The role of independent directors of mutual funds has been the subject of considerable debate recently and is the topic of an SEC roundtable this week in Washington. (see box page 36.) MFMN free-lance reporter Lori Pizzani drew together several industry leaders to discuss aspects of the issue.
To begin, Stanislaw ("Stas") Maliszewski, former independent trustee of the Yacktman Funds, told Pizzani some of his ideas about improving mutual fund governance and how better to empower independent trustees who are charged with fund oversight and making decisions in the best interests of shareholders. Pizzani then asked four mutual fund industry leaders (see box) to give their views on Stanislaw's suggestions.
Stanislaw Maliszewski: First, in my opinion no manager should carry the fund manager's name. There's an inherent contradiction of terms. It gives the perception of ownership by the manager, which is not true because share-owners are the real owners. We often hear, "He sold his mutual fund group" but that's a misnomer. The money in the fund is not "his" it is "theirs." How, as an independent director, can you negotiate with someone who owns the entity?
Barry Barbash: I can understand why this suggestion was made, but I think it wouldn't prove particularly workable. People will likely associate names with funds whether managers' names are on them or not. When I think of Magellan, I think of Peter Lynch; with John Neff, Windsor. To keep managers from affixing their names would be inconsistent with the way American society operates.
Mutual funds aren't started by an entity that then looks for the mechanism for managers to provide investment management services. Managers start funds; they have a proprietary interest. It might be a nice idea but I don't think it's consistent with the way this industry operates.
Carl Frischling: The shareholders buy shares because of the manager's name. I would not preclude the name because I do not believe that shareholders perceive that the manager "owns" the fund. Most times where you have the name of a company or an advisory, you have a license to the name. If you're the star, your name is fine.
Paul Haaga: I think the "star manager system" is a bad idea, but I do not think that giving the manager power or implying that the manager owns the fund are the reasons. I would not suggest that the response be to eliminate manager names from the funds.
Don Phillips: I think it's absurd. What's in a name, anyway? When investors buy a fund, they buy either for exposure to an asset class or to buy the services of a professional manager. The notion that you would prohibit a manager from naming a fund is silly.
Maliszewski: One-hundred percent of a mutual fund's board of directors should be independent and no affiliated directors should be seated on the board at anytime. Then, there's no conflict in dealing with someone you are supposed to have an arms-length contract with. Affiliated trustees can exert undue influence over independent trustees and create an impediment. Right now, all boards must have at least a 40 percent minority of independent trustees. But that allows advisers to keep the control. Despite all of the rhetoric, mutual fund advisers don't want independent directors. They want the credibility; they want people to think the independent directors are there.
Barbash: In 1996, the SEC looked at possible legislative changes and had all kinds of discussions with the industry about raising that percentage of independent trustees. We thought that some 90 percent of boards were majority non-affiliated. But we found out that many did not want a majority of independent directors mandated.
Some money managers look at mutual fund management as a business and believe there must be a balance between enterprise and corporate governance. Moving the fund industry to a majority of independent trustees would be seen as tipping the balance toward directors and many would find that unpalatable.
Frischling: I agree with the present regulatory structure with one exception. I believe that all boards should have a majority of disinterested trustees, now only required for three years after a merger or change in control, or for funds with 12b-1 flows. I would continue the 75 percent requirement for the three-year period. Let's remember that "disinterested" does not mean "not interested." An inside director reflects management's views. But where there's a conflict, the independents are the ones who must vote.
Haaga: I believe it is a good idea to have a majority or even super-majority of fund directors independent of the adviser. But I believe that requiring a 100 percent independent board is wrong. It's useful to have an inside person chair the board in many instances because of their knowledge and ability to prepare the agenda items.
It's a good idea to have a few knowledgeable insiders on the board and I do not believe that it causes them to dominate others or to ignore their duties. This may be a moot point because most funds already have a super-majority of independent directors and very few have only 40 percent independents.
Phillips: I think a substantial percentage of a fund board should be independent, but you want a team approach and the checks and balances that come along with that. If a board were composed of all independents, the directors would think they were running the fund. You don't want the board as a separate entity. You don't want two competing groups. Having some insiders provides the necessary perspective.
Maliszewski: There should be no common attorneys, period between the trustees and the advisory firm. There's an inherent conflict. If one lawyer represents both, you can basically assume they are the adviser's attorney- in their pocket- and trustees are doomed.
Even common insurance policies (such as errors and omission policies for both directors and officers) aren't a smart idea. The usual cry is that it's cheaper if we combine the policies into one. But therein lies a conflict. The insurance company won't insure trustees if the parties being insured are in conflict (as in the case of a proxy battle.) The intertwining is a mis-application.
Barbash: As an attorney, this one is tough for me. Independent counsel can be an important part of the board. But mandating it? No. Some recommend that boards have a lawyer who is separate from the counsel to the adviser. But if you don't need it, why have the expense? You have to look at the bigger picture. Many lawyers believe they can objectively provide guidance to both. Mandating separate counsel would place a burden on smaller funds. But it can make sense if there are conflicts of interest.
Frischling: Counsel for the trustees should be independent of the adviser. But in some cases, i.e. small funds, it should be allowed with the board's blessing on a fully-disclosed basis. Small funds cannot afford the expense. But let the board decide.
Haara: Independent counsel is a good idea, whether you characterize the firm as counsel to the independent directors or counsel to the fund. I would not mandate it, however, because there may be cases, such as start-ups, where the organization simply cannot afford that degree of separation.
Phillips: I would stop short of saying it should be mandated. But it could be advocated as a "best practice."
Maliszewski: I don't think shareholders should be required to vote to change a manager. At the very least, if a shareholder vote must be required, it shouldn't take the form of a majority of shareholders blessing the board's actions. Rather the process should require a super-majority vote among shareholders to override the board's termination decision.
Consider what happens where there is a conflict with the adviser. Historically, many investors "vote with their feet" and flee the fund. After they redeem, consider who are the "eligible voters" left to vote. And what happens to those who sold and face tax complications? Why should investors be forced to do something they really don't want to do? The investing public needs to be protected at the board level.
Barbash: I find the notion difficult to accept. Saying that the will of the board should supersede that of the shareholder assumes that if a dispute arises, the shareholders should side with the board. When push comes to shove, it's the adviser the shareholder knows. Trustees are acting in the interest of shareholders but it's shareholders who ultimately choose.
Frischling: I would not allow the board to terminate the advisory agreement without shareholder approval. That would be inconsistent with the basic democracy of the industry. I would, however, allow for a super-majority to override the board's termination proposal. This has precedence in a number of corporate governance cases, and it would reflect the fact that the board has access to more information than shareholders.
Haara: I find a lot with which to disagree. First of all, the shareholders purchased the fund because they were selecting the adviser, not because they were selecting the trustees. Accordingly, there should be a shareholder vote if any advisory change is to be effected.
I think the requirement to obtain shareholder approval is a good check on the process. Among other things, it requires that the reasoning behind the decision to change advisers be articulated in a proxy statement for which there is legal liability.
Finally, I think the whole topic of terminating advisers is misplaced. Fund boards have a great deal of power and influence even when they are not terminating a contract. Moreover, people who measure the effectiveness of boards by how many contracts they've terminated miss the point about how the governance process works.
Phillips: As much as I am for shareholder rights, I disagree. A board could be acting in a way that is inconsistent with shareholder views. You also don't want the adviser running rampant over shareholder interests. But something needs to be done.
There should be more communication between the board and shareholders so that shareholders can communicate more directly with the board. Perhaps a special e-mail address set up for that purpose. Additionally, there should be more trustee visibility where shareholders can find out who these people are and what they do.