Fund Objectives and Policy Changes

Before examining how open-end funds operate day to day, you need to understand the governance rules that control what a fund can and cannot do, and what it takes to change course.

Fundamental Investment Policies

Under Section 13(a) of the Investment Company Act of 1940, a registered investment company cannot change its fundamental investment policies without a vote of a majority of outstanding voting securities.

"Majority" has a specific legal definition: the lesser of:

  • 67% of shares present at a meeting where more than 50% of outstanding shares are represented, OR
  • More than 50% of all outstanding shares

Fundamental policies include:

  • The fund's investment objectives (growth, income, capital preservation)
  • Borrowing policy (whether the fund can borrow and how much)
  • Concentration policy (whether the fund can concentrate in a single industry)
  • Issuing senior securities (leverage restrictions)

Why does this matter? Investors buy a fund based on its stated objectives. Requiring a shareholder vote prevents fund management from dramatically changing strategy without investor consent.

Exam Tip: Gotchas

  • Changing fundamental policies requires a shareholder vote. The board alone cannot make this change.
  • The "majority" definition has two prongs (67% of shares present, or 50%+ of all outstanding). Whichever is lesser controls.

Board of Directors Requirements

The board provides independent oversight of fund management:

  • Under Section 10, at least 40% of the board must be non-interested persons (independent directors)
  • If the fund has an investment adviser, no more than 60% of the board may be "interested persons"
  • Under Section 16(a), the initial board must be elected by shareholders

Board responsibilities include:

  • Approving the advisory contract (and renewing it annually)
  • Selecting auditors
  • Setting the price at which shares are offered
  • Approving 12b-1 plans (distribution fees)

Exam Tip: Gotchas

  • The 1940 Act baseline is 40% independent directors, but many specific rules require a majority. SEC exemptive rules (e.g., Rule 12b-1, Rule 18f-3) require a majority of independent directors as a condition for reliance. The exam may test either threshold.
  • The advisory contract must be renewed annually by the board or shareholders (Section 15(a)).