Like common stockholders, mutual fund shareholders have certain rights. This chapter covers:
Right to vote for the Board of Directors
Right to vote on fund-specific matters Right to pro-rata share of dividend and capital gain distributions
Right to fund disclosures
Right to vote for the Board of Directors
Mutual fund shareholders have the right to vote for the Board of Directors (BOD) (sometimes called the Board of Trustees). The BOD is a group of shareholder-approved board members who bring industry knowledge or other valuable insight. Their main job is to represent shareholder interests. The BOD oversees the fund’s overall operations and helps ensure the fund complies with securities laws and regulations. If problems arise (for example, the fund isn’t complying with the law or the portfolio no longer matches the fund’s stated objectives), the BOD is responsible for addressing them. Additionally, the BOD nominates and oversees the fund’s investment adviser (the firm responsible for investing the fund’s assets). The investment adviser employs the fund manager, the person who makes the day-to-day investment decisions. These roles matter because they control how shareholder money is invested. Once the investment adviser is appointed, shareholders must approve* the initial advisory contract. The initial contract can last no more than two years. After that, it’s renewed annually, and renewal requires approval by either:
the BOD, or a majority of shareholder votes
(Only one of these approvals is required, not both.) If the fund performs poorly, the BOD can replace the investment adviser and fund manager. *Approval requires a majority of shareholder votes. Like common stockholders, shareholders receive more voting power as they own more shares. Specifically, a shareholder gets one vote for each dollar invested in the fund. A “majority of shareholder votes” means a majority of the voting power, not a majority of individual shareholders. For example, suppose one shareholder owns 51% of the fund’s value and a million other shareholders own the remaining 49%. If the 51% shareholder votes to approve an item and the million other shareholders vote against it, the approval passes. The outcome depends on voting power, not the number of people voting. The Investment Company Act of 1940 requires at least 40% of the BOD to be independent to help keep the board as unbiased as possible. Independent board members are also called non-interested. To be considered independent, a board member must not have had related business with the fund sponsor, investment adviser, or fund affiliates within the past two years. By contrast, interested (non-independent) board members typically do business with, or are employees of, the sponsor, investment adviser, or fund affiliates (for example, a subsidiary of the fund sponsor). Any board member should raise concerns when something needs fixing, but independent members are generally more likely to do so because they have fewer ties to the fund’s management.
Right to vote on fund-specific matters Shareholders are typically asked to vote on a variety of fund-specific matters each year. Like common stockholders, shareholders can vote by proxy or attend the annual shareholder meeting (if one is held). The most common matters requiring a vote include:
Changes to the fund’s objective
For example, changing a stock fund to a bond fund
Changes to the fund’s structure
For example, changing from an open-end to closed-end fund
Changes to the fund’s fee schedule
For example, implementing 12b-1 fees*
Changes to the fund’s diversified status
For example, reclassifying a non-diversified fund as diversified
*12b-1 fees are marketing fees, which we will discuss later in this unit. Right to pro-rata share of dividend and capital gain distributions Most mutual funds make distributions to shareholders each year. Dividends represent income the fund receives from investments in its portfolio. For example, the Schwab Dividend Equity Fund (ticker: SWDSX) primarily invests in dividend-paying stocks and makes quarterly dividend distributions to shareholders. In 2022, the fund made dividend distributions totaling roughly $0.30 per share. A fund may also make a capital gain distribution. This happens when the fund manager sells a security in the portfolio at a gain and then distributes the profit to shareholders. For example, assume the Schwab fund buys $10 million of Coca-Cola Co. stock (ticker: KO) and sells the position a few years later for $15 million. The fund could then distribute the $5 million gain to shareholders. These distributions are typically made once per year, often in December. Shareholders have the right to receive dividend and capital gain distributions on a pro-rata basis, but they don’t vote on whether distributions are made. Instead, the BOD approves dividend payments. It’s common for the BOD to approve distributions because there are tax incentives to do so (covered later in this unit).
Right to fund disclosures Most securities issuers must provide detailed disclosures to investors, and mutual funds are no exception. Mutual fund disclosures include:
Prospectus
Statement of additional information (SAI)
Annual SEC report
Semi-annual shareholder report
Prospectus
The prospectus, sometimes called a statutory prospectus, provides key fund information to potential investors and current shareholders. It must be delivered:
at or prior to a solicitation (recommendation), or by settlement of a fund purchase if the purchase is unsolicited (no recommendation from a financial professional)
In practice, many investors receive electronic access to the prospectus (for example, a link during an online purchase or an emailed copy).
