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News January 19, 2009 Issue

Donohue: Boards Should Give Extra Scrutiny to 15(c) Reviews This Year

Division of Investment Management director Buddy Donohue wants mutual fund boards of directors to conduct an especially diligent annual 15(c) review this year. "[M]arket events in 2008 likely have driven fund expense ratios up, fund performance down, and have impacted investment adviser profitability," said Donohue. Given those events, "this year, the 15(c) process will be even more critically important."

Speaking at a January 13 Mutual Fund Directors Forum conference, Donohue highlighted certain issues that fund directors "will likely want to consider" when evaluating fund advisory contracts. For example, if a fund with an expense cap has experienced an increase in its expense ratio due to a decline in asset values or redemptions, is it appropriate to modify or eliminate the expense cap? If so, what standard should the board employ to determine any such modification?

Donohue also had words of caution for boards of funds that use peer group benchmarks to analyze fees and expense ratios. When evaluating funds against a peer group, boards "should be mindful" that funds that historically comprised the peer group "may no longer be a member of that group or have comparable assets under management," he said. "The challenges you face in evaluating certain data regarding peer funds, especially historical expense ratio and other cost data, are not insignificant." Given the presence of "extreme conditions," directors should be "sensitive" to the limitations of using data for comparison purposes. This sensitivity, he said, "will be particularly essential in the coming year."

In other news: Donohue said that following his "Directors Outreach" initiative, the IM Division is considering whether to recommend rule changes that would allow independent directors to delegate certain responsibilities to others. The rule changes also would unify the requirements imposed on independent directors in certain ICA exemptive rules.