AMR Investment Services, Inc.
January 7, 2004
Mr. Jonathan G. Katz
Re: Exemption from Shareholder Approval for
Dear Mr. Katz:
AMR Investment Services, Inc. ("AMRIS"), manager of the American AAdvantage Funds family of mutual funds (the "AA Funds"), is pleased to have the opportunity to provide comment on the Securities and Exchange Commission's proposal to adopt new Rule 15a-5 under the Investment Company Act of 1940 which would, under certain conditions, permit an adviser to serve as a subadviser to an investment company without approval by shareholders of the fund.
Since the inception of the AA Funds in 1987, we have recognized the benefits that multiple subadvisers can provide to fund shareholders through added diversification and minimization of the risk of underperformance by a single subadviser. Accordingly, out of sixteen AA Funds series, seven currently operate under this so-called "manager of managers" approach. Most of these funds utilize sub-advisers who manage other assets for AMRIS as well, which results in reduced overall costs to AA Funds shareholders in the form of expense ratios that are significantly below industry averages. In 1996, the Commission granted an order to permit AMRIS, as investment adviser to the AA Funds, to enter into or amend sub-advisory contracts on behalf of one or more series of the AA Funds without obtaining prior shareholder approval.1 This order has allowed the AA Funds to make changes to the lineup of subadvisers to "manager of managers" funds promptly and with minimal additional expense to shareholders.
We generally support the proposal and its goal of eliminating the need for other fund groups to obtain from the Commission exemptive orders that facilitate "manager of managers" arrangements. However, we are concerned about the potential negative impact upon the AA Funds and their shareholders of the proposed new requirement that would prohibit a new or modified subadvisory contract from "directly or indirectly" increasing the management fee charged to the fund or its shareholders.
The Proposing Release states that the purpose of this new condition regarding fees is to preserve the statutory requirement that increases in the rate of advisory fees paid by the fund be approved by shareholders. For the reasons set forth below, we oppose this new condition because it does not encompass the nature of all subadvisory arrangements (including that of the AA Funds), and would result in unanticipated and potentially harmful burdens on AA Fund shareholders.
The Proposing Release describes perhaps the most common type of fee arrangement for "manager of manager" funds, pursuant to which the fund's adviser charges a unified or "flat" fee to the fund, which includes both the adviser's fees and the fees of any subadvisers retained to manage all or a portion of the fund. As noted in the Proposing Release, the adviser may negotiate lower subadvisory fees, which will benefit the fund to the extent that lower subadvisory fees are passed on through lower advisory fees. However, since there is one unified fee, if an adviser is able to negotiate a lower fee with a subadviser, the adviser is not necessarily obligated to pass the cost savings along to fund shareholders by lowering the advisory fees charged to the funds.
By contrast, for the multi-manager AA Funds AMRIS charges an advisory fee for the services it provides in selecting, monitoring and overseeing the subadvisers. The fees of subadvisers hired by AMRIS are negotiated on an arms length basis and charged to the AA Funds separately and in addition to AMRIS' fees. Thus, if AMRIS is able to negotiate a lower fee arrangement with a subadviser, this cost savings directly benefits AA Fund shareholders.
Under the proposed rule, AA Funds shareholders would be harmed if AMRIS is able to negotiate a very low initial fee from a subadviser, but subsequently determines that it would be in the best interests of the fund to replace that subadviser with another subadviser with a better performance record that could potentially provide better returns to shareholders but at a slightly higher fee. Under that scenario, even though subadvisory fees would remain low, AMRIS would be required to obtain shareholder approval prior to hiring the new subadviser. Thus, prior to making a recommendation to the Board of Trustees, AMRIS would have to consider the additional costs and delays associated with convening a shareholder meeting even though the proposed change could potentially have an immediate benefit to AA Fund shareholders.
We are sensitive to the Commission's concerns regarding the statutory requirement that increases in the rate of advisory fees paid by the fund be approved by shareholders. Yet, we believe there is no need for shareholders to approve an increase in subadvisory fees that does not impact the overall management fee charged to the fund. In the proposing release, the Commission recognizes that the Board of Trustees is in a better position than fund shareholders to make determinations regarding the appropriate level of management fees. This goal will still be accomplished without adding the condition that the change not involve an increase in subadvisory fees. Although shareholders will not vote on the new subadvisory arrangement, they will receive an information statement that includes all the information about the new subadviser that would be included in a proxy statement, including all fees payable by AMRIS to the subadviser.
The proposing release also states that once Rule 15a-5 is adopted, the Commission anticipates that it will rescind its existing manger of managers orders. The proposing release notes the Commissions concern that if existing orders are not rescinded, fund groups may be operating under different sets of conditions, which may have an adverse effect on competition. We note that it is highly unusual for the Commission to rescind prior exemptive orders when adopting a new rule and question whether allowing fund groups to continue to rely upon individual orders granted to date will in fact have any effect on competition among funds. As noted in the release, over 100 exemptive orders have been issued, and although the conditions to each order vary slightly, to our knowledge none have produced a significant advantage to one fund group over another. Rather than focusing upon competitive differences, we believe that the Commission should be concerned with the potential harmful effects of the proposed rule upon fund groups with non-flat fee structure arrangements, such as the AA Funds. In conclusion, we recommend that the Commission either delete the requirement in the rule proposal regarding fee increases or, in the alternative, reconsider the proposal to rescind existing manager of manager orders because we believe that the current rule proposal does not take into consideration the structure of the AA Funds and, if the exemptive order granted to AMRIS is rescinded, there will be a negative impact upon AA Fund shareholders.
Thank you for the opportunity to provide comments on this proposal. If you have any questions regarding our comments, or would like any additional information, please contact me at (817) 967-1525 or Barry Greenberg at (817) 967-3514.