SECURITIES AND EXCHANGE COMMISSION

17 CFR PART 270

Release No. IC-29778; File No. S7-34-11 

RIN 3235-AL21 

Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related 

Instruments

AGENCY: Securities and Exchange Commission.

ACTION: Concept release; request for comments.

SUMMARY: The Securities and Exchange Commission (“Commission”) and its staff 

("Commission staff" or "staff") are reviewing interpretive issues under the Investment Company 

Act of 1940 (“Investment Company Act” or “Act”) relating to the status under the Act of

companies that are engaged in the business of acquiring mortgages and mortgage-related 

instruments and that rely on the exclusion from the definition of investment company in Section 

3(c)(5)(C) of the Act (together, “mortgage-related pools”). This review is focusing, among 

others, on certain real estate investment trusts (“REITs”). To help facilitate this review, the 

Commission requests information about these companies and how Section 3(c)(5)(C) of the Act 

is interpreted by, and affects investors in, these companies. The Commission solicits 

commenters’ views about the application of the Investment Company Act to mortgage-related

pools, including suggestions on the steps that the Commission should take to provide greater 

clarity, consistency or regulatory certainty with respect to Section 3(c)(5)(C).

DATES: Comments should be received on or before November 7, 2011.

ADDRESSES: Comments may be submitted by any of the following methods: 

Electronic Comments: 
2 

Use the Commission’s Internet comment form http://www.sec.gov/rules/concept.shtml); 

or send an e-mail to rule-comments@sec.gov. Please include File No. S7-34-11 on the subject 

line; or use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the 

instructions for submitting comments.

Paper Comments: 

Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, 100 F Street, NE Washington, D.C. 20549-1090. 

All submissions should refer to File No. S7-34-11. This file number should be included on the 

subject line if e-mail is used. To help process and review your comments more efficiently, 

please use only one method. The Commission will post all comments on the Commission’s 

Internet Web site (http://www.sec.gov/rules/concept.shtml). Comments are also available for 

public inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE, 

Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. 

All comments received will be posted without charge; we do not edit personal identifying 

information from submissions. You should submit only information that you wish to make 

available publicly.

FOR FURTHER INFORMATION CONTACT: Rochelle Kauffman Plesset, Senior Counsel, 

at (202) 551-6840, or Nadya Roytblat, Assistant Chief Counsel, at (202) 551-6825, Division of 

Investment Management, Securities and Exchange Commission, 100 F Street, NE, Washington, 

DC 20549. 
3 

TABLE OF CONTENTS

I. Introduction and Executive Summary 

II. Companies That Rely on Section 3(c)(5)(C)

A. Overview

B. Management Style and Corporate Governance 

C. Similarities to Traditional Investment Companies 

D. Request for Comment 

III. The Exclusion Provided by Section 3(c)(5)(C) 

A. Legislative and Administrative Background

B. Commission Staff No-Action Letters and Other Interpretations 

 C. Request for Comment on the Current Interpretation of Section 3(c)(5)(C)

IV. Request for Comment on Possible Commission Action

V. General Request for Comment 

 

I. INTRODUCTION AND EXECUTIVE SUMMARY

The Commission and staff are reviewing interpretive issues relating to the status of 

mortgage-related pools under the Investment Company Act.

1

 Companies that are engaged in the 

business of acquiring mortgages and mortgage-related instruments, and that issue securities, 

generally hold assets that are securities under the Investment Company Act and typically meet 

the definition of investment company under the Act.2

 

1

 Certain companies that are engaged in the business of acquiring mortgages and mortgage-related 

instruments are issuers of mortgage-backed securities that may rely on Section 3(c)(5)(C). Such issuers are not 

included in the term "mortgage-related pools" as it is used in this release. See infra note 

 While some such companies register as 

5 and accompanying text. 

2

 Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer which “is 

or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, 

reinvesting, or trading in securities.” 15 U.S.C. 80a-3(a)(1)(A). Section 3(a)(1)(C) defines an investment company 

as any issuer which “is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or 

trading in securities, and owns or proposes to acquire investment securities [as that term is defined in the Act] 

having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government 

securities and cash items) on a unconsolidated basis.” 15 U.S.C. 80a-3(a)(1)(C). A company that issues securities 

and is primarily engaged in investing in, owning, or holding mortgages and mortgage-related instruments typically 

meets one, if not both, of these definitions. See, e.g., SEC, Report on the Public Policy Implications of Investment 

Company Growth, H.R. Rep. No. 2337, 89th Cong. 2d Sess. 328 (1966) ("PPI Report") (stating that mortgages and 

other interests in real estate are investment securities for purposes of the Act).

Section 2(a)(36) of the Investment Company Act broadly defines "security" as "any note, stock, treasury 

stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profitsharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, 

investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, 

gas, or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of 

deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or any 

put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, 
4 

investment companies under the Act,3 many seek to rely on Section 3(c)(5)(C) of the Act, which 

generally excludes from the definition of investment company any person who is primarily 

engaged in, among other things, "purchasing or otherwise acquiring mortgages and other liens on 

and interests in real estate."4 The exclusion provided by Section 3(c)(5)(C) sometimes also is 

used by issuers of mortgage-backed securities, whose reliance on this statutory provision is 

discussed in a companion release.5

Section 3(c)(5)(C) of the Act was enacted in 1940 to exclude from regulation under the 

Investment Company Act companies that were engaged in the mortgage banking business and 

that did not resemble, or were not considered to be, issuers that were in the investment company 

business.6 Since that time, as the mortgage markets have evolved and expanded, a wide variety 

of companies, many of them unforeseen in 1940, have relied upon Section 3(c)(5)(C).

7

 

in general, any interest or instrument commonly known as a 'security', or any certificate of interest or participation 

in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any 

of the foregoing." 

 The 

3 According to industry statistics derived from Lipper’s LANA Database, as of June 30, 2011, there were 23 

series of registered open-end investment companies with total assets of $70.6 billion that invested “at least 65% of 

their assets in Government National Mortgage Association securities.” In addition, as of that date, there were 34 

series of registered open-end investment companies with total assets of $26.6 billion, and 11 registered closed-end 

investment companies with total assets of $1.8 billion, that invested “at least 65% of their assets in 

mortgages/securities issued or guaranteed as to principal and interest by the U.S. government and certain federal 

agencies.” 

4 15 U.S.C. 80a-3(c)(5)(C). Section 3(c)(5) excludes from the definition of investment company "[a]ny 

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: (A) Purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other 

obligations representing part or all of the sales price of merchandise, insurance, and services; (B) making loans to 

manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and 

services; and (C) purchasing or otherwise acquiring mortgages and other liens on and interest in real estate." 

5

 Treatment of Asset-Backed Issuers under the Investment Company Act, Investment Company Act Release 

No. 29779 (Aug. 31, 2011) ("3a-7 Companion Release").

6

 See infra note 38 and accompanying text.

