Board, Advisor Tensions Mount Reserve
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VOL. 18, NO. 2 FEBRUARY 2009 RESERVE SUES FORMER COUNSEL HOW BOARDS WORK The Reserve is suing Dechert and K&L Gates for failing to inform its board that two trustees were incorrectly identified as independent, thus making it non- AQUILA BOARDS COVER compliant in subadvisor agreements and potentially subject to fines, penalties and THEIR TAIL…WITH bureaucratic nightmares. INSURANCE During the time the board was not in compliance, it carried out amendments to advisor agreements with subadvisors without shareholder approval – an action that The boards at the Aquila Group of Funds requires the board to have an independent majority. The Reserve’s complaint states recently decided to look into tail insurance that although the law firms were “fully advised of the relevant facts, not once, but for its trustees. Tail insurance covers retired on repeated occasions” they failed to advise the board that it was not in compliance directors for a certain amount of time if there with Section 15(a) of the 1940 Act. The trustees were affiliated with “a major is no entity left to indemnify – such as if the fund complex is liquidated or goes out of (continued on page 9) business. “It’s not something people are “Be Sensitive” particularly focused on when things are going well, but when things start getting tough they BOARD, ADVISOR TENSIONS MOUNT want to become more defensive and Shrinking assets, negative returns and ballooning protective,” said Ted Mason, chairman for costs are causing increasing tension between one of the Aquila boards. boards and advisors. Discussions about Trustees are generally covered by their divestitures or merging funds are also cause funds’ regular directors and officers insurance for increased tension as trustees look out for for a few years after they retire. “You don’t shareholders while advisors try to stay afloat. need to buy protection for acts you made five “I’m sure you are seeing [more tension] years ago,” said an insurance expert. “As long particularly in the smaller fund companies as the D&O policy is maintained, you are where they may not have such deep pockets,” covered.” But, if the fund is merged, sold or said Kathy Dennis, independent director for the decides to switch insurance providers, (continued on page 3) coverage lapses and the retired trustees are left with nothing. “It is an enormously IN THIS ISSUE untended to exposure,” said Tony How To Deal With Negative Yield Galban, senior v.p. and underwriting See Learning Curve, page 10 manager for directors and officers liability at Chubb Group of Insurance 2 MFDF Boosts Director Resources 5 Ditch Raw Data, Lawyer Says 3 DWS Goes Deutsch 7 G-30 Gives Money Fund Companies. “Most directors that retire 4 Closed-End Shareholders Make Suggestions just assume the company will be there – Some Noise 8 Wells Fargo To Replace Retirees they don’t do a lot of home work to make 5 FAF Gets Amortization Cost 9 Federated Promotes New Chair sure that is the case.” Extension 12 Calendar (continued on page 3)
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Industry MFDF Launches Online Resource Center The Mutual Fund Directors Forum launched an online resource center for EDITORIAL PUBLISHING TOM LAMONT MIKE FERGUS directors last month. The new website component will provide Forum members Editor Publisher with guidance on key topics such as risk assessment, the economic stabilization (212) 224-3266 STEVE MURRAY RONDA DIMASI program and valuation, speeches by legislators and regulators and podcasts of Deputy Editor Marketing Manager (212) 224-3569 conference panel discussions. JACQUELYN VISKOVICH LAURA PAGLIARO Managing Editor Renewals Manager The Forum previously provided information to its members, but it was not (212) 224-3613 (212) 224-3896 as comprehensive or organized. The resource center is arranged by topics so STANLEY WILSON CHRISTOPHER DUNNE Associate Marketing Manager Washington Bureau Chief directors can easily access additional materials on each subject. (212) 224-3096 (202) 393-0728 Forum members said they didn’t have enough to time sort through all the VINCENT YESENOSKY KIERON BLACK Senior Operations Manager newspapers and law firm alerts they were receiving daily, said Susan Wyderko, Sketch Artist (212) 224-3057 executive director. As a result, the Forum launched a news feed in September DAVID SILVA PRODUCTION Senior Fulfillment Manager (212) 224-3573 (FD, October) but directors were still asking for more. “Directors wanted more DANY PEÑA explanation such as what’s out there, what has been done and what are some Director SUBSCRIPTIONS/ ELECTRONIC LICENSES good pointers and that’s how we came up with the idea,” she added. LYNETTE STOCK, DEBORAH ZAKEN DAN LALOR Directors can request topics they would like to see covered and what should Managers Director of Sales (212) 224-3045 be expanded upon. Current requests have included a glossary to cover all the MELISSA ENSMINGER, JOHN DIAZ JAMES BAMBARA, Account Manager (212) 224-3366 acronyms floating around. The Forum also expects to have a number of original DOUGLAS LEE DON CATO Associates pieces written by industry professionals to add to its stockpile of information. Renewal Manager (212) 224-3015 JENNY LO REPRINTS Unlike the Forum’s news feed, the resource center will be restricted to Forum Web Production & Design Director DEWEY PALMIERI members. The Independent Directors Council also has a members-only online Reprint & Permission Manager ADVERTISING AND (212) 224-3675 resource center that mainly covers director’s legal responsibilities and is updated BUSINESS PUBLISHING [email protected] as the requirements change. The group is planning to roll out a new Web site in JONATHAN WRIGHT Publisher CORPORATE the coming weeks which is expected to be more user-friendly and appealing to (212) 224-3566 GARY MUELLER Chairman & CEO ERIK KOLB directors, according to Amy Lancellotta, managing director. The IDC also Editor, Business Publishing CHRISTOPHER BROWN keeps directors updated on hot topics through its monthly newsletter and posts (212) 224-3785 President PAT BERTUCCI, MAGGIE DIAZ, STEVE KURTZ updates to its website as needed. LANCE KISLING, ADI HALLER Chief Operating Officer Associate Publishers ROBERT TONCHUK BRIAN GOLDMAN Director/Central Operations & Fulfillment Advertising Production Manager (212) 224-3216 Customer Service: PO Box 5016, SCHAPIRO OFFICIALLY CONFIRMED AS SEC CHAIR Brentwood, TN 37024-5016. LESLIE NG Tel: 1-800-715-9195. Advertising Coordinator Fax: 1-615-377-0525 ary Schapiro was officially sworn in as the 29th chairman of the (212) 224-3212 UK: 44 20 7779 8704 Hong Kong: 852 2842 6910 MSecurities and Exchange Commission late last month. E-mail: [email