Investment Company Act of 1940- Section 3(c )(5)(C) 

Capital Trust, Inc 

May 24, 2007 

Our Ref. No. 2006-1221 

RESPONSE OF THE OFFICE OF CHIEF COUNSEL Capital Trust, Inc. 

DIVISION OF INVESTMENT MANAGEMENT File No. 132-3 

In your letter, dated May 16, 2007, you request that we concur with your view 

that certain mezzanine loans, described below, that are held by Capital Trust, Inc., a 

public company that has elected treatment as a real estate investment trust for federal tax 

law purposes (the “Company”), would be considered qualifying interests, as defined 

below, for purposes of complying with the exclusion in Section 3(c)(5)(C) of the 

Investment Company Act of 1940. 

Facts 

You state that the Company engages primarily in commercial real estate 

financing. Among other things, the Company invests in certain mezzanine loans made 

specifically and exclusively for the financing of real estate, which for purposes of this 

letter shall be referred to as “Tier 1 mezzanine loans.” You explain that in a Tier 1 

mezzanine loan arrangement, the Company lends money as mezzanine lender to a special 

purpose bankruptcy remote entity (“mezzanine borrower”) whose sole purpose is to hold 

all of the ownership interests of another special purpose entity that owns the commercial 

real estate being financed and that is subject to a mortgage loan secured by the property 

(“property-owning entity”).1 You state that under the terms of their respective 

organizational documents and loan documents, the property-owning entity may not 

engage in any business other than owning and holding the underlying property and the 

mezzanine borrower may not engage in any business other than owning and holding the 

ownership interests in the property-owning entity. You state that the ownership interests 

held by the mezzanine borrower has no value apart from the underlying real property that 

is held by the property-owning entity other than incidental assets related to ownership of 

the property.2 

You explain that the mezzanine borrower enters into an agreement with the 

Company as Tier 1 mezzanine lender pursuant to which it pledges its entire ownership 

interests in the property-owning entity to the Company as collateral for the mezzanine 

1

 You state that mezzanine loans are junior to the senior position of the mortgage holder but senior to the 

equity position of the owner of the underlying real property. You state that while there may be multiple 

tiers of mezzanine loans made in connection with the financing of a property, your request for relief is 

limited to mezzanine loans that are granted to a mezzanine borrower that directly owns interests in the 

entity that owns the property being financed (i.e., Tier 1 mezzanine loans). 

2

 You note, for example, that the property-owning entity may also hold incidental assets, such as cash 

generated from rental payments and held for short periods of time pending distribution or disbursement to 

meet operating expenses. 
loan.3

 The Company obtains a first priority perfected security interest in the ownership 

interests in the property-owning entity.4 You state that if the mezzanine borrower were to 

default on the mezzanine loan, the Company has the right to foreclose on the collateral 

and, through its 100% ownership of the property-owning entity, become the owner of the 

underlying real estate.5 

You further explain that the Company as Tier 1 mezzanine lender also enters into 

an intercreditor agreement with the mortgage lender in connection with the issuance of 

the Tier 1 mezzanine loan that sets forth the relative priority of rights between the two 

parties with respect to claims on the underlying property being financed. Among other 

things, you state that the Company obtains rights under the intercreditor agreement that 

allow it to readily cure defaults or purchase the mortgage loan in the event of a default on 

the mortgage loan. You state that the agreement also gives the Company as Tier 1 

mezzanine lender various control rights over the management of the underlying property. 

You state that in the commercial real estate financing industry second mortgages 

have effectively been replaced in part by Tier 1 mezzanine loans. You explain that 

second mortgages are rarely offered as a result of the increased practice of securitizing 

senior commercial mortgages. You state that the nationally recognized statistical rating 

organizations (“NRSROs”) have expressed an unwillingness to assign the highest ratings 

to securities issued by a trust holding a pool of senior commercial mortgages when the 

underlying properties associated with these mortgages are encumbered by second 

mortgages. You explain that the NRSROs are concerned that the presence of a second 

mortgage may negatively impact the trust’s remedies in the event that the senior 

mortgage should default, which in turn could impede payments made to the trust’s 

securities holders. You claim that such concerns are not found in the Tier 1 mezzanine 

loan arrangement because you explain that the absence of a second lien on the underlying 

property minimizes the likelihood that payments made to the trust’s securities holders 

might be affected in the event of a default of a senior mortgage in the pool. 

