U.S. SECURITIES LAWS

Note: There are some important changes being made to the securities laws right now that are not reflected in the black wording of this text. These changes have principally arisen from Congressional amendments to the 1933 Act required by the Dodd-Frank Act or mandates to the SEC under the “JOBS Act”. These changes are in red below.

I. MAIN GOAL OF U.S. SECURITIES LAWS

All of the U.S. securities laws have the same purpose: to create an efficient marketfor the allocation of financial resources based on all investors having simultaneousand timely access to the same basic information about each security offered in thepublic markets in a manner that permits them to compare investment opportunities andfinancial results.

II. GENERAL REGULATORY FRAMEWORK

A. Principal Federal Laws (Statutes)

1. Securities Act of 1933 (“1933 Act”) - Sales of Securities – Issue

a. Every sale of securities must be registered with the Securitiesand Exchange Commission (“SEC”) unless an exemption fromregistration is available.

b. Principal Sections

(i) Section 2(11) - Definition of “underwriter”

(ii) Section 3 - Exempt securities

(iii) Section 4 - Exempt transactions

(iv) Section 5 - Registration and prospectus deliveryrequirements

(v) Regulation D - Safe harbor from registration and prospectusdelivery requirements

(vi) Rule 144 - Safe harbor from definition of “underwriter”

2. Securities Exchange Act of 1934 (“1934 Act”) - Trading Markets

a. Issuers of publicly traded securities must insure that all playersin the market have access to accurate, complete materialinformation about the company and the securities at the same time,and brokers, dealers and other market professionals must adhere tocertain standards.

b. Principal Sections

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(i) Section 10 - Antifraud provisions

(ii) Section 12 - Registration requirements

(iii) Section 13 - Reporting requirements

(iv) Section 14 - Proxy solicitation rules

(v) Section 16 - Short swing profits restrictions

3. Investment Advisers Act of 1940 (“IAA”) - Investment Advisers, includingmanagers of venture capital funds, hedge funds, leveraged buy-out funds,real estate funds and private equity funds.

a. Any person giving investment advice to more than 15 persons mustbe register as an investment adviser and adhere to certainstandards.

b. Principal Sections

(i) Section 203 - Registration Requirement

(ii) 203(b) and 203A - Exemptions

4. Investment Company Act of 1940 (“ICA”) - Investment Pools

a. Any pooled investment vehicle (mutual fund, hedge fund, privateequity fund, real estate fund, etc.) offered to the general publicmust be registered as an investment company and adhere to certainstandards.

b. Principal Sections

(i) Section 8 - Registration Requirements

(ii) Section 3(a) - Exemptions

5. Trust Indenture Act of 1936 (“TIA”) - Multiple-lender debt securities

a. Debt instruments sold in public offerings must be subject to an“indenture” providing for a trustee who can exercise securityholders' rights on a collective basis.

b. Intended to create enforcement mechanism by widely dispersed bondholders.

c. Principal Sections

(i) Section 305 - Requirements of Registration statements underthe 1933 Act for any security covered by the TIA

6. Sarbanes-Oxley Act of 2002 (“SOX”) - Corporate Governance and FinancialStatement and Audit Requirements

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a. Creates standards designed to prevent and detect fraud at publiclytraded companies.

b. Principal Sections

(i) Section 302 - Corporate Responsibility for Financial Reports

(ii) Section 404 - Assessment of internal controls

B. Principal Regulatory Agencies

1. SEC

2. Financial Industry Regulatory Authority (FINRA) formerly NYSE/NASD

3. Public Company Accounting Oversight Board (“PCAOB” or “Peekaboo”)

C. Regulatory Philosophy

1. U.S. Securities laws are generally based on disclosure requirements.

2. System is not based on “merit” review.

3. Liability is generally based on not providing complete and accurateinformation:

a. Status of business and future prospects

b. Quality of management

c. Risks

d. Financial information

e. Terms of the investment

4. Increasingly the securities laws are beginning to distinguish betweendifferent categories of company, either by size (such as annual revenues) orby market float (i.e., the value of the securities trading in the publicmarket, which is considered to give an indication as to how closely thesecompanies are being watched by investment professionals (and therefore needfaster reporting but maybe less oversight by the SEC). Examples of thesedistinctions are certain prohibitions for “shell companies” (i.e., companieswith no real business operations) and “reverse merger” companies (many Chinesecompanies become public in the U.S. through a reverse merger with a publicshell); faster filing deadlines under the 1934 Act for quarterly and annualreports, and more restrictions under SOX for the biggest companies, known as“accelerated filers”; more liberal use of “shelf registration” (a way to getsecurities registered for sale almost immediately under the 1933 Act) for“well known seasoned issuers” (known as “WKSIs” or “wicksees”) and seasonedissuers; more liberal use of free writing prospectuses under the 1933 Act forseasoned issuers, and certain faster and easier IPO rules for “emerging growthcompanies under the 1933 Act.

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D. Hierarchy of Laws

1. U.S. Constitution

2. U.S. Statutes

3. U.S. Court rulings (Supreme Court, Circuit Courts, District Courts)

4. Administrative Rules

a. SEC Rules

(i) Most statutes are supplemented by rules and regulationsdeveloped by the SEC.

(ii) The rules and regulations are vital for understanding thecontext and meaning of the statutory provision.

(iii) Some rules provide a “safe harbor”, which states that ifcertain criteria are met, the SEC will not seek enforcementaction under that rule or statutory provision.

(a) Examples

(1) Rule 147 – If an issuer meets specified criteriafor “resides in” and “doing business” it fallswithin the safe harbor for the Section 3(a)(11)intrastate offering exemption.

(2) Rule 506 – Provides safe harbor for Regulation Dprivate offering exemption.

(b) SEC safe harbors are not binding on courts, but inpractice it is unlikely a court would ignore an SECsafe harbor and find a defendant liable under the ruleor statutory provision if the defendant met the safeharbor provisions.

b. SEC Forms provide the categories of disclosure requirements of theperiodic reporting requirements of the 1934 Act.

c. Regulations provide the detailed disclosure requirements of theperiodic reports.

(i) Regulation S-K – General Information

(ii) Regulation S-X – Financial Information

d. Administrative Positions

(i) SEC No-Action Letters

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(ii) SEC Releases

(iii) SEC Telephone Interpretations and other compilations

(iv) SEC Comment Letters

5. Definitions

Definitions included in statutes, rules, administrative pronouncementsand rule releases are vital to understanding the securities laws.

6. Customs and Practices

Some practices are not officially approved or authorized in any statute,rule or SEC publication but are a result of informal dialogue with theSEC staff through seminars, speeches, etc. and become accepted practiceover time.

7. Getting Information

(i) SEC website (www.sec.gov)

(ii) Private service (www.liveedgar.com)

E. Interaction with State Securities (Blue Sky) Laws

1. Each of the 50 States has its own Securities Department and laws

2. Dual Regulatory System

a. Sales of Securities

b. Licensing of broker/dealers/investment advisors

3. Federal Supremacy in Registration of Sales

a. Registered Public Offerings

b. Rule 506 Offerings1

F. Role of the Lawyer/Investment Banker/Auditor

1. Under SOX lawyers have obligation to take certain steps to prevent fraud

2. Professionals viewed as “gatekeepers” for the system

III. THE SECURITIES ACT OF 1933 (governs actions of any person offering and sellingsecurities)

1 Rule 506 is one of three exemptions provided by Regulation D of the SEC's Rules andRegulations under the 1933 Act. Offerings made under the other two exemptions, Rule 504and Rule 505, do not qualify for federal supremacy over state blue sky laws under Section18 of the 1933 Act.

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A. Applicability of the 1933 Act - it dictates what every person seeking to raisemoney in the U.S., or seeking to liquidate an investment in the U.S., can do.

1. Because the 1933 Act could apply to many types of common transactions,it can impact Chinese companies doing business in the U.S., includingwith respect to:

a. debt instruments

b. employee stock options and other equity incentives to employees

c. partnerships amongst commercial enterprises

d. investments by third parties, including venture capital firms

e. sale of the company, including to private equity firms

2. 1933 Act requirements can have a negative impact on the value of thesecurities.

3. Other investors, including venture capital funds and private equityfunds, may not be willing to invest in or purchase a company that hasnot complied with the 1933 Act.

4. Investors may not be able to sell their securities at any price withoutcompliance due to transfer restrictions.

5. Penalty for not complying with 1933 Act is rescission to investors,being barred from securities industry and employment with any publiccompany and possibly civil and criminal penalties.

B. Purpose of 1933 Act - Give prospective investors access to complete andaccurate material information (see definition below) while they are makingtheir investment decisions.

C. Key Definitions (most terms are defined very broadly by the 1933 Act, the SECand the courts).

1. “Security” - almost any stock, bond, note, or other document or contractinvolving a transfer or property by one person to another with the hopeof earning a profit in the form of interest, dividends or appreciationin value (see detailed definition and certain specific exemptions fromthe definition described below).2

2 Pursuant to Section 2(1) of the 1933 Act, the term “security” means any note, stock,treasury stock, security future, bond, debenture, evidence of indebtedness, certificate ofinterest 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 undividedinterest in oil, gas, or other mineral rights, any put, call, straddle, option, orprivilege on any security, certificate of deposit, or group or index of securities(including any interest therein or based on the value thereof), or any put, call,

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Howey test:1. investment of money due to2. an expectation of profits arising from3. a common enterprise4. which depends solely on the efforts of a promoter or third party

2. “Issuer” - the entity issuing the securities, but also includesaffiliated entities and “control persons” (generally taken to meanofficers, directors and 10% or larger stockholders in the issuer).

3. “Seller” - the person selling the securities, but can also includeanyone involved in the sales process, such as investmentbanker/underwriter, broker/dealer, etc.

4. “Sale” - includes any disposition of a security for value.

5. “Offer to Sell” (or “offer”) - any attempt to dispose of, orsolicitation of an offer to buy securities, including, in certain cases,the mere mention that securities are available for sale. However, Thepublication or distribution by a broker or dealer of a research reportabout an emerging growth company that is the subject of a proposedpublic offering of the common equity securities of such emerging growthcompany pursuant to a registration statement that the issuer proposes tofile, or has filed, or that is effective, shall be deemed not toconstitute an offer for sale or offer to sell a security, even if thebroker or dealer is participating or will participate in the registeredoffering of the securities of the Issuer.

6. “Emerging growth company” means an issuer that had total annual grossrevenues of less than $1,000,000,000 (as such amount is indexed forinflation every 5 years by the SEC.

7. “Underwriter” - Any person who: (i) purchases securities from an issuerwith a view to their distribution; (ii) offers or sells securities foran issuer in connection with the distribution of the securities; (iii)participates or has direct or indirect participation in any distributionof securities; or (iv) participates or has a participation in the director indirect underwriting of a distribution of securities. Any personwho is considered to be “in control of” an issuer at the time the issueroffers or sells securities may be deemed to be an underwriter in suchoffer or sale, including any officer, director or more than 10%stockholder).

straddle, option, or privilege entered into on a national securities exchange relating toforeign currency, or, in general, any interest or instrument commonly known as a“security”, or any certificate of interest or participation in, temporary or interimcertificate for, receipt for, guarantee of, or warrant or right to subscribe to orpurchase, any of the foregoing.

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8. “Prospectus” any prospectus, notice, circular, advertisement, letter, orcommunication, written or by radio or television, which offers anysecurity for sale or confirms the sale of any security, unless precededby a statutory prospectus (as defined in Section 10 of the SecuritiesAct).

9. “Accredited Investor” - any (i) individual with income of more than$200,000 (US) for each of past 2 years (or $300,000 together withspouse) or who has net assets in excess of $1 million, and (ii) any ofseveral types of entities (generally requires assets of more than $5million), including banks and other financial institutions, trusts,corporations and partnerships, pension plans, etc.

10. “Material Information” - any information that a reasonable investorwould be substantially likely to consider important in making aninvestment decision.

