An Alternative Retail Offering: "Conglomerate Vehicles" and Their Regulatory Considerations

• Published in: The Investment Lawyer 2024-06, Vol.31 (6), p.8-16
• Main Authors: Doherty, Michael C, Childs, Chelsea M, Lawson, Andrew C
• Format: Article
• Language: English
• Subjects: Conglomerates; Equity funds; Government securities; Investors; Liquidity; Operating companies; Regulation D; Stockholders; Subsidiaries
• ISSN: 1075-4512

[...]in the congressional hearings leading to the passage of the 1940 Act, David Schenker, Chief Counsel to the Investment Trust Study conducted by the Securities and Exchange Commission (SEC), explained the 1940 Act's intended reach: Courts and industry practitioners generally look to the five factors enumerated in In re Tonopah Mining Co. of Nevada^ and the additional public perception layer of review recognized in SEC v. National Presto Industries, Inc.,n to determine whether an issuer is "engaged primarily" in an investment company business.13 The Tonopah factors are (1) the issuer's history; (2) the way the issuer holds itself out to the public; (3) the activities of the issuer's officers and directors; (4) the nature of the issuer's assets; and (5) the sources of the issuer's income.14 The Tonopah test balances both qualitative and quantitative factors in analyzing whether an issuer is primarily engaged in a non-investment-company business. Byits terms, Section 3(a)(1)(C) excludes from the definition of investment company many operating companies but may pick up companies that operate through non-majority-owned subsidiaries (because, as discussed below, unlike majority-owned subsidiaries, interests in these entities are considered investment securities) or other companies that meet the 40 percent test (sometimes referred to as prima facie investment companies) but have a different primary business (for example, reinsurance, and tech companies engaged in research and development).16 The SEC Staff has taken an expansive view of what constitutes being "in the business" of holding investment securities for purposes of Section 3(a) (1)(C), although it typically requires some ongoing investment company activity17 An issuer's continued holding of, or investment in, investment securities could be considered activity that may constitute being "in the business. The SEC considers investment in the securities of a majority-owned subsidiary as being "more akin to activities of a holding company than an investment company"19 Section 2 (a) (24) of the 1940 Act defines a majority-owned subsidiary of a parent as a company in which the parent owns 50 percent or more of the outstanding voting securities,20 either directly or through one or more majority-owned subsidiaries of the parent.