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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Remarks at Mutual Fund Directors Forum


Chairman Harvey L. Pitt

U.S. Securities and Exchange Commission

Washington, DC
January 8, 2003

These remarks reflect solely the personal views of Mr. Pitt, and do not necessarily reflect the views of the Commission, the individual members of the Commission, or its Staff.

Thank you for the gracious introduction, David.

I get nervous talking in front of Professor Ruder so close to Northwestern Law's final exam period. He's in "examination mode." And, when he is, he tends to ask lots of questions, which typically begin with complex fact patterns — involving things like car crashes and unsigned contracts — and then end with something like, "What were the 50 most significant events that impacted the securities laws in 2002, and why?" Then, he grades your answer. Because he's a law professor, this usually involves throwing the answers down the stairs and grading each according to the stair on which it lands. This grading process can be painful, especially if your answer is oral!

But the wonderful thing about David's questions is that you learn a lot just from his asking them! David's contribution to the securities laws is unparalleled, and I have been the beneficiary of his wisdom and intellect throughout my career, not that I want to saddle David with any responsibility for the last eighteen months!

It's a privilege to be here this evening and to be a part of this forum. I applaud the efforts of the Mutual Fund Directors Forum, and especially David Ruder, to provide a vehicle for the continuing education of fund directors. As we all know, mutual funds are the investment and savings choice for millions of Americans. Mutual fund investors benefit from groups like the Forum that seek to improve and elevate fund governance, and promote the development of vigilant, dedicated and well-informed independent directors.

I commend those mutual funds and fund complexes that already have elected to join the Forum — thereby enrolling all of their independent directors in the Forum — and I encourage those who have not yet done so to consider seriously the benefits of joining. Independent directors can avail themselves of the Forum's annual policy conferences, newsletters, executive education courses and related programs, all of which will help fund directors to improve their skills as fund overseers, as well as provide an opportunity to exchange ideas, experiences and information.

Being a good and an effective director is a learned, not an innate, skill. Nor is it a static proposition. Standards for directors change over time, as we learn more about the things directors should be asked to consider and do, and as we learn what happens when they don't! Mutual funds and mutual fund directors have been at the forefront of examining and considering improvements in corporate governance, not just for the fund industry, but also as an example for all of Corporate America. And, through intensive and thought-provoking conferences like this, I'm sure you'll continue to be leaders in protecting shareholder interests.

Today, more than half of all Americans participate in our securities markets, most through mutual funds. SEC-registered investment advisers manage and have discretion over $19 trillion of assets, including large equity securities holdings. Mutual funds they manage hold nearly one-fifth of all publicly traded US equity securities.

Since the 1940 passage of the Investment Company Act, the mutual fund industry, for the most part, has been remarkably free from scandals that have plagued other areas of the financial services industry. The trust and confidence investors have in the mutual fund industry is due in no small part to the vigilance of fund directors, and the efforts of the Commission, in ensuring compliance with the Act's core investor protection concerns. However, you as fund directors, and we as regulators, cannot become complacent or set in our ways. We must remain on guard and continue to challenge, probe, and ask difficult questions. And, we must be flexible enough to recognize that doing things the way they've always been done just isn't always good enough.

This evening, I'd like to share some thoughts about how to address these challenges — first from the perspective of independent directors and then from our perspective at the SEC. Independent directors and the SEC have much in common: we both serve investors. Shareholders' interests must be a driving force behind everything we do.

The Investment Company Act and SEC regulations lay out specific responsibilities for fund directors. In essence, independent fund directors are responsible for policing conflicts between the fund's adviser and its shareholders. This requires vigilance and dedication. Just like we advise investors, fund directors need to:

Do their homework.
Pay attention.
Ask questions.
And get help.

Part of doing your homework is keeping up with, and being responsive to, current mutual fund issues. In that regard, albeit as an aside, you may have read recently that the NASD and we are focused on whether mutual fund investors are being charged the correct sales load on mutual fund transactions. To emphasize the importance of this issue, the NASD issued a Notice to Members (02-85) early Christmas week, alerting members to take immediate action to ensure that their customers receive the advantage of breakpoints to which they are entitled. A letter accompanied the Notice from Annette Nazareth and Paul Roye, urging those at the highest levels of affected firms to pay attention to this fundamental issue.

Directors of load funds should be concerned that their investors are not overcharged. To do this, I urge you to inquire into the policies and procedures concerning sales loads at each broker-dealer that sells your funds' shares. As watchdogs for fund investors, this is a critical issue deserving your time and effort.

Several years ago, Paul Roye outlined how independent directors could ensure and improve their effectiveness.1 He drew on his experience as Director of the Division of Investment Management as well as 16 years in private practice advising mutual fund clients. I commend the entirety of Paul's April 14, 2000 speech to you, but here in brief are his recommendations.

  1. Understand your responsibilities
  2. Learn the mutual fund business
  3. Recognize your limitations
  4. Focus on important issues
  5. Pay proper attention to compliance, internal controls and risk
  6. Insist on quality information
  7. Be prepared
  8. Be committed
  9. Have a stake in the enterprise
  10. Be independent

Paul explained the concept of independence by referencing a book entitled "The Uneasy Chaperone," in which the authors analogize being an independent director to serving as a chaperone at a party: the chaperone should monitor and step in when necessary but should never join in the merrymaking.2 If you've got teenagers at home, as I do, you'll value this advice.

