By Amy Leisinger, J.D.
The Independent Directors Council filed a supplement to its comment letters on the SEC’s proposals regarding liquidity risk management and funds’ derivatives use. According to the IDC, both proposals raise issues regarding the fund boards’ oversight role and the responsibilities of independent directors, and the SEC should hold a roundtable to provide a forum for a full discussion of fund governance and appropriate parameters for directors’ oversight responsibilities. The Commission must be cautious against imposing management functions on directors that contradict their stated duties, the group stated.
Liquidity risk management proposal. The SEC proposed a new rule and amendments to promote effective liquidity risk management and to reduce the possibility that funds will be unable to meet redemption obligations and mitigating dilution of the interests of fund shareholders. The Commission proposed new Rule 22e-4, which would require each registered open-end fund, including open-end exchange-traded funds but not including money market funds, to establish a liquidity risk management program. The SEC also proposed to permit a fund, under certain circumstances, to use swing pricing and to change disclosure requirements to give investors, market participants, and Commission staff improved information on fund liquidity and redemption practices.
Derivatives use proposal. The SEC proposed rules to enhance regulation of the use of derivatives by registered investment companies. Specifically, the proposal would require each fund to comply with limitations on the amount of its leverage derivatives and other transactions and to manage risks associated with derivatives transactions by segregating assets in an amount sufficient to enable the fund to meet its obligations under stressed conditions. A fund that engages in more than a limited amount of derivatives transactions would also be required to establish a formalized derivatives risk management program under the rule. The proposed reforms would also address funds’ use of financial commitment transactions by requiring funds to segregate certain assets to cover their obligations.
IDC on directors’ role. According to the IDC’s comments, directors are most effective when they can provide an independent perspective regarding management decisions without direct day-to-day involvement in the process. Board members need to focus on the oversight of forest, not the individual trees, the group continued, and participation in daily management matters is not where they can add value.
The SEC needs to consider which obligations can be appropriately imposed on independent directors and which activities go too far into management function, the IDC explained. In the past, the Commission has imposed specific responsibilities on independent directors when a matter involves a conflict of interest, the group noted, but the two proposals do not present conflicts that warrant independent scrutiny. In fact, according to the IDC, the interests of a fund’s adviser and the fund are typically aligned in matters of liquidity management and limitations on derivatives use. In addition, under the proposals, directors would have to develop deep understanding of technical matters, which could divert their focus from the matters most important to shareholders, the IDC stated.
According to the group, imposing specific managerial obligations could also set directors up for failure in making on-the-ground managerial decisions and increase the potential for liability. Moreover, managerial responsibilities on board members could lead to overemphasis on directors with subject-matter expertise, thereby limiting the pool of qualified candidates. The SEC should consider how the existing Rule 38a-1 oversight framework for boards addresses the proposals’ concerns and whether the proposed changes would create uncertainty in relation to current compliance programs, the IDC said.
The Commission must clearly draw the line between board oversight and day-to-day management, the IDC concluded.