Exam Answer Outline
The following answer outlines are not intended to be model answers, nor are they
intended to include every issue students discussed. They merely attempt to identify the
major issues in each question and some of the problems or questions arising under each
issue. They should provide a pretty good idea of the kinds of things I was looking for. If
you have any questions about the exam or your performance on the exam, feel free to
contact me to talk about it.
I graded each question separately. Those grades appear on the front cover of your
blue books. To determine your overall average, each question was then weighted in
accordance with the time allocated to that question. The following distribution will give
you some idea how you did in comparison to the rest of the class:
Question 1: Range 0-9; Average 6.47
Question 2: Range 4-9; Average 7.06
Question 3: Range 3-9; Average 6.24
Question 4: Range 3-9; Average 6.12
Total (of exam, not final grades): Range 4.24-8.57; Average 6.53
Section 12(d)(1)(B) does not apply. It makes it unlawful for an registered open-
end investment company to sell securities to another investment company. Vandal, the
seller, is a registered investment company, but it is a closed-end company. Therefore, the
sale does not violate section 12(d)(1)(B). [It would, if subsection (B) applied because
after the sale, more than 10% of Vandal’s outstanding voting stock (11%) is owned by
Felony and other investment companies.]
Section 12(d)(1)(A) does apply. Felony, a registered investment company, is
purchasing the securities of another investment company. Subsection (A) says Felony
cannot do that if it violates the provisions in (i), (ii), or (iii).
The purchase does not violate subsection (A)(i) because Felony is only
purchasing 2.5% of the stock of the acquired company, Vandal, below the 3% limit.
The purchase does violate subsection (A)(ii). The aggregate value of the Vandal
securities—the $2.5 million purchase price—is more than 5% of the value of the total
assets of Felony, the acquiring company. Felony’s total assets have a value of $30
million; 5% of that is $1.5 million.
The purchase does not violate subsection (A)(iii). These are the only investment
company shares Felony, the acquiring company, owns. Their aggregate value, $2.5
million, is not in excess of 10% of the value of Felony’s total assets. Ten percent of $30
million is $3 million.
Section 12(d)(1)(C) applies because Felony, an investment company, is
purchasing the securities of a closed-end investment company, Vandal. After the
acquisition, felony and other investment companies own more than 10% of Vandal’s
outstanding voting stock. However, it’s a violation only if investment companies with
the same investment adviser exceed the 10% level. We don’t know if Felony and the
other investment companies that own the Vandal stock share the same investment
adviser. If not, there is no violation of section 12(d)(1)(C).
Felony and Vandal are related closely enough for their transaction to be covered
by section 17(a). Biz, as a director of Vandal, is an affiliate of Vandal. Section
2(a)(3)(D). As an officer of Felony, Biz is also an affiliate of Felony. Section 2(a)(3)(D).
That makes Vandal and Felony affiliated persons of affiliated persons (second-tier
affiliates), each subject to the prohibitions of section 17(a) as to the other, since the other
is a registered investment company.
Section 17(a)(2) applies to Felony, since Felony purchased a security from a
registered investment company. Felony’s purchase does not violate section 17(a)(2)
because the securities purchased were “securities of which the seller is the issuer,” and
those are excepted from the prohibition in section 17(a)(2).
Section 17(a)(1) applies to Vandal, since Vandal sold a security to a registered
investment company. The subsection (A) exception does not apply because Felony, the
buyer, was not the issuer. The subsection (B) exception applies only if, in addition to
Vandal being the seller, which it was, this was part of a general offering to the holders of
a class of Vandal’s securities. This was a private purchase by Felony, not part of a
general offering to Vandal’s existing security holders. Therefore, Vandal has violated
This also appears to be a violation of section 17(e)(1) by Biz. Biz, as an officer of
Felony, is an affiliate of Felony. Section 2(a)(3)(D). She was acting as its agent in
purchasing the Vandal stock, and it was not in connection with her business as an
underwriter or broker. She received compensation for doing so. Her normal wages,
which presumably include the usual 1% “bonus,” are excluded from this prohibition. The
payment of the extra $500 to her for, according to the note, “work handling the Vandal
purchase” is compensation for the transaction, and therefore a violation of section
Plus is an “Issuer”
To be an “investment company” at any of these times, Plus must be an “issuer.”
