January 8, 2004
Jonathan G. Katz, Secretary
Dear Mr. Katz:
We commend the staff of the Securities and Exchange Commission (Commission) on the extensive effort and thoughtful consideration given to establishing procedures designed to prevent violations of the federal securities laws. We further appreciate the staff's willingness to consider other measures that would enhance the independence and effectiveness of chief compliance officers. It is our view that the release contains much of what is necessary to achieve an effective and efficient oversight of service providers. However, we believe additional tools are required in order for independent directors to receive the information necessary to evaluate whether service providers are conducting their business for the benefit of a fund and its shareholders.
The Commission's release states, "We (the Commission) have observed that compliance failures have occurred when a fund service provider has denied information to the fund's board, or has been less than forthright, because the service provider viewed full disclosure as detrimental to its own interests." We agree this is the problem. We believe four new tools are necessary to fix the problem:
A number of Congressional proposals seek to fix the problem of service providers denying independent directors relevant information. We believe that many of the areas addressed in House Bill 2420 and in proposed bills before the U.S. Senate are best addressed through the Commission's rule-making process. We believe that Congress should narrow its focus and pass legislation to ensure that relevant information is given to the independent directors.
Congress and the Commission attempted to fix the problem in the 1970 amendment to Section 15(c) of the Investment Company Act. The Commission sought to require the investment adviser to inform independent directors about matters reasonably necessary to evaluate the terms of any contract. Instead, Congress adopted language making it the duty of the board to request that the investment adviser provide information. Only after information has been requested is the investment adviser required to provide it. This language has been used by investment advisers as an excuse for not providing information to the independent directors.
Absent Congressional action to amend Section 15(c), we believe the Commission's rule can be strengthened by requiring the following:
In addition, we believe the Commission should prepare a list identifying conflicts and other compliance factors for all service providers, similar to the one set out in the release for investment advisers, and periodically update that list as part of a collaborative ongoing education process for the benefit of independent directors and shareholders.
We will and believe independent directors of all other investment company boards will determine whether the policies and procedures proposed by the service providers address the conflicts. We will exercise the standard of care required by the laws of the State under which our respective funds are organized in making that determination. We do not believe that it is necessary to create a federal fiduciary standard for independent directors of investment companies in order to ensure that they do their job.
The Commission's rule seeks to support the independent directors in their effort to ferret out information by creating a position of chief compliance officer. The release states the Commission's view on what qualifications and authority that person should have. The rule, however, does not mandate those qualifications or authority. Further, there is no accountability of senior management of service providers for the information relied on or actions taken by the chief compliance officer.
The current investigations referred to in the release were initiated and have been able to proceed because employees came forward with information. They were unable or unwilling to do so within their own organizations earlier for fear of reprisal. Accordingly, to assure the needed flow of information, employees must be willing to provide relevant information. The whistleblower provisions of the Sarbanes-Oxley Act, Sections 806 and 1107, may not cover employees who provide the type of information that is most relevant to the work of the chief compliance officer and the independent directors. Legislation or rule making must ensure employees are protected.
Finally, the rule seems to increase the likelihood that the fund and its independent directors will be named in legal actions that arise from the misconduct of service providers. This will cause the fund to bear litigation costs. It blurs the responsibility of a service provider for the proper conduct of its business. It also exposes independent directors to substantial personal liability at a time when insurance carriers are significantly narrowing the coverage in directors and officers liability policies.
The reason for the increased exposure of the fund and independent directors to legal actions is the way in which the rule requires the chief compliance officer to report to the independent directors. While the release states that in order to have the necessary authority and access to information the chief compliance officer most likely will be an employee of the investment adviser, the direct confidential reporting and control over her employment would be used to contend that a relationship akin to employment exists. Most contracts with service providers protect the service providers against liability except for willful misfeasance, bad faith, gross negligence or reckless disregard of obligations. Often the contracts require the fund to pay legal expenses. Under current contract terms and the language of the rule it appears that service providers might be protected by the terms of the contracts for the conduct of the chief compliance officer, even where she has been denied information by her fellow employees and officers, while the fund and independent directors will not.
We believe it would be efficient for the Commission by rule to provide the additional tools needed to address the imbalance of power between service providers and independent directors when it comes to monitoring the day-to-day operations of a fund and to place the responsibility on the appropriate persons. This rule needs to:
The rule could require that:
We appreciate the opportunity to comment on the proposed compliance programs for investment companies.
Arne H. Carlson
Independent members of American Express Funds' Board of Directors: