Despite heightened awareness within the fund industry and increased scrutiny by the SEC of fund trustee independence, three newly-registered funds have, in recent months, placed individuals whose independence might be questioned, on their boards.

In September, famed portfolio manager Ryan Jacob, former manager of The Internet Fund, registered a new fund, the Jacob Internet Fund. Jacob, now founder and CEO of his own firm, Jacob Asset Management in New York, was named as the new fund board's chairman. Among the board's four independent trustees is Leonard S. Jacob, a medical doctor who is also Ryan Jacob's uncle.

When the Valgro Funds of Chicago registered in October to launch its flagship mutual fund, the fund's initial board of directors was to be composed of two individuals - one affiliated director and one independent trustee. Robert Allen Rintel, president of Valgro Funds, was to serve as chairman and an "interested" member of the fund board. But Max Noy, Rintel's grandfather and the chief executive of two New York real estate firms, was chosen to serve as Valgro Fund's sole independent board trustee.

These and other new fund filings beg the question that the SEC has recently been grappling with - How far removed must a fund trustee be to be truly independent?'

Immediate family members which include children, spouses, parents, brothers or sisters, including those members connected by foster or adoptive relationships, are prohibited by law from serving as "independent" trustees, according to an SEC spokesperson. The SEC declined further comment.

Securities regulations clearly spell out which family members are prohibited from serving as independent trustees on a fund board and the law does not specifically preclude a grandfather or an uncle from board service, said David Sturms, attorney with Vedder Price Kaufman & Kammholz in Chicago. But, then there is the "classic," and equivocal, case of a brother-in-law, said Sturms.

The SEC in recent months has increased its scrutiny of "independent" board members.

In October, the SEC proposed that fund advisers provide additional disclosure to investors regarding areas of potential conflicts of interest. The regulator is also proposing a regulation that would require fund boards to keep detailed records of any notable personal or business relationships independent trustees may have with an advisory company or its executives. The SEC says in its proposal that it would have the authority to inspect those records.

In reviewing the Valgro Funds' registration statement, the SEC contacted Rintel to seek more information and question the nature of the relationship between him and Noy, said Rintel in an interview.

"I expected the issue might come up," said Rintel. "But my grandfather met the minimum requirements of the law."

It was not the grandfather/grandson family bond per se that the SEC objected to, said Rintel. Rather, the regulator wanted to understand if any affiliation or business relationship existed beyond Noy and Rintel being members of the same family. Rintel told the regulator that he owned five percent of a building that Noy manages.

Shortly after that, Rintel decided to remove Noy from the fund's proposed board. In mid-December, Rintel proposed a different independent trustee for his fund, F. Joseph Moretti. Moretti, a software developer, has no family ties to Rintel.

Possible conflicts are likely to arise because it is a challenge to find independent trustees willing to sit on the boards of small, start-up mutual funds, said C. Meyrick Payne, partner of Management Practice, a consulting firm in New York.

Often small funds with limited resources ask newly-appointed board trustees to forego any compensation for the first year or more. According to fund documents, Valgro Fund's independent trustee, Moretti, will serve without compensation until at least October 2000, the end of the fund's first fiscal year.

"Often friends and family members are the only ones willing to sit on the board of a small fund," said one industry executive.

Leonard Jacob, uncle of Ryan Jacob, would earn the same $4,000 annual compensation for serving on the Jacob Internet Fund board as the fund's three other independent trustees. Jacob had not returned a call seeking comment.

Organizing a board of directors for a new fund is fraught with challenges, said Aaron Brown, co-founder of Privateer Asset Management, adviser to the Allied Owners Action Fund, which is registered but is not yet available. (MFMN 1/3/00)

The Allied Owners fund's registration document says that those who are willing to serve as fund trustees are usually those who know and trust the fund's adviser. In general, these trustees "may be disposed to care more about getting the sponsor's money back than defending interests of Fund shareholders," the fund filing said. A related issue is pay, said the filing.

"If the pay is too low, only friends of the sponsor will serve," the filing said. "If the pay is too high, directors will quickly become friendly with the sponsor." While saying that there is no perfect way to eliminate questions of independence, the Allied Owners fund struck what it considers is a temporary compromise in structuring its initial board of directors.

The fund's board will consist of four unaffiliated trustees, all of whom are friends of Brown but who did not know each other. Moreover, said the fund document "...the Fund believes all have the character to place duty above friendship."

But the fund's intended board compensation plan has raised some questions. Each of the Allied Owners fund's proposed independent trustees will be granted a 500-share stake in Privateer, the fund's investment adviser, in addition to earning $150 in fund shares for each monthly board meeting attended. While the fund share compensation plan tends to align trustees' interests with that of fund shareholders, being granted an equity stake in the fund management company blurs the lines between trustees' independence and affiliation, said an industry attorney.

"If a fund meets certain requirements, the law requires that only one trustee be independent," said Les Ogg, counsel to the independent trustees of the American Express Funds in Minneapolis, Minn. "One director has to be independent and I cannot figure out which one that is supposed to be if everyone owns 500 shares of the adviser."

"No system is free of conflict," said Brown of Privateer. "This is the least bad method of compensation."

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