George O. Martinez, Executive Director of Fund Administration at J.P. Morgan Worldwide Securities Services, spoke with an industry publication in March about board involvement in the service provider RFP process. This article is intended to inform readers of developments in the industry and to provide information of general interest. It is not intended to constitute accounting, legal or tax advice and should not be relied upon as such.

With all the noise about financial stability in the financial services space, fund boards and management companies are inquiring into the financial stability of their mutual fund service providers. This has prompted a number of fund complexes to issue requests for proposals (RFPs). Historically, fund boards played a relatively passive role in the RFP process until the “short list” of service provider candidates was fully vetted by the fund management company. However, in some instances, fund boards have become more active; in today’s environment, from a due diligence perspective, perhaps a more active approach is warranted.

Phase I
Getting Started
Typically, the process begins with a conversation between the management company and the fund board about the reasons for engaging in an RFP. Whether the reason is service issues, pricing concerns or today’s hot topic, financial stability, a decision is made to start the process.

The board can add valuable input at this early stage. Its first step should be to work with management to set forth the guiding principles under which providers will be measured and selected. Knowing what is important to all the constituents (i.e., fund shareholders, management, board, etc.) at the beginning of the process will pay dividends throughout the process, and will be critical in rating and ranking providers.

Some examples of guiding principles:
• The service provider must have a strong balance sheet.
• The service provider must have the required core competencies.
• The service provider must be flexible enough to adapt its process to our unique requirements.
• The service provider must be prepared to adhere to service level agreements.
• The service provider must have a client list that is similar in size and scope to that of our fund   family.
• The service provider must have a defined client reporting and escalation protocol.
• The service provider must have a well-defined enterprise-wide risk management function.
• The service provider’s fees must be no more than X% above or no less than X% below current   fees.

In addition, at this stage the board may also want to get involved in making the decision whether the RFP process should be managed internally by the management company or externally by a consultant. The board may also want to consider whether a separate committee of the full board should be created. At this stage, it is critical that the parties (i.e., board members, board committee, management and consultants) agree to the roles and responsibilities and set a timeline.

Phase II
Development of the RFP
Development of the RFP document is typically the purview of the management company or the consultant, if one is chosen. However, the board may be in a position to add value at this stage by asking itself and fund management to spell out required core competencies, additional competencies and value-adds. For example:

Core Competencies
If the RFP is for fund accounting, fund administration and custody, then the core competencies of the provider would naturally require each of those “first-level competencies.” However, what are the second- or third-level competencies that the fund, management or board require from, for example, a fund accounting service provider? A fund group may have funds that use a variety of derivatives. A second- or third-level competency may be related to the fund accounting agent’s capabilities related to processing derivatives.

Additional Competencies
Beyond the core competencies, what else may the funds, management or board want from the provider? For example, the management company may be providing tax services internally to the fund, so an outsourced tax solution may not be a necessary core competency requirement. However, a service provider with a known tax competency may be something worth considering, in which case this additional competency would be added to the RFP.

Value-Adds
What “value-adds” can the service provider offer the fund, management or board? For example, the board may be getting volumes of hardcopy board meeting materials for each quarterly meeting. Perhaps a provider has a Web portal for board members to access meeting materials and other relevant information that may be a differentiator in the process.

In addition, a board member may have particular expertise in an area to be covered by the RFP. For example, a board member may have a background in business resiliency, operations management or internal audit, around which it would be beneficial to craft certain questions to be included in the RFP. At a minimum, the board may want to review the document once complete to make sure it is comprehensive and touches on areas that the board may have a particular regulatory interest in, such as pricing or valuation, or the support services to be provided to the fund’s chief compliance officer. Once complete, the RFP document is ready to be distributed to the candidates selected in Phase III.

Phase III
Selection of Service Provider Candidates
With the spate of consolidation that has occurred in the mutual fund service provider space over the last several years, the number of major players has decreased. Most boards and fund management companies are familiar with the major players because of existing relationships, past relationships or general market visibility. It may be too early in the process to eliminate a major provider at this stage unless, for example:
• The management company or board has an existing or prior business relationship with a   potential service provider that is or was less than acceptable.
• A provider simply does not have one of the required core competencies.
• A provider’s profile does not fit well within the guiding principles initially
  set forth.

Phase IV
Review of Responses
Upon receipt of the candidates’ responses, boards may want to request the management company or the consultant to provide an executive summary of the responses including pricing from all the providers solicited, with appropriate comparisons. Depending on the original reason for engaging in the RFP process, the board may want to pay particular attention to that section of the RFP response document, versus just relying on the executive summary.

For example, if financial stability of the provider was a significant reason, the board may want to dive into the details in the response related to the parent organization, its financial position and resources, investment dollars earmarked for the business line, and any significant reductions in the particular service line’s workforce, training expenditures or technology initiatives. After review of the executive summary and sections of the RFP responses of particular interest, the board will be in a better position to engage management in developing the short list.

Phase IV
Short List Selection and Due Diligence
Typically, the board, fund management and the consultant, if one is used, would select a short list of providers based on the RFP responses to engage in more detailed discussions and due diligence. As with the initial selection of candidates, the short list selection process should take into consideration the guiding principles, core competency requirements, additional competencies and value-adds previously set forth. A round of site visits and board presentations by each short list provider is typically warranted. If a board committee has been established, the committee or some board members may want to be involved with management on visits to the providers’ places of business. Site visits can be extremely valuable if structured appropriately. For example, touring the facility and spending time talking to the provider’s operations personnel can be much more productive than sitting in a conference room and listening to a presentation.

What Should Directors Do?
Get involved in the RFP process at the outset and stay involved during the process. With careful planning and involvement, the board can exercise the appropriate amount of due diligence while adding value to the process and, ultimately, to the fund and
its shareholders.