Representatives of the mutual fund industry are moving quietly in Massachusetts to enact a law which would help define what makes a mutual fund director independent, an increasingly contentious issue.

The legislative proposal was sparked by a decision last year in U.S. District Court which held that under Maryland law, directors may lose their independence by virtue of being paid to serve simultaneously on the boards of several funds in the same mutual fund group. The proposed legislation calls for the Massachusetts standard for fund director independence to be the same as that under the Investment Company Act, the federal law governing mutual funds. That act permits directors to serve on multiple boards.

The Massachusetts proposal has been pending for several months according to a Fidelity Investments spokesperson and industry lawyers. But, lawyers and other fund companies with knowledge of the specifics of the legislation declined to discuss it in detail. Aides in key Massachusetts legislative committees said they were unfamiliar with the proposed law. Online searches by state officials did not turn up the proposal, its sponsor or status.

The Massachusetts proposal comes as the mutual fund industry's largest company, Fidelity Investments of Boston, faces a lawsuit challenging the independence of its directors based on the fees they receive. That suit, filed last month in federal district court in Boston, alleges violations of federal rather than state law. Fidelity denies the allegations.

Debra McConnell, the Fidelity spokesperson who confirmed the legislation's existence, said the company supported it. She said it would mean that fund directors will be governed by the same standard of independence for both state and federal law. Fidelity officials declined further comment.

Funds organized under Massachusetts law have long had directors who served on several boards within the same fund complex. The Massachusetts legislation appears to be an effort to make a preemptive strike to reduce the risk of successful litigation challenging directors' independence under Massachusetts law.

Massachusetts, Maryland and Delaware are the states in which the vast majority of mutual funds are incorporated or organized. In April, the Maryland legislature passed a law similar to that pending in Massachusetts. (MFMN 4/20) Industry lawyers said the new law has attracted funds to incorporate in Maryland.

Robert Zutz, a partner in the law firm of Kirkpatrick & Lockhart in Washington, said he was unaware of the particular Massachusetts proposal. But, he said adoption of legislation in Massachusetts similar to the Maryland law would be a positive response to what Zutz called the "troubling trend" of litigation challenging directors' independence based on their fees and multiple board memberships.

Mutual fund industry officials have defended the practice of having directors serve on multiple boards for practical reasons as well as legal ones. The Investment Company Institute has warned that limiting multiple board membership will increase fund expenses and decrease operating efficiency. Independent directors are crucial for funds because they serve as a check on the actions of a fund's investment adviser. At least 40 percent of a fund's directors must be independent. One of the directors' major responsibilities is to approve the fees a fund pays its investment adviser.

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