Ch 2 S 4 Investment Companies Flashcards
INVESTMENT COMPANY is…
a portfolio or trust through which investors pool
their money in order to obtain the following:
- 1) diversification; reducing risk to investor
- 2) professional selection of investments
- 3) ongoing management
INVESTMENT COMPANY ACT OF 1940 DEFINES 3
TYPES OF COMPANIES
1) Face Amount Certificate Company
- 2) Management Company
- 3) Unit Investment Trust
Face Amount Certificate Company
virtually obsolete; investors pay fixed
monthly amount to investment company
which invests funds in highest quality
obligations (i.e. U.S. Gov’t Debt & AAA
municipal and corporate debt)
certificate promises investor a guaranteed
rate of return
total payments made by investor are less
than face amount received at maturity
Management Company
investment company organized as a
corporation, issuing shares of stock
Management Company-
Investment Advisor
used to decide what securities to place
in portfolio
• this ‘‘manager” is free to buy and sell
securities consistent with fund’s
investment objective
Management Company
-Open End Management Company
• mutual fund; most popular investment
company structure
• company issues only common shares
the number of shares issued is “open
ended’’
• as investors place new money in fund.
they’re issued additional shares
• shares are non-negotiable, BUT they
are redeemable
Management Company
-Closed End Management Company
- fund has one time issuance of stock
- negotiable “publicly traded” funds
• shares are listed on exchanges and
trade like regular stocks and can be
traded at prevailing market price
• NOT redeemable, but negotiable
INVESTMENT COMPANY ACT OF 1940 DEFINES 3
TYPES OF COMPANIES
3) Unit Investment Trust (UIT)
organized under a “trust indenture” rather
than being set up by a corporation
corporations issue shares while trusts issue
“shares of beneficial interest”
Unit Investment Trust (UIT)
Fixed UIT
Participating UIT
:-)
Unit Investment Trust (UIT)
Fixed UIT
• trust selects a portfolio of securities
• once selected, portfolio is NOT
changed
• no continuous buying or selling
of securities, thus, there’s no
ongoing management
• trust then sells “units” of fixed
portfolio to investors
( usu. bonds)
Unit Investment Trust (UIT)
Participating UIT
• instead of tmst selecting individual
securities, trust invests in shares of a
management company - specifically
mutual fund shares
• purchasers indirectly buy mutual fund
shares; participating tmst structures
are used when investors buy mutual
fund “contractual purchase plans”
and “variable annuities”
• under a contractual plan, at the
end of the plan period, the
investor can take out his
investment either as a lump sum,
in periodic payments, or in the
fonn of an annuity
- variable annuity
- used as a retirement vehicle
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
formed when someone conceives an idea for an
investment company objective needed by investors • i.e. fund targeted to investors who want absolute
safety
U.S. Gov’t & Agency securities
• i.e. fund targeted to corporate treasurers with
excess funds to invest
high dividend rate preferred shares to take
advantage of corporate dividend exclusion
• i.e. fund targeted to speculators willing to buy
bankrupt companies in hopes of achieving large
capital gains if some companies emerge from
bankruptcy
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
list
FllND SPONSOR
PROSPECTUS
SELLING GROUP
OPEN-END FUND
CLOSED-END FUND
INVESTMENT ADVISOR
CUSTODIAN BANK
:-)
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
FUND SPONSOR
underwriter
• must register fund with SEC before security can
be sold
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
PROSPECTUS
discloses the structure of the fund - detailing
fees involved, track record of sponsor, etc …
whether open or closed end
• P.O.P. = Net Asset Value per share+ Maximum
Sales Charge
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
SELLING GROUP
underwriter can hire a number of finns to form
a selling group
• selling group member acts as agent, selling fund
for sponsor at the public offering price (P.O.P)
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
OPEN-END FUND
continuously issued
• purchaser must receive latest Prospectus
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
CLOSED-END FUND
one time issuance. then shares trade
• prospectus no longer required after shares trade
