Most fund directors are aware that Morningstar assesses the governance and ethics of mutual funds by assigning a Stewardship Grade. This process was started about five years ago but has recently been rejuvenated and reemphasized. Morningstar’s overall intent with the grades is to “shine a light on better/best practices.” They have currently rated about 1,000 out of 7,000 funds representing about 30% of all fund assets.

In September 2008 two well-known and respected money market mutual funds (MMF) imploded.  In the case of the first, The Reserve Primary Fund, the problem was due to credit quality issues, stemming from its ownership of Lehman Brothers commercial paper. In the case of the second, Putnam Prime Money Market Fund, credit quality seemed to play no role. The Putnam Fund held no AIG, Washington Mutual or Lehman paper. Putnam’s predicament was due to the fear of a credit quality problem that precipitated a run on the fund. Keep in mind that both funds operated entirely within the confines of the existing regulations for money market funds, principally Rule 2a-7.

     One of the difficult tasks that a fund director faces involves assessing the reasonableness of the fees charged by either an affiliated or independent service provider. The most frequent services are (1) transfer agency, which typically represents about 20% of fund expenses and is the largest fund expense other than investment advisory fees and distribution fees, (2) fund accounting, which may represent about 5% of fund expenses, and (3) administration, which might represent about the same.  A considerable part of the difficulty is that some tasks might be included under any of the three services, thereby making comparisons tricky. Another difficulty is that the contracts, although reported on a fund-by-fund basis, are typically negotiated on a complex-wide basis.

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.