Op-Ed: For better or worse, 15(c) process may suffer from SEC’s rulemakings

May 7, 2024

By Sara Yerkey and Paul Ellenbogen, Management Practice LLC

The impact of the Securities and Exchange Commission’s tailored shareholder reports rule, effective Jan. 24, 2023, is being felt by not only the adviser but also is entering the mutual fund boardroom and has the potential to hinder the annual contract renewal process when the new report formats begin to be filed. Among the sticking points is the SEC’s definition of “broad-based” index, which now assumes the role of “primary benchmark.” This is a potential problem for a number of reasons.


As with other rulings, the Commission cited best interest as the rationale for requiring all funds to compare their performance to the “overall” applicable securities market rather than only a “narrowly tailored” index in prospectuses and annual reports. The intent of this ruling, according to the SEC, is to allow an investor to compare their fund’s performance not only to its peers but to the market as a whole. However, the effect may not be what the agency hoped for.


The new rule focuses on investors’ understanding of fund performance compared to broad-based benchmark indexes, but many advisers and fund directors have moved beyond that type of comparison because their strategies—both active and passive—often are not designed to exceed (or match) the broad market. A fund does still have the option to compare its performance to both the broad market and other more narrowly defined indexes, but introducing a second benchmark can raise more questions than it answers among investors and the fund’s directors.


For instance, the narrow index is demoted to secondary status under the rule in three key locations: 1) management’s discussion of fund performance; 2) the “performance line graph,” aka “growth of $10,000”; and 3) the performance table. This demotion of the second index creates a dilemma for directors focused on assessing the “nature and extent of services.”


Directors, who act as fiduciaries to shareholders, are obliged as part of the 15(c) process to review the same benchmarks that investors see in their reports (not to mention on websites, in marketing materials, in third-party reports, etc.). If investors first see a chart or table of fund performance relative to a broad-based benchmark, should directors now give some or any weight to what is likely to be extensive outperformance or underperformance? Or should directors table what those shareholders see first—performance relative to a broad-based benchmark—to assess the adviser’s stated strategy to outperform or match a narrowly tailored benchmark?


There may be very different returns between the narrow and broad-based index that are presented, and the data actually may undermine what the SEC is trying to accomplish with the part of this rule that favors a broad-market comparison. If the assessment of returns relative to the narrow index were clearly more representative of the fund’s performance, that would validate the argument that is at times and, in our opinion, now rightly made by advisers that relative performance compared to the broad index is not germane because it is not a reasonable measure of the investment strategy the adviser is being paid for.  


While specific proprietary or blended benchmarks may have been the target of this ruling, these comprise only about 11% of the current open-end fund and exchange-traded fund prospectus primary benchmarks, according to our research. Moreover, an additional 45% of funds have what could be defined as a “narrow” benchmark. Explaining performance relative to a broad-based index thus threatens to become an obstacle to the work at hand, which is evaluating performance. For example, value funds have underperformed the broad market for the last decade, and growth funds have outperformed the broad market. Comparing these types of funds to a broad-based benchmark is an added step that only delays directors’ inquiries into the “narrow” value and growth benchmarks against which the funds are managed.


In our view, the SEC’s approach has increased the difficulty and complexity of independent directors’ work without enhancing benefits to shareholders. Time spent discussing what comparisons are more relevant distracts from assessing the nature and extent of the quality of service to shareholders. The SEC touts its approach as “layered,” keeping the old (maintaining to narrowly tailored benchmarks) while adding the new (comparisons to broad-based benchmarks). While the SEC has added a layer, the additional information seems to cloud rather than clarify the directors’ already difficult job of deciding whether an adviser’s services are worth their cost to investors.  

Sara Yerkey has worked for Management Practice since 2007, leading MPI's 15(c) practice and focusing on the areas of mutual fund governance, contract renewal, and profitability analysis. She began her career in Standard & Poor’s financial analysis and product sector, shifting in 2001 into the mutual fund industry at Janus Capital Group in the firm’s corporate finance division and serving in her final role as director of financial analysis and strategy.

Paul Ellenbogen joined Management Practice in 2023. He most recently was a vice president of the U.S. regulatory and risk practice at Broadridge, following its acquisition of Morningstar’s 15(c) team in January 2018. At the time of the deal, Ellenbogen had worked at Morningstar for more than 12 years, serving as head of global regulatory solutions and before that as a senior investment consultant and director of board consulting services. Earlier in his career, he held marketing positions at Scudder Kemper Investments (now The DWS Group) and Calamos Investments after starting his professional life as a mutual fund analyst at Morningstar, where he covered equity, fixed-income, and specialty funds.



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