1
Q
Ch 2 Sec 4 Inv Companies
Investment Companies
A
- collects funds from individuals and purchases securities with those funds that are consistent with the investment company’s objective.
2
Q
Ch 2 Sec 4 Inv Companies
what does an invesment company offer
A
diversification and professional selection of investments, and ongoing management of the portfolio (most cases)
3
Q
Ch 2 Sec 4 Inv Companies
What act regulates investment companies
A
The investment company act of 1940
4
Q
Ch 2 Sec 4 Inv Companies
The Invest Company Act of 1940 defines 3 types of companies
A
- Face Amount Certificate companies
- Management Companies
- Unit Investment Trusts
5
Q
Ch 2 Sec 4 Inv Companies
Face Amount Certificate Company
A
- virtually obsolete
- investors pay a fixed monthly amount to the investment compnay, which invests the funds in the highest quality obligations (e.g. us gov debt, AAA muni and corp debt).
- certificate promises the investor a guranteed rate of return so that a fixed date the certificate matures and the investor receives the ‘face’ amount.
- the total payments are less than the face amount, wiht the diff being the compound interest on all investments.
6
Q
Ch 2 Sec 4 Inv Companies
Management Companies
A
- Investment company organized as a coproration issuing shares of stock.
- uses an investment advisor or manager to decide what securites to invest in
- The manager is free to manage the portoflo consistent wiht the funds stated objective
- may be open-end or closed end.
7
Q
Ch 2 Sec 4 Inv Companies
Open end
A
- Mutual Fund
- Redeemable
- most popular
- the company issues only common shares
- the number of common shares is open ended
- shares cannot be traded, they must be redeemed (at any time)
8
Q
Ch 2 Sec 4 Inv Companies
Closed End
A
- Publicly Traded Funds
- Not redeemable
- the fund has a one-time issusance of stock
- The stock is listed on an exchagne and trades like any other negotiable security.
- usually invests in bonds, shareholdres receive income distributions from interst earned as well as cap gains.
9
Q
Ch 2 Sec 4 Inv Companies
Unit Investment Trust
A
- investment company organized under a trust indenture (vs corp)
- trusts issue shares of beneficial interest - which represents an undivided interest in a unit of specified securities
- Two types 1) UITs/ Fixed Trusts 2) Participating Trusts
10
Q
Ch 2 Sec 4 Inv Companies
two types of UITs
A
- fixed UIT
- Participating UIT
10
Q
Ch 2 Sec 4 Inv Companies
Fixed UIT
A
- Investments - usually bonds - are selected.
- once set it is not changed, no buying or selling, no management
- Interest payments are mdade on bonds and passed to the trust
- when bonds mature principal is paid to unit holders
- when all bonds mature the trust self-liquidates
11
Q
Ch 2 Sec 4 Inv Companies
Participating UIT
A
- the trust invests in shars of a management company - specifically mutual fund shares
- purchasers are indirectly buying mutual fund shares
- these are used when investors buy mutual funds within an insurance company ‘wrapper’ to fund variable annuity contracts
12
Q
Ch 2 Sec 4 Inv Companies
Variable Annuity
A
- generally used as retirement planning vehicles
- investors make lump sum or periodic payments to buy ‘units’
- @retirement age the customer can cash out either as lump sum or periodic payments
- payements vary based on the performance of the mutual fund shares
13
Q
Ch 2 Sec 4 Inv Companies
Fund sponsor
A
- a fund is established by the fund sponsor or underwriter
- can be a large investment firm (MS) or a firm that specilializes only in running funds (i.e. fidelity)
- the sponsor registers the fund wiht the SEC before it can be sold
- much of the regisration statement is the proposed “prospectus” (details BOD, fees, fund objective, track record of sponsor)
14
Q
Ch 2 Sec 4 Inv Companies
management company
A
- formed when someone conceives of an idea for an investment compnay objective that is needed by investors
15
Q
Ch 2 Sec 4 Inv Companies
what does the prospectus detail
A
- fund objective
- BOD
- fees
- track record of sponsor
- structure of fund
16
Q
Ch 2 Sec 4 Inv Companies
Open-end Fund
A
- Mutual funds
- continuously issues shares by the sponsor
- every purchaser must receive the latest prospectus
- POP (public offering price) stated in propsectus is NAV per share plus a sales charge
17
Q
Ch 2 Sec 4 Inv Companies
Puplic offering price
A
- stated in prospectus
- Net Asset Value per share plus a sales charge the equivalent of a spread)
*
18
Q
Ch 2 Sec 4 Inv Companies
Selling Group
A
- the underwriter can hire a number of firms to help with the sales of mutual funds
- Act as agent, selling the fund for the sponsor
- sponsor gives them a part of the sales charge as a selling consession.
