Section 3(c)(5)(C) of the Investment Company Act of 1940 runs the real-estate exception against a private mortgage fund primarily engaged in the business of purchasing or acquiring mortgages and other liens on and interests in real estate. Seven mistakes recur on a mortgage fund operating under the §3(c)(5)(C) framework, and each runs the fund into an exemption exposure against the SEC and the fund’s investor base. This article walks the seven mistakes and runs the corrective framework against each.

1. Classifying B-notes as qualifying interests

The SEC no-action framework runs B-notes as real-estate-related interests rather than qualifying interests in real estate. The fund that runs a B-note portfolio against the qualifying-interest classification runs the first-tier asset framework on a misclassified asset set. The fund auditor and SEC counsel find the B-note classification running outside the no-action framework and run a finding against the fund’s qualifying-interest discipline.

2. Classifying mezzanine loans as qualifying interests

The SEC no-action framework runs mezzanine loans as real-estate-related interests on the same framework as B-notes. The fund that runs a mezzanine portfolio against the qualifying-interest classification runs the same misclassification framework against the first-tier asset test. The corrective runs the mezzanine portfolio against the real-estate-related classification and runs the qualifying-interest floor against the whole-mortgage-loan and fee-interest base.

3. Excess cash and Treasury balances

The §3(c)(5)(C) framework runs the eighty-percent real-estate-related floor against the fund’s balance sheet. Cash and Treasury balances run outside the real-estate-related framework against the second-tier asset test. A fund that runs a large pending acquisition pipeline against a Treasury reserve runs the eighty-percent floor on a thin framework against the measurement date. The corrective runs the cash-and-Treasury balance against a defined cap framework and runs the asset-rebalancing framework against the fund’s pipeline cycle.

4. Agency MBS misclassification

The SEC no-action framework runs agency-issued mortgage-backed securities — Fannie Mae, Freddie Mac, and Ginnie Mae pass-through securities — as real-estate-related interests rather than qualifying interests. The fund that runs an agency MBS portfolio against the qualifying-interest classification runs the first-tier asset test on a misclassified asset set. The corrective runs the agency MBS against the real-estate-related classification and runs the qualifying-interest framework against the whole-mortgage-loan base.

5. No documented loan-level classification

The fund runs the asset-classification framework against the loan-by-loan and investment-by-investment inventory on each measurement date. The fund that runs the asset classification on an aggregate framework rather than a loan-level framework runs the audit-documentation framework against the fund’s auditor and SEC counsel on a thin framework. The corrective runs the loan-level classification framework against each note, each MBS position, and each fee-interest holding on a per-asset documentation cycle.

6. Quarterly testing without an annual review

The standard runs the §3(c)(5)(C) test on the quarterly cycle against the fund’s balance sheet. The fund that runs the quarterly testing framework without an annual review against the fund’s auditor and SEC counsel runs the exemption framework on self-attestation rather than against an independent review. The corrective runs the annual review framework against the auditor and SEC counsel and runs the documentation framework against the annual cycle.

7. No defined cure-period framework

The fund that runs below the fifty-five-percent qualifying-interest floor or the eighty-percent real-estate-related floor on a measurement date runs into a §3(c)(5)(C) exemption violation. The fund that runs the violation without a defined cure-period framework runs the corrective action on an ad-hoc framework against the regulator. The corrective runs a documented cure-period framework — the standard runs a thirty- to sixty-day cure period on the fund’s SEC counsel discipline — against the asset-rebalancing cycle.

Related Topics

• The SEC Real Estate Exception 3(c)(5)(C) Explained
• Mortgage Fund Subservicing Done Right
• Multi-Lender Notes With Up to 10 Investors
• Fidelity Bonds for Trust Account Signatories
• Fractional Note Distributions: The Pro-Rata Math

This article is educational and does not constitute legal advice. The §3(c)(5)(C) framework runs under the Investment Company Act of 1940 against an entity primarily engaged in the business of purchasing or acquiring mortgages and other liens on and interests in real estate. The qualifying-interest classification runs against the SEC no-action position framework. Consult qualified SEC counsel on the specific asset-classification and operational framework against any private mortgage fund.

Sources

• Investment Company Act §3(c)(5)(C) — Real Estate Exception. Securities and Exchange Commission.
• SEC Division of Investment Management — No-Action Letters. Securities and Exchange Commission.
• Securities Act Regulation D — Rules 506(b) and 506(c). Securities and Exchange Commission.
• Investment Company Act §3(c)(1) and §3(c)(7). Securities and Exchange Commission.
• SEC Form D — Notice of Exempt Offering of Securities. Securities and Exchange Commission.