in secondary market
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
INVESTMENT ADVISOR
prospectus details which advisor is to manage
fund within its objective
• earns a management fee based on percentage of
all assets under management
• advisor’s contract is initially set for 2 years and
subject to shareholder vote every year thereafter
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
CUSTODIAN BANK
safeguards funds assets
• can act as transfer agent and paying agent
receives custodial fee
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
FUND CAN BE SET UP As A
Diversified Fund
75 - 5 - 10 RULE
• 75% or more assets invested in
securities;
• maximum of 5% of its assets invested
in any one issuer;
• maximum holding of 10% of voting
securities in any one issuer
• Non-Diversified Fund
one that doesn’t meet the “diversified”
definition
• whether the fund is “diversified” or “nondiversified”
is stated in the prospectus
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
Diversified Fund
75 - 5 - 10 RULE
• 75% or more assets invested in
securities;
• maximum of 5% of its assets invested
in any one issuer;
• maximum holding of 10% of voting
securities in any one issuer
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
Non-Diversified Fund
one that doesn’t meet the “diversified”
definition
• whether the fund is “diversified” or “nondiversified”
is stated in the prospectus
GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES
RULE35-D-1
states that if a fund focuses 011 a particular
investment, then 80% oftheassets in the fund
must be in that asset type
BUYING AND SELLING MUTUAL FUND SHARES
gen procedures
MAXIMUM SALES CHARGE
FORWARD PRICING
REDEmPTION
CONTINGENT DEFERRED SALES CHARGE
BUYING AND SELLING MUTUAL FUND SHARES
open-end shares are continuously issued;
redeemable at any time (non-negotiable)
everyday Net Asset Value is computed; securities
are “MARKED To MARKET”
• Total Market Value divided by number of
common shares outstanding
•
if fund is No LOAD, there’s no sales charge and
customer can buy at net asset value
BUYING AND SELLING MUTUAL FUND SHARES
MAXIMUM SALES CHARGE
8 ½% of the P.0.P.
under FINRA Rules
the “true” sales charge as a percentage of the
NAY is greater than 8 ½%
Sales Charge % = A - B = Ask - Bid
A Ask
BUYING AND SELLING MUTUAL FUND SHARES
FORWARD PRICING
purchase price is computed at that day’s closing
Net Asset Value; same goes for redeeming
shares
BUYING AND SELLING MUTUAL FUND SHARES
REDEMPTION
when a customer redeems a fund, payment must
be received within 7 calendar days under the
1940 Act
• mutual funds CAN charge a REDEMPTION FEE,
but ALL fees combined cannot be greater than
8 1/2%
under FINRA rules
BUYING AND SELLING MUTUAL FUND SHARES
CONTINGENT DEFERRED SALES CHARGE
a fund charging no sales charge to purchase
shares, but if investor redeems shares within an
allotted time period, a redemption charge is
imposed
some funds give the investor a choice of either a
sales charge paid upon purchasing a fund, or a sales
charge when redeeming the fund
• Class A Shares
shares which charge a sales charge to buy
• Class B Shares
shares subject to a contingent deferred sales
charge
BUYING AND SELLING MUTUAL FUND SHARES
IN ORDER FOR FUND TO CHARGE MAXIMUM
8 1/2% SALES CHARGE, UNDER FINRA RULES,
FUND MUST OFFER:
hint 3 things
Breakpoints • Letter of Intent • Rights of Accumulation
BUYING AND SELLING MUTUAL FUND SHARES
Breakpoints
allows the investor to receive a reduced
sales charge for large dollar purchases
investment clubs (groups of individuals) cannot obtain breakpoints, though individuals living in the same household are generally allowed to receive break-points
BUYING AND SELLING MUTUAL FUND SHARES
Letter of Intent
if signed, the investor says he will buy more
of the fund LATER on to get the reduced
sales charge NOW
• if the investor doesn’t complete the
letter of intent, his purchases are
recalculated based on the actual
breakpoint level reached
can be backdated 90 days
good for 13 months, inclusive of the 90 day
backdate
Rights of Accumulation
the investor’s accumulated position in the
mutual fund counts towards future
breakpoints for any additional purchases
based upon the higher of cost or market
value
SWITCHING BETWEEN FllNDS IN SAME FAMILY
in most cases there is no sales charge if
customer switches mutual funds in same
“family’’
• however, the .IRS considers this a taxable e
DISCOUNTS FROM P.0.P.
