Operating company or investment company: what would a reasonable investor think?

Purpose This paper aims to discuss a recently‐decided Seventh Circuit case in which the Securities and Exchange Commission (SEC) alleged that National Presto Industries, Inc., a seller of household goods and munitions, was unlawfully operating as an investment company. The paper also aims to explain concisely the definition of investment company under the Investment Company Act of 1940 (the 1940 Act). Design/methodology/approach Using the Seventh Circuit's decision as an introduction, this paper summarizes the definition of investment company under the 1940 Act, highlights a statutory exclusion from the definition and a related SEC interpretation, reviews the judicial opinion and offers commentary on the court's decision. Findings The study finds that a typical investment company, such as a mutual fund, is nothing more than a pool of securities and cash. Most operating companies, such as manufacturers or service providers, look nothing like an investment company. Their assets consist of buildings, plants, inventory, computers and more. Yet, it is possible for an operating company to become an investment company. The definition under the 1940 Act provides a rather mechanical test for making this determination. The Seventh Circuit's decision concerned an operating company that the SEC believed satisfied the definition. In disagreeing with the SEC, the court seemed to focus on how a reasonable investor would perceive the company's business. Originality/value This paper provides a useful summary of how an operating company inadvertently could become an investment company. It should be valuable to officers and employees, particularly those who are engaged in cash management activities, of both public and private operating companies because it raises awareness of the ease with which an operating company can become an investment company and the availability of options to avoid such an outcome.