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SEC backs fund directors
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June 1, 2000: 7:26 p.m. ET
Commission seeks to bolster mutual fund's independent directors
By Morningstar's Odyll Santos
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CHICAGO (morningstar.com) - Seeking to strengthen the role mutual funds' independent directors play in key decisions, government regulators have filed a brief supporting a federal court's dismissal of a lawsuit against two investment-management firms.
In the brief, the Securities and Exchange Commission stressed that directors are the watchdogs of a fund. They, and not just a fund's shareholders, have the right to act in situations that involve breaches of fiduciary duty and conflicts of interest, the agency said in the friend-of-the-court brief filed recently at the U.S. Court of Appeals for the Second District.
 The Investment Company Act of 1940 and SEC rules give independent directors numerous responsibilities, including review of contracts involving advisory and underwriting services. Under the act, these directors cannot be affiliated with the investment advisor or be so-called interested persons, thus strengthening their independence.
"The primary responsibility for protecting the interests of shareholders lies with the independent directors, who must constitute at least 40 percent of an investment company's board," the SEC wrote in the brief.
"It would be contrary to the role of independent directors under the act to rule that only shareholders, and not investment companies, can bring a private action under Section 36(a)," which governs fiduciary duty, the agency said.
The SEC didn't take a stance on the state-law issue in the appeal, which centers around whether a shareholder should "make demand on the board of directors" to bring a lawsuit.
The plaintiff in the case, Ariel Marquit, claimed that the investment-management firms allowed their closed-end products, Alliance Capital's Spain Fund and Deutsche Bank's New Germany and Central European funds, to trade at a discount to net asset value, taking no action to correct the situation.
A U.S. District Court in New York dismissed the case, noting that Marquit did not bring her claim to the fund directors initially nor had she shown that presenting the claim to the directors would have been futile. Marquit appealed, claiming that she was forced to bring the suit herself because directors lacked the right to sue their fund's advisor.
If Marquit wins on appeal, her case could derail the SEC's efforts to boost the power of fund directors.
Last year, the SEC proposed rules that would require independent directors to make up the majority of a fund's board instead of the current 40 percent minimum. The agency also proposed that the directors be self-nominating, that their legal counsel be independent, and that disclosure of information showing directors' independence be improved. 
Copyright 2000 Morningstar All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.
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