Investment Companies - Structure, Management and Operation of Mutual Funds



Board of Directors
A management investment company (mutual fund company) has a CEO, a team of officers and a board of directors. Each one of these entities is responsible for serving the interests of the shareholders. The primary responsibility of the officers and the board of directors is to handle the investment company's administrative matters.

The board of directors is elected by the investment company's shareholders. The board defines the type of funds that will be offered to the public. For example, it will suggest offering a selection of funds - growth funds, international funds, income funds and so on - to meet the investment needs of many individuals. It will also define each fund's objectives. The board will also approve and hire the investment advisor, transfer agent and custodian (defined below) for each fund.

Sponsor
The principal underwriter of a mutual fund is called a distributor, or more commonly, the sponsor. The sponsor has a written contract with the investment company that allows it to purchase fund shares at the current net asset value and resell the shares to the public at the full public offering price, either through outside dealers or through its own sales force. The contract with the mutual fund company is subject to annual renewal, but as long as the sponsor is distributing and marketing the shares in a satisfactory manner, there is no reason why the sponsor's contract should be discontinued.

Custodian
The custodian is responsible for the possession of the securities purchased by the investment company for its portfolio. The custodian also handles most of the investment company's clerical functions. Once securities are transferred to the custodian for safekeeping, the custodian must keep the assets physically segregated at all times, restrict access to the account to officers and employees of the investment company, and allow withdrawal only according to SEC rules.

Investment Advisor
The board of directors hires an investment advisor to invest the cash and securities held in the fund's portfolio, implement the objectives outlined by the board, manage day-to-day trading of the portfolio, and handle other tasks that involve the tax implications of the share. For these services, the investment advisor is acting as a fund advisor or fund manager, and earns a management fee paid from the fund's net assets. Usually, the fund manager earns an annual percentage of the fund's value, plus an incentive bonus if he or she exceeds certain performance goals.

Transfer Agent
The mutual fund contracts with a transfer agent to issue, redeem and cancel fund shares, handle the distribution of dividend and capital gains to shareholders, and send out trade confirmations. In certain instances, the custodian will act as transfer agent. The fund company usually pays the transfer agent a fee for services rendered.

Dealers
As mentioned before, the sponsor usually distributes shares of the mutual fund through dealers. The dealers purchase shares from the sponsor at a discount to the public offering price and fill their customers' orders. It is important to note that dealers cannot buy shares for their own inventory to sell at a later date. They may purchase shares to fill customer orders or for their own investment, but any purchase that occurs for a dealer's own investment must be redeemed when sold; it cannot be sold to an investor.

Restrictions on Mutual Fund Operations
The SEC prohibits a mutual fund from engaging in the following activities unless it meets strict financial and disclosure requirements:

  • Selling securities short
  • Buying securities on margin
  • Participating in joint investment or trading accounts
  • Distributing its own securities, except through a sponsor

Otherwise, the fund must disclose these activities and the extent to which it plans to participate in these activities in its prospectus.

Affiliated and Interested Parties
The 1940 act and its amendments identify two types of people, defined as affiliated and interested parties, who may influence the investment company's management and operations and whose actions must be regulated and restricted by the SEC. They may not borrow money from the investment company or sell any security or property to the investment company or companies the management company controls.

  • An affiliated person is someone who controls an investment company's operations in any way.
  • An interested person includes those individuals who have a relationship with an affiliated person that the SEC deems influential in matters of fund operation. These people would include immediate family members of affiliated parties, legal counselors, broker-dealers, and so on.

Furthermore, the board of directors must have 40% outside representation: that is, at least 40% of the board must be made up of individuals who do not have a position with, or affiliation to, the fund. This restriction includes anyone associated with the underwriter, investment advisor, custodian or transfer agent.

Types of Investment Companies


Related Articles
  1. Professionals

    Structure, Management, and Operation of Mutual Funds

    FINRA Series 6: Section 10 Structure, Management, and Operation of Mutual Funds. Board of Directors, Sponsor, Custodian, Investment Advisor, Transfer Agent, Dealer are reponsible the structure, ...
  2. Professionals

    B. Investment Company Components

    Investment companies have several different groups that serve specialized functions. Each of these groups plays a key role in the investment company’s operation.
  3. Professionals

    Restrictions on Mutual Fund Operations

    FINRA Series 6: Section 10 Restrictions on Mutual Fund Operations. In this section: Affiliated and Interested Parties.
  4. Professionals

    What You Must Know To Pass The Series 6 Exam

    Learn what you need to know about the creation and components of a mutual funds to pass the Series 6 exam.
  5. Mutual Funds & ETFs

    How A Mutual Fund Works

    By Richard Loth (Contact | Biography)A fund sponsor - generally a financial intermediary like Fidelity Investments or Vanguard - organizes a mutual fund as a corporation; however, it is not an ...
  6. Professionals

    Investment Company Act of 1940

    FINRA/NASAA Series 66 Section 1 - Investment Company Act of 1940. In this section the investment comany act of 1940, interested person, affiliated person, redeemable securities and principal ...
  7. Professionals

    Rules and Reporting Requirements for Mutual Funds

    FINRA Series 6 Exam Study Guide - Rules and Reporting Requirements for Mutual Funds. In this section Rules and Reporting Requirements for Investment (Mutual Fund) Companies. Rule 12b-1 and shareholder ...
  8. Investing

    Advising FAs: Explaining Mutual Funds to a Client

    More than 80 million people, or half of the households in America, invest in mutual funds. No matter what type of investor you are, there is bound to be a mutual fund that fits your style.
  9. Mutual Funds & ETFs

    A Mutual Funds Guide for Young Investors

    Learn how mutual funds work, why they are so popular and how younger investors can get started by putting mutual funds in their IRAs or 401(k)s.
  10. Retirement

    Analyzing The Best Retirement Plans And Investment Options: Mutual Funds

    What they are: A professionally managed pool of stocks, bonds and/or other instruments that is divided into shares and sold to investors. Pros: Diversification; liquidity; simplicity; ...
RELATED TERMS
  1. Mutual Fund Custodian

    A trust company, bank or similar financial institution responsible ...
  2. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected ...
  3. Advisor

    1. The person or company responsible for making investments on ...
  4. Investment Company

    A corporation or trust engaged in the business of investing the ...
  5. Investment Fund

    A supply of capital belonging to numerous investors that is used ...
  6. Investment Company Act Of 1940

    Created in 1940 through an act of Congress, this piece of legislation ...
RELATED FAQS
  1. What is the difference between a custodian bank and a mutual fund custodian?

    Read about the difference between a normal custodian bank and a mutual fund custodian, why mutual funds use custodians and ... Read Answer >>
  2. How do I calculate the loan-to-value ratio using Excel?

    Learn what a mutual fund and a money market fund are, and understand the differences between each and how they serve various ... Read Answer >>
  3. How do mutual funds work in India?

    Find out how mutual funds work in India, including what types of funds are available, how they are structured and how they ... Read Answer >>
  4. What information does the SEC require in an investment company's prospectus?

    Understand the lengthy list of required information that investment companies such as mutual funds must include in a prospectus ... Read Answer >>
  5. Do mutual funds pay interest?

    Find out how and why some mutual funds pay interest, and which types of funds make regular dividend distributions to shareholders ... Read Answer >>
  6. Do mutual funds pay dividends or interest?

    Learn how and why mutual funds pay interest or dividends, including the different funds and which types generate each type ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center