There was little suspense when Fund Directions set out to ask fund directors what topics they were thinking about headed into 2024.
The concern at the top of most trustees’ lists was the same as it has been all year: Namely, after another year of breakneck rulemaking and enforcement, will the SEC continue adding to funds’ regulatory and compliance burdens?
“The first thing I’m thinking about is whether or not the tidal wave or tsunami of regulation coming out of the SEC is going to accelerate, abate, or simply remain at its feverish pace,” said Tom Seip, independent chair of the Neuberger Berman Funds.
Some trustees remained hopeful the SEC might soften its often-aggressive tone after provoking historic industry pushback this year, but few expected it to ease up on the pace of its rule rollout during 2024.
Boards still reeling from having implemented the valuation and derivatives rules in 2022 are readying to see two more rules move up their agenda.
Funds will have until July 2024, for instance, to comply with the tailored shareholder report rule adopted in 2022. The rule requires fund advisers to streamline their annual and semi-annual shareholder reports to highlight key information in a shorter and more concise format.
The work of complying with these requirements will mostly fall to fund advisers, but boards will want to stay apprised of how their shareholders’ access to information could change.
Trustees of the Morningstar Funds, for instance, have discussed how the updated reports will no longer include components like board diversity disclosures, which have long been a priority for the group, according to independent chair Theresa Hamacher.
“Are there other things that we want to communicate with shareholders about, and where would we do it?” Hamacher said. “It’s giving us a good opportunity to think about our communication with shareholders, in general … and is there some way that we, specifically the board, working with Morningstar can contribute to financial education in our communications?”
Meanwhile, boards are only starting to learn about the implications of the amended names rule adopted this September. It requires funds to define how they apply certain terms like “growth” or “value” in their names, as well as to periodically review their portfolios to make sure at least 80% of the fund’s holdings match their stated strategies.
While few expect the rule to result in a widespread overhaul of fund names, critics have described the rule’s requirements as vague and complained about the burden of conducting periodic due diligence on the accuracy of their funds’ names.
“It may not require any changes, but you’re going to have to check that,” said Adela Cepeda, independent trustee of the Mercer Funds and independent chair of the UBS Funds and the Morgan Stanley Pathway Funds. “The board is going to have to be satisfied that it’s done sufficiently.”
Between the names rule and the tailored shareholder report rule, boards will have plenty of implementation to oversee—even as some are still fine-tuning their implementation of the derivatives and valuation rules.
“What we hope for on our boards is that the regulatory climate will relax somewhat so that we can absorb all the rules and implement them properly,” Cepeda said.
Swing pricing: The proposal that galvanized boards into speaking out
And then there are the controversial liquidity rule amendments and swing pricing proposal for open-end funds, which dominated the industry conversation in 2023 and could dwarf all other board agenda items when the SEC adopts a final version next year.
Critics have argued the proposal, especially its requirement for a hard close, has the potential to permanently damage the mutual fund industry, while the SEC has defended it as a necessary corrective to liquidity vulnerabilities that were exposed in the market turmoil of March 2020.
“It’s just going to add to costs. I don’t know who benefits from that,” said Arnold Reichman, independent chair of the RBB Fund.
After turning out in unprecedented numbers to oppose the proposal this year, boards have little new to say about the most hotly contested piece of fund regulation in living memory.
“I think everybody’s just sort of waiting with bated breath,” Hamacher said.
At this point, observers can only speculate as to whether the SEC will adopt swing pricing as proposed or heed industry pleas and replace it with a less-controversial alternative, as it did in the final money market fund reform in July.
“By their actions in finalizing the money market rule without swing pricing in it, it gives me hope, but God only knows,” Seip said. “I just don’t know.”
If the SEC finalizes the swing pricing and hard close requirements, many believe industry groups would sue to have the rule overturned, which could generate courtroom drama and boardroom confusion.
“It’s important for the fund board to think about what happens if the SEC adopts swing pricing as it is proposed, and somebody out there challenges that rule,” said David Blass, a partner at Simpson Thacher who counsel fund boards. “They should be asking questions about what it means for the fund and whether the fund manager should be getting ready for the rule, if it’s been challenged in courts.”
“I wouldn’t be surprised to see if a lot of the [swing pricing provisions] meet with strong pushback from the industry,” Reichman said, adding that he generally approves of the SEC’s performance under Gensler and expects the agency will ultimately take a conciliatory approach.
“Wiser heads will prevail. Not all regulation is good regulation.”
Trying to wrap their heads around AI
The other major concern for boards heading into 2024 is artificial intelligence, which burst onto agendas this year after OpenAI’s ChatGPT debuted at the end of 2022.
Most boards have only just begun the process of educating themselves on the new technology, which has drawn the attention of both the SEC and state regulators this year.
“We’re going to have more discussions about that next year,” Cepeda said. “For sure.”
Unlike SEC regulation, which, despite all its uncertainty, can still be distilled into several discrete areas of concern, artificial intelligence poses a trickier problem because nobody yet knows how it will affect the fund industry.
“I’m real worried about artificial intelligence as it applies to the mutual fund world because there’s just so much I don’t know,” Seip said. “I don’t think at this point anybody really knows the reach of artificial intelligence in the investment management business, and really what to be worried about.”
The prospect of artificial intelligence being used in the fund industry has trustees wondering how to oversee its use by both asset managers and service providers, and a common theme of boards’ current attitudes toward AI appears to be wariness of embracing it too quickly.
“How is it that you force people to disclose that they’re using AI?” said James McMonagle, independent chair of the Clipper Fund and the Selected Funds. “Once you have that disclosure, then all of a sudden you have to make some determination as to what is the validity of [the AI-generated work]. Because AI has the ability to be confidently wrong.”
Artificial intelligence in 2023, much like websites in the ’90s, appears to be a nascent technology that may not have practical industry uses for years, Blass observed.
“We need to understand what it is and where it’s going, but I’m not sure it’s there yet,” he said.
The challenges of overseeing artificial intelligence could end up aligning with the way boards have decided to handle other areas driven by cutting-edge developments, such as cybersecurity and blockchain technology.
In general, that means balancing investments in board education and technological expertise with a reliance on management-side specialists who can report to the board. It could also mean practicing patience until knowing for sure that a new technology is worth investing in.
Blockchain, for instance, used to be a hot topic in boardrooms within the past few years, causing board members to ramp up education around the topic. But its prominence on agendas has receded since experts have found limited uses for it in the mutual fund industry. “Until we see a big application for it being proposed, then I don’t think there’s a lot of discussion around it,” Seip said of blockchain.
