Two customers buy the same mutual fund on the same afternoon. One pays a 5% sales charge and the other pays nothing. Both prices are legal because the fund's prospectus schedules each one. Much of a representative's job with packaged products is getting each customer to the price they qualify for.
A packaged product pools money from many investors into one portfolio. You own a slice of the pool instead of picking securities yourself. You get diversification, professional management and low minimums, and in return you pay fees and often sales charges. The investment company types you need are open-end funds, closed-end funds, unit investment trusts (UITs) and variable annuities. The Investment Company Act of 1940 classifies them in Sections 3(a), 4 and 5.
Section 3(a)(1) defines an investment company as an issuer whose main business is investing, reinvesting or trading in securities. An issuer also qualifies if it issues installment-type face-amount certificates. It qualifies, too, if investment securities make up more than 40% of its total assets, not counting government securities and cash.
Common mistakes
- Wrong source for caps: The 0.75% asset-based and 0.25% service fee limits are FINRA Rule 2341 caps. Rule 12b-1 sets no cap. It covers the written plan, its approval by shareholders and the board, annual renewal and quarterly reports.
- Using 8.5% everywhere: A fund that pays a service fee is capped at 7.25%. A fund with an asset-based charge is capped at 6.25% per transaction if it pays a service fee (7.25% if it does not), and variable annuities fall outside Rule 2341 entirely.
- Forward pricing an exchange trade: A closed-end fund with a $15.00 NAV that trades at $13.50 fills at $13.50. Only fund purchases and redemptions use the next computed NAV.
Bottom line
- Open-end funds issue redeemable shares at the next computed NAV and pay redemptions within seven days; Most ETFs are open-end funds listed on an exchange, and a few are UITs.
- Closed-end funds trade on exchanges at a premium or discount to NAV; UITs have a fixed portfolio, no board and redeemable units.
- POP equals NAV divided by (1 minus the load rate), because the load is a percentage of the POP.
- Rule 2341 caps loads at 8.5% of the offering price (7.25% if the fund pays a service fee), asset-based charges at 0.75% and service fees at 0.25%; Rule 12b-1 sets no cap.
Exam shortcut
Match the key phrase in the stem to its rule. "Just below a breakpoint" points to Rule 2342. A percentage cap on 12b-1 fees points to Rule 2341, while a written plan renewed annually is Rule 12b-1. "Seven business days" after the OSJ gets the package is Rule 2330, and "seven days" to pay a redemption is Section 22(e). Given NAV and a load, divide NAV by (1 − load).
The full lesson (about 5,016 words, 33 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- B8
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