June 1, 2020

Mutual Fund Boards Should Rethink Advice To Destroy Notes

A version of this article was published by Law360.

On April 30, 2020, the Mutual Fund Directors Forum (“MFDF”) -- an organization serving independent mutual fund directors -- released a sort of “guidance” on the use of board minutes and notes. [1] Its advice to directors may surprise you. 

The commentary arose from a question from a member/mutual fund director who noted that “[o]ver the last few meetings we have had some important discussions thatI carefully recorded in my notes and that have not appeared in the board minutes.”  (Note, for the analysis that follows, the use of the term “important.”) This director apparently spoke with counsel, who stated that “not all matters need to be reflected in the minutes in great detail” for “a number of legal reasons.”  The MFDF not only agreed with this analysis, but went even further.

First, as to board minutes, the MFDF acknowledged that they are the “official record of the board meeting,” but argued that they are “not expected to function as a transcript of the conversations,” and need only reflect “the actions taken and the essence of the board’s discussion and process in making its determinations and conclusions.”  The MFDF reasoned that “[t]here are several process, business and legal reasons why certain matters are not described in detail in minutes, and the decision is not driven simply by a fear of litigation.”  To drive this point home, it provided a seemingly incomprehensible (at least to this lawyer) example of why sparse minutes are superior: “A discussion can be one-sided and the boardroom discussion may not accurately reflect all of the information available at the time, for instance.” [2]

Second, as to director notes, the MFDF acknowledged that such notes are “contemporaneous writings” reflecting what happened during a board meeting (at least from one director’s viewpoint), albeit “not an official part of the corporate record.”  Nonetheless, the MFDF noted that such notes have previously “become part of the record during litigation,” and thus recommended a policy for destroying them regularly. Such notes, in the MFDF’s view, can be“cryptic and incomplete,” “can reflect inconsistencies [with the minutes],” and“can be misinterpreted under the scrutiny of litigation.”

Independent directors should pause to consider this advice before taking it. Clearly minutes are not intended to be transcripts, but the MFDF’s overly selective approach to recording the topics and discussions of a board meeting, coupled with its recommendation to destroy any other “contemporaneous writings,” could be troublesome for fund directors.

For example, it’s not clear that the SEC would agree with, or appreciate, this approach.  In a speech in 2004 on investment management compliance practices, the then-director of the SEC’sOffice of Compliance Inspections and Examinations identified a potential compliance problem with “board minutes [that] are vague or inadequate to record that fiduciary duty was met,” and stated that “[g]ood corporate governance policies and procedures would dictate that a fund compile and preserve an accurate and complete record of board meetings. With respect to board minutes and records, ‘the less said’ is not the better course.  In the absence of minutes and records that document board members' performance of their statutory and fiduciary responsibilities, our examiners will have to assume that little or no discussion was held.” [3]

The same type of trouble may haunt directors in other areas as well.  For example, the authors of one corporate governance treatise note that, in the context of a books and records demand, “[c]orporations and their counselors are recognizing . . . the fact that the production of poorly drafted minutes -- or nothing -- in response to a [books and records] demand can lead to complaints alleging, for example, that directors did not devote sufficient time to a particular decision and did not consider factors that may in fact have been considered but not recorded in minutes.” [4] 

Similar issues can also arise once a litigation is filed.  In an infamous case involving corporate directors under Delaware law, the court ultimately found -- after years of litigation and a trial -- that the directors had discussed and considered the agreement at issue for a “not insignificant length of time,” but noted that “[i]t would have been extremely helpful to the Court if the minutes had indicated in any fashion that the discussion relating to the [agreement] was longer and more substantial than the discussion relating to the myriad of other issues brought before the compensation committee that morning.” [5]

And don’t assume that such issues are unique to corporate boards.  For example, in a recent case involving mutual funds, the plaintiffs argued that the fund board had failed to conduct a Gartenberg analysis before approving an administrative services agreement with the advisor, pointing to, among other things, the absence of any reference to such an analysis in the minutes. [6]  Although the directors attempted to contradict that evidence with testimony at trial, the issue is now a disputed fact subject to the judge’s ruling post-trial.

