Greater independence is good for fund boards

Fund boards should be turning to "better practices."

The credo for how mutual funds are run should be "If better is possible, good is not enough."

Instead, it seems to be simply "Good is enough."

That's the two-sided take-away from a study released last week by the Independent Directors Council and the Investment Company Institute, reviewing common fund governance practices.

The study showed that the industry's "best practices" are widely in use, but in praising these now-widespread governance procedures, it also seems to be settling for them. They're good, so they're sufficient.

For shareholders, there's no denying that it's good news that nearly 90 percent of fund boards now have at least three-quarters of their seats filled by independent directors.

Likewise, nearly two-thirds of the fund complexes surveyed have an independent chairman for their board. Throw in "independent lead directors" -- a fine-line distinction where the top director doesn't have the title of chairman of the board -- and nearly 85 percent of fund boards have an independent leader.

This, too, is a positive move compared to past numbers, but it, too, was driven by the threat of rules changes that would have required an independent leadership.

The other strong positive from the industry study was that more than 90 percent of fund firms have separate legal counsel to serve their independent directors, a huge increase from 2000. It's hard to be truly independent if you get your legal advice from the fund company's lawyers.

The problem is that the industry is so busy touting its best practices that it's not pursuing "better practices."

For example, most fund firms have just one board to serve all their funds, or may have a few boards, each covering a specific fund type (so that the equity funds have a different directorate than the bond funds). In some cases, that means the board oversees dozens or even hundreds of issues.

When a director gets a fat paycheck for overseeing an entire fund family, their independence comes into question.

Further, the definition of "independent director" needs to be examined. Someone who worked their entire career at a fund company and who then retires is still allowed to be considered independent, and fund boards are frequently dotted with trustees whose work career came in the family.

The Securities and Exchange Commission has backed off its plans to require an independent chairman for fund boards, but it could rekindle that effort, while also redefining what constitutes a potential conflict of interest for trustees. It should also up the independence quotient and make the minimum standard 75 percent; fund companies moved to the higher levels anticipating this change, and they will backslide if they don't believe a change is coming.

Anytime there are changes to how fund boards work, the rules must be tweaked carefully, so they don't add layers of costs and concerns to small operators. That can be tackled with an exemption for funds under a certain asset size.

But for the industry's big firms, having an independent chair and directors whose background is with the competition and who can't serve on too many funds would be a better practice than what's in place.

Charles A. Jaffe is senior columnist at MarketWatch. He can be reached at or at Box 70, Cohasset, MA 02025-0070.