Investment Company Basics

Investment companies are financial organizations that pool money from multiple investors to purchase a diversified portfolio of securities. They are governed by the Investment Company Act of 1940, which establishes the regulatory framework for their operation.

Why Investment Companies Matter for Series 7

Investment companies, particularly mutual funds, represent one of the most popular investment vehicles for retail investors. The Series 7 exam tests your knowledge of:

• Different types of investment companies
• Fee structures and sales charges
• NAV calculations
• Share class differences
• Regulatory requirements

---

Types of Investment Companies

The Investment Company Act of 1940 identifies three types of investment companies:

1. Face-Amount Certificate Companies

These companies issue certificates stating they will pay a fixed sum (face amount) at a specified future date. They are rarely used today and unlikely to appear heavily on the exam.

2. Unit Investment Trusts (UITs)

UITs are investment companies that:

• Purchase a fixed portfolio of securities (stocks or bonds)
• Sell units to investors representing proportionate ownership
• Have a termination date specified at creation
• Do not actively manage the portfolio (no trading)
• Have no board of directors or investment adviser

3. Management Companies

Management companies are divided into two types:

Open-End Companies (Mutual Funds)

• Continuously issue and redeem shares
• Shares priced at Net Asset Value (NAV)
• Most common type of investment company
• Forward pricing (transactions at next calculated NAV)

Closed-End Companies

• Issue a fixed number of shares in an IPO
• Trade on exchanges like stocks
• May trade at premium or discount to NAV
• No redemption with the fund

---

Key Regulatory Framework

Investment Company Act of 1940

This Act requires investment companies to:

• Register with the SEC
• Provide prospectus to investors
• Have a board of directors (at least 40% independent)
• Maintain accurate records
• Calculate NAV at least daily (for open-end funds)

Prospectus Requirements

Before purchasing mutual fund shares, investors must receive:

• Statutory Prospectus - Full disclosure document
• Summary Prospectus - Condensed version with key information

The prospectus must include:

• Investment objectives and strategies
• Fees and expenses
• Risk factors
• Past performance
• Management information

Important: The 40% Rule At least 40% of a mutual fund's board of directors must be independent (non-interested). This requirement protects investors from conflicts of interest.