In the Future IBs and Financial Advisors Compete Head to Head | Part 2

In our previous article, the benefits of managed futures mutual funds were discussed. This article tackles some of the major issues in establishing a mutual fund.

Steps Necessary for Mutual Fund Formation and Registration

From a legal standpoint, the “mutual fund” is a Securities Exchange Commission (“SEC”) registered and regulated pooled investment vehicle that is required to comply a complex set of rules, regulations and statutes, including the Investment Company Act 1940 (“1940 Act”).

Mutual funds are often times referred to as open ended investment companies. While SEC registered mutual funds may be organized in almost every state within the United States, a key insight is that many legal practitioners view the state of Delaware as the jurisdiction of choice when it comes to establishing an investment company.

Once established in a particular jurisdiction, the investment company is put through a rigorous registration process with the SEC. In this process, the shares of the investment company are registered under the Securities Act of 1933 (“1933 Act”) and the investment company, as an entity, is registered under the 1940 Act. After this registration process is completed and the registration statement becomes effective, the shares of the investment company may be offered to the public for sale.

While the intricate details of registration are important, so too is setting up the fund’s corporate structure.

Establishing Fund Corporate Structure

A key point to consider is the investment company itself, which is governed and operated by an appointed Board of Trustees. The Trustees are responsible for the oversight of the investment company’s operations and affairs, including oversight of the investment adviser(s) and the other service providers to the investment company. Some of the specific responsibilities within this very broad mandate include:

  • Establishment of meeting agendas for periodic (quarterly at a minimum);
  • Annual approval of investment advisory and distribution agreements and, if applicable, any Rule 12b-1 plans;
  • Selection, appointment and evaluation of independent auditor (audit committee)
  • Securing fidelity bond coverage as required by the 1940 Act and monitoring to ensure appropriate coverage and filings with the SEC of the fidelity bond;
  • Ensuring appropriate books and records of the investment company are maintained
  • Declare dividends and oversee appropriate distribution thereof to ensure compliance with requirements under the Internal Requirements applicable to investment companies.;
  • Oversight of the investment company’s compliance program, including the appointment of the investment company’s chief compliance officer.
  • Quarterly approvals of specific securities transactions and activities mandated by the 1940 Act.
  • SEC audit support

The process for fund establishment and ongoing back office management takes into consideration all these factors. The actions and procedures necessary for establishment and registration of an investment company vary depending on the specific structure of the investment company. Generally, however, the steps associated with formation process may be summarized as follows:

  1. Formation of the trust under applicable state law (e.g., Delaware);
  2. Preparation of organizational documents;
  3. Preparation of Form N-8A;
  4. Preparation of Registration Statement on Form N-1A:
    • Definition and description of investment objective and strategies;
    • Identification of applicable securities types and transaction in which the investment company will invest/engage;
    • Portfolio turnover (trade frequency);
    • Identification of risk;
    • Identify appropriate class structure, if any;
    • Definition of management fees and fee structure;
    • Definition of fee cap/waiver arrangements, if any;
    • Crafting applicable disclosure to describe the investment adviser and other applicable service providers;
    • Craft disclosure regarding portfolio managers;
  5. Liaising with the SEC staff regarding the filings, including preparing response letters for comments received and filing of pre-effective amendments;
  6. Preparing filings that must be submitted following effectiveness of registration statement (e.g., 497, 18f-1, 17g-1, . . .);
  7. Preparation of all organizational materials for the initial organization meeting, including, among others, 12b-1 plans (a plan pursuant to which a fund may pay 12b-1 fees to certain registered entities), 18f-3 plans (allow the fund to issue multiple classes of shares), appropriate resolutions, 15c requests (annual information requests to advisers and distributors), 12b-1 requests (annual information requests to advisers and distributors), 18f-1 notices (notice to SEC that permits in-kind redemptions), 38a-1 procedures (policies and procedures of the various services providers (and the trust itself) that are in place to ensure compliance with federal securities laws);
  8. Preparation and negotiation of service provider agreements, including transfer agent, principal underwriter, fund accountant, legal counsel, auditors, administrator, and custodian; and
  9. Verification of the independence of trustees.

