INVESTMENT ADVISERS ACT OF 1940
Release No. 2294 / September 15, 2004
ADMINISTRATIVE PROCEEDING
File No. 3-11659
In the Matter of BRIDGEWAY CAPITAL MANAGEMENT, INC. AND JOHN NOLAND RYAN MONTGOMERY, Respondent. |
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ORDER INSTITUTING ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER PURSUANT TO SECTIONS 203(e), 203(f), AND 203(k) OF THE INVESTMENT ADVISERS ACT OF 1940 |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act") against Bridgeway Capital Management, Inc. ("Bridgeway Capital") and John Noland Ryan Montgomery ("Montgomery"), (collectively "Respondents").
II.
In anticipation of the institution of these proceedings, Respondents have submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and the subject matter of these proceedings, Respondents consent to the entry of this Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of 1940 ("Order"), as set forth below.
III.
On the basis of this Order and Respondents' Offer, the Commission finds that:
Respondents
1. Bridgeway Capital, a Texas corporation headquartered in Houston, Texas, has been registered as an investment adviser with the Commission since August 2, 1993. Bridgeway Capital provides investment advisory services to Bridgeway Funds, Inc. ("Bridgeway Funds"), a registered investment company that presently operates 11 mutual funds ("the Funds") with combined net-assets of approximately $1.4 billion.1
2. Montgomery is the founder and president of Bridgeway Capital and Bridgeway Funds. He is also a director of Bridgeway Funds and is the majority owner of Bridgeway Capital. Since the inception of these entities, Montgomery has been the person primarily responsible for their activities. He is responsible for, among other things, setting the policies and investment objectives of the Funds and establishing the performance-based fee under which Bridgeway Capital managed certain of the Funds.
Summary
3. This matter arises as a result of Bridgeway Capital's charging three of the funds operated by Bridgeway Funds performance-based compensation in violation of Section 205 of the Advisers Act.2 Bridgeway Capital charged each fund an illegal performance-based fee against the fund's current assets instead of against its assets averaged over the period during which the fund's performance was computed, as Section 205 requires. As a result, Bridgeway Capital charged the three funds and, consequently, their respective shareholders, approximately $4.4 million in the aggregate more than it would have if its performance-based fees had complied with Section 205.3
Performance-Based Fees under Section 205 of the Advisers Act
4. Section 205 of the Advisers Act generally prohibits investment advisers, unless exempt from registration under Section 203(b) of the Advisers Act, from entering advisory contracts that provide for compensation based on a share of capital gains upon or capital appreciation of the assets or any portion of the assets of a client ("performance-based compensation" or "performance-based fee") except as provided in Section 205(b) of the Advisers Act. Under Section 205(b)(2), an investment adviser may enter into an advisory contract with a registered investment company that provides for performance-based compensation "based on the asset value of the company or fund under management averaged over a specified period and increasing and decreasing proportionately with the investment performance of the company or fund over a specified period in relation to the investment record of an appropriate index of securities prices." Rule 205-2(b) under the Advisers Act defines "specified period over which the asset value of the company or fund under management is averaged" to mean the "period over which the investment performance of the company or fund and the investment record of an appropriate index of securities prices . . . are computed."4 For example, if an advisory contract specifies that the fund's performance will be measured against the performance of the S&P 500 index over a rolling five-year period, then the adviser's performance-based fee must be calculated using the asset value of the fund averaged over the same five-year period. These provisions are designed to link an adviser's performance-based compensation to the fund's investment performance and thereby prevent such compensation from being influenced unduly by the amount of sales or redemptions in the fund. 5
Bridgeway Capital's Method for Computing Its Performance-Based Fee
5. Bridgeway Capital charged a performance-based fee in three of the Funds-the "Aggressive Investors 1" fund, the "Aggressive Investors 2" fund, and the "Micro-Cap Limited" fund. The advisory contract for each of these funds provided that the fund's performance would be measured against the performance of an external index during a rolling five-year period. In the case of Aggressive Investors 1 and Aggressive Investors 2, the performance was compared to that of the S&P 500 index. Micro-Cap Limited used another index, comprised of "micro-cap" companies. Each advisory contract provided that Bridgeway Capital would assess its performance-based fee against "the average daily net assets of the fund for the month" rather than against the asset value of the fund averaged over the rolling five-year period in which the fund's performance was measured. As a result, Bridgeway Capital failed to assess its performance-based fees against the asset value of each fund averaged over the rolling five-year period specified in the contract as required under Section 205(b) of the Advisers Act and Rule 205-2 thereunder.
