This article focuses on a topic covered in Investment Company Determination Under the 1940 Act: Exemptions and Exceptions, Third Edition by Robert H. Rosenblum and Benjamin D. Rosenblum, published by the ABA Business Law Section in 2025. The full book may be consulted for further information on this topic.
A recurring issue under the Investment Company Act of 1940 (“Investment Company Act”)[1] is whether particular types of loans are considered “securities.” If an operating company holds too many loans that are securities, that company inadvertently could become an investment company.[2] This issue arises, for example, for certain nonbank lending entities, for companies that sell merchandise on credit (the receivable created could be a note or other instrument that is a security), and for companies that make intercompany loans to affiliates.
While the U.S. Supreme Court addressed the issue of when a loan or note is a security under the Securities Act of 1933 (“Securities Act”)[3] and the Securities Exchange Act of 1934 (“Exchange Act”),[4] the Court did not expressly address the issue of when a note or loan is a security under the Investment Company Act. And, despite the fact that the definition of “security” in each of the Securities Act, the Exchange Act, and the Investment Company Act (collectively, “Acts”) includes the term “note,”[5] the U.S. Securities and Exchange Commission (“SEC”) and its staff have suggested, with at least some merit but almost no actionable guidance, that the definition of the term “note” may be broader under the Investment Company Act than it is under the Securities Act or the Exchange Act.
This article analyzes the law governing when a loan constitutes a security for purposes of the Investment Company Act. It discusses the views expressed by the SEC on the question and suggests that some of these views are overbroad (and in some cases likely wrong). It also discusses some of the challenges created by the SEC’s views, particularly with respect to intercompany loans.
Reves and the Family Resemblance Test
While none of the Acts have identical definitions of the term “security,” each definition includes “notes” as securities, and each definition is identical with respect to the inclusion of “note.” Despite the inclusion of the term “note” in each definition, however, determining whether a note, loan, or similar instrument is actually a security is not always a straightforward analysis, particularly for purposes of the Investment Company Act.
The seminal Supreme Court case of Reves v. Ernst & Young[6] sets out the core analysis of when such an instrument meets the definition of “security” for purposes of the Securities Act and the Exchange Act. However, that opinion (and subsequent case law building on Reves) did not discuss the definition in the Investment Company Act.
In Reves, the Supreme Court held that promissory notes payable on demand issued by a farmers’ cooperative were notes, and thus securities, within the meaning of the Securities Act and the Exchange Act.[7] The Court stated, however, that not all notes are necessarily securities because they “are used in a variety of settings, not all of which involve investments.”[8]
In order to determine whether a note is a security, the Court adopted the “family resemblance” test.[9] Under the family resemblance test, a note is presumed to be a security.[10] That presumption may be rebutted by a showing that the note bears a strong resemblance to one of an enumerated category of instruments that are not securities, such as consumer financing notes, mortgages, short-term notes secured by a lien on a small business or some of its assets, short-term notes secured by an assignment of accounts receivable, a note that simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized), or notes evidencing loans by commercial banks for current operations.[11]
In order to determine whether a note bears a strong resemblance to one of these enumerated categories, four factors should be examined.[12]
First, the motivations of both the buyer and the seller must be examined. According to the Court,
[i]f the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investment and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a “security.” If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash-flow difficulties, or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a “security.”[13]
Second, the plan of distribution is examined “to determine whether it is an instrument in which there is common trading for speculation or investment.”[14]
Third, the reasonable expectations of the investing public are examined. In this regard, the Court stated that it would “consider instruments to be ‘securities’ on the basis of such public expectations, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not ‘securities’ as used in that transaction.”[15]
Fourth, it is necessary to examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Act and the Exchange Act unnecessary.[16]
If, based upon these factors, an instrument is not sufficiently similar to an item on the list, the decision of whether another category should be added is to be made by examining the same factors.[17]
Since the Reves decision, courts have applied the family resemblance test to determine whether loans are securities for purposes of the Securities Act and the Exchange Act.[18] However, courts have generally not had occasion to determine whether the same test applies for purposes of the Investment Company Act. Furthermore, while the SEC and its staff have made several statements evidencing the view that many loans that may not be securities under Reves for purposes of the Securities Act and the Exchange Act are securities for purposes of the Investment Company Act, there has been little SEC or staff guidance regarding whether Reves should apply and how to analyze whether any particular loan, note, or similar instrument is a security for purposes of the Investment Company Act.
