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Series 26 study materials
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Series 26 practice questions

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Question 1Supervision of Investment Company and Variable Contracts Products Activities

A customer telephones the transfer agent of an open-end fund at 3:45 p.m. Eastern time on a business day and places an order to buy shares. At what price must the order be filled?

  1. At the net asset value computed at the close of the preceding business day
  2. At the net asset value computed at the close of business that same day
  3. At the offering price quoted by the distributor when the call was taken
  4. At the net asset value next computed after the order is received Correct answer.

Explanation

Rule 22c-1 under the Investment Company Act requires that redemption and purchase orders be executed at the price next computed after receipt of the order, a concept known as forward pricing. Because the fund has already struck its daily price for that day, the order is priced at the next computation, typically the following business day's close.

Question 2Supervision of Investment Company and Variable Contracts Products Activities

A unit investment trust that has issued redeemable securities must pay a unitholder who tenders units for redemption within how many days, absent an applicable suspension?

  1. Fifteen calendar days
  2. Thirty calendar days
  3. Seven days Correct answer.
  4. Three calendar days

Explanation

Section 22(e) of the Investment Company Act prohibits a registered investment company from postponing payment for more than seven days after tender of a redeemable security, except under limited circumstances such as a market emergency or an SEC-ordered suspension.

Question 3Supervision of Investment Company and Variable Contracts Products Activities

A registered representative submits a deferred variable annuity purchase application to her principal on March 3. Under FINRA rules, by when must the principal complete the review and approve or reject the transaction?

  1. By the end of the next business day after receiving it
  2. At any time before the insurer issues the contract
  3. Within seven business days of the representative's submission Correct answer.
  4. Within thirty calendar days of the representative's submission

Explanation

FINRA Rule 2330 requires a principal to review and approve or reject a deferred variable annuity transaction within seven business days after the representative submits it. The review must consider factors such as the customer's age, investment objectives, liquidity needs, surrender charges, and any other annuity purchases in the preceding 36 months.

Question 4Supervision of Investment Company and Variable Contracts Products Activities

An insurer issues a variable annuity contract supported by a separate account. Which statement accurately describes the registration status of the two elements?

  1. The separate account is registered under the 1933 Act and the contract under the 1940 Act
  2. Both are registered under the Investment Company Act of 1940
  3. Separate account registered under the 1940 Act; contract registered under the 1933 Act Correct answer.
  4. Neither is registered because the insurer is licensed by the states

Explanation

Because the separate account holds assets and issues interests to contract holders, it is an investment company required to register under the Investment Company Act of 1940, typically as a unit investment trust. The contract itself is a security that must be registered under the Securities Act of 1933.

Question 5Supervision of Investment Company and Variable Contracts Products Activities

A customer says he intends to invest $24,000 in Class A shares of a fund that offers a breakpoint at $25,000, and the representative knows the customer has another $2,000 available in cash. What is the most appropriate action?

  1. Execute the order exactly as the customer placed it
  2. Wait for the fund to lower its breakpoint level before investing
  3. Switch the customer to Class C shares to avoid the sales charge
  4. Inform the customer that the breakpoint is $2,000 away Correct answer.

Explanation

A representative must make customers aware of breakpoint discounts for which they may qualify, including how a slightly larger purchase would reduce the sales charge. Executing the order without disclosure deprives the customer of a discount the fund makes available.

Question 6Supervision of Investment Company and Variable Contracts Products Activities

How often must a member firm inspect an office of supervisory jurisdiction under FINRA Rule 3110?

  1. Annually Correct answer.
  2. Every two years
  3. Every three years
  4. Every five years

Explanation

Rule 3110(c) requires each office of supervisory jurisdiction to be inspected at least annually, while every other branch office must be inspected at least every three years. The firm's written supervisory procedures must set a schedule for the inspections.

Question 7Supervision of Investment Company and Variable Contracts Products Activities

An open-end fund proposes to acquire shares of another open-end fund. Absent an exemption, the limits of Section 12(d)(1)(A) of the Investment Company Act restrict the acquiring fund to:

  1. 10% of outstanding voting stock, 3% of total assets, and 25% in the aggregate with affiliates
  2. 5% of outstanding voting stock, 10% of total assets, and 3% in the aggregate with affiliates
  3. 3% of outstanding voting stock, 5% of total assets, and 10% in the aggregate with affiliates Correct answer.
  4. 25% of total assets with no limit on voting stock

Explanation

Section 12(d)(1)(A) prohibits a registered fund from acquiring more than 3% of another fund's total outstanding voting stock, investing more than 5% of its own total assets in that fund, or holding more than 10% of the acquired fund's voting stock together with affiliated funds. These are commonly called the 3/5/10 limits.

