3C1 refers to a portion of the Investment Company Act of 1940 that allows private funds to avoid the requirements of the Securities and Exchange Commission (SEC). 3C1 is shorthand for the 3(c)(1) exemption found in section 3 of the act. It reads in part:
(c) Notwithstanding subsection (a), none of the following persons is an investment company within the meaning of this title:
(3) Any issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities.
Funds that meet the terms of 3C1 are not considered investment companies. This allows private funds with 100 or fewer investors and no plans for an initial public offering to sidestep SEC registration and other requirements, like ongoing disclosure and restrictions on derivatives trading. 3C1 funds are also referred to as 3C1 companies or 3(c)(1) funds.
Breaking Down 3C1
3C1 is often used by hedge fund companies to avoid the SEC scrutiny that other investment funds, like mutual funds and other publicly traded funds, are under. That said, the investors in 3C1 funds must be accredited investors, meaning investors who have an annual income over $200,000 or a net worth in excess of $1 million.
The Difference Between 3C1 Funds and 3C7 Funds
Private equity funds are usually structured as 3C1 funds or 3C7 funds, the latter being a reference to the 3(c)(7) exemption. Both 3C1 and 3C7 funds are exempt from SEC registration requirements under the Investment Company Act of 1940, but the nature of the exemption is slightly different. Whereas the 3C1 exemption hinges on not exceeding 100 accredited investors, a 3C7 fund must maintain a total of 2,000 or fewer qualified purchasers. Qualified purchasers must clear a higher bar, with over $5 million in assets, so a 3C7 fund is permitted to have more of these people or entities participating as investors.
Challenges for 3C1 Compliance
Although 100 accredited investors sound like an easy limit to watch out for, this can be a tricky area for fund compliance. Private funds are generally protected in the case of involuntary share transfers, for example, the death of a large investor results in shares being split up among family members. They do, however, run into problems with shares given as employment incentives. Knowledgeable employees, including executives, directors, and partners, do not count against the fund's tally. However, if the employee leaves carrying the shares with him, he will count against the 100 investor limit. Because so much counts on the investment company exemption and 3C1 status, private funds put a great deal of effort into making certain they are in compliance.