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Private Funds and Investment Company Law
A fund that primarily invests in or trades securities must be registered under the Investment Company Act unless it falls within an exception to the definition of an investment company. The exception is found in Section 3(c) of the Investment Company Act. For private equity, venture capital, hedge and similar funds, reliance on one of the exceptions is essential, as the regulatory quagmire of the Investment Company Act prohibits some important functions of private funds. is. Sponsors of these funds overwhelmingly rely on Section 3(c)(1), which limits the fund to 100 investors, or Section 3(c)(7), which limits the fund to qualified purchasers. and in each case includes knowledgeable employees. Managers and investors alike are familiar with the extensive documentation associated with the formation of funds aimed at ensuring that the requirements of either exception are met.
These two exceptions form the basis of the Investment Advisers Act’s definition of “private fund.” This is a fund that is an investment company unless Section 3(c)(1) or 3(c)(7) applies. The SEC’s recent regulatory efforts target investment advisers to “private funds.” The most notable examples are the marketing rules and private funds rules adopted by the SEC under the Investment Advisers Act in 2021 and 2023, respectively. While the scope of the SEC’s regulation of investment advisers’ “private funds” is broad and some might argue overreaching, the SEC’s regulation of investment advisers’ “private funds” is broad and, some might say, overreaching. There is renewed interest in other exceptions that would be placed outside the rule. One such exception is section 3(c)(9).
Section 3(c)(9)
Section 3(c)(9) excludes the definition of investment company.
“[a]Substantially all of the business by owning or holding oil, gas or other mineral royalties, leases or fractional interests, or interest certificates or participation or investment agreements with respect to such royalties, leases or fractional interests; The individuals who make up the. ”
Reliance on Section 3(c)(1) or 3(c)(7) is based on the number or status of investors at closing, whereas Section 3(c)(9) focuses on the fund’s activities. estimated and subject to change. over time. Even funds that invest primarily in oil and gas interests have historically relied on Section 3(c)(1) or Section 3(c)(7). Simply because all that mattered was the certainty that it was not an investment company. This indicates that most of his no-action letters referencing Section 3(c)(9) interpretations are more than 40 years old. * There is renewed interest in Section 3(c)(1) and Section 3(c)(7) alternatives. Section 3(c)(9) is once again relevant. Oil and gas fund sponsors seeking to rely on Section 3(c)(9) should consider the following:
- Substantially all of the Fund’s business must consist of owning or holding oil, gas or other mineral interests. Administrators are encouraged to read “substantially all” as “always.” 3(c)(9) A Fund may not sell its investments as securities, even if the Fund initially invests only in oil and gas interests. However, the SEC staff recommends that 3(c)(9) funds hold cash and temporary investments because all funds must manage cash from capital calls, portfolio distributions, and sales proceeds. I was allowed to keep it.
- The fund must “own or hold” the qualifying asset. According to the SEC staff, the 3(c)(9) exception does not apply to funds that trade or trade in such assets.
- The SEC staff interpreted the scope of “oil, gas, or other mineral royalties or leases, or fractional interests thereof” to permit most investment structures common in the upstream industry. Simple ownership of oil and gas real estate, which is generally not a security, is also considered subject to the fee. 3(c)(9) Funds may also engage in related business activities, such as exploration, development, and production.
- Although Section 3(c)(9) does not refer to investments in the securities of oil and gas companies, it does include a “certificate regarding an interest in or participation in oil and gas property or an investment agreement.” has been interpreted to include equity interests in Partnerships and joint ventures, as well as interests in limited liability companies that hold only qualifying assets, should also be included. Loans to oil and gas companies, on the other hand, are not subject to the exception.
- The sponsor should be recorded in the fund’s disclosure documents and regulatory filings (g., Form D, ADV and PF) indicate reliance on Section 3(c)(9). We also recommend that a fund’s management agreement include a provision limiting permitted investments to those referred to in Section 3(c)(9) (in securities, such as real estate owned for a fee). In addition to oil and gas assets that may not be simple) and temporary investments.
- Managers of oil and gas funds that meet the requirements of Section 3(c)(9) but previously relied on Section 3(c)(1) or 3(c)(7) may change their position. Can it be changed? The answer is not obvious. At a minimum, disclosure documents and regulatory filings to reflect the prior position would need to be amended, provided that such amendments would terminate the Fund’s status as a “private fund” for all regulatory purposes. We don’t know of any precedent where enough was enough.
Regulatory impact
investment company law
3(c)(9) funds are, by definition, not limited by sections 3(c)(1) and 3(c)(7). You can accept more than 100 investors, even if they are not qualified buyers or knowledgeable employees. For oil and gas fund sponsors who still expect to stay within these limits, to demonstrate that the fund can also rely on Section 3(c)(1) or 3(c)(7). We recommend that you obtain the necessary information from investors. ), in case you wish to make investments that would fall outside the scope of Section 3(c)(9).
investment advisory law
An undivided interest in oil, gas, or other mineral rights is a security. 3(c)(9) Fund managers are still investment advisers and, depending on the amount of assets under management, are subject to the Investment Advisers Act and its rules and regulations. However, relying on Section 3(c)(9) with respect to a fund avoids the application of some SEC rules only with respect to the management of that particular fund.
- The Private Funds Rule imposes a number of prohibitions, disclosure or consent requirements, and affirmative obligations that fund managers are familiar with and applies only to investment advisers to “private funds.” The scope of the rules varies from fund to fund, and so does the scope of exceptions. The same goes for investment advisers for 3(c)(9) funds that also manage 3(c)(1) or 3(c)(7) funds. Of course, you must follow the private fund rules for those funds.
- The Marketing Regulation imposes various requirements on advertising by investment advisers to prospective clients (in the case of funds, the fund itself) or prospective “investors,” but most importantly, the presentation of gross performance is not net. Performance is also to be shown. Invest in private funds advised by an investment advisor. ” Implicitly, this requirement does not apply to advertisements directed to prospective investors in his 3(c)(9) funds.
- 3(c)(1) A fund’s investment adviser may not charge carry interest unless each investor in the fund who incurs the carry is a “qualified customer.” This currently means a net worth of $2.2 million or his $1.1 million investors. In assets under management with advisors. Look-through for fund investors does not apply to 3(c)(9) funds. It is sufficient that the fund itself meets these criteria.
securities law
Despite greater regulatory flexibility under the Investment Company Act and the Investment Advisers Act, all relevant securities laws apply to the financing of 3(c)(9) funds in the same way as “private funds.” I have to emphasize that. Sponsors of private placements of 3(c)(9) fund interests that rely on the safe harbor in Rule 506(b) under Regulation D should not engage in general solicitation and should only accept accredited investors. is.
* In fact, most of these inaction letters are no longer published. The following summary is based primarily on Robert H. Rosenblum. Investment Company Determinations Under the 1940 Act: Exemptions and Exceptions (Am. Bar Ass’n 2d ed. 2003).
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