[Federal Register Volume 88, Number 54 (Tuesday, March 21, 2023)]
[Notices]
[Pages 17043-17045]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-05683]


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SECURITIES AND EXCHANGE COMMISSION

[Investment Company Act Release No. 34856; File No. 812-15441]


Cloudflare, Inc.

AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice.

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    Notice of application for an order under section 3(b)(2) of the 
Investment Company Act of 1940 (``Act'').

APPLICANT:  Cloudflare, Inc.

SUMMARY OF APPLICATION:  Applicant seeks an order under section 3(b)(2) 
of the Act declaring it to be primarily engaged in a business other 
than that of investing, reinvesting, owning, holding or trading in 
securities. Applicant states that it is in the business of providing 
secure network cloud services.

DATES:  Filing Dates: The application was filed on March 3, 2023.

HEARING OR NOTIFICATION OF HEARING:  An order granting the requested 
relief will be issued unless the Commission orders a hearing. 
Interested persons may request a hearing by emailing the Commission's 
Secretary at [email protected] and serving applicants with a 
copy of the request, by email if an email address is listed for the 
relevant Applicant below, or personally or by mail, if a physical 
address is listed for the relevant Applicant below. Hearing requests 
should be received by the Commission by 5:30 p.m. on April 10, 2023, 
and should be accompanied by proof of service on the applicants, in the 
form of an affidavit, or for lawyers, a certificate of service. 
Pursuant to rule 0-5 under the Act, hearing requests should state the 
nature of the writer's interest, any facts bearing upon the 
desirability of a hearing on the matter, the reason for the request, 
and the issues contested. Persons who wish to be notified of a hearing 
may request notification by emailing the Commission's Secretary at 
[email protected].

ADDRESSES: The Commission: [email protected]. Applicant: Thomas 
Seifert, Chief Financial Officer, Cloudflare, Inc., at [email protected]; Amy Caiazza, at [email protected].

FOR FURTHER INFORMATION CONTACT: Jennifer O. Palmer, Senior Counsel, or 
Terri G. Jordan, Branch Chief, at (202) 551-6825 (Division of 
Investment Management, Chief Counsel's Office).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. For Applicant's

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representations, legal analysis, and conditions, please refer to 
Applicant's application, dated March 3, 2023, which may be obtained via 
the Commission's website by searching for the file number at the top of 
this document, or for an Applicant using the Company name search field, 
on the SEC's EDGAR system. The SEC's EDGAR system may be searched at 
https://www.sec.gov/edgar/searchedgar/legacy/companysearch.html. You 
may also call the SEC's Public Reference Room at (202) 551-8090.

Applicant's Representations

    1. Applicant states that it is a Delaware corporation formed in 
2009 that, directly and through its wholly-owned subsidiaries,\1\ is 
engaged in the business of providing secure network cloud services.
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    \1\ Applicant states that 13 of its 24 wholly-owned subsidiaries 
conduct businesses that are integrally related to the Applicant's 
business, such as sales and marketing or research and development 
(``R&D'') activities in their respective jurisdictions. Applicant 
states that its remaining 11 subsidiaries are non-operating holding 
companies or non-operating companies with de minimis assets. 
Applicant further states that none of its subsidiaries meet the 
definition of an ``investment company'' in section 3(a) of the Act.
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    2. Applicant states that its business is highly capital intensive, 
requires R&D of new technologies, and does not involve the Applicant 
acquiring or retaining significant ``hard'' operating assets. Applicant 
states that it maintains significant cash reserves that it seeks to 
invest for purposes of conserving capital and providing liquidity until 
the funds are used in its cloud-based services and technology business. 
As described more fully in the application, Applicant states that it 
requires significant liquid capital primarily to: (i) fund R&D for new 
products and services, (ii) otherwise fund its operations, and (iii) 
make other capital expenditures in keeping with the growth of the 
Applicant's cloud-based services and technology business.
    3. Applicant states that it has financed operations primarily 
through offerings of debt and equity securities, but ultimately seeks 
to generate cash from its operations to support its business. Applicant 
states that it seeks to preserve capital and maintain liquidity, 
pending the use of such capital for its operations, by investing in 
``Capital Preservation Instruments.'' \2\ Applicant states that it may 
in the future make strategic investments in ``other investments'' 
consistent with Rule 3a-8. Applicant states that such securities will 
not be acquired for speculative purposes.
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    \2\ As used in Applicant's application, Capital Preservation 
Instruments refers collectively to any cash items and securities 
that are held for the purpose of conserving Applicant's capital and 
liquidity until they are used by Applicant to support its business 
(as such business is described in Applicant's application). Such 
holdings are liquid (i.e., can be readily sold), earn competitive 
market returns and present a low level of credit risk, including 
short-term investment grade securities, Government securities (as 
defined in section 2(a)(16) of the Act), securities of money market 
funds registered under the Act, and other cash items; but excluding 
investments in equity or speculative instruments.
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Applicant's Legal Analysis

