Series 99

Chapter 5: Investment Companies - 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.  They are:

  • The board of directors
  • The investment adviser
  • The custodian bank
  • The transfer agent

Board of Directors

Management companies have an organizational structure that is similar to that of other companies. The board of directors oversees the company’s president and other officers who run the day-to-day operations of the company. The board and the corporate officers concern themselves with the business and administrative functions of the company. They do not manage the investment portfolio.  The board of directors:

  • Define investment objectives
  • Hire the investment adviser, custodian bank, and transfer agent
  • Determine what type of funds to offer, such as growth or income
The board of directors is elected by a vote of the shareholders.  The Investment Company Act of 1940 governs the makeup of the board.  The Investment Company Act of 1940 requires that at least a majority of the board be non-interested persons.  A non-interested person is a person whose only affiliation with the fund is as a member of the board.  Therefore, a maximum of 49% or less than 50% of the board may hold another position within the fund company or may otherwise be interested in the fund. An affiliated person is anyone who could exercise control over the company, such as:

  • Officers, directors, and employees of the investment company
  • The investment adviser
  • A company in which the investment company owns at least 5% of the voting stock
  • Any entity owning 5% or more of the investment company’s voting stock
  • The person who deposits the assets of a UIT into the custodian banks
An interested person includes:

  • All broker dealers
  • Anyone who has been an attorney, investment adviser, affiliated person, or the principal underwriter for the investment company within the last two years
  • The principal underwriter
  • Employees of the investment adviser
  • Most affiliated persons
  • Immediate family of an affiliated person
  • Anyone else the SEC designates
Both affiliated and interested parties are prohibited from selling securities or property to the investment company or any of its subsidiaries. Anyone who has been convicted of any felony or securities-related misdemeanor or who has been barred from the securities business may not serve on the board of directors.

Bonding of Key Investment Company Employees

The investment company is required to obtain a bond to cover itself and each officer, director, and employee with access to the investment company’s assets. The company may obtain a bond for each employee or may obtain a blanket bond for all employees that are required to be bonded. In the case of a blanket bond, the company must list the names of the employees to be covered. The bond only covers the employees for negligence. Any criminal acts or acts of bad faith are not covered.

Investment Adviser

The investment company’s board of directors hires the investment adviser to manage the fund’s portfolio. The investment adviser is a company, not a person, and must also determine the tax consequences of distributions to shareholders and ensure that the investment strategies are in line with the fund’s stated investment objectives. The investment adviser’s compensation is a percentage of the net assets of the fund, not a percentage of the profits, although performance bonuses are allowed. The investment adviser’s fee is typically the largest expense of the fund, and the more aggressive the objective, the higher the fee. The investment adviser may not borrow from the fund and may not have any security-related convictions. The investment adviser’s contract requires initial and annual re-approval by a majority vote of the board of directors and the outstanding shares.

Custodian Bank

The custodian bank, or the exchange member broker dealer that has been hired by the investment company, physically holds all of the fund’s cash and securities. The custodian holds all of the fund’s assets for safekeeping and provides other bookkeeping and clerical functions for the investment company, such as maintaining books and records for accumulation plans for investors. All fund assets must be kept segregated from other assets. The custodian must ensure that only approved persons have access to the account and that all distributions are done in line with SEC guidelines.

Transfer Agent

The transfer agent for the investment company handles the issuance, cancellation, and redemption of fund shares. The transfer agent also handles name changes and may be part of the fund’s custodian or a separate company.  The transfer agent receives an agreed fee for its services.


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