IFIC conference update: Concerns raised over fund review committees

The Securities and Exchange Commission (SEC), along with U.S. state regulators began requiring mutual funds to set up boards of directors following scandals that surfaced within the industry during 2003.

U.S. laws require the directors of such boards to be independent of the fund companies. William Foulk, chairman of AllianceBernstein funds in New York, notes the job is no different from sitting on the board of directors at any other large corporation — save that his job requires him to place more emphasis on compliance with federal and state securities regulations and do more work in the area of trading surveillance to ensure the fund does not get mired in market timing or late trading abuses that damaged the industry’s reputation a few years ago.

Foulk notes the directors’ primary jobs are to manage conflicts of interest and performance, and that some U.S. fund companies, including Putnam, maintained them as a best practice before they were required.

Another problem with moving to an American model, says Schwartz, is that investors in U.S. mutual funds qualify as shareholders, whereas that’s never been the case in Canada. Investors in this country can put their money into the fund and then take it out if they’re unhappy with what the manager is doing. There’s not the same sense of ownership, and that flies in the face of the idea of creating boards of directors that owe a fiduciary duty to shareholders.

Where the roles would differ, notes AIM Funds Management general counsel Susan Han, is under the CSA’s proposal, IRC members would not be responsible for setting the fund’s short and long-term strategic directions. Directors at U.S. funds, by contrast, have a say in such matters. “What’s contemplated is more there as a check to make sure those managers aren’t doing something they ought not do,” she says.

“The U.S. regulatory model is a lot more adversarial, there’s a lot more litigation. In Canada, marketplace discipline is created through cooperation between the regulators and those who are regulated.”

Creation of full-fledged boards also can lead to regulatory nightmares, says Schwartz. In the notable late-1990s Navallier and Yacktman litigations in the U.S., mutual fund directors tried to dismiss managers only to have investors (who are shareholders) insist they be reinstated because they were producing good returns. When the fund board tried to take it to the SEC, they were essentially told to sort it out for themselves.

Likewise, if IRCs became full-fledged boards, Schwartz suggests, they’ll be able to turn down requests from regulators to dismiss managers, although they’d still likely be required to discipline them in other ways.

Schwartz also expressed concerns about the costs of creating IRCs and says the CSA’s estimates for what fund companies will have to shell out for setup and maintenance are understated. He calls the direct fees a “drop in the bucket” and points out the soft costs for things like having the chief compliance officer travel to meet with an IRC aren’t factored in, nor are the costs of having a highly paid professional away from the office for a couple of days.

Filed by Philip Porado, Advisor’s Edge philip.porado@advisor.rogers.com