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JG ser 24 > Ch 2 S 4 Investment Companies > Flashcards

Ch 2 S 4 Investment Companies Flashcards

1
Q

INVESTMENT COMPANY is…

A

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
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2
Q

INVESTMENT COMPANY ACT OF 1940 DEFINES 3
TYPES OF COMPANIES

A

1) Face Amount Certificate Company

  • 2) Management Company
  • 3) Unit Investment Trust
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3
Q

Face Amount Certificate Company

A

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

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4
Q

Management Company

A

investment company organized as a
corporation, issuing shares of stock

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5
Q

Management Company-

Investment Advisor

A

used to decide what securities to place
in portfolio

• this ‘‘manager” is free to buy and sell
securities consistent with fund’s
investment objective

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6
Q

Management Company

-Open End Management Company

A

• 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

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7
Q

Management Company

-Closed End Management Company

A
  • 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

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8
Q

INVESTMENT COMPANY ACT OF 1940 DEFINES 3
TYPES OF COMPANIES

3) Unit Investment Trust (UIT)

A

organized under a “trust indenture” rather
than being set up by a corporation

corporations issue shares while trusts issue
“shares of beneficial interest”

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9
Q

Unit Investment Trust (UIT)

Fixed UIT

Participating UIT

A

:-)

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10
Q

Unit Investment Trust (UIT)

Fixed UIT

A

• 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)

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11
Q

Unit Investment Trust (UIT)

Participating UIT

A

• 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
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12
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

A

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

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13
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

list

FllND SPONSOR

PROSPECTUS

SELLING GROUP

OPEN-END FUND

CLOSED-END FUND

INVESTMENT ADVISOR

CUSTODIAN BANK

A

:-)

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14
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

FUND SPONSOR

A

underwriter

• must register fund with SEC before security can
be sold

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15
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

PROSPECTUS

A

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

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16
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

SELLING GROUP

A

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)

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17
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

OPEN-END FUND

A

continuously issued

• purchaser must receive latest Prospectus

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18
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

CLOSED-END FUND

A

one time issuance. then shares trade

• prospectus no longer required after shares trade
in secondary market

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19
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

INVESTMENT ADVISOR

A

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

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20
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

CUSTODIAN BANK

A

safeguards funds assets

• can act as transfer agent and paying agent

receives custodial fee

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21
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

FUND CAN BE SET UP As A

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

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22
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

Diversified Fund

A

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

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23
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

Non-Diversified Fund

A

one that doesn’t meet the “diversified”
definition

• whether the fund is “diversified” or “nondiversified”
is stated in the prospectus

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24
Q

GENERAL CHARACTERISTICS OF MANAGEMENT
COMPANIES

RULE35-D-1

A

states that if a fund focuses 011 a particular
investment, then 80% oftheassets in the fund
must be in that asset type

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25
Q

BUYING AND SELLING MUTUAL FUND SHARES

gen procedures

A

MAXIMUM SALES CHARGE

FORWARD PRICING

REDEmPTION

CONTINGENT DEFERRED SALES CHARGE

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26
Q

BUYING AND SELLING MUTUAL FUND SHARES

A

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

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27
Q

BUYING AND SELLING MUTUAL FUND SHARES

MAXIMUM SALES CHARGE

A

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

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28
Q

BUYING AND SELLING MUTUAL FUND SHARES

FORWARD PRICING

A

purchase price is computed at that day’s closing
Net Asset Value; same goes for redeeming
shares

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29
Q

BUYING AND SELLING MUTUAL FUND SHARES

REDEMPTION

A

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

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30
Q

BUYING AND SELLING MUTUAL FUND SHARES

CONTINGENT DEFERRED SALES CHARGE

A

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

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31
Q

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

A

Breakpoints • Letter of Intent • Rights of Accumulation

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32
Q

BUYING AND SELLING MUTUAL FUND SHARES

Breakpoints

A

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
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33
Q

BUYING AND SELLING MUTUAL FUND SHARES

Letter of Intent

A

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

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34
Q

Rights of Accumulation

A

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

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35
Q

SWITCHING BETWEEN FllNDS IN SAME FAMILY

A

in most cases there is no sales charge if
customer switches mutual funds in same
“family’’

• however, the .IRS considers this a taxable e

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36
Q

DISCOUNTS FROM P.0.P.

