New SEC regs seek to crack exclusive fund-director club

Mutual fund company executives say the Securities and Exchange Commission’s newly proposed fund governance rules address problems that don’t exist. Indeed, the agency has not cited any big blow-ups in recommending the changes.

But challenges against the independence of closed-end fund directors is another matter. These challenges, mounted mostly by professional investors, have resulted in a string of high-pitched confrontations.

The proposals aim to bolster the effectiveness of directors and help investors size up their independence.

But investors in closed-end funds — which have a limited number of shares and are valued like stocks, according to supply and demand — say they lack the bite to truly level the playing field.

Early last year, for example, Ronald Olin, president of Deep Discount Advisors in Asheville, N.C., led a successful shareholder proxy battle at Alliance Capital Management LP’s Austria Fund Inc. which ousted four directors, including Alliance chairman Dave Williams. The remaining pro-Alliance directors — including Mr. Williams’ wife — made an end run around the vote by expanding the board and reappointing the four losers.

The directors of the Austria Fund and Alliance’s Southern Africa Fund Inc. and Spain Fund Inc. have since adopted by-laws that increase the percentage of voting shares needed to call special meetings and to remove directors, and imposed strict new director qualifications that effectively disqualify most of the funds’ U.S. shareholders from serving on the boards.

“Shareholders are best served by having representatives on the board that represent their interests,” says an Alliance spokesman. “In our mind, that includes people with strong, well-established experience in the markets where the funds invest. In each one of these country funds, the directors often have served as a chairman of a listed company in the country, or representative of the government, and bring a great deal of perspective on the future and opportunities within these countries.”

Alliance isn’t alone in using this tactic: Directors of the Germany Fund Inc., New Germany Fund Inc. and Central European Equity Fund Inc. — all closed-end funds managed by Deutsche Bank Capital Corp. — adopted similar restrictions last month. Robert Gambee, chief operating officer and secretary of the funds, says that the bylaws were overhauled to reflect corporate law changes in Maryland, where the funds are domiciled, and that the new director qualifications codify existing practice.

“Blatant entrenchment tactics like establishing `qualifications’ so burdensome that [SEC] Chairman [Arthur] Levitt would not meet them are difficult to reconcile with the notion of independent directors who are supposed to be watchdogs for the shareholders,” closed-end fund shareholder activist Phillip Goldstein wrote last month in a letter to the SEC concerning its proposals to improve oversight by fund boards.

`it seems pointless’

“I think I am safe in predicting that the sort of proposals contained in the release will have no discernible effect on shareholder protection and will do nothing to pacify the critics of investment company governance,” added Mr. Goldstein, who runs a hedge fund in Pleasantville, N.Y., and serves as a director of the Clemente Strategic Value Fund Inc. “It seems pointless to compel additional disclosure that may suggest that a director is not all that independent when shareholders have no practical way to act on that information.”

Closed-end fund investors like Mr. Goldstein and Mr. Olin buy funds trading at steep discounts to their net asset value and then seek to gain by pressing for changes — such as share buybacks or conversion to an open-end fund — to narrow the discount.

“Instead of focusing on how many independent directors are on a board, one should focus on not creating impediments and roadblocks on shareholders putting alternate candidates up for board election,” says Mr. Olin, who currently serves as a director of the Austria Fund, Clemente Strategic Value Fund, Central European Value Fund and Portugal Fund.

swimming against tide

“But that doesn’t seem to be the direction in which people are moving,” he continues. “More and more of these funds are adopting bylaws and restrictions which make it more difficult for shareholders to exercise their will.”

But Donald Cassidy, a senior research analyst at Lipper Inc. in Denver, believes that the proposals could prompt closed-end fund boards to pay more attention to frustrated shareholders.

“Given that the SEC has put a spotlight on this area, it might prompt existing boards of directors to be more willing to listen to proposals than they had in the past,” he says. “At a minimum, there’s probably going to be a lot more documentation of the processes and the steps they take to decide on a proposal.”

Cynthia Fornelli, a senior policy adviser in the SEC’s division of investment management, says that none of the commission’s proposals are aimed at promoting changes in closed-end-fund governance structures.

But Mr. Goldstein is troubled by one proposed SEC rule change, which would drop a requirement that funds seek shareholder approval of the appointment of an outside auditor so long as they maintain an audit committee comprising independent directors.

Though shareholders rarely contest votes over the selection of independent accountants, Mr. Goldstein says it is important to keep open the possibility, citing the current government investigation of PricewaterhouseCoopers LLP for violating auditor independence rules. “This would send a message to all public accounting firms that there is a price to be paid for flouting the independence rules,” says Mr. Goldstein.

Mr. Goldstein says additional disclosure and access rules are needed to empower closed-end fund investors.

Among his recommendations: require directors to report annually any conflicts and how they were resolved; allow shareholders and the media to attend fund board meetings, or make fund board meeting minutes available to shareholders; and invite the fund’s largest shareholder to serve on the fund’s board.