3

 You state that the aggregate principal balance of a mortgage loan and mezzanine loan at origination would 

be less than the value of the underlying property so that the mezzanine loan would be fully secured by the 

underlying real property. 

4

 You note that typically both the mezzanine borrower and the mezzanine lender are limited liability 

companies. You also state that in very rare cases the property-owning entity may be organized as a limited 

partnership. In such cases, the mezzanine borrower would own all of the limited partnership interests in the 

property-owning entity as well as all of the ownership interests in the general partner of the propertyowning entity. The mezzanine borrower would pledge the ownership interests in both the property-owning 

entity and the general partnership as collateral for the mezzanine loan. 

5

 You note, moreover, that the process of foreclosing on the ownership interests in the property-owning 

entity is governed by the Uniform Commercial Code rather than the state laws that control the process of 

foreclosing on real estate. Consequently, you claim that a Tier 1 mezzanine lender could foreclose on the 

ownership interests in the property-owning entity more quickly than a mortgage lender can foreclose on the 

mortgage, because the equitable rights of redemption granted to mortgage borrowers under most state laws 

can cause the real estate foreclosure process to be drawn out over an extended period of time. 

2 
Analysis 

Section 3(c)(5)(C) provides an exclusion from the definition of investment 

company for any issuer that 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 . . . purchasing or otherwise acquiring 

mortgages and other liens on and interests in real estate.” We previously have taken the 

position that an issuer may not rely on the exclusion provided by Section 3(c)(5)(C) 

unless 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. To meet the 45% real estate-type interests test, an 

issuer must invest at least 25% of its total assets in real estate-type interests (subject to 

reduction to the extent that the issuer invests more than 55% of its total assets in 

qualifying interests) and may invest no more than 20% of its total assets in miscellaneous 

investments.6 

You argue that the Tier 1 mezzanine loan that you describe in your letter should 

be considered a qualifying interest for purposes of Section 3(c)(5)(C) even though such a 

loan is not directly secured by real estate. You argue that, except for the lack of a 

mortgage loan against the property, such a mezzanine loan is the functional equivalent of, 

and provides its holder with the same economic experience as, a second mortgage. 

Specifically, you argue that the Tier 1 mezzanine loans that the Company holds 

are the functional equivalent of second mortgages because, except for the lack of a 

mortgage lien on the property, all of the principal terms and features of a second 

mortgage loan are present. You explain that both are loans, made specifically and 

exclusively for the financing of real estate, that are junior to the first mortgage loan but 

senior to the equity position of the owner of the property. You also note that second 

mortgages and Tier 1 mezzanine loans are underwritten based on the same considerations 

and after the lender performs a hands-on analysis of the underlying commercial property, 

including, among other things, inspection of the property, review of revenue leases and 

property agreements, analyses of local commercial real estate market conditions, and 

review of the financial performance of the property. You state that, as is typically the 

case with a second mortgage lender, the Company exercises ongoing control rights over 

the management of the underlying property, such as rights relating to the approval of 

major leases, budget improvements, capital expenditures and the application of insurance 

proceeds or condemnation awards, as well as the right to replace the property manager in 

case of default on the loan. Finally, you state that the Company has rights under the 

intercreditor agreement to readily cure defaults or purchase the mortgage loan in the 

event of a default on the mortgage loan. 

You also argue that the economic experience of the Company as a Tier 1 

mezzanine lender is no different from the economic experience of a second mortgage 

 See, e.g., Citytrust, SEC Staff No-Action Letter (Dec. 19, 1990); Greenwich Capital Acceptance Inc., 

SEC Staff No-Action Letter (Aug. 8, 1991). 

