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.

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.

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.

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. Investing Basics

    Calculating The Present And Future Value Of Annuities

    Here's everything you need to account for when calculating the present and future value of annuities.
  2. Economics

    The World's Top 10 Economies

    A look at the top ten economies in the world.
  3. Forex Education

    Understanding The Income Statement

    Learn how to use revenue and expenses, among other factors, to break down and analyze a company.
  4. Stock Analysis

    Will J.C. Penney Come Back in 2016? (JCP)

    J.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
  5. Mutual Funds & ETFs

    Should Investors Take a BITE Out of This New ETF?

    ETF BITE offers a full menu of restaurants. Is now the right time to invest?
  6. Retirement

    Going Back to Ecuador to Retire: A How-to Guide

    Spending your retirement years in Ecuador can be an affordable and attractive proposition, provided you know the country's laws.
  7. Personal Finance

    The Ten Commandments of Personal Finance

    Here are the simple financial Ten Commandments that, when faithfully followed, can lead to a secure economic future.
  8. Professionals

    Project Manager: Career Path & Qualifications

    Learn more about what project managers job, the qualifications necessary for the position and the most common careers for these professionals.
  9. Stock Analysis

    If You Had Invested Right After Coca-Cola's IPO

    Discover how one $40 share, with dividend reinvestment, over 90 years ago in the Coca-Cola Company would have made you a multimillionaire today.
  10. Economics

    Why It Is Important to Follow Crude Oil Inventories

    Discover what oil inventories are, how they are communicated and what important insights they provide into the state of the oil market.
  1. Percentage Change

    Percentage change is a simple mathematical concept that represents ...
  2. Horizontal Line

    A line that appears to proceed from left to right, or parallel ...
  3. Brand Identity

    Brand identity is the way a business wants consumers to perceive ...
  4. Elastic

    A situation in which the supply and demand for a good or service ...
  5. Earnings Stripping

    Earnings Stripping is a commonly-used tactic by multinationals ...
  6. Skinny Down Distribution

    Skinny down distribution is corporate practice of slimming down ...
  1. Is North Korea a developed country?

    North Korea is one of the poorest and least developed countries in the world. It is far from a developed country. Because ... Read Full Answer >>
  2. Does Netspend accept wire transfers?

    NetSpend accepts some types of wire transfers to add money to the prepaid debit cards it issues to its customers. There are ... Read Full Answer >>
  3. Is Mexico a developed country?

    As of 2015, Mexico is not a developed country. However, it beats the majority of its peers in the developing world on most ... Read Full Answer >>
  4. Is China a developed country?

    Despite having the world's second-largest economy and third-largest military, China is still, as of 2015, not classified ... Read Full Answer >>
  5. Do FHA loans require escrow accounts?

    Federal Housing Administration (FHA) loans require escrow accounts for property taxes, homeowners insurance and mortgage ... Read Full Answer >>
  6. Is Greece a developed country?

    Greece is a developed country by most meaningful metrics. However, its financial struggles have been well documented in the ... Read Full Answer >>
Hot Definitions
  1. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center