Question 8Supervision of Investment Company and Variable Contracts Products Activities

A member firm prepares a new mutual fund sales brochure and mails it to 500 retail prospects. Which statement is correct?

  1. No filing or approval is required because a prospectus accompanies the brochure
  2. The brochure must be filed with FINRA at least 10 business days before first use
  3. Principal approval plus FINRA filing within 10 business days of first use Correct answer.
  4. The brochure needs only compliance department approval and three-year retention

Explanation

Retail communications concerning investment company products require prior approval by a registered principal and must be filed with FINRA's Advertising Regulation Department within 10 business days of first use. The presence of a prospectus does not eliminate the approval and filing requirements.

Question 9Supervision of Investment Company and Variable Contracts Products Activities

Which statement about shares of a closed-end investment company is accurate?

  1. They are sold continuously at the public offering price by the distributor
  2. They may be redeemed at net asset value on any business day
  3. They trade in the secondary market and are not redeemable with the fund Correct answer.
  4. Their market price can never fall below net asset value

Explanation

A closed-end fund raises a fixed amount of capital in an offering and then lists its shares for trading, so shareholders exit by selling in the market rather than by redeeming with the fund. Consequently the market price can trade at either a premium or a discount to net asset value.

Question 10Supervision of Investment Company and Variable Contracts Products Activities

Under FINRA rules, which combination of asset-based distribution fees is permitted for a mutual fund?

  1. A 0.75% distribution fee plus a 0.25% service fee Correct answer.
  2. A 1.00% distribution fee plus a 0.50% service fee
  3. Any percentage approved by the distributor and the board
  4. A 0.75% service fee plus a 0.75% distribution fee

Explanation

FINRA Rule 2341 limits asset-based sales charges to 0.75% of average annual net assets and shareholder service fees to 0.25%, so total 12b-1 fees may not exceed 1.00%. Amounts above those caps require the fees to be structured outside the plan or are simply impermissible.

Question 11Supervision of Investment Company and Variable Contracts Products Activities

Which list correctly identifies the three suitability obligations imposed by FINRA Rule 2111?

  1. Suitability, disclosure, and best execution
  2. Reasonable-basis, customer-specific, and quantitative suitability Correct answer.
  3. Know-your-customer, anti-money-laundering, and disclosure
  4. Fair dealing, supervision, and recordkeeping

Explanation

Rule 2111 requires a reasonable basis for believing a recommendation suits some investors, a customer-specific determination based on the particular customer's profile, and a quantitative assessment when a series of recommendations together would be excessive.

Question 12Supervision of Investment Company and Variable Contracts Products Activities

Which statement about the annual renewal of a mutual fund's investment advisory contract is correct?

  1. Automatic renewal unless a majority of the independent directors objects in writing within 30 days
  2. Approval by the board and a majority of the disinterested directors Correct answer.
  3. An annual vote of shareholders as well as approval by the board of directors
  4. Approval by the fund's distributor acting on behalf of the board of directors

Explanation

Section 15(a) requires that an advisory contract be approved annually by the board of directors, including a majority of the directors who are not interested persons of the adviser. Shareholder approval is required for a new contract, but not for each annual renewal.

Question 13Supervision of Investment Company and Variable Contracts Products Activities

Under SEC Rule 17a-4, a member firm must generally retain its required books and records for:

  1. Three years, with the first year in an easily accessible place
  2. Six years, with all records kept on microfilm only
  3. Five years, with all records immediately retrievable
  4. Six years, with the first two years in an easily accessible place Correct answer.

Explanation

Rule 17a-4 requires most broker-dealer records to be preserved for six years from the end of the fiscal year in which they were created, with the first two years maintained in an easily accessible place.

Question 14Supervision of Investment Company and Variable Contracts Products Activities

A person becomes an access person under a fund's code of ethics adopted pursuant to Rule 17j-1. When must that person submit an initial holdings report?

