Speech by SEC Chairman:
Opening Remarks at the SEC Roundtable on the Role of Independent Investment Company Directors
Chairman Arthur Levitt
U.S. Securities & Exchange Commission
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
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
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
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
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.