protected] Editorial Offices: 225 Park Avenue Schapiro was appointed by President Barack Obama on Jan. 20 and South, New York, NY 10003. Tel: (212) 224-3613 unanimously confirmed by the U.S. Senate. She is the first woman to Email: [email protected] Fund Directions is a general circulation serve as the agency’s permanent Chairman. [For her thoughts on monthly. No statement in this issue is to be construed as a recommendation to transparency, see page 8.] buy or sell securities or to provide investment advice. Fund Directions ©2009 Former Chairman Christopher Cox left the position on Jan. 20 with the Institutional Investor, Inc. ISSN# 1076-4135 Copying prohibited without the changing administration. The last time an administration turnover led to permission of the Publisher. an SEC chairman’s replacement from the opposite party was in 2001, when Democrat Arthur Levitt vacated the position in February and Republican Harvey Pitt was confirmed in August. Cox was able to eek out a final version of one of his big mutual fund projects before he left – final regulations on the new summary prospectus were okayed Jan. 13.
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Governance AQUILA BOARDS once the coverage is enabled and costs vary between funds and their elections. (continued from page 1) Mason also spent time deciding how to implement the There are a number of nuances to figuring out what kind of insurance. Since D&O insurance is renewed every year, trustees insurance policy is right for every fund and depends on what have to ensure their benefits remain if a new policy is put in place kind of extra coverage the trustees want. Mason, who heads an by a future board. Legal advice led Mason to create the agreement insurance subcommittee for Aquila’s committee of chairs, said he directly with the fund--making the insurance contract a direct spent a lot of time deciding the details such as how long retired liability of the fund’s assets. So whether the fund is shut down or trustees should be covered, such as three or six years, and what liquidated, before it distributes its last dollars, assets would have to would be covered. The fund group, which uses ICI Mutual, be set aside to pay for the tail insurance. decided that retired trustees should have coverage equal to that of those serving on the board. The coverage will be added to the EXAMPLE OF LANGUAGE: contracts, pending board approvals. “The Trust agrees that with each Trustee’s retirement there “The idea of tail insurance is usually something that is shall be maintained… for a period of at least six years contemplated while renewing your policy,” the insurance expert thereafter, director and officer insurance coverage for that Trustee …it being understood that the fulfillment of this said. “There are a lot of reasons for directors to protect obligation may entail the purchase of “tail” insurance coverage themselves and a lot of ways they can do it.” Tail insurance can in the event, for example, of the sale of assets of the Trust, also be used as way of strengthening the incentive to become or liquidation or merger of the Trust with a fund that is not within remain a director, especially in the current market conditions. the group of funds, or a change of insurance carriers by all the There is no cost to set up tail insurance for future retirees as it funds within the Trust.” is merely an addition to the contract. The fund would be charged BOARD, ADVISOR moot – there should be no discussion about that. No one had the capacity to anticipate this would happen.” (continued from page 1) Dennis said boards should prioritize what to focus on when it Morgan Stanley funds and an industry consultant. “This is why comes to pushing back against what the advisor may want to do. the 40 Act has an independent board making some of these She cites scenarios involving auction-rate preferred shares and decisions – for when the times get tough,” added another money market funds as both extremely important and requiring consultant. a lot of focus from both sides. “As directors we need to be One board came across trouble when it needed a capital understanding of how the management companies look at their support agreement from its advisor for some floundering issues,” she said. securities in its money market fund. The board went back and forth with the advisor, which was part of a state bank, on whether they would provide the support or not. At the same DWS Board Meetings time, the board was also consulting with its legal counsel on what to disclose to shareholders about the situation. While the To Head Overseas problem securities have since matured, it took about a week for The board of the DWS Investments funds is the advisor to agree to support the fund. But in the end the planning to ship out to Germany to hold one board wasn’t even sure whether the support agreement would formal board meeting a year at the Frankfurt- hold up if they needed it. “It wasn’t like there was $50 million based headquarters of Deutsche Bank, its sitting in an escrow account,” the chairman said. parent company. Although some fund groups When it comes to pushing the advisor for more, boards need are attempting to cut back on travel, “half of to pick and choose their battles. “The board has to be sensitive to our equity funds are managed by non-U.S. the issues that management is facing and needs to be somewhat Paul Freeman based portfolio managers,” explained Paul selective in looking for answers,” Dennis said. “You can’t just Freeman, chairman. “I think the sense is that it makes sense to complain about everything – it’s certainly not the time to get into hold a meeting in Germany.” discussions about breakpoints!” As of right now, for the next two years the board plans to head Another independent director agreed, adding, “With such a overseas for one meeting a year, most likely in May. “It’s a big large downdraft, to argue ‘Could we have done 2% better?’ is change for us but increasingly, senior bank personnel need to see