11. “Regulation D” - The most commonly used exemptions from the Section 5registration and prospectus delivery requirements of the 1933 Act. Mostunregistered securities offerings in the U.S. rely on one of the three“Reg. D” exemptions.

12. “Regulation S” - an exemption from the Section 5 requirements for salesof securities by U.S. issuers made outside the U.S. (known as the“Offshore” or “Reg. S” exemption).

D. Registration Requirement for offers and sales for which no exemption appliesor Issuer chooses to do a registered offering): The easiest way to understandSection 5 is to read it backwards because Section 5(c) is applicable to periodof time that is before what 5(b) and 5(c) is about.

E. Section 5(c) – the “Quiet Period”. Section 5(c) states that before aregistration statement is filed with the SEC, it is illegal to make anyoffers, oral or written. However, the JOBS Act has added a new Section 5(d)that permits emerging growth companies or any person acting on its behalf toengage in oral or written offers to “qualified institutional buyers” (“QIBs”)3

or institutions that are accredited investors, both before and after aregistration statement is filed, to see if these investors are interested ingetting the information about the offering when it is available, subject tocertain limitations.

F. Section 5(b) states that after a registration statement has been filed it isunlawful to offer any securities through a prospectus unless the prospectusmeets the requirements of Section 10(b)4. Prospectuses (written materials)

3 Rule 144A generally defines QIBs as investment companies, insurance companies ERISA pension plans and other institutional investors with significant assets invested in securities.4 Section 10(b) provides requirements for the type of prospectus that may be used to offersecurities while a registration statement is pending with the SEC (known as a preliminary

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that do not meet the requirements of Section 10(b) are known as “freewritings.” Because the term “prospectus” generally means any kind of writtenmaterial, or any kind of information provided verbally that is being read orderived from written materials, Section 5(b) governs any kind of radio ortelevision or Internet broadcast, PowerPoint presentations, or almost anythingelse that is not a live, in person, meeting. In about 2004 the SEC createdsome additional exemptions for materials deemed to be free writings if theissuer and its representatives followed certain rules, including filing thematerials with the SEC before their first use. These new kinds of permittedwritings are known as Free Writing Prospectuses (“FWPs”).

G. Section 5(a) states that until the registration statement has been declaredeffective by the SEC, it is illegal to sell or deliver any security throughinterstate commerce.

H. Confidential Filing of IPO Registration Statement. In the past the entireworld would know an issuer filed for an IPO the day it filed because the electronicfiling would appear on the SEC’s website. This caused problems for issuers whobelieve that when they are in the “registration process” with the SEC they arevulnerable to many risks, such as litigation plaintiffs knowing the issuer wouldprobably rather settle than go public with litigation to ruin their good story;suppliers, customers and employees who might get nervous if the IPO was not highlysuccessful, etc. The JOBS Act establishes a new Section 6(e) that permits emerginggrowth company to file for an IPO confidentially so that nobody knows the Companyhas filed.5

1. Analysis of Section 5(a) - All offers and sales of securities must beregistered with the SEC unless the sale is made pursuant to an exempttransaction.

2. Is it an offer or sale (see definition of offer above)?

a. Gifts

(i) Pure gift for non-business purposes is not a “sale” -however, even a gift without any financial considerationwill be deemed a “sale” if purpose or result is to enhancebusiness reputation or relationship

(ii) General rule - a gift to anyone other than a close familymember or a charity is probably a “sale”

b. Stock dividends

or “red herring” prospectus) and the type of prospectus (a “final” prospectus) that mustbe delivered when a sale of securities is finalized.5 And a new Section 7(a) limits certain types of information emerging growth companies need to provide in the registration statement, as compared to other IPO filers. For example, EGCs only need two years of audited financial statements and generally do not need five years of selected financial information, whereas non-EGCs need three years of audited information and five years of selected information.

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(i) Stock dividend is not a sale if:

(a) No payment is made by stockholders for the shares

(b) Stockholders have no choice to receive other propertyin lieu of shares of stock for the dividend

c. Sale of entire business

(i) Sale of 100% of shares/interests of an entity is a sale ofsecurities.

3. Is it a security?

a. Definition of security in Section 2(a)(1)

(i) If security is labeled as “stock” there is a presumption itis a security but presumption can be rebutted based on“economic reality test.

(ii) A transaction will be found to involve a security if thenature of the transaction created an “investment contract”as determined by the Howey test:

(a) Is the money of more than one person being pooledtogether for a common use by a third party where thecontributors’ principal reason for making thecontribution is an expectation of receiving a profit?

(1) Expectation of Profit – Sometimes hard to tell

(2) Example: Resort condominiums - Did purchaser buythe unit to live in or for vacation purposes?Did purchaser buy the unit because a developerpromised to rent it to others for a profit whenthe purchaser was not using it?

(b) Will a person who contributes money earn a profitlargely based on the actions of someone else insteadof themselves?

(1) Persons contributing funds to a businessenterprise in which they will have substantialparticipation in the management generally arenot considered to have purchased a security.

i) A general partner in a general partnershipor member of a limited liability companywhere the management is shared by allgeneral partners or all members.

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ii) Franchisees (but separate franchise lawsapply).

(2) Where the expectation of profit is based solely(or largely) on the actions of others, will beseen to have purchased a security.

i) A limited partner in a limitedpartnership.

ii) A member of a limited liability companythat is managed by a manager or board ofmanagers.

(iii) A debt instrument (i.e., a promissory note or other type ofdebt instrument, including a loan participation orsyndication) will generally be considered a security, butthe presumption can be rebutted based on the followingcriteria:

(a) If the note matures in less than 9 months it is probably not going to be found to be a security.

(b) It is one of the “family” (type) of debt instruments commonly thought to not be an investment:(1) A note delivered in consumer financing.

(2) A note secured by a mortgage on a home.

(3) A note secured by a lien on a small business or some of its assets.

(4) A note relating to a “character” loan to a bank customer.

(5) A note which formalizes an open-account indebtedness incurred in the ordinary course of business.

(6) Short-term notes secured by an assignment of accounts receivables.

(7) Notes given in connection with loans by a commercial bank to a business for current operations.

(c) “Family Resemblance Test” – If it is not a familymember (see above), then does it resemble those typesof debt instruments? In Reves v. Ernst & Young the

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Supreme Court used the following factors to make thisdetermination:

(1) Whether the borrower’s motivation is to raise money for general business use, and whether the lender’s motivation is to make a profit, including interest?

(2) Whether the borrower’s plan of distribution of the Note resembles the plan of distribution of a security?

(3) Whether the investing public reasonably expects that the note is a security?

(4) Whether there is a regulatory scheme that protects the investor other than the securities laws. Examples include notes subject to Federal Deposit Insurance and ERISA?

b. Is it an exempt security under Section 3?

Securities that are “exempt securities” under Section 3 are exemptfrom all provisions of the 1933 Act because they are excluded fromthe definition of securities.

(i) Section 3(a) - Excludes securities issued by certain typesof issuers.

(a) Governmental entities

(b) Certain debt instruments with a maturity of less than9 months

(c) Not-for-profit organizations (religious, education,charity, etc.)

(d) Federal and state chartered banks (but not bankholding companies)

(e) Railroads

(f) Issuers undergoing a bankruptcy reorganizations

c. Additional securities exempt under Section 3(a)

(i) Two of the exemptions created under Section 3(a) are reallyfor certain types of transactions:

(a) Intrastate offerings - Section 3(a)(11)

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(1) Offers and sales made in only one state, and

(2) Issuer is located in that state.

i) Must be a “resident” of the state

ii) Must be “doing business” in the state

iii) Rule 147 “safe harbor” provides guidance

(b) Exchange offers - Section 3(a)(9)

(1) Must be solely to existing security holders, and

(2) No commissions paid for soliciting exchange.

d. Exempt securities under Section 3(b)

(i) Sales of less than $5 million. Section 3(b)(1) permits theSEC to exempt securities under Section 3 that are sold intransactions involving no more that $5 million. The SEC hascreated several “limited offering” exemptions under Section3(b):

(a) Rules 504 and 505 under Regulation D (see below)

(b) Regulation A - Provides a “mini” registration processinvolving somewhat less information, a lower form ofSEC review and the ability for issuers to “test thewaters” prior to filing an offering statement with theSEC, unlike a registered public offering, in which nooffers of securities may be made prior to filing aregistration statement. After a Regulation A offeringstatement has been approved by the SEC, the issuer maymake public offers of the securities.

(c) Rule 701 - Provides an exemption for securities soldor otherwise issued for compensation purposes toemployees, officers, directors, advisors andconsultants.

(ii) Section (3)(b)(2). A new Section (3)(b)(2) has been addedby Congress ordering the SEC to create a new exemption for offersand sales of up to $50,000,000 within 12 months that may beoffered and sold publicly. Such securities will not be“restricted securities” but the issuer will have to file auditedfinancial statements annually and any other restrictions the SECmay place on use of this exemption, including filing an offeringdocument with the SEC. Issuers will also be able to “test thewaters” under this exemption.

Is it an exempt transaction under Section 4?

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Section 4 provides exemptions from the registration requirements of the1933 Act for six types of transactions. Securities issued pursuant to aSection 4 exemption are still subject to the other provisions (e.g.,antifraud) provisions of the 1933 Act.

e. Section 4(1) – Exemption for sales by persons who are not issuers,underwriters, or dealers.

(i) General Public . Exemption is used by members of the generalpublic, including professional investors, who are notaffiliated with the issuer, for selling investmentsecurities they own, including transactions on the publicmarkets (Nasdaq/NYSE, etc.). But see exceptions below.

(ii) Control Persons . Officers, directors and other controlpersons are deemed to be underwriters for the issuer forpurposes of this exemption and therefore cannot use thisexemption. See Rule 144 below.

(iii) Restricted Securities . Securities sold in any transactionother than an SEC registered offering are referred to as“restricted securities.” Purchasers of restrictedsecurities can be deemed to be underwriters and cannot usethis exemption. See Rule 144 below.

f. Section 4(2) - Sales by issuers not involving a “public offering”.This is known as the “private offering exemption.”

(i) The term “public offering” is not defined in the 1933 Act oranywhere else in the securities laws. The U.S. SupremeCourt has held that a public offering is: (i) any sale ofsecurities made to more than a very small group (e.g., 1-3persons) unless all such persons have a meaningful abilityto obtain the type of information that would be required tobe provided to investors in a registered public offering or(ii) any sale of securities accomplished by means of generaladvertising.

(ii) Officers, directors and other persons who control an issueror are under common control of the issuer are not deemed tobe part of the “issuer”, and therefore such persons cannotuse this exemption either. See “Resales by statutory underwriters”below.

(iii) Most securities lawyers are reluctant to rely solely onSection 4(2) due to lack of clear requirements. See RegulationD, Rule 506 described below.

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(iv) Rule 506 of Regulation D is a safe harbor designed toprovide certainty to the Section 4(2) exemption. SeeRegulation D below.

g. Section 4(3) - Most transactions by dealers other than during apublic offering by the issuer.

h. Section 4(4) - Brokers transactions executed on behalf ofcustomers.

i. Section 4(5) - Sales by an issuer to accredited investors (seedefinition above) in a private transaction and a Form D is filedby the issuer with the SEC.

j. Section 4(6) – “Crowd Funding” - Sales by the issuer of less than$1,000,000 of securities in a 12 month period of the lesser of (i)the greater of $2,500 or 5% of annual income or net worth of thepurchaser if the purchaser’s net worth is less than $100,000, or(ii) 10% of the purchaser’s annual income or net worth if thepurchaser’s net worth exceeds $100,000. However, the offeringmust be made through a broker or “funding portal” (which is anewly permitted activity that is like a dating service forinvestors and companies trying to raise money, and the “finders”that assist them) that meets the requirements of new Section 4A.Section 4A provides the rules for “crowd funding” offerings, whichare very small offering to many people, often to pursue somepolitical or social cause in the form of a business.

