With so much attention focused on shoring up voting rights, investors might be surprised to learn that their right to vote their mutual fund shares is being steadily whittled away -- seemingly with the
Securities and Exchange Commission's
The SEC has exempted hundreds of so-called multimanager funds from having to obtain shareholder approval to replace subadvisers. Multimanager funds, the best known of which is probably
Littman/Gregory Fund Advisors'
Master's Select Equity, apportion the fund's portfolio among a team of money managers, known as subadvisers. One problem with the exemption, as I explained in my
Tuesday column, is that it has been granted to dozens of "multimanager" funds that never actually hire more than one subadviser.
Another problem with the exemptions is that they effectively strip shareholders of their right to approve increases in managers' advisory fees. Interestingly, many of these exemptions themselves may be legally invalid.
Unauthorized Fee Increases
Multimanager funds pay the manager a percentage of assets in the fund, and subadvisers are paid out of the manager's fee. The manager thus can increase its fee simply by reducing the subadviser's fee and pocketing the difference. Because the total fee paid by shareholders does not change, their approval is not required.
exploited this loophole when it replaced subadvisers for eight multimanager funds last year. On a net basis, Skandia stands to collect $342,000 more annually as a result of changes in subadviser fees, based on the funds' asset sizes on the date the new fees went into effect.
When Skandia replaced
as the subadviser to the
ASAF Alliance Growth and Income
AST Growth and Income
funds, it reduced the subadviser's fee from 0.5% of fund assets to 0.3% of fund assets.
As a result, Skandia saved itself approximately $377,000 annually that it would have paid Lord Abbett. Rather than passing the savings along to shareholders by reducing its own fee, Skandia left its fee unchanged and pocketed the savings.
When Skandia replaced
T. Rowe Price
as the subadviser of the
ASAF American Century International Growth
fund and the
AST American Century Growth
fund, it also reduced the subadviser's fee, resulting in annual savings for Skandia -- but not the funds' shareholders -- of approximately $93,000.
For four other funds, fees paid to subadviser replacements increased, which in the aggregate reduced Skandia's take by approximately $128,000. But one of these reductions will turn into an increase for Skandia as the fund grows.
As a result of Skandia's replacement of
as the subadviser of the
ASAF Index 500
AST Index 500
funds, Skandia must pay $66,000 more to Bernstein. But if the funds' assets grow to a combined $300 million, Skandia will pay about $50,000
annually to Bernstein than it would have paid to Bankers Trust. When the funds' assets reach $1 billion, Skandia will pay Bernstein about $260,000 less annually.
If you assume similar increases in all eight funds over five years, the net gain to Skandia during that period will be approximately $2.5 million. The chart below shows the growth of American Skandia's fees for these funds under that scenario.
Source: SEC Filings
When asked what justified Skandia's retention of these fees, Christian Thwaites, a Skandia senior vice president, argued that subadviser switches led to increased sales of fund shares, which resulted in lower fees for shareholders and improved investment performance. Thwaites also said Skandia had added more shareholder services and benefits but declined to elaborate.
If the increased fees received by Skandia had been subject to shareholders' scrutiny in a proxy statement, it might have been more inclined to share the savings with shareholders. On one occasion when it negotiated a lower fee with a subadviser
it was exempted from putting the switch to a shareholder vote, it reduced its fee in the same amount, thereby passing along the savings to shareholders.
Would shareholders reject a reduced subadviser fee without an offsetting reduction in Skandia's fee? Not necessarily. On another occasion when Skandia had to obtain shareholder approval before reducing a subadviser's fee, it brazenly kept the savings to itself, notwithstanding shareholder scrutiny.
Nonetheless, the shareholder vote requirement undoubtedly has a deterrent or limiting effect on fee increases, which is exactly what
intended by requiring one when funds change advisers and their contracts. The specter of shareholder vote gives fund directors more negotiating leverage, not to mention the moderating effect on management excesses that publicly filed proxies can have. And there's always the possibility that shareholders will reject the fee increase.
The multimanager voting exemption removes these restraining influences, leaving only fund directors between the manager and shareholders' money. As I discussed in my
Jan. 24 column, fund directors have little incentive to negotiate hard for lower fees.
Other firms apparently plan to follow Skandia's lead. In a conference call in December,
executives explained to their stockholders and the media how the firm planned to increase revenue. Part of MetLife's plan is "to renegotiate fees with subadvisers to get a bigger share for MetLife," reports
New England Zenith
funds obtained a multimanager voting exemption in 1997, and MetLife's application for an exemption for its
Met Investors Series
funds is pending with the SEC.
Has the SEC Exceeded Its Authority?
It is somewhat surprising that the usually investor-friendly SEC would authorize stripping shareholders of a right as fundamental as voting on a subadviser or an increase in a fund manager's fee.
The explanation for the SEC's actions may be, ironically, that the agency itself was denied its right to exercise its voting rights.
After SEC commissioners approve a particular type of exemption, the SEC staff can grant similar exemptions without putting them to a vote if the exemptions "present no significant issues that have not been previously settled by the Commission."
The first and only multimanager voting exemption ever voted on by the agency was granted in 1995 to the
funds. Frank Russell had a long history and established reputation as a manager of managers. It manages 24 multimanager funds that employ 109 subadvisers, all but three of which have had at least two subadvisers from their inception.
But many of the multimanager exemptions granted since Frank Russell raise issues that have not been "previously settled" by the SEC, thus undermining their legal validity.
Equitable and Skandia offer at least 108 multimanager funds that have never had more than one adviser, 107 of which include the name of the subadviser in the fund's name, a practice the staff has stated in nonpublic letters (obtained under the
Freedom of Information Act
) is "inconsistent with the fundamental concept on which multimanager applications have been premised."
The SEC required that multimanager funds hold themselves "out to the public as employing the multimanager structure." Yet the Equitable and Skandia funds effectively hold themselves out as conventional, single-manager funds.
The Equitable and Skandia funds bear only a vague resemblance to the Frank Russell funds and raise issues that the SEC commissioners have never considered.
The staff should give the commissioners the opportunity to vote on the new multimanager voting exemptions. Hopefully, the SEC will then give shareholders the opportunity to vote on who manages their money and how much they are paid.
Mercer Bullard, a former assistant chief counsel at the Securities and Exchange Commission, is the founder and CEO of Fund Democracy, a mutual fund shareholder advocacy group in Chevy Chase, Md. He welcomes your feedback at