Human Capital & Careers

New Rules for Mutual-Fund Governance

At least 75 percent of directors, including the chairman, must be independent.
Ed ZwirnJuly 29, 2004

The Securities and Exchange Commission announced that it adopted a rule, proposed in January, designed to improve the governance of mutual funds and similar investment companies. The new rule will likely add to the difficulties of finding independent directors that have mounted since the advent of the Sarbanes-Oxley Act.

The new rule applies to all investment companies claiming exemptions from rules governing underwriting, securities transactions, advisory transactions and other activity under the Investment Company Act of 1940.

According to the rule:

  • At least 75 percent of the directors of the fund must be independent directors. If the fund board has only three directors, all but one must be independent.
  • The chairman of the board must be an independent director.
  • The board must perform a self-assessment at least annually.
  • The independent directors must meet separately at least once a quarter.
  • The independent directors must be affirmatively authorized to hire their own staff.

Rules passed in 2001 called for a simple majority of independent directors.

The SEC, in a background statement accompanying the new rule, added that it “proposed these rule amendments, along with a number of other initiatives, in the wake of a troubling series of enforcement actions involving late trading of mutual fund shares, inappropriate market timing activities, and misuse of nonpublic information about fund portfolios” and that funds, in some cases, were being “used for the benefit of fund insiders, often the management company or its employees.”

In a joint dissent, commissioners Cynthia Glassman and Paul Atkins wrote that while they “support the rulemaking’s commendable objective of strengthening investor protection for fund shareholders,” they fear that “the path chosen to achieve this objective may lead in the opposite direction — at a substantial cost to fund shareholders.”

“Because the fund industry is a $7.6 trillion industry,” the dissenting commissioners continued, “it is easy to ignore or lose sight of the fact that the costs of regulatory requirements are ultimately paid by fund shareholders, for whom small differences in fees are of great importance.”

The new rule takes effect September 7.

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