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SEC Targets Another Fund Servicer: SEI Must Reveal All About Client Marketing Arrangements

The Securities and Exchange Commission is investigating another third-party back-office service company for potential improper marketing arrangements with mutual fund clients.

SEI Investments of Oaks, Pa., is the latest provider of outsourced services to the mutual fund industry to become the target of the regulator's scrutiny of administrative, marketing and distribution fees clients paid as part of service contracts. The SEC has raised concerns about the industry's apparent practice of-and lack of disclosure regarding-the bloating of service fees. The regulator is concerned that a portion of these higher-than-warranted fees paid by fund shareholders for administrative and distribution costs are being rebated to fund companies, which then spend the money to pay other, possibly unrelated, fund company marketing expenses.

In a regulatory filing with the SEC last week, SEI played down the investigation but revealed that while the company often responds to varied regulatory requests, "one of these regulatory requests and inquiries relate to the payment by certain of our subsidiaries of expenses related to the marketing and distribution of shares of certain mutual fund clients of our fund administration and distribution business." The filing mentions a recent SEC sanction against competitor BISYS Fund Services, without naming the company, but fails to provide details as to what SEI's practices have been.

Also last week, one of SEI's administrative clients quietly disclosed that it, too, is under the SEC's microscope. Union Bank of California, sponsor of the HighMark Funds complex of Boston, noted that "the SEC is conducting an inquiry regarding certain practices related to our mutual fund activities. The inquiry concerns the use of a portion of the fees received under an agreement from the HighMark Funds by an unaffiliated administrator to pay expenses related to the marketing and distribution of fund shares. We are cooperating with this inquiry."

A spokeswoman for Union Bank confirmed the investigation and that SEI provides back-office services to the fund group, but declined to provide further details.

Both SEI and the SEC declined to comment for this story.

This past September, after a lengthy SEC investigation that coincided with the regulator's unrelated investigation of financial restatements by its parent company, BISYS Fund Services, the fund administrative arm of BISYS Group of Roseland, N.J., was sanctioned and ordered to pay $21.4 million, which included a $10 million civil penalty.

The regulator found that from July 1999 until June 2004, BISYS had entered into undisclosed side agreements, sometimes written, sometimes oral, which required BISYS to rebate a portion of its administrative fees to 27 bank-sponsored fund groups. Excess fees were credited to a special marketing account then used by the fund advisor to pay various expenses (see MME 4/2/05).

In total, BISYS paid $230 million in kickbacks to curry favor with fund sponsors and win their repeat business, the SEC charged. In one case, the regulator found that these fees were used to pay the mutual fund company president's salary and went toward the initiation fee and monthly dues for a golf country club. BISYS neither admitted to nor denied the SEC's findings.

Industry insiders predict that additional investigations of other fund service companies are likely. Moreover, if the SEC finds that this type of undisclosed rebate program is pervasive within the industry, serious sanctions against individual fund companies, as well as fund administrators, will be forthcoming.

Among other issues, the SEC is highly concerned that such side agreements were not only never disclosed to fund investors, out of whose pockets those country club dues and other expenses were paid, but, that in many cases, the funds' boards were not apprised of these side agreements, industry executives said.

"It is sad that some advisors don't seem to realize that fund shareholders' money is not theirs," said Meyrick Payne, principal of Management Practice, a fund board consulting firm in Stamford, Conn.

SEI provides administrative services to several single-fund and multiple-fund families, some of which are bank-sponsored. These include the Bishop Street Funds sponsored by Bancwest Corp., the CNI Charter Funds, managed by the asset management arm of City National Bank, and the Commerce Capital Funds run by Commerce Capital Markets, a subsidiary of Commerce Bank. However, none of these banks have filed documents with the SEC indicating that their fund agreements are being investigated.

In the BISYS case, several of the 27 fund firms that inked questionable deals with the administrator have revealed that the SEC has stepped in to request information. These include the BNY Hamilton Funds sponsored by The Bank of New York, and the OneGroup Funds, which have since been merged into the JPMorgan Funds complex.

Industry critics question just how invisible such fund group partnerships with administrators really were. Although a lack of disclosure may have kept investors in the dark and fund boards may have been uninformed or unknowingly glossed over the specific details of these rebate agreements, the advisors and their lawyers were in the know, or should have been, said one industry insider who spoke on condition of anonymity.

"I would not be surprised to see a number of [fund] clients, or ex-clients, entering into consent decrees with the SEC over these agreements," the source said.

Fund attorneys may also be reconsidering whether these were wise arrangements, especially in light of Rule 12b-1, which is clearly earmarked for marketing expenses.

"I firmly believe that any lawyer who served as counsel to [one of these] funds should take a thorough look at what they did or didn't know," the source continued. "Did they believe that nothing was wrong with the arrangements? To have them all stick their heads in the sand is ridiculous."

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