A 40 Act fund is any pooled investment vehicle registered with the Securities and Exchange Commission under the Investment Company Act of 1940, the federal law codified at 15 U.S.C. § 80a-1 and the sections that follow it. Registration is what turns a pot of investor money into a “40 Act fund,” and it locks the vehicle into a defined set of rules covering how it holds assets, pays its managers, uses leverage, discloses information, and treats its shareholders. Mutual funds, most ETFs, closed-end funds, interval funds, and unit investment trusts all fall under this umbrella. Hedge funds and private equity funds generally do not.
The Types of Funds Registration Covers
The statute sorts registered investment companies into three main classes: face-amount certificate companies, unit investment trusts, and management companies.1Office of the Law Revision Counsel. 15 USC 80a-4 – Classification of Investment Companies Face-amount certificate companies issue contracts promising a fixed payout at maturity and are rare today. Management companies are the catch-all, and they split further into open-end and closed-end subclasses based on whether shares are redeemable directly from the fund.2Office of the Law Revision Counsel. 15 USC 80a-5 – Subclassification of Management Companies That single distinction — redeemable versus not — drives most of the practical differences between fund types.
Open-End Funds (Mutual Funds)
Open-end funds price their shares once per day at the close of trading. Investors buy and redeem at that day’s net asset value directly from the fund. Because the fund must always be able to pay departing shareholders, it faces constant pressure to hold liquid assets. This is the traditional mutual fund structure and by far the most common 40 Act format.
Closed-End Funds
Closed-end funds raise capital through an initial public offering, then their shares trade on stock exchanges. An investor who wants out sells to another buyer on the exchange rather than redeeming from the fund itself. Because the fund never faces a rush of redemption requests, it can invest in less liquid assets such as private credit, real estate, or infrastructure. The trade-off is that the market price of the shares often drifts away from the underlying per-share asset value, sometimes trading at a meaningful discount.
Interval Funds
Interval funds are a hybrid. They operate as closed-end funds but periodically offer to buy back a portion of their shares directly from investors, typically every three, six, or twelve months. Each repurchase offer must cover between 5 and 25 percent of outstanding shares.3eCFR. 17 CFR 270.23c-3 – Repurchase Offers by Closed-End Companies The structure has grown popular for strategies involving illiquid assets where full daily redemption is impractical but locking investors in indefinitely is unattractive.
Exchange-Traded Funds
ETFs trade throughout the day on exchanges, like closed-end funds, but use a mechanism involving authorized participants who create and redeem large blocks of shares. This keeps the market price close to net asset value. For years, every new ETF needed its own individual exemptive order from the SEC. In 2019, the SEC adopted Rule 6c-11, which created a standardized framework letting most ETFs launch without that custom relief.4U.S. Securities and Exchange Commission. Exchange-Traded Funds Final Rule Leveraged, inverse, and certain non-transparent ETFs still need their own exemptive orders.
Unit Investment Trusts
A unit investment trust buys a fixed portfolio at inception and holds it, with no active management, until a set termination date. Investors buy units representing a proportional share of the trust. When the trust ends, the securities are liquidated and proceeds distributed. Because there is no adviser making ongoing decisions, UITs do not have a board of directors.
What Isn’t a 40 Act Fund
Not every pooled investment vehicle is registered. Hedge funds, private equity funds, and venture capital funds typically avoid registration by relying on one of two carve-outs in the statute’s definition of “investment company.”
Section 3(c)(1) exempts funds with no more than 100 beneficial owners that do not make a public offering. Qualifying venture capital funds get a higher cap of 250 owners.5Office of the Law Revision Counsel. 15 USC 80a-3 – Definition of Investment Company Section 3(c)(7) has no fixed owner cap but requires every investor to be a “qualified purchaser,” which for an individual means owning at least $5 million in investments.6Legal Information Institute (LII). 15 USC 80a-2(a)(51) – Qualified Purchaser Definition
Funds that use these exemptions escape virtually all of the governance, diversification, leverage, and disclosure rules described below. That is the core trade-off: investors in a 40 Act fund get layers of structural protection, while investors in exempt private funds rely on negotiated contract terms and general anti-fraud provisions.
Board Governance and Adviser Oversight
Every registered management company must have a board of directors or trustees that oversees the investment adviser. Federal law caps the number of “interested persons” on the board — directors with a material business relationship to the fund or adviser — at 60 percent. The remaining seats must be held by independent directors.7Office of the Law Revision Counsel. 15 USC 80a-10 – Affiliations or Interest of Directors, Officers, and Employees In practice, most fund boards run with independent supermajorities.
Independent directors serve as a check on the fund’s biggest recurring expense, the management fee. They also approve service providers, oversee valuation, and monitor whether operations serve shareholders rather than the adviser. The fund must also designate a Chief Compliance Officer, whose appointment, compensation, and removal require board approval, including a majority of the independent directors.8eCFR. 17 CFR 270.38a-1 – Compliance Procedures and Practices of Certain Investment Companies That structural independence lets the CCO flag problems without fearing dismissal by the management team.
No one can act as a fund’s investment adviser without a written contract that specifies compensation. Shareholders must approve the initial advisory contract, and it terminates automatically if the adviser undergoes a change of control.9Office of the Law Revision Counsel. 15 USC 80a-15 – Contracts of Advisers and Underwriters After the first two years, the contract must be renewed annually by either a shareholder vote or the board (including a majority of independent directors), and it must be terminable on no more than 60 days’ notice, without penalty. Long-term lock-ins are not allowed.