6. Depending on the fund's performance, the performance-based fee could range from as low as 0.2% to as high as 1.6% of the fund's net assets. During the relevant period, the net assets in each fund increased steadily and significantly. Moreover, each fund's performance generally exceeded the performance of its benchmark during this time, pegging the fee rate in most periods at the highest or near the highest level. Given that Bridgeway Capital applied these rates to each fund's net asset value averaged over the current month rather than to its net asset value averaged over the rolling five-year period, which was by far lower than the net asset value averaged over the current month in each case, Bridgeway Capital's illegal performance-based compensation resulted in significantly higher fees than if Bridgeway Capital had charged its performance-based fee in accordance with Section 205 of the Advisers Act.6 Bridgeway Capital overcharged the funds as follows:
| Fund | Period Since Inception of Performance Fee | Net Overcharge |
| Aggressive Investors 1 | July 1, 1995 to March 22, 2004 | $3,989,346 |
| Aggressive Investors 2 | January 1, 2003 to March 22, 2004 | $110,365 |
| Micro-Cap Limited | July 1, 1999 to March 22, 2004 | $307,989 |
7. The advisory contracts between Bridgeway Capital and Bridgeway Funds accurately described the method actually used by Bridgeway Capital to calculate its performance-based fees. This description was also included in Bridgeway Funds' prospectuses and periodic Commission reports.
Conclusion
8. As a result of the conduct described above, Bridgeway Capital willfully violated and Montgomery willfully aided and abetted and caused Bridgeway Capital's violation of Section 205(a) of the Advisers Act, which prohibits an investment adviser from entering into an advisory contract with a registered investment company that provides for performance-based compensation unless, pursuant to Section 205(b) of the Advisers Act, the contract provides for performance-based compensation based on the asset value of the fund averaged over a specified period and increasing and decreasing proportionately with the investment performance of the fund over a specified period in relation to the investment record of an appropriate index of securities prices.
Respondents' Remedial Efforts
9. In determining to accept the Offer, the Commission considered remedial acts promptly undertaken by Respondents and cooperation afforded the Commission staff.
Undertakings
10. Bridgeway Capital has undertaken to:
a. Retain experienced counsel to review Bridgeway Capital's advisory contracts with Bridgeway Funds to ensure that the performance-based fee provisions comply with the federal securities laws;
b. Pay the costs of soliciting shareholder approval of new advisory contracts with the Aggressive Investors 1, Aggressive Investors 2, Micro-Cap Limited, Small-Cap Growth, Small-Cap Value, Large-Cap Growth, and Large-Cap Value funds, which comply with the Advisers Act; and
c. Hire or designate experienced compliance personnel to, among other things, ensure that Bridgeway Capital applies its counsel-reviewed performance-based fee in accordance with the federal securities laws in the future.
11. Bridgeway Capital has also undertaken as follows
:a. Bridgeway Capital shall retain, within 60 days of the date of entry of the Order, the services of an Independent Distribution Consultant not unacceptable to the staff of the Commission. The Independent Distribution Consultant's compensation and expenses shall be borne exclusively by Bridgeway Capital. Bridgeway Capital shall cooperate fully with the Independent Distribution Consultant and shall provide the Independent Distribution Consultant with access to its files, books, records, and personnel as reasonably requested.
b. Pursuant to Rule 1101 of the Commission's Rules on Fair Fund and Disgorgement Plans [17 C.F.R. § 201.1101], Bridgeway Capital shall require the Independent Distribution Consultant, in consultation with Bridgeway Capital and the staff of the Commission, to develop a Distribution Plan for the distribution of the disgorgement and interest provided for in the Order to each current or former shareholder of the Aggressive Investors 1, Aggressive Investors 2, and Micro-Cap Limited funds who were overcharged as a result of the performance-based fee that violated Section 205. The Distribution Plan shall include the following elements:
1. an explanation of the method used to calculate the payments to eligible shareholders, including the shareholders who hold or held their shares through an omnibus account at a third-party brokerage firm;
2. the procedures for locating eligible shareholders and providing notice to such shareholders; and
3. the procedure for distributing the disgorgement and interest to eligible shareholders, including provision for the disposition of any funds not otherwise distributed.
