Mutual Fund Boards : A Failed Experiment in Regulatory Outsourcing

The Investment Company Act of 1940 anticipated mutual fund boards would remedy a dysfunctional market of fund investors. Rather than the SEC, the fund board (and its independent members) would regulate the conflicts between fund investors and management firms by negotiating the management contract, approving advisory fees and other expenses, and generally serving as a regulatory compliance office.The fund board has not fulfilled its promise. A large and uniform body of empirical studies in the finance literature finds the fund board has failed as outsourced regulator. As fund families have grown, economies of scale have redounded mostly to management firms, not investors. Negotiation of most management contracts has been perfunctory, with boards passively accepting management-proposed fee levels, sales expenses, and marketing programs. Investors find little protection from other quarters. The SEC has generally assumed that fund boards, with periodic infusions of more outside members, are working. The courts have viewed management services and fees as beyond their purview. The current investor market has responded only marginally to high fund fees, return-sapping portfolio turnover, and the misleading marketing of past fund performance.Other investment intermediaries, such as hedge funds and mutual funds outside the United States, do not use boards. Alternatives to board oversight through invigorated SEC and judicial standards, along with more investor education and investor-appropriate disclosure, merit consideration. The illusion of investor protection by a docile watchdog may be worse than no protection at all