Analysis of the SEC’s Views
The SEC’s Position
Over the years, the SEC and its staff have tried to distance the loan/security analysis under the Investment Company Act from the test set forth by Reves and its progeny. The SEC staff has argued, for example, that
while excluding commercial [loan] instruments from the disclosure requirements of the Securities Act and the Exchange Act is consistent with the purposes of those Acts, issuers that pool these instruments nevertheless may be functionally equivalent to, and present the same investor protection concerns as, investment companies that invest in securities that are registered under those Acts.[19]
The rationale behind this view presumably is that, in the hands of an issuer, a receivable owed by another person in exchange for a loan is, from an economic and risk-based perspective, no different than owning a debt security of the other person. An investment in Issuer A, the assets of which primarily consist of loan receivables owed by other persons, presents the same risks as an investment in Issuer B, the assets of which primarily consist of debt securities of those same persons. Given that Issuer B would generally need to be registered as an investment company, it arguably makes sense from a policy and investor protection standpoint to require Issuer A to register as well.
However, this policy objective runs squarely into a legal issue, alluded to above and discussed further below—that is, the Reves Court held that certain types of notes are not securities, and Congress did not include a provision in the Investment Company Act expressly stating that notes should be deemed to be securities for purposes of the Investment Company Act even when they are not securities for purposes of the Securities Act and the Exchange Act. If certain notes are not securities under the Investment Company Act, then a company or pool holding those notes is not an investment company, regardless of the policy and investor protection considerations of concern to the SEC and its staff.
Informally, and with some merit, the SEC staff has suggested that there also is a statutory basis under the Investment Company Act to treat loans as securities even if they are not securities under Reves. As discussed below, the structure of the Investment Company Act could indicate that Congress intended to include at least some issuers in the definition of an investment company where those issuers’ assets consist primarily of loans. However, that is not the only plausible interpretation of the drafting decisions made by Congress. And even to the extent that a broader category of loans are securities under the Investment Company Act than would be under the Reves test, the structure of the Investment Company Act does not imply that all loans are securities for purposes of the Investment Company Act.
Certain Exemptions Under the Investment Company Act
The SEC’s view that a loan may be a security for purposes of the Investment Company Act, even where it is not a security for purposes of the Securities Act or the Exchange Act, likely stems from several provisions of the Investment Company Act exempting issuers that are engaged in certain lending businesses from the definition of “investment company.”
Section 3(c)(3) of the Investment Company Act, for example, exempts from the definition of “investment company,” in relevant part, “[a]ny bank or insurance company; any savings and loan association, building and loan association, cooperative bank, homestead association, or similar institution, or any receiver, conservator, liquidator, liquidating agent, or similar official or person thereof or therefor; or any common trust fund. . . .”[20]
Most categories of assets that would typically be held by a bank—cash; property, plant, and equipment; etc.—are clearly not “securities” and, therefore, would not contribute to the 40 percent limit for “investment securities” under § 3(a)(1)(C). However, in addition to these assets, banks may also hold large amounts of loan receivables. By exempting such “banks” from the definition of “investment company,” an implication could be that, absent the exemption, at least some banks could meet the “investment company” definition in § 3(a)(1)(C).
Similarly, § 3(c)(4) of the Investment Company Act exempts from the definition of investment company “[a]ny person substantially all of whose business is confined to making small loans, industrial banking, or similar businesses.”[21] The SEC staff has interpreted this provision to apply only to consumer financing agencies,[22] and like § 3(c)(3), an implication of this provision could be that absent this exemption, the loan receivables held by such entities could constitute “securities” under the Investment Company Act.
