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Can Our Club Have Silent Partners?

Q. I am a member of an investment club that is a member of NAIC. We have formed our bylaws and philosophy based on their samples. One question has recently been poised to our club: Can a member join as a silent partner, and pay a monthly contribution without being involved in the monthly functions? Since we were initially formed for the education and personal growth of our members, we did not include this in our bylaws. Are their any resources that address this issue of silent members?

A. There are two reasons why you should generally avoid having silent partners in your club.

The first is a bit legalistic. As long as an investment club operates within a specific set of guidelines, it doesn't have to register as a security with the U.S. Securities and Exchange Commission.

As you may know, publicly-traded stocks and mutual funds must be registered before they can be offered for sale to the public, as must the people and organizations who are engaged in selling those securities. The SEC looks at a couple of criteria to determine if a security must be registered, such as how many investors are involved, if the security is advertised for sale to the general public, and if there are silent partners in the entity. This last point is important in this case. It's possible that the SEC could look at a partnership that allows silent partners and determine that it falls into the category requiring SEC registration -- and that could be costly.

The second reason is practical. Investment clubs are built around the idea that each member plays a part in managing the club, from researching potential investments to managing the club's portfolio. Club members learn about investing because they are actively investing in a real portfolio. Silent partners don't get the benefit of this education; in fact, they benefit solely from the work done by active members. I would even go as far as to call silent partners freeloaders! After all, if all the club members were silent partners, the club would never get anything accomplished.

I think it's best to require all club members to be active, both for your sake and for theirs.

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