Fund sponsors may offer their employees and other investment professionals an opportunity to invest in its funds through a co-investment program, which a lender may partially finance. While co-investment loan programs can provide various benefits, complications can arise when the co-investment program includes interests in employee securities companies (“ESCs”). In this Legal Update, we explain various options for dealing with potential complications of ESCs in co-investment loan programs.

Background

ESCs are investment entities that benefit from certain exemptions under the Investment Company Act of 1940 (“1940 Act”). The 1940 Act defines an ESC as “any investment company or similar issuer all of the outstanding securities of which (other than short-term paper) are beneficially owned (A) by the employees or persons on retainer of a single employer or of two or more employers each of which is an affiliated company of the other, (B) by former employees of such employer or employers, (C) by members of the immediate family of such employees, persons on retainer, or former employees, (D) by any two or more of the foregoing classes of persons, or (E) by such employer or employers together with any one or more of the foregoing classes of persons.”

Because of the close relationship between the fund sponsor and its employees, after applying for an ESC exemptive order with the Securities and Exchange Commission, the entity can receive a waiver of certain requirements of the 1940 Act, including many of its reporting requirements. Without ESC status, the 1940 Act generally limits privately offered, unregistered investment vehicles to those with not more than 100 beneficial owners, or whose securities are owned exclusively by “qualified purchasers.”

Employee Co-Investment Programs

Employee co-investment loan facilities are typically organized and administered by the sponsor; however, the lender extends the loans directly to participating employees and other...