility to ensure that, when forming, offering interests of and managing any pooled investment vehicle, whether supported by Repool’s administrative services or not, you are in material compliance with applicable laws including obtaining any and all applicable licenses, permits, registrations, memberships, and approvals that are required in order to form, offer securities of and manage such pooled investment vehicle.  You should not rely upon Repool in making any such determinations or as a replacement for licensed, third-party professionals.

Welcome to the future of fund services

© 2022. Repool, Inc.