7.9.2008 The Townsend Group, Inc. ("Townsend"), a registered investment adviser, serves as investment adviser two private equity fund-of-funds: the Core Plus Real Estate Fund - A, L.P. ("Core A") and the Core Plus Real Estate Fund - Q, L.P. ("Core Q").

Core A is an open-end fund-of-funds investment vehicle which invests in multiple private equity real estate funds. Core A is exempt from the 1940 Act under Section 3(c)(1). Investors in Core A are "accredited investors" under the 1933 Act and "qualified clients" under the Advisers Act. Core A has 71 beneficial owners (excluding its general partner), taking into consideration all Section 3(c)(1) look-through and attribution rules.

Core Q is an open-end fund-of-funds investment vehicle which invests in multiple private equity real estate funds. Core Q is exempt from the 1940 Act under Section 3(c)(7). Investors in Core Q are "accredited investors" under the 1933 Act, "qualified clients" under the Advisers Act and "qualified purchasers" under the 1940 Act. Core Q has 153 beneficial owners, taking into consideration all applicable look-through and attribution rules.

Core A and Core Q share essentially the same investment objectives, have overlapping investment portfolios and substantially similar portfolio risk/return characteristics. But for Section 3(c)(7)(E) of the 1940 Act, which provides that a Section 3(c)(1) exempt fund will not be integrated with a Section 3(c)(7) exempt fund, the incoming letter stated that Core A and Core Q could be subject to integration under the 1940 Act.

Townsend desired to combine the Core A Fund with the Core Q Fund. For purposes of the no-action letter, the combined fund would be called the "3(c)(1) Plus Fund.” The issue raised by this combination is that the 3(c)(1) Plus Fund would not fall entirely within Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, as the number of beneficial owners in the 3(c)(1) Plus Fund would exceed 100 beneficial owners and not all of them would be "qualified purchasers."

The incoming letter unsuccessfully argued that that the 3(c)(1) Plus Fund, as long as it maintains no more than 100 non-qualified purchaser "accredited investor" beneficial owners, should be permitted to have more than 100 overall beneficial owners and not have to register as an investment company under the 1940 Act. The incoming letter called it the “Section 3(c)(1) Plus Exemption.” The 3(c)(1) Plus Fund would have 224 beneficial owners, taking into consideration attribution and look-through rules as noted above. Of such investors, 71 beneficial owners in the 3(c)(1) Plus Fund would be "accredited investors" and 153 beneficial owners in the 3(c)(1) Plus Fund would be "qualified purchasers."

The SEC did not grant the requested no-action relief. It did not agree with the following reasons why no-action relief permitting the 3(c)(1) Plus Fund was appropriate:

  • the Section 3(c)(1) Plus Fund would be limited to up to 100 "accredited investors" and an unlimited number of "qualified purchasers”;
  • the Section 3(c)(1) Plus Exemption would not pose integration circumvention concerns;
  • enforcement is burdensome to Core A and Core Q as well as to the investors in Core A and Core Q, and of little practical benefit to investors in Core A and Core Q because there will be (a) no actual oppression of "accredited investors" by "qualified purchasers," (b) increased private investment opportunities for "accredited investors" which are adequately regulated through disclosure and anti-fraud rules under Rule 10b-5 under the Securities Exchange Act of 1934, Section 206 and Rule 206(4)-8 of the Advisers Act, and (c) elimination of the disproportionate economic drag borne by "accredited investors" in parallel funds;
  • the purpose of the 1940 Act is to regulate "public" as opposed to "private" matters and that the Section 3(c)(1) Plus Exemption effectively satisfies all "private" criteria under the 1940 Act;
  • the Section 3(c)(1) Plus Exemption, in addition to satisfying private criteria under the Investment Company Act, also generally satisfies all other criteria under Section 3(c)(1) and Section 3(c)(7), including providing disclosure, adequate notice and opportunity to redeem consistent with the spirit of the "grandfather clause" in Section 3(c)(7)(B); and
  • the Section 3(c)(1) Plus Exemption is within the intended purposes of the 1940 Act.

Click http://www.sec.gov/divisions/investment/noaction/2008/townsendgroup070908-sec7.htm#1 for a copy of the no-action letter.