Chapter 13 Part 6

Question 1

Normally, distribution expenses for a mutual fund, including advertising and commissions, may be paid only out of the

Answer 1

sales charge, not out of the fund’s portfolio assets. However, SEC rules allow mutual funds to assess a charge on fund assets to pay distribution costs if certain conditions are met. Such plans, called 12b-1 plans, may be used lo finance a variety of distribution activities including commissions to salespeople

Question 2

Although 12b-1 fees may not be used to pay up-front commissions, they may be used to pay

Answer 2

continuing commissions (trails). A retired representative may be able to continue receiving these ongoing commissions as long as a written contract was in force prior to retirement. Under no circumstances may a retired representative be compensated for new business

Question 3

Class A summary

Answer 3

Front end load charge, 12b-1 fees low or none, breakpoints available for large purchases

Question 4

Class B summary

Answer 4

contingent deferred sales charge if held less than 6-8 years, 12b-1 fees higher than Class A shares, often converted to Class A after 6-8 years

Question 5

Class C summary

Answer 5

may have a front end load or a contingent deferred sales charge or both, higher than Class A shares generally the same as Class B, no conversion to Class A shares

Question 6

Mutual funds must be quoted at

Answer 6

the maximum sales charge percentage the particular fund charges. However, most mutual funds have sales breakpoints on front-end loads that are dollar levels at which the sales charge is reduced. A fund’s breakpoints must be clearly stated in its prospectus

Question 7

Since breakpoints are available to certain investors, it is necessary to be able to determine a mutual fund’s offering price based on the actual sales charge percentage an investor is paying. This may be determined by

Answer 7

dividing the fund’s net asset value by the complement of the sales charge percentage

Question 8

For example, XYZ Fund has a NAV of $10. John Smith is investing $40,000 in the fund, which en Li ties him to a 6% breakpoint. To determine his offering price per share,

Answer 8

divide the NAV of $10 by the complement or the sales charge (100% - 6%). Therefore, Mr. Smith will purchase 3,762.93 shares ($40,000/$10.63).

Question 9

A letter or intent enables an investor to

Answer 9

qualify for the discount made available by breakpoints without initially depositing the entire amount required. The letter states the investor’s intention to deposit the required money over the next 13 months. The letter or intent may be backdated 90 days. Letters of intent are not binding on the investor. An investor will not be penalized for failing to make the additional investments. Investors who fail to make the additional investments are charged the amount that would equal the higher sales charge that applied to the original purchase. The fund insures that it will be able to recover the additional sales charge by withholding sufficient shares in escrow for this purpose

Question 10

rights of accumulation give investors

Answer 10

the right to receive cumulative quantity discounts when purchasing mutual fund shares. For example, $20,000 of new money is invested in a fund. The client’s current value is $36,000. The sales charge is 3% for amounts or $50,000 or higher but 4% for amounts below $50,000. The client’s total sales charge is $600 (3% or $20,000 since the cumulative value in the fund is $56,000)

Question 11

Breakpoints, letters of intent, and rights of accumulation are available to

Answer 11

any person, which includes an individual, the members of her immediate family (spouses and dependent children), a fiduciary for a single fiduciary account, or a trustee for a single trust account. Pension plans and profit-sharing plans that qualify under the Internal Revenue Code are also eligible

Question 12

RRs should inquire if a client buying a mutual fund

Answer 12

already owns other mutual funds within the same fund family in a related account. The account can even be held at another broker-dealer. For example, a minor’s account, joint account, or ira account could be combined with an individual account in determining the appropriate breakpoint on a new purchase

Question 13

Under industry rules, a fund may assess an

Answer 13

8.5% sales charge–the maximum permitted–Only if it offers breakpoints and rights of accumulation. For each of these features that the fund omits, the maximum sales charge it is permitted to assess is lowered according to a set schedule

Question 14

An investor who owns investment company shares can dispose of the shares by

Answer 14

redeeming them at the net asset value (bid price) that will typically be computed at the end of the day. Investors who wish to redeem part or all of their shares may do so through the dealer who sold the shares or by dealing directly with the transfer agent

Question 15

Mutual funds are required under the Investment Company Act of 1940 to pay the proceeds of redemption within

Answer 15

seven calendar days. The SEC may order or allow, upon the request of a fund, that redemptions he suspended for the protection of the shareholders. This would occur during an emergency that makes disposal of the fund’s securities or the valuation of the net assets impractical because of market conditions

Question 16

Although most mutual funds redeem their shares at NAV, some mutual funds charge a

Answer 16

redemption fee based on the net asset value when the shares are redeemed. A redemption fee is calculated as a percentage of the NAV and is subtracted from the amount to be paid.
Note that a redemption fee is different from the contingent deferred sales charge we previously discussed. A deferred sales charge is paid to the sponsor to defray distribution expenses, while a redemption fee is retained in the fund’s portfolio

Question 17

The term fund families or fund complexes is used to define a

Answer 17

single investment company or mutual fund company with many different types of mutual funds that a customer may choose to purchase. The objective is to provide a large number of mutual funds providing a broad range of suitability for investors. A customer may be able to invest a large sum of money with one fund family, receive a sales breakpoint (reduced sales charge), diversify his assets, and have the ability to switch between mutual funds

Question 18

An agent who is soliciting sales of investment company shares must disclose

Answer 18

ALL costs including sales charges, management fees, 12b-1 fees, and contingent deferred sales charges. The agent must also inform clients about any available methods of reducing their sales charges, such as breakpoints or letters of intent. An agent should never refer to an investment company as a no-load fund nor tell a client that the fund has no sales charges, if it assesses a front-end sales charge, a contingent deferred sales charge, or a 12b-1 fee that is greater than .25% of the fund’s net asset value.

Question 19

An agent should not advise a client to purchase shares in different mutual funds with similar investment objectives unless

Answer 19

the agent has reason to believe this is a suitable strategy based on the client’s individual needs. A client who invests in similar funds sponsored by different fund families might not receive the benefit of breakpoints and will often pay higher sales charges as a result. Also, an agent should not advise a client to liquidate or redeem shares of one investment company
in order to purchase shares of a different investment company with similar investment objectives unless she has a valid reason for believing the change is in the client’s best interest. The client will usually be required to pay new sales charges and may also be required to pay capital gains taxes on any increase in the value of the fund that she sold

Question 20

When soliciting sales of investment company shares, agents may not state or imply

Answer 20

1. A fund’s current yield or income without disclosing the fund’s most recent average annual return calculated for 1-, 5-, and 10-year periods. 2. That a fund’s investment performance is comparable to that of a savings account, CD, or other bank account without disclosing that the shares are not insured or otherwise guaranteed by the FDIC or other government agency. 3. The existence of insurance, credit quality, guarantees, or similar features regarding the fund’s portfolio without disclosing the other kinds of relevant investment risk such as interest-rate, political, liquidity, or currency exchange risk. 4. That the purchase of shares shortly before an ex-dividend date is advantageous to clients unless there are specific, clearly described tax advantages.