In a February 13, 2012 post, we introduced the topic of Fund Restructuring and noted a number of ways in which a mutual fund could restructure itself to better align with today’s marketplace. In this post, we will touch on some of the operational issues relating to fund mergers. Tax considerations will be discussed in a future post, but it should be noted that one of the most significant challenges from an operational standpoint is ensuring coordination between operational and tax issues.

With a fund merger, two or more funds consolidate into one surviving entity. While the legal survivor and the accounting survivor are often the same entity, there are situations based on the below criteria where they differ. The accounting survivor should be based on consistency with the pre-merger entity of the following:

• Portfolio management
• Portfolio composition
• Investment policies, objective, and restrictions
• Expense structures and ratios
• Asset size

Shares of the surviving fund are typically exchanged for all the shares of the acquired fund at an exchange ratio that usually reflects the surviving fund’s net asset value per share divided by the net asset value per share of the fund being acquired. This serves to maintain a consistent value of the investment for the shareholder, while reflecting the true dilutive effect of the combined entity. Since each fund’s assets are at fair market value, there should not be any significant adjustments once merged, however to the extent that the funds taking part in the merger have different valuation policies, adjustments may be necessary to get value in line.

As one would expect, there are certain expenses related to a merger including legal costs, auditor fees, proxy solicitation, mailing costs, etc. The responsibility for these costs is usually addressed in the plan of reorganization, but are often paid by the fund incurring the expense. Certain advisors also absorb the costs of the merger. There are also transactional costs which result from the advisor re-aligning the portfolio post-merger. These expenses are accounted for in the period in which they are incurred.

Due to tax requirements, the acquired fund must ensure that all distributable earnings have been distributed prior to the merger, ensuring that the fund qualifies as a regulated investment company. The surviving fund may also decide to make a pre-merger distribution, although not required, for purposes of avoiding the dilutive effect of distributions to the combined entity’s shareholders reflective of pre-merger earnings.

A Form N-14 filing is required as part of any fund merger. Form N-14 is a proxy statement soliciting a vote from the acquired fund’s shareholders to approve the transaction. It is also a prospectus because it registers the surviving fund’s shares to be issued as part of the transaction. Pro-forma financial statements are usually included in this filing meant to show the potential effects of the merger. Pro-forma expenses are also presented to show the impact the merger will have on fund expenses highlighting one of management’s likely considerations in going through with the merger, that of gained cost efficiencies.

The above was meant to skim the surface of some of the significant operational issues that can be faced when going through with a merger. Please contact BBD with further concerns/considerations.