Investment Management
APRIL 2004
SEC Proposes New Disclosure on Portfolio Managers
The Securities and Exchange Commission (“SEC”)
recently proposed new disclosure requirements
related to portfolio managers of registered investment
companies. The proposals would require funds to
disclose: (1) the individual team members of portfolio
management teams; (2) the other accounts managed
by fund managers and the potential conflicts of
interest involved in managing those other accounts;
(3) the structure of portfolio manager compensation;
and (4) the ownership interests of portfolio managers
in the funds and other accounts they manage, as well
as other accounts managed by the same investment
adviser.1
PORTFOLIO MANAGEMENT TEAM MEMBERS
These proposals are designed to increase
transparency regarding the identity of portfolio
managers, their incentives in managing a fund and
the potential conflicts of interest they may encounter
in managing multiple investment accounts. The
proposals attempt to address the issues involved in
the side-by-side management of registered
investment companies and unregistered hedge funds,
as well as the conflicts and incentives involved in
managing other accounts with performance-based
fees. Comments on these proposals must be
submitted to the SEC on or before May 21, 2004.
In the release proposing these disclosure
amendments (“Proposing Release”), the SEC
explained that some observers have argued that the
use of portfolio management teams has provided
funds with a way to avoid disclosing who is
responsible for managing a fund and how long (or
briefly) a manager has held that position.3 Although
not expressly discussed in the Proposing Release,
the portfolio management team concept could be
used as a means to manipulate the portability of a
manager’s prior performance. For example, when
individual portfolio management team members and
The proposed amendments would require funds to
state in their prospectuses the name, title, length of
service, and business experience of each member of a
portfolio management team. Under current
requirements, investment companies managed by a
committee or team are not required to give
information about the individuals comprising the
group, but are simply required to state that the fund
is managed by a group.2 The proposals also would
require funds to include a brief description of the role
of each member on the portfolio management team,
such as “lead member.”
1
The proposals would amend Forms N-1A, N-2 and N-3, the registration forms used by management investment
companies to register their shares under the Investment Company Act of 1940 (“1940 Act”) and to offer their securities
under the Securities Act of 1933. With respect to closed-end investment companies, the proposals would amend Form
N-CSR under the 1940 Act and the Securities Exchange Act of 1934, the form on which investment companies file
shareholder reports with the SEC. The SEC proposed that closed-end funds provide the disclosures in their annual reports
on Form N-CSR since they are not required to update their registration statements annually.
2
Form N-3, the registration form used by insurance company managed separate accounts that issue variable annuity
contracts, does not currently require disclosure about portfolio managers. The proposed amendments would require these
separate accounts to make the same disclosures relating to portfolio managers required by the other investment company
forms, including disclosure about the individual members of a portfolio management team.
3
Investment Company Act Release No. 26383 (Mar. 11, 2004).
Kirkpatrick & Lockhart LLP
their roles are not identified, a portfolio manager who
moves to a different fund group could claim that he
was the team member primarily responsible for
managing another similarly managed fund at the
previous adviser who employed him, and use that
fund’s prior performance to his advantage.4 The SEC
is seeking comment on whether all members of a
portfolio management team should be identified or
only certain members, such as the lead member, and
whether the disclosures should be required of all
team members.
