Investment Companies and Investment Advisers
April 23, 2007
1. This is a partially open book exam. You may use the course materials, the statute
book, and any materials prepared exclusively by you. You may not use any other
materials, written, digital, or recorded. You may not consult with or communicate with
any other person during this exam.
2. This exam has seven (7) pages, including the instructions. The page numbers
appear on the top right-hand corner of each page. Please check to be sure that this copy has
all the pages.
3. You have three hours (3:00) to complete the exam. You must turn in your
answers in this room, even if you are taking the exam somewhere else in the building. If you
finish more than five minutes early, you may turn in your answers in the Dean’s Office.
4. The exam consists of five (5) questions. The recommended time for each
question is as follows:
Question 1……………………..……..30 Minutes
Question 2………………..…………..35 Minutes
Question 3…………………..………..35 Minutes
Question 4..…………………………..45 Minutes
Question 5……………………………35 Minutes
Each question will be weighted in accordance with its recommended time.
5. Do not spend all of your time writing. Think about the issues and organize your
answers before writing. Be concise. Be organized. Long, disorganized, rambling answers
will be penalized, as will merely “dumping” portions of your notes or outline into your
answers rather than answering the question posed.
6. This exam will require you to interpret and apply many of the statutory
provisions and regulations we have examined. YOU SHOULD NOT JUST STATE
GENERAL PRINCIPLES, BUT SHOULD CITE THE RELEVANT SECTIONS
AND SUBSECTIONS OF THE STATUTES AND REGULATIONS AND EXPLAIN
HOW THE LANGUAGE OF THOSE RULES APPLIES TO THE FACTS OF THE
7. If you believe that additional facts are needed to answer a question, state exactly
what those facts are and how they would affect your answer. If you believe that a question is
ambiguous or unclear, note the ambiguity or lack of clarity and indicate how it affects your
8. The Honor Code is in effect.
9. Good luck and have a pleasant summer.
Instructions Concerning Taking the Exam on a Computer
10. You must take the exam on a computer that has the latest version of the
Exam 4 software installed. Use the OPEN mode. If you have not previously installed
the Exam 4 software, please notify the exam administrator immediately.
11. Be sure to enter your exam number in the Exam ID field. (Do not use your NU
Card ID number or your social security number.) You will be required to enter your exam
number twice. Select the course name from the drop-down box. Be sure you find the folder
for this course, because that is where your exam will be stored. Verify that the information
is correct just before you select “Begin Exam.”
12. Do not worry about headers, footers, page numbers, or double spacing your
exam; the software does all that for you when the exam is printed.
13. When you are finished, please submit your exam electronically. A pop-up box
will show the status of your exam. It should show a black bar with 100% in it and a
message that says, “Your file has been successfully stored.” If you do not get this message,
please see Vicki in the Registrar’s office immediately.
14. If you have any technical problems during the exam, please report them
immediately to the Dean’s Office; we will assume you had no technical problems until
when you reported them. Be prepared to finish your exam by writing it. (Regular
notebook paper is O.K.)
DO NOT TURN THIS PAGE UNTIL YOU ARE GIVEN THE SIGNAL TO BEGIN.
The Cortes Fund is a registered investment company. Its investment adviser is
Infidelity has been having trouble attracting personnel, so it has decided to set up a
retirement plan for its employees. The Infidelity employees will contribute 5% of each
month’s salary to the retirement plan and Infidelity will match that amount. Infidelity
employees won’t be able to cash out of the Fund until they either retire or quit working for
Infidelity has hired a new employee, Jones, to handle employee questions and to
handle routine administration of the plan (making sure the right amount is deducted from
each paycheck and so on).
All of the money will be invested in the Cortes Fund; Infidelity will be treated
identically to all other Fund investors. Infidelity has presented documentation of its plan to
Cortes, and Cortes has no objection.
Discuss whether investing the retirement money in the Cortes Fund violates the
Investment Company Act.
You are the general counsel for Omega Corporation, a Delaware corporation whose
common stock is traded on the New York Stock Exchange. Omega recently acquired 51%
of the voting securities of Hedgco, a hedge fund. Hedgco’s only business is trading
securities, but it falls within section 3(c)(7) of the Investment Company Act, so it is not
registered as an investment company.
Omega also owns interests in several other companies, none of which is in the
business of investing, reinvesting, owning, holding, or trading in securities. Omega owns
98% of the voting stock of Trainco, which operates a railroad. Omega owns 40% of the
voting stock of Compco, which sells computers and computer peripherals in retail outlets.
