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Donaldson Salutes New Independent Directors Council

SEC Chairman William Donaldson last week spoke before the newly created Independent Directors Council which will serve as a forum for communication among independent directors. Donaldson said he admired the job that independent directors do, but also posed four suggestions or challenges. He urged independent directors to enhance their oversight functions, to always serve as investor advocates in the boardroom, to stand up to management when appropriate and to help shape mutual fund regulatory policy.

The past year has been a troubling period, Donaldson said, during which the SEC brought 51 enforcement cases related to mutual fund scandals that resulted in levies of $900 million in disgorgements and $730 in penalties. Funds have paid an even higher price as angry investors have withdrawn money from what was once a trusted investment vehicle, he said. Donaldson added that recent actions by the SEC and independent directors can help restore investors' trust and confidence.

Donaldson believes that the fund governance reform measures adopted by the Commission will realign fund boardrooms for the benefit of investors. Funds that rely on certain exemptive rules must have an independent chairman and 75% of the board members must be independent. The SEC also adopted a new compliance policies and procedures rule and a chief compliance officer requirement. Donaldson said the presence of a chief compliance officer who answers to the fund's board should lead to a greater focus on compliance controls and procedures. The requirement that all registered investment advisers adopt a code of ethics will also foster an ethical, compliance-oriented atmosphere, in Donaldson's view.

The SEC also adopted new disclosure requirements to improve the information that fund investors receive about fair value pricing, selective disclosure policies and procedures, expenses, and portfolio managers.

The disclosure that most directly affects independent directors is the requirement that the fund's annual report include a discussion of the board's considerations when approving or renewing a management contract. Donaldson emphasized that the discussion should bring clarity to the factors the board considered when voting.

Donaldson reviewed the SEC's new oversight regime that was adopted to improve the anticipation and mitigation of financial risk, potential fraud and malfeasance. The new Office of Risk Assessment will look for potential areas of concern. Donaldson said the SEC's hedge fund adviser registration initiative is an example of this forward-looking approach. The SEC is scheduled to vote on the proposal tomorrow. He believes the SEC needs to know more about the activities of hedge fund managers and the impact of their trades on the "other side of the transaction."

Donaldson said he is encouraged by signs that many in the fund industry are embracing reform. He acknowledged the Investment Company Institute's efforts to ensure the full implementation of the SEC's rules, even though it opposed some of them. Everyone will not agree with the SEC's policy choices, but Donaldson said he hopes everyone can agree on the importance of preserving the SEC's ability to maintain a flexible regulatory framework that still allows for innovation and creativity in the fund industry.

Donaldson urged the Council to identify areas where additional best practices or industry standards should be established. He said that director education programs are more important now than ever and believes that the Council's education function should be one of its core missions.