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Review Sought on Multi-Manager Exemptions

Fund Democracy, a shareholder advocacy group in Chevy Chase, Md., wants the Securities and Exchange Commission to tighten its policy on granting funds exemptions that remove shareholders' rights to vote on changes of sub-advisers and sub-adviser fees.

Some funds are seeking the exemption for the sole purpose of allotting a greater portion of the management fee to the fund by lowering sub-adviser fees and pocketing the difference, according to Fund Democracy.

Last week, the group filed a hearing request with the SEC on an application filed by Hillview Capital of Stamford, Conn. The firm is seeking exemptive relief from the Investment Company Act of 1940 that would allow it to use multiple advisers with its funds.

Fund Democracy is using Hillview's application to compel the SEC to tighten its policies, said Mercer Bullard, founder and CEO of Fund Democracy and former assistant chief counsel of the SEC's division of investment management.

"The larger goal is to get the SEC to change the conditions [of the exemptions] to only grant this, going forward, to bona fide multi-manager funds," he said.

Hillview is confident that its exemption application is justified and in the best interests of its shareholders, said Joe Bracken, a director with the firm.

"Fund Democracy is not aware of how we operate and may be using this as a platform for concerns that are not applicable to us," he said.

The problem with exemption applications like Hillview's is that they deny shareholders the right to vote on changes to sub-advisers and the fees paid to them, said Bullard. Moreover, many funds which have been granted multi-manager voting exemptions are flouting the conditions of the exemption.

When determining whether to grant an exemption, the SEC "considers the discussion of management structure and investment strategy in the fund's prospectus," the SEC wrote in 1995, when it granted its first multi-manager exemption. "Prospectus disclosure alone is not sufficient, however. The Division also examines the number of sub-advisors employed for each portfolio, and the fund's operating history." The first such exemption was granted to Frank Russell Company of Tacoma, Wash.

However, the SEC has not upheld the conditions it initially set in the Frank Russell order, according to Bullard.

"Since the first multi-manager voting exemption was granted in 1995, dozens of funds operating under such an exemption have done so in a manner that appears to violate the conditions under which the exemption was granted and is inconsistent with the basis on which the Commission has granted multi-manager relief," Bullard wrote in his hearing request.

Many funds that have been granted multi-manager exemptions have never had more than one sub-adviser, he said. These funds have sought exemptions because the exemptions allow them to lower sub-adviser fees and keep the difference without shareholder input, Bullard said.

But that is no different than a fund cutting management costs by firing a portfolio manager and hiring a new one at a lower salary, said Pamela Wilson, a mutual fund lawyer at Hale & Dorr LLP in Boston.

"If an adviser had the ability to change the compensation of individual portfolio managers, and that doesn't require shareholder approval, then why should it require shareholder approval to change the compensation of its sub-advisers?" she said. "It's doing the same job as an individual portfolio manager."

Still, most of the 111 funds granted multi-manager voting exemptions that were examined by Fund Democracy have never had more than one sub-adviser. In a memorandum accompanying the hearing request, Fund Democracy said it examined 66 funds operating under a multi-management structure offered by American Skandia of Shelton, Conn., and 45 similarly-structured funds offered by Equitable Life Assurance of New York. Of the 111 funds, 97 percent of the funds have never had more than one sub-adviser. Moreover, 83 percent of the funds have never changed sub-advisers, according to the memorandum.

The funds that did change sub-advisers generally do so to raise fees, according to Fund Democracy.

American Skandia generated $342,000 in 2000 simply by reducing the fees it paid to sub-advisers, according to Fund Democracy.

The odds are against Fund Democracy receiving a SEC hearing, Bullard said.

"They almost always deny hearing requests," he said. "I don't recall there ever being a hearing request from some third party claiming it was bad for shareholders. It's completely unprecedented."

But, Bullard is optimistic that the issue will be addressed, if not by the SEC, then by a judicial body, he said.

"If they deny it, then I'll appeal to the U.S. Circuit Court of Appeals and from there to the Supreme Court," he said. "And the [SEC] knows that. Because this is such a strong argument for a hearing, I don't think that will happen."