The Securities and Exchange Commission has settled a case involving eight former directors of the Morgan Keegan & Co. Inc. mutual funds, but the agency's effort to put pressure on fund directors to accurately value assets is likely to continue.
“The parties have agreed in principle to a settlement on all major terms,” said a joint motion released by the SEC. “A stay is thus appropriate to afford the parties an opportunity to present the settlement offer to the commission for its consideration.”
In a civil enforcement action filed in December against eight former directors of five Morgan Keegan mutual funds, the agency alleged that the directors violated their responsibility to ensure accurate valuations of the assets in the funds, which totaled about $3.85 billion in 2007. Investors lost more than $1 billion when the funds, which contained below-investment-grade debt backed by subprime mortgages, collapsed during the financial crisis.
The hearing was widely anticipated throughout the fund industry. That's because it highlighted the SEC's recent focus on the role of mutual fund directors in looking out for the interests of fund shareholders — particularly when it comes to making sure a fund's holdings are properly valued.
“In the area of valuation, it's a wake-up call,” said Jay Baris, a partner and chairman of the investment management practice at Morrison & Foerster LLP. “The SEC is peering into the boardroom. This signals that not only are they going after fund directors, there are indications they will come after professionals who serve the directors, including accountants and lawyers.”
The Morgan Keegan case is likely an example of more to come.
“They've been looking for cases of egregious board behavior to send a message to the industry about what boards should be doing,” said Gregory Sheehan, a partner at Ropes & Gray LLC. “Valuation is a very high-priority area for the SEC. It's high risk.”
Norm Champ, director of the SEC Division of Investment Management, emphasized the agency's focus on mutual fund boards in a March 17 speech at an Investment Company Institute conference in Palm Desert, Calif.
“Fund directors serve as the eyes and ears of fund investors,” Mr. Champ said, according to his prepared text. “Directors even serve, in part, as the eyes and ears of regulators. Given the critical oversight role of fund directors, we need to ask some tough questions.”
The commission is trying to determine whether directors are being asked to do too much when they oversee multiple funds. It's also delving into whether fund directors “are equipped to ask tough questions” about fees paid to advisers and securities lending agents.
But the guidance for boards that the SEC laid out in its complaint against Morgan Keegan, and a related brief from former SEC Chairman Harvey Pitt, goes too far, according to Mr. Sheehan.
“You're really going to be facing a situation where trained economists and valuation experts have to sit on the boards,” he said. “That's a pretty scary vision.”
Cracking down on board directors could make recruiting for the positions difficult, according to Terry Reilly, who is of counsel at Montgomery McCracken Walker & Rhoads LLP.
“You don't want to chase away talented people,” Mr. Reilly said. “You don't want to create extreme liability.”
Mr. Baris said that it's unfair to judge a board's valuation of a security several years after the decision.
“As long as they are independent and diligent, they should not be judged after the fact with the benefit of 20/20 hindsight,” he said.