19
Q
Ch 2 Sec 4 Inv Companies
Closed End Fund
A
- one -time issuance
- then shares trade
- capitalized like a corporate stock offering
- one-time issuance of stock and then shares are listed and trade on an exchange
- original offering of the stock is made under a prospectus at the offering price, with underwriters earning a spread which is disclosed in the prospectus.
- if a selling group is used they are given a selling consession
- once the issue is sold out it trades in the secondary market - at which point the prsopectus is no longer required
*
20
Q
Ch 2 Sec 4 Inv Companies
Investment Advisor for fund
A
- listed in teh prospectus with the objective
- earns a management fee based on a percentage of all assets under management
- advisors contract is initially set for 2 years and is subject to shareholder vote annually thereafter
21
Q
Ch 2 Sec 4 Inv Companies
Custodian Bank
A
- holds the assets of the fund
- acts as a transfer agent for the fund, canceling old shares and issuing new shares
- keeps the shareholder list (i.e. mailing reports, proxies, and distributions)
- earns custodial fees
- listed in the prospectus
22
Q
Ch 2 Sec 4 Inv Companies
diversified funds
A
- 75% or more of its assets invested in securities
- max of 5% of its assets in any one issuer
- max holding of 10% of the voting securities in any one issuer
23
Q
Ch 2 Sec 4 Inv Companies
75/5/10 Rule
A
- required of diversified funds
- 75% or more of its assets invested in securities
- max of 5% of its assets in any one issuer
- max holding of 10% of the voting securities in any one issuer
24
# Ch 2 Sec 4 Inv Companies
Rule 35d-1
* rule that states if a fund focuses on a paticular type of investment (in the investment policy) then it must invest 80% of its assets in that investment type
e.g. a 'bond fund' must invest at least 80% of its assets in bonds
25
# Ch 2 Sec 4 Inv Companies
Selling open end shares
* open end shares are redeemable at any time by the sponsor of the fund.
* non-negotiable, redeemable securities
26
# Ch 2 Sec 4 Inv Companies
Net Asset Value
* every day the fund computes its NAV per common share
* to do this:
* all securities are marked to market, with the total market value dividied by the number of common shares of the fund outstanding
* assume that a fund has computed its current net asset value to be 9.15 per share
27
# Ch 2 Sec 4 Inv Companies
No-Load
* there is no sales charge and customers can buy at Net asset value
* sold directly by mutual fund sponsors who do not use selling groups or salesmen
* most all money market funds are no-load (since they are viewed as short term)
28
# Ch 2 Sec 4 Inv Companies
max sales charge for funds
* sales cahrge on top of the net asset value
* the max sales charge is 8 1/2% of POP
29
# Ch 2 Sec 4 Inv Companies
sales charge percentage =
= (ask -bid) / ask
NAV is BID
POP is the ASK
30
# Ch 2 Sec 4 Inv Companies
foward pricing
* when a customer places an order to buy a mutual fund he does not know the exact price at which he will buy becuase the purchase price is computed based on the closing NAV that day.
if a customer redeems a mutual fund they receive that days closing NAV
31
# Ch 2 Sec 4 Inv Companies
Payment upon redemption of a fund
Must be paid wihtin 7 calendar days
32
# Ch 2 Sec 4 Inv Companies
Redemption Fee
* funds can cahrge redemption fees
* all fees combined cannot exceed 8 1/2% of POP
* if a fund charged 8 1/2 % sales charge they cannot charge a reemption fee
* if a fund charged 8% sales charge they can charge up to a 1/2% redemption fee
*
33
# Ch 2 Sec 4 Inv Companies
In order for a fund to charge the maximum sales charge (8 1/2%) the fund must:
the fund must offer:
* breakpoints
* letter of intent
* rights of accumulation
34
# Ch 2 Sec 4 Inv Companies
Breakpoints
* reduced sales charge for large dollar purchase
* FINRA sets breakpoint schedules that it considers to be fair and reasonable
* mutual funds may lower the sales charge in the breakpoints but may not esceed them
35
# Ch 2 Sec 4 Inv Companies
Revised offering price based on breakpoint =
= NAV "bid" / (100%-Sales Charge %)
36
# Ch 2 Sec 4 Inv Companies
who can take advantage of breakpoints
individuals or groups of individuals living in the same household.
fund families will apply breakpoints to all funds wihtin the family
37
# Ch 2 Sec 4 Inv Companies
letter of intent
* a customer can sign a letter of intent to purchase up tot a breakpoint in order to get the breakpoint sales charge
* if he doesnt complete the breakpoint the his purchases are recalculated based on the actual breakpoint level acheived.
