A private fund sponsor that offers its qualifying person- nel the opportunity to invest in or alongside its funds generally relies on the Investment Company Act’s “knowledgeable employee” definition to permit such investments. Under the Investment Company Act, “knowledgeable employees” need not meet the quali- fied purchaser tests otherwise required of investors in funds exempt under §3(c)(7) of the Investment Company Act, and need not be counted against the 100-investor  limit  applicable  to  funds  exempt  under §3(c)(1).

The knowledgeable employee definition includes two categories of natural persons:

  1. executive officers (i.e., a president, any vice president in charge of a principal business unit and any other officer or other person who performs a policy-making function),1 directors, trustees, general partners, advisory board members and/or any persons serving in a similar capacity; and
  2. employees who have participated in  investment activities for the sponsor, certain affiliates or other companies for at least the last 12 months.

In a recent no-action letter,2 the SEC provided relief that is generally broader and more favorable than pre- vious SEC interpretations. Although the SEC empha- sized that the ability to qualify as a knowledgeable employee is based on facts and circumstances, the letter included the following notable items:

  • Employees  Participating  in  Investment Activities. ​The SEC expanded previous interpretations by stating that “employees participating in investment activities” may include tax professionals and attorneys who regularly analyze investment structures in a manner material to investment decisions (as opposed to personnel that prepare tax filings or negotiate agreements that evidence investment decisions). The letter also expanded previous SEC interpretations by stating that analysts who research only portions of a private fund’s portfolio can qualify as knowledgeable employees, where previous guidance required such analysts to have researched “all potential portfolio investments.”
  • Executive  Officer/Principal  Business  Unit. The SEC indicated that the knowledgeable employee definition provides flexibility in assessing whether a business unit is “principal,” noting in particular that a sponsor may have several principal business units. As examples, the SEC agreed that principal business units could include (1) an investor relations department that conducts substantive portfolio reviews with investors and responds to substantive due diligence inquiries, as opposed to merely arranging meetings and performing other relatively administrative tasks, and (2) an IT department where IT is an important element of the investment process.
  • Policy-Making Function. The letter describes a substance-over-form approach in the SEC’s determination of which employees have a policy-making function. Accordingly, an employee need not have a senior-level management title or sole responsibility for policy-making in order to perform a policymaking function. Instead, regular involvement in the development and adoption of a sponsor’s policies, whether individually or as a member of a policy- making committee or group, will suffice. As an example, the SEC agreed that an active member of a valuation committee could be a knowledgeable employee, although the SEC distinguished as nonpolicy making those individuals who merely observe proceedings or merely provide information to committee decision-makers.

The SEC’s guidance should provide many private fund sponsors more latitude and increased comfort in deter- mining which of their employees qualify as knowledge- able employees.