Securities and Exchange Commission v. National Presto Industries, Inc.
2007 U.S. App. LEXIS 11345, 486 F.3d 305 (2007)
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Rule of Law:
An operating company holding over 40% of its assets in investment securities is not an "investment company" if a holistic, multi-factor analysis shows it is "primarily engaged" in a non-investment business, with the central inquiry being how a reasonable investor would perceive the company's principal activities.
Facts:
- National Presto Industries (Presto) was a company that sold consumer goods, such as cookware and diapers, as well as military munitions.
- Historically a manufacturer, Presto began divesting its manufacturing facilities in the 1970s and contracting out production.
- In 1993, a Department of Defense facility that Presto used for production was closed, leaving the company with a large amount of cash.
- Presto retained this cash with a long-term plan to acquire other businesses, rather than distributing it to shareholders.
- By 1994, financial instruments constituted 86% of Presto's total assets, and by 2003, they still represented 62% of its assets.
- Throughout this period, Presto continued to actively run its consumer and military product businesses, which generated over 90% of its gross income.
- Presto consistently represented itself to the public through its website, annual reports, and publicity as an operating company, not as an investment vehicle.
Procedural Posture:
- The Securities and Exchange Commission (SEC) filed a lawsuit against National Presto Industries in the U.S. District Court for the Northern District of Illinois.
- The SEC sought an injunction to compel Presto to register as an investment company under the Investment Company Act of 1940.
- The district court granted summary judgment in favor of the SEC.
- The district court then issued an unconditional injunction requiring Presto to register as an investment company.
- Presto registered as an investment company to comply with the injunction and then appealed the district court's decision to the U.S. Court of Appeals for the Seventh Circuit.
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Issue:
Is a company that derives the vast majority of its gross income from manufacturing and sales, and presents itself to the public as an operating company, "primarily engaged" in a non-investment business under § 80a-3(b)(1) of the Investment Company Act, even if over 60% of its assets consist of investment securities?
Opinions:
Majority - Easterbrook, Chief Judge
Yes, the company is primarily engaged in a non-investment business. To determine if a company that exceeds the 40% asset threshold is nonetheless exempt as being 'primarily engaged' in another business, courts apply a five-factor test that focuses on the company's history, public representations, management activities, asset composition, and income sources. The court first rejected Presto's arguments that its refunded municipal bonds were 'Government securities' and its variable-rate demand notes were 'cash items,' holding that securities law respects the form of a transaction, not just its economic substance. Applying the five-factor test from In re Tonopah Mining Co., the court found that Presto's history, public representations, management activities, and gross income all overwhelmingly indicated it was an operating company. Only the nature of its assets favored the SEC's position. The court concluded that making the asset test dispositive would render the 'primarily engaged' exception meaningless and that the ultimate question is how the company's activities lead investors to perceive it. Because reasonable investors would view Presto as an operating enterprise, not a mutual fund, it qualifies for the exception and is not an investment company.
Analysis:
This decision significantly clarifies the 'inadvertent investment company' doctrine by emphasizing that the 'primarily engaged' exception under § 80a-3(b)(1) requires a holistic, qualitative analysis rather than a mechanical application of asset or income tests. By elevating the role of investor perception as the core of the inquiry, the court provides a clearer path for operating companies that accumulate large cash or securities holdings for legitimate business purposes (like future acquisitions) to avoid being reclassified as investment companies. The ruling limits the SEC's ability to rely solely on the 40% asset threshold and forces the agency to consider the total business context, thereby protecting companies that remain fundamentally operational despite their balance sheets.
