Fund Boards: Much has changed; expectations have not

April 23, 2020

By Todd Spillane, Mercury Compliance and Risk Services

As the world progresses through these unprecedented and difficult economic times, mutual fund boards are faced with enormous issues to oversee the funds in their charge. Boards must feel certain that management companies have a solid plan to address the concerns currently facing each fund complex. Below I will highlight some of these issues to give board members a road map for this process.


The first critical assumption is that the virus can and will impact virtually every person in some way. There can be no assumption that anyone is immune, and therefore both the risk assessment and the business continuity plans must receive close scrutiny. Boards may not have really delved into the risk assessment spectrum other than in the area of cybersecurity. While cyber is important, there are many more significant risks that fund boards need to understand, as well as what their management companies are doing about mitigating those risks.


There are many areas of concern for boards to consider, but at a high level the issues can be broken down to the following four areas:


  1. business continuity considerations
  2. business-related issues
  3. regulatory requirements
  4. board-specific issues


Business Continuity Considerations

  • Business Continuity Plan — Business continuity is clearly the critical focus at this time, and will most likely remain critically important for the foreseeable future. The questions the Securities and Exchange Commission will ask during the next examination are: How did the BCP plan work? What changes did you find that you needed to make to the plan? Did you include a pandemic event in your plan, and what new risks did the funds face because of the pandemic? Because boards have an oversight role, I would not be surprised to hear that the SEC staff would like to talk to board members as part of a routine examination to find out what information was shared with the board and when it was shared.
  • Staffing — Board members must consider the quantitative aspects of overseeing the funds, but the qualitative factors (human capital) are just as important. The questions to pose to the managers are: Have employees been impacted? Have the managers had to reduce staff and if so, in what areas? What does this mean for the managers' ability to manage the fund assets either in-house or by your sub-advisers?
  • Working from Home — Non-essential employees are working from home to the best of their abilities, but the important question is: Are the essential areas (fund accounting, operations, valuations, portfolio management, trading, technology) able to get the daily work done on a timely basis? The board should be comfortable with the reports (either written or oral, but written is preferable) from each key department on their current status of staffing, production, timeliness, and accuracy and must reflect information on any degradation in the level of services. The chief compliance officer can be invaluable here, providing information on "trade errors" and also the number of cancelled and rebooked trades. Trade errors and cancelled and rebooked trades are a good leading indicator to see if the portfolio management and trading functions are working efficiently.
  • Succession planning — Firms must establish what they plan to do if a portfolio manager is impacted or if a number of employees from operations, fund accounting or compliance are impacted?


Business-Related Issues

  • Firm financials — Has the fund sponsor decided to pursue any government loans or grants?
  • Key-person risk — Consideration to staff in general, not just your "star" portfolio manager but others key parts of the business.
  • Third-party service providers — What is the management company doing to make sure that the business relationship is sustainable, and can they continue to provide the required services at the same level as before the crisis? 
  • Subscriptions and redemptions — Normally boards look to see what the overall fund family is doing in terms of subscription and redemption activity. In a crisis situation, boards should look at this activity very closely. Management must be acutely aware of the potential liquidity issues that may occur due to a sharp increase in the number of redemption requests.


Regulatory Issues

  • Disclosures — Is fund counsel coordinated with legal in the event a disclosure must be made due to a key person being incapacitated by the virus?
  • Regulatory Examinations — Can the fund sponsor handle an SEC examination in the current state of affairs with the staff available? The SEC is not hibernating; they are actively conducting examinations. The SEC is continuing to monitor and enforce regulations, so your managers need to be ready as if it were a normal business day.
  • Liquidity, Liquidity, Liquidity — As a board, are you comfortable with where the funds are positioned from a liquidity perspective? For funds that are primarily in U.S. equities, the liquidity may not be as big a concern when compared to fixed-income funds, particularly those that are heavily invested in bank loans, high-yield debt or municipal bonds.
  • Valuations — In any market there are always challenges, with a small subset of securities to price on a daily basis. In this environment, it is critical that the board feels comfortable the management company has a strong process in place to evaluate and price on a daily basis all of the publicly held securities. However, the private placements in the funds must get extra attention now. Private securities are more and more common in funds currently, and these securities place a burden on the pricing committees in times of stress. The SEC is always concerned about valuations, questioning if they are too high or too low, but either way, it can be a problem.


Board Issues

  • Rely on your CCO — It is imperative that boards address the stress and the strain on the compliance departments at this point in time. Compliance departments are not excluded from the financial situation of the company, however the board needs to feel comfortable that the CCO has the resources to get all of the day-to-day work done, as well as managing all of the other expectations from a regulatory perspective. Firms are facing new regulations (Reg BI in particular) and with many compliance departments being short staffed, facing budget pressures and regulatory pressures, this is a very difficult time for a CCO. Boards that recognize the CCO is in a position of being overloaded can consider if it makes sense to have a joint CCO, meaning the CCO for the adviser is the same person acting as the fund CCO. This may be an appropriate time to consider having a fully dedicated fund CCO who will focus exclusively on the issues of the funds.

  • Contract Renewal Process — How will the virus (or any other crisis) impact your 15(c) process and your evaluation of the manager and their ability to add value for shareholders? This may be a very different, new world as boards go about completing the 15(c) process, but the same standards will apply. While a great deal has changed in the environment around us, nothing is changed for the requirements of your evaluation process.

  • Board Members — Has the board thought about what it will do in the event that one of the board members becomes ill with the virus? Is the governance committee prepared to update the committee structure in the event that members can no longer serve? How will that impact the number of independent and elected board members?


We are all aware that boards have significant responsibility to oversee the activities of the funds. As the country struggles in these difficult times, shareholders and the regulators expect management companies, with the oversight of the board, to deliver on all of the expectations that were in place prior to the virus and the economic downturn. It is essential that fund boards require their management companies to continue to manage shareholders' assets with the same level of oversight and prudence as they have done for many years.


Never forget: While much in the world has changed, expectations have not.

Todd Spillane is co-founder of full-service consulting firm Mercury Compliance and Risk Services. He most recently was an executive director at Morgan Stanley and before that served as COO for Star Compliance. Spillane was CCO for Invesco for 11 years, from December 2004 to August 2015, and earlier in his career served as CCO for SunAmerica, American General Investment Management, Nicholas Applegate, and Aetna Capital Management.



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