Last week, an advisory group of the
Investment Company Institute
, the mutual fund industry's trade association, released a list of 15 recommendations to strengthen the independence of fund boards. The proposals, among other things, suggest that at least two-thirds of a fund's directors be independent from the fund-management company and that former senior officials from the fund company be prohibited from serving as independent directors.
Some of these practices seem to set a higher standard for board independence. Having a substantial majority of independent directors, for example, "will help ensure at least that you have people asking the hard questions," says Ann Yerger, director of research at the
Council of Institutional Investors
, an association of pension funds in Washington, D.C.
On the other hand, many, if not most, of these "best practices" are already in place at the biggest fund companies. For example,
complies with the majority of the recommendations and only needs to tweak two of its own practices to be in compliance with the entire list.
The ICI group could have gone farther. How? Let's look at a few of its recommendations:
- Former officers or directors of a fund's investment adviser, underwriter or certain affiliates cannot serve as independent directors on funds. This certainly would dispel any unacknowledged conflicts. However, board members still get to work in virtual obscurity, hidden from the people who matter the most: the shareholders.
Fund companies are only required the disclose the names, addresses and minimal background information for board members in the statement of additional information, an unfriendly document that is sent to shareholders only upon request.
It's time to shine some light on these directors -- really big, white hot klieg lights. Try putting this information in documents that an investor might actually read, such as the annual report. Even the prospectus would be a better venue. There's nothing like greater exposure to increase their accountability to shareholders.
I know from first-hand experience that some directors are utterly shocked when they get calls asking about their actions as board members. When I've happened to get a few on the phone, some become immediately apoplectic at the mention of a fund.
Better yet, let the fund companies start publishing their phone numbers.
Independent directors will complete an annual questionnaire on business, financial and family relationships, if any, with the adviser, its affiliates and other service providers. According to the advisory group's report, "the questionnaire should be reviewed by the nominating committee of independent directors (if any), a lead independent director and/or counsel, as appropriate. Such questionnaires may be available to the SEC staff during examinations." The recommendation says nothing about disclosing this information to fund investors. I say let the shareholders know what these questionnaires reveal. More disclosure! More disclosure!
Independent directors will establish the appropriate compensation for serving on fund boards. A board's compensation is already included in a fund's statement of additional information. But again, this information should be nicely charted in one of the more readable fund documents. Also, tell us how many hours these directors worked to earn these salaries, which sometimes reach six figures.
OK, so this extra information in, say, an annual report might increase printing costs, which comes out a fund's operating expenses. So, fund companies should disclose this information on their Web sites as well. Like anybody, I always love to hear what people get paid.
Fund directors should invest in funds on whose boards they serve. I am a big believer in requiring directors and even managers to invest in their funds. People's interest is certainly heightened when their own money is at stake. There should be a minimum investment requirement for the board members. For example, directors should be required to invest a certain percentage of their board salaries back in the fund.
Independent directors should meet outside the presence of management representatives in connection with their consideration of the fund's advisory and underwriting contracts and otherwise as they see fit.This will certainly help distance independent directors from any fund company allies when reviewing the agreement with the fund adviser. But here, the industry should take a page from the rules that govern the boards of corporations.
In the early 1990s, the
Securities and Exchange Commission started requiring increased disclosure of executive compensation. Under those disclosure rules that took effect in 1993, a corporate board's compensation committee is required to draft and sign a justification of executive salaries that is included in the proxy statements.
To lend even greater accountability and to increase the transparency of a fund board's role, make those directors prepare a yearly report on the factors they considered in determining the fees paid to the investment adviser and the renewal of the management contract. The board should outline and justify its decision-making process. Then send this summary to shareholders along with the standard annual report.
The word transparency really gets at the heart of my central complaint about the fund company boards. Who really knows what goes on at board meetings? The minutes aren't available, and there is no discussion of what happens. I would like to see the fund companies actually explain to shareholders what boards actually do. The ICI has an electronic pamphlet on its
Web site about understanding the role of directors, but let the fund firms help communicate this as well.
Next week, the ICI's complete board will vote on whether to adopt the 15 recommendations. If passed, these best practices will not be binding, but they will serve as a standard for the fund industry. The SEC is considering its own rules for fund governance.
But I want to hear your own best-practices suggestions. I will send them to John Brennan, chairman of the ICI and chief executive officer at Vanguard, along with a box of PowerBars since he is an avid runner. Send them to me at
email@example.com and include your full name.
More on SPDR Costs
After last week's
column on the cost of
, I received a few emails from readers pointing that I missed -- or as one reader put it, "ignored" -- one very valuable point.
With mutual funds, you are required to pay taxes on capital gains distributions. "I realize that index funds do not have high turnover, and the taxes are small compared with
those of normal mutual funds, but taxes on SPY are only paid on the gains when you sell them. This difference more than compensates for the brokerage commission you pay when you buy SPY," writes
With the SPDR, you can have capital gains distributions from the underlying trust. Still, "this structure is more tax-efficient than a traditional mutual fund structure," says Jay Baker, vice president of derivatives marketing and research at the
American Stock Exchange
. In fact, the SPDR did have a 9-cent capital gains distribution in 1996, but that has been the only one, says Baker. As with a mutual fund, these distributions are taxable.
Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.
As originally published, this story contained an error. Please see
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