A big debate in the mutual-fund industry has left investors somewhere between “new and improved” and “if it ain’t broke, don’t fix it.”
Alas, when it comes to the debate over whether mutual-fund boards should have chairs and a supermajority of directors who are independent of the management company, it appears that fund interests are going to win out.
In 2004, the Securities and Exchange Commission passed a rule requiring all funds to appoint an independent chairman and to make three-quarters of the directors independent. The rule came in the aftermath of the rapid-trading scandals of 2003, and while it was universally applauded by consumer groups, it was railed against by the Investment Company Institute and by several big-name fund firms that said it was unnecessary and costly.
The rule was rejected twice in a federal appeals court, which cited the SEC’s administrative process as a big part of the problem. So the agency reopened the discussion.
And while there is no official word from the SEC yet, it is pretty clear talking to agency insiders that the issue is dead.
While a few of the SEC’s commissioners remain in favor of the rule, it lacks sufficient support to rise again.
“The essence of a mutual fund is that investors are buying professionals to manage their money, plus effective oversight for how their money is managed,” says Susan Ferris Wyderko, executive director of the Mutual Fund Directors Forum. “Will shareholders be harmed without an independent chairman and board? It’s hard to say or quantify. But the studies and the comments have made it pretty clear that the shareholder benefits of effective government are significant, and the costs of achieving effective government are low.”
The case against the rule boils down to a slap at why it was proposed in the first place.
Having an independent board would not have stopped the scandals of ’03 and will not stop the next one, whatever it may be. In fact, a few of the firms that got tagged by regulators met the higher independence standard.
“It’s hard to say that funds function better with an independent chair,” says Geoff Bobroff of Bobroff Consulting in East Greenwich, R.I., who serves as the independent chairman for the Matthews Asian funds. “But what you can say is that the independent board could eliminate conflicts of interest and generally just make us feel better.”
Specifically, here’s what we would feel better about with an independent chairman and board:
Negotiating fees. While there are independent boards that have allowed fee increases, studies have shown that the higher the percentage of directors who are independent, the lower the fees.
Eliminating other conflicts. Independent directors are more likely to look for the lowest-cost services.
Protection. It’s not just that an interested chairman has potential conflicts of interest, it’s that they’re doing the job for free. This is a case where you get what you pay for, and hiring an independent chairman improves the odds of having someone in charge who is earning their keep.
One consolation for investors – assuming the SEC lets the issue die – is that firms that have moved to independent boards are not likely to step back in time. But if the SEC won’t go all the way to “new and improved,” it should at least suggest that having an independent chair, lead trustee and supermajority of the board is the ideal setup.
Investors who want a superior board structure could then vote with their feet, and the fund-industry leaders might recognize that they should aspire to a higher standard than “ain’t broke.”
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.