7

 Some companies that privately place their securities may instead rely on the private investment company 

exclusions set forth in Sections 3(c)(1) and 3(c)(7) of the Act. Section 3(c)(1) of the Investment Company Act 

excludes from the definition of investment company any issuer whose outstanding securities (other than short-term 

paper) are beneficially owned by not more than 100 investors and which is not making and does not presently 

propose to make a public offering of its securities. 15 U.S.C. 80a-3(c)(1). Section 3(c)(7) of the Investment 

Company Act excludes from the definition of investment company any issuer whose outstanding securities are 
5 

statutory exclusion from the definition of investment company provided by Section 3(c)(5)(C)

does not have an extensive legislative history and has not been comprehensively addressed by 

the Commission. Section 3(c)(5)(C) has been addressed in staff no-action letters on a case-bycase basis.8

In light of the evolution of mortgage-related pools and the development of new and 

complex mortgage-related instruments, the Commission is reviewing interpretive issues relating

to the status of mortgage-related pools under the Investment Company Act and whether 

mortgage-related pools potentially are making judgments about their status under the Act without 

sufficient Commission guidance. It appears that some types of mortgage-related pools might 

interpret the statutory exclusion provided by Section 3(c)(5)(C) in a broad manner, while others 

might interpret the exclusion too narrowly, suggesting that there may be confusion among some 

mortgage-related pools about when the exclusion applies. The Commission also is concerned 

that the staff no-action letters that have addressed the statutory exclusion in Section 3(c)(5)(C) 

may have contained, or led to, interpretations that are beyond the intended scope of the exclusion 

and inconsistent with investor protection. The Commission is concerned that certain types of 

mortgage-related pools today appear to resemble in many respects investment companies such as

closed-end funds and may not be the kinds of companies that were intended to be excluded from 

 

owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers” as 

defined in the Act and which is not making and does not at that time propose to make a public offering of its 

securities. 15 U.S.C. 80a-3(c)(7).

8

 This release includes extensive discussion of staff no-action letters; accordingly the Commission notes that 

its discussion of staff statements is provided solely for background and to facilitate comment on issues that the 

Commission might address. The discussion is in no way intended to suggest that the Commission has adopted the 

analysis, conclusions or any other portion of the staff statements discussed here. Staff no-action letters are issued by 

the Commission staff in response to written requests regarding the application of the federal securities laws to 

proposed transactions. Many of the staff no-action letters are “enforcement-only” letters, in which the staff states 

whether it will recommend enforcement action to the Commission if the proposed transaction proceeds in 

accordance with the facts, circumstances and representations set forth in the requester’s letter. Other staff no-action 

letters provide the staff’s interpretation of a specific statute, rule or regulation in the context of a specific situation. 

See Informal Guidance Program for Small Entities, Investment Company Act Release No. 22587 (Mar. 27, 1997).
6 

regulation under the Act by Section 3(c)(5)(C). Therefore, the Commission believes that both 

investors and mortgage-related pools may benefit from the Commission’s comprehensive review

of the status of mortgage-related pools under the Investment Company Act and from any 

resulting guidance. 

Accordingly, the Commission is requesting data and other information from the public 

about mortgage-related pools and soliciting views about the application of Section 3(c)(5)(C) of 

the Investment Company Act to mortgage-related pools, including steps that the Commission 

might take in this area. The Commission’s goals in this effort are to: (1) be consistent with the 

Congressional intent underlying the exclusion from regulation under the Act provided by Section 

3(c)(5)(C); (2) ensure that the exclusion is administered in a manner that is consistent with the 

purposes and policies underlying the Act, the public interest, and the protection of investors; (3) 

provide greater clarity, consistency and regulatory certainty in this area; and (4) facilitate capital 

formation. 

II. COMPANIES THAT RELY ON SECTION 3(c)(5)(C)

A. Overview

By its terms, Section 3(c)(5)(C),

9

 excludes from the definition of investment company 

“[a]ny 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 the business of] purchasing or otherwise acquiring mortgages and other liens on 

and interests in real estate.” Many different types of companies that engage in a variety of 

businesses rely on this exclusion.10

 

9 Section 3(c)(5) was initially enacted in 1940 as Section 3(c)(6). Congress redesignated the provision as 

Section 3(c)(5) in 1970. Investment Company Amendments Act of 1970, Pub. L. No. 91-547, 84 Stat. 1413 (1970)

(codified as amended 15 U.S.C. 80a-3(c)(5)).

 Such companies include: those that originate and hold 

10 See infra note 13. 
7 

mortgages and participations of mortgages that they originated; companies engaged in the 

business of acquiring from affiliates or third parties mortgages and mortgage-related instruments

(such as mortgage participations, mezzanine loans and mortgage-backed securities); companies 

that invest in real estate, mortgages and mortgage-related instruments; and companies whose 

primary business is to invest in so-called agency securities11 and other mortgage-backed 

securities.12

 Companies that rely on the exclusion in Section 3(c)(5)(C) are structured and operated in 

various ways. Nevertheless, it appears that several general observations about mortgage-related 

pools can be made.

 

13

Many, if not most, mortgage-related pools are corporations or business trusts that have 

elected to be treated as REITs for purposes of their tax status under the Internal Revenue Code.14

 

11 Agency securities are mortgage-backed securities issued by the government-sponsored enterprises, 

Government National Mortgage Association (Ginnie Mae), Federal National Mortgage Association (Fannie Mae) 

and Federal Home Loan Mortgage Corporation (Freddie Mac).

 

Special tax provisions for REITs were created by Congress in 1960 as a means to make available 

to retail investors opportunities to invest in income-producing real estate and real estate-related 

12 A summary review by the staff of filings under the Securities Exchange Act of 1934 ("Exchange Act") of 

issuers identifying themselves as REITs suggests that, as of April 2011, there were approximately 49 REITs that had 

disclosed that they were primarily engaged in the business of holding mortgages and/or mortgage-related 

instruments, with most indicating that they or their subsidiaries were relying on Section 3(c)(5)(C). Of these 

companies, 15 stated that they were primarily engaged in the business of acquiring agency securities and other types 

of mortgage-backed securities. The staff's review also identified 57 companies that had disclosed in their Exchange 

Act filings that they were investing in both (i) real estate, and (ii) mortgages and mortgage-related instruments, with 

28 of such companies suggesting that they or their subsidiaries may be relying on Section 3(c)(5)(C). This review 

did not include those companies that have not elected to be treated as REITs under the Internal Revenue Code but 

may nevertheless be relying on the Section 3(c)(5)(C) exclusion.

13 The Commission's information about mortgage-related pools discussed in this release is derived primarily 

from the staff's review of registration statements filed under the Securities Act of 1933 ("Securities Act") and 

periodic reports filed under the Exchange Act, to the extent that these filings discuss whether a company is relying 

on Section 3(c)(5)(C). Information available to the Commission is further limited by the fact that companies that 

rely on Section 3(c)(5)(C) also include companies that privately place their securities without registering under the 

Securities Act and companies that may not be subject to the periodic reporting requirements under the Exchange 

Act. The description of mortgage-related pools provided in this section of the release relates primarily to companies 

that make filings with the Commission under the Securities Act and the Exchange Act, and is based on these filings. 

14 The REIT provisions are set forth in Sections 856 through 859 of the Internal Revenue Code. 26 U.S.C. 

856-859.
8 

assets.15 In a REIT structure, investor assets are pooled together to acquire, or provide financing 

for, various types of income-producing real estate interests that are selected and managed by 

professional asset managers. Like most registered investment companies, companies that 

qualify for REIT status typically seek pass-through tax treatment. To achieve this tax benefit, a 

company electing REIT status must comply with restrictions and limitations set forth in the 

Internal Revenue Code.16

Although mortgage-related pools may utilize a variety of investment strategies, most 

mortgage-related pools use leverage to magnify their returns.

