March 9, 2004
Jonathan G. Katz
Re: Investment Company Governance, Rel. No. IC-26323, File No. S7-03-04
Dear Mr. Katz:
Versanture Consulting ("Versanture")1 welcomes the opportunity to comment in connection with Investment Company Act Release No. 26323 (the "Release") regarding the proposed adoption of amendments to the rules under the Investment Company Act of 1940 ("1940 Act") which would require registered investment companies ("mutual funds" or "funds") relying on Exemptive Rules (as defined in the Release) to adopt certain governance practices to (i) enhance the independence and effectiveness of fund boards and (ii) improve the ability of fund boards to protect the interests of the funds and of the fund shareholders they serve.
Versanture respectfully submits the following in response to the Securities and Exchange Commission's (the "Commission") request for comments.
Versanture believes that fund governance will be most successful when it is undertaken by individuals who:
Versanture believes that it is the responsibility of each director on a fund board to ensure that all directors - interested or independent; chairperson or "lead" director; currently serving or being nominated - fit this or a similar profile. These individuals must then collectively define an approach to establish and maintain appropriate polices and procedures to fulfill their fund governance responsibilities.
To this end, Versanture believes that the requirement for an annual self-assessment of the board is an essential element in helping fund directors ensure that their work, both individually and collectively, is effective in protecting shareholder interests, even as circumstances change. We believe that such periodic self-assessments will enhance the ability of fund boards to provide effective fund governance for the long-term.
Versanture also believes the independent directors bear much of the responsibility for the ongoing, objective review of fund governance practices. Accordingly, we believe that the proposed reforms increasing the number of independent directors and explicitly permitting independent directors to hire employees and others to assist them in fulfilling their fiduciary duties will have a positive effect on fund governance.
A. Increasing Percentage of Independent Directors to 75%
Versanture supports the Commission's proposal that would require a fund board of directors whose independent directors constitute at least seventy-five percent (75%) of the board.
Many academic studies, of corporations in general and of mutual funds in particular, have found that boards with a higher percentage of independent directors are more likely to take actions that are generally deemed favorable to shareholders. For example, funds with a higher percentage of independent directors on the board tend to have lower fund expense ratios and lower director compensation and, for closed end funds, are more likely to consider share repurchases, open-ending proposals and rights offerings. On the other hand, academic studies have not found that increasing the ratio of independent to interested directors has any demonstrated effect on corporate or fund performance.
Versanture believes that increasing the percentage of independent directors to 75% has a number of potential costs. For example:
Versanture believes that, overall, the benefits of having a supermajority of independent directors is likely to outweigh the potential costs.
B. Requiring an Independent Chairperson
Versanture does not support the Commission's proposal that would require that the chairperson of a fund board be an independent director.
Versanture believes that a majority of independent directors (or a supermajority if the preceding proposal increasing independent directors to at least 75% of a fund board is adopted) should be sufficient to balance any conflicts with the management company introduced by a chairperson who is an interested director. In addition, Versanture found no evidence that an independent chairperson or separating the lead director role results in a better governance outcome.
For the reasons above, we believe that a fund board should be permitted to elect as its chairperson the most qualified director for the position regardless of whether the qualified individual is an interested director or an independent director. Further, we believe that independent directors should be permitted, but not required, to designate a "lead director." In addition, we believe a fund board should be permitted to constitute committees (other than those controlled by applicable regulation) of interested and/or independent directors as they see fit.
C. Requiring an Annual Self-Assessment
Versanture strongly supports the Commission's proposal that would require fund directors to perform, at least once annually, an evaluation of the effectiveness of the board and its committees.
Versanture believes the Commission should require the board's self-assessment to focus on both the substantive and procedural aspects of the board's operations but leave it for the directors to decide those aspects of board operations they should address. Further, Versanture believes that the directors should be permitted, but not required, to address two procedural matters that have been the subject of recent scrutiny: (1) the effectiveness of the board's committee structure and (2) whether they have taken on responsibility for overseeing too many funds.
Versanture believes a self-assessment process is critical to developing effective fund governance practices that favor the long-term interest of fund shareholders.
