A Management Company's Piece Of Open-Ended Pie

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Open-end investment companies usually have contracts with a management company. This organization provides investment advice on a fee basis. The management companies also generally are the underwriters or "sponsors" of the fund or group of funds.

Management fees and underwriting commissions run into large sums when the assets of the funds managed amount to several hundred million dollars and sales of new shares reach many millions of dollars annually. Until 1959, with one exception, the shares of management companies were closely held and not traded publicly. In fact, the Securities and Exchange Commission (SEC) frowned on public offerings of such shares because of provisions in the Investment Company Act. It contended that changes in control could be made only on the basis of book value of the management companies, which was slight outside of the value of the management contract itself. The views of the Commission were not upheld in litigation.

Beginning with the spring of 1959, a number of the owners of management companies sold part of their stock through public offerings. Several management company stocks sold much higher than the price at which the shares were first offered, but later issues were not as successful. In part, the stocks suffered from indications of opposition to the practice of maintaining the annual management fee at a fixed level (say, .5 percent of net assets) regardless of the size of the fund. Although the cost of sales is generally proportionate to the size of the sales that have been made, it is obvious that the cost of research and other management expenses does not rise in a ratio equal to the increase in net assets. For example, management costs do not differ substantially when the assets of a fund have risen from $100 to $300 million.

It has been suggested that ". . . it is rarely asked whether an┬ľother advisor might be able to render equally competent service at lower cost. Control of investment advisors has been transferred and non-voting stock issued at prices obviously based on the expectation that the advisor will continue its services to a particular fund at what might be termed monopoly prices."

Numerous suits were brought in the courts against open-end investment companies, which sought the cancellation of management contracts as well as damages and an accounting of fees. Some complaints alleged that officials who served as directors of both a fund and an affiliated management or advisory company stood in a conflict-of-interest position.

Although a scaling down of management fees as total assets mount may well be reasonable and shareholders are admittedly prone to approve contract renewals without too much thought, it must also be recognized that shareholders have the opportunity to know the facts and that their purchase and holding of stock are voluntary. The basis of the Investment Company Act is disclosure of the facts.

If the prevailing practices border on wrongdoing or injury to shareholders, the SEC can be expected to take the initiative to obtain prosecution of offenders or Congressional modifications of the law.

All the groups holding underwriting agreements and management contracts sold part of their holdings within a short period of time for various reasons such as the problem of taxes on estates after their owners' death; the desire to take profits during a period of high prices, especially for securities bearing the tag "growth stocks"; the possibility of lower future prices; and potential competition from variable annuities.

Whatever the merits of management company shares, they are entirely different from investment company shares. Management companies do not own, directly or indirectly, the securities of the funds, which they manage or sell. Management companies depend on advisory fees and commissions; the shares of their companies do not increase in value merely because of general industrial and economic growth, and if redemptions were to exceed new sales, fees and commissions would shrink.

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