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Directors' Pay Could Be in Fund Shares

WASHINGTON - What is becoming a standard business practice in the corporate world - paying independent corporate directors in stock - may become more common in the mutual fund industry.

The SEC is considering a change in securities regulations that will encourage mutual funds to pay their independent directors using mutual fund shares, said Paul Roye, director of the SEC's division of investment management. Roye did not provide details of the possible proposal but said the SEC is considering the change as part of the agency's revision of its regulations intended to strengthen the role of independent mutual fund directors. The SEC expects to propose new rules this summer, Roye said.

Roye's remarks came during an informal question and answer session after he spoke at the Investment Company Institute's general membership meeting here two weeks ago.

Funds can use shares to pay directors now, but only after going through a sometimes lengthy regulatory process, mutual fund lawyers said last week.

The idea of directors owning shares of the funds they govern is not new. Management Practice of New York, a consulting firm which serves fund directors, found in an August 1997 survey that 36 percent of the 24 fund complexes it questioned had a suggested or required policy that directors own fund shares.

In some instances, funds have paid directors in cash and urged or required them to buy shares, Management Practice said in a September 1997 report. In other cases, funds have paid directors their deferred compensation in the form of fund shares, according to Management Practice.

At least 30 percent of fund complexes with assets of more than $10 billion paid directors deferred compensation in the form of fund shares, said C. Meyrick Payne, a senior partner at Management Practice. Payne could not recall an instance in which a fund paid a director in shares for non-deferred compensation.

Some of the reluctance to pay directors with shares may be due to the regulatory process which funds must go through to gain approval for the arrangement, said Pamela Wilson, an attorney at Hale Dorr in Boston. Funds must prepare a lengthy and arcane application for an exemption to the securities laws before they can pay directors in shares, Wilson said. The SEC then must review the application and approve it.

The applications "are the least plain English documents on earth," said Wilson, alluding to the SEC requirement that prospectuses be written in plain English.

A change in rules which permits funds to skip the exemption process would save time and money, Wilson said.

"It's hard to see a down side to it," Wilson said.

Paying directors in stock or stock options has become increasingly common among publicly-traded companies. The Conference Board of New York reported in September that 88 percent of the 614 companies it surveyed paid independent directors at least part of their compensation in stock or stock options. Only 62 percent of the companies used stock or stock options as part of directors' compensation in 1994, said Kay Worrell, a research associate at the Conference Board.

The practice of using stock or options for pay "was really increasing dramatically for the last five years," Worrell said.

The idea of changing securities rules for fund directors grows out of the popularity of paying corporate directors at least part of their compensation in stock or stock options, said Barry Barbash, a lawyer at Shearman Sterling in Washington and former director of the division of investment management. Ownership of stock or fund shares gives directors a greater stake in company or fund performance, Barbash said.

Edwin S. Mullett, a mutual fund shareholder in Lake Toxaway, N.C., has been a persistent advocate of requiring mutual fund directors to own shares in the funds they oversee. (MFMN 8/10/98) Mullett said last week that an SEC rule which prompted directors to invest in their funds would be a positive development. But, directors might circumvent the spirit of such rules by such means as investing in a money market fund, he said.

"These guys ought to be willing to invest in the (funds) they're running," Mullett said.

A change in SEC rules could have limited effect if fund complexes themselves do not adopt a requirement that directors maintain an investment in their funds. A key aspect of mutual funds is that they can be redeemed on demand at their net asset value, making it possible for directors paid in fund shares to sell the shares immediately.

The ICI has formed a panel to examine directors' issues and propose best practices for the industry. The group is expected to issue its recommendations this summer.