  1. Immediately upon hire, with no grace period
  2. Within 10 days after becoming an access person Correct answer.
  3. Within 30 days after the end of each calendar quarter
  4. Within 45 days after the end of the fiscal year

Explanation

Rule 17j-1 requires access persons to file an initial holdings report no later than 10 days after becoming an access person. Annual holdings reports are due within 45 days of the fiscal year end, and quarterly transaction reports are due within 30 days of quarter end.

Question 15Supervision of Investment Company and Variable Contracts Products Activities

A fund with $90 million of total assets issues $30 million of senior debt securities. Which statement is correct under Section 18 of the Investment Company Act?

  1. The issuance violates Section 18 because asset coverage must be at least 400%
  2. The issuance is permitted because asset coverage is exactly 300% Correct answer.
  3. The issuance is permitted because asset coverage exceeds 200%
  4. The issuance violates Section 18 because investment companies may not borrow money

Explanation

Section 18 requires at least 300% asset coverage for senior debt, meaning total assets must be at least three times the debt outstanding. Here $90 million of assets against $30 million of debt equals exactly 300%, which satisfies the minimum.

Question 16Supervision of Investment Company and Variable Contracts Products Activities

Which statement about a variable life insurance policy is accurate?

  1. Premiums are invested in the insurer's general account
  2. The death benefit may vary with separate account performance Correct answer.
  3. The policy is not a security because it is an insurance product
  4. The cash value of the policy is guaranteed by the insurer

Explanation

In variable life insurance, premiums are allocated to subaccounts of a separate account whose value fluctuates with the underlying investments, so both cash value and, within limits, the death benefit can change. The insurer does not guarantee the investment portion.

Question 17Supervision of Investment Company and Variable Contracts Products Activities

A customer writes to the firm complaining that a representative overstated a mutual fund's performance. How must the firm handle the complaint?

  1. Record the complaint in a complaint log and retain it as required Correct answer.
  2. Discard the complaint once the customer's issue is resolved
  3. Report every written complaint to FINRA within 10 business days
  4. Forward the complaint to the SEC within 24 hours of receipt

Explanation

FINRA rules require member firms to capture written customer complaints in a complaint record, respond to them, and preserve the record for the prescribed retention period. Not every complaint is a reportable event to FINRA, but every written complaint must be logged and retained.

Question 18Supervision of Investment Company and Variable Contracts Products Activities

Under FINRA rules, the maximum front-end sales charge that may be imposed on the sale of mutual fund shares to a single purchaser is:

  1. 8.5% of the public offering price Correct answer.
  2. 5.75% of the amount invested
  3. 10% of the amount invested
  4. 3.5% of the public offering price

Explanation

FINRA Rule 2341 caps the front-end sales charge on investment company securities at 8.5% of the public offering price, with lower caps required as the size of the purchase increases through breakpoint schedules.

Question 19Supervision of Investment Company and Variable Contracts Products Activities

A customer wants to exchange one deferred variable annuity for another. Under FINRA Rule 2330, which factor must the principal consider when reviewing the transaction?

  1. Whether the customer will incur a surrender charge or a new surrender period Correct answer.
  2. The amount of commission the representative will earn on the exchange
  3. Whether the customer's existing contract has appreciated in value
  4. Whether the issuing insurer appears on the firm's approved product list

Explanation

Rule 2330 lists specific replacement concerns the principal must weigh, including whether the customer would incur a surrender charge, begin a new surrender period, lose existing benefits, face increased fees, or has made another annuity purchase in the preceding 36 months.

Question 20Supervision of Investment Company and Variable Contracts Products Activities

A mutual fund advertisement includes a client's statement that she doubled her money in two years in the fund. Under FINRA Rule 2210, the firm must:

  1. File the testimonial with the SEC before publication
  2. Remove all performance data from the advertisement before it is used
  3. Obtain FINRA approval before publication
  4. State that the result is not typical and not a guarantee Correct answer.

Explanation

Rule 2210 requires communications to be fair and balanced and prohibits misleading implications about likely results. A testimonial about performance must be accompanied by disclosure that the experience is not representative and that past results do not guarantee future performance.

Question 21Supervision of Investment Company and Variable Contracts Products Activities

A fund's investment adviser proposes to sell a portfolio security it owns to the fund. Absent an SEC exemptive order, the transaction is:

  1. Permitted if a majority of the independent directors approves
  2. Prohibited only if the security is a restricted security
  3. Permitted if the price is at or above the current market price
  4. Prohibited as a principal transaction with an affiliate Correct answer.

Explanation

Section 17(a) prohibits affiliated persons such as the adviser from selling securities to or buying securities from the fund in principal transactions without an SEC exemption. The conflict is structural, so board approval or a fair price does not cure it.

Question 22Supervision of Investment Company and Variable Contracts Products Activities

Which office must be designated as an office of supervisory jurisdiction under FINRA Rule 3110?

  1. Any office that has been open for more than one year
  2. Only the firm's principal executive office
  3. Any office staffed by more than ten registered representatives
  4. An office where supervisory functions such as order review take place Correct answer.

Explanation

An office of supervisory jurisdiction is defined by the supervisory functions performed there, such as approving new accounts, reviewing customer orders, or supervising sales activities, rather than by headcount or location. Firms must designate these offices and inspect them annually.

Question 23Supervision of Investment Company and Variable Contracts Products Activities

Under the Investment Company Act of 1940, at least what percentage of a registered investment company's board of directors must be non-interested?

  1. 75%
  2. 51%
  3. 40% Correct answer.
  4. 25%

Explanation

Section 10(a) requires that no more than 60% of a registered fund's board consist of interested persons, which means at least 40% must be disinterested. Many funds voluntarily maintain a majority of independent directors.

Question 24Supervision of Investment Company and Variable Contracts Products Activities

A customer plans to invest $100,000 in a mutual fund for at least 15 years and wants to minimize total costs. The fund offers a Class A breakpoint at $100,000 and a Class C share with a 1.00% annual distribution fee. Which recommendation is most consistent with suitability requirements?

  1. Class A shares at the breakpoint, given the long holding period Correct answer.
  2. Class C shares, because the 12b-1 fee is charged only in the first year
  3. Class B shares, because they convert to Class A shares after eight years
  4. Class C shares, because the contingent deferred sales charge expires after one year

Explanation

Over a long holding period, the lower annual asset-based fees of Class A shares purchased at a breakpoint typically produce lower total costs than Class C shares, whose ongoing 12b-1 fees compound over many years. The representative must weigh the customer's time horizon and the amount invested when recommending a share class.

Question 25Supervision of Investment Company and Variable Contracts Products Activities

Which of the following changes at an open-end fund requires a shareholder vote under the Investment Company Act of 1940?

  1. Changing the fund from diversified to non-diversified Correct answer.
  2. Replacing the fund's custodian bank
  3. Changing the fund's name from Growth Fund to Growth Opportunities Fund
  4. Hiring a new transfer agent for the fund

Explanation

Section 13(a) requires shareholder approval before a fund may deviate from a fundamental policy such as diversification or change its subclassification. Service provider changes and cosmetic changes such as a name change generally do not require a shareholder vote.

Question 26Supervision of Investment Company and Variable Contracts Products Activities

A registered representative has prepared a new written sales piece promoting a variable annuity and intends to begin using it with retail prospects. Under FINRA Rule 2210, which step must occur before the piece is used?

  1. The branch office manager must initial a copy after the first mailing.
  2. No approval is required because the piece describes a registered insurance product.
  3. A registered principal must approve the piece in writing before it is used. Correct answer.
  4. The representative must file the piece with FINRA and wait ten business days.

Explanation

FINRA Rule 2210(b)(1) requires a registered principal to approve retail communications in writing before first use, subject to limited exceptions for unchanged, previously filed materials. Principal pre-approval is a separate requirement from any filing obligation with FINRA's Advertising Regulation Department.

Question 27Supervision of Investment Company and Variable Contracts Products Activities

An insurer establishes a separate account to fund the variable annuity contracts it issues. The separate account must be registered under which federal statute?

  1. The Trust Indenture Act of 1939
  2. The Securities Exchange Act of 1934
  3. The Investment Advisers Act of 1940
  4. The Investment Company Act of 1940 Correct answer.

Explanation

A separate account funding variable contracts is an investment company under the Investment Company Act of 1940, typically registered as a unit investment trust or an open-end management company. The contracts themselves are registered as securities under the Securities Act of 1933.

Question 28Supervision of Investment Company and Variable Contracts Products Activities

Under FINRA Rule 2210, a written communication that is distributed to 25 or fewer retail investors within any 30-calendar-day period is classified as:

  1. a retail communication
  2. sales literature
  3. an institutional communication
  4. correspondence Correct answer.

Explanation

Rule 2210(a) defines correspondence as a written communication distributed to 25 or fewer retail investors within any 30-calendar-day period. Correspondence is subject to firm supervision but is not subject to the principal pre-approval and filing requirements that apply to many retail communications.

