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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks Before the 2006 Investment Company Directors' Conference


Brian G. Cartwright1

General Counsel
U.S. Securities and Exchange Commission

Washington, D.C.
November 15, 2006

Good afternoon. Thank you very much, Bob, for that kind introduction. I am very pleased to be with you today at the 2006 Investment Company Directors' Conference.

I'm sure many of you are disappointed that Buddy Donohue, the Director of our Division of Investment Management, couldn't be here today. Buddy sends his regrets. Unfortunately, he was called away by Chairman Cox on short notice to assist with an important matter. I know he very much wanted to be here and, if the Chairman had not interceded, he certainly would have been.

Some of you may know that before coming to the SEC I practiced law in California, for a period of time I prefer to refer to somewhat delicately as "more than twenty years." I understand the West Coast edition of the 2006 Investment Company Directors Conference was held two weeks ago in San Francisco. So I'm thinking: maybe next time Buddy can arrange to be called away from the West Coast meeting!

I very much appreciate your indulgence in accepting me as a last-minute substitute. I would like to thank the officers, staff and members of the Independent Directors Council, particularly Bob, Chairman of the Council, for the warm reception you have given me today.

Before I go any further today, though, I need to remind you that my remarks represent my own views and not necessarily the views of the Commission, the individual Commissioners or my colleagues on the Commission staff. It definitely would not be setting the right example were the General Counsel of the SEC to forget to give that disclaimer!

Whether on the West Coast, on the East Coast or in the great heartland of America, I have long admired the important work performed by independent directors, and today's event affords me the opportunity to congratulate you on the outstanding work you do to further our common goal of protecting America's almost 100 million mutual fund investors.

One thing is certain: Being a good independent director is not easy. During the last several years, journalists, politicians, regulators and, indeed, ordinary citizens have all come to have a heightened understanding of the importance of independent directors. And while good independent directors are essential, I want to say straightaway right at the outset that we must be careful not to have unrealistic expectations about what even the best independent directors can achieve.

For one thing, the work of independent directors on any given board is, of necessity, occasional, part-time work. In ordinary circumstances, the aggregate hours devoted by even the most dedicated board by all the independent directors combined equate to far less than a single "full-time equivalent," as the folks in HR would put it. And then, of course, directors work, by and large, in meetings and by committee. Enough said about that.

For another thing, when not attending board meetings, independent directors are rarely on-site. They don't have the opportunity to pick up the low-down about what's really going on around the coffee machine or water cooler. The informal, on-going sources of information available to someone who's working full-time on-site, simply aren't available to the independent directors. Even the most diligent director must rely on management as the source of almost all of the information he or she needs to do the job. It can't really be otherwise.

Strong independent directors like you play an indispensable role in investor protection. These inherent limitations of your role make it even more extraordinarily challenging. We therefore are all in your debt for the service you provide. I applaud you.

With an understanding of these limitations in mind, you could be forgiven if you sometimes feel as if no single mortal human being could possibly live up to the expectations set for you as an independent director. So it's important to keep in mind that you are not alone. A well-functioning board of directors is just that — a board, made up of multiple members, each of whom brings his or her own talents, experiences and personal attributes to the boardroom. When a board works effectively as a team, the complementary strengths of individual board members add up to more than the sum of the parts.

That's why, in my experience, collegial boards are by far the most effective. Given the tall task independent directors face, investors are poorly represented by a strutting prima donna on the board, or by factions working at cross purposes behind the scenes, leading to a dysfunctional board environment. Regulators need to take care not to impose requirements that could encourage, rather than discourage, such dysfunctional behavior. As independent directors, you already know the importance of maximizing the diversity of talents present on your boards, appropriately allocating work and responsibilities, learning from one another, and working constructively together.

What, then, does it take to be an effective independent director today? At the risk of emphasizing what may already be obvious to all present, I'd like to describe the key attributes you bring to your important and difficult task.

Of course, I should first humbly confess that as a private practitioner I had no registered investment companies or investment company boards as clients. The closest I came to the 1940 Act was occasional work to ensure that a client did not inadvertently become an investment company. So when I agreed to fill in for Buddy today, I asked a colleague in the Division of Investment Management what qualities were important for an independent fund director. I wanted to see if there was something unique about this specialized context that I hadn't seen in my decades of experience with other companies and boards. That doesn't seem to be the case.

So I'm going to dare to describe what I regard as the key attributes of a good fund director. Since I'd like to believe anyone who has taken the time to attend this conference surely qualifies as not just a good, but in fact an outstanding, fund director, I'm merely cataloguing the characteristics you already possess.

First is commitment. As I've just noted, by your very presence here today you have demonstrated that you are willing to commit the extra time it takes to stay on top of regulatory developments, learn about recent industry innovations and engage in a dialogue with your fellow independent directors from other fund complexes. The investors in the funds you serve will be the beneficiaries of your commitment to continued learning and development.

Of course, you display your commitment in other ways, as well. Being an independent fund director is not easy. The time commitment expected undoubtedly is greater today than ever before. As effective directors, you arrive at board meetings well-prepared, having taken the time to thoroughly review the board materials in advance. You come armed with insightful questions. You closely follow developments with the funds you oversee. You engage in an on-going dialogue with fund management, fund counsel and your fellow directors to keep abreast of compliance issues and business developments. You are committed to performing a truly meaningful oversight role, rather than just go through the motions.

