SEC Proposes Rule Changes Relating to Investment Company Directors
Washington, DC, October 20, 1999 - The Securities and Exchange Commission has issued proposed rule and form changes designed to enhance the independence and effectiveness of fund directors and provide investors with greater information about fund directors. The SEC also has issued an interpretive release addressing the SEC’s role in disputes involving directors and fund management, as well as other issues relating to independent directors. Comments on the rule proposals are due on January 28, 2000; the staff views expressed in the Interpretive Release became effective on October 14, 1999.
Proposed Rule Amendments
The proposals for rule and form changes fall into three categories: (1) conditions for reliance on certain exemptive rules, (2) other rule amendments relating to directors, and (3) changes designed to provide better information to investors concerning the directors of their funds.
Exemptive Rules. A large number of funds currently rely on exemptive rules under the Investment Company Act of 1940 that require fund boards to approve and oversee activities that involve potential conflicts of interest. The proposed rule amendments would require that funds relying on any of ten commonly used exemptive rules meet the following additional conditions designed to enhance director independence and effectiveness:
- Independent directors must constitute at least a majority of the fund’s board of directors.
- Incumbent independent directors must select and nominate new independent directors.
- Legal counsel to the independent directors must be independent.
Additional Rule Changes. Other rule changes included in the proposal would:
- Amend Rule 17d-1(d)(7) under the 1940 Act, which permits the purchase of joint D&O/E&O policies by funds and their affiliates, to make the rule available only for joint liability insurance policies that do not exclude coverage for litigation between the independent directors and the fund’s adviser.
- Exempt funds that have an independent audit committee from the requirement to have shareholders approve the fund’s selection of an independent public accountant.
- Amend Rule 2a-19 to prevent unnecessary disqualification of independent directors.
- Require funds to preserve any record of the initial determination that a director qualified as an independent director, and each subsequent determination of whether the director continues to qualify as an independent director.
Disclosure Requirements. In an effort to improve the information available to investors about fund directors, the proposed amendments would require funds to disclose the following to supplement the information currently available in a fund’s statement of additional information (SAI) and in proxy statements:
- Basic information about the identity and business experience of directors. This information would be set forth in tabular form and would combine the current disclosure found in the SAI and proxy statements. The table also would require that "interested" directors describe the relationship, events, or transactions that make the director an interested person. The table would be required in the fund’s annual report to shareholders, the SAI, and any proxy statement for the election of directors.
- The aggregate dollar amount of equity securities of funds within the fund complex owned beneficially and of record by each director.
- Information about interested and independent directors’ potential conflicts of interest as a result of positions, interests, and transactions and relationships.
- The board’s role in governing the fund’s operations. The SEC proposes to require that the factors and conclusions that formed the basis for the board’s approval of the existing investment advisory contract be included in the SAI. In addition, funds would have to identify each standing committee of the board in both the SAI and any proxy statement for the election of directors. Funds also would be required to provide a concise statement of the functions of each committee; identify the members of the committee; indicate the number of committee meetings held during the last fiscal year; and state whether the nominating committee would consider nominees recommended by fund shareholders and, if so, describe the procedures for submitting recommendations. The proposed amendments would require that the information relating to independent directors, either in chart or narrative form, be presented separately from that for "interested" directors.
In addition to the rule proposals described above, the SEC issued a companion release that, after providing general background information: (1) expresses the views of the Commission and the staff on certain interpretive issues related to independent fund directors; and (2) briefly describes the role of the SEC with respect to disputes between independent fund directors and fund management.
Interpretive Guidance. The release provides interpretive guidance in four areas: (1) analysis of whether a fund director is an "interested person," (2) transactions involving independent directors and the fund, (3) advances of legal expenses to independent directors, and (4) compensating fund directors with fund shares.
Role of the SEC in Disputes Between Independent Directors and Management. The interpretive release notes that the SEC has been criticized in recent years for not taking certain actions in connection with disputes between independent fund directors and fund management. It explains that the SEC’s role in such disputes generally is to provide guidance regarding the requirements of the federal securities laws, investigate possible violations of these laws, and institute enforcement proceedings in appropriate circumstances when the SEC believes these laws have been violated. It also describes the procedures followed by the SEC and the staff in connection with internal fund disputes. The release states that the SEC and the staff "are committed to carefully reviewing all allegations of violations of the federal securities laws, and taking appropriate action when a violation has occurred." It further indicates that the SEC’s and staff’s actions, and any decisions not to act, will not necessarily be explained to the public, noting that these positions are necessary to ensure the fairness and integrity of the examination and investigative process.