3C1 Details

3C1 stands for section 3, subsection (c), and chapter 1 of the Investment Company Act of 1940, which is the law that defines what an investment business entity is. An investment company invests, trades, or re-invests securities as of its main business engagement. The 3C1 exception states that investment houses do not have to register with the SEC or Securities and Exchange Commission if they have less than one hundred members.

Many pension funds, charitable organizations, and hedge funds use this designation to avoid registering with the SEC, but they must adhere to specific requirements to support these exceptions. The preceding section 3(b) 1 establishes which companies can be considered investment firms, essentially excluding those that don't own, invest, hold, reinvest or trade in securities. 3(c) outlines the further exceptions to investment companies' classification, including pension plans, charitable organizations, brokerages, and religious plans.

In 3(c) 1, the exceptions list featured in 3(c) is added with requirements and parameters. When these exceptions are satisfied, a private investment firm can be classified apart from a traditional investment firm as stipulated under the 1940 Act.

Example of a 3C1

Once an investment fund establishes that it's not owned by more than a hundred benefactors, the second factor to satisfy is that it's not going to make a public offering. Due to its structuring and funding, an investment fund that qualifies as a 3C1 fund must limit its offering to not comply with investor status limitations.

A private fund prototype offers interests under rule 506, accepting investments from no more than ninety-nine investors, especially if a general partner's interest can be considered a security. The methodology for calculating the hundred-owner rule is more complex than it sounds and can often invalidate an investment house's exception.

To ensure the number of investors in a firm complies with the ownership rule, regulations to be followed include:

  • Counting individuals as one investor and interests held by a joint entity such as a couple as one investment
  • Under 3(c) 1 or 3(c) 7 of the Act, entities that invest in the fund and which aren't companies can be deemed as a single owner with any percentage of the fund's interests. This caveat only works if the entity wasn't founded with the sole purpose of investing in that particular fund.
  • In the case of another hedge fund investing or owning more than 10% of the securities with voting capabilities within the fund, each member of that company will be perceived as a single investment house owner. Known as the look-through rule, it prevents fund owners from circumnavigating the hundred-ownership rule by operating 3C1 funds with affiliates as part of a pyramid.
  • Employees, especially those termed knowledgeable, such as the director, general partner, a long-serving employee, an advisory board member, and any executive officer, won't count towards the ownership rule.
  • Involuntary transfers, such as those bequeathed inheritors after a fund investor passes on, will be counted as owned by the transferor. Ownership interest is also transferred as gifts or under divorce decrees, and the fund doesn't lose its exemption from such involuntary transfers.
  • Exception for offshore investment funds from being considered for SEC registration hinges on if the fund has no more than one hundred investors of US origin and there are no plans to make public securities offerings within the country.

Significance of a 3C1

According to the SEC, a 3C1 excerpts a fund or "any issuer of outstanding securities other than short-term paper" from an investment company's definition. This plan is specific to those funds that are beneficiary owned by less than a hundred people and have no plans or purpose for making public offerings of their securities.

To sidestep ongoing SEC registration, restrictions, disclosures, and other requirements, investment funds comply with the attributes of ownership and public funding and are thus called 3C1 companies.

3C1 is significant to hedge funds and other private investment entities that must avoid SEC scrutiny that others like mutual funds have to adhere to under the Investment Company Act of 1940. The investors in a 3C1 fund should be accredited, meaning they are individuals or joint persons with a net worth of over $1,000,000 and over $200,000 in annual income.

A 3C1 vs. A 3C7

While 3C1 and 3C7 funds are regulated by the same section of the Investment Company Act of 1940, it's the manner of their investors that creates the main differences. 3C1 investment funds work with accredited investors and individuals, not more than one hundred, with annual incomes of over $200,000 and net worth of not less than $1,000,000.

While the public offering of securities remains a restriction for 3C7 funds, they don't have such stringent ownership limits. The investors, however, must be qualified purchasers. This is a much higher standard of an investment portfolio that requires ownership of investments that total more than $5,000,000.

Although stricter rules are applied to 3C7 funds than 3C1 companies, the membership slots can go up to 499. Startup hedge fund managers find it feasible to initially employ a structure within the 3C1 clause. Once the ninety-nine slots are maximized, they attract qualified purchasers who launch into a 3C7 vehicle. Without the 3C1 clause, hedge funds would have a hard time complying with the Investment Company Act of 1940 and SEC regulation.