SEC Issues Concept Release on 1940 Act Real Estate Structured Finance Exclusion

Concerned that mortgage-related pools are making judgments about their status under the Investment Company Act without sufficient SEC guidance, the Commission has issued a concept release on interpretive issues relating to mortgage-related pools that rely on the Section 3(c)(5)(C) exclusion from the Investment Company Act. The SEC is also concerned that some mortgage-related pools appear to resemble investment companies such as closed-end funds and may not be the kinds of companies that were intended to be excluded. Companies that are engaged in the business of acquiring mortgages and mortgage-related instruments have been relying on Section 3(c)(5)(C) to be excluded from the definition of investment company and consequently from the requirements of the Investment Company Act. Section 3(c)(5)(C) was enacted to exclude from the definition of investment company those companies that were engaged in the mortgage banking business and were not considered to be in the investment company business. Since Section 3(c)(5)(C) was enacted in 1940, the mortgage markets have evolved and expanded, and the provision has been used by a wide variety of types of pooled vehicles and other companies unforeseen at the time of enactment. These issuers include certain mortgage-backed securities issuers and certain REITs The Concept Release provides an overview of mortgage-related pools and requests data and comment on their management styles, corporate governance, and similarities to traditional investment companies. It also discusses the legislative, administrative and interpretive background of Section 3(c)(5)(C). The Concept Release asks, for example, whether a test could be devised to differentiate companies that are primarily engaged in the real estate and mortgage banking business from those companies that look like traditional investment companies, and what factors the SEC should consider in such a test. In the seminal study of the 1940 Act, Protecting Investors: A Half-Century of Investment Company Regulation, the SEC staff noted that many issuers of mortgage-backed securities and similar products have relied on Section 3(c)(5)(C), noting that an issuer seeking to rely on this exception must invest at least 55 percent of its assets in mortgages and other liens on and interests in real estate. Another 25 percent of the issuer's assets must be in real estate related assets, although this percent may be reduced to the extent that more than 55 percent of the issuer's assets are invested in qualifying interests.

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