 

17 For example, some mortgagerelated pools that primarily hold agency securities and other mortgage-backed securities operate 

using a business model that depends on the use of leverage, with their profits, if any, generated

by the spread between the cost of borrowing and the return on holdings purchased with the 

proceeds from such borrowing.18

 

15 See, e.g. Real Estate Investment Trusts, H.R. Rep. No. 2020, 86th Cong. 2nd Sess. 3-4 (1960). REITs may 

be classified into one of three categories. The National Association of Real Estate Investment Trusts (“NAREIT”) 

generally defines equity REITS to be companies that own and operate income-producing real estate, and mortgage 

REITs to be companies that lend money directly to real estate owners and their operators, or indirectly through the 

acquisition of loans or mortgage-backed securities. See NAREIT, The REIT Story: and Introduction to the Benefits 

of Investing in Real Estate Stocks, REIT.com (Feb. 2011). Hybrid REITs generally are companies that use the 

investment strategies of both Equity REITs and Mortgage REITs. As noted above, mortgage REITs and some 

Hybrid REITs typically seek to rely on Section 3(c)(5)(C). See supra note 

 According to data provided by the National Association of 

12. Equity REITs that hold fee interests 

directly typically do not invest in securities to such an extent as to fall within the definition of investment company 

under the Investment Company Act. See supra note 2. 

16 These requirements generally provide that: (1) the company distribute at least 90% of its taxable income in 

dividends to its shareholders annually; (2) at least 75% of the company’s total assets on the last day of each quarter 

of the company’s taxable year consist of real estate assets (including interests in real property, interests in mortgages 

on real property and shares of other REITs), cash and cash items, and government securities; and (3) the company 

derive at least 75% of its gross income during the past year from, among other things, rents from real property,

interest on obligations secured by mortgages on real property or on interests in real property, and 95% of its gross 

income from the same assets that qualify for the 75% test or from dividends or interest from any source. In addition 

to the asset and income tests and the 90% dividend distribution requirements, the Internal Revenue Code requires a 

company that elects REIT status to: be a corporation, trust, or association; be managed by one or more trustees or 

directors; have transferable shares; have a minimum of 100 shareholders; have no more than 50% of its shares held 

by five or fewer individuals; and not engage in certain prohibited transactions. See supra note 14. 

17 See, e.g., Peter C. Beller, Bet Against the Fed, Buy Mortgage REITs, Forbes.com, Jan. 25, 2010; Anthracite 

Capital Files Chapter 7, REITwrecks.com (Mar. 15, 2010). 

18 See, e.g., Vivian Marino, Some REITS Have a Contrarian Flavor, NY Times.com, Mar. 29, 2009.
9 

Real Estate Investment Trusts (“NAREIT”), as of September 30, 2010, the debt ratio of publicly 

traded Mortgage REITs averaged 83.5%, a debt-to-equity ratio of nearly five to one.19 In 

contrast, as of June 30, 2010, the debt-to-equity ratio of registered closed-end investment 

companies that use borrowings was generally less than one quarter to one.20

B. Management Style and Corporate Governance

Some mortgage-related pools are internally managed and have their own employees to 

carry out the administrative, investment and other activities necessary to operate the companies. 

Other mortgage-related pools have few, if any, employees and instead rely on separate advisory 

entities for the day-to-day operations of the companies. These advisory entities often are the 

mortgage-related pool’s sponsor (typically, a real estate investment firm, an investment 

management firm, a private equity manager or other similar company that sponsors REITs, 

hedge funds and/or private equity funds) or an affiliate of the sponsor. An adviser of an 

externally managed mortgage-related pool is compensated by the company through a variety of 

different compensation schemes, which may include a performance or incentive fee. Regardless 

 

19 NAREIT REITWatch: A Monthly Statistical Report on the Real Estate Investment Trust Industry (Apr. 

2011). NAREIT calculates the debt ratio by dividing the total debt outstanding in a REIT sector by that REIT 

sector’s total market capitalization. Total capitalization equals the sum of total debt plus implied market 

capitalization. 

20 See Thomas J. Herzfeld, Survey of Closed-End Fund Leverage, Investor’s Guide to Closed-End Funds 

(Oct. 2010). We compared REITs to registered closed-end investment companies because, as discussed below, 

certain mortgage-related pools have characteristics similar to such registered companies. See infra section II.C.

We note that certain REITs follow the North American Securities Administrators Association’s Statement 

of Policy Regarding Real Estate Investment Trusts (“NASAA Guidelines”), which generally state that the maximum 

level of borrowings (in relation to the company’s net asset value) should not exceed 300% without “a satisfactory 

showing that a higher level of borrowing is appropriate” and that any borrowing in excess of that level must be 

approved by a majority of the company's independent trustees and disclosed to shareholders. NASAA Guidelines at 

V.J. See infra note 22. We understand from filings made by mortgage-related pools under the Securities Act and 

the Exchange Act that other mortgage-related pools may specify in their organizational documents the level of 

leverage that they may use, although that level often may be increased with the approval of a majority of the 

company’s board of directors or trustees, and still others may use leverage up to any level deemed appropriate by 

their investment advisers. 
10

of whether they are internally or externally managed, most mortgage-related pools have boards 

of directors or trustees to oversee the companies’ management.

Many mortgage-related pools list and trade their securities on a national securities 

exchange and, like other public companies listed on a national securities exchange, must comply 

with the exchange’s listing and maintenance requirements, including corporate governance rules. 

Such rules require, among other things, that a majority of the members of the company's board of 

directors or trustees be independent of its management.21 Other mortgage-related pools do not 

list and trade their securities on a national securities exchange and may not be subject to any 

such corporate governance rules. Many non-exchange traded REITs, however, are structured in 

accordance with the NASAA Guidelines, as well as any applicable regulations of the states in 

which they sell their shares.22 Among other things, the NASAA Guidelines provide for a REIT 

to have a board of trustees that has a majority of independent members.23

C. Similarities to Traditional Investment Companies

 

Some mortgage-related pools today have characteristics similar to, and may operate like, 

traditional investment companies. For example, both mortgage-related pools and traditional 

investment companies pool investor assets to purchase securities and provide investors with 

professional asset management.24

 

21 See, e.g., Section 303A of the New York Stock Exchange Listed Company Manual. 

 Like traditional investment companies, mortgage-related 

pools may be internally or externally managed, with externally managed mortgage-related pools 

22 Most states require non-exchange traded REITs to comply with the provisions of the NASAA Guidelines, 

although certain states have adopted their own guidelines. See supra note 20. See, e.g., Foss, et al., Real Estate 

Investment Trusts Handbook, §4:1 (2009-2010 ed).

23 NASAA Guidelines at III.B. The NASAA Guidelines also address: a REIT's issuing certain securities, 

including redeemable securities; minimum suitability requirements; leverage concerns; potential conflicts of 

interests (such as providing for a majority of a REIT’s board of trustees, including a majority of its independent 

trustees, to approve transactions between the REIT and its affiliates); and annual reports to shareholders. NASAA 

Guidelines at III., V.,VI.

24 Like registered investment companies, many mortgage-related pools publicly offer their securities to both 

retail and institutional investors. 
11

typically having few, if any, employees, and instead relying on their investment advisers, which 

may be their sponsors or the sponsors' affiliates, to operate the companies.

