The mutual fund industry’s growth in the last decade has been phenomenal. At the end of 1984, mutual funds managed assets totaling about $371 billion. By 1990 managed assets had grown to over $1 trillion, and by December 1994 this figure had doubled to about $2.2 trillion, second only to the $2.4 trillion in total deposits held in U.S. commercial banks. According to the Investment Company Institute (ICI), the national trade association of the mutual fund industry, there are a number of reasons for the industry’s growth. These include appreciation in the value of assets held by the mutual funds; additional purchases by existing shareholders; the introduction of new types of products and services; the growth of the retirement plan market; increased investment by institutional investors; the introduction of new distribution channels—such as banks; and a shift by individual investors from direct investments in stocks, bonds, and other securities to investment in securities through mutual funds. Also, in recent years investors have shifted to mutual funds in an attempt to obtain a better investment return than has been available through alternative investments, such as certificates of deposit. A mutual fund, formally known as an open-end investment company, pools the money of many investors. These investors, which can be either individuals or institutions, have similar investment objectives, such as maximizing income or having their investment capital appreciate in value. Their money is invested by a professional manager in a variety of securities to help the investors in the fund reach their objectives. By investing in a mutual fund, investors are able to obtain the benefits of owning a diversified portfolio of securities rather than a limited number of securities. This can lessen the risks of ownership. In addition, investors gain access to professional money managers, whose services they might otherwise be unable to obtain or afford. Each dollar that an investor puts into a mutual fund represents some portion of ownership in that fund. Funds must calculate their share price on days on which purchase or redemption requests have been made based on the market value of the assets in the fund’s portfolio, after expenses, divided by the number of shares outstanding. This leads to a figure known as the net asset value (NAV). Per-share values change as the value of the assets in the fund’s portfolio changes. Investors can sell their shares back to the fund at any time at the current NAV. Many newspapers carry the purchase and redemption prices for mutual funds on a daily basis. A mutual fund is owned by its hundreds or thousands of shareholders. A board of directors is responsible for overseeing the fund’s investment policies and objectives. The board generally does not do the work of the fund itself, but instead contracts with third parties to provide the necessary services. The Investment Company Act of 1940 requires that at least 40 percent of the board of directors be independent of the fund, its adviser, and underwriter. One of the functions of the board is to approve the mutual fund’s contracts with its investment adviser. The investment adviser plays a key role in the operation of a mutual fund. The investment adviser manages the fund’s investment portfolio by deciding what securities to buy and sell in accordance with the fund’s stated investment objectives. Other functions of the board include choosing the administrator, who generally acts as the fund’s manager by keeping the books and records, filing necessary reports with the Securities and Exchange Commission (SEC), and calculating NAV; the distributor or “underwriter,” who either sells the fund’s shares directly to the public or enters into agreements with broker-dealers or banks that will in turn sell them to retail customers; the transfer agent, who keeps track of fund shareholders and maintains information about the number of shares owned by investors; and the custodian, who is responsible for safeguarding the cash and securities assets of the fund, paying for securities when they are purchased by the fund, and collecting the income due when securities are sold. Mutual funds are sold to the public in two basic ways: directly to the public or through a sales force, such as a broker. With direct marketing, funds often solicit customers through newspaper, television, and magazine advertising or direct mail. These funds typically have low or no sales fees, or “loads.” Funds that are marketed primarily through a sales force are usually available through a variety of channels, including brokers, financial planners, banks, and insurance agents. These sales people may be compensated through a load, which is included in the price at which the fund’s shares are offered; through a distribution fee paid by the fund; or both. The mutual fund activities of banks and thrifts are subject to a number of federal and state securities and banking laws and regulations—and to the shared oversight of a variety of federal and state securities and banking regulators. In general, the mandate of securities laws is to protect investors through full and timely disclosures, while many banking laws are geared to protecting depositors and ensuring bank safety and soundness. The principal securities laws that apply to mutual funds are the Investment Company Act of 1940; a companion law, the Investment Advisers Act of 1940; and the