Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, May 2, 2013

SEC Charges Gatekeepers of Two Mutual Fund Trusts with Inaccurate Disclosures

The SEC charged the gatekeepers of a pair of mutual fund trusts with causing untrue or misleading disclosures about the factors they considered when approving or renewing investment advisory contracts on behalf of shareholders.

An SEC investigation that arose from an examination of the Northern Lights Fund Trust and the Northern Lights Variable Trust found that some of the trusts' shareholder reports either misrepresented material information considered by the trustees or omitted material information about how they evaluated certain factors in reaching their decisions on behalf of the funds and their shareholders. The trustees and the trusts' chief compliance officer Northern Lights Compliance Services (NLCS) were responsible for causing violations of the SEC's compliance rule, and the trusts' fund administrator Gemini Fund Services (GFS) caused violations of the Investment Company Act recordkeeping and reporting provisions.

The firms and the trustees have agreed to settle the SEC's charges.

The five trustees named in the SEC enforcement action are: Michael Miola of Arizona, Lester M. Bryan of Utah, Anthony J. Hertl of Florida, Gary W. Lanzen of Nevada, and Mark H. Taylor of Ohio.

Some trusts are created as turnkey mutual fund operations that launch numerous funds to be managed by different unaffiliated advisers and overseen by a single board of trustees. The federal securities laws require all mutual fund directors to evaluate and approve a fund's contract with its investment adviser, and the funds must report back to shareholders about the material factors considered by the directors in making these decisions. The SEC Enforcement Division's Asset Management Unit has been taking a widespread look into the investment advisory contract renewal process and fee arrangements in the fund industry.

According to the SEC's order instituting settled administrative proceedings, the Northern Lights trusts included up to 71 mutual fund series from January 2009 to December 2010, most of which were managed by different advisers and sub-advisers. The trustees conducted 15 board meetings during that time period, and made decisions about 113 advisory and 32 sub-advisory contracts during what's known as the 15(c) process. Section 15(c) of the Investment Company Act requires fund directors to request and evaluate information that is reasonably necessary to evaluate the terms of any contract for an investment adviser of a registered investment company.

The SEC's order found that some boilerplate disclosures related to the 15(c) process that were included by GFS in some fund series shareholder reports contained untrue or misleading information. For example, one disclosure claimed that the trustees had considered peer group information about the advisory fee, however no such data had been provided to the trustees. Other disclosures misleadingly indicated that the fund's advisory fee was not materially higher than its peer group range, when in fact the fee was nearly double the peer group's mean fee or even higher. GFS failed to ensure that certain shareholder reports contained the required disclosures about the trustees' evaluation process and failed to ensure that certain series within the trusts maintained and preserved their 15(c) files.

The SEC's order also found that certain mutual fund series did not follow their policies and procedures for the trustees' approval of the investment advisers' compliance programs. Fund boards are required to approve the policies and procedures of service providers to a fund, including its adviser. The policies and procedures of each series within the Northern Lights trusts stated that the trustees could approve the compliance program of each series' investment adviser based on their review of an adviser's compliance manual or based on a summary provided by NLCS that familiarized them with the salient features of the compliance program and provided a good understanding of how the program addressed particularly significant compliance risks. Rather than following this process, the trustees' approval of the advisers' compliance programs was based primarily on their review of a brief written statement prepared by NLCS saying that the advisers' compliance manuals were "sufficient and in use" and a verbal representation by NLCS that such manuals were adequate.

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