The Investment Company Act of 1940 is the legislation that was passed by Congress to protect the investing public's interests in investment companies. The act dictates the rules of investment company registration and regulation.

An investment company is a corporation or a trust through which individuals invest in diversified, professionally managed portfolios of securities by pooling their funds with those of other investors. Rather than purchasing combinations of individual stocks and bonds for a portfolio, an investor can purchase securities indirectly through a package product like a mutual fund.

According to the Investment Company Institute, there were 8,107 mutual funds (excluding funds of funds, or mutual funds made up of other mutual funds), 254 closed-end funds, 226 exchange-traded funds and 37 unit investment trusts by the end of 2004. About 91.2 million people owned mutual funds in 2004, with nearly $8.6 trillion invested in these investment vehicles alone. With so many different products to choose from, it is easy to see why the NASD requires that you master the fundamentals of investment company function, management, regulation and operation.

There are three fundamental types of investment companies: unit investment trusts (UITs), face amount certificate companies and managed investment companies. Later in the section, we discuss each investment company type in more detail. Remember that all three types have the following things in common:

  • An undivided interest in the fund proportional to the number of shares held
  • Diversification in a large number of securities
  • Professional management
  • Specific investment objectives

Definitions
Section 2 of the Investment Company Act of 1940 defines a number of the terms used throughout the act. The following definitions are likely to be tested on the exam:

  • Affiliated person - Thisrefers to any officer, director, partner or employee of the investment company. It also includes an investment advisor or member of the investment company's advisory board, as well as any person who owns at least 5% of the voting stock

  • Interested person - Thisrefers to any affiliated person as well as immediate family members of an affiliated person. It also includes any broker-dealer, principal underwriter or anyone who has served as legal counsel for the investment company within the last two years. Finally, another investment company that shares the same principal underwriter is considered to be an interested person.


Look Out!
Note that "affiliated person" and "interested person" have similar, but not identical, definitions. An interested person includes, but is not limited, to an affiliated person.


  • Redeemable securities - Investment company shares (including mutual funds) are issued as redeemable securities. This means that they are not bought and sold in any type of open market and they may be redeemed only by the issuer. Note that closed-end mutual funds are not redeemable securities because they trade like a stock on an exchange.

  • Principal underwriter - Thisrefers to the sponsor or distributor of the mutual fund.This underwriter has an exclusive agreement with the mutual fund to purchase shares at the net asset value (NAV) and resell either to dealers, the public, or both.


Registration of Investment Companies

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