25 Like investment 

advisers to traditional investment companies, investment advisers to mortgage-related pools 

typically are compensated with an asset-based fee.26 Some mortgage-related pools invest in the 

same types of assets as registered investment companies and private investment funds.27 Finally, 

some mortgage-related pools are perceived by investors and the media as being investment 

vehicles and not as companies that are engaged in the mortgage banking business.28

 

25 In addition, as discussed previously, both registered investment companies that seek to avoid corporate 

taxation and mortgage-related pools that elect REIT status must distribute at least 90% of their income to investors 

annually so as to avoid corporate taxation. See supra note 16 and accompanying text.

26 Investment advisers to mortgage-related pools also may receive incentive-based fees of a type that is 

prohibited for investment advisers to registered investment companies under the Investment Advisers Act of 1940 

("Advisers Act"), but typically charged by investment advisers to hedge funds and certain other private investment 

companies. See Section 205 of the Advisers Act. 15 U.S.C. 80b-5. An investment adviser to a mortgage-related 

pool may be required to register under the Advisers Act. See generally Section 203 of the Advisers Act and 

Commission rules thereunder. 

27 For example, many mortgage-related pools and registered investment companies, including money market 

funds, invest in agency securities. According to the Federal Reserve, as of March 31, 2011, registered investment 

companies (not including money market funds) held $800.8 billion (or 10.5%), and money market funds held $373.4

billion (or 4.9%), of outstanding “agency-and GSE-backed securities,” defined as issues of federal budget agencies 

(such as those for TVA), issues of government-sponsored enterprises (such as Fannie Mae and FHLB) and agencyand GSE-backed mortgage pool securities issued by Ginnie Mae, Fannie Mae, Freddie Mac and the Farmers Home 

Administration. In contrast, REITs held $191.1 billion (or 2.5%) of such securities. Federal Reserve Statistical 

Release, Flow of Funds Accounts of the United States: Flows and Outstandings First Quarter 2011 (June 9, 2011). 

As noted previously, certain registered investment companies focus their investments on the same types of assets as 

mortgage-related pools that primarily hold agency securities and other mortgage-backed securities. See supra note 

3. In addition, in recent years, some hedge funds and offshore funds have been investing in the same types of assets 

as some mortgage-related pools. See, e.g., Hedge Funds Investing in Delinquent Mortgages, MSNBC.com (July 30, 

2008). 

28 For example, a number of mortgage REITs appear to have been formed with the intent of targeting retail 

investors who may be unable to make the high minimum investments often required of large bond funds. See A.D. 

Pruitt, Mortgage REITs on a Tear as High Yields Fuel Demand, Wall St. J. (Apr. 13, 2011). Press reports have also 

characterized some such companies as investment vehicles. See, e.g., Jonathan Weil, Hedge Fund Instant IPO Tests 

the New Complacency, Bloomberg.net (Jun. 18, 2009) (“PennyMac is a hedge fund dressed up as a real estate 

investment trust”). See also Nathan Vardi, High-Profile Investor Sues Carlyle Group, Forbes.com (July 13, 2009) 

("Michael Huffington, the wealthy former Republican congressman from California, is suing the Carlyle Group and 

its co-founder, David Rubenstein, over misrepresentations and deceptions Huffington claims they made regarding 

his $20 million investment loss in Carlyle Corp., Carlyle’s failed . . . mortgage fund.”). 
12

With respect to investment companies, the Investment Company Act29 seeks to prevent 

such companies from, among other things, (i) employing unsound or misleading methods, or not 

receiving adequate independent scrutiny, when computing the asset value of their investments or 

their outstanding securities;30 (ii) engaging in excessive borrowing and issuing excessive 

amounts of senior securities;31 and (iii) being organized, operated, managed, or having their 

portfolio securities selected, in the interests of company insiders.32 In addition, the Investment 

Company Act seeks to protect the assets of investment companies, including imposing custody 

controls and preventing controlling persons of an investment company from commingling the 

investment company’s assets with their own and misappropriating them.33

 

29 See, e.g., Section 1(b) of the Investment Company Act (setting forth findings and declaration of policy). 15 

U.S.C. 80a-1(b).

 

30 The Investment Company Act places significant emphasis on the manner in which a registered investment 

company must value its portfolio. See, e.g., Section 2(a)(41) of the Act. 15 U.S.C. 80(a)-2(a)(41) (defining "value," 

with respect to securities held by a registered investment company, to be (a) market value for securities for which 

market quotations are readily available or (b) for other securities or assets, fair value as determined in good faith by 

the company's board of directors).

31 Prior to 1940, some investment companies were highly leveraged through the issuance of “senior 

securities” in the form of debt or preferred stock, which often resulted in the companies being unable to meet their 

obligations to the holders of their senior securities. See generally Investment Trusts and Investment Companies: 

Report of the Securities and Exchange Commission (1940) (“Investment Trusts Study”). Excessive leverage also 

greatly increased the speculative nature of the common stock of the companies. Id. Section 18 of the Investment 

Company Act limits the ability of registered investment companies to engage in borrowing and to issue senior 

securities. 15 U.S.C. 80a-18.

32 A study conducted prior to the adoption of the Act documented numerous instances in which investment 

companies were managed for the benefit of their sponsors and affiliates to the detriment of investors. See Investment 

Trusts Study, supra note 31. Section 17 of the Investment Company Act prohibits certain transactions involving 

investment companies and their affiliates. 15 U.S.C. 80a-17(a). Other provisions of the Investment Company Act 

also effectively limit opportunities for overreaching by investment company sponsors and affiliates. See, e.g., 

Section 10(f) of the Investment Company, which generally prohibits a registered investment company from 

knowingly purchasing, during the existence of any underwriting or selling syndicate, any security a principal 

underwriter of which is an affiliated person of the investment company. 15 U.S.C. 80a-10(f).

33 See, e.g., Investment Trusts Study, supra note 31. Prior to 1940, investment company assets were not 

adequately protected from misuse by investment company insiders. Id. In many cases, controlling persons of 

investment companies commingled the investment companies’ assets with the investment advisers’ assets and then 

proceeded to misuse the assets themselves. Id. Section 17(f) of the Investment Company Act and the rules 

thereunder set forth requirements with respect to the custody of investment company assets. 15 U.S.C. 80a-17(f). 

See, e.g., Rule 17f-2 under the Investment Company Act governing custody of investments by a registered 

investment company. 17 CFR 270.17f-2. 
13

We are concerned that some mortgage-related pools, as pooled investment vehicles, may 

raise the potential for the same types of abuses, such as deliberate misvaluation of the company’s 

holdings,34 extensive leveraging,

35 and overreaching by insiders.36 The Commission also has 

brought a number of enforcement cases, for example, in which controlling persons of companies 

that hold mortgage-related assets used such companies’ assets to further their own interests.37

D. Request for Comment

 

The Commission is interested in learning more about mortgage-related pools. 

Accordingly, commenters are requested to provide information about companies that rely on 

Section 3(c)(5)(C) of the Act, including, among other things, the various types of such 

 

34 For example, the Commission has brought an enforcement action against the management of a company 

that had, among other things, improperly recorded mortgages that had decreased in value at cost rather than at 

market value in order to avoid writing down certain mortgages held for resale, thereby adversely affecting the 

company’s income and equity. See SEC v. Patrick Quinlan, 2008 Fed. Sec. L. Rep. (CCH) ¶95,005 (E.D. Mich. 

Nov.7, 2008), aff’d, 373 Fed. Appx. 581 (6th Cir. 2010). 

