Investment Company Act of 1940

Investment Company Act of 1940
The SEC summarizes this federal securities law like so:
This Act regulates the organization of companies, including mutual funds, that engage primarily in invest¬ing, 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. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis.
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.
So, mutual funds must register their securities and provide a prospectus to all investors under the Securities Act of 1933. The Investment Company Act of 1940 requires the investment company itself to register and then lays out an exhaustive array of dos and don'ts for their operations. The Investment Company Act of 1940 classified investment companies as face amount certificate companies, unit investment trusts, or management companies. As we saw in an earlier chapter, the management companies are either open-end or closed-end funds. The distinguishing factor is that the open-end funds are redeemable, while the closed-end shares trade on the secondary market among investors. The unit investment trust has no investment adviser managing the portfolio and is sometimes linked with "having no board of directors." Note that the separate account for a variable annuity is registered under this Act, too, either as an open-end fund or as a UIT.
To fit the definition of "investment company," the shares must be easily sold and the number of shareholders must exceed 100. Hedge funds go the other way to avoid fitting the definition of "investment company." That is, they don't let people sell their investment freely and they keep the number of investors under 100, because if you can escape the definition of "investment company," you can escape the hassle of registering the investments and providing lots of disclosure to the SEC and the public markets. As usual, under the Act of 1940 the average investor is protected more than the sophisticated investor. Mutual funds and variable annuities are for the average investor; therefore, they need to be registered and watched closely by the SEC. Hedge funds are for the sophisticated investor primarily, so maybe things don't need to be watched so closely with them.


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