Practical insights on fund mergers for independent directors

February 8, 2019

By Joanne A. Skerrett, Mutual Fund Directors Forum

The upward trend in industry consolidation is expected to continue into 2019 with increasing mergers of funds and investment adviser acquisitions. Investment advisers or their parent companies combine, reorganize and restructure to grow and streamline their businesses or gain access to new markets, technology or expertise. Fund mergers have been a time-tested way to manage a complex’s fund lineup, and the decision to merge away or acquire a new fund is often a prudent strategic move. These transactions implicate Securities and Exchange Commission rules and regulations and hold practical and legal considerations for fund independent directors. This article will focus on a board’s role in mergers between funds.


It is likely that during their time on a fund board, most directors will have to consider at least one merger proposal within their fund complex, or an affiliated merger. Directors must make a number of critical legal and business determinations before approving a particular transaction.


From proposal to consummation, a fund merger transaction may last over several months, or even years, depending on complexity. Necessary steps include everything from the initial proposal from the adviser, negotiation of the advisory contract, and, if necessary, preparation and review of proxy proposals and filings, and holding shareholder meetings. Boards will need adequate time to gather information from the adviser, conduct due diligence of the materials received, and make their determinations and approvals.


When a merger is being considered, board discussions typically include a comparison of the merging funds’ investment objectives, policies, strategies and risks; fund performance; distribution and other fund services; repositioning of fund securities (i.e. retaining or selling securities); direct costs of the merger, comparison of fund fees and expenses; board composition; and director insurance and indemnification. A thorough record of the board’s determinations should be recorded in the board’s meeting minutes.


Adviser’s Perspective

An adviser may consider a merger to address the following issues, particularly if they are sustained over a significant period of time:


  • slow asset inflows or increasing outflows,
  • short or unimpressive performance track record,
  • high loads, and/or
  • poor performance.


A fund complex with struggling or inefficient funds is likely to prefer to maintain its assets under management, and a fund merger may better accomplish that goal than fund liquidation, which results in the loss of assets and may be taxable for investors.


An adviser will consider the costs and structure of the merger and the expected impact on its business and then evaluate the acquiring and acquired funds considering, among other things: 


  • which will be the fund accounting survivor (which is not always the surviving entity);
  • the compatibility of the merging funds’ share classes;
  • the similarity of the funds’ investment objectives and policies; and
  • distribution channels for the surviving fund.


These adviser considerations bear heavily on the board’s consideration of whether the proposed merger is in the best interests of a fund and its shareholders, and directors may wish to carefully evaluate the adviser’s analysis with input from independent counsel. A fund merger is not always an appropriate solution, and the adviser may present options for the board’s consideration, including replacing the fund’s portfolio manager, liquidating the fund, or selling the fund to another adviser.


Regulatory Considerations

Once a merger is agreed to, directors of both the acquiring fund board and the target fund board are obligated to ensure that shareholders are treated fairly and that shareholder economic interests are protected. Under most states’ laws, the business judgment rule presumes directors will act on an informed basis and in good faith to determine whether a transaction is in the fund’s best interests.[1] Directors have a duty of care under state laws to act diligently and in good faith and a duty of loyalty to act in the best interests the fund and its shareholders.[2] In addition, the Investment Company Act of 1940 requires fund independent directors to make certain determinations before approving a new advisory contract or a fund merger.[3] On a practical level, fund directors will need to commit to overseeing the merger process, which can, at minimum, include extensive due diligence and reviewing and approval of regulatory filings. The board will have to make the following determinations before approving a fund merger:


  • The adviser considered alternative actions besides merging the fund.
  • The merger is in the best interests of the fund.
  • The adviser has provided enough information to help the board evaluate the transaction and inform its determinations.
  • The merger will not dilute the interests of existing shareholders.


Key 1940 Act Considerations

The boards of both the acquiring fund and the acquired fund, including a majority of the independent directors of each fund, must determine that the merger is in the fund’s and shareholders’ best interests and will not dilute the interests of the fund shareholders.[4]


The Securities and Exchange Commission has recommended[5] specific factors boards should consider before approving fund mergers, including:


  • fees or expenses in connection with the merger that will be borne directly or indirectly by the fund;
  • the effect of the merger on annual fund operating expenses and shareholder fees and services;
  • any change in fees or expenses to be paid or borne by shareholders of the fund (directly or indirectly) after the merger;
  • any direct or indirect federal income tax consequences of the transaction to fund shareholders.


