Industry Will Focus on Directors Issues
January 31, 2000
The mutual fund world can expect to hear and read a lot more in the next few weeks about the independence of mutual fund directors, thanks to several events.
Mutual fund executives and the public had until Friday, Jan. 28 to comment on an extensive SEC rule proposal intended to strengthen the independence of mutual fund directors. Those comment letters have trickled into the SEC this month and industry observers expected a high volume of letters would arrive late last week.
The comments on the rule proposal also undoubtedly will be part of the discussions when a special panel formed in October to promote directors' independence holds a public meeting Feb. 17 and 18. SEC Chairman Arthur Levitt, who has pushed the proposed changes in SEC rules, is the scheduled keynote speaker at the Mutual Fund Directors Education Council meeting in Washington, D.C. on those dates. Several senior SEC officials, including Paul Roye, director of the division of investment management, are also on the meeting agenda.
Meanwhile, industry lawyers will undoubtedly be analyzing recent court decisions which - while they ultimately may offer limited value as legal precedent - concern themselves with a system in which directors sometimes are well compensated for work that industry critics describe as ministerial rather than substantive.
Indeed, one of the lawyers representing shareholders in class action lawsuits, Joel Feffer of Wechsler Harwood Halebian & Feffer LLP of New York, has filed his own comment letter with the SEC on the directors proposal. The proposed rules are inadequate to rectify a system where independent directors have demonstrated their lack of independence by failing to keep mutual fund fees reasonable, Feffer said in a letter to the SEC Jan. 14.
"In our view, the [proposal] applies a Band-Aid to a problem when a tourniquet is required," Feffer said. "Moreover, the [proposal], if adopted, may exacerbate the problem of the general lack of utility of independent directors by lulling the investing public into the mistaken belief that independent directors effectively represent their interests."
Feffer's clients will have an opportunity to air those views in court. A U.S. District Court judge in New York Jan. 19 allowed one of Feffer's clients, Robert Strougo, to continue to litigate a class action lawsuit alleging that the Brazilian Equity Fund charged excessive fees. Judge Robert Sweet also ruled that fund directors might lose their independence by serving on multiple boards within the same fund complex. Sweet issued the 17-page ruling after the fund's adviser, Credit Suisse Asset Management of New York, asked Sweet to throw out the case as lacking merit, long before trial.
Feffer declined to comment. Credit Suisse believes Sweet's decision was "wrongly decided and is actively reviewing its litigation options," said Jeremy Condie, a spokesperson. Credit Suisse believes it ultimately will be vindicated in the case, Condie said.
Sweet's rulings came after a federal district court judge in West Palm Beach, Fla. in December rejected arguments from independent directors that they could not lose their independence merely by serving on multiple fund boards in the same complex. (MFMN 1/24/00)
The SEC proposal, issued Oct. 13, provides that a minimum of 50 percent of fund directors be independent. Federal law currently requires that only 40 percent be independent.
The proposal also calls for directors to disclose far more personal information than in the past about themselves, their family members and business relationships they and their family members have with the mutual fund firm that the directors oversee. That facet of the proposed SEC rules is drawing opposition from the industry, according to mutual fund industry lawyers and consultants.
The independent directors of the American Express Funds in a Jan. 14 letter to the SEC, in fact, expressed reservations about the added disclosure requirement.
"What seems to us to be missing in the proposal is how shareholders can conclude from the limited amount of information provided that a relationship, transaction or position of a family member [living outside the director's household] co-opts the judgment of an independent director," the American Express directors said. "Given the wide ranging business activities of investment advisers and their parent companies, the uncertainty about what constitutes a material transaction and the reasonable doubt that remote family relationships influence an independent director, simply disclosing the relationships provides shareholders with little useful information."
Cindy Fornelli, an advisor to Roye, said industry executives in informal, oral comments to SEC officials have criticized the extent of the directors' disclosure requirement. In addition, industry lawyers have questioned a requirement that would limit independent directors' ability to hire lawyers whose firms have a significant business relationship with the fund adviser, Fornelli said.
That complaint has shown up in at least one comment letter that the SEC has received. The requirement that independent directors - when they hire a lawyer - hire one who does not represent the fund adviser, would unnecessarily increase fund expenses, said Fred Lager, an independent director of the $380 million Fenimore Asset Management Trust of Cobleskill, N.Y. Fenimore, the fund adviser and the independent directors all have the same lawyer, Lager said.
"We have full knowledge of the scope of counsel's representation of the advisor and understand the potential for conflict this arrangement creates, but feel it is appropriate for a fund group of our size," Lager said. "Having separate counsel would, in our opinion, needlessly increase expenses for our shareholders. What we feel is most important is that we have access to counsel with adequate knowledge of the (Investment Company) Act, which our counsel clearly provides us with."
The SEC hopes to adopt final regulations on the directors changes this year, Fornelli said.