3(c)(1) Exemption (3C1): What It Is and How It’s Applied

Overview

3(c)(1) refers to a provision of the Investment Company Act of 1940 that exempts certain private investment funds from being treated as registered investment companies subject to the Act’s registration, disclosure, and operational requirements. Funds that meet the 3(c)(1) criteria can operate with fewer regulatory constraints than public investment vehicles like mutual funds.

Key requirements

• Ownership limit: The exemption applies to issuers whose outstanding securities (other than short-term paper) are beneficially owned by no more than 100 persons. For qualifying venture capital funds, the owner limit can be up to 250 persons.
• No public offering: The issuer must not be making and must not presently propose to make a public offering of the securities.
• Result: Funds that meet these conditions are not treated as “investment companies” under the Act and therefore are relieved from many registration and reporting obligations imposed by the SEC.

Typical investor qualifications

In practice, private funds relying on 3(c)(1) generally restrict investors to accredited investors. Common accredited thresholds often used in practice:
– Annual income over $200,000 (or $300,000 with a spouse), or
– Net worth exceeding $1 million (excluding primary residence).

These investor limitations are typically implemented to satisfy securities-law exemptions used for the fund’s capital raising.

3(c)(1) vs. 3(c)(7)

• 3(c)(1): Limits ownership to 100 persons (250 for certain venture capital funds) and is commonly paired with accredited-investor restrictions.
• 3(c)(7): Allows up to 2,000 qualified purchasers. Qualified purchasers face a higher wealth standard (generally $5 million in investments for individuals), which lets a 3(c)(7) fund admit more investors who meet that higher threshold.

Choice between the two depends on whether the fund prefers a larger pool of very wealthy investors (3(c)(7)) or a smaller group of accredited investors (3(c)(1)).

Compliance challenges and considerations

• Counting owners: Determining who counts toward the 100-person limit can be complex—especially for entities, joint owners, and transfers.
• Involuntary transfers: Events like an investor’s death that result in transfers to heirs are generally treated as involuntary transfers and typically do not automatically disqualify the fund, but they must be handled carefully.
• Employee holdings: “Knowledgeable employees” (e.g., certain executives, directors, partners) often do not count against the 100-person limit while employed. If employees leave the firm and continue to hold interests, those holdings may count toward the investor cap.
• Secondary sales and transfers: Funds must monitor secondary transfers and enforce transfer restrictions to avoid unintentionally exceeding the owner limit.
• Operational controls: Accurate recordkeeping, transfer restrictions in governing documents, and processes for verifying investor status are critical to maintaining 3(c)(1) status.

Takeaways

• 3(c)(1) is an exemption under the Investment Company Act allowing private funds with a limited number of investors and no public offering to avoid registration as an investment company.
• The exemption usually operates alongside investor-quality standards (commonly accredited investors).
• Funds must actively manage ownership counts, transfer rules, and employee interests to remain compliant.
• Fund sponsors choose between 3(c)(1) and 3(c)(7) based on investor eligibility preferences and investor-count trade-offs.

References

• Investment Company Act of 1940 (sections covering 3(c)(1) and 3(c)(7))
• U.S. Securities and Exchange Commission — materials on accredited investors and investment company registration requirements