OTHER ACCOUNTS MANAGED BY THE FUND
MANAGER AND POTENTIAL CONFLICTS
OF INTEREST
Under the proposed amendments, a registered
investment company would be required to provide
information in its Statement of Additional Information
(“SAI”) regarding other accounts for which the
fund’s portfolio manager has day-to-day management
duties. The disclosure would include the total
number of other accounts, the total assets in the
accounts and the number of accounts and total
assets for which the adviser receives a performancebased fee. “Accounts” include registered and
unregistered investment companies, other pooled
investment vehicles and other accounts. In addition,
if a fund’s portfolio manager is part of a team that
manages another account and that team is jointly and
primarily responsible for the day-to-day management
of that account, the fund would be required to
include the required disclosures regarding that
account.5
The proposals also would require disclosure of the
potential conflicts of interest involved in managing a
fund and these other accounts. The Proposing
Release states that this disclosure would include, for
example, conflicts between the fund’s investment
strategy and the investment strategy of the other
accounts managed by the fund’s portfolio manager
and conflicts in allocation of investment
opportunities between the fund and the other
accounts. Funds would also be required to disclose
the policies and procedures they or their advisers use
to address such conflicts. Alternatively, funds would
be permitted to include a copy of these policies and
procedures.6
The SEC is seeking comment specifically on whether
it should prohibit portfolio managers of registered
funds from managing certain types of accounts. It is
not clear from the Proposing Release whether the
SEC believes that requiring that such conflicts be
disclosed could alleviate the conflicts involved in
side-by-side management.
PORTFOLIO MANAGER COMPENSATION
STRUCTURE
Under the proposed amendments, funds also would
be required to disclose in their SAIs the structure of,
and the method and criteria used to determine, the
compensation of their portfolio managers. The
disclosure would be required to include information
about the compensation received by a fund’s
portfolio manager with respect to management of the
fund as well as any other accounts managed by the
portfolio manager. According to the Proposing
Release, compensation would include, without
limitation, salary, bonus, deferred compensation and
pension and retirement plans and arrangements and
any non-cash compensation. Funds would not need
to disclose the actual amount of the compensation,
although the SEC is seeking comment on whether
this information should be disclosed. Critics of the
proposal have argued that fund managers who do
not want information regarding their compensation
shared with the public will choose to manage only
unregistered investment vehicles, particularly if the
proposal is revised to require disclosure of the actual
dollar amount of a manager’s compensation.
4
See, e.g., Bramwell Growth Fund, SEC No-Act. (Aug. 7, 1996) (permitting use of portfolio manager’s prior performance
information at another firm because she had primary responsibility for managing the old fund and played the same role in
managing the new fund).
5
The Proposing Release does not clarify what it means to be “jointly and primarily responsible.” However, it appears that
a fund would not be required to include the disclosures relating to the other account, for example, if that account is
managed by a team that designates a lead member and the fund’s portfolio manager is not the lead member of the team
that manages the other account.
6
These types of procedures are already required by Rule 38a-1 under the 1940 Act.
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2
The description of compensation would be required
to disclose any differences in the compensation
received for managing the fund versus other
accounts, including, for example, whether the
manager receives a portion of a performance-based
fee on some accounts other than the fund.
According to the Proposing Release, this information
would assist investors in assessing the manager’s
incentives. For each type of compensation, funds
would be required to describe the criteria on which
the compensation is based, e.g., whether
compensation is based on before- or after-tax
performance and whether compensation is based on
the value of assets in the fund’s portfolio.
SECURITIES OWNERSHIP OF PORTFOLIO
MANAGERS
The proposed disclosure amendments would require
a fund to disclose in a tabular format in its SAI the
dollar range of securities owned beneficially or of
record by the fund’s portfolio manager in the fund
and in other accounts managed by an investment
adviser of the fund, or by any person directly or
indirectly controlling, controlled by, or under
common control with an investment adviser or
principal underwriter of the fund. The dollar ranges
would mirror the current requirements for disclosure
of fund shares owned by the fund’s directors. The
disclosure would apply to the portfolio manager and
his immediate family members; “immediate family
members” is defined as a person’s spouse, child
residing in the person’s household (including step
and adoptive children) and any dependent of the
person, as defined in section 152 of the Internal
Revenue Code. According to the Proposing Release,
this would assist investors in assessing the potential
conflicts of interest between their interests and the
interests of other clients or investment accounts in
which the manager holds an interest.
