Fund directors and others in the mutual fund industry almost always refer to the attorney that is providing advice to them as “our lawyer.” They will then tell you how experienced the attorney is, how broad her practice and that of her law firm is, and how she provides the best legal and practical advice. The relationship they have with the attorney is one of trust and confidence. Trust that the attorney provides unbiased legal advice and confidence that the attorney has the experience and judgment to provide sound, timely advice. In this article I will explore the potential conflicts of interest that attorneys might have when representing clients in the mutual fund industry. I would note that in my experience, attorneys and the mutual fund industry have done a remarkable job in properly handling those potential conflicts.

The mutual fund industry can be quite complicated, and having an experienced attorney to help in navigating your way through the variety of issues presented is essential. Experienced attorneys need to have a deep understanding of the variety of laws and regulations that apply, including the Investment Company Act of 1940, the Investment Advisers Act of 1940, and others[1]. In addition to those statutory provisions, there are a host of rules, regulations,[2] and interpretations that also need to be considered. It is also important for that attorney to have practiced in the area for quite some time to gain an appreciation for the issues that can arise and the tools that can be used to best resolve them.

Key Advisor

The attorney is often a key advisor to the fund, the board, independent directors, the investment adviser, or other service providers, and in many cases may represent several of those parties at the same time. Some of the many areas where attorneys assist their clients are the preparation and filing of the registration statements for the funds, the negotiation and execution of the many agreements that funds have with service providers, the monitoring of regulatory developments, the drafting and review of policies and procedures, the preparation and review of board materials, the annual review of investment advisory and principal underwriting agreements, and a variety of other matters as well.

To develop the necessary experience and skill set to properly serve fund clients, attorneys benefit from having a wide range of clients providing them with exposure to the many issues facing the industry. It is also critical that the law firm has a deep bench of practitioners who specialize in the many areas of the law that apply to the fund and its operations. As you might expect, this breadth of clients and necessary specialization can likely increase the opportunity for potential conflicts.

 As we are exploring the potential conflicts that attorneys might have, a few thoughts to bear in mind: First, be mindful of who the client is and what legal services the attorney is being asked to provide; second, have any potential conflicts of interest that might affect the ability of the attorney to properly represent the interests of the client identified; third, understand how the attorney intends to manage those conflicts; and finally, evaluate how the potential conflicts of interest, as managed by the attorney or otherwise addressed, impact the representation of the client and the advice or legal services being provided.

Potential for Conflict

There are a wide variety of potential conflicts, but let us explore just a few of them.

Fees: It is always important to appreciate not just the level of the fees being charged but also the structure of those fees. For example, attorneys often charge an hourly rate for providing legal services. This arrangement provides an incentive for attorneys to potentially take a bit longer in performing the legal task. In contrast, a fixed fee can have the opposite effect, providing an incentive to the attorney to complete a legal task as quickly as possible. This can be a difficult area for a client to monitor as it is not easy to determine which fee structure to utilize or how to evaluate the result.

Outside counsel with multiple clients: It is common for outside counsel to represent several clients that can have conflicting interests. This can occur within the fund complex or outside the fund complex.

• Within the fund complex: Outside counsel often provides legal representation to the investment adviser or others, as well as the fund within the fund complex. There are several very practical benefits that can result from this arrangement for the fund and for the service providers, but it is essential that the potential conflicts be identified and properly resolved. A few of those conflicts can relate to: (a) the terms of the contract the service provider has with the fund; (b) advice regarding the interpretation of the contract when an issue arises; (c) the approval of the contract by the fund. The Securities and Exchange Commission, recognizing the potential conflicts as they might impact fund independent directors, adopted a rule that provided for independence standards for attorneys who act as “independent legal counsel” to fund independent directors.[3]
• Outside the fund complex: Outside counsel usually has a variety of other clients, including those within the financial services industry who may be engaging in activities with the fund or have interests that might be adverse to the interests of the fund. Counsel also frequently represents other clients who may be in competition with the fund. The fund complex often derives benefits from this broad representation by outside counsel, but identifying and understanding the potential conflicts and their resolution is quite important.

Inside counsel: Many fund complexes benefit from utilizing the services of attorneys that are employed by the investment adviser or another service provider. These attorneys often perform a variety of legal tasks for the fund that may include, among others, the preparation of fund registration statements and amendments, negotiating agreements, and acting as chief legal officer[4]. Many of the potential conflicts involving inside counsel are readily apparent, but some may not be. For example, if an inside attorney is acting as the fund’s “chief legal officer,” she will be the individual who initially receives notice of potential material violations and is obligated, on behalf of the fund, to investigate them. As these potential material violations might involve the attorney’s employer, that conflict might be quite important.

If you are a fund director, you might wish to identify the tasks that are being performed by inside counsel on behalf of the fund and the potential conflicts that exist and how they are properly managed and resolved. Outside counsel can be quite helpful in assisting fund directors in this endeavor.

Professional Standards: It is important to remember that attorneys are seeking to do what is right, and there are professional standards that assist them in that regard. Attorneys are subject to the standards that apply to them in the states in which they are licensed, and those standards may vary from state to state. So rather than trying to sift through the various state requirements, let us look at the model rules of the American Bar Association,[5] especially those addressing conflicts of interest. They are quite helpful in providing some guidance on how attorney conflicts of interest should be addressed.

The ABA model rules provide that a lawyer should generally not represent a client if the representation involves a concurrent conflict of interest. It then provides for an exception, provided: (a) the attorney reasonably believes she will be able to provide competent and diligent representation to each client; (b) the representation is not prohibited by law; (c) the representation does not involve the assertion of a claim by one client against another client; and (d) each affected client gives informed consent, confirmed in writing. These are sensible standards for us all to keep in mind as we consider the potential conflicts of interest that attorneys might have.

Final thoughts: There are many variations in the potential conflicts of interest that attorneys might have, so be alert to identify, understand, and properly resolve them. You can take some comfort in the fact that attorneys are subject to several professional standards in this area from the SEC,[6] the states, and bar associations—and the fact that your attorney is seeking to do what is right. It is best to raise the issue of potential conflicts of interest with your counsel and understand how they are being handled. A perspective to utilize is to always be mindful of how the potential conflicts of interest might affect the ability of your attorney to provide you with unbiased legal and other services that are in your best interests. Put differently: Are potential conflicts of interest affecting the ability of the attorney to truly be “our attorney?”

*This is the third in a series of five articles examining potential conflicts of interest in specific areas of the financial services industry. Each article will discuss the areas where potential conflicts may exist, some abuses involving conflicts that have arisen, some resolutions that have been employed to resolve those conflicts, and the legal and regulatory standards, if any, that may apply. Access the first article, on investment advisers, here, and the second article, on broker-dealers, here. 

Andrew J. Donohue (Buddy), who has almost 50 years of experience in the financial services industry, is currently the chair of the Mutual Fund Directors Forum and an independent director of various BNY Mellon Funds. He previously served as chief of staff, from 2015 to 2017, and director of the Investment Management Division, from 2006 to 2010, at the Securities and Exchange Commission. Donohue also was executive vice president and general counsel at OppenheimerFunds, global general counsel at Merrill Lynch Investment Managers, and managing director and investment company general counsel at Goldman Sachs.