A

no discounts from the public offering price can
be given to customers, other than what is stated
in the prospectus

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37
Q

FUND EX DATES

A

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

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38
Q

FUND EX DATES

SELLING DIVIDENDS

A

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

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39
Q

REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940
SHAREHOLDER RIGHTS

A

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

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40
Q

REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940

A

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

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41
Q

REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940

40% OF THE B.O.D. MUST BE “NON-INTERESTED

A

(thus, the managers of the fund cannot exceed 60%
of the Board)

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42
Q

REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940

ANNUAL VOTE FOR THE B.O.D.

A

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
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43
Q

REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940

MINIMUM FUND CAPITAL=

A

MINIMUM FUND CAPITAL= $100K

44
Q

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

A

bonus, no answer…so you can’t get it wrong!

45
Q

REQUIREMENTS UNDER THE INVESTMENT
COMPANY ACT OF 1940

REGISTRATION INFORMATION

A

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

46
Q

REGISTRATION INFORMATION

TO CHANGE FUND OBJECTIVE

A

a majority vote of outstanding shares is required

47
Q

REGISTRATION INFORMATION

PROHIBITED FUND ACTIONS

A

purchasing share of companies on margin

• selling short shares of companies

• participating in joint trading accounts in
securities

48
Q

INVESTMENT ADVISOR

A

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

49
Q

FUND SHARES ARE PRICED AT THE NEXT
COMPUTED NAV PLUS SALES CHARGE

A

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

50
Q

ADVERTISING EXPENSES ARE NOT CHARGED TO
SHAREHOLDERS UNLESS THE FUND COMPLIES
WITH RULE 12B-1

A

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

51
Q

Adopting the Plan
• the 12b-1 plan must be approved by:

A

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

52
Q

Terminating the Plan

12b-1 Funds

A

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.

53
Q

FINRA SALES CHARGE RULES

A

CONDUCT RULES DETAIL THE REQUIREMENTS
FOR MEMBERS SELLING MUTUAL FUNDS SHARES
TO THE PUBLIC

54
Q

MAXIMUM SALES CHARGE (S.C. %) FOR
NON-12B-1 FUNDS

A

8 ½% of the P.O.P. and the fund must offer:

  • Rights of Accumulation; and
  • Breakpoints
55
Q

MAXIMUM SALES CHARGE (S.C. %) FOR
NON-12B-1 FUNDS

REQUIRED BREAKPOINT SCHEDULES • Two Alternatives

A
  1. Purchase MaxS.C.%
    Amount
    0 - $10,000 8 1/2%
    $10,001 - $25,000 7 3/4%
    $25,001- over 6 1/4%
  2. 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%

56
Q

MAXIMUM SALES CHARGE (S.C. %) FOR
NON-12B-1 FUNDS

MAXIMUM S.C. % IS REDUCED IF:

A

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%

57
Q

MAXIMUM SALES CHARGE (S.C. %) FOR 12B-1
FUNDS

A

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%

58
Q

12B-1 funds

3 Share Classes

A

Class A

Class B

Class C

59
Q

12B-1 funds

Class A Shares

A

Class A Shares

impose higher up-front sales charge and
no ( or very low) 12b-l fees

suitable for long term investors

60
Q

12B-1 funds

Class B Shares

A

Class B Shares
impose a contingent deferred sales charge
and higher 12b-1 fees
suitable for intermediate term investors

61
Q
A
62
Q

12B-1 funds

Class C Shares

A

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

63
Q

12B-1

Late Trading

A

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

64
Q

12B-1

MARKET TIMING

A

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

65
Q

FINRA DOES NOT ALLOW A FIRM T O OFFER
SHARES IF:

A

service fees exceed .25%, of net assets; or

• sales charges are imposed on dividend
reinvestment

66
Q

FINRA SELLING AGREEMENT RULES

4

A

WRITTEN SELLING GROUP AGREEMENTS

PLACING ORDERS

PAYMENT FOR SHARES

REDEMPTION OF SHARES

67
Q

FINRA SELLING AGREEMENT RULES

WRITTEN SELLING GROUP AGREEMENTS

A

must be signed by FINRA member who joins in
a selling group

• specifies concessions to be received by selling
group member

68
Q

FINRA SELLING AGREEMENT RULES

PLACING ORDERS

A

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

69
Q

FINRA SELLING AGREEMENT RULES

PAYMENT FOR SHARES

A

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

70
Q

FINRA SELLING AGREEMENT RULES

REDEMPTION OF SHARES

A

if customer redeems within 7 days of purchase,
the member forfeits any sales concessions
received

