SEC Division of Investment Management staff letter: Maxine Harry

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON. D.C. 20549

DIVISION OF

INVESTMENT MANAGEMENT
December 6, 1995
ArJ :ic.A
SETION 3L(A)c.1 )

Ms. Maxine Harry

4978 Dalton. Drive RULE
Columbia, MD 21045 PUBLIC
A V AILA I i/ Co I c¡ s;

Dear Ms. Harry:
In our recent telephone conversation, you indicated that you

are considering organizing an "investment club." You requested

our guidance generally as to whether an investment club must be

registered with the Sei..urities and Exchange Commission ("SEC").

The initial question that must be considered is whether the

investment club must be registered with the SEC às an "investment

company" under the Investment Company Act of 1940 (" 1940 Act") . 1 As described in more detail below, most investment clubs are not

required to register as investment companies, either because the

club does not issue interests that are "securities," or because

the club's membership interests are privately offered and are not

held beneficially by more than 100 persons.

An investment club will only be required to register under

the 1940 Act if (1) the club invests in securities, (2) the club ~ issues membership interests that are themselves securities, and

(3) no exclusion from the definition of investment company is

available. While an investment club. typically will invest in

securities, its membership interests may not be securities.

A membership intenest in an investment club would be a

security if it is an "investment contract. ,,2 To determine

whether an investment contract exists, we look to the "presence

of an investment in a common venture premised on a reasonable

expectation of profits to be derived from the entrepreneurial or

Section 3 (a) (1) of the 1940 Act defines "investment company"

as "any issuer which is or holds itself out as being engaged

primarily, or proposes to engage primarily, in the business of

investing, reinvesting, or trading securities (...)" A

partnership (the organizational form of many investment clubs)

is included in the definition of. "company" for 1940 Act

purposes. See Sections 2 (a) (8), 2 (a) (22), and 2 (a) (28) of the 1940 Act. 2 Section 2 (a) (36) of the 1940 Act includes in the definition of "';:' "security" any investment contract.

I
Ms ~ Maxine Harry
December 6, 1995

~~ : managerial efforts of others. ,,3 Generally, where all of the ~ii members of an investment club participate actively in managing

the club, the membership interests in the club would not be

securities because a member would not rely on the entrepreneurial

or management expertise of others. 4 The investment club

therefore would not be an investment company subj ect to

regulation under the 1940 Act. In contrast, an investment club

with passive members may be issuing securities.

Even if the club's membership interests are securities, many

clubs rely on the "private investment company" exclusion from the definition of investment c"mpany. Section 3 (c) (1) excludes from m~ regulation under the 1940 Act any issuer that is not making and rm does not propose to make a public offering of its securities and

whose securities are owned by 100 or fewer shareholders. An

investment club that has passive members (and that therefore may

be issuing securities) may rely on this exception to avoid

regulation as an investment company. I ~m enclosing a copy of

the SEC's Investment Company Registration Package, which contains

a SEC release discussing when a public offering exists. 5 I am

also enclosing an article from the Business Lawyer that discusses
Section 3 (c) (1) of the 1940 Act in more detail.
In addition, you may. wish to consult the appropriate state

securities regulatory authority (authorities). The names and

addresses of securities regulators in the state of Maryland and

other states can be obtained by contacting the North American

Securities Administrators Association, Inc., One Massachusetts

Ave., N.W., Suite 410, Washington, D.C. 20001, Tel: (202) 737
0900. You may also want to speak with an attorney experienced in
federal and state securities laws.

i.. ,''
3 United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852 (1975) (emphasis supplied). 4 If the membership interests are not securities, they need not be registered as such under the Securities Act of 1933 (" 1933 Ac t ") .

5 See Securities Act Rel. No. 4552 (Nov. 6, 1962). Securities sold in a private offering generally need not be registered /'.,', ~';'" under the 1933 Act. ~.;~ '."'N

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Ms. Maxine Harry

December 6, 1995

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I hope that you will find this information useful. If you

have any questions relating to specific provisions òf the 1940

Act, you may call this office at (202) 942 - 0659.

Sincerely,
Lo¿BJ'&y' Attorney
Office of Chief Counsel

Enclosures