March 2, 1994
TO: BOARD OF GOVERNORS NO. 21-94
SEC RULES COMMITTEE NO. 25-94
RE: SEC COMMISSIONER ROBERTS' SPEECH ON DIRECTORS'
RESPONSIBILITIES
__________________________________________________________
Securities and Exchange Commissioner Richard Roberts recently delivered a
speech, concerning the responsibilities of mutual fund directors, to the
directors of the IDS Mutual Funds. A copy of the speech is attached. In his
remarks, Commissioner Roberts stated that the investment company industry has
been "a shining example of investor protection," which he attributed to "vigilant
oversight" by boards of directors and by federal regulators. He indicated that
the industry's growth is over-taxing federal oversight, making necessary "a more
vigorous first line of defense" at the board level.
Commissioner Roberts spoke of the board's important role in policing
conflicts of interest, and discussed in particular the inherent conflicts
involved in fee proposals from management. He suggested that fund directors
consider alternatives to straight, percentage-based investment advisory fees, and
observed that it is not much more difficult for a portfolio manager to manage
$500 million than $100 million. Roberts also urged vigilant board oversight in
the area of contracts for ancillary services with affiliates of the investment
adviser.
Concerning board independence, Commissioner Roberts noted his agreement
with the recommendations contained in the staff's Investment Company Act study
that a majority of the board be independent and that independent directors be
self-nominating. He added that he would entertain a requirement that all
directors be independent, stating that, in his opinion, "independence is the
tonic for conflict of interest situations."
Acknowledging that the board cannot and should not "micromanage" a fund's
day-to-day operations, Commissioner Roberts referred to the Commission's recent
elimination of certain unnecessary annual board review requirements and suggested
that the board use its resulting extra time to give additional scrutiny to issues
relating to personal securities trading, derivative securities and foreign
securities.
Specifically, with respect to personal trading by portfolio managers,
Commissioner Roberts expressed his own preference for a ban on this practice
because of the great potential for a fund manager's economic interest to be
"nonaligned" with those of shareholders. He advised that if personal trading is
to be permitted, the board should be very careful to establish a screening
process to minimize potential conflicts of interest, stating that the greatest
risk in this area is the loss of investor trust and confidence, which has been
critical to the investment company industry's success.
On the subject of derivatives, Roberts cited certain recent instances of
financial losses resulting from the use of these instruments and said that these
experiences should serve as a warning to fund directors to take greater interest
in fund investments in derivatives. Roberts recommended that, at a minimum, the
board take the following four steps on a periodic basis: (1) review the fund's
disclosure documents to determine whether the risks associated with its
investment strategies are appropriately disclosed and are compatible with the
fund's disclosed investment philosophy; (2) meet with the adviser to ensure
comfort with the adviser's knowledge of the risks associated with using
derivatives and with hedging in particular; (3) become comfortable that the
fund's trading strategies do not violate the restrictions on leveraging under
Section 18 of the Investment Company Act; and (4) review the fund portfolio to
ensure compliance with the 15% limit on investments in illiquid securities.
Finally, in the area of foreign securities, Commissioner Roberts stated
that the volume of fund investments is "staggering," and expressed concern that
recen "red hot" performance may mask the risks associated with such investments.
Roberts urged that directors devote special attention to possible liquidity
problems, and to the adequacy of disclosure to investors of the risks of
investing in foreign securities, including in particular the risks of currency
fluctuations.
Paul Schott Stevens
General Counsel
Attachment