Corsell Law Group, Ltd.
January 7, 2004
Via Email and FedEx
Jonathan G. Katz. Secretary
Re: File No. S7-20-03
Dear Mr. Katz:
In release No. IC-26230 dated October 23, 2003, ("Proposing Release"), the Securities and Exchange Commission ("Commission") proposed to adopt Rule 15a-5 ("Rule") under the Investment Company Act of 1940 ("1940 Act") and requested comments on the proposal. This letter has been prepared in response to the Commission's request.
Our comments are specifically designed to reflect the perspective of mutual funds that are provided with portfolio management services by two or more subadvisers each under the direct supervision of an investment advisory organization and that have chosen to pay the fees of each such subadviser directly.
Part I: Specific Recommendations with Respect to the Rule.
In concept, we support the adoption of the Rule. We would, however, recommend that the Commission consider making the following specific changes in the Rule prior to its final adoption.1
We recommend that subsection (a)(2) of the Rule be modified:
Part II: Request for Clarification.
In addition, we suggest that, in any release that accompanies the adoption of the Rule, the Commission clarify the following points:
Part III. Response to Certain Specific Commission Inquires.
The Commission specifically requested comment on whether it should permit fund directors to enter into subadvisory contracts that increase advisory fees without the consent of shareholders. As indicated above, we believe that the important factor is whether there is an increase in the rate at which advisory fees are calculated, as disclosed in the fund's prospectus and relevant advisory and subadvisory contracts. If, for example, a subadvisory contract that provided for the payment of a performance fee is terminated, shareholder approval should not be required for a "successor" subadvisory contract that includes the same performance fee arrangement, even if the new subadviser subsequently is entitled to a higher fee due to relatively better performance than the terminated subadviser.10
The Commission also requested comment on whether it should limit relief to subadvisory contracts that do not increase the portion of the advisory fee retained by the principal adviser in order to assure that subadvisers are selected based on ability and performance. We do not believe such a limitation is necessary. Although "fee transparency" is a much discussed issue at the present time, we believe that the primary interest of most shareholders is (i) the reputation of the investment advisory organizations responsible for managing the fund and/or selecting investments; and (ii) the "net performance" of their investment, as shown in the Expense Table and accompanying Example required by Form N-1A to be included in a fund's prospectus. We note, however, that the benefit realized by a principal adviser if a subadviser is willing to accept a lower fee is a conflict of interest that does not arise where the subadviser is paid directly by the fund pursuant to subadvisory contracts that name the fund as a contracting party. Accordingly, we believe that direct payment of subadvisory fees by a fund may be desirable in order to secure the benefit of fee reductions for a fund's shareholders. Such arrangements also carry the corollary benefit -- if fee transparency is a desired result -- of ensuring that the fees paid by a fund, directly or indirectly, are disclosed in the expense table required to be included in the fund's prospectus (See, Item 3 of Form N-1A).11
Finally, we offer the following thoughts on the difference between the circumstances of funds served by a single subadviser and those served by multiple subadvisers. While there are business and administrative challenges faced by multi-manager funds, particularly those whose subadvisers are "actively" managed by their principal advisers, we do not believe that the Rule needs to be specially crafted for either investment structure. By the same token, however, we do not believe that the Rule should require a principal adviser to engage multiple subadvisers. While we believe that the manager of manager structure was originally conceived to accommodate active management of subadvisers, the concept has evolved in a way that, at its best, permits principal advisers to seek out portfolio management services that complement those available within the principal adviser's organization in a way that preserves continuity of management, supervision and shareholder services.
We appreciate the opportunity to comment on the Commission's proposals. If we can provide any further information, we would welcome the opportunity to speak with members of the Commission's staff with respect to this matter.
Very truly yours,
Laura Anne Corsell, Esq.
cc: William H. Donaldson, Chairman
Paul S. Atkins, Commissioner
Roel C. Campos, Commissioner
Cynthia A. Glassman, Commissioner
Harvey J. Goldschmid, Commissioner
Paul F. Roye, Director, Division of Investment Management
Cynthia M. Fornelli, Senior Adviser to the Director, Division of Investment Management
Robert E. Plaze, Associate Director, Division of Investment Management
C. Hunter Jones, Assistant Director, Office of Regulatory Policy
Adam B. Glazer, Attorney, Division of Investment Management
The following material reflects the text of each of the several amendments proposed in Investment Company Act Release No. 26230 (October 23, 2003), including the text of proposed Rule 15a-5. Each is marked to show changes that we believe would implement the recommendations discussed in the accompanying letter.
