Remarks at the IDC - 2018 Fund Directors Conference
Oct. 16, 2018
Good morning. Thank you, Amy [Lancellotta], for that kind introduction, and thank you for inviting me to join you this morning.
Early in my tenure as Director, the Division launched its Board Outreach Initiative. Through this initiative, we have had the opportunity to meet and engage in an informative dialogue with a number of fund boards and independent directors over the last year. I appreciate the opportunity to continue the dialogue with all of you at this conference. Since 1940, you have been entrusted to oversee key aspects of fund management on behalf of shareholders. The service you provide is more important than ever as funds now play a central role in the financial lives of many Americans. Today, over 100 million individuals representing nearly 60 million households own funds — that’s 45 percent of U.S. households. Over the last two decades, assets in mutual funds have grown from around $4.5 trillion to over $19 trillion, a growth of over 330 percent. During that same time period, ETF assets grew from $6.7 billion to over $3.6 trillion. This growth represents the earnings and investments of millions of Americans, who are saving for retirement, college tuition and other goals.
I have heard from many of you that these investors are at the heart of how you approach your role. In a way, this reminds me of the counsel that Atticus Finch, the attorney in the novel To Kill a Mockingbird, gives to his daughter. He tells her, “[y]ou never really understand a person until you consider things from his point of view.” That is good advice not just for fund directors but also for a Division Director. Just as many fund directors approach their roles with a close eye on the shareholder perspective, my team and I have sought to understand the perspectives of investors, directors and other market participants so we are well-informed when thinking about policy.
With that in mind, I would like to reflect today on some of the lessons we’ve learned from you and your colleagues through the Board Outreach Initiative. After that, I will wrap up by highlighting a couple of our other projects and how they relate to fund boards.
First, however, let me pause to say that I am speaking today only for myself and not for the Commission, the Commissioners, or the staff.
The Perspectives of Fund Boards
The goal of the Board Outreach Initiative is to review and reevaluate what we ask fund boards to do. Ultimately, we’re asking ourselves, should we recommend any recalibration of board duties? Can we enable boards to focus on the inquiries that serve investors best? Our thoughts on these questions are, of course, informed by our extensive research, analysis and experience as regulators. But we knew that these alone could not give us the full picture. That’s why this is an outreach initiative. Our outreach has included hearing your perspectives and understanding what you see as the key opportunities and challenges.
So, what have we learned through this outreach? I can’t do it all justice in one speech, but I will share a few observations and reflect on some of the insights you and your colleagues have shared with us:
First, there’s a striking amount of commonality among what directors believe boards should be doing and where they believe existing requirements are not serving investors as well as they should. I have spoken with boards in different cities, overseeing different types of funds and with different sized complexes, and yet I heard many similar themes. For example, directors consistently talked about three questions that help organize their oversight: (1) Are we seeing the quality of service we expect from the fund’s service providers? (2) Are the costs of the fund reasonable? and (3) Is the fund delivering the performance that investors would expect?
Why these questions? I think they resonate because directors see these as the questions shareholders would ask if they were in the room. They allow the directors to step into the shoes of shareholders and frame their work around the shareholder perspective.
Another common theme among directors is respecting the line between oversight and management. My favorite expression of this idea came from one of your colleagues, who referred to this as “nose in, fingers out.” Others expressed this differently, but the sentiment was consistent. Directors see themselves as adding value in different ways from management – they are there to hold management accountable but not to delve into the day-to-day running of the fund.
My second significant takeaway is the idea of having the right conversation. While directors expressed concern about some of the existing legal requirements, I never heard them say, “we don’t want to be part of that conversation.” Instead, I heard consistently, “we want to make sure we’re having the right conversation.” I’ll give you an example. The cross-trade rule requires boards to make a quarterly determination that all cross-trades of each fund were made in compliance with the rule. The directors that I have spoken with did not question the value of this kind of trade-by-trade determination. They also recognized that cross-trades are an important area of potential conflicts that the board should be considering. They questioned, however, whether directors are adding the most value when focused on reviewing pages of data for individual trades. They want to focus their time on the inquiries that are more likely to reveal problems. Why is a fund crossing? How does that compare to similar funds in the complex? When the trade-by-trade data is analyzed as a whole, do we see a change or a trend that’s noteworthy? Directors argued that questions like these are part of the right oversight conversation for the boardroom.
