Wednesday, September 19, 2007

Role of Independent Investment Company Directors - Part 1

Transcript of the Conference on the Role of
Independent Investment Company Directors
U.S. Securities and Exchange Commission, Washington, D.C.
February 23 & 24, 1999
February 23, 1999

Introductory Remarks
Paul Roye, Director of the Division of Investment Management: Good morning. I'd like to welcome you all to the SEC's roundtable on the role of independent investment company directors. We have a great program planned for you over the next two days. We will hear from independent directors and others on a variety of issues, key issues facing independent directors today.

First, I would like to thank our moderators and panelists for agreeing to contribute their time to our Roundtable, and I would also like to thank the SEC staff, many of whom worked to pull this program off behind the scenes. First, I'd like to highlight a few housekeeping matters. To the extent that during the course of the proceedings over the next two days you can't find a seat, we do have an overflow room down the hall to the left, where we have video monitors set up, where you can observe the proceedings. I would also like to remind you that the press is present, so any remarks will be on the record. Time permitting for each of the panels, we'll have an opportunity for questions. In your seats, you will find index cards.

If you have questions, if you could write them down on the cards, toward the end of each of the panels, we'll have SEC staff persons walking through to gather those cards and relay them to the moderators.

I would also like to point out that many of our panelists have prepared thoughtful papers on the subjects that we're going to cover over the next two days, and those are outside in the table outside the room.

To kick off our roundtable this morning, I would like to introduce Arthur Levitt, Chairman of the SEC. As many of you know, he has been a tireless advocate of enhancing independent director effectiveness. So I would like you to join me in welcoming the Chairman of the SEC, Chairman Arthur Levitt.

Chairman Levitt: Thank you, Paul, and good morning. It's a pleasure to welcome everyone to the SEC roundtable on the role of independent investment company directors. I, too, would like to thank the moderators and the panelists for agreeing to participate in what I regard to be a very, very important endeavor. I would also like to thank the staff, which continues to work tirelessly on behalf of America's investors.

We are here today to discuss the increasingly important role that independent directors play in protecting fund investors, and precisely how their effectiveness may be enhanced. These issues are not academic, nor are they peripheral. They directly affect every mutual fund investor. Accordingly, I will ask the Commission to make improved investment company governance one of its top priorities. I expect that this roundtable will help shape our agenda on issues facing independent directors today.

As we all know, the growth of the mutual fund industry has been absolutely staggering. At the end of last year, the assets of mutual funds exceeded $5.5 trillion, up from just over $1 trillion in 1990. Mutual funds are the primary investment vehicle of choice for most Americans. At last estimate, over 66 million people were invested in mutual funds. We owe it to those 66 million people to ensure that funds are being run in their best interests. For that to happen, one word above all must define a fund's overall management structure, and that word, of course, is accountability. Without strong independent directors, accountability is nothing more than a word on a page.

Twenty years ago, the late Justice William Brennan described independent fund directors as watchdogs. The Investment Company Act, according to Justice Brennan, was designed to place the directors who are unaffiliated with a mutual fund's adviser in the role of independent watchdogs, who would furnish a "independent check upon the management of investment companies" – an independent check, a force for accountability on behalf of shareholders who depend on their independence to maintain the integrity of the fund.

This objective seems simple enough, so let me ask three straightforward questions, which I believe go to the very heart of our discussion over the next several days: First, are independent directors really effective? Second, do they, can they really act as a check on management? Third, are they serving the shareholders' interests above all else?

The answer to these questions will serve as a basis for our agenda on investment company governance. I hope that if there is one point that we can agree on it's this: regulators shouldn't be the only ones asking these questions. If a fund's management isn't proactively addressing these questions, what does that say about an investment company? If a fund's governance has no culture of independence and accountability, who looks after the investor's interests?

I realize that these are very difficult questions to answer. But can we afford not to answer them? Over the next two days, we will hear from independent directors, senior fund executives, legal counsel to funds, investor advocates, and leading academics. I hope that we can work together towards solutions that will improve the current system of fund governance.

As you know, we've designed the roundtable around a series of panel discussions. I would like to mention a few of these topics, and perhaps raise some additional more specific questions that I believe should be addressed to each panel. Following some general background by Paul, our first panel this morning deals with negotiating fund fees and expenses. Perhaps no other issue addressed by independent directors has as much impact on investors' returns than the level of fund fees. Now, while fund performance is unpredictable, certainly the impact of fees is not. As I've emphasized before, a 1 percent annual fee will reduce an ending account balance by 17 percent over 20 years.

Now, we all understand that directors aren't required to guarantee that their fund will be able to employ the lowest fees, but they are required to ask whether fund investors are really getting their money's worth. What do independent directors know about management's costs and management's profitability? If the fund assets under management have ballooned, have fees been reduced to reflect any economies of scale? Again, there are no simple answers to these questions, but they are necessary questions. They are, if I may say so, essential questions. Some, no doubt, might prefer that they go unanswered. But effective regulation and investor interests demand that we reassess our assumptions. Following fees, we'll discuss another important issue, fund distribution arrangements.

As you know, independent directors have special responsibilities under the Investment Company Act when fund assets are used to pay distribution expenses. They must determine that there is a reasonable likelihood that the payments will benefit the fund and its shareholders. Do directors really understand what payments are being made to whom and why? What are the implications of fund supermarkets to investors? Are the increased benefits to some shareholders at the expense of others? These are all questions that independent directors must consider. Fund portfolio brokerage is another area where I think that independent directors have a duty to ask some tough questions. Which broker is the fund using, and why? Why one over another? And if the adviser has soft dollar arrangements, in whose interests are they? Are they in the best interests of fund shareholders? Can soft dollar arrangements be used to reduce direct costs to the fund, as well as for securing research for the management company?

Now, our remaining panels will take a look at issues that have received a good deal of attention at the Commission and in the press in recent years. Mutual fund disclosure has been one of our top priorities. Our panel on fund disclosure will look at what directors can do to ensure that shareholder communications are clear, are easily understood by investors, and tell the whole story about the fund. Consolidation in the securities industry has become an increasingly common occurrence. It seems like we hear an announcement of a new merger or alliance nearly every day. What is the proper role of independent fund directors when fund advisers merge? Our panel on adviser and fund reorganizations is intended to address this issue. The question of when it's appropriate for a fund to value its portfolio using fair value pricing has been of concern in light of recent market volatility. The panel on valuation will address this and similar questions.

Finally, we'll discuss the special issues faced by independent directors of closed-end funds, variable insurance products funds, and bank-related funds. For example, in the past few years, we've seen increased activism by closed-end fund shareholders to reduce or eliminate trading discounts. What should the role of independent directors be when these shareholders clash with fund management? Finally, to close our roundtable tomorrow afternoon, we will have two distinguished panels that will focus on the larger question of how to enhance the effectiveness of independent directors. These two panels will draw upon discussions of the previous panels, to give us a sense of where we are and where we may be going. For example, when is a director truly independent? Does our current definition under the law still reflect reality? Should a majority of all of the directors of a fund be independent rather than just the 40 percent that the law currently requires? Should a former officer of a management company be able to serve as an independent director without a two, three, or even a five-year hiatus? And should fund management pay directors for their services?

In overseeing a fund's operations, how should directors strike a proper balance between indifferent acquiescence and overzealous interference with management? In a worst-case scenario, when management and the board are at an impasse and on the road to proxy fights and litigation, do the directors really have the tools to protect the interests of fund shareholders? Should independent directors, for example, have the right to terminate the investment adviser's contract? I know I'm asking lots of questions, and some of you are probably thinking of that line, "Question everything, learn something, answer nothing." Well, I really hope that, together, we will begin to develop the right answers. The purpose of this roundtable is not to have the Commission tell independent directors how to do their jobs. I want you to tell us how you do your jobs. We want to know what works under the current system, and more importantly than that, we want to know what doesn't work. I want to make clear at the outset that I do not favor government intervention in this area. But to think that the results of this will merely be some lukewarm effort at best practices I think mistakes the purpose of this roundtable. The industry has done extremely well at policing itself, has read the signals, and has acted upon them promptly and appropriately, but the need is greater today than ever. The industry, for the most part, has been responsive, but at a time when more people than ever are investing in mutual funds, and the vast majority of them have never experienced a down market. The public and private sector together need to be asking these questions and need to be generating substantive responses, not cosmetic fixes. I regard this roundtable as an essential first step in that process. While the Commission is not afraid to search for solutions alone, I'm quite confident, judging by today's participation, that together we can serve the investor interest.

In that spirit, I've asked our moderators, all of whom are current or former senior Commission staff members, to challenge the panelists, to ask some tough questions, and I expect our panelists to give us their frank and their honest answers. If you think that a current practice does not serve investors' interests, speak up. If you think that a Commission rule of position is ineffectual, or some action that we have taken is inconsistent with what we set forth, let us know about it. No matter what our conclusions are, there's one thing of which I am absolutely certain: board independence does not come from a specific legal structure. I've often said that I don't believe in constituent boards representing different interests, but I believe passionately in boards made up of men and women of good, sound independent judgment. Board independence comes from directors who do their jobs aggressively. I said it before, but it's worth repeating: independent directors must take their jobs and their fiduciary duties seriously. Independent directors must have the courage to question fund managers and the status quo. Without that, even our best proposals for improving investment company governance will certainly fail.

I have every confidence that working together in a spirit of openness, of creativity, and with the determination above all else to see to it that investor interests are jealously, fearlessly, courageously protected, I believe we will succeed. Thank you.



Overview - Role of the Independent Director
Mr. Roye: I would like to thank Chairman Levitt for those remarks. He has raised a number of provocative and challenging questions that we will discuss over the next two days. As the Chairman has noted, we are very enthusiastic about the roundtable and this unique opportunity to explore the role and key issues facing independent investment company directors today. Before our panels get started, I thought it would be helpful to provide some background on the duties of fund directors, how these duties have evolved over time, how investment company directors are different, how their responsibilities are different from the general responsibilities of corporate directors, why Congress imposed upon independent investment company directors special responsibilities. The special role of independent investment company directors can be explained in part by the unique nature of the typical investment company structure.