H. Regulation D.

1. Regulation D is an SEC rule that provides three separate exemptions.

a. Rule 504 (an exemption under Section 3(b) of the 1933 Act)

(i) Exempts sales of securities for up to $1 million in any 12-month period.

(a) No public solicitation is permitted.

(b) No limit on the number of purchasers.

(c) No requirement that any purchasers be accreditedinvestors.

(d) No information requirements (but see discussion ofRule 10b-5 under 1934 Act).

(e) Issuer must inform purchasers that securities arerestricted and cannot be sold unless registered orsold pursuant to an exemption from registration.

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(f) Issuer must place transfer restrictions oncertificates.

(g) Purchasers must not be underwriters.

(h) Issuer must file a Form D within 15 days of firstsale.

(i) State blue sky registration and other requirementsstill apply.

b. Rule 505 (an exemption under Section 3(b) of the 1933 Act)

(i) Exempts sales of securities for up to $5 million in any 12-month period.

(a) No public solicitation is permitted.

(b) Limit of 35 purchasers, excluding accreditedinvestors.

(c) Certain information requirements if any purchasers arenon-accredited investors.

(d) Issuer must inform purchasers that securities arerestricted and cannot be sold unless registered orsold pursuant to an exemption from registration.

(e) Issuer must place transfer restrictions oncertificates.

(f) Purchasers must not be underwriters.

(g) Issuer must file a Form D within 15 days of firstsale.

(h) State blue sky registration and other requirementsstill apply.

c. Rule 506 (an exemption under Section 4(2) of the 1933 Act)

(i) No dollar limit.

(a) No public solicitation is permitted. Actually, in avery big shift from prior law, this has been changedunder the JOBS Act and the SEC is required to publishrules effecting this change.

(b) Limit of 35 purchasers, excluding accreditedinvestors.

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(c) Any purchasers who are non-accredited must also be“sophisticated”, either alone or with a purchaserrepresentative.

(d) Certain information requirements if any purchasers arenon-accredited investors.

(e) Issuer must inform purchasers that securities arerestricted and cannot be sold unless registered orsold pursuant to an exemption from registration.

(f) Issuer must place transfer restrictions oncertificates.

(g) Purchasers must not be underwriters.

(h) Issuer must file a Form D within 15 days of firstsale.

(i) State blue sky registration requirements do not apply,but all other blue sky laws do.

2. Aggregation of Offering Amounts

a. Any securities sold in the 12 months prior to or during the Rule504 or 505 offering under any Section 3(b) exemption (Rule 504,505, 701, etc.), or in violation of Section 5, count towards thedollar limits.

3. Integration.

a. All sales that are part of the same offering must meet all of therequirements of an exemption.

b. Sales will be deemed to be a separate offering or part of the sameoffering based on a five factor test:

(i) Constitute a single plan of financing

(ii) Same class of securities

(iii) Made at about the same time

(iv) Same type of consideration received

(v) Made for the same general purpose

c. Sales made more than 6 months before, or more than 6 months after,an offering will not be considered part of such offering, so longas no other securities of the same class were offered or sold inthat 6 month period (except under an employee benefit plan).

4. Non-Exclusive Exemption

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a. Regulation D is a “safe harbor”; e.g., Rule 506 is not the onlyway to comply with Section 4(2) exemption.

b. Issuers relying on Regulation D may also rely on other exemptionsas well, just in case compliance with one or more of theexemptions is not met.

I. Offshore Sales - Regulation S

1. Applies to sales of debt, equity and derivative securities sold outsidethe U.S.

2. No directed selling efforts in the U.S. are permitted (except under aseparate exemption).

3. Securities sold under regulation S are restricted securities in the U.S.

4. Securities sold under Regulation S may not be resold in the U.S. for aperiod of between 90 days and 270 days (depending on type of security).

5. Offers and sales of warrants have certain addition requirements.

J. Resales by “statutory underwriters.” Persons who technically meet thedefinition of “underwriter” because (i) they are control persons (sometimesreferred to as “affiliates”) or (ii) because they purchased restricted(unregistered) securities, are referred to as statutory underwriters.

1. No statutory exemption available – Statutory underwriters cannot use theexemption under Section 4(1) because they might be underwriters, andcannot use the Section 4(2) exemption because they are not the issuer.No other exemption under Section 4 applies.

2. The “Section 4 1/2 exemption” – The SEC has long recognized a quasi-exemption known as a “Section 4 1/2” exemption” for (i) persons whotechnically are control persons or (ii) are holders of restrictedsecurities, in either case, where these persons seem to not haveintended to, and did not, act like underwriters based on the length oftime they have held the security.6 However, the Section 4 1/2 exemptionis problematic:

a. Advice to Clients . Lawyers are reluctant to advise their clientsthat a sale will qualify for a Section 4 1/2 exemption, especiallybecause the exemption has no formal basis in the statutes or SECregulations.

6 The theory is that if someone holds a security for a long period of time, they haveassumed a risk that the security will go down in value before they sell it, and, becausenobody acting as an underwriter would generally be willing to assume that risk for anylength of time merely to make a commission on the sale, the person's intent is more likelyto have engaged in the investment rather than to have acted as an underwriter. This isreferred to as having the “requisite investment intent.”

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b. Legal Opinions . Lawyers are also reluctant to issue opinions thata transfer of restricted securities or securities held by acontrol person qualifies for an exemption because of the inabilityto confirm the correctness of their analysis.7

3. Rule 144 safe harbor – The SEC has created a safe harbor to assistsecurity holders and legal counsel in determining whether someone is anunderwriter and when, and in what volumes and manners, may such personsnevertheless sell their security without a registration statement beingfiled.

a. Rule 144 has several requirements for persons who hold restrictedsecurities. Rule 144 has additional requirements for person whoare control persons, regardless of whether the securities werepurchased in a registered offering or are restricted securities.

(i) Control Persons . Persons who are control persons must meetthe following requirements to qualify for the Rule 144 safeharbor:

(a) Current public information (Rule 144(c))

(1) If the issuer is required to file reports underthe 1934 Act, it must have filed all reportsrequired to be filed during the past 90 days.

(2) If the issuer is not required to file reportsunder the 1934 Act, there must be similar typesof information publicly available.

(b) Holding period for restricted securities (Rule 144(d))

(1) If the securities are restricted securities, atleast one year must have passed since the timeof the sale of the securities by the issuer.

(2) The beginning of the one year period is subjectto certain requirements, including that thepurchase price is deemed to have been paid infull under Rule 144(d).

(c) Volume limitation (Rule 144(e))

7 Most restricted securities have a legend on the back side of the stock certificate orother document stating that any transfer of the security can only be made pursuant to aregistration statement or with an opinion of legal counsel that the transaction qualifiesfor exemption from the registration requirements. When stock certificates are not used,this requirement is generally included in the subscription agreement, partnership oroperating agreement, stockholder agreement or in another written contract among theparties.

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(1) The amount of securities of the issuer sold bythe person in any three month period cannotexceed the greater of:

i) 1% of the outstanding securities of theclass, or

ii) the average weekly trading volume of theclass of securities.

(d) Manner of sale (Rule 144(f))

(1) The securities must be sold in a “brokertransaction” as defined in Rule 144(g).

(2) Broker must make a reasonable inquiry anddetermine that the seller is not an underwriteror that the transaction is part of adistribution of securities of the issuer. Rule144(g)(3).

(e) Form 144 (Rule 144(h))

(1) If the amount of securities to be during anyperiod of three months exceeds 500 shares orother units or has an aggregate sale price inexcess of $10,000, a Form 144 must be filed withthe SEC and any securities exchange on which thesecurities are traded.

(2) The seller must also have a bona fide intentionof selling the securities within a reasonabletime after filing the Form 144.

(ii) Holders of Restricted Securities .

(a) Persons who are not control persons but who holdsecurities purchased in an unregistered offering (orwho hold securities purchased from someone whopurchased them in an unregistered offering) are alsosubject to all of the requirements of Rule 144.

(b) However, if a non-control person has held thesecurities for two years, none of the other Rule 144requirements apply. Rule 144(k).

K. Conclusions.

1. If the transaction involves an offer or sale of a security that is notexempt under Section 3 in a transaction that is not exempt under Section

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4, it is subject to the registration and prospectus deliveryrequirements of Section 5 of the 1933 Act.

2. If a security holder is a control person or holds restricted securities,additional requirements apply to resales.

3. Compliance with the 1933 Act does not guaranty compliance with the anti-fraud provisions of the 1934 Act or the provisions of any other state orfederal securities laws. However, under Section 18 of the 1933 Act,securities sold to certain qualified purchasers, sold in a registeredoffering, or sold under Rule 506 or under Sections 4(4) and 4(6) and,subject to certain limitations, Section 3(b)(2), are not subject to theregistration requirements of any state securities laws (but are stillsubject to enforcement actions for fraud.

IV. THE SECURITIES EXCHANGE ACT OF 1934 (governs public issuers, national securities markets and broker-dealers)

A. Applicability of the 1934 Act - Sets forth reporting and other requirementsfor any company that has sold securities in a registered public offering underthe 1933 Act or any other company with securities listed on a stock exchange.

1. Because the 1934 Act applies to any company with securities trading on aU.S. market, including American Depository Receipts (ADRs) and AmericanDepository Shares (ADSs), it can apply to Chinese companies in thefollowing manners:

a. Quarterly and annual reports.

b. Audited financial statements.

c. Large stockholder reporting

d. Section 16 reporting and short-swing profit prohibitions

e. Antifraud provisions

2. This outline is limited to the requirements for issuers and stockholdersof publicly traded companies and does not discuss the requirements forbroker-dealers, stock exchanges, transfer agents, debt rating agenciesor others subject to the 1934 Act's other requirements.

B. Purpose of the 1934 Act - Provides rules and procedures for efficient tradingmarkets and fair handling of brokerage accounts, trading activity, proxysolicitations, tender offers, etc.

C. Key Definitions.

1. “Reporting Company” - an issuer required to file reports under the 1934Act. Companies that are reporting companies but not Section 12companies (see below) incurred their reporting obligation by filing aregistration statement under the 1933 Act. They may or may not also

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become Section 12 companies, depending on whether they (i) list on astock exchange or (ii) ) have (a) 2,000 persons or 500 accreditedinvestors8, or, if it is a bank or bank holding company, has more than2,000 record holders (other than exempted securities) and has $10million in assets.

2. “Section 12 Company” (also known as a “Section 13(a) Company”) - anissuer that has a class of securities registered under Section 12 of the1934 Act, and is subject to the same reporting requirements as areporting company, but is also subject to the proxy solicitation rules,the Section 16 short-swing trading rules and the Section 13(d) largestockholder reporting requirements.

3. “Proxy Solicitation” - means any request for a stockholder to authorizesomeone else to vote their shares.

4. “Form 10-K” - means an Annual Report on Form 10-K required to be filed75- 90 days after the end of each fiscal year by reporting companies.

5. “Form 10-Q” - means a Quarterly Report on Form 10-Q that is required tobe filed 45-60 days after the end on each fiscal quarter by reportingcompanies.

6. “Form 8-K” - means a Current Report on Form 8-K that is required to befiled within four business days after the occurrence of many materialevents, such as entering into material contracts, amending articles ofincorporation, hiring or firing senior management, etc.

7. “Periodic Reports” - means Forms 10-K, 10-Q and 8-K.

8. “Foreign Private Issuer” - means any foreign issuer other than a foreigngovernment except an issuer where (i) more than 50 percent9 of theissuer's outstanding voting securities are directly or indirectly heldof record by residents of the United States, and (ii) the majority ofthe executive officers or directors are United States citizens orresidents, more than 50 percent of the assets of the issuer are locatedin the United States, or the business of the issuer is administeredprincipally in the United States.

