Regulation

Section 3(c)(7) of the Investment Company Act

Quick Definition

3(c)(7) is an exemption from registration with the SEC used by hedge funds. Typically, investment companies are required to register under the Investment Company Act, but a fund that meets certain requirements under 3(c)(7) can avoid registration. Its sibling section, 3(c)(1), is the most common exemption.


What you need to know about Section 3(c)(7)

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)(7) is one of two commonly used exemption frameworks, alongside its more common sibling, Section 3(c)(1).  An even rarer exemption framework, Section 3(c)(5), also exists, but only applies to certain types of real estate funds.

How to be exempt via Section 3(c)(7):

Exemption under Section 3(c)(7) is relatively straightforward to understand, although potentially challenging to actually satisfy, with two key prongs that must be satisfied by the investment company in question:

  1. All beneficial owners (investors) must be Qualified Purchasers.
    • Most people are familiar with the notion of an “accredited investor”, which for a natural person means someone who either meets (a) a net worth test: investable assets of $1 million or greater, not including the value of their primary residence, if any, either individually or counted jointly with a spouse; or (b) an income test: an income of at least $200,000 per year for the last two years, with an expectation that such income will continue in the current year and forthgoing; if that person has a spouse, then joint income of at least $300,000 qualified similarly is acceptable as well.  For an entity to be an accredited investor, it must both be considered a qualifying entity – certain types of entities, which will not be discussed herein – as well as have investable assets of at least $5 million.
    • Qualified Purchaser (“QP“) status can only be met via a net worth test of a standard much higher than that of an accredited investor.  QPs must have investable assets of $5 million or greater, not including the value of their primary residence, if any, either individually or counted jointly with a spouse. For an entity to be a QP, it must botb be considered a qualifying entity – certain types of entities, which will not be discussed herein – as well as have investable assets of at least $25 million.
  2. No more than 2,000 investors in the fund. 
    • Assuming everyone meets the standard to qualify as a QP, then you can have as many as 2,000 investors in the fund, which is a much higher threshold than the 100 investor cap in a 3(c)(1) fund.

Final thoughts:

While the idea of having up to 2,000 investors is quite attractive, because the standard required to be a QP is high, it is often uncommon for emerging or first time managers – and even sometimes institutional funds – to structure their funds as 3(c)(7) exempt. Consequently, 3(c)(1) ends up being a more common exemption utilized by hedge funds.

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.


Explore more with Repool


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.