3 

6
lender. Although the Company holds as collateral the ownership interests of the 

property-owning entity rather than the property itself, you argue that the value of the 

collateral is economically the same under both loan forms. In essence, you explain that 

the ownership interests in the property-owning entity have no economic value apart from 

the underlying real property (other than incidental assets related to the ownership of the 

property) because the property-owning entity in a Tier 1 mezzanine loan arrangement is 

not permitted to engage in any business except the ownership of the real property.7 

Consequently, the Company as Tier 1 mezzanine lender, like the second mortgage lender, 

looks to the underlying real property as the true measure of the value of its collateral. 

You also note that despite the absence of a mortgage lien, the Company has the right to 

foreclose on the collateral and, through its ownership of the property-owning entity, 

become the owner of the underlying real estate.8 

We generally take the position that a qualifying interest is an asset that represents 

an actual interest in real estate or is a loan or lien fully secured by real estate. Thus, for 

example, we have not objected if an issuer treats as qualifying interests, among other 

things, fee interests in real estate,9 mortgage loans fully secured by real property,10 

second mortgages secured by real property11 and leasehold interests secured solely by 

real property.12 We also have provided no-action relief where an asset can be viewed as 

being the functional equivalent of,13 and the asset provides its holder with the same 

7 See supra note 2 and accompanying text. 

8 See supra note 5. You also argue that the economic experience under both a Tier 1 mezzanine loan and a 

second mortgage should be considered the same because, in your view, the ownership interests of the 

mezzanine borrower in the property-owning entity are unlikely to be considered “securities.” You explain 

that in such case, the collateral that the mezzanine lender is receiving is not a “security” that has a value 

independent of the underlying property held by the property-owning entity. We take no position whether 

under this arrangement the ownership interests are “securities.” 

9 See, e.g., United Bankers, SEC Staff No-Action Letter (Mar. 23, 1988). 

10 See, e.g., United States Property Investment N.V., SEC Staff No-Action Letter (May 1, 1989). 

11 See, e.g., Prudential Mortgage Bankers & Investment Corp., SEC Staff No-Action Letter (Dec. 4, 1977); 

The State Street Mortgage Co., SEC Staff No-Action Letter (July 17, 1986). 

12 See, e.g., Health Facility Credit Corp., SEC Staff No-Action Letter (Feb. 6, 1985). 

In contrast, we generally take the position that an asset is not a qualifying interest if it is not fully secured 

by real estate. See, e.g., NAB Asset Corp., SEC Staff No-Action Letter (June 20, 1991) (loans that are not 

fully secured by real estate are not qualifying assets). We also take the position that an asset is not a 

qualifying interest if it is in the nature of a security interest in another person engaged in the real estate 

business. See, e.g., The Realex Capital, SEC Staff No-Action Letter (Mar. 19, 1984) (Section 3(c)(5)(C) 

not available to an issuer who invests solely in limited partnership interests in an underlying limited 

partnership that would own and operate a building). 

13 See, e.g., Investors GMNA Trust, Inc., SEC Staff No-Action Letter (July 22, 1983) (counsel opined that 

that issuer’s ownership of GNMA Mortgage Pass-Though Securities representing 100% beneficial interests 

in mortgage pools constitutes an investment in mortgages within the meaning of Section 3(c)(5)(C) because 

ownership of these securities “is the functional equivalent of ownership of the underlying mortgage 

loans”); GEM Savings Association, SEC Staff No-Action Letter (Sept. 28, 1983) (counsel argued that 

issuer’s ownership of GNMA certificates is the “functional equivalent of ownership in an interest in real 

estate,” thereby permitting the issuer to rely on Section 3(c)(5)(C), because the certificates represent 100% 

beneficial interests in each underlying mortgage pool, the payment of principal and interest on the 

4 
economic experience as,14 a direct investment in real estate or in a loan or lien fully 

secured by real estate, albeit in a context different from the facts you present. 