71
Q

FINRA SPECIAL DEALS INTERPRETATION I ANT/RECIPROCAL
RULE / SOLICITED
CONTRIBUTIONS

A

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

72
Q

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)

A

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

73
Q

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)

A

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

74
Q

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

A

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

75
Q

FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS

PROHIBITED COMPENSATION FROM
UNDERWRITERS TO SELLERS OF FUND

A

stock, warrants, or options

  • merchandise or trips
  • any compensation not stated in the prospectus
  • any item of material value
76
Q

FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS

SUMMARY • a Fund Underwriter canNOT

A

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

77
Q

FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS

SUMMARY each Selling Group CAN:

A

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

78
Q

FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS

ALLOWED COMPENSATION

A

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

79
Q

FINRA SPECIAL DEALS INTERPRETATION/ ANTI/RECIPROCAL
RULE /SOLICITED
CONTRIBUTIONS

CHARITABLE SOLICITATIONS BY EMPLOYEES OF
INSTITUTIONAL CUSTOMERS

A

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

80
Q

SOFT DOLLAR REMUNERATION

A

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

81
Q

SEC FUNDADVERTISING RULES
SEC RULE 135A

A

outlines conditions under which investment
companies can distribute advertising of a
generic information without giving the
customer a prospectus

82
Q

SEC FUNDADVERTISING RULES
SEC RULE 135A

Communication Is Limited To:

A

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

83
Q

SEC FUNDADVERTISING RULES
SEC RULE 135A

Past Performance can be shown if:

A

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)

84
Q

SEC FUNDADVERTISING RULES
SEC RULE 135A

Sales Literature Defined
SEC Rule 156

A

sets requirements for sales
literature used by a person to offer
investment company securities

85
Q

SEC FUNDADVERTISING RULES
SEC RULE 135A

Sales Literature Defined Prohibited Representations in Sales
Literature

A

• 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

86
Q

VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)

A

This space intentionally left blank

87
Q

VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)

UITs are…

A

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

88
Q

VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)

Fixed Annuity

A

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!)

89
Q

VARIABLE ANNUITY OVERVIEW
UNIT INVESTMENTT RUSTS( UITs)

Variable Annuity

A

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

90
Q

VARIABLE ANNUITY STRUCTURE

A

ASSUMED INTEREST RATE (AIR)

SEPARATE ACCOUNT

ACCUMULATION UNITS

ANNUITY UNITS

91
Q

VARIABLE ANNUITY STRUCTURE
ASSUMED INTEREST RATE (AIR)

A 
a conservative (not guaranteed) estimate as to
the performance of the annuity
92
Q

VARIABLE ANNUITY STRUCTURE

SEPARATE ACCOUNT

A

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)

93
Q

VARIABLE ANNUITY STRUCTURE

ACCUMULATION UNITS

A

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

94
Q

VARIABLE ANNUITY STRUCTURE

ANNUITY UNITS

A

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

95
Q

OTHER VARIABLE ANNUITY CONSIDERATIONS

A

variable annuities are sold under a prospectus which
details the investment objective, policies, sales
charge ….

96
Q

OTHER VARIABLE ANNUITY CONSIDERATIONS

IN ANY ANNUITY, THERE ARE Two GUARANTEES

A

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

97
Q

OTHER VARIABLE ANNUITY CONSIDERATIONS

SURRENDER CHARGES

A

surrendering the annuity before completing all
of the payments usu. results in this

98
Q

OTHER VARIABLE ANNUITY CONSIDERATIONS

BORROWING AGAINST ACCUMULATION UNITS

A

customer can borrow against the value of his
accumulation unites

99
Q

OTHER VARIABLE ANNUITY CONSIDERATIONS

VARIABLE WHOLE LIFE INSURANCE

A

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

100
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

A

payments received (accepted by the insurance
company) to buy the annuity must be sent promptly
by the member to the insurance company

101
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

WRITTEN SELLING GROllP AGREEMENT

A

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
102
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

RECOMMENDING VARIABLE ANNUITIES

A

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

103
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

EXCHANGING ANNUITIES

A

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

104
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

APPLICATION SENT TO OSJ

A

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

105
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

EXCHANGE OF WHOLE LIFE POLICY FOR
VARIABLE LIFE POLICY

A

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

106
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

Invalid Reasons for Policy Exchange

A

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

107
Q

FINRA AND SEC RULES REGARDING THE SALE
OF VARIABLE ANNUITIES

In-Force Ledger

A

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

JG ser 24 (7 decks)

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