no discounts from the public offering price can
be given to customers, other than what is stated
in the prospectus
FUND EX DATES
dividends are distributed periodically
capital gains are distributed ONCE a year
closed end fund ex date is set by exchange
mutual fund ex date is set by Board of Directors
FUND EX DATES
SELLING DIVIDENDS
a prohibited practice where the broker
recommends the purchase of fund shares to
customers just prior to ex-date to receive a
dividend
this isn’t prudent because on ex-date, the
shares are reduced in value by the
distribution AND the customer must pay tax
on the distribution
basically, he receives a return of his
investment on which tax must be paid
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
SHAREHOLDER RIGHTS
To vote for:
the Board of Directors (B.O.D.)
changes in the investment objective
investment advisor annually
• To receive annual and semi-annual reports
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
SHAREHOLDER RIGHTS
40% OF THE B.O.D. MUST BE “NON-INTERESTED”
ANNUAL VOTE FOR THE B.O.D.
MINIMUM FUND CAPITAL= $100K
FUND MUST BE REGISTERED THROUGH F0R:Vl NI
A WITH THE SEC WITHIN 3 MONTHS AFTER
FILING WITH SEC
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
40% OF THE B.O.D. MUST BE “NON-INTERESTED
(thus, the managers of the fund cannot exceed 60%
of the Board)
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
ANNUAL VOTE FOR THE B.O.D.
it is not required for all Board members to be
voted annually •
the Directors can be divided into classes, with a
term of office from 1 year to 5 years
one class must come up for election annually
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
MINIMUM FUND CAPITAL=
MINIMUM FUND CAPITAL= $100K
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
FUND MUST BE REGISTERED THROUGH F0R:Vl NI
A WITH THE SEC WITHIN 3 MONTHS AFTER
FILING WITH SEC
bonus, no answer…so you can’t get it wrong!
REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
REGISTRATION INFORMATION
Investment Objective
• Borrowing Restrictions
open end funds can’t borrow more than 1/3
of Net Assets
can’t borrow to make dividend distributions
• Restrictions On Issuing Senior Securities
for closed-end funds only
• preferred stock can be issued if asset
coverage is at least 200%
• debt can be issued if asset coverage is
at least 300%
• lllvestment Concentration
• Investing in Real Estate
• Policy On Making Loans
• Portfolio Turnover For The Previous 3 Years
• Names, Addresses, And Information On
Affiliated Persons
REGISTRATION INFORMATION
TO CHANGE FUND OBJECTIVE
a majority vote of outstanding shares is required
REGISTRATION INFORMATION
PROHIBITED FUND ACTIONS
purchasing share of companies on margin
• selling short shares of companies
• participating in joint trading accounts in
securities
INVESTMENT ADVISOR
2 year written contract approval initially
• contract is reapproved annually by the 8.0.D.
or majority of shareholder vote; and must
provide for termination at any time by the
Board or majority vote within 60 days’ notice
FUND SHARES ARE PRICED AT THE NEXT
COMPUTED NAV PLUS SALES CHARGE
Rule 22-c-1 - computes NA V daily
• Rule 22-d-1- permits funds to offer variations
in sales loads as long as they are uniformly
applied
ADVERTISING EXPENSES ARE NOT CHARGED TO
SHAREHOLDERS UNLESS THE FUND COMPLIES
WITH RULE 12B-1
12b-1 Funds
Investment Co. can charge existing
shareholders for the cost (expense) of
soliciting new investment activities such as
advertising, mailing prospectuses, … which
are all used to increase Net Assets
Adopting the Plan
• the 12b-1 plan must be approved by:
a majority vote of
shareholders;
• Board of Directors (B.O.D.);
AND
• a majority of “uninterested”
directors (i.e. a person who is
neither affiliated with the fund
NOR is receiving payment from
the fund for work performed)
plan is re-approved annually and a person
(who reports to the B.O.D.) must review the
amounts expended under the plan and the
purposes for which the expenditures were
made at least quarterly
Terminating the Plan
12b-1 Funds
plan can be terminated at any time
through:
• a majority vote of either
shareholders; OR
• uninterested B.O.D. members
E also, plan provides that it cannot be
amended to increase funds spent for the plan
unless approved by both shareholders and
B.O.D.