35 For example, an offshore fund that held mortgage-backed securities reportedly had a 32:1 leverage ratio 

(borrowing against the security of the mortgage-backed securities), so that when the mortgage-backed securities lost 

value, the fund could not service its debts, resulting in lenders seizing the fund’s assets. See, e.g., Nathan Vardi,

High-Profile Investor Sues Carlyle Group, Forbes.com (July 13, 2009). 

36 For example, the Commission brought a settled administrative proceeding against a former chief executive 

officer of both a publicly held REIT and its manager (which owned approximately 52% of the REIT) who had used 

his significant influence on the advisory services provided by the REIT manager to cause the REIT, its manager and 

other related parties together to purchase over a million shares of a publicly traded company over a 13-month period, 

representing 16.1% of the total shares of that company. These purchases accounted for approximately 54% of the 

total trading volume in the company’s stock during that period, and on some days these parties purchased all of the 

company’s stock that traded that day. Although no entity itself purchased more than 5% of the company’s 

securities, the Commission determined that given the interrelationships that existed, the REIT and others constituted 

a “group” for purposes of Section 13(d), and that a Schedule 13D should have been filed. See In the Matter of Basic 

Capital Management Inc., et al., Exchange Act Release No. 46538 (Sept. 24, 2002). This case illustrates how a 

mortgage-related pool insider has the potential to influence the management of the company’s assets for the insider's 

benefit. 

37 See, e.g., SEC v. Pittsford Capital Income Partners LLC, et al., No. 06-6353 (W.D.N.Y. Aug. 23, 2007), 

aff'd, 305 Fed. Appx. 694 (2d. Cir. 2008) (persons that controlled certain real estate investment companies sold to 

senior citizens engaged in a fraudulent scheme involving, among other things, transfers of large amounts of money 

from the companies to entities in which the controlling persons had significant personal interests); SEC v. Global 

Express Capital Real Estate Investment Fund I et al., No. 03-1514 (Nev. Mar. 28, 2006), aff’d in part, rev’d and 

remanded in part, 289 Fed. Appx.183 (9th Cir. 2008) (a Ponzi-like scheme which purported to pool investor funds to 

purchase interests in mortgage loans and trust deeds); SEC v. LandOak Securities, LLC, et al., No. 3:08-209 (E.D. 

Tenn., Mar. 29, 2011) (persons that controlled a mortgage company misappropriated funds due to the company's 

investors).
14

companies; how such companies are operated, including their strategies for the acquisition and 

management of their holdings; the types of investors that invest in such companies; and the roles 

of such companies in the mortgage markets. We ask commenters to discuss the differences, if 

any, between companies that originate mortgages and then continue to hold all or portions of 

those mortgages, and companies that only invest in mortgages and mortgage-related instruments. 

The Commission also invites commenters to provide the same type of information about any 

similar companies that do not rely on Section 3(c)(5)(C) and to explain whether they are 

registered under the Act or rely on another exclusion or exemption and, if so, which exclusion or 

exemption. The Commission is interested in obtaining information about both public (exchangetraded and non-exchange traded) and privately offered mortgage-related pools and similar 

companies. The Commission also requests that commenters provide any other information about 

mortgage-related pools they believe is relevant to the Commission’s review of the status of such 

companies under the Investment Company Act.

We also ask commenters for their views on the apparent similarities between certain 

mortgage-related pools and traditional investment companies. We ask commenters to describe 

any key operational or structural characteristics of mortgage-related pools that serve to 

distinguish them from traditional investment companies regulated under the Investment 

Company Act. The Commission requests that commenters provide any other information that 

may be relevant to evaluating the similarities and differences between mortgage-related pools 

and investment companies. 

 Finally, we request comment on the types of potential abuses that the Investment 

Company Act was intended to prevent that might be associated with mortgage-related pools. We 

also are interested in learning about any existing safeguards in the structure and operations of 
15

mortgage-related pools that may address concerns similar to those addressed by the Investment 

Company Act. Commenters also are invited to comment on whether certain concerns addressed 

by the Investment Company Act may not be relevant to mortgage-related pools and the reasons 

why. Commenters also should discuss whether, and to what extent, such potential abuses are 

addressed by any industry practices or other regulatory schemes that may be applicable to 

mortgage-related pools. 

III. THE EXCLUSION PROVIDED BY SECTION 3(c)(5)(C)

A. Legislative and Administrative Background 

Section 3(c)(5) originally was intended to exclude from the definition of investment 

company, among other things, companies that did not resemble, or were not considered to be, 

issuers that were in the investment company business.38

 

38 See, e.g., H.R. Rep. No. 2639, 76th Cong., 3d Sess. 12(1940) (“Subsection (c) specifically excludes . . . 

companies dealing in mortgages. . .”); H.R. Rep. No. 1382, 91st Cong., 2d Sess. 17 (1970) (“Although the companies 

enumerated. . . have portfolios of securities in the form of . . . mortgages and other liens on and interests in real 

estate, they are excluded from the act’s coverage because they do not come within the generally understood concept 

of a conventional investment company investing in stocks and bonds of corporate issuers”) (“1970 House Report”). 

See also PPI Report, supra note 

 In 1970, Congress amended Section 

3(c)(5) to prohibit any issuer relying on the exclusion from issuing redeemable securities. 

According to the legislative history, certain companies that had been relying on Section 3(c)(5) 

2 at 328 (“Section 3(c)(6) provides for an exclusion from the definition of 

investment company for companies primarily engaged in the . . . real estate businesses. Although these companies 

are engaged in acquiring . . . mortgages and other interests in real estate – thus acquiring investment securities, such 

activities are generally understood not to be within the concept of a conventional investment company which invests 

in stocks and bonds of corporate issuers”); Exclusion from the Definition of Investment Company for Certain 

Structured Financings, Investment Company Act Release No. 18736 (May 29, 1992) (“Proposing Release to Rule 

3a-7”) at text following n.5 (“section 3(c)(5)] . . . originally was intended to exclude issuers engaged in the 

commercial finance and mortgage banking industries.”). 

 As initially enacted by Congress in 1940, Section 3(c)(5) was limited to companies that did not issue faceamount certificates of the installment type or periodic payment plan certificates, in response to the abuses found 

prior to 1940 in the sale of these types of securities by certain companies, including those of the type that would 

have otherwise been excluded by this provision. See generally Investment Trusts and Investment Companies: 

Hearings Before a Subcomm. of the Senate Comm. on Banking and Currency on S. 3580, 76th Cong., 3d. at 182 

(1940) (statement of David Schenker). The prohibition on issuing face-amount certificates also may have been

added to ensure that Investors Syndicate, a face-amount certificate company that held real estate and mortgage 

interests, would not be able to rely on Section 3(c)(5)(C) and instead be required to register under the Investment 

Company Act, as detailed in the Investment Trusts Study, supra note 31, at Ch. II of Companies Issuing Face 

Amount Installment Contracts (1940). 
16

sought to capitalize on the popularity of mutual funds by issuing redeemable securities.39 

Because Section 3(c)(5) was not intended to cover those companies that fell within the generally 

understood concept of a traditional investment company,40 the 1970 amendment sought to ensure 

that companies that structured themselves like mutual funds would be subject to regulation under 

the Investment Company Act, regardless of the types of securities that they held.41

In 1960, the Commission addressed Section 3(c)(5)(C) in a release that discussed the 

applicability of the federal securities laws to REITs.

