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In the United States, following the stock market crash of 1929 and the Great Depression, federal lawmakers set out to regulate the securities industry to help protect the public. Congress passed a number of laws including The Securities Act of 1933, The Securities Exchange Act of 1934, The Investment Advisors Act of 1940, and The Investment Company Act of 1940. The Investment Company Act of 1940 focused on regulating investment firms that offered securities investments to the public.
This act required that all such companies register with the Securities and Exchange Commission (SEC). Under The Investment Company Act of 1940, investment firms must also regularly disclose their investment policies and financial conditions to the public. The act also set operating standards to help ensure investment companies’ continued financial health and fair treatment of investors. These guidelines included limiting the amount of assets that could be leveraged to purchase additional assets, and regulating sales of shares in the investment company itself.
Another main goal of The Investment Company Act of 1940 was to help eliminate any conflicts of interest that could arise from a financial company selling shares, related to its own investments, to the public. To this end, this law limits transactions with affiliated companies. The act also clearly outlines the makeup and duties of an investment company’s board of directors.
Under this regulation, the board must be at least 75% independent. This means that three-quarters of the directors cannot be employees of, or otherwise directly profit from, the performance of the investment company. Directors must also approve many of the financial transactions that directly affect public investors, such as determining fees charged by mutual funds.
There are three classes of companies that fall under the jurisdiction of The Investment Company Act of 1940. These classes include face-amount certificate companies, unit investment trusts, and management companies. Face-amount certificate companies issue certificates and make installment payments to investors.
Unit investments do not have a board of directors but are managed under a trust with a custodian instead. Investors have redeemable shares in these trusts, but no voting rights. All other investment companies fall into the management company class.
There are many companies that are exempt from The Investment Company Act of 1940. These include, but are not limited to, companies with home offices in United States territories, commonwealths, or other possessions. Companies that do not issue redeemable securities are also exempt. Businesses can apply for exemptions with the SEC.
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