In this chapter, we will look at how an investment company pools investors’ funds in order to purchase a diversified portfolio of securities. Series 99 operations professionals will be providing will be providing support to firms that transact business in investment company products, so it is imperative that candidates have a complete understanding of this material. Some of the test focus points will be on:

  • Types of investment companies
  • Investment company structure
  • Investment company registration
  • Investment company taxation
  • Investment strategies and recommendations
  • Investor benefits

Investment Company Philosophy

An investment company is organized as either a corporation or as a trust. Individual investors’ money is then pooled together in a single account and used to purchase securities that will have the greatest chance of helping the investment company reach its objectives. All investors jointly own the portfolio that is created through these pooled funds, and each investor has an undivided interest in the securities. No single shareholder has any right or claim that exceeds the rights or claims of any other shareholder, regardless of the size of the investment. Investment companies offer individual investors the opportunity to have their money managed by professionals who may otherwise only offer their services to large institutions. Through diversification, the investor may participate in the future growth or income generated from the large number of different securities contained in the portfolio. Both diversification and professional management should contribute significantly to the attainment of the objectives set forth by the investment company. There are many other features and benefits that may be offered to investors that will be examined later in this chapter.

Types of Investment Companies

All investment company offerings are subject to the Securities Act of 1933, which requires the investment company to register with the Securities Exchange Commission (SEC) and to give all purchasers a prospectus. Investment companies are also subject to the Investment Company Act of 1940, which sets forth guidelines on how investment companies must operate. The Investment Company Act of 1940 breaks down investment companies into three different types:

  • Face amount company
  • Unit investment trust (UIT)
  • Management investment company (Mutual funds)

Face Amount Company/Face Amount Certificates

An investor may enter into a contract with an issuer of a face amount certificate to contract to receive a stated or fixed amount of money (the face amount) at a stated date in the future. In exchange for this future sum, the investor must deposit an agreed lump sum or make scheduled installment payments over time. Face amount certificates are rarely issued these days, as most of the tax advantages that the investment once offered have been lost through changes in the tax laws.

Unit Investment Trust (UITs)

A unit investment trust (UIT) will invest either in a fixed portfolio of securities or a non-fixed portfolio of securities. A fixed UIT will traditionally invest in a large block of government or municipal debt. The bonds will be held until maturity, and the proceeds will be distributed to investors in the UIT. Once the proceeds have been distributed to the investors, the UIT will have achieved its objective and will cease to exist. A non-fixed UIT will purchase mutual fund shares in order to reach a stated objective. A non-fixed UIT is also known as a contractual plan. Both types of UITs are organized as a trust and operate as a holding company for the portfolio. UITs are not actively managed and they do not have a board of directors of investment advisers. Both types of UITs issue units or shares of beneficial interest to investors, which represent an undivided interest in the underlying portfolio of securities. UITs must maintain a secondary market in the units or shares to offer some liquidity to investors.

Management Investment Companies (Mutual Funds)

A management investment company employs an investment adviser to manage a diversified portfolio of securities designed to obtain its stated investment objective. The management company may be organized as either an open-end company or as a closed-end company. The main difference between an open-end company and a closed-end company is how the shares are purchased and sold. An open-end company offers new shares to any investor who wants to invest. This is known as a continuous primary offering. Because the offering of new shares is continuous, the capitalization of the open-end fund is unlimited. Stated another way, an open-end fund may raise as much money as investors are willing to put in. An open-end fund must repurchase its own shares from investors who want to redeem them. There is no secondary market for open-end mutual fund shares. The shares must be purchased from the fund company and redeemed to the fund company. A closed-end fund offers common shares to investors through an initial public offering (IPO), just like a stock. Its capitalization is limited to the number of authorized shares that have been approved for sale. Shares of the closed-end fund will trade in the secondary market in investor-to-investor transactions on an exchange or in the over-the-counter market (OTC), just like common shares.

Series 99 test prep materials



B. Investment Company Components

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