Following the Securities and Exchange Commission's new requirements regarding mutual fund boards and independent trustees, the Mutual Fund Directors Forum, at the request of SEC Chairman William Donaldson, has weighed in with its own set of 32 best practices. Donaldson made the request in November, just 2-1/2 months after the fund scandal broke, at a point when the SEC was finalizing a flurry of regulatory proposals to enhance board members' independence to stem further abusive activities.
Led by the Chairman David Ruder, a professor at the Northwestern University School of Law and an SEC chairman from 1987 to 1989, the forum was originally convened in 1999 as the Mutual Fund Directors Educational Council and reorganized in 2002. While some of the forum's best practices are now SEC requirements, most are merely recommendations. However, they are worth noting, said Allan Mostoff, forum president and former head of the financial services practice at Washington law firm Dechert. The Investment Company Institute came out with 17 governance standards in June 1999 and October 2003, but the forum's sole focus is independent directors, Mostoff said.
One of the forum's recommendations, for instance, is to better define what constitutes an independent director. While current regulations permit a person who worked for the advisor or affiliate within two years to serve as an independent trustee, the forum would expand that to five years. The forum also suggests how to best handle investment management contract and fee reviews, and the process for valuing and pricing securities. For the latter, the group recommends forming a specialized board committee. However, the group does not suggest that all issues be handled by creating a slew of new committees. A small board with three to five board members probably doesn't need a proliferation of committees, Mostoff said.
The recommendations also suggest that boards draft guidelines relating to trustees' ownership of the funds they oversee and conduct annual self-assessment reviews (now a necessity through an SEC mandate). The forum also would like board members to participate in ongoing educational programs. The forum stopped short, however, of recommending that board trustees be required to attain a minimum level of annual continuing education-like credits, in much the way certain professional organizations do.
The forum also suggested that boards pressure investment advisors to provide more disclosure to the board regarding trading costs, best execution, and revenue sharing, and to encourage advisors not to direct trades to brokerage firms with which they have a sales agreement but to firms that will truly deliver best execution. Perhaps its thorniest recommendation is the elimination of all soft-dollar programs, a suggestion the ICI came out in favor of last December. But the forum noticeably did not address the issue of 12b-1 fees.
The SEC is currently considering whether to limit soft-dollar arrangements or curtail the practice altogether and has solicited the assistance of the Mutual Fund Task Force, a joint venture between the SEC and NASD assembled last May. The 20-member task force includes members of nine securities firms, nine investment companies, a college professor and a lawyer. Not surprisingly, the investment management industry is bitterly divided on the controversial issue of soft dollars. Some support an outright ban. Others argue that a fix for a system that isn't broken isn't needed. Still others contend that a simple tune up is in order.
"I feel like [soft dollars] present a serious conflict of interest between the advisor and the client," said Bernie Horn, president of Polaris Capital Management of Boston, which does not engage in any soft-dollar arrangements. Although soft dollars could save the firm more than $30,000 in research, market data and equipment, Horn said he simply doesn't "believe in doing that to the client."
The Alliance in Support of Independent Research, a Washington consortium of securities firms, quickly chastised the Mutual Fund Directors Forum for its hard-line position. "Without citing any quantitative or empirical evidence, the [forum] has attacked a practice that has been used by mutual fund advisors for decades to improve the performance of managed funds," shot back Lee A. Pickard, counsel to the alliance. Pickard is managing partner of Pickard and Djinis of Washington and a former director of the SEC's division of investment management.
Robert M. Braun, institutional sales manager with Midwood Securities in New York, which provides third-party research to institutional clients, believes a soft-dollar ban is a ruse aimed at weeding out small, niche independent research providers in favor of having both research and trading conducted by an oligopoly of large firms. Instead of a ban on soft dollars, he favors better, more quantitative disclosure of research obtained through soft dollars. "The difficulty is when people use soft dollars to pay for carpeting in their office. That's when the client gets ripped off," he said.
"Doing away with soft dollars would be a loss of independent research firms that some companies depend on," agreed Mark D. Foster, chief investment officer of Kirr Marbach & Co., a fund advisor in Columbus, Ind., that uses soft dollar credits to obtain research. "Could [trading costs] be a penny or two less? Yes, but in order to have access to research services, we would have to raise fees," he said. He also noted that any ban would run contrary to the recent push for even more independent research to be available.