Section 3(a)(1). Plus clearly is, at all times, an issuer, which section 2(a)(22) defines as
every person who issues, proposes to issue, or has outstanding any security it has issued.
Plus is a corporation, and stock which it has issued is outstanding and traded on
NASDAQ. Stock clearly is a security. Section 2(a)(36); Landreth Timber. Moreover,
Plus is a person. “Person” includes a company, section 2(a)(28), and “company” includes
a corporation. Section 2(a)(8).
November 1, 2000
At this time, Plus clearly is not an investment company. It is not within section
3(a)(1)(A) because it is not primarily engaged “in the business of investing, reinvesting,
or trading in securities.” The manufacture of computer software accounts for 70% of its
assets, revenues, and income and clearly is its primary business. It does not appear that
Plus trades securities at all; it merely holds the stocks of the computer companies.
Plus is not an investment company under subsection (B), since it has not issued
and does not propose to issuer face-amount certificates. Subsection (B) does not apply at
any time in this question.
Subsection (C) also does not make Plus an investment company. Given its
ownership of the stock of the computer companies, Plus is in the business of owning or
holding securities. However, “investment securities” do not account for 40% of the value
of its total assets. The computer company stock only accounts for 30% of Plus’s value.
December 1, 2000
At this point, Plus still does not appear to be an investment company under
subsection (A). Active trading of securities (the stock trading account) only accounts for
15% of its assets, revenues, and income, so “investing, reinvesting, or trading in
securities” is not its primary business. Subsection (A)’s language doesn’t include merely
holding securities, as Plus is doing with the CDs and the computer companies.
Subsection (C) does seem to apply here. Plus clearly is in the business of owning,
holding, and trading securities. That does not have to be its primary business under
subsection (C). Moreover, “investment securities” have a value exceeding 40% of the
value of Plus’s total assets (excluding government securities). The SEC takes the
position that CDs are securities for purposes of the Investment Company Act, Merrill
Lynch, even though they are not for purposes of other securities laws. Marine Bank.
Those CDs, plus the stocks Plus owns, account for 80% of the value of Plus’s assets. The
CDs are government securities, since they are insured by the U.S. government. See
section 2(a)(16). Therefore, they are not “investment securities.” Section 3(a)(2). None
of the stocks Plus owns are majority-owned subs, so they are not excluded. Therefore,
investment securities still constitute 42% of Plus’s total assets, and an even greater
percentage of its total assets excluding government securities (42/62 = 70%).
Section 3(b)(1) does not help Plus. It has no wholly-owned subs, and its direct
operations, although not securities-related, only account for 20% of its assets, revenues,
and income. Section 3(b)(2) also is not helpful, as Plus has no majority-owned subs or
controlled companies. Plus is presumed not to control a company if it owns less than
25% of the voting stock, and it doesn’t own more than 10% of any of the computer
Neither section 3(c)(1) nor section 3(c)(7) will help Plus. Its stock is publicly
traded on NASDAQ, so it must have more than 100 beneficial owners. And it is highly
unlikely that these public owners are all qualified investors as required by section 3(c)(7).
Plus appears to be an investment company. However, Plus may fall within Rule
3a-2. It provides that Plus is not an investment company for up to one year if it has a
bona fide intent to be engaged in some other business as soon as possible. Plus might
argue that its securities investments are merely a temporary disposition of its antitrust
judgment money and that its long-term goal is to be a non-securities operating company.
However, to use Rule 3a-2, there must be a board resolution to this effect. Rule 3a-
2(a)(2). Even absent such a resolution, Plus might still win if it can convince a court it is
in a transitional stage and has not yet made investing or holding securities its primary
business. See Fifth Avenue Coach Lines.
August 1, 2002
Plus is clearly now an investment company, for the reasons discussed above.