Securities Act of 1933. These laws are intended to foster full disclosure of the risks involved in buying mutual funds and to protect investors. The Investment Company Act requires all mutual funds to register with SEC. The act contains numerous requirements relating to the operation of funds, including rules on the composition and election of boards of directors, disclosure of investment objectives and policies, approval of investment advisory and underwriting contracts, limitations on transactions with affiliates, permissible capital structures, custodial arrangements, reports to shareholders, and corporate reorganizations. Investment advisers to mutual funds, except banks, are subject to the Investment Advisers Act, which requires that any firm in the business of advising others as to the value of securities register with SEC. The Advisers Act also imposes reporting requirements on registered investment advisers and subjects them to restrictions against fraudulent, deceptive, or manipulative acts or practices. The Securities Act of 1933 requires that all publicly offered shares of any issuer, including mutual funds, be registered with SEC. In addition, SEC has adopted rules under that act to require extensive disclosures in a fund’s prospectus, including information about the fund’s investment objectives and policies, investment risks, and all fees and expenses. The act also regulates mutual fund advertising. In addition to the above laws, another securities law, the Securities Exchange Act of 1934, regulates how shares in mutual funds are sold. This act requires that persons distributing shares or executing purchase or sale transactions in mutual fund shares be registered with SEC as securities broker-dealers. SEC oversees the regulation of mutual funds and their investment advisers under the Investment Company Act and the Investment Advisers Act. SEC reviews disclosure documents, such as prospectuses, and inspects mutual fund operations. It also registers and inspects investment advisers. Broker-dealers who sell mutual funds are regulated and examined by SEC and the National Association of Securities Dealers (NASD). NASD was established pursuant to the Securities Exchange Act of 1934 as a self-regulatory organization for brokerage firms, including those that engage in mutual fund distribution, and is itself subject to SEC’s oversight. SEC and NASD regulate broker-dealers by regularly examining broker-dealer operations on-site and investigating customer complaints. NASD has also established Rules of Fair Practice, which govern standards for advertising and sales literature, including filing requirements, review procedures, approval and recordkeeping obligations, and general standards. In addition, NASD tests individuals to certify their qualifications as registered representatives and has primary responsibility for regulating advertising and sales literature used to solicit and sell mutual funds to investors. The Securities Exchange Act of 1934 exempts banks from its broker-dealer registration requirements. As a result, banks may choose to have their own employees sell mutual funds and other nondeposit investment instruments without the need to be associated with an SEC-registered broker-dealer or subject to NASD oversight. In those instances, the banking regulators, instead of NASD, are responsible for overseeing the sales activities of bank employees. Banks are also exempt from being defined as investment advisers under the Investment Advisers Act. As a result, banks may serve as investment advisers to mutual funds without registering with SEC. However, some banking organizations place their advisory activities in a nonbank subsidiary of a bank holding company. In these cases, the subsidiary is required to register as an investment adviser and is subject to SEC oversight under the Investment Advisers Act. In addition to the oversight provided by securities regulators, a number of banking laws apply to banking organizations’ mutual fund activities. One such law is the Glass-Steagall Act, which was enacted in 1933. The Glass-Steagall Act was designed to curb perceived securities abuses and speculative investments by banks that were thought to have contributed to the collapse of commercial banking in the early 1930s. The act prohibits certain securities activities by banks and their affiliates. For example, the act generally prohibits all banks from underwriting (publicly distributing new issues of securities) and dealing (trading for its own account) in certain securities directly. It also prohibits Federal Reserve System member banks from purchasing certain securities for the bank’s own account and from having interlocking management relationships with firms that are engaged primarily or principally in underwriting securities.Until the early 1980s, Glass-Steagall was viewed as prohibiting banks from engaging in most mutual fund activities. Since then, a series of federal banking agency decisions and court rulings have eroded the Glass-Steagall restrictions and allowed banks to engage in a wide variety of mutual fund activities that had not been permitted previously. These include serving as the investment adviser to a mutual fund, selling mutual funds to retail and institutional customers, and offering various administrative services, such as recordkeeping and custodial functions. Essentially, banks can now do everything but underwrite a mutual fund.