Answer:
Mutual Funds:
A mutual fund is an investment
vehicle made up of a pool of funds collected
from many investors for investing in securities such as stocks, bonds, money
market instruments and similar assets.
REGULATORY
FRAMEWORK FOR 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 investment company’s
shareholders elect the board of directors. 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 soon 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, through either 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:
Ø Selling
securities short
Ø Buying
securities on margin
Ø Participating
in joint investment or trading accounts
Ø 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.
Ø An
affiliated person is someone who controls an investment company's operations in
any way.
Ø 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.
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