SEC to examine loophole on fund holders’ votes

Investor advocates are seeking to plug a loophole that allows mutual fund companies to change subadvisers without a shareholder vote.

The Securities and Exchange Commission is expected to soon schedule a hearing that would get the ball rolling. At issue: Whether certain funds should be granted exemptions from requiring shareholder approval to change subadvisers.

Advocates hope that a hearing would lead to fewer exemptions and stricter guidelines.

“The exemptions undercut the most important shareholder right under law – to approve the fund’s adviser,” says Mercer Bullard, CEO of Fund Democracy LLC, a Chevy Chase, Md., shareholder advocacy group.

negative impact

The hearing, requested in March by both Fund Democracy and Institutional Shareholder Services in Rockville, Md., would focus on an exemption request made by Hillview Capital Advisors LLC in Stamford, Conn.

“Essentially, we think there should be more fact-finding with respect to this exemption [request],” says Erin McNally, senior mutual fund analyst at Institutional Shareholder Services, which advises institutional investors about proxy votes.

“We keep seeing this type of proposal,” she says. “And on the surface, they appear to have a negative impact on shareholders.”

David Smith, an associate director at the SEC’s division of investment management, halted review of the 30 or so exemption requests in the pipeline.

“We’re trying to deal with this as quickly as possible,” Mr. Smith says, although he declined to provide a time frame.

The SEC also could move toward proposing a rule that would replace the exemption process and allow funds with a true multimanager structure to avoid seeking shareholder approval for changes to subadviser contracts.

exemptions

Under the Investment Company Act, no one can serve as the investment adviser to a fund unless shareholders have approved a contract with the adviser.

But since 1995, the SEC has granted exemptions to dozens of funds whose management companies, like Hillview, say they are multimanaged – that is, they employ more than one subadviser who makes investment decisions.

Those funds argue that seeking shareholder approval to replace one of several subadvisers on one fund interferes with efficient operation of the fund. They also say the process is costly and burdensome.

Investor advocates agree. But they argue that much of the regulatory relief has gone to funds that have just one subadviser, meaning they aren’t truly multimanaged.

shareholders undercut

The problem, they say, is that the exemption gives single-subadviser funds latitude to move all the assets to a subadviser without first getting investor approval.

For example, investors who put money in the American Skandia Advisor Funds’ Oppenheimer Large-Cap Growth Fund in 1999 had their money moved – without approval – to the ASAF Alliance Growth Fund in May 2000.

Most of the exemptions have gone to variable annuities.

According to a study by Financial Research Corp. in Boston, the underlying funds used in variable annuities tend to use subadvisers more frequently.

Out of 7,234 variable-annuity funds examined, 4,787, or 66%, were subadvised. Such funds account for 80% of the money going into variable annuities.

For Hillview’s part, its lawyer argues in a letter to the SEC that the funds in its Investment Trust II series, for which it seeks the exemption, have at least four subadvisers.

It also says its multimanager structure is made clear in its prospectus and that it does not include the subadvisers’ names in its fund names – two things that critics say the exempted funds also all too often are guilty of.

Mr. Bullard says that if Hillview holds that its current structure and approach are good ones, the company should be willing to agree to legally binding conditions to ensure that it continues managing its funds that way.

Calls to Hillview and its lawyer were not returned.

Mr. Bullard hopes that if the hearing is held, the SEC will impose four conditions on Hillview and on existing exemptions:

* A minimum number of subadvisers under normal circumstances.

* No increase to advisory fees without shareholder approval.

* Clear prospectus disclosure of multimanager structure.

* A ban on using a subadviser’s name in the fund’s name.