5.1.1. Structure of Mutual Funds
Mutual fund companies are managed by a shareholder-elected board of directors. The board establishes the company’s investment policy and selects and oversees the investment adviser, custodian, and transfer agent. The Investment Company Act of 1940 says that 40% of a fund’s board of directors must be independent (also called outside or non-interested). If the fund’s underwriter (also called the distributor, wholesaler, or broker-dealer) is affiliated with the fund (and most are), then a majority of fund board members must be independent. This means board members may not be involved with the company or its investment adviser, custodian, law firm, or transfer agent, except through their work on the board. Members of the board of directors have a fiduciary responsibility to the shareholders.
The investment adviser, also known as the portfolio manager, manages the fund’s investment portfolio by implementing the board’s objectives and policies. The investment adviser does this by choosing the investments and by making the buy and sell decisions. The investment adviser is on a short-term contract that must be approved annually. The investment adviser is usually a company rather than an individual and must be registered under the Investment Advisers Act of 1940. The investment adviser is paid a percentage of the fund’s value, so it has incentive to grow the company. Investment advisers make their investment decisions based on federal securities regulations and federal, state, and local tax laws. The investment adviser also identifies the tax status of distributions made to shareholders.
The custodian, a bank or stock exchange member broker-dealer,