Alert February 02, 2010

Independent Directors Council Issues Report on Board Oversight of Sub-Advisers

The Independent Directors Council (the “IDC”) issued a report designed to provide practical guidance to mutual fund directors on their oversight of fund sub-advisers.  (The Mutual Fund Directors Forum issued a report on director oversight of sub-advisers which was discussed in the May 5, 2009 Alert).  In preparing the report, the IDC assembled a task force of independent directors, in-house fund lawyers and compliance personnel experienced in working with sub-advisers.  The report begins by summarizing several common arrangements involving sub-advisers and industry trends in the use of sub-advisers.  The report continues by discussing the board’s role in the selection of a sub-adviser, including the board’s evaluation of the recommendation by the principal adviser relating to the engagement of a sub-adviser, related due diligence inquiries and assessment of whether the proposed sub-adviser will raise any director independence issues.  The report highlights a number of considerations for a board in approving a sub-advisory agreement, including the structure of the sub-advisory agreement, the services to be performed under the sub-advisory agreement, the fee to be paid to a sub-adviser, potential conflicts of interest and sub-adviser profitability.  The report also suggests that a board should assess the proposed integration of a sub-adviser in terms of operational functions, SEC reporting, portfolio management, valuation, proxy voting and soft dollar arrangements, among other matters.  The report discusses a board’s ongoing oversight role in areas such as portfolio management and performance, compliance programs, codes of ethics, affiliated transactions, litigation and related matters and changes in control.  The report concludes by addressing the termination of a sub-advisory relationship, including issues related to operational impact.  Appendices to the report provide a summary of trends in the use of sub‑advisers, a listing of terms commonly contained in sub-advisory agreements, a sample compliance certification and a sample compliance questionnaire.