July 6, 1994
TO: BOARD OF GOVERNORS NO. 59-94
SEC RULES COMMITTEE NO. 72-94
RE: SEC COMMISSIONER'S SPEECH ON CURRENT ISSUES FOR FUND
DIRECTORS
__________________________________________________________
SEC Commissioner Roberts recently delivered a speech on some
current issues in the fund industry and the role of the board of
directors in resolving those issues. A copy of the speech is
attached.
A. General
At the outset, Commissioner Roberts noted that since the
passage of the Investment Company Act of 1940, the investment
company industry has been "remarkably free from the scandals that
have plagued other areas of the financial services industry." He
attributed the trust and confidence that many investors have in the
industry, in large part, to the vigilance of fund boards and the
SEC in ensuring compliance with the core investor provisions of the
Investment Company Act. He noted, however, that the SEC's
resources have not been able to keep pace with the growth of the
industry and recommended, as a partial solution to the shortfall in
the SEC's resources, "a more active and inquiring board of
directors."
B. Specific Issues
1. Approval of Advisory, Distribution, and Other
Contracts
Commissioner Roberts expressed concern that while Section
15 of the Investment Company Act and Rule 12b-1 thereunder contain
specific language about the board's duties when approving and
renewing an advisory contract and when approving asset-based sales
charges, respectively, some fund directors "may not have been
either careful or informed" in performing those duties. His
concern was based on his finding that the average fund's expense
ratios have increased, even though there has been significant
growth in industry assets, which should have produced economies of
scale. In response, he recommended that fund boards investigate
alternative compensation methods, such as fulcrum fees, and take a
closer look at fees paid to affiliated persons of the adviser for
other services to the fund, such as custody and shareholder
servicing.
2. Pricing Problems
Commissioner Roberts recommended increased board scrutiny
of "whether the fund is adhering to its stated investment
objectives, investment restrictions, and internal controls,
especially in the area of pricing, such as with respect to
investments in derivative securities." Noting recent press
accounts of fund advisers who recently purchased derivative
securities from funds, including money market funds, or injected
capital into the funds, Commissioner Roberts expressed concern that
in these situations the funds' boards "may have been asleep at the
switch." He urged that directors assure themselves that the
pricing methods used by the adviser are appropriate and adhered to
by fund employees. In addition, directors must monitor the
adviser's investment decisions, which would require directors to
"make every effort to educate themselves, and to ask hard questions
of the fund's adviser, to ensure that they are adequately
representing the shareholders' interests."
3. Personal Trading
Commissioner Roberts urged funds to examine their policies
on personal securities trading by fund portfolio managers. He
noted that the Institute has issued a "model policy," which he
believes all funds should consider adopting.
Paul Schott Stevens
General Counsel
Attachment