SEC Brings Charges Related to 15(c) Process Failures

Investment Management Update

Date: June 22, 2015

On June 17, 2015, the Securities and Exchange Commission (SEC) charged a fund adviser, its principal and three mutual fund board members with failures to meet their obligations in connection with the approval of mutual fund advisory agreements under Section 15(c) of the Investment Company Act of 1940.

15(c) Requirements

Section 15(c) mandates that mutual fund directors must request and evaluate, and the fund’s adviser must furnish, information that may be reasonably necessary for the directors to assess the terms of a fund’s advisory agreement, known as the “15(c) process.” The board should consider the following factors, commonly known as Gartenberg factors, in its evaluation:

  • The adviser’s cost of providing services to the fund
  • The nature and quality of the adviser’s services
  • The extent to which the adviser realizes economies of scale as the fund grows in assets
  • The profits the adviser receives from the fund
  • Fee structures for comparable funds
  • Any fall-out benefits accruing to the adviser or its affiliates

Additionally, the fund’s next shareholder report must include a discussion of material factors and conclusions that formed the basis of the directors’ initial approval or annual renewal of that contract. In 2004 the SEC adopted rules requiring this disclosure to include the following factors:

  • The nature, extent and quality of the services to be provided by the adviser
  • For an operating fund, the investment performance of the fund and the adviser
  • The costs of the services to be provided and the profits realized by the adviser and its affiliates from the relationship with the fund
  • The extent to which economies of scale would be realized as the fund grows
  • Whether fee levels reflect these economies of scale for the benefit of fund investors

Also, a fund is required to disclose in the shareholder report whether the board relied upon fee comparisons with other funds or other types of clients in approving or renewing the advisory agreement.

Failures Cited

In this case, the adviser and its principal failed to provide complete and accurate information to the fund board during the 15(c) process, and the three board members approved the advisory agreements without having all of the information they requested to properly evaluate the agreements using the Gartenberg factors.

Specifically, the adviser and its principal failed to provide requested information regarding fees comparable funds paid to the adviser. Although the adviser disclosed the services the sub-adviser and fund administrator would provide, the adviser also neglected to supply complete and accurate information about the services it would provide the funds. While the adviser did provide a chart of funds that were similar in size and had a comparable investment strategy to the fund, the chart included inappropriate share classes of other funds, share classes with different distribution fees, funds that are organizationally different (ETFs and an unmanaged index fund) and funds with different fee structures.

The directors also requested the adviser’s financial statements for the most recent two-year period and the methodology used to allocate indirect cost and expenses to the fund in calculating the adviser’s profitability. The adviser did provide an income statement for one year but did not supply any balance sheet information for the period requested. It also failed to provide any description of its allocation methodology in its profitability calculation. In the 15(c) questionnaire, the adviser responded that it had not waived any fees during the relevant fiscal period despite the fact that it had waived a portion of its advisory fees for the period. Finally, the adviser informed the board that the fee breakpoints in the advisory agreement were appropriate even though the advisory agreement reflected no such breakpoints.

The SEC also cited the fund administrator because it was responsible for preparing the fund shareholder reports and had failed to provide the required discussion of the directors’ 15(c) process. Thus, the fund administrator’s failure caused the fund to file an incomplete report.

Ensuring Compliance

This most recent SEC case involving the 15(c) process, coupled with its 15(c) action in April 2015 regarding the adviser’s profitability calculation, clearly indicate an increased SEC focus on each element of a board’s 15(c) process and its interaction with a fund’s adviser. Boards and fund advisers should review their 15(c) processes to ensure that the information necessary to evaluate the terms of an advisory agreement is requested by the board, provided by the adviser, discussed and properly documented. If information is missing or incomplete, the board should follow up to make sure the adviser supplies all requested information.


For more information, please contact:

Andrew J. Davalla

Michael V. Wible

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