Thoughts on Mutual Fund Governance

Performance of funds matters, always (both absolute and relative v peer group), but is largely out of the hands of directors/trustees If so, what is?

• In a world where perception often becomes reality, transparency is crucial to an investor’s search for a sense of “fairness” in a situation where he or she is, necessarily, an owner in absentia.

• Investors, as “owners”, have a right to information – they should not have to “ask” or “dig” for it (most do not have the knowledge or training to do so – a primary reason for their choosing the mutual fund vehicle).

• The name of a mutual fund should accurately reflect its holdings; i.e., raise threshold minimum to 100% of a fund’s “name” category of stocks or bonds with “cash” as the only other alternative (thereby, indirectly, letting the client make the diversification choice).

• Disclosure each portfolio manager’s qualifications, employment history, compensation and ownership in the fund he or she manages in ALL fund literature.

• Disclose each fund’s total expenses in % terms versus peer group’s high, low and mean %; and in absolute $ terms, broken down into major categories, in ALL fund literature.

• Disclose name of fund counsel and counsel to outside directors in ALL fund literature.

• Disclose directors’ qualifications, employment history, compensation and ownership in each fund on which he or she sits as a board member in ALL fund literature.

• Disclose number of physical and telephonic board and board committee meetings held each quarter.

• Require election of a so-called “lead” independent director.

• Require a statement that the board has met independent of fund management every quarter.

• Require a statement that the board has met personally with the portfolio manager of each fund every quarter.

• Encourage experienced securities industry professionals to become directors subject to a total cessation of fund brokerage, dealing and investment banking activity with his or her securities firm employer.

Director/Trustee Compensation

Based on my own experience, it is hard for me to imagine being a director of more than 20 mutual funds [not unlike a research analyst’s difficulty in covering more than 20 companies – a “capacity” issue].

Suggestions:

• Annual retainer of $500/month from each fund (20 in this example)

$500 x 20 = 10,000 x 20 = $120,000 per year.

• $120,000 ÷ $500 per hour = 240 hours ÷ 12 = 20 hours per month of serious work/reading/self education in order to stay current. You simply cannot “parachute” into four board meetings per year and call yourself a professional, committed mutual fund director/trustee.

• Minimum of 4 meetings of two full days each per year.

8 hours per day = 64 hours x $500 per hour = $32,000 or $4,000 per day plus ad hoc meetings as necessary (telephonic meetings @ $500 to $1,000 per meeting).

Director/Trustee Economics:

$120,000.00

32,000.00

$152,000.00 x 4 directors = $608,000 cost to fund owners.

x 3 directors = $456,000 cost to fund owners.

As Richard Breeden, former SEC Chairman, turnaround expert and federal court appointed monitor of WorldCom’s corporate governance overhaul, aptly noted an interview coincident with release oh his August 2003 formal report on governance, “You have to pay people [directors] enough that they take it as a job, but not as much that they wouldn’t quit if they see something very wrong happening’.[1]

Three to four qualified independent directors are sufficient to monitor 20 funds.

Final thought – a truly committed mutual fund director/trustee has to be prepared to “bet” his or her board seat on issues of major importance.

Bruce S. Foerster

September 2003