Statement by SEC Commissioner
Regarding Investment Company Governance Proposal
Commissioner Cynthia A. Glassman
U.S. Securities and Exchange Commission
SEC Open Meeting
June 23, 2004
Thank you, Mr. Chairman. The fund governance proposals before us today were drafted with the best possible of intentions to strengthen investor protection for mutual fund shareholders in light of the recent mutual fund scandals. I believe we are making significant progress towards that goal.
We have already increased disclosure requirements of funds' market-timing policies, and we have required mutual funds to designate compliance officers reporting directly to the fund board. We have proposed expanded and more timely disclosures about the costs and conflicts of interest in connection with the purchase of mutual fund shares through broker-dealers, and we are considering longer-term initiatives on fair value pricing and increased transparency of fund transaction costs and expenses. I would also include three parts of today's proposal the board self-assessment, the separate meetings of the independent directors, and recordkeeping requirements as good additions to our efforts.
Against this background, I do not believe that either the requirement for 75% independent directors or the requirement for an independent chair will help investors. The 75% independent director requirement may do no harm, but it will accomplish little. Mutual funds are currently required to have a majority of independent directors, and it is my understanding that most funds have at least two-thirds independent directors, and many nearly 60% already meet the 75% or more. I do not know what more we achieve by requiring 75% independent directors rather than two-thirds, for example, or why if a high percentage of mutual funds already meets the 75% we need a rule at all. Further, as the adopting release recognizes, "legal" independence does not equate with "real" independence, but we have not addressed that issue. And it is important to remember that all fund directors, whether inside or outside, have a fiduciary duty to the shareholders.
Of even more concern is the requirement for an independent chair, which has the potential for negative consequences. When we voted to propose the fund governance package, I challenged the proponents of this rule to come up with empirical data that would support the rule. I wanted to know whether there was any significant positive correlation between funds with high performance and/or low costs and having an independent chair. No one met that challenge. The Commission itself didn't commit resources to study this question, and the proponents have not provided any compelling quantitative or qualitative support. As the adopting release acknowledges, the Commission is "not aware of any conclusive research that demonstrates that the hiring of an independent chairman will improve fund performance and reduce expenses, or the reverse."
Some have noted that a high percentage around 80% of the mutual fund companies that have been the subject of recent market-timing enforcement actions had inside chairs. But the proportion of funds with inside, as opposed to independent, chairs is about 80% to 20% in the industry today. Accordingly, these statistics on our enforcement actions are simply representative of the population and are not meaningful in evaluating the proposed rule. Clearly, having an independent chair did not prevent market-timing abuses in several of our enforcement cases.
I recognize the potential conflicts inherent in the investment company and investment adviser relationship, but based on my discussions and review of the comments, I believe there is a countervailing pressure at work. An inside chair has an incentive to maximize fund performance because good performance is what is important to mutual fund investors and what sells the adviser's reputation and its "brand." Clearly, high fees adversely affect performance. Therefore, the inside chair must take fees into account in order to maximize performance and maintain the integrity of the "brand," especially when the brand covers a broad umbrella of funds and other financial products. In any case, the inside chair is already excluded from the final determination on advisory fees; under current law, the advisory contract must be approved by a majority of independent directors.
It is a fact that many of the top-rated funds today based on high performance and low fees have inside chairs. Why should we tell shareholders they can no longer have the form of governance that produced this high level of performance? And further, why should we require them to pay for it? There can be no doubt that this requirement will add to fund expenses. An independent chair cannot be expected to have and in most cases, will not have hands-on knowledge about fund operations. Therefore, to be effective, the chair would have to hire a staff. Shareholders will bear that expense as well as the likely additional cost of the independent chairman. In sum, the benefits are illusory, but the costs are real.
There were alternatives we could have considered. We could have considered requiring mutual funds to disclose prominently whether or not they had an independent chair and let investors decide whether that matters to them. We could have left the decision on an independent chair to the best judgment of the board of directors, a majority of whom are independent, or we could have endorsed the lead independent director concept. The advantage of these alternatives is that they leave the decision on the independent chair to the independent directors or the marketplace, rather than imposing the requirement by regulatory fiat. We could also have considered tightening the definition of "independence," and we could have looked more broadly at the whole structure of mutual funds. But we didn't.
Therefore, while I would support the three other parts of this proposal, I cannot support the requirements for 75% independent directors or the independent chair. As I have explained, I see no compelling evidence regarding the benefits of either of these proposals. In the absence of such evidence, I am unwilling to risk requiring 80% of the mutual fund industry to change its governance structure.