c. Bridgeway Capital shall require the Independent Distribution Consultant to submit a Distribution Plan to the staff of the Commission no more than 90 days after the date of entry of the Order.
d. The Distribution Plan developed by the Independent Distribution Consultant shall be submitted to the Commission for notice in accordance with Rule 1103 of the Commission's Rules on Fair Fund and Disgorgement Plans [17 C.F.R. § 201.1103] unless, within 105 days after the date of entry of the Order, Bridgeway Capital or the staff of the Commission advises, in writing, the Independent Distribution Consultant, with notice to the Commission staff or Bridgeway Capital as appropriate, of any determination or calculation from the Distribution Plan that it considers to be inappropriate and states in writing the reasons for considering such determination or calculation inappropriate.
e. With respect to any determination or calculation with which Bridgeway Capital or the staff of the Commission do not agree, such parties shall attempt in good faith to reach an agreement within 120 days of the date of entry of the Order. In the event that Bridgeway Capital and the staff of the Commission are unable to agree on an alternative determination or calculation, the determinations and calculations of the Independent Distribution Consultant shall be used.
f. Bridgeway Capital shall require that, within 135 days of the date of entry of the Order, the Independent Distribution Consultant submit the Distribution Plan for the administration and distribution of disgorgement funds pursuant to Rule 1103. Following a Commission order approving a final plan of disgorgement, as provided in Rule 1104 [17 C.F.R. § 201.1104] of the Commission's Rules on Fair Fund and Disgorgement Plans, Bridgeway Capital shall require that the Independent Distribution Consultant, with Bridgeway Capital, take all necessary and appropriate steps to administer the final plan for distribution of disgorgement and interest funds. Bridgeway Capital shall bear the costs of administering and implementing the final plan of disgorgement.
g. Bridgeway Capital shall require that the Independent Distribution Consultant, for the period of the engagement and for a period of two years from completion of the engagement, not enter into any employment, consultant, attorney-client, auditing or other professional relationship with Bridgeway Capital, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such. Bridgeway Capital shall require that any firm with which the Independent Distribution Consultant is affiliated in performance of his or her duties under the Order shall not, without prior written consent of the staff of the Commission, enter into any employment, consultant, attorney-client, auditing, or other professional relationship with Bridgeway Capital or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such for the period of the engagement and for a period of two years after the engagement.
IV.
In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions agreed to in the Respondents' Offer.
Accordingly, it is hereby ORDERED:
A. Pursuant to Sections 203(e) and 203(f) of the Advisers Act, Bridgeway Capital and Montgomery are censured.
B. Pursuant to Section 203(k) of the Advisers Act, that Bridgeway Capital and Montgomery cease and desist from committing or causing any violations and any future violations of Section 205(a) of the Advisers Act.
C. Within ten days of the entry of the Order, Bridgeway Capital shall pay a civil money penalty in the amount of $200,000 and Montgomery shall pay a civil money penalty in the amount of $50,000 to the United States Treasury. Such payments shall be: (A) made by United States postal money order, certified check, bank cashier's check, or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312; and (D) submitted under cover letter that identifies Bridgeway Capital and Montgomery as Respondents in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Harold F. Degenhardt, Fort Worth Office, Securities and Exchange Commission, Burnett Plaza, Suite 1900, 801 Cherry Street, Unit #18, Fort Worth, Texas 76102-6882.
D. Within ten days of the entry of the Order, Bridgeway Capital shall pay disgorgement in the amount of $4,407,700 plus prejudgment interest of $485,714, for a total payment of $4,893,414, to the Office of Financial Management of the Securities and Exchange Commission ("Office of Financial Management"). Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check, or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312; and (D) submitted under cover letter that identifies Bridgeway Capital and Montgomery as Respondents in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Harold F. Degenhardt, Fort Worth Office, Securities and Exchange Commission, Burnett Plaza, Suite 1900, 801 Cherry Street, Unit #18, Fort Worth, Texas 76102-6882.
E. Within ten days of the entry of the Commission order approving a final plan of disgorgement, referenced in Section III. 11. f., above, the Office of Financial Management shall return the $4,893,414, referenced in Section IV. D., above, to Bridgeway Capital for distribution in accordance with the approved final plan of disgorgement.
F. Respondents shall comply with the undertakings enumerated in Section III. 10 and 11, above.
By the Commission.
Secretary
Endnotes