Open-End Fund

The SEC's guide defines a closed-end fund as a type of investment company that does not continuously offer its shares for sale but instead sells a fixed number of shares at one time, in the initial public offering, which then typically trade on a secondary market, such as the New York Stock Exchange or the Nasdaq Stock Market.

The Investment Company Act of 1940 classifies investment companies in sections 4 and 5. Section 4 provides that, for the purposes of the subchapter, investment companies are divided into three principal classes: face-amount certificate companies, unit investment trusts and management companies. It defines a management company as any investment company other than a face-amount certificate company or a unit investment trust, and it defines a unit investment trust as an investment company which is organized under a trust indenture, contract of custodianship or agency, or similar instrument, does not have a board of directors, and issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities, but does not include a voting trust. Section 5, titled Subclassification of management companies, then defines an open-end company in paragraph (a)(1) and, in paragraph (a)(2), defines a closed-end company as any management company other than an open-end company.

Redeemable Securities

The definition of an open-end company depends on the term redeemable security. Section 2(a)(32) of the Investment Company Act of 1940 defines a redeemable security as any security, other than short-term paper, under the terms of which the holder, upon its presentation to the issuer or to a person designated by the issuer, is entitled, whether absolutely or only out of surplus, to receive approximately his proportionate share of the issuer's current net assets, or the cash equivalent thereof.

The SEC's guide states that mutual funds issue redeemable shares that investors purchase directly from the fund, or through a broker for the fund, instead of purchasing from investors on a secondary market. Investor.gov states that mutual fund shares are redeemable.

How Open-End Funds Sell and Redeem Shares

FINRA states that the mutual fund raises money by selling its own shares to investors. It states that one of the key distinguishing features of a mutual fund is that investors can buy and sell shares at any time, and that the fund will create new shares to meet increased demand and buy back shares from investors who want to sell.

The SEC's guide states that investors in mutual funds buy their shares from, and sell or redeem their shares to, the mutual funds themselves, and that mutual fund shares are typically purchased from the fund directly or through investment professionals like brokers.

FINRA states that sometimes mutual funds get so large that they close to new investors. It states that even if a mutual fund is closed, it still remains an open-end fund since existing shareholders can continue to buy and sell fund shares.

The Structure of an Open-End Fund

The SEC's guide states that most funds and exchange-traded funds are managed by investment advisers who are registered with the SEC. It states that operating expenses are ongoing mutual fund and exchange-traded fund costs such as investment advisory fees for managing the fund's holdings, marketing and distribution expenses, as well as custodial, transfer agency, legal, and accountant's fees.

Section 10(a) of the Investment Company Act of 1940 provides that no registered investment company shall have a board of directors more than 60 percent of the members of which are persons who are interested persons of such registered company.

Section 17(f)(1) of the Act provides that every registered management company shall place and maintain its securities and similar investments in the custody of (A) a bank or banks having the qualifications prescribed in paragraph (1) of section 26(a) of the Act for the trustees of unit investment trusts; or (B) a company which is a member of a national securities exchange as defined in the Securities Exchange Act of 1934, subject to such rules and regulations as the Commission may from time to time prescribe for the protection of investors; or (C) such registered company, but only in accordance with such rules and regulations or orders as the Commission may from time to time prescribe for the protection of investors.

Section 2(a)(29) of the Act defines a principal underwriter of or for any investment company other than a closed-end company, or of any security issued by such a company, as any underwriter who as principal purchases from such company, or pursuant to contract has the right (whether absolute or conditional) from time to time to purchase from such company, any such security for distribution, or who as agent for such company sells or has the right to sell any such security to a dealer or to the public or both, but states that the term does not include a dealer who purchases from such company through a principal underwriter acting as agent for such company.

The SEC's page on transfer agents states that transfer agents record changes of ownership, maintain the issuer's security holder records, cancel and issue certificates, and distribute dividends.