I also heard from directors that the right conversation often goes beyond those areas where the law requires boards to focus. For example, to be responsive to dynamic trends and developing issues, many directors told me that they believe it is important to track and discuss macroeconomic issues that may affect the funds and their service providers. This may include exploring the impact and risks of domestic and international market developments as they relate to the three questions I highlighted earlier about quality, cost and performance. Conference panels later on this morning on paradigm shifts and enterprise risk oversight are emblematic of the topics directors said they see as important to their oversight of funds.
My third takeaway is that technology is coming to the board room. It’s almost cliché at this point to observe that technology is transforming every aspect of asset management. But usually this brings to mind technologies that affect trading, operations or investor tools. I was fascinated to learn, however, that some boards are starting to consider how technology can improve their effectiveness. This may be as simple as enabling more effective virtual meetings. In the future, though, perhaps new analyses and resources could help directors identify areas of focus. Some directors talked about how algorithmic and artificial intelligence advances might help them analyze trends and sift through information in a way that would not be apparent to a human. Applied in the right way, this certainly seems promising.
My fourth takeaway is that training matters. A number of directors spoke with us about the value of educational opportunities for boards. Earlier this year, my staff participated in an abbreviated form of one training that directors receive, and it was apparent how valuable this type of experience would be in preparing a director for challenging conversations. Fund directors can benefit from a practical understanding of their oversight role, including the fundamentals of fund operations and governance, important legal requirements and some of the typical challenging decisions fund board members have to make. Boards have also established a variety of educational tools to support new members. While a new director may have substantial experience in her professional field, the role of fund director comes with its own challenges, history, language and law.
Finally, we heard that directors want clarity from regulators regarding their responsibilities – but not at the cost of effectiveness. Directors want principles, not checklists. They want to know their responsibilities and authorities, but they also want the flexibility to dig in where and how it counts. For example, I consistently heard from fund boards that they look to the fund compliance rule – rule 38a-1 – as a strong model for how compliance, management and boards should interact. In their view the rule strengthens the hand of fund boards and compliance personnel in a way that is principles-based, allowing funds the flexibility to tailor compliance policies and procedures to the needs of that particular fund.
Framework for Staff Consideration of Board Responsibilities. The Division has already started putting to work what we’ve learned. We have developed an informal framework to guide the Division’s thinking about board responsibilities. This framework consists of four questions that we plan to consider each time we develop a recommendation for board involvement or reevaluate an existing obligation. These are:
- Should a given regulatory action require board engagement, and if so, what is the policy goal for the board’s involvement?
- When the staff recommends board involvement, is it necessary to require a specific board action or can we instead focus on the goal and leave the means to the board?
- Are the board responsibilities prescribed consistent with the board’s oversight and policy role?
- Are the board responsibilities clear, up-to-date, and consistent with other regulatory actions?
For me, when answering each of these questions, it is important that we, as a staff, lean in favor of the answer that most effectively empowers boards to follow robust lines of inquiry. The answers will depend on the specific facts and circumstances, but my hope is that these questions will help guide the Division in a direction of consistent and effective recommendations.
Areas of Action. As I indicated earlier, this framework has started to bear fruit. On Friday, the staff issued a no-action letter that reflects the principles of the framework and acknowledges the input we received from our outreach.
I mentioned earlier the feedback we received on the cross-trade rule. Over and over, we heard that this rule and similar affiliated transaction rules require compliance reviews that are duplicative of work that fund CCOs are already doing. Moreover, rather than adding a helpful additional layer of oversight, this duplication is competing for board time with more effective lines of inquiry. These rules were adopted long before the fund compliance rule and, therefore, do not themselves leverage the role of a fund CCO who reports to the board. The new no-action letter responds to a request describing an alternative approach to these affiliated transaction reviews that fully utilizes the CCO and the compliance rule structure, and the letter explains that Division staff would not recommend enforcement action if a fund follows that approach.
