Fund Auditor Selection Process Questioned
March 18, 2002
The troubles at Big Five accounting firm Arthur Andersen of Chicago over its auditing of the financial statements of Enron Corp. may be raising issues for the mutual fund industry.
At least one vocal investment adviser and shareholder activist is questioning the rules regarding the appointment of independent auditors who are hired to annually review and approve the financial statements and accounting methodology used by both open-end and closed-end funds.
George Karpus, president and CEO of Karpus Investment Management of Pittsford, NY, sent a letter dated March 5 to the SEC, asking the nation's top securities regulator to rescind a rule amendment that went into effect last year and, according to Karpus, stripped investors of their right to approve or disapprove the appointment of an accounting firm to serve as independent auditor.
The rule, which took effect Feb. 15 of last year, allows regulated investment companies to bypass the shareholder approval process for the appointment or continuation of a fund's independent auditors, but only if the fund's board of directors maintains an audit committee that is composed wholly of independent directors. The rule also requires the audit committee to adopt a charter detailing the committee's duties, powers and methods of operation.
The new rule exempts funds that meet the criteria from having to periodically seek shareholder approval of the fund adviser's choice for auditor. The rule mandates that the board's audit committee continue to oversee the fund's accounting and auditing process. According to the SEC, many fund groups had considered the shareholder auditor ratification process to be largely perfunctory.
The change was part of a package of regulatory amendments the SEC adopted early last year, all of which dealt with the evolving role of independent directors of investment companies. The rules apply unilaterally to all open-end mutual funds and closed-end or interval funds.
Watering Down a Good System
In the '20s and '30s fraudulent activities and abuses were rampant, Karpus said. Then came the '40 Act which gave investors the responsibility of passing judgment on the recommended auditor.
"There was a clear strategy and wisdom under the '40 Act for shareholders. But the SEC has watered it down," said Karpus, who first made his contrary opinion known two years ago, when the SEC was seeking public comment on its amendment proposals.
Karpus' firm currently manages $400 million in closed-end funds, and another $80 million in open-end funds invested through hedge funds.
Karpus said that having a system of checks and balances in place, which previously included investors being required to give thumbs up or down to auditors, prevents a fund or company from abusing its position. In his recent letter to the SEC, Karpus implored the regulatory body to rescind its one-year-old amendment and reinstall shareholders' power to authorize a fund's auditor.
A spokesman for the SEC said that the Commission has a policy of not commenting on letters it receives asking for some specific action to be taken.
John S. Capone, who had served as the chief accountant for the SEC's Division of Investment until last April when he left and signed on as a partner with Andersen's Boston office, declined to comment for this article. The SEC's amendment had become effective during Capone's tenure.
Karpus has experience on his side. In 1997 and 1998 he challenged Bull & Bear Advisers of New York, manager to a closed-end product that at the time was known as the Bull & Bear U.S. Government Securities Fund. Karpus, who controlled a significant block of shares of the fund on behalf of his investment clients, voted against the continuation of the fund's independent auditor. He charged that the fund's auditor had turned a blind eye to the real and extraordinarily high expenses of the fund, which would have negatively impacted the fund's net asset value. Karpus was successful in blocking the accounting firm's appointment.