Investment Company Act of 1940

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The Investment Company Act of 1940 (commonly referred to as the '40 Act) is an act of Congress which regulates investment funds. It was passed as a United States Public Law (Pub. L. Tooltip Public Law (United States)  76–768) on August 22, 1940, and is codified at 15 U.S.C.   §§ 80a-1 – 80a-64. Along with the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and extensive rules issued by the U.S. Securities and Exchange Commission; it is central to financial regulation in the United States. It has been updated by the Dodd-Frank Act of 2010. It is the primary source of regulation for mutual funds and closed-end funds, now a multi-trillion dollar investment industry. [1] The 1940 Act also impacts the operations of hedge funds, private equity funds and even holding companies.

Contents

History

Following the founding of the mutual fund in 1924, investors invested in this new investment vehicle heavily. Five and a half years later, the Wall Street Crash of 1929 occurred in the stock market, followed shortly thereafter by the United States entry into the Great Depression. In response to this crisis, the United States Congress wrote into law the Securities Act of 1933 and the Securities Exchange Act of 1934.

In 1935, Congress requested that the SEC report on the industry, and the Investment Trust Study was reported between 1938 and 1940. [2] The law as originally introduced was different from the law which passed; the original draft granted more broad power to the SEC, while the final bill was a compromise between the SEC and industry which was drafted and submitted to Congress by joint members of the SEC and industry, and Congress ultimately passed a similar version, unanimously. [3] [4] David Schenker, who became the head of the Investment Company Division at the SEC, [5] was one of the original drafters. [6]

By 1992, the act had remained largely unchanged aside from amendments in 1970 to provide additional protections particularly around independent boards and limiting fees and expenses. [2]

Scope

The act's purpose, as stated in the bill, is "to mitigate and ... eliminate the conditions ... which adversely affect the national public interest and the interest of investors". Specifically, the act regulated conflicts of interest in investment companies and securities exchanges. It seeks to protect the public primarily by legally requiring disclosure of material details about each investment company. The act also places some restrictions on certain mutual fund activities such as short selling shares. However, the act did not create provisions for the U.S. Securities and Exchange Commission (SEC) to make specific judgments about or even supervise[ clarification needed ] an investment company's actual investment decisions. The act requires investment companies to publicly disclose information about their own financial health.

Jurisdiction

The Investment Company Act applies to all investment companies, but exempts several types of investment companies from the act's coverage. The most common exemptions are found in Sections 3(c)(1) and 3(c)(7) of the act and include hedge funds.

In October 2021, over 60 law firms issued an "extremely unusual joint statement" that special-purpose acquisition companies (SPACs) are subject to regulation under the Act when the SPAC does not acquire an operational business within one year of offering company shares to the public. The statement followed opposition from Yale law professor John Morley and New York University law professor Robert Jackson regarding the dismissal of a lawsuit against the blank-check company GO Acquisition Corp. that had been filed on behalf of an investor. [7] [8]

Scale

When Congress wrote the act into federal law, rather than leaving the matter up to the individual states, it justified its action by including in the text of the bill its rationale for enacting the law:

The activities of such companies, extending over many states, their use of the instrumentalities of interstate commerce and the wide geographic distribution of their security holders, make difficult, if not impossible, effective state regulation of such companies in the interest of investors.

Type

The act divides the types of investment company to be regulated into three classifications:

Contents

Summary of notable provisions

Sections 1 - 5 define terms and classify investment companies. The definition of investment company also includes some exemptions. [6]

In addition to exemptions in the definitions, section 6 describes additional exemptions, with 6(c) notably giving the SEC broad discretion to "conditionally or unconditionally exempt any person ... from any provision". [6] One of the original drafters, David Schenker (who became the head of the Investment Company Division at the SEC [5] ), explained the provision in 1940 by pointing to the complexities of the industry. [6] This was notably used to exempt venture capital firms in the 1970s, which preceded changes to the statute, ultimately including a section 3(c)(7) which exempts issuers of non-public securities to qualified purchasers. [6] Section 3(c)(11) generally exempts collective trust funds.

Section 7 prohibits investment companies from doing business until registration, [9] including public offerings; in 2018, the SEC acted against a cryptocurrency hedge fund for allegedly violating section 7. [10] Section 7(d) is notable in that it restricts foreign investment firms from offering securities, and by 1992 no foreign firms had registered since 1973. [2] : xxvi 

Section 9 outlines disqualification provisions which restrict people who have committed misconduct from practice in the industry; in practice, the SEC has historically granted waivers to allow such persons to remain involved. [11]

Various provisions restrict the powers of investment companies in corporate governance over management particularly in transactions with affiliates, [2] including section 10. These laws were passed as a reaction to self-dealing excesses in the 1920s and 1930s, where funds would, for example, dump worthless stocks into certain funds, saddling investors with their losses. [12]

Filings

To register, a firm initially files a notification with Form N-8A, followed by a form which depends on the type of fund. [13]

Among others, firms with open-end funds must file Form 24F-2. [14]

See also

Related legislation

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References

  1. ↑ Lemke, Lins and Smith, Regulation of Investment Companies (Matthew Bender, 2013).
  2. 1 2 3 4 "Protecting Investors: A Half Century of Investment Company Regulation" (PDF). Securities and Exchange Commission. Retrieved 2020-02-28.
  3. ↑ Jaretzki, Alfred (1941-01-01). "The Investment Company Act of 1940". Washington University Law Review. 26 (3): 303–347. ISSN   2166-7993.
  4. ↑ "2 Investment Bills Signed". Newspapers.com. The Honolulu Advertiser. 24 Aug 1940. p. 11. Retrieved 9 September 2023. ...the legislation had passed unanimously in both the Senate and the House.
  5. 1 2 "The Investment Company Act of 1940". Yale Law Journal. 50 (3). 1941-01-01. ISSN   0044-0094.
  6. 1 2 3 4 5 Zeng, Feng. "SEC's Exemptive power in regulating investment companies" (PDF). Rand Corporation. Archived (PDF) from the original on 2020-02-28.
  7. ↑ "Law profs defend theory that SPAC is illegal under Investment Company Act", by Alison Frankel Reuters, November 1, 2021. Retrieved November 1, 2021.
  8. ↑ "49 firms in 72 hours: How the SPAC bar united against law profs' splashy lawsuits", by Alison Frankel Reuters, August30, 2021. Retrieved November 1, 2021.
  9. ↑ Montgomery, Paige Holden. "The Inadvertent Investment Company: Private Litigation Risk Under the Investment Company Act of 1940" (PDF). Andrews Securities Litigation and Regulation Reporter. Archived (PDF) from the original on 2020-02-28. Retrieved 2020-02-28.
  10. ↑ "Crypto Enforcement - SEC Announces First Action for Investment Company Act Violation - O'Melveny". www.omm.com. Retrieved 2020-02-28.
  11. ↑ "Ropes & Gray's Investment Management Update: October 2014 – November 2014". www.ropesgray.com. Retrieved 2020-02-28.
  12. ↑ Roe, Mark (1991-06-01). "Political Elements in the Creation of a Mutual Fund Industry". University of Pennsylvania Law Review. 139 (6): 1469. doi:10.2307/3312388. JSTOR   3312388. S2CID   154008914.
  13. ↑ "SEC.gov | Investment Company Registration and Regulation Package". www.sec.gov. Retrieved 2020-03-27.
  14. ↑ Kenton, Will. "SEC Form 24F-2". Investopedia. Retrieved 2020-03-27.
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