1. Proposed changes to Regulation S-X (§ 210.6-07 Statements of operations).
(d) If a registered investment company or separate series of a registered investment company ("Fund") or a principal adviser (as defined in § 270.15a-5(b)(2) of this chapter) of the Fund, in reliance on § 270.15a-5 of this chapter, has entered into a contract or contracts with a subadviser (as that term is defined in § 270.15a-5(b)(3) of this chapter) of the Fund without approval by a vote of the securities of the Fund and if the fee payable to the subadviser is paid by the principal adviser and not by the Fund,12 the investment advisory fee paid to any subadviser that is not an affiliated person (as defined in 15 U.S.C. 80a-2(a)(3)) of the principal adviser or of the Fund (other than by reason of serving as an investment adviser to the Fund) need not be disclosed as a separate expense item in response to paragraphs 2.(a), (b), or (c) of this section.
2. Proposed changes to Schedule 14A (Item 22. Information required in a proxy statement)
Instructions to paragraph (c). 1.
2. Where information is furnished in response to this item in order to comply with the requirements of § 270.15a-5(a)(5) of this chapter, the rate of compensation and the aggregate amount of the fee paid to the subadviser (as that term is defined in § 270.15a-5(b)(3) of this chapter) need not be disclosed in response to any paragraph of this item, and the information required by paragraph (c)(9) of this item need not be disclosed, unless such subadviser is a wholly-owned subsidiary (as defined in 15 U.S.C. 80a-2(a)(43)) of the principal adviser (as that term is defined in § 270.15a-5(b)(2) of this chapter) with which the fund has contracted or unless the subadviser's fee is paid directly by the fund.
3. Proposed Rule 15a-5: § 270.15a-5 Exemption from shareholder approval for certain Subadvisory contracts.
(a) Exemption from shareholder approval. Notwithstanding section 15(a) of the Act (15 U.S.C. 80a-15(a)), a subadvisory contract need not be approved by a vote of a majority of the outstanding voting securities of a fund, if the following conditions are met:
(1) No increase in fees. The subadvisory contract does not increase the rate at which the management fee paid to the principal adviser or thesubadvisory fees charged to the fund or its shareholders and described in the manner contemplated by Section 15(a)(i) of the Act (15 U.S.C. 80a-15(a)) in investment advisory contracts pursuant to which the fund is provided with investment advisory services, are computed.
(2) Conflicting relationships prohibited.
(i)(a) The subadviser is not an affiliated person of the principal adviser or of the fund (other than by reason of serving as an investment adviser to the fund), and no director or officer of the fund (other than officers of the fund who serve in such capacity within the scope of their employment by the fund's administrator as that terms is defined in [cite to 38a-1(?)] and in accordance with procedures adopted in the manner contemplated by rule 38a-1 under the Act. , and (b) no principal adviser or director or officer of the principal adviser, knowingly has a beneficial interest, directly or indirectly, in any security issued by the subadviser or any person who controls the subadviser other than an interest through ownership of shares of (A) a pooled investment vehicle (other than a registered investment company) if investments made on behalf of such vehicle are committed to the discretion of a person that is not affiliated with the principal adviser or (other than as a result of a subadvisory contract) the fund; or (B) shares of a registered investment company for which the principal adviser provides investment advisory services, provided that the fund and the principal adviser have implemented procedures in accordance with rule 38a-1 under the Act and Rule 206(4)-7 under the Investment Advisers Act of 1940 to monitor purchases and redemptions of shares of any such mutual fund by the officers and directors of the fund and of officers and employees of the principal adviser; or
(ii) The subadviser is a wholly-owned subsidiary (as defined in section 2(a)(43) of the Act (15 U.S.C. 80a-2(a)(43)) of the principal adviser, and the wholly-owned subsidiary has been hired as a subadviser to replace another wholly-owned subsidiary that has been terminated as a subadviser to the fund, or the subadvisory contract of a wholly-owned subsidiary has been materially amended.
(3) Shareholder authorization. Shareholders of the fund have authorized the fund and/or a principal adviser, subject to approval by the board of directors, to enter into contracts with subadvisers without approval by a vote of the outstanding voting securities of the fund or, if the fund's securities have not been publicly offered or sold to persons who are not promoters or affiliated persons of the fund, the directors of the fund have authorized the principal adviser and/or the fund to enter into such contracts.
