New IDC Guidelines Encourage Board Activism: Recommendations Reflect Reform Movement
February 28, 2005
The Independent Directors Council has just released a task force report on how mutual fund boards might best approach self-evaluation, an annual checkup that will become mandatory next year, and while the 28-page document stops short of issuing any rigid mandates, it clearly urges directors to play a more active role in fund management.
Specifically, the report, which is available at www.idc1.org, offers recommendations to boards of directors that may be conducting a self-evaluation for the first time and for those boards that might be re-examining their existing evaluation process.
As the mutual fund industry struggles to put its scandalous past behind, however, the task force report seems to go a long way in encouraging greater oversight by individual directors and the collective board.
And those folks are looking forward to exerting more influence, experts say.
"One thing you see now is that boards of directors, who are very smart men and women, are looking for ways to express themselves and have more of their fingerprints on the process - even if it means going beyond what is required by the law," said Mike Rosella, co-chairman of the investment management practice group at Paul, Hastings, Janofsky & Walker in New York and a longtime consultant to fund directors.
"They're doing it on their own, not because it's required, but because we've had a wake-up call. Even groups that haven't done things inappropriately see this as a chance to renew their commitment," he said.
For example, the task force report recommends that boards of directors examine whether they should form additional standing committees to focus sharper attention on specific areas of the fund's operations, including the sensitive topic of renewing the investment advisor contract. Some critics, including Securities and Exchange Commission Chairman William H. Donaldson, argue that that relationship is much too cozy and a board's annual assessment of its investment advisor amounts to little more than a rubber-stamping.
Avi Nachmany, director of research at the New York consulting firm Strategic Insight, sternly objects to such arguments. He thinks the task force's recommendation reflects an increasingly "insatiable desire" among directors for information about the business of mutual funds, rather than an opportunity to affect change at underperforming funds.
"Boards take their jobs very seriously, and I don't think anyone considers their job a rubber stamp," said Nachmany, whose firm is launching a Web site for directors next month called mutualfundsinsight.com. "These are seriously successful people, and I wouldn't underestimate their experience."
If anything, Rosella added, a special subcommittee to examine advisor performance would afford directors the depth of insight necessary to tackle such a complicated issue as the investment advisor's performance.
"The law isn't and shouldn't be that the worst performing fund of the year should have its advisor fired. I don't think anybody believes that is the right answer, from a legal standpoint or from an investor's standpoint," he remarked. "By the same token, I think everyone grapples with funds that traditionally underperform the marketplace. [But] people have to be sensitive to the realities of a particular situation and realize that it's not very effective or practical on regular basis to change advisors."
Fire an investment advisor, and a board could risk a serious disruption in assets, as many investors might decide to redeem their shares. Those investors who remain would also be impacted, should the size of the fund shrink.
The important thing, Rosella noted, is that the board of directors should rigorously review performance and make it clear to the advisor that it's an important factor for the continuation of their contract. The board could then put pressure on the advisor to reexamine fund personnel, consider cost-cutting measures, lower fees, or more generally, do any number of things short of replacing the advisor to demonstrate that they are acting in a manner that maximizes shareholder value.
Two other sensitive areas addressed in the task force report include director compensation and independent oversight.
The task force - which included members from leading complexes like American Funds, Thrivent Financial and Columbia Funds - suggests that a third party be hired to determine director compensation. While that's been a longstanding practice at most fund complexes, Meyrick Payne, a partner at the Stamford, Conn.-based consultancy Management Practice, said the recommendation could reflect a trend toward determining more accurate compensation figures.
"It's one thing to hire a third party to have a benchmark and another thing entirely to have it set on that benchmark," said Payne, whose firm helps determine director compensation based on three principle metrics: effort, expertise and exposure.