On May 2, 2013, the SEC charged the trustees of two “turnkey” mutual fund trusts with causing untrue or misleading disclosures about their review of the funds’ advisory contracts. The Commission also charged the trustees with failure to follow their own procedures in connection with approving compliance policies and procedures of certain service providers, and charged the funds’ administrator and the firm providing the funds with chief compliance officer (CCO) services with related violations. Without admitting or denying the allegations, the trustees consented to cease and desist from future violations of Section 34(b) of the 1940 Act and Rule 38a-1 under the 1940 Act. The funds’ administrator and CCOeach agreed to pay a civil money penalty of $50,000.
The five trustees oversaw two fund structures, encompassing more than 70 series portfolios, which serve as platforms for various unaffiliated investment advisers to manage mutual funds. These so-called “turnkey” funds provide multiple advisers with the corporate, regulatory and compliance infrastructure needed to operate mutual funds that would be too costly or burdensome to operate individually.
The SEC staff found that some shareholder reports either misrepresented material information considered by the trustees, or omitted material information about how the trustees evaluated certain factors in reaching their decisions to approve the funds’ advisory agreements, in each case in violation of Section 34(b) of the 1940 Act. The trustees were charged with “causing” this violation because the disclosures were based on board minutes that were reviewed and approved by the trustees.
Rule 38a-1 under the 1940 Act requires that fund trustees approve the policies and procedures of fund service providers through which the fund conducts its activities. In this case, the funds’ compliance policies required the trustees to review copies of the investment advisers’ policies and procedures or a summary of the advisers’ compliance programs sufficient to provide the trustees with a good understanding of how the advisers’ compliance programs addressed particularly significant risks. The Commission charged that, rather than complying with the funds’ own compliance policies, the CCO simply reported to the trustees that the compliance policies and procedures maintained by the various investment advisers were “sufficient and in use.” The Commission claimed that the CCO and the trustees “caused” the funds to violate Rule 38a-1(a)(1), and that the trustees failed to ensure that each fund implemented its own policies and procedures upon which the trustees could rely in approving the compliance manuals of the funds’ advisers.
This case demonstrates the Commission’s willingness to peer into the boardroom and review the adequacy of boards’ governance processes related to investment advisory contract renewals and oversight of fund compliance programs. The case also signals that the Commission considers turnkey mutual fund operations and fund complexes with multiple advisers to be active areas of inquiry.
For more information on the case, click here to read our alert.