ROGERS & WELLS
Two Hundred Park Avenue
New York, New York 10166-0153
TELEPHONE (212) 878-8000
FACSIMILE (212) 878-8375
January 20, 1998
VIA ELECTRONIC MAIL
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W., Stop 6-9
Washington, D.C. 20549
We are writing in response to the request of the Securities and Exchange Commission (the "Commission") for comment on proposed amendments (the "Proposed Amendments") 1 to Rule 205-3 under the Investment Advisers Act of 1940, as amended (the "Advisers Act"). The Proposed Amendments would modify the rule's criteria for clients eligible to enter into performance-based compensation arrangements and eliminate required terms and disclosures with respect to those arrangements.
Rogers & Wells has a substantial number of clients that manage assets, or have assets that are managed, pursuant to investment advisory agreements that provide for performance-based compensation. Many of these clients are considering the implications of the Proposed Amendments in connection with their existing and prospective advisory arrangements. The views we express in this letter, however, are our own and do not necessarily reflect those of our clients.
We commend the Commission's efforts in promptly proposing amendments to Rule 205-3, thereby implementing Section 205(e) of the Advisers Act, which was included among the many provisions of the National Securities Markets Improvement Act of 1996. While we support the Proposed Amendments in their entirety, we would like to address specifically the concerns raised by the Commission in connection with (1) the elimination of the contractual and disclosure requirements of current Rule 205-3 and (2) the revised criteria for entering into a performance-based compensation arrangement.
Sophisticated clients, among all investors, are most able to identify and protect their interests, and therefore have no need for the protections of Section 205(a)(1) of the Advisers Act. Investment advisers, on the other hand, are least able to successfully overreach in negotiations with sophisticated clients, who are typically represented by experienced financial and legal advisers. In addition, because reputation and trust play important roles in the selection of investment advisers by sophisticated clients, such advisers face additional incentives (beyond the embarrassment of detection) to negotiate at arm's length and volunteer full and complete disclosure.
It is also important to acknowledge the high level of competition among the investment advisers that specialize in servicing sophisticated clients. This competition arises principally from the attractive compensation arrangements that such advisers may negotiate. The fruits of this competition, for the sophisticated client, include, among other things, product innovation and increasing performance levels relative to risk.
Finally, certain of the provisions of Rule 205-3, such as the one-year calculation period requirement imposed by Rule 205-3(c)(3), are viewed by many sophisticated clients and investment advisers as arbitrary and unnecessarily restrictive. The noted provision is particularly offensive because it incentivizes clients to make a so-called "efficient breach" of the agreement just short of the one-year anniversary, which, of course, is avoided by contractual provisions that "lock-up" a client's invested capital for one-year or longer periods. Investment advisers and their sophisticated clients should not be forced to adopt inefficient and undesirable contractual provisions when they are fully able to negotiate terms that are more appropriate to their peculiar needs.
The one-year calculation period requirement, as well as certain other requirements for calculating a performance fee under the Rule that the Proposed Amendments would eliminate, have another undesirable result. Because some investors are simply unwilling to accept substantial periods of illiquidity, many money managers have elected not to register with the Commission as investment advisers, even if such managers are eligible to so register. In this way, such managers avoid the one-year calculation period requirement of Rule 205-3. Removing this requirement from the Rule would remove a substantial deterrent to registration under the Advisers Act and would, therefore, be in the public's best interest. Eliminating the Rule's requirements regarding the form of performance fee agreements would remove an additional deterrent in this regard.
/s/ Leonard B. Mackey, Jr.
Leonard B. Mackey, Jr.