Compco is not a manufacturer; it sells equipment manufactured by others. Omega also
owns 40% of the voting stock of Paperclips, Inc., which owns a chain of discount office
Omega has no operations of its own; all of its business is conducted through the
companies in which it invests. However, Omega’s founder and chairperson is a very
conservative investor, so Omega has some of its assets invested directly in federally insured
certificates of deposit.
Omega’s investments account for the following percentages of its net income and net
assets (exclusive of cash items and Government securities):
Business Percentage Percentage of Percentage of
ownership net assets net income*
Certificates of deposit 100% 3% 1%
Trainco 98% 46% 48%
Hedgco 51% 45% 45%
Compco 40% 3% 3%
Paperclips 40% 3% 3%
*NOTE: Percentages of income are calculated including Hedgco’s pre-
acquisition income as part of Omega’s net income.
Omega would prefer not to register as an investment company. Discuss whether
Omega can avoid registration under the Investment Company Act. (Assume Omega is not
entitled to any of the exemptions in § 6.)
You are an attorney working for the SEC. Your supervisor has presented you with
the following information and asked you to evaluate whether the SEC could successfully
challenge the investment adviser’s fee under either the Investment Company Act or the
Investment Advisers Act. Discuss.
Adviser Corporation is an investment adviser registered under the Investment
Advisers Act. It advises a closed-end fund, The Performance Fund, an investment company
registered under the Investment Company Act. The Performance Fund’s shares are publicly
Adviser’s contract with the Fund provides for a Base Fee equal to 2% of the Fund’s
average net assets for the year, plus or minus what the contract calls the “Kicker.” The
Kicker is calculated by determining the amount the Fund’s net return differs from the net
return to the S&P 500, a broad-based stock index. The difference (in percentage points),
subject to a maximum of 1.5%, is added or subtracted to the base fee.
To see how the Kicker works, assume the S&P 500 earned a 4% return. If the Fund
earned a 5.2% return, the Kicker would be 1.2%, and Adviser’s fee would be 2 + 1.2 =
3.2%. If the Fund earned a return of 7%, the cap on the Kicker would kick in and Adviser’s
fee would be only 2 + 1.5 = 3.5%. If the Fund earned a return of only 3.1%, Adviser’s fee
would be 2 - .9 = 1.1%.
However, the contract also provides that the Kicker will not be added or subtracted
in two consecutive years. So, if an adjustment was made for the Kicker in 2006, the Adviser
would receive only the Base Fee of 2.0% in 2007, and the Kicker would not be used again
Adviser’s contract has been approved by the Fund’s shareholders and board as
required by the Investment Company Act. (NOTE: Your boss asks you to assume that a
fee of 3.5% would not be excessive or unreasonable.)
The Friendly Fund is an investment company registered under the Investment
Company Act. Its investment adviser is Adviser, Inc., and its principal underwriter is
Underwriter Corporation. Friendly is managed by a four-person board of trustees. The four
trustees are Williams, Xerxes, Young, and Zappa.
The trustees have the following ties relevant to this question. Assume that the
trustees have no other relevant connections.
1. Zappa is an employee of Underwriter.
2. Young is a director, but not an officer or employee, of Adviser.
3. Xerxes owns shares in an unrelated market-index mutual fund that owns 5% of
the voting stock of Parent Corporation, which in turns owns all of the stock of
4. Williams owns 50% of Quickie Food, a very profitable general partnership that
operates a fast-food restaurant. Charley Chief, the CEO of Friendly Fund, owns
the other 50% of Quickie Food.
5. Williams’ spouse works as an administrative assistant to Invesco Corporation,
which owns 30% of the stock of Adviser.
Discuss whether the composition of Friendly’s board violates the Investment
Money Limited Partnership is in the business of buying, selling, and trading
securities. That is its only business. Money does not own more than 5% of any other
Money has one general partner, General Corporation. Until a month ago, Money
had 99 limited partners. However, a month ago, one of its limited partners, Carl Croak, died
and left his limited partnership units to his five sons, a transfer allowed by Money’s
partnership agreement. As a result, Money now has 104 limited partners.
Money’s limited partners are individuals from all walks of life—everything from
corporate executives and financial consultants to fishing guides and forest rangers. Not all
of them are wealthy; some have very small investments in Money. Money has only one
limited partner that is not an individual: the Acme Retirement Trust, a retirement plan for
Acme Corporation, a large manufacturer. The Trust has a 2% limited partnership interest in
The Trust is managed by a five-person board of trustees. The board of trustees is
selected by Acme Corporation’s management without the participation of the employees.
Employees have no say in how their retirement money is invested by the Trust, except an
employee may order the plan trustees not to invest his money in a specified company or
industry if the employee believes the company or industry is not “socially responsible.”
Discuss whether Money is an “investment company” as defined in the Investment
Company Act of 1940. (Assume that Money’s limited partnership interests are