Investment Company Act Of 1940

Posted in Markets Compliance on January 1, 2024
Investment Company Act Of 1940

The Investment Company Act of 1940 regulates mutual funds, and other companies, that are engaged primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The regulation is designed to minimize conflicts of interest that arise in these complex operations. 

Investment Company Act Of 1940

The Investment Company Act Of 1940

The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, regularly. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations. It is important to remember that the Act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments.

The Investment Company Act applies to all investment companies, but its exempts some investment companies. The most common exemptions are found in Sections 3(c)(1), and 3(c)(7) of the act, which include hedge funds. The Investment Company Act 1940 limits the ability of the registered investment company, to borrow money or issue securities. Loans made in violation of the requirements of the Act are unenforceable. For this reason, bank loan agreements contain a representation that the borrower is not an investment company within the meaning of the Investment Company Act 1940. 

The underwriting agreement for an offering registered with the SEC, and the purchase agreement for a private placement also typically include a representation that the issuer is not, and will not be required to register as an investment company under the Investment Company Act 1940. 

Investment Companies

These investment companies are also required to have a Board of Directors, with 75% of the Board members being independent directors. Additionally, the Act requires mutual funds to limit the use of leverage, and maintain a certain amount of cash that will cover investors who want to sell their shares at any time. With the advent of the Dodd-Frank Act of 2010, the Investment Company Act of 1940 received various updates including new regulations around mutual and hedge funds.

That said, several hedge funds can exempt themselves from the Investment Company Act based on Sections 3(c)(1) and 3(c)(7). The SEC does not supervise or make specific judgments on the investments an investment company chooses to make. Further, certain commodity pools, as well as managed future funds, do not fall under the Act’s jurisdiction.

Understanding The Investment Company Act Of 1940

Following the 1929 Stock Market Crash, the Investment Company Act of 1940 was enacted in order to establish and integrate a more stable financial market regulatory framework. It is the primary piece of legislation that governs investment firms and their investment product offerings. In response to the crash, the Securities Act of 1933 was also passed, but it focused on greater transparency for investors; the Investment Company Act of 1940 focuses primarily on the regulatory framework for retail investment products.

The Act lays out the rules and regulations that US investment firms must follow when offering and maintaining investment product securities. The Act’s provisions address filing requirements, service charges, financial disclosures, and investment companies’ fiduciary duties.

The Act also includes regulations for certain affiliated persons and underwriters’ transactions, accounting methodologies, record-keeping requirements, auditing requirements, how securities can be distributed, redeemed, and repurchased, changes to investment policies, and actions in the event of fraud or breach of fiduciary duty.

Furthermore, it establishes specific guidelines for various types of classified investment companies, as well as provisions governing the rules of the companies’ operating products, such as unit investment trusts, open-end mutual funds, closed-end mutual funds, and others.

The Investment Company Act of 1940 is a congressional act that governs the formation and operations of investment companies. The Securities and Exchange Commission enforces and regulates the legislation in the Investment Company Act of 1940. (SEC). Companies that want to avoid the Act’s product obligations and requirements may be eligible for an exemption. FDR signed the Act into law in order to protect investors following the 1929 stock market crash and the subsequent Great Depression. The Act has undergone numerous revisions over the years as financial markets have evolved and become more complex.

Final Thoughts

The Investment Company Act of 1940 is a congressional act that governs the organization of investment companies and the activities they undertake, as well as setting standards for the investment company industry. The Act, along with the Investment Advisers Act of 1940, was signed into law by President Franklin D. Roosevelt, and both gave the Securities and Exchange Commission (SEC) the authority to regulate investment trusts and investment counselors. The acts were enacted to protect investors.