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News July 5, 2004 Issue

Some Advisers Exiting Fund Business Due to Compliance Costs

Several advisory firms are looking to merge their proprietary funds out of existence by October 5, rather than face the costs of developing a compliance program encompassing the federal securities laws.

One source told IM Insight about an adviser "that was specifically looking to get rid of their mutual fund business before October 5." The source said that they were shopping around for a buyer so that they would not have to comply with the compliance program rule. "That was their goal," said the source.

Several other fund lawyers also reported hearing that small fund companies are shopping around for buyers specifically as a result of the compliance rule.

The problem isnít the cost of hiring a CCO, explained Bingham McCutchen partner Roger Joseph. Itís the cost of developing a set of procedures in which "everything you need to comply with the federal securities laws is written down professionally and competently." Smaller fund companies "just canít do this," he said. "Itís too expensive." Joseph predicted that while many small fund groups will do their best to comply with the rules, some smaller fund groups will be acquired by larger ones, resulting in a greater concentration of the industry.

And, added Joseph, advisers will be dissuaded from setting up funds. The fund compliance rule, he said, has created "high and real barriers to entry."

In the past, many small institutional advisers created their own proprietary funds to cater to clients who asked for a pooled product instead of separately managed accounts. As a result of the compliance program rule, said one fund lawyer, it is likely that advisers will "think twice before doing that" in the future. "There are real implications to this," he added.

For more on the costs of compliance, check out the February 23 comment letter†on the compliance rule submitted by the independent directors of a closed-end fund managed by Flaherty & Crumrine.