D. Anti-Fraud Provisions (Section 10)

1. Section 10(a) authorizes the SEC to make rules regarding short sales.

2. Section 10(b) and Rule 10b-5 make it illegal to use or employ anydeceptive device or to make any untrue statements of material fact or

8 But Rule 12g3-2b exempts foreign private issuers from being required to register undersection 12 solely by virtue of exceeding this size, subject to certain limitations,including the filing of certain information with the SEC.9 Ownership percentage is calculated pursuant to Rule 12g3-2(a).

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fail to disclose any material information necessary to make thestatements true in the context in which they were made.

a. Section 10(b) and Rule 10b-5 apply to purchase and sales ofsecurities.

b. Section 10(b) and Rule 10b-5 apply to any securities, whetherregistered under the 1933 Act or the 1934 Act or not, and whetherlisted on a stock exchange or not.

3. Section 10A imposes requirements on persons performing audits offinancial statements to be included in any 1934 Act report filed withthe SEC and on issuers receiving reports from such auditors.

E. Issuer Registration Requirements (Section 12)

1. Mandatory registration – Issuers, including foreign private issuers,that meet any of the following criteria must register the applicableclass of securities under Section 12 of the 1934 Act:

a. Has a class of securities registered on a national exchange.

b. Has over $10 million in assets and a class of equity securities(other than exempt securities) held of record by more than 500 (i)2,000 persons or (ii) 500 accredited investors10, or, if it is abank or bank holding company, has more than 2,000 record holders(other than exempted securities).

c. Is a “Successor issuer”, i.e., a non-reporting issuer who acquiresa class of securities registered under the 1934 Act through astock-for-stock acquisition where stockholders of the formerpublic company receive shares of the private issuer. The privateissuer must register so that stockholders of target companycontinue to have 1934 Act registered shares.

d. Persons whose ownership arose solely from purchased under Section 4(6) of the 1933 Act shall not be counted for the above requirements.

2. Voluntary registration.

a. Listing on a national securities exchange

(i) If an issuer wants to list a class of securities on anational securities exchange, it must register that class ofsecurities under Section 12.

10 But Rule 12g3-2b exempts foreign private issuers from being required to register undersection 12 solely by virtue of exceeding this size, subject to certain limitations,including the filing of certain information with the SEC.

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(ii) Section 12(a) make it unlawful for brokers to effecttransactions on a national securities exchange unlesssecurities are registered under Section 12.

b. An issuer may also voluntarily register a class of securitiesunder Section 12

(i) Prior to Sarbanes-Oxley this was rare but not unheard of.

(ii) It is not done today unless there is a very, verysignificant reason.

3. Termination of Registration

a. Domestic Issuers – Domestic issuers may deregister theirsecurities if the securities are not listed for trading on anynational exchange and are held of record by less than 300 persons(or, if the issuer is a bank or bank holding company, has lessthan 1,200 holders of record).

b. Foreign private issuers – recent amendments to Rule 12h-6 permit aforeign private issuer to terminate its 1934 Act registration andreporting obligations regarding a class of equity securities,regardless of the express requirements of Section 12, if the U.S.average daily trading volume of the subject class of securitieshas been no greater than 5 percent of the average daily tradingvolume of that class of securities on a worldwide basis for arecent 12-month period.

(i) To qualify for deregistration under Rule 12h-6, even wherethe foreign private issuer has in excess of $10 million inassets and 300 stockholders, it must meet the followingadditional requirements:

(a) have been a 1934 Act reporting company for at leastone year, have filed or submitted all 1934 Act reportsrequired for this period, and have filed at least one1934 Act annual report;

(b) have not sold its securities in a registered offeringin the United States, except for specified offerings,during the preceding 12 months; and

(c) have maintained a listing on one or more exchanges forat least a year in a foreign jurisdiction that, eithersingly or together with one other foreignjurisdiction, constitutes the primary trading marketfor the issuer's subject class of securities.

F. Issuer Reporting Requirements (Section 13(a))

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1. Issuers with a class of securities registered under Section 12

a. U.S. issuers that register under Section 12 are required to fileperiodic reports as follows:

(i) Annual Reports on Form 10-K within 90 days of the completionof each fiscal year (75 days for accelerated filers).

(ii) Quarterly Reports on Form 10-Q within 60 days of thecompletion of each fiscal quarter (45 days for acceleratedfilers).

(iii) Forms 8-K (generally) within four business days of theoccurrence. Examples of events requiring a Form 8-Kinclude:

(a) Entry into or termination of material contracts oracquisitions or dispositions of material assets;

(b) Filing of bankruptcy;

(c) Any public announcement of the financial results ofoperations for a fiscal quarter or year;

(d) Creation of, or triggering event related to, an offbalance sheet financial obligation, including

(1) Long-term debt obligation,

(2) Guaranty of third party debt,

(3) Capital lease,

(4) Operating lease, and

(5) Short-term debt outside ordinary course ofbusiness;

(e) Material impairment of assets;

(f) Certain events related to delisting, changes to orsales of securities; and

(g) Matters related to restatements of, or non-relianceon, prior financial statements or changes toindependent auditors.

b. Foreign private issuers registered under Section 12 are requiredto file reports as follows:

(i) Annual Reports on Form 20-F within six months after the endof their fiscal year, but foreign private issuers are exempt

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from the requirements of filing quarterly or current reportson Form 10-Q and Form 8-K pursuant to Rule 13a-13.

(ii) Foreign private issuers are also required to file a Form 6-Kto disclose any other information that is

(a) required to be or is filed by its domesticjurisdiction,

(b) required to be publicly filed or is filed with anystock exchange where its securities are traded, or

(c) required to be distributed to, or is distributed toits stockholders. See Rule 13a-16 and Rule 15d-16.

(iii) The Form 6-K is to be filed promptly after the publicdisclosure of the information required to be filed in thereport.

2. Issuers that have sold securities under a 1933 Act registrationstatement

a. Every U.S. issuer that has registered shares for sale under the1933 Act (i.e., has done a public offering) is also required tofile Forms 10-K, 10-Q and 8-K under Section 13(a) in the samemanner as registered U.S. companies noted above.

b. Foreign private issuers that have registered shares for sale underthe 1933 Act are required to file an Annual Report on Form 40-F(unless otherwise required to file an Annual Report of Form 20-F).

3. Termination of reporting requirements

a. Registered Companies . The reporting requirements for domesticissuers and foreign private issuers terminate upon deregistrationso long as the issuer is not otherwise subject to the reportingrequirements as a result of a 1933 Act registration statement.11

b. Non-registered Companies .

(i) For domestic issuers, reporting requirements continue untilthe first day of a fiscal year on which the issuer has lessthan 300 stockholders of record for that class ofsecurities, at which time the reporting requirements aresuspended until the first day of a fiscal year that theissuer has 300 or more stockholders of record of that classof security.

11 Previously the exemption for reporting for foreign private issuers under Rule 12g-3-2b required a foreign private issuer to continue reporting for 18 months following deregistration.

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(ii) Rule 12h-6 is also available for foreign private issuers toterminate their reporting obligations based on relative U.S.trading volume instead of a less than 300 stockholderrequirement.

G. Large Stockholder Reporting Requirements (Section 13(d))

1. Applies to any person or group of affiliated persons who beneficiallyown more than 5% of a class of securities registered under section 12.

a. Requires a report on Schedule 13D of such holdings to be filedwithin 10 days of ownership exceeding 5%.

(i) The report must provide information as to whether thereporting person has any intention to seek to control orinfluence the management of the issuer (this puts managementon notice of a possible hostile takeover effort, proxybattle for board positions, etc.).

(ii) The report must be amended promptly upon any material changein the information previously filed.

(iii) Institutional stockholders having no management or controlintentions are permitted to file a short form Schedule 13Gunless their ownership exceeds 20%.

2. Ownership percentage is calculated pursuant to Rule 13d-3.

H. Reports by Investment Managers

1. Applies to any investment manager that exercises investment control overmore than $100 million of exchange listed equity securities.

2. Such investment managers must file reports on Form 13F each quarter andon an annual basis disclosing their holdings of exchange listedsecurities.

I. Self-Tender Offer Rules (Section 13(e))

1. Securities registered under Section 12 of the 1934 Act are subject torules pertaining to tender offers by the issuer or its affiliates.

a. Rule 13e-1 places restrictions on an issuer's repurchase ofsecurities that are the subject of a tender offer by a thirdparty.

b. Rule 13e-3 regulates the notice and stockholder informationprocedures for going private transactions.

c. Rule 13e-4 sets forth “best price” requirements to prevent twotier freeze out mergers.

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J. Proxy Solicitation Rules (Section 14(a))

1. Apply to any solicitation of a proxy for a security registered undersection 12, other than foreign private issuers (foreign private issuersare exempt from Section 14(a)).

2. Prohibit any person from soliciting a proxy for a registered securityother than in compliance with Regulation 14A of the SEC.

a. Rules 14a-3 to 14a-6 set forth certain stockholder informationrequirements and SEC filing procedures for proxy solicitations.

(i) Stockholders must receive a proxy statement meeting therequirements of Schedule 14A and an annual report tostockholders.

(ii) Rule 14a-8 provides stockholders rights to include proposalsin the proxy statement, subject to certain limitations.

3. Rule 14a-9 prohibits false or misleading statements regarding materialinformation in connection with a proxy solicitation.

4. Rule 14a-16 permits the delivery of proxy materials via Internet access,subject to certain limitations.

5. Emerging growth companies are exempted from certain proxy disclosuresregarding performance based executive compensations, and votes on “say-on-pay”and golden parachutes.

K. Tender Offers (Section 14(d) and (e))

1. Section 14(d) and the rules thereunder sets forth certain proceduralrequirements for tender offers.

2. Section 14(e) prohibit material misrepresentations in connection withthird party tender offers.

L. Short-Swing Profits and Insider Trading Reporting (Section 16)

1. Reports of Ownership

a. Section 16(a) requires directors, officers and 10% or greaterstockholders of issuers with a class of securities registeredunder Section 12 of the 1934 Act to file reports regarding theirbeneficial ownership in the issuer.

(i) Reports must be filed within 2 business days of almost anychange in beneficial ownership.

(ii) Beneficial ownership for persons who are not 10%stockholders means any pecuniary (economic) interest, evenif indirect.

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(iii) Beneficial ownership for purposes of determining 10%ownership is determined in the same manner as ownershippursuant to Section 13(d).

(iv) The term “officer” means an issuer's president, principalfinancial officer, principal accounting officer (or, ifthere is no such accounting officer, the controller), anyvice-president of the issuer in charge of a principalbusiness unit, division or function (such as sales,administration or finance), any other officer who performs apolicy-making function, or any other person who performssimilar policy-making functions for the issuer. Officers ofthe issuer's parent(s) or subsidiaries shall be deemedofficers of the issuer if they perform such policy-makingfunctions for the issuer.12

b. Foreign private issuers are exempt from Section 16(a).

2. Forfeiture of Short-Swing Profits

a. Section 16(b) requires a person subject to Section 16 to return tothe issuer any positive difference between the price paid for asecurity and the price received in the disposition of suchsecurity in any six month period, subject to limited exceptions.

(i) Purchases and sales made by family members, partnerships,trusts, etc. in which the insider has a pecuniary interestare counted for purposes of calculating short-swing gains.

(ii) Even if the two trades that are within six months of eachother are unrelated, the penalty can still be imposed.Example: If an insider purchases 100 shares of hiscompany's stock in January 2007 for $90 per share, and sellsthe 100 shares in March 2007 for $80 per share (a loss of$10 per share or $1,000 total), and then purchases another100 shares in June 2007 at $60 per share and sells them inJuly 2007 at $50 per share (again, a loss of $10 per shareor $1,000, for a total loss on both trades of $2,000), theinsider owes his company $2,000, because he bought 100shares at a price of $60 per share and sold 100 shares at aprice of $80 per share within six months of each other.

b. Foreign private issuers are exempt from Section 16(b).12 In addition, when the issuer is a limited partnership, officers or employees of thegeneral partner(s) who perform policy-making functions for the limited partnership aredeemed officers of the limited partnership. When the issuer is a trust, officers oremployees of the trustee(s) who perform policy-making functions for the trust are deemedofficers of the trust.