 

42 In the 1960 Release, the Commission, 

among other things, stated that a REIT may fall within the definition of investment company 

under the Investment Company Act but, depending on the characteristics of its assets and the 

nature of the securities it issues, the REIT may be able to rely on Section 3(c)(5)(C).43 In the 

1960 Release, the Commission also generally stated that the applicability of the Section 

3(c)(5)(C) exclusion could be determined only on the basis of the facts and circumstances of the 

particular REIT. The Commission further stated, however, that any REIT that invested 

“exclusively in fee interests in real estate or mortgages or liens secured by real estate” could rely 

on the Section 3(c)(5)(C) exclusion, provided that the REIT also met the exclusion’s other 

criteria with respect to the nature of the securities it issued.44 The Commission explained that a 

REIT might not qualify for the exclusion if it “invested to a substantial extent in other real estate 

investment trusts . . . or in companies engaged in the real estate business or in other securities.”45

 

39 See, e.g., 1970 House Report, supra note 38 at 17; PPI Report, supra note 2 at 328-329. 

40 See supra note 38. 

41 See, e.g., 1970 House Report, supra note 38. 

42 Real Estate Investment Trusts, Investment Company Act Release No. 3140 (Nov. 18, 1960) (“1960 

Release”) (discussing Section 3(c)(6)(C), which was subsequently redesignated as Section 3(c)(5)(C)). See supra

note 9. 

43 Id.

44 Id.

45 Id. 
17

The Commission has not specifically addressed the scope of Section 3(c)(5)(C) since the 1960 

Release.46

B. Commission Staff No-Action Letters and Other Interpretations

 

As noted above, Section 3(c)(5)(C) generally excludes from the definition of investment 

company any person who is primarily engaged in, among other things, "purchasing or otherwise 

acquiring mortgages and other liens on and interests in real estate." The staff, in providing 

guidance on this exclusion, generally has focused on whether at least 55% of the issuer’s assets 

will consist of mortgages and other liens on and interests in real estate (called “qualifying 

interests”)47 and the remaining 45% of the issuer’s assets will consist primarily of real estatetype interests.48

 

46 The Commission testified before Congress in 1983 and 1984 concerning the applicability of the Investment 

Company Act to issuers of some mortgage-related securities in connection with legislation that became the 

Secondary Mortgage Market Enhancement Act of 1984. Statement of the Securities and Exchange Commission 

Submitted to the Subcommittee on Housing and Urban Affairs, U.S. Senate, on S. 1821 (Sep. 27, 1983) ("The 

Commission believes that the Investment Company Act offers important protections to investors in entities coming 

within the definition of the term 'investment company' that should not be sacrificed lightly, even in the name of an 

objective as worthwhile as enhancing the private secondary mortgage market"). 

 The staff generally has viewed the following types of assets as qualifying

interests: 

In the Proposing Release to Rule 3a-7, issued in 1992, the Commission discussed the reliance on Section 

3(c)(5) by certain private sector issuers of asset-backed securities, including mortgage-backed securities. See 

Proposing Release to Rule 3a-7, supra note 38. In that release, the Commission requested comment on whether 

Section 3(c)(5) should be amended to prevent such issuers from continuing to rely on this exclusion, because such 

issuers could instead rely on Rule 3a-7. In response to commenters' arguments, including that it would be 

inappropriate to narrow the scope of Section 3(c)(5) until both the market and the Commission gained experience 

with Rule 3a-7, the Commission decided not to pursue any legislative changes with respect to Section 3(c)(5) at that 

time. See Exclusion from the Definition of Investment Company for Structured Financings, Investment Company 

Act Release No. 19105 (Nov. 19, 1992) [57 FR 56248 (Nov. 27, 1992)] ("Adopting Release to Rule 3a-7"). In the 

3a-7 Companion Release, the Commission once again is seeking comment on whether Section 3(c)(5) should be 

amended to limit the ability of asset-backed issuers to rely on this exclusion. 3a-7 Companion Release, supra note 

5.

47 See, e.g., Salomon Brothers, Inc., SEC Staff No-Action Letter (June 17, 1985).

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

Staff No-Action Letter (Aug. 8, 1991) (issuer represented its intention to invest at least 25% of its total assets in real 

estate-type interests (subject to reduction to the extent that the issuer invested more than 55% of its total assets in 

qualifying interests) and no more than 20% of its total assets in miscellaneous investments). 
18

• Assets that represent an actual interest in real estate or are loans or liens fully 

secured by real estate. Thus, the staff generally took the position that an issuer 

may treat as qualifying interests such assets as mortgage loans fully secured by 

real estate, fee interests in real estate, second mortgages secured by real property, 

deeds of trust on real property, installment land contracts and leasehold interests 

secured solely by real property.

49

• Assets that can be viewed as being the functional equivalent of, and provide their

holder with the same economic experience as, an actual interest in real estate or a 

loan or lien fully secured by real estate. Thus, the staff took the position that a 

Tier 1 real estate mezzanine loan, under certain conditions, may be considered a 

qualifying interest if the loan may be viewed as being the functional equivalent 

of, and provide its holder with the same economic experience as, a second 

mortgage.

 

50

Consistent with the view the Commission expressed in the 1960 Release, the staff has 

taken the position that an issuer that is primarily engaged in the business of holding interests in 

the nature of a security in another person engaged in the real estate business, generally may not 

 

 

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

loan secured exclusively by real estate in which the value of the real estate was equal or greater than the note 

evidencing the loan); Division of Investment Management, SEC, The Treatment of Structured Finance Under the 

Investment Company Act, Protecting Investors: A Half Century of Investment Company Regulation (1992) Ch. 1 

(“Protecting Investors Report”) at n. 345 and accompanying text (mortgage loan in which 100% of the principal 

amount of each loan was fully secured by real estate at the time of origination and 100% of the market value of the 

loan was fully secured by real estate at the time of acquisition); United Bankers, SEC Staff No-Action Letter (Mar. 

23, 1988) (fee interests in real estate); The State Street Mortgage Co., SEC Staff No-Action Letter (July 17, 1986) 

(second mortgages); First National Bank of Fremont, SEC Staff No-Action Letter (Nov. 18, 1985) (deeds of trust on 

real property); American Housing Trust I, SEC Staff No-Action Letter (May 21, 1988) (installment land contracts); 

Health Facility Credit Corp., SEC Staff No-Action Letter (Feb. 6, 1985) (leasehold interests).

50 See Capital Trust Inc., SEC Staff No-Action Letter (May 24, 2007). 
19

rely on Section 3(c)(5)(C).51

• The staff has expressed the view that “whole pool certificates” that are issued or 

guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (“agency whole pool 

certificates”) provide the holder with the same economic experience as an

investor who purchases the underlying mortgages directly, and therefore would 

be qualifying interests;

 Thus, securities issued by REITs, limited partnerships, or other 

entities that invest in real estate, mortgages or mortgage-related instruments, or that are engaged 

in the real estate business, generally are not considered by the staff to be qualifying interests. In 

two particular circumstances, however, the staff expressed the view that certain interests in 

another person engaged in the real estate business may be regarded as qualifying interests: 

52

• The staff has expressed the view that certain subordinate participations in 

commercial real estate first mortgage loans, called B-Notes, have a number of 

attributes that, when taken together, may allow them to be classified as an interest 

in real estate rather than an interest in the nature of a security issued by a person 

that is engaged in the real estate business.

and 

53

 

51 See 1960 Release, supra note 

 

42. See also Urban Land Investments Inc., SEC Staff No-Action Letter 

(Nov. 4, 1971); The Realex Capital, SEC Staff No-Action Letter (Mar. 19, 1984); M.D.C. Holdings, SEC Staff NoAction Letter (May 5, 1987). The staff also has stated its view that an issuer that is engaged primarily in purchasing 

or otherwise acquiring participations or fractionalized interests in individual or pooled mortgages or deeds of trust 

would not qualify to rely on Section 3(c)(5)(C) because such participations and interests are in the nature of a 

security in another person engaged in the real estate business. MGIC Mortgage Corp., SEC Staff No-Action Letter 

(Oct. 6, 1972 and Aug. 1, 1974); M.D.C Holdings, SEC Staff No-Action Letter (May 5, 1987). 