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the funds,” Freeman said. “We’re a big client of the bank – not returned. Baer could not be reached. everyone has a $100 billion client.” While the votes voice shareholders’ opinions, the advisory The board held a meeting at the Frankfurt headquarters in contract is not required to be terminated because a super- September 2007 and met with senior management, including majority was not present. A narrow majority also voted to not Josef Ackermann, chief executive (FD, Feb 2008). But recent retain UBS as manager, but a greater number of votes were cast discussions between directors suggested a formal German-based in favor of creating a new advisor contract. board meeting should be arranged ahead of time as part of the “Shareholders have clearly sent them a message by voting two regular schedule, not on an ad-hoc basis. The equity or fixed- times to end the contract with UBS,” said Arthur Lipson, income committees may also hold an additional meeting at the managing member at Western Investments. “The message has headquarters. got to be very clear to the board – shareholders are very unhappy Meeting face to face with senior personnel as well as the with the way things are done.” The incumbent board will internationally-based portfolio managers is more efficient and consider the recommendations once the final results are productive for the board than bringing one portfolio manager to tabulated. the U.S. for a meeting. “We get to meet more people and After hearing the preliminary results, Western immediately become more immersed,” Freeman said. The trip also allows the purchased more shares. “We’re more committed than ever to board to understand the direction the bank wants to go and severing the relationship with UBS who stands accused of tax listen to thoughts about an international platform. fraud and miss-valuing assets,” Lipson said. “Western is certainly in it for the long haul.” Shareholders Send Message To UBS Shareholders also attempted to gain board seats for the Insured Activist shareholders are waging wars against two closed-end Municipal Income Fund earlier in 2008. Bulldog Investors filed a funds managed by UBS and while they haven’t actually won, proxy in May to gain seats at the July 17 shareholder meeting they feel their message is getting across. Shareholders of the and open-end the fund. The proposal was denied after the Investment Grade Municipal Income Fund voted to prohibit UBS incumbent board informed the shareholders they did not submit from managing the fund last month, preliminary tallies showed. the proposal with enough advanced notice. Phillip Goldstein, Activist shareholder groups filed to end the advisory agreements co-founder of Bulldog, said the proposal has been submitted after the U.S. government launched an inquiry into whether again for this year’s shareholder meeting but they have still not UBS helped about 20,000 wealthy Americans evade taxes. A final received a response from the board. “We just sent them a letter tally was not immediately available. again – we want to make sure we can vote our shares,” he said. A U.S. Senate subcommittee alleged that affiliates of UBS helped tax cheats avoid billions in taxes earlier in 2008, according to proxy Lawyers: Take New Look filings. UBS Chairman Raoul Weil was indicted in November in connection with the on-going investigation. Weil was head of UBS At Compliance Wealth Management International from 2002 to 2007. Attorneys at Bingham McCutchen have Walter Baer initially filed a proxy to block the board from advised chief compliance officers to retaining UBS as manager due to the legal inquiry. Western reexamine their compliance programs in the Investments also submitted a preliminary solicitation against wake of the financial crisis. Nancy UBS managing the funds and Persechino, partner in the firm’s filed a proxy to gain board Washington, D.C. office, said that while seats. Karpus Management CCOs work on the annual review process, proposed the investment Nancy Persechino “They should use last year’s market turmoil agreement between the as a test of [compliance] systems.” fund and UBS be In planning for 2009, Persechino said firms need to pay terminated due to the close attention to risk functions and determine if they had fund’s massive discount. properly identified risk over the course of the last year. Lori In response to the activist Richards, director of the Securities and Exchange proposals, management Commission’s Office of Compliance Inspections and offered changes to the Examinations, recently identified risk management as an area management contract which the agency will be paying close attention to. She urged firms to would lower the advisory fee. Calls to Karpus and UBS were not make sure that their compliance and risk programs
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complement each other and also noted there will be a particular monitored and available – such as how many rings it takes for a focus on newly-merged entities to make sure that nothing has customer service representative to answer a phone call. fallen through the cracks. Any information provided by the advisor in the board book is In a note to clients, Bingham lawyers also recommended the responsibility of directors to digest and it all should be clear- that CCOs assess their firms’ valuation processes to make sure ly explained for the board to understand. “Be careful what you they’re accurate and look at whether disclosures to investors are ask for,” Rosella said. “You touch it you own it.” appropriately designed to handle liquidity issues and redemptions. Governance: Small Board U.S. Bancorp Nets Extra Time With Amana Snags Three 2a-7 Exemption Diverse Directors The Securities and Exchange Commission has extended its no- The board for the Amana Mutual Funds had action relief on amortized cost for the Mount Vernon Securities a laundry list of qualities to find while Lending Trust—Mount Vernon Securities Lending Prime Portfolio hunting for their three new directors. The to mid-February. The Division of Investment Management said board wanted to expand its diversity of in October it would not recommend action if U.S. Bancorp, the backgrounds and geography, replace its fund’s parent, or its subsidiaries bought any securities at the financial expert, who retired last year, as well as find directors with international amortized cost from the fund to allow it to pay for redemptions. Miles Davis The original no-action relief, which was available to all eligible experience as the funds plan to expand into money market funds, expired Jan. 12 (FD, November). oversees investments. The board eventually came across Salim FAF Advisors, the fund’s investment adviser and a subsidiary Manzar, Miles Davis and Herbert Grubel, of U.S. Bancorp, asked the SEC to extend the relief to Feb. 13. whose broad range of knowledge and “While there has been some improvement in the liquidity of experience fit their narrow mold. instruments held by money market funds...the market continues “Chairman Talat Othman had for a long to be in stress and we anticipate that redemption requests may time wanted to expand the board, to bring in accelerate,” wrote Charles Manzoni, general counsel at FAF other expertise and plan for succession,” said Advisors, in a letter to the agency. To meet these redemptions, James Winship, chief compliance officer. But Herbert Grubel the fund might need to liquidate portfolio securities at the board had hit its