These recommendations are non-exhaustive and are meant to guide the board’s process. A board’s considerations will be determined by the characteristics of each merger transaction. In making those determinations, directors also may consider the following factors, if relevant:


  • any change in services to be provided to shareholders of the fund after the merger;
  • any change in the fund’s investment objectives, policies and restrictions;    
  • any change in investment adviser;
  • the net assets and performance record of the acquired and acquiring fund;
  • whether one fund has certain tax benefits or disadvantages that should be reflected in the price at which its shares are exchanged in the transaction;
  • the experience of the portfolio managers who will manage the surviving fund;
  • the expected timeline and costs of buying and selling securities to reposition the portfolio and how portfolio repositioning costs will be allocated;
  • the compliance background of the adviser and service providers to the surviving fund;
  • the current lineup of funds in the adviser’s complex; and
  • potential for more efficient cost allocations.


Contract Review Process, Shareholder Approval

The same analysis of factors[6] that directors undertake when evaluating whether an advisory fee is fair or reasonable will be applied in considering the new advisory contract in a fund merger. The board, with the assistance of independent counsel, should give comprehensive and diligent review to the investment advisory contract and all related materials, particularly in light of private litigation challenging advisory fees.


Under the 1940 Act, the shareholders of the acquired fund must vote to approve a fund merger unless the two funds being merged share the same adviser, investment objectives, principal policies, and risks, and the distribution fees will remain the same (or be lower); and a majority of the disinterested directors of the acquiring fund comprises persons who were elected disinterested directors of the acquired fund.[7] Additionally, a fund’s governing documents, and/or the statutory requirements of the fund’s domicile determine whether shareholders of the acquired fund need to approve the merger at a shareholder meeting. For mergers requiring shareholder approval, the board has increased responsibilities, including setting the shareholder meeting date and authorizing the preparation of a proxy statement that will be filed with the SEC and mailed to shareholders.


Role of Experts

A fund board typically will not oversee a fund merger on its own. Independent counsel, fund counsel, and tax counsel can help a board evaluate the fiduciary, financial and tax aspects of the transaction. For certain complex transactions, involving business development companies for instance, accounting, valuation and pricing specialists may be necessary. Independent counsel also can help fund directors understand the structure of the transaction to ensure it complies with regulatory standards and manage board reorganization and governance issues.


Overall, boards should seek to undertake their oversight responsibilities with diligence, and maintain a cooperative and accountable relationship with the adviser, while prioritizing the interests of the fund and its shareholders.

Joanne A. Skerrett is counsel to the Mutual Fund Directors Forum, which she joined in September 2016. Prior to that, she was in private practice at Sullivan & Worcester LLP, Seward & Kissel LLP, and K&L Gates LLP.


[1] See The Board’s Role in M&A Transactions, Holly Gregory, Sidley Austin LLP. Available at:

[2] See Smith v. Van Gorkum, 488A.2d 858 (Del. 1985).

[3] Rule 17a-8 of the 1940 Act permits affiliated fund mergers regardless of the reasons for the funds' affiliation. The rule requires that each fund's board (including a majority of disinterested directors) determine that the merger is in the best interests of the fund and will not dilute the interests of shareholders. 

[4] See Rule 17a-8(a)(2) of the 1940 Act.

[5]Rule 17a-8 of the 1940 Act. See SEC Release No. IC-25666; File No. S7-21-01, July 26, 2002. Available at:

[6]The “Gartenberg” factors cited in the Supreme Court case Jones v. Harris Associates L.P., 559 U.S. 335 (2010) include: The nature and quality of the adviser’s services; the performance of the fund and the adviser; the adviser’s cost in providing services to the fund; the profitability of the fund to the adviser; the extent to which the adviser realizes economies of scale as the fund grows larger; fee structures for comparable funds; any “fall-out” benefits accruing to the adviser or its affiliates; and the independence, expertise, care, and conscientiousness of the board. 

[7] See Rule 17a-8(a)(3) of the 1940 Act.



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