While one plausible reading of these provisions is that the loans held by these lending institutions are or could be securities, a perhaps more straightforward interpretation is that Congress thought that banks and other lending institutions were comprehensively regulated by federal and state regulators, and that the application of the Investment Company Act to those entities was therefore inappropriate, regardless of whether they held securities (whether those securities were in the form of “loans” or otherwise).
Another example that the staff often informally points to is § 3(c)(5) of the Investment Company Act, which exempts from the definition of the term “investment company”:
Any person who is not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates, and who is primarily engaged in one or more of the following businesses: (A) purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance, and services; (B) making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services; and (C) purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.[23]
As is the case for the exemptions in §§ 3(c)(3) and 3(c)(4), an implication of the exemption in § 3(c)(5) could be that the instruments described in the section—such as notes, open accounts receivable, loans, mortgages, and other liens on real estate—are or may in some instances be securities under the Investment Company Act.
Again, however, another and perhaps more likely basis for the § 3(c)(5) exceptions is that when enacting the Investment Company Act in 1940, Congress concluded that “factoring” companies (as described in clause A), “sales financing” companies (as described in clause B), and mortgage lenders (as described in clause C) are not entities that Congress thought should be regulated under the Investment Company Act, regardless of whether the instruments that those entities held were or were not securities. This interpretation is consistent with the structure of the “3(c)” exemptions (i.e., the other exemptions under § 3(c) of the Investment Company Act). Aside from §§ 3(c)(1) and 3(c)(7), each of the 3(c) exemptions exempt a specific business from the definition of “investment company,” rather than discussing which assets constitute “investment securities.” And §§ 3(c)(1) and 3(c)(7)—the exemptions primarily used by private funds—provide exemptions based on the owners of an issuer rather than the business or the nature of its assets.
Furthermore, this interpretation of Congress’s intent is supported by the identical use of the word “note” in the definition of “security” in each of the Acts. Had Congress intended that the term “note” in the Investment Company Act’s definition should mean something different than the term “note” in the Securities Act’s and Exchange Act’s definitions, it would have been a simple matter to explicitly provide for a different meaning. Opting instead to imply a different meaning for the term through the inclusion of certain exemptions in the statute seems an unlikely way for Congress to indicate a difference in the definitions.
Examination of Sections 3(c)(5)(A) and (B)
Sections 3(c)(5)(A) and (B), in particular, merit a deeper examination.
Section 3(c)(5)(A) applies to companies primarily engaged in the business of purchasing or acquiring notes, drafts, acceptances, open accounts receivable, etc. This exemption seems to indicate Congress’s belief that, in the hands of a purchaser or acquirer, such notes, drafts, acceptances, open accounts receivable, etc., could be investment securities, and therefore, a specific exemption for factoring businesses was needed to ensure that such businesses would not inadvertently become investment companies.
Section 3(c)(5)(A) does not apply to companies that originate such instruments. Take, for example, a company (“Tractor Co.”) that manufactures and sells tractors. Tractor Co. sells some of its tractors for cash and some of its tractors on credit. When selling such tractors on credit, Tractor Co. has created, depending on the terms, an open account receivable, a note, or another type of loan receivable owed by its customer. Section 3(c)(5)(A) does not apply to Tractor Co. because (i) Tractor Co. is engaged in the business of manufacturing and selling tractors, not in purchasing instruments described in the section, and (ii) it originated the instrument rather than purchasing it. However, if a factoring company (“Factoring Co.”) purchases instruments such as the one originated by Tractor Co., § 3(c)(5)(A) implies that such instruments in the hands of Factoring Co. could be investment securities, but provides that Factoring Co. may be eligible for the exemption if it meets the § 3(c)(5)(A) conditions.
As § 3(c)(5)(A) applies only to companies that purchase or acquire loans, it does not say anything about, or imply any particular treatment of, loans in the hands of the company that makes the loan, like Tractor Co.
