SEC Division of Investment Management staff letter: Mr. Frank Mason

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SECURITiES N,m EXCHANGE COMMISSION SETIOiJ -'(A)( I) WASHINGTON. D.C. 20549 RULlJ NvESTMENT MANAGEMENT .vISfON OF PUBLIC 7 0 J¿¡ /_ AVAILABILIT I ~ i ( p July 3, 1996

"
Mr. Frank Mason

Dear Mr. Mason:

This letter is in response to your letter dated June

11, 1996, requesting information regarding registration of

an investment club with the Securities and Exchange

Commission ("Commission"). You also request information

regarding the formation of a mutual fund.

The initial question that must be considered is whether

the proposed investment club has an obligation to register

wi th the Commission as an "investment c omp an¥,' under the Investment Company Act of 1940 ("1940 Act") . Generally,

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 held by

not more than one hundred persons.. .
An investment club will be required to register under

the 1940 Act only if (1) the club invests in securities, (2)

it issues membership interests that are themselves securities, and (3) no exclusion from the definition of

investment company is available. Assuming that the proposed

investment club will invest in securities, the next question

to be addressed is whether its membership interests are

themselves securities.

A membership interest in an investment club would be a

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

i 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. " The term "issuer" is defined in section

2 (a) (22) as "every person who issues or proposes to issue any security, or has outstanding any security which it has

issued. "

..
Mr. Frank Mason

July 3, 1996

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 managerial efforts of others." If every

member of an investment club actively participates in

managing the club, the membership interests in the club

would not be securities because each member would not rely

solely on the efforts of others. Therefore, the investment

cl ub would not be an investment company subj ect to regulation under the 1940 Act. However, if the club "

consisted of even a few passive members, it 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 company.

Section 3 (c) (1) of the 1940 Act excludes from regulation any
issuer that is not making and does not propose to make a

public offering of its securities and whose securities are

owned by one hundred or fewer shareholders. I have 3 enclosed for your information a copy of the Commission's

Investment Company Registration Package which includes a

Co~misslon release discussing when a public offering exists. If, however, you wish to form a mutual fund and offer

its shares to the public, you will need to comply with the

requirements of the 1940 Act and the Securities Act of 1933

("1933 Act"). A public mutual fund must register as an

investment company with the Commiss.ion under the 1940 Act,

and if it is publicly offering its' securities, must register those securities under the 1933 Act. The 1940 Act, among

other matters, limits transactions between an investment

company and its affiliates, contains provisions that govern

the company's capital structure, and sets forth requirements

regarding the composition of the company's board of

directors and the purchase and redemption of the company's

shares. The 1940 Act also requires that an investment

company have a net worth of at least $100,000 in total

assets before it can offer its securities to the public.

The enclosed Investment Company Registration Package

includes additional information on investment company

2 United Housinq Foundation, Inc. v. Forman, 421 U.S. 837, 852 (1975). 3 In your letter, you refer to an investment club with more

than twenty-five members being required to register with the

Commission. As noted above, the 1940 Act specifies that the

limit on the number of investors in a private investment

company is one hundred, not twenty-five.

4 See Securities Act Release No. 4552 (Nov. 6, 1962).

Mr. Frank Mason

July 3, 1996

regulation as well as the form that must be filed to register. You should also be aware that a person selecting the.

investments for a registered investment company generally is

required to register as an investment adviser under the

Investment Advisers Act of 1940 ("Advisers Act"), and that a

person selecting investments for an investment club may also

be required to register as an investment adviser. Section 202 (a) (11) of the Advisers Act generally defines an " investment adviser as "any person who, for compensation,

engages in the business of advising others, either directly

or through publications or writings, as to the value of

securities or as to the advisability of investing in,

purchasing, or selling securities, or who for compensation

and as part of a regular business, issues or promulgates

analyses or reports concerning securities."

Section 203 (a) of the Advisers Act requires an

investment adviser to register with the Commission unless

exempt from registration under Section 203 (b) of the Advisers Act. Section 203 (b) (3) exempts from registration any investment adviser who, during the course of the

preceding twelve months, has had fewer than fifteen clients,

does not hold himself out to the public as an investment

adviser, and does not act as a~ investment adviser to any

registered investment company. Any person that meets the definition of investment adviser, regardless of whether or

not he is required to register, must comply with the

antifraud provisions of the Advisers Act. I have enclosed

with this letter a copy of the Commission' s Investment

Adviser Registration Package, which discusses the definition

of an investment adviser in more detail, and contains the

forms necessary to register as an investment adviser should

you determine it necessary to do so.

In addition, you should contact the appropriate state

authority (or authorities) to determine what, if any, state

requirements may apply to your proposed activities. The

names and addresses of appropriate state officials can be

obtained by contacting the North American Securities

Administrators Association, Inc., One Massachusetts Avenue,

5 A person holds himself out to the public as an investment adviser if, among other things, he uses such terms as "investment adviser" or "investment manager" on his stationery or in a business or telephone directory, or lets it be known, by word of mouth through existing clients or otherwise, that he is willing to take on new advisory clients. George J. Dippold (pub. avail. May 7, 1990). 6 See Section 206 of the Advisers Act.

Mr. Frank Mason

July 3, 1996

N.W., Suite 310, Washington, D.C. 20001, Telephone: (202)

737-0900. Due to the complexity of investment company and

investment adviser regulation, you also may wish to consult

with an attorney familiar with this area before proceeding.

I hope that you find this information helpful. If you

have any further questions, please contact this office at

(202) 942-0659.

sinCZ
~ ay Lamba

Law Clerk

Enclosures

--
June 11, 1996

Securities Exchange Commission

Office of Chief Council

Di vision of Investment Management

450 Fifth St. NW

Washington, DC 20549

To Whom It May Concern:

If this is not addressed to the correct office, please forward it to the

appropriate office. Thank you.

I am requesting information on two issues.

1) I have been informed that investment clubs with more than twenty-five

members need to be registered with the SEC. Please provide me with the

necessary information so that I can comply.

2) I am interested in exploring the formation of a mutual fund. Please send

the information detailing restrictions and regulations and the necessary forms

for registration.

Thank you.
Sincerely, r¡ (Y~ Frank Mason