Investment companies (mutual funds) are regulated by the Investment Company Act of 1940. The roots of government regulation of investment companies are found in the great stock market crash of 1929, which caused Congress to begin an extensive investigation of the U.S. securities industry. The bulk of federal powers over the activities of investment companies is contained in the Investment Company Act of 1940, which provides for the registration and regulation of companies primarily engaged in the business of investing in securities. The major provisions of the Act are summarized as follows:
The Act provides for registration, "full" disclosure and regulation of investment companies to prevent fraudulent abuses.
Generally, not more than 60 percent of the board of directors may be affiliated with the fund, its banks or brokers.
A company must redeem shares duly offered by shareholders within seven calendar days at per share net asset value.
Open-end companies (mutual funds) may borrow from a bank and use the proceeds for investment purposes (leverage); such debt must be collateralized three to one.
Shareholders must be sent complete financial reports at least semiannually, and the SEC must see such reports.
To qualify as a regulated investment company, the fund must have at least 75 percent of its total assets invested in securities, with not more than 5 percent of its assets invested in the securities of any one issuer and not holding more than 10 percent of the voting securities of any one corporation.
A prospectus must be given to a prospective fund investor before sales can be solicited.
Securities and cash must be kept by either a bank or a broker who is a member of a national securities exchange.
In addition to federal registration, a mutual fund must register in and abide by the laws and regulations of each state in which its shares are sold. In other words, unless a fund is registered in your state of residence, it cannot legally sell its shares to you.