These instances suggest that, at least in some circumstances, drafting minutes may create a conflict between a fund board and the advisor (the latter of which is often responsible for preparing, or at least assisting in the preparation of, board minutes).  The board owes a fiduciary duty under state law to shareholders with respect to its process for overseeing the funds, and the board minutes are the best record of that process.  Directors should harbor a strong bias toward including in the minutes anything relevant to their process and fulfillment of their fiduciary duty to shareholders (and, certainly, that would include items regarded as “important,” for example, by the inquisitive director above who wrote to the MFDF). Setting aside that directors owe it to shareholders to be forthcoming in their minutes, directors should, at least, acknowledge the self-serving benefit of securing business judgment protection for decisions made, and items considered, during a meeting.  Directors don’t get business judgment protection for things that they did not consider, and if a board did, in fact, consider a range of factors in making a decision, those factors and the discussions around them should be in the minutes.

To be sure, there may be reasons why an advisor might not want facts and information discussed at a board meeting in a written record (as the MFDF seems to acknowledge).  Perhaps, in making a decision, the board considered, in good faith, some unfortunate facts about the advisor’s services.  The board’s ultimate decision may be protected by the business judgment rule, but the advisor would not receive similar protections in litigation (for example, in litigation over an investment guidelines violation or an excessive fee).  A board need not -- for its own good -- be overly swayed by such concerns.  It has its own fiduciary duties and constituency that it must account to, and a robust record will generally aid in this process. A fund board does not owe a duty to protect the advisor’s financial interest (indeed, it doesn’t owe any duty to the advisor at all).

Similarly, directors should be cautious in agreeing to destroy their notes, as directors may someday like to rely on their own personal record of their fiduciary services, if only to refresh their recollection of their thinking and reasoning at the time.  If directors are not diligent in ensuring that all material considerations and reasoning are recorded in the minutes, and also agree to destroy all other contemporaneous writings, they may find the record disappointingly bare if they are ever required to defend their actions as a fiduciary.

In conclusion, this article does not call for a wholesale alteration of current practices, which, in any event, vary in thoroughness between complexes.  Rather, it is simply a reminder to independent directors to consider their fiduciary roles, and the purpose and benefits of board minutes in documenting the same, notwithstanding an advisor’s preference, if it arises, that things not be written down. While fund directors have not been subject to litigation arising from their fiduciary duties in recent years, those duties under state law (and the potential individual liability exposure) remain significant, as does the creativity of the plaintiffs’ bar.  For non-interested directors, such concerns should take precedence over an advisor’s when a conflict arises regarding what to write down.

[1] The referenced guidance was part of the MFDF’s “Dear BoardDoc” series of articles that features questions from members/fund directors.  It is available here. To be fair, the guidance is accompanied by the following disclaimer: “The answers and commentary provided in our responses do not constitute legal advice and should not be treated as such.”

[2] One might question whether the gist here is that board minutes may be supplemented with information not available to the board at the time of the meeting.  If so, that raises a wholly different sort of issue not addressed in this short article.

[3] Lori A. Richards, Put The Compliance Rule To Work: IA Compliance Best Practices Summit (March 15,2004), available here.

[4] Business Judgment Rule: Fiduciary Duties of Corporate Directors, Radin (6th Edition).

[5] In re Walt Disney Co. Derivative Litigation, 907 A.2d 693, 769 (Del. Ch. 2005), aff'd, 906 A.2d 27 (Del. 2006).

[6] Obeslo v. Great-WestLife & Annuity Ins. Co., No. 16-cv-00230-CMA-SKC (D. Colo.) (a bench trial was held in February 2020 and a decision is expected later this year).