Accessor Capital Management of Seattle is now the second firm the Securities and Exchange Commission has targeted for miscalculating its mutual fund performance-based management fees. In addition, several other investment managers that have sub-advised the Accessor Capital funds may also be implicated if the SEC follows through on its threats of regulatory action.

In a Jan. 31 amendment to its funds' prospectus, the advisor disclosed that the SEC staff will recommend that the Commission institute an enforcement action against the advisor, but not the funds themselves. The SEC, Accessor Capital noted, is charging that the fund advisor has been miscalculating both the core and performance-based fees it has paid to sub-advisors on eight of Accessor Capital's 16 funds dating as far back as 1992.

Those miscalculations have resulted in overpayments to the funds' sub-advisors, the disclosure noted. What's more, the SEC announced its intention to recoup overpayments from the various sub-advisors, noted the public filing. The filing did not provide details on how the miscalculations had occurred.

That list of sub-advisors from which the SEC may demand repayment could be lengthy. A review of the Accessor Funds' sub-advisory partners show that most of the current sub-advisors have only been engaged for a few years, meaning there are several predecessor firms that may have to pony up part of their compensation.

Current sub-advisors include BlackRock Financial Management, Cypress Asset Management, Financial Management Advisors, JPMorgan Fleming Asset Management, SSgA Funds Management, which is a unit of State Street Corp., and Wellington Management. INTECH, a subsidiary of Janus Capital, is also a recently added sub-advisor, but has not yet qualified for a performance fee. INTECH had supplanted Chicago Equity Partners in March 2004.

Although Accessor Capital and most of the sub-advisors declined comment, citing the ongoing investigation, two of the sub-advisors noted that they had not yet been contacted by the SEC. In addition, only those sub-advisors that earned a higher fee by outperforming their benchmarks will be on the SEC's list.

Mathematically Challenged

Accessor Capital is the second firm to be tagged under the SEC's sweeping investigation of mutual fund firms that sport performance-based management fees. That investigation began last May after the SEC uncovered the first case of miscalculated fees.

This past September, Bridgeway Capital Management of Houston and company President John Montgomery, without admitting or denying the findings, settled charges with the SEC and agreed to reimburse investors $4.4 million in overcharges, in addition to other sanctions and monetary fines (see MME 10/16/04). The SEC alleged that Bridgeway had miscalculated the performance-based fees on three of the Bridgeway Funds through March 2004, in one case dating back to July 1995, by making its calculations based on current fund assets instead of average fund assets.

Not surprisingly, in light of the SEC investigation, Accessor Capital quietly filed a new fund prospectus in early January banishing performance-based fees altogether. The prospectus disclosed that new advisory agreements had been struck with its current fund sub-advisors under which they will each be paid a flat fee.

Likewise, on Jan. 25, Bridgeway Capital filed a proxy asking shareholders of seven of its 11 funds to bless a variety of fee alterations including reducing funds' expense limitations and reducing the performance-fee adjustment range.

Accessor Capital's mutual fund lineup has $2.6 billion in assets and includes an array of nine equity and fixed-income funds, in addition to six asset allocation funds that are structured as funds-of-funds. It also manages one money market fund.

Although Accessor Capital officials would not comment, the firm noted that last May, the SEC's Ft. Worth, Texas, regional office asked it for information regarding its performance-fee calculations. Accessor voluntarily responded to that inquiry and subsequent requests for information. The regulator's Ft. Worth office was the same office that uncovered the miscalculations at Bridgeway. The SEC's Houston regional office did not respond to a request for comment.

Overall, less than 3% of mutual funds currently charge performance-based advisory fees, according to Lipper. While some advisors only apply such variable fees to one or two funds, both Fidelity Investments and Vanguard, which itself employs a myriad of sub-advisors on its funds, apply performance-based advisory rewards to many of their funds.

These fees, also known as fulcrum fees, are typically structured in two parts. First is a core management fee that can be increased or decreased by a pre-determined amount based upon the fund's performance over a specified rolling time period that the advisor sets. The fund's performance is then compared over that time period to the performance of a pre-selected benchmark index. If the fund outperforms the index, the advisory fee is raised, usually by several basis points at a time. Conversely, if the fund failed to beat its bogey, the core advisory fee is reduced proportionally.

By law, the fund's performance must be compared to an appropriate benchmarked index, and the law is very specific about how calculations can, and cannot, be made, explained Tom Westle, a partner with the law firm of Blank Rome in New York. In addition, the amount that the management fee can increase must be equivalent to the amount it can be reduced, he said, and there are limits on how much the core fee may be increased or reduced. "Consequently, not many mutual funds do this because it can be disadvantageous to the advisor," Westle said.

While the law dictates how these fees must be calculated, advisors that calculate performance-based fees themselves, as opposed to a fund administrator, can be at greatest risk as there is an inherent conflict of interest, said Jeff Squires, a principal with Vista360, a Milwaukee-based compliance consulting firm.

At fund administrator U.S. Bancorp Fund Services of Milwaukee, the performance-based advisory fee process starts with a detailed written explanation of precisely how and when the calculations will be made. The advisor, the advisor's law firm and the fund's audit firm all must sign off on that procedure so that everyone is in perfect agreement, said Joe Neuberger, senior vice president at USBancorp.

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