SEC Rules & Regulations
Investment Advisers Act of 1940
Investment Company Act of 1940
Rules under the Investment Advisers Act of 1940
North American Securities Administrators Association (NASAA)
Investment Adviser Registration Depository
Financial Industry Regulatory Authority (FINRA)
Recent SEC Rulemaking
From the Quote Board:
Frequently Asked Questions
An investment company is an entity that holds investments, distributes its income and realized capital gains, and does not have to pay income tax at the entity level. A number of rules and regulations define and regulate an investment company – the Investment Company Act of 1940 and Subchapter M of the Internal Revenue Code being the most well known and most critical to an investment company’s operations and compliance.
A private fund can be organized as an investment company, or might be organized as a limited partnership. Private funds are not eligible to be sold to retail investors, but rather are limited to purchases by sophisticated investors as defined under Regulation D of the Securities Act of 1933.
A mutual fund is an investment company that is also registered for distribution to retail investors by making the necessary filings with the SEC under the Securities Act of 1933.
Many people refer to “private funds” and “hedge funds” as being the same thing. In the strictest sense a hedge fund utilizes investment strategies that “hedge” against market direction movements. Investment strategies such as being long and short in similar securities, hoping to take advantage of the relative valuations of those securities rather than the macro movements of the securities markets, might be prevalent. In theory a hedge fund performance is derived from the inefficiencies of the relative valuation of individual securities or market sectors generates the fund’s investment return, rather than upward or downward movement of the securities markets as a whole.
A closed end interval fund has many characteristics similar to an open end mutual fund. The primary difference is closed end interval funds can only be redeemed at certain “intervals”, typically monthly or quarterly. Closed end interval funds are best when a fund strategy includes less liquid investments that can not be easily liquidated without some advance notice.
An exchange traded fund (ETF) has many characteristics similar to an open end mutual fund in portfolio construction. The main difference is the ability for an investor to purchase and sell shares in the ETF during the business day, not having to wait for closing net asset value (NAV). ETFs can also be traded in a margin account, and are available for short selling.
The most popular forms of organization for an investment company are the Massachusetts and Delaware business trust forms of organization. Maryland corporations are also popular with many fund complexes.
A series trust is a business trust that is organized in such a way that multiple funds, or series, may be organized under a single business trust. An analogy is a holding company or “umbrella” organization where a single governing entity has multiple sub-entities underneath its umbrella.
A publicly registered mutual fund must use a bank as custodian of its securities, or if a custodian other than a bank is used, that entity (a broker dealer usually) must be audited three times each year, two of which must be surprise. Due to the expense of three audits, almost all mutual funds use a bank as custodian of investment assets.
A fund that is not publicly registered has more flexibility in how its investment assets are held. Many private funds use a prime broker, or registered broker dealer, to hold investment assets. While the investment advisor to a private fund might trade securities with multiple broker dealers, each broker dealer delivers its trades to one designated prime broker.
As with many questions, the real answer is “it depends”. To answer the question let’s make some assumptions. Assume the fund wants to maintain an expense ratio of 1.25% or below. Assume the investment advisor fee is 0.75%. And assume the fund chooses to register in all 50 states for blue sky registration. In this instance, a mutual fund will need approximately $15mm in assets to cover its expenses without paying the investment advisor any fees. The fund will need to get to approximately $55mm for the investment advisor to get a full 0.75% investment advisory fee. In order to fine tune such an analysis with different assumptions, give us a call and we can help.
The costs of administering a private fund allow for a lower threshold of breakeven. A private fund can keep an expense ratio below 1.25% and the investment advisor get a full 0.75% investment advisory fee with $20mm or possibly less. It is not uncommon, however, for private fund investors to expect a lower expense ratio, so the variables need to be adjusted accordingly.
Not necessarily. There may be any number of circumstances where it might make sense to organize an investment fund as an investment company per the Investment Company Act of 1940 but not register the fund for public sale under the Securities Act of 1933.
Funds are sold, not bought. A common misconception is “we have wonderful performance, investors will flock to our new fund because of our past performance/future performance/our investment genius/our incredible good looks”. The truth is that investors have so many options in today’s world that someone needs to sell the investor on the reason they need to purchase the fund. Performance is important, but it is not the only item.
Funds that fail typically do not have a strong method of distribution, do not have adequate sales efforts to convince investors to make an investment. Funds that do a good job gathering assets in early years can lose those assets with poor investment performance. Client’s advisors get paid to recommend changes in their client portfolios. A poor performing fund for several quarters or years is a ripe candidate for replacement.
With the investment industry moving more and more towards wealth managers and fee only financial planners, platforms can be very important. Platforms such as Fidelity, Schwab, LPL, TD Ameritrade and any number of broker dealers may be critical to distribution and marketing of a fund.
A transfer agent is registered with the SEC under Form TA. Transfer agents are required to hold and register in the name of shareholders shares in a mutual fund or any variation of publicly traded investment companies. There are very few registered transfer agents left relative to how many were registered 30 years ago. Nottingham is the only transfer agent registered in the southeastern U.S.
If your fund is available for public sale under the Securities Act of 1933, yes. If your fund is exempt from public registration, then likely no. We might argue that a firm that is set up and used to the regulatory oversight under the transfer agent registrations is great preparation for working with private funds. A square is a rectangle but a rectangle is not necessarily a square.
This is a great case study question, and many of our case studies address this issue. Combining multiple sub-accounts with similar investment objectives can make management and operations much simpler and allow for economies of scale that comes with larger investment pools. The issue that must be addressed is to properly allocate cost basis, net income, and realized and unrealized gains. Unitized accounting used for mutual funds is an ideal way to ensure this accuracy and proper allocation.
Government investment pools are typically exempt from any registration with the SEC under long standing rules and regulations and precedent.
There are several private letter rulings that specifically exempt religious affiliated groups from registration, allowing those entities to pool their investment assets for efficiency and diversification.