Diversified and Non-Diversified Funds

Section 5(b) of the Investment Company Act of 1940 is titled Diversified and non-diversified companies. Paragraph (b)(1) provides that a diversified company is a management company which meets the following requirements: at least 75 percent of the value of its total assets is represented by cash and cash items (including receivables), Government securities, securities of other investment companies, and other securities for the purposes of this calculation limited in respect of any one issuer to an amount not greater in value than 5 percent of the value of the total assets of such management company and to not more than 10 percent of the outstanding voting securities of such issuer. Paragraph (b)(2) provides that a non-diversified company is any management company other than a diversified company.

Pricing at Net Asset Value

The SEC's guide states that mutual funds are required by law to price their shares each business day and that they typically do so after the major U.S. exchanges close. It describes the price as the per-share value of the mutual fund's assets minus its liabilities, called the NAV or net asset value, and states that mutual funds must sell and redeem their shares at the NAV that is calculated after the investor places a purchase or redemption order. It states that when an investor places a purchase order for mutual fund shares during the day, the investor will not know what the purchase price is until the next NAV is calculated. Its glossary states that SEC rules require mutual funds and exchange-traded funds to calculate the NAV at least once daily.

FINRA states that mutual funds calculate the value of one share, known as the net asset value, only once a day, when the investment markets close, and that all purchases and sales for the day are recorded at that NAV. To figure its NAV, according to FINRA, a fund adds up the total value of its investment holdings, subtracts the fund's fees and expenses, and divides that amount by the number of shares that investors are currently holding.

SEC Rule 22c-1 under the Investment Company Act of 1940 is titled Pricing of redeemable securities for distribution, redemption and repurchase. Paragraph (a) provides that no registered investment company issuing any redeemable security, no person designated in the issuer's prospectus as authorized to consummate transactions in any such security, and no principal underwriter of, or dealer in, any such security shall sell, redeem, or repurchase any such security except at a price based on the current net asset value of the security which is next computed after receipt of a tender of the security for redemption or of an order to purchase or sell the security. Paragraph (b)(1) provides that the current net asset value of any such security shall be computed no less frequently than once daily, Monday through Friday, at the specific time or times during the day that the board of directors of the investment company sets, in accordance with paragraph (d), except on the days listed in paragraphs (b)(1)(i) through (b)(1)(iii).

FINRA states that, unlike stock prices, NAV is not necessarily a measure of a fund's success. It states that since mutual funds can issue new shares and buy back old ones all the time, the number of shares and the dollars invested in the fund are constantly changing, and that it makes more sense to compare mutual funds by looking at their total return over time rather than comparing their NAVs.

Redemption and Payment

Investor.gov states that mutual fund shares are redeemable, which means investors can sell the shares back to the fund at any time at the next calculated NAV, minus any fees charged at the time of redemption. The SEC's guide states that mutual fund investors can readily redeem their shares at the next calculated NAV, minus any fees and charges assessed on redemption, on any business day, and that mutual funds must send investors payment for the shares within seven days, but many funds provide payment sooner.

Section 22(e) of the Investment Company Act of 1940 sets the seven-day period and its exceptions. It provides that no registered investment company shall suspend the right of redemption, or postpone the date of payment or satisfaction upon redemption of any redeemable security in accordance with its terms, for more than seven days after the tender of the security to the company or its agent designated for that purpose for redemption, except for three kinds of periods. The first is any period during which the New York Stock Exchange is closed other than customary week-end and holiday closings, or during which trading on the New York Stock Exchange is restricted. 

The second is any period during which an emergency exists as a result of which disposal by the company of securities owned by it is not reasonably practicable, or it is not reasonably practicable for the company fairly to determine the value of its net assets. The third is such other periods as the Commission may by order permit for the protection of security holders of the company. Section 22(e) adds that the Commission shall by rules and regulations determine the conditions under which trading shall be deemed to be restricted and an emergency shall be deemed to exist.

SEC Rule 22c-2 under the Investment Company Act of 1940 is titled Redemption fees for redeemable securities. Under paragraph (a)(1), the fund's board of directors, including a majority of directors who are not interested persons of the fund, must either approve a redemption fee or determine that imposition of a redemption fee is either not necessary or not appropriate. The fee that the board may approve is one in an amount of no more than two percent of the value of shares redeemed, on shares redeemed within a time period of no less than seven calendar days, that in its judgment is necessary or appropriate to recoup for the fund the costs it may incur as a result of those redemptions or to otherwise eliminate or reduce so far as practicable any dilution of the value of the outstanding securities issued by the fund, the proceeds of which fee will be retained by the fund.