Rule 3a-2 no longer applies because it only protects Plus “during a period of time not to
exceed one year.” After 18 months, Plus’s argument that it is still in transition is unlikely
May 1, 2003
Plus still does not fall within subsection (A) of section 3(a)(1). It holds securities,
but does not trade them. It does, however, fall within subsection (C). It is in the business
of owning and holding securities—the Flyways, Honk, and Food stocks. And
“investment securities” are more than 40% of the value of its total assets. The Flyways
stock is not “investment securities” because Flyways is a majority-owned sub of Plus.
Section 3(a)(2)(C). But the stock of the other two companies constitutes 60% of the
value of Plus’s total assets.
Section 3(b)(1) does not help Plus. Plus has no wholly-owned subs. Section
2(a)(43) requires 95% ownership, and Plus owns only 60% of Flyways. Plus’s direct
operations account for only 20% of its assets, revenues, and income, clearly not enough
to establish a primary business unrelated to securities investments.
Section 3(b)(2) might be helpful. Flyways is a majority-owned sub since Plus
owns 60% of its voting stock. Section 2(a)(24). Honk is a controlled company, since
Plus owns 40% of its voting stock. Ownership of more than 25% of a company’s voting
securities presumptively establishes control, absent an SEC order to the contrary. Section
2(a)(9). Food is not a controlled company, since Plus only owns 20% of its stock.
Directly, through a majority-owned sub, and the only controlled company, Plus is
engaged in a primary business other than “investing, reinvesting, owning, holding, or
trading in securities.” Section 3(b)(2). Computer software, an airline, and trucking
clearly are not securities-related businesses. Thus, Plus would not be an investment
company if it obtains an SEC order pursuant to section 3(b)(2). But note that section
3(b)(2) is not self-enforcing. Absent the order, Plus is an investment company.
The definition of “investment adviser” is in section 202(a)(11) of the Investment
Advisers Act. To be an investment adviser, Prof must be engaged in one of two
activities: (1) “advising others, either directly or through publications or writings, as to
the value of securities or as to the advisability of investing in, purchasing or selling
securities,” or (2) “issu[ing] or promulgat[ing] analyses or reports concerning securities.”
In addition, under either prong of the definition, this must be part of a “business” or
“regular business” and she must be doing it “for compensation.”
Prof is clearly offering her seminars for compensation. She receives $100 per
person. She may not profit from the seminars, but section 202(a)911) does not require
that she profit, merely that she receive compensation.
Prof also appears to meet the “business” requirement. Her primary job is being a
college professor, but investment advice does not have to be her principal business
activity, or meet any percentage test, to meet the “business” requirement. Investment
Adviser Act Release No. 1092. It is enough if she gives advice with “some regularity.
Id. This is not a one-time action on Prof’s part; her seminars appear to occur with at least
some regularity. The SEC has indicated that she is in the business of advising if, among
other possibilities, she receives any separate compensation for providing advice about
securities or if she provides specific investment advice. Id. Specific investment advice,
for purposes of this requirement, would include recommendations about specific
categories of securities, as in the example concerning the person in his fifties.
The advice requirement is met if Prof advises clients concerning the advantages
and disadvantages of securities generally, as opposed to other investments. Id. Prof
doesn’t have to be recommending specific securities. Prof appears to meet this
requirement as well.
For the foregoing reasons, Prof appears to fall within the general section
202(a)(11) definition. But she might fall within one of the exceptions to the definition.
Prof does not qualify for the section 202(a)(11)(D) exception because she isn’t
really publishing anything except her course materials and, even if they’re excepted, the
same advice occurs in the oral component of her seminar, which clearly is not a
Section 202(a)(11)(B) might apply. As a college professor, Prof probably
qualifies as a “teacher.” The problem is that the seminars are not “solely incidental” to
the practice of her job as a college professor. She does the seminars separately, outside
the college and on her own time. But the seminars themselves might qualify as
“teaching” for purposes of this exemption; if so, the advice given in the seminars could
be incidental to most of the teaching that occurs. The exception might apply if (1) Prof
doesn’t hold herself out to the public as providing investment advice; (2) she provides
such advice only in connection with her teaching; and (3) the charge for her advice is the
same as the usual charge for her “teaching.” Hauk, Soule, & Fasani. It’s unclear
whether the first requirement is met her, although it probably helps that she tells her
students to seek advice from their own adviser. The second requirement appears to be
met; the advice only occurs in connection with the teaching in her seminar. Finally, there
is no separate charge for the “advice” component of the course. Therefore, Prof might
have the section 202(a)(11)(B) exemption. If so, she’s not an investment adviser even
though the general definition fits her.
