February 21, 2018
In a no-action letter dated February 12, 2018, the SEC expanded the scope of Section 3(c)(5)(C) of the Investment Company Act to apply to a sponsor of multiple securities trusts that hold whole mortgage loans.
Section 3(c)(5)(C) generally excludes from the definition of investment company any entity that is primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. In a 2011 SEC concept release, the SEC staff expressed concern that it has not provided sufficient guidance on Section 3(c)(5)(C) interpretive issues, which resulted in confusion and inconsistent approaches in the market. The 2011 release also invited feedback from market participants as to how Section 3(c)(5)(C) should be applied. In the recently released no-action letter, the SEC staff indicates that it will take a more expansive view in certain circumstances relating to mortgage securitizations, and also suggests the possibility of interpreting Section 3(c)(5)(C) more broadly to cover various additional issuers deemed to be primarily engaged in the business of real estate finance.
Great Ajax Funding LLC (the “Applicant”) is an indirect subsidiary of a publicly traded REIT, Great Ajax Corp. (“Great Ajax”) that acquires, invests in and manages a portfolio consisting primarily of whole mortgage loans. The Applicant acquires such mortgage loans from Great Ajax and then transfers them to certain securitization trusts sponsored by the Applicant. These securitization trusts issue senior Class A notes to institutional investors in private offerings, and subordinate Class B notes to the Applicant as consideration for contributing the mortgage loans. Payment on the Class A and Class B notes is dependent on cash flows from the mortgage loans. Proceeds from the notes are used by Great Ajax to acquire additional mortgages.
The SEC staff has historically interpreted Section 3(c)(5)(C) to be available to an issuer that holds at least 55% of its assets in mortgages and other liens on and interests in real estate (“qualifying interests”), with at least 25% of the remaining assets being real estate-related interests.
While whole mortgage loans themselves and real estate fee interests and leaseholds are unquestionably qualifying interests, the SEC generally has not considered the securities of other issuers engaged in a real estate business to be qualifying interests for purposes of this test. In the Great Ajax letter, however, the SEC staff agreed with the Applicant that the securities of the securitization trusts held by the Applicant (i.e. the trust certificates and Class B notes) could be deemed “qualifying interests” for purposes of Section 3(c)(5)(C). In reaching this conclusion, the staff viewed the Applicant as being functionally engaged in the business of real estate finance even though it did not hold direct interests in the underlying mortgages. The Applicant’s sponsorship and control of the securitization trusts appear to be important facts here, and the SEC staff cautioned that their position does not extend to securities issued by a securitization trust to an unaffiliated third party (e.g., as in the case of the Class A notes acquired by unaffiliated institutional investors).
Perhaps as significant as the SEC’s primary conclusion in the Great Ajax letter are two footnotes that appear to be clear overtures to the market and signal the possibility of further guidance. In the first footnote, the SEC staff states that it is willing to entertain additional no-action relief where an issuer acquires other mortgage-related assets in connection with being engaged in the mortgage business (such as “A-Notes” or servicing rights). In the second, the staff calls into question a strictly assets-based approach to the application of Section 3(c)(5)(C), and invites additional no-action requests that would broaden the analysis to include other factors indicating whether an issuer is primarily engaged in the business of real estate finance. We will be monitoring any further developments in this regard.
 Such loans remain on Great Ajax’s balance sheet even after being transferred to one of the trusts.
 In addition to the Class B notes, the Applicant holds each trust’s equity interests (evidenced by trust certificates). These Class B notes and trust certificates are the Applicant’s only assets.
 The SEC staff reasoned that acquisition of the trust certificates and Class B notes was “a direct result of the issuer being engaged in the business of purchasing or otherwise acquiring whole mortgage loans.”
 Both the incoming letter and the SEC’s response suggest that the Applicant may not even fall within the definition of an investment company as an initial matter (and hence not need to rely on Section 3(c)(5)(C)) given that the trusts could be viewed as majority-owned subsidiaries of the Applicant. Nevertheless the Applicant asked for no-action relief only with respect to Section 3(c)(5)(C) reliance, and the SEC staff tailored its findings accordingly.
 Earlier in the letter it is suggested that such other factors could include sources of income, historical development, public representations of policy and the activities of officers, directors and employees.