SEC Charges Investment Adviser and Mutual Fund Board Members With Failures in Advisory Contract Approval Process
The Securities and Exchange Commission today charged a mutual fund adviser, its principal, and three mutual fund board members with failing to satisfy their statutory obligations in connection with the evaluation and approval of mutual fund advisory contracts.
Richmond, Va.-based advisory firm Commonwealth Capital Management was charged with violating Section 15(c) of the Investment Company Act of 1940 for providing incomplete or inaccurate information to two mutual fund boards, and the firm’s majority owner John Pasco III was charged with causing the violations. They and former trustees J. Gordon McKinley III, Robert R. Burke, and Franklin A. Trice III have agreed to settle the SEC’s charges.
Commonwealth Capital Management acted as the investment adviser to various mutual funds within World Funds Trust (WFT) and World Funds Inc. (WFI). Commonwealth Capital Management was part of a turnkey mutual fund platform that provided various services to small to mid-size mutual funds. An SEC investigation found that as part of what’s known as the 15(c) process, the WFT board of trustees requested that Commonwealth Capital Management and Pasco 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 Commonwealth Capital Management provided or that the trustees evaluated fees paid by comparable funds. Commonwealth Capital Management also provided incomplete responses about the nature and quality of services provided by Commonwealth Capital Management versus services provided by the funds’ sub-adviser and administrator, and the trustees did not request or receive additional materials. Nevertheless, the trustees approved the advisory contracts without having all of the information they requested as reasonably necessary to evaluate the contracts.
“As the first line of defense in protecting mutual fund shareholders, board members must be vigilant,” said Andrew J. Ceresney, Director of the SEC Enforcement Division. “These trustees failed to fully discharge their fund governance responsibilities on behalf of fund shareholders.”
Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, added, “The advisory fee typically is the largest expense reducing investor returns. The WFT trustees fell short as the shareholders’ watchdog by essentially rubber-stamping the adviser’s contract and related fee.”
According to the SEC’s order instituting a settled administrative proceeding, Commonwealth Capital Management also omitted or provided inaccurate information requested by independent directors in the WFI series of mutual funds in connection with board meetings to approve the firm’s advisory contract. Commonwealth Capital Management supplied a fee chart containing inapt comparisons and erroneous information while omitting other details. The firm additionally failed to provide certain information about profitability and an expense limitation agreement that had been in place to limit the relevant fund’s expenses. Commonwealth Capital Management also informed the WFI independent directors that the fund had appropriate breakpoints when, in fact, breakpoints were omitted from the advisory contract.
The SEC’s order finds that Commonwealth Capital Management, McKinley, Burke, and Trice violated Section 15(c) of the Investment Company Act, and Pasco caused the firm’s violations. The order finds that Commonwealth Capital Management’s affiliated administrator Commonwealth Shareholder Services was contractually responsible for preparing the shareholder reports on behalf of the WFI funds, and failed to include required information concerning the 15(c) process in one fund’s 2010 shareholder report in violation of Section 30(e) of the Investment Company Act and Rule 30e-1. Without admitting or denying the findings, they each consented to the order and agreed to cease and desist from committing or causing any such violations. Pasco and the firms agreed to jointly and severally pay a $50,000 penalty, and the trustees each agreed to pay $3,250 penalties.
The SEC’s investigation was conducted by Jacob Krawitz, Brian Privor, and John Farinacci, and the case was supervised by Anthony Kelly of the Asset Management Unit. Christian Schultz assisted with the investigation. The SEC examination that led to the investigation was conducted by Miguel A. Torres, Andrew B. Green, Cormac J. Logue, and Tamara D. Young, and managed by Margaret Jackson.