The Regulation of Mutual Fund Boards of Directors: Financial Protection or Social Productivity?

Abstract:     
Section 2(a)(19) of the Investment Company Act classifies directors of mutual funds and other types of investment companies as either interested or not interested. Under section 10(a) of the Act, directors who are deemed not interested by section 2(a)(19) must comprise at least 40% of the board of a registered investment company, and rules of the Securities and Exchange Commission require a higher percentage. The preceding sections of the Act and rules of the Commission are based on the assumption that only non-interested directors consistently protect the shareholders of investment companies from financial exploitation. The assumption exists even though all directors, regardless of their classification by section 2(a)(19), are subject under state law to the same fiduciary duties and to the same test for determining whether they breached a fiduciary duty. Notably, social science studies on the accuracy of the assumption have reached contradictory conclusions. Because a considerable body of research casts doubt on the effectiveness of law as a mechanism to regulate social behavior in general, the instant article suggests that law manifesting the assumption does not markedly reduce the frequency with which investment company shareholders are financially exploited but, instead, benefits society in ways captured by the concept of social productivity. In particular, the article hypothesizes that such law serves as a symbol of a commitment by society to combating shareholder exploitation and thereby aids in bonding individuals to the society. Such law can also be expected to preserve public trust in, and protect the reputation of, investment companies. Under this reasoning, law on investment companies is important because of its sociological effects, not because of its economic impact.

Number of Pages in PDF File: 63

Keywords: mutual funds, boards of directors, investment company act

JEL Classification: K2, G28, K29

Accepted Paper Series