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October 19, 2006

Big Brother's Watching

By Hillary Jackson

Also in this article

  • Big Brother's Watching

Get with it.

That was the message for a gathering of mutual fund board executives this summer from a commissioner of the Securities and Exchange Commission, who stressed that part of their job included understanding issues important to the equity trading desks they oversee.

SEC Commissioner Annette L. Nazareth encouraged these board directors to get a better handle on issues like best execution and the factors that impact trading costs. "While it is unlikely most of you will become technical experts," Nazareth said, "you can certainly ask probing questions of your fund

managers, and they in turn [of] their executing brokers, about the reasons for selecting certain trading opportunities and the advantages of one or another market for types of securities." Nazareth, no stranger to equity trading, is the former director of the SEC's Division of Market Regulation. She addressed members of the Mutual Fund Directors Forum.

Mutual fund boards have come under considerable criticism in recent years from regulators and some industry executives, so it's no surprise Nazareth would use her time at the podium to hammer away at the obligations of fund boards to keep tabs on trading desks and their associated costs.

Watchdog?

In interviews with board members and trading executives, Traders Magazine discovered that many board members are monitoring traders and trading costs, and that traders meet regularly with board members.

The fund universe is enormous. There are 8,719 investment companies, or mutual funds, that hold $9.2 trillion for about 89.5 million investors in the United States, according to the Investment Company Institute.

A mutual fund board, which may oversee one or more funds, is supposed to act as a watchdog to protect the investors' interests. Today, SEC rules require a certain percentage of board members be independent, that they not be associated with the investment company. The SEC recently passed rules requiring that 75 percent of fund board members must be independent and that the board chairman also must be independent. The forces driving boards to sharpen their focus on trading are subject to debate.

Some say it's simply a natural progression of the mutual fund industry, which is following corporate America in jumping on the corporate governance bandwagon.

Others say mutual fund board directors are being pressured by the SEC and have been shamed by a host of recent-and very costly-scandals.

Another factor may also be the criticism that mutual fund boards have not been independent and that they have not looked after the best interests of the investors of the funds they oversee.

Fund Scandals

More recently, mutual fund late-trading and gift-and-gratuities scandals have also shined a brighter light on the need for independent mutual fund boards. Consequently, the trading desk has been one of the targets of this increased scrutiny.

In any event, the focus on trading is growing. "There is more money involved [in trading] than anything else that affects performance, and it is the biggest detraction from alpha," says C. Meyrick Payne, senior partner at Management Practice in Stamford, Conn. The consulting firm works exclusively with mutual fund boards.

Alpha reflects the value of an investment idea beyond the return of the market, and that's what mutual fund investors are paying for: active management that beats benchmarks or the market.