# The investment company and advisers acts in practice
A Vanguard index fund with over a trillion dollars in assets and a boutique fund running $200 million both answer to the same 1940 rulebook. Both must strike a net asset value every business day, seat a majority-independent board, and register the firm advising them with a federal regulator. These are not best practices. They are legal obligations written 86 years ago that still shape how every US mutual fund and ETF operates today.
Two laws do most of this work: the Investment Company Act of 1940 (the "'40 Act") governs the fund itself, and the Investment Advisers Act of 1940 (the "Advisers Act") governs the firm managing it. Both are enforced by the SEC (Securities and Exchange Commission), the US federal markets regulator. Let's see exactly what they force you to do.
When someone says a strategy is offered as a "'40 Act product," they mean it is a registered investment company: a mutual fund, an ETF (exchange-traded fund), or a closed-end fund available to ordinary US retail investors. The label matters because it signals a specific package of investor protections and constraints.
The alternative is a private fund (a hedge fund or private equity fund) sold only to wealthy or institutional investors under exemptions. Private funds skip most '40 Act rules. That is the whole point of the structure. So the '40 Act is really the price of admission for reaching the mass retail market.
Every US mutual fund is legally a company with a board of directors, and the '40 Act requires that a portion of that board be
In practice, funds relying on common regulatory exemptions must have a board where a majority of directors are independent, and independent directors must select and nominate other independent directors. The SEC's investor bulletin on mutual fund boards explains the role in plain language.
What does the board actually do? The single most important job under Section 15(c) of the Act: approve the advisory contract every year. The adviser (say, Fidelity or T. Rowe Price) cannot simply keep managing the fund and collecting fees. Independent directors must review the fees, compare them to peers, and vote to renew. This annual "15(c) process" is a real, documented negotiation, and it is why fund boards demand fee benchmarking data from the adviser each year.
Concrete effect: if you launch a mutual fund, you cannot staff its board entirely with your own employees. You must recruit and pay independent directors, and they can vote you out.
Open-end mutual funds must let investors buy and redeem shares at net asset value (NAV): total assets minus liabilities, divided by shares outstanding. Section 22 of the '40 Act and its rules require this, and it drives the operational rhythm of the entire industry.
NAV must be calculated each business day, typically after US markets close at 4:00pm Eastern. Every position gets marked, the fund's expenses are accrued, and one price is struck. Orders received before the cutoff get that day's NAV; orders after get the next day's. This is forward pricing, and it exists to stop the market-timing and late-trading abuses the Act was designed to prevent.
A fund holds:
NAV = ($500m + $20m - $5m) / 25m shares = $515m / 25m = $20.60 per share
Every buyer and seller that day transacts at $20.60. No negotiation, no intraday pricing for the open-end fund itself.
This is also why hard-to-value assets are a compliance headache. If a fund holds illiquid private securities or thinly traded bonds, someone must produce a defensible "fair value" every single day. The SEC's Rule 2a-5 (effective in recent years) formalized who is responsible: the board must designate a valuation process, usually delegating day-to-day work to the adviser under oversight. You cannot just guess.
The '40 Act deliberately keeps registered funds boring compared to hedge funds.
Liquidity: Because investors can redeem daily, open-end funds must hold enough liquid assets to pay them. The SEC's liquidity risk management rule (Rule 22e-4) requires funds to classify holdings by how fast they can be sold and to limit "illiquid" holdings (broadly, assets that cannot be sold within seven days without a significant price impact) to no more than 15% of the portfolio.
Leverage: Section 18 limits borrowing. A traditional rule of thumb is 300% asset coverage, meaning for every dollar borrowed the fund must hold three dollars of assets. The derivatives rule (Rule 18f-4) modernized this for funds using futures, swaps, and options, requiring most to run a value-at-risk (VaR) based limit and a derivatives risk management program.
Concrete effect: you cannot run a 5x-levered strategy inside a mutual fund and sell it to retail. The structure forbids it. That is why leveraged strategies live in private funds or in specialized ETFs using swaps under the constraints of 18f-4.
🎬 [VIDEO: "The Investment Company Act of 1940 Explained" - https://www.youtube.com/results?search_query=investment+company+act+1940+explained - a concise overview of the Act's structure and investor-protection purpose]
Now the second law. The firm that manages the fund is an investment adviser, and under the Advisers Act it generally must register with the SEC if it manages assets above a threshold (broadly $100 million+ in regulatory assets under management; smaller advisers register with state regulators instead).
Registration is not a one-time form. It creates ongoing duties:
Concrete effect: a portfolio manager cannot buy a stock in her personal account the morning before her fund buys a large position. The code of ethics and pre-clearance rules exist to catch exactly that.
Vérification des acquis
1. A boutique fund with $200 million in assets and a Vanguard fund with over a trillion dollars are subject to the same core '40 Act obligations. What concept does this illustrate?
2. Why do private funds (hedge funds, private equity) deliberately structure themselves to avoid '40 Act registration?
3. What is the fundamental distinction in what the Investment Company Act and the Investment Advisers Act each govern?
4. Select ALL correct answers about what the label "'40 Act product" signals to investors.
Sélectionnez toutes les réponses correctes.
5. Select ALL correct answers about the independent director requirement under the '40 Act.
Sélectionnez toutes les réponses correctes.
Say a team spins out to launch an equity mutual fund in 2026. Here is the '40 Act / Advisers Act checklist they cannot avoid:
1. Register the management firm as an investment adviser (Form ADV), appoint a CCO, and adopt compliance policies and a code of ethics. (Advisers Act)
2. Organize the fund as a registered investment company and file a registration statement with the SEC. (Investment Company Act)
3. Seat a board with a majority of independent directors. (Investment Company Act)
4. Sign an advisory contract the independent directors approve under the 15(c) process. (Investment Company Act)
5. Appoint a qualified custodian to hold the securities. (both Acts)
6. Stand up daily NAV striking, a fair-value process under Rule 2a-5, a liquidity program under Rule 22e-4, and a derivatives program under 18f-4 if applicable. (Investment Company Act)
None of this is optional, and all of it costs money before the fund earns a dollar of fees. This is precisely why small managers often start as private funds or sub-advise inside an existing fund complex: the '40 Act infrastructure is expensive.
The 1940 Acts were a response to abuses of the 1920s and 1930s: funds looting their own investors, pyramided leverage, self-dealing advisers. The drafters chose structural fixes (independent boards, daily pricing, custody, registration) rather than trying to police behavior after the fact. That is why the constraints feel operational rather than aspirational. They are baked into how the product is built.
The SEC updates the rules under these Acts regularly (Rule 2a-5, 22e-4, and 18f-4 are all recent modernizations), but the skeleton is unchanged. If you work anywhere near a US retail fund, you are working inside the 1940 framework.