Starting a Mutual Fund: The Board's Role in Approving an Investment Adviser
In a series trust for unaffiliated investment managers (a Trust), the investment adviser or investment manager (the Adviser) is the sponsor of their fund(s). The Adviser develops each fund’s strategy and manages each fund's portfolio of investments and assets. The Adviser is responsible for the expenses of their funds, including start-up costs, the ongoing operating expenses to the extent each fund’s assets do not cover these and the costs of marketing and selling each fund to the extent these costs are not covered by a 12b-1 plan. While each fund is a product of the Adviser, and there would be no fund without the Adviser, it is the Trust's Board of Trustees (Board or Trustees) that oversees the Adviser and employs the Adviser to manage the fund(s).
The terms of this employment are set forth in an Investment Advisory Agreement between the Adviser and the Trust. Section 15 of the Investment Company Act of 1940 (the 1940 Act) requires the initial approval, and annual renewal, of an Investment Advisory Agreement between the Adviser and the Trust. Section 15(c) also requires that the Board request and that the Adviser provide information necessary to evaluate:
- The nature and quality of the services to be provided by the Adviser;
- The capability of the Adviser to provide those services; and
- The compensation to be paid to the Adviser in connection with the Investment Advisory Agreement.
Given the Board's mandated considerations and responsibilities, an Adviser must provide the Board with transparency into its operations through initial and ongoing communications.
The following is intended to provide an Adviser with an understanding of the requirements, processes and key considerations involved with the Board’s fiduciary responsibilities to fund shareholders and its oversight of an Adviser.
Initial Due Diligence
Just as an Adviser will perform due diligence on a series trust and its associated administrator, the Trust will also perform due diligence on the Adviser. Atlantic Fund Services (Atlantic) is the administrator for Forum Series Trust and facilitates the due diligence process. The Adviser is typically asked to provide information about its:
- Advisory business, i.e., assets under management, number of staff and experience managing investment products, insurance, etc.;
- Proposed fund strategy, holdings and expenses to assess if the fund(s) can operate within the guidelines of the 1940 Act and if the expenses appear reasonable (which ultimately the board will determine); and
- Policies and procedures, CCO and compliance discipline.
Once the parties agree to move forward, Atlantic will coordinate an introductory meeting between the Adviser and a Trustee of the Trust. Implementation planning begins following the meeting and includes preparing for the Board meeting in which the Trustees will be asked to consider approving the Adviser’s Investment Advisory Agreement for the proposed fund(s).
Investment Advisory Agreement
The Investment Advisory Agreement defines the duties of a mutual fund investment adviser, including:
- Providing the Adviser full discretion to make investment decisions and execute trades on behalf of each fund;
- Requiring that the Adviser maintain records of its trading activity;
- Requiring that the Adviser communicate trades to the fund accountant and custodian daily;
- Requiring that the Adviser report to the Board about its operations and fund performance, at least quarterly, but also as matters arise that may impact the Adviser’s performance in connection with its Investment Advisory Agreement;
- Requiring that the Adviser maintain policies and procedures reasonably designed to prevent violating federal securities laws and that the Adviser report on compliance with those policies and procedures; and
- Defining the Adviser’s compensation and reimbursement obligations in connection with an Expense Limitation Agreement that limits the amount of expenses the fund(s) may pay, which in turn obligates the Adviser to waive its fees or reimburse the fund(s) if expenses exceed the expense limitation.
The Board will ensure an Investment Advisory Agreement is fair to shareholders and in doing so, will consider:
- The nature and quality of services to be provided;
- The appropriateness of the fees; and
- The structure of the Adviser’s compensation.
When considering whether to approve an Investment Advisory Agreement, Section 15(c) of the 1940 Act requires that the Board consider certain information about an Adviser. Advisers are requested to submit a detailed, written response to questions (15(c) Questionnaire) designed to enable the Board to fulfill its obligations under Section 15(c).
In support of the Board's process, an Adviser may expect to address:
Services to the Fund(s)
- Proposed advisory services to the Fund(s) and comparison to other advisory services provided
- Use of leverage
- Liquidity management to meet redemptions
- Anticipated operating issues
- Portfolio risks
- Distribution plan and expenses Adviser will bear; intended use of intermediaries, compensation arrangements and payment sources, i.e., Fund via 12b-1 plan or Adviser
- Adviser staffing and back-up procedures for critical staff
- Comparison of each Fund’s historical performance with other vehicles with the same strategy managed by the Adviser and with applicable peer groups
- Nature, extent and quality of sub-advisory services
- Frequent trade monitoring
- Proposed advisory and sub-advisory fees, if applicable, and expense cap
- Advisory fees and Fund expense comparison to Independent peer group (Lipper report)
- Comparison to fees charged for comparable funds or accounts managed by Adviser with a rationalization of any differences
- Economies of scale and appropriateness of break points
- Profitability from Fund operations
- Ability too obtain and monitor for best execution, brokers used, trading volumes, commissions paid and use of third-party research
- Form ADV
- Changes of control
- Primary business activities
- Operating agreement and organizational documents
- Upcoming initiatives and impact to business
- Assets under management
- Closures of material separately managed accounts
- Financial condition; ability to operate as a going concern, e.g., recent financials
- Insurance and assets to satisfy the deductible
- Cybersecurity and disaster recovery
- Adviser’s CCO and compliance staffing
- Sub-adviser oversight
- SEC and other exam results
- Summary of annual review and compliance problems
- Conflicts of interest and performance related compensation arrangements
- Investing in the Fund(s)
- Convictions; litigation
Trust and Trustee counsel reviews the Adviser’s 15c response and may request additional information or clarification. At the Board meeting to consider the Investment Advisory Agreement, the Adviser will be asked to attend in person to discuss the fund(s), its 15(c) response and the its qualifications and compensation.
