Yesterday the SEC released the final text of “new” Rule 3a-8 under the Investment Company Act of 1940, a rule the SEC formally adopted on May 27. Rule 3a-8 will protect certain investment-rich development companies principally engaged in research and development activities from being ensnared as “inadvertent investment companies” under the 1940 Act.

 What does it mean?

post9aUnder new Rule 3a-8, if a company can demonstrate that its R&D; expenses are a “substantial percentage” of its total expenses (note that “substantial” was purposely left undefined in Rule 3a-8), its net investment income is no more than twice its R&D; expenses, and it satisfies a few other tests designed to ensure that investing money is not its principal business, it will not be considered an investment company under the 1940 Act.

The history behind it all

This R&D; exception under the 1940 Act has a long history. The whole thing started in February 1993 when ICOS Corp., then a young a biotech company, obtained an order from the SEC that permitted it to hold a significant amount of investment securities without having to register as an investment company, so long as it used those securities to fund its research and development activities (Rel. IC-19274 (Feb. 18, 1993)). A few months later, the SEC proposed adopting a new Rule 3a-8 that would codify and expand the ICOS Corp. order (Rel. IC-19566 (July 8, 1993)).

Sometime afterward, the rule proposal died and R&D; companies fell back on the ICOS Corp. order when structuring their operations. Flashing forward 8 years or so, the biotech industry and the SEC began informal discussions that resulted in this May 2002 petition from Wilmer, Cutler & Pickering on behalf of the Biotechnology Industry Organization “BIO”. The BIO petition asked the SEC to resurrect the long-dead proposal to adopt Rule 3a-8, which the SEC eventually did in this proposing release last November. After receiving a few comment letters, the SEC finally decided to adopt the rule pretty much as proposed.

post9bBy the way, if you’re puzzled as to what this “inadvertent” investment company thing is, I highly recommend Robert H. Rosenblum’s Investment Company Act Determination Under the 1940 Act: Exemptions and Exceptions, the definitive (but out-of-print) monograph on this topic published by Aspen Law & Business in 1997.

More information

This Investment Company Act is applied to all companies that are investment type, and it also exempts various types of companies from its coverage.  There are three classifications in which investment companies can be divided and regulated and such are: face-amount certificate companies, unit investment trusts, and management companies. We are talking about the backbone of one of the most important things – this is how many of us save our money for our dreams or our retirements. It helps us to know that our investments are safe and sound.