Former SEC Heads Cowboy Up on Fund Governance
June 21, 2004
They were seven and they fought like seven hundred. That was the famous tag line of the classic 1960 western film "The Magnificent Seven," a tale about a septet of mercenaries called on to protect the inhabitants of a small village from being pillaged by outlaws.
While the trenches of the mutual fund industry may not exactly resemble the lawlessness of the Old West, there has certainly been a lot of gun slinging over a widespread trading scandal that effectively bilked small investors of their returns As a result of the endemic and abusive trading practices coupled with the perception of a lack of transparency in mutual funds, the Securities and Exchange Commission proposed a series of corporate governance reforms last fall.
Back in the Saddle
In recent months, shots have been fired from both sides about the efficacy of implementing a rule requiring funds to have an independent chairman. Recently, the seven living former chairmen of the SEC have banded together to back an SEC proposal that would require mutual funds to have an independent chairman.
In a letter sent last Tuesday to the SEC's five commissioners, the former sheriffs of the securities industry said mutual funds should appoint a chairman who has no ties to the management companies that run the fund portfolios.
"An independent mutual fund board chairman would provide necessary support and direction for independent fund directors in fulfilling their duties by setting the board's agenda, controlling the conduct of meetings and enhancing meaningful dialogue with the advisor," wrote David Ruder, chairman of the SEC from 1987 to 1989 and now a law professor at Northwestern University in Chicago and chairman of the Mutual Fund Director's Forum.
"We believe an independent board chairman would be better able to create conditions favoring the long-term interests of fund shareholders than would a chairman who is an executive of the advisor." Six other former chairmen of the Commission, including Harvey Pitt and Arthur Levitt, also signed the letter.
That position puts a burr under the saddle of many fund companies because they believe the operation of the mutual fund industry is working well now and are averse to change. At present, a majority of fund firms are chaired by executives who are affiliated with the fund management company. Fund giant Fidelity Investments, for one, has been quite vocal in its criticism of the provision, arguing that the decision to have an independent chairman should be left up to the board.
In support of its argument, Fidelity CEO Ned Johnson pointed out that a number of fund companies involved in the recent scandals already had independent chairmen in place. He also owns part of the management company and has a stake in Fidelity funds, which he believes aligns his interests with those of the shareholders. Johnson stressed the importance of having a chairman who represents the management company because of their expertise in the nuances of the fund business.
"The argument that this will somehow deprive the independent directors of the expertise of the advisor is wrong," Ruder said. "There's never been any suggestion that the advisor should not be able to attend or participate in the board meetings nor even that the advisor shouldn't have a director on the board. The point is that the way to protect investors is to allow the independent directors to act on their behalf without being unduly influenced by the advisor."
Some regulators, including SEC Chairman William Donaldson, believe an independent chair would alleviate some of the conflicts of interest that exist under the current structure. With a deadlocked panel of commissioners on his hands, the letter from the former SEC chairmen may serve as a shot in the arm. Democratic Commissioners Harvey Goldschmid and Roel Campos are said to be aligned with Donaldson's support of the rule. However, Republican Commissioners Cynthia Glassman and Paul Atkins appear to be leaning the other way. Glassman has said that the proposed rule is not supported by any empirical evidence and that it may "put form over substance."
"The argument that this puts form over substance is just wrong," former SEC chairman Ruder told Money Management Executive in a telephone interview. "I don't think they're so concerned about the immediate impact of the independent director and changes in board practices as a result of it. They're more frightened about the implications in terms of the balance of power between the independent directors and the advisors in the long run."
The idea of rounding up the former SEC chairman was initiated by a ranking member of the House Financial Services Committee, which is chaired by Rep. Michael Oxley (R-Ohio). Oxley supports the independent chairman rule, along with Rep. Richard Baker (R-La.), and Sen. Peter Fitzgerald (R-Ill.), author of the Mutual Fund Reform Act of 2004.