We are often told in many areas of our life that "one size doesn't fit all," and I believe that in my years of experience in the industry, this adage is applicable to fund boards—except that I contend a better analogy is "boards are like fingerprints," in that no two are alike. The rules and regulations around fund boards have changed since the 1940 Act was passed, and the characteristics of boards' members and the criteria under the board nomination process are now very different in many ways, for varied reasons.
The boards that I first got to know were non-diverse in most categories (gender, race, ethnicity, experience, and, lastly, independence). The products have become more complex and time-consuming, and the board's responsibilities have increased because of a creative industry that has generated new and complicated products requiring board members to have a significant amount of knowledge of financial information, a basic requirement of their oversight role.
Even though the size of current boards may not be different among complexes in different AUM categories, a fund board's demographics are now trending to have a number of varied characteristics that existing boards recognize as important to meet the challenges facing them. Boards have become more diverse in some areas that I have listed above, such as gender, independence and experience, although progress has been much slower in the areas of race and ethnicity. However, the two criteria that I have always counseled boards to focus on are character traits of congeniality and collaboration, which often do not become apparent until after a person joins a board. This puts the onus on a board's members to use all of their own skills and those of the board's service providers (recruiters and counsel) to make sure they choose persons who have all of the necessary financial skills, but also those who "play well in the sandbox" and "work well and play well with others" (as depicted in our grade school report cards).
Oversight Process Hasn't Changed
As the duties of the '40 Act fund board member have changed over the years because of the complexities of these varied products, their oversight role has really not (except where delegation to others has been permitted or courts have determined that boards do not have responsibilities in certain areas). These changes have been in the substance of what they oversee but not in the process. Oversight is the primary responsibility of the board, whereas investment, distribution, administration, etc., are the responsibilities of management and other service providers. Fund boards do not employ the funds' officers (as compared to a non-mutual fund corporate boards), but rather oversee their performance through the 15(c) process.
The board oversight role and its committee structure should be emphasized through the governance process, rather than board members moving into management's role. The board should recognize the differences between these roles and most importantly, board members should be able work together in a collegial and collaborative way using their skills, background and experiences that they bring to the board upon joining and then gather while serving on the board. It also helps having strong leadership at the board chair (or lead independent director) and committee chair levels with some balance between having rotation among committee members versus the loss of institutional knowledge of special skills. If a board has term limits or a retirement policy, its constitution may change gradually which allows for new members bringing knowledge of investment innovations to the board.
Common Sense, Respect, Luck
I have avoided using statistics in this article—generally available from the ICI/IDC or from industry consultants such as Management Practice Inc. or Strategic Insight—which reflect the changes in board characteristics over the past decades. The major industry factors that have been relatively constant have been the aggregate number of board members and the concentration of the top industry complexes. There are far fewer investment company directors than public non-mutual fund corporate directors, with the population of mutual fund directors staying around 2,500 over many years. The concentration of large complexes as a percentage to the entire investment company universe has been very high for decades (the top 20 are approximately 65% of the industry, and the top 50 constitute approximately 85%). The concentration of very large complexes has increased more recently, but so has the number of new entrants, especially in the ETF area.
Implementing the role of an effective overseeing board, with all of its moving parts, requires many ingredients that I would sum up as follows: It takes a lot of common sense among team board members, along with a management respectful of the board's role, and good luck in choosing the right people over time.
Carl Frischling is a 50-year veteran of '40 Act law community and has been a partner at Perkins Coie LLP in New York since 2016. Among the most highly regarded investment management lawyers, Frischling represents and advises leaders in the financial services industry on laws and regulations pertaining to financial services, investment companies and mutual funds and advises independent directors, investment advisers and investment companies. He is a director emeritus of the Mutual Fund Directors Forum and served for 35 years as an independent director of Invesco Funds before retiring at the end of 2012.