Enhanced Corporate Governance for Mutual Funds: A Flawed Concept that Deserves Serious Reconsideration
Enhanced Corporate Governance for Mutual Funds: A Flawed Concept that Deser ves Serious Reconsideration
Martin E. Lybecker 0 1
Recommended Citation
0 Martin E. Lybecker, Enhanced Corporate Governance for Mutual Funds: A Flawed Concept that Deserves Serious Reconsideration, 83 Wash. U. L. Q. 1045 (2005). Available at: https://openscholarship.wustl.edu/law_lawreview/vol83/iss4/5
1 Thi s F. Hodge O'Neal Corporate and Securities Law Symposium is brought to you for free and open access by the Law School at Washington University Open Scholarship. It has been accepted for inclusion in Washington University Law Review by an authorized administrator of Washington University Open Scholarship. For more information , please contact , USA
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* Martin E. Lybecker is a partner of Wilmer Cutler Pickering Hale and Dorr LLP, located in
Washington, D.C., and is a Senior Lecturing Fellow in Law at Duke University. Wilmer Cutler
Pickering Hale and Dorr LLP represents or has represented some of the entities mentioned in this
Article. This Article bears a date of December 15, 2005.
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INTRODUCTION
Mutual funds1 are the most popular retail investment in America,2 a
testament to the simplicity and transparency of the mutual fund concept. A
mutual fund investor owns a share of common stock issued by a company
that invests in debt or equity securities issued by other operating
companies.3 Like operating companies, a mutual fund distinguishes itself
by its business objective—for example, to exceed the Standard & Poor’s
500 Index (an equity fund), to match the Lehman Brothers Aggregate
Bond Index (a bond fund), or to maintain a current net asset value of $1.00
1. Technically, a mutual fund is an open-end management company registered with the
Securities and Exchange Commission (“SEC” or “Commission”) under
the Investment Company Act
of 1940
, 15 U.S.C. §§ 80a-1 to -52 (2000) (the “Investment Company Act”). An “open-end company”
is a management company that issues a redeemable security. 15 U.S.C. § 80a-5(a)(1). The term
“redeemable security” is defined in section 2(a)(32) of the Investment Company Act to mean a
security the terms of which entitle the holder, upon presentation, “to receive approximately his
proportionate share of the issuer’s current net assets, or the cash equivalent thereof.” 15 U.S.C. §
80a2(a)(32). Management companies are divided into two categories: “diversified companies” and
“nondiversified companies.” 15 U.S.C. § 80a-5(b). A “diversified company” has at least seventy-five
percent of the value of its total assets invested in “cash and cash items (including receivables),
Government securities, securities of other investment companies, and other securities,” but no more
than five percent of the value of the total assets of the management company can be invested in any
one issuer and such investment cannot exceed ten percent of the issuer’s outstanding voting securities.
15 U.S.C. § 80a-5(b)(1). A “non-diversified company” is “any management company other than a
diversified company.” 15 U.S.C. § 80a-5(b)(2). A closed-end fund is any management investment
company other than an open-end fund. 15 U.S.C. § 80a-5(a)(2). After the initial public offering, shares
of a closed-end fund trade like shares of an operating company: they can be listed on an exchange,
traded in the over-the-counter markets, or bought and sold in direct transactions between individuals or
institutional investors. DIV. OF INV. MGMT., SEC, PROTECTING INVESTORS: A HALF CENTURY OF
INVESTMENT COMPANY REGULATION 423 (1992). The corporate governance issues facing the boards
of directors of closed-end funds are beyond the scope of this Article, as is the general topic of
corporate governance for operating companies.
2. See INV. CO. INST., 2004 MUTUAL FUND FACT BOOK 79–83 (2004).
3. A mutual fund that invests in shares issued by other investment companies is known as a
“fund of funds.” See Martin E. Lybecker, Fund of Funds: The 1996 Act and Related Industry
Developments, INVESTMENT LAW., Jan. 1997, at 33.
2005]
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per share (a money market fund).4 Unlike an operating company that is
managed by its officers and employees, most mutual funds are managed
by an external investment adviser, pursuant to a contract. In recognition of
the obvious conflict of interest between a mutual fund and its investment
adviser because of or resulting from that contract,
the Investment
Company Act of 1940
(“Investment Company Act”)5 has always required
that at least forty percent of the members of the mutual fund’s board of
directors be independent.6 In July 2004, the Securities and Exchange
Commission (“SEC” or “Commission”), in a three-to-two vote,7 amended
certain existing exemptive rules (the “Corporate Governance
Amendments”) to require that no less than seventy-five percent of the
members of a mutual fund’s board of directors be independent, that the
chairman of the board of directors be an independent director, and that the
board of direc (...truncated)