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Directors Adjust to Greater Oversight Role

Trustees Dubbed 'SEC Deputies'


LAKE BUENA VISTA, Florida - Mutual fund boards are grappling with their increasingly expanding roles as risk overseers, management coaches and shareholder advocates as the Securities and Exchange Commission continues to add new rules and raise its expectations, including the creation last week of the Division of Risk, Strategy and Financial Innovation.

"It seems like the rules are always changing, as are the expectations laid out by the SEC," said Joseph Carrier, director of strategic initiatives at Legg Mason, at the Investment Company Institute's annual Tax and Accounting Conference here.

Carrier said the recent financial crisis was caused by a failure of imagination among regulators and industry leaders to predict dramatic changes.

"We're in the business of taking risks, but they must be smart, understood and carefully calculated risks," he said. "We don't necessarily need more rules; we need to follow the existing rules. Exercise good judgment, put your clients first and do what you say you're doing."

"Mutual fund directors have a split loyalty between protecting the interest of shareholders and the need to generate profitability for the firm," said Garry Moody, an independent director for AllianceBernstein Funds. One example of split loyalties is determining both the fees that shareholders pay and approving executive compensation.

There are a number of safeguards in place to make sure boards stay honest, such as the SEC's requirement that 75% of directors to be independent and include an independent lead director.

"I consider my role as the eyes, ears and voice of shareholders," said Alan Latshaw, an independent director at Mainstay Funds and State Farm Funds. "I have to ask the questions shareholders would ask."

Board oversight has expanded dramatically over time, said Marguerite Bateman, a partner at the law firm Sutherland Asbill & Brennan LLP. As the SEC has deputized directors, their responsibilities have grown, she said.

"We have seen an increased number of requests for reports, documents and executive summaries," she said. "Boards are relying on fund management for information, but it's more valuable for directors to have analysis, rather than be a data dump."

Creating meaningful analysis takes an enormous amount of time and energy, but with the sluggish economy trimming staff from virtually every department, this demand for intelligent information can stress resources.

Ideally, the boardroom should be a collaborative effort between directors and management, but at times, the requirements placed on each group can result in an adversarial relationship, Bateman said.

Risk Oversight

"Organizations have different appetites for risk," she said. "It's important to have a culture throughout the organization where everyone feels responsible for risk and isn't afraid to bring an issue to someone's attention."

This may be easier said than done. In addition to the drop in morale, another drawback to staffing cuts is that employees are less willing to point out problems and inefficiencies, Moody said.

"When staff cuts come and everyone is scared, do you really want to be the one to blow the whistle?" he asked. "In a situation where a company is reducing personnel, it is critical for the board to ask the right questions."

But boards can't ask the right questions unless they have the necessary knowledge, experience and information. When assembling a board, trustees should try to get a diverse background among members with expertise in various areas, Moody said.

"If you don't have experience and background, you can't ask the right questions," he said.

"Risk management is about identifying risks in new and existing areas and mitigating controls so they can't bring down the ship," said Nicholas Constantakis, an independent director at Federated Funds. "A good risk manager is not a policeman who comes in after the fact to say 'gotcha!' but more like a coach who tries to help them understand risks and think about mitigating controls."

Another important question to ask is whether the new investment makes sense, or if it is just stretching for yield, Latshaw said.

"The first impression I get is not always the warm and fuzzy feeling that I completely understand the product," he said. "Tell us the truth, and help us make the decision. I'm not willing to assume more risk so you can be more profitable."

While most boards meet quarterly, the rapidly changing financial environment demands their almost constant attention. "Our meetings may be only periodically, but the connectivity is constant," Moody said. "If there is a problem, we need you to bring it to us quickly."

Constantly Connected

"If you've got something big, I don't want to wait for it," Latshaw added. "I want it in 24 to 48 hours, not in four to six months."