Section 3(c)(5)(B) applies to companies primarily engaged in the business of making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services. This exemption seems to indicate Congress’s belief that, in the hands of a company primarily engaged in the business of making such loans, the loans could be investment securities, and therefore, a specific exemption for sales financing businesses was needed to ensure that such businesses would not inadvertently become investment companies.
Section 3(c)(5)(B) also does not apply to companies like Tractor Co., which are primarily engaged in other businesses (e.g., manufacturing and selling tractors) and not in the business of making loans. And § 3(c)(5)(B) does not say anything about, or imply any particular treatment of, loans in the hands of a company that is not primarily engaged in the business of making loans but that nevertheless makes a loan.
As a result, neither § 3(c)(5)(A) nor § 3(c)(5)(B) would apply to a company like Tractor Co., which makes loans rather than acquiring them but is not “primarily engaged” in the business of making loans. But that does not mean that a loan extended by Tractor Co. is an investment security in the hands of Tractor Co. It is highly unlikely that Congress intended for Tractor Co. to be an investment company solely because it sells merchandise to customers on credit. The test in Reves, including whether Tractor Co. had an investment or a commercial intent when making the loan, seems to fit naturally in determining whether such an instrument should be a security in the hands of Tractor Co.
The SEC and its staff, however, have put forward a much broader analysis. In particular, the SEC and its staff have stated on multiple occasions that “notes representing the sales price of merchandise, loans to manufacturers, wholesalers, retailers and purchasers of merchandise or insurance, and mortgages and other interest in real estate are investment securities for purposes of the [Investment Company] Act.”[24] Given the specific language used (mirroring that in § 3(c)(5)), the SEC and its staff seem to be taking the position that §§ 3(c)(5)(A) and (B) provide a default position that loans are securities, and therefore, an issuer holding large enough amounts of loans must generally meet one of the exemptions in § 3(c)(5) (or another exemption) in order to avoid investment company status.
For the reasons discussed above, this analysis is almost certainly overbroad. If this analysis were correct, §§ 3(c)(5)(A) and (B) would seem to imply that Tractor Co. extending credit to its purchaser would result in Tractor Co. owning an investment security—yet being ineligible to rely on either § 3(c)(5)(A) (as the maker, rather than purchaser, of the loan) or on § 3(c)(5)(B) (as a company not primarily engaged in the business of extending loans).[25]
Applicability of Reves
As discussed above, it is not clear that Congress actually intended the definition of “security” under the Investment Company Act to be broader than the definitions under the Securities Act or the Exchange Act. But even if a broader set of loans may be securities under the Investment Company Act, that does not mean that Reves does not apply, at least in part, when determining whether a loan is a security for purposes of the Investment Company Act. Given the similarity in the definition of “security” between the Acts, it is hard to imagine that Reves is not at least relevant in the determination of when a loan is a security for purposes of the Investment Company Act.
One could envision the SEC taking Reves into consideration in any such determination. For example, a sensible approach might be to start any analysis of whether a loan is a security with the Reves family resemblance test and then, where the analysis is for purposes of the Investment Company Act, separately make a determination of whether, notwithstanding the instrument not being a security under the Reves test, the activities of the issuer indicate that the instrument should be treated as an investment security for purposes of determining whether the issuer is an investment company.
Implications for Companies with Intercompany Loans
One area of particular difficulty for many issuers, in light of the SEC’s aggressive views with respect to loans under the Investment Company Act, arises in the case of intercompany loans (i.e., a loan between two related companies). Companies with multiple subsidiaries may put intercompany loans in place for a variety of valid business reasons. For example, a company wishing to focus its resources on parts of the enterprise that the company feels could be most impacted by additional capital might establish a loan from one subsidiary to another.