Unlike a regular operating company, investment companies are not operated by their own employees. Instead, funds normally rely on external service providers, like the fund's investment adviser, to conduct the fund's day-to-day business, including managing the fund's portfolio and providing administrative services. In return, these service providers receive a specified fee from the fund pursuant to various agreements with the fund. Additionally, the officers of funds are usually affiliated with the fund's adviser, or the other outside service providers, such as the fund's administrator or underwriter. Consequently, the interests of fund management and shareholders of a fund are not completely aligned.

A fund's investment adviser has a separate interest in the maximization of its own profits. In contrast, officers of an operating company are paid directly by the company, often have an equity interest in the company, and devote themselves to profit maximization to benefit both the company and themselves. While a fund's management and fund shareholders have some common interests, such as seeking outstanding investment performance, there are important areas in which these interests may conflict, such as the level of management fees.

Because of the conflicts of interest in the investment company structure, independent directors play a crucial role in ensuring that fund shareholders' interests are protected. Indeed, the courts, as Chairman Levitt has alluded to, refer to this role as a watchdog, to protect the interests of fund shareholders. Since investment companies, like other corporations, are organized pursuant to state law rather than federal law, the Investment Company Act is not the only source of authority for the management power of investment company directors. State law is the basic source of director authority, while the Investment Company Act functions to impose specific additional duties and responsibilities on fund directors, both affiliated and independent. State laws generally impose the specific duty of care on directors, which requires them to discharge their responsibilities in good faith and to exercise the degree of skill, diligence, and care that a reasonably prudent person would exercise in the same circumstances in a manner he or she reasonably believes to be in the best interests of the company.

This duty requires directors to obtain adequate information about matters they are called upon to decide and exercise their business judgment with respect to matters on which the board is expected to act. The business judgment rule, which is a construct of state common law, is important in applying this duty of care. The business judgment rule provides that directors will not be found liable for their actions, provided that they act reasonably and in good faith for the best interests of the corporation, even if their decisions turn out to be erroneous. State law also imposes a duty of loyalty. This duty prohibits directors from converting to their own personal benefit opportunities that properly belong to the company. Thus, the interests of the corporation must take precedence over the interests of the individual director. State law, particularly in Delaware, Massachusetts, and Maryland, where most investment companies are organized, has in recent years been catching up to the role envisioned for investment company directors under the 1940 Act, but still has some way to go.

Now, in 1936-1939, the SEC did an investment trust study which identified the need for federal regulation in the area of investment companies. It was determined that disclosure under the 1933 and 1934 Acts was not enough. Additional regulatory authority was required to control the conflicts of interest inherent in the structure of the industry. Congress, in passing the Investment Company Act in 1940, placed unique responsibilities on the independent investment company directors, imposing duties on fund directors that are more fundamental and pervasive than those of directors of conventional corporations. The Act, among other things, requires independent directors to review and approve the contracts with the fund's investment adviser and principal underwriter, imposes the duty to select the accountants that prepare the fund's financial statements, as well as gives the directors responsibility regarding the pricing of the fund's portfolio securities. The structure and purpose of the Investment Company Act reflects Congress's judgment that it was appropriate to entrust to independent directors the primary responsibility for safeguarding the interests of mutual fund shareholders and to protect the conflicts of interest and the financial affairs of the fund. Congress could have chosen to address the conflict of interest problem through alternative means, such as mandating an internalized management function, but it instead chose to rely on independent directors. But Congress recognized that certain relationships between directors and management would impair the ability of directors to effectively police conflicts. Prior to the adoption of the Investment Company Act, a fund's board was often comprised mostly of individuals who worked for the investment adviser. Thus, fund boards were dominated by the fund's adviser, which was hardly an adequate check on the adviser's actions. As a result, in 1940, Congress required that 40 percent of the directors on a fund's board be unaffiliated with the fund or its adviser. The function of this provision was to supply an independent check on management and to provide a means for the representation of shareholder interests in investment company affairs.

Twenty years after the Act was adopted, questions arose regarding the effectiveness of this governance structure. In 1962, the Wharton School at the University of Pennsylvania completed a study of the mutual fund industry that was authorized by the Commission. This study offered a comprehensive review of the mutual fund industry, the first done since the Investment Trust Study in the '30s. The study found, among other things, that the main problems affecting funds related to potential conflicts of interest between fund management and shareholders, and the possible lack of arms-length bargaining between funds and their managers. The study found that actual decision making functions, in many cases, were in the hands of a few individuals who functioned in multiple capacities with the fund and the adviser.

Additionally, the study found that fees charged by advisers to funds tended to be substantially higher than those fees charged by the same advisers to most of their non- fund clients at comparable asset levels. The study noted that the relatively high rates commonly charged by advisers did not appear to be a consequence of extensive services rendered to, or expenses incurred on behalf of, the funds. The Wharton Report found that as of 1960, most advisers were not sharing the economies of size with the funds and the shareholders, and noted that four out of every five funds had no breakpoints in their advisory fees as those funds got larger. The Commission transmitted the Wharton Report to Congress indicating that it would evaluate the public policy questions raised in the report with a view to determining and formulating appropriate regulatory and enforcement proposals.

In 1966, the Commission issued the PPI Report, more formally known as the Report on the Public Policy Implications of Investment Company Growth. In the PPI Report, the Commission concluded that the abuses which had prevailed prior to the enactment of the 1940 Act had largely been eliminated, but expressed concerns that fees paid by funds to their advisers might be higher than necessary, and determined that such fees were, in part, due to limitations on the effectiveness of unaffiliated directors. The PPI Report found that while unaffiliated directors performed a valuable service to fund shareholders, their usefulness was limited by several factors, including working part-time, working without independent staff, usually without independent counsel, and from obtaining most of their information about fund operations from employees of the fund's adviser. In large measure, as a result of the PPI report, Congress amended the 1940 Act in 1970 to strengthen the definition of independent director.

So today, an independent fund director, in addition to not being an affiliate of a fund's investment adviser, cannot be an immediate family member of an affiliated person of an adviser, cannot have a beneficial interest in securities issued by the adviser or the principal underwriter or any of their controlling persons, cannot generally be a registered broker dealer or affiliated with a broker dealer or have an affiliation with any recent legal counsel to the fund. To enable directors to effectively serve the fund and its shareholders when negotiating with management over fund advisory and underwriting agreements, Congress also imposed a statutory duty on fund directors to request and consider any information necessary to evaluate the terms of both advisory and underwriting contracts. To ensure that directors could carry out this obligation, Congress also imposed a statutory duty on fund management to furnish this information to the directors. Moreover, Congress imposed a statutory fiduciary duty on the fund's adviser with respect to receipt of compensation from the fund. In combination, these statutory amendments were designed to rebalance the scales regarding the conflicts of interest between the funds and their managers.

In 1992, the Division of Investment Management conducted a study of the regulation of investment companies to determine whether existing regulations imposed unnecessary constraints on investment companies and whether there were gaps in investor protection. A portion of the study re- examined the adequacy of investment company governance structure. The Division concluded that the governance model embodied in the Act was sound and had served investors well. However, the Division recommended legislation that was never enacted to strengthen director independence. The Division recommended that the Investment Company Act be amended to require that the minimum proportion of independent directors be increased from 40 percent to a majority, that independent director vacancies be filled by the remaining independent directors, and that independent directors be given the authority to terminate advisory contracts. These and other recommendations to strengthen director independence will be discussed during the roundtable.

Since the passage of the 1940 Act, the investment company industry, for the most part, has been remarkably free from the scandals that have plagued other areas of the financial service industry. The trust and confidence many investors have in the mutual fund industry is due in no small part to the vigilance of fund directors and the Commission, in ensuring compliance with the Investment Company Act's core investor protection concerns. However, fund directors and we as regulators cannot become complacent. We must remain on guard and continue to challenge, probe, and ask the difficult questions. Changes in the financial markets, development of new financial instruments and investment strategies, and technological advances, require that independent directors be active and inquiring, and that we as directors consider measures to assist directors in fulfilling their responsibilities.

The statute and the Commission asks much of fund directors, and we may ask more of directors in the future, but we also recognize that the Commission has an obligation to directors as well. And I want to assure fund directors that we will aggressively and vigorously pursue reports by directors of violations of federal law and not sit idly by. It is appropriate that almost 30 years after the 1970 amendments to the Investment Company Act, and as we approach the new millennium, that we consider how we can strengthen the Investment Company governance structure.

Today, we are holding our roundtable in the William O. Douglas Room, dedicated to the former Chairman of the Commission, and a distinguished Supreme Court Justice. Justice Douglas succinctly summarized the mission of the SEC when he said, simply, "We are the investor's advocate." In the fund boardrooms, it is the independent directors who are the investor's advocate. Millions of Americans are relying on independent directors to protect their interests. We hope that this roundtable will highlight ideas and approaches that can lead to enhancing effectiveness of independent directors in advocating and protecting the interests of fund shareholders. We thank you for coming, and hope you enjoy the roundtable.


Mr. Roye: We will get started with our first panel, on the director's role in negotiating fees and expenses.


Negotiating Fees and Expenses
Mr. Sirri: Good morning, and welcome to the first panel of our two-day roundtable on the role of investment company independent directors. I'm Erik Sirri. I'm the Chief Economist with the Securities & Exchange Commission. The first panel is going to be discussing the role of independent directors in negotiating fees and expenses. I think we all understand what a charged topic it is. It's an emotionally charged topic. I think it's something that lies at the core of independent directors' role in overseeing fund companies. By my reading, the rhetoric around this particular topic has been fairly high. It has been high in the press. It has been high in discussions inside advisers, and it's even been high here at the Securities & Exchange Commission. It's a topic we care desperately about.
Let me emphasize that the topic of this roundtable is about the role of independent directors in setting fees and expenses as opposed to being about fees and expenses themselves. I think we best serve the role of this roundtable by focusing on independent directors and exactly what their tasks are. I understand that the topics of fees and expenses are intertwined with directors' roles, but we're going to try and focus specifically on directors themselves, as opposed to the general topic of fees. Now, to help us separate those problems, the staff of the SEC has prepared a short handout that summarizes some studies of fees and expenses that were done by other parties. It's important to note that in summarizing these studies, the staff tried to be objective. We're in no way ratifying or advocating the results of those studies. Rather, what we really meant to do was provide a concise, one-page summary and description of what those studies conclude, and in that way sort of push aside some of the rhetoric, and let us concentrate on the issues at hand.