limit of shareholder disadvantageous market prices, something FAF Advisors did not elected directors and had to have a shareholder vote to add to want to happen, he said. that number without violating the two-thirds rule. The funds also follow Islamic investing principles – which “Careful What You Ask For” generally avoid investments in businesses such as liquor, pornography, gambling and banks – and the board was looking Boards Should Get Explanations, to add someone with knowledge of the principle. “And there are Not Data not a lot of people that fit that role,” Winship said. Boards should steer clear of raw data, accord- Manzar, executive director of Princeton Advisory Group, ing to Michael Rosella, partner at Paul satisfies the need for Islamic knowledge and a financial expert. Hastings. As boards try to dig deeper into Miles, an associate professor of management at Shenandoah information - especially during the current University, and Grubel, a senior fellow at the Fraser Institute, market conditions - the advisor can start feed- bring international experience as well as more diversity and ing directors data instead of well thought out geographic reach to the board. Although Grubel is already 74 information with explanations of what is years old, “he’s an internationally-known economist and a well- Michael Rosella being shown. “You never want data in your known figure and when you find the right person you need to board book that you don’t understand,” Rosella said, citing lia- take them,” Winship said. bility concerns. The three new independent directors expand the board’s size There shouldn’t be any raw data or schedules for the board to to eight from six, which includes one interested trustee. The look over as they are often “worthless and dangerous,” Rosella directors oversee two funds with combined assets of over added. Especially at larger fund groups, data of all kinds are $1 billion.
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or the past 16 years, the highly-coveted Mutual Fund Industry Awards have recognized the mutual funds, fund leaders, marketers, trustees and independent counsel who stood-out for their excellence, achievements, innovation and contributions to the industry. The annual awards dinner and ceremony has become the premier celebration and networking event for the industry, growing in attendance and prominence each year. Last year’s gala event hosted more than 500 leaders and luminaries from every facet of the mutual fund industry. Join us on March 19th as we honor this year’s nominees and announce and award the winners!
LIFETIME ACHIEVEMENT AWARD RECIPIENTS AWARDS DINNER & CEREMONY SPONSOR FUND ACTION FUND DIRECTIONS Jack Brennan, Retired CEO, David S. Ruder, Chairman, Vanguard Group Mutual Fund Directors Forum AWARD CATEGORIES & NOMINEES Fund Action Categories & Nominees Fund Marketer of the Year Philipp Hensler, CEO, DWS Distributors TABLE SPONSORS Fund Leader of the Year Bruce Hoffmann, Chief Marketing Officer, Bill Gross, Co-CEO, PIMCO Sentinel Investments Keith Hartstein, CEO, John Hancock Funds Andy O’Rourke, Marketing Director, Direxionfunds James Kennedy, CEO, T. Rowe Price Stuart Parker, Executive V.P., JennisonDryden Bob Reynolds, CEO, Putnam Investments Fund Directions Categories & Nominees Sales Success of the Year Thomas Butch, Head of Distribution, and Brad Ross, Trustee of the Year National Sales Manager, Ivy Asset Strategy Fund Faith Colish, Independent Director, Brad Evans, Senior V.P., and Dave Ribbens, V.P. of Neuberger Berman Sales and Marketing, John Hill, Independent Chair, Putnam Funds Heartland Advisors’ Value Plus Fund J. Atwood Ives, Independent Chair, MFS Funds This year’s Frank Porcelli, Head of U.S. Retail, BlackRock Stephen Lewis, Independent Chair, RiverSource event Michael Sapir, CEO, ProShares ETFs will again Small Board Trustee of the Year celebrate the Ad Campaign of the Year William Givens, Independent Chair, The Japan Fund Invesco Aim Rising Stars Franklin Golden, Independent Chair, John Hancock Financial Services Diamond Hill Financial Trends Fund of Mutual Funds, up-and-coming, OppenheimerFunds talented young professionals who Michael LeRoy, Independent Director, Bjurman, Barry Funds are poised to be the future leaders Deal of the Year Edward Pittman, Independent Chair, Van Wagoner of the industry. Lighthouse Holdings’ Acquisition of American Beacon Independent Counsel of the Year Neuberger Berman’s Buyout by Senior Management Arthur Delibert, Partner, K&L Gates Wells Fargo’s Acquisition of Wachovia Burton Leibert, Partner, Willkie Farr Proceeds from Brian Lorenz, Partner, Bleakley Platt SMA Player of the Year Reinaldo Pascual, Partner, Paul Hastings Mutual Funds Gary Jones, V.P. of Industry Operations, Against Cancer’s Money Management Institute Operations Management live auction and Jac McLean, National Sales Manager, raffle will benefit MFS Investment Management Category & Nominees the revolutionary Roger Paradiso, Managing Director, Center for Applied Citi Smith Barney Best Post-Trade Technology Implementation Cancer Sciences American Beacon Advisors, (CACS), part of the Belfer Institute for VISIT THE 2009 AWARDS WEBSITE Financial Reporting Automation Innovative Cancer Science at the Dana- OppenheimerFunds, 22c-2 Monitoring Technology Farber Cancer Institute. www.iinews.com/site/MFA09 Saturna Capital, Document Imaging Technology
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Regulatory Schapiro: Funds Need Corporate other areas outside the fund industry, such as the regulation of derivatives and municipal bonds. Stevens did not delve deeper Transparency Intact into the specifics of how a new plan like this would be carried Mary Schapiro said that corporate out because there is so much that still needs to be reviewed. transparency must remain intact and The ICI is also looking in particular for investment product exchanges must be regulated to protect funds. regulation to be driven by the tenets of the mutual fund industry Schapiro, who officially became chairman of — investor protection, fair and orderly markets and the the Securities and Exchange Commission last promotion of efficiency, competition and capital formation. month, told the Senate Banking Committee “The fund industry has many lessons to offer,” he wrote. “Our on Jan. 15, “The protection of mutual funds kind of investing…runs counter to the behaviors that helped Mary Schapiro and investment advisors through full and fair create and spread the financial crisis.” disclosure by corporate issuers” must continue to exist and there “The ICI will dedicate its efforts to ensuring that the fund will be a need not just “to monitor risk but to protect investors” industry is an active participant in the debate and that any new and regulate