DEFINITION of Section 12D-1 Limit

The Section 12D-1 limit is a rule added in 1964 to the Investment Company Act to provide registered investment companies with conditional exemptions from provisions of the act's Section 12(d)(3). The provisions prohibit a registered investment company from purchasing or acquiring a security or business interest from someone who is a broker, dealer, underwriter, investment company adviser or investment adviser registered under the Investment Advisers Act of 1940.

The 12D-1 limit lets registered investment companies, on a case-by-case basis, acquire securities from companies that are directly or indirectly involved in business activities referred to in Section 12(d)(3). Securities may only be purchased for portfolios and only from companies that derived no more than 15% of their total gross revenues over the previous three fiscal years from the specified businesses. In addition, the registered investment company and all affiliated companies cannot own more than 10% of the total outstanding voting stock of the portfolio company immediately following the securities acquisition.

BREAKING DOWN Section 12D-1 Limit

The original rule under the Investment Company Act was meant to prevent investment companies from investing in each other or otherwise merging. The 12D-1 limit allows investment for the purpose of adding the security to a portfolio. It limits the percentages that can be acquired to prevent the investment from becoming a subtle merger or takeover.

How the Section 12D-1 Limit Is Applied

A registered investment company that claims the 12D-1 limit exemption must review its portfolio on a semi-annual basis to ensure its holdings are within compliance. If not, the company must sell or otherwise dispose of the security within 90 days. Section 12(d)(3) of the Investment Company Act exempts all investments by registered investment companies in certain businesses including small loan, factoring and finance companies.

This compares with the unconditional exemptions of Rule 12D3-1 that allow investment companies to acquire securities issued by most any entity that derived 15% or less of its gross revenue in its most recent fiscal year from securities-related businesses.

Under Rule 12D3-1, a registered investment company cannot acquire more than 5% of the outstanding equity securities of the equity issuer. A registered investment company is also prohibited from acquiring more than 5% of the value of its total assets in an issuer’s securities. The investment company cannot acquire more than 10% of the issuer’s outstanding principal debt securities.

Further amendments to Rule 12D3-1 gave funds permission to acquire securities issued by sub-advisers when that sub-adviser could not take advantage of the fund.