* the letter can be backdated to include purchases in the preceding 90 days
* 13 month length, 90 day backdate
38
# Ch 2 Sec 4 Inv Companies
letter of intent length and backdate
* letter of intent can only last 13 months
* inclusive of the 90 day back date period
* extra shares pruchased under the breakpointt are held in escrow until the breakpoint level is reached.
* if the breakpoitn level is not reached the extra shares are not released from escrow
39
# Ch 2 Sec 4 Inv Companies
Rights of accumulation
* based upon either cost or the current market value of the fund shares
* FINRA also permits funds to use the higher of cost or market value
* i.e. if the funds shares have appreciated this growth may move the customer to a lower breakpoint sales charge when they wish to buy new shares
40
# Ch 2 Sec 4 Inv Companies
switching between funds in the same fund family
* typically no sales charge, switch is made at NAV
* not a finra requirement, typically a sales/marketing tool
* swithing between funds is conidered a sale from a tax perspective and capital gains will be due if they have appreciated / capital loss will be realized if they went down in value
41
# Ch 2 Sec 4 Inv Companies
Annual statement requirements for funds
* dividend distributions and capital gains distributions must be distinguished on an annual statement sent to shareholders for tax purposes (IRS form 1099)
42
# Ch 2 Sec 4 Inv Companies
Distributions of dividends and capital gains for funds
* made by the board of directors of the fund
* dividends may be paid more than once per year
* net capital gains can only be distributed once a year
43
# Ch 2 Sec 4 Inv Companies
closed end fund ex date
* set by FINRA
* distribution is reported to he exchange where the shares trade
* BOD includes declaration date, record date, and payable date
* based on this FINRA sets the ex-date and the share price is reduced on that date
44
# Ch 2 Sec 4 Inv Companies
Mutual fund ex-date
* open end do not trade
* BOD sets the ex-date
* BOD sets the declaration date, record date, payable date and ex-date
* on the ex-date the share price is reduced for the distribution
*
45
# Ch 2 Sec 4 Inv Companies
why is buying fund shares just prior to the ex-date not prudent
* investor may pay tax on the distribution and after the ex-date has shares that are reduced in value by the "before tax" distribution amount
46
# Ch 2 Sec 4 Inv Companies
selling dividends
* prohibited
* recommending the purchase of fund shares to customers just prior to the ex0date to receive a dividend or capital gains distribution
47
# Ch 2 Sec 4 Inv Companies
shareholder rights
Invest Company Act of 1940
* vote for the BOD
* vote for changes to investment objecitve
* to vote annually on the investment advisor
* receive annual and semi-annual reports from the investment company
48
# Ch 2 Sec 4 Inv Companies
BOD make up for investment companys
* mangers of the fund cnanot exceed 60% of the borad
* 40% of the board must be 'disinterested persons"
49
# Ch 2 Sec 4 Inv Companies
BOD elections
* BOD must be elected by the shareholdres at an annual meeting
* not all board members must be voted annually
* directors can be divided into classes with a term of office from 1 to 5 years
* one class must come up fro election annually
50
# Ch 2 Sec 4 Inv Companies
Minimum fund capital
* the sponsor must have total net assets of $100K of its own
51
# Ch 2 Sec 4 Inv Companies
fund registration
* registers with SEC within 3 months after filing the notification of registration
* filing for mutual funds is done through form N-1A
52
# Ch 2 Sec 4 Inv Companies
fund registration includes the following information
* investment objective
* classifcation and subclassifcation of the fund (eg: Face amount/ uit or trust managment compnay; open end or close end; diversified or non-diversified)
* bowrrowing restrictions / policy on borrowing money
* restrictions on issuing senior securities (only issued by closed-end funds)
* policy on concentration
* policy on investing in real estate
* policy on making loans
* portoflio turnover for the last 3 years
* names and addresses of affiliated persons, oter companies in which these persons are officers or directors, business experience for the last 5 years
* other filings made with the SEC under the '33 and '34 acts
53
# Ch 2 Sec 4 Inv Companies
borrowing restrictions
* open end fundscannot borrow more than 1/3 of net assets
* funds cannot borrow to make dividend distributions
54
# Ch 2 Sec 4 Inv Companies
restrictions on issuing senior securities
* can only be issues by closed end funds
* can only issue bonds and make interest payments if asset coverage is at least 300%
* preferred stock can be issued and div payments allowed if asset coverage is at least 200%
55
# Ch 2 Sec 4 Inv Companies
change in objective or policies
requires a majority vote of outsanding shares
56
# Ch 2 Sec 4 Inv Companies
Inv Comp Act of 1940 prohibits mutual funds from:
