Major Shift Seems Unlikely in Fund Governance
March 1, 1999
WASHINGTON - The corporate structure that the mutual fund industry says is a key to its effectiveness - the system which permits independent mutual fund directors to serve on numerous boards in the same fund complex - appears unlikely to change any time soon.
SEC Chairman Arthur Levitt said Wednesday that the number of boards on which a fund director serves is, "not a matter for rulemaking or regulation." In addition, Levitt said during a two-day conference here that he saw no, "correlation between compensation and independence" when it comes to fund directors.
The two statements support the mutual fund industry's contention that federal law, SEC pronouncements and longstanding industry practice permit mutual funds, in effect, to be run by independent directors who receive six-figure incomes from serving on multiple boards in the same fund complex.
That system has been attacked in lawsuits, criticized in court decisions and derided in the press. Critics argue that the current system can compromise directors' independence because of the amount of money they receive from funds for serving on numerous boards.
While Levitt said he wants changes in mutual fund governance to reinforce the role of independent directors, he did not support new SEC rules to overhaul the system of multiple directors or SEC-sponsored legislation directed toward that goal.
"Board independence comes from directors who do their jobs aggressively," Levitt said. "Board independence does not come from any particular legal structure."
Levitt made his remarks in public comments and during an impromptu news conference following the SEC's roundtable, "The Role of Independent Investment Company Directors" held at SEC headquarters last week. The conference- attended by more than 300 mutual fund industry lawyers, executives, independent directors and consultants- was the "first step" in a process of evaluating how well the current system of independent directors works, Levitt said.
At the conclusion of the conference, Levitt instructed the SEC staff to conduct a 30-day review of mutual fund corporate governance issues. The staff is to report on ways to strengthen the role of independent directors and improve mutual fund governance. Levitt urged the mutual fund industry to undertake a similar effort.
The goal of the SEC's work should be to make proposals which bring "meaningful change" to fund governance, Levitt said. The result should go beyond a simple listing of best practices in the industry, Levitt said. Nevertheless, he said he was reluctant to seek changes through legislation or institute new regulatory guidelines.
Although Levitt did not mention the possibility, the SEC conceivably could make recommendations to the industry to curb the practice of having directors serve on multiple boards. Such a suggestion would have influence but would fall short of an outright legal requirement on the fund industry.
The system of mutual fund governance implicitly was criticized in a court decision in May, 1997. In a case involving a closed-end fund shareholder, Robert Strougo, a federal court judge said that the pay an independent director receives for serving on multiple fund boards can be evidence that a director has lost his independence.
Levitt alluded to the decision in a speech in May, 1998 when he announced plans for the SEC's roundtable. On Wednesday, John C. Coffee, a prominent securities law expert and professor at Columbia University law school, said the mutual fund industry has a "Strougo problem." The problem is that directors who serve on multiple fund boards can begin to see themselves as serving the fund adviser rather than fund shareholders, Coffee said. The mutual fund industry's response has been that investors care only about investment returns and not theoretical conflicts of interest, Coffee said. But such conflicts gradually result in fund directors compromising their own independence, Coffee said.
"Conflicts inevitably grow and invisibly erode the investment return" of funds, Coffee said.
Levitt questioned Coffee's link between pay and independence and industry lawyers and independent directors attacked Coffee's argument. Independent directors frequently are nominated by other independent directors, are elected and fired by fund shareholders and set their own compensation, industry executives and lawyers said repeatedly.
"We may be overpaid, but we set our own compensation and it's paid by the fund," said John R. Haire, an independent director of the Morgan Stanley Dean Witter Funds.
Paul Roye, the director of the SEC's division of investment management, played devil's advocate on the issue of multiple directors in his role as moderator of Haire's panel. He suggested that it seems logical to believe that there is a finite number of funds any one director can oversee effectively.
"We haven't reached it at Fidelity yet," said Gerald McDonough, an independent director for Fidelity Investments who said he helps oversee more than 200 funds. McDonough said Fidelity directors meet at least 11 times a year and divide up their responsibilities. The funds also have overwhelmingly common management issues, McDonough said. Dividing responsibilities made serving on multiple boards "no burden at all," McDonough said.
McDonough also reacted angrily to criticism of directors reported in the press, saying it was often ill informed and irresponsible. The criticism "undermines the confidence" of mutual fund investors in the industry, McDonough said.
Neither Levitt nor Roye predicted what the ultimate conclusion of the SEC review would be. But, Levitt stressed that he wants the SEC to focus attention on and instigate change to strengthen independent directors' roles.
Independent directors must serve as, "a force for accountability on behalf of shareholders who depend on their independence to maintain the integrity" of mutual funds, Levitt said. "Without strong independent directors, accountability is nothing more than a word on a page."