U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Opening Remarks at the SEC Roundtable on the Role of Independent Investment Company Directors

Remarks by

Chairman Arthur Levitt

U.S. Securities & Exchange Commission

Washington, D.C.

February 23, 1999

Thank you, and good morning. It is a pleasure to welcome you to the SEC Roundtable on the Role of Independent Investment Company Directors. I'd like to start off by thanking the moderators and the panelists for agreeing to participate in this important endeavor. I also want to thank everyone on the staff who has worked to make this event possible.

We are here today to discuss the increasingly important role that independent directors play in protecting fund investors and how their effectiveness can be enhanced. These issues are not academic or peripheral. They directly affect every mutual fund investor. Accordingly, I will ask the Commission to make improved investment company governance one of its top priorities. I expect that this Roundtable will help shape our agenda on issues facing independent directors today.

As we all know, the growth of the mutual fund industry has been staggering. At the end of last year, the assets of mutual funds exceeded five and a half trillion dollars, up from just over one trillion dollars in 1990. Mutual funds are the primary investment vehicle of choice for most Americans. At last estimate, over 66 million people were invested in mutual funds. We owe it to those 66 million Americans to ensure that funds are being run in their best interests.

For that to happen, one word – above all – must define a fund's overall management structure. That word is accountability. And, without strong independent directors, accountability is nothing more than a word on a page.

Twenty years ago, the late Justice William Brennan described independent fund directors as "watchdogs." The Investment Company Act, according to Justice Brennan, was designed to place the directors who are unaffiliated with a mutual fund's adviser in the role of "independent watchdogs," who would furnish a quote "independent check upon the management of investment companies" end quote. An independent check – a force for accountability on behalf of shareholders who depend on their independence to maintain the integrity of the fund.

The objective seems simple enough. So let me ask three straight forward questions, which I believe go to the very heart of our discussion over the next two days. First, are independent directors effective? Second, do they – can they – really act as a check on management? And, third, are they serving shareholders' interests above all else? The answers to these questions will serve as a basis for our agenda on investment company governance.

I hope that if there is one point we can agree on it's this: Regulators shouldn't be the only ones asking these questions. If a fund's management isn't addressing these questions, what does it say about that investment company? If a fund's governance has no culture of independence and accountability, who looks after the investor's interest? I realize these are not easy questions to address. But can we afford not to answer them?

Over the next two days we will hear from independent directors, senior fund executives, legal counsel to funds, investor advocates, and leading academics. And I hope that we can work together toward solutions that will improve the current system of fund governance.

As you know, we've designed the Roundtable around a series of panel discussions. I'd like to mention a few of these topics, and raise some additional, more specific questions that I think should be addressed in each panel.

Following some general background by Paul Roye, our first panel this morning deals with negotiating fund fees and expenses. Perhaps no other issue addressed by independent directors has as much direct impact on investors' returns than the level of fund fees. While fund performance is unpredictable, the impact of fees is not. As I have emphasized before, a one percent annual fee will reduce an ending account balance by 17 percent after 20 years.

Now, we all understand that directors aren't required to guarantee that their fund has the lowest fees. But they are required to ask whether fund investors are getting their money's worth. What do independent directors know about managements' costs and their profitability? If the fund's assets under management have ballooned, have fees been reduced to reflect any economies of scale?

Again, not easy questions, but necessary questions. Some, no doubt, would prefer they go unanswered. But effective regulation and investor interests demand we reassess our assumptions.

Following fees, we'll discuss another important issue: fund distribution arrangements. As you know, independent directors have special responsibilities under the Investment Company Act when fund assets are used to pay distribution expenses.

They must determine that there is a reasonable likelihood that the payments will benefit the fund and its shareholders. Do directors really understand what payments are being made to whom, and why? What are the implications of fund supermarkets to investors? Are the increased benefits to some shareholders at the expense of others? These are all questions that independent directors must consider.

Fund portfolio brokerage is another area where I think independent directors have a duty to ask some tough questions. Which broker is the fund using, and why? Why one over another? Is the fund truly receiving best execution? And if the adviser has soft-dollar arrangements, are they in the best interests of fund shareholders? Can soft-dollar arrangements be used to reduce direct costs to the fund as well as for securing research for the management company?

Our remaining panels will look at issues that have received a good deal of attention at the Commission and in the press in recent years. Mutual fund disclosure has been one of our top priorities at the Commission. Our panel on fund disclosure will look at what directors can do to ensure that shareholder communications are clear, easily understood by investors, and tell the whole story about the fund.

Consolidation in the securities industry has become an increasingly common occurrence. It seems like we hear an announcement of a new merger or alliance nearly every day. What is the proper role of independent fund directors when investment advisers merge? Our panel on adviser and fund reorganizations will address this issue.

The question of when it's appropriate for a fund to value its portfolio using "fair value" pricing has been a concern in light of recent market volatility. Our panel on valuation will address this and similar questions.

Finally, we'll discuss the special issues faced by independent directors of closed-end funds, variable insurance products funds, and bank-related funds. For example, in the past few years we've seen increased activism by closed-end fund shareholders to reduce or eliminate trading discounts. What should be the role of the independent directors when these shareholders clash with fund management?

To close our Roundtable tomorrow afternoon, we will have two distinguished panels that will focus on the larger question of how to enhance the effectiveness of independent directors. These two panels will draw upon discussions of the previous panels, to give us a sense of where we are, and where we're going.

For example, when is a director truly independent? Does our current definition under the law still reflect reality? Should a majority or all of the directors of a fund be independent, rather than just 40%, as the law currently requires? Should a former officer of the management company be able to serve as an independent director without a two, three, or five year hiatus? Should the fund pay management directors for their service?

In overseeing a fund's operations, how should directors strike a proper balance between indifferent acquiescence, and overzealous interference with management? In a worst case scenario, when management and the board are at an impasse, and on the road to proxy fights and litigation, do directors have the tools available to them to protect the interests of fund shareholders? Should independent directors, for example, have the right to terminate the investment advisor's contract?

This morning I have posed many questions. Some of you are probably thinking of that line, "Question everything. Learn something. Answer nothing." Well, I hope that, together, we can develop the right answers. The purpose of this Roundtable is not to have the Commission tell independent directors how to do their jobs. I want you to tell us how you do your jobs. We need to know what works under the current system, and more importantly, we need to know what doesn't work.

I want to make clear that I do not favor government intervention in this area. The mutual fund industry, for the most part, has been responsive to our concerns. But, at a time when more people than ever are investing in mutual funds and the vast majority of them have never experienced a down market, the public and private sector, together, need to be asking these questions and generating substantive responses – not cosmetic fixes. This roundtable is an important first step in that process.

While the SEC is not afraid to search for solutions alone, I'm quite confident – judging by today's participation – that together we can serve the investor interest.

In that spirit, I've asked our moderators, all of whom are current or former senior Commission staff members, to challenge the panelists and to ask some tough questions. And I expect our panelists to give us their frank and honest answers. If you think that a current practice does not serve investors' interests – speak up. If you think that a Commission rule or position is ineffectual – please tell us.

No matter what our conclusions are, there is one thing of which I'm sure: board independence does not come from any particular legal structure. Board independence comes from directors who do their jobs aggressively. I've said this before, but it's worth repeating. Independent directors must take their jobs and their fiduciary duties seriously. Independent directors must have the courage to question fund managers, and the status quo. Without that, even our best proposals for improving investment company governance will fail. I have every confidence that, together, we will succeed.

Thank you very much.