Information disclosed in the prospectus includes:
The investment objective
Shareholder fees
Past performance (at least 1, 5, and 10-year returns)*
Details on investment adviser and fund manager
Related risks
Fund policies**
Financial highlights***
*Funds that have existed for at least 10 years must disclose the past 1, 5, and 10-year returns. If a fund is not at least 10 years old, it must disclose as much of the typical requirements, plus the life of the fund. For example, a fund in existence for 7 years would disclose the past 1, 5, and 7-year returns. Or, a fund in existence for 4 years would disclose the past 1 and 4-year returns. **Fund policies include minimum required investment (e.g., minimum $2,500 required to invest), availability of shares (e.g., shares only available to US citizens), and excessive trading policies (restrictions imposed on investors that quickly liquidate shares). ***Financial highlights include the fund’s historical income and expenses. A fund prospectus can be dozens of pages long and difficult to read cover to cover. A summary prospectus, which is a condensed version of the prospectus, may be delivered instead of the statutory prospectus. To view a real world version of these documents, click these links:
Fidelity Value Fund statutory prospectus
Fidelity Value Fund summary prospectus
Statement of additional information (SAI)
The statement of additional information (SAI) provides detailed, “in the weeds” information about the fund. Most shareholders don’t read the SAI, but it’s useful if you want a deeper look at how the fund operates.
Information in the SAI includes micro-details on:
Fund policies
Investment-making decisions
Fund’s financials
Board member backgrounds
The SAI doesn’t have to be delivered to investors, but it must be available upon request. Click this link to view the SAI for the Fidelity Value Fund, a real world version of this disclosure.
Annual SEC report Funds must file annual Securities and Exchange Commission (SEC) reports, which the SEC makes publicly available after receiving them. These reports include:
Market recaps over the previous year
Fund manager comments
Investment summary (details on fund portfolio)
Financial statements (balance sheet, income statement)
Financial highlights (income, expenses, returns)
Click this link to view the SEC annual report for the Fidelity Value Fund, a real world version of this disclosure.
Semi-annual shareholder report Funds must make semi-annual reports available to shareholders. Much of the information overlaps with the annual SEC report, including:
Investment summary (details on fund portfolio)
Financial statements (balance sheet, income statement)
Financial highlights (income, expenses, returns)
Click this link to view the semi-annual shareholder report for the Fidelity Value Fund, a real world version of this disclosure.
Key points
Shareholder rights
Right to vote for Board of Directors
Right to approve investment adviser contract
Right to vote on fund-specific matters, including:
Fund’s objective
Changes to fund structure
Changes to fee schedule
Changes to diversified status
Right to receive pro-rata share of dividends
Right to fund disclosures
Prospectus
Statement of additional information
Annual SEC filing
Semi-annual shareholder report
Board of Directors (mutual fund)
Represents shareholder interests
Oversees overall operation of the fund 40%+ must be independent (non-interested)
No more than 60% “interested”
Approve dividend and capital gain distributions
Statutory prospectus
Primary fund disclosure document
Must be delivered when:
Financial professionals solicit investors
An investor purchases shares unsolicited
Information disclosed includes:
The investment objective
Shareholder fees
Past performance (at least 1, 5, and 10-year returns)
Details on investment adviser and fund manager
Related risks
Fund policies
Financial highlights
Summary prospectus
Condensed version of the prospectus
May be delivered instead of statutory prospectus
Statement of additional information (SAI)
Provides micro-details on fund operations
Annual SEC report
Required disclosure report to regulators, which includes:
Market recaps over the previous year
Fund manager comments
Investment summary (details on fund portfolio)
Financial statements (balance sheet, income statement)
Financial highlights (income, expenses, returns)
Semi-annual shareholder report
Required disclosure report to shareholders, which includes:
Investment summary (details on fund portfolio)
Financial statements (balance sheet, income statement)
Financial highlights (income, expenses, returns)
Like common stockholders, mutual fund shareholders have certain rights. This chapter covers:.