* purchasing shares of companies on margin
* selling short shares of companies
* participating in joint trading accounts in securities
57
# Ch 2 Sec 4 Inv Companies
Inv Comp Act of 1940 requirements for invest advisor contracts
* be made in writing for not longer than an initial two year duration
* must be approved by the majority vote of the shareholders
* must be reapproved annually by the BOD or by the majority vote of shareholders
* must provide for termination by either the BOD or majority shareholder vote with 60 days notice
* cannot be assigned to another firm (if done automatically terminated)
58
# Inv Comp Act of 1940
What are shareholder rights under the Inv Company Act of 1940
* to vote for the board of directors
* to vote for changes in investment objective
* to vote annually on the investment advisor
* to receive annual and semi-annual reports from the investment company
59
# Inv Comp Act of 1940
What is the max % of the board that can be managers of the fund
Max 60%
40% must be 'disinterested persons' / 'non-affiliated'
60
# Inv Comp Act of 1940
what are the requirements for board of directors elections
* board of directors must be elected by the shareholders in an annual meeting called for this purpose
* not all board members need to be voted annually
* directors may be divided into classes, terms of 1-5 years
* one clase must come up for election annually
61
# Inv Comp Act of 1940
Minimum to establish a fund
the sponsor must have Total Net Assets of $100K of its own
62
# Inv Comp Act of 1940
How does a fund register
* all investment companies must register with the SEC within 3 Months after filing notification of registration iwth SEC
* Filing is done through Form N-1A
63
# Inv Comp Act of 1940
what is included in the investment comany registration
* investment objective and policies of fund
* classifcation and subclassifcation (e.g. FAC, UIT or Mngment Company, Open-end, closed-end; diversified or non-diversified)
* Borrowing restrictions: policy on borrowing money
* restrictions on issuing senior securities (can only be issued by closed end funds)
* Policy on inv concentration
* policy on investing in real estate
* policy on making loans
* portoflio turnover for the previous 3 years
* name and addressses of affiliated pesrons, other companies in which these people are officers/directors, business experience for the last 5 years for these people
* any other filings made with the SEC under the '33 and '34 acts
64
# Inv Comp Act of 1940
limitation of boarrowing by investment companies
* open-end funds cannot borrow more than 1/3 of Net assets
* funds cannot borrow to make dividend distributions
65
# Inv Comp Act of 1940
Who can issue senior securities
* only closed-end funds can issue senior securities
* can only issue bonds and make interest payments if asset coverage is at least 300%
* preferred stock issueance and dividend payments are allowed if asset coverage is allowed if asset coverage is at least 200%
66
# Inv Comp Act of 1940
how do investment companies change objective or policies
* need to put it to shareholders
* need a majority voite of outstanding sharholders to approve
67
# Inv Comp Act of 1940
Prohibited fund actions by the inv company act of 1940
* purchasing shares of companies on margin
* selling short shares of companies
* participating in joint trading accounts in securities
68
# Inv Comp Act of 1940
Investment Advisor contract requirements
* contract in writing
* no longer than an initial 2 year duration
* must be approved by majority vote of the shareholders
* must be reapproved annually by the BOD or by majority vote of shareholders
* must provide for termination at any time by either the board or majority shareholder voite with 60 days notice
69
# Inv Comp Act of 1940
How are Fund Shares Priced
* Section 22 of the Act
* Shares are priced a the next computed Net Asset Value Plus Sales Charge (as long as the sales charge is dislcosed in teh registration statement and offering materials)
70
# Inv Comp Act of 1940
Rule 22c-1
* Requires management companies to compute net asset value at least once daily
* computed monday through friday, at a specficied time by BOD
* for most funds its the closing of the NYSE each business day
71
# Inv Comp Act of 1940
Rule 22d-1
*permits breakpoints
* permits funds to offer variations in the sales loads ('breakpoints') as long as they are uniformly applied to all offerees
* changes are disclosed in a revised prospectus, existing shareholders must be advsied within 1 year (usually through prospectus mailing)
72
# Inv Comp Act of 1940
Rule 12b-1
* allows some selling and distribution expenses to be charged to fund shareholders
* under this rule an investment company can finance activies intended to result in the sale of shares, such as advertising, mailing of prsopectuses to persons other than current shareholders, printing and mailing of saels literature and compensation of sales personnel.
