Roundtable on the role of independent investment company directors:

Issues for Independent Directors of Bank-Related Funds, Variable Insurance Product Funds and Closed-End Funds

By Diane E. Ambler *
The Business Lawyer, American Bar Association | November, 1999
55 Bus. Law. 205

* Ms. Ambler is a partner with Mayer, Brown & Platt in Washington, D.C. C. Dirk Peterson, an associate in the D.C. office of Mayer, Brown & Platt, co-authored the section on bank-related funds. Thomas E. Bisset, counsel in the D.C. office of Mayer, Brown & Plaff, co-authored the section on variable insurance funds. Beth R. Kramer, counsel in the New York office of Mayer, Brown & Platt, co-authored the section on closed-end funds. The authors wish to express their appreciation to Kristin H. Smith, Monica S. Amparo, and Michael G. Palek for their contributions to this Article.

LENGTH: 24502 words

INTRODUCTION
The independent directors who are members of a board of directors (Board) of a registered investment company (or mutual fund) n1 serve a central role, by virtue of their independence from management, in the operation of the mutual fund under the Investment Company Act of 1940 (1940 Act). n2 The Commission has expressed the view that “the disinterested representation of shareholders in the management of investment companies constitutes an important investor protection.” n3 Judicial decisions also have emphasized the investor protection aspect of independent directors’ duties, characterizing independent directors as “independent watchdogs” whose role is “looking after the interests of the fund’s shareholders.” n4 The scope of the role of independent directors has been the focus of recent public attention. n5 The discussion below relates to the role of independent directors of three specific fund types: bank-related funds, variable insurance product funds, and closed-end funds.

A bank-related fund has been defined very generally as “[a] fund that is managed by a bank or sold through bank distribution channels . . . subject to certain restrictions . . . under the banking laws.” ABA SECTION OF BUSINESS LAW, FUND DIRECTOR’S GUIDEBOOK 73 (1996) [hereinafter FUND DIRECTOR’S GUIDEBOOK].

Issue: Do the bank exclusions from the federal securities laws create any unique issues requiring special review or monitoring by the independent directors of the Board of a bank-related fund?

Conclusion: Generally speaking, a bank, or an affiliate of a bank, acting as distributor of or adviser to a mutual fund presents no materially unique issues to the independent directors of the Board. Obviously, the Board must be made aware of the limitations of the federal securities laws in connection with bank-related funds and should be apprised of specific aspects of those limitations as they may affect the mutual fund and its shareholders. Nevertheless, in the absence of contradictory evidence, the Board, and its independent directors, would be justified in relying on the representations of the mutual fund’s distributor and investment adviser as to their compliance with the existing regulatory structure that Congress, in its wisdom, has determined sufficiently protects mutual funds and their shareholders.

BANKS UNDER THE FEDERAL SECURITIES LAWS

The Securities Exchange Act of 1934

National banks, member state-chartered banks and trust companies, and nonmember state chartered banks (but not thrifts or credit unions) rely on the bank exclusion from the definition of “broker” n7 and “dealer” n8 in the Securities Exchange Act of 1934 (Exchange Act), n9 in performing their securities brokerage functions. As excluded banks, they are not subject to registration with or regulation by the Commission or the National Association of Securities Dealers, Inc. (NASD) as a broker or a dealer. n10 An affiliate of an excluded bank that acts as a broker-dealer does not itself fall within the bank exclusion and is subject to Exchange Act and NASD regulation.
….
Citation:

