3C7 Details

One of the initial requirements that private funds must satisfy is showing that they have no purpose or plans to make an IPO or Initial Public Offering. Another factor of compliance is that their investors must be qualified purchasers, with investment portfolios worth at least $5 million.

As a private fund, a 3C7 firm isn't required to undertake Securities and Exchange Commission or SEC registration; neither does it have to provide disclosure or periodic reporting. This is one of the two common exemptions accorded to private equity funds such as hedge funds or venture capital funds under the Investment Company Act of 1940.

These private investment firms use compliance to 3C7 to avoid SEC regulation and free up derivatives and leverage tools unavailable to publicly traded brokerages. However, to remain exempt under the 1940 Act, funds citing 3C7 must comply by only taking investments from qualified purchasers. Failure to comply with these standards would open funds up for SEC enforcement while facing litigation from investors and parties with whom they will have breached contracts.

Example of a 3C7

According to section 3(c) 7, private issuers are exempt from registration as investment companies if they restrict membership to qualified purchasers. The number of investors isn't limited, unlike in section 3(c) 1. A private brokerage could take on up to 1,999 members before registration under the Securities and Exchange Act of 1934 is deemed necessary.

Qualified purchasers, according to the Qualified Institutional Buyers, are defined under the Securities Act under Rule 144A, and in this sense include:

  • An individual or family-owned entities that own investments of more than $5 million
  • Trust sponsors for a fund managed by a qualified purchaser
  • An individual acting on their behalf or others who owns investments of at least $25 million
  • An entity that's exclusively qualified purchaser owned

Investments stand for a broad range of value liabilities held for investment purposes, including securities, financial contracts, real estate, commodities, cash, insurance, and cash equivalents. On a discretionary basis, qualified purchasers invest in securities and can include knowledgeable employees of an investment company without jeopardizing the 3C7 exemption.

Significance of a 3C7

If a hedge fund were to take on more than 499 investors, it would become subject to federal securities law under the Securities Exchange Act of 1934. A section 3C7 fund would have to register as a reporting company if they have more than 500 qualified purchaser investors or $10 million in investment assets.

Since for qualified purchasers, the $10 million in asset threshold is easy to overcome. Hedge funds select to comply with section 3(c) 7s 499 investor limitations. A hedge fund manager would rather register under the Exchange Act than be subject to the Securities Act of 1933, but it's still undesirable.

If that happened, as some managers in the non-securities segment have often chosen to do, the fund becomes a reporting company, submitting periodic reports to the SEC. Reports are expensive and time-consuming, and as such, hedge fund managers find the 3C7 regulations for no more than 499 investors easier to comply with.

A 3C7 vs. A 3C1

While private brokerages that comply with section 3C1 have accredited investors for members, who must number less than one hundred, 3C7 funds take investments from qualified purchasers. Investors to 3C7 are held to higher wealth esteems than those who invest in 3C1 funds, which essentially limits the investor pool with at most ninety-nine individual, joint, or entity sponsors.

3C7 funds don't have an investor limitation cap, but if they exceed 2,000 qualified purchasers, they become quasi-public entities, open to SEC scrutiny under the Securities Exchange Act of 1934. When starting a new private fund or maintaining an existing one's compliance, it must be structured under the investment company exemptions according to the Investment Company Act of 1940.

If your fund becomes redundant in one of the mentioned requirements, you could be liable to SEC enforcement action or litigation from contractual parties or investors. Section 7 of this Act clarifies that any contract of unregistered investment companies, including those categorized inadvertently, can give investors rescission rights as they are unenforceable. Your private fund's proper functioning depends on how well maintained or established the company's status exemption is.