Most ETFs are 1940 Act funds, but not all of them. An ETF registered as an investment company under the Investment Company Act of 1940 comes with a board of directors, custody rules, leverage limits, diversification standards, and daily holdings disclosure. An ETF that holds physical gold, oil futures, or unsecured bank debt does not, because those products register under a different statute and answer to a different regulator. The label on your brokerage screen looks the same. The rulebook behind it can be very different.
Which ETFs Are 1940 Act Funds
The Investment Company Act defines an investment company as an issuer primarily engaged in investing, reinvesting, or trading in securities. An ETF that holds stocks or bonds fits that definition and has to register with the SEC before selling shares to the public. The Act runs from 15 U.S.C. ยงยง 80a-1 through 80a-64 and sets the rules for how these funds are organized, governed, and operated.
For years, every new ETF sponsor had to ask the SEC for individualized permission to operate, because the standard 1940 Act framework was not built for shares that trade on an exchange all day. In 2019 the SEC adopted Rule 6c-11, creating a standardized path for most ETFs to launch without a custom exemptive order.1SEC.gov. Exchange-Traded Funds (Conformed to Federal Register version) Under the rule, an ETF has to be organized as a registered open-end management company, issue and redeem shares in large blocks called creation units, and list its shares on a national exchange.
The creation and redemption mechanism is the operational heart of a 1940 Act ETF. Authorized participants, usually large broker-dealers, deposit a basket of securities and receive creation units in return. This in-kind exchange keeps the ETF’s market price close to the net asset value of its holdings and lets the fund shed low-cost-basis positions during redemptions without generating capital gains distributions to remaining shareholders.1SEC.gov. Exchange-Traded Funds (Conformed to Federal Register version)
Two structures qualify as 1940 Act ETFs. Most are open-end management investment companies, which have a board of directors, can create and redeem shares continuously, and can reinvest dividends and adjust holdings. A smaller number are unit investment trusts, which hold a largely fixed portfolio, have no board, and typically hold dividends as cash until distribution.2Office of the Law Revision Counsel. 15 USC 80a-26 – Unit Investment Trusts Some of the earliest index ETFs used the UIT format, but new launches almost universally use the open-end structure.
Rule 6c-11 does not cover every 1940 Act ETF. Leveraged and inverse ETFs, unit investment trusts, ETFs organized as a share class of a multi-class fund, and non-transparent active ETFs still need individual exemptive orders.3U.S. Securities and Exchange Commission. SEC Adopts New Rule to Modernize Regulation of Exchange-Traded Funds They are still 1940 Act funds. They just operate under older, customized conditions.
Which ETFs Are Not 1940 Act Funds
Three common product types trade like ETFs but sit outside the Investment Company Act.
Grantor Trusts
Funds that hold physical commodities such as gold or silver bullion are structured as grantor trusts. They register under the Securities Act of 1933 but not under the 1940 Act, because they hold a single physical asset rather than a portfolio of securities. Each share represents a fractional interest in the metal held in the trust’s vault.4SEC.gov. SPDR ETFs – Basics of Product Structure There is no independent board, and no diversification or leverage limits apply.
Commodity Pools
ETFs that invest in futures contracts for oil, natural gas, agricultural products, or currencies are typically organized as commodity pools. The Commodity Futures Trading Commission regulates these products under the Commodity Exchange Act, not the SEC under the 1940 Act. The first practical difference you’ll see is on your taxes: commodity pools issue Schedule K-1 forms rather than Form 1099-DIV, which adds complexity and can delay your filing.
Exchange-Traded Notes
An exchange-traded note looks like an ETF on a trading screen but is fundamentally different. An ETN is an unsecured debt obligation issued by a bank, not a pooled investment. You are lending money to the issuer in exchange for a promise to pay a return linked to an index. If the bank fails, your ETN can become worthless regardless of how the linked index performed.5SEC.gov. ETN Overview ETNs register as debt securities under the 1933 Act. No board, no diversification requirements, no custody rules protecting an underlying pool, because no pool exists.
What You Give Up Outside the 1940 Act
The structural protections built into the 1940 Act framework are the main reason the distinction matters.
Independent Board Oversight
Every registered investment company has to maintain a board of directors, and at least 40% of that board must be independent of fund management.6U.S. Securities and Exchange Commission. Role of Independent Directors of Investment Companies Independent directors review the advisory contract, evaluate the adviser’s performance, and approve policies on matters like securities lending and proxy voting. Shareholders also vote on director elections and material changes to the advisory contract. None of that exists for grantor trusts, commodity pools, or ETNs, where your relationship with the sponsor is contractual.
