No doubt you are more than conversant with the names of the portfolio managers running your mutual funds -- and their track records, backgrounds, investment philosophies and so on.
Now quick! Name an independent director -- just one -- of any of your funds. Go on, take a minute.
Chances are, even if I gave you an hour, you'd come up blank. What was the last time you called up your fund's director and gave him or her an earful? Who, in fact, ever even thinks about fund directors? Who the heck are these guys and why should we care?
Securities and Exchange Commission
wants more fund shareholders to ask themselves those questions. To encourage more inquiring minds among investors, the regulators are hosting a two-day gabfest in Washington next week about independent directors. Heavyweights from the industry and academia, investor advocates, and directors themselves will brainstorm about how independent directors can, and should, exercise more control over everything from the fees and expenses you pay to how your fund is distributed to how the portfolio is managed.
Without a doubt, it's the issue of fund fees that resonates most with investors. Little wonder: In a decade, total mutual fund assets have increased to nearly $5 trillion from $734 billion. Expense ratios, meanwhile, have also increased, to 1.1% of assets from 0.9%, according to fund tracker
Where are the economies of scale, and why haven't fund fees come down as those economies have been realized? Good question. And here's one you can bet will come up next week: Why haven't fund directors insisted on lower fees?
Paul Roye, the new head of the SEC's Investment Management Division and, as such, the top cop of the mutual fund industry, says regulators will be looking closely at fees in coming months, particularly in regard to the completeness and quality of information about fees provided to directors from management. Rubber-stamping fees after routine reviews will not be winked at, Roye says.
But he also assures me that in his experience, directors are a conscientious lot. "For 16 years I was in private practice working with investment companies and fund directors. And in large part, the directors I dealt with took their role seriously."
There are those who disagree, but first, some background. An independent director is nominated by fund management, then voted in by shareholders. (Picture the names listed in the small print under the big Vote for This heading on your proxy.) By law, at least 40% of a fund's board must be made up of independent directors -- folks with no financial interest in the fund or its adviser. In reality, 71% of the average fund board is independent, according to the
Investment Company Institute
, the mutual fund industry trade group. The framers of the Investment Company Act of 1940, the law that governs mutual funds, envisioned such directors as fiduciaries, charged with protecting investors' interests. Roye calls independent directors "watchdogs."
What's behind the newfound interest in directors? A couple of high-profile showdowns between directors and portfolio managers, and a couple of lawsuits against fund giants
T. Rowe Price
, filed by shareholders who claim there's not enough "independence" in independent directors.
In the spring on 1997, independent directors of the
Navellier Aggressive Small Cap Equity fund fired manager Louis Navellier, charging that he kept them out of the loop on important fund decisions. Last year, directors of the
Yacktman fund tried to oust manager Donald Yacktman after questioning his performance. Following bitter proxy fights, shareholders sided with the portfolio managers, who kept their jobs. (See
coverage, for more info.)
The lawsuits allege that directors can't claim independence when they sit on multiple boards within a fund family, collecting numerous paychecks that add up to generous sums. The case against T. Rowe Price was dismissed in January, Fidelity recently filed a motion to dismiss.
For the record, some 76% of fund complexes surveyed by the ICI in 1997 said the same directors served on a single board for all the funds in the complex. Another 15% said boards served in clusters within the family, with one board serving one group of funds, another, a different group and so on. The ICI survey found that independent directors earn an average of $46,644 annually. Bigger funds hand out bigger paychecks: At Fidelity, most directors earn more than $200,000, according to fund documents.
But it's not the money that makes for too cozy a relationship between directors and management, says Don Phillips, chief executive officer of
. "It's not about compensation. Ultimately, it's that directors only have interaction with one party -- management. They spend a lot of time with management and precious little with shareholders." As proof, Phillips recounts a recent conversation with a Fortune 500 CEO who also sits on the board of a mutual fund.
"I get a couple dozen letters a month" from corporate shareholders, the CEO told Phillips, "and those letters make me a better CEO." But in the five years he's been on the fund board, the CEO hasn't heard a peep from the fund's investors.
Part of the communication problem, however, could be that shareholders have to jump through hoops just to learn who their directors are, let alone to chat them up about any concerns. On most prospectuses, the topic of independent directors is barely touched on -- an oversight made even worse by the new, simplified profile prospectuses, Phillips complains.
Fidelity will tell you who the directors are in semiannual and annual reports, but you have to call to receive a Statement of Additional Information and turn to the back to learn about their backgrounds and what they're paid. That's standard industry practice.
The most frustrating thing about how the system works now is that it reinforces the idea that mutual fund shareholders are customers who are sold a product, with directors often as interested in marketing more product as in increasing shareholders' returns.
In truth, and by law, fund investors are owners of a common enterprise, and directors are their advocates -- and theirs alone. If the SEC's Roundtable gets that idea across to the investing public, then it will have been worthwhile.
Anne Kates Smith is a senior editor at U.S. News & World Report in Washington.