Caliber Exchange
Ask or search…
K
Links

Registered Funds

Types of Registered Funds (RICs)

The Investment Company Act of 1940 (1940 Act) seeks to regulate investment companies in order to protect investors, promote transparency, and ensure fair dealing. Under this legislation, different types of registered investment companies exist, including open-end funds, closed-end funds, interval funds, tender offer funds, and business development companies. This analysis outlines and distinguishes amongst these various types.
Open-end Funds (Form N-1A)
Closed-end Funds (Form N-2)
Interval Funds
Tender Offer Funds
Business Development Companies (BDCs)
Open-end funds, also known as mutual funds, issue new shares and redeem existing ones according to investor demand. They are required to register with the SEC by submitting Form N-1A, which includes key information about the fund for potential investors. These funds are continuously offered, and their net asset value (NAV) is calculated at the end of each trading day. Open-end funds are highly liquid, as investors can buy or sell shares directly from or to the fund at the current NAV.
Closed-end funds issue a fixed number of shares through an initial public offering (IPO). They are registered with the SEC using Form N-2, which also provides essential information about the fund. Unlike open-end funds, closed-end funds do not continuously issue shares and redeem existing ones. Instead, their shares trade on stock exchanges like stocks, with prices determined by market supply and demand. Closed-end funds have a fixed capital structure and can trade at a premium or discount to their NAV.
Interval funds are a type of hybrid between open-end and closed-end funds. They issue shares in a continuous manner like open-end funds but feature limited liquidity by allowing periodic redemptions at predetermined intervals. Share prices are based on the NAV at the time of the redemption period. These funds allow fund managers to invest in less liquid assets, as they do not have to make continuous redemptions.
Similar to interval funds, tender offer funds provide shareholders with limited liquidity opportunities. However, the key difference lies in the method employed for providing liquidity. Tender offer funds do not have set redemption periods; instead, liquidity is offered through tender offers initiated by the fund. During these tender offers, shareholders are allowed to sell a certain percentage of their shares back to the fund at the NAV, though they are not obligated to do so.
BDCs are closed-end investment companies designed to encourage investments in small and developing businesses or financially troubled businesses. BDCs can provide equity capital, long-term loans, or advisory services to these businesses. They are subject to many of the same regulations as closed-end funds, including the requirement to register with the SEC. Often, BDCs trade on stock exchanges and invest in private companies to promote economic growth.
In summary, different types of registered investment companies each possess distinctive characteristics concerning capital structure, trading, liquidity, and investment strategies. Understanding their differences aids in making informed investment choices and comprehending the diverse landscape of investment company options.

RIC Compliance Programs

Both the compliance programs for an institutional investment adviser under the Investment Advisers Act of 1940 (Advisers Act) and a registered investment company under Rule 38a-1 of the 1940 Act share a common objective, which is to safeguard the interests of investors and ensure that these entities comply with relevant laws and regulations. However, the specific requirements and focal points of these programs differ due to the nature of their operations and the scope of the regulatory standards they must adhere to.

Similarities of Compliance Programs

Chief Compliance Officer (CCO) appointment

Both mandates require the appointment of a CCO, whose role is to manage and design the compliance program, oversee its implementation, conduct periodic reviews and report the findings to the board. Written Policies and Procedures: Both programs require the development of written policies and procedures that take into consideration the regulation's risk-based approach, specifying sufficient measures to prevent securities law violations. Periodic review: Both programs require the annual review and assessment of the effectiveness of their written policies and procedures. Board involvement: In both cases, the board of directors (or trustees) is responsible for approving the implementation of the compliance programs, the appointment of the CCO, and reviewing annual reports prepared by the CCO. Differences of Compliance Programs:

Scope of regulations

The Advisers Act targets investment advisers (those who provide advice on securities for compensation), while the 1940 Act deals with registered investment companies (mutual funds, exchange-traded funds, closed-end funds, and unit investment trusts). Thus, the specific regulations and standards in each compliance program will differ based on the applicable rules for each category. Types of risks: Investment advisers face different types of risk than registered investment companies, as they have different types of advisory relationships, fee structures, and fiduciary responsibilities. Compliance programs for investment advisers must focus on mitigating risks associated with advisory services and conflicts of interest, while the registered investment company compliance program is designed to function around the risks related to the management of funds, pricing, and valuation, as well as conflicts of interest. Regulatory oversight: The Securities and Exchange Commission (SEC) is the primary authority responsible for overseeing investment advisers and registered investment companies. However, registered investment companies are also subject to additional regulation under the Investment Company Act of 1940 that mandates certain governance structures, financial reporting, disclosure requirements, and restrictions on transactions with affiliates. In conclusion, though the compliance programs of institutional investment advisers and registered investment companies share a common goal of ensuring compliance with their respective laws and regulations, they differ in the specific requirements and focus areas to cater towards the distinct risks each type of entity encounters.

