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Directors Council Provides Guidance on Fund Board Self-Assessments

A task force of the Independent Directors Council has provided a roadmap for mutual fund boards when they conduct the annual self-assessment required by the SEC. While board self-assessments have historically been voluntary, under new SEC fund governance rules, after January 16, 2006 virtually all investment company boards will be required to conduct annual self-assessments (Rel. No. IC-26520). With respect to the timing of the board self-assessments, the IDC has confirmed with the SEC staff that the first self-assessment must be accomplished no later than January 16, 2007.

The annual self-assessment requirement is intended to strengthen the directors' understanding of their role and foster better communication and greater cohesiveness. The SEC rules do not proscribe the specific aspects of a board's operations that must be considered in a self-assessment, except in two areas: 1) the effectiveness of the board's committee structure, and 2) the number of funds overseen by directors. Also, while the self-assessment does not have to be in writing, the SEC emphasized that the minutes of the board meeting at which the self-assessment was discussed should reflect the substance of the matters covered.

While every mutual fund board shares a fundamental commitment to overseeing and protecting the interests of shareholders, the actual structure, composition and operating needs of boards vary widely among different fund complexes. Because of these differences, the task force decided that it was not practicable to suggest a single methodology or enumerate universally applicable criteria for board self-assessments. However, the task force identified a number of key considerations for a board embarking on the self-assessment exercise.

These decisions will now be made in a context where board self-assessments are no longer merely a recommended best practice for investment companies, but are required by regulation. As a result, the task force cautioned that the self-assessment may be subject to scrutiny by regulators or litigators.

The threshold issues facing a board conducting a self-assessment include determining how the process should be administered and who the coordinator should be. For example, the process could be administered and coordinated by the chair of the board, the chair of the nominating committee, an outside consultant or counsel.

In addition, the task force suggests that counsel be actively involved in all aspects of the self-assessment process, including the provision of legal guidance and assisting the board in meeting the self-assessment requirement.

According to the group, both counsel and the directors should consider taking appropriate steps to designate communications with counsel as privileged and to preserve the confidential nature of these attorney-client communications. Matters that arise in a self-assessment also may encompass conduct or events that are the subject of pending claims, litigation or government investigations and enforcement actions. In the IDC's view, counsel should exercise care to recognize and preserve the confidentiality of attorney work product with respect to such matters.

If the board elects to conduct the self-assessment orally, the task force believes that providing board members with a discussion guide or an agenda of topics in advance of the meeting will promote a more focused discussion. Alternatively, if the board prefers to use a written questionnaire and review response compilations, the task force said the board, in consultation with counsel, should adopt a procedure for the disposition of the documentation. In each case, minutes of the meeting should document the process and record key board considerations and conclusions.

The directors should next reach a consensus on what aspects of the board's operations are to be evaluated. One issue to be considered in the self-evaluation is the board's composition. An important area to explore is whether the board should be composed exclusively of independent directors, which would go beyond statutory or regulatory requirements. While inside directors can provide useful industry expertise, the council noted that a senior representative of the adviser can provide the board with the same insights without being given a seat.

Similarly, the board should consider whether to adopt director independence requirements that go beyond the minimum statutory requirements. Since there are no express mandated qualifications for serving on a mutual fund's board, the board may wish to specify attributes sought in board candidates. Given today's environment, a legal or accounting background could be stipulated.

A self-assessment also might consider such issues as whether the board should have a retirement policy and term limits, and whether the board's nominating process effectively produces the best candidates.

The guidance on self-assessments will continue in tomorrow's edition of SEC Today.