52 See Protecting Investors Report, supra note 49 at n.267. A whole pool certificate is a security that 

represents the entire ownership interest in a particular pool of mortgage loans. Id. See also American Home 

Finance Corp. (pub. avail. Apr. 9, 1981). 

53 Capital Trust Letter, SEC Staff No-Action Letter (Feb. 3, 2009) (“Capital Trust B-Note Letter”). The 

Capital Trust B-Note Letter was intended to clarify the staff’s earlier statements with respect to mortgage 

participations as qualifying interests. In prior letters, the staff had expressed the view that a trust that held certain 

participation interests in construction period mortgage loans acquired from mortgage lenders may rely on Section 

3(c)(5)(C), concluding that each mortgage participation interest held by the trust was an interest in real estate 

because the participation interest was in a mortgage loan that was fully secured by real property and the trustee had 

the right by itself to foreclose on the mortgage securing the loan in the event of default. See, e.g. Northwestern Ohio 

Building and Construction Trades Foundation, SEC Staff No-Action Letter (Apr. 20, 1984); Baton Rouge Building 
20

Finally, the staff has expressed the view that certain mortgage-related instruments that 

were not treated as qualifying interests may be treated as real estate-type interests. In the staff's 

view, such instruments would include loans in which at least 55% of the fair market value of 

each loan was secured by real estate at the time the issuer acquired the loan,

54 and agency partial 

pool certificates.55

Some mortgage-related pools have determined that certain other assets constitute 

qualifying assets for purposes of that exclusion. For example, we understand that mortgagerelated pools generally treat bridge loans, certain construction and rehabilitation loans, wraparound mortgage loans and investments in distressed debt as qualifying interests, provided that 

the loans are fully secured by real estate. We also understand that some mortgage-related pools 

have determined to treat a convertible mortgage (which is a mortgage plus an option to purchase 

the underlying real estate) as two assets -- a mortgage loan (treated as a qualifying interest 

provided that it is fully secured by real estate) and an option to purchase real estate (which is 

assigned an independent value and treated as a real estate-type interest). 

With respect to certain other mortgage-related instruments, there appears to be a degree 

of uncertainty or differing views among mortgage-related pools as to the availability of the 

Section 3(c)(5)(C) exclusion. For example, it appears that some mortgage-related pools that 

invest in certificates issued by pools that hold whole loans and participation interests in loans 

 

and Construction Industry Foundation, SEC Staff No-Action Letter (Aug. 31, 1984). Although the Capital Trust BNote Letter specifically did not withdraw the prior staff no-action letters, it noted the staff's view that, while the 

right to foreclose is an important attribute to consider when determining whether an asset should be considered a 

qualifying interest, other attributes of the asset also need to be considered when making such a determination.

54 NAB Asset Corp., SEC Staff No-Action Letter (June 20, 1991). 

55 The staff has expressed the view that, while an agency partial pool certificate (which is a certificate that 

represents less than the entire ownership interest in a mortgage pool) is not a qualifying interest because it is more 

akin to being an investment in the securities of an issuer holding mortgages rather than an investment directly in the 

underlying mortgages, such asset may be treated as a real estate-type interest for purposes of determining whether an 

issuer may rely on Section 3(c)(5)(C). See, e.g., Nottingham Realty Securities, SEC Staff No-Action Letter (Apr. 19, 

1984); Protecting Investors Report, supra note 49 at n.268 and accompanying text. 
21

that are secured by commercial real estate (“CMBS") limit the amount of CMBS that they hold, 

treating such assets as real estate-type interests under Section 3(c)(5)(C), whereas others treat 

certain CMBS as qualifying interests. 

C. Request for Comment on the Current Interpretation of Section 3(c)(5)(C)

As the discussion above indicates, the exclusion from the definition of investment 

company provided by Section 3(c)(5)(C) does not have an extensive legislative history, has not 

been comprehensively addressed by the Commission, and generally has been addressed in staff 

no-action letters only on a case-by-case basis. The evolution of mortgage-related pools and the 

development of new and complex mortgage-related instruments have led us to be concerned that

mortgage-related pools are making judgments about their status under the Investment Company 

Act without sufficient Commission guidance.56

 

56 In this regard we note that most mortgage-related pools, when publicly offering their securities, disclose in 

their registration statements that their determinations whether they may rely on the Section 3(c)(5)(C) exclusion will 

be based on staff no-action letters and Commission guidance and, where such guidance does not exist, on their own 

judgments. Such companies also state that there can be no assurance that the Commission staff will concur with 

their views, or that the laws governing the Investment Company Act status of mortgage-related pools, or the 

guidance provided by the Commission or its staff, will not change in a manner that would not adversely affect their 

operations. 

 It appears that some types of mortgage-related 

pools might interpret the statutory exclusion provided by Section 3(c)(5)(C) in a broad manner, 

while others might interpret the exclusion too narrowly. The Commission also is concerned that 

the staff no-action letters that have addressed the statutory exclusion in Section 3(c)(5)(C) may 

have contained, or led to, interpretations that are beyond the intended scope of the exclusion and 

inconsistent with investor protection. The Commission is concerned that certain types of 

companies today appear to resemble in many respects management investment companies that 

are registered under the Act and may not be the kinds of companies that were intended to be 

excluded from regulation under the Act by Section 3(c)(5)(C). 
22

The Commission requests comment from mortgage-related pools, investors, and the 

public on the current state of guidance and interpretation concerning Section 3(c)(5)(C). The 

Commission is interested in learning from mortgage-related pools and their legal counsel about 

any difficulties they may have encountered in determining the status of such companies under 

the Investment Company Act. Are we correct that there is uncertainty or differing views among 

companies as to the availability of the Section 3(c)(5)(C) exclusion? If so, please explain and 

provide specific examples. Do commenters believe that the exclusion provided by Section 

3(c)(5)(C) is generally being used consistent with the purposes and policies underlying that 

provision and investor protection? Do commenters believe that certain mortgage-related pools 

may be giving too broad an interpretation to this statutory exclusion? If so, does such broad 

interpretation result in companies that resemble traditional investment companies avoiding 

regulation under the Act and, if so, is it inconsistent with the purposes and policies underlying 

that provision and investor protection? Do commenters believe that certain companies may be 

giving too narrow an interpretation to this statutory exclusion? Commenters are requested to 

provide detailed explanations of their views, including specific examples, if appropriate. 

We noted above that companies generally determine whether they are primarily engaged 

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

real estate, based on whether at least 55% of the company’s assets consist of qualifying interests 

and the remaining 45% of the company’s assets consist primarily of real estate-type interests. Is 

this an appropriate approach to determining an issuer’s primary engagement for purposes of 

Section 3(c)(5)(C)? Is it a difficult determination to make? Is the approach too broad or, 

conversely, too narrow in terms of identifying the types of companies that are able to rely on the 

exclusion, consistent with legislative intent? Does this approach lead certain companies to invest 
23

their assets in a different manner than they otherwise would in accordance with their business 

model, in order to have the certainty of being able to rely on Section 3(c)(5)(C)? Are there 

companies that have concluded that they do not qualify for the exclusion in Section 3(c)(5)(C)? 