Question 29Supervision of Investment Company and Variable Contracts Products Activities

Under state insurance requirements applicable to deferred variable annuity contracts, the purchaser is generally entitled to a free-look period of at least:

  1. 7 days
  2. 10 days Correct answer.
  3. 45 days
  4. 30 days

Explanation

State replacement and annuity regulations generally give the contract holder at least 10 days after delivery to return a variable annuity for a refund of premium or account value. The free-look right is disclosed in the contract and prospectus.

Question 30Supervision of Investment Company and Variable Contracts Products Activities

A member firm's Firm Element continuing education program must be administered to covered registered persons at least:

  1. every two years
  2. quarterly
  3. annually Correct answer.
  4. every three years

Explanation

FINRA Rule 1250 requires the Firm Element to be delivered at least annually, based on a needs analysis of the firm's business and the covered persons' responsibilities. The Regulatory Element is a separate requirement triggered by registration anniversaries.

Question 31Supervision of Investment Company and Variable Contracts Products Activities

Under FINRA Rule 4513, a member firm must preserve records of customer complaints for a period of:

  1. three years
  2. four years Correct answer.
  3. six years
  4. two years

Explanation

Rule 4513 requires the firm to keep a record of each written customer complaint, and the firm's response, for at least four years. Complaints must also be recorded in the firm's complaint log and made available to FINRA on request.

Question 32Supervision of Investment Company and Variable Contracts Products Activities

A fund wants to satisfy its prospectus delivery obligation by giving investors a summary prospectus. Under SEC Rule 498, which condition must be satisfied?

  1. The investor must sign an acknowledgment agreeing to receive only the summary.
  2. The summary prospectus must be filed with FINRA before it is used.
  3. The full statutory prospectus must be accessible on a website and provided on request. Correct answer.
  4. The summary prospectus may be used only for money market funds.

Explanation

Rule 498 permits use of a summary prospectus only if the full statutory prospectus and other required materials are posted online and are sent to the investor upon request. The summary must follow the prescribed content and order.

Question 33Supervision of Investment Company and Variable Contracts Products Activities

A fund's board is considering continuation of its Rule 12b-1 distribution plan. Annual continuation of the plan requires approval by:

  1. the fund's chief compliance officer
  2. a majority of shareholders
  3. a majority of the board, including a majority of interested directors
  4. a majority of the board, including a majority of directors who are not interested persons and have no direct or indirect financial interest in the plan Correct answer.

Explanation

Rule 12b-1 requires that a distribution plan and its continuance be approved by the board, including a majority of directors who are not interested persons of the fund and who have no direct or indirect financial interest in the plan. This ensures disinterested review of distribution costs.

Question 34Supervision of Investment Company and Variable Contracts Products Activities

A customer is replacing an existing variable annuity with a new contract from a different insurer. Which document must the representative generally provide as part of the transaction?

  1. A breakpoint schedule for the new contract
  2. A replacement notice that compares the existing and proposed contracts Correct answer.
  3. A letter of intent signed by the customer
  4. A prospectus for the separate account only

Explanation

Replacement regulations and FINRA Rule 2330 require disclosure comparing the existing and proposed contracts so the customer can weigh surrender charges, a new surrender period, fees, and lost benefits. The representative must also make reasonable efforts to obtain the existing contract information.

Question 35Supervision of Investment Company and Variable Contracts Products Activities

Under FINRA Rule 2330, a principal reviewing a recommended exchange of deferred variable annuities must complete the review within how many business days after the representative submits the transaction?

  1. 30 business days
  2. 3 business days
  3. 10 business days
  4. 7 business days Correct answer.

Explanation

Rule 2330 requires the representative to transmit the exchange information to a principal, who must review it and determine whether the exchange is suitable within seven business days. The review covers the customer's profile, surrender costs, and the features exchanged.

Question 36Supervision of Investment Company and Variable Contracts Products Activities

A firm has a reasonable belief that a specified adult customer is being financially exploited. Under FINRA Rule 2165, the firm may:

  1. report the customer to FINRA before taking any other action
  2. place a temporary hold on a disbursement from the customer's account Correct answer.
  3. liquidate the customer's portfolio to protect the assets
  4. close the customer's account without notice

Explanation

Rule 2165 permits a member to place a temporary hold on a disbursement of funds or securities when it reasonably believes financial exploitation of a specified adult has occurred, is occurring, or will be attempted. The hold is time-limited and must be reviewed and documented by a qualified person.

