Document ID: SEC-2011-1346-0001
Agency: sec
Document Type: Proposed Rule
Title: Companies Engaged in Business of Acquiring Mortgages and Mortgage-Related Instruments
Posted Date: 2011-09-07T04:00Z

[Federal Register Volume 76, Number 173 (Wednesday, September 7, 2011)]
[Proposed Rules]
[Pages 55300-55308]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-22771]

[[Page 55300]]

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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.

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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

    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, DC 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 a.m. and 3 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.

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\ While some such companies register as 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

[[Page 55301]]

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\
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    \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 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 profit-sharing 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, 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.''
    \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'').
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    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\ The 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-by-case basis.\8\
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    \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 
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).
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    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 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\ Such companies include: Those 
that originate and hold 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 securities \11\ and other mortgage-backed 
securities.\12\
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    \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, Public Law 91-547, 
84 Stat. 1413 (1970) (codified as amended 15 U.S.C. 80a-3(c)(5)).
    \10\ See infra note 13.
    \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).
    \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.
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    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

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observations about mortgage-related pools can be made.\13\
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    \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.
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    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\ 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 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\
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    \14\ The REIT provisions are set forth in Sections 856 through 
859 of the Internal Revenue Code. 26 U.S.C. 856-859.
    \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 
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.
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    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 mortgage-related 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\ According to data provided by the National Association 
of 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\
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    \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.
    \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.
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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 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

[[Page 55303]]

trustees that has a majority of independent members.\23\
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    \21\ See, e.g., Section 303A of the New York Stock Exchange 
Listed Company Manual.
    \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, Sec.  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.
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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\ Like traditional investment 
companies, mortgage-related pools may be internally or externally 
managed, with externally managed mortgage-related pools 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\
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    \24\  Like registered investment companies, many mortgage-
related pools publicly offer their securities to both retail and 
institutional investors.
    \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 agency- and 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.'').
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    With respect to investment companies, the Investment Company Act 
\29\ 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\
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    \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.
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    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

[[Page 55304]]

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\
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    \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).
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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 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 (exchange-traded 
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 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\ 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) 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\
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    \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 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 face-amount 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).
    \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.
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    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

[[Page 55305]]

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\ The Commission 
has not specifically addressed the scope of Section 3(c)(5)(C) since 
the 1960 Release.\46\
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    \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.
    \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'').
    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.
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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 estate-type interests.\48\ The staff generally has 
viewed the following types of assets as qualifying interests:
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    \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).
---------------------------------------------------------------------------

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

    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 rely on Section 3(c)(5)(C).\51\ 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:
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    \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 No-Action 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).
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     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; \52\ and
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    \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).
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     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.\53\
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    \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 and 
Construction Industry Foundation, SEC Staff No-Action Letter (Aug. 
31, 1984). Although the Capital Trust B-Note 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.

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[[Page 55306]]

    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\
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    \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.
---------------------------------------------------------------------------

    Some mortgage-related pools have determined that certain other 
assets constitute qualifying assets for purposes of that exclusion. For 
example, we understand that mortgage-related pools generally treat 
bridge loans, certain construction and rehabilitation loans, wrap-
around 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 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\ 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).
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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 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

[[Page 55307]]

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\ Commenters are encouraged to discuss the costs and benefits of 
their recommendations.
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    \57\ See supra note 53.
---------------------------------------------------------------------------

    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 staff's view that agency whole pool 
certificates may be treated as interests in real estate? \58\ 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.
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    \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.
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    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 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 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\ Commenters are urged to be specific in their responses.
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    \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 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.

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[[Page 55308]]

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.

    Dated: August 31, 2011.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-22771 Filed 9-6-11; 8:45 am]
BILLING CODE 8011-01-P