Independent fund directors vocalize their wish list

Feb 21, 2006 @ 12:01 am

By David Hoffman

WASHINGTON - Several independent mutual fund directors have a short list of industry reforms they would like to see implemented, and it appears that they have a receptive audience at the Securities and Exchange Commission.

"We need your insights to better implement an effective regulatory regime," Susan Ferris Wyderko, acting director of the SEC's division of investment management, told attendees at last week's Mutual Fund Directors Forum policy conference here.

But industry experts cautioned that even with the support of the SEC, it may still be a long time before the proposals become reality.

For example, some directors who attended the conference said they would like to see an all-out ban on soft dollars, which is the use by funds of brokerage commissions to buy investment research, shelf space and related items.

Last year, an SEC task force studying the issue narrowed the definition of "research" and offered better ways to disclose the arrangements to investors.

But the commission can't just ban soft dollars, said Gene A. Gohlke, associate director of the SEC's office of compliance inspections and examinations.

It is an unfortunate situation for fund directors, because it means they must stay on top of soft-dollar arrangements.

"Inherent in soft-dollar arrangements is conflicts of interest," Mr. Gohlke said.

12(b)-1 fees a focus

Some independent directors who attended the conference also said they would like to see the elimination of 12(b)-1 fees, an issue that is of keen interest to advisers who rely heavily on them as payment for continuing advice to clients.

The SEC is looking at 12(b)-1 fees. But because there are so many competing interests involved, virtually no one in the industry expects to see the commission address the issue anytime soon.

One proposal championed by several independent directors that may have a better chance is the complete unbundling of commission arrangements.

Under such arrangements, investment managers pay commissions above and beyond execution costs to broker-dealers in exchange for obtaining research products and services from the broker (in the case of bundled commissions) or another third-party provider (using soft dollars).

"I would ask that you mandate unbundling," an attendee at the conference told Ms. Wyderko.

Ms. Wyderko wouldn't give any assurances but did say that it is an issue the SEC is monitoring.

The unbundling train, however, has left the station, and the industry will soon have no choice but to accept it as reality, said John D. Meserve, president of BNY Research Commission and Payment Services LLC, a unit of The Bank of New York Co. Inc.

The unbundling of commission arrangements already has occurred in the United Kingdom, meaning that it probably will soon come to the United States, he said.

When that happens, it will be a positive, Mr. Meserve said.

Increased competition created from a transparent marketplace can provide the investment community with more-dynamic and more-valuable products in research and brokerage, he said.

Partly because of the increased pressure fund directors will put on regulators to mandate unbundling commission arrangements, Mercer Bullard, founder and president of Oxford, Miss.-based Fund Democracy Inc., agrees that unbundling will happen.

Once it does, he predicted, independent directors will turn their attention to the use of third-party research purchased with soft dollars, possibly eliminating it.

Of course, fund directors need not wait for Washington to accomplish such things, said John A. Hill, the independent chairman for the Putnam Funds group, advised by Putnam Investors LLC of Boston.

He told the directors in attendance: "You have the ability to shape the future of your own fund groups."

That may be true, but it was suggested that those directors in attendance were atypical in their desire to fight for their investors.

It would help if more directors also were the shareholders in their own funds, linking their interests with their funds', said Don Phillips, a managing director with Morningstar Inc. in Chicago.

Fund boards also need to be more visible to investors, he said.

Of course, that puts them in a riskier position.

Several attendees said they already are uneasy with the liability they feel they're being forced to take on by regulators.

But Robert E. Plaze, associate director of the SEC's division of investment management, said he doesn't think their liability has changed. They have always had to uphold their fiduciary duties, and new regulations giving them a more visible role don't change that, he said.

Of course, one rule - a controversial one that requires 75% of fund directors be independent, including the fund chairman - is in limbo, pending the outcome of a legal challenge by the U.S. Chamber of Commerce.

Conference attendees, however, feel that most fund boards are already made up of 75% independent directors, and many have decided to go the route of an independent chairman. The consensus at the conference was that even if the rule is struck down, the industry basically will have adopted it.


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