Reza Comments on Tweaks in 15(c) Process in Board IQ Article

In The News
April 12, 2011
In the year since the Supreme Court handed down the Jones v. Harris Associates decision, mutual fund boards have made slight shifts in how they assess advisory fees, according to industry attorneys. Many boards were already taking more time to work through the 15(c) process even before the court ruling, and now they are requesting more information about the fees their advisers charge to institutional clients.
The high court decision gave deference to fund boards that use a “robust” process to decide whether advisory fees are appropriate, and it affirmed the Gartenberg standard that prohibits fees that are so high they could not have been the product of arm’s-length bargaining. But it also warned against relying too much on other mutual funds’ fees and said institutional fees, which are almost always lower, should be considered when the board believes that data is relevant.
“The boards are taking to heart the admonition in Jones that comparisons to other funds only take you so far because you can’t be sure that the other funds’ fees were negotiated at arm’s length,” says Joel Goldberg, a partner at Stroock & Stroock & Lavan and former director of the SEC's Division of Investment Management. “There was a time before Jones that that was considered one of the most important things. It isn’t assigned quite as much importance as it was pre-Jones.”
Now, Goldberg says, “There seems to be more emphasis since Jones v. Harris on how the mutual fund fees compare to the fees that the adviser charges to its other institutional clients.”
Boards appreciate that mutual funds require a higher level of service than institutional clients, such as pension funds, but now they want more detail about those distinctions, he says.
“When they’re told that the differences in fees are justified by the different types of services provided, they will burrow into that perhaps more than they did in the past – what are the differences?” Goldberg says.
However, it is too soon to know whether that increased attention will lead to lower fees, he says.
The March 30, 2010, Supreme Court decision resolved a lower-court dispute over the fiduciary duties advisers owe when they charge fees to funds. In their lawsuit, investors accused Harris Associates of violating its fiduciary duties by charging its affiliated mutual funds more than double what it charged its outside clients. The Court of Appeals for the Seventh Circuit ruled in the adviser’s favor.
The Supreme Court’s ruling sparked conversations among fund directors about how fees should be assessed, says Elizabeth Reza, a partner at Ropes & Gray.
“Typically, it was a fair amount of discussion about what does it mean and was there a message for us as directors,” she says. “And for advisers it was a question as well: Has anything changed in terms of what we should be providing to the boards?”
Ultimately, she says, the decision had a greater impact on district courts than it did on mutual fund boards. “It really is more of a case of the Supreme Court talking to the lower courts and saying, ‘Here’s what you need to think about,’” she says.
Even before Jones v. Harris, fund boards were devoting more time and attention to assessing advisory fees, industry attorneys say.
Instead of a single meeting to review and approve the advisory contract, some boards are scheduling two meetings to evaluate all the data about fees and performance, Marguerite Bateman, a partner at Schiff Hardin, said during a panel discussion at a recent ICI conference in Palm Desert, Calif.
Boards have always carefully considered the advisory contract renewal materials, Bateman said, but “now that material is far more defined and detailed than it was before.”
In some cases, Reza says, independent directors will even meet three times. The first meeting will take place roughly six months before the advisory contract is up for renewal, to draft questions and decide whether to use a consultant to review the adviser’s fees and performance.
At a second meeting, the independent directors will go over the adviser’s report and ask additional questions. The 15(c) decision about whether to approve the advisory contract takes place at a third meeting in certain cases, she says.
Increased competition from low-cost ETFs and index funds, as well as pressure due to poor performance during the market downturn, have focused boards’ attention on the need to control fees. Investors’ lawsuits, media attention and scandals, such as the Enron and WorldCom implosions and the investigations into market timing, have put further pressures on funds, attorneys say.
“Everybody in the industry since the market timing scandals understands that now, mutual funds will be subjected to the same level of scrutiny that any other major financial player would face,” says Mark Perlow, a partner at K&L Gates.
The scrutiny is an indication of the “tremendous success” mutual funds have enjoyed, he says. “The large amount of assets in funds has brought attention, which I think is just the price of being an important part of the financial landscape.”