Mary Jo White, Chairperson of the Securities and Exchange Commission, said in a speech before the Mutual Fund Directors Forum 2016 Policy Conference that “most” directors of mutual funds “should not fear enforcement.” This is because, she noted, “judgments made in good faith based on responsibly performing their duties will not be second guessed.” However, she cautioned, “being a director … does not provide immunity from charges. When directors fail to perform their duties they should expect action to punish and deter such conduct.” Ms. White referenced the facts underlying two recent SEC enforcement actions as example of the type of conduct where directors might expect to be charged for wrongful conduct by the SEC: one where the directors allegedly did not, as required by law, approve any fair valuation methodology for securities in a fund and review the use of an approved methodology on an ongoing basis, and another where the directors did not request and consider information that is “reasonably necessary” for the board to consider an advisory contract – a core requirement of directors, according to Ms. White. (Click here to access the SEC order of settlement In the Matter of Kenneth Alderman and here to access the SEC order of settlement In the Matter of Commonwealth Capital Management, the two matters referenced by Ms. White.) Ms. White acknowledged that these cases “generated some controversy” but claimed that “the facts involved should reassure conscientious directors." According to Ms. White, “[t]he message of these cases is simply that independent directors must be familiar with and carry out their responsibilities.” (Click here for further details regarding the SEC's Commonwealth Capital Management order in the article, “Investment Adviser and Mutual Fund Board Members Sued by SEC for Inadequate Advisory Contract Approval Process” in the June 21, 2015 edition of Bridging the Week.)
Compliance Weeds: The requirement that an investment company’s board members request and evaluate information “as may be reasonably necessary” to appoint an adviser is established by statute (Section 15(c) of the Investment Company Act; click here to access). Thus the failure of board members to follow this requirement, including following up when incomplete information was provided in response to a request for information, may be deemed a violation of law, as the SEC charged in the second matter referenced by Chairperson White. However, not following up on incomplete or facially inaccurate information in response to anyinternal investigation or review, or due diligence inquiry, could cause later regulatory issues for any regulated firm or person, whether the initial request was mandated by law or not, if something bad happens and later it is thought that review of the missed information might have “reasonably” prevented a regulatory incident. However, the determination of reasonableness will likely only be determined after the fact. Be mindful!