SEC Chairman Arthur Levitt is expected to recommend changes in the way mutual funds are governed at an industry conference on mutual fund regulation which begins today.
Industry lawyers and executives expect Levitt will propose some best practices - non-binding guidelines for industry conduct - and perhaps, outline new regulations with respect to mutual fund directors. The most widely-anticipated proposal would require that at least a majority of mutual fund directors be unaffiliated with a fund adviser, according to industry lawyers. Lawyers also expect Levitt will suggest a new standard which would make it more difficult for a former employee of a fund adviser to qualify as an independent director.
Levitt's scheduled keynote speech today at the Federal Bar Association/Investment Company Institute (ICI) Mutual Funds and Investment Management Conference was unexpected. The SEC's top mutual funds official, Paul Roye, has been scheduled to deliver the address. The event was not on Levitt's public schedule as recently as March 1.
But at the conclusion of an SEC conference on mutual fund directors on Feb. 24, Levitt ordered the SEC staff to examine practices regarding directors and recommend substantive changes in 30 days. Industry lawyers and executives speculated that Levitt would not speak at the mutual funds conference unless he intended to urge significant changes in mutual fund management.
A spokesperson for Levitt declined to comment on the contents of Levitt's address. A spokesperson for the ICI said the group was uncertain what Levitt would say.
Robert Zutz, a lawyer with Kirkpatrick & Lockhart in Washington, said the scheduling of today's speech and last month's conference on directors suggest that Levitt intends at least to press the mutual fund industry for changes in fund corporate governance. Zutz expressed some concern, however, if the proposals come in the form of best practices guidelines. Zutz and other industry lawyers said that best practices are effectively regulations that are set without the safeguards built into the regulatory process.
"Best practices have a way of becoming de facto regulations," Zutz said.
The SEC's usual process of adopting regulations is very structured. Lawyers on the staff draft regulations internally and then publish proposals. The public is invited to comment. The SEC staff then examines comments and often makes at least some modifications to the original proposals. The SEC commissioners ultimately must vote to adopt the regulations. Although the SEC has great discretion in writing rules, its regulations are more readily subject to court challenge than a list of best practices.
In addition to proposing best practices, the SEC may increase scrutiny of directors as part of its routine inspections and bring enforcement cases in selected instances, said Pamela Wilson, a lawyer at Hale & Dorr in Boston. She said that ultimately, the agency must rely on the diligence of directors rather than expect new rules or laws to provide special protection for shareholders.
"How can you legislate how hard the board has to bargain" with the adviser, Wilson said. Directors negotiate with fund advisory firms on key issues such as management fees and marketing expenses.
Levitt can rely on some previous work of the SEC as a starting point for change. In 1992, the SEC staff recommended that the commission back Congressional legislation which would require that a majority, rather than 40 percent, of a fund's directors be independent. It also recommended that independent directors nominate new independent directors. The adviser now can play a role in that nomination process. Shareholders ultimately vote for directors.
Neither the proposed law nor the change in selecting directors was adopted. Both practices, however, have become commonplace in the industry, according to lawyers and fund directors.
At last month's conference, Levitt raised questions about whether a former officer of a fund adviser should be required to wait as long as five years before becoming an independent director for a fund. There is no formal rule regarding that practice now. As a result, an individual can join a fund board as an independent director shortly after retiring from a fund adviser. Industry lawyers speculated that Levitt would suggest a mandatory waiting period in such circumstances.