73
# Inv Comp Act of 1940
Approvals to adopt a 12b-1 plan
* 3 levels of voting are required
* the plan must be approved by majority vote of the:
1. shareholders
2. board of directors
3. uninterested directors
74
# Inv Comp Act of 1940
how is the 12b-1 plan managed
* a person is appointed to direct expenditures of funds allcoated to the plan
* this person must give a quaterly report to the board
* plan must be reapproved annually
* increases in funds spent must be approved by the shareholders and board
75
# Inv Comp Act of 1940
termination of a 12b-1 plan
* may terminate at any time by majority vote of either the: shareholders or uninterested directors
**majority vote of the board is not needed to temrinate
76
# Inv Comp Act of 1940
FINRA Sales Charge Rules
the rule is speratated into a max sales cahrge for funds that impose 12b-1 fees and max for those that do not
77
# Inv Comp Act of 1940
Maximum sales charge for non-12b-1 funds
* 8 1/2% of the offering price
* applies to the total of both front-end and deferred sales charges
78
# Inv Comp Act of 1940
To charge the maximum permitted sales charge the fund must:
offer both:
* cumulative quantity discounts (rights of accumulation)
* quantity discounts (breakpoints)
There are minimum breakpoint schedules provided by FINRA
79
Maximum sales charge for non-12b-1 funds
* 8 1/2% of the offering price
* applies to oth front-end and deferred sales charges
80
What must be true in order to charge the maximum permitted sales charge?
* max sales charge is 8 1/2%
* the fund must offer both:
1. cumulative quantity discounts (Rights of accumulation)
2. Quantity discounts (breakpoints)
81
Minimum breakpoint schedules
* two alternatives
82
Conditions where FINRA may redue the maximum sales charge
1. if ROA is not at least as favorable as the two schedule options: (max charge 8%)
2. if breakpoints are not at least as favorabel as the two schedule options (max charge 7.75%)
3. if both ROA and breakpoints are not at least as favorable as the schedule options (max charge 7.25%)
4. if an investment company pays a service fee (paid to 3rd party for sharholder account maintenance) (mas fee is 7.25%)
83
what is the max fee for investment companies with 12b-1 fees (asset backed sales charge)
* Max sales charge is 6/25% for funds that pay service fees (to 3rd parties for shareholder account maintenance)
* 7.25% for funds that do not impose service fees.
84
Caps on 12b-1 fees
* Max 1% annually
* for "no load" funds max is .25%
85
Class A Shares
* impose higher up-front sales charge
* no / very low (.25%) annual 12b-1 fees
* Most suitable for: Long term invetment
86
Class B shares
* Impose a contingent deferred sales charge that declines to "0" the longer the investor stays in the fund
* higher (.50%) annual 12b-1 fee
* Most suitable for intermediate investements
87
Class C Shares
* Impose no up-frotn sales charge
* Rear load is smaller
* Highest 12b-1 fees
* Only suitable for short term investments
88
Who are class A shares appropriate for
large amounts to invest with a long term time horizon
89
Late Trading
The practice of placing orders to buy, redeem or exchange mutual fund shares after the time as of which the fund calculates its daily NAV (4 pm est)
Prohibited under Inv Company Act of 1940
90
Market Timing
The practice of frequently buying and selling a funds shares to exploit inefficiencies in how the mutual fund company copmutes NAV per share
91
what have funds done to prevent market timing
most mutual funds have placed restrictions on excessive trading and monitor accounts for excesssive short-term trading
92
# FINRA
FINRA prohibits member firms from offering investment company shares if:
* service fees paid by the investment company exceed .25% of net assets
* Divividend reinvestment at NAV is not offered (a sales charge is imposed on reinvested dividends)
93
Written Selling Group Agreements
* FINRA requires any member joining a selling group must sign a selling agreement
* Agreement must specify the conessions to be received by the selling group member
94
Requirements for placing orders for mutual funds
* FINRA members must promptly submit the order to the underwriter
* Orders placed with the underwriter must be:
1. to fill an existing customer order
2. for securities to be placed in the firms investment account
95
Payment requirements for mutual fund orders
Payment must be transimitted to the underwriter within 3 business days of receipt of the customer order.
OR
within 1 busienss day of receipt of payment whichever is later
95
why must orders placed with underwrites be for an existing customer order or for the finra firms own account?
