Section 3(c)(7)

Section 3(c)(7) was added by the . This regulatory provision created a pathway for larger hedge funds to exceed the 100-investor limit that applies under . The exemption became the dominant structure for institutional-focused hedge funds. It represents one of the most significant regulatory developments that enabled the modern hedge fund industry's expansion and institutional adoption.

During the early 1990s, market participants recognized that the Section 3(c)(1) investor limit had become unnecessarily restrictive. This was particularly true for professionally managed investment pools seeking to raise capital from institutional investors. Policymakers and the SEC acknowledged that certain investor categories possessed sufficient sophistication and financial capacity. These investors—particularly large institutional investors—did not require the full array of protective regulations applicable to registered investment companies.

The National Securities Markets Improvement Act of 1996 responded to this recognition by federalizing the regulatory framework for private investment funds. NSMIA created a more uniform system of exemptions. Rather than requiring private funds to navigate varying state regulations, NSMIA established federal standards focused on investor sophistication. The centerpiece of this initiative was Section 3(c)(7), which eliminated the investor count limitation for funds whose investors met specified wealth thresholds.

The introduction of Section 3(c)(7) catalyzed significant industry expansion. Institutional investors began allocating meaningful portions of their portfolios to hedge funds that were structured to accept unlimited numbers of . These institutional investors included , , foundations, and insurance companies. This institutional capital influx transformed hedge funds from primarily affluent individual investor vehicles into major participants in global capital markets. The change enabled fund managers to launch larger, more operationally sophisticated vehicles.

To qualify for the Section 3(c)(7) exemption, a private fund must satisfy two fundamental conditions under the Investment Company Act. First, the fund cannot make or propose to make a public offering of its securities. Second, all of the fund's securities must be "qualified purchasers," as defined in the . Alternatively, beneficial owners must fall within specific statutory exclusions or exemptions from the qualified purchaser requirement.

This two-part approach distinguishes Section 3(c)(7) from . Section 3(c)(1) restricts funds to a maximum of 100 beneficial owners without regard to how sophisticated those investors are. Section 3(c)(7) instead focuses on investor qualification status rather than investor count. This allows funds to scale significantly while maintaining the principle that sufficiently sophisticated investors require less regulatory protection.

The Investment Company Act establishes specific financial criteria to define qualified purchaser status. A natural person qualifies by owning at least $5 million in investments. Alternatively, a company can qualify if it owns at least $5 million in investments and meets certain ownership requirements. The company must not be organized specifically for the purpose of acquiring fund securities. It must also be owned directly or indirectly by two or more natural persons who are related as spouses, siblings, direct descendants, or through foundations and trusts established for their benefit.

A trust established for purposes other than acquiring the fund's securities may qualify under specific conditions. Both the trustee and each must meet the qualified purchaser standard independently. Entities without direct beneficial owner connections may also qualify if they own and invest on a discretionary basis at least $25 million in investments. These entities must not have been formed specifically to acquire the offered securities.

Additionally, qualified institutional buyers as defined under of the generally qualify as qualified purchasers. This excludes certain dealers and self-directed employee benefit plans. The Investment Company Act recognizes that certain entities function as extensions of qualified purchasers. These include self-directed retirement accounts and revocable trusts, which are treated as qualified purchasers in their own right. Similarly, entities where every beneficial owner meets the qualified purchaser definition are themselves deemed qualified purchasers.

The SEC applies a relatively strict standard when evaluating trusts. An fails to qualify if either the trustee or any settlor lacks qualified purchaser status. This applies even if all beneficiaries would individually satisfy the requirement. When a trust has multiple trustees, only the trustee responsible for investment decisions must meet the qualified purchaser test. The SEC determines a trustee's qualified purchaser status at the time the trustee commits trust assets to a fund. A settlor's status is determined when the settlor transfers assets into the trust.

Investment advisers and their representatives do not bear an absolute obligation to verify investor status with mathematical certainty. Instead, the regulations require only a that each investor qualifies as a qualified purchaser at the time of each new investment. This standard permits advisers to rely on investor representations provided during subscription procedures, supported by reasonable inquiry procedures.

Accordingly, fund documentation typically includes investor representations and warranties attesting to qualified purchaser status. These representations are often supported by net worth or investment statements. To maintain compliance and prevent inadvertent violations when investors transfer fund interests, investment fund documents customarily require consent before any transfer of interests may occur. This approval mechanism allows the fund manager to reconfirm investor status. Alternatively, it allows managers to limit transfers to individuals or entities meeting the qualified purchaser definition.

Although Section 3(c)(7) imposes no statutory limit on the number of qualified purchasers a fund may accept, several practical regulatory constraints affect fund structure decisions. The requires companies with more than $10 million in assets and certain shareholder thresholds to register and file periodic reports with the SEC. Companies must register if they have either 2,000 or more holders of record, or 500 or more non-accredited investors among their holders. The Jumpstart Our Business Startups Act of 2012 and the of 2016 modified these thresholds.

Since Section 3(c)(7) restricts investors to qualified purchasers, most Section 3(c)(7) funds' investors constitute under the Securities Act definition. Qualified purchasers by definition hold at least $5 million in investments. Consequently, the operative Exchange Act registration trigger for most 3(c)(7) funds is the 2,000 holder-of-record threshold rather than the non-accredited investor threshold. To avoid mandatory Exchange Act registration and the associated periodic reporting burdens, most 3(c)(7) funds adopt internal policies limiting the number of investors. These funds typically cap investors at 499 to maintain a significant safety margin below the 2,000-person threshold.

Additional constraints include the administrative complexity of managing large investor bases. Other considerations include state securities law compliance obligations and tax considerations related to whether the fund might be classified as a for federal income tax purposes. Fund structures must carefully address investor transferability restrictions to prevent unintended tax classification.

The Section 3(c)(7) exemption permits fund managers to achieve scale and institutional reach that would be unavailable under the 100-investor limit of Section 3(c)(1). Managers may structure sophisticated investment strategies, deploy leverage and , and implement performance-based compensation arrangements. They can do this without triggering the restrictions that apply to . The qualified purchaser standard is predicated on the legislative determination that investors meeting the specified wealth thresholds possess sufficient financial sophistication and capacity. These investors can understand and bear the risks associated with complex alternative investment vehicles.

By permitting funds to access deep pools of institutional capital, Section 3(c)(7) enabled the development of specialized hedge fund strategies and multi-billion-dollar vehicles. It also enabled the institutional infrastructure supporting the modern alternatives industry. The exemption's availability made hedge fund management an increasingly viable business model for investment professionals seeking to build differentiated investment vehicles tailored to institutional investor needs.