SEC Expands Ability of Employees to Invest into In-House Private Funds

  • The SEC's Division of Investment Management has issued a No-Action Letter that expands the pool of possible employee investors in in-house private funds.
  • While the SEC's new in-house investment flexibility may help those who seek employee participation in their funds but face headcount or qualification impediments, the change is not a green light in every instance.

On February 6, 2014, the staff of the SEC's Division of Investment Management issued a No-Action Letter to the Managed Funds Association expanding its interpretation regarding who may qualify as a "Knowledgeable Employee" under the Investment Company Act of 1940, as amended.

Private funds – which are typically exempt from Company Act registration under Sections 3(c)(1) or Section 3(c)(7) thereof (collectively, "Private Funds") – may offer interests to Knowledgeable Employees, as defined under Rule 3c-5 of the Company Act. Importantly, Knowledgeable Employees are: (1) excluded for purposes of determining whether a 3(c)(7) fund's outstanding securities are owned exclusively by "qualified purchasers"; and (2) not required to be counted for purposes of the 100 beneficial owner limitation in a 3(c)(1) fund.

By way of background, the term Knowledgeable Employee generally covers two categories of employees:

  • First, the term includes "Executive Officers" – directors, trustees, general partners, advisory board members, and persons serving in similar capacities, of a Private Fund or an affiliated person (e.g., a fund's investment manager) who manages the investment activities of a Private Fund (an "Affiliated Management Person"). NOTE: The rule defines executive officers to mean the president, vice president in charge of a "principal business unit, division, or function" (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for a Private Fund or for an Affiliated Management Person of a Private Fund.
  • Second, the term includes employees of a Private Fund or an Affiliated Management Person of a Private Fund (other than an employee performing solely clerical, secretarial or administrative functions) who, in connection with their regular functions or duties, participate in the investment activities of such Private Fund, other Private Funds or investment companies managed by such Affiliated Management Person of the Private Fund, provided that such employees have been performing such functions and duties for the Private Fund or the Affiliated Management Person, or substantially similar functions or duties for or on behalf of another company, for at least 12 months.

The SEC No-Action Letter expanded its interpretation of what employees may be considered apart of these two categories of Knowledgeable Employee. Such clarifications in the No-Action Letter are as follows:

  • Executive Officers (Principal Business Unit, Division or Function/Employees Who Make Policy)

As noted, under Rule 3c-5, Knowledgeable Employees include, among other things, "Executive Officers," which means a "president, any vice president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy making functions." The No-Action Letter confirms that:

  • determining what constitutes a "principal business unit" depends on the relevant facts and circumstances of a particular investment adviser's operations
  • several business units, divisions or functions within an investment adviser may each be considered a principal unit, division or function
  • the unit, division or function need not form part of the investment activities of an investment adviser's private fund(s) to be considered a principal unit, division or function (e.g., the No-Action Letter cites an investment adviser's information technology and investor relations departments as examples groups that may be deemed a principal business unit under certain circumstances)
  • an employee may serve a policy-making function regardless of such employee's title, and employees may satisfy this standard either individually or as part of a group
  • Employees Who Participate in Investment Activities

  • Participating in Part of a Private Fund's Portfolio. An employee may be participating in the investment activities of a Private Fund even if his or her functions relate only to a portion of a portfolio of the Private Fund rather than the entire Private Fund.
  • Analysts, Risk Managers, Tax Professionals and Attorneys. Importantly, employees who form part of analytical or risk teams, tax professionals or attorneys whose analysis or advice is material to an investment adviser's investment decisions may all be considered to participate in investment activities depending on the facts and circumstances.
  • Separate Accounts. For purposes of the rule, an employee's participation in the investment activities of a separate account (rather than a Private Fund) will qualify such employee for Knowledgeable Employee status if the separate account is established for a client that is a "qualified client" and is otherwise eligible to invest in the Private Fund(s) advised by the Affiliated Management Person and the account pursues an investment objective or strategy substantially similar to one pursued by one or more of the Affiliated Management Person's Private Funds.
  • Fund Participation by Knowledgeable Employees. A person who qualifies as a Knowledgeable Employee of an investment adviser or one of its relying advisers may be treated as such with respect to any Private Fund managed by the filing investment adviser or one if its relying advisers.
  • Other Employees. The list of employees identified in the No-Action Letter is not intended to be exclusive and other employees not specifically identified may also qualify as Knowledgeable Employees, depending on the facts and circumstances.
  • Additional Miscellaneous Guidance in the No-Action Letter


The No-Action Letter expands the pool of possible employee investors, especially regarding non-executive employees other than portfolio managers. This new flexibility may be helpful to you if you desire employee participation in your funds and you face headcount or qualification impediments. However, the analysis remains very fact specific and the new relief should not be viewed as a green light to admit all employees. Please read the letter carefully and consult counsel in specific cases.

Topics:  C-Suite Executives, Employee Definition, Investment Management, Investors, No-Action Letters, Portfolio Managers, Private Funds, SEC

Published In: Finance & Banking Updates, Labor & Employment Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Holland & Knight LLP | Attorney Advertising

Don't miss a thing! Build a custom news brief:

Read fresh new writing on compliance, cybersecurity, Dodd-Frank, whistleblowers, social media, hiring & firing, patent reform, the NLRB, Obamacare, the SEC…

…or whatever matters the most to you. Follow authors, firms, and topics on JD Supra.

Create your news brief now - it's free and easy »