What is the Investment Company Act of 1940?

The Investment Company Act of 1940 was created through an act of Congress to regulate the organization of investment companies and the activities they engage in. This act also set standards for the industry. This piece of legislation clearly defines the responsibilities and requirements of investment companies and the requirements for publicly traded investment product offerings, including open-end mutual funds, closed-end mutual funds, and unit investment trusts. It primarily targets publicly traded retail investment products.

Understanding the Investment Company Act of 1940

The Investment Company Act of 1940 followed market sentiment invoking interest and the passing of the Securities Act of 1933. Provisions of the Investment Company Act of 1940 were created to establish and integrate a more stable financial market regulatory framework following the stock market crash of 1929. The Securities Act of 1933 focused on greater transparency for investors. The Investment Company Act of 1940 is focused primarily on the regulatory framework for retail investment products.

As a function of its title, the Investment Company Act of 1940 lays out the regulations US investment companies must abide by when offering and maintaining pooled investment funds. The legislation is enforced and regulated by the Securities and Exchange Commission (SEC). It defines an “investment company” and sets forth obligations and regulations that an investment company must abide by in the investment product securities that it offers. It builds on the Securities Act of 1933 which requires registration of securities. The Investment Company Act of 1940 details the required obligations of an investment company’s product offerings. It includes provisions regarding filings, service charges, financial disclosures, and the fiduciary duties of investment companies. Companies seeking to avoid the product obligations and requirements of the Act may be eligible for an exemption. For example, hedge funds sometimes fall under the Act's definition of "investment company" but may be able to avoid the Act's requirements by requesting an exemption under sections 3(c)(1) or 3(c)7.

Key Takeaways

  • The Investment Company Act of 1940 was enacted by Congress to regulate the formation of investment companies and their activities.
  • The Securities Exchange Commission (SEC) is authorized to regulate investment companies and oversee investment company registration.
  • The Act has introduced industry standards, such as regular public disclosure of their investment policies.

Investment Companies

In accordance with the Investment Company Act of 1940, investment companies must register with the SEC to offer their securities in the public market. The Investment Company Act of 1940 lays out the steps a company should take in the investment company registration process. Investment companies must file and complete the registration process with the SEC.

The SEC does not have the authority to directly oversee or judge investment companies' investment decisions.

Types of Investment Companies

Any company considered an “investment company” by the provisions of the Investment Company Act of 1940 must register with the Securities and Exchange Commission. Companies register for different classifications based on the type of product or the range of products that they wish to manage and issue to the investing public. In the US, federal securities laws categorize investment companies into three different types: mutual funds/open-end management investment companies, unit investment trusts (UITs), and closed-end funds/closed-end management investment companies.

A Management Investment Company, the most common type of investment company registered with the SEC, manages publicly issued fund shares. Management Investment Companies can be diversified, and diversified Management Investment Companies can take many forms. Management Investment Companies can handle closed-end funds, open-end funds, or both. They may also offer a range of market products.

1940 Act Provisions

The Investment Company Act of 1940 is the primary legislation governing investment companies and their investment product offerings. It has been impacted by the Dodd-Frank Act of 2010 with numerous revisions. The 1940 Act sets forth requirements for investment companies by classification and product offering.

Its provisions include regulations for transactions of certain affiliated persons and underwriters; accounting methodologies; recordkeeping requirements; auditing requirements; how securities may be distributed, redeemed, and repurchased; changes to investment policies; and actions in the event of fraud or breach of fiduciary duty. Further, it sets forth specific guidelines for different types of classified investment companies and includes provisions governing the rules of companies' operating products, including unit investment trusts, open-end mutual funds, closed-end mutual funds, and more.

Other pertinent requirements of the Investment Company Act of 1940 include:

  • A board of directors, 75% of whom must be independent.
  • Limitations on investment strategies, such as the use of leverage.
  • Maintenance of a certain percentage of assets in cash for investors who might wish to sell.
  • Disclosure of investment company structure, financial condition, investment policies, and objectives to investors.