CRITERIA AND MEASUREMENT FOR BOARD EFFECTIVENESS

      Boards initially dedicate significant effort establishing their structure to support the fund shareholder, but how effective are the current structure and procedures in continuing to support the fund shareholder interests?  The annual board self-assessment requirement implemented by the SEC in 2006 attempted to ensure that this question was being addressed. Using tangible tools in the annual assessment allows for a more productive and efficient process.

      In addition to assessing their own performance, it is often helpful to have industry benchmarks for directors to gain perspective. The criteria for a board to be successful should be well defined, long term, and focused on supporting aspects of governance over which the fund directors have control. The following list highlights some of the criteria for which quantitative benchmarks are available from the ICI/IDC or MPI Annual Fund Director Compensation and Governance Surveys.

• Age distribution and retirement schedule maps (if applicable)
• Assessed skills or diversity  needed over time and board members hired or skills acquired to fill need
• Streamlining board materials or technological improvements for meetings

ALIGNING SHAREHOLDER INTERESTS

      While the overall strength of the board is in the direct interest of the fund shareholders, and the qualities previously discussed are imperative factors in this strength, fund shareholders are also interested in how their directors are monitoring their investments.

      Within the 15(c) process, directors are responsible for reviewing the comparative performance and expense ratios of the funds they oversee. While the directors have an oversight (and not daily management) role over the funds, the long-term performance reflects their overall effectiveness – certainly in the eyes of the fund shareholders.

      With regard to expenses, by looking at the trends over time, directors can observe realized and potential economies of scale, and determine whether their actions have been effective in maintaining a competitive and fair fee structure for the shareholder.

      Shareholders want their fund to stay true to the investment style they chose, and they do not want higher expenses dragging down their fund’s performance. Other impacts on the expenses (and directors’ responsibilities to review) are the merging, opening, and closing of funds, as well as new share classes. One of the great hidden drags on fund performance is the brokerage that funds pay to transact portfolio changes. As a result, fund directors have an explicit responsibility to monitor “best execution”.

      A trailing look at year-to-year change in three- or five-year performance is a possible basis of evaluation for directors to evaluate their oversight abilities. While this will be impacted by a fund’s risk tendencies, industry exposure and other prospectus disclosures, funds that remain in high or low quartiles consistently over time make a definitive statement about the performance of a fund board.

      The difficulty with the typical fund director evaluation today is that (1) it is carefully constructed, but still arbitrary, (2) it measures aspects of governance that are of little immediate interest to fund shareholders, and (3) it often does not provide tangible measurements that highlight areas of possible discussion.  The addition of some quantitative objective metrics would greatly improve the measurement of fund board effectiveness.