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Report on Best Practices for Fund Directors "The Advisory Group recommends that former officers or directors of a fund's investment adviser, principal underwriter or certain of their affiliates not serve as independent directors of the fund." Return
to Discussion of Protection of In June 1999, the Investment Company Institute, the trade organization for fund management companies, published a report by an advisory group on recommended best practices for mutual fund directors. Among other things, the report specifically recommended the persons formerly associated with a fund's manager or underwriter, or affiliates of the manager or underwriter, not serve as independent directors. This position directly conflicts with the ICI's support for the Maryland Protection for Self-Dealing Fund Directors bill. The bill would require courts to treat former employees of fund affiliates as independent under Maryland law. The bill also directly conflicts with the SEC's position that there are many situations in which a director's relationships or affiliations make him nonindependent in fact, although he may be technically independent under federal law. The relevant section of the ICI Report is provided below: PERSONS FORMERLY AFFILIATED WITH THE ADVISER,PRINCIPAL
The Advisory Group recommends that former officers or directors of a fund's investment adviser, principal underwriter or certain of their affiliates not serve as independent directors of the fund. Former officers and directors of the fund's investment adviser or principal underwriter often may be highly desirable candidates for board membership because of their extensive knowledge of the industry, the fund complex and the operations of the adviser and/or underwriter. Nevertheless, prior service as an officer or director of the adviser or principal underwriter may affect the director's independence, both in fact and in appearance. In particular, it may call into question whether the former officer or director would be able to effectively "switch hats." The Advisory Group therefore recommends that former officers or directors of a fund's investment adviser or principal underwriter not serve on that fund's board as independent directors. The Group further recommends that former officers and directors of certain affiliates of the fund's adviser and principal underwriter - in particular, parent companies that own a majority interest, and majority-owned subsidiaries - likewise not serve as independent directors, as the same potential conflicts can arise in these situations. The Group considered applying this standard to former directors and officers of all affiliates of the fund's adviser and underwriter, but decided against doing so in light of the strength of the prohibition and the fact that the prior relationship to a significant service provider to the fund may be much more remote in those cases. Nevertheless, the Advisory Group recommends that the board's nominating committee (or other body charged with nominating independent directors), as part of the selection process, carefully consider any such relationships and their potential effect on a candidate's de facto independence./23/ The Advisory Group recognizes that its recommendation goes far beyond current law./24/ It is not meant in any way to call into question the character and integrity of current independent directors that do not meet this standard, nor the propriety of any actions taken by the boards on which they serve. The Group believes, however, that this standard should be adopted because it provides more meaningful assurance of directors' independence and enhances the overall credibility of the system of independent directors. The Advisory Group does not believe that its recommendation need deprive a fund board of the experience of a former officer or director of the adviser, underwriter or their affiliates. A board that would benefit from the knowledge and experience of such a person may choose to retain the individual as an affiliated director. Alternatively, the individual could serve as a member of an "advisory board." Under these approaches, the fund would benefit from the expertise and experience stemming from a person's former associations, without that person being counted as an independent director. The Advisory Group considered an alternative proposal to impose a period of time (e.g., five years) between a board member's serving as an officer or director of the fund's adviser or underwriter and as an independent director, but decided against recommending it. The Advisory Group believes that such a period would not eliminate questions as to the continuing identification of the former officer or director with the adviser or underwriter. Because of this, as well as the importance of maintaining the public's confidence in the independence of outside fund directors, the Advisory Group has concluded that a permanent prohibition is preferable. /23/ For similar reasons, the Advisory Group decided not to recommend applying this standard to all former employees of the fund's adviser and underwriter. Such a prohibition could lead to absurd results (e.g., disqualifying an individual who worked for the adviser for a summer while in college) and could be very difficult to administer. The nominating committee, however, should carefully scrutinize the appropriateness of any such individual serving as an independent director. The Advisory Group believes that former employees of the investment adviser or principal underwriter who had significant responsibilities should be treated similarly to former officers and directors. /24/ As noted above, the definition of "interested person" under the Act provides that any person not having a current affiliation with the adviser or principal underwriter, but who had a "material business relationship" with the adviser or the principal underwriter within the last two years, may be deemed "interested" if the SEC issues an order to that effect. See Section 2(a)(19)(A)(vi) and (B)(vi) in Appendix C. |