New Director Rules Mean More Disclosure
October 18, 1999
Independent mutual fund directors must provide more information about themselves and, in some cases, their families but also stand to receive valuable protection if the SEC eventually adopts new and revised rules and guidelines that the agency proposed last week.
Directors would be required to disclose the number of fund shares they own and identify potential conflicts of interest under the proposals SEC officials announced Oct. 13. The potential conflicts would include any significant business relationships that independent directors and their family members entered into with a fund management company, said Paul Roye, director of the SEC's division of investment management.
The SEC would require directors to disclose possible conflicts in the fund's statement of additional information, a routine SEC disclosure document which describes the details of how funds work, and in proxy statements in which the directors are up for election, Roye said. The SEC proposals also provide guidance for fund directors on when a business relationship with an adviser or one of its affiliates jeopardizes a director's independence, Roye said.
"We're trying to force these kinds of things into the sunlight," Roye said in an interview. "Sunlight is the best disinfectant."
The new rules and a related SEC interpretive statement also would help insure that directors have their legal expenses covered if their fund's investment adviser sues them. Independent directors have expressed concern about the issue in light of disputes in the past two years between mutual fund boards and fund advisers.
The proposals and interpretive statements are part of a more than 200-page package which the SEC began drafting in March in an effort to strengthen fund governance and the independence of fund directors.
"I think all and all this is really going to reaffirm the role directors play in fund management," Roye said.
Written comments on the proposals are not due until Jan. 28. It is unclear when the SEC may adopt a final version of the rules, Roye said.
The SEC's proposals mark the next step in a process that began in May,
1998 when SEC Chairman Arthur Levitt announced plans to hold a special conference on mutual fund directors. The conference took place in February. The next month, Levitt announced the broad outlines of the rules that the SEC proposed last week at a meeting of the SEC commissioners in Washington, D.C.
"To be effective, an independent director must be willing - and must be equipped - to ask the tough questions and make the tough calls," Levitt said in a statement at the meeting. "The proposals before us today are designed to ensure that independent directors have the tools to do so by transforming the best of this year's ideas and recommendations into a reality."
Although the SEC announced the broad outlines of its plans, an SEC spokesperson said the text of the proposed rules would not be available for several days. Roye described the proposals in a statement at the SEC meeting and elaborated on aspects of the proposals in a telephone interview.
Fund lawyers and industry executives were circumspect in their reaction to the SEC's proposals, saying they wanted to review the language. Matthew Fink, president of the Investment Company Institute, said in a statement that the SEC's rule proposals were significant and that the ICI planned to comment on them in writing.
One aspect of the proposal, in particular, is expected to receive a great deal of scrutiny. One of the new rules requires that independent directors must have independent legal counsel. Lawyers must not have acted as legal counsel for the fund's investment adviser, principal underwriter or administrator for two years prior to representing the directors in order to be characterized as independent, Roye said.
The SEC has built some flexibility into that proposed rule, however. The proposal creates a so-called "carve out" which allows directors to use their judgment to hire lawyers whose connection to a fund adviser is so far removed or isolated that it is insignificant, Roye said. The proposal requires directors to make such a decision by a majority vote and record the reasons for their decision in minutes of their meeting.
The independent counsel requirement has troubled fund lawyers, who say that a strict interpretation of such a standard could force many large law firms to stop representing independent directors. If a strict standard is adopted, independent directors at many fund groups are going to be told that their lawyers can no longer represent them, said David Sturms, a lawyer at Vedder, Price, Kaufman & Kammholz in Chicago.
The danger is that directors will have access to a smaller pool of lawyers who are familiar with the intricacies of the arcane federal securities laws which govern the mutual fund industry, Sturms and other lawyers said.
The SEC also is backing an effort led by former SEC Chairman David Ruder who will serve as chairman of the newly-formed Mutual Fund Directors Education Council. The council - which will include 50 regulators, independent fund directors, fund executives, lawyers and academics - is intended to promote independence among fund directors. Northwestern University law school in Chicago will administer the program.
[Lee Barney contributed to this story.]