FINRA SALES CHARGE RULES
CONDUCT RULES DETAIL THE REQUIREMENTS
FOR MEMBERS SELLING MUTUAL FUNDS SHARES
TO THE PUBLIC
MAXIMUM SALES CHARGE (S.C. %) FOR
NON-12B-1 FUNDS
8 ½% of the P.O.P. and the fund must offer:
- Rights of Accumulation; and
- Breakpoints
MAXIMUM SALES CHARGE (S.C. %) FOR
NON-12B-1 FUNDS
REQUIRED BREAKPOINT SCHEDULES • Two Alternatives
-
Purchase MaxS.C.%
Amount
0 - $10,000 8 1/2%
$10,001 - $25,000 7 3/4%
$25,001- over 6 1/4% - Purchase MAX
Amount S.C.%
0-$15,000 8 1/2%
$15,001 - $25,000 7 1/2%
$25,00 I- over 6 1/2%
8½%
7½%
6 ~’4%
MAXIMUM SALES CHARGE (S.C. %) FOR
NON-12B-1 FUNDS
MAXIMUM S.C. % IS REDUCED IF:
rights of accumulation is not available - 8%
• breakpoints are not offered as stated above -
7.75%
• both rights of accumulation and breakpoints are
not available - 7.25%
also, for funds that pay service fees to third parties
for maintenance of shareholder accounts, the
maximum sales charge = 7 .25%
MAXIMUM SALES CHARGE (S.C. %) FOR 12B-1
FUNDS
6.25% for funds that pay service fess (i.e. payments
made by investment companies to third paiiies for
maintenance of shareholder accts ); and
7 .25% for funds that do not impose service fees
MAXIMUM ANNUAL 12B-1 S.C.% IS .75% OF NET
ASSETS; BUT if a fund advertises itself as a no-load
fund, the l 2b- l fee cannot be greater than .25%
12B-1 funds
3 Share Classes
Class A
Class B
Class C
12B-1 funds
Class A Shares
Class A Shares
impose higher up-front sales charge and
no ( or very low) 12b-l fees
suitable for long term investors
12B-1 funds
Class B Shares
Class B Shares
impose a contingent deferred sales charge
and higher 12b-1 fees
suitable for intermediate term investors
12B-1 funds
Class C Shares
impose no up-front sales charge and the
back-end sales charge is smaller; however
these have the highest 12b-1 fees
suitable for short term investors
for long term investors with a large amount to
invest, Class A shares are better because an up
front sales charge (perhaps at a breakpoint) is a
one time event, while 12b-1 fees are an annual
“drag” on earnings
12B-1
Late Trading
placing orders to buy or redeem mutual fund
shares after the time when the fund calculates its
NAV
any such “late” orders should be processed at
the following day’s NAV
12B-1
MARKET TIMING
buying and selling a fund’s shares to exploit the
inefficiencies in how the fund company
computes NAV
i.e. if the fund has overseas stocks that might
prevent the most cuuent computation of
NAV, while a sophisticated investor may
have proprietary software to compute the
NAV faster than the fund companythereby
it could buy shares that it found
undervalued; or sell shares that it found
overvalued
• while not “technically” illegal. FINRA
says that this activity can hurt existing
fund shareholders
most mutual funds have now placed
restrictions on excessive trading in their
prospectuses and monitor accounts for
excessive short-term trading
FINRA DOES NOT ALLOW A FIRM T O OFFER
SHARES IF:
service fees exceed .25%, of net assets; or
• sales charges are imposed on dividend
reinvestment
FINRA SELLING AGREEMENT RULES
4
WRITTEN SELLING GROUP AGREEMENTS
PLACING ORDERS
PAYMENT FOR SHARES
REDEMPTION OF SHARES
FINRA SELLING AGREEMENT RULES
WRITTEN SELLING GROUP AGREEMENTS
must be signed by FINRA member who joins in
a selling group
• specifies concessions to be received by selling
group member
FINRA SELLING AGREEMENT RULES
PLACING ORDERS
if FINRA member receives a customer order to
buy the mutual fund, the member must
promptly submit the order to the underwriter
• if order is placed with the underwriter, it must
be an order:
to fill an existing customer order; OR
for securities to be placed in the firm’s
investment account
FINRA members canNOT make a market in, nor
trade, fund shares
FINRA SELLING AGREEMENT RULES
PAYMENT FOR SHARES
payment for fund shares must be sent to the
fund underwriter within 3 business days of the
receipt of customer order or within 1 business
day ofreceipt of payment, whichever is later
FINRA SELLING AGREEMENT RULES
REDEMPTION OF SHARES
if customer redeems within 7 days of purchase,
the member forfeits any sales concessions
received
FINRA SPECIAL DEALS INTERPRETATION I ANT/RECIPROCAL
RULE / SOLICITED
CONTRIBUTIONS
FUND UNDERWRITER CANNOT PAY SALESMEN OF
BROKER-DEALERS BASED ON SALES OF THAT
FUND ( other than selling concession)
MEMBER FIRMS CANNOT PAY THEIR BROKERS
BASED ON VOLUME OF SALES OF THE FUND (other
than regular selling concession)
UNDERWRITER CANNOT SELECT A SPECIFIC