Question 37Supervision of Investment Company and Variable Contracts Products Activities

Under FINRA Rule 4512, for an account held by a natural person, the member firm must make reasonable efforts to obtain:

  1. the name and contact information of a trusted contact person Correct answer.
  2. the customer's employer identification number
  3. the customer's credit report
  4. a copy of the customer's will

Explanation

Rule 4512 requires firms to make reasonable efforts to obtain the name and contact information of a trusted contact person for accounts held by natural persons. A trusted contact may be used to address concerns about the customer's health, whereabouts, or possible exploitation.

Question 38Supervision of Investment Company and Variable Contracts Products Activities

A registered representative wants to serve as a paid director of a local bank. Under FINRA Rule 3270, the representative must:

  1. provide prior written notice to the firm, which must evaluate the activity for conflicts Correct answer.
  2. resign from the firm before accepting the position
  3. obtain FINRA's prior written approval
  4. limit the activity to hours outside the firm's business day

Explanation

Rule 3270 requires written notice to the member before a registered person accepts an outside business activity or compensation for it, and the firm must assess whether the activity creates conflicts or supervisory concerns. The firm may prohibit or impose conditions on the activity.

Question 39Supervision of Investment Company and Variable Contracts Products Activities

A representative wants to sell interests in a private limited partnership to customers of the firm and receive compensation for those sales. Under FINRA Rule 3280, the representative must:

  1. do nothing if the securities are exempt from registration
  2. provide written notice to the firm and obtain approval before participating Correct answer.
  3. obtain approval only if the compensation exceeds $5,000
  4. notify the firm within 30 days after completing the sales

Explanation

Rule 3280 requires prior written notice to, and approval by, the member firm before a registered person participates in a private securities transaction for compensation. The firm may treat the transaction as if it were done on behalf of the firm and supervise it accordingly.

Question 40Supervision of Investment Company and Variable Contracts Products Activities

A member firm plans to first use a new retail communication concerning a variable life insurance product. Under FINRA Rule 2210, the firm must file the communication with FINRA's Advertising Regulation Department at least:

  1. on the same day it is first used
  2. within 30 days after first use
  3. 10 business days before first use Correct answer.
  4. within 10 business days after first use

Explanation

Rule 2210(c)(3) requires retail communications concerning investment companies or variable contracts to be filed at least 10 business days before first use, unless an exception applies. This pre-use filing applies to new communications not previously filed in materially identical form.

Question 41Supervision of Investment Company and Variable Contracts Products Activities

A fund's name includes the term 'tax-free.' Under SEC Rule 35d-1, the fund must invest at least what percentage of its assets in tax-exempt securities?

  1. 65%
  2. 80% Correct answer.
  3. 50%
  4. 100%

Explanation

Rule 35d-1 requires a fund whose name suggests a type of investment or tax treatment to invest at least 80% of its assets in the investments suggested by the name. The 80% policy must be stated and may be changed only with appropriate notice to shareholders.

Question 42Supervision of Investment Company and Variable Contracts Products Activities

A shareholder submits a redemption request to an open-end fund on a business day. Under Section 22(e) of the Investment Company Act of 1940, the fund must generally pay the redemption within:

  1. ten business days
  2. thirty calendar days
  3. three business days
  4. seven calendar days Correct answer.

Explanation

Section 22(e) prohibits a fund from suspending the right of redemption or postponing payment for more than seven days after the tender, subject to limited statutory exceptions such as trading halts or emergencies. Faster payment may be required by other rules or the prospectus.

Question 43Supervision of Investment Company and Variable Contracts Products Activities

An investor places an order to buy open-end fund shares at 2:00 p.m. on a business day; the fund computes its NAV at 4:00 p.m. that day. The price the investor will pay is based on:

  1. the offering price quoted at the moment the order was placed
  2. the NAV computed at the close of that day Correct answer.
  3. the next day's NAV
  4. the previous day's NAV

Explanation

SEC Rule 22c-1 requires forward pricing: purchase and redemption orders received before the fund computes its NAV must be priced at that day's NAV (plus any applicable sales charge). Pricing at a known or stale NAV is prohibited.

Question 44Supervision of Investment Company and Variable Contracts Products Activities

An open-end fund presents its total return in a sales advertisement. Under SEC Rule 482, the advertisement must also present total return for which periods?