Based on the facts and representations in your letter and in particular your 

representations that: (1) a Tier 1 mezzanine loan is a subordinated loan made specifically 

and exclusively for the financing of real estate; (2) both second mortgages and Tier 1 

mezzanine loans are underwritten based on the same considerations and after the lender 

performs a hands-on analysis of the property being financed; (3) the Company as Tier 1 

mezzanine lender exercises ongoing control rights over the management of the 

underlying property; (4) the Company as Tier 1 mezzanine lender has the right to readily 

cure defaults or purchase the mortgage loan in the event of a default on the mortgage 

loan; (5) the true measure of the collateral securing the Tier 1 mezzanine loan is the 

property being financed and any incidental assets related to the ownership of the 

property; and (6) the Company as Tier 1 mezzanine lender has the right to foreclose on 

the collateral and through its ownership of the property-owning entity become the owner 

of the underlying property, we agree that the Tier 1 mezzanine loan which you describe 

in your letter can be viewed as being the functional equivalent of, and provide its holder 

with the same economic experience as, a second mortgage which is a qualifying interest 

underlying mortgages is passed through to holders of GNMA certificates and the certificates are secured by 

the real estate associated with the underlying mortgages). See also NAB Asset Corp., SEC Staff No-Action 

Letter (June 20, 1991) (counsel stated that an issuer that has general partnership interests in partnerships 

that hold real estate and loans backed by real estate should be “functional equivalents of direct ownership in 

the real estate and loans held by the partnerships and not be ‘securities’ for securities law purposes”); 

United States Property Investments N.V., SEC Staff No-Action Letter (May 1, 1989) (counsel argued that 

issuer’s joint venture investments in real estate and mortgages are the “functional equivalents of direct 

ownership by the . . . [issuer], and would not constitute ‘securities’ under the ‘investment contract test’ used 

for securities law purposes”). 

14 See, e.g., Premier Mortgage Corp., SEC Staff No-Action Letter (Mar. 14, 1983) (holder of notes secured 

by a pool of whole mortgage loans “would have essentially the same investment experience that it would 

have were it directly investing in the mortgage loans.”). See also Protecting Investors: A Half Century of 

Investment Company Regulation 72 (1992) (we stated that qualifying interests include agency whole pool 

certificates because “the holder of these certificates generally has the same economic experience as the 

investor who purchases the underlying mortgages directly, including the receipt of both principal and 

interest payments and the risk of prepayment on the underlying mortgage loans, notwithstanding the 

guarantees provided by the agencies.”). 

5 
for purposes of complying with Section 3(c)(5)(C). Accordingly we concur with your 

view that the Tier 1 mezzanine loan described in your letter may be considered a 

qualifying interest for purposes of complying with the exclusion from the definition of 

investment company provided by Section 3(c)(5)(C). 

 Please note that our views are based upon the facts and representations contained 

in your letter and that any different facts or representations may require a different 

conclusion. 

Rochelle Kauffman Plesset 

Senior Counsel 

Incoming Letter: 

May 16, 2007 

CONFIDENTIAL 

Elizabeth Osterman, Assistant Chief Counsel 

Division of Investment Management 

U.S. Securities and Exchange Commission 

100 F Street, N.E. 

Washington, D.C. 20549 

Re: Capital Trust, Inc.: No Action Request 

Dear Ms. Osterman: 

We are writing on behalf of Capital Trust, Inc. (the “Company”), a public company that has 

elected treatment as a real estate investment trust for federal tax law purposes. We are 

seeking the concurrence of the staff of the Division of Investment Management with our 

view that certain mezzanine loans which the Company invests in, as described below, would 

be considered Qualifying Assets (as defined below) for purposes of the exclusion in Section 

3(c)(5)(C) of the Investment Company Act of 1940, as amended (the “Investment Company 

Act”). Alternatively, we seek the staff’s concurrence that it will agree not to recommend 

enforcement action to the Securities and Exchange Commission (“Commission”) if the 

Company were to treat these mezzanine loans as Qualifying Assets for purposes of Section 

3(c)(5)(C) of the Investment Company Act. 

I. 

BACKGROUND

6 
The Company is engaged primarily in the business of commercial real estate financing. It 

invests in, among other things, mezzanine loans as described below.15 

In these mezzanine loan arrangements,16 the Company lends money to a special purpose 

bankruptcy remote entity, typically organized as a limited liability company (“mezzanine 

borrower”), whose sole purpose is to hold all of the ownership interests in another special 

purpose entity, also organized typically as a limited liability company, that owns commercial 

real property (“property-owning entity”) and is subject to a mortgage loan secured by the 

property.17 Under the terms of their respective organizational documents and loan 

documents, the property-owning entity and the mezzanine borrower may not engage in any 

other business. The ownership interests of the mezzanine borrower in the property-owning 

entity, therefore, have no value apart from the underlying real property that is held by the 

property-owning entity essentially as its only asset. 18 The value of the underlying property in 

excess of the mortgage loan is the ultimate collateral that secures the mezzanine loan. 

