SEC to Review Accountants' Roles with Funds
March 29, 1999
PALM DESERT, Calif. The SEC will scrutinize the business relationships of mutual fund accountants as part of a larger effort intended to strengthen the independence of fund directors.
Arthur Levitt, chairman of the SEC, last week expressed concern that fund independent directors may not be getting the information they need because of potential conflicts of interest with fund auditors. SEC officials said they are concerned that auditors, particularly those whose affiliates do consulting work for a fund adviser, might temper their reports to a fund board's independent directors because of separate business relationships with the fund adviser.
"It is vital that (independent directors) receive objective advice from their counsel and their auditors, particularly when there is a conflict with management interests," Levitt said. "Those upon whom directors rely for such guidance need to be truly independent of fund management in fact and appearance."
The SEC also will propose guidelines which require that independent directors have their own counsel rather than rely on lawyers who work for the fund adviser, Levitt said. In addition, SEC examiners will review the material which independent directors receive from fund advisory firms to make sure that it is adequate and that potential conflicts of interest are disclosed fully, Levitt said.
Each of the moves are part of an effort to insure that fund directors are getting sufficient, unbiased information to do their jobs, Levitt said.
Levitt made his remarks in a speech to more than 1,500 lawyers, compliance officers and mutual fund executives here at the "Mutual Funds and Investment Management Conference" sponsored by the Federal Bar Association and the Investment Company Institute. Levitt said that by this summer, the SEC expects to propose new rules and issue new guidelines on independent directors.
Several of the proposed changes such as a proposal requiring that a majority of a fund's directors be independent were expected. The scrutiny of mutual fund accountants took executives by surprise, however.
Richard Phillips, a lawyer in the Washington office of Kirkpatrick & Lockhart, said any rule which would require separate auditors for funds and fund advisory firms could pose more problems than it solves. At a minimum, such a requirement would create "a great deal of overlap, a great deal of expense," Phillips said.
Having separate auditors for funds and fund advisers also might result in accountants missing key information, Phillips said. The knowledge that auditors have in dealing with both the funds and the advisory firms can result in fuller information for fund directors, Phillips said.
At least to begin with, Levitt said he did not expect to back a rule which would bar the same auditor from serving a fund and its advisory firm. Nevertheless, regulators are concerned that independent directors might be "spun" by auditors serving two clients with potentially divergent interests, said Meyer Eisenberg, deputy general counsel for the SEC. Eisenberg said the SEC's goal is that accountants provide directors with "advice free of bias."
Other proposals which the SEC plans to adopt include a requirement that new independent directors be nominated by existing independent directors. Currently, a fund adviser can nominate independent directors. In addition, in its upcoming examinations, the SEC will pay particular attention to the quality of information which directors receive in evaluating fund advisory fees and renewing Rule 12b-1 plans, Levitt said.
The SEC also will propose that more information on independent directors' business relationships be disclosed in SEC filings. And, Levitt backed a directive which would require independent directors to disclose in SEC filings how much each director has invested in the funds he supervises. There is no such requirement now and very few funds provide the information.
The SEC also may require funds to disclose in their annual reports or other filings that directors serve on more than one board in the same fund complex and the pay they receive for those duties, Levitt said. The agency, however, will not adopt a rule or guideline which limits either the number of boards on which a director serves or the amount of compensation he receives.
"There is no particular correlation between the amount of compensation and the level of independence," Levitt said.
With the exception of the call for more scrutiny of accountants, Levitt's proposals did not surprise the ICI. Immediately after Levitt's speech, Matthew Fink, president of the ICI, announced that the trade group had formed its own special committee to examine directors' issues. The six-member Advisory Group on Best Practices for Fund Directors' will identify the business practices which the group believes should serve as a model for fund boards.