(4) Supervision of subadvisers. A contract between the fund and a principal adviser provides that the principal adviser must supervise and oversee the activities of the subadviser under the subadvisory contract on behalf of the fund.
(5) Disclosure to shareholders. Within 90 days after entry into a new subadvisory contract or after a material change to a wholly-owned subsidiary's existing subadvisory contract is approved by the fund's directors in the manner contemplated by Section 15(c) of the Act, the fund furnishes its shareholders with an information statement, which must be filed with the Commission in accordance with the requirements of § 240.14c-5(b) of this chapter, that describes the new agreement, and contains the information specified in Regulation 14C (17 CFR 240.14c-1 through 240.14c-7), Schedule 14C (17 CFR 240.14c-101), and Item 22 of Schedule 14A (17 CFR 240.14a-101) under the Securities Exchange Act of 1934 (15 U.S.C. 78a - mm).
(6) Fund name. If the fund identifies the subadviser as a part of the fund's name or title, it also clearly identifies in its name or title the principal adviser that is obligated to supervise and oversee the activities of the subadviser, before the name of the subadviser.
(7) Board of directors composition, selection, and representation.
(i) A majority of the directors of the fund are not interested persons of the fund, and those directors select and nominate any other disinterested directors; and
(ii) Any person who acts as legal counsel for the disinterested directors is an independent legal counsel.
(1) Fund means a registered open-end management investment company, or separate series of a registered open-end management investment company.
(2) Principal Adviser means an investment adviser as defined in section 2(a)(20)of the Act (15 U.S.C. 80a-2(a)(20)) that is obligated under an investment advisory agreement with the fund, which agreement has been approved by the shareholders of the fund in the manner contemplated by Section 15(a) of the Act, to supervise and oversee the activities of a subadviser that provides investment advice to the fund pursuant to a subadvisory contract.
(3) Subadviser means an investment adviser as defined in section 2(a)(20) of the Act (15 U.S.C. 80a-2(a)(20)) that provides investment advice to the fund pursuant to the terms of a subadvisory contract.
(4) Subadvisory contract means a contract between a principal adviser and/or a fund and subadviser to a fund, pursuant to the terms of which contract (i) the subadviser agrees to perform investment advisory services on behalf of the fund; (ii) the subadviser is expressly subject to the supervision and oversight of the principal adviser; and (iii) the subadviser may be terminated at any time by the principal adviser with the approval of the fund's board of directors, on no more than 60 days written notice, without payment of penalty.
4. Proposed Amendments to Form N-1A
Item 4. Investment Objectives, Principal Investment Strategies, and Related Risks
Instructions. * * *
3. A Fund that uses (or reserves the right to use) the services of any other investment adviser to implement the investment objectives, strategies, and policies of the Fund, without shareholder approval of those advisers' contracts in reliance on § 270.15a-5, should regard such use (or reservation to use) as a principal investment strategy.
Item 6. Management, Organization, and Capital Structure
(a) * * *
(1) Investment Adviser.
(i) * * * If the investment adviser is a subadviser whose contract has not been approved by shareholders in reliance on § 270.15a-5, explain that the subadviser may be replaced, and that additional subadvisers may be retained, without shareholder approval.
Note: If the Fund uses the services of more than one subadviser whose contracts have not been approved by shareholders in reliance on § 270.15a-5, then the Fund may include a general statement, appropriately located, explaining that any of the subadvisers may be replaced, and that additional subadvisers may be retained, without shareholder approval.
Item 15. Investment Advisory and Other Services
5. If the Fund and an investment adviser comply with the conditions of § 270.15a-5(a)(1) - (7) and (b)(4) (which permits a Subadviser to advise the Fund without shareholder approval) and if the fee payable to the subadviser under the subadvisory contract is paid to the Subadviser by and investment adviser obligated to supervise and oversee the Subadviser and not by the Fund, the Fund may elect not to disclose separately the fees paid to each Subadviser that is not an affiliated person of the principal adviser obligated to supervise and oversee the subadviser , if the Fund instead discloses, both as a dollar amount and as a percentage of its net assets:
(a) The individual fees paid to the principal adviser of the Fund and to each subadviser that is an affiliated person of the principal adviser obligated to supervise and oversee the subadviser;
(b) The net advisory fee retained by the principal adviser after payment of fees to all subadvisers; and
(c) The aggregate fees paid to all subadvisers of the Fund that are not affiliated persons of the principal adviser.