If so, how did such companies address their status under the Investment Company Act? 

Commenters are requested to comment on their experiences in this area, including the economic 

impact of this approach. 

With respect to the staff no-action letters, we ask for comment on whether any of the 

staff's analysis relating to the determination of whether an asset is a "lien on or interest in real 

estate" for purposes of Section 3(c)(5)(C) would be relevant in formulating Commission 

guidance for today’s mortgage-related pools. Commenters should identify any such staff 

position and explain its relevance. For example, should certain mortgage participations be 

treated as interests in real estate and, if so, what types of participations and why? Is a company 

whose primary business activity consists of holding mortgage participations, the type of entity 

that should be excluded from the definition of investment company? Why or why not, and does 

it matter what type(s) of participations the company holds? If participations are to be treated as 

interests in real estate, what features should be considered in making a determination about such 

assets? For example, should the right to foreclose be considered an important attribute, even 

though such right only exists if the underlying mortgage defaults?57

We also request comment on the view that the Commission should take concerning 

agency whole pool certificates under Section 3(c)(5)(C). Should the Commission revisit the 

 Commenters are 

encouraged to discuss the costs and benefits of their recommendations. 

 

57 See supra note 53. 
24

staff's view that agency whole pool certificates may be treated as interests in real estate?58

Finally, we ask for comment generally on whether guidance is needed with respect to

other mortgage-related instruments. If so, which instruments and what should that guidance 

provide? We note in particular the differing approaches taken by certain mortgage-related pools 

as to the appropriate treatment of certain types of CMBS for purposes of determining a 

company’s ability to rely on Section 3(c)(5)(C). Should the Commission provide guidance with 

respect to these mortgage-related instruments, what should that guidance address, and what 

would be the potential economic impact of this guidance? We also request comment on whether 

a company whose primary business consists of investing in CMBS, or any other type of 

 

Should we view a company whose primary business consists of investing in agency whole pool 

certificates – or other mortgage-backed securities – as the type of entity that Congress intended 

to be encompassed by the exclusion provided by Section 3(c)(5)(C) or not? What would be the 

economic impact of the Commission adopting a position that would not treat agency whole pool 

certificates as interests in real estate? Commenters should explain how such companies are 

similar to, or differ from, traditional investment companies that invest in similar assets, and how 

any such similarities or differences should affect the status of such companies under the 

Investment Company Act. 

 

58 The Commission issued a similar request for comment in 1992. See Proposing Release to Rule 3a-7, supra

note 38 at n.103 and accompanying text. That request for comment stemmed from the Protecting Investors Report, 

issued in 1992, in which the staff discussed whether it should reconsider its position with respect to agency whole 

pool certificates, noting that an agency whole pool certificate holder does not have the same economic experience as 

an investor who holds the underlying mortgages because of the agency guarantee, which increases the certificates' 

liquidity. Protecting Investors Report, supra note 49 at text following n.346. Commenters strongly urged the staff 

not to withdraw its position, arguing that agency whole pool certificates are interests in real estate because certificate 

holders receive payment streams that reflect payments on the underlying mortgages. Commenters also argued that 

withdrawal of the position could result in some REITs and mortgage bankers that held these instruments becoming 

subject to the Investment Company Act. In response to commenters' concerns at that time, the staff ultimately 

decided not to withdraw its position. Adopting Release to Rule 3a-7, supra note 46 at nn. 90-92 and accompanying 

text. 
25

mortgage-backed security, is the type of entity that Congress intended to be encompassed by the 

exclusion provided by Section 3(c)(5)(C).

IV. Request for Comment on Possible Commission Action

The Commission requests comment on what steps, if any, it should take to provide 

greater clarity, consistency or regulatory certainty regarding the status of mortgage-related pools 

under the Investment Company Act. The Commission potentially could engage in rulemaking

(such as a safe harbor or definitional rule), issue an interpretive release, and/or provide 

exemptive relief to address mortgage-related pools and the scope of Section 3(c)(5)(C), or take 

no further action at this time. Commenters are encouraged to discuss the benefits and costs of 

each such option. 

Commenters are asked to address whether a test could be devised that would differentiate 

companies that are primarily engaged in the real estate and mortgage banking business from 

those companies that resemble traditional investment companies. If commenters believe that 

such a test is appropriate, the Commission is interested in commenters’ views as to the factors 

that would be suitable in such a test, the benefits and costs associated with any suggested test, 

and the effect that any suggested test may have on investor protection, competition, efficiency 

and capital formation. 

Section 3(c)(5)(C) suggests that one factor that must be considered when determining 

whether a company is primarily engaged in the business set forth in Section 3(c)(5)(C) is the 

composition of the company’s assets. Would it be helpful for the Commission to define the term 

"liens on and other interests in real estate" for purposes of Section 3(c)(5)(C)? If so, how should 
26

the Commission define that term? For example, in light of the reference to "mortgages" in

Section 3(c)(5)(C), should the term "liens on and interests in real estate" also be defined to 

include only those assets that are directly related to real estate, rather than include, for example, 

interests in a mortgage or in a pool or other entity that holds real estate? The Commission 

requests comment on the advantages and disadvantages of defining the term "liens on and 

interests in real estate" in this manner. If commenters believe that a broader definition of the 

term "liens on and interests in real estate" is more appropriate, the Commission requests 

comment on the principles or concepts that could be used to craft such a definition. Commenters 

are encouraged to discuss the benefits and costs of alternative definitions.

In addition to the composition of a company’s assets, other factors may help to

differentiate companies that are primarily engaged in the real estate and mortgage banking 

business from those companies that resemble traditional investment companies. What are such 

other factors? Should a company also look to its sources of income in determining its "primary 

business" under Section 3(c)(5)(C)? 59 Should factors such as the company's historical 

development, the activities of its officers, directors and employees, and its public representations 

also be considered in determining the company's primary business under Section 3(c)(5)(C)? Are 

there factors that may be potentially indicative of a company’s non-investment company 

business? For example, are there any types of business activities or types of business expenses 

that differentiate such a company from an investment company?60

 

59 See, e.g., Section 3(c)(6) of the Investment Company Act. 15 U.S.C. 80a-3(c)(6). We note that the Internal 

Revenue Code’s REIT provisions contain an asset and income test. See supra note 

Commenters are urged to be 

specific in their responses. 

16. 

60 See e.g., Rule 3a-8 under the Investment Company Act (addressing the status under the Act of certain 

research and development companies based on, among other things, their research and development expenses, the 

activities of their officers, directors and employees, their public representations of policies, and their historical 

development). 17 CFR 270.3a-8. 
27

IV. GENERAL REQUEST FOR COMMENT

 In addition to the issues raised or mentioned in this release, the Commission requests and 

encourages all interested persons, including investors in mortgage-related pools, to submit their 

views on any other issues relating to the status of such companies under the Investment 

Company Act. The Commission particularly welcomes statistical, empirical, and other data 

from commenters that may support their views and/or support or refute the views or issues raised 

in this release. 

By the Commission.

 Elizabeth M. Murphy 

 Secretary 

August 31, 2011