5.1 Investment Company Basics
The Investment Company Act of 1940 regulates entities that pool client funds to purchase securities. Understanding the legal classifications and diversification criteria is a foundation for Series 7 questions.
Key FINRA Exam Takeaways
- Investment Company Act of 1940 establishes 3 classifications: Face-Amount Certificate Companies, Unit Investment Trusts (UITs), and Management Companies.
- Management companies are subdivided into Open-End (Mutual Funds) and Closed-End funds.
- Diversified Investment Company (75-5-10 Rule): At least 75% of assets invested such that no more than 5% is in any one issuer, and the fund holds no more than 10% of any issuer's voting stock.
- The remaining 25% of assets can be invested in a single issuer without restrictions.
Unit Investment Trusts (UITs)
UITs have no board of directors; they are governed by trustees. They hold a fixed, unmanaged portfolio of stocks or bonds until a specified termination date. Shares are redeemable units of beneficial interest.
The 75-5-10 Diversification Rule
To market a fund as 'diversified', the fund must satisfy the 75-5-10 test at inception. 75% of assets must be diversified with no more than 5% in one company, holding at most 10% of that company's voting shares. The other 25% can be concentrated in one single position.
Under the Investment Company Act of 1940, what is the maximum percentage of a diversified mutual fund's portfolio that may be invested in a single issuer?