SEC Proposals Would Give Mutual Fund Boards the Means to Challenge Management

In a move that largely toes the line drawn up by an industry lobbying group earlier this year, the Securities and Exchange Commission proposed new rules Wednesday to help strengthen the role of independent directors on mutual fund boards.

The proposals would make independent directors a majority on fund boards and take their appointments out of the hands of fund executives. They also would give these directors some resources -- their own lawyers and protection from begin assessed legal fees -- that might help them mount a challenge to fund executives, if necessary.

Declaration of Independence
SEC proposals for strengthening independent mutual fund directors include:
Making independent directors a majority or "super majority" (two-thirds) of a fund's board.
Requiring fund boards to have their own legal counsel separate from the lawyers representing the fund.
Having incumbent independent directors - not the fund's management - nominate new independent directors
Protecting independent directors from the costs of disputes with fund management
Source: Securities and Exchange Commission

Boards of directors are supposed to act as watchdogs over the management of mutual funds. But currently, only 40% of directors on a mutual fund's board must be independent, having no ties or former employment with mutual fund management. In recent years, fund boards have been criticized for being too close to the management they are supposed to watch over.

The SEC and the industry have reason to be concerned about that relationship. In an incident that has become known simply as "the Yacktman mess" to industry insiders, fund manager Donald Yacktman was essentially allowed to fire his independent directors last year after they questioned his lagging performance. A similar situation, involving Louis Navellier and his eponymous funds, played itself out just a year earlier.

Wednesday's proposals appear to be a step in the right direction, says Geoff Bobroff, a mutual fund consultant in East Greenwich, R.I.

"Does it give the directors more of backbone to stand up to management? Probably. But it's too early to tell in real terms," Bobroff says. "It doesn't change the landscape, but it may alter the Yacktman or Navellier matters, where you end up at cross purposes with the independent directors."

In June, the Investment Company Institute, the mutual fund industry's lobbying group in Washington, D.C., made up its own list of 15 "best practices" for independent mutual fund directors. Many of the SEC proposals Wednesday were similar to those on ICI's list.

When ICI's proposals came out, skeptics suggested they didn't go far enough and noted that many of "best practices" were already in place at several large fund groups. But the SEC proposals, if they become rules, would put some "meat on the bones" of those practices, an SEC spokesman says.

"When the ICI came up with its best practices, it was sort of like, which came first, the chicken or the egg," says the SEC's Chris Ullman. "We're not worried about taking credit. It's more important to get it right."

Getting it right has been a major concern of the SEC and the mutual fund industry over the last year. In February, the SEC called mutual fund executives to Washington for a roundtable discussion on the role of independent directors in fund governance. Then in March, SEC Chairman Arthur Levitt outlined some changes he'd like to see in how the boards operate -- suggestions that are reflected in Wednesday's proposals.

Other aspects of the proposals call for fund companies to keep records detailing the independence of their fund boards so the SEC can monitor a board's degree of independence, and to set up an independent audit committee that would be exempt from getting shareholder approval for the selection of an independent public accountant.

In addition, the SEC is proposing stricter disclosure requirements for mutual fund boards. These include providing basic information about directors so shareholders know who they are and what their business experience is, how many shares they own in the fund family, and what situations could be deemed a conflict of interest. Boards also would be required to explain their role in governing the fund.

The proposed rules are subject to a 90-day comment period. They will then go back to the SEC staff for changes and then to the commission for approval. The process likely will stretch well into the next year. When approved by the commission, they'll be binding on mutual fund companies.

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