Not everyone is permitted to establish and operate a mutual fund in the stock market. A comprehensive set of regulations protects the funds of investors in mutual funds.
The approval process
In the United States, establishing a mutual fund requires authorization from the SEC (Securities and Exchange Commission).
In order to obtain such authorization, an entity must prove its credibility and professionalism. It must also submit periodic reports and publish a prospectus in relation to the offer of participation units in the mutual fund to the public.
A trustee must be appointed to supervise the fund manager.
Naming the mutual funds in stock market
The name of the mutual fund is usually determined by the name of the company operating that fund and the fund’s range of investment.
The fund’s bank account
The fund trustee opens a bank account, which is called the fund’s account. The money invested by the public in the fund’s units is deposited into that account. The fund manager is granted Power of Attorney authorizing him or her to withdraw money from that account in order to purchase securities, and to deposit money obtained by selling the securities.
Investors wishing to join the fund purchase participation units in the fund on the stock exchange. Their money is deposited into the fund’s bank account. The investors receive participation units in return representing their shares of the fund.
The money in the fund belongs to the owners of these units, and not to the fund manager. The fund trustee verifies that the fund manager does not misuse the money deposited in the bank account. Like other bank accounts, the fund’s account is usually split into two sub-accounts:
The fund’s cash is kept in the current account.
When the fund manager buys securities, money is withdrawn from the current account, and the securities are deposited into the securities account.
Choosing a Trustee
Every mutual fund must appoint a trustee. The trustee is usually a bank or accounting firm. The trustee monitors the fund to assure that the fund manager obeys the appropriate regulations.
Restrictions on the fund manager
A fund manager can use the money in the fund’s bank account only to buy and sell stocks, and within the scope of his professional discretion. He cannot withdraw funds from the account for other purposes. He is subject to the restrictions stipulated by the fund’s prospectus.
Example: Founding a Mutual Fund
An experienced financial adviser named McHale decided in mid-2006 to establish a new mutual fund, which he called “Tulip”.
After obtaining all of the necessary permits, McHale opened a principal account at Citibank, and chose Barclays Bank as trustee. Three of McHale’s clients (Joey, Mandy and Allan) had money, but did not know how to invest it. McHale convinced them to invest their money in the Tulip Fund, as follows:
Their money was deposited in the fund’s account.
McHale, the fund’s manager, used the money to buy the following securities:
Keep in mind that the keys to the account belong to Citibank, which serves as the fund’s banker (i.e. funds not invested in financial assets are deposited in that account).
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How to Join a Mutual Fund
To join a mutual fund, investors ask a broker at their bank to buy shares in the fund for them. Their money is transferred from their bank account to the fund’s bank account.
The fund issues shares in the fund, and then transfers them to the investors’ securities accounts at the bank. These stock market shares constitute proof that the investors own a share of the fund.