to prohibit the firm from makign a market in the fund shares
96
What is required if a customer redeems a mutual fund within 7 days of purchase
the member firm forfeits sales consessions to the fund underwriter
resasonable redemptions fees are permitted
redemption takes place at the next computed NAV
97
"Special Deals"
* FINRA prohibits "special deals" between the underwriter and the FINRA firm
* the only compensation to be received by a FINRA member for selling fund shares is the selling concession
* No additional incentives are allowed
98
What are prohibited incentives between underwriter and salesmen
* commissions paid by investment company to the broker as a condition of selling fund shares
* commissions paid by another finra firm to the broker as a condition for selling fund shares
* special incentive campaigns promoting the sales of a fund, financed by the commissions directed or arranged by the underwriter
99
Member firms are prohibited from special compensation for selling fund shares, including:
prohibted:
* placing specific mutual funds on a "recommended" or "preferred" list
* Providing sales people with additional compensation for the sale of shares of specific investment companies
* giving commissions to sales personnel on fund portoflio transactions, where the commisssionss are directed by the investment company
100
what is the only allowable basis for selecting a member frim to perform portfolio trade execution
* FINRA prohibits underwriters from directing portoflio trades through a FINRA member as a consession for selling the fund (cant be based on the volume of the fund being sold by the member)
the only basis for selection is capabilitiy
101
Direct Brokerage Arrangements
* Member firms are prohibited from selling the shares of a mutual fund or acting as an underwriter for the fund if he member has a directed borkerage arrangement that is intended to promote the sale of that investment company's securities.
102
Prohibited Compensation items from underwriters
FINRA prohibits underwriters from compensating persons for retail distribution of fund shares with:
* stock, warrants or options
* merchandise or trips
* any compensation not stated in the prospectus
* any item of material value
103
Sales contests and selling group members
Each selling group can hold a sales contest within its firm as long as it does not favor one fund over another
104
3 things Fund Underwriters are prohibited from doing re: compensation
* cannot hold fund contests for selling group members
* cannot compensate RRs in the selling group
* cannot direct portfolio trades to specfiic selling group members based on fund sales
105
Allowable gifts from fund underwriter to reps in the selling group
* gifts of no more than $100 per person per year
* educational seminars held by the fund underwriter, provided that:
- prior approval by member firm
- location is appropriate
- sponsor pays for training, education, meals, lodging and transportation of the associated person (no guests / spouses)
* Loans or guarantees to a person not controlled by the underwriter or member
* wholesale overrides stated in the prospectus
* occaisonal meals, sporting tickets, paid by the sponsor (not frequent, not excessive and not conditioned on sales of fund shares)
106
to whom does the FINRA interpretation on charitable solicitation apply?
applies only to the employees of institutional customers seeking charitable contributions from Broker Dealers.
107
FINRA recommends member firms have written procedures covering solicitated contributions that cover:
* Broker-dealer approval: require BD approval for institutional customer solicited charitable contributinos that exceed a threshold amount or frequency
* Customer Approval: require approval be obtained form the appropriate rep from the insitutinoal cusomer for requests above a threshold
* Cannot tie contribution to amount of directed brokerage: prohibit lining the contribution amount to a level of business
* Frequent review of solicited contribution activity: require review by the BD of the nature and amount of business received from customers whose employees have solicited charitable contributions.
108
Soft Dollar Remuneration
* rebates in the form of services
* typically research provided by the BD to the insitutional cusomter
* BD gives their institutional customers such as mutual funds free research in return for getting their "full commission"
* allowed by SEC
109
Requirements for soft dollar payments
* SEC requires that "free" services provided by soft dollar items directly benefit the shareholders of the mutual fund.
* allowable:
- free research
- trading software
- asset allcoation software
* these are provided to the mutual fund in return for getting that mutual funds full commission trades
* Not allowed:
- rent subsidies (as they dont directly benefit the shareholders)
110
Generic Advertising SEC Rule 135A
* outlines under which investment compnaies can distribute generic advertising without first giving the customer a prospectus.
111
"generic" advertisements
(SEC rule 135A)
* do not specifically refer, by name to the specfici securities in which a fund invests.
* name of the reigstered BD sponsoring the communication must be included and it must state if the sponsor is the principal underwriter.
* limited to:
-explanatory information about invesment company securities, the nature of investment companies and services offered
-explanation of differing investment objectives
- explanation of various products and services
- an invitation to inquire for more information
112
When can past performance be included in generic advertising?
* if total return is shown for 1,5 and 10 year periods or for the life of the fund if shorter)
* total return is broken down into income and capital gains
* all sales charges and expenses are reflected
113
SEC Rule 156
Requirements for Investment Company Sales Literature
* sets requirements for investment company sales literature.
* makes it a violation of the Securites Acts for any person to use sales literature that is materially misleading in connection with the offer of investment company securities.
* literature is materially misleading if it contains an untrue statement of material fact, or omits a fact necessary to make material not miselading.
