The US Court of Appeals for the Seventh Circuit in SEC v. National Presto Industries, No. 05-4612 (7th Cir. May 15, 2007) ruled against the SEC in an appeal from a district court decision that a company was an inadvertent investment company. The ruling addresses the issues of when companies that conduct business operations while holding significant investment securities risk becoming an inadvertent investment company, subject to registration under the 1940 Act.

An investment company is an issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting, or trading in securities. A company is also an investment company, and required to register as such with the SEC, if it holds 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, unless it is primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities (or another exception from the definition is available). A company can seek an order from the SEC that it is primarily engaged in a non-investment company business, and many companies with substantial financial reserves do so as a precaution.

National Presto Industries sells cookware. It sold its cookware plants. It has acquired some operating companies with a portion of the proceeds from the sales, but it continues to have most of its assets in investment securities, from which it derives much of its income. The SEC in 2002 brought an action against National Presto as an unregistered investment company, and the district court in 2005 granted the SEC summary judgment and ordered the company to register. National Presto appealed to the Seventh Circuit.

The SEC noted that the principal relevant considerations established by courts and the SEC in determining whether an issuer is principally engaged in a non-investment company business are (1) the company's historical development; (2) its public representations of policy; (3) the activities of its officers and directors; and, most important, (4) the nature of its present assets; and (5) the sources of its present income. The SEC cited Tonopah Mining Co., 26 S.E.C. 426 (1947). After ruling that National Presto's securities holdings were in fact investment securities, the Seventh Circuit said that all of these factors, except the nature of its assets, argued against investment company status. The court further stated that "what principally matters is the beliefs the company is likely to induce in investors. Will its portfolio and activities lead investors to treat a firm as an investment vehicle or as an operating enterprise?" The court concluded that reasonable investors would treat National Presto, which earned over 60% of its net income from operating sources in the past three years, as an operating company rather than a closed-end fund. The court's analysis implies that if a company gets more than half of its net profits from non-investment sources, the income factor will support non-investment company status.

National Presto, which had registered as an investment company with the SEC, is free to drop its 1940 Act registration without SEC approval.

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