While Congress’s drafting of the Investment Company Act did not obviously scope intercompany loans into the definition of “investment security,” and while the limited case law that exists on the topic seems to weigh against treating an intercompany loan as an investment security,[26] the SEC has indicated that it generally views intercompany loans as investment securities. For example, in a 2022 enforcement action, the SEC charged BlockFi Lending LLC with, among other things, acting as an illegally unregistered investment company.[27] In determining that BlockFi met the definition of an investment company in § 3(a)(1)(C), the SEC pointed to several different assets held by BlockFi that the SEC asserted were investment securities, including (without any analysis, citations, or explanation) “intercompany receivables.”[28]
The view that intercompany loans are “investment securities” can mean that a corporate subsidiary making such intercompany loans might face Investment Company Act status challenges. However, in most cases, a corporate subsidiary with a large percentage of its assets consisting of intercompany loan receivables would not raise the same risks from an investor protection standpoint as an investment company. An investor in a company that primarily invests in traditional securities, or else primarily extends loans to third parties, is relying on the ability of company management to pick the right third parties to invest in (or loan money to), and the investor’s returns will depend on the performance of those third parties. Investors in a company that has extended a large intercompany loan to a corporate affiliate have completely different considerations. The investors are not relying on company management to pick the right entity to loan to—they are relying on the ultimate parent of the company to efficiently engage in commercial activities and generate a profit from those activities. The point of most intercompany loans is not for the lender to generate returns from lending money to an affiliate, but instead to aid the overall enterprise in its commercial activities.
Additionally, the SEC’s view that intercompany loans are “investment securities” can mean that a parent of a subsidiary making such intercompany loans might face Investment Company Act status challenges as well. For example, if the subsidiary fails the test in § 3(a)(1)(C), the parent may have to treat its interest in the subsidiary as an “investment security” for purposes of its own § 3(a)(1)(C) analysis. And in this case, an investment in the corporate parent certainly does not raise the same risks from an investor protection standpoint as an investment company. Rather than looking to the performance of one party on a loan, an investor in the parent company likely would not care one way or the other that an intercompany loan exists between two of the parent’s subsidiaries. The economics of that loan cancel out at the level of the parent, and the investor’s returns are not related to the performance of the loan at all.
Due to the potential draconian consequences of transacting with an unregistered investment company,[29] lenders, underwriters, or other counterparties to a transaction often require an issuer to obtain an unqualified opinion from its counsel prior to any such transaction, which states that the issuer is not, and is not required to register as, an investment company. Given the SEC’s expressed view that intercompany loans are generally investment securities, many practitioners treat them as such for purposes of determining whether an issuer is an investment company, despite the unclear legal or policy-based reasoning behind the SEC’s view.[30] This creates unnecessary challenges for issuers that are plainly operating companies but that have large enough intercompany loans in place such that a practitioner treating intercompany loans as securities would not be able to deliver an unqualified opinion that the issuer is not an investment company.
Conclusion
The SEC should reconsider its stance on loans under the Investment Company Act and, in particular, its stance on intercompany loans. The legal basis for the SEC’s apparent position that Reves does not apply to the determination of when a loan is a security for purposes of the Investment Company Act is unclear, and in many cases the policy basis is unclear as well. Until the SEC revisits this stance, issuers that have substantial intercompany loans in place will continue to face challenges in avoiding investment company status, despite not raising the concerns that the Investment Company Act was designed to address.
