Definitions of Investment Companies
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 managed portfolio | Most common type; includes mutual funds and closed-end 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
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): Issue a fixed number of shares through an IPO; shares trade on exchanges like stocks
Key characteristics:
- Have a board of directors with oversight responsibilities
- Employ an investment adviser to manage the portfolio
- Must register with the SEC under the Investment Company Act
Unit Investment Trusts (UITs)
- Organized under a trust indenture or similar instrument
- Hold a fixed portfolio of securities that does not change (no active management)
- 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 at a discount, paying the full face value at maturity
- 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 = fixed shares, trade on exchanges at market price.
- Face-amount certificate companies are virtually extinct but still testable.
Exemptions from the Investment Company Act
Two important exemptions prevent certain private funds from being classified as investment companies:
| Exemption | Section | Requirement |
|---|---|---|
| 3(c)(1) | ICA Section 3(c)(1) | Fewer than 100 beneficial owners (holders) |
| 3(c)(7) | ICA Section 3(c)(7) | Limited to qualified purchasers only |
- 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 3(c)(1) exemption is based on the number of holders (fewer than 100), while the 3(c)(7) 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.