SEC commissioner Harvey J. Goldschmid stated his case on the state of the mutual fund industry at the ICI's annual conferenace for fund lawyers. Like the commission's other members, he acknowledged that change was necessary to move the industry past the scandal to realistic reform. However, he said that changes would not come without cooperation on all sides.
Not suprisingly, Goldschimd said independent directors were imperative to fund reform. But, he said no director can be truly independent because they are "heavily dependent on information flows, proper disclosure, and the effectiveness of gatekeepers like auditors, lawyers, and compliance officers." To help directors make better decisions, Goldschimd made a few suggestions:
Apply public company audit committee listing rules to mutual funds.
Require boards to establish effective programs and procedures to assist them in their decision-making and monitoring roles. He reasoned that even the best boards cannot detect every fraud or violation of fiduciary duty but with the controls in place, there would be proper recourse for violators.
Mandate that at least 75 percent of a fund's board be independent.
Require that a fund board's chair always be an independent director.
Goldschimdt also weighed in on the new role of chief compliance officers and suggested that a 'reporting up' strategy become the norm for fund companies. Under the newly proposed SEC rules, ccos would act as watchdogs for funds but if an environment where any employee at any level felt comfortable reporting abuses or potential violations of fiduciary duties, catching violations would prove easier for boards to do.
In fact, Goldschimdt said lawyers already have reporting up duties.
"Under these rules, an attorney who is aware of credible evidence of a material violation of the securities laws, or a material breach of fiduciary duty, must report this evidence up the chain-of-command or ladder to the fund's chief legal officer, and ultimately, to the independent members of the mutual fund board," he wrote.
"This reporting up requirement should significantly enhance the flow of key legal information involving "reasonably likely" material violations) to independent members of the fund board," he continued. "Reporting up also empowers lawyers. The requirement will allow dispassionate, independent fund directors — not conflicted fund investment managers — to resolve key securities law and conflict-of-interest issues.
Last but not least, Goldschimd said that disclosure should be the priority of the SEC going forward. He added that full disclosure would actually help to drive fees and expenses down and frequent porfolio disclosure should be the norm going forward.
He also said that it was necessary to push for new disclosures relating to broker-dealer "preferred lists," portfolio manager personal trading, breakpoint discounts, Rule 12b-1 fees, and revenue sharing arrangements.
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