114
# Variable Annuity
UIT
- common type of investment company form
- issues "shares of beneficial interest"
115
Shares of Beneficial Interest
* issued by UITs
* called " units"
* represent an undivided interest in the portfolio of securities
* they are redeemable with the trust sponsor at any time at their NAV
116
Two types of UITs
FIxed UIT
Participating UIT
117
Fixed UIT
* sponsor selects a fixed portoflio and places it in a trust
* units of the portoflio are sold to investors
* once established, no buing or selling of securities takes place in the portofolio
118
Participating UIT
* The trust buys shares of a management company
* once the shares are purchased they reamain in the trust until the unit is redeemed
* The shares held in trust are used to fund annuity contracts issued by insurance companies (variable annuities)
*
119
Fixed Annuity
* the insurer guarantees a specific rate of return to the investor
* no matter how good or bad the investments perform
* the insurance company assumes the investment risk
* NOT a security - its an insurance product regulated by insurance laws
120
Variable Annuity
* no guarantee of a specific rate of return
* based on the performance of the investments funding the annuity
* the investor assumes the investment risk
* considered to be a security - regulated under the securities laws (inv compnay act of 1940)
121
How do investment companies structure most variable annuities
* a trust is created that collects payments from investors
* the trust can only invest in management companies
* the managment companies that are designated for invesment are ususally operated by another subsidiary of the insurance company
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AIR - Assumed Interest Rate
*assumed interest rate included in the prospectus
* not a guarantee of an annual rate of return but an illustration of the annuity amount the customer will receive assuming it grows at that rate.
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where are securities invested for an annuity held
* in a seperate account seperate from teh insurance copmany's other holdings
* a portoflio operated as a management company
* a baord of managers oversees the operating of the account
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who oversees the operating of the variable annuity account (portoflio)
* a board of managers
* contract owners vote for managers and changes to investment policies
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accumulation units
* the contract holder puchases accumulation usits (instead of shares)
* the NAV is computed daily
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how are div and interest payments and cap gains treated for variable annuities
* mandatory reinvestment
* automatically reinvested to buy more accumulation units for the contract holder
* they cannot be distributed to the unit holders until the contract is completed.
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Annuity Units
* when payments are completed the accumulation units are converted to annuity units.
* this is the "annuitization" of the seperate account.
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how are annuity units determined
* the number of annuity units received is dependent on the age, sex, health/habits, and the annuity payment option made by the contract holder.
* the periodic payment to the annuitant is the number of annuity units times the annuity unit value.
* the annuity unit value fluctuates as the securities fluctuate in value
* each annuity check may be a different amount (although units are fixed)
*
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annuity payments vs inflation
* variable annuities tend to keep pace with annuity if they are invested in equities
* fixed annuity payments tend not to keep up with inflation
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How are variable annuities sold.
* under a prospectus
* considered to be a security and not an insurance product
* the prospectus includes:
- detailed investment objective
- policies of the seperate account
- management fees
- brokerage fees
- admin expenses etc
- sales charges, breakpoints early redemption penalties and redemption fees
- insurance related mortality and expense charges
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Mortality Guarantee
the insurance company guarantees to pay the annuity for one's life (or toher designated payment option)
if a person dies later than his projected mortality the payments will continue
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Expense Guarantee
* if expenses exceed a given percentage he insurace company absorbs the excess
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Surrender charges
* may be imposed on accumulation units that are liquidated before a stated time period
* usually the longer the units have been held the smaller the surrender charge
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Interest Rate Guarantee
* only offered in fixed annuities
* interest rates are not guaranteed for variable annuties
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Borrowing against accumulation units
* a customer can borrow against the value of his accumulation units similar to borrowing agains a whole life insurance policy
*
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what can someone do to insure a fixed annuity payment with a variable annuity?
* take a lump sum distribution at annuitization and purchase a fixed immidiate annuity
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Accumulation Units
* variable annuity contract holders purchase accumulation units (instead of shares).
The net asset value per unit is computed daily
As each $100 payment is collected it is used to buy more accumulation units
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Variable Annuity Mandatory Reinvestment
when interest, dividend and capital gains payments are realized they are automtically reinvested to buy more accumulation units
cannot be distributed to the unit holders until the contract is completed
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Annuity Units
* When 120 payments of $100 are completed the number of accumulation units purhcased plus the additional units bouht with reinvested dividents and capital gains are converted into annuity units.
* Annuitization of the seperate account
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How is the periodic payment to the annuitant calculted?
* number of annuity units based on sex, age, habits of contract holder
* payment = annuity units X annuity unit vlaue
* Annuity unit value fluctuates
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Fixed and variable annuity payments in comparison to inflation
variable annuit payments - tend to keep up wiht inflation
Fixed - tend to lose value as inflation increases
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Variable Annuities are defined as ________ by the SEC
* a security
* requires a prospectus
* They are not considered to be an insurance product
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what are two guarantees with any annuity
* mortality guarantee
* expense guarantee
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Mortality Guarantee
* the insurance company guarantees to pay the annuity for one's life (or other designated payment option).