We have with us this morning five very distinguished members that I think we're very fortunate to take some of their very valuable time. I would like to say a few words about each of them. The introductions will be very brief, and in no way can possibly do justice to their individual personal accomplishments.

First, we have with us Bob Pozen. Bob is the President and Chief Executive Officer of Fidelity Management & Research. He has responsibilities for all of Fidelity's portfolio managers, for their analysts, and for their traders around the world. Before he was at Fidelity, he worked at the Washington, DC law firm of Caplan & Drysdale, and before that, he was a professor at NYU. Next, we have with us Ken Scott. Ken is a Senior Research Fellow at the Hoover Institution and a Ralph M. Parsons Professor of Law and Business at Stanford Law School. Professor Scott spent five years after law school in private practice at Sullivan & Cromwell in New York, and at Musick, Peeler, and Garrett, in LA He is the author of two books on corporation law and securities regulation, and also on retail banking in the electronic age.

Next we have with us Bruce MacLaury. Bruce was the president of the Brookings Institution from 1977 to 1995, and after he retired from Brookings, he was given the title of Professor Emeritus, and continues his affiliation there. He also served as Vice President of the Federal Reserve Bank of New York and in the Treasury Department as Undersecretary for Monetary Affairs. Dr. MacLaury is currently a director of the American Express Bank, the National Steel Corporation, The St. Paul Companies, and The Vanguard Funds, and he has served as director of Dayton Hudson Corporation for 15 years.

Fourth on our panel is John Markese. John is the president of the 170,000- member Chicago-based American Association of Individual Investors. He earned his doctorate in finance at the University of Illinois. John has also served as a portfolio manager and consultant to individuals and to pension plans. Finally, we have Harold Evensky. Harold is a CFP in his own firm of Evensky, Brown & Katz in Coral Gables, Florida. Mr. Evensky received his bachelor's and master's degrees from Cornell University. In 1998, Mr. Evensky testified before the House Subcommittee on Finance and Hazardous Materials in the US House of Representatives on the topic of mutual fund expenses. In addition, he has written for and is quoted frequently in the national press and is the author of Wealth Management. What I have asked these five panelists to do is to give a brief five-minute opening statement, after which I hope there will be enough on the table for us to begin an honest give-and-take discussion. To begin this discussion, I've asked Bob Pozen to tee up some issues associated with negotiating fees and expenses and an overview of the legal requirements for the approval of advisory and other service contracts. Bob.

Mr. Pozen: Thank you. I will outline the regulatory requirements I've been asked, for negotiating fees, and then I'm going to make a few comments about what I believe are some deficiencies of the current regulatory framework. The current regulatory framework is, the key case is a case named Gartenberg, and the judge said that a fee may not be, and I quote, "so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arms-length bargaining." That's a pretty vague standard, and I think that it's helpful to sort of think about what independent directors do in terms of looking at a series of factors, and these factors, I think, can be usefully grouped into three categories. First is what I call process factors. When the independent directors approve the contract, it's very important what process they go through. Judges will look at what the qualifications of directors are, what information they have been given, at the carefulness of their deliberative process, and they will also look whether they got advice from independent counsel.

The second set of factors really has to do with the quality of what is being provided by the adviser. Obviously, directors look at the quality of investment management, the expertise of the people involved, the research process, compliance responsibilities, and performance statistics along various parameters. They also need to look at other services that are provided by the adviser, the range of funds, for instance, whether they have international funds, sector funds, and the range of services, consolidated statements funds, all these types of things. The third set of factors has to do with financial. And there, there are a number of things that directors need to look at. They look at the cost of the services provided, the adviser's cost of providing the services. They look at the payments that are received by the adviser. These include comparison of expense ratios and looking at the structure of the fees. The courts also ask that independent directors look at so-called spin-off benefits. These are some potential ancillary benefits that the adviser may receive. Last of all, the advisers are required to present information, and independent directors look at profitability. The courts have said there is no one correct method of evaluating profitability, there are a series of different methods, and independent directors can look at profitability from a number of perspectives. I think that gives you a sort of summary of the current process.

Now, I would like to, just in the rest of my time, express three concerns about deficiencies in the regulatory process. The first is that the '40 Act, the whole structure of the '40 Act, is based on the concept of one fund and one set of directors. This historically was probably accurate at the time the '40 Act was passed, but now almost all directors are dealing in the context of a complex. In the context of a complex, the key questions are allocation questions. For example, most complexes have research that's done that's spread among a number of funds, have a trading desk that serves a number of funds, have found systems that serve investors from many different funds. So that in that sense, the Act isn't responsive to the way things are, and there are a lot of allocation questions. The second deficiency is one that the SEC has chosen to take a position on that I have always believed doesn't make any sense. The SEC's position is that independent directors are not allowed to see sales and promotional expenses. They're not allowed to consider them, unless there is a 12b-1 plan in place.

Now, in a context of a load fund with a big 12b-1 fee, that makes sense, to look at the 12b-1 revenues and the sales loads and then to look at the sales and promotional expenses, which you're allowed to do. But in the context of a no-load fund, everyone realizes that the investment manager is using its own resources to pay for the promotional expenses, but unless you have a 12b-1 plan, you're not allowed to show those promotional expenses in the revenues and expenses to the directors. The only argument I've heard that attempts to support this position is that maybe the directors would allow the management fee to be bloated up and artificially inflated, and therefore some part of the management fee might actually be going artificially to support distribution. I happen to think that's a very weak argument, and that most of the no-load funds have fees that are competitive and at the median or below, so it's very hard to think that these fees would be bloated, and of course it's something the directors can see very easily. So I think most people have found that the directors do want to see all the revenues and all the expenses, and it's an anomaly that you can't have the directors consider promotional and sales expense in the context of many no-load funds.

The third deficiency, I think, is probably the most important, and that is that there's a 300-pound gorilla that's not sitting at this table or even represented here, and that's all the hedge funds in the United States. Since Congress recently expanded the number of shareholders that there can be in a hedge fund from 100 to 500, we've witnessed a very great expansion of hedge funds. There are now over 1200 hedge funds with over $110 billion in assets; and, despite what happened in Long Term Capital this year, they're continuing to grow. Now, most hedge funds have a very simple fee structure: 1 percent management fee plus 20 percent of the profits, 20 percent of the upside; nothing of the downside. Now, there are tremendous implications of hedge funds for this fee discussion we're having. Let me outline several of them. One is that hedge funds are the biggest competitors for portfolio management talent with the mutual fund industry. But the mutual fund industry has not given a fair playing field to compete against hedge fund managers and the best portfolio management talent in this country will go to a small number of wealthy elite and will not be available to the middle class public shareholders of mutual funds. Now, the question is this a fair playing field? And the answer is clearly, no. And neither the SEC nor the Congress has really done anything about this. And, basically, hedge funds are unregulated. There's been a total abdication here. And I know that there are a lot of people who feel and I would agree with them that it would be inappropriate to apply the full '40 Act to hedge funds; but I'd suggest that there are three things that can be done and should be done in terms of imposing regulation on hedge funds that offer their interest to US investors.

First of all, they should be required to disclose their holdings twice a year. We are, as mutual funds are required to list every holding twice a year. This is very important because as we've seen from Long Term Capital, the holdings of these hedge funds are very important in terms of the dynamic of the marketplace. It is almost impossible to find out what these people hold or how leveraged their holdings are. The second thing is the mutual fund industry has been very aggressive in adopting a very tough code of ethics for personal investing and for lots of personal conflicts of interest. There is no code of ethics requirement. There is no personal conflicts of regulation in the hedge fund area. I think that is really inappropriate.

Last of all, I think that the SEC should require every hedge fund as it requires mutual funds to have symmetrical performance fees; that is, if you're going to get 20 percent of the upside, if things don't go well, you ought to lose 20 percent on the downside. These three simple regulations would go a long way to making mutual funds have a fair playing field in terms of competing with hedge funds. I think the last thing I want to say about hedge funds is that they show you how successful independent directors are in the mutual fund area. These very sophisticated investors in hedge funds paid, in my estimate, over 3 percent in management fees in 1998 – on average over 3 percent in management fees. By contrast, independent directors have been very aggressive in terms of dealing with fees for mutual fund shareholders and that independent directors have clearly done a much better job in terms of bargaining and negotiating for fees lower for the mutual funds' public shareholders – and they're the representatives of the public shareholders – than these sophisticated investors have done for themselves. Thank you.

Mr. Sirri: Thank you, Bob. Our next two panelists are independent directors themselves, so what we have asked them to do is say a few words about the practice of what actually goes on inside a boardroom when the time comes to negotiate with the adviser over the advisory contract. I have asked Bruce MacLaury to begin. I wonder, Bruce, if you would say a few words about how that process works for you?

Mr. MacLaury: Thank you, Erik, and let me say it's a pleasure to be here today. I'd like to express my appreciation to Chairman Levitt and the Commission for their interest in hosting this roundtable. I have always though of my role as an independent director of Vanguard to be an enviable one in the field of mutual fund directors. As most of you know, Vanguard Group has a unique structure in which the Vanguard funds and, therefore, the shareholders, own the management company. This structure gives the Vanguard fund directors and the fund shareholders some distinct advantages. First, unlike much of the industry, the Fund's management company has no shareholders to serve other than the Fund shareholders. The interests of the management company and the board of directors are structurally aligned. There's no room for conflict of interest.

