January 18, 2002
Mr. Jonathan G. Katz
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Investment Company Mergers (File S7-21-01)
Dear Mr. Katz:
Fidelity Management & Research Company ("FMR")1 appreciates the opportunity to comment on the Commission's proposed amendments to Rule 17a-8 under the Investment Company Act of 1940.2
Rule 17a-8 currently exempts from the affiliated transaction prohibitions under Section 17(a) mergers, consolidations or purchases or sales of substantially all of the assets involving registered investment companies, which may be affiliated persons, or affiliated persons of affiliated persons, solely by reason of having a common investment adviser, common directors, and/or common officers, provided that certain conditions are met. The Commission's proposal would make the rule available for mergers between affiliated funds regardless of the nature of affiliation and for mergers between funds and certain unregistered entities. In order to rely on the rule, each fund's board (including a majority of its non-interested directors) would be required to consider certain enumerated factors, if relevant, in determining that the merger is in the best interests of the fund and each merger would require the approval of the shareholders of the fund not surviving the merger (the "acquired fund").
While we generally support the underlying purposes of the proposed amendments to extend exemptive relief for a broader range of mergers among affiliated funds and other collective investment vehicles, we urge the Commission to reconsider those parts of the proposed amendments requiring shareholder approval of all fund mergers and echo voting by certain shareholders. In our view, these proposed requirements would impose unnecessary costs and burdens, would act as disincentives for certain mergers that would be in the interests of fund shareholders, and would undermine recent efforts by the Commission to strengthen the role of independent fund directors to act in the best interests of shareholders.
A. Shareholder Voting
Since its adoption in 1980, Rule 17a-8 has not imposed any shareholder voting requirements for fund mergers. As a consequence, this has been left to governing state law and applicable provisions of funds' corporate charters or trust instruments. It is our understanding that the vast majority of fund mergers are made subject to approval by shareholders of the fund that will not survive the merger. The Commission is proposing to require that all mergers, without exception, be approved by shareholders of the fund to be acquired and is requesting comment on whether shareholders of the acquiring fund should be required to vote on all fund mergers as well.
While we agree that the rule should address shareholder voting for fund mergers, we strongly caution against extension of a voting requirement to all fund mergers.
We oppose a requirement under Rule 17a-8 that shareholders of an acquiring fund approve a merger, absent another basis (apart from the merger itself) upon which to require shareholder approval. In most mergers, the acquiring fund's policies, procedures, and features remain unchanged or are revised to be more favorable to shareholders (e.g., imposition of a fee cap). In these cases, the principal effect of a merger on an acquiring fund is an increase in assets, which typically benefits shareholders by introducing economies of scale. If, however, an acquiring fund's fundamental policies would be modified or fees increased as a result of a merger, the fund would be required to obtain shareholder approval under other sections of the Act. Therefore, it is not necessary to impose a separate requirement for shareholder vote and doing so would result in unnecessary expense to the acquiring fund.
In FMR's experience, there are many mergers that do not have a significant impact on shareholders of an acquired fund. For example, mergers may be undertaken purely for legal or accounting reasons that have little or no impact on shareholders - such as when an existing fund is merged into a shell fund for purposes of changing the fund's domicile or fiscal year. These mergers can result in significant legal or accounting advantages but have no bearing on the fund's performance or the manner in which it is managed. We believe that funds involved in these types of mergers should not be required to incur the expense of soliciting shareholder approval and should be excluded from the scope of the Rule.
More broadly, we are of the view that shareholder approval of a merger should not be required under Rule 17a-8 if the resulting changes, from the standpoint of the shareholders of the acquired fund, do not go beyond changes which would not require a vote by those shareholders in the absence of a merger. Under the Investment Company Act, a fund's board, for example, without submitting the matter to shareholder vote, may agree to a lowering of management fees or changes to non-fundamental investment policies. There is nothing in a merger context that makes these types of changes more significant - and certainly nothing to raise them to the level of requiring prior shareholder vote. Accordingly, it seems incongruous to require a vote by shareholders (of either the acquired or acquiring fund) for fund mergers that result in changes that, if occurring outside the merger context, would not require shareholder approval. This is not to say that the preferable course in all such cases necessarily is to avoid submitting a merger proposal to shareholders. We do suggest, however, that this decision ought to be left to the directors of the respective boards of the acquiring and acquired funds, who should be in a position to make an informed judgment that would take into account such factors as the costs of soliciting shareholder approval and the delay that might be attendant to convening a shareholder meeting and to weigh such factors in light of the purposes of a particular merger and the significance of the changes which a merger would bring about.
The approach we urge is in keeping with the Commission's recent rulemaking to strengthen the role of independent directors. As the Commission has noted, these rules are intended to "reinforce [a board's] independence" and enable it to "represent shareholders from a position of strength."3 Particularly given the role which a fund's board is expected to play under Rule 17a-8 in evaluating whether a merger is in the best interests of a fund's shareholders, the Rule should afford directors the ability to reach, and implement, an informed judgment that certain fund mergers are in the best interests of shareholders and do not warrant the expense and delay of a shareholders meeting.