The Kinds of Mutual Funds

Investor.gov's section on the types of mutual funds names four. Stock funds invest primarily in stocks or equities. Bond funds or income funds invest primarily in bonds or other types of debt securities. Target date funds typically hold a mix of stock funds, bond funds and other funds, and are created for individuals with a particular date for retirement or other goal in mind. Money market funds invest in liquid, short-term debt securities, cash and cash equivalents.

Investor.gov defines a mutual fund as an SEC-registered open-end investment company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. It states that the combined holdings the mutual fund owns are known as its portfolio, which is managed by an SEC-registered investment adviser.

Open-End Funds and Exchange-Traded Funds

The SEC's guide states that mutual funds are open-end funds and that exchange-traded funds are generally structured as open-end funds, but can also be structured as unit investment trusts. It describes an exchange-traded fund as a type of investment company, either an open-end company or a unit investment trust, that differs from traditional mutual funds because shares issued by exchange-traded funds trade on a secondary market and are only redeemable by Authorized Participants from the fund itself in very large blocks, called creation units.

The guide states that, unlike mutual funds, exchange-traded funds do not sell individual shares directly to, or redeem their individual shares directly from, retail investors, and that typically only Authorized Participants purchase and redeem shares directly from the exchange-traded fund. It states that, like a mutual fund, an exchange-traded fund must calculate its NAV at least once every day.

SEC Rule 22e-4 and Liquidity Risk Management

SEC Rule 22e-4 under the Investment Company Act of 1940 is titled Liquidity risk management programs. Paragraph (a)(4) defines an exchange-traded fund or ETF as an open-end management investment company, or series or class thereof, the shares of which are listed and traded on a national securities exchange, and that has formed and operates under an exemptive order under the Act granted by the Commission or in reliance on an exemptive rule adopted by the Commission. Paragraph (a)(9) defines an In-Kind Exchange Traded Fund or In-Kind ETF as an ETF that meets redemptions through in-kind transfers of securities, positions, and assets other than a de minimis amount of cash and that publishes its portfolio holdings daily. Paragraph (b) provides that each fund and In-Kind ETF must adopt and implement a written liquidity risk management program that is reasonably designed to assess and manage its liquidity risk. Paragraph (a)(5) defines a fund as an open-end management investment company that is registered or required to register under section 8 of the Act, and states that the term includes a separate series of such an investment company but does not include a registered open-end management investment company that is regulated as a money market fund under SEC Rule 2a-7 or an In-Kind ETF.

Paragraph (b)(1) lists the elements of the program under five headings: assessment, management, and periodic review of liquidity risk; classification; highly liquid investment minimum; illiquid investments; and redemptions in kind. Under the heading illiquid investments, the rule provides that no fund or In-Kind ETF may acquire any illiquid investment if, immediately after the acquisition, the fund or In-Kind ETF would have invested more than 15 percent of its net assets in illiquid investments that are assets. 

Under paragraph (b)(2), a fund or In-Kind ETF's board of directors, including a majority of directors who are not interested persons of the fund or In-Kind ETF, must initially approve the liquidity risk management program, approve the designation of the persons designated to administer the program, and review, no less frequently than annually, a written report prepared by the persons designated to administer the program that addresses the operation of the program and assesses its adequacy and effectiveness of implementation, including, if applicable, the operation of the highly liquid investment minimum, and any material changes to the program.

Open-End Funds in FINRA's Examination Outline

FINRA's Securities Industry Essentials examination content outline carries a 2025 copyright. Section 2 of the outline, Understanding Products and Their Risks, includes topic 2.1.4, Packaged Products. The topic lists the types of investment companies as closed-end funds, open-end funds, unit investment trusts and variable contracts or annuities, and lists knowledge of loads, share classes, net asset value, disclosures, costs and fees, breakpoints, right of accumulation, letter of intent, net transactions, surrender charges and sales charges. The Section 2 rules list includes three sections of the Investment Company Act of 1940: Section 3(a), Definitions, Investment Company; Section 4, Classification of Investment Companies; and Section 5, Subclassification of Management Companies. Candidates should check the current outline before the examination.