We agree, at least in theory, that the self-assessment process should provide an opportunity to improve fund governance by strengthening directors' understanding of their role and fostering better communications and greater cohesiveness. Further, we agree that the self-assessment process should give directors an opportunity to step back and review their own performance, so that they can best consider any changes in their governance practices.
Although Versanture views the need for periodic self-assessment as a critical element in developing effective governance practices, we question whether the self-assessment process will actually result in frank and candid discussions regarding the board's operations, including its performance, strengths and weaknesses. We also question whether self-assessment will produce a true measure of the performance, strengths and weaknesses of each individual director. Our concern is that, due to fears of creating liability for themselves or others, individual directors will hesitate to be openly critical of the board or its members and/or that criticisms expressed in the course of a self-assessment may not result in appropriate remedial action. For these reasons, we ask the Commission to consider providing some method for limiting such liability.
One approach would be for the Commission to consider limiting director liability for fund boards that voluntarily adopt and follow written codes of business standards and/or ethics where such codes would be consistent with some minimum standard established by the Commission and would be disclosed to fund shareholders. A second approach would be for the Commission to permit fund boards to engage an independent third-party to to conduct the assessment on an anonymous basis and exempt all but a written description of the assessment process and the final report from any recordkeeping requirements.
A third approach would be for the Commission to consider treating the self-assessment process in a manner similar to the peer review performed by medical professionals.2 Under this approach, a formal self-assessment committee would be formed of properly qualified individuals. The committee's function would be to evaluate or improve of the quality of governance provided by the fund board and by individual directors. Members of the committee would be protected from liability other than for their own negligence or failure to act in good faith. The committee's mandate could include, but not be limited to, making a determination of whether:
In addition, this self-assessment committee would be empowered to take appropriate remedial actions such as calling for a vote for a new chairperson or asking for the resignation of underperforming or underqualified individual directors.
D. Separate Sessions of Independent Directors
Versanture supports the Commission's proposal that independent directors be required to meet in a separate session at which no interested persons of the fund are present. We suggest, however, that such meetings be required no more often than once annually and that a board be permitted to determine whether such meetings should be held more frequently.
Versanture believes that separate sessions of independent directors are already held by some fund boards when circumstances warrant it. We agree that such meetings would afford independent directors the opportunity for discussions among themselves regarding the services provided by a fund's management company and its strengths and weaknesses.
E. Authorizing Separate Director Staff
Versanture supports the Commission's proposal that a fund's independent directors should be explicitly authorized, but not required, to hire employees and others to help the independent directors fulfill their fiduciary duties. From time-to-time, we believe it may be both necessary and desirable for a board to be able to engage consultants, experts or other advisors or administrative staff. The expense of hiring such persons should be a fund expense unless such expense would place an undue burden on the fund. In this event, the directors should have the option of negotiating for payment of the expense by the fund's management company.
Versanture recommends against explicitly authorizing committees of the board to hire their own employees. We believe such an authorization could have a divisive effect and that any hiring should be done at the board level even if the duties to be performed are for the benefit of a particular committee.
F. Requiring Independent Counsel for the Independent Directors
Versanture does not believe that the Commission should require that independent directors retain independent legal counsel. However, Versanture supports the Commission's current position that if the independent directors retain counsel such counsel must be "independent legal counsel," that is, counsel who the independent directors determine at least annually is free of significant conflicts of interest that might affect the legal advice received.
G. Recordkeeping for Approval of Advisory Contracts
Versanture supports the Commission's proposal to amend rule 31a-2, the fund recordkeeping rule, to require that funds retain copies of the written materials that directors relied upon in approving an advisory contract under Section 15 of the 1940 Act, which requires that fund directors, including a majority of independent directors, approve the fund's advisory contract each year. We believe it is reasonable to require funds to retain such materials for at least six years, the first two years in an easily accessible place, provided it is clear that such records are retained at the fund's expense. Consistent with other recordkeeping requirements, we recommend that the fund have the option of retaining such documents electronically.
If you have any questions regarding this letter, please contact Elizabeth A. Watson or Theresa A. Hamacher at 617-512-7745.