Quick Answer
The Investment Company Act of 1940 defines three types: management companies (the catch-all category, actively OR passively managed, open-end or closed-end), unit investment trusts (relatively fixed, unmanaged, no board or adviser), and face-amount certificate companies (nearly extinct). Private funds can avoid investment-company status by staying at no more than 100 beneficial owners or by limiting sales to qualified purchasers, provided they also don't make a public offering; antifraud rules still apply.
With your understanding of securities registration and exemptions in place, you can now look at how the Investment Company Act of 1940 classifies the companies that pool and manage investor capital.
Three Types of Investment Companies
The Investment Company Act of 1940 (ICA) defines three categories of investment companies:
| Type | Structure | Management | Key Feature |
|---|---|---|---|
| Management company | Has a board of directors | Actively OR passively managed portfolio | Most common type (the "catch-all" category); includes mutual funds, closed-end funds, and index funds |
| Unit investment trust (UIT) | Trust structure | Fixed, unmanaged portfolio | Has a termination date; no board of directors |
| Face-amount certificate company | Issues debt certificates | N/A | Pays face value at maturity; extremely rare today |
Management Companies
A management company is any investment company other than a unit investment trust or a face-amount certificate company; it's the residual, catch-all category, and can be actively OR passively managed (an index mutual fund is a management company too). Management companies are divided into two sub-types:
- Open-end (mutual funds): Continuously issue and redeem shares at net asset value (NAV); no limit on shares outstanding
- Closed-end (closed-end funds): Typically issue shares through an IPO and trade on exchanges like stocks; the share count is not fixed forever, since the fund can conduct follow-on or rights offerings
Key characteristics:
- Have a board of directors with oversight responsibilities
- Typically employ an outside investment adviser to manage the portfolio, though some (internally managed funds) manage the portfolio in-house
- Must register with the SEC under the Investment Company Act
Unit Investment Trusts (UITs)
- Organized under a trust indenture or similar instrument
- Hold a relatively fixed portfolio of securities, with no active/discretionary management (the trust instrument may permit limited dispositions or substitutions in specified circumstances)
- Do NOT have a board of directors or corporate officers
- Do NOT have an investment adviser
- Issue only redeemable securities (units)
- Have a specific termination date when the trust dissolves and returns principal
Face-Amount Certificate Companies
- Issue debt certificates (typically funded through installment or lump-sum payments) obligating the issuer to pay a stated or determinable amount at a later date
- Similar in concept to a zero-coupon bond
- Virtually nonexistent in today's market
- Still part of the legal definition and testable on the exam
Memory Aid: "MUF": Management companies, Unit investment trusts, Face-amount certificate companies (the three types under the Investment Company Act of 1940 (ICA))
Exam Tip: Gotchas
- UITs do NOT have a board of directors, investment adviser, or active management. They hold a fixed portfolio.
- Open-end funds (mutual funds) = unlimited shares, redeemed at NAV. Closed-end funds = a share count that doesn't grow from ongoing sales like a mutual fund's (though it can still change via a follow-on or rights offering), trading on exchanges at market price.
- A management company can be actively OR passively managed; it's defined by what it ISN'T (not a UIT, not a face-amount certificate company), not by active management alone.
- Face-amount certificate companies are virtually extinct but still testable.
Exemptions from the Investment Company Act
Two important private-fund exemptions prevent certain pooled vehicles from being classified as investment companies:
| Exemption | Eligibility Requirement |
|---|---|
| Small-investor private-fund exemption | No more than 100 beneficial owners |
| Qualified-purchaser private-fund exemption | All investors must be qualified purchasers (no holder cap) |
- Both exemptions also require that the fund not make or propose to make a public offering of its securities; they're private-placement vehicles, not just a holder-count or investor-type test
- These exemptions are commonly used by hedge funds and private equity funds
- Funds relying on these exemptions do not need to register as investment companies with the SEC
- However, their advisers may still need to register as investment advisers (covered in the next unit)
Exam Tip: Gotchas
- The small-investor private-fund exemption is based on the number of beneficial owners (no more than 100), while the qualified-purchaser private-fund exemption is based on the type of investor (qualified purchasers only). These are often confused on the exam.
- Exemption from Investment Company Act registration does NOT exempt funds from antifraud provisions.
What Should You Check on Exam Day?
- Can you name the three investment-company types under the ICA (management company, UIT, face-amount certificate company) using the "MUF" memory aid?
- Do you know the difference between open-end funds (continuously issue/redeem shares at NAV) and closed-end funds (don't continuously issue/redeem; exchange-traded, share count can still change via follow-on/rights offerings)?
- Can you list what a UIT lacks compared to a management company: no board, no investment adviser, no active management?
- Do you know a UIT has a termination date and issues only redeemable units?
- Can you state the two private-fund exemptions from investment-company status (no more than 100 beneficial owners, or all investors are qualified purchasers) and that BOTH also require no public offering of the fund's securities?
- Do you know that these exemptions do not exempt the fund from antifraud provisions?