I sat down with a few people last week to discuss various fee structures with fund managers and investment advisers. One fee was raised as potentially problematic. “I’m not sure if this fee is a conflict.”
My thought is that every fee is an inherent conflict. You are taking money from the fund investor or client and putting it into the hands of the fund manager / adviser.
The first step of the fee analysis is whether it is disclosed. One of the primary commands of the Investment Advisers Act is disclosure. You must make your clients and investors aware of the fees you charge. Compliance must make sure that the fee information is clearly disclosed in accordance with the regulations and SEC actions.
The second step is the analysis of whether the fee could cause a distortion in behavior that could cause the fund manager / adviser to act in a different way because of the fee income.
If the fund charges an acquisition fee, then the fund may be more likely to make acquisitions because it gets extra income when it does so.
Even the asset based management fee that most people think keeps the fund manager and investor most aligned can cause distortions. In June 2012, the SEC announced its pursuit of zombie funds. It was concerned that fund managers are keeping portfolios together merely to collect the management fee instead creating realizations to return capital to investors.
Fees are always a conflict. You must disclose them and understand the distortions so you can keep your fund’s interest aligned with the investor’s interest.