Definition
The Investment Company Act of 1940 (15 U.S.C. §§ 80a-1 et seq.) regulates companies that engage primarily in investing, reinvesting, or trading in securities — what are commonly called mutual funds, ETFs, closed-end funds, and other pooled investment vehicles. Under Section 3(a)(1) of the Act, a company is an “investment company” if it is engaged primarily in the business of investing in securities, or if it owns or proposes to acquire “investment securities” worth more than 40% of its total assets (excluding US government securities and cash). Investment companies must register with the SEC, comply with comprehensive investor protection requirements (including restrictions on leverage, affiliated transactions, and management compensation), provide detailed periodic disclosures to investors, and operate under the oversight of a board of directors with specific independence requirements. Failure to register as an investment company when required is a violation of federal law.
The Act’s reach extends directly to tokenized fund structures: any pooled investment vehicle that holds financial assets — tokenized Treasuries, tokenized private equity, tokenized bonds — on behalf of investors and meets the 40% investment securities threshold must either register as an investment company or qualify for one of the Act’s exemptions. The most important exemptions for tokenized funds are Section 3(c)(1), which exempts funds with 100 or fewer beneficial owners who do not make public offerings, and Section 3(c)(7), which exempts funds whose securities are owned exclusively by “qualified purchasers” and which do not make public offerings. These exemptions determine the investor base, structural constraints, and compliance requirements for the tokenized fund market.
Key Facts
- BlackRock’s BUIDL (BlackRock USD Institutional Digital Liquidity Fund) operates as a 3(c)(7) fund, requiring all investors to be qualified purchasers with a minimum $5 million investment — enabling the fund to avoid Investment Company Act registration while holding tokenized US Treasury securities.
- Franklin Templeton’s FOBXX (Franklin OnChain US Government Money Fund), by contrast, is a registered investment company under the 1940 Act — one of the first mutual funds to record share ownership on a public blockchain (Stellar, then Polygon).
- The 3(c)(1) exemption limits a fund to 100 beneficial owners, which makes it unsuitable for widely distributed tokenized funds seeking mass institutional participation.
- The 3(c)(7) exemption has no cap on the number of investors but requires every investor to be a “qualified purchaser” ($5M+ in investments for individuals, $25M+ for entities) — a higher standard than accredited investor.
- An “investment company” must register on Form N-1A (open-end fund), Form N-2 (closed-end fund), or Form N-14 (business development company), each with extensive disclosure and governance requirements.
- The SEC’s Division of Investment Management has not issued specific guidance on how 1940 Act requirements apply to tokenized fund share ownership, creating uncertainty about whether blockchain-based transfer records satisfy traditional transfer agent recordkeeping requirements.
- Arca Labs received an SEC exemption in 2020 to issue tokenized shares of its Arca US Treasury Fund on the Ethereum blockchain, operating as a registered closed-end interval fund under the 1940 Act — demonstrating that full registration is achievable, though complex.
Relevance to Tokenization
The Investment Company Act of 1940 is the primary regulatory framework governing the most significant category of tokenized assets in the institutional market: tokenized money market funds and short-duration bond funds. The success of BUIDL ($500M+ AUM within months of launch), FOBXX, and similar products demonstrates that the 1940 Act framework can accommodate blockchain-based share issuance and transfer when structured appropriately, but the choice between registered fund status and exempt status has profound implications for the addressable investor market and the operational structure of the tokenized fund.
The 3(c)(7) exemption used by BUIDL and most institutional tokenized fund products restricts participation to qualified purchasers — a wealthy, institutionally sophisticated subset of the market representing a small fraction of the total investor population. This restriction aligns with where institutional demand is strongest and where regulatory complexity is most manageable, but it limits the democratization narrative that tokenization advocates emphasize. A tokenized Treasury fund using 3(c)(7) cannot be sold to individual retail investors, college savings accounts, or small pension funds — the investor populations that most need access to efficient, low-cost money market alternatives.
Franklin’s FOBXX demonstrates that registered 1940 Act fund status is achievable with blockchain-based share records, but at the cost of ongoing regulatory compliance that rivals that of traditional mutual funds. The SEC has not streamlined the 1940 Act framework for tokenized funds, meaning that registered tokenized funds must comply with the same proxy voting, prospectus delivery, redemption period, and leverage restriction rules as non-tokenized funds — negating some of the efficiency advantages of blockchain-based architecture. Future regulatory reform efforts should focus on creating a streamlined 1940 Act registration pathway for tokenized funds that preserves investor protections while allowing blockchain-native mechanics like programmable distributions and automated compliance.
Related entries: Qualified Purchaser, Accredited Investor, Real-World Assets (RWA)