    1. Applicant seeks an order under section 3(b)(2) of the Act 
declaring that it is primarily engaged in a business other than that of 
investing, reinvesting, owning, holding or trading in securities and 
therefore is not an investment company as defined in the Act.
    2. Section 3(a)(l)(A) of the Act defines the term ``investment 
company'' to include an issuer that is or holds itself out as being 
engaged primarily, or proposes to engage primarily, in the business of 
investing, reinvesting or trading in securities. Section 3(a)(l)(C) of 
the Act further defines an investment company as an issuer that is 
engaged or proposes to engage in the business of investing, 
reinvesting, owning, holding or trading in securities, and owns or 
proposes to acquire investment securities having a value in excess of 
40% of the value of the issuer's total assets (exclusive of Government 
securities and cash items) on an unconsolidated basis. Section 3(a)(2) 
of the Act defines ``investment securities'' to include all securities 
except Government securities, securities issued by employees' 
securities companies, and securities issued by majority-owned 
subsidiaries of the owner which (a) are not investment companies and 
(b) are not relying on the exclusions from the definition of investment 
company in section 3(c)(1) or section 3(c)(7) of the Act. Applicant 
states that it has never been, is not now, and does not propose to be, 
primarily engaged in the business of investing, reinvesting, owning, 
holding, or trading in securities. Applicant states, however, that it 
historically held and currently holds investment securities that exceed 
40% of its total assets on an unconsolidated basis (exclusive of 
Government securities and cash items). Applicant states that it 
therefore may be an ``investment company'' pursuant to section 
3(a)(l)(C) of the Act absent an exclusion or exemption.
    3. Rule 3a-8 under the Act provides an exclusion from the 
definition of investment company if, among other factors, a company's 
R&D expenses are a substantial percentage of its total expenses for the 
last four fiscal quarters combined. While Applicant states that it 
believes that it complies with the conditions of Rule 3a-8, Applicant 
states that it is concerned that its R&D expenses, while substantial in 
absolute terms, may not always be considered substantial as a ratio of 
overall expenses. Although Applicant states that it anticipates R&D 
expenses to increase in absolute terms, such expenses are not 
anticipated to increase proportionately with Applicant's overall 
expenses, particularly given increases in expenses related to sales and 
marketing, the administration of a rapidly expanding employee base, and 
other administrative expenses. Applicant states that its R&D expenses 
have fluctuated between 18.34% and 25.04% of total expenses over the 
past six years, and Applicant expects R&D expenses to decrease relative 
to total expenses over time.
    4. Section 3(b)(2) of the Act provides that, notwithstanding 
section 3(a)(l)(C) of the Act, the Commission may issue an order 
declaring an issuer to be primarily engaged in a business other than 
that of investing, reinvesting, owning, holding, or trading in 
securities directly, through majority-owned subsidiaries, or controlled 
companies conducting similar types of businesses. Applicant requests an 
order under section 3(b)(2) of the Act declaring that it is primarily 
engaged in a business other than that of investing, reinvesting, 
owning, holding or trading in securities, and therefore is not an 
investment company as defined in the Act.
    5. In determining whether an issuer is ``primarily engaged'' in a 
non-investment company business under section 3(b)(2) of the Act, the 
Commission considers the following factors: (a) the company's 
historical development, (b) its public representations of policy, (c) 
the activities of its officers and directors, (d) the nature of its 
present assets, and (e) the sources of its present income.\3\
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    \3\ Tonopah Mining Company of Nevada, 26 SEC 426, 427 (1947).
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    6. Applicant submits that it satisfies the criteria for issuance of 
an order under section 3(b)(2) of the Act because Applicant is 
primarily engaged in the business of providing secure network cloud 
services and is not in the business of investing, reinvesting, owning, 
holding or trading in securities.
    a. Historical Development. Applicant states that, since its 
inception in 2009, Applicant has operated in the cloud software sector 
to develop comprehensive, scalable network cloud services for business 
use. Applicant's business has focused on the development of new such 
products, and

