Section 3(a)(1) of the 1940 Act includes two definitions of "investment company" that may be relevant to R&D companies. Section 3(a)(1)(A) defines an investment company as any issuer that is, holds itself out as, or proposes to be engaged primarily in the business of investing, reinvesting, or trading in securities. Section 3(a)(1)(C) defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of Government securities and cash items) on an unconsolidated basis.
Certain R&D companies can avoid meeting the definition of investment company in Sections 3(a)(1)(A) and 3(a)(1)(C) of the 1940 Act by relying on the nonexclusive safe harbor that is provided by Rule 3a-8 under the 1940 Act. Specifically, the rule provides that an R&D company would not be an investment company under Sections 3(a)(1)(A) and 3(a)(1)(C) of the 1940 Act if the R&D company complies with certain conditions that are designed to demonstrate that it is engaged in a non-investment company business. As relevant in the no-action letter, paragraph (a)(1) of Rule 3a-8 provides that an R&D company that relies on the rule must have research and development expenses, for the last four fiscal quarters combined, that comprise a substantial percentage of its total expenses for the same period. Paragraph (b)(9) of the rule defines the term "research and development expenses" to mean "research and development expenses as defined in FASB Statement of Financial Accounting Standards No. 2, Accounting for Research and Development Costs, as currently in effect or as it may be subsequently revised." The term "substantial," however, is not defined in the rule.
The SEC took the position that an R&D company complies with Rule 3a-8(a)(1) if it has an R&D Expense Ratio of at least 20%, and complies with all other requirements of Rule 3a-8.
Please click http://www.sec.gov/divisions/investment/noaction/2007/cgk071207-3a-8.htm for a copy of the no-action letter.