The mezzanine borrower pledges its entire ownership interests in the property-owning entity 

to the mezzanine lender as collateral for the mezzanine loan. The mezzanine lender obtains 

a first priority perfected security interest in this collateral. If the mezzanine borrower were 

to default on the mezzanine loan, the mezzanine lender has the right to foreclose on the 

collateral and, through its ownership of the property-owning entity, effectively become the 

owner and operator of the underlying real property. 

The mezzanine loan is issued pursuant to the terms of a mezzanine loan agreement between 

the mezzanine borrower and the Company, as the mezzanine lender. In addition, the 

relative priority of rights of the Company as mezzanine lender and the mortgage lender, with 

respect to claims on the underlying commercial property, is set forth in an intercreditor 

agreement between these two parties. The intercreditor agreement provides for 

communication between the mortgage lender and the mezzanine lender and gives certain 

rights to the mezzanine lender, such as cure rights and purchase rights that allow it to readily 

cure defaults or purchase the mortgage loan in case of a default on the mortgage loan. The 

mezzanine lender may also obtain through negotiation various control rights over the 

management of the underlying property, such as the right to approve major leases, budgets, 

improvements, capital expenditures and the application of insurance proceeds or 

condemnation award and, in the case of default, the right to replace the property manager. 

Further, the mezzanine loan documents and the intercreditor agreement contain various 

15 The loans described in this letter are considered “mezzanine” because they occupy a place in the 

relative priority of creditor and ownership interests in the underlying real property that is junior to the 

senior position of the mortgage holder but senior to the equity position of the owner of the underlying real 

property. 16 In accordance with the staff’s request, we are limiting our request for relief in this letter only to 

mezzanine loans that are granted to a mezzanine borrower that directly owns interests in a property-owning 

entity. We are not requesting relief in this letter for other levels of mezzanine loans. 17 In very rare cases, the property owning entity may also be organized as a limited partnership. In 

these cases, the mezzanine borrower would own all of the limited partnership interests in the propertyowning entity, as well as all of the ownership interests in the general partner of the property-owning entity, 

and would pledge all of these ownership interests as collateral for the mezzanine loan. 18 The property-owning entity may also hold incidental assets related to ownership of the 

commercial property, such as cash generated from rental payments from tenants and held temporarily for 

short periods of time pending distribution or disbursement to meet operating expenses. 

7 
restrictions on the mortgage lender’s ability to modify loan documents or grant material 

consents or waivers to the mezzanine borrower. 

Like many of the Company’s commercial real estate financing industry competitors, the 

Company rarely makes second mortgage loans. The second mortgage has been effectively 

replaced by the mezzanine loan. This change is due to the practice of senior mortgage 

lenders contributing first mortgages into securitized offerings of commercial mortgagebacked securities (“CMBS”) and selling classes of securities collateralized by the mortgages 

and rated by the nationally recognized statistical rating organizations (“NRSROs”). The 

NRSROs have expressed an unwillingness to assign the highest ratings to CMBS when the 

underlying property for a mortgage loan included in a pool of underlying commercial 

mortgage loans is encumbered by a second mortgage loan.19 

II. 

LEGAL ANALYSIS AND DISCUSSION

Section 3(c)(5)(C) of the Investment Company Act provides an exclusion from the definition 

of “investment company” for certain companies engaged primarily in the real estate 

business. Under this section, an issuer would be excluded from the definition of investment 

company if it does not issue “redeemable securities,” as defined in Section 2(a)(32) of the 

Investment Company Act,20 and is engaged primarily in the business of “purchasing or 

otherwise acquiring mortgages and other liens on and interests in real estate.” 