exchanges. She added that credit default swaps need regulatory scheme reflects the needs and priorities of funds and to be regulated as part of any regulatory changes. their investors,” Stevens said. Schapiro also said she wants to restructure the SEC’s Office of Risk Assessment, which as of recently, consisted of only two Volcker Group Says Nix Money Fund people (FD, May). Hundreds of SEC examiners need direction from the Office of Risk Assessment to know where to target their $1 NAV efforts and better coordination is needed, said Schapiro. “I would A report from the Group of Thirty, chaired by Paul Volcker, calls like to have risk assessment permeate everything the SEC does.” for the replacement of money funds’ $1 NAV with a floating value Schapiro did not provide any suggestions on how any new based on market price. Volcker is chairman of President Barack regulatory regime should be structured. She said the changes Obama’s Economic Recovery Advisory Board and, more she suggested need to be put in place by either “the SEC as we importantly, is believed to be the lead Obama advisor on redrawing know it today, or the SEC as a larger agency potentially regulatory reform for financial institutions, so his G-30 document combined with other agencies or an entirely new structure we may provide the best guidance available on Obama’s intentions. haven’t devised yet.” Connie Bugbee, managing editor at iMoneyNet, said removal of the $1 NAV could shake the confidence of investors and cause ICI Suggests One Agency Approach a run on money funds. Money fund investors are used to the security of the dollar-in, dollar-out method used by the funds, To Reform she said. “The last time confidence in money funds was shaken, Paul Schott Stevens, president of the $220 billion went out the door” in two weeks, she added. Investment Company Institute, wants to Bugbee said the money fund industry has been sound for over reorganize financial industry regulations under 30 years and provides a secure investment. “It’s an excellent one umbrella agency, most likely the Federal product offered to the public that is obviously needed, otherwise Reserve. A number of smaller “functional it would not have grown to $4 trillion. There needs to be very regulators” would work closely with the healthy discussion before any changes are made,” she said. Bugbee Reserve to govern different sectors, such as one added that while many investors in stocks have lost large amounts Paul Stevens focusing on funds, broker-dealers and of money, investors in The Reserve’s Primary Fund—which broke exchanges — for example a combined entity of the Commodity a buck in September—will lose five cents on the dollar at most. Futures Trading Commission and Securities and Exchange The Investment Company Institute is driving to get its own Commission. Others would be tasked with oversight of banking ideas for financial institution reform out by the end of March, institutions and insurers, he said in his quarterly letter to directors. though a spokeswoman did not say what ideas the industry Stevens hopes this new structure would help close gaps in group has. Paul Schott Steven, ICI president, made some legislation of funds and other asset-management vehicles by suggestions in his quarterly report to directors including having bringing them all under the same watchful eyes rather than one overarching agency (see related story, page 7). Andrew handfuls of different organizations. These include gaps between “Buddy” Donohue, director of the Securities and Exchange how broker/dealers and investment advisors are regulated, as well Commission’s Division of Investment Management, suggested in
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October that money funds be split into two categories—a stable …Provides Update value fund that sticks to a $1 NAV and another type offering more price fluctuation that would have a target $10 NAV (FD, On SEC Initiatives November). Donohue noted that his staff has been reviewing the handful of If Washington nixes the $1 NAV there should be a transition comment letters received regarding last year’s proposal on soft period of several months to allow money funds to adjust, said a dollars. He said the proposal received some comments criticizing fund lawyer. This would allow funds to phase out of long-term the lack of guidance on what directors should do with the commercial paper to shorter term paper to have liquidity on information they receive. “These comments are important as the hand to allow for possible investor redemptions. purpose of the guidance is to help fund directors in this Attempts to reach Volcker were not successful. challenging area,” he said. “Rest assured the staff will keep your (For more information on how to maintain a fund’s $1 NAV comments in mind as we prepare a recommendation.” in response to negative yield, turn to the featured Learning Curve Donohue also reintroduced the idea of culling the amount of on page 10). director duties through delegation and unifying the ten exemptive rules which govern director oversight. He said his staff believes that unifying the standards and requirements could cut Donohue Urges Extra Sensitivity In back on the overlapping and time-consuming requirements that Current Market… directors currently must fulfill. Directors received some tips last month on dealing with the 15(c) process and shadow Bulletin Board pricing in the crumbling credit markets from Andrew “Buddy” Donohue, director of the Brandywine Founder Retires Division of Investment Management at the Foster Friess, interested director and founder of the Brandywine Securities and Exchange Commission. But Funds, retired last month after spending over 23 years with the while he touched on shadow pricing, he funds. The retirement was expected as part of a succession plan Buddy Donohue skipped over the much needed valuation after Brandywine became an affiliate of Affiliated Managers guidance that was expected last summer. “And that’s certainly the Group in 2001. Shortly after, William D’Alonzo became ceo of most important piece directors are waiting for,” one independent the funds and took over as chairman in 2004. counsel said. Friess’ retirement shrinks the board size to six, which includes Donohue suggested to directors attending a members-only one interested. The board currently is not planning to seek a Mutual Fund Directors Forum conference that boards replacement. The directors oversees three funds with concerned about receiving inaccurate prices from service approximately $8.8 billion in assets. A call to D’Alonzo was providers should develop a price override policy. Boards referred to a spokesman who declined comment. overseeing money market funds were briefly allowed to use amortized