The BISYS Group of New York revealed a few more sketchy details last week about the continuing Securities and Exchange Commission investigation it is embroiled in over fees it paid for distribution, marketing and certain other expenses on behalf of its mutual fund clients.
BISYS' investor relations release aside, Industry sources point to side reimbursement agreements between BISYS and its fund clients as the cause for the regulatory rumble.
With $240 trillion in assets,1 the nation's sixth-largest full-service mutual fund provider, has yet to explain the exact nature of these payments, , BISYS did reveal that such payments were made out of the servicing fees it collected from some of its mutual fund clients. That practice has either been terminated or is in the process of being terminated, BISYS conceded, fueling speculation that whatever that practice is, it may have raised the ire of the securities industry regulators who've been grappling with a gamut of mutual fund practices since September 2003.
BISYS provides outsourced administrative and distribution services to banks, insurance companies and investment firms, including 2,200 mutual funds, hedge funds and private equity funds with a collective $750 billion. It also provides retirement plan recordkeeping for 18,000 companies' retirement plans, and is the parent to Financial Research Corp., a Boston consulting firm that has served the financial services industry for more than 20 years.
Retooling Agreements
BISYS noted that all of the arrangements in question had been entered into its records prior to December 2003 and that, in response to a specific SEC request, it had identified a number of such arrangements with fund clients. It also said that it was fully cooperating with the SEC and making relevant personnel available for interviews and depositions. Moreover, BISYS said it is implementing "revised procedures regarding distribution and administration arrangements with its mutual fund clients," although it failed to detail the specific revisions.
"As a matter of policy, we cannot comment on ongoing regulatory investigations," said Daniel Briggs, finance VP for BISYS.
It was early last December that the parent company first revealed its BISYS Fund Services unit was responding to an SEC investigation. No other details were provided.
Speculation among industry watchers has been that those arrangements were probably some type of revenue-sharing agreement. Revenue-sharing agreements have been squarely on regulators' agenda for some time now. Last December, for example, the SEC, NASD, and New York Stock Exchange jointly charged broker/dealer Edward D. Jones, St. Louis, with, among other things, failing to adequately disclose tens of million of dollars in annual payments. Ed Jones received this money, the regulators charged, under revenue-sharing agreements with seven "preferred" mutual fund companies. Jones settled the regulatory matter and agreed to pay a $75 million fine.
In February, the NASD charged the distribution unit of American Funds with paying $100 million in revenue-sharing brokerage commissions to more than 50 brokerage firms that sold the American Funds, including Ed Jones. That fund complex, the best-selling in the nation, is managed by Capital Research & Management of Los Angeles.
Grandfather Clause
According to sources familiar with the SEC investigation into BISYS, while lack of disclosure is likely at the heart of the problem, revenue sharing was not the practice that triggered the current probe.
Instead, years ago, BISYS entered into grandfathered agreements with mutual funds, many of them managed by banks. These agreements were originally designed to prevent the banks from acting as their own distributors, as stipulated under the Glass-Steagall Act [see MME 2/28/00]. That law, which has since been repealed, sought to separate commercial banking from investment banking activities.
In hatching agreements to provide marketing and distribution services for its fund clients, in addition to other administrative services charged separately, BISYS typically would agree to a fee of around 25 basis points.
But a second, negotiated side agreement would allow the fund group's advisor to submit invoices to BISYS for expenses related to marketing of the funds, with BISYS picking up the tab and reimbursing the advisor, industry sources tell MME. Through this type of arrangement, BISYS essentially repaid fund advisors a portion of the fees it had received. That add-on agreement sometimes meant that the funds' actual marketing and distribution costs were exceeding 25 basis points. "This is not something the SEC is happy about," said the source.
While most of those side arrangements have gone the way of the dinosaur, there are probably still a handful remaining that BISYS is desiring to unwind, said a source. Moreover, it's a sure bet that the SEC has been in touch with every single solitary one of those fund clients seeking information relating to these agreements.
BISYS' client list includes the BNY Hamilton Funds, managed by The Bank of New York. BoNY's March 1 10-K reveals that the fund company and its advisor are being investigated by the SEC about its arrangement with "a third-party service provider that acts as administrator and principal underwriter of the Hamilton Funds.
"This investigation principally concerns the appropriateness of certain expenditures made in connection with marketing and distribution of the Hamilton Funds," the filing continued. While BISYS was not specifically named, sources confirmed that BISYS is the unnamed third-party.
Settling for a Settlement?
In releasing some additional information last week, BISYS also noted that it had hired the law firm of Wilmer Cutler Pickering Hale and Dorr to review the matters under SEC investigation. Separately, the firm's board of directors' audit committee has commenced an internal investigation of its own and has retained Paul, Weiss, Rifkind, Wharton & Garrison.
BISYS has also retained Skadden, Arps, Slate, Meagher & Flom to represent it in response to information requests and subpoenas from the Commission, which is now working in cooperation with the United States Attorney's Office for the Southern District of New York.
Financial Blessing
The fact that BISYS has now hired these three law firms is a likely signal the company is ready to talk turkey with regulators and even reach a settlement, which could include a monetary fine. That could be a financial blessing for BISYS, which is incurring several million dollars a quarter in expenses related to this investigation, according to one industry source.
It could also put an end to one of several battles BISYS is fighting, and allow it to get back to the business of servicing - and distributing - mutual funds.
But that won't entirely move BISYS out of the regulatory spotlight. In May 2004, BISYS Group, as a publicly traded corporation, announced it would have to restate its financial results for years 2001 through 2003 to the tune of $103 million. That restatement, related to insurance commissions, aroused the interest of the SEC as well as the United States A.G. and sent the plaintiff's bar racing to court to file several lawsuits on behalf of corporate shareholders. Myriad complaints have since been consolidated into one lawsuit and BISYS, in a recently filed document, avers that it will "defend itself vigorously against these claims."
1As ranked in SourceMedia's 2004 Mutual Fund Service Guide.
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