Accordingly, FMR urges the Commission to modify the Proposed Rule to require shareholder approval only for those mergers where a change would be effected that would require a shareholder vote under the Investment Company Act in the absence of a merger.
At a minimum, FMR requests that the Commission clarify that the Proposed Rule does not apply to a merger (i) undertaken solely to change a fund's domicile, fiscal year or corporate structure or (ii) of one fund into another upon its stated maturity, provided such merger is appropriately disclosed in the fund's prospectus.
For those fund mergers that would be subject to shareholder approval under our approach, we recommend that a majority vote, as specified under Section 2(a)(42) of the Investment Company Act, be required.
B. Notice to Shareholders
The Commission has requested comment on whether, in the absence of a shareholder vote, shareholders should receive advance notice of their change in investment. As explained above, we recommend that shareholder approval be required for mergers only under circumstances that would result in changes that would require shareholder approval in the absence of a merger. Unless advance notice is required for such a change under other sections of the Act (e.g., an increase in a sales load or redemption fee), there is no reason to require a fund to incur the cost of providing advance notice to shareholders merely because the change is being effected pursuant to a merger.
If the Commission does impose a notice requirement, FMR urges the Commission to exempt mergers (i) undertaken solely to change a fund's domicile, fiscal year or corporate structure or (ii) of one fund into another upon its stated maturity, provided such mergers are appropriately disclosed in the fund's prospectus. These transactions, while having significant legal or accounting ramifications, have no direct effect on shareholders or the management of the fund. For this reason, FMR believes it would be unnecessary and unfair to require a fund to incur the cost of providing prior notice to its shareholders in these situations.
C. Echo Voting
The Commission is proposing to add a requirement to Rule 17a-8 which would provide that if an owner of more than five percent of the shares ("owner affiliate") of the fund holding the vote is another merging fund, or an investment adviser, principal underwriter, or owner affiliate of another merging fund ("related shareholder"), the related shareholder must vote its shares in the same proportion as non-related shareholders. This is apparently intended to prevent fund affiliates from having both the ability and pecuniary incentive to affect the terms of a merger.
FMR opposes this proposal, at least where the "owner affiliate" under Rule 17a-8 is not in a control relationship with the adviser, principal underwriter or promoter of the acquiring fund. A requirement for echo voting, especially by non-control affiliates, is simply not necessary to advance any public interest and would effectively disenfranchise a group of shareholders who would be deemed to have interests adverse to other shareholders. Given the role to be played by fund boards, comprised of a majority of non-interested directors, in reaching the informed judgment that a proposed merger is in the best interests of shareholders, we see no purpose in depriving non-control affiliates of a fund the ability to vote on the merger when a shareholder vote is required.
If echo voting is required, FMR requests the Commission to recognize there are other forms of echo voting that have the same result as the method required by the Proposed Rule - that is, precluding a legal owner from exercising discretion. Today, there are several types of mutual fund investors who routinely "echo vote" - for example, IRA custodians and insurance separate accounts. Typically, these entities are required by law or contractual terms with the beneficial owners to vote all shares in the proportion that they have received instructions from beneficial owners. FMR believes that the Proposed Rule should not specify the type of echo voting, but rather require only that the legal owner utilize some kind of objective methodology in voting on behalf of beneficial owners. This should sufficiently protect shareholders while not conflicting with other echo voting formats that may be legally or contractually binding on a legal owner.
Finally, FMR believes shares that (i) are subject to echo voting by legal or contractual obligations other than those imposed by the Proposed Rule or (ii) fall within the exceptions set forth in Section 4(ii) of the Proposed Rule should not be included in calculating the percentage threshold for owner affiliate. As discussed above, the very purpose of the Proposed Rule's echo voting requirement is to preclude a legal owner from using its own discretion in voting on behalf of beneficial owners. Because the legal owner exercises no control over the shares described in (i) and (ii) above, it cannot use them to affect the terms of a merger in a manner favorable to itself. These shares, for all intents and purposes, are owned by someone else and therefore should not be attributed to the legal owner.
The Commission proposes adding a provision to Rule 17a-8 prohibiting any merger from being "a part of a plan or scheme to evade the affiliated transaction prohibitions of Section 17(a) of the Act." FMR believes this provision is superfluous. Section 48 of the Investment Company Act, which applies to all mutual fund transactions, precludes any person to cause to be done directly or indirectly any act or thing which it would be unlawful to do under the provisions of the Act. There does not appear to be any added protection by including the proposed provision to Rule 17a-8 and risks creating ambiguity as to the scope of Section 48.
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We trust the foregoing is responsive to the Commission's request for comments, and would be happy to provide any additional information to assist the Commission in its consideration of the Proposed Rule.
|1||FMR is the investment manager for over 260 registered investment companies in the Fidelity Group. The Fidelity funds currently have aggregate assets in excess of $740 billion.|
|2||SEC Release No. IC-25259 (November 8, 2001) ("Proposed Rule").|
|3||SEC Release No. IC-24816 (January 2, 2001) ( "Independent Director Rules") at pages 4 and 6.|