Can a Mutual Fund File for Bankruptcy?
- A mutual fund usually is sponsored and created as a separately registered entity by a financial institution that does not own the mutual fund. Mutual funds are owned by their fund shareholders. The sponsoring company functions as the fund administrator overseeing general fund activities. As an independent entity, mutual funds have a formal corporate structure featuring a board of directors. The board appoints and hires an investment adviser to manage mutual fund investments. The investment adviser also is a separate entity, such as an affiliate of the sponsoring company or an independent investment advisory firm. By keeping fund shareholders' investment capital apart from the sponsoring company and fund management company, the mutual fund structure aims to protect fund investors' financial interest.
- A mutual fund sponsor is often a bank, securities broker or investment adviser, and it can go bankrupt. The fund sponsor may derive certain income in fees for its work of coordinating mutual fund activities, such as maintaining shareholder account information. But any gains and losses from a mutual fund's investment activities do not become part of the sponsoring company's business results, because the sponsor does not own the mutual fund. When a fund sponsor has filed for bankruptcy protection, its creditors can go after only assets in the sponsor's principal business of banking or brokerage, or any income earned from sponsoring a mutual fund. The mutual fund as a separate entity cannot be included in any of its sponsor's bankruptcy liquidation.
- Investment advisers can go out of business as a result of their poor advisory services to investment clients. Investment advisers can retain mutual funds only as clients with no ownership connection. Mutual funds pay management fees to investment advisers for managing fund investments. The investment advisory business itself incurs various costs, such as expenses on hiring research analysts, portfolio managers and administrative staff. If management fees earned on advising mutual funds cannot cover related expenses, an investment adviser would sustain losses, which could lead to bankruptcy if they worsened over time. However, the failure of the fund adviser does not cause any bankruptcy concern for the mutual fund, although this may negatively affect a fund's investment performance.
- A mutual fund may be dissolved and sell its investment holdings, but not in a normal court bankruptcy proceeding. Continued fund underperformance and investor dissatisfaction may result in increased shareholder redemption, which mutual funds cannot suspend. At some point, the board of directors may consider discontinuing fund operations. Folding a mutual fund would need shareholder approval, and the government regulator would oversee the sale of fund holdings and the distribution of liquidation proceeds to fund shareholders. Alternatively, a fund can merge with another fund, so it will be under a new sponsor and managed by a different investment adviser.