USA Law and Practice Contributed by: Bill Sturman, Matthew Holt, Steven Starr and Cliff Cone, Clifford Chance
mums. Mutual funds qualify for “pass-through” tax treatment, meaning that there is no taxation of the entity itself. Each mutual fund typically has an investment adviser registered under the Advisers Act, as well as a principal underwriter that is registered under the Exchange Act and is a FINRA member. Exchange-traded funds, in contrast to mutu - al funds, trade intraday on listed securities exchanges. Authorised participants are financial institutions that buy and sell an ETF’s shares at net asset value (NAV) in large quantities known as creation units. Authorised participants then redeem creation units in kind for a part of the ETF portfolio. The price of ETF shares is deter - mined by both its NAV and supply and demand. Mutual funds and exchange-traded funds may not have more than 15% of assets invested in illiquid securities. Common legal vehicles for mutual funds and ETFs are limited liability com - panies, limited partnerships, business or statu - tory trusts, and corporations. A main advantage of open-end funds is that they often have smaller minimum investments and are generally liquid. However, as a result of allowing investors to redeem their shares at will (hence the high liquidity), a downturn in the mar - ket may cause the fund to sell at lower prices to cover the redemptions. Closed-End Funds Closed-end funds do not issue redeemable securities. The traditional closed-end fund typi - cally offers a fixed number of shares in an initial public offering whose price is determined by supply and demand. In addition to the tradition - al model for closed-end funds, other types of closed-end funds include interval funds, tender
offer funds, and business development compa - nies (BDCs). Interval funds and tender offer funds are not generally traded on a listed exchange. Inter - val funds offer shares continuously at NAV and repurchase their own shares periodically. Tender offer funds also offer their shares continuously at NAV but are not mandated to repurchase shares and only do so when authorised by the fund’s board of directors. BDCs, while not registered under the Investment Company Act, generally elect to be regulated pursuant to certain pro - visions thereunder. BDCs are designed to pro - vide capital to middle-market companies in the United States and their shares may be traded on- or off-exchange. BDCs generally offer profit- sharing compensation to management and may use more leverage than other funds registered under the Investment Company Act. Unlike open-end funds, closed-end funds are not subject to the 15% limit on investing in illiq - uid securities. Closed-end funds are also permit - ted to issue preferred shares and are more likely to utilise leverage compared to open-end funds. A disadvantage of closed-end funds is that their share prices are subject to fluctuations in the market and, due to their increased use of lever - age, may be susceptible to greater losses in the event of a market downturn. Unit Investment Trusts UITs are passive vehicles without a board of directors which have a predetermined maturity. When a UIT reaches the end of its term, the fund is terminated, and its assets are sold off. Some ETFs, such as the first ETF established in 1993, qualify as UITs. UITs are advantageous for rais - ing capital efficiently for a specific purpose. A potential disadvantage is that should the trust
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