Second, the Vanguard Group provides administrative distribution and advisory services to all of its funds at cost. And, third, we use independent investment managers for some of our actively managed funds, but in all of these arrangements, the funds are not dependent upon the adviser for administrative services and so cannot be held captive. All of the advisory agreements are negotiated at arms-length, are competitive and can be terminated when necessary. Although our corporate structure is unique, our approach to the selection and compensation of investment managers is not unique. Like everyone else, we seek talented managers to provide the highest quality investment management for our funds. When we are selecting new managers, and I emphasize the word, "new managers," we consider what Jack Bogle, the founder of Vanguard, refers to as the four P's: people, philosophy, portfolios and performance. In that order. People, we mean experience, conviction and integrity. Philosophy, it must be clear and it must be aligned with the intent of the fund. Portfolios, they have to reflect that philosophy and performance, that's the final step in this looking for a new manager.

Only when we are satisfied with these four P's do we negotiate the advisory fee and then we obviously are looking for a competitive rate. In our advisory fee structures, we make extensive use of two features that enhance shareholders' interests, we believe: incentive fees and breakpoints. Incentive fees are a critically important way of aligning the interests of the advisers with the interest of fund shareholders. I am talking about what's called fulcrum fees in which the adviser's fee increases when the fund outperforms its benchmark and decreases when the fund under performs its benchmark. They should not be confused with what Bob just referred to or the hedge funds' performance fees that are often used by advisers of non- mutual fund accounts. With performance fees, there is usually a minimum or a base fee with additional fees paid for high relative performance but no fee penalty for poor performance. Fulcrum fees, on the other hand, adjust the adviser's compensation both on the upside and the downside. They, therefore, align the performance with both the adviser and the investor.

Second, breakpoints. With the phenomenal growth of mutual funds over the past decade, we believe it is imperative to incorporate breakpoints into the adviser's fee. There has been a lot of talk about whether investors benefit from economies of scale. One way to make sure that fund shareholders enjoy the benefits of larger asset size is to negotiate scaled fees, fees that decrease as a percentage of the fund's assets as the fund grows. Using these scale fees acknowledges that it is the dollar amount paid to the adviser that is meaningful and that advisers should not be the only ones who benefit from asset growth. Thirty-two of Vanguard's 109 funds are managed by external advisers, 32 out of 109 by external advisers. The remainder of the funds, mainly index funds and fixed income funds are managed internally at cost and that works out at cost to be less than one basis point for those internally managed fees for the advisory cost. Twenty of the externally managed funds are subject to incentive fees, twenty out of 32, and 26 of the 32 have fee arrangements that include breakpoints.

The average outside equity adviser fee is about 15 basis points. The average outside bond adviser or fixed income adviser is less than 3 basis points for the advisory fee. Once we have an adviser in place, we do focus first and foremost on the adviser's performance; and, with the support of the Vanguard staff, the board undertakes comprehensive quarterly reviews to assess whether the fund is being managed consistently over time and whether the fund has competitive results over various time periods. We also review a broad range of categories to see whether the risk characteristics of the fund as it is actually managed match what we have said to investors that the fund represents, such things as price earnings, yield, stability and performance, relative broad market, turnover, concentration, industry diversification and the like. We also consider advisory costs on a continuing basis. We have re negotiated advisory fees on a number of occasions, adding both breakpoints and incentive fees. By implementing complex-wide fee reductions in 1996, we estimate that we have saved Vanguard's shareholders approximately $30 million in advisory fees in the last couple of years from what they would have been had this reduction not been negotiated in 1996.

By including breakpoints in our advisory fees, we have assured our shareholders that growth in asset size will automatically – and that's the key phrase – automatically mean reductions in advisory fee rates. Our high standards for quality performance from advisers is not just a statement of theory. There have been at least nine significant adjustments in the lineup of advisers over the last five years, including both replacements of advisers and reallocations of assets. Let me close by emphasizing that the Commission's spotlight on the role of independent directors is both appropriate and timely. An open forum like this is an excellent way to stimulate discussion of the issues. It should be apparent that boards work best when the possibilities for conflict of interest are minimized so that truly independent directors can exercise their best judgment on behalf of the interest of the shareholders. At Vanguard we believe that that task is made much easier by the structured alignment between the interests of the fund's shareholders and the management company that Jack Bogle engineered more than two decades ago. Thank you.

Mr. Sirri: Bruce, thank you very much. Next will be Ken Scott. Ken, I believe, is a director on more than one fund company. So I wonder if you could talk about what it's like working for different fund families and perhaps how those processes differ.

Mr. Scott: By way then of establishing a background framework, I do serve on the boards of two different complex companies. One is the old Benham Funds which are now a segment of the American Century operation, the old 20th Century operation. And the other is RCM which is now Dresdner RCM; but the funds there of which I am board member are highly atypical. That is to say, they are essentially investment pools for the institutional clients of the firm. They therefore have only a few dozen investors, they are not retail funds, the investors are highly sophisticated. I don't think they need me on the board to protect or look at their own interests; therefore, these are very much apples and oranges. It makes more sense, I think, to talk about the apples which are the retail funds which are what most of the people here I presume have an interest in. There are several questions that have been raised here by Erik, by Chairman Levitt and by others, and part of them have to do with what do directors do and what can you expect of directors. I'll say a few words about that and how the theme here is how can directors be more effective. What directors can do to be more effective is one part of the picture. I think the other part of the picture which I haven't heard a lot about is what can the SEC do to help directors be more effective. My impression is that the level on which that subject has been pursued at the Commission is a rather negative concept. That is, they can help by bringing more suits against directors. This is the World War I general, you know, who encourages the troops by executing a few.


And I would like to suggest the possibility that there can be positive assistance in various forms. And by that I do not mean simply giving sermons about doing our duty.
Okay. So looking at the directors' performance – well, it seems to me directors in the typical retail complex which Vanguard clearly is not, are monitors of the management company which is a separate organization in terms of its investment performance, its shareholder service, its total costs. I don't think a focus on the management fee is particularly well-conceived. You're really focusing on total cost for total performance. To perform that kind of a role, you need to be able to do rather objective measurements of performance, both in service and in terms of portfolio. And it seems to me, there the issue is the role of the director in pushing to get objective measurements of quality of service, of returns in relation to risk. There's a lot of focus on total returns. The treatment of risk both in terms of the SEC prospectuses and I suspect sometimes internally in the complexes is much cruder. The name of that game is devising appropriate benchmarks that include measures that are for both of return and risk and monitoring the performance of the fund managers with respect to the benchmark and also with respect to adherence to the risk levels that are implied by the benchmark. And, you know, bar graphs as a measure of volatility as a measure of risk are, again, a very primitive way to go about this. On objectively measuring costs, it's in relation to what? Well, it's in relation to, among other things, the size of the fund and the size of the complex. And what we have been doing internally for several decades is following a regression methodology to try to establish a cost benchmark that is sensitive to the particulars of the cost environment. The second part of this, though, is what do you do with the measurements assuming you have the data which I don't think has ever been much of a problem in obtaining, and have found an appropriate way to measure it. And one answer to what you can do, of course, is disclose. And I think there could be more disclosure, for example, in prospectuses of relevant benchmark information. But the other thing, of course, the concept of the independent director is something about bargaining, that the independent directors are supposed to use that information derived from their measurements to bargain. And here I think there are two concepts of the role of the board that have never really been sorted out or very clearly distinguished. One concept of the role of the board, of the independent directors on the board is keep it reasonable. Keep the fee reasonable. You're an outer check, if you like, on the management company. The major check, the greater check is, of course, this is a competitive industry, and the greater check is in the marketplace. But that this is a secondary kind of check. And, therefore, you invoke things like business judgment rule and so on. A second concept is that the independent directors are there to be an independent bargaining agent for the shareholders. It has never been completely clear that that is really what the '40 Act is all about. And here you have to distinguish between a standard of conduct and a standard of liability. The standard of liability clearly is duty of care, gross negligence, business judgment rule, that kind of thing. What is, however, the standard of – not the liability rule, but the conduct norm that one could say the '40 Act is striving for or that the SEC is striving for, is it the independent directors as independent directors – we're just – we're not interested persons of the adviser. That's what the statute really simply says. Are we supposed to be there as a line of defense against management overreaching or management failure, a safeguard against the extremes, or are we supposed to be there as bargaining representatives on behalf of the shareholders? And, of course, those are the polar positions; you can be somewhere along the continuum. If the SEC believes that it wants the bargaining representative point of view, then I think it should give serious consideration as to how it might support that. And the conclusion I think that some might draw, at least tentatively from recent cases like Yacktman and Navellier is that you're no independent, you may be a disinterested director, you're not an independent director if you're subject to removal by the management company. Independence is a question not of fees, not of your compensation, you know, this is a kind of misdirection. It fascinates Barrons and the Wall Street Journal. I don't think it should fascinate people who think hard about these matters. Independence is a question of how did you get on the board and how do you – how can you be taken off the board. Who puts you there and who keeps you there? Who can take you off? If the answer to that question is the management company, then you are not independent of the management company. And if you are not independent of the management company, the notion that you can act in an arms-length bargaining capacity, vis-୶is, the management company is silly. And so I think that there are some issues here that really require a little harder analysis on the part of the SEC as well before we simply deliver another sermon.

Mr. Sirri: Thank you, Ken. Our final two panelists have a different role. They're here as investor advocates. They have said at times and I think they've expressed themselves to think that at times they felt that fees might be too high and I would like them to share those views with us. So, John, I wonder if you could speak about what you think about fees and how you think that reflects back on independent directors.