cost to value illiquid securities (FD, November), but Advisory Board Replaces Wells the Commission’s exemptive relief expired last month. Boards often use override policies for non-money market funds and Fargo Retirees should be familiar with them if they decide they are necessary. The two members of the Wells Fargo Funds’ recently established Directors were also urged to consider carefully additional advisory board will join the actual board in April. Pending information or issues in contract renewal that may not have been shareholder approval, Isaiah Harris, Jr. and David Larcker will present before. Specifically, Donohue pointed to funds with fill the gaps left by interested director J. Tucker Morse, who expense caps that have experienced an increase in expenses. “Is it retired January 1, and Thomas Goho, who plans to resign at the appropriate to modify or eliminate the expense cap? What end of March. Both Morse and Goho have served on the board standard will the board employ to determine any such for more than 20 years. modification?” he asked. Donohue also warned boards to The board added independent director Judith Johnson in monitor changes in the peer groups they use for comparing fund August 2008 which filled the vacancy left by Richard Leach’s performance. “Directors should be sensitive to the limitations of retirement earlier in the year. But the board could not add any comparable data,” he said. Specifically, funds which may have other trustees without violating the rule requiring two-thirds to previously made up a peer group may no longer have comparable be elected by shareholders. The trustees approved the creation of assets under management. the advisory board in May and Harris and Larcker were
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appointed in November (FD, December). As members of the audit chair and financial expert, L. Joe Moravy, was previously a advisory board, they can attend all board and committee partner at Ernst & Young. meetings but can not vote. They also receive the same meeting The four member board, which includes one interested fees as current directors but are not paid a retainer. Calls to Peter director, John Liew, chairman and principal at AQR Capital, Gordon, chairman, were not returned. will eventually oversee eight funds. Calls to Grenadier and an Harris and Larcker will be independent directors and are AQR spokeswoman were not returned. Armour and Moravy expected to be elected along with the five incumbent directors at could not be reached. a shareholder meeting February 27. The seven-member board will be completely independent and will oversee the complexes’ Federated Bumps Madden To Chair 134 funds with over $31 billion in assets under management. Federated Investors has named Peter Madden independent chairman, replacing John Murray, Jr., who retired January 1 after AQR Builds Board With Experience nearly 14 years on the board. Independent director Marjorie AQR Capital Management jumped into the mutual fund Smuts has also retired after spending 24 years. market last month and has chosen directors with experience that Now retired, Madden was previously president and chief runs the gamut from finance to fund ratings. Three independent operating officer at State Street Bank and Trust and State Street directors began overseeing the new AQR Diversified Arbitrage Corporation, as well as spent a short tenure as a representative to Fund in January and will take on oversight of a global and an the Massachusetts state legislature. Madden has been a member international fund expected to launch this month. AQR of the board since 1991 and will join the board’s executive previously managed only hedge funds. committee and remain on the nominating committee. Madden Timothy Armour is a former managing director at could not be reached. Morningstar and serves as the chairman of the nominating and There are no plans to replace the retired directors as the governance committee. Steven Grenadier is a professor of finance smaller 10-member board is more in line with industry peers, a at Stanford University and also serves on the boards of the spokeswoman said. The board, which includes two interested E*TRADE Funds and Nicholas Applegate Funds. The board’s trustees, oversees 147 funds with over $41 billion in assets.
RESERVE SUES to prevent any conflicts of interest in independence. The information for the two Reserve trustees, who were not named in (continued from page 1) the complaint, was clearly identified in board material and fund investment bank” and a trust company which received revenue filings throughout this period, according to court documents. and distributions from the funds while they served the board. Billing records also show the law firms had numerous discussions The group filed a complaint with the Superior Court of the with the board about proper board composition, the complaint District of Columbia Civil Division on January 13 for the time says. between 1997 through 2005 that the law firms represented them. The SEC initially threatened to disgorge all of the profits It subsequently resolved the issue with the Securities and earned by the Reserve during the eight years, but the fund group Exchange Commission but is seeking more than $4 million for was able to convince the Commission that it had, on its own, the expenses it incurred rectifying the errors made under the ratified the contracts that had been handled by the improperly supervision of the law firms, as well as repayment of all fees paid constituted board. The problem was spotted by another law firm, to the firms. Willkie Farr & Gallagher, which was later hired to advise Joseph DeMaria, partner at Tew Cardenas, which is Reserve. representing Reserve, said that the firms had a duty to review “Vigilance by everyone is key,” said Bruce Leto, partner at whatever information they needed to ensure compliance with the Stradley Ronon and who is not involved in the suit, about 40 Act. “Our position is that both firms blew it and they’re both ensuring the board is properly constituted. Because there are so specialists on the ’40 Act,” he said. many rules — such as 2a-9, which defines the term “control,” as A spokeswoman for Dechert said, “This matter has no merit in of a company, and 10b-1 and 10b-2, which prohibit directors and we intend to defend it vigorously.” Spokesmen for The with certain employment histories — it is important to elicit as Reserve and K&L Gates and an attorney at Willkie Farr declined much information from directors as possible. “Especially since to comment. SEC officials did not return calls. fund sponsors like to use people from the financial services Directors and officers fill out questionnaires on a yearly basis industry on the board,” Leto said.
