Has the time-honored system of mutual fund directors served shareholders well, providing an important independent watchdog for investors' money? Or is there a connection between the six-figure salaries the directors are paid and the fees that mutual fund shareholders are charged?
Those are questions more easily asked than answered. But the mutual fund industry believes that the current system works and is moving to protect it, whether in the courts or the legislatures. Massachusetts' mutual fund companies last month quietly secured final approval for state legislation that would make it more difficult for unhappy shareholders to challenge the independence of directors.
The legislation and a similar bill passed in Maryland come as a handful of companies have been targeted in shareholder suits challenging the independence of directors and the effect of the system on fund fees. Suits have been filed against Fidelity Investments, Prudential, T. Rowe Price, BlackRock and BEA Associates.
Mutual fund assets have quadrupled to $5 trillion this decade, offering chances for economies of scale that critics say have not materialized. Morningstar says the average expense ratio for an equity fund has risen to 1.53 percent, or $1.53 per $100, from 1.25 percent, or $1.25 per $100, in 1985. On the other hand, Kanon Bloch Carre, a Boston consulting firm, says fees for all growth funds have declined 5 percent in five years.
Whoever is right, it is the fund directors who must sign off on these fees. While most investors know next to nothing about the people who oversee their funds, the directors play a key role in setting policies and, most important, negotiating the management contract between shareholders and money management firms. Fund boards include company insiders, but by law at least 40 percent of the boards must be independent directors recruited from outside.
Directors often sit on dozens or even hundreds of individual fund boards within one fund company, a practice that has raised questions about how independent directors -- who can easily make $100,000 or more a year as part-timers -- really are. The industry believes that allowing directors to sit on multiple boards increases their expertise and holds down costs; they say directors set their own salaries and cannot be fired by the companies.
The recent suits try to make a direct link between "fee gouging and multiple directorships."
In the Fidelity suit, filed in October in U.S. District Court in Boston, a New York shareholder charges that directors serve on more than 200 boards and receive "significant compensation," frequently in excess of $200,000 a year. The suit paints a picture of "assembly-line" board meetings that "merely rubber-stamp" Fidelity's proposals.
The suit says fee-gouging by Fidelity has been "especially dramatic." To quantify the claim, the suit says Fidelity's assets under management grew to $373 billion from $36 billion from 1985 to 1995; revenue grew to $4.3 billion from $388 million. Using those numbers, the suit figures that revenue as a percentage of assets under management grew to 1.146 percent from 1.085 percent in that time. That kind of increase would have yielded Fidelity an extra $228 million in compensation in 1995 alone, the suit says.
Fidelity has yet to file a response, but a spokeswoman previously said the company would defend the suit vigorously. A recent survey by Kanon Bloch Carre found Fidelity's expenses were the sixth lowest among 42 fund complexes.
While the suits are all in federal court, the fund industry appears to be trying to strike at potential threats to the director system on the state level.
Both Massachusetts and Maryland acted after a federal judge in May 1997 unexpectedly allowed a suit to proceed after finding that the "substantial remuneration" directors received by sitting on multiple boards could call their independence into question. The suit has since been dismissed on different grounds.
While the Massachusetts bill attracted no attention, the Maryland legislation was opposed by both plaintiffs' attorneys and organized labor, who complained that the measure reduced shareholder protections. T. Rowe Price cited the new provision, passed as an amendment to a largely unrelated bill on the final day of the Maryland legislature's session in April, in its efforts to have the federal suit against it dismissed.
Pub Date: 12/13/98