Adviser’s Expense Allocation Plan Gets Thumbs Down From SEC Staff

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By Phyllis Diamond

Mutual of America Life Insurance Co.'s wholly owned advisory subsidiary could risk enforcement action if it proceeds with its plans to allocate the operating expenses of a fund it advises without prior SEC approval, the agency’s staff said Oct. 26.

The allocation plan proposed by the adviser, Mutual of America Capital Management LLC, “creates the potential for conflicts of interest,” and could work to disadvantage some funds, the Securities and Exchange Commission Division of Investment Management said.

Richard D. Marshall of Katten Muchin Rosenman LLP, New York, said the fund, an open-end management investment company, is organized as a series fund with multiple series, each a fund. There currently are 25 funds, which serve as investment vehicles for account balances under variable insurance products of the parent company.

Eleven of the funds invest directly in securities to meet their investment objectives. according to Marshall. The other 14 funds invest solely in shares of underlying funds—the funds of funds. The funds have a common board, a majority of which is independent. The funds or the independent directors may want to have the funds of funds’ non-advisory operating expenses borne by the underlying funds, the attorney said.

He asked the staff not to recommend enforcement action under 1940 Investment Company Act Section 17(d) and Rule 17d-1, which restrict transactions between affiliated parties. According to counsel, the funds shouldn’t be considered affiliated with each other for purposes of the proposed expense allocations. Even if the staff were to consider the funds affiliated persons of each other, he said, the proposed expense allocations shouldn’t be precluded by Section 17(d) and Rule 17d-1.

“The abuses that Section 17(d) were designed to prevent are simply not present,” Marshall said, “and expense allocation decisions by Independent Directors should not represent a `joint enterprise or other joint arrangement or profits-sharing plan’ within the meaning of Rule 17d-1" that would require an SEC exemptive order.

Staff Response

The staff didn’t agree. In a letter signed by Senior Counsel Jean E. Minarick, it said some of the operating expenses proposed to be allocated to the underlying funds wouldn’t be incurred by the underlying funds “but rather would be incurred by or attributable solely to the Funds of Funds.”

This creates the potential for conflicts of interest and for participation by a fund on a basis less advantageous than that of other participants. This potential isn’t present, or is present to a much lesser degree, “in the typical industry practice of allocating certain shared expenses among the relevant funds in a fund family without an order under rule 17d-1.”

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