Through various no-action letters, the Commission staff has provided guidance on the 

circumstances under which it would regard a company as being engaged primarily in the 

business of “purchasing or otherwise acquiring mortgages and other liens on and interests in 

real estate” for purposes of Section 3(c)(5)(C) of the Investment Company Act. The staff 

has granted no-action assurance to permit an issuer to rely on Section 3(c)(5)(C) where (a) at 

least 55% of the value of the issuer’s total assets consisted of real estate interests 

(“Qualifying Assets”), (b) at least an additional 25% of the value of the issuer’s total assets 

consisted of real estate-type interests (“Real Estate-Related Assets”), reduced by any amount 

the issuer held in excess of the 55% minimum limit for Qualifying Assets, and (c) no more 

than 20% of the value of the issuer’s total assets consisted of assets other than Qualifying 

Assets and Real Estate-Related Assets.21 

19 The NRSROs are concerned that in a workout situation involving a defaulted mortgage loan 

included in a CMBS pool, the presence of a second mortgage loan may impact negatively the trust’s 

exercise of remedies and ultimate realization on the underlying property because the second mortgagee, as 

a lienholder, may assert rights under state law. In addition , the second mortgagee’s claims on the 

underlying real property might cause significant delays in a bankruptcy proceeding involving the property 

owning entity. By contrast, the absence of a lien on the underlying property in the mezzanine loan context 

minimizes the likelihood that payments to be made to CMBS holders might be affected during the workout 

of a defaulted mortgage loan. 20 The term “redeemable security” is defined in Section 2(a)(32) of the Investment Company Act to 

mean any security (other than short-term paper) that gives its holder the right to receive, upon tender to the 

issuer or the issuer’s agent, the holder’s approximate share of the issuer’s current net assets or the cash 

equivalent thereof. 21 See, e.g., Citytrust (pub. avail. Dec. 19, 1990); Prudential-Bache Securities, Inc. (pub. avail. Aug. 

19, 1985); Salomon Brothers, Inc. (pub. avail. June 17, 1985). 

8 
The staff has indicated that Qualifying Assets include fee interests in real estate,22 whole 

mortgage loans,23 and agency whole pool certificates (which represent the entire beneficial 

interest in the underlying pool of mortgage loans).24 The Commission staff also has granted 

no-action assurance to permit pass-through notes secured by whole pools of conventional 

mortgage loans to be treated as Qualifying Assets.25 Further, the staff has granted no-action 

assurance to permit an issuer that has a substantial holding of second mortgage loans to rely 

on Section 3(c)(5)(C) even though the holder of such a loan is generally required to obtain 

the consent of the mortgage holder before pursuing foreclosure on the underlying real 

property.26 

We believe, on the basis of the foregoing legal authorities, that a mezzanine loan should be 

treated as a Qualifying Asset for purposes of Section 3(c)(5)(C) of the Investment Company 

Act because, except for the lack of a mortgage lien against the property, a mezzanine loan is 

the functional equivalent of a second mortgage and provides the lender with the same 

economic experience as a second mortgage lender. We respectfully request the staff’s 

concurrence with this view or, in the alternative, that the staff grant our request for noaction relief to permit mezzanine loans to be treated as Qualifying Assets. 

A. A mezzanine loan is the functional equivalent of a second mortgage loan. 

A mezzanine loan functions in a manner that is equivalent to the function of a second 

mortgage loan. Except for the mortgage lien against the property, all of the principal terms 

and features of the second mortgage loan are present in the mezzanine loan arrangement. 

Both loans are made specifically and exclusively for the financing of real estate, and occupy a 

structural position in the borrower’s debt hierarchy that is junior to the first mortgage loan 

but senior to the borrower’s equity in the property. Both are priced generally with higher 

interest rates that give effect to their subordinate position with respect to the priority 

accorded the mortgage loan lender.27 In both cases, a filing is made with a public official 

with respect to the borrower’s assets pledged as collateral for the loan – a Uniform 

Commercial Code filing to record a first priority security interest in the collateral, in the case 

of the mezzanine loan, and a filing made with the registrar of deeds or other similar county 

official, in the case of the second mortgage loan. 