Mr. Markese: Thank you, Erik, and good morning, everyone. I know you represent all different activities. We have press here, SEC people, I'm sure from the industry and so forth, but you all might be individual investors also and hope you are. For a moment, think about your mutual funds if you have them, your investments. I'm going to talk about two disconnects. And the two disconnects I think are in essentially key disclosure and understanding, the ability of individuals to make reasoned judgments on those disclosures. And, secondly, the disconnect between independent directors and fund shareholders. Okay. Times up on your thinking about your mutual funds. Do you feel you have any influence on independent directors? On expenses, for instance, and fees? Do you feel you have any influence whatsoever on who is selected as an independent director? In fact, do you even know who your independent directors are of your funds? My guess is not. I don't think you can answer most of those questions. It would be unusual if you could. So we have a problem with how we select or how independent directors are selected, number 1. They are nominated by essentially the companies. Are they good people? I hope so. Are they independent? Well, if you're nominated then you're not in any way connected to the shareholders, I would guess there is a serious disconnect. You have no influence, you don't know the process selection and you don't have really a way of communicating, nor do directors have a feeling of contact with their shareholders is my guess in general. Present company obviously excluded. Secondly, the SEC has pushed very, very hard for disclosure and I commend them for that. We have fee tables today. We have very elaborate definitions of expense ratios, for instance; but let me challenge you to do this. How many of you actually know your expense ratio on your mutual fund? Secondly, have you ever multiplied that expense ratio out times the amount of money you have in a fund?. Have you ever looked at a competing fund, one you've thought about and looked at the fee charges for your fund in dollars versus another fund that you're considering in dollars? Probably not. What we have also is a problem of basis points. We're looking at maybe a quarter percent difference, maybe half a percent at worse, and that's pretty bad. When you look at expense ratios, it probably falls by the wayside. But if you think about a quarter of a percent over 20 years difference times the amount of money you've had invested in that fund, those are enormous differences. So I think we have two serious disconnects that we need to rectify. I also have to comment on all these studies. You have probably three of them before you on our mutual fund expense is too high. There's another one out by Morningstar I think just hot off the press. As an ex-academic and professor, if you give enough data and a big enough computer I can probably tell you anything you'd like to hear. You can slice and dice this any way. My comments are I think in general we have seen some economies of scale, but certainly not enough. And if you look at all the data, I think the ICI and Lipper and Morningstar and all their studies, probably the conclusion you would reach if you looked at it and you beat on it for awhile intellectually is that basically we have seen a decline in some ways – if you measure fees and expenses including loads – because we have had a decline in front-end loads.

Finally, individual investors realized that 8.5 percent as a front-end load is probably exorbitant, but it took a while. It took a while for them to understand they are actually paying that load and then they started multiplying out eventually. So now we have front-end loads that are lower and we have, let's call them distribution fees, that continue on. So we have had a move in the industry simply because we could not longer do that. Disclosure kept I think the industry from charging 8.5 percent. So you will see some declines in expenses simply because we've moved. The second thing is we have seen a move towards no- load funds and some of those are low cost funds. The index funds, for example, and we have seen moves towards families. Fidelity, for one, Vanguard probably is the leader in a crusade, a missionary zeal against the cost of the industry. When you factor that all together, what has happened over time is that we have seen probably some economies of scale. When you take out all the index funds, the institutional funds, the international funds and you break it down for load versus no-load, we have had declines probably in the load area simply due to the fact that we moved from front-end loads to continuous loads 12b-1. And in the no-load industry if we pull out the Vanguards and Fidelities, probably expenses have gone up if anything.

So I see it as a problem. I think there are a few things we can do. Number 1, I would expect independent directors to somehow be a process of the individual investor. In other words, let's get nominations out there. Let's get people who are obviously competent, qualified, but there is some connect with their actual shareholders rather than appointments strictly by the companies themselves. Secondly, independent directors should be pushing to have fees printed out on their statements in dollars so all of you can look at the actual cost you incur with your mutual fund on a quarterly, semi-annual and annual basis. Simple to do? I think so. Although I'm not a computer programmer, I suspect it would be some cost to the industry, but I think it would be small. We're getting more connects then. We're getting where we have feedback from investors to fund directors. We have funds giving better disclosure. We have people able then to make intelligent decisions based upon that. I would also tell you that the comments about breakpoints are very important. No one envisioned funds in the $50 billion to $60 billion to $70 billion range. And the fact that we don't have very many breakpoints tells me that effectively we have not been passing on the economies of scale to the individual investors. So I would encourage all of that. I think the SEC has helped that competition would do that; but if you look at the industry, it requires sort of a grassroots effort of individual investors to say, "I can make a decision by looking at my actual costs and comparing it and I can influence my independent directors, those directors who should be influencing the funds to make those decisions. I think we could do more on both those accounts. Thank you.

Mr. Sirri: John, thank you. Harold, do you want to wrap up for us?

Mr. Evensky: Well, first, I'd like to think the Chairman and the staff of the SEC and the panel for including me in what I think is an extraordinary opportunity. I definitely feel like a little fish in a very big pond. I am immensely complimented to be here; but the reality is I'm the one person that deals every day with this with clients. I mean, this is my business. I also want to preface it by saying since I tend to be perceived as a critic of the mutual fund industry, I am not. I think it is probably one of the most extraordinarily positive industries in the United States if not the world. And, as I've said before, my clients would be ill-served and I'd be out of business without it. So, with that preface, in preparing for the roundtable, I've been reading and discussing with many others the issue of independent directors and fees and expenses. I have reached a number of conclusions and really a lot more questions, but I will start with my conclusions. Are fund fees an important issue to the individual investor? Absolutely. Unfortunately, the recent market's extraordinary performance I think has masked for most if not all investors the importance of fees in terms of long-term returns. Have fees dropped as a result of the explosive growth of fund assets? I really don't think it's that complicated of an issue. And my conclusion is the no and the evidence is overwhelming. Two recent studies that contradict this conclusion I don't believe addressed the question at hand; namely, if fees and expense is attributable to the management of the fund dropped over time to reflect the fund's growth in asset size. Specifically, the ICI study, "Trends and Ownership Cost of Equity Mutual Funds," developed an interesting measure. They call it total shareholder cost. And while possibly of interest for some discussions in this case, the definition I don't think has validity. At best, the study demonstrates an almost negligible 8 basis points reduction in the expense ratio of the 100 largest funds from roughly '80 to '97. The asset-weighted drop was only 5 basis points and the median was just 3 basis points. This was during a period the average asset base rose over 20- fold from $282 million to $5.8 billion. Morningstar's follow-up study to the ICI study I think confirms this conclusion. Lipper's Analytical Services Third White Paper I believe also fails to demonstrate any substantive reduction in cost. Even if you accept the analytical adjustments recommended by the study and limit it to the fairly narrow universe they studied, reductions calculated from '86 to '97 were a minuscule 1.2 basis points. Do investors have enough information to evaluate the fees they are paying? My answer to that one is more equivocal. All fee schedules in the prospectus and data provided in the statement of additional information provides much useful information, it neither provides the information in a way that's meaningful to most investors, nor does it provide all of the information necessary.

For purposes of presenting meaningful fee and expense disclosure for the assumption I believe of the rational investor should be jettisoned in favor of the real investors described by behavioral finance. And, basically, I'm not going where John had suggested. Regular statements to individual investors reflecting how much they have actually paid, similar to those required of investment advisers such as myself would be more meaningful. As to additional information, if what I consider debatable compensation practices such as soft dollars and performance compensation are allowed, a more detailed, more accessible, and more meaningful disclosure should be provided. In regard to negotiation of fees or independent directors doing their job in accordance with the law. Based on my own clearly amateurish legal research, the answer seems to be yes. The problem I believe if there is one may be with the law, not the directors. According to some legal scholars, during the development of Section 36(b) there as a shift in the standard of judging management fees from reasonableness to fiduciary duty. The result seems to have become a standard that provides what I believe is a significant barrier to challenge. To quote from the Gartenberg case referred to by Mr. Pozen, one that I understand is the current legal basis, it does indeed say the adviser manager must charge a fee that is so disproportionately large that it bears no reasonable resemblance to the service rendered and could not have been the product of arms-length bargaining. With standards as broad as that, no independent director could reasonably be expected to argue too strenuously against most adviser fee recommendations. Are funds competitive? Yes. As Mr. McNabb, managing director of Vanguard noted in his recent congressional testimony with the universe of 10,000 mutual funds, there are many low-cost mutual funds in almost every investment category. If there is no problem, vis-୶is, the independent director and fees and there is indeed competition among firms and funds, is there, in fact, a problem with fees? My answer to that is, yes. How else can you explain that at best, the static nature of the fees in spite of a stupendous growth in mutual fund assets, how can you explain the range of expense ratios for funds of generally similar characteristics? For example, I did a quick study in a narrow universe of almost 1,000 large cap domestic managers and I found the expense ratio ranged from roughly 20 basis points to 300 basis points. I screened for high quality national and municipal fixed income funds, had a universe of 80 funds with expense ratios from 15 to 120 basis points. It is difficult to understand how arms-length negotiations could result in ranges of expenses as narrowly defined in similar styles unless we use a fiduciary standard of so disproportionate as the measure. Even more important, given that there are many low expense choices, who do so many investors invest in high expense funds? The answer can't be performance as many studies have shown a high correlation between high expenses and low performance. It can't be because the high expense funds offer better services; many of the lower expense funds are recognized for their superior services. The answer seems to be that as behavioral finance experts have demonstrated, many investors simply make non-rational decisions. My conclusion is that the problem is not simply the directors or the funds, but as Pogo said, "The enemy is us, the individual investor." It seems to me that the challenge for the SEC, the funds and advisers like myself is how to work together to help the investor make better decisions. Now, for my questions which, except for the last, are in no particular order, has the investors in funds or the owners should fund managers that are not publicly traded provide information similar to publicly traded firms? For example, senior management compensation costs and profits attributable to the fund. Should fund managers provide the investor owners with details of non-direct fees and expenses such as soft dollars and trading floor arrangements?