  1. 1-, 5-, and 10-year periods, or since inception if shorter Correct answer.
  2. since-inception only
  3. 1- and 3-year periods only
  4. monthly periods for the past 12 months

Explanation

Rule 482 requires standardized total return for 1-, 5-, and 10-year periods (or since inception if the fund is younger), computed net of the maximum sales load. This allows investors to compare performance on a consistent basis.

Question 45Supervision of Investment Company and Variable Contracts Products Activities

A mutual fund's principal underwriter is best described as:

  1. the bank that holds the fund's portfolio securities in safekeeping
  2. the entity that maintains shareholder records and processes redemptions
  3. an entity that distributes the fund's shares to the public, often an affiliate of the adviser Correct answer.
  4. an unaffiliated broker-dealer that executes the fund's portfolio trades

Explanation

The principal underwriter is the distributor that offers and sells the fund's shares, frequently an affiliate of the investment adviser. Its compensation and any 12b-1 payments must be disclosed and approved under the fund's distribution arrangements.

Question 46Supervision of Investment Company and Variable Contracts Products Activities

A fund has a fundamental investment policy limiting it to investment-grade bonds, and the adviser proposes to change that policy. Which approval is required?

  1. Approval by the fund's chief compliance officer
  2. Approval by the board and the adviser only
  3. Approval by a majority of the outstanding voting securities Correct answer.
  4. Approval by a majority of the independent directors only

Explanation

Section 13(a) of the Investment Company Act requires shareholder approval to change a fundamental policy, and the required vote is a majority of the outstanding voting securities as defined in Section 2(a)(42). Board approval alone cannot amend a fundamental policy.

Question 47Supervision of Investment Company and Variable Contracts Products Activities

Under Rule 38a-1, at least annually a fund's board must review and approve:

  1. the compliance policies and procedures of the fund and its service providers, including the chief compliance officer's compensation Correct answer.
  2. the independent auditors' engagement letter
  3. the distributor's sales literature before use
  4. the fund's portfolio holdings disclosure policy

Explanation

Rule 38a-1 requires the board, including a majority of independent directors, to approve the fund's and its service providers' compliance policies and procedures and to approve the chief compliance officer's compensation at least annually. The rule is designed to give the board direct oversight of the compliance program.

Question 48Supervision of Investment Company and Variable Contracts Products Activities

An investor purchases a deferred variable annuity and allocates premiums among subaccounts. If the subaccount investments decline in value, the investor bears the loss because:

  1. the contract holder, rather than the insurer, bears the investment risk on separate account assets Correct answer.
  2. the insurer must eventually be reimbursed from the general account
  3. the contract is a security and therefore carries no insurance features
  4. the separate account assets are subject to the claims of the insurer's general creditors

Explanation

In a variable contract the contract holder bears the investment risk on assets held in the separate account, while the insurer guarantees only mortality, expense, and certain other charges. This risk allocation is a defining feature that distinguishes variable from fixed products.

Question 49Supervision of Investment Company and Variable Contracts Products Activities

An open-end fund wishes to reserve the ability to pay very large redemptions in portfolio securities rather than cash. This practice is permitted when:

  1. the fund's NAV has declined for 30 consecutive days
  2. FINRA approves each in-kind redemption in advance
  3. the fund has reserved the right and the redemption is large, such as one exceeding $250,000 or 1% of fund assets Correct answer.
  4. any shareholder requests in-kind payment for any amount

Explanation

Funds may redeem in kind where the board has reserved that right, and Rule 18f-1 permits a fund to limit cash redemptions only if it commits to pay cash for requests up to the lesser of $250,000 or 1% of assets in any 90-day period. In-kind redemption protects the fund's remaining shareholders from forced portfolio sales.

Question 50Supervision of Investment Company and Variable Contracts Products Activities

A fund offers multiple classes of shares with different sales loads and 12b-1 fees. Under Rule 18f-3, the fund may do so only if:

  1. each class is overseen by a separate board of directors
  2. FINRA approves the class structure before the shares are offered
  3. all classes carry identical 12b-1 fees
  4. the board adopts a written plan specifying the class arrangements and the allocation of expenses Correct answer.

Explanation

Rule 18f-3 permits a fund to issue multiple classes only under a written plan adopted by the board that describes the classes, their different services and expense allocations, and related voting and exchange features. The plan must be approved by the directors, including a majority of the independent directors.