So the second question is, "Should they have known?" The answer is almost certainly yes; but the board source of information was cut off. The compliant alleges "..the compliance officer's concerns were satisfied when …. bank officers informed him that .. the business was worthwhile….". Clearly the compliance department owed its primary loyalty to the manager, not to the board who are appointed to represent the shareholders.

The third question is, "What happened to the timing police?" The timing police, typically part of the compliance department, were once again turned off by senior management personnel. The complaint alleges "the e-mail granting special timing dispensation to Canary was forwarded to the timing police", who presumably then let it slide. It appears that the Board was never informed of the existence or extent of market timing that was going on. Once again the compliance department seems to have forgotten that they act as the arms and legs of the Board.

The fourth question is, "Should the board have seen data which made the late trading and linked market timing obvious?" The answer is probably yes, but periodic sales and redemption data is not something independent directors have historically focused on. They have been too busy worrying about performance, fees and expenses, soft dollars, best execution, proxy votes, privacy, The Patriot Act, audits and Sarbanes-Oxley. The truth is that asset gathering is the key factor for success in managing money. Many directors have been side-tracked into legal process and technological babble, while oversight of sales and marketing has played second fiddle.

If one looks at the monthly net new flows and redemptions of one of the key funds involved in the Canary scandal it is obvious that something was amiss (Exhibit 1).

For years, monthly investment sales and redemptions averaged about $50 million per month. Beginning in early 2000 (precisely when the late trading and related market timing began) the monthly inflows and outflows suddenly shot up to an average of about $250 million per month while the net flows stayed about the same. The lesson learned must be that the directors need to spend more time thinking about the economics of managing money and the inevitable conflicts involved. It is their job to identify, analyze and resolve these conflicts as representatives of the shareholders who could not possibly have the detailed level of knowledge or expertise to do it for themselves.

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Despite the clear need for compliance personnel to inform the Board of errors and suspicious events, the industry has not readily embraced the idea that the Board should take a leading role in the selection of the Chief Compliance Officer and his or her compensation. In early 2003, the SEC put out a proposed rule for comment that said, in part, "the fund's board …would have to approve the chief compliance officer, who would have additional duties that reflect the important role of the fund boards in overseeing fund compliance…". The proposal drew the ire of fund companies, auditors and industry lawyers, who argued that compliance was too big a job for someone who did not work for the manager and that oversight of compliance issues would take the Board into micro-management rather than governance.

Certainly one lesson from the Canary scandal is that compliance officers must understand that their job is precisely to bring exceptions and suspicious events to the Board's attention and not to be turned off by the reassuring, but misguided, hand of a senior executive.

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