With the recent popularity of "incubator" and similar companies that aim to assist other companies in management and access to financial markets, a recurring question has been how to avoid registration as an investment company.

Biting the bullet and simply registering is rarely an option, as the 1940 Act's affiliate transaction restrictions are inconsistent with incubators' business plans. Usually incubators try to avoid investment company status, typically relying on Investment Company Act Rule 3a-1 or an order under section 3(b) of the 1940 Act that it is primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities.

Some incubators instead have chosen to be business development companies, which have relatively less strict affiliate transaction restrictions. Business development companies, however, are limited in their ability to invest in public companies.

Now the SEC has given notice of a proposed exemptive order to a "managerial strategic investment company," apparently a new term. XSource, Inc., 65 Fed. Reg. 50245 (Aug. 11, 2000) (notice of application).

The MSIC will be under a regulatory regime generally similar to that for business development companies, but it will not be required to purchase in private placements. It will, however, have to make available significant managerial assistance to its portfolio companies, which must be U.S. companies, and at least 50% of its assets must consist of greater-than-25% holdings

The proposed XSource order is also notable in that the applicant does not necessarily expect that it even will be an investment company; the order apparently is just a contingency arrangement. The applicant acknowledges that, if it does not register under the 1940 Act within three years, the order will terminate.

The notice of the application can be downloaded from the Federal Register page at http://www.access.gpo.gov/su_docs/aces/aces140.html