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SEC Settles Case with Fund Adviser Over Undisclosed Side Agreement with Sub-Adviser

The SEC recently settled charges with a fund adviser stemming from a side agreement that prevented an adviser from terminating a sub-adviser without cause.  Orinda Asset Management sought a multi-manager order from the SEC, which would allow the adviser to hire and fire sub-advisers without seeking shareholder approval, because flexibility with the selection and oversight of sub-advisers was necessary for its investment approach.  Prior to filing the application, Orinda made an agreement with its primary sub-adviser that would have required Orinda to make termination payments to the sub-adviser if the sub-adviser was terminated for any reason other than cause.  According to the settlement, the sub-adviser was just entering the registered fund space and wanted assurances of the “certainty” of the relationship.  The board was told about the agreement and retained its ability to terminate the sub-adviser without restriction.  The board also was assured that any payments would come from the adviser rather than the funds.

Orinda’s initial application for the multi-manager order included information about the side agreement; however, the staff of the Division of Investment Management informed Orinda that it would not recommend approval of the application if the agreement was in place.  While Orinda removed the provisions addressing the termination payments from the application, it failed to inform the staff that it had entered into another side agreement with the sub-adviser that waived Orinda’s right to terminate the sub-adviser for any reason other than cause. 

The settlement order states that the board was informed of the new side agreement; however, the funds’ registration statements stated that all sub-advisers could be terminated at any time by Orinda.  As a result, the SEC found that Orinda had violated Section 34(b) of the 1940 Act, which prohibits untrue or misleading statements in any registration statement (or information required to prevent statements from being misleading).