Securities Law Considerations for Investment Fund Formation: Part 1


Investment fund formation is the comprehensive process of establishing a collective investment vehicle that pools capital from multiple investors to engage in various securities or other financial asset investments. The primary goal is to provide investors with a professionally managed portfolio often designed to provide diversification, but equally as often to deploy funds into a specific asset class, or according to a particular investing philosophy, strategy, or methodology.

This process involves several key steps and considerations. At the outset, the structural design of the fund needs to be determined, including its legal structure and the selection of an appropriate jurisdiction for regulatory and tax purposes. This foundational step sets the framework for the fund’s operations together with initial and ongoing compliance.

Regulatory compliance is another critical aspect of fund formation. Investment funds are among one of the most tightly regulated industry sectors, governed by a swath of regulations set forth by various regulatory entities. Notable among these are the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), both wielding significant influence over the industry’s operational landscape.

Different types of funds are subject to varying degrees of regulatory oversight, necessitating careful consideration of legal requirements and potential exemptions.

This article is for potential or current sponsors and managers of private funds aiming to initiate a new fund or revamp their current fund structures.

Defining Investment Funds

An investment fund is ultimately a financial product that consolidates capital from multiple investors, utilizing it to acquire assets whether that be a diversified portfolio of securities, real estate, or loans. The primary objective is often to achieve above-market returns compared to traditional investment avenues, but may also be to achieve a consistent rate of return while limiting downside risk.

In operation, investment funds aggregate funds from numerous investors, employing the capital to build a portfolio comprising stocks, bonds, commodities, and alternative investments like real estate and venture capital. Although investors own individual shares, they lack influence over the fund’s investment decisions. A professional manager oversees the portfolio, making choices based on the fund’s objectives and strategy, determining which assets to buy or sell, and when to do so.

Three major fund categories are prominent in the market:

Mutual Funds:

  • Pool funds from numerous investors to create a diversified portfolio of stocks, bonds, and other securities.
  • Traded once a day and designed for longer-term investors.
  • Investors receive profits in the form of dividends and capital gains.

Exchange-Traded Funds (ETFs):

  • Similar to mutual funds but traded like stocks on exchanges.
  • Offer diversification, often at lower costs than traditional mutual funds.
  • Can be traded at any point during the trading day.

Hedge Funds:

  • Private, actively managed investment vehicles with aggressive strategies.
  • Use tactics like short selling, arbitrage, leverage, and derivatives.
  • Typically only available to accredited investors and/or qualified purchasers due to high risk and complexity.

Investment funds can be open-ended or closed-ended. Open-ended funds can issue and redeem shares at any time, while closed-ended funds issue a fixed number of shares traded in the market.

Further categorization includes public and private, as well as actively and passively managed funds. Publicly-traded funds offer a diverse selection of assets and are bought and sold on stock exchanges. Private investment funds, traditionally set up as limited partnerships but currently more often set up as limited liability companies, are managed by professionals and tend to be less liquid, requiring larger minimum investments. Actively managed funds involve the fund manager’s active decision-making and execution on strategies, while passively managed funds aim to track a specified benchmark without requiring constant management.

Regulatory Landscape

Understanding the regulatory framework on which investment fund formation is built is essential for private fund sponsors and managers.

The Securities Act of 1933

The Securities Act of 1933, often known as the “Securities Act” or “33’ Act”, serves dual objectives:

  • Disclosure Requirement: It mandates that investors receive comprehensive financial and other pertinent information about securities offered for public sale.
  • Anti-Fraud Provision: The Securities Act aims to prohibit deceit, misrepresentations, omissions, and outright fraud in both the offering and sales of securities.

Requiring disclosure of material information is the primary mechanism the Securities Act imposes to achieve its goals.  Access to and provision of crucial information is intended to empower investors to make informed decisions regarding the purchase of a company’s securities.

One way in which the Securities Act seeks to ensure disclosure of critical information is through registration of securities intended to be offered and sold to the public.  A key component of the Securities Act, the registration process necessitates the disclosure of essential facts through a highly regulated formal process and documentation. Accuracy of information disclosed in the registration process and documentation is not only expected but demanded by statute, regulation and case-law; however, the Securities and Exchange Commission (SEC) does not qualify or offer any guarantee on information provided in registered offerings or subsequent reporting arising after the fact. Investors experiencing losses due to incomplete or inaccurate disclosure have recovery rights, provided they can substantiate the lack of vital information.

Registration forms filed by companies are designed to furnish essential facts, minimizing the burden of compliance with the law. Generally, these forms include:

  1. A description of the company and its business.
  2. Details about the security offered for sale.
  3. Information concerning the company’s management.
  4. Disclosure of risks associated with the company, its business, and the offering itself.
  5. Financial statements certified by independent accountants.

Registration statements and prospectuses become public shortly after filing with the SEC, accessible on the EDGAR database at for U.S. domestic companies. These statements undergo scrutiny to ensure compliance with disclosure requirements.

However, not all security offerings are required to undergo SEC registration. Several exemptions exist, including:

  • Private offerings to a limited number of individuals or institutions.
  • Offerings of limited size.
  • Intrastate offerings.
  • Securities issued by municipal, state, and federal governments.

These exemptions, particularly for small offerings, aim to foster capital formation by reducing the cost of offering securities to the public.

The Investment Company Act of 1940

The Investment Company Act of 1940 (ICA) defines an “investment company” as an issuer primarily involved in the business of investing, reinvesting, or trading securities. It explicitly prohibits any engagement in buying and selling securities without SEC registration or a valid exemption. Hedge funds and comparable pooled investment vehicles fall under this definition, compelling registration unless specific exemption criteria are met.

When considering offshore funds looking to market their securities to U.S. investors or within the United States, strict adherence to the ICA becomes imperative. The ICA restricts offshore funds from conducting a public offering in the U.S. through U.S. jurisdictional means without an SEC-issued order allowing registration. In practice, this requirement often leads offshore funds to structure themselves as registered investment companies, a step that has presented challenges for many in obtaining the necessary SEC order.

Two critical provisions of the ICA, Section 3(c)(1) and Section 3(c)(7), serve as the primary avenues for registration exemption for hedge funds, venture capital funds, private equity funds, and similar pooled investment vehicles.

In Part 2 of Securities Law Considerations for Investment Fund Formation, Mr. Leander will cover SEC Registered Funds, Exemptions and Regulatory Considerations for Investment Fund Formation.

Jacko Law Group, PC has extensive experience in Investment Fund Formation and regulatory compliance to ensure clients’ efforts are successful and meet the requirements of regulatory bodies. Get in touch with our legal team today by calling 619.298.2880 or emailing

Author: Eric M. Leander, Senior Attorney, Jacko Law Group, PC (“JLG). JLG works extensively with investment advisers, broker-dealers, investment companies, private equity and hedge funds, banks and corporate clients on securities and corporate counsel matters. For more information, please visit

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