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3. Short Sales

a. Section 16(c) prohibits persons subject to Section 16 from sellingthe issuer's shares short or failing to deliver a security upon asale.

b. Foreign private issuers are exempt from Section 16(c).

M. Summary of the 1934 Act

1. Establishes an ongoing disclosure framework for publicly tradedcompanies based upon current, quarterly and annual reportingrequirements.

2. Provides antifraud provisions that apply to both the purchase and thesale of any security, whether the offer and sale of such security isexempt from registration under Sections 3 or 4 of the 1933 Act or not.

3. Governs proxy solicitations, tender offers and other transactions insecurities registered under Section 12 of the 1934 Act, but securitiesthat are not registered are not subject to these provisions even ifreports are required to be filed by the issuer because of a 1933 Actregistration statement.

4. Creates a “trap for the unwary” under Section 16 by requiring anypositive difference between the per share price of any purchase ofsecurities and any sale of securities made within six months of eachother by an officer, director or 10% stockholder of securitiesregistered under the 1934 Act to be forfeited to the issuer.

V. INVESTMENT ADVISERS ACT OF 1940

[This outline has not been updated for the 1940 Act changes effected by the Dodd-Frank Act]

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A. Applicability of the IAA – governs activity of every person giving investmentadvice in the U.S., including managing any type of venture capital, hedge,private equity, leveraged buy-out or other type of investment fund.

1. The IAA can apply to Chinese investment advisers if they are advisingclients located in the U.S., even if such clients are not U.S. citizens.

2. The IAA can also apply to publishers and other media persons if theirpublications and broadcasts in the U.S. make specific investmentrecommendations.

3. In certain circumstances the IAA can apply to attorneys, accountants andother professionals if the level of investment advice given and the feesreceived for such advice are outside the normal boundaries of theprofession.

B. Purpose of IAA - The primary goal of the IAA is to achieve a high standard ofbusiness ethics in the adviser industry, primarily by eliminating (or at leastexposing through disclosure) conflicts between the interests of advisers andtheir clients.

C. Definition of “Investment Adviser” – any person who, for compensation, engagesin the business of advising others, either directly or through publications orwritings, as to the value of securities or as to the advisability of investingin, purchasing, or selling securities, or who, for compensation and as part ofa regular business, issues or promulgates analyses or reports concerningsecurities. (Section 202(a)(11))

1. For purposes of analysis, the investment adviser definition consists offour elements: (a) compensation, (b) engaging in the business, (c)providing reports or analysis, (d) to others.

a. Compensation

(i) The SEC interprets this element broadly to include thereceipt of any economic benefit, whether in the form of anadvisory fee, a commission, or some form of indirectcompensation.

(ii) This element is satisfied if a single fee is charged for anumber of services, any one of which is advisory services.

(iii) The IAA does not require that a person receive the economicbenefit directly from the person receiving the advice. The''compensation'' element is satisfied if the person receivescompensation from any source in connection with providingthe investment advice.

b. Engaged in the business – probably the most difficult of the fourelements to apply. It looks to the frequency and regularity withwhich the person gives advice.

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(i) Giving advice need not be the sole or principal business ofthe person to satisfy this element, but the advice must begiven as part of a regular business.

(ii) The SEC staff considers a person to be in the ''business''of providing advice if it:

(a) holds itself out as an adviser; or

(b) receives any separate or additional compensation thatis a clearly definable charge for investment advice;or

(c) receives transaction-based compensation if the clientimplements the advice; or

(d) on anything other than rare, isolated, and non-periodic instances, provides specific investmentadvice.

c. Providing advice, reports, etc. as to the value of securities – encompasses tworelated, but distinct, activities:

(i) advising as to the value of securities

(a) Consultants who advise clients on the selection of aninvestment manager or on the investment performance ofadvisers are deemed to be giving advice aboutsecurities.

(b) However, the SEC staff has given relief to uniqueprograms that provide information on various advisersin a manner that is not highly selective or structuredto recommend particular advisers.

(ii) Issuing reports or analyses concerning securities

(a) Advice about market trends or market timing satisfiesthis element.

(b) General statistical or historical data aboutsecurities may be deemed to be ''analyses or reportsconcerning securities” unless the following are true:

(1) the information provided is readily available inits raw state;

(2) the categories of information presented are nothighly selective; and

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(3) the information presented is not organized orpresented in a manner that suggests thepurchase, holding or sale of securities.

(iii) Advice regarding the issuance of one's own securities doesnot meet this element.

(iv) A person who confines his or her advice to assets that arenot securities, would not satisfy this third element.

d. To others – a person must give advice to ''others'' to come withinthe definition of an investment adviser.

(i) Partnerships - In the case of a partnership that invests insecurities, the general partner will be deemed to be givingadvice to ''others'' if it provides substantial advisoryservices to the partnership for a fee, but not if anexternal adviser has ultimate investment authority for thepartnership's investments or if the general partner sellspartnership interests to investors without advising thepartnership as to investments.

(ii) Investment Companies – Directors and officers of aninvestment company generally will not be deemed to beadvising others, but an outside investment manager or ageneral partner will be.

2. Status of Financial Planners.

a. The SEC staff has indicated that ''generally a person engaged infinancial planning activities is an investment adviser.”

b. The SEC staff has suggested that a financial planner would nothave to register would be if the financial planner merelydiscusses in general terms the advisability of investing insecurities in the context of a discussion of economic matters orthe role of securities in a client's overall financial plan, andeither:

(i) discusses no more frequently than on rare and isolatedinstances the advisability of investing in specificsecurities or categories of securities, or

(ii) does not issue reports or analyses about specific securitiesor specific categories of securities.

3. U.S. Advisers Who Advise Foreigners

a. Any U.S. resident adviser who uses U.S. jurisdictional means tosolicit foreign clients must register under the IAA if it alsosatisfies the four elements of the investment adviser definition,

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and is not otherwise excepted or exempt from registration (asdescribed below).

4. Non-Resident Advisers who advise U.S. Residents

a. Non-resident advisers conducting investment advisory services areexpected to register under the IAA.

b. However, the staff also has allowed non-resident advisers who arenot registered under the IAA more flexibility in establishingU.S.-registered subsidiaries to carry on their U.S. activitieswithout subjecting the non-resident adviser to U.S. regulation.

(i) In particular, the staff has stated that generally it willrecognize the ''separateness'' of the U.S. subsidiary fromthe non-resident parent if, among other things:

(a) The entities are separately organized;

(b) The U.S. subsidiary has personnel, whether in the U.S.or abroad, who are capable of giving investmentadvice; and

(c) The SEC has adequate access to trading and otherrecords and personnel of each affiliate involved inU.S. activities, to the extent necessary to monitorand police conduct that may be detrimental to U.S.clients or markets.

c. Additionally, non-significant U.S.-related activities may notrequire registration.

(i) For example, a non-resident adviser need not register if ituses jurisdictional means only to acquire information aboutU.S. securities for the benefit of its foreign clients.

(ii) Such a non-resident adviser also would not be required toregister if it merely telephones U.S. broker-dealers toeffect transactions in U.S. securities for its foreignclients.

5. Non-Resident Advisers who Advise Foreigners.

a. Generally, the staff has taken the position that the IAA'ssubstantive provisions should not apply to a non-residentadviser's non-U.S. clients.

D. Exceptions to the Definition.

1. Similar to Section 3(a) of the 1933 Act, which creates exceptions to thedefinition of “security” and provides that the 1933 Act does not applyto those exempt securities, Section 202(a)(11) excludes from the

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definition of “investment advisor” certain categories of persons who mayact in a similar manner as investment advisers in the performance oftheir other professional duties:

a. These categories of persons are not subject to the IAA – not evenanti-fraud provisions of Section 206.

2. These categories of exceptions include:

a. Banks – any bank or any bank holding company, except when advisinga registered investment company.

b. Professionals in four professions – lawyers, accountants,engineers, and teachers.

(i) Only applies if investment advice is ''solely incidental''to the practice of the profession.

(ii) The SEC staff has identified three factors as relevant indetermining whether investment advice is ''solelyincidental'' to the practice of a specifically enumeratedprofession:

(a) whether the professional holds himself or herself outto the public as an investment adviser (or as afinancial planner);

(b) whether the advice is reasonably related to theprofessional services being rendered; and

(c) whether the professional's fees for advisory servicesare different from, or are based on different factorsthan he or she uses to determine, fees forprofessional services.

(iii) Of these three factors, the first is probably the mostimportant.

(a) SEC staff appears to treat it as a per se requirement.

(b) If a professional holds himself or herself out as aninvestment adviser, the exception is automaticallyunavailable, irrespective of the remaining twofactors.

(iv) With regard to the third factor, the SEC appears to view anytype of fee other than the professional's regular fees topreclude reliance on this exception.

c. Broker-Dealers.

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(i) A broker-dealer must satisfy two elements to rely on theexclusion:

(a) provides investment advice solely incidentally to theconduct of its business as a broker-dealer, and

(b) receives no ''special compensation'' for such advice.

(ii) Registered Representatives – the SEC staff has stated thatthe broker-dealer exception is available to any registeredrepresentative whose investment advisory activities aresubject to control by his or her employer broker-dealer.

d. Publishers, TV, Radio, Internet, other Media. (Section 202(a)(11)(D))

(i) General Investment Topic – the exception is available to thepublisher of any bona fide newspaper, magazine, or businessor financial publication of general and regular circulation.

(ii) Investment Advisory Newsletters. The availability of theexception to investment advisory newsletters (i.e.,publications devoted to giving investment advice) isdependant on meeting certain tests, known as Lowe factorsfrom a case by that name:

(a) the newsletter must offer only ''impersonalized''advice, i.e., advice not tailored to the individualneeds of a specific client or group of clients;

(b) the newsletter must be ''bona fide''; and

(c) the newsletter must be of general and regularcirculation.

(1) Not about consistent circulation, but timing.

(2) Must not be ''timed to specific market activity,or to events affecting or having the ability toaffect the securities industry.''

(iii) Authors.

(a) The language of the publisher's exception does notexpressly extend to authors of books, pamphlets, orarticles that contain formulae to be used indetermining what securities to buy or sell or whichcontain specific recommendations.

(b) May come within the exception if:

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(1) the publication did not contain recommendationsor analyses about specific securities; and

(2) the publication was not one of a series ofpublications or intended to be supplemented orupdated.

E. Exemptions from Registration

1. Section 203(b) and Section 203A exempt several types of advisers fromregistration under the IAA. However, these persons are still subject tothe anti-fraud provisions of Section 206 of the IAA.

a. Section 203(b) – exempts six categories of persons from theregistration requirements of the IAA:

(i) Intrastate Advisers – exempts from registration under theIAA any adviser all of whose clients are within the samestate as the adviser's principal business office and whodoes not provide advice or issue reports about securitieslisted on any national securities exchange. (Section 203(b)(1))

(ii) Advisers to Insurance Companies – exempts any adviser whoseonly clients are insurance companies. (Section 203(b)(2))

(iii) Private Advisers – exempts from registration any adviserwho, during the previous twelve months, met all three of thefollowing requirements. (Section 203(b)(3))

(a) Has had fewer than fifteen clients

(1) In the case of limited partnerships,corporations, trusts, and similar entities, thequestion often arises as to whether the entityor each of its individual members should becounted as the ''client'' for purposes of theexemption.

(2) Under Rule 203(b)(3)-1, an adviser to acorporation, partnership, trust or similarentity counts the entity as a single client aslong as the advice concerns the entity'sobjectives rather than the objectives ofindividual members or investors.

(b) Does not hold itself out generally to the public as aninvestment adviser; i.e., the adviser does not:

(1) Advertise for clients;

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(2) use to ''investment adviser'' or a similar termin its business card or letterhead;

(3) list itself as an investment adviser in atelephone, business, or building directory; or

(4) let it be known by word of mouth or otherwisethat it is available to provide investmentadvisory services or to accept new clients.

