Understanding the 3(c)(7) Exemption From SEC Regulations

What the 3(c)(7) exemption is

Section 3(c)(7) of the Investment Company Act of 1940 permits certain private investment funds to avoid registration and many of the Act’s disclosure requirements by limiting investors to “qualified purchasers.” This exemption is commonly used by hedge funds, private equity, and venture capital funds, and it enables strategies—such as greater use of leverage and derivatives—that are generally restricted for registered public funds.

Key takeaways

• 3(c)(7) lets private funds bypass many Investment Company Act registration and disclosure obligations if all investors are qualified purchasers.
• Qualified purchasers must meet higher investment thresholds than accredited investors.
• Funds that reach 2,000 or more investors must register and cannot rely on the exemption.
• Losing qualified-purchaser status exposes a fund to SEC enforcement and potential investor litigation.

Who counts as a qualified purchaser

To rely on 3(c)(7), a fund’s investors must meet the qualified purchaser standard. Typical categories include:
* Individuals or family-owned businesses owning at least $5 million in investments.
Trusts managed by qualified purchasers.
Individuals or entities owning and investing at least $25 million for their own account or for other accounts.
* Entities wholly owned by qualified purchasers.

(Those thresholds are more stringent than the accredited investor tests, which rely on income and net worth.)

How funds use the exemption

Funds relying on 3(c)(7):
* Are not required to register under the Investment Company Act of 1940 as “investment companies.”
Generally do not make the same ongoing public disclosures required of registered investment companies, such as prospectuses.
Can pursue more flexible strategies unavailable to most registered funds.

However, funds must demonstrate they do not plan an initial public offering (IPO) and must ensure investor eligibility is maintained.

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

• Investor standard: 3(c)(7) requires qualified purchasers (higher wealth/investment thresholds); 3(c)(1) permits accredited investors (lower thresholds).
• Investor count: 3(c)(1) funds are limited (historically to 100 investors), which constrains their pool; 3(c)(7) funds can have many investors so long as each is a qualified purchaser, but registration is required at 2,000+ investors.
• Use cases: 3(c)(7) is better suited to funds seeking a wealthier, more sophisticated investor base and more regulatory flexibility.

Compliance risks and consequences

Maintaining the qualified purchaser requirement is essential. If a fund accepts investments from non-qualified purchasers or otherwise falls out of compliance, it risks:
* SEC enforcement actions and sanctions.
Investor lawsuits and contractual disputes.
Loss of the exemption and possible requirement to register as an investment company.

Fund sponsors typically implement investor eligibility checks and transfer restrictions to preserve the exemption.

What is not an “investment company”

Certain pools and organizations are excluded from the Investment Company Act’s definition of an investment company, such as:
* Charitable organizations.
Pension plans and certain employee benefit plans.
Church plans.

These entities are governed by other statutes and rules.

Accredited investor vs. qualified purchaser

• Accredited investor: a legal standard based on income and net worth that permits purchase of many private securities offerings.
• Qualified purchaser: a higher standard based on the amount of investments owned or managed (e.g., $5 million or $25 million thresholds).
  The qualified purchaser standard is intended to ensure investors in 3(c)(7) funds are sufficiently sophisticated and financially able to bear investment risk without the protections that registration provides.

Conclusion

Section 3(c)(7) is a key exemption enabling private funds to operate without many of the registration and disclosure obligations that apply to public investment companies. It provides flexibility for sophisticated investment strategies but requires strict investor eligibility and ongoing compliance. Funds and sponsors relying on 3(c)(7) must carefully verify and maintain qualified purchaser status or face regulatory and legal consequences.