| A Realistic Approach to Evaluating Board Performance |
|
|
| Written by C. Meyrick Payne of Management Practice Inc., a consulting firm focused on the needs of independent | |
|
One of the most important of the ICI's Advisory Committee on Best Governance Practice is that Board periodically evaluates its performance. In spite of this recommendation, the process has not been fully embraced partly because of fear that any written document which is even slightly critical might be used by the plaintiff's bar to bring a lawsuit against the directors. The ICI Advisory Committee was deliberately vague about the measures and criteria to use because each board is quite different and faces different set of priorities. Now the SEC is set to require a similar process. The time has come to delve into the philosophical foundation of a realistic Board evaluation. Several years ago a well known financial planner came up with an evaluation method which tried to correlate certain elements of governance with fund performance, expense control and investor service. This index became known as the Mutual Fund Board Index (MFBi). While arithmetically correct, the MFBi was misleading because it was based on historical data and assumed that fund directors had control over investment performance. Additionally the index assigned grades and expressed them in rank order which meant that a board which had strong oversight procedures might score badly because fund performance was poor. The experience with MFBi unnerved directors and counsel alike. A well known mutual fund board has now adopted an evaluation technique which is future orientated. Under this the board thinks through the challenges which it is likely to face in the next 2 to 3 years and then makes an assessment of its capability to handle them. This approach is far more actionable as it allows for changes in the composition or skills of the board rather than finger pointing about a past which can not be changed. One way in which a professional management consultant might implement this approach is to ask individual members of the board to imagine he or she is in a car driving along the highway. The consultant then asks the director to symbolically describe the terrain that he can see in the rare view mirror. Up until the Enron scandal and the ensuing Sarbanes-Oxley legislation, many fund directors might describe the scenery behind as relatively placid, with only a few undulations. Those bumps in the roadway represent the classic valuation problems of narrowly traded securities or derivatives, the sharing of economies of scale as fund assets grew and the allocation of brokerage in a rapidly growing environment. The great bull market of 1990s masked a multitude of latent problems. The consultant might then ask how the terrain looks out of the side windows. The end of the dot.com boom started a three year malaise in which long dormant problems began to stir. The countryside was changing from plains to foothills. The problems of the fund industry became more pronounced; changing from the sharing of relatively easy investment growth to one of competitively snatching one persons' return by another. Furthermore, some multinational financial conglomerates had overpaid for investment managers and were now determined to earn a handsome return on their excessive investment. In this new environment fund directors have to ensure that investors are not manipulated or misused by the manager, or its owner. The consultant might then ask the directors to look out of the front windscreen. They are likely to see a rugged mountain terrain. The problems of the industry are much more sharply drawn. Instead of happy investors and happy managers gladly sharing the spoils of a economic boom, there are angry shareholders, regulators, owners, strike suit lawyers and politicians. As a result the directors' attitude has to change from one of the collegiate monitoring of laws and regulations to activist advocacy on behalf of their unique constituency, the shareholders. In this environment, the independence of the fund directors is critical. The most important attribute is an inquisitive mind combined with an ability to understand economic and business models. Of course, the independent director must be thorough, tough minded and well prepared; unable to be co-opted or manipulated. A fund director must be prepared to stick to his principals. Above all, a fund director must not be so dependent on his director's fees that he does not want to disturb the status quo. This changing dynamic means that board work will not be as much fun as it has in the past. Some directors will appear cantankerous and difficult; hopefully for good reason rather than mere crankiness. The reciprocal is also true; good boards will be tolerant of a member who wants to understand completely or a new member who is just learning the complexities of the fund business. A key criteria will be encourage an independent frame of mind. In the past board votes have tended to be unanimous; in the future there will be more dissention. Each board chairman will have to establish parliamentary procedures to cope with dissent, to table a motion, to cut off debate and to recognize the rights of minority groups with the board. Board minutes will often reflect a dissenting minority. An effective board will monitor that its own members are effective. Since there are few shareholder meetings, the only realistic check and balance on the individual attentiveness, preparation, analytical capability and thoroughness are the other board members. In the future the chairman of the fund board is likely to be an independent director. Occasionally he or she will have to ask a fellow board member to step down. The job of fund director will no longer be a long term appointment, but rather one where there is constant and persistent evaluation by the other trustees ñ an evaluation which will be based on how well the directors have looked after the interests of the shareholders. |
| < Prev | Next > |
|---|
