June 27, 2007
IDC Releases Task Force Report on
Board Oversight of Certain Service Providers
The Independent Directors Council (IDC) recently released a report entitled “Board Oversight of Certain Service
Providers.” The report, produced by an IDC task force comprised of independent directors, offers boards
guidance regarding selection or review of the performance of the following fund service providers (SPs):
•
administrator
•
custodian
•
fund accounting agent
•
transfer agent
•
securities lending agent.
Examples of the kinds of services each of these providers may offer are included in the report, as are potential
criteria specific to each kind of SP that directors may want to consider as part of their oversight responsibilities.
The report focuses on general guidance, noting that directors should be “cognizant of the difference between
oversight, on one hand, and day-to-day management . . . on the other hand.” Highlights of the report, released on
June 11, are below.
Evaluating SP Agreements
•
Although board approval of contracts with the SPs generally are not required under either the Investment
Company Act of 1940 or any formal regulations of the SEC, “many boards are, nevertheless, involved to
some degree in the selection and approval process.”
•
Board evaluation of an SP agreement may include:
(i) “whether the agreement is in the best interest of the fund and its shareholders;
(ii) whether the services to be performed under the agreement are required for the operation of the fund;
(iii) whether the services provided are of a nature and quality at least equal to the same or similar services
provided by independent third parties; and
(iv) whether the fees for the services are fair and reasonable in light of the usual and customary charges
made by others for services of the same nature and quality.”
•
“Each SP agreement should clearly outline the scope of the provider’s responsibilities.”
Evaluating SPs
•
“Directors generally should understand the division of responsibilities among SPs.”
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Management is generally charged with providing information for initial evaluations of a proposed SP.
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•
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Upon selecting an SP for consideration, management should share its decision-making process with the
board (including, when appropriate, data such as cost comparisons and the capabilities and reputation of
the SP).
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Management also should “clearly describe the compensation to be paid under the proposed arrangement
and whether it expects to receive any ancillary benefits from the selection of the proposed SP.”
The timetable for review of existing SPs may vary due to different contract lengths. However, boards need
not wait until the contract is up for renewal; they may review SPs at any time.
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For existing SPs, the focus of evaluation may appropriately shift from indicative information (such as that
considered in evaluation of new SPs) to the SP’s actual performance over the prior contract period,
including its ability to improve if requested to do so.
•
As part of their evaluation of an SP, directors may consider the relationship between the SP and the fund’s
chief compliance officer, including whether the SP provides CCO support services as part of the standard
service package.
•
If a change in SPs is contemplated, a board should consider the potential costs and technical difficulties that
may be involved; if a change in SPs is certain, management should plan carefully to ensure that the transition
goes smoothly.
Evaluating Fees
•
“In assessing the level of [a] fee, boards should be aware of the nature and extent of the services that will be
provided in return for the fee, including any indirect benefit or compensation to the provider that may arise
from its relationship with the fund.”
•
A board may tailor its fee evaluation to accommodate the specific factors of an arrangement.
•
“The general standard for assessing fees is whether they are reasonable in light of the services to be
provided;” to assess this, boards may “consider comparative data provided by third-party vendors or
consultants.”
Evaluating Potential Conflicts of Interest
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“. . . [T]he board should be alert for any arrangements that could unfairly benefit the adviser or others to the
detriment of the fund and its shareholders.”
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•
“Fund management should fully disclose . . . potential conflicts, as well as any circumstances in which
one fund may benefit to the disadvantage of, or disproportionately to, another fund (or type of fund) in the
same complex.”
“In general, directors reviewing arrangements involving funds, management, and SPs should seek to assure
themselves, after consultation with counsel, the fund’s CCO, and/or independent consultants, that:
(i) they are satisfied with the information they receive,
(ii) they have been informed about the extent of the relationship between the parties, and
(iii) any required disclosure to shareholders has been or will be made.”
2
•
“Directors should be especially attuned to the potential conflicts of interest that may arise between the fund
and a SP that is affiliated with the fund’s adviser.”
-
•
“When an adviser receives a material benefit as a result of an arrangement with a fund’s SP, boards
should include a review of the arrangement as part of the fund’s annual advisory contract review.”
Boards should be mindful that conflicts of interest may arise not only with affiliated SPs but also with
unaffiliated SPs.
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For example, a board might inquire about the existence of any revenue or expense sharing agreement
between the third-party SP and fund management or its affiliates.
Ongoing Oversight of SPs
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“The board typically is engaged in ongoing oversight of the quality of services received by the fund from its
providers,” though the way this oversight is conducted “will depend on the facts and circumstances of each
fund.”
•
For affiliated SPs, the board’s oversight role may be more substantial due to “the greater potential for conflicts
of interest inherent in these relationships.”
•
“A fund should have a system to monitor the quality of services provided;” this monitoring will likely include
input from management.
Although the report finds that the nature and extent of board involvement in SP selection and oversight varies
across the fund industry according to funds’ different SP structures and needs, it stresses that “regardless of the
extent of that involvement, directors should be aware of the potential for conflicts of interest that may arise under
certain circumstances and the protections in place to address such conflicts.”
For further information, please contact Cameron Avery 312-807-4302, Kevin Bettsteller 312-807-4442,
Paul Dykstra 312-781-6029, Jennifer Esquibel 312-807-4262, Alan Goldberg 312-807-4227, Anna Paglia 312-781-7163,
Alicia Perla 312-807-4318, Andrew Pfau 312-807-4386, Paulita Pike 312-781-6027, Bruce Rosenblum 202-955-7087,
Donald Weiss 312-807-4303 or Stacy Winick 202-955-7040 of Bell, Boyd & Lloyd’s Investment Management and Financial
Markets Group or visit our Web site at www.bellboyd.com.
This publication has been prepared by the Investment Management and Financial Markets Group of Bell, Boyd & Lloyd for
clients and friends of the firm and is for information only. It is not a substitute for legal advice or individual analysis of a
particular legal matter. Readers should not act without seeking professional legal counsel. Transmission and receipt of this
publication does not create an attorney-client relationship.
© 2007 Bell, Boyd & Lloyd LLP All Rights Reserved
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