When I was in private practice, I advised clients by drawing on my experiences as a parent. This ranged from telling clients to sit up straight to admonishing them to tell the truth. Recently, while I was browsing in a bookstore over the holidays, I came across the perfect book for children and clients alike. It's called "How to Behave and Why," by Munro Leaf. It was first published in 1946, but went out of print. It was rediscovered and republished last year as a "sure guide for teaching children (and adults) how to behave."3

The book outlines a four-part approach to being a good person that's equally applicable to children, corporate executives and directors: "No matter where you are or who you are, there are four main things you have to do," Leaf writes:


And, he warns, there's no sense fooling yourself. Doing all that isn't easy.4

Just as Leaf advised children, independent fund directors have to be honest, fair, strong and wise. Unfortunately, it isn't any easier for you than for Leaf's original audience, but it's worthwhile, and in the case of corporate America, it's absolutely critical.

James Madison observed that, if all men were angels, there'd be no need for laws, much less government.5 That's where we come in. At the outset of my tenure, we launched the most aggressive reform agenda in the agency's history. The corporate scandals and collapses, and the Sarbanes-Oxley Act, accelerated and, in some instances broadened, our efforts. The Commission's chief focus of late is implementing the Sarbanes-Oxley Act. In January alone, we'll consider nine final rules related to Sarbanes-Oxley and produce four major studies to fulfill obligations under the Act.

We're also working on other far-reaching regulatory reforms, including mutual funds. For example, this morning we adopted rules permitting investment companies to engage in transactions with certain affiliates and portfolio companies without first obtaining an exemptive order. This action reflects changes in how funds operate; it will bring needed balance to our regulation of affiliated transactions and reduce costs for the millions of fund investors, without sacrificing one iota of investor protection.

We're also considering rules to enhance mutual fund disclosures. Last month, we proposed to require mutual funds to disclose their complete portfolio holdings four times a year instead of twice. Many funds already volunteer more frequent information about their holdings, and I expect this requirement can be implemented without significant disruption or cost. This proposal would also improve and demystify disclosures of mutual fund expenses.

Another rule about which I'm sure you've heard, and which I hope we can finalize this month, involves disclosure of proxy votes for shares of public corporations that mutual funds own. In thinking about the issues raised by this proposal, I start from the proposition that mutual fund securities are held for the benefit of the individuals who own fund shares. The voting power these securities represent carries the ability to influence the governance of US companies. Moreover, voting decisions by funds and advisers have an enormous impact on the financial well being of millions of ordinary citizen-investors.

Despite the influence this voting power can have, many mutual funds and investment advisers don't have specific policies to guide them in voting portfolio securities; those that have them rarely disclose their policies; and fewer yet enable shareholders to learn if their voting policies were in fact followed. Many wield voting power in the face of conflicts; they may cast votes furthering their own interests rather than those for whom they vote.

Particularly since recent events have caused an erosion of confidence in public companies and financial institutions, I'm pleased we proposed these rules, which are premised on bedrock principles: transparency and adherence to fiduciary duties that require advisers to vote in shareholders' best interests. And that's in all of our interests.

Just as we're focused on corporate reform, independent directors should be, too. You're key participants in our efforts. We need you to partner with us to make sure the mutual fund industry meets the highest possible standards for investors. This will become increasingly important as we look for ways to best use our resources. We must and will call upon you to help us ensure that mutual fund investors are fully protected.

The securities industry has a long history rich in private-sector regulation and partnership with the SEC. Congress long ago realized it isn't enough to have vigorous laws. The highest ethical standards and the most demanding competence requirements also must be imposed. Government can focus on illegality. But, the highest ethical standards and the best standards of competence must come from, and be enforced vigorously by, the affected industry or profession. We need you to help us fashion new and creative solutions to enhancing oversight of the mutual fund industry. Even with a substantial increase in our budget, we will not have the resources to be everywhere at all times.

This is all the more true today, as more money enters the investment management industry, and as more funds emerge. You, as independent directors, must be leaders in setting the highest standards for your funds and investment advisers and making sure they meet them.

Just as we must be creative in how we use our resources and how we regulate the industry, I ask you to find creative ways for your fund complexes to set and meet the highest standards in the industry. Committing resources to oversight, compliance and quality controls is vital. Resist the temptation to cut back, or skimp, on compliance assurance, especially in down or stagnant markets. Set the bar high, be an industry leader. Don't make the mistake of thinking it won't enhance your bottom line. It will help your fund complex retain and improve its reputation, and allow it to thrive in a competitive environment.

It's unfortunately easier to talk about corporate governance than it is to implement it. But if the events of the last eighteen months have taught us anything, it must be that this is an area where we need far more than lip service. And now I'll turn the podium back over to Professor Ruder to grade my remarks.


1 Paul Roye, "What Does It Take to be an Effective Independent Director of a Mutual Fund," Keynote address at ICI Workshop for New Fund Directors (Washington, DC April 14, 2000), copies available at http://www.sec.gov/news/speech/spch364.htm.

2 The Uneasy Chaperone : A Resource for Independent Directors of Mutual Funds, by James M. Storey and Thomas M. Clyde (Management Practice Inc. 2000).

3 Munro Leaf, How to Behave and Why (Universe 2002).

4 Munro Leaf, How to Behave and Why at 12-13.

5 James Madison, The Federalist No. 51 (Feb. 8, 1788) ("But what is government itself, but the greatest of all reflections on human nature. If men were angels, no government would be necessary.").



Modified: 01/08/2003