Should fund fee benchmarks used by the independent directors in making their decisions be disclosed? If Vanguard funds are offered at cost, is it reasonable to assume that by subtracting Vanguard's costs from those of a comparable fund, the difference is the fund's profit? Should the SEC and/or fund industry develop more appropriate fee benchmarks to assist investors in making their decisions? Can independent directors effectively meet their fiduciary responsibilities in each fund if the director serves on boards of multiple funds for the same family? Why aren't all the directors independent? Why does there seem to be a relation between high independent director compensation and high fund expenses? Why is there a perception of many reports and retail investment advisers that fund management independent directors are not sensitive to the issue of fund expenses? Can independent directors give the wide latitude for determining acceptable fees provide any additional protection over and above that afforded by all the directors in setting fees? Should there be a legal standard for fees? Is the current legal fiduciary standard required of the independent director adequate to protect the public in setting reasonable fees? And, finally, is the independent director an effective system for establishing fund fees? Is the independent director even relevant in negotiating fees? Is Mr. McNabb right in asking if it really matters whether fund fees are too high or whether the fund industry is sufficiently price-competitive? Should the question be, is better and more effective disclosure coupled with free-market competition a more effective mechanism for protecting the consumer's interest? I look forward to a discussion of these issues. And thank you.

Mr. Sirri: Thank you, Harold. I told you there would be a lot to talk about. I think a lot of what we said here harks back here to the comments of the Chairman a few minutes ago about whether directors are, in fact, really effective, whether they are, in fact, independent. And whether independent directors are, in fact, serving shareholders. Let me begin our informal dialogue by reflecting on a statement that Ken Scott made about certain fund shareholders not needing him. I think you were talking between the Dresdner Fund shareholders, the institutional ones. I think your remark was, "Gee, they don't need me as an independent director, because they can take care of themselves." If I step back from this, I'm an economist, I'm not an attorney, so as the chief economist I'll step back from this and I'll say, "My gosh, we've got an industry where there's 10,000 funds," when we have simple products with much fewer numbers like peanut butter, we don't regulate the price of peanut butter. We make sure the price is on the jar. We make sure the ingredients are there; but then we basically let the market price peanut butter. What's the reason why we can't be content here to let the market price funds? Why is it that independent directors have such an instrumental, important role here in a way that the market wouldn't be able to solve that problem? John or Harold, I know that's something you think about.

Mr. Markese: Just a quick comment. The price of peanut butter is on the jar, but the price of management fees isn't on your statement, so there is a difficulty in making that comparison. We don't have effective disclosure. Again, I challenge all of you to go home and multiply your expense ratio times the amount of money times the year you've been in it and add it up and, again, we don't have the price of peanut butter on the jar in the mutual fund industry.

Mr. Evensky: That was exactly my observation, that there's not the information available for investors to make intelligent decisions. If there were more information, as I've suggested, I'm not sure of what the role of the independent director, vis-୶is, setting of fees would be.

Mr. Sirri: You're saying that things like a fee table where expenses are clearly laid out are not the equivalent of putting the price on the jar.

Mr. Evensky: I'm suggesting that it's not remotely equivalent. It is not – it is demonstrably not meaningful to the average investor in terms of what is their cost. I would be very pleased in my business if that's the only information I ever had to give a client. It would be much easier for the independent adviser to charge significantly higher fees if someone was not in effect getting on a regular basis, monthly or quarterly, a dollar amount that they have paid for our services.

Mr. MacLaury: I think your analogy of peanut butter deserves to be pushed a step further. The fact that the price of peanut butter is on the jar tells me nothing except what I have to pay for that jar. The relevance, it seems to me in this context, is whether there's another jar with the ingredients beside it that is also priced and I can see the unit cost per pound of peanut butter or per ounce. If we are talking about dollars on statements, that tells me how much I am paying for my service, but it does not tell me what I could get that service for down the street or from another complex. It seems to me the question that we need to face here is – it's very hard to argue against more information. We, but we also know that we are suffering from information overload. The question is comparative costs for similar products and that does not come from dollars on statements. I'm not opposed to dollars on statements, but I am saying that it will not solve the problem that people are talking about.

Mr. Sirri: Bruce, do you ever as an independent director have discussions worrying about or considering whether your investors have the information they need to do comparison shopping? Is that something that enters discussion amongst you?

Mr. MacLaury: Well, I think, coming from Vanguard, the answer is that costs are costs are costs and we are very, very sensitized to it and that providing the information for the investor in terms of benchmarks both as to fund performances and with respect to expenses is something we talk about and think about a lot.

Mr. Pozen: I guess I would generally disagree. I think the fee table is an excellent summary of fees. It also includes for a hypothetical $10,000 investment what the actual dollar amount of the fees will be year by year so that it is, in fact, quite easy. I think if you compare the disclosures that mutual funds make to pension funds, insurance companies, and banks, you will see that our disclosure is much, much better. Second of all, in terms of getting comparative information on expenses, I think that the amount of comparative information that's available on expenses is overwhelming. There are so many different magazines that publish this, there are so many different studies that are available, there are so many different measuring firms that do this, that anyone who claims that they can't easily find what another equity fund or money market fund charges in expenses really just isn't spending any time doing it. Obviously, somebody like Vanguard spends a lot of time advertising that it's a low expense place. The third is that I think that we should realize that these studies that show that, for instance, that if you take Vanguard and Fidelity out of no-load expenses, then the expenses look differently ignore the obvious. Fidelity has brought down its fees substantially. Vanguard has low-cost fees. We do happen to be the two largest complexes in the United States and growing quite rapidly. I think that shows that there are a segment of the population that seems to be quite persuaded and quite impressed by the fact that we're delivering good performance at low fees. On the other hand, when we get to the issue of comparability, there are clearly lots of people who are paying different fees for mutual funds because they are getting a different package of services. Some people want more guidance, more hand-holding, more advice. Some people want more asset allocation. There are just so many different things and Vanguard has been able to keep its low cost because it's focused on the investor doing a large part of the work. Nothing wrong with that, but I just say that you have a lot of choices that are being made by people who are not going to the most low-cost alternatives because they are looking for a different package of services. I think that the independent directors do have a role in this and I think – I'm sure that Bruce and Ken would agree with me that, you know, having sat through more director board meetings than I choose to remember, the independent directors are, in my experience, quite knowledgeable, they are quite aggressive about getting information. These issues are discussed, but they're discussed in the context of what are the costs here, what are the expenses here, what are you delivering? What is the quality of product? What is the range of product? What is the range of services? So that the independent directors have played a role. I would agree with Ken's configuration. This is a very vigorous marketplace. There is huge amount of competition. There is very good disclosure about fees, including this dollar amount in the fee table. And the independent directors are really a secondary device that then provides another way to make sure that the shareholders are getting a decent deal.

Mr. Scott: On the question of what can – if you assume a competitive market, largely competitive, I want to get back to that point: how competitive and what are the limits of competition. But if you assume a competitive market, then what is the role of the independent director? I think it is quite a limited role. I think what you're talking about is the competitive market works through customers switching. Well, it's one thing to switch from one brand of peanut butter to another brand of peanut butter. I do not have a very high switching cost. The transaction cost is pretty low. Even if I am switching from one automobile to another automobile, you know, the automobile I have if I decide that I don't like its performance all that well, my investment in that automobile is running down over time. I can at some point probably make a relatively low cost transition. I get to the point where I want to buy a new car anyway. But what I think what you're looking at is what is the measure of transaction cost in switching in this particular industry, in this kind of product. And it is not almost zero as it is with the peanut butter. It is partly an information cost and that gets us back into the realm of disclosure, it's partly over the way the market has performed in the last half-dozen/dozen years, it's partly all the deferred capital gain tax that I will trigger if I make my decision to switch. Is that a full lock-in? No. Is it in some instances a fairly significant transition transaction cost? Yes. It's within that margin of the transaction cost in switching, it seems to me, that you're exploring whether or not the independent director can save a bit or does not save a bit in terms of the factors that bear on your decision to switch. Coming back to the point, though, of peanut butter as the appropriate image, with peanut butter as with most products, what I am buying, what the price tag tells me I am going to get, is already there. It's in the bottle. When you buy a mutual fund, you're not buying something in the bottle. You're buying some future expectations. You're buying future performance. And that means that determining comparability is far, far more difficult than when we're talking about peanut butter or automobiles. And, so, you know, what can be done to assist people in that regard and to assist people in general to know about what they are buying when they are buying a mutual fund? The data we get in the prospectus is all historical data, backward looking. This is what it did in times past. Well, to the extent that the past is a good predictor of the future which, of course, every prospectus denies, and which every investor disregards, you know, it does have some value. But, you know, what do you do internally within a complex in looking at the performance of your portfolio managers? You do not reward them on the basis of what they did two years ago. In most complexes, I think – I don't know, I'll speak for just one I'm familiar with, what you're looking at is the benchmarks that you've established for the manager and how the manager performs with respect to those benchmarks in the time periods to come. Well, if that's what makes sense to us, how is the benchmark doing vis-୶is his bogey? Wouldn't you think that that would be the kind of information that would be more relevant to investors than how this manager or some other manager did in times past with respect to some other benchmark or bogey. I would think that forward-looking disclosure and this, of course, has always been a problem at the Commission, but I would think that forward-looking disclosure would actually be of greater investor value.

Mr. Sirri: Let me highlight what I think is going on here. I think a conflict that we've realized or at least an issue that disclosure is important and it's critical because it's what allows investors to comparison shop. It's the input to that shopping decision that we all feel is so important as consumers. On the other hand, people's ability to do that is somewhat suspect in the belief of a couple of our panel members. But there is another point I think that we haven't quite dealt with. The SEC has done some surveys and other folks have done surveys that showed that even if there is complete and accurate disclosure, individuals don't really ingest and process that information. If you survey investors, they tend not to know what the cost of their funds are or how they're structured. So my question to you is what does that say then? Does that put a special responsibility back to the independent directors? Or are you just – can you rest comfortably knowing that you have full complete and accurate disclosure and, therefore, you're off the hook?