n111 Some 80% of domestic closed-end equity funds and 86% of foreign equity funds trade at discounts to their net asset values, far more than the half of all closed-end funds that historically traded below net asset value. These discounts can be wide, currently averaging about 15% and running as high as 35%. See Periodic Repurchases by Closed-End Management Investment Companies Redemptions by Open-End Management Investment Companies and Registered Separate Accounts at Periodic Intervals or with Extend Payment, Investment Company Act Release No. 18,869, [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) P85,022, at 83,160 n.10 (July 28, 1992) [hereinafter Release No. 18,869]; Alyssa A. Lappen, Why Closed-End Funds Will Survive, INSTITUTIONAL INVESTOR, Oct. 1998, at 220; see also PROTECTING INVESTORS, supra note 3, at 432-36; Eric Balchunas, CDA/Weisenberger to Provide Daily NAVs for Closed-End Funds, FUND ACTION, Aug. 4, 1997, at 1 (stating that the average closed-end fund has been trading at a 13% discount over the past two years); Paul J. Lim, Thinking Foreign? Closed-End May Be the Ticket, L.A. TIMES, Nov. 3, 1998, at C6 (stating that the typical closed-end emerging markets stock fund is trading at a 16.1% discount to net asset value).

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Securities Trading Via the Internet

By Paul D. Cohen*
Stanford Journal of Law, Business and Finance | Winter, 1999

LENGTH: 19386 words

* Duke University, B.A., 1992; Washington University School of Law, J.D., 1996; Washington University John M. Olin School of Business, M.B.A., 1997. I would like to express my appreciation to Professor John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University School of Law, for his insights and suggestions; to Ms. Ann D. Wallace, Special Associate Director, Division of Corporation Finance, U.S. Securities and Exchange Commission, for her advice and inspiration; to Kevin Coenen, Kirkland & Ellis; and to Scott J. Golde, Greensfelder, Hempker & Gale, for their comments.

SUMMARY:
… Moreover, new economic approaches to investing have led to modernized trading strategies. … All types of investors have access to an Internet-based bulletin board to trade securities. … One crossing system promises to provide investors access to a database of offers to buy and sell as well as the ability to communicate with other investors. … These markets will enhance an investor’s ability to trade securities in short periods of extreme trading. … Implementing the tiered approach to regulation of Internet-based trading systems would require the SEC to use an expanded application of the “limited volume” exception for exchange registration. … The proposed rules would permit Internet-based trading systems to choose between regulation as a national securities exchange and regulation as a broker-dealer with additional requirements depending on their activities and level of trading volume. … For those exchange-listed and NASDAQ securities in which a system has five percent or more of the trading volume, Regulation ATS requires Internet-based trading systems registered as broker-dealers to publicly disseminate through a registered exchange or the NASD their best priced orders, including institutional orders. … The regulations also prohibit unfair discrimination by an Internet-based trading system that has twenty percent or more of trading volume. …

Citations:
n10 David P. Brown, Why Do We Need Stockbrokers? 52 FIN. ANALYSTS J. 21 (1996). The Designated Order Turnaround (DOT), technologically updated with the SuperDOT system, permits exchange members to forward orders of up to 100,000 shares to the trading floor electronically. Nyquist, supra note 2, at 298, 318. Other markets also offer automatic routing systems. Id. at n. 86. Money managers often use electronic networks such as SuperDOT, which charge 2.5 cents per share, because of the price advantages they offer. By using these systems, money managers also reduce or avoid market impact. Use of SuperDOT accounts for 80% of the orders placed on the NYSE and more than half of the NYSE’s annual share volume that measures 74.4 billion shares. Alyssa A. Lappen, The Cost of Inefficiency, MONEY MANAGEMENT, [Institutional Investor] Mar. 1995, at 65. For further discussion of these systems, see LOUIS LOSS & JOEL SELIGMAN, 5 SECURITIES REGULATION 2556, 2557-58 (1990).

Corporate Governance Out of Focus: The Debate Over Classified Boards

By Richard H. Koppes, Lyle G. Ganske and Charles T. Haag
Business Lawyer | Vol. 54, No. 3, 1999

Note:
4: See Alyssa A. Lappen, “America’s Top 300 Money Managers,” INSTITUTIONAL INVESTOR, July 1, 1998, at 87.

The Siskel and Ebert of Financial Markets?

