SEC Form N-18f-1

What Is SEC Form N-18f-1?

SEC Form N-18f-1 is a notification form that must be filed with the Securities and Exchange Commission (SEC) if a fund company wishes to take advantage of benefits awarded under SEC Rule 18f-1. Rule 18f-1 allows investment funds to limit their redemptions in kind, which is an exemption from Rule 18f of the Investment Company Act of 1940. Redemption in kind refers to honoring redemptions with assets other than cash.

A registered, open-ended investment fund that has the right to redeem securities in kind of which it is the issuer is eligible to file SEC Form N-18f-1, stating that it will pay redemptions in cash to shareholders pursuant to SEC Rule 18f-1.

Key Takeaways

  • Registered, open-ended investment funds are allowed to make redemptions in kind.
  • Redemptions in kind refer to redeeming shareholders with assets other than cash.
  • SEC Rule 18f does now allow treating one class of owner different than another class of owner; meaning that some shareholders will receive cash while others will only receive redemptions in kind.
  • SEC Rule 18f-1 allows an exemption to Rule 18f, allowing funds to redeem shareholders in cash based on certain requirements.
  • SEC Form N-18f-1 is a notification form filed with the SEC notifying it that the fund will redeem in cash based on the requirements laid out in Rule 18f-1.

Understanding SEC Form N-18f-1

Registered, open-ended investment funds have a different redemption process than closed-ended investment funds when shareholders decide to redeem their shares. For open-ended funds, shares are sold back to the fund directly. The fund must comply with this redemption by buying back the shares and paying the shareholder the cash value of the shares within seven days.

When an investment fund would rather not pay redeeming investors in cash, they may have the option to pay them in kind; meaning in any asset other than cash. SEC Rule 18f-1 allows funds to redeem in kind only for shareholders that hold the lower of $250,000 of the fund's value or 1% of its assets; the rest has to be paid in cash. SEC Form N-18f-1 is the notification of a fund utilizing Rule 18f-1.

Form 18f-1 is a workaround to SEC Rule 18f of the Investment Company Act of 1940. Rule 18f prevents funds from treating one class of owner differently than another class of owner, in this case, small shareholders versus large shareholders.

Redemptions in Kind

There may be certain times where a fund would rather not pay out cash in seven days; primarily because of liquidity concerns. This could be during periods of market turmoil where the fund is experiencing significant cash outflows versus cash inflows (more redemptions that new investors coming in with additional investment capital). It might also want to avoid redeeming shares at distressed prices, paying out cash at a loss, which would impact remaining investors.

In an ideal scenario, an investment fund would be receiving more money from new investors than having to pay out departing investors; it can use the new money to pay the investors that are leaving instead of having to sell assets to generate cash to pay those investors, which could negatively impact the fund's performance.

In these scenarios, an open-ended fund can pay the redeeming investors in kind, that is, in assets other than cash. This is usually done on a pro-rata basis, most often as payments in the form of the shares of the underlying companies in the fund.

For example, if an investment fund tracked the Dow Jones Industrial Average (DJIA), it could redeem in kind to an investor by giving them shares in some of the companies that make up the DJIA, such as Visa, Intel, or Nike. The investor would then take these shares and put them in their own brokerage account and handle them as they wish; either holding on to them or selling them.

Rule 18f-1 ensures that certain shareholders receive cash while allowing other, larger investors to receive redemptions in kind.

Disadvantages of Redemptions in Kind

Most funds will state in their prospectus that they have the right to meet redemptions with assets other than cash, so redemptions in kind do not come as a surprise to the investor. Furthermore, redemptions in kind are usually made with institutional investors rather than retail investors, as institutional investors may not need the cash and find a payment in shares of companies to be acceptable. Retail investors are smaller and don't have the same large-sized wallet that institutional investors do.

One of the main disadvantages to receiving redemptions in kind is the tax burden. If an investment fund has held onto certain stocks for years, even decades, and those have appreciated in value, and they pass the stocks onto a redeeming investor, they avoid the capital gains tax burden on those shares, whereas the redeeming investor would be stuck having to pay the capital gains tax if they decided to sell their shares.

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  1. Securities and Exchange Commission (SEC). "Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of Comment Period for Investment Company Reporting Modernization Release," Pages 9-10. Accessed Jan. 29, 2021.

  2. Cornell Law School. "17 CFR § 270.18f-1 - Exemption from certain requirements of section 18(f)(1) (of the Act) for registered open-end investment companies which have the right to redeem in kind." Accessed Jan. 29, 2021.