By James Langton

(January 3 – 17:30 ET) – The U.S. Securities and Exchange Commission announced today that it has adopted a comprehensive set of initiatives designed to enhance the ability of independent mutual fund directors to protect investors.

The SEC says, “Today’s action marks the culmination of the commission’s reevaluation of the role of mutual fund independent directors that began in May 1998 when chairman Arthur Levitt announced that the commission would host a roundtable on fund governance to work toward a consensus on whether changes were needed.”

That roundtable was followed by another held in February 1999. Following from those meetings the SEC proposed a set of initiatives in October 1999 that became the basis for the reforms announced today.

Today’s reforms reaffirm the important role that independent directors play in protecting fund investors. “They are intended to strengthen independent directors’ hand in dealing with fund management, reinforce their independence, and provide investors with greater information to assess directors’ independence.”

The initiatives state that:

  • independent directors must constitute at least a majority of the fund’s board of directors, rather than the 40% currently required;
  • independent directors select and nominate other independent directors; and
  • any legal counsel for the fund’s independent directors be an independent legal counsel.

Mutual funds will have to improve their disclosure about directors. They will be required to disclose basic information about the identity and experience of directors and the fund shares owned by them. Funds will also have to disclose information about directors that may raise conflict of interest concerns, and information about the board’s role in governing the fund.

The initiatives are designed to prevent qualified individuals from being unnecessarily disqualified from serving as independent directors because they invest in index funds that hold shares of the fund’s adviser or other affiliates.

As well they are designed to protect the independence of independent directors by requiring that joint “errors and omissions” insurance policies not exclude lawsuits against them brought by investment advisers.

Today’s initiatives should also encourage the development of independent audit committees by exempting funds that have these committees from seeking shareholder approval of the fund’s auditor.

Paul Roye, director of the SEC’s Division of Investment Management, said, “Mutual fund independent directors are an investor’s front-line defense against conflicts of interest and other potential abuses. Although no regulation can ensure director independence and effectiveness, the initiatives announced by the commission today represent a significant step in providing fund directors with the tools, the access, and the power to faithfully fulfill their legal duty and moral mandate as the shareholders’ representative.”