Christopher P. Healey · July 2011
79 GEO. WASH. L. REV. 1535 (2011)
In the late 1930s, the U.S. Securities and Exchange Commission (“SEC”) was commissioned by Congress to study the then-unregulated investment company industry. This series of studies “laid the foundation” for the current system of investment company regulation under the Investment Company Act of 1940 (“1940 Act”). A critical component of investment company regulation is the definition of an investment company. Companies that fit the definition of an investment company are required to register with the SEC, unless they can rely on an exception or exemption from registration. Registered investment companies are subject to the 1940 Act’s disclosure requirements and to restrictions on many aspects of their corporate structure and day-to-day operations. These restrictions can drastically alter a company’s capital structure, investment activities, interactions with subsidiaries, and the duties of its directors. For companies not primarily engaged in investment company business, these restrictions impose a heavy burden. For example, the capital structure restrictions imposed by section 18(d) of the 1940 Act would preclude a company from issuing stock options as a form of compensation.
Currently, some companies that are clearly not engaged in investment company business face the prospect of registering as investment companies if their balance sheet looks too much like the balance sheet of an investment company. In order to avoid such a predicament, these companies are forced to operate in a way that is economically inefficient and against the best interest of shareholders. In particular, technology and internet companies, which comprise an important and growing industry, face this problem more frequently than other types of companies. If these companies cannot rely on any of the statutory exemptions to the definition of an investment company, they must apply to the SEC for exemptive relief. This entails a process that can take years and does not exempt a company from the 1940 Act’s restrictions until the process is complete.
This Essay proposes two ways to improve the SEC’s current handling of exemptive applications. First, the SEC should enact reforms to the mechanics of the exemptive process that would streamline it and reduce the administrative burden on the SEC’s Division of Investment Management (“IM”), which handles requests for exemption under the 1940 Act. These reforms include creating a form for exemptive applications, issuing new guidelines for the application process, and allowing electronic filing of applications. Second, the SEC should enact a rule granting certain bona fide applicants an automatic extension of the statutory sixty-day temporary exemption period if IM is unable to grant a final order within the first sixty days. Bona fide applicants are those who file their exemptive applications in good faith and have obtained an opinion of counsel stating that they are similarly situated to past applicants who have been granted exemptive orders. This proposed rule would relieve the burden placed on applicants and allow the SEC to more fully utilize its statutory authority under the 1940 Act.
Part I of this Essay provides background information on the definition of an investment company and the statutory provisions on which a company seeking to be exempted from the 1940 Act’s requirements could rely in theory, but not in practice. Part II gives an overview of IM’s current process for exemptive orders and highlights several areas for improvement. Next, Part III discusses the application and exemptive processes of other federal agencies and identifies certain practices that could improve IM’s exemptive process. Finally, Part IV makes several recommendations for reform.
