Congress is poised to eliminate the exemption in the Investment Company Act of 1940 (the 1940 Act) for investment companies located in Puerto Rico, the Virgin Islands, and other U.S. possessions. The 1940 Act governs investment companies, such as mutual funds, with the aim of protecting investors in those investment companies. Since its enactment, the 1940 Act has exempted investment companies located in U.S. possessions, apparently due to the challenges the Securities and Exchange Commission would have faced in administering the 1940 Act in remote territories at the time. That may be about to change.

On July 11, 2016, upon the unanimous support of the House Committee on Financial Services, the U.S. House of Representatives passed H.R. 5322: the U.S. Territories Investor Protection Act of 2016. H.R. 5322 would strike Section 6(a)(1) of the 1940 Act, which exempts U.S. possessions from the 1940 Act’s scope.

On the House floor, before the vote, the bill’s sponsor, Nydia Velazquez (D-NY), explained that “[a]s a result of this exemption, investment companies located in U.S. territories can sell products to the residents and not be subject to the oversight, disclosure, and conflict-of-interest requirements that such companies located in the mainland U.S. are subject to. The outcome is that those located in the U.S. territories have been subject to investment losses, some resulting from behavior that likely would have been prohibited if the act applied to the island’s investment companies.” Rep. Velazquez went on to highlight the importance of extending the 1940 Act’s reach to Puerto Rico, stating that federal oversight is critical in light of the current fiscal crisis.

Significantly, H.R. 5322 would provide a three-year safe harbor period to allow investment companies time to comply with the 1940 Act.

H.R. 5322 now goes to the Senate for consideration.

Should the U.S. Territories Investor Protection Act of 2016 become law, investment companies located in Puerto Rico, the Virgin Islands, and other U.S. possessions will face significant new legal and regulatory challenges. It will be important for those investment companies to promptly seek the counsel of experienced 1940 Act practitioners at the beginning of the three-year safe harbor period to make the necessary changes to comply with the 1940 Act.