Role of the Custodian of a Mutual Fund

by William Pirraglia

    Whether you are a passionate or occasional investor, you have probably considered mutual funds for your portfolio. You have heard the term "custodian," but may be a bit fuzzy as to its role. Federal regulations mandate that an investment adviser, the fund manager and the fund assets remain separate for protection. This is where the custodian is critical. As an outside third party, the custodian's role is to safeguard and protect the assets of the mutual fund.

    Who Serves as Custodian

    Most often, banks and credit unions serve as custodians, along with other securities firms. Since these organizations are heavily regulated by the federal government, they are excellent, safe and reliable options to act as mutual fund custodians. Although other third parties can be named custodians, financial institutions and uninvolved securities firms are the most popular choices. Both entities typically excel at record keeping and monitoring assets to protect against inappropriate actions with investors' assets.

    Duties

    Keeping track of mutual fund assets, sales and purchases, shareholder transactions and identities are the primary duties of mutual fund custodians. Tracking and recording trades by investors is vital to maintaining accurate records. Measuring, monitoring and tracking shareholder values, dependent on the size of their investment, is critical to eliminating even the hint of fraud or impropriety. Custodians can also collect and distribute interest and dividends to shareholders. Custodians typically process investor redemption, purchases and sales of mutual fund shares.

    Fund Transactions

    Investors buying and selling mutual fund shares do not do so through fund managers. Transfer agents handle the direct responsibility for shareholder purchases and sales of mutual fund shares. The custodian then records these transactions without fund manager involvement. Custodians report these transactions to fund managers so they can continue to keep fund assets and fund cash positions healthy.

    "Power" Distribution

    Custodian roles are important in dividing the responsibilities of managing the mutual fund. This division of authority eliminates the potential for fund managers to acquire too much power. The custodian, official recording of mutual fund transactions, safeguarding fund assets and tracking shareholder values provide a "checks and balances" function. While both the custodian and fund manager have a fiduciary responsibility to the mutual fund and its shareholders, separating these requirements between the two entities minimizes perceived improprieties.

    Mutual Fund Board

    The mutual fund board selects the custodian to ensure the integrity of the mutual fund assets they oversee. Since the custodian manages and records all investor transactions, including tracking any interest or dividends paid to the fund, the board enhances the safety of the securities owned by the fund, while the custodian reconciles all fund balances, including individual investor shares. The custodian also has board authority to pay and control mutual fund expenses for administration and sales commissions.

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    About the Author

    For 34 years Bill Pirraglia served as a senior executive in the banking industry. Since 2005, he has authored articles, blog entries, tips and advice columns, SEO web copy and two published books. He specializes in personal and business finance topics, along with legal articles for clients large and small.

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