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The Securities and Exchange Commission (SEC) has adopted Rule 3a-8 under the Investment Company Act of 1940, as amended (1940 Act), which provides a nonexclusive safe harbor from the definition of investment company for certain bona fide research and development companies (R&D companies). (1) Rule 3a-8 is designed to provide R&D companies, like companies involved in the research and development of biotechnology products, with increased flexibility in raising and investing capital for research, development and other operations.
Briefly, under Rule 3a-8, an R&D company may rely on the nonexclusive safe harbor if:
1. Its research and development expenses, for the last four fiscal quarters combined, are a substantial percentage of its total expenses for the same period;
2. Its net income derived from investments in securities, for the last four fiscal quarters combined, does not exceed twice the amount of its research and development expenses for the same period;
3. Its expenses for investment advisory and management activities, investment research and custody, for the last four fiscal quarters combined, do not exceed 5 percent of its total expenses for the same period;
4. Its investments in securities are generally "capital preservation investments," with certain exceptions for "other investments" including "collaborative research and development arrangements" with strategic partners;
5. It does not hold itself out as being an investment company and is not a special situation investment company;
6. It is primarily engaged, directly or through majority-owned subsidiaries or companies that it controls primarily, in a non-investment company business, as evidenced by the activities of its officers, directors and employees, its public representations of policies, its historical development and an appropriate resolution of its board of directors; and
7. Its board of directors has adopted a written investment policy regarding the company's capital preservation investments.
Background of Rule 3a-8
Rule 3a-8 became effective on August 19, 2003. Its background and its elements are discussed subsequently.
Definition of Investment Company
The 1940 Act contains two definitions of investment company that are relevant to an operating company. Section 3(a)(1)(A) defines an investment company as any issuer that is, or holds itself out as being engaged primarily, or proposes to be engaged primarily in the business of investing, reinvesting, or trading in securities. Section 3(a)(1)(C) defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and that owns or proposes to acquire investment securities having a value exceeding 40 percent of the …