The term “interested person,” when used with respect to an investment company,
is defined in section 2(a)(19)(A).
1. Jones Directly
Jones does not appear to directly fall within section 2(a)(19)(A). Upon election,
as a director, she will be an affiliated person of Invesco. Section 2(a)(3)(D). However,
the proviso at the end of section 2(a)(19)(A) provides that no person shall be an interested
person of an investment company solely by reason of being a member of its board. She is
not otherwise an affiliated person of Invesco, and, in fact, she appears to have no other
relationship with Invesco at all. Thus, the only issues are whether Mom’s or Idiot’s ties
to Invesco make Jones an interested person of Invesco.
Jones’s Mom falls within section 2(a)(19)(A)(iv), since she works for a firm that
has acted as Invesco’s legal counsel (assuming at least some of the legal work occurred in
the last two years), but this does not make Jones an interested person. Jones’s family
relationship comes up only in section 2(a)(19)(A)(ii). Jones is in Mom’s immediate
family, since the definition in section 2(a)(19) specifically includes “any parent”, but
(A)(ii) makes Jones an interested person only if Mom is an affiliated person of Invesco.
Section (A)(iv) makes Mom an “interested person” of Invesco, not an “affiliated
person.” Mom does not appear to be an affiliate. The only possibility would be if Mom
had a control relationship with Invesco. Section 2(a)(3)(C). It might be argued that
Invesco “controls” its outside law firm, but that is doubtful. A client doesn’t really
control the “management or policies” of its outside law firm. Section 2(a)(9). Even if it
did, that wouldn’t give Invesco control over Mom, especially since Mom does no work
for Invesco. Moreover, a natural person is presumed not to be controlled, and that
presumption may be overcome only by an SEC order. Section 2(a)(9). Therefore, Mom
does not appear to be an affiliate of Invesco, so section 2(a)(19)(A)(ii) does not make
Jones an interested person.
Section 2(a)(19)(A)(iii) says that a person is an interested person of an investment
company if the person is an interested person of its principal underwriter. Section
2(a)(19)(B) tells us when someone is an interested person of the principal underwriter.
Idiot clearly is an interested person of Underwriter and therefore an interested
person of Invesco. Idiot is an employee of Underwriter, which makes him an affiliate of
Underwriter. Section 2(a)(3)(D). This is turn makes him an interested person of
Underwriter. Section 2(a)(19)(B)(i). Idiot is also an interested person of Underwriter
because he owns its securities. Section 2(a)(19)(B)(iii). However, all of this makes Idiot
an interested person, not Jones.
The only possible concern for Jones is section 2(a)(19)(B)(ii). Idiot is an
affiliated person of Underwriter, as stated above. Jones would be an interested person of
Underwriter if she were a member of Idiot’s immediate family, but she does not appear to
be. “Member of the immediate family” is defined at the end of section 2(a)(19). It
includes a parent, but Jones is not Idiot’s parent, nor is she the spouse of his parent, or the
spouse of his child. The definition includes step or adoptive relationships but Jones is not
a step or adoptive parent or child of Idiot. Thus, if we take the definition literally, she is
not a member of Idiot’s immediate family.
This literal construction produces a strange result, however, because Idiot is a
member of Jones’s immediate family under the definition. Idiot is the spouse of her
child. Perhaps this non-reciprocal definition was a legislative drafting mistake and the
proper result is that, if Idiot is a member of Jones’s immediate family, then she is also a
member of his. If so, Jones is an interested person of Underwriter under section
2(a)(19)(B)(ii) and therefore an interested person of Invesco under section