Retail funds

Available vehicles

What are the main legal vehicles used to set up a retail fund? How are they formed?

US law does not require registered funds to be organised using a particular corporate form. In practice, registered funds are typically organised under state law as Massachusetts business trusts, Delaware statutory trusts or Maryland corporations. In addition, the 1940 Act requires registered funds to establish a board of directors or trustees (the board).

Laws and regulations

What are the key laws and other sets of rules that govern retail funds?

The 1940 Act and the 1933 Act, and the rules thereunder, primarily govern registered funds and the public offering of their securities. In addition, the SEC has issued no-action letter guidance and interpretive statements and publications clarifying the application of these laws and rules. Investment advisers to registered funds are subject to the Advisers Act and the rules and guidance thereunder.

Registered exchange-listed closed-ended funds and open-ended exchange-traded funds (ETFs) are also subject to the listing and trading rules of the relevant exchange.


Must retail funds be authorised or licensed to be established or marketed in your jurisdiction?

Registered funds must be registered under the 1940 Act. To market or sell their securities in a public offering, registered funds must also register their securities under the 1933 Act and comply with applicable requirements. Additionally, mutual funds and non-exchange listed closed-ended funds generally must file state sales reports indicating the value of securities sold or offered in the state and must pay associated state filing fees.


Who can market retail funds? To whom can they be marketed?

Registered funds are principally marketed by broker-dealers, although banks and insurance companies may also distribute registered fund shares.

Shares of registered open-ended funds (except ETFs) may be offered and sold to any investor. Registered closed-ended funds listed on an exchange are typically offered to investors via an initial public offering where broker-dealers act as underwriters to the publicly offered shares.

ETF shares are only sold to certain broker-dealers who are authorised participants in large blocks known as creation units. The authorised participants then sell individual ETF shares on an exchange.

Managers and operators

Are there any special requirements that apply to managers or operators of retail funds?

An investment adviser to a registered fund generally must be registered with the SEC under the Advisers Act. A registered fund, and, in practice, its investment adviser, must also maintain policies and procedures to comply with the requirements of the 1940 Act, including a code of ethics. In addition, a registered fund must have a written investment advisory agreement with an investment adviser, and the agreement must be approved at least annually by the fund’s board.

Investment and borrowing restrictions

What are the investment and borrowing restrictions on retail funds?

Fundamental investment policies

A registered fund’s registration statement must recite the fund’s fundamental investment policies with respect to certain types of investments and investment practices, and the fund cannot deviate from these policies without a shareholder vote. Fundamental investment policies include:

  • diversification (ie, whether a registered fund will operate as a diversified or non-diversified fund);
  • concentration in a particular industry or group of industries;
  • policies around borrowing money and the issuance of senior securities;
  • underwriting;
  • making loans; and
  • investing in commodities or real estate.

To be considered diversified, at least 75 per cent of a registered fund’s total assets must be represented by cash, government securities, securities of other investment companies and securities of other issuers, subject to certain additional restrictions.

Non-fundamental investment policies

In addition to fundamental investment policies, a registered fund may adopt non-fundamental investment limitations, which may be changed by the fund’s board without shareholder approval. Common non-fundamental investment policies include ‘names rule’ policies and policies regarding a registered fund’s investments in illiquid securities (as described below).

Names rule policy

Under the 1940 Act, a registered fund that has a name suggesting that the fund focuses its investments in a particular type of investment or in a particular industry must adopt a policy to invest, under normal circumstances, at least 80 per cent of the value of its assets in the particular type of investments suggested by the fund’s name. Likewise, if a registered fund’s name suggests that the fund focuses its investments in a particular country or geographic region, at least 80 per cent of the value of its assets must be invested in assets that are tied economically to the particular country or geographic region.

Illiquid securities

In 2016, the SEC adopted a new liquidity rule, which codified a requirement pursuant to which a registered open-ended fund may not invest more than 15 per cent of its net assets in illiquid investments (ie, investments that cannot be sold in seven calendar days or less without the sale significantly changing the market value of the investment). This 15 per cent limit on illiquid investments applies also to ETFs but does not apply to money market funds and registered closed-ended funds. Compliance with the codified 15 per cent limit on illiquid investments has been effective for larger entities as of 1 December 2018 and will be effective for smaller entities on 1 June 2019. In the meantime, smaller entities are required to comply with the SEC staff-imposed 15 per cent limit on investments in illiquid assets (the liquidity rule includes a somewhat different definition of what qualifies as an illiquid investment).


