An investment company (a "fund") generally is an entity that pools investors' funds to provide them with the advantages of professional investment management and diversification of ownership in the securities markets. Typically, an investment company sells its capital shares to the public and invests the net proceeds in a broad range of stocks, bonds, government obligations or other securities intended to meet the fund's stated investment objectives. The term "investment company" may refer to both registered and non-registered entities. The definition of an investment company can be found in ASC 946-10-15-4 through 15-9.
ASC 946 and the AICPA Audit and Accounting Guide: Investment Companies (the "Audit Guide") provide detailed guidance regarding many issues, including the practices discussed below. Through many years of auditing investment companies, the firm has addressed numerous industry specific accounting issues.
Below is a summary of some common types of investment companies.
Closed-End Funds
A closed-end fund is an investment company that does not stand ready to redeem its outstanding shares. It can, however, offer its shares to the public at its discretion. Its shares are traded similarly to those of other public corporations.
Offshore Funds
Offshore funds may be described generally as investment funds set up to permit international investments with minimum tax burden on the fund shareholders. This is achieved by setting up the fund in countries with favorable tax laws as well as countries with non-burdensome administrative regulations and/or countries where there is greater latitude in selecting the generally accepted accounting principles and practices to be followed in the preparation of financial statements. Popular offshore locations include Bermuda, the Cayman Islands, the Channel Islands, Dublin, Luxembourg, Mauritius, and the Netherlands Antilles.
Investment Partnerships
Common types of investment partnerships include hedge funds, venture capital funds, and private equity funds. The term "hedge funds" has become a generic industry term for an investment partnership (or other non-registered investment company), although this may be a misnomer depending on the partnership's investment strategy. Investment partnerships must meet certain requirements in order to avoid registration under the Investment Company Act of 1940 ("1940 Act") as a regulated investment company ("RIC"). Also, they are generally not subject to the Internal Revenue Code rules and regulations that apply to RIC's.
Commodity Pools
A commodity pool is an investment vehicle that may be structured as a partnership, limited liability company or similar form of enterprise for the purpose of making investments in the commodities markets, i.e., trading in commodity futures, options, and options on futures (either directly or through another commodity pool). Commodities generally include grains, petroleum products, metals, livestock, foreign currencies and financial instruments.
Commodity pools are organized by commodity pool operators ("CPOs" or "sponsors") and are advised by commodity trading advisors ("CTAs"). CPOs may also be the CTAs or there may be two (or more) unrelated entities.
Commodity pools are subject to oversight by the U.S. Commodity Futures Trading Commission ("CFTC"), subject to limited exemptions, and the CPO must register with, and be a member of, the National Futures Association ("NFA"). The CFTC regulations are available at cftc.gov under Title 17 Chapter I of the Code of Federal Regulations (CFR). The NFA regulations are available at www.nfa.futures.org.
Part 4 of the CFTC rules detail the periodic reporting requirements applicable to commodity pools, as well as the related exemptions from certain disclosure, reporting and recordkeeping requirements. The CFTC has been on record to say that even if you are in liquidation you still need all of the required statements in accordance with CFTC regulations.
The NFA is a self-regulatory body that incorporates certain of the CFTC's rules and regulations as they pertain to commodity pools, CPOs and CTAs. The NFA's primary responsibility is to assure high standards of professional conduct and financial responsibility on the part of the individuals and organizations that conduct futures business. Its members include CPOs, CTAs and futures commission merchants ("FCMs"), introducing brokers, and other associated persons.
The NFA conducts periodic audits of its members’ financial and other records, monitors sales practices, and provides arbitration of futures-related disputes. The NFA is also responsible for the processing of applications by some futures organizations for registration with the CFTC. Under CFTC and NFA rules, CPOs are required to file one copy of a commodity pool’s annual report with the NFA and are no longer required to file copies of such reports with the CFTC as was the previous practice. Filing instructions are noted on NFA's website at https://www.nfa.futures.org/NFA-electronic-filings/easyFile-Pool-filers.HTML.
Commodity Exchange Traded Funds
Certain exchange-traded funds (ETF’s) that invest solely in physical commodities (such as gold bullion) file reports under the 1933 Act and the 1934 Act. Physical commodities do not qualify as "securities" as defined by the Investment Company Act of 1940, which prevents such ETF's from qualifying as 1940 Act Investment Companies.
However, as part of discussions with the SEC, it is our understanding that the Staff believes that an exchange- traded fund that solely holds physical commodities generally qualifies as an investment company under ASU 2013-08. The SEC does not consider the fact that the ETF solely holds physical commodities and lacks trading would preclude the ETF from qualifying as an investment company and likely would require the ETF to be an investment company. To the extent such a fund did not report as an investment company previously, this would have resulted in a change in reporting upon adoption of ASU 2013-08. Upon qualifying as an investment company under ASU 2013-08, the ETF would be required to prospectively measure its investment in physical commodities at fair value in accordance with industry guidance, which is different from the accounting treatment under ASC 330, Inventory.
Engagement teams should not analogize this interpretation to any fact pattern other than an exchange traded fund that holds physical commodities.
Small Business Investment Corporation ("SBIC")
An SBIC is an investment company which, through a license from the Small Business Administration (SBA), is able to borrow funds or obtain loan guarantees from the SBA. Leverage opportunities available to the owners of SBICs are not available to other investment companies. SBICs, by statute, may borrow from the Small Business Administration (SBA), often at advantageous rates, up to two or three times their paid-in capital. SBICs are typically organized under the Small Business Investment Act of 1958 and generally provide venture capital, chiefly in the form of long-term loans or equity financing, to qualified small businesses. As the ultimate realization of these investments is subject to many indeterminate long-range factors, this type of investment should generally be regarded as having higher inherent risk relating to the valuation assertion. While many SBIC investments will mature and appreciably increase in value, it should be recognized that there will also be numerous situations where the loss rate may be high.
Business Development Corporation ("BDC")
The Small Business Investment Incentive Act of 1980 (the "1980 Amendments") amended the 1940 Act by establishing a new system of SEC regulation for certain investment companies called BDCs. BDCs are registered under the 1933 Act; they also may elect to report in accordance with the 1940 Act. Periodic financial reporting requirements are in accordance with the 1934 Act (i.e., Forms 10-K, 10-Q, and 8-K) instead of the 1940 Act. BDCs are also subject to the internal control reporting requirements of Sarbanes-Oxley Act Section 404.
A BDC a U.S. closed-end company in the business of investing and trading securities; however, it also makes available significant managerial assistance to the issuers of such securities. RICs are passive investors while BDCs are required to offer technical or management assistance to investees as needed or requested.
In the past few years, there has been rapid growth in the number of BDCs and their assets under management. Additionally, we are aware that the SEC staff has been closely reviewing BDC financial reports and operating practices, and they have indicated that their reviews have revealed a number of reporting and compliance issues. The SEC has focused on adequacy of disclosures related to S-X 3-09 and S-X 4-08(g) reprinted at SEC 4900. These rules require information be presented for certain unconsolidated subsidiaries. Refer to SEC IM Guidance Update No. 2013-07, which is available on the SEC's website.
The SEC has also provided comments regarding registrants’ policy of consolidating "blocker entities." The SEC has suggested that BDCs consolidate wholly-owned and substantially wholly-owned subsidiaries such as blocker entities and holding companies, as these entities may act as an extension of the BDC. For additional information, refer to SEC IM Guidance Update No. 2014-11, which is available on the SEC's website.
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