Accredited Investor Verification

As described in the previous regulatory subsection (Platform level), certain private offerings in the United States rely on Rule 506(c) of Regulation D to engage in general solicitation without triggering public offering requirements. In contrast to Rule 506(b), which does not allow general solicitation, Rule 506(c) imposes an additional requirement on relying issuers in the form of taking active steps to verify each investors accreditation status. Both the Poolit Imagine and Horizon Funds rely on this rule and therefore have compliance procedures in place for accredited investor verification. Please see our corresponding Product section for more operational detail.

Taxes

Being treated as a Regulated Investment Company (RIC) for U.S. federal income tax purposes offers several advantages, both for the RIC itself as well as the investors, including non-U.S. investors. Some key advantages are as follows:

Pass-through taxation

A RIC is not generally subject to corporate-level federal income tax. Instead, it "passes through" the income and gains to its shareholders, who are taxed on their share of the RIC's distributions. This avoids the double taxation issue typically faced by corporations and their shareholders.

Deduction of dividends

A RIC can deduct dividends paid to its shareholders, which prevents the company from being taxed on this portion of its income. As a result, the RIC only needs to distribute at least 90% of its investment company taxable income (ICTI) and net tax-exempt interest income to maintain its RIC status.

Capital gains and qualified dividend income

RIC shareholders are treated as though they directly realized their proportionate share of the RIC's capital gains and qualified dividend income. This allows individual investors to benefit from preferential tax rates on long-term capital gains and qualified dividend income, which can be lower than ordinary income tax rates.

Limited withholdings for non-U.S. investors

Non-U.S. investors in a RIC may benefit from reduced U.S. withholding taxes on certain types of income, such as interest and short-term capital gains. Additionally, tax treaties between the U.S. and the investor's country of residence could provide for reduced withholding rates or exemptions.

Form 1099 reporting

RICs must generally provide shareholders with a Form 1099 that reports the shareholder's portion of the RIC's distributions, capital gains, and other relevant tax-related items. This facilitates U.S. tax reporting for both U.S. and non-U.S. investors and simplifies compliance.
Before considering investment in a RIC, non-U.S. investors should carefully evaluate the potential advantages, taking into account their specific tax situation, applicable tax treaties, and any additional reporting requirements in their home country. Consulting with a tax professional is always recommended to ensure the appropriateness of the investment based on the investor's unique tax situation.

Governance & Service Providers

The board of directors plays a critical role in overseeing management and operations of RICs on behalf of their shareholders. As a fiduciary, the board is required to prioritize the interests of shareholders under both federal and state laws. The 1940 Act places particular emphasis on independent directors, who are tasked with monitoring potential conflicts of interest between the fund and its adviser. These independent directors must satisfy stringent requirements to ensure impartiality and transparency in their decision-making processes.
Mutual fund boards differ from corporate boards in their focus on the performance and potential conflicts of interest among advisers and other service providers. While their duties may overlap, they are separate entities, as mutual fund boards do not oversee the management and operations of the investment adviser itself.
Directors are entrusted with fiduciary duties to represent shareholders' interests, exercising loyalty and care in their decisions. Federal securities laws impose specific responsibilities on them, including the annual evaluation of the fund's contract with the adviser, oversight of fair valuation determinations, proxy voting, compliance functions, and fund disclosure.
Throughout the year, mutual fund boards meet regularly to review reports on fund matters and engage in fruitful discussions with the adviser, counsel, and others. An essential part of their role is to approve the adviser's fees, ensuring that it is a competitive, rather than the lowest possible rate, to achieve optimal performance. While the board can legally fire the fund's investment adviser, this action is rarely taken as it can be costly, disruptive, and imprudent. Instead, directors may urge the adviser to effect other changes, such as hiring a new portfolio manager or enhancing its services.
Despite the protective 'business judgment rule' reducing their liability, directors can still be held legally accountable for breaches of their fiduciary duties or misleading statements within the fund's prospectus.
Independent directors are crucial to maintaining the integrity of the mutual fund board. Practically, the majority of board seats are independent, with many fund complexes also adopting independent board chairs or independent lead directors. To further enhance independence and effectiveness, the SEC enforces governance standards and recommends that good governance practices be followed.
Boards generally meet quarterly, and many rely on committees for in-depth reviews and oversight. These practices demonstrate the significant role played by directors in achieving the best outcomes for the fund and its shareholders.