Investment Company Act of 1940

Investment Companies Concepts

• Investors pool their money
• Investors own an undivided interest in the portfolio of
  securities
• Professional Money Management
• Diversification

Types of Investment Companies

• The Investment Company
  Act of ’40 establishes the guidelines
• Unit Investment
  Trust
• Face Amount
  Certificate Companies
• Management
  Investment Companies
  • Open-ended Mutual
    Funds
  • Closed-end Mutual
    Fund
  • Separate Account of
    an insurance company

The Securities Act of ’33 requires registration and a prospectus

Unit Investment Trusts

• Operates as a holding company
• A trustee supervises the company’s portfolio
• Shares are redeemable
• Known as shares of beneficial interest (SBI’s)
• Trust holds a fixed portfolio of bonds until maturity
• Owners may redeem their shares before maturity at the current
  market value

Face Amount Certificates

• These companies issue debt certificates that offer
  predetermined interest rates
• Purchased in periodic payments or lump sum
• Maturities of at least 24 months
• Can be redeemed for a fixed amount at a specified date
• Redemption during first year guarantees 50% of purchase price
  Redemptions after first year gets current surrender value minus any surrender
  charge

Management Companies offer:

• Professional Money
  Manager (Fund Manager)
• Diversified
  portfolio of securities
• Specific investment
  objectives
• Specific investment
  policies
• Two types:

• Open-end funds
• Closed-end funds

Open-end	Closed-end
Continuous offering Common share Full and fractional shares Continuous redeeming of shares Non-marketable Forward pricing Voting rights Right to Dividends Does not issue Senior securities May borrow (1:3 debt to assets)	Single IPO May include senior securities Full shares only Sold on the secondary market Marketable Supply and Demand Voting rights Right to Dividends May include Senior securities Preemptive rights

Closed-end Funds

• Capitalized through one-time offering of shares
• Afterwards share price fluctuates with market demand
• Shares may be traded on an exchange or in the OTC market
  based on supply and demand
• The investment company does not continuously redeem its
  shares

Open-end Funds

• Diversified

• 75-5-10 Rule
• 75% of the fund’s assets must be invested in a way that;
• No more than 5% can be invested in one company;
• Cannot hold more than 10% of the voting stock of any company.
• Non-diversified
• Does not meet the 75-5-10 rule

Subchapter M

• Special tax treatment is afforded to investment
  companies that qualify as a regulated
  investment company
• Investment companies must distribute 90% of its
  net investment income to shareholders
• You may see “pipeline conduit“
• Distributions include dividends and interest
  minus expenses

Investment Company Tax Issues

• Capital Gains
• Short term gains will be taxed at the ordinary
  income tax rate
• Long term gains will be taxed at about 15-20%
• Income distributions
• Form 1099 DIV (income)
• Form 1099-B (capital gains)
• Exchange of funds is a taxable event

Investment company names

• 80% rule
• Assets of the fund must be invested in investments stated in the name of the fund
• Example: ABC Equity Fund = 80% of the assets of the fund must be invested in stocks

Features and Characteristics of Open End Companies

• Diversification
• Various Industries
• Different types of instruments
• Variety of security issuers
• Geographic areas
• Non-diversified
• Professional Management
  • What to buy
  • What to sell
  • What to hold
  • Financial research and analysis

• Investment Objectives
  • Growth or income
• Investment Policies
  • Domestic stocks versus international

Fund Shares

• Investors purchase shares at the Public offering price
• Net asset value + sales charge = POP
• Full and fractional shares may be purchased
• The fund continuously offers and redeems shares
• Shareholders have voting rights

Interlocking Directorate

• The board of director’s responsibility is to establish and
  maintain the fund’s investment policies
• 60% of the board may be affiliated with the fund
• 40% of the board must be unaffiliated with the fund

Investment Advisor

• Elected by the Board of Directors
• Initial 2 year term with 1 year renewals
• Supervises funds
• Provides investment advice
• Financial research and analyses
• Follows investment objectives and policies

Underwriter

• Has an agreement to buy fund shares at the current Net Asset
  Value (NAV) and then sells to the public at the Public Offering Price (POP)
• Underwriters cover all or most of the costs for sales
  literature and promotional items
• Underwriters compensate dealers that have selling agreements
  with the fund

Custodian

• Typically a commercial bank
• Safeguards the assets of the fund
• Performs payable and receivable functions of the
  securities transactions
• Tracks interest and dividends for the fund

Transfer Agent

• Contracted by the fund
• Issues shares or makes book entry
• Cancels redeemed shares
• Disburses dividend and capital gains to the shareholders