A registered open-ended fund may borrow money, provided that the borrowing is from a bank and the fund has asset coverage at least equal to 300 per cent of such borrowings. A registered closed-ended fund may borrow money from a bank or from a private source, and must also meet the asset coverage limitation of 300 per cent. A registered closed­ended fund may also issue preferred shares, subject to a 200 per cent asset coverage limitation.

Generally, a senior security is any security or obligation that has priority over any other class to a distribution of assets or payment of a dividend. Certain financing and derivative transactions such as reverse repurchase agreements, short sales, options, forwards and futures, can create economic and legal exposures that are similar in some respects to the issuance of senior securities. To address this concern, the SEC and its staff have generally taken the position that these transactions will not be subject to the limitations on borrowing and issuing senior securities if a registered fund segregates liquid assets sufficient to meet its future obligations arising from such transactions.

Tax treatment

What is the tax treatment of retail funds? Are exemptions available?

The tax treatment of registered funds is governed by the US Internal Revenue Code (IRC). Under the IRC, registered funds receive pass­through tax treatment, meaning that the fund itself is not subject to US federal income tax, but rather that income and capital gains are passed through to the fund’s investors. To qualify as a regulated investment company, and therefore receive pass-through tax treatment, a fund must meet certain eligibility requirements.

Asset protection

Must the portfolio of assets of a retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?

The assets of a registered fund must be held by a qualified custodian under conditions designed to assure the safety of the fund’s assets. Assets may also be posted to a futures commission merchant to support trading futures and swaps, or held by a foreign custodian that segregates fund assets from its proprietary assets.


What are the main governance requirements for a retail fund formed in your jurisdiction?

All registered funds must establish a board of directors or trustees. At least 40 per cent of the board members must be independent; however, to take advantage of many exemptive rules under the 1940 Act a majority of the board’s members must be independent. The board retains overall responsibility for the operation of the fund, which specifically includes the review and approval of the fund’s advisory contract or contracts, underwriting agreements, distribution plans and related agreements, the selection of the fund’s independent auditors and oversight of potential risks and conflicts faced by the fund. Although the board is not involved in the day-to-day management of the fund, it is also responsible for approving the fund’s compliance policies and procedures.

All registered funds must designate an individual as chief compliance officer (CCO). The CCO is tasked with administering the fund’s compliance policies and procedures and must have sufficient authority to compel others to adhere to them. The CCO reviews the adequacy and application of the compliance policies and procedures, and provides an annual written report to the fund’s board.


What are the periodic reporting requirements for retail funds?

Registered funds must maintain registration statements with the SEC, as discussed in question 3, and are also required to file periodic reports including annual and semi-annual shareholder reports with the following detailed financial information:

  • Form N-CSR: disclosure of a fund’s complete portfolio holdings required within 10 days of delivery of any semi-annual or annual shareholder report;
  • Form N-PX: annual disclosure of the proxy record for all portfolio securities; and
  • Form N-MFP: monthly disclosure of portfolio holdings and other information required for money market funds.

In 2016, the SEC imposed extensive new disclosure and reporting obligations for most registered funds. In addition to amending existing forms, the SEC adopted three new forms:

  • Form N-PORT: portfolio-wide and position-level disclosure of monthly holdings data filed quarterly;
  • Form N-CEN: census-type disclosure filed annually; and
  • Form N-LIQUID: confidential disclosures required by the Liquidity Rule upon certain triggering events.
Issue, transfer and redemption of interests

Can the manager or operator place any restrictions on the issue, transfer and redemption of interests in retail funds?

Registered open-ended funds (except ETFs) may set minimum investment requirements. Minimum investment requirements are typically related to the type of investor the fund intends a share class to be sold to (eg, shares with a higher minimum will typically be marketed or sold to high net worth individuals or institutional investors). Although a share class may have a distinct investment minimum and certain expenses may vary by share class, all share classes of a fund must charge the same advisory fee. In addition, a registered fund’s board may adopt a policy of not selling shares to certain investors whose ownership in the fund may be disruptive to the fund’s operations (eg, market timers that exploit pricing inefficiencies).

A registered fund generally must pay redemption proceeds to a shareholder within seven days of receiving the redemption request. Exceptions exist in certain instances (eg, when the SEC issues an order delaying redemptions to protect shareholders in the fund). Registered funds are permitted to charge a redemption fee when shareholders redeem; however, the SEC has limited the fee to 2 per cent.

Registered closed-ended funds do not issue redeemable securities.