Foreign Corporation for Managed Futures Strategies


Mutual funds are required to distribute annually ninety percent (90%) of their securities related income. Income derived from futures and commodities trading activities does not qualify as securities related income, therefore, if the fund will generate more than 10% of its income from these activities it is necessary to convert trading income to securities income. This is typically accomplished through the formation of a wholly owned subsidiary wherein the trading activity occurs. The income created within this subsidiary is then distributed as dividends (security related income) to the fund.

The above structure contemplates single stand-alone investment companies. Under Rule 18f-2, registered investment companies, if and only if structured appropriately, may establish and designate multiple series. For all practical purposes, each series is treated as if it is its own separate legal entity – there are exceptions to this that may be relevant and post risks to your investment company if it is not appropriately organized, established and structured. As a part of a series investment company the assets and liabilities of each series are separate and distinct for all purposes, including bankruptcy. When appropriately organized, established and structure, a “series investment company” may offer an investment adviser seeking to establish a mutual fund significant advantages. Principally, the series investment company is structured to give a mutual fund the advantage of being in a large investment company complex without the potentially significant cost – this is essentially accomplished by sharing certain costs among the various series in the investment company and obtaining volume based pricing from the investment companies service providers. Put another way, the series investment company greatly reduces the barriers to entry for investment advisers seeking to establish a mutual fund.

Considerations for Fund Manager (Trader)

What are the biggest challenges you or the trader faces when developing these documents?

For those individuals who have not prepared a disclosure document the normal challenges of describing the trading methodology, etc. are involved. For those individuals who have only been involved in managing accounts, the challenges are more related to becoming familiar with an SEC registered product and the disclosure necessary to complete registration. The SEC is very thorough with its review and response time and therefore, time to completion may be lengthy and frustrating. This process is typically well managed by the mutual fund attorney preparing the documents. Typically this process includes a questionnaire that helps organize your information and set the foundation properly.

Areas of Concern

The operation of a mutual fund is not unlike the regulation surrounding any other investment product offered directly to the public. The rules and regulations are extremely detailed and the fund, and fund manager, must operate in a compliant fashion or face disciplinary action by the SEC. A proper process helps establish this foundation. For instance, it should be noted that the fund requires a significant amount of operational formality; i.e. scheduled Board meetings, formal meeting agendas, etc. In addition to the formality, the investment opportunities within a mutual fund are far more restrictive than might be considered by a hedge fund. There are numerous investment limitations that are normally programmed into the mutual funds order management system, providing compliance. These limitations are identified and clearly discussed during the development process.

The mutual fund management fees are typically limited to 1.95% annually. Having said this, fully disclosing fees is an issue the NFA and CFTC are currently considering in a current debate regarding regulation of managed futures mutual funds. Managed futures mutual funds are currently primarily regulated by the SEC and FINRA, with the NFA petitioning that the funds should have the same disclosure requirements as a Commodity Pool Operator.

How should the investment/trading advisor approach the process?

The advisor should approach the process as a means of gaining exposure to the several trillion dollar market, which makes up the mutual fund segment, and the benefits are not instant but more of a long term nature. The advisor should engage early on an experienced team of professionals to manage the process on their behalf. The team would include an attorney who practices mutual fund law and has a track record of efficiently processing registrations with the SEC and a fund administration company who is familiar with the administration of the registered product.

What types of information will they need to provide and how long can the process take?

The information necessary for registration is the same information needed for the development of any other offering (disclosure) document. The time planned for the process should be three to four months. Should the manager choose to join an existing series trust, the process take approximately seventy five days.

This said, the process begins with needs assessment. The form helps get the process started.


  • It is important for the investment advisorto understand their distribution channel options
  • Understand how financial advisors view your fund, create points of differentiation
  • From a legal standpoint, the mutual fund development process can be complex, you should select the appropriate total package of fund development and back end administration, with consideration to channel marketing.
  • Registration is an issue, but properly organizing and presenting fund information is critical.

These are the top level issues in creating a mutual fund to which CTAs should be aware.

Mark Melin has written three books, including High Performance Managed Futures. Click here to purchase a copy of the book: Contact Mark at 312-451-8368 or [email protected].

The Opinions expressed are the opinions of the author. The opinions, the trading styles, trading information and trading programs are not endorsed by the NIBA, but are the individual opinions, styles, information and programs of the author.