Fund Characteristics

• Automatic
  reinvestment of dividend income and capital gains
• Diversification
• Professional Money
  Management
• Liquidity
• Example of dollar
  cost averaging:

Investment	Share Price	Shares Bought
$ 200	$ 20	10
$ 200	$ 15	13.3
$ 200	$ 10	20
$ 200	$  5	40
$ 200	$ 10	20
$ 200	$ 20	10

• Exchange privileges
• Safekeeping of
  securities
• Ease of account inquiry
• Simplified tax
  information (1099)
• Ease of buying and
  redeeming shares

Basis of Comparing Funds

• Investment objectives
• Investment policies
• Management
• Risk factors
• Portfolio turnover

Exchange of Securities

• Redeem
  at NAV, reinvest at NAV, within the same family of funds
• No
  sales charge on the reinvestment
• Considered
  a sale for tax purposes

Gift of Securities

• The
  cost basis depends on the donor’s cost basis
• If
  the market is higher than the donor’s, the cost basis to the recipient is the
  same as the donor’s
• If
  the market is lower that the donor’s, the cost basis to the recipient is the
  value of the account

Inheritance of Securities

• If
  inherited, the beneficiary gets a stepped up basis
• The
  cost basis is the market value of the securities as of the day of the
  deceased’s death
• The
  holding period is treated as long-term gain

Securities and Taxes

• Interest
  and dividends are reinvested at NAV
• Prices
  are determined by forward pricing
• Wash-Sale
  Rule
• An
  investor sells securities at a loss to offset a gain
• If
  the investor repurchases the security within 30 days, the IRS will disallow the
  loss
• Defining
  period applies to dates 30 days prior to and 30 days after the sale. (61-day
  period)

Open End Mutual Funds Types

• Equity funds
• Common and preferred stocks

• Income funds
• Focus is on current income
• High dividends and interest yields
• Exposed to interest and credit risk

• Growth funds
• Appreciation not income is the focus
• May be exposed to market risk

• Growth and Income funds
• Combination of the two previous funds.
• May be subject to market and purchasing power risk

• Aggressive Growth
• May be heavily invested in cutting edge industries or start ups
• Potential for substantial gains in advancing markets
• Susceptible to market and timing risks

• Value funds
• Holds stock that are deemed to be undervalued in price
• These funds tend to under-perform during a market advance and out-perform in a decline

• Blend funds
• Contains a mix of growth and value stock
• Does not hold fixed income securities
• Designed to appreciate by means of capital gains

• Balanced funds
• Combination of fixed income instruments and equities
• The goal is to achieve both growth in value and income

• Fixed Income
• Debt and preferred securities
• Returns fixed periodic income
• Classifications of Fixed income funds

• Government fixed income
• Tax-exempt
  • Munis’
• High-yield fixed income
  • Junk bonds

• Money Market
• Designed to provide capital preservation
• Holds short-term high yield debt
• Not guaranteed
• 2 types of money market funds
  • Taxable
  • Tax-exempt
    • Uses Federal tax-exempt entities and short term debt

• Specialized funds
• Invests in a specific industry, market sector, or geographic region
• May be vulnerable to sector specific economic trends

• Industry (Sector) funds
• Allocates funds in one industry
• Such as manufacturing, technology, pharmaceuticals
• Geographic concentration
  • Invests in a specific region
  • Southwest, northeast, Midwest”¦.

• Asset Allocation
• 60% Equities
• 40% corporate bonds
• Periodically reallocate

• International
• Invests in overseas companies and markets
• Does not include U.S. securities

• Global funds
• Invests in overseas companies and markets
• Includes U.S. securities

• Socially Responsible Funds
• Pursues high returns but avoids investing in companies that engage in activities that some people find objectionable.
• People accept somewhat lower returns for the satisfaction of knowing that their savings don’t support commercial activities that they object to.

• Index
• Mimics a particular index
• Such as Dow 30 or S&P 500

• Precious metal funds
• Invest in gold, platinum, and/or silver

• Funds of funds
• Holds shares in different funds within the same family of funds to obtain a specific objective

• Principal-protected funds
• Guarantees principal for a period of 5 or 10 years
• After that, no guaranteed return
• Money is locked up for 5 or 10 years
• Blend of stocks and bonds
  • Higher expense ratios

Market capitalization is another area to consider with regards to different investment policies.  Here is a sample list of approximate classes:

• Micro Cap       less
  than $300 million
• Small Cap        $300
  million to $2 billion
• Mid Cap          $2
  billion to $10 billion
• Large Cap        $10
  billion to $200 billion
• Mega Cap        $200
  billion or more

Contractual plans

• Accumulate shares by making scheduled payments
  for a period of 10 to 15 years
• Maximum sales charge is 9% over the life of the
  plan

