Section 12D-1 Limit

A rule added to the Investment Company Act in 1964 to provide registered investment companies with conditional exemptions from provisions of the Act’s Section 12 (d)(3). The provisions prohibit a registered investment company from purchasing or acquiring a security or business interest from someone who is a broker, dealer, underwriter, investment company adviser or investment adviser registered under the Investment Advisers Act of 1940.

The 12D-1 limit allows registered investment companies, on a case-by-case basis, to acquire securities from companies that are directly or indirectly involved in business activities referred to in Section 12 (d)(3). Securities may only be purchased for portfolios, and only from companies which derived no more than 15% of their total gross revenues over the previous three fiscal years from the specified businesses. In addition, the registered investment company and all affiliated companies cannot own more than 10% of the total outstanding voting stock of the portfolio company immediately following the securities acquisition.

Basically, the original rule was meant to prevent investment companies from investing in each other or otherwise merging. The 12D-1 limit allows investment for the purpose of adding the security to a portfolio. It limits the percentages that can be acquired to prevent the investment from becoming a subtle merger or takeover.

A registered investment company that claims the 12D-1 limit exemption must review its portfolio on a semi-annual basis to ensure its holdings are within compliance. If not, the company must sell or otherwise dispose of the security within 90 days. Section 12(d)(3) of the Investment Company Act exempts all investments by registered investment companies in certain businesses including small loan, factoring and finance companies.