Investment Companies: General Characteristics

An investment company is a business entity whose primary function is to invest in and issue securities. It collects money from multiple clients and invests the money in a pool of securities, whose profits and losses are then shared in proportion to the clients’ ownership share of that pool. In this way, investment companies offer securities investors an economical way to diversify risk. Investment company shares are also known as packaged securities, since the investment company is essentially buying securities and “packaging” them into new securities that offer investors a pro rata share of the packaged security.

An investment company differs from other issuing companies in that the securities it issues are also its product. For example, General Motors issues its securities to fund the manufacture of cars and trucks. A broker-dealer will issue securities to fund the buying and selling of securities issued by others. An investment company, in other words, is primarily engaged in the business of trading its own securities.

Any issuing company that holds more than 40% of its total assets in securities (excluding government securities and cash) is subject to regulation under the Investment Company Act. Brokerage firms do not fall under this definition, because the securities they hold are owned by their customers, making the securities a liability of the firm, not an asset.

The Investment Company Act defines three types of investment companies: face-amount certificates, unit investment trusts, and management companies. Face-amount certificate companies issue debt securities to their investors, called face-amount certificates. The certificates are generally