Investment Company Act
The Investment Company Act of 1940 (“ICA”) regulates investment funds. An investment fund pools capital from investors in order to pursue a common investment strategy. Investment funds are managed by professional asset managers, who are paid a fee (plus expenses) by investors. Before the ICA, this separation of the ownership of the investment funds from the control over the funds led to serious concerns of conflicts of interest. That is to say, because there was no effective way to monitor what managers were doing, and because managers are able to manage multiple funds at the same time due to the separation between ownership and control, there was an acute fear that managers would act in their own self-interest, which sparked the need for regulation.
In response, the ICA was enacted, and became a starting point for the regulation of investment funds, by imposing registration requirements, mandatory disclosure requirements, balance sheet constraints and fund governance rules which are all enforced and regulated by the Securities Exchange Commission (“SEC”). The following outlines the main components of the ICA restrictions on investment funds; however, it is important to note that there are also large exemptions to the ICA.
Registration Requirements:
The ICA requires every investment company to register with the SEC. The definition of an investment fund is interpreted broadly, and includes all companies that are or hold themselves out to be engaged primarily in investing or trading in securities.
Mandatory Disclosure:
The ICA requires that companies file a registration statement including a prospectus with the SEC. In addition to this initial disclosure, companies are required to provide shareholders with continued periodic event driven disclosures. This continued disclosure includes information about the risks of investing in the fund, historical performance information of the fund and the investment strategy of the fund.
Balance Sheet Constraints:
The ICA also imposes constraints on both the liabilities and assets held by investment funds. On the liability side, the ICA imposes a limit on the amount of debt that investment companies could use to fund investments. On the asset side, the ICA restricts the ability for investment companies to have ownership of other funds or financial firms, and prohibits buying securities on the margin. Finally, the ICA requires investment funds to ensure that they can meet requests from investors to redeem shares without having to sell illiquid portfolio assets at a discount.
Fund Governance Rules:
The ICA imposes restrictions on how the investment funds are governed. The Act states that at least 40% of the investment company’s directors need to be unaffiliated with its advisor, sponsor or other key affiliates. The Act also limits transactions between funds and affiliated parties. Finally, the Act imposes fiduciary duties onto officers, directors and investment advisors.
Exemptions:
There are a number of exemptions to the ICA, the biggest being that of private funds, which includes hedge funds. Private funds are funds that do not offer their securities to the public and have fewer than 100 owners, or only qualified purchasers. These funds are exempted from the requirements of the ICA.
See: 15 U.S. Code Chapter 2D - Investment Companies and Investors
[Last reviewed in February of 2025 by the Wex Definitions Team]
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