Few would dispute that the investment management industry has witnessed transformational changes in the past decade…both the Commission and investors should have access to more substantive… information about funds and their advisers.David W. Grim, SEC Director of the Division of Investment Management, March 2016
When Section 15(c) of the Investment Company Act of 1940 was written, there were no fax machines, computers, cell phones, and certainly no electronic board books. Color television had just been invented. Boards were faced with the daunting task of finding and obtaining information to assess their fund’s performance. Today, any person can study a fund’s disclosure on their phone, from almost any location, in addition to accessing fund metrics from various independent data sites. At first blush, it seems obtaining information is no longer a challenge.
However, with the explosion of information and ever-increasing level of regulation, many fund boards now struggle to identify what information is important. A clear message that has resonated from the SEC to the Boards and back is that more is not better. Overwhelming volumes of board materials can add little additional value and confuse, instead of enlighten, directors and management.
If there is one over-arching idea in the 1933, 1934 and 1940 Acts, it is that there will always be conflicts of interest in financial services, and that these conflicts of interest must be mitigated using boards and regulatory bodies. Despite all the communication and analytical technology developed since the 1940s, there have been no workable substitutes for the involvement of boards, and their cumulative business experience, in the governance of mutual funds.
However, as Director Grim pointed out, the fund business has and is being transformed on many levels. The introduction of board counsel, consultants, and data providers has been established as a valuable resource for the boards’ independence. However, too much reliance on outside parties has its risks, because as the ratings scandal of the sub-prime crisis made clear, everyone has conflicts of interest. It has become more imperative that the board and management engage in a satisfactory resolution of the contract renewal process and development of materials in order to focus on the fund’s important issues and appropriate benchmarks.
If the performance, risk and other benchmarks that are used internally by management are separate from those used from the Board, the conversation during contract renewal can be counterproductive. For example, if management and the board determine that a fund’s objective is similar to the style box strategies or published indices, it makes perfect sense to use reports which publish standard benchmarks. However, if the product has skewed from the standard strategies, custom benchmarks may be more appropriate for the conversation, in addition to what benchmarks that are published in the prospectus.
What’s important is that each party work together to find the right balance between shareholder and management in the goals of the fund. These goals are never simple. If they were simply about reducing fees, for example, then Congress would have passed a law in the past 75 years to lower them. We don’t take a cynical view. We believe the process, with all its warts, is by democratic choice.
As an independent data provider, our view of 15(c) process is that we have no pre-determined view. That is, we certainly see our role as working on the “side” of the shareholder by providing independent data and analytics. However, this doesn’t necessitate an adversarial relationship to management, which is also expected to have the shareholder’s interest at heart. The board and management are the experts on their products, and a goal is to provide analytics while avoiding being a “3rd wheel” opinion in a process when unnecessary, and possibly introducing conflict.
Our job is to help define the needed metrics that further useful discussion between management and the board, allowing the parties to resolve questions rationally though requested data, reports and/or analysis, including Gartenberg factors beyond quality of service and fees. Even if the data is readily available, it takes time and expertise to put it in context in an efficient and effective manner.
In today’s evolving environment we find this process rarely translates to permanent, every-year-the-same solutions for contract renewal materials or set of benchmarks. Revisiting the current firm environment, fund operations and industry influences may determine changes in informational needs for the board. Emphasizing the change, and not necessarily the addition. With the ever advancing technology and information available, boards have the ability to access effective and efficient materials, and although many things have changed…a residing message has stayed and perhaps resounded louder:
It shall be the duty of the directors of a registered investment company to request and evaluate, and the duty of an investment adviser to such company to furnish, such information as may reasonably be necessary to evaluate the terms of any contract whereby a person undertakes regularly to serve or act as investment adviser of such company. –Excerpt 1940 Act, Section C