The Securities and Exchange Commission sued a mutual fund adviser, its principal and three mutual fund board members for violating their legal obligation to evaluate and approve contracts with any investment adviser to a mutual fund and for an investment adviser to provide such information as is “reasonably necessary” by the mutual fund board to evaluate the terms of such contracts. According to the SEC, Commonwealth Capital Management acted as an investment adviser to various mutual funds within the World Funds Trust and World Funds Inc. family. Prior to retaining CCM as investment adviser in 2008, WFT’s board requested certain documents from CCM and its owner, John Pasco, III, and asked them to complete a questionnaire. Among the information requested by the board was certain information related to how CCM’s fees compared to other advisers. This information was not provided. According to the SEC, the board asked for other information related to the nature and quality of CCM’s services; however, said the SEC, “[t]he materials CCM provided to the Trustees in response … did not permit a sufficient evaluation of the nature and quality of such services.” Nevertheless, the trustees of WTF approved the retention of CCM, claimed the SEC, without receiving all the information they reasonably needed to evaluate the relevant advisory contracts. Similarly, prior to retaining CCM as its investment adviser in 2009 and 2010, WFI’s board of directors implemented a similar process of requesting information from CCM and Mr. Pasco, and received similarly inadequate (and sometimes incorrect) information and documents, said the SEC. Similarly, WFI’s trustees approved CCM’s retention without receiving all the information they reasonably needed to evaluate CCM. As a result, charged the SEC, CCM did not provide all necessary information requested by the two funds’ boards, and, in the case of WTF, its trustees likewise failed to follow up when they did not receive information necessary for their evaluation. Mr. Pasco, claimed the SEC, caused CCM’s violations. Each of the three trustees agreed to a fine of US $3,250 by the SEC, while CCM, Mr. Pasco and Commonwealth Shareholder Services, Inc. – the fund administrator to WFT and WFI – agreed to be jointly and severally liable to pay an aggregate fine of US $50,000.
Compliance Weeds: In this matter, the requirement that an investment company’s board members request and evaluate information “as may be reasonably necessary” to appoint an adviser is established by statute (Section 15(c) of the Investment Company Act; click here to access). Thus the failure of board members to follow this requirement, including following up when incomplete information was provided in response to a request for information, may be deemed a violation of law, as the SEC charged in this matter. However, not following up on incomplete or facially inaccurate information in response to any internal investigation or review, or due diligence inquiry, could cause later regulatory issues for any regulated firm – whether the initial request was mandated by law or not – if it turns out that review of the missed information might reasonably have prevented a regulatory breach down the line. Moreover, the determination of reasonableness will likely only be determined after the fact. Be mindful!