THE DECISION by the Securities and Exchange Commission to charge eight Morgan Keegan & Co. Inc. mutual fund directors with failure to oversee asset valuation in the early days of the financial crisis should
serve as a warning to other fund directors.
Although the SEC and the directors last week agreed to a settlement, the enforcement action suggests that the SEC will be paying closer attention to the job performance of mutual fund directors to ensure they are fulfilling their obligations to be the eyes and ears of fund shareholders, and to represent their interests.
The SEC last stepped up its monitoring of mutual fund directors after the late-trading and market-timing scandals of 2003. While many firms reached settlements with the SEC and paid penalties, no actions were taken against directors.
This time, the SEC appears determined to drive home to directors that they must pay close attention to what is going on in the funds they oversee, and take action to halt practices they believe might be against the best interests of the fund shareholders.
There are more than 8,600 mutual funds, according to the Investment Company Institute (excluding closed-end funds, exchange-traded funds and unit investment trusts). They manage more than $11 trillion in Americans' savings.
Each fund is overseen by a board of directors, though often one board oversees many funds within one fund company. The directors have the fiduciary duty to put the shareholders' interests ahead of their own. According to the Supreme Court, they are to serve as watchdogs who furnish an independent check on the management of the fund.
Directors are required to be informed, to apply their business judgment and to make reasonable decisions.
Among the duties imposed on directors by federal securities laws is overseeing the fair-value determinations of certain securities in the funds, which is where the SEC believes the Morgan Keegan directors fell short.
In its complaint, the SEC alleged that the directors delegated their fair-valuation responsibility to a valuation committee without providing substantive guidance on how fair-valuation determinations should be made, and they made no “meaningful effort” to learn how fair values were being determined.
The SEC noted that fair-value securities made up the majority of the funds' net assets, in most cases more than 60%. It said that the funds' valuation procedures required that the directors be given explanatory notes for the fair values assigned to securities. No such notes were ever provided to or sought by the directors, the agency alleges.
The SEC is to be commended for examining the directors' performance and holding them accountable.
The commission is sending a strong reminder that fund directors must pay attention to their legal responsibilities and be prepared to challenge fund company management and employees when procedures are not being followed, or when management is not running the fund in the long-term interests of shareholders.
The SEC action also serves as reassurance to fund shareholders, and those who help them select funds, that the fund directors will be focused on protecting their interests.
Now the SEC must commit to maintaining the pressure on fund directors and fund management so that the warning does not fade as it so often has in the past..
