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SEC's Norm Champ Discusses the Role of Fund Directors

The SEC’s Director of the Division of Investment Management, Norm Champ, discussed the role of fund boards (among other topics) in a recent speech at the ALI CLE 2013 Conference on Life Insurance Company Products.  He described potential conflicts of interest unique to the insurance space, including “that management of a fund could be influenced by the risk exposure faced by the insurance company.”   He noted that “conflicts of interest that may affect the management of a fund are a primary reason behind the important watchdog role given to independent directors under the Investment Company Act."

Champ also discussed the recent private litigation alleging “that a fund’s subadviser does most of the work but the primary adviser retains a large portion of the fee.”  While acknowledging that a fund’s investment adviser has a fiduciary duty with respect to its compensation, he reminded boards that “approval of advisory arrangements for funds is among the most critical functions of a mutual fund board.  Thus, I cannot overstate the importance of the watchdog role of the board of directors, and in particular the independent directors, in performing this function.”

Champ discussed key take-aways from the SEC’s recent enforcement actions against fund directors.  In discussing the Northern Lights case, he stated “[t]his case highlights the regulatory disclosure requirements for registered funds, relating to the process for approving advisory contracts, including the need for accurate, non-boilerplate disclosure of the factors the board considered in approving an advisory contract.”  With respect to the case against the directors of the Morgan Keegan Funds, Champ stated “[t]his case furthered the important regulatory goal of ensuring that directors of registered funds fulfill their critically important obligations under the Investment Company Act to fair value securities for which market quotations aren’t readily available.  I urge you to take a look at the Morgan Keegan order, which reiterates Commission guidance in the area of fair valuation.”

Champ addressed concerns that recent Commission attention on fund directors may discourage individuals from wanting to serve on fund boards.  He stated “I acknowledge this concern.  However, I would note that being a director where you owe a fiduciary duty to shareholders is aligned with our mission of protecting those investors.  And, in addition, the Commission staff does not seek to pursue enforcement action against directors who do their jobs by asking the hard questions, demanding answers, looking for red flags, and addressing any red flags they find.”