SEC Division of Investment Management staff letter: Richard L. Mertz

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON. DC. 20549

:VISIDN OF
April 1, 1993
.-ENT MANAGEMENT
Mr. Richard L. Mertz

Executive Discount Realty

Company ::~::::'~~~r:5t Iqvo
1122 Silverado Street

La Jolla, CA 92037

Dear Mr. Mertz: ~r~~::1 ty 1-~ / ~9. i_..:"..-..
Chairman Breeden forwarded your letter dated February 2 3 , 1993 to this Office for response. You have requested information

-regarding the registration requirements for mutual funds. I have

enclosed a copy of the Commission's Investment Company

Registration Package, which includes Form N-1A, the form used to

register a mutual fund with the Commission under the Investment

Company Act of 1940 ("1940 Act") and to register the securities

issued by the mutual fend under the Securities Act of 1933 ("1933

Act"); a copy of the 1940 Act; and other explanatory materials.

You also ask the following specific questions:

1. Is an investment company exempt from the registration

requirements because the total amount of securities offered

is less than -$500,000 and will be less than $500,000 in a 12

month period?

Section 3(c)(1) of the 1940 Act generally excludes from the

def ini tion of "investment company," and thus from registration and regulation under the 1940 Act, any issuer

whose outstanding securities are beneficially owned by not

more than 100 persons, and which is not making and does not

propose to make a public offering of its securities. This

private offering exclusion is not contingent upon any particular dollar amount. Whether an offering is public

depends on the facts and circumstances of the offering. In

determining whether an investment company's offering of its securi ties is nonpublic for purposes of section 3 (c) (1), the Division of Investment Management generally looks to whether an offering is nonpublic for purposes of section 4 (2) of the 1933 Act and Rule 506 thereunder. ii The enclosed

registration package contains a release entitled "Nonpublic

Offering Exemption," on page 58, which may assist you in

determining whether your proposed offering will be public.

If you decide to register the investment company under the

ii See,~, Frontier Capital Management Company, Inc. (pub.

avail. July 13, 1988); Santa Barbara Securities (pub. avail.

Apr. 8, 1983).

1940 Act, you should note that section 14 (a) generally prohibits an investment company from registering with the

Commission and making a public offering of that company's secur i ties unless the company has a net worth of at least $100,000.
2. Does being exempt from the registration requirement have any

effect on being a regulated investment company under

Subchapter M of the Internal Revenue Code (" IRC") ?

To qualify under Subchapter M of the IRC, an investment

company must be registered under the 1940 Act. In addition,

an investment company must comply with the other

requirements set forth in Subchapter M, including certain

gross income and diversification requirements. You may wish

to contact the Internal Revenue Service for further

information on the taxation of registered investment

companies.
3. Are both a prospectus and a statement of additional

information ("SAI") required?

Form N-1A is a three part registration form, consisting of a

prospectus, SAI, and other information. Thus, both a

prospectus and SAI are required to be filed with the

Commission. An investment company need not automatically distribute its SAI to investors, but only must make it

available free of charge to investors upon request.

4. Are audited financial statements required?

Item 23 of the SAI requires a registered management

investment company to include in its registration statement:

(1) an audited balance sheet or stòtement of assets and

liabilities as of the end of the most recent fiscal year;

(2) an audited statement of operations for the most recent f isca 1 year; and (3 ) audited statements of changes in net assets for the two most recent fiscal years. These

statements must conform to the requirements in Regulation

s-x. Item 3 of Form N-1A also requires the registrant to

furnish in its prospectus condensed financial information,

including per share income and capital changes for each of

the last ten fiscal years of the registrant (or for the life of the registrant, if less).
5. Is incorporation of the fund required?

The 1940 Act does not require that an investment company be

organized in a certain form. Most investment companies are

organized as corporations or business trusts, and some are

organized as limited partnerships.

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6. What does the Investment Company Institute's ("ICI")

requireme.nt thùt a member be "fully registered under the

1940 Act" mean?

The ICI is a trade group, not associated or affiliated with

the Commission. You should contact the ICI directly

regarding its membership qualifications. The ICI is located

at 1600 M street, N.W., Washington, D.C. 20036, (202) 293 7700. I hope this information is helpful. I have also enclosed a

copy of an unpublished article entitled "The Regulation of

Investment companies in the united States," which briefly

explains the structure under which the Commission regulates

mutual funds and other investment companies. You may want to

consider contacting an attorney who has experience in this area

for guidance with respect to the issues involved in organizing a

mutual fund. If you have any further questions, you may write or

call this Office at (202) 272-2030.

Sincerely,
QlJU" ç fi~.~

Thomas S. Harman

Associate Director
(Chief Counsel)

Enclosures

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Richard L. Mertz ED Executive Discount 6): Owner. Broker 1~I:ALlY CUMfJANY 1122 Silvi;ak"Street Tel: (619) 459-4440 R-C- La Jolla, C?i: 92037 The Honorable Mr. Richard Breeden February '2~, 1993 Chairman United states Securities and Exchange Commission

Washington, D.C. 20549

Dear Mr. Breeden:

I am a small businessman (on a tight budget) that is interested in starting a

diversified open-end no-load registered investment company/mutual fund and

realize that they are complex, vigorously regulated-having to comply with a

large number of federal and state laws and regulations. Having gained an

appreciation for this high degree of regulation, I am writing to you hoping it

will be possible to obtain references or answers to some questions.

~n trying to obtain information on this mutual fund dream of mine, I have

contacted the Investment Company Institute which mailed me a disappointing and

discouraging guide: "The Organization and Operation of a Mutual Fund" (eight

pages and $25.00!!!) that summaries "the numerous factors that should be

considered carefully when deciding whether or not to organize and operate a mutual fund." To me, this guide seems like a scare tactic to discourage the small businessman from their interests in this area.

My five year plan for this proposed registered investment company/mutual fund

~o start with $100,000 and one investor; and, to grow this to at least

,000 and 35 investora over a five year period. Eventually, in the five to

tçil year time-frame, I would plan to develop this registered investment company

into a "full scale" multi-million dollar mutual fund.

In the first five years, my goal is to avoid a complicated and costly process;

at the same time having strict adherence to the "myriad of regulatory

requirements." My advertising would be limited, if at all.. (Advertising via

family, friends, word of month, and possibly listed by a no load mutual fund

quide). 11m a newly registered investment adviser and am considering

incorporating this proposed fund in either Maryland or California, and

registering it in California initially. (I am a California resident).

The following questions are in regard to the registration requirements of this

fund: 1) My understanding is that this proposed investment company would be

exempt for the registration requirement because the total amount of securities

offered is less than $500,000 and will be less than $500,000 in a 12 month

period. Is this correct? 2) Does being exempt from the registration

requirement have any effect on being a regulated investment company under

Subchapter M of the Internal Revenue Code? 3) Are both a Prospectus and a

Statement of Additional Information required? 4) Is incorporation of the fund

required? 5) Are audited financial statements required? 6) The Investment

Company Institute has a requirement that members be fully registered under the

1940 Investment Company Act--under the above scenario does this qualify as

being fully registered?
Arw additional informa.tfIl ifr~~¡ ~_~~tlY appreciated!
_ Truly Yours, ~ichar~ ~er~