All mutual funds and exchange-traded funds (ETFs) are legally required to have a board of directors to oversee fund management and performance. In essence, these boards are intended to act as fiduciaries and regulatory “watchdogs,” ensuring fund operations represent the best interests of both existing and future shareholders.
According to The Investment Company Act of 1940 (1940 Act), at least 60 percent of a board must be comprised of independent directors, meaning they cannot have a significant business relationship with the fund’s advisor, principal underwriter or affiliates presently or within the last two years. Additionally, an independent trustee cannot have an economic interest in the investment advisor or related entities, such as parent companies or subsidiaries.
Independent trustees are responsible for a litany of critical decisions related to the fund, including the selection and/or removal of the investment manager, approval of documents filed with the SEC and setting fees, among other things.
There is no value in having inside trustees on a board of directors because they don’t have any voting power. For over 20 years, Nottingham has not had any personal employees or “interested” directors on our board for this reason.
Failure to comply with the 1940 Act can result in stark consequences, including hefty fines from the SEC and subsequent legal fees at upward of six figures. To avoid running into any legal ramifications, it’s important for the fund sponsor, usually the investment advisor, to understand that all decisions they make are an arm’s-length transaction and subject to review from a board acting independently.
The last thing an investment advisor wants is the SEC calling into question whether insider trustees on a board have conflicts of interest by rubber-stamping decisions without conducting due diligence and putting themselves or the parent organization first rather than the fund’s investors. There have been recent SEC administrative actions on this point, and it is a very public rebuke of the fund sponsor and fund service providers.
At Nottingham, we believe in the value of an independent board. Therefore, as part of our white label ETF platform services, we help fund sponsors identify good, independent trustees who are interested, well-versed and competent in both investment and prudent business practices space to provide independent counsel. Otherwise, investment advisors tend to gravitate toward previous business partners without fully realizing the pitfalls associated with having a board of directors too close to the vest.
With our selection of independent boards, we give fund sponsors an insurance policy with an additional degree of separation to ensure an enjoyable and unbiased relationship without the hassle of unnecessary legal fees.
If you have additional questions, please feel free to contact us here.