Among other issues, the SEC is seeking comment on:
(1) whether the groups of accounts covered by the
proposal are too broad or too narrow; (2) whether the
actual value (as opposed to the dollar range) of
securities owned by the portfolio manager is more
appropriate; and (3) whether a fund should be
required to disclose the percentage of a portfolio
manager’s net worth that is invested in securities of
the fund or other accounts. As noted above, critics
of the proposal have argued that fund managers who
do not want this information shared with the public
will choose to manage only unregistered investment
vehicles, particularly if the proposal is revised to
include some reference to the portfolio manager’s net
worth.
Compiling the required information, particularly for
fund groups that have funds with different fiscal
year-ends, may prove quite burdensome. With
respect to the portfolio manager’s securities
ownership, as well as the information regarding other
accounts managed and compensation structure, the
proposals require that the information be provided as
of the fund’s most recently completed fiscal year.
Thus, funds would be required to update this
disclosure annually. Funds would not be required to
update their SAIs during the year, except to identify a
new portfolio manager and provide the disclosure for
that new manager. Similarly, an initial registration
statement or an update to an existing registration
statement that identifies a new portfolio manager
(including post-effective amendments for a new
series) would be required to include the disclosures
as of the most recent practicable date and identify
that date.
AVAILABILITY OF INFORMATION AND
ACCESS TO SAI
The SEC also proposed to require, adjacent to the
disclosure identifying the portfolio managers, new
disclosure that the SAI provides additional
information regarding portfolio managers’
compensation, other accounts managed by the
portfolio managers, and the portfolio managers’
ownership of securities and other accounts managed
by the investment adviser or portfolio managers. In
addition, in order to encourage funds to provide
greater access to investors to the SAI, the SEC also
proposed to require that the back cover page of
mutual fund prospectuses state whether the fund
makes available its SAI and shareholder reports, free
of charge, on or through its website at a specified
Internet address. If it does not, it must disclose the
reasons why it does not do so, including why the
fund does not have a website. These proposals have
the potential to penalize smaller firms that have not
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3
established websites. By requiring such disclosure,
the SEC is effectively requiring firms to have the
technology in place or risk being singled out for
failing to do so. Funds may (but are not required to)
indicate that the SAI, shareholder reports and other
information are available by e-mail request.
The SEC has proposed similar disclosure for the front
cover page of the prospectus for closed-end funds
and insurance company separate accounts that issue
variable annuity contracts. The proposals also
would require the front cover page of the
prospectuses for these entities to include a statement
explaining how the shareholder reports can be
obtained, and a toll-free (or collect) telephone
number for investors to call and request the SAI,
shareholder reports and other information, and to
make shareholder inquiries.
DISCLOSURE RELATING TO PORTFOLIO
MANAGERS OF INDEX FUNDS
Currently, index funds are excluded from the
requirement to identify and provide disclosure
regarding their portfolio managers in fund
prospectuses. Index funds were originally excluded
from this requirement because of the mechanical
nature of the portfolio management of these funds.
The SEC proposals would extend to index funds the
existing and proposed disclosure requirements
relating to portfolio managers. The Proposing
Release explains that such disclosure would assist
investors in assessing whether the portfolio
manager’s interests are aligned with fund
shareholders’ and the potential conflicts of interest
involved in managing an index fund and other
accounts, such as allocation of trading execution
priorities.
*
*
*
This article does not address all of the issues raised
by the proposed disclosure requirements. If you
wish to obtain more information on the proposals,
please contact your K&L relationship attorney
or the author of this article, Lori Schneider, at
(202) 778-9305.
LORI SCHNEIDER
202.778.9305
lschneider@kl.com
Kirkpatrick & Lockhart LLP
4
Kirkpatrick & Lockhart LLP maintains one of the leading investment management practices in the United States,
with more than 60 lawyers devoting all or a substantial portion of their practice to this area and its related
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variety of projects, including legislative and policy matters.
We work with clients in connection with the full range of investment company industry products and activities,
including all types of open-end and closed-end investment companies, funds of hedge funds, variable insurance
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visit our website at www.kl.com for more information, or send general inquiries via email to
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