More independence on fund boards is good but unlikely

Your Funds

Your Money

March 27, 2007|By Charles Jaffe | Charles Jaffe,Marketwatch

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."

Intuitively, shareholders want the former - every improvement is seen as good news - and fund companies want the latter.

Alas, when it comes to the debate over whether mutual fund boards should have chairmen and a super majority of directors who are independent of company management, it appears that fund interests are going to win.

In 2004, the Securities and Exchange Commission adopted a rule requiring all funds to appoint an independent chairman and to make three-quarters of the board of directors independent. The rule came in the aftermath of the rapid-trading scandals of 2003, and while it was universally applauded by consumer groups but railed against by the Investment Company Institute and by several big-name fund firms - most notably Fidelity Investments - which said it was unnecessary and costly.

The rule was rejected twice in a federal appeals court, which pointed to the SEC's administrative process as a big part of the problem. So, the agency reopened the discussion.

In December, the SEC released two reports from the Office of Economic Analysis examining the costs and benefits of having a chairman and 75 percent of the fund's board independent from the investment adviser. Both sides of the debate had until March 2 to file comments.

While there is no official word from the SEC yet, it is pretty clear talking to agency insiders that the issue is dead.

A few of the SEC's commissioners remain in favor of the rule, but it lacks sufficient support to rise again. About the best investors can hope for is that the SEC suggests that increasing independence would be the industry's "best practice."

In other words, the agency is settling for "ain't broke," rather than improving the situation.

"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 2003 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. The board sets a fund's fee structure on behalf of investors; lower fees are good for shareholders, and high fees enrich the management firm. While there are independent boards that have allowed fee increases, studies have shown that the higher the percentage of directors that are independent, the lower the fees.

Eliminating other conflicts. Many fund companies have sister businesses that handle backroom operations, recordkeeping services and more.

Independent directors will be more likely to look for the least costly services, and there have been cases where fund boards run by interested directors accepted more expensive deals to work with sister firms. That's a rip-off.

Protection. It's not just that an interested chairman has potential conflicts of interest, it's that they're doing the job 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 his keep, rather than considering this just one more chore in a busy day.

One consolation for investors - assuming the SEC lets the issue wither and 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 chairman, 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. His postal address is: Box 70, Cohasset, MA 02025-0070.

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