Investment Company Act, 15 U.S.C. § 80a-1–a-64 (1940). ↑
See id. § 3(a)(1)(C) (providing that an issuer that owns or proposes to acquire “investment securities” having a value exceeding 40 percent of the issuer’s total assets may, depending on its business, be an “investment company” for purposes of the Investment Company Act). ↑
Securities Act, 15 U.S.C. §§ 77a–77m (1933). ↑
Securities Exchange Act, 15 U.S.C. §§ 78a–78jj (1934). ↑
Securities Act, 15 U.S.C. § 77b(a)(1); Securities Exchange Act, 15 U.S.C. § 78c(a)(10); Investment Company Act, 15 U.S.C. § 80a-2(a)(36). ↑
494 U.S. 56 (1990). ↑
Based upon the family resemblance test articulated in the Reves decision, the Reves Court found that the notes were securities because they were sold to raise capital for the cooperative, sold to a broad segment of the public, characterized by the issuer as investments, and not regulated by any other regulatory scheme. Id. at 67–70. ↑
Id. at 62. The Court stated that “the phrase ‘any note’ should not be interpreted to mean literally ‘any note,’ but must be understood against the backdrop of what Congress was attempting to accomplish in enacting the Securities Acts.” Id. at 62–63 (footnote omitted). This statement is notable in light of the Court’s frequent statement that “[t]he starting point in every case involving construction of a statute is the language itself.” See, e.g., Landreth Timber Co. v. Landreth, 471 U.S. 681, 685 (1985). ↑
494 U.S. at 64. The Court noted that the family resemblance test and an alternative test evaluating whether a note was made for investment versus commercial purposes “are really two ways of formulating the same general approach.” Id. However, the Court adopted the family resemblance test because the Court believed that test “provides a more promising framework for analysis.” Id. at 64–65. ↑
Id. at 67. ↑
Id. at 65, 67. ↑
Id. at 66, 67. ↑
Id. at 66. ↑
Id. (citation and internal quotation marks omitted). ↑
Id. ↑
Id. at 76. ↑
Id. ↑
See, e.g., Kirschner v. JP Morgan Chase Bank, N.A., 2020 U.S. Dist. LEXIS 90797 (S.D.N.Y. May 22, 2020), aff’d No. 21-2726-cv, 2023 WL 5439495 (2d Cir. Aug. 24, 2023). ↑
U.S. Sec. & Exch. Comm’n Div. of Inv. Mgmt., Protecting Investors: A Half Century of Investment Company Regulation, at n.339 (1992); see also Brief for the United States as Amicus Curiae, at *22–23, Marine Bank v. Weaver, 455 U.S. 551 (1982) (No. 80-1562), 1981 WL 390025 (SEC explaining that “[w]hile the language in the Investment Company Act’s definition of the term ‘security’ is identical to that in the Securities Act, the regulatory context under the Investment Company Act differs fundamentally from that under the Securities Act and the . . . Exchange Act”—and that, as a result, the definitions should be interpreted differently (in this case, the instrument at issue was a bank certificate of deposit)). ↑
15 U.S.C. § 80-3(c)(3). In addition, Investment Company Act Rule 3a-6 provides a similar exemption for foreign banks. 17 C.F.R. § 270.3a-6. ↑
15 U.S.C. § 80-3(c)(4). ↑
See, e.g., GINS Cap. Corp., SEC Staff No-Action Letter (Sept. 16, 1985); Brody, Robert D., SEC Staff No-Action Letter (Nov. 22, 1979); Prudential Mortg. Bankers & Inv. Corp., SEC Staff No-Action Letter (Dec. 4, 1977); Douglass-Carver Cmty. Devs., SEC Staff No-Action Letter (July 25, 1974); Commonwealth Fund, SEC Staff No-Action Letter (July 15, 1971); see also Navidec Fin. Servs., Staff Response to Registrant’s Response to Staff Threshold Comment Letter on Registration Statement on Form 10-SB (July 13, 2006) (the mere fact that registrant is regulated by federal consumer protection regulations, such as the Truth in Lending Act and Real Estate Settlement Procedures Act, is not enough to establish that registrant can avail itself of § 3(c)(4) exception). ↑
15 U.S.C. § 80a-3(c)(5). ↑
See, e.g., U.S. Sec. & Exch. Comm’n Div. of Inv. Mgmt., supra note 19, at n.251 (emphasis added) (citing SEC Report on the Public Policy Implications of Investment Company Growth, H.R. Rep. No. 2337, at 328 (1966)). ↑
A surface-level reading of §§ 3(c)(5)(A) and (B) could give the impression that Congress intended for loan receivables to generally be considered securities for purposes of the Investment Company Act, and for an issuer holding large amounts of loan receivables to be an investment company unless (i) the issuer has purchased or acquired the loan receivables and meets the conditions of § 3(c)(5)(A) or (ii) the issuer has made the loans and meets the conditions of § 3(c)(5)(B). However, as discussed above, this analysis overlooks the fact that many entities making loans, such as Tractor Co., are not entities covered by § 3(c)(5)(B), as they are not “primarily engaged” in the business of making loans but instead are primarily engaged in their own operating activities. Given that Congress believed a sales financing company, primarily engaged in the business of making certain types of loans, does not raise investment company registration concerns, it seems inconceivable that Congress believed that an operating company, primarily engaged in a noninvestment, non-loan business and extending such loans as part of its business, somehow does raise investment company registration concerns.