* if a person dies at a later date than his projected mortality the payments continue until death
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Expense Guarantee
if the expense exceeds a certain percentage, the insurance company absorbs the excess
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interest rate guarantee
* only for fixed annuities
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Surrender charges
* variable annuity can impose surrender charges on accumulation units that are liquidated before a stated time period.
* typcially the longer the units are held the smaller the surrender charge
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Borrowing against accumulation units
* can borrow against accumulation units (similar to whole life policy)
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Variable Whole Life Insurance
* the holder receives a death benefit in addition to an investment benefit
* the investment benefit is funded by the variable annuity investments
* the death benefit is funded seperatley and guaranteed
* Must be registered as a security and sold under a prospectus
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Qualified Variable Annuity
* when an annuity is purchased in a qualified retirement:
* the contribution is deductible
* the earnings growth tax deferred
* distributions are taxed 100% as ordinary income
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Non-Qualified Variable Annuity
When a variable annuity is purchased in a non-qualified retirement account:
- the contribution is not deductible
- earning build tax deferred
- and distibutions attributable to growth are taxable at ordinary income tax rates
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Maximum sales charge for variable annuities
must be "fair and reasonable"
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How are payments for variable annuity contracts made?
*payment made to finra member by investor.
finra member sends payments "promptly" to the insurance compnay for at least the amount to be credited to the insurance contract.
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What is required between the firm and the insurance company prior to being able to place orders for a variale annuity contract.
FINRA requires that a written selling group agreement is in force wiht the issuing insurance company
the insurance company must have a registered BD with FINRA
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if a redemption is made within 7 days of contract acceptance then:
* the selling concession will be returned to the issuer
* redemption request must be transmitted promptly to the issuer
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SEC Rule 22e-1
prohibits companies from suspending redemptions for more than 7 business days after the tender of that security
the SEC exempts variable annuity contracts from this provision during the annuity period
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Under FINRA rules, in order to recommend a variable annuity contract to a customer:
the rep must have a reasonable basis to believe that:
* the customer has been informed, in general terms, of the material features of the product
* the customer would benefit from one or ore of the features of the products
* the particular variable annuity as a whole, the underlying seperate accounts to which funds are allocated at the time of purchase and the riders to the policy are suitable
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clear product description requirement
FINRA requires that when an insurance product is recommended that the customer be told clearly that it is either a variable insurance or variable annuity product.
in order to insure they dont assume that they are buying a mutual fund
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Considerations when exchanging an annuity
* when recommending an exchange the rep must consider whether the customer:
* would incur a surrender charge, be subject to the commencement of a new surrender period, lose exisiting beneifts or be subject to increased fees and charges
* would benefit from product enhancements or improvements
* has had another annuity exchange in the past 36 months
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1035 exchange
annuity exchanges are not a taxable event.
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1035 exchange requirement
* rep must sign a statement saying required determinations were completed
* must complete a detailed suitability questionnaire
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what should be included in the detailed suitabilty questionnaire for 1035 exchanges
age
annual income
financial situation / needs
investment experience
investment objectives
intended use for the deferred annuity
investment time horizon
existing assets including life insurance
liquidity needs
liquid net worth
risk tolerance
tax status
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where do appications for variable annuities go who must approve it?
* the associated person must send it to the OSJ for review
* the OSJ must review the completed application prior to transmitting it to the insurance company
* review must happen within 7 days
* review by principal must state wehter they approve or disapprove the purchase or exchange
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# vairable annuity
when must the check be sent to the insurance company?
once a principal approves an application for a variable annuity purchase or exchange the check must be forwarded to the insurance company no later than noon the next business day
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what types of exchanges is finra worried about
exchange of whole life policy for a variable life policy
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what are valid reasons to exchange an existing whole life insurance policy
* better coverage at a lower cost
* more desirable features or benefits
* if the customer is concerned about solvency of the company that issued the original policy or with the service of the agent that sold the origianl policy
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what are invalid reasons for exchanging a policy
* use an existing policy's cas value to pay for a new policy's first year expenses
* if the existing policy is in its early years and cashing out will incur high surrender charges
* if the existing policy is past its two - year "contestable period" and any new policy could allow the insurance company to challene a death calim that occurs in the first two years
* if there are unfavorable tax consequences
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In force ledger
* the stateent of the existing whole life policy's cash value
* surrender charges
* and projections of future death benefit and cash value
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why is the in force ledger examined?
* used to see what the current coverage amount is
* if there are any surrender charges
* if there is a cash value that can be used to pay for a new policy
* if the insurance amount provided by the new policy is comparable or better that provided by the old policy
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