Custody and Affiliated Transactions
Registered funds must keep their securities and cash with a qualified custodian: a bank meeting specified standards or a member of a national securities exchange.10Office of the Law Revision Counsel. 15 USC 80a-17 – Transactions of Certain Affiliated Persons and Underwriters The custodian holds assets separately from the adviser’s own accounts, and regular audits confirm the holdings actually exist. This structural separation is one of the most basic protections in the 40 Act framework.
The Act also sharply restricts dealings between a fund and its insiders. An affiliated person of the fund — the adviser, officers, directors, major shareholders — generally cannot buy securities from the fund, sell securities to it, or borrow from it. Joint transactions between the fund and an affiliate are prohibited unless the SEC has specifically approved the arrangement. These rules exist to prevent self-dealing, where an adviser steers the fund’s assets into transactions that benefit the adviser at shareholder expense.
Diversification, Leverage, Liquidity, and Derivatives
Diversification
A fund that calls itself “diversified” in its registration statement must follow the 75-5-10 rule. At least 75 percent of total assets must be spread across cash, government securities, securities of other investment companies, and other holdings. Within that 75 percent, no more than 5 percent of total assets can sit in any single issuer, and the fund cannot own more than 10 percent of any issuer’s voting securities.11U.S. Securities and Exchange Commission. SEC Staff Report on Threshold Limits Applicable to Diversified Companies The remaining 25 percent is unrestricted. A fund that doesn’t want these constraints can classify itself as non-diversified, but it must disclose that fact.
Borrowing
Open-end funds can borrow from banks, but total assets immediately after the borrowing must equal at least 300 percent of total borrowings: three dollars in assets for every dollar borrowed. If the coverage ratio slips below 300 percent, the fund has three business days to sell assets or repay debt to restore compliance.12Office of the Law Revision Counsel. 15 USC 80a-18 – Capital Structure of Investment Companies That’s a strict cap compared with what hedge funds can use.
Liquidity
Open-end funds cannot hold more than 15 percent of net assets in illiquid investments, defined as positions that can’t be sold within seven calendar days without significantly moving the market price.13U.S. Securities and Exchange Commission. Investment Company Liquidity Risk Management Program Rules If a fund breaches that limit, it must notify its board and produce a remediation plan. Persistent breaches trigger board review and confidential reporting to the SEC.
Derivatives
Funds that use derivatives — options, futures, swaps — must comply with Rule 18f-4. A fund using more than a limited amount must adopt a written derivatives risk management program and designate a derivatives risk manager approved by the board. The fund must then satisfy one of two value-at-risk tests: a relative test capping portfolio VaR at 200 percent of a designated reference index (250 percent for certain closed-end funds), or an absolute test capping portfolio VaR at 20 percent of net assets (25 percent for certain closed-end funds).14eCFR. 17 CFR 270.18f-4 – Exemption From the Requirements of Section 18 and Section 61 for Certain Senior Securities Transactions
Distribution and 12b-1 Fees
Many open-end funds charge ongoing fees under a 12b-1 plan to cover marketing and distribution. Adopting or renewing such a plan requires board approval, including a vote by the independent directors at a meeting called specifically for that purpose.15GovInfo. 17 CFR 270.12b-1 – Distribution of Shares by Registered Open-End Management Investment Company The plan is renewed annually by the same process.
FINRA caps these charges. The asset-based sales charge portion cannot exceed 0.75 percent of average annual net assets, and any service fee component cannot exceed 0.25 percent, for a combined ceiling of 1 percent per year.16FINRA. FINRA Rule 2341 – Investment Company Securities These fees appear in the fund’s prospectus fee table and are deducted from fund assets, so they reduce returns whether or not you notice them.
Tax Status as a Regulated Investment Company
Most 40 Act funds elect to be taxed as regulated investment companies under Subchapter M of the Internal Revenue Code. That election allows the fund to pass income and gains through to shareholders without paying corporate-level tax. To keep the election, the fund must distribute at least 90 percent of its net investment income and net tax-exempt interest income each year.17Office of the Law Revision Counsel. 26 USC 852 – Taxation of Regulated Investment Companies and Their Shareholders
The fund must also pass quarterly asset diversification tests under IRC Section 851. At least 50 percent of assets must sit in cash, government securities, other RIC securities, and diversified positions (subject to the 5-percent-per-issuer and 10-percent-of-voting-securities limits). No more than 25 percent can sit in any single issuer, or in two or more controlled issuers in the same business.18Office of the Law Revision Counsel. 26 USC 851 – Definition of Regulated Investment Company A fund that fails either test loses RIC status and gets taxed as a regular corporation, meaning corporate tax on income and shareholder tax on distributions. Fund managers treat maintaining RIC status as non-negotiable.
Disclosure and Reporting
Before a fund can sell shares to the public, it must produce a prospectus describing objectives, risks, fees, and past performance. A companion document called the Statement of Additional Information carries deeper operational and financial data and is available on request.
Once operational, the fund files Form N-CSR with the SEC within 10 days of sending annual and semi-annual reports to shareholders.19U.S. Securities and Exchange Commission. Form N-CSR Those reports include a standardized fee table and a full schedule of holdings. Funds also file portfolio data on Form N-PORT monthly, with the third-month filing of each quarter made public after a delay. The Act makes it unlawful to include an untrue statement of material fact, or to omit a fact that would make a filing misleading, in any registration statement or report.20Office of the Law Revision Counsel. 15 USC 80a-33 – Destruction and Falsification of Reports and Records
Penalties
Anyone who willfully violates the Act, or willfully makes a materially misleading statement in a required filing, faces criminal penalties of up to $10,000 in fines and up to five years in prison.21Office of the Law Revision Counsel. 15 USC 80a-48 – Penalties The SEC can also bring civil enforcement actions seeking injunctions, disgorgement of profits, and administrative sanctions, including barring individuals from the securities industry.