Persons who serve as directors of mutual funds are reminded of their obligations to the funds and the funds’ shareholders by a recent SEC enforcement filing against several individual fund directors whose allegedly ineffective governance activities caused violations under the Investment Company Act of 1940. The funds involved were RMK High Income Fund, RMK Multi-Sector High Income Fund, RMK Strategic Income Fund, RMK Advantage Income Fund, and Morgan Keegan Select Fund.

According to the SEC’s complaint filed recently against eight former members of the board of directors of five registered mutual funds based in Memphis, Tennessee, the directors delegated their responsibility to a valuation committee for determining the fair value of securities held by the funds which were not marketable. In each of these funds, a majority of the assets consisted of securities with no public market, making the determination of the fair value of such securities imperative if the funds’ net asset value was going to be a meaningful number in determining the value of the shares on an ongoing basis. According to the SEC’s complaint, the failure of the directors to adopt and implement appropriate fair valuation methodologies and procedures and having ineffective controls over financial reporting resulted in the funds’ violations of certain requirements under the Investment Company Act of 1940.

According to the SEC’s complaint, the funds’ net asset values were materially misstated for about a five-month period in 2007 due to the directors’ inaction and/or ineffective action. As a result, the prices for purchases and redemptions of the funds’ shares during the period were inaccurate.

The charges in this matter demonstrate the SEC’s concern with fair pricing methods employed for both publicly registered and private funds. Those persons who serve as directors of funds need to adopt effective and reasonable policies for determining fair value and then follow-up to ensure that the implemented policies have been administered. In addition, the directors need to review those policies periodically and fine-tune them as warranted, to ensure that the methodology utilized is effective in determining fair value of securities where no public market is present.