Originally created 11/29/03

Critics question independence of mutual fund boards

NEW YORK -- Every year the board that runs Fidelity Investments' biggest mutual fund, Magellan, votes to pay Fidelity hundreds of millions of dollars in management fees.

Overseeing that vote is the board's chairman, Edward Johnson, who is also chief executive and chairman of Fidelity.

In fact, Johnson is chairman of the independent boards of 266 Fidelity funds. His daughter, Abigail, Fidelity's president, is also on the boards. While no one is suggesting any shady dealings, critics say that kind of dual role, which is commonplace in the mutual fund business, creates potential conflicts of interest and questions of credibility.

The criticism is becoming more vocal and gaining more attention as the broad scandal over management of mutual funds at several companies spreads. Fidelity's practices are being scrutinized, like those at most major companies, and no improprieties have yet been found.

"I don't have any reason to think Mr. Johnson is doing anything wrong, but if Fidelity's interests lie one way and the fund's interest is another way, which one do you think is going to win?" said Chris Traulsen, an analyst at stock and fund researcher Morningstar Inc.

The board of individual funds should be truly independent, and "should really be the advocate for shareholders."

Fidelity is far from alone. At Vanguard, chairman and CEO John Brennan is the board chairman for the 118 funds managed by his company. Until recently, similar leadership arrangements could be found at funds managed by Strong Financial Co. and Alliance Capital, two of the companies under scrutiny for improper fund trading.

The Securities and Exchange Commission, which is under enormous political pressure to restore public faith in fund governance, is now reconsidering the wisdom of allowing fund company employees to head the boards of the funds they manage. Lawmakers are also pursuing the issue.

Advocates for reform say that a board led by an independent chairman is more likely to negotiate lower management fees for fund shareholders or rebuke an errant manager, a task more difficult when the person leading the board stands to directly benefit from higher fund fees or is management.

But opponents say the fuss is unwarranted, as rules require that a majority of a fund board's members be independent.

"Our view is it ought to be up to the fund board," said Craig Tyle, general counsel for the Investment Company Institute, the trade association for the mutual fund industry.

Tyle also notes that, in many cases, board actions have to be approved by a majority of the independent directors in addition to a majority of the entire board - giving independent directors a powerful voice.

"The mutual fund shareholders can vote on this everyday when they make decisions about what funds to invest in," said Vin Loporchio, a Fidelity spokesman, noting that the Magellan fund's expense ratio at 0.72 percent is half of the industry average. "The chairman is elected by the independent trustees on the board, and 10 of the 14 trustees on our board are independent."

At Vanguard, which prides itself on offering low-cost mutual funds, Brennan is the only management company employee on the board; the other six board members are all independent.

Others say the real issue is the need to toughen the definition of "independent" and put teeth in the fund board's powers and liabilities.

Although fund board members can in theory be held to the same level of responsibility as their counterparts on corporate boards, it is rare for a fund board member to be held legally accountable for wrongdoing at a fund. Since 1993, the SEC has filed six cases involving boards of directors where there was a question about how the fund was being priced.

"The SEC and courts have sent a message that directors are generally not held to a very high standard of conduct," said Mercer Bullard, a former SEC lawyer, and the founder of Fund Democracy, a shareholders advocacy group.

Critics also say the definition of an independent director is not stringent enough. Currently, an independent director can be anyone one who does not work for the fund management company, has had no ties with the management company for 2 years and has no close family members who work for the management company.

That means someone like Joseph DiMartino, the chairman of the board for 191 Dreyfus Funds , can be listed as an independent - even though he was the president and chief operating officer for the fund's manager, Dreyfus Corp., from 1982 to 1994. In return for his board services this year, he will earn $815,938, according to the company.

Funds don't always pay a fee to board directors who work for the fund adviser, such as Vanguard's Brennan and Fidelity's Johnson, but the independent directors usually make at least a few thousand dollars per board they serve on. For independent directors who sit on multiple boards, the income can reach well into the six-figures.

"It's nice work if you can get it," said Nell Minnow, editor of Corporate Library, a shareholder advocacy group. "It's a big fat paycheck for very little work."

She would like to see the SEC approve a pending proposal that would make it easier for shareholders to nominate directors to fund boards - currently, most fund directors are nominated by the board chairman, who frequently works for the management company. That relationship can also make it difficult for a director to stand up to a chairman.

Still, others doubt that an independent chairman would have made any difference in the current improper trading scandals sweeping the industry.

They note that Putnam Investments, which recently settled with the SEC following accusations that it allowed and some fund managers participated in improper fund trading, had an independent board chairman - and that didn't stop the scandals.

"I don't think we should change the whole way we view governance because there are a few people determined to break the rules. If we're going to regulate everyone as if they were a crook, it's going to become so costly for us to be in these types of investments," said Conrad S. Ciccotello, a professor at the Robinson College of Business at Georgia State University.


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