The Securities and Exchange Commission instituted and settled an administrative proceeding against an investment adviser, its principal, and three independent directors of a registered investment company for process failures in connection with the directors' evaluation of fund advisory contracts. Release No. IC-31678 (June 17, 2015). The proceeding was brought under Section 15(c) of the Investment Company Act of 1940, which requires fund advisory contracts to be approved by the independent directors.

Key Takeaway. The enforcement action signals that the SEC will take it seriously when fund advisers and independent directors fail to adhere to best practices in the advisory contract approval process.

Summary. The investment advisor provided investment management services to various mutual funds within two multi-series structures. The SEC investigation found that as part of the approval of the continuation of the advisory agreements, what is known as the “15(c) process,” the board of trustees requested that the advisor provide certain information regarding advisory fees paid by comparable funds as well as the nature and quality of the firm’s services. There was no documentary evidence that the advisor provided or that the trustees evaluated fees paid by comparable funds.

The SEC investigation also found that the advisor provided incomplete responses about the nature and quality of services provided by the advisor versus services provided by the funds’ sub-adviser and administrator, and the trustees did not request or receive additional materials. And the SEC found that the advisor omitted or provided inaccurate information requested by independent directors in connection with board meetings to approve the firm’s advisory contract:

  • By supplying a fee chart containing inapt comparisons and erroneous information while omitting other details
  • By failing to provide certain information about profitability and an expense limitation agreement that had been in place to limit the relevant fund’s expenses
  • By informing independent directors that a fund had appropriate breakpoints when, in fact, breakpoints were omitted from the advisory contract

As a result of the SEC findings, the SEC stated: “As the first line of defense in protecting mutual fund shareholders, board members must be vigilant,” and these “trustees failed to fully discharge their fund governance responsibilities on behalf of fund shareholders.” The staff of the SEC added: “The advisory fee typically is the largest expense reducing investor returns,” and these trustees “fell short as the shareholders’ watchdog by essentially rubber-stamping the adviser’s contract and related fee.”