Common Misunderstandings

The corrections below come from the SEC's guide, Investor.gov, FINRA's investor page on mutual funds, the Investment Company Act of 1940, SEC Rule 22c-1, SEC Rule 22c-2 and SEC Rule 22e-4.

Open-end does not mean that shares trade on an exchange. The SEC's guide states that mutual funds issue redeemable shares that investors purchase directly from the fund, or through a broker for the fund, instead of purchasing from investors on a secondary market, and that shares issued by exchange-traded funds trade on a secondary market.

A mutual fund that has closed to new investors is still an open-end fund. FINRA states that existing shareholders of a closed mutual fund can continue to buy and sell fund shares.

Mutual funds do not price their shares continuously through the day. FINRA states that mutual funds calculate the value of one share only once a day, when the investment markets close, and SEC Rule 22c-1 provides that the current net asset value shall be computed no less frequently than once daily, Monday through Friday.

An order is not executed at the NAV in effect when the order is placed. The SEC's guide states that mutual funds must sell and redeem their shares at the NAV that is calculated after the investor places a purchase or redemption order, and SEC Rule 22c-1 requires a price based on the current net asset value which is next computed after receipt of the order.

The right to redeem is not a right to payment on the same day. The SEC's guide states that mutual funds must send investors payment for the shares within seven days, but many funds provide payment sooner, and section 22(e) lists exceptions to the seven-day limit.

Redeeming does not return the full NAV in every case. Investor.gov states that investors sell the shares back to the fund at the next calculated NAV, minus any fees charged at the time of redemption.

Comparing mutual funds by NAV is not the better comparison. FINRA states that, unlike stock prices, NAV is not necessarily a measure of a fund's success, and that it makes more sense to compare mutual funds by looking at their total return over time rather than comparing their NAVs.

A diversified fund is not required to meet the 5 percent and 10 percent limits for all of its assets. Section 5(b)(1) states the requirement as applying to at least 75 percent of the value of its total assets.

Not every investment company is an open-end fund. Investor.gov states that closed-end funds often sell a fixed number of shares that later trade on secondary markets, and section 4 of the Investment Company Act of 1940 defines a unit investment trust as an investment company that, among other conditions, does not have a board of directors and issues only redeemable securities, each of which represents an undivided interest in a unit of specified securities.

Not every exchange-traded fund is an open-end fund. The SEC's guide states that exchange-traded funds are generally structured as open-end funds, but can also be structured as unit investment trusts.

Key Points

Section 5(a)(1) of the Investment Company Act of 1940 defines an open-end company as a management company which is offering for sale or has outstanding any redeemable security of which it is the issuer.

The SEC's guide states that open-end funds sell shares on a continuous basis, purchased from, and redeemed by, the fund or through a broker for the fund, and that mutual funds are open-end funds.

FINRA states that investors can purchase and redeem shares in a mutual fund on a daily basis based on the net asset value of their shares, calculated once a day when the investment markets close.

SEC Rule 22c-1 bars a registered investment company issuing a redeemable security, and the other persons it names, from selling, redeeming or repurchasing the security except at a price based on the current net asset value next computed after receipt of the order.

Section 22(e) bars a registered investment company from suspending the right of redemption, or postponing payment, for more than seven days after tender, except for the periods it lists.

Section 5(b) of the Act divides management companies into diversified companies and non-diversified companies, and section 10(a) provides that no registered investment company shall have a board of directors more than 60 percent of the members of which are persons who are interested persons of such registered company.

SEC Rule 22e-4 requires each fund, as the rule defines the term, and each In-Kind ETF to adopt and implement a written liquidity risk management program, and it bars the acquisition of an illiquid investment if, immediately after the acquisition, more than 15 percent of net assets would be in illiquid investments that are assets.

FINRA's outline for the Securities Industry Essentials examination lists open-end funds, closed-end funds and unit investment trusts as types of investment companies, and lists Sections 3(a), 4 and 5 of the Investment Company Act of 1940 in the Section 2 rules list.