(c) Is not an adviser to a registered investment companyor business development company. (Section 203(b)(3))

(iv) Charitable Organizations, Officials and Church Plans.Section 203(b)(4) exempts any investment adviser that is acharitable organization as defined in Section 3(c)(10)(D) ofthe ICA where advice, analyses or reports are provided onlyto the charitable organization, certain funds excluded fromthe ICA and certain charitable trusts.

(v) Certain Employer and Benefit Plans – exempts certain plansunder Section 414(e) of the Internal Revenue Code. (Section203(b)(4))

(vi) Registered Commodity Trading Advisors.

(a) Section 203(b)(6) exempts an investment adviser that:

(1) is registered with the Commodity Futures TradingCommission (''CFTC''); and

(2) whose business does not consist primarily ofacting as an investment adviser under Section202(a)(11) of the IAA.

(b) However, this exemption does not apply to an adviserto a registered investment company or a businessdevelopment company.

b. Section 203A - Advisers with less than $25,000,000 undermanagement.

(i) Section 203A exempts advisers with assets under managementof less than $25,000,000, if:

(a) it is regulated or required to be regulated in thestate in which it maintains its principal office andplace of business; and

(b) it does not serve as an investment adviser to aregistered investment company.

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(ii) It should be noted that, except in limited circumstances,this exemption is mandatory -- i.e., an investment adviseris prohibited from registering under the IAA if it comeswithin Section 203A.

(iii) Conversely, where an adviser has its principal office andplace of business in a state that does not regulateadvisers, registration with the SEC is required regardlessof the amount of the adviser's assets under management.Note: Currently only one state does not regulate advisers.

(iv) The SEC has adopted several rules implementing Section 203A.Most notably, Rule 203A-1 provides that registration withthe SEC is optional for investment advisers with$25,000,000-$30,000,000 under management. This $5 million''window'' is intended to avoid the situation where anadviser is forced to register and promptly de-register dueto relatively minor fluctuations in assets under management.

F. Requirements Applicable to Registered Investment Advisers.

1. Fiduciary Duty to clients - Registered investment advisers are deemed toowe their clients a fiduciary duty to act in the client's best interestsat all time.

2. Books and Records – Section 204 of the IAA requires a registeredinvestment adviser to make and keep such books and records as prescribedby the SEC.

3. Brochure Rule – Rule 204-3 requires registered advisers to furnish eachclient and prospective client, at specified times, with a writtendisclosure statement containing certain information.

a. The brochure must be delivered either (i) at least 48 hours beforethe advisory contract is entered into or (ii) at the time thecontract is entered into, if the client has the right to terminatethe contract without penalty within five business days afterentering into the contract.

b. In addition to its initial delivery requirements, an adviser has aduty to deliver annually, or offer in writing to deliver, withoutcharge, an updated brochure.

c. In general, the SEC views information distributed throughelectronic media as satisfying disclosure obligations if theintended recipient receives substantially equivalent informationas they would in a paper format.

4. Advisory Contracts and Fees – Sections 205 and 206 regulate contractsfor advisory services and the fees that can be charged for suchservices.

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a. Assignments – An assignment of the contract cannot be made withoutthe consent of the client. (Section 205)

b. General Prohibition on Performance Fees. (Section 205)

(i) Section 205(a)(1) prohibits advisory contracts that providefor compensation based on a share of the capital gains orcapital appreciation of clients' funds because such fees arethought to contribute to a “no-risk” speculative attitude byadvisers.

(a) Section 205(a)(1) does not prohibit an adviser fromcharging a fee based on a percent of interest,dividend or other income (exclusive of capital gainsor appreciation) in a client's account.

(b) However, an income based fee must exclude premiumincome received for writing options, since the sale ofan option is a capital transaction.

(ii) Specifically excepted from the prohibition of Section 205(a)(1) is a type of fee known as a ''fulcrum fee.''

(a) A fulcrum fee provides for compensation based upon thetotal value of the fund under management over a''specified period'' that must increase and decreaseproportionately with the ''investment performance'' offunds under management in relation to an ''appropriateindex of securities prices.''

(1) For example, a fulcrum fee might provide that anadviser's fee would increase/decreaseproportionately by how much it out performs orunderperforms the S&P 500.

(2) A fee that decreases at a rate faster than itincreases is permissible under this provision.

(b) Fulcrum fees may be used only where the advisorycontract is with a registered investment company orcertain persons or entities with at least one milliondollars in assets.

c. Safe Harbor for Performance Fees for Certain Clients. (Section205)

(i) Rule 205-3 permits a registered adviser to receive aperformance fee, provided that it meets the followingrequirements:

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(a) the client has at least $ 750,000 under the adviser'smanagement or is reasonably believed to have a networth of at least $ 1,500,000;

(b) the client is a ''qualified purchaser'' as defined inSection 3(c)(7) of the IAA;

(c) the client is an executive officer, director, trustee,general partner (or similar person) of the adviser; or

(d) the client is an employee of the adviser who possessescertain qualifications as to investment duties andexperience.

(ii) There is no mandatory percentage limit on the amount of apermissible performance fee under Rule 205-3, and the ruledoes not prohibit an appropriate performance fee from beingcombined with any other lawful fee structure.

d. Additional Restrictions on Advisory Fees – the general anti-fraudprovisions of Section 206 have been interpreted to impose certainrestrictions on advisory fees.

(i) An adviser must disclose material information regarding itscompensation.

(ii) An advisor disclose fully any interest it has in arecommendation to a client, including any benefits it mayreceive from a third party.

(iii) An adviser must recommend only those securities it believesare in the best interests of the client, even if that meansforegoing the additional compensation it would have receivedunder the arrangement with the client for recommendingdifferent securities.

5. Antifraud Provision – Section 206.

a. Generally, it is unlawful for any adviser, whether registered orexempt from registration, to use interstate commerce to defraud,deceive, or manipulate any client or prospective client.

b. Section 206(4) specifically empowers the SEC to adopt rulesdefining fraudulent acts and practices and prescribing meansreasonably designed to prevent their occurrence. Pursuant to thisauthority, the SEC has adopted rules dealing with advertising,custody of clients' assets, cash referral fees, and disclosure offinancial and disciplinary information.

(i) Advertising – Rule 206(4)-1 prohibits an adviser from usingfive categories of advertisements.

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(a) Testimonials – prohibits an advertisement that refersto any testimonial. (Rule 206(4)-1(a)(1))

(1) However, the SEC staff has taken the positionthat bona fide, unbiased third-party reports arenot prohibited by Rule 206(4)-1 as long as theydo not include a statement of a client'sexperience with, or endorsement of, the adviser.

(b) Past Specific Recommendations – prohibits anyadvertisement that refers to past specificrecommendations of securities by the adviser that wereor would have been profitable. (Rule 206(4)-1(a)(2))

(1) This provision is premised on the view that anadvertisement that refers only to profitablerecommendations and ignores those that were orwould have been unprofitable is inherentlymisleading and deceptive.

(2) The rule does not prohibit an advertisement thateither sets out all recommendations made withinat least the last year or offers to furnish alist of all such recommendations.

(c) Charts or Formulae – prohibits advertisements thatrepresent that a graph, chart, formula or other devicebeing offered can, in and of itself, be used todetermine which securities to buy or sell or to assistpersons in making those decisions, unless theadvertisement prominently discloses the limitationsthereof and the difficulties regarding its use.(Rule 206(4)-1(a)(3))

(d) ''Free'' Reports or Services – prohibits an adviserfrom representing that any report or service will beprovided free or without charge unless it is entirelyfree and subject to no conditions or obligations.(Rule 206(4)-1(a)(4))

(e) Misleading Advertisements Generally – prohibits anadviser from using any advertisement that contains anuntrue statement of material fact or is otherwisefalse or misleading. (Rule 206(4)-1(a)(5))

(ii) Custody of Clients' Assets – Rule 206(4)-2 imposes substantialrequirements on any adviser, whether registered or exemptfrom registration, who has custody or possession of clients'securities or funds.

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(iii) Cash Referral Fees to Client Solicitors – Rule 206(4)-3, known as the“Solicitors Rule”.

(a) An adviser cannot pay a cash fee to a solicitor unlessit satisfies the following three conditions:

(1) the adviser is registered;

(2) the solicitor is not subject to any court orderor administrative sanction; and

(3) the cash fee is paid pursuant to a writtenagreement between the adviser and the solicitor.

(b) In addition, the solicitor, at the time ofsolicitation, must provide the prospective client witha copy of the adviser's brochure and a separatedisclosure document mandated by the rule.

(c) Subsequently, the adviser must obtain a writtenacknowledgement from the client that these twodocuments were received.

(d) The adviser also must make a bona fide effort toascertain that the solicitor has complied with theterms of the written agreement.

(iv) Disclosure of Financial and Disciplinary Information – Rule 206(4)-4requires both registered and exempt advisers to disclose toclients material facts about certain financial conditionsreasonably likely to impair an adviser's ability to meetcontractual commitments to clients and certain legal ordisciplinary events.

(v) Proxy Voting – Rule 206(4)-6. Investment advisers generallyhave a fiduciary duty to vote proxies in the best interestsof clients (except where the client retains proxy votingauthority).

c. Agency Cross and Principal Transactions – Section 206(3). It isnot uncommon for an investment adviser also to be a broker-dealer(or to have a broker-dealer affiliate) and for the adviser to wantto effect brokerage transactions on behalf of its clients. In suchcases, Section 206(3) requires that, when knowingly engaging inany agency cross or principal transaction in securities with aclient, an adviser, whether registered or not, disclose certainfacts to the client and obtain the client's consent.

d. Trading Errors – Section 206(2). When an investment adviser makesa trading error in a client's account, it needs to ensure that theerror correction process does not disadvantage the client.

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e. Duty to Supervise – Section 203(e)(6). A registered investmentadviser must supervise the activities of persons acting on itsbehalf.

f. Duties in Connection with Brokerage Transactions.

(i) Registered advisers have several duties regarding tradeexecution.

(ii) Best Execution and Allocation – an adviser who directsbrokerage transactions for a client must do so in the bestinterests of the client.

(a) Thus, an adviser must use reasonable diligence toobtain the best price and execution of clients'brokerage transactions.

(b) When purchase or sale orders will be aggregated,although no particular methodology is required, theSEC staff has permitted a system with the followingmajor conditions:

(1) participation on average price basis;

(2) disclosure of aggregation policies;

(3) written aggregation statement;

(4) compliance approval for deviations fromaggregation policies;

(5) adequate recordkeeping; and

(6) no additional compensation for the adviser fromthe aggregation.

g. Soft Dollars.

(i) In general, registered advisers are not permitted to receiveany type of non-cash benefits (i.e., “soft dollars”) frombrokerage firms to which it provides trading business thatcould be disguised compensation for directing the businessto that broker.

(ii) Safe Harbor for Soft Dollars--Section 28(e) of the 1934 Act.To take advantage of the Section 28(e) safe harbor, theinvestment adviser must make a good faith determination thatthe amount of the brokerage commission it is causing theclient to pay is reasonable in relation to the value of thebrokerage and research provided by the broker-dealer, inlight of the terms of the particular transaction or theadviser's overall responsibilities to the client.

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G. New Anti-Fraud Rule for Advisers of Investment Pools

1. On July 11, 2007 the SEC adopted Rule 206(4)-8 to help clarify itsauthority to regulate advisers to hedge funds and other investmentpools.13

2. The rule prohibits investment advisers from:

a. making any false or misleading statement to investors orprospective investors in any pooled investment vehicle theyadvise; or

b. otherwise defrauding these investors or potential investors.

3. The rule lowers the standard by which advisers may be found liable forfraud by removing the “scienter” requirement that exists in Rule 10b-5actions.

