Dodd-Frank created a new legal definition for a “private fund” as pooled investment vehicles that are excluded from the definition of “investment company” under the Investment Company Act of 1940 by section 3(c)(1) or 3(c)(7) of that Act. Real estate funds managers have used these standards because they are bright-line tests. It also skirts around the issue of whether the fund is investing in “securities” and “what is a security”.
Real estate fund managers have also looked at 3(c)5 and wondered if they can rely it as an exclusion under the Investment Company Act:
(5) Any person who is not engaged in the business of issuing redeemable securities, face-amount certificates of the installment type or periodic payment plan certificates, and who
is primarily engaged in one or more of the following businesses:
… (C) purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.
In 2017, Redwood Trust obtained a no-action letter from the SEC that the credit risk transfer certificates that the firm held would be allowed under 3(c)5.
On August 15, 2019, Redwood Trust, Inc. obtained another no-action letter for their mortgage servicing rights (MSRs) and cash proceeds.
In reviewing eligibility for the Real Estate Exception, the SEC has
taken the position that the exclusion in Section 3(c)(5)(C) may be available to an issuer if: at least 55% of its assets consist of “mortgages and other liens on and interests in real estate” (called “qualifying interests”) and the remaining 45% of its assets consist primarily of “real estate-type interests;” at least 80% of its total assets consist of qualifying interests and real estate-type interests; and no more than 20% of its total assets consist of assets (“miscellaneous assets”) that have no relationship to real estate (these factors together, the “Asset Composition Test”). .
In a no-action letter issued to Great Ajax Funding, the SEC staff acknowledged that an issuer that acquires whole mortgage loans may acquire certain other assets as a direct result of being engaged in the business of acquiring whole mortgage loans and that those assets might also be indicative of the issuer being in the business of acquiring whole mortgage loans.
For Redwood, the SEC staff ruled that the MSRs could be qualifying interests for purposes of the Asset Composition Test in utilizing Section 3(c)(5)(C) because “such assets are acquired as a direct result of the issuer being engaged in the business of purchasing or otherwise acquiring whole mortgage loans. “
The other problem that Redwood asked for no-action on was cash proceeds from selling the real estate interests. The SEC state that:
“An entity may treat cash proceeds from asset dispositions as Qualifying Real Estate Assets or Real Estate-Related Assets if, prior to such dispositions, such assets were themselves Qualifying Real Estate Assets or Real Estate-Related Assets, respectively. “
The Staff did qualified the cash proceeds. The relief applies only if the company only holds it for less than 12 months from receipt. The company then needs to reinvest it or distribute it.
Sources:
- Definition of Investment Company
- Analysis of a 3(c)5 Fund
- Redwood No Action Letter August 15, 2019
- Great Ajax Funding LLC No action Letter February 12, 2018