BROKER To Do PORTFOLIO TRADES BASED ON
SALES OF THE FUND by the broker
PROHIBITED COMPENSATION FROM
UNDERWRITERS TO SELLERS OF FUND
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
•
FUND UNDERWRITER CANNOT PAY SALESMEN OF
BROKER-DEALERS BASED ON SALES OF THAT
FUND ( other than selling concession)
prohibited incentives include:
commissions paid directly by investment
company to the broker as a condition for
selling the fund
commissions paid by another FINRA
member to the broker as a condition for
selling the fond
special incentive campaigns promoting sales
ofa fund
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
MEMBER FIRMS CANNOT PAY THEIR BROKERS
BASED ON VOLUME OF SALES OF THE FUND (other
than regular selling concession)
prohibited incentives include:
placing specific mutual funds on a
“recommended” list
providing sales personnel with additional
compensation for sale of fund
giving commissions to sales personnel on
fund portfolio transactions where
commissions are directed by the investment
company
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
UNDERWRITER CANNOT SELECT A SPECIFIC
BROKER To Do PORTFOLIO TRADES BASED ON
SALES OF THE FUND by the broker
i.e. a fund cannot tell FINRA member “if you
sell my fund, I will direct my portfolio trades
through your firm”
• member firms are prohibited from selling
mutual fund shares or acting as underwriter for
the fund if the member has a “directed
brokerage arrangement” that is intended to
promote the sale of that investment company’s
securities
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
PROHIBITED COMPENSATION FROM
UNDERWRITERS TO SELLERS OF FUND
stock, warrants, or options
- merchandise or trips
- any compensation not stated in the prospectus
- any item of material value
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
SUMMARY • a Fund Underwriter canNOT
hold sales contests for selling group
members;
- compensate reps in the selling group;
AND/OR
= direct portfolio trades to specific selling
group members based on how much of the
fund that member sells
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
SUMMARY each Selling Group CAN:
hold a sales contest within the firm as long
as it doesn’t favor one fund over another;
and
compensate reps within that firm for fund
share sales
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
ALLOWED COMPENSATION
gifts of no more that $100
• loans or guarantees to a person not controlled by
the underwriter or member
• wholesale overrides stated in prospectus
• educational seminars held by the fond
underwriter regardless of where the seminar is
held (HOWEVER, travel expenses associated
with the RR attending the seminar canNOT be
paid by the underwriter)
• occasional meals, sporting tix, etc … as long as
not excessive nor too frequent and are NOT
conditioned on sales of fund shares
FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS
CHARITABLE SOLICITATIONS BY EMPLOYEES OF
INSTITUTIONAL CUSTOMERS
employees of mutual funds and investment
advisers, who are in the role of determining
which broker-dealer their finn uses, might
solicit charitable contributions to seek an
improper benefit for themselves individually,
rather than for their employer
• thus, written supervisory procedures must be
created by the finn that:
require prior broker-dealer approval for
institutional customer-solicited charitable
contributions that exceed a threshold amount
or exceed a stated frequency;
require obtaining specific approval from
someone at the mutual fund or investment
adviser who is not involved in directing
business to broker-dealers;
prohibit linking the amount of charitable
contributions given to the level of business
done by the institutional customer soliciting
the contribution; and
require frequent reviews by the brokerdealer
of the nature and amount of business
received from customers whose employees
have solicited charitable contributions
SOFT DOLLAR REMUNERATION
this is where an institution directs its portfolio trades
to a specific broker-dealer in return for research -
i.e. the broker-dealer’s compensation for the research
is included in the commission charges to the
institution
this is NOT prohibited as long as the services
provided to the investment adviser or investment
company by the broker-dealer benefit the investment
adviser’s,broker-dealer’s customers
SEC FUNDADVERTISING RULES
SEC RULE 135A
outlines conditions under which investment
companies can distribute advertising of a
generic information without giving the