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LEARNING CURVE®
What Boards Should Know About Negative Yield on Money Funds
Money market funds have money funds that are at risk for experiencing a negative yield
recently been battling negative should consider the various benefits and detriments of the yields and breaking the buck as they adopted options described below, among others, in light of the specific more defensive investment strategies with higher circumstances of each particular fund. credit quality and correspondingly lower credit risk. Three lawyers at Morgan, Lewis & Negative Yield Bockius – partners Timothy Levin and A money fund has a negative yield when its yield is less than its Timothy Levin Jennifer Klass and associate John O’Brien — overall expense ratio, meaning that the expenses it incurs exceed have put together a number of options that the income it derives from investment activities. For the funds have for dealing with negative yield – purposes of this article, negative yield is defined as a money including two seemingly radical approaches. fund with a total return, inclusive of proceeds from sales of For funds that are looking to address the securities, that is less than its overall expense ratio. When this negative yield flat out, the lawyers provide a occurs, the fund must continue to pay its expenses, but handful of simple methods to minimize or essentially must do so out of shareholder capital. prevent the negative return. But the three bring up a couple new approaches, originally Jennifer Klass Options to Limit or Prevent the Impact suggested by Peter Crane of Crane Data, of of Negative Yield preventing a fund from breaking the buck by Several options are available to money funds that are faced with either assessing negative dividends or the prospect of persistent negative yield and fall into two calculating a daily reserve share split. While general approaches: the Securities and Exchange Commission has not issued guidance on either strategy, nor 1. Addressing The Negative Yield: have any funds implemented them, the The first approach is to address the issue of negative yield options offer a way of maintaining an John O’Brien directly – either by minimizing the negative return or, equilibrium between real per share net asset preferably, taking steps to prevent a fund from generating value and a fund’s $1 NAV. negative return. Each of these options appears to have been “We are not aware of any fund groups that have yet implemented, to varying degrees, in the current marketplace. implemented negative dividends or reverse share splits – due in part to the financial implications for fund shareholders and also • Close or Limit Money Funds to New Investors - One the operational difficulties associated with implementation,” said problem in a declining yield environment is that new cash Klass. “However, they are theoretical options and my guess is that — whether from new shareholder investments or from an increasing number of funds may have to consider them if the maturing securities — is invested in securities that are likely current negative yield environment continues over the long term.” to have a lower yield than securities purchased when available yields were higher. Accordingly, minimizing Here is what the three Morgan Lewis professionals suggest for fund inflows to a fund by, for example, closing the fund to new directors: investors is one way to reduce the need to buy into the very Directors of money funds may wish to engage fund low yield market environment. This strategy might not management in a discussion of the extent to which their funds avoid the “negative yield” problem indefinitely, but it can have the potential to experience a negative yield – especially make it easier for the fund’s advisor to manage the problem. money funds with significant exposure to U.S. Government From a board perspective, this strategy may be appealing and U.S. Treasury securities, as well as funds that have tightened because it preserves the benefit of the fund’s older, higher their investment restrictions in the current market. Directors of yielding investments for current fund shareholders.
Fund Directions is now accepting submissions from industry professionals for the Learning Curve® section. For details and guidelines on writing a Learning Curve®, please call Jacquelyn Viskovich at (212) 224-3613.
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• Expand the Investment Mandate – As some money funds implications of these options. move to more conservative, but lower yielding, investments one possible solution is for a fund to seek to invest in • Assess Negative Dividends - One possibility to reducing securities that offer higher yields. Of course, this strategy shares outstanding in order to compensate for investment has an important trade-off: the higher yield likely comes with loss caused by negative yield is for a money fund to assess a higher risk. Fund boards and investment advisors must be charge to investors, payable in shares, for each day that the careful that such investments satisfy the fund’s objective of fund is in negative yield position. In this method, any daily maintaining a stable $1 NAV and that any new investments negative yields would be offset by such charges, while daily are consistent with the fund’s investment policies. For U.S. positive yields accrued during the same month would be Treasury money funds and U.S. declared as dividends. On a monthly basis, shareholders would “pay” any net Government money funds, which “They are theoretical options generally are required to invest at least negative yield (the difference between 80% of their assets in U.S. and my guess is that an the amount of daily negative yield and Government and U.S. Treasury increasing number of funds the amount of daily positive yields) to securities, respectively, it may be the fund in the form of shares. This possible to invest in other money may have to consider them if approach would have the effect of market instruments as part of the the current negative yield creating a “negative dividend.” Funds “20% basket.” In addition, these considering this approach should make funds may be able to invest in other environment continues over the sure that their governing documents money market instruments in reliance allow recoupment of the negative yield long term.” —Jennifer Klass on their “temporary defensive” from the dividends otherwise earned or investment policies when faced with accrued during the month. Such