The Investment Company Act of 1940 ("Investment Company Act") requires registration of an investment company. The Investment Company Act defines an "investment company" as any issuer that "is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities." Without certain exemptions, all private equity funds, hedge funds and the like ("private funds") would require registration under the Investment Company Act.
There are two primary exemptions from registration that private funds typically rely on. The first is found under Section 3(c)(1); it exempts a private fund with "not more than 100 persons" and that is not making or proposing to make a public offering of its securities from registration.
The second exemption is found under Section 3(c)(7). This section exempts from registration any issuer whose outstanding securities are owned exclusively by qualified purchasers at the time of acquisition. The term "qualified purchaser" is most commonly defined as "any natural person […] who owns not less than $5 million in investments." Section 3(c)(7) also allows for a private fund to issue securities to an unlimited number of qualified purchasers.
Both Sections 3(c)(1) and 3(c)(7) have further provisions that allow private funds to recruit additional investors who do not necessarily meet the definition of accredited investor or qualified purchaser. Rule 3(c)(5) under the Investment Company Act excludes certain "knowledgeable employees" of a private fund from the 100 person limitation in Section 3(c)(1) and the qualified purchaser requirement in Section 3(c)(7).
The term "knowledgeable employee" includes executive officers, directors, trustees, general partners, advisory board members and certain people serving in similar capacities with the fund. The term also includes employees of the fund "who, in connection with his or her regular functions or duties, participates in the investment activities of such [private fund] or entities managed by the same manager as the fund … provided that such employee has been performing such functions and duties for or on behalf of the [private fund], or substantially similar functions or duties for or on behalf of another company, for at least 12 months."
