Basics of Investment Companies

An investment company is an issuer of securities that;

Holds itself out as being engaged in the business of investment, reinvesting, or trading securities,
Engaged in the business of issuing Face Amount Certificate Companies (FACCs), or
Engaged in the business of investing, reinvesting, owning, holding, or trading securities as an over 40% valuation of its business.

Excluded would be government securities, securities issued by employee’s securities companies, and securities issued by majority owned subsidiaries of the owner which are not investment companies, and are not relying an an exception from the definition of investment company.

Depending on how we want to break them down, there are either 3 or 4 different types of investment companies. The most basic 3, are FACCs, Unit Investment Trusts (UITs), and management companies. Management companies are split into open-end management companies and closed-end management companies. That would therefore be how we could break them into 4 types of investment companies: FACCs, UITs, open-end management companies, and closed-end management companies.

An open-end company is a management company that offers redeemable securities for sale. Most often called mutual funds, only the open-end company can buy, redeem, shares from clients, and only the open-end company can sell, issue, shares to the client. As the issuer is involved in every sale, all sales of open-end company stock are primary offering and require a prospectus. Open-end mutual funds are the most common security sold by series 6 representatives. Open-end companies may only issue common stock, no other type of security. We will go into more detail into open-end companies in the next section.

A closed-end company is a management company that offers a fixed number of shares that are sold on exchanges or OTC. Once issued in the primary offering the shares will trade on exchanges. Initial sales require only a 6, but sales on exchanges would require a 7 or similar. Closed-end companies most often issue common stock, but could issue senior securities such as preferred stocks and bonds. We go a bit more into closed-end funds, specifically ETFs, in the next section.

A Unit Investment Trust (UIT), is a fixed portfolio of redeemable securities for a finite time. These units of the portfolio, represent equal ownership in all securities in the portfolio. UITs do not have a board of directors as other investment companies do, they have managers that are basically responsible for taking in any dividends or income and sending them out to the unit owners. The managers make no investment decisions and no changes to the portfolio. The portfolio is fixed, unchanging for the life of the UIT. All UITs, when created, have a fixed life time, and at the end are liquidated and send to the unit holders.

Sidenote

Simple example of a 30 year bond UIT.

UIT forming raises a bunch of money from investors. It divides the money into 6 equal piles, and in January goes and buys 1/6th of the total in 30-year bonds. It does the same in February, in March, April, May, and June. In July it goes to the office and finds that all the money is now gone, 6 piles, 6 months, each month spending the entire ⅙ of the investment on 30-year bonds. July though, is 6 months after January, meaning we do collect January’s interest payment. In August, we would collect February’s, and it would continue for the next 30 years. Every month, the UIT gets the interest from one of those first 6-month purchases, and then sends them out to the UIT holders. This is clearly a 30-year fixed-time UIT, because 30 years after the company bought those bonds, the bonds mature, and the UIT collects those maturity payments and the final interest payment, and sends them to their UIT holders.

A Face Amount Certificate Company (FACC) is an investment company that doesn’t really exist anymore. They were popular in the 40s as an alternative to banks when people were concerned about the banking system. They issue debt securities that are backed by some security interest. They work similar in nature to mortgage bond financing.

Municipal Fund Security is based in MSRB Rule D-12 and is defined as a municipal security, that really looks like an investment company, but being a municipal security is specifically excluded from being an investment company. The most common example would be 529 plans. These are not investment companies, by legal definition, but can easily be confused for them.

Registration of Investment Companies

All investment companies must register with the SEC under the Investment Company Act of 1940. As part of that, there are requirements of what must be included and disclosed.

Policy of the company on classifications and subclassifications within investment companies, if they can borrow money, the potential to issue senior securities, whether they will be engaged in the business of underwriting securities issued by others, concentrating within a given sector, purchase or sale of real estate and/or commodities, making loans to other persons, and portfolio turn-over.
It must also include all investment policies not already stated, which are only changeable by a vote of the shares.
The registration statement also will include name and address of each affiliated person of the company, the name and principal address of every other company in which they are an officer, director, or partner, along with a brief statement of business experience for the preceding 5 years for year officer and director.
It will also include copies of the most recent registration statement under the Securities Act, or if they haven’t filed them under the Securities Exchange Act, along with copies of any reports filed by the registrant to the SEC.

The names of any investment company must either be non-descript of the investment policy, or if it implies a policy that investment company must follow that strategy at least 80% of its investments. If a fund is called the “ABC Growth Fund”, that is implying growth, and therefore at least 80% of its investments must be in growth investments. If a fund was named “DEF Achievable Fund”, well it’s a great name, but it doesn’t imply any style or investments, and therefore reading the objectives is even more important. Reading the objectives is always important, but with the Naming Rule, you can be pretty sure of what the investments are based on the name.