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Applicant has received global recognition as an innovative technology 
company.
    b. Public Representations of Policy. Applicant states that it has 
consistently represented that it is engaged in the business of 
providing secure network cloud services. Applicant further states that 
it has never held and does not now hold itself out as an investment 
company within the meaning of the Act or as engaging in the business of 
investing, reinvesting, owning, holding, or trading in securities. 
Applicant explains that in its annual reports, stockholder letters, 
prospectuses, Commission filings, press releases, marketing materials, 
and on its investor website, its public representations consistently 
state its mission to help build a better internet by providing 
solutions to managing individual network hardware for companies of all 
sizes and growth. Applicant submits that its public representations 
make clear that shareholders invest in the Applicant's securities with 
the expectation of realizing gains from Applicant's development and 
sale of its suite of cloud services and not from returns on an 
investment portfolio. Applicant states that its only public 
representations regarding its investment securities are those required 
to be disclosed in public filings with the Commission.
    c. Activities of Officers and Directors. Applicant represents that 
its officers and directors spend substantially all of their time 
managing the Applicant's cloud-based services and technology business. 
Applicant states that its cash management activities are managed 
internally by its Chief Financial Officer and externally by three 
investment managers, whose activities are supervised by the Chief 
Financial Officer. In addition, of the Applicant's approximately 3,181 
employees (as of September 30, 2022), Applicant states that only five 
employees spend time on matters relating to the management of 
Applicant's Capital Preservation Instruments. Applicant states that 
none of its officers, directors or employees spends or proposes to 
devote more than 1% of his or her time, if even that, to management of 
Capital Preservation Instruments on behalf of the Applicant.
    d. Nature of Assets. Applicant states that, as of September 30, 
2022, Applicant's investment securities constituted approximately 65.4% 
of its total assets (excluding Government securities and cash items) on 
an unconsolidated basis.\4\ Furthermore, Applicant states that as of 
September 30, 2022, 100% of its investment securities consist of 
Capital Preservation Instruments. Applicant uses its Capital 
Preservation Instruments to finance its continued operations. Applicant 
states that it may in the future make strategic investments in ``other 
investments'' consistent with Rule 3a-8. Applicant states, however, 
that no more than 10% of its total assets (exclusive of Government 
securities and cash items, including securities of money market funds 
registered under the Act) will consist of investment securities other 
than Capital Preservation Instruments.\5\ Applicant uses current 
assets, including its Capital Preservation Instruments, to finance its 
continued R&D program and operations in connection with the development 
of the Applicant's software.
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    \4\ Applicant states that none of its subsidiaries hold any 
investment securities.
    \5\ Applicant states that it intends to calculate this 
percentage by consolidating its financial statement with the 
financial statements of its wholly-owned subsidiaries (but not with 
any majority-owned subsidiary that may be acquired in the future).
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    e. Sources of Income and Revenue. Applicant represents that since 
its inception it has carried net operating losses. Applicant states 
that it does, however, derive income from its investment securities. 
Applicant states that a review of its current source of revenues 
provides a more accurate review of its operating company status, 
particularly given the upward trend in recognizing substantially 
increased revenues due to sales of new subscriptions. Applicant states 
that it recognizes substantially all of its revenues from fees based on 
subscriptions and support. Applicant states that its revenues for the 
years ended December 31, 2019, 2020 and 2021 were $287 million, $431.1 
million, and $656.4 million, respectively, on an unconsolidated basis. 
By contrast, Applicant states that its net investment income in 2019, 
2020, and 2021 was $5.8 million, $6.6 million, and $2.0 million in, 
respectively. Applicant states that all such income was derived from 
Capital Preservation Instruments.\6\ Applicant states that if net 
investment income were compared to its revenue, it would be less than 
1.0% of revenue for the fiscal year ended December 31, 2021, and to 
less than 1.5% of revenue for the fiscal year ended December 31, 2020.
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    \6\ Applicant states that it has not, and does not expect to, 
earn investment income from strategic investments.
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    For the fiscal nine months ended September 30, 2022, Applicant 
earned $6.6 million of net investment income, an increase compared to 
$2.0 million for the fiscal year ended December 31, 2021. This 
nonetheless represents less than 1% of revenue for the fiscal nine 
months ended September 30, 2022. The increase in net investment income 
is due to the increase in interest rates in the fixed income markets.
    7. Applicant asserts that its historical development, its public 
representations of policy, the activities of its officers and 
directors, the nature of its assets and its sources of revenue and 
income, as discussed in the application, demonstrate that it is engaged 
primarily in a business other than that of investing, reinvesting, 
owning, holding or trading securities. Applicant thus asserts that it 
satisfies the criteria for issuing an order under section 3(b)(2) of 
the Act.

Applicant's Conditions

    Applicant agrees that any order granted pursuant to the application 
will be subject to the following conditions:
    1. Applicant will continue to use its accumulated cash and 
securities to support its primary business (as such business is 
described in Applicant's application);
    2. Applicant will refrain from investing or trading in securities 
for speculative purposes; and
    3. No more than 10% of Applicant's total assets will consist of 
investment securities other than Capital Preservation Instruments (as 
such capitalized term is defined in Applicant's application). For 
purposes of this condition, total assets excludes cash items (including 
securities issued by money market funds registered under the Act) and 
Government securities (as defined in section 2(a)(16) of the Act). This 
percentage is to be determined on an unconsolidated basis, except that 
Applicant should consolidate its financial statements with the 
financial statements of any wholly-owned subsidiaries.

    For the Commission, by the Division of Investment Management, 
under delegated authority.

    Dated: March 15, 2023.
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-05683 Filed 3-20-23; 8:45 am]
BILLING CODE 8011-01-P