What Is the 3(c)(7) Exemption?
The 3(c)(7) exemption refers to a portion of the Investment Company Act of 1940 that allows private investment companies an exemption from some Securities and Exchange Commission (SEC) regulation, providing that they meet certain criteria. 3C7 is shorthand for the 3(c)(7) exemption.
Key Takeaways
- The 3(c)(7) exemption refers to the Investment Company Act of 1940's section permitting qualifying private funds exemption from some SEC regulations.
- Private funds must not plan to issue an IPO, and their investors must be qualified purchasers to qualify for the 3C7 exemption.
- 3C7 funds with over 1,999 investors are required to register with the SEC.
History of the 3(c)(7) Exemption
The Investment Company Act of 1940 defines an “investment company” as an issuer that “holds itself out as being engaged primarily or proposes to engage primarily, in the business of investing, reinvesting or trading in securities.”The Act regulates the organization of companies whose securities are offered to the public. Companies must disclose their financial condition and investment policies regularly.
However, 3C7 is one of two exemptions in the Investment Company Act of 1940 that hedge funds, venture capital funds, and other private equity funds use to avoid SEC restrictions. This frees up these funds to use tools like leverage and derivatives that most publicly traded funds cannot. Hedge funds, private equity funds, venture capital funds, and other private investment vehicles are commonly organized to fall outside the purview of the Investment Company Act of 1940.
Claiming 3C7 Exemption
3C7 funds are not required to register with the Securities and Exchange Commission or provide ongoing disclosure. They are also exempt from issuing a prospectus that would outlineinvestment positions. 3C7 funds are also referred to as 3C7 companies or 3(c)(7) funds.
There is no limit on the number of investors under Section 3(c)(7), however, the fund can have up to 1,999 investors before registration would be required under the Securities Exchange Act of 1934.
To qualify for the 3C7 exemption, the private investment company must show that they have no plans of making an initial public offering (IPO) and that their investors are qualified purchasers. A qualified purchaser is a higher standardthan an accredited investor and is defined as:
- Individuals or family-owned businesses that own no less than $5 million in investments
- A trust managed by qualified purchasers
- An individual acting for their account or the account of someone else who owns and invests at least $25,000,000 in investments
- Any entity solely owned by qualified purchasers.
3C7 Funds vs. 3C1 Funds
Both 3C7 and 3C1 funds are exempted from the requirements imposed on “investment companies” under the Investment Company Act of 1940 (the “Act”). However, there are differences between them. 3C7 funds take investments from qualified purchasers, whereas 3C1 funds work with accredited investors.
Investors in 3C7 funds are held to a higher wealth measure than those in 3C1 funds, which can limit the investor pool for a fund hoping to raise money. 3C1 funds are capped at 100 investors, limiting the number of investors the fund can take in from the pool they can pull from.
What Happens to a Fund That Does Not Comply With 3C7 Rules?
3C7 funds must maintain their compliance to continue utilizing the exemption from the 1940 Act. If a fund were to fall out of compliance by taking in investments from non-qualified purchasers, it would open itself to SEC enforcement actions and litigation from its investors and any other parties it has contracts with.
What Types of Investments Are Not Defined As an Investment Company?
Some investment pools that do not qualify as an “investment company” inSection 3(a) of the Investment Company Actinclude charitable organizations, pension plans, and church plans.
What Is the Difference Between an Accredited Investor and a Qualified Purchaser?
Accredited investors typically must meet income and net worth requirements to purchase financial investments, such as securities or real estate. Companies such as financial institutions screen participants and must determine who is an accredited investor.The qualified purchaser is a legal term not based on net worth or income but on investment holdings. Qualified purchasers must meet higher standards so that funds with a small group of private equity investors can buy and sell public assets.
The Bottom Line
The 3(c)(7) exemption is part of the Investment Company Act of 1940 and allows private funds to avoid some SEC regulations, which include SEC registration and public disclosure. Investment in a 3C7 fund is limited to qualified purchasers.
