Mutual funds are pools of equities owned by the fund's investors and professionally managed by a fund manager. A frequent topic in online financial articles and blogs is the possibility of investors losing their equity if the fund's management becomes insolvent or declares bankruptcy. The organizational structure of mutual funds is designed to make this a remote possibility. In 2012, there were more than 9,000 mutual funds. While many funds fail each year, there is no known instance of this affecting the equity of investors.
The Board of Directors
The fund itself, the investment pool owned by investors, has no employees and is externally managed by third parties. At the center of this third-party organizational structure is the board of directors. Board members are elected, either by the board itself or by the fund's shareholders. By law -- specifically the Federal Investment Company Act of 1940 -- the board is responsible to the investors and to the SEC. The board often has its own legal counsel and administrative staff. They hire, usually by contract, all other fund entities, including the fund's investment adviser.
The board hires several different kinds of fund administrators, each of which is more likely to be another organization rather than a single individual. Two functions, the fund's sponsor and the fund's investment adviser, are often conducted by a single organization. The sponsor's primary responsibility is to launch the fund. The fund's investment adviser, under control of a fund manager, is the organization that makes decisions about fund investments and undertakes the buying and selling (and sometimes lending) of equities. A fund administrator, organizationally separate from the sponsor/adviser, handles back-office functions such as accounting and internal auditing. The administrator also prepares necessary fund reports to the SEC.
Each fund has a principal underwriter registered with the SEC who carries out trades initiated by the fund's adviser. The principal underwriter is almost always a broker/dealer organization, with its own regulatory back-office that oversees activities to ensure SEC compliance. A separate transfer agent for the fund keeps track of trading activities and calculates and prepares dividend statements and federal tax information. Every fund also has an external independent fund accountant who certifies the fund's financial statements. Lastly, there is the fund custodian. The custodian is usually a specialized investment bank that holds the fund's cash and tracks all the fund's activity, including trades. The custodian's most important responsibility is to ensure the safety of investor assets.
The safety of mutual fund investments depends upon a fund structure with redundant oversight functions. The board and its legal stuff, the independent fund accountant, the fund manager's compliance officer, the transfer agent, the underwriter's compliance staff and the custodian all have overlapping accounting, trade-tracking, and compliance functions, each with separate reporting obligations to the SEC. If a fund fails, this affects all the fund's managers and staff, but not its investors. The custodian oversees the transfer of the investors' equity to another fund or its return to its investors.
- ICI: How U.S.-Registered Investment Companies Operate and the Core Principles Underlying Their Regulation
- U.S. Securities and Exchange Commission: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation
- Independent Directors Council: Frequently Asked Questions About Mutual Fund Directors
- Marketplace: If a Mutual Fund Company Fails?
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