a the possibility of having a negative yield. negative dividend would be calculated daily and assessed pro rata against all fund classes. • Implement Fee and Expense Limitations – Another way to address the issue of a negative yield is to reduce the fund’s • Calculate a Daily Reverse Share Split - In the same vein as a expenses to a level below its current yield by negotiating with daily negative dividend calculation, another way to the fund’s various service providers to reduce or waive fees or potentially reduce the number of shares outstanding in order temporarily reimburse fund expenses. Such an arrangement to maintain a $1 NAV is for funds to effect a reverse share should be documented, and it generally should be possible split periodically. Such a reverse share split would stabilize for the service providers to later recapture waived or NAV at $1 per share, but would result in each shareholder reimbursed fees when the fund’s yield increases, subject to owning a fraction of the shares held prior to the reverse split. timing restrictions imposed under accounting rules. Money For example, if a fund has a -0.15% negative yield, the fund funds offering multiple classes of shares should be careful to could effect a reverse split so that each investor in the fund consider whether the arrangement complies with tax rules would own 0.985 shares worth $1.00 per share instead of 1 that require certain fees to be borne by all classes at the same share worth $0.985). Such a reverse share split is probably rate in order to avoid a preferential dividend. the most feasible means of addressing negative yield without breaking the buck because most fund governing documents 2. Preventing a Fund from “Breaking the Buck” allow for boards to implement share splits and reverse splits The second approach is to implement practices intended to within their reasonable business judgment. prevent a money fund from “breaking the buck.” In a negative yield environment, one way for a money fund to maintain Disclosure equilibrium between its real per share NAV and its $1 NAV is to Regardless of the option selected, it is critical that money reduce the number of shares outstanding. The following options funds consider the need to disclose the implementation of any do not alter the reality that the fund and its shareholders are potential actions to eliminate negative yield or maintain a experiencing a negative return and are losing part of their stable $1 NAV and address the potential consequences and investment. It is believed that none of these alternatives has been risks associated with such actions. This disclosure should be implemented by a fund, nor has the Securities and Exchange provided through a prospectus supplement and also may be Commission provided any guidance as to the regulatory reinforced through web site disclosure, as appropriate.
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Calendar • Nov. 11-13: IDC’s Investment Company Directors • Feb. 10: Mutual Fund Directors Forum’s Director Discussion Conference in Amelia Island, Florida (202-326-8300) on Regulatory Reform in San Francisco (202-973-0535) • Jan. 26-28: MFDF’s Fourth Annual Directors’ Institute in • Feb. 12: Independent Directors Council’s Florida (Naples) Coral Gables, Florida (202-973-0535) Chapter Meeting (202-326-8300) • April 15-16: MFDF’s 10th Annual Policy Conference “Critical • Feb. 12: Investment Company Institute’s Webinar on Issues for Investment Company Directors” (202-973-0535) Summary Prospectus Rule (202-326-5968) • Feb. 18: MFDF’s Director Discussion on Regulatory Reform Correction in Washington, D.C. (202-973-0535) Performance of the S&P 500 was stated incorrectly in last • Mar. 11: IDC’s New York Chapter Meeting (202-326-8300) month’s issue in the article “Directors Refocus On Performance.” The index actually dropped around 40% through December 10, • Mar. 12: IDC’s Boston Chapter Meeting (202-326-8300) compared to the Diamond Hill Financial Trends Fund which • Mar. 18: IDC’s Mid-Atlantic Chapter Meeting (202-326- dropped around 45%. 8300) Quote Of The Month • Mar. 19: Fund Directions’ and Fund Action’s 16th Annual Mutual Fund Awards with Charity Auction Benefiting Mutual “It’s not something people are particularly focused on when things are Funds Against Cancer in New York (212-224-3239) going well, but when things start getting tough they want to become more defensive and protective.” —Ted Mason, chair for one of the Mar. 22-25: ICI’s Mutual Funds and Investment Management • Aquila Funds boards, on why his fund group decided to look into tail Conference in Palm Desert, Calif. (202-326-5800) insurance (see story, page 1.) • April 2: IDC’s Texas Chapter Meeting (202-326-8300) • April 16-17: IDC’s Investment Company Directors Workshop One Year Ago In Fund Directions in Boston (202-326-8300) Paul Schott Stevens, president of the Investment Company Institute, told directors in his quarterly report that he did not May 4-5: MFDF’s Ninth Annual Policy Conference in • recommend eliminating boards in an earlier letter to the U.S. Washington, D.C. (202-507-4488) Treasury Department on global competitiveness. [In his most • May 6-8: ICI’s General Membership Meeting in Washington, recent letter to directors, Stevens is makes some suggestions for D.C. (202-326-5968) even broader regulatory reform in the wake of the financial crisis (see story, page 7).] • May 13: IDC’s Denver Chapter Meeting (202-326-8300) • May 14: IDC’s Chicago Chapter Meeting (202-326-8300) • June 4-5: ICI’s Mutual Fund Compliance Programs HELP US PICK THE BIG WINNERS Conference in Alexandria, Va. (202-326-5968) Who do you think deserves to be Trustee of the Year, Small • June 23: MFDF’s Risk Principles For Fund Directors in New Board Trustee of the Year and Independent Counsel of the York (202-507-4488) Year? Why? June 23: IDC’s San Francisco Chapter Meeting (202-326- • Send your comments to [email protected]. 8300) • June 24: IDC’s Los Angeles Chapter Meeting (202-326-8300) For information on the candidates, visit www.funddirections.com. Winners will be announced at the 16th Annual Mutual Fund Sept. 13-16: ICI’s Tax & Accounting Conference in Lake • Industry Awards Dinner on March 19 at Ciprani Wall Street. Buena Vista, Florida (202-326-5968) Complete coverage of the awards dinner will appear in the April • Oct. 11-13: ICI’s Operations and Technology Conference and issue of Fund Directions. Service Provider Exhibition in Orlando (202-326-5968)
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