The 15(c) season, now winding down, is the second fund boards have faced under red-flag warning that the SEC is paying extra attention to fund fees, but with no concrete information about what that extra scrutiny means.
Recent comments about fund fees by SEC officials have been at the top of boards’ minds during this year’s 15(c) advisory contract approvals, but many boards find their deliberations hampered by uncertainty over the exact nature of the SEC’s scrutiny.
Fund boards have been on edge since the controversial March 2022 speech during with William Birdthistle introduced himself to the industry as the newly appointed director of the SEC Division of Investment Management by saying he suspected funds were getting away with charging excessive fees and hinting that he wanted to do something about it.
The SEC also conducted a sweep last summer looking into the 15(c) processes of some funds and asking questions about fund-adviser profitability and the setting of fees.
Taken together, the actions signalled to industry observers that the SEC was exploring whether to shake up the status quo around fee-setting, especially for funds that charge relatively high fees while underperforming.
The rapid pace of new rules and rule changes — many of which are likely to increase the operating cost of mutual funds and ETFs — may also intensify concern about potential changes in the SEC’s focus on fund fees.
SEC officials have said little about any concrete plans for changes in regulations or enforcement priorities, however, leaving fund boards worried but lacking any solid idea how to interpret the SEC’s actual intentions.
“I’ve had a few trustees sort of state that they’re a little perplexed as to what the issue is and what the SEC is really searching for,” said Jeff Keil, an independent 15(c) consultant.
Generally, a 15(c) review begins with the board sending a list of questions to the fund adviser, who provides answers and furnishes the board with requested materials in a timely manner.
These questions usually follow a consistent framework shaped by the Gartenberg factors, but they also consider current events.
“Every year there’s something new,” said Molly Moynihan, a partner at Perkins Coie who counsels fund boards. “This year, one of the things that’s new is the additional scrutiny that the SEC has put on the process. So maybe your spotlight is a little more focused on that.”
To make sure all their bases are covered, some boards are spending more time during 15(c) asking advisers about funds with high fees and low relative performance, according to Devin McCune, a vice president of regulatory and compliance at Broadridge Financial Solutions who consults with fund boards on 15(c) reviews.
“There’s heightened scrutiny on those funds,” he said.
Boards haven’t explicitly attributed that “heightened scrutiny” to concern about SEC examinations, but that was probably a major motivation, he said.
Without a clear message as to what to look for, however, boards trying to be responsive to regulators may simply end up going in circles and becoming less efficient in the way they approach their evaluations, said one fund lawyer who asked not to be named.
“Anytime the SEC speaks, people sit up and pay attention, and rightfully so,” the lawyer said. “But at some point you wonder and worry that, when they speak, it may stifle discussion.”
The lawyer compared the uncertainty of dealing with this SEC’s scrutiny to their own recent interactions with a nitpicky homeowners’ association.
“They sent me a picture of one weed in my yard, and they’re like, ‘Hey, you’ve got to clean that up,’” the lawyer said. “So now for the last four weeks, I have just been hypervigilant, and if I see any little sprout, I’m on it. It’s to the detriment of everything else in my life. My whole focus is on these little sprouts.”
While some boards may understandably be thinking about trying to anticipate SEC scrutiny by proactively overhauling their 15(c) processes, now is probably not the time to change policies, according to Paul Ellenbogen, an independent 15(c) consultant.
“Then you’re trying to outguess the regulator, and it’s risk without benefit,” he said. “There’s no first-mover advantage here.”
Instead, one appropriate course of action might be for boards to document their 15(c) meetings with minutes that detail their deliberations with extra clarity — in case the SEC wants to review them, according to Ellenbogen.
Using the analogy of the SEC as a homeowners’ association, the board could say, “I’m going to show you that I apply weedkiller five times, and I go out there 10 times every summer to yank them up, or I employ a gardening service, or whatever it is,” Ellenbogen said.
Besides keeping detailed records of their meetings, boards may also consider whether to formalize the specific policies and procedures they use each year.
Most boards already have well-established internal practices and schedules that govern their annual advisory contract reviews, but often those practices are kept as institutional knowledge and not written down, according to Moynihan. The SEC’s attention to 15(c) has prompted some boards to consider documenting those policies and procedures more clearly, she said.
“I have seen those conversations happening, and I believe that the law firms that are advising this area have different views,” Moynihan said.
For example, she said, outlining a process for exactly how an adviser should gather and provide information in response to a board’s 15(c) request may give boards and advisers a blueprint for consistent annual reviews, but some might fear that it could open a fund to complaints or legal action if the information-gathering process deviated from the written policies in any way.
McCune said that demand for the fund-board 15(c) training classes he offers has risen so fast that he has completed seven training classes so far this year, compared to three or four most other years.
Overall, though, the improvements most boards are trying to make in response to SEC scrutiny are just added polish on 15(c) processes that are already pretty solid.
“We haven’t gone from 1 to 10,” McCune said. “We’ve gone from 9 to 9.5.”
The SEC as a friend to boards
The SEC’s hints about aggressive enforcement can make life difficult for boards, but the perception that regulators have become overzealous in defense of the interests of shareholders can also give the board leverage that can make fund management more responsive to trustee demands.
The board of one small fund was finally able, after years of trying, to convince its adviser to increase staffing for certain investment management functions the board believed were lacking, according to a member of the board, who asked to remain anonymous to avoid calling attention to the fund or embarrassing its adviser.
The argument over staffing might well have concluded the same way regardless of the SEC’s actions, but the issue tilted in the board’s favor when management perceived regulators to be looking over their shoulder at how they responded to 15(c) requests.
“I think our arguments carried even more weight with management than would have been the case had the commission not been appearing to be a little bit more interventionist,” the trustee said. “Sometimes it’s good to have the sense of urgency that comes from a little bit more regulatory scrutiny.”
A little more regulatory clarity would help even more, however, especially for fund boards that “are doing the right things, and now they feel like the ball is moved and they’ve got to meet a new set of ambiguous expectations,” the trustee said.
The SEC has clearly staked 15(c) as an area where it wants to make an impact, but until it says more about how it wants fee evaluations to change, most boards feel they have no option except to wait for the other shoe to drop, Moynihan said. “Everybody’s thinking about it. Because we do want to be sure the process is good. But I don’t think people have landed on a response,” Moynihan said.