Diversification Standards
A fund classified as diversified has to keep at least 75% of its total assets in a mix of cash, government securities, and other holdings where no single issuer accounts for more than 5% of total assets or more than 10% of that issuer’s outstanding voting securities.7Office of the Law Revision Counsel. 15 USC 80a-5 – Subclassification of Management Companies A fund can elect non-diversified status, but it has to disclose that choice prominently.
Leverage Limits
Section 18 sharply limits borrowing. A registered open-end fund can only borrow from a bank, and immediately after any borrowing it must maintain asset coverage of at least 300%: total assets have to be at least three times the amount borrowed.8Office of the Law Revision Counsel. 15 USC 80a-18 – Capital Structure of Investment Companies If coverage drops below that threshold, the fund has three business days to reduce its borrowings. Products outside the 1940 Act face no equivalent borrowing ceiling under this Act.
Custody of Assets
Fund securities have to be held in the safekeeping of a bank or other regulated institution and physically segregated from the assets of anyone else.9eCFR. 17 CFR 270.17f-2 – Custody of Investments by Registered Management Investment Company An independent public accountant physically verifies the securities at least three times each fiscal year, with at least two of those examinations occurring on a surprise basis. These layered controls make it very difficult to misappropriate fund assets.
Liquidity Rules
SEC Rule 22e-4 requires every open-end fund to maintain a liquidity risk management program and caps illiquid investments at 15% of net assets. A breach has to be reported to the board within one business day, and a problem persisting 30 days forces the board to reassess its plan for coming back into compliance.10eCFR. 17 CFR 270.22e-4 – Liquidity Risk Management Programs The rule matters most for fixed-income and alternative ETFs holding assets that don’t trade easily.
Daily Disclosure
Under Rule 6c-11, a 1940 Act ETF has to post its full portfolio holdings on its website every business day before the market opens, reflecting holdings as of the prior day’s close and listing the ticker, identifier, description, quantity, and percentage weight for each position.11U.S. Securities and Exchange Commission. ADI 2025-15 – Website Posting Requirements The fund also has to publish its daily net asset value, market price, premium or discount, and historical premium and discount data in both a table and a line graph.12U.S. Securities and Exchange Commission. Exchange-Traded Funds – A Small Entity Compliance Guide If the premium or discount exceeds 2% for more than seven consecutive trading days, the fund has to explain why.
How the Structure Affects Your Taxes
The regulatory bucket determines the tax forms you receive and, in some cases, the rate you pay.
Most 1940 Act ETFs elect regulated investment company treatment under Subchapter M of the Internal Revenue Code. To qualify, the fund distributes at least 90% of its investment company taxable income to shareholders each year.13Office of the Law Revision Counsel. 26 USC Subtitle A, Chapter 1, Subchapter M, Part I – Regulated Investment Companies The fund itself pays no federal income tax on the distributed earnings; you do. The in-kind creation and redemption mechanism keeps capital gains distributions rare, which is why these ETFs tend to be more tax-efficient than traditional mutual funds using the same 1940 Act registration.
Grantor trusts holding physical precious metals face a steeper bite. The IRS treats gold, silver, and other precious metals as collectibles, with a maximum long-term capital gains rate of 28% instead of the 20% top rate on stocks held more than a year. Sell a gold ETF after a strong run and the higher rate can meaningfully cut into your profit. Short-term gains are taxed at ordinary income rates regardless of structure.
Futures-based commodity ETFs organized as commodity pools fall under Section 1256 of the Internal Revenue Code. Open positions are marked to market at year-end, and any resulting gain or loss is split 60% long-term and 40% short-term, regardless of your actual holding period.14Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market The blended rate can beat short-term ordinary income treatment, but the K-1 reporting adds complexity and often delays your return.
How to Check Your Own ETF
Look at the front page of the prospectus. A fund registered under the Investment Company Act will describe itself as an open-end management investment company or a unit investment trust. Products outside the 1940 Act will reference the Securities Act of 1933 and describe themselves as a grantor trust, a commodity pool, or a debt security. You can pull any fund’s prospectus from the SEC’s EDGAR database using the fund name or ticker.
Two ETFs can track a similar index or commodity and behave very differently in your account. A 1940 Act ETF gives you an independent board, strict custody controls, leverage limits, and daily holdings disclosure. A non-1940 Act product may strip away most of that. Knowing which set of rules governs the fund is worth a minute before you buy.