Fund Shares

• Investors purchase shares at the Public offering price
• Net asset value + sales charge = POP
• Full and fractional shares may be purchased
• The fund continuously offers and redeems shares
• Shareholders have voting rights

Shareholder’s Rights

• Right to vote, proxies
• Vote for the board
• Approve changes in funds policies and objectives
• Approve the investment advisor agreement
• Approve changes in fees
• Approve independent auditors

Sales Charge

• Maximum Sales Charge = 8.5%
• Expressed as a percentage of the POP
• In order to charge the maximum sales charge, the
  fund must offer:
• Reinvestment
  at NAV
• Breakpoints/Letter
  of intent
• Rights
  of Accumulation
• If not, the maximum sales charge is 7.25%

Share Class

• Class A = Front-end sales charge
• Class B = Back-end sales charge
• Class C = Back-end for one year, sometimes
  called a level load
• Class M = No Load

12b-1 Fee

• Investment Company Act of 1940
• Used to cover costs of promotion and
  distribution of funds
• Subject to an annual limit of .75% of NAV
• No load maximum is .25% of NAV
• May be changed by majority vote by:
• Board
  of Directors
• Outstanding
  shares

Cost of Operation of Mutual Fund

• Expense Ratio
• Total
  expenses / Total net assets = Expense Ratio
• Management Fee
• Other expenses:
• Custodian
• Transfer
  Agent
• Board
  of Directors

Valuation of Mutual Fund Shares

• Total net assets / Total outstanding shares =
  Net asset value per share
• Ex-dividend date is determined by the Board of
  Directors, usually the next business day
• Some funds have redemption fees to discourage
  short-term trading

Redemption of Shares

• Methods of Redemption
• Written
  Request
• Telephone
• Check
  Writing
• Through
  a Broker/Dealer
• Redemption Price is based on forward pricing
• Funds pay within 7 calendar days, (Investment Company
  Act of ’40)

Withdrawal Plans

• Minimum Investment
• Types of payouts:
• Fixed
  Amount
• Fixed
  Percentage
• Fixed
  Shares
• Fixed
  Period
• Possible exhaustion of principal

Act of ’40 Required Reports

• Annual report by company
• Semiannual or quarterly filing of information
• Semiannual reports to stockholders
• Semiannual reports to investment company investors:
• Must include a
  balance sheet
• List and value of
  securities
• Income statement
• Certificate of independent public accountants
• Duties and liabilities of affiliated persons
• Disclosure to church plan participants
• Copies of periodic reports or extracts

Investment Strategies

Objectives	Recommendations
Capital preservation	Government securities Ginnie Maes
Growth	Common Stock Common Stock Funds
Income	Bonds Preferred Stock
Liquidity	Money market funds

Taxation of investment returns:

Investment return	Taxation Standard
Dividends from stock Interest from bonds Short term capital gains	Taxed as ordinary income
Long term capital gains Qualified Dividends	15-20% tax rate
Cost basis (return of principal)	Tax free

Annuity Characteristics

Licensing Requirements

Life insurance license is required for fixed and indexed annuities

Securities license is also needed to offer variable annuities

Periods of Time

Accumulation Period/Paying In

Single Premium

Flexible Premium

Tax-deferred growth

Annuity Period/Taking Out

Immediate or Deferred

Periodic Payments start after one payment period

Not designed to pay lump sum

Gains are taxable per Exclusion Ratio

Variable Life/Variable Universal Life

Flexible or Scheduled Premiums

Level or increasing death benefit

Cash value grows at market rate, depending on investment choices

Cash value is invested in the Separate Account

Tax-deferred growth of the cash value

Tax-free loans and withdrawals under certain conditions/surrender charges

Income tax-free death benefit (possible estate taxes)

Voting Rights

One vote per $100 of cash value

Securities Act of ’33 requires delivery of a prospectus

Sales charges based on Investment Company Act of ’40 (Front end)

Exchanges (1035 Exchange)

Exchanges of subaccounts

No guaranteed minimum cash value

Scheduled premium program has a guaranteed minimum death benefit

1035 exchange

Tax-free transfer of cash or assets from one policy to another

May have surrender charge

Allowable 1035 exchanges are:

• Life to life
• Annuity to annuity
• Life to annuity

Modified Endowment Contracts (MEC)

Technical and Miscellaneous Revenue Act of 1988 limits how much may be paid into a life insurance policy typically during the first 7 years.  By over funding your life insurance policy, you may lose the tax advantages that life insurance affords.  

Your life insurance policy loans will be treated as a withdrawal (like taking money out of a traditional IRA)

If under age 59 ½, a 10% federal penalty will also apply