In addition to being committed to the task, effective independent directors are vigilant. As a vigilant director, you have a healthy degree of skepticism. You stay alert. You spot negative trends and identify outliers and follow up with questions for management and requests for explanations. You are active and engaged. And you're not afraid to admit to ignorance. You ask questions if you don't understand. You're willing to seek fuller discussion of an important topic that seems to have been too quickly passed over. You dig into the details, as necessary, to find answers. In short, your "head is in the game" at all times.

Being vigilant, however, doesn't mean you're a vigilante. We all know there's a line between productively probing and challenging and being needlessly aggressive. We've all known directors who seem to enjoy toying with management, always searching for some question management is unprepared to answer, not in the interest of investor protection, but in order to inflate their own egos. You know who you are. To be effective, independent directors must work together with management and affiliated directors as a team. One strong personality should not dominate board discussions.

On the other hand, as an effective independent director, you must be, well, independent. And not only in the technical sense that you qualify as independent for purposes of the Investment Company Act.

Undoubtedly, the counsel for the funds you represent has thoroughly vetted your background to make sure you technically qualify as "independent" under the Investment Company Act. And that's important. The framers of the Investment Company Act reserved a special role for independent or — to use their term — "disinterested" fund directors. Congress's purpose in structuring the Investment Company Act as it did is clear: Congress wanted unaffiliated directors in the role of "watchdogs" who could act as an independent check on fund management.

That means there are times, most notably when you are reviewing the advisory contract, that your perspective must necessarily be different than your management counterparts, who must serve as representatives both for the fund and for the management company. Those are the times when an independent director can't afford to "go along to get along."

We've all read about those experiments performed in university psychology departments. The unsuspecting subject is given some task to perform that is just a diversionary foil for the experiment — maybe he or she is asked to fill out a lengthy questionnaire. At some point while the subject is engaged in that activity, the experimenters start to leak smoke into the room. If the subject is alone, it doesn't take too many whiffs before the subject jumps up and takes flight. On the other hand, if the subject is surrounded by shills of the experimenter who pretend to continue to fill out their own questionnaires without reacting to the smoke, it takes the subject far longer to work up the nerve to make a quick exit.

We're all like that, of course. In the face of uncertainty, we seek comfort in the reactions of others. Up to a point, that makes sense. But to be independent in more than merely the technical sense, you need to be willing to rely on your own instincts and speak up before you get too much smoke in your eyes.

In fact, one of the greatest mistakes you can make is to assume there's safety in numbers. When dubious conduct is involved, it's just the opposite: there's peril in numbers. Perhaps those who got caught up in the late-trading and market-timing scandals thought they were safe because "everyone was doing it." But once the word was out, the perception that "everyone was doing it" also meant that everyone's conduct became subject to heightened scrutiny, dramatically increasing the likelihood of the detection and punishment of misconduct that might otherwise have flown "under the radar screen." Being willing to ask questions about something that smells fishy, even though "everyone's doing it," is the essence of being truly independent.

And believe me, there truly is no safety in numbers. Just ask any one of the more than 120 companies we currently have under investigation for stock option backdating irregularities.

So there you have it: commitment, vigilance and independence.

But even that's not enough. Because even the advantages of commitment, vigilance and independence can be blunted by inadequate board process and procedure. Careful consideration paid to the "mechanics" of board meetings — schedules, agendas and board materials — can significantly improve board effectiveness. The basics of blocking and tackling remain important.

That's why board members need to work with management to make sure the board is getting the kinds of information it needs, in a form it can use, starting with the board materials that arrive before the meeting. As I'm sure you know from experience, too much detail can provide the illusion of care and diligence, but in fact leave board members unable to determine what truly matters and exposed. Therefore, I'm sure you already are in the habit of insisting that the written materials provided to the board be of high quality, relevant and appropriately concise. The nature of the agenda and way the meeting is organized also can facilitate or hinder effectiveness. In this regard, board members with experience on other boards often have constructive suggestions for improvements, based on the different approaches they've seen.

Following an agenda that has been carefully and thoughtfully developed to cover the material and noteworthy issues, being well and appropriately informed, having the time to fully discuss key issues, having the board's activities organized in an efficient and effective way — this is how to ensure that your most scarce and precious resource, your time, is used to greatest advantage. Paying attention to board structures and procedures that create such an environment is an important aspect to being an effective director.

In many ways, we at the SEC have the same task you do: investor protection. So it's no surprise that, just like you, we at the SEC also need to be committed, vigilant and independent. Like you, America's investors have entrusted us with a tough, challenging job. Because we share the same goal, your effective oversight complements our work at the SEC. We at the SEC benefit directly from the good work you perform as independent fund directors. When you succeed in your role as effective independent directors, America's investors benefit. I therefore pledge my continued support and thank you from the bottom of my heart for your critical contribution to the protection of America's investors.

I very much appreciate the opportunity to have been with you today in Buddy's stead. Thank you.



Modified: 11/20/2006