H. SEC Examinations

1. The SEC has the authority to perform examinations, including “no-notice”inspections of IAA offices.

2. In recent years the SEC has stepped up its examination efforts, havinghired several new examiners in 2005-2006 in anticipation of massregistrations of hedge fund managers.14

I. Conclusions.

1. The IAA imposes a number of substantive restrictions on registeredinvestment advisers.

2. Most persons acting as investment advisers try to avoid registrationunless their operations will be large enough to warrant the extra costsand SEC scrutiny.

13 See the following footnote.14 This mass registration was expected as a result of the SEC adopting Rule 203(b)(3)-2,which required investment advisers to count each investor in a “private fund” as aseparate client. Under that rule a private fund was defined as any company that (1) wouldbe an investment company under the Investment Company Act of 1940 except for theexemptions from such definition provided by Sections 3(c)(1) or 3(c)(7) of the ICA; (2)permits an investor to redeem its investment within two years (except for certainspecified reasons); and (3) is offered based on the adviser's expertise. It thereforeincluded most hedge funds because at the time most hedge funds permitted redemptions on aquarterly basis beginning in year one or two. The rule was overturned by the courts asbeing outside the authority of the SEC (Goldstein v SEC, 451 F3d 873 (D.C. Cir. 2006).

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VI. THE INVESTMENT COMPANY ACT OF 1940 (regulates investment pools and funds)

A. Applicability of the ICA – applies to any type of investment pool, i.e., wherefunds from a group of investors are aggregated and used to invest in or tradesecurities.

1. Investment pools include hedge funds, venture capital funds, privateequity funds, leveraged buy-out finds, mutual funds, etc.

2. The ICA affects any person seeking to aggregate pools of capital for anypurpose other than controlling and operating business entities.

3. The ICA will apply to any Chinese company that aggregates capital foruse in the U.S. if any of the investors in the pooled investment vehicleare located in the U.S.

4. Investment pools are also subject to the 1933 Act when they sell theirownership interests to investors, and are subject to the proxysolicitation rules (Section 14(a)) of the 1934 Act.

B. Purpose of the ICA - According to the SEC, the ICA's regulatory requirementsare designed to promote five objectives:

1. full disclosure in the sale of investment companies securities;

2. honest and unbiased management;

3. greater participation in management by shareholders;

4. adequate and feasible capital structures; and

5. appropriate financial statements and accounting.

C. Definition of Investment Company

1. Subject to numerous exclusions, exceptions and exemptions describedbelow, Section 3(a)(1) of the ICA sets forth three definitions of theterm ''investment company'': “orthodox investment companies,”“inadvertent investment companies,” and “face amount certificatecompanies” (only the first two have significance in today's U.S.marketplace15).

15 Section 3(a)(1)(B), defines as an investment company any issuer of face-amountcertificates. Face-amount certificate companies issue fixed-income debt securities thatobligate the company to pay a fixed sum (i.e., the ''face amount'') at a future date. Therate of return on these certificates is predetermined and typically is relatively low. Theproceeds from the sale of the certificates are invested in a portfolio of securities andthe major portion of any earnings from these investments, after payment of the face amounton the certificates, inures to the benefit of the company's equity shareholders. Thesetypes of companies do not play a large role in today's financial industry, as few suchcompanies are active currently. This outline will not discuss face amount certificate

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a. Orthodox Investment Companies – Section 3(a)(1)(A). Section 3(a)(1)(A)defines an investment company as any issuer that

(i) is or holds itself out

(ii) as being engaged primarily, or proposes to engage primarily,

(iii) in the business of investing, reinvesting, or trading insecurities.

b. Inadvertent Investment Companies – Section 3(a)(1)(C). Section 3(a)(1)(C) isthe more problematic type of investment company for many entities.Section 3(a)(1)(C) contains two elements.

(i) First, a company must be an issuer that is engaged orproposes to engage in the business of investing,reinvesting, owning, holding or trading in securities.

(ii) Second, the company must own or propose to acquire''investment securities'' with over 40% of the value of itstotal assets.

2. Differences Between the Section 3(a)(1)(A) and Section 3(a)(1)(C) Tests– Although there is considerable overlap in the concepts and theterminology used in Section 3(a)(1)(A) and Section 3(a)(1)(C), threebasic differences apply:

a. Section 3(a)(1)(A) requires the issuer to be ''primarily'' engagedin the business of investing in securities; Section 3(a)(1)(C)requires only that the issuer be ''engaged'' in that business.

b. Section 3(a)(1)(A) applies to issuers that invest in any type of''security;'' Section 3(a)(1)(C) applies only to issuers investingin ''investment securities.''

c. Section 3(a)(1)(A) does not apply to issuers that merely ''own''or ''hold'' securities; Section 3(a)(1)(C) applies to suchissuers.

3. Statutory Exclusions: Sections 3(b)(1) and 3(b)(2).

a. In practice many companies that are not investment companies fallunder the definition of an inadvertent investment company whenthere is no substantial purpose for those companies to beregulated by the ICA.

b. Section 3(b)(1) provides that, notwithstanding Section 3(a)(1)(C),an issuer primarily engaged in a business other than that of

investment companies.

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investing, reinvesting, owning, holding, or trading securities isnot an investment company.

(i) The issuer may be engaged in this non-investment companybusiness directly or indirectly through a wholly-ownedsubsidiary or subsidiaries.

(ii) Where an issuer satisfies these requirements, the exclusionis automatic, and no formal action by the SEC is necessaryto rely on Section 3(b)(1).

(iii) The SEC staff generally will not issue no-action lettersunder Section 3(b)(1) because of the fact-specific nature ofthe determinations required.

c. Section 3(b)(2) is available to any issuer that the SEC, uponapplication, finds and declares by order to be primarily engagedin a business other than that of investing, reinvesting, owning,holding, or trading in securities.

(i) The issuer may be engaged in this non-investment companybusiness directly, or through majority-owned subsidiaries orthrough controlled companies conducting similar types ofbusinesses.

(ii) Control of majority-owned subsidiaries alone is not asufficient basis for exception under Section 3(b)(2).Rather, the issuer also must be engaged in the same or asimilar business as the controlled companies.

(iii) The filing of an application in good faith under thisprovision automatically exempts the applicant from the ICAfor 60 days or such longer period as the SEC may order, andextensions customarily are granted.

d. Under both Sections 3(b)(1) and 3(b)(2), the key requirement is afactual determination that the company is ''primarily engaged'' ina non-investment company business.

(i) The following five factors are regularly analyzed todetermine an issuer's primary engagement:

(a) its historical development;

(b) its public representations of policy;

(c) the investment activities of its officers anddirectors;

(d) the nature of its present assets; and

(e) the sources of its present income.

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(ii) Of these factors, the fourth and fifth are most significant.As a general rule, the SEC and its staff deem an issuer tobe primarily engaged in a business if at least 55% of itsassets are invested in, and at least 55% of its investmentincome is derived from, that business.

4. Exclusions By SEC Rule

a. Prima Facie Investment Companies – Rule 3a-1. Rule 3a-1 deems an issuerthat meets the statutory definition of an investment company inSection 3(a)(1)(C) not to be an investment company if it meetscertain statistical tests described below.

(i) This type of issuer is commonly referred to as a prima facieinvestment company and typically is either a holding companyor an industrial company that has a substantial portion ofits assets invested in securities of non-controlledcompanies.

(ii) Rule 3a-1 requires generally that the issuer satisfy tworequirements:

(a) First, no more than 45% of the value of its totalassets (exclusive of government securities and cashitems) may consist of securities other than governmentsecurities, securities issued by employees' securitiescompanies, securities of certain majority-ownedsubsidiaries, and securities of certain controlledcompanies.

(b) Second, it must receive no more than 45% of its incomeafter taxes (over the last four fiscal quarterscombined) from such securities. These percentages areto be determined on an unconsolidated basis, exceptthat the issuer must consolidate its financialstatements with those of any wholly-ownedsubsidiaries.

(iii) This rule is a safe harbor rule that is not intended toprovide the exclusive method for a prima facie investmentcompany to avoid the ICA. However, the staff generally willnot respond to no-action requests under Rule 3a-1.

b. Transient Investment Companies – Rule 3a-2. Rule 3a-2 deems an issuer thatotherwise comes within Section 3(a)(1)(A) or Section 3(a)(1)(C),not to be subject to the ICA for a period of up to one year. Therule, in effect, provides a safe harbor for companies that,usually because of an unusual corporate occurrence, may have thecharacteristics of an investment company for an interim period,i.e., a ''transient'' investment company.

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(i) Among the typical types of transient investment companiesare the following:

(a) a ''start-up'' company that invests its offeringproceeds in securities while arranging to purchaseoperating assets;

(b) a company that sells a large operating division andinvests the proceeds in securities pending acquisitionof additional operating assets; and

(c) a company that makes a tender offer to stockholders ofa non-investment company and fails to obtain amajority of the target's stock.

(ii) Rule 3a-2 deems an issuer not to be an investment companyfor purposes of Sections 3(a)(1)(A) or 3(a)(1)(C) for up toone year provided, generally, that the issuer has a bonafide intent to engage, as soon as reasonably possible (butin any event by the termination of the one-year period), ina business other than investing, reinvesting, owning,holding or trading in securities.

(iii) On several occasions, the SEC has granted exemptionspermitting a transient investment company to rely on Rule3a-2 beyond the one-year period, but an issuer may not relyon the rule more than once during any three-year period.

c. Subsidiaries of Industrial Companies – Rule 3a-3. Rule 3a-3 deems certaincorporate subsidiaries of industrial companies not to beinvestment companies under Section 3(a)(1)(A) or 3(a)(1)(C).

(i) This rule is designed to address the situation where anindustrial company effects its securities transactionsthrough a wholly-owned subsidiary, an arrangement thatCongress deemed not to warrant regulation under the ICApresumably because the subsidiary has no publicshareholders.

(ii) Rule 3a-3 is available only if the parent and its subsidiaryhave no more than 45% of their consolidated assets investedin, and receive no more than 45% of their consolidated netincome after taxes from, investment securities.

d. ''Mini-Accounts'' and Similar Programs – Rule 3a-4. Many investment advisersand mutual fund complexes have programs under which clients withrelatively small accounts pay a fee to the adviser for adviceregarding asset categories in which the client's assets areinvested. Rule 3a-4 provides that these programs will not be

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deemed to be investment companies, as long as the followingconditions are met:

(i) Each client's account is managed on the basis of theclient's financial situation, investment objectives, andreasonable restrictions;

(ii) At the opening of an account, the program's sponsor (ordesignee) obtains information from each client about itsfinancial situation, investment objectives, and reasonablerestrictions on the account's management;

(iii) At least annually, the sponsor (or its designee) contactsthe client to determine if there have been any changes infinancial situation or investment objectives;

(iv) At least quarterly, the sponsor (or its designee) notifiesthe client to contact the sponsor with any changes to itsfinancial situation, investment objective or restrictions;

(v) The sponsor and personnel of the manager are reasonablyavailable to consult with clients;

(vi) Clients have the ability to impose reasonable restrictionson the management of their accounts (e.g., designatingparticular securities not to be purchased);

(vii) Clients are provided with a quarterly statement containing adescription of all activity in the client's account (e.g.,transactions, contributions, withdrawals, fees andexpenses); and

(viii) Each client retains indicia of ownership of securitiesin his or her account.

e. Finance Subsidiaries – Rule 3a-5. Rule 3a-5 provides an exclusion forcertain companies organized primarily to finance the businessoperations of their parents or companies their parents control,from the investment company definition, subject to certainconditions.

(i) Among other things, the rule requires that:

(a) Any debt securities of the finance subsidiary issuedor held by the public must be unconditionallyguaranteed by the parent company as to the payment ofprincipal, interest, and premium (if any);

(b) The finance subsidiary must invest in or loan to itsparent or a company controlled by the parent at least85% of any cash and cash equivalents raised by the

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finance subsidiary through offerings of its debt ornon-voting preferred stock or through other borrowingsas soon as practicable; and

(c) The parent must guarantee unconditionally the non-voting preferred stock of its finance subsidiary as topayment of dividends and payment of the liquidationpreference in the event of liquidation.