Public Disclosure of Board Considerations
An investment company is required to disclose to shareholders the factors the Board considered and the conclusions it made in its decision to approve an Investment Advisory Agreement. Factors include:
- The nature, extent and quality of services to be provided by the Adviser.
- The investment performance of each fund and the Adviser.
- The costs of the services to be provided and the profits realized by the Adviser and its affiliates from the relationship with each fund.
- The extent to which economies of scale would be realized as each fund grows and whether fee levels reflect these economies of scale.
- Comparison to other advisory agreements, either for the same Adviser or another Adviser with a similar strategy, the Board relied upon.
These factors mirror the factors identified in case law resulting from actions against investment companies and investment advisers. The disclosure must be provided to shareholders within six months of the Board’s consideration and therefore such disclosure is typically included in a fund’s semi-annual or annual shareholder report.
Compliance – Adviser’s Policies and Procedures
Rule 38a-1 of the 1940 Act requires the Board to approve an Adviser’s written policies and procedures. The Trust's CCO will review an Adviser’s policies and procedures and work with the Adviser to address any gaps. The Trust’s CCO will review and recommend the Board approve the Adviser’s:
- Policies and procedures based on a finding that they are reasonably designed to prevent violations of the federal securities;
- Code of ethics (Code) based on a finding that the Code contains provisions reasonably necessary to prevent access persons from violating the Code; and
- Proxy voting procedures based on a finding that they are reasonably designed to vote fund securities in the best interest of each fund's shareholder.
The Code and proxy voting procedures will be filed as part of a fund's registration statement with the SEC and will be publicly available. Other sections of the Adviser's policy and procedures manual will not be publicly available.
The CCO’s review will address Adviser-related risks of noncompliance with federal securities laws. The following identifies typical policies and procedures the CCO will review.
- Code of Ethics
- Sales literature and advertising review
- Portfolio management
- Best execution
- Allocation of investments and trade aggregation
- Trade error correction
- Commodity pool operations
- Schedule 13D or 13G
- Proxy voting
- Derivative and segregation of assets
- Class actions
- Short selling (public offering)
- Record retention
- Information security
- Business continuity
- Sub-adviser oversight
The compliance review is typically an iterative process to ensure all gaps are addressed and the Trust CCO is comfortable recommending that the Board approve the Adviser’s policies and procedures.
A fund’s registration statement is prepared during implementation. The registration statement is comprised of thee parts: Part A - the prospectus, Part B - the Statement of Additional Information (SAI) and Part C - other exhibits and agreements of the Trust. Form N-1A is used by open-end management investment companies to register under the 1940 Act and offer shares under the Securities Act of 1933, and outlines the requirements for a mutual fund's registration statement filed with the U.S. Securities and Exchange Commission (SEC). Atlantic drafts a fund’s registration statement based on information provided by and discussions with the Adviser. Certain registration statement language is consistent across all series of the Trust and therefore the drafting process focuses on information specific to each fund and Adviser.
The process to prepare a fund’s registration statement for filing with the SEC typically requires 30 to 45 days. Once filed, the SEC will comment on the registration statement which will be automatically effective 75 days after the filing date. The registration statement drafting and filing process of 105 to 120 days defines the fund launch timeline.
Initial Board Meeting
To support a fund launch Atlantic will prepare an implementation timeline which includes preparation and review of the above materials for consideration by the Board. Forum Series Trust Board meetings typically occur in March, June, September and December (March and December meetings are in New York City and June and September meetings are in Portland, Maine). The timeframe to launch a fund is typically 105-120 days and therefore consideration of a new fund can usually be accommodated without convening a special Board meeting. In support of the implementation, the Adviser will be requested to:
- Review the Investment Advisory Agreement and Expense Limitation Agreement;
- Respond to the 15(c) Questionnaire;
- Provide its compliance policies and procedures; and
- Provide its pitch book.
The timing of the Board meeting and target fund launch date will influence response expectations and deadlines.
At the Board meeting, the Adviser will be asked to provide a presentation regarding each proposed fund and the Adviser’s operations. Advisers typically refer to their pitch books and responses to their 15(c) Questionnaire during their presentation to the Board.
In addition to the Adviser’s presentation, the Trust’s CCO will provide a report on the Adviser’s compliance policies and procedures, code of ethics and proxy voting policies. Trust counsel and counsel to the disinterested trustees may also discuss relevant factors of the materials provided and advise the Board.
The initial term of an Investment Advisory Agreement is two years with an annual renewal thereafter. The processes and considerations for renewal are similar to the initial approval. The Board will be asked to consider the investment advisory approval at an in-person meeting of the Board based on a presentation (in-person or telephonic) by the Adviser and review of the materials, i.e., 15(c) response and compliance update.
While there is much focus on the Investment Advisory Agreement approval process, providing transparency to the Board is an ongoing process. Advisers are requested to provide quarterly reporting to the Board and CCO, facilitated by questionnaires provided by the Atlantic. If issues or potential issues arise, Advisers are expected to escalate to Atlantic and the Trust’s CCO. Atlantic will work with the Adviser to assess the issue, identify corrective actions and report the matter to the Board.
To learn more about the process for launching a mutual fund, please contact Jessica Chase at 207 347 2016 or submit an inquiry via Contact Us.