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Independent Directors Council Offers Views on Conducting Self-Assessments

The Independent Directors Council has provided guidance on the issues that mutual fund boards should consider when conducting annual self-assessments. The self-assessment requirement goes into effect next year.

One of the items that the SEC specifically requires in the self-assessment is the effectiveness of the board's committee structure. While a board's size and the complexity and number of funds it oversees are basic considerations in how many committees it should have, the council said the directors' perspective on workload management and their comfort in delegating their duties to a committee are important factors to probe as well.

The board may expand the scope of its inquiry to include consideration of whether additional committees should be formed to focus attention on specific aspects of the fund's operations, including the annual consideration of its relationship with its investment adviser and affiliated service providers, the fund's investment performance, best execution and related brokerage issues, valuation of the fund's portfolio securities, overall compliance matters, the fund's disclosure documents, matters relating to pricing and distribution of the fund's shares, and the fund's relationships with its non-affiliated service providers. Each of these specific areas also might be evaluated separately in a self-assessment.

The scope of a committee's activities also should be examined, which is usually reflected in its charter. In addition, the adequacy and frequency of the committee's communication to the full board should be reviewed.

Since an in-depth evaluation of how it conducts meetings is fundamental to a board's self-assessment, the task force recommended frequent evaluations of board meeting effectiveness and the process by which decisions are made on behalf of shareholders. In particular, the group said directors should determine whether board meetings are frequent and long enough to cover expanding agendas, as well as the appropriateness of the location and the format of the meetings.

The Council also noted that the importance of agenda-setting and the chair's involvement in formulating the agenda was underscored by the SEC in connection with the requirement that the chair be an independent director. Another consideration is whether board members have sufficient access to counsel and management.

Another SEC-mandated area for the board self-assessments is the number of funds overseen by each director. The task force believes that the SEC intends for boards as a whole, and directors individually, to consider their ability to represent effectively the interests of a single fund and its shareholders while simultaneously overseeing additional funds in the same family or in a different fund complex.

Although the SEC has offered little guidance on the nature or scope of this consideration, the task force believes that workload management is fundamental to the issue of director oversight of multiple funds. How a board and its individual members manage the board's workload is affected by a variety of factors, and boards will likely reflect wide differences in how they address the issues.

In this regard, the Council said that it is important to confirm the ability of directors to devote sufficient attention to issues both specific to each fund and common to all funds in the complex, as well as their expertise and ability to understand and address multiple investment products. The task force cautioned that a director's workload cannot be measured simply by mechanically counting the number of funds he or she oversees.

In a fund family, a significant portion of the directors' workload involves governance issues common to all of the funds. Even fund-specific matters, such as portfolio management, performance, fund expenses and valuation of portfolio securities, often involve aspects common to all funds or groups of funds. The task force suggests that one potential factor affecting a director's ability to oversee multiple funds is how the fund complex is structured.

Another important part of the self-assessment is whether the board has a fair compensation system able to attract and retain qualified directors. In determining fair compensation, the board may wish to engage third-party consultants to facilitate data-gathering and analysis. Considerations relating to deferred compensation and retirement benefits may also fall within the scope of these questions. The board may wish to consider whether there should be a policy requiring or encouraging directors to invest in the funds they oversee.

The task force acknowledged that the adequacy of directors' and officers' liability insurance coverage and indemnification is also critical to attracting and retaining qualified directors and is a subject closely related to compensation. While the task force recognizes that the adequacy of the directors' protection from personal liability could be included in a self-assessment program, D&O insurance is subject to in-depth consideration and analysis by a board on an annual basis.

Although not required by the SEC, the task force said that carefully constructed self-evaluations of individual board members should be considered since they can ultimately strengthen the entire board by making each board member more effective. The Council also suggests that, as part of the self-assessment, the board should step back and gauge its overall effectiveness from a broader perspective.

At the conclusion of the self-assessment, board members should discuss the results and, as required by the SEC, the minutes should reflect the substance of the matters evaluated. The task force also encouraged boards to develop an action plan for any matters to be pursued, including a timeline and follow-through program. At subsequent meetings, the board should discuss the status of implementation and the minutes should record the progress in completing the action plan.