BI > APRIL 2006

When Inactive Members Are on Your Roster

It's Better When Everyone's Involved

Q. We have a member who wants to go on inactive status indefinitely but leave his contributions invested. Can you point me to the rules stating that investment clubs cannot have inactive members whose investments are left as part of the club's overall investment?

A. The Securities and Exchange Commission (SEC) is the main regulator of the U.S. securities markets. Two key federal securities laws that may apply to your investment club are the Securities Act of 1933 and the Investment Company Act of 1940. The former regulates the offer and sale of membership interests. The latter allows for some investment clubs to be classified as investment companies and thus be regulated.

State securities laws sometimes differ from those at the federal level. To learn about the laws of your state, contact your state securities regulator. Contact information can be found at the North American Securities Administrators Association website.

On the SEC webpage for investment clubs, the commission has this to say about inactive members: "If every member in an investment club actively participates in deciding what investments to make, the membership interests in the club would probably not be considered securities. If the club has any passive members, it may be issuing securities. Sometimes offers and sales of securities do not have to be registered because they are exempt under the law. For example, a nonpublic offering is exempt."

Concerning public offerings, the SEC says: "An announcement that a club is looking for new members might be considered a public offering, but this is determined on a case-by-case basis. An attorney with experience in securities law can help the club determine if its membership interests are securities, and if the club is making a public offering of those securities."

So the law is open to interpretation. I suggest you take the conservative road and not allow inactive members. It simply isn't worth the risk that the SEC or state regulators won't agree with your interpretation of the laws.

Geraldine Walsh of the SEC's investor education office had this to say about the principles outlined on the site: "The guidance on our website evolved from a number of responses to 'no-action' requests that the agency has provided to individual clubs over the past several decades." In other words, the guidelines were created because some investment clubs were found to have violated federal regulations. For club members who want to discuss the Investment Company Act of 1940 registration issues with a member of the SEC staff, Walsh suggests contacting the Division of Investment Management's Office of Chief Counsel at 202/551-6825 or IMOCC@sec.gov.

Having only active members in your club provides other benefits besides avoiding possible legal hassles. If all members are active participants, the responsibilities for education and investment decisions are shared by all. This can help to avoid burnout of the active members and their resentment of inactive members. Team spirit is improved, which frequently leads to better club investment decisions and stronger education offerings.

When a club makes sound investment decisions and has a strong education program, membership recruitment is easier and membership retention is improved. In other words, the ultimate outcome of purging inactive members is often a longer life for the club. (Editor's note: Keep in mind, however, that some members might have good reasons for becoming inactive, such as leaving the country on a volunteer mission. This issue would be a wonderful topic for a club meeting.)

Some clubs find it difficult to recruit new members and might risk having inactive members so long as they continued making monetary contributions. But to help the recruitment process, BetterInvesting has launched a pilot program that matches members to clubs. The following BetterInvesting chapters are participating in the test phase: New Jersey, Sacramento, Puget Sound, San Diego, Minneapolis, Southeastern Michigan, Space Coast, Atlanta, Maine, D.C. Regional and Yankee.

Clubs that are members of any of these chapters and that meet certain criteria can be placed on a list of clubs looking for members. This list will be made available to individuals looking for a club to join. Members can contact participating chapters for more information.

Ask Colleen your club question by writing to colleen@ColleenMulder-Seward.com. Colleen holds an M.B.A. from Wayne State University. Since 2000 she has served on the board of directors for BetterInvesting's Southeastern Michigan Chapter. Colleen also writes the Retirement Intelligence Information Services newsletter for retirementcalc.com.