customer a prospectus
SEC FUNDADVERTISING RULES
SEC RULE 135A
Communication Is Limited To:
explanatory information about investment
company securities; nature of investment
companies; or services offered;
explanation of:
- differing investment objectives
- various products and services
an invitation to inquire for more infonnation
SEC FUNDADVERTISING RULES
SEC RULE 135A
Past Performance can be shown if:
Total Return is shown for 1, 5, and 10 years
Total Return is broken down into income
and capital gains
all sales charges and expenses are reflected
( or the life of the fund, if shorter)
SEC FUNDADVERTISING RULES
SEC RULE 135A
Sales Literature Defined
SEC Rule 156
sets requirements for sales
literature used by a person to offer
investment company securities
SEC FUNDADVERTISING RULES
SEC RULE 135A
Sales Literature Defined Prohibited Representations in Sales
Literature
• misleading, incomplete inforn1ation,
untrne statements, …
• general economic conditions affecting
the information given …
• portrayals of past income, gain, or
asset growth giving an unjustified
impression of results achieved
• expressing statements or implications
about future investment perfonnance
• statements of possible benefits and not
mentioning possible risks
• exaggerated or unwarranted claims
VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)
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VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)
UITs are…
unlike management companies which issue
redeemable shares (mutual funds) or tradable
shares (publicly traded funds) shares, unit
investment tmsts issue “shares of beneficial
interest”
• these “units” represent an undivided interest in
the portfolio of securities and are redeemable
with the tmst sponsor at any time at Net Asset
Value
• Two Types Of Unit Investment Trusts:
1) Fixed UIT
• sponsor selects fixed portfolio and
places it in trust
• units are sold to investors
• once portfolio is established, no
buying/selling takes place
2) Participating UIT
• trust buys shares of management
company
• once shares are purchased they sit in
trust until unit is redeemed
• the shares in trust are used to fund
annuity contracts issued by insurance
companies
• a.k.a. variable annuity
VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)
Fixed Annuity
Fixed Annuity
the insurer guarantees a specific rate of
return to the investor
• the insurance company assumes the
investment risk so this is NOT
considered a security and is
regulated by insurance laws (not the
securities industry!)
VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)
Variable Annuity
there is NO guarantee of a specific rate of
return
• the investor assumes the investment
risk, so it must be registered as a
security
here, the trust that collects the payments
from investors can only invest in
management company shares
VARIABLE ANNUITY STRUCTURE
ASSUMED INTEREST RATE (AIR)
SEPARATE ACCOUNT
ACCUMULATION UNITS
ANNUITY UNITS
VARIABLE ANNUITY STRUCTURE
ASSUMED INTEREST RATE (AIR)
a conservative (not guaranteed) estimate as to the performance of the annuity
VARIABLE ANNUITY STRUCTURE
SEPARATE ACCOUNT
insurance company keeps investments in
variable annuities separate from its other
holdings, used specifically to fund the annuity
• Board of Managers (NOT Directors) oversees
operating the account
• contract owners can vote for the managers and
for changes in the investment policies (like
mutual funds)
VARIABLE ANNUITY STRUCTURE
ACCUMULATION UNITS
instead of buying “shares”, holder purchases
units
• these units represent the ownership interest in
the separate account
• Mandatory Reinvestment
any dividend payments, interest
payments, … are automatically reinvested
and grow tax-defen-ed
VARIABLE ANNUITY STRUCTURE
ANNUITY UNITS
when payments are completed, accumulation
units plus any interest/dividend payments are
converted into annuity units (tem1ed
“annuitization”)
• there is a Fixed Number Of Annuity Units,
depending on certain criteria (i.e. age, sex,
habits - such as smoking); AND the annuity
payment option chosen by the contract holder
• as the securities’ values fluctuate in the separate
account, the annuity unit value fluctuates
each monthly payment equals the fixed # of
annuity units X the varying unit value
• so each annuity check received can be
a different amount
OTHER VARIABLE ANNUITY CONSIDERATIONS
variable annuities are sold under a prospectus which
details the investment objective, policies, sales
charge ….