22 See, e.g., Investment Company Act Release No. 3140 (Nov. 18, 1960). 23 Id. See also Merrill, Lynch, Pierce, Fenner & Smith (pub. avail. Nov. 4, 1981). 24 See, e.g., American Home Finance Corp. (pub. avail. Apr. 9, 1991) (no-action relief granted to 

permit certificates representing the entire ownership interest in a particular pool of mortgage loans to be 

treated as Qualifying Assets). The staff has reasoned that holding the certificates with respect to a whole 

pool of mortgages is the functional equivalent of owning the mortgages and that the investor in such 

certificates would have the same economic or investment experience as if the investor held the underlying 

mortgages. See, e.g., Security Mortgage Acceptance Corp. I (pub. avail. Jan. 6, 1986); Salomon Brothers 

Inc. (pub. avail. Dec. 4, 1985). 25 See, e.g., Premier Mortgage Corp.(pub. avail. Mar. 14, 1983). 26 See The State Street Mortgage Co. (pub. avail. Jul. 17, 1986). 27 Indeed, a second mortgage loan and a mezzanine loan involve substantially the same underwriting 

considerations which are examined through similar underwriting procedures. Before granting or acquiring 

a mezzanine loan, the Company, like a second mortgagee, undertakes a hands-on analysis of the underlying 

commercial property, including an analysis of local commercial real estate market conditions, the 

creditworthiness of tenants and the financial performance of the property. The Company, similar to a 

second mortgagee, also conducts on-site inspections of the property, revenue leases and property 

agreements. 

9 
Further, in connection with a mezzanine loan, the Company exercises ongoing control rights 

over the underlying property, such as rights relating to the approval of major leases, budgets, 

improvements, capital expenditures, and the application of insurance proceeds or 

condemnation awards, as well as the right to replace the property manager in case of a 

default on the loans, as is typically the case with a second mortgage loan. In addition, like a 

second mortgage lender, the Company has the rights under the terms of the intercreditor 

agreement to readily cure a default or to purchase a mortgage loan in case of a default on the 

mortgage loan. 

B. Economically, the mezzanine loan provides the same rights to repayment as a second 

mortgage loan. 

The economic experience of the Company, as mezzanine lender, is no different than the 

economic experience of a second mortgagee. 

First, the form of ownership of the underlying commercial real property in the mezzanine 

loan arrangement has no practical significance given that the mezzanine borrower’s 

ownership interests in the property-owning entity pledged as collateral to secure the 

mezzanine loan have no economic value apart from the underlying real property held as the 

only principal asset of the property-owning entity. Consequently, the mezzanine lender 

would have to look to the underlying real property as the true measure of the value of its 

collateral. The aggregate principal balance of a mortgage loan and mezzanine loan at 

origination would be less than the value of the underlying property, so that the mezzanine 

loan would be fully secured by the underlying real property. 

Second, since the Company, as mezzanine lender, can readily realize on its collateral and 

succeed to ownership of the property-owning entity in case of default on the mezzanine 

loan, the Company does not view the absence of the mortgage lien as a material distinction 

between a mezzanine loan and a second mortgage loan. The Company considers the 

underlying collateral to be economically the same under both loan forms since the propertyowning entity in a mezzanine loan arrangement is not permitted to engage in any business 

except the ownership of the real property. In fact, the Company’s ability to more quickly 

foreclose on the collateral ownership interests under a mezzanine loan can provide it with a 

distinct advantage compared to a mortgage lender which is subject to more strict procedures 

when foreclosing on a second mortgage.28 

The view that the Company’s economic experience under both a mezzanine loan and a 

second mortgage should be considered the same is supported by the conclusion that for 

purposes of the Investment Company Act, the ownership interests of the mezzanine 

borrower in the property-owning entity are unlikely to be considered “securities.”29 In such 

28 A mezzanine lender could foreclose more quickly on ownership interests in a mezzanine borrower 

because this form of security is governed by the Uniform Commercial Code and is not subject to state laws 

controlling the process of foreclosing on real estate, which (because of the equitable right of redemption 

granted to borrowers under most state laws) can cause the foreclosure process to be drawn out over an 

extended period of time. 29 The mezzanine borrower’s ownership interests in the property-owning entity should not be 

considered “securities” under the applicable Howey investment contract test because in the typical 

mezzanine loan arrangement, as discussed above, the mezzanine borrower owns all of the outstanding 

limited liability company interests in the property-owning entity and exercises such a degree of control over 

the operations and management of the entity that the “reliance solely on the efforts of others for profits’” 

10 
case, the Company may properly consider the collateral it receives as mezzanine lender in 

connection with providing a mezzanine loan not as “securities” having a value independent 

of the underlying property held by the property-owning entity, but as the underlying 

property itself.