Two thumbs down for the credit rating agencies
By Frank Partnoy
Washington University Law Quarterly | Vol. 77, No. 3, 1999

notes 228 and 236 cite:
Alyssa A. Lappen, “Extra Lot,” Institutional Investor, Aug. 1993, p. 37

Crony Environmentalism

By Bernard Issel
Non-profit Accountaibility Project | June 1999

Note 123: Alyssa A. Lappen, “A chip off the old block,” Forbes, p. 120, Apr. 16, 1990

Corporate governance out of focus:

The Debate Over Classified Boards

By Richard H. Koppes, Lyle G. Ganske, and Charles T. Haag *
The Business Lawyer, Vol. 54, No. 1023
American Bar Association | May, 1999

LENGTH: 18769 words

* Mr. Koppes is of counsel in the Sacramento, California office of Jones, Day, Reavis and Pogue (Jones Day) and a consulting professor of law at the Stanford University Law School. He is former deputy executive officer and general counsel of the California Public Employees’ Retirement System (CalPERS). Mr. Ganske is a partner, and Mr. Haag an associate, in the Cleveland office of Jones Day. The views expressed in this Article are solely the personal views of the authors. The authors wish to thank Joseph D. Hatina and Adam R. Beringer for their assistance in the preparation of this Article.

For those concerned that Mr. Koppes has lost some of his activist views, he notes that he remains a strong proponent of shareholder votes on poison pills and the repricing of stock options (at least for officers and directors), as well as an independent board chairperson and/or a lead director position.

INTRODUCTION

Shareholder activists have rallied in recent years to declassify U.S. corporate boards. n1 The rally is based predominantly on the argument that the annual election of directors ensures a higher level of accountability to shareholders. n2 Curiously, the same shareholder activist groups advocating or supporting annual elections to ensure accountability usually are led by classified boards of directors. n3 Are these boards of directors, often in charge of multibillion-dollar pension funds, n4 less in need of accountability controls than U.S. corporations? The answer, which most would agree is obvious, discredits the assertion that accountability and the desire for good corporate governance is the driving force behind the move to repeal classified boards. The key significance of a classified board, and the key reason certain shareholder activists seem to be fighting to eliminate them, is that classifying a board of directors greatly improves the ability of a corporation to defend itself against unsolicited takeover bids and proxy fights. n5

While a classified board can prevent a high-premium unsolicited takeover proposal from being successful, n6 the evidence continues to be inconclusive regarding the impact that a classified board has on a corporation’s share value. n7 Given the ambivalence of empirical studies, it seems premature for corporations to abandon classified boards in all circumstances, and thereby eliminate an important tool that can be used to negotiate higher share premiums in a takeover contest. In addition, classified boards can be valuable for corporations in other ways, including promoting the continuity, stability, and independence of the corporation’s leadership and allowing the board to focus on long-term strategies to improve shareholder value. n8 The foregoing arguments, with the exception of defending unsolicited takeover bids, are essentially the same arguments that shareholder activists would be expected to use to justify their own use of classified boards.

The first part of this Article reviews the history of classified boards, including a review of the legal framework that enables their adoption and guides any attempt to repeal them. The Article then takes a look at the environment that led to the recent movement by shareholder activists to repeal classified boards. This section also reviews recent specific proposals by shareholder activists to repeal the classified boards at two major U.S. corporations. The Article considers the arguments for and against classified boards, finding that benefits of structuring a board in staggered classes apply equally to corporations and governmental and regulatory bodies, including certain institutional investors, that choose to classify their directors. This part also acknowledges the value of good corporate governance, but raises the question of whether declassifying the board is really connected to the core of good governance. Finally, the Article emphasizes that shareholders’ efforts would be better spent encouraging better corporate governance practices by directors and management than attacking classified boards, which can be effective and useful tools for corporations to maximize shareholder value.

Citations:
n4 Shareholder activist pension funds having classified boards (with the dollar amount under management in parentheses), include: CalPERS ($ 81.5 billion), the Public Employees’ Retirement Association of Colorado ($ 15.2 billion), TIAA-CREF ($ 209.6 billion), the Teachers’ Retirement System of Ohio ($ 38.6 billion), and SWIB ($ 25.3 billion). See Alyssa A. Lappen, America’s Top 300 Money Managers, INSTITUTIONAL INVESTOR, July 1, 1998, at 87.