OTHER VARIABLE ANNUITY CONSIDERATIONS
IN ANY ANNUITY, THERE ARE Two GUARANTEES
1) Mortality Guarantee
insurance company pays the annuity for
one’s lie ( or other designated option)
if person dies later than “projected
mortality”, payments continue
• 2) Expense Guarantee
if expenses exceed a given percentage, the
insurance company absorbs the excess
OTHER VARIABLE ANNUITY CONSIDERATIONS
SURRENDER CHARGES
surrendering the annuity before completing all
of the payments usu. results in this
OTHER VARIABLE ANNUITY CONSIDERATIONS
BORROWING AGAINST ACCUMULATION UNITS
customer can borrow against the value of his
accumulation unites
OTHER VARIABLE ANNUITY CONSIDERATIONS
VARIABLE WHOLE LIFE INSURANCE
holder receives a death benefit in addition to an
investment benefit which is funded by variable
annuity investments
• must be registered as a security, and sold under
a prospectus, since the investment benefit may
vary
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
payments received (accepted by the insurance
company) to buy the annuity must be sent promptly
by the member to the insurance company
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
WRITTEN SELLING GROllP AGREEMENT
members must have a written selling group
agreement in force with the issuing insurance
company before orders to buy can be placed
• any Selling Concessions received will be
- Forfeited If* the Customer Redeems the annuity
- Within 7 Business Days* of contract acceptance
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
RECOMMENDING VARIABLE ANNUITIES
to recommend variable annuities. the rep. must
have a reasonable basis to believe that:
the customer has been infonned of the
material features of the productt
the customer will benefit from the features
of the product; and
the particular annuity, the separate accounts
to which funds are allocated, and the riders
to the policy are suitable
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
EXCHANGING ANNUITIES
if the recommendation is to exchange annuities,
the rep must consider whether the customer:
would incur surrender charges; be subject to
the commencement of a new surrender
period; lose existing benefits; or be subject
to increased fees/charges;
would benefit from the improved product;
has had other annuity exchanges within the
past 36 months
• the rep. signs a statement that these
detenninations are suitable
• lastly, the rep. must make a reasonable effort to
obtain information regarding the customer’s:
age, income, investment
experience/objectives, risk tolerance, tax
status … and any other info that is needed to
make a reasonable recommendation to the
customer
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
APPLICATION SENT TO OSJ
promptly after receiving the info necessary to
prepare/complete an application, the associated
person recommending the annuity must transmit
the application to an OSJ for review
• the principal in the OSJ reviews the completed
application prior to transmitting it to the
insurance company for processing within 7
business days
•
the review states whether the principal
approves or disapproves of the
recommended purchase or exchange
transaction
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
EXCHANGE OF WHOLE LIFE POLICY FOR
VARIABLE LIFE POLICY
registered reps who recommend customers to
exchange their whole life policy to a variable
life policy must have ( obviously) valid reasons
for the recommendation, like getting the
customer:
better coverage at lower cost;
more benefits and service; and/or
reassurance regarding solvency of the
insurance company that issued the original
policy
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
Invalid Reasons for Policy Exchange
using an existing policy’s cash value to pay
for the new policy’s first year expenses
(which are mostly commissions);
if cashing out the policy results in high
surrender charges;
if the policy is past its 2-year “contestability
period” and any new policy allows the
insurance company to challenge a death
claim that occurs in its first 2 years; and
if there are adverse tax consequences due to
the exchange
FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES
In-Force Ledger
the statement of the existing whole life
policy’s cash value, any surrender charges,
and projections of future death benefit and
cash value
this is used to compare whether the new
insurance policy is actually better than the
old one
