What is the 3(c)(7) exemption?
The 3(c)(7) exemption is a carve‑out in the Investment Company Act of 1940 that lets certain private investment vehicles avoid many of the Act’s registration and public‑disclosure obligations. “3(c)(7)” is shorthand for Section 3(c)(7) of the Act. Funds that rely on this exemption typically include hedge funds, private equity funds and venture capital funds that prefer greater operational flexibility than public investment companies.
Clear definitions
– Investment company: under the 1940 Act, an issuer that primarily holds, invests or trades in securities and that publicly offers its securities. Such companies are subject to registration and periodic disclosure rules.
– 3(c)(7) exemption: an exemption allowing a private fund to be outside the Act’s definition of an “investment company,” provided it meets specified conditions.
– Qualified purchaser: a legal status for investors that sets a higher wealth/holding threshold than the accredited‑investor test; it’s based on investment holdings rather than simple income or net‑worth tests.
– Accredited investor: a lower standard than a qualified purchaser; typically determined using income and net‑worth criteria (used in other exemptions).
Key takeaways (short)
– 3(c)(7) lets private funds avoid many SEC registration and disclosure requirements under the Investment Company Act of 1940.
– Funds relying on 3(c)(7) usually accept only qualified purchasers (a more demanding investor standard than accredited investor).
– 3(c)(7) funds can use strategies often restricted for registered funds — for example, leverage and derivatives — because they are not treated as public investment companies under the 1940 Act.
– A fund that loses compliance (e.g., admits non‑qualified purchasers) risks SEC enforcement, litigation and losing the exemption.
How 3(c)(7) evolved and why it matters
When the 1940 Act was written, it was designed to protect ordinary public investors by requiring registration, periodic reporting and limits on certain practices. The 3(c)(7) exemption recognizes that very wealthy or sophisticated investors (qualified purchasers) may need less statutory protection. By limiting investors to that higher threshold, the exemption allows private funds more freedom in strategy and reporting.
How to qualify for the 3(c)(7) exemption — practical checklist
For fund managers considering (or maintaining) 3(c)(7) status:
1. Confirm investor eligibility
– Accept only qualified purchasers. Set up investor questionnaires and document verification procedures.
2. Demonstrate no IPO intent
– Have written policies and representations in subscription documents indicating the fund does not plan to make a public offering (IPO).
3. Control transfers
– Use transfer restrictions and notice/approval processes to prevent non‑qualified purchasers from becoming investors.
4. Maintain records and periodic reviews
– Keep investor records, KYC (know your customer) files, and review investor status on a regular schedule.
5. Engage legal counsel
– Use an attorney experienced in private fund regulation to draft subscription agreements and compliance procedures.
6. Monitor investor counts
– Although 3(c)(7) does not impose a small‑investor cap, funds with 2,000 or more investors must register under the Securities Exchange Act of 1934; track investor totals closely.
7. Plan for remediation
– Have contingency plans if a non‑qualified purchaser is admitted (repurchase, cure mechanisms, or other corrective steps).
Comparing 3(c)(7) and 3(c)(1)
– Investor standard:
– 3(c)(7): accepts qualified purchasers (higher wealth/holding test).
– 3(c)(1): accepts accredited investors (lower income/net‑worth test).
– Investor count limit:
– 3(c)(1): limited to 100 investors.
– 3(c)(7): no explicit small cap, but registration obligations kick in at 2,000+ investors under the Exchange Act.
– Practical effect: 3(c)(7) funds typically have a narrower but wealthier investor base and correspondingly greater strategy flexibility.
What investments or entities are not treated as an “investment company”
Certain pools and entities fall outside the Act’s investment company definition by design, for example: charitable organizations, pension plans and church plans. These are governed by other statutes and regulatory frameworks.
Consequences of non‑compliance
If a fund admitted investors who are not qualified purchasers or otherwise violated the terms of the exemption, it can face:
– SEC enforcement actions;
– Civil litigation from investors and contracting counterparties;
– Potential requirement to register as an investment company, with attendant reporting, disclosure and operational changes.
Small numeric example — investor count and registration trigger
Scenario:
– A 3(c)(