30 As noted, if there is a default on the mezzanine loan, followed by a 

subsequent foreclosure on the collateral, the Company readily becomes the sole owner of 

the property-owning entity. 

As noted, the Commission staff has used the “same economic experience” rationale in the 

past in granting no-action relief to permit particular real estate investments to be treated as 

Qualifying Assets. The staff has used this rationale in granting relief to permit agency 

“whole pool certificates” to be treated as Qualifying Assets.31 Similarly, in Premier Mortgage 

Corp.,

32 the staff granted no-action assurance to permit pass-through notes secured by whole 

pools of conventional mortgage loans to be treated as Qualifying Assets on the basis that the 

issuer would have essentially the “same investment experience” were it investing directly in 

the mortgage loans. Although there are differences in the mezzanine loan arrangement 

when compared with the circumstances under which the staff has granted relief in the whole 

pool context, the fundamental thrust of the underlying rationale is the same in both cases – 

i.e., a mezzanine lender on the one hand, or the holder of all of the certificates issued with 

respect to a pool of mortgage loans on the other, would have essentially the same economic 

experience as if the mezzanine lender instead held a second mortgage loan or as if the 

certificate owner owned the underlying mortgages directly. It should be appropriate, 

therefore, to accord similar treatment in both cases, so that a mezzanine loan, like a second 

mortgage loan, may be classified as a Qualifying Asset for Section 3(c)(5)(C) purposes. 

III. 

CONCLUSION

For the foregoing reasons, we respectfully request that the staff concur with our position 

that mezzanine loans of the type described in this letter should be considered Qualifying 

Assets for purposes of Section 3(c)(5)(C) of the Investment Company Act or, in the 

alternative, that the staff agree not to recommend enforcement action to the Commission if 

the Company were to treat these mezzanine loans as Qualifying Assets for purposes of 

Section 3(c)(5)(C). 

We would be willing to respond to any questions the staff may have concerning this request 

or to supplement in any way the arguments made in this letter. Please call Michael R. Rosella 

element of the Howey test would not be met. See generally Williamson v. Tucker, 645 F.2d 404 (5th Cir.), 

cert. denied, 454 U.S. 897 (1981); Robinson v. Glynn, 349 F.3d 166 (4th Cir. 2003) (applying the Howey 

investment contract test in analyzing membership interests in a limited liability company); Great Lakes 

Chemical Corporation v. Monsanto Company, 96 F. Supp.2d 376 (D. Del. 2000) (also applying the Howey 

investment contract test to analyze membership interests in a limited liability company). See also Frazier v. 

Manson, 484 F. Supp. 449, 450-53 (N.D. Tex. 1980), aff’d, 651 F.2d 1078 (5th Cir. 1981) (holding that 

limited partnership interests may not be securities if special factors showing involvement of limited 

partners in management are met). 30 Cf. NAB Asset Corporation (pub. avail. June 20, 1991) (no-action assurance to permit a company 

to treat its general partnership interests in a partnership holding real estate and loans as the functional 

equivalent of direct ownership of the real estate and loans for Section 3(c)(5)(C) purposes and not be 

considered “securities” for securities law purposes). 31 See supra n. 10. 32 See supra n. 11. 

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at 212-318-6800, Michael L. Zuppone at 212-318-6906 or Wendell M. Faria at 202-551-1758 

with any question. 

In accordance with Securities Act Release No. 6269 (Dec. 5, 1980), we enclose seven 

additional copies of this letter and identify in the upper right hand corner of the first page of 

this letter the specific statutory provisions to which this letter pertains. 

Sincerely, 

Michael R. Rosella Michael L. Zuppone 

of PAUL, HASTINGS, JANOFSKY & WALKER LLP 

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