Read with this understanding, it seems plain that Congress did not intend §§ 3(c)(5)(A) and (B) to imply that all loan receivables should generally be considered securities for purposes of the Investment Company Act, and that any issuer holding large amounts of loan receivables needs to fit within one of the exemptions. ↑
See, e.g., SEC v. Fifth Ave. Coach Lines, Inc., 289 F. Supp. 3, 33 (S.D.N.Y. 1968), aff’d, 435 F.2d 510 (2d Cir. 1970). In Fifth Avenue Coach Lines, the court held (among other things) that an advance by a parent company for the benefit of a subsidiary, which was a type of intercompany loan, was a cash item and not an investment security. The court noted that to treat these advances as “evidence of indebtedness,” and thus investment securities, “is an unrealistic and incorrect construction of the statutory language.” Id. at 33–36. ↑
In re BlockFi Lending LLC, SEC Release No. 33-11029, ¶ 29, at 7–8 (Feb. 14, 2022). ↑
Id. ¶ 26, at 7. ↑
Section 7(a) of the Investment Company Act generally prohibits illegally unregistered investment companies from, among other things, offering, selling, or purchasing any securities (including their own securities) through the use of the mails or interstate commerce, or engaging in any business in interstate commerce. Section 47(b) of the Investment Company Act provides that a contract that violates the Investment Company Act is unenforceable by any party to the contract, or by a non-party to the contract with knowledge that the contract violated the Investment Company Act, unless a court finds that enforcement of the contract would produce a more equitable result and that the result would not be inconsistent with the purposes of the Investment Company Act. As a result, underwriters, banks and other lenders, and certain other parties that contract with a company may be concerned that if that company is an illegally unregistered investment company, that company’s sale of securities or agreement to borrow money or agreement to enter into other arrangements may be illegal under § 7(a). If so, such an underwriter, bank, other lender, or other party may be concerned that any agreement it entered into with the company (such as an agreement to underwrite the sale of the company’s securities or loan the company money) could be void under § 47(b). This might lead to, for example, a purchaser of the company’s securities in an underwritten offering being able to force the underwriter to unwind the transaction in which the purchaser bought those securities, or the illegally unregistered investment company arguing that it was permitted to unwind a loan transaction notwithstanding any restrictions on termination in the lending agreement. See, e.g., Herpich v. Wallace, 430 F.2d 792, 814 (5th Cir. 1970) (“Section 7 of the [Investment Company Act] imposes the penalty of exclusion from all channels of interstate commerce of investment companies that fail to register in compliance with section 8 [of the Investment Company Act], and contracts made by unregistered companies are subject to the voiding provisions of section 47(b). . . .”). But see Saba Cap. Master Fund, Ltd. v. Blackrock ESG Cap. Allocation Tr., No. 23-8104, 2024 WL 3174971 (2d Cir. June 26, 2024), cert. granted sub nom. FS Credit Opportunities Corp. v. Saba Cap. Master Fund, Ltd., No. 24-345, 2025 WL 1787708 (U.S. June 30, 2025) (granting a writ of certiorari in a case challenging whether a private right of action exists under § 47(b)). ↑
Practitioners that treat intercompany loans as investment securities often take the position that a loan from a parent company to a majority-owned subsidiary is not an investment security because any security issued by a majority-owned subsidiary is not an investment security under § 3(a)(2). ↑