As you can see, we have greatly benefited from engagement with the fund director community. To those that have spoken to us, or wrote us letters, thank you. We look forward to meeting with more boards and independent directors and gaining further insights from them.
The Perspective and Experience of Investors and Market Participants
Before I close, I would like to touch briefly on the broader work of the Division and how they relate to the work of fund boards. We have organized our priorities around three principles: (1) improving the retail investor experience; (2) modernizing our regulatory framework and engagement; and (3) leveraging our resources efficiently.
Following these principles, one of our most important projects is the Investor Experience Initiative. Just as boards play a key role in making funds work for investors, I believe that ensuring investors have the tools they need to make informed investment decisions is foundational to our capital markets. While the number and characteristics of investors have evolved over the last decades, much of the design, delivery, and content of mandated fund disclosure have seen few fundamental changes. To begin the process of modernizing fund disclosure, the Commission recently issued a request for comment that seeks to improve the experience of Main Street investors who are considering fund investments. This is an opportunity to examine whether fund disclosures are working as well as they can for the millions of individuals who invest in funds. We recognize that fund boards have an interest in effective disclosure for investors and can provide valuable perspectives. Disclosures can take many forms, but regardless of the medium used, an effective disclosure system should help investors find what they need; understand what they find; and use what they find to make informed investment decisions. We invite directors to weigh in on this initiative. The comment period ends October 31.
Moving to the second principle, modernizing our regulatory framework and engagement, as I noted earlier, the asset management space has seen significant growth over the last two decades. In light of the importance of the asset management industry to investors and the markets, the Division is working on several initiatives to help our markets grow and develop for the benefit of all market participants, including Main Street investors. The Board Outreach Initiative is a core component of our efforts to modernize our regulatory approach in order to be as dynamic and responsive as the markets we regulate. For example, in June the Commission proposed a new rule designed to create a consistent, transparent, and efficient regulatory framework for the types of exchange-traded funds (“ETFs”) that routinely receive exemptions today. In developing the recommendation for that rule, the staff took into account the fiduciary duties of, and regulatory requirements already placed on, fund boards. As you may have noticed, the rule as proposed is not framed as a new, added set of responsibilities for ETF boards. Instead, it recognizes that the rules already require ETF boards to play an important role in overseeing an ETF and its compliance policies and procedures. The comment period on this rulemaking recently closed, and the staff are carefully reviewing comments received as we develop a recommendation for the Commission on next steps.
Finally, with respect to the third principle, we are looking at how we can employ our resources effectively and efficiently. This is critical to our ability to serve Main Street investors and develop informed policy. We are a Division of around 180 people responsible for policy affecting more than 20,000 registered funds and investment advisers. Just as with boards, enhanced use of technology and continuous process improvements are critical to our effectiveness and efficiency. In that regard, one of our main focuses is enhanced use of data analysis in our oversight, disclosure and regulatory initiatives.
In closing, I would like to circle back to the wise counsel of Atticus Finch – a reminder that we all are better off when we consider the points of view of others. I have the privilege to work with a diverse staff of lawyers, accountants, quantitative analysts, industry experts, and others who are dedicated to the agency’s mission. I value their diverse perspectives and contributions to our mission, particularly given the importance of the asset management industry to investors and the markets. Thank you for the opportunity to speak with you today. We look forward to your continued engagement.
 I would like to thank Kaitlin Bottock, Andrea Magovern and Naseem Nixon for their assistance in preparing these remarks.
 See 2018 Investment Company Fact Book (ICI, 58th ed. 2018), available at https://www.ici.org/pdf/2018_factbook.pdf; Investment Company Institute, Trends in Mutual Fund Investing (July 2018), available at https://www.ici.org/research/stats/trends/trends_07_18.
 The Securities and Exchange Commission (the “Commission”) disclaims responsibility for any private publication or statement of any Commission employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
 Rule 17a-7 under the Investment Company Act of 1940.
 See Request for Comment on Fund Retail Investor Experience and Disclosure, Securities Act Release No. 10503 (June 5, 2018).