In addition to the myriad duties mutual fund directors must carry out with regard to the funds they oversee, they are faced with the added burden of setting their own pay.  The demands of the job, including the expertise required and time involved, justify being paid fairly.  However the optics of being overpaid would not be perceived favorably by fund shareholders or the financial press.

Management Practice Inc. (MPI) has just completed its sixteenth annual “Survey of Mutual Fund Director/Trustee Compensation and Governance Practices”, with data covering 2,140 directors from 411 fund families. Copies of, and specific comparisons to, the survey detail are available from MPI.

The last quarter of 2008 saw unprecedented upheaval in the financial markets.  New revelations of crises and scandals broke almost weekly; the most recent being the colossal Madoff investor fraud, which involved an investment offering that turned out to be a Ponzi scheme.  Standing relatively untarnished amidst all of this has been the mutual fund industry.  Apart from a few isolated incidents, the overwhelming majority of the industry has performed as intended, providing diversification, transparency, and liquidity to shareholders.  While performance and flows are down, and downsizing -- along with the rest of the industry and economy -- will likely take place, it is clear that the mutual fund industry will survive this crisis and, in our view, successfully emerge as a solid model of safe, effective, and well-governed money management.
 
In this environment, independent mutual fund directors and the regulations that empower them have played a significant role in the industry’s success.   Most directors have faced a substantially increased workload in the form of additional meetings and materials to review.  Many have been presented with new issues to understand and manage, including ARPS, CMOs, and CDSs, and the once relatively routine review of money market funds has topped many boards’ agendas.  Some directors may also feel increased legal exposure. 

Presented with the task of setting their own compensation, directors must resolve the dilemma of ensuring that they are fairly paid.  In addition, they are responsible for setting the pay of their Chief Compliance Officer, who faces similar new challenges. 

C. Meyrick Payne and Jay Keeshan, Management Practice, Inc (MPI).  Data for this Bulletin is principally drawn from the  MPI Annual Survey of Trustee Compensation and Governance Practices.

Independent mutual fund directors, who have the authority to annually review and renew the investment advisory contract, have proven to be a cost efficient and effective way to govern the collective investments of millions of Americans. Occasionally this statement is called into question. In the paragraphs which follow, we highlight four ways to quantify the cost efficiency and market effectiveness of independent mutual fund directors.

Management Practice Inc. (MPI) has just completed its fifteenth annual Survey of Mutual Fund Director Compensation and Governance Practices, with data covering 2,158 directors from 406 fund families. Copies of, and specific comparisons to, the survey detail are available.

Year over year “same director” compensation increased an average of 7.3% last year, a slower growth rate after more than five years of double digit increases since the passage of Sarbanes-Oxley and the fund scandals at the start of the decade.

Mutual fund boards typically evaluate their compensation annually or bi-annually, often using the traditional method of comparing their compensation to that of a peer group of directors with similar governance responsibilities; that is, similar assets under management and number of funds governed. They will often try to set their pay at the 50th percentile—or perhaps higher, say 75%—of the peer group pay range. This approach potentially facilitates a “Lake Wobegone” upward spiral effect, in which all mutual fund directors are “above average” and pay levels continue to ratchet up on their own momentum.
Whether these increases are merited or not, this “outside-in” method of setting director pay may not truly reflect a fair value for the job. A more solid and rational technique would involve evaluating the various aspects and requirements of the job to determine what rate of pay would be appropriate to attract, motivate, and retain appropriate and competent directors. This requires more of an “inside out” approach. The E3 + O methodology described below examines the effort, expertise, exposure, as well as an additional element—opportunity cost—involved with serving as a mutual fund director.

For the second year in a row, the increase in fund director compensation was
driven more by the number of meetings than by the retainer. After a robust increase of
8% in the first half of 2004, the pace of pay raises for independent mutual fund
trustees/directors slackened slightly in the second half but still wound up the year with an
annual increase of approximately 13%. This second full year of Sarbanes-Oxley impact,
along with continued fund regulatory reform, saw a continued increase in the
responsibilities of evermore influential fund directors, resulting in a two-year (’03-’04)
compensation gain of 27%.
Directors are finding the job requires more and more time to stay on top of
governance issues. The increase in total compensation is 72% attributable to additional
meetings and more paid committee work. Only 28% of the increase is attributable to
increased board retainer. The median number of board meetings has risen from just under
5 in 2003 to nearly 6 in 2004 reflecting the increased complexity and time consuming
nature of board work. The typical board meeting lasts 6 or more hours, with many board
meetings spanning 2 days.

Pay for the independent trustees/directors has risen sharply in the last six months as governance reforms force funds to hold longer and more frequent meetings. In the just completed half yearly update, MPI found that the annual compensation of fund trustees rose 8% in the six months between January and June 2004; or an annual growth rate of 16%. If this holds for the year as a whole it will represent the fastest growth MPI has seen in its ten years of tracking mutual fund director compensation.

In addition, the premium paid to the Chairman, who will shortly be required to be drawn from the independent Board members, has also risen sharply over the premium which used to be paid to the lead independent director. Furthermore, the premium paid to the Audit Committee Financial Expert, a new designation of trustee mandated by the Sarbanes Oxley legislation is also increased.