Continuous self assessment is key to building strong boards

Careful succession planning and broad recruitment for the right skills are important; so are tough conversations about individual strengths, weaknesses and the impact of the board as a whole

As markets change, activists prowl and new regulations come and go, one concern remains constant for fund directors: how do boards ensure they have the right talent to meet the challenges that face them?

When it comes to wrestling with board composition, trustees should remember that their task is never done, nor can it be reduced to a single meeting, according to experts.

“If they’re doing their jobs right, it’s not just an episodic, week-long kumbaya of holding hands,” said George Wilbanks, founder of Wilbanks Partners executive search firm. “That’s one of the things that keeps you out of trouble in terms of the ability to spot succession needs, to have prospects in the pipeline that are interesting and to have identified these areas of skill deficits and be working on it.”

Besides the skills evaluation process, mutual fund boards also need to consider how to handle underperforming board members, policies for mandatory retirement or term limits, and other decisions in building out a well-rounded set of skills and a diverse membership.

Strengths and weaknesses

To identify skill gaps and to plan for upcoming retirements or rotating committee assignments, fund boards can either perform a self-assessment or bring in an independent professional to make the assessment based on talking to the directors individually or as a group, said Carl Frischling, partner at Perkins Coie. The assessment can also include a “360-degree” review where each director is asked to describe the strengths and weaknesses of all the other board members, he said.

If the self-assessment determines that the skillset of an individual board member is falling short, then the board may bring in an expert from management or from the outside to educate the board as a whole or individuals. But unless a board member is simply unable to perform–because of a major sickness, for example—typically they aren’t removed for a deficit of skills in a particular area, Frischling said.

The ouster of a board member based on a skills evaluation is rare, agreed Carolyn McPhillips, president of the Mutual Fund Directors Forum.

“There are a few boards that do it, so it’s not entirely unheard of, but I think it’s not mainstream among fund boards,” McPhillips said. “Those kinds of evaluations can be used to evaluate your board and see if there’s somebody who maybe should consider stepping down, and you can use them to facilitate turnover. But they’re not widely used across the fund board community.”

Through their SEC-required annual self-assessment process, most mutual fund boards create a grid or matrix of the skills they need on the board and their grades for their existing skill levels, Wilbanks said. “The searches are usually guided by that; trying to fill the skillset hole.”

The skills matrix approach has been more commonplace for fund boards over the last five years, as they have been more deliberate about examining their board members’ skills and identifying skill gaps, McPhillips said.

In addition to skills in areas of financial acumen and specific industry issues, board members should also evaluate how well they work with each other—an area that an external evaluator can’t really judge, Frischling said. “That’s something that you really have to do internally and basically be honest with yourself as to how [good] you are at working together.”

Another key requirement for a mutual fund board member is to understand their role—that they are overseeing service providers and dealing with contract renewals, and not hiring, firing and overseeing people as a corporate board member does, Frischling said. “That nuance, which doesn’t exist in the corporate world, is something that has to be understood,” he said.

New board members also have to understand the time commitment and that the time spent at board meetings is just a fraction of the total work involved, with time spent between meetings reading up and staying current on industry topics or attending conferences and seminars, he said.

If the skills evaluation turns up an area of weakness for the board, the board then must decide whether to “rent or buy” the expertise—rent meaning bringing in an outside expert to speak with the board or management, or “buying” the expertise by adding a new board member with those skills, Frischling said.

Currently, Wilbanks said, the three skill areas in most demand by mutual fund boards recruiting new members are in investments—people with an investment background and a good understanding of the complexities of global markets; technology, including cybersecurity and tech for digital marketing, trade processing and portfolio construction; and distribution, including an understanding of digital marketing. Most boards already have a former lawyer or accountant who worked with mutual funds.

Typically a board’s nominating and governance committee administers the skills assessment, and though its label is “annual review,” it should be a continuous, year-long process that encompasses succession planning, recruiting, networking for good candidates, making sure that existing board members are actively engaged in the industry and making use of continuing education, Wilbanks said.

Limiting board service

Of the two objective means for creating turnover for independent directors—mandatory retirement ages and term limits—retirement ages are most common. –

Six years ago, the typical mandatory retirement age for mutual fund directors was 72, said Jay Keeshan, partner at Management Practice. That change tracks with how views on aging were changing in American culture and with what corporate boards were doing–corporate boards started moving their mandatory retirement age to 75, and mutual fund boards quickly followed suit, he said.

The percentage of boards with mandatory retirement ages has been holding steady for about 10 years. “Some boards like to leave it a little open because there are some directors well into their eighties who are serving and it just seems to work for them,” Keeshan said. “A director who has served for 30, 35 years is hugely valuable and in many cases will just have incredible knowledge that the shareholders probably benefit from.”

Meanwhile, term limits for mutual fund board members are “hugely, widely discussed, but rarely implemented,” Keeshan said. He estimates that 5 percent of the mutual fund boards—or at most 10 percent–have term limits for their directors, and 15 years is the most typical length. A similar percentage have director emeritus plans in place, where a retired director can stay on in a non-voting capacity to mentor new directors or advise the board in general.

In the last five to 10 years, more and more boards have been getting ahead of vacancies by taking on board member before a seat comes open from a retirement or term limit, sometimes added the new board member as a non-voting member, initially, Keeshan said.

While mandatory retirement ages and term limits help guarantee a constant flow of “fresh blood” on a board, they can also be disruptive, Keeshan said. “It takes a while for a director to get up to speed and then they get going and they’re serving and 15 years goes by pretty quick and then suddenly they’re out the door and there’s a complete loss of all of that background and institutional knowledge.”

One strategy to soften a mandatory retirement policy is to require that a board member to submit a letter of resignation at the retirement age, but then leave it up to the board to vote whether to accept the resignation. In effect, the board can extend that director’s term for another year or few years.

Boards should consider granting waivers to retirement age or term limit policies for board members who are still highly effective, McPhillips said, but that also has its drawbacks. “Once you make an exception, it’s hard to make everyone else adhere to the objective standard that you’ve set.”

The benefit of mandatory retirement ages and term limits is that they are completely objective, so “you’re not making personality-driven decisions about who’s staying on the board and who is going off of the board,” McPhillips said. And, short of adding seats to a board, it will be otherwise difficult to change the diversity for a particular board.

Even with mandatory retirement and term limits, a board member can become less effective before their retirement age or the end of their term. “The really hard part is dealing with individuals who haven’t reached that age limit and somehow are not doing the best possible job,” said Faith Colish, who served an independent director for Neuberger Berman funds for more than 30 years.

In the case of a non-performing board member, the responsibility typically lies with the board chair to manage the situation, Keeshan said.

“It’s a very tricky situation,” he said. “It may simply be the chair just sets up a meeting and has a very frank discussion to discuss what’s going wrong. It may be a disruptive issue; it may be a lack of participation and preparation, or it may be that the director is sort of slipping.”

Boards that forego mandatory retirement and term limit policies can take better advantage of valuable experience that their board members have banked over the years, Colish said, but they also have to be prepared to make painful decisions without the safety net of the mandatory policies.

“As a director, you’re a fiduciary and your obligation is to the fund as an entity and, indirectly, to the shareholders,” Colish said. “That always has to be your Pole star. So if this person is taking money for being a director, but you’re not getting your money’s worth, that’s not good for the fund and it’s not good for the shareholders.”