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Why Have Mutual Fund Independent Directors Failed as “Shareholder Watchdogs”?
... For additional insights into the issues discussed, see Birdthistle [2006], Bullard [2006], Edelen, Davis, and Kadlec [2007], Gil-Bazo and Ruiz-Verda [2008], Greene and Ciccotello [2006], Haslem [2008], Palmiter [2006], and Zitzewitz [2003 and. ...
The 2003 mutual funds scandal that exploded upon the public revealed something that had long been known
to insiders: Mutual fund advisers often approve and allow frequent trading, frequent trading arbitrage, and late trading arbitrage to selected traders. To increase adviser profits, fund advisers often require approved arbitrage traders to make “sticky asset” purchases of fund shares to “grow” fund assets. These costly mutual fund adviser practices increase transaction costs along several dimensions and lower current fund and shareholder assets, along with opportunity costs of dilution in fund share values and returns to long-term shareholders. Independent directors have either not been informed or have acquiesced in the decisions. In any case, independent directors have not performed their primary fiduciary duty as “shareholder watchdogs.”
This study uses the portion of a new Total Expense Ratio construct that discloses the reality of adviser/distributor payments of distribution fees (hidden) to sales brokers behind the mutual fund curtain. Distribution fees consist of dealer (broker) concessions, account servicing (12b-1) fees), types of revenue sharing payments, and soft-dollar trades. Distribution fees are one of four categories in the Total Expense Ratio, the others being (1) management fees, (2) other expenses, and (3) transaction costs. Distribution fees and their sub-categories are the scope of this study, but adoption of the complete Total Expense Ratio would provide mutual fund investors with normative transparency of disclosure of its four categories and their sub-categories. Such transparent disclosure would provide necessary, but not sufficient, conditions for complete adoption of transparent disclosure to the full scope of fund adviser managerial and regulatory practices and decisions. Adoption of the complete Total Expense Ratio with normative transparency of disclosure followed by prohibition of 12b-1 fees, revenue sharing payments, and soft-dollar trading requires strong action by fund independent directors, the fund industry, and, most importantly, by Congress and the SEC. Only a few fund advisers are likely to join in this effort to change their very profitable status quo. But, fund shareholders deserve to receive their fiduciary protections under law.
This study uses a new database to describe the composition and compensation of boards of directors of U.S. open-end mutual funds. We use these data to examine the relation between board structure and the fees charged by a fund to its shareholders. We find that shareholder fees are lower when fund boards are smaller, have a greater fraction of independent directors, and are composed of directors who sit on a large fraction of the fund sponsor's other boards. We find some evidence that funds whose independent directors are paid relatively higher directors' fees approve higher shareholder fees.