(ii) The exclusion is available if neither the parent company norany company controlled by the parent is an investmentcompany for purposes of Section 3(a) or is excepted orexempted by order from the investment company definitionunder Section 3(b) or by the rules adopted under Section3(a).

f. Foreign Banks and Foreign Insurance Companies – Rule 3a-6. Rule 3a-6 excludesforeign banks and foreign insurance companies from the definitionof investment company.

(i) To qualify as a ''foreign bank'' entitled to rely on therule, the bank must be regulated as a banking institutionunder a foreign country's laws, be engaged substantially incommercial banking activity (rather than investmentbanking), and not be operated for purposes of evading theICA.

(a) The SEC staff has confirmed that in most cases timedeposits and interbank deposits may be considereddeposits and extensions of credit and, thus,''commercial banking activity'' for purposes of Rule3a-6.

(b) What constitutes being ''engaged substantially'' incommercial banking depends on the facts andcircumstances of the situation. While the SEC staffrecognizes that various percentages could demonstratethat a foreign bank derives a substantial portion ofits business from extending commercial and other typesof credit, it believes that the foreign bank's bankingactivities must be more than nominal.

(c) In addition, the staff would expect that a foreignbank relying on Rule 3a-6 would:

(1) be authorized to accept demand and other typesof deposits and to extend commercial and othertypes of credit;

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(2) hold itself out as engaging in, and engage in,each of those activities on a continuous basis(including actively soliciting depositors andborrowers); engage in both deposit taking andcredit extension at a level sufficient torequire separate identification of each inpublicly disseminated reports and regulatoryfilings in describing the bank's activities; and

(3) engage in either deposit taking or creditextension as one of the bank's principalactivities.

(d) It is important to note that the exclusion is notavailable for common or collective trusts or otherseparate pools of assets in which interests areseparately offered.

(ii) Foreign insurance companies are also eligible for theexclusions.

(a) To qualify as a ''foreign insurance company'', theinsurance company must be:

(1) regulated as an insurance company under aforeign country's laws;

(2) be engaged predominantly and primarily inwriting insurance agreements or reinsuring riskson insurance agreements; and

(3) not be operated for the purpose of evading theICA.

(b) The exclusion is not available for separate accountsor other pools of assets in which interests areseparately offered.

g. Structured Finance – Rule 3a-7. Structured finance transactions typicallyinvolve the transfer by a financial institution of mortgages orother asset-backed securities into a pool and the issuance of thedebt-like interests in the pool to investors, with the financialinstitution receiving the proceeds.

(i) Because the resulting investment pool issues securities orinterests and holds what could be considered securities, thepool could be considered an investment company under Section3(a) of the ICA.

(ii) To rely on Rule 3a-7, an entity must be engaged in thebusiness of purchasing, or otherwise acquiring, and holding

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''eligible assets'' and engaging in activities related orincident thereto.

(a) ''Eligible assets'' generally include fixed orrevolving financial assets that by their terms convertinto cash within a finite period of time as well asrights or other assets designed to assure servicing ortimely distribution of proceeds.

(b) In addition to holding eligible assets, an entity mayissue only non-redeemable securities that meet certainrequirements.

h. Research and Development Companies – Rule 3a-8.16 Rule 3a-817 excludes aresearch and development company from the ''investment company''definition if all of the following criteria are met:

(i) Research and Development Expenses. For the last four fiscalquarters combined, the company's research and developmentexpenses must be a substantial percentage of its totalexpenses.

(a) What constitutes ''substantial'' is undefined in orderto accommodate variations in these expenses.

(b) According to the SEC, there may be circumstances whereresearch and development expenses that constitute lessthan a majority of the company's total expenses maynonetheless be considered ''substantial.''

16 Research and development companies, such as biotechnology companies, often raisecapital during their product development stage--which can be very long--that they theninvest in securities pending its use in operations. Likewise, these companies may acquirenon-controlling equity positions in other companies to help achieve their goals. Dependingon the circumstances, these investments may cause the research and development company tofall within Section 3(a)(1)(C) of the ICA, because its holding of investment securitiesexceeds 40 percent of its total assets. This possibility is exacerbated because theintellectual capital from research and development expenses may not be considered''assets'' for purposes of Section 3(a)(1)(C). In recognition of the fact that thetraditional investment company tests may not reflect research and development companies'non-investment businesses, as well as the fact that these companies are not intended to beinvestment vehicles and do not raise the same types of potential abuses that otherinvestment vehicles raise, Rule 3a-8 excludes a research and development company from the''investment company'' definition if all of the above described criteria are met.17 While Rule 3a-8 is clearly intended primarily for research and development companies, acompany in another non-investment company business that meets its terms can also rely onit.

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(ii) Net Income from Securities Investments. For the last fourfiscal quarters combined, the company's net income frominvestments in securities does not exceed twice the amountof its research and development expenses for the sameperiod.

(iii) Expenses for Investment Advisory and Custody Activities.For the last four fiscal quarters combined, the company'sexpenses for investment advisory and management activities(including advisory fees paid to an outside advisor),investment research and custody do not exceed five (5)percent of the company's total expenses.

(iv) Investments in Capital Preservation Securities – In generalthe company's securities holdings must be ''capitalpreservation'' investments.

(a) However, the company can have up to ten percent (10%)of its total assets in other investments or it canhave up to twenty-five percent (25%) of its assets inother investments if at least seventy-five percent(75%) of these other investments are pursuant to a''collaborative research and developmentarrangement.'' These percentage limits are applied atall times a company seeks to rely on Rule 3a-8.

(b) Whether particular investments are ''capitalpreservation'' investments depends on the facts andcircumstances. As such, securities that are capitalpreservation investments for one company may not befor another.

(c) In addition, according to the SEC staff, under certaincircumstances non-U.S. securities may be capitalpreservation investments, provided they are not usedin a speculative manner.

(v) Holding Out – The company cannot hold itself out as beingengaged in the business of investing, reinvesting or tradingin securities and also cannot be a ''special situations''company.

(vi) Primary Activities.

(a) The company must be primarily engaged (either directlyor through majority owned subsidiaries or primarilycontrolled companies) in a business or businesses otherthan investing, reinvesting, owning, holding ortrading in securities.

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(b) The company's primary activities must be evidenced bythe activities of its officers, directors andemployees; its public representations; its historicaldevelopment; and a resolution of its board ofdirectors (or persons performing similar functions).

(vii) Written Investment Policy – the company's board of directors(or persons performing similar functions) must adopt awritten investment policy with respect to the company'scapital preservation investments.

5. Exceptions to Definition of Investment Company – Section 3(c). Section 3(c) exceptsfrom the definition of an investment company thirteen types of entitiesthat otherwise presumably would be subject to the ICA. The mostimportant are as follows:

a. Private Investment Companies – Section 3(c)(1). Section 3(c)(1)excludes privately held investment companies from regulation underthe ICA.

(i) To rely on this provision, an issuer must satisfy tworequirements:

(a) it must not be making or proposing to make a publicoffering of its securities; and

(b) it must not have more than 100 beneficial owners ofits securities.

(ii) No Public Offering.

(a) Whether an entity is making a public offering of itssecurities under Section 3(c)(1) depends on the factsand circumstances involved.

(b) The SEC staff takes the position that, for purposes ofSection 3(c)(1), an offering is non-public if itcomplies with Section 4(2) of, or Rule 506 under, the1933 Act.

(c) If an offering does not comply with Rule 506, thestaff will not, as a matter of policy, issue no-actionletters on the question of whether the offering isnon-public.

(iii) Not More Than 100 Beneficial Owners.

(a) The 100-beneficial-owner limitation applies to ownersof all types of the entity's securities (includingdebt securities and non-voting securities), but doesnot apply to owners of short-term paper.

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(b) When an entity's security holders are natural persons,determining compliance with the one hundred beneficialowner limit is fairly straightforward, although issuesof family members can arise.

(c) A more difficult question arises in the case ofinvestment vehicles that invest in a Section 3(c)(1)fund because application of this strictly numericalapproach of treating each investing entity as a singlebeneficial owner could lead to undesirable results.

(d) To prevent circumvention of Section 3(c)(1) by usinginvestment funds or similar vehicles, Section 3(c)(1)(A) includes a two-part ''attribution'' test forinvestment funds or vehicles.

(1) Originally, the ''attribution'' test was a two-part test and applied to any investing entity,including a corporate security holder that held10 percent or more of a Section 3(c)(1) fund'svoting securities and had ten percent (10%) ormore of its assets invested in Section 3(c)(1)funds.

(2) However, in 1996 Congress amended Section 3(c)(1)(A) to apply the ''attribution'' test only toinvestment vehicles or similar funds that investin a Section 3(c)(1) fund, rather than to anytype of investing entity.

(3) As a result, an entity that is not an investmentcompany nor a Section 3(c)(1) or Section 3(c)(7)fund may acquire more than 10 percent of aSection 3(c)(1) fund's voting securities andstill be considered one beneficial owner of thefund, irrespective of the percentage of itsassets that the entity has invested in theSection 3(c)(1) fund (or other Section 3(c)(1)funds).

(e) Direction of Investment by Partners or PlanParticipants – while Section 3(c)(1)(A) of the ICAsets forth the general principles of attribution,special circumstances arise when equity owners orother participants -- who may not otherwise be countedas beneficial owners under Section 3(c)(1)(A) -- havethe power to direct investments for their own account.

(1) For example, in some partnerships each partnerhas the right to determine the amount of his or

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her contribution to a particular investment thepartnership is making. In this situation, theSEC staff generally views each partner as makinga separate investment decision and, thus, as aseparate beneficial owner of the investment.

(2) Likewise, when a defined contribution planpermits participants to decide whether and howmuch to invest in a private investment company,the SEC staff typically views each participant,rather than the plan itself, as a separatebeneficial owner of the private investmentcompany.

(3) However, under certain specified conditions, theSEC staff has confirmed that participants in aparticipant-directed defined contribution planwould not be considered as separate beneficialowners of an underlying fund.

(f) Involuntary Transfers – Section 3(c)(1)(B) providesthat, pursuant to rules the SEC may prescribe,transfers of securities resulting from legalseparation, divorce, death or other involuntary eventsshall not increase the number of beneficial owners ofa Section 3(c)(1) entity.

(g) Investments by Knowledgeable Employees – Rule 3c-5under the ICA generally permits ''knowledgeableemployees'' of a Section 3(c)(1) fund or the fund'smanager (defined to include directors, executiveofficers, general partners, advisory board members orcertain predecessor entities) to purchase interests inthe Section 3(c)(1) fund without being counted towardthe 100-beneficial-owner limit.

b. ''Qualified Purchaser'' Private Investment Companies: Section 3(c)(7). Section 3(c)(7) of the ICA excepts from the definition of aninvestment company an issuer who has not made, and does not intendto make, a public offering of securities and whose outstandingsecurities are owned exclusively by ''qualified purchasers''(determined at the time of acquiring the securities). Forpurposes of the Section 3(c)(7) exception, a ''qualifiedpurchaser'' is defined as:

(i) a natural person (including a spouse owning a joint orsimilar interest) owning not less than $5 million ininvestments;

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(ii) a company owning not less than $5 million in investmentsthat is owned directly or indirectly by or for two or morerelated natural persons;

(iii) a trust that was not formed for the purpose of investing ina Section 3(c)(7) fund that is managed solely by ''qualifiedpurchasers'' and whose settlers or other contributors wereall ''qualified purchasers''; and

(iv) any person acting for its own account or the accounts ofother ''qualified purchasers'' who in the aggregate owns andinvests on a discretionary basis at least $25 million ininvestments.

c. In addition, Sections 2(b) and 6 exempt certain other entitiesfrom the ICA, including governmental entities and pension plans.

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