Impact Voices | August 12, 2021

To build inclusive, community-scale funds, modernize the Investment Company Act of 1940

Janice Shade
Guest Author

Janice Shade

A growing number of Americans who never considered themselves impact investors are now taking a long hard look at the wealth they’ve amassed through hard work — and, often, privilege — and wondering how they can use it to be part of a solution rather than an unwitting perpetuator of the problem.

Over the past year or so, as many folks realized their jobs would remain secure and their wealth might actually increase despite life in a COVID world, they found themselves thinking, “I’m ok, but my local economy is not. How can I put my money to work to help businesses in my community that are struggling, and preserve this place I love and call home?”

The answer, unfortunately, is complicated.

Well, at least for the 90% of Americans who do not qualify as accredited investors. For the other 10% – who control over 75% of all private wealth in the U.S. – it’s fairly easy to invest in non-public companies, as most local businesses are. Some may contend that the greatest results would come by focusing efforts to shift that big pile of money toward impact investing. Hard to argue with that fact. 

But I’m talking about impact investing at the community level to create and sustain strong, vibrant, resilient local economies. This form of impact investing – community-sourced and community-focused capital – should know no limits based on wealth status. It should be open to any citizen investor with the desire and financial wherewithal to invest for positive impact.

Simple in principle, yet complicated to execute.

The entry point into local or community-based investing is often through alternative investment funds that take a strong position toward positive impact and may even have specific geographic focus. These include structures such as private equity and venture capital funds, hedge funds, and REITs or other property funds. CDFIs also fall within this category. Yet all of the above – even most CDFIs – tend to exclude unaccredited investors, due in large part to restrictions imposed by the Investment Company Act of 1940 (also known as the 1940 Act). 

The 1940 Act was enacted by Congress over 80 years ago to regulate the organization and activities of investment companies (such as mutual funds and those listed above) and to set standards for the investment industry. Compliance obligations under the 1940 Act make it very expensive to set up and manage a fund, especially one that intends to include unaccredited, or “retail,” investors. With a legal price tag that could run into the hundreds of thousands of dollars, only multi-billion dollar mutual funds tend to include retail investors. For a community for which a $5 million fund would be sufficient to deliver significant investment impact, the compliance costs are prohibitively expensive.

A new pathway for unaccredited individuals to invest directly in local businesses was created by Regulation Crowdfunding, a central provision of the JOBS Act of 2012 that allowed for investment crowdfunding. “Reg CF,” along with similar measures at the state level, was a revolutionary step in the right direction, to be sure. But it left yawning gaps in education and advisory services for neophyte investors. 

The dual burdens of finding deals and performing due diligence fall squarely on the shoulders of individual investors, many of whom lack the skill, time or desire to do so. 

So, while “Reg CF” created the ability for retail investors to engage in local impact investing, the Investment Company Act of 1940 exposes local investors to greater risk by excluding them from funds that employ skilled and licensed professional managers to create diversified, well-researched portfolios.

Modernizing the law

It doesn’t have to be this way. The JOBS Act of 2012 delivered much-needed revisions to the Securities Act of 1933 to create exemptions for small, private companies to raise money directly from their networks. Its equally outdated cousin, the Investment Company Act of 1940, is due for a 21st century makeover as well. 

It wouldn’t even require a major overhaul of the 1940 Act, just a few simple revisions creating exemptions that allow community-scale funds to 1) accept investment from retail investors, 2) give fund managers flexibility to structure investments according to businesses’ needs, and 3) share profits for wealth-building opportunities among all investors. 

Exemptions have been carved out of the 1940 Act over the years, such as one that makes it easier for nonprofits to create funds that accept unaccredited investors. (Community development financial institutions and organizations such as the Calvert Foundation and RSF Social Finance have used such exemptions). Yet none can deliver all three of these important features. That leaves would-be community funds to contort themselves to fit the ungainly existing exemptions. 

Where Regulation Crowdfunding elevated the concept of investment crowdfunding to national awareness, revisions to the 1940 Act would create a new tool for economic development and community revitalization: the Community Investment Fund.

To this end, the National Coalition for Community Capital (NC3), a nonprofit founded in 2017 by a group of community capital pioneers including myself, last April launched a Community Investment Fund (CIF) Task Force.  Comprised of financial experts, attorneys, economic development professionals, and champions of community capital, the task force is working to create: 

•  Long term, permanent capital solutions for communities to recover from the economic impacts of the COVID-19 pandemic while creating more resilient local economies that can weather future crises

•  Widespread awareness of the value of engaging all stakeholders in community investment to support Main Street businesses that are the backbone of the economy

•  Establishment of Community Investment Funds as a powerful financing tool to fill the gap in capital markets for formerly marginalized demographic groups, with the goal of creating economic justice for all

The CIF Task Force has submitted a detailed proposal to the Division of Investment Management of the Securities and Exchange Commission requesting policy changes to the 1940 Act to facilitate community-scale funds. Specifically, we ask the agency to expand retail investor access to funds through appropriately structured and professionally managed local, in-state regulated investment vehicles that are exempt from registration under the 1940 Act and are able to raise capital in exempt securities offerings.

The requested policy revisions would create opportunities for any investor, regardless of wealth status, to aggregate their investment dollars with other citizen-investors into a diversified portfolio to mitigate risk while expanding their impact beyond what an individual investor could do alone. They would also allow for professional management to shoulder some of the burden of due diligence and to structure investments in ways that maximize effectiveness for both capital providers and capital recipients.

Opening up avenues for Americans to invest in their communities in pooled investment vehicles, if done right, would help reverse recent trends toward increasing wealth inequality – and help the millions of uninvested Americans who currently lack savings start to build durable wealth.

Janice Shade is founder of the Initiative for Local Capital and a founding member of the National Coalition for Community Capital.

To support NC3’s efforts toward revising the Investment Company Act of 1940, read and sign their petition on