Mr. Pozen: Well, I can say that I think for many investors while fees are a factor, the most important thing they're interested in is the net performance of the fund. And I think the SEC has developed a very good standardized formula for performance. They also don't let you cherry pick, so you have to give, if you're going to give one year's performance, you also have to give five years and ten years. And I think that you would find in your survey that a lot more shareholders knew how their funds did in terms of net performance than they did about expenses. So I think that if you spend more and more time on trying to have more and more fee and expenses disclosure, it's a little bit missing the boat because the main thing is what the actual performance is. Now, I would like to understand better Professor Scott's suggestion. I would be very interested in a more forward looking information in the prospectus. But I'm not sure exactly – I think we would all be very interested, I think every one in this room, in fact, every cocktail party I go to people say, "Well, tell me, Bob, what is the one fund that's going to be the best next year." If I knew that information, you know, if we all knew that information, then we could disclose it, but we really don't. And I think that all we can say is that these are the investment objectives. This is what it has done in the past and I think the Commission has given some sense of the volatility returns, given some sense of the background. Unfortunately, I think that the thing that people are most interested in is what's going to be the net performance in the future is the most difficult for us to give disclosure without just really allowing people to hype funds which we really wouldn't want to happen.

Mr. Sirri: Bruce?

Mr. MacLaury: It seems to me disclosure about the future, this comes back to one of Ken's points in the peanut butter, infamous peanut butter jar. The idea is that we are buying as investors an unknowable future with respect to performance; but we are buying a knowable future with respect to costs. That's a key element which has been mentioned here before, but it's why the disclosure of cost is so important. It's one thing that the investor can know about the future. Not about the net performance, not about the whole performance. So I at least think that that's a key. And I think in direct response to your question, Erik, does the fact that investors despite all the best disclosure one can imagine, are they going to ignore that disclosure and make their bet. The answer is yes; and, yes, that does put an added responsibility on independent directors, it seems to me, inevitably.

Mr. Scott: Just one thing. I wasn't suggesting that you in the prospectus would predict how the fund would do next year. That is beyond us all. All I was saying was that internally we do and externally I presume one could disclose an existing fact. What benchmarks have you established for this fund that this manager is going to try to aim for in some specified future period? Always subject to change. You can decide that you're going to change your strategy or whatever and if you give – if there's agreement on that and there's notification of that, no problem. But the disclosure is of a fact. What is the benchmark for which this manager is trying to manage this fund?

Mr. Sirri: Let me use my prerogative and move us on to what I think is another important topic that is quite related to this. In 1998, The New York Times published an article that said, and I quote: "When independent directors of two fund families, the Navellier and Fundamental Funds, asserted the legal authority to remove portfolio managers at some of those funds, they swiftly found themselves the targets of nasty proxy battles waged by the fund managers. And, in the case of the Navellier directors, a shareholder lawsuit." This suggests at least to me that it is perhaps difficult to terminate an adviser. My question then is how can a board really effectively, especially the independent members, really effectively negotiate a contract with an adviser? Is it the case that they're armed with only two weapons, a peashooter and a thermonuclear bomb with nothing in between? It's a yes or no decision? What is the club that they have to really hold an adviser's feet to fire? How do you contract in that world?

Mr. Pozen: I'd just start off by saying that there were a number of remarks that were made that suggested that at least in some situations that the independent directors were just people chosen by the management company and then the management company had the ability to throw out the independent directors. I think everyone on this panel and I'm sure everyone in this room who has been involved with boards of mutual funds knows that both those statements are untrue. Every board that I've been involved with and know about has the independent directors taking the lead role in choosing other independent directors. And I would say it is generally the commonplace rule that independent directors serve as the nominating committee for new independent directors. Second of all, I know of no – I guess I don't know of anyplace in which the management company even thinks that it has the ability to throw out independent directors. Now, given that context and the practicalities that you cite – I mean remember, these independent directors threw out the manager and then the shareholders, remember, they felt that they wanted these managers. I think that raises an issue as to whether these, you know, independent directors were representing the interests or explaining the interests that they were representing. But I don't think it is just an all or nothing situation. Again, if you sat through these negotiations and these discussions, there are lots of middle grounds. There are lots of times in which the Fidelity independent directors have suggested certain types of fee reductions, they've suggested certain breakpoints, they've suggested a number of these things. These things are discussed and it isn't an all or nothing situation; but at least my experience has been that the independent directors do play a very useful role in structuring fees and bringing them down and changing them and considering the relevant facts without this being nuclear war or nothing. There are a lot of grounds in between.

Mr. Evensky: It seems to me that the question of fees vis-୶is fees is a moot point. As I said I – a simple study I came up with fees in a fairly narrow universe between 20 basis points and 300 basis points but my understanding of the law with the basis of fiduciary duty in the Gartenberg case, anything within that range is defensible. So, certainly at the table I would say between Vanguard and Fidelity the funds are sort of the same. The ones who – whether it's the independent directors and/or the other directors in the funds have made I believe very good decisions for their investors but there are many funds that perhaps have not. But I don't know without changing the criteria of the law what an independent director could do. So under current circumstances I don't think they need either a peashooter or a nuclear bomb. They can only make the observations but there's no basis for pushing it further at this time.

Mr. Markese: Just a comment. I guess the question becomes the independence of the independent director we keep coming back to the same issue. And, you know, as Bob said they're nominated by the company and then they nominate other directors, independent directors. But that goes back to the heart of the matter that there's no shareholder representation in the selection or nomination. When you have a body that is originally nominated – in essence, that will perpetuate itself. Without any connect to individual investors who are the shareholders I think they don't have that power, Erik. You know, the peashooter or the thermonuclear bomb. It's really an influence that's a ground swell from the shareholders. I think probably that ultimately is the only way they're going to have influence.

Mr. Sirri: I wonder if Ken or Scott – Ken or Bruce – do you feel that when you're in that negotiation that you have sort of the suitable arsenal, the suitable basket, of what you want to have to negotiate? If, in fact, it is a negotiation model, which I think is one of the points that Ken raised earlier.

Mr. Scott: Well, I certainly think the answer is that if the board so used its role it does have a certain amount of clout and can use it. I think probably we've all experienced that. The amount of the clout, you know, I was posing it in polar terms. Obviously, the amount of clout you have is a function of institutional factors such as what the law says is the percentage of outside directors or the process by which vacancies are filled. I think in response to John's comment, at the outset in a new complex and a new fund obviously the directors are chosen by management. There's no – there should be no illusions about that. But then if they are, indeed, in mind to be independent or independence develops over time that tie to the initial source of appointment becomes attenuated. People change, management turns over, directors turn over, new people come in. I think as a sociological matter, not that I know that a study has ever been done, you would expect to see that there would be a growing degree of independence and, after all it's a matter of degree and not on or off, developing over time. I do find it kind of interesting I guess – it was in one of these studies – Lipper or something, suggesting that over time – you said older funds. That's what we're talking about. There was a different trend visible on those funds than in the newer funds. Well, you know, what's the explanation? This may be a kind of factor. So that I think a lot of things bear on it, the composition of the nominating committee, the time from initial establishment, the attitude of the individual board members. If the individual even under the present state of law – if the individual board members have an attitude of independence how far can they push it? Well, what I was using was Navellier and Yacktman to suggest there are limits as to how far they can push it. But note that those limits, nonetheless, give them quite a bit of potential bargaining power because in both cases, you know, okay, the independent director was lost, they were gone. The shareholders knew the name on the fund. That's not too surprising. But the fight was a costly fight. It was a costly fight to the funds. They shrank enormously in assets. It was also costly to the independent directors or defendants in lawsuits. So, again, you have to make a kind of nuance judgment about the degree of your clout and what warrants trying to actually make use of it. But is there some bargaining power if the directors are sufficiently independent in attitude that they want to use it? You know, of course there's some.

Mr. MacLaury: Erik, it seems to me your question brings to heart the uniqueness of the structure of Vanguard. I won't keep harping on it. But to the notion that we as a board of directors are negotiating or bargaining with the management company is foreign to my experience. The fact of the matter is that, as I said, a very high proportion of the funds that are done are managed by Vanguard are managed internally. Therefore, the directors as in any corporation not just the fund, as in any corporation, have to be assured that the management is watching its costs, that its meeting its budgets and so forth and so on. That's how we control the costs of internally managed. In effect, we are not negotiating – the board is not negotiating with the outside advisers. It is the management company that is negotiating with the outside advisers for the – and we, the board, are ratifying in effect those agreements that are reached. It's a very different set-up and so this whole nexus of issues that arises in terms of bargaining power, independence, and so on, simply doesn't arise in the same fashion in our unique set-up.

Mr. Evensky: I want to go back to the question of independence. I think it's the issue that John's raised a couple of times. I'm willing to accept and I believe the independent directors as boards mature become independent of the funds but they're also independent of the shareholders. That's the problem. John asked at the beginning how many of you know your independent directors? I'd ask how many independent directors know anything about the shareholders? The answer is generally zero. So when an issue such as Yacktman and Navellier, and Yacktman in particular, when that comes up I, representing my clients, I hear from Don Yacktman. He calls up well in advance saying there's a problem. He knows his clients and in some cases directly, usually people like myself, and in effect is in a position to lobby. There's a personal relationship. The only time the client hears is when it's totally blown up and the independent directors are asking for support from someone that they are totally independent of and have no relationship with. So there's a real structural problem with being independent of both sides – of both parties.

Mr. Scott: And I think you're describing, you know – John, the problem with your solution, the shareholders somehow take over and deal with the process of selection and election of outside directors. I think this is an illusion. You're talking about the world of publicly-held companies. I don't care whether they're mutual funds or they're New York Stock Exchange. You have these hundreds of thousands of shareholders and they are not going to be the ones who themselves organize and nominate and elect directors in that sense. That isn't the way it works for a mutual fund. It's not the way it works for any company on the New York Stock Exchange, either. Institutional investors, large holders, there is some prospect of their playing that role. Individual small holders, no.

