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SEC Holds Line With Final Directors Rules

The Securities and Exchange Commission has adopted new independent directors rules that will require that a fund board's membership be made up of a majority of independent directors instead of the current 40 percent requirement.

The new rules are effective as of Feb. 15, according to the SEC.

The adopted rules will also require that independent directors select and nominate other independent directors and that any legal counsel for independent directors must be independent, according to the SEC.

The new rules will also require funds to disclose more information about the identity and experience of their directors, what fund shares they own and any facts that could create conflicts of interest between a director and a fund, according to the SEC. Also, the new rules require funds to disclose the role a board of directors plays in governing a fund.

The adopted rules resemble the proposed rules with a few notable exceptions, according to Susan Nash, an associate director at the division of investment management for the SEC. In the proposed rules, the SEC had considered requiring independent directors to disclose any business relationship family members might have with the fund.

"The biggest change was narrowing the covered family members because we had gone out really broadly," Nash said. "We had all kinds of in-laws covered. And because we also had a lot of entities covered in terms of all of the affiliates of the adviser and the underwriter, it was going to end up casting just a huge net of relationships by the time you got to all of the entities and all of the family members. So we did scale back the covered family members."

The adopted rules will require independent directors to disclose the fund holdings of spouses, children residing in the directors' household and any dependents, Nash said.

"It's either people who are directly interacting with the directors or that are financially dependent," she said.

Another notable change in the disclosure section of the adopted rules is the level of information directors must provide about their ownership of fund shares, Nash said. In the proposed rules, the SEC recommended fund directors disclose their aggregate ownership within the fund complex, she said.

"We changed that in two ways," Nash said. "The first way was that instead of doing it for the complex as a whole, it [will] only be for the funds as to which they are a director."

The SEC's adopted rules increase the amount of disclosure directors must provide in that they require the directors to report the level of ownership that they have in individual funds, not just an aggregate number for a complex, Nash said. Instead of requiring an exact dollar figure, directors will be allowed to report their level of ownership using a range of figures, she said.

The Investment Company Institute of Washington, D.C. will study the new rules and work with its members to help them implement them, said Matthew Fink, president of the ICI, in a statement.

"In addition, the Institute will continue to work with our members in adopting the series of best practices recommended by the Advisory Group on Best Practices for Fund Directors that were unanimously endorsed by the Institute's Board of Governors in 1999," he said.

The adopted rules are not significantly different from what was originally proposed by the SEC, said Mercer Bullard, president and founder of Fund Democracy LLC of Chevy Chase, Md., and former assistant chief counsel at the SEC's division of investment management.

"They did an admirable job of holding the line against significant pressure from the industry and the mutual fund bar," he said. "The industry was adamantly opposed and the heat [the SEC] was getting was pretty well indicated by the fact that they felt they needed a commissioner to respond. Commissioner Carey recently devoted an entire speech to just this requirement, which is a highly unusual event and one that shows that [the SEC] felt it had to respond forcefully to industry criticism."

The ICI's advisory group on best practices for fund directors, was an attempt by the ICI to establish its own guidelines for fund directors and to preempt SEC action, Bullard said.

"They basically tried to get out in front of this by issuing their own set of recommended practices," he said. "Further, the ICI opposed provisions in the new rules requiring fund boards have a majority of independent directors."