Section 4.5 — Disclosure Documents & Conduit Theory

  • Summary List — Mutual Fund Disclosure Documents

  • How Conduit Theory Works

Four Mutual Fund Disclosure Documents

1. Full (Statutory) Prospectus:

  • The main disclosure document for investors.

  • Provides material information needed to make an informed investment decision.

  • Must be in English, clear, concise, and can be delivered electronically.

  • Must include:

    • Fund’s objective

    • Investment policies and strategies

    • Sales charges

    • Management expenses & expense ratio

    • Services offered

    • 1-, 5-, and 10-year performance histories (or life of fund if shorter)

  • Required for all new investors before purchase.

2. Summary Prospectus:

  • A standardized summary version of the full prospectus.

  • Can be used for solicitation and delivered electronically.

  • Investors may request a full prospectus at any time.

  • Must include:

    • Fund’s name and share class(es)

    • Ticker symbol

    • A legend stating this is a summary

    • Risk and performance information

    • Fee tables

    • Investment objectives and strategies

    • Portfolio holdings and management details

    • Shareholder information

    • Financial highlights

3. Statement of Additional Information (SAI):

  • Provides extra data not found in the prospectus.

  • Delivered within 3 business days upon request.

  • Not required for solicitation, but supports transparency.

  • Typically contains:

    • Balance sheet

    • Statement of operations

    • Income statement

    • Current portfolio holdings

4. Omitting Prospectus (Tombstone Ad):

  • An advertisement for a mutual fund, not a full disclosure.

  • Provides limited, basic information (fund name, investment objective, contact info).

  • Does not contain sufficient detail to make an investment decision.

  • Used primarily for marketing and awareness.

✅ Summary List — Mutual Fund Disclosure Documents

Document / Key Use / Contain

  • Full Prospectus / Main disclosure for investors / Objectives, policies, fees, past performance

  • Summary Prospectus / Simplified version for solicitation / Key info + request for full prospectus

  • Statement of Additional Information (SAI) / On request (3 business days) / Detailed financials, holdings, operations 

  • Omitting Prospectus (Tombstone Ad) / Advertising only / Basic facts, no full disclosure

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Investment Company Structure:

  • Legal Form: Corporation or trust.

  • Governed under the Investment Company Act of 1940.

Conduit (Pipeline) Theory:

  • Purpose: Avoid triple taxation on the same dollar of earnings.

  • Taxation levels without conduit rule:

    1. Corporation pays taxes on profits.

    2. Mutual fund pays taxes on dividends it received from corporations.

    3. Shareholders pay taxes again on fund dividends.

  1. How Conduit Theory Works

    • Allows the investment company to pass income directly to shareholders without paying corporate tax, if it qualifies.

    • Governed by Subchapter M of the Internal Revenue Code (IRC).

  2. Qualification Requirements

    1. Must distribute at least 90% of Net Investment Income (NII) to shareholders.

    2. NII Formula:

      Dividends+Interest−Expenses=NII

    3. The fund is taxed only on the undistributed portion of NII.

  3. Example

    • Fund receives $500,000 in dividends + $600,000 in interest = $1,100,000 gross income.

    • Expenses = $100,000, so NII = $1,000,000.

    • Must distribute 90% of $1,000,000 = $900,000 to avoid taxes on that amount.

    • If it distributes less than $900,000, the entire $1,000,000 is taxed at the fund level.

    • Shareholders are always taxed on dividends they receive.

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✺ Review questions ✺

  • Full Prospectus, Summary Prospectus, Statement of Additional Information (SAI), Omitting Prospectus (Tombstone Ad).

  • To provide all material facts needed for an informed investment decision.

  • 1-, 5-, and 10-year performance histories, or life of fund if shorter.

  • A simplified version of the full prospectus; yes, it can be used for solicitation.

  • The investor must be given access to the full prospectus.

  • Within 3 business days.

  • An advertisement; it’s not a full disclosure document.

  • To prevent triple taxation by passing income directly to shareholders.

  • At least 90% of the fund’s Net Investment Income (NII).

  • Dividends + Interest − Expenses = NII.