Investment Adviser Settles Charges for Failing to Disclose a Material Side Letter Agreement in Application for Exemptive Relief

September 2, 2016

The Securities and Exchange Commission (“SEC”) recently announced its settlement of charges against a registered investment adviser (the “Adviser”) for failing to disclose a material side letter agreement in an application for exemptive relief. The exemptive application, jointly submitted by the Adviser and the registered investment company (the “Trust”) that engaged the Adviser on behalf of two of the Trust’s portfolios (the “Funds”), sought relief from the 1940 Act requirement to obtain shareholder approval to enter into and materially amend advisory agreements. The SEC determined that the Adviser violated Section 34(b) of the Investment Company Act of 1940, as amended (the “1940 Act”) by, among other things, not disclosing to the SEC staff in connection with its review of the exemptive application a side letter between the Adviser and a subadviser (the “Subadviser”) relating to the ability of the Adviser to terminate the Subadviser.

The initial exemptive application disclosed that the Adviser had agreed to make termination payments to the Subadviser if the Adviser recommended the termination of the Subadviser for a reason other than cause. The Staff indicated that it would not support the application for exemptive relief unless the termination provision was removed.

Subsequently, the Adviser agreed to terminate the side letter and an amended application was filed. Prior to filing the amended application, however, the Adviser agreed to waive its ability to terminate, or recommend the termination of, the Subadviser. The Staff was not informed of this waiver agreement, and the amended application did not disclose any restrictions on the Adviser’s oversight of the Subadviser. In addition, disclosures in the Funds’ prospectuses and statements of additional information conflicted with and failed to disclose the terms of the waiver agreement. Following the filing of the amended application, and in the absence of any information about the waiver agreement, the Staff granted the exemptive order.

In the SEC’s view, the waiver agreement was material to the Staff’s evaluation of the request for exemptive relief. Consequently, the SEC determined that the Adviser willfully violated, and caused the Trust to violate, Section 34(b).

In light of this settlement, advisers and subadvisers to registered funds operating under manager-of-managers arrangements should examine the terms of their arrangements and consider whether any arrangement limits or otherwise restricts a party from exercising its fiduciary duties to a fund and its shareholders. These advisers and subadvisers should also assess whether any arrangement creates a conflict of interest in exercising their fiduciary duties, and if adequate disclosures relating to such arrangements have been made.


If you have any questions regarding the matters covered in this memo, please contact any of the partners and counsel listed below or your primary attorney in Seward & Kissel’s Investment Management Group.