Mr. MacLaury: The only case that I can think of, there probably are others, where what I'm hearing suggested is in practice is with TIAA-CREF and there it's a membership organization and the membership does both on the directors of the TIAA-CREF board. But that's – I agree with Ken. I do not see this as a model that is implementable. Fine as it sounds in theory to have shareholders, in effect, by plebiscite elect the directors other than through the nomination process that we have described. One other thing, whether directors are staying in touch with shareholders – one of the things that clearly we do and I'm sure other boards do as well is that we insist that the management company survey. We don't have to insist very hard, they would do it anyway, shareholder surveys. Find out what shareholders think about the services and performance that is being provided then we get some feedback. Similarly essays in the press, not always reliable but there's something to be learned from that. How does the press rank the various fund families and their surveys? So it's not as though we were sitting there in isolation in some dark room. We do know what shareholders think about the funds and whether we are representing them well.

Mr. Sirri: Chairman Levitt?

Chairman Levitt: Professor Scott raised an interesting point about the relationship of shareholders to corporate boards as well as investment company boards. Whereas I'd be curious to know how the panel would compare or analogize the responsibilities of a corporate director with those of investment company directors?

Mr. Pozen: Let's say that because of the statute and the regulations the independent director of a mutual fund has more specific responsibilities in very focused areas like advisory fees, etceteras. I would say that most of the people who are independent directors of mutual funds and also serve on industrial boards would say they get much more extensive information in the mutual fund context about expenses, fees, costs, than they do get in the industrial context. It's at a much broader level. I would echo what Bruce said, is that again Fidelity, most of the large complexes do survey our customers, our shareholders, both in terms of their satisfaction and in terms of specifically how well problems were handled and how well – how fast phones were answered and all these things. That information is given to the independent directors. So I think most independent directors would say that the amount – if you just see the amount of information they get in the board books it's much more extensive than industrial companies and much more specific in detail.

Chairman Levitt: And you think that they are as influential as corporate directors?

Mr. Pozen: I actually – well, it's again difficult to make a general statement but I actually think that they are more influential because you have to have a majority of independent directors to approve the advisory contract every year and that gives them a lever, it's not an all or nothing situation, but that gives them a lever that I believe makes them more powerful because of this specific statutory role that they've been given.

Mr. Scott: My answer would be that I think there are at least three differences. There's clearly a legal difference in the legal framework and the structure of position – of statutory powers and obligations and so on in the mutual fund compared to the corporate fund. That tends to work potentially toward the mutual fund independent director having a stronger position. Secondly, the mutual fund is relatively speaking a narrow product line kind of business. I think it is possible for the independent directors, either initially or over time, to have a better grasp of the business than is true probably for a great many large New York Stock Exchange-type companies. The third distinction though cuts the other way. That is that to some degree there are large stockholders on New York Stock Exchange companies who can significantly potentially play a role in the corporate governance of the firm either directly through contact or potentially by taking positions in proxy contests or takeover bids. There's no counterpart to that in the mutual fund world. Therefore, the kind of incentive that a large block holder has because of a large economic stake in the firm to pay attention and to exert influence over the management of the firm and its performance simply is lacking in the mutual fund world.

Mr. Sirri: Well, time is running short. Let me shift this to one last topic that I think has been certainly in the press a lot and has been a concern of some folks. It concerns the question of the growth of the fund industry and fund assets and people's perceived inequality there with the decline in fees. I know we touched on that earlier. Let me put a little bit of structure on that problem and then ask you a very precise question. Let's take a world where there are two different funds, both funds have a size of $100 million. The first fund over a period of time grows to $150 million and it does that because over this period of time new assets are gathered, new accounts are gathered, and so there are more investors in the fund. The fund grows from $100 to $150 million. Take the second fund and it's at a different point in time. That fund, too, grows from $100 to $150 million but it does so not because it gathers new investor accounts and not because it gathers new investor assets but, rather, because the market goes up. It's invested well and the market goes up say 50 percent over this period and that fund, too, rises from $100 to $150 million. So here you have two funds and each has grown from $100 to $150 million and for each of them their fees have risen 50 percent. So the question I would ask you then is, is it equally true that for each of those funds that their cost structures have also risen by 50 percent? Are the costs equivalent for those two funds? The point being here that the conventional way that funds charge is through a flat asset-based fee. In that world the second fund has the same number of accounts, the same number of investors, and it's not clear to me that the costs have risen 50 percent. Perhaps you could argue they could, they have, for the first fund. I wonder since the fund charges treat those two the same I wonder how we think about that problem?

Mr. Scott: Can I view that as a rhetorical question?


Mr. Sirri: No, it's actually – it is an actual question.
Mr. MacLaury: Well, let me take a stab. I'll take it at face value it is an actual question. I would say by your hypothesis the costs have not risen comparably in the two complexes, funds, that you site. But the question seems to me that's not the question that we should be answering. The question we should be answering is so what? Does it mean that we should be a rate that there should be somewhere in the United States a rate-making agency on the model of a public utility that is going to scrutinize the costs of one firm as opposed to another firm and insist that there be a reduction and that there are excess profits that either are to be taxed or are to be otherwise disposed of or prevented from occurring. That's the bogeyman that I see in your question.

Mr. Sirri: Please don't misunderstand me. I didn't mean to say that there was a role for a central planner there. It may be, in fact, that it was a role for an independent director to say, "Oh, my gosh! Our assets have grown for a different reason and we might treat that case differently."

Mr. MacLaury: But I guess my bottom line is that that's where this question of competition – whether competition exists in the marketplace among funds or not is paramount. Yes, you could see a role for directors but I would say first and foremost it is competition and whether one of the funds wants to become not $150 million but $250 million and is willing to reduce fees along the way if it can afford to do so to take that advantage.

Mr. Pozen: Well, I think that the – you know, all the data we have here, the Lipper studies and the other studies, show that the large funds, most large funds in the United States, do have a form of breakpoint and do reduce fees and that those fees are reduced through breakpoints and those breakpoints are triggered by change in assets no matter how they go about that. Second of all, I think that to ask the question between $100 and $150 million is actually not a particularly useful way to ask the question because the level of cost and change between $100 and $150 million may be very different than let's say if you have a fund at $10 billion or $20 billion. I suggest to you that when – you can have diseconomies of scale as well as you can have economies of scale. The third point which is more of a conceptual point, therefore, I address it to Ken, is that the process of renewal of the advisory context tends to be on a yearly basis as required by statute. But really the business is a much broader time frame. I think Bruce was referring to this. I mean you can spend millions of dollars building a fund to $100 million and lose money for 10 years and then you can actually have profits for a few years and then it depends what you want to do in the future. So that I think when you view that problem you'd have to see it over not just one – different asset sizes but you'd also have to see it over time frames that were different in order to make an intelligent answer.

Mr. Sirri: We're coming down to the end of our time so I think I'm safe in asking this one final question. Is there anything that the SEC could do to help independent directors in their jobs? Is there something that you would like from us? Is there something we're not doing that we should do or is there something we are doing that we shouldn't be doing to help in this process of getting more effective oversight from independent directors as regards to the fee-setting process?

Mr. Evensky: I'll take a shot. One would be changing the standards with which fees are judged to make a tighter band for independent directors to work within; two would be revisiting the form of disclosure information to the public so that they become part of the process in working with the independent directors and making competition more effective; and three, and the last one I haven't got a clue how to accomplish is to eliminate the total disconnect between the independent directors and the shareholders.

Mr. Pozen: I have to go back to the points I made in my original opening statement about hedge funds. Ultimately we're talking about performance. What we want to do here is to get to the middle class public shareholders of the United States who own mutual funds the best talent you can managing those funds. As I've said, the single most important thing that the SEC could do is to level the playing field a little more between mutual funds and hedge funds. It probably will never be fair and level but it's so disparate now that that is really a significant factor in terms of the quality of the performance that we really deliver to our shareholders. It's really a sad thing that the whole structure is geared to make it very attractive to a very small group of wealthy shareholders and not to the broad base of the American public.

Mr. Scott: Yeah, that comment could of course cut two ways. If you look at the performance of the hedge funds the management – the portfolio managers are more highly compensated and the performance is much higher, as well, even if you are doing it on a risk adjusted basis. Even if I do it in terms of Sharpe ratios and so on. I know there are some studies that are about to come out in which a universe of some 3,000 hedge funds, domestic and foreign, and their performance over a substantial period of time has been analyzed. So you could make the argument that maybe the change ought to be not that you extend regulation to your competitor, which is the usual way in which people who talk about level playing fields have in mind. But that perhaps there could be some rethinking of the nature of the incentive fee structure within the mutual fund industry, as well. I would just like to go back to the point that I opened with, that – you know, there are carrots and sticks. The emphasis tends to be on let's see if we can take a larger stick and, you know, and execute a few more and encourage the rest. I really think that there are limits as to how far and how effective that kind of an approach can ever be and that a more constructive as well as a more palatable way to think about it is what are the things within the framework of the SEC's say current regulatory authority that independent directors would, if you surveyed them and talked to them and so on, knowing your constituents, would say that it would be helpful in their performance of their responsibility. One thing it seems to me is to – you have to go beyond asking the questions. You have to go to the level of what do you do with the information? How do you process the information? Then what is the role that you are going to play? If you have the bargaining agent model rather than the check on managerial extremes model what are the things that might strengthen that? That would take us into another panel or another discussion.

Mr. Sirri: John, do you want to have a quick last word?

Mr. Markese: Yes. Number one, I don't think it's fantasy to think that we can have share representation among the individual investors. There's some communication process. I think it's within the power of the SEC and their purview to do so. Secondly, I think NASD and the SEC have had an initiative to define what just is an independent director when it comes to audit committees of corporations and the board of directors. I think probably the SEC can do the same thing for the independent directors of mutual funds. Thank you.

Mr. Sirri: You know, by no means I don't think we did not cover ever topic. We did not spend as long as we would have liked to on every topic. But I certainly think that our panels did a fine job in giving us their candid and honest responses and I'd like to thank them. Thank you very much.

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