Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
RE: Proposed Rules Relating to the Role of Independent Directors of Investment Companies (File No. S7-23-99)
Dear Mr. Katz:
We are members of the Board of Directors of the ICAP Funds, Inc. (File Nos. 33-86006; 811-8850) (the "Fund")1, and are currently the only independent directors on the Board. The Fund's Board is comprised of eight directors: five "interested" and the three of us as "disinterested" directors. While this is not the standard composition of mutual fund boards, because the Fund meets the requirements of Section 10(d) of the Investment Company Act of 1940, as amended (the "1940 Act"), the Fund is only required to have one independent director, but has nevertheless chosen to have three.
At the last meeting of the Board of Directors of the Fund, we discussed at length the rule proposals referred to above. Based on this discussion, we are filing this comment letter with respect to several of the proposed changes. Accordingly, what follows is a summary of our comments.
1. Independent Directors as a Majority of the Board-Proposed Board Composition Requirements
The SEC proposes to amend certain exemptive rules under the 1940 Act to require funds relying on such rules, such as the Fund, to have boards with at least a majority of independent directors. The SEC requests comment on whether it should adopt a simple majority requirement or a two-thirds (or higher) super-majority requirement.
We are of the view that if a simple majority of a fund's board is independent, this is sufficient to allow the independent directors to exercise their role as the independent "watchdogs" of fund management. This is particularly true if the charter of the fund requires the approval of a majority of the fund's directors for action on various matters, which is true with respect to the Fund's charter.
Furthermore, as indicated in the SEC proposing release, because most mutual funds have boards with at least a simple majority of independent directors, by requiring all funds to conform to this requirement, relatively few funds would have to change the current composition of their boards. If a super-majority requirement is imposed, since fewer funds have boards which currently meet this requirement, this alternative could result in substantial costs to shareholders.
In our situation, if a simple majority requirement is imposed, the Board will in all likelihood handle this by asking the requisite number of interested directors (which would be three) to resign, resulting in two interested and three disinterested directors. Accordingly, there would be no need to elect additional directors (or incur the costs of soliciting shareholder approval in connection therewith)2. On the other hand, if a super-majority requirement is imposed, the Board will in all likelihood handle this by asking at least three interested directors to resign and by calling a shareholder meeting to elect at least one, and maybe two, additional disinterested directors, resulting in two interested and four, or five, disinterested directors. This alternative would prove to be costly and time consuming for the Fund and its shareholders.
Based on the foregoing, we believe a simple majority requirement to be sufficient to protect the integrity of fund boards and the interests of fund shareholders, and that a super-majority requirement serves no additional useful purpose and, in fact, would be quite burdensome, particularly for smaller fund complexes, like ours.
The SEC requests comment on whether the proposed transition period of one year would be sufficient to allow funds to bring their boards into compliance with the majority independence condition. We believe that if the standard is a simple majority requirement, which in our case would not require selecting and nominating additional disinterested directors, then a one year time period is sufficient for a transition. However, should the SEC decide to require a two-thirds (or higher) super-majority, then a transition period of two years would be more appropriate. We would anticipate that the process to select and nominate additional disinterested directors would be quite time consuming and unlikely to be accomplished in a one year time period (assuming four regularly scheduled Board meetings) without holding additional board meetings and thereby incurring additional expenses to the Fund.
2. Independent Legal Counsel
The SEC proposes to amend certain exemptive rules under the 1940 Act to require that, with respect to funds relying on such rules, like the Fund, counsel for such funds' independent directors may not also act as counsel to such funds' investment adviser, principal underwriter or administrator (collectively, "management organizations") (or their control persons). Under the proposal, any legal counsel for a fund's independent directors would have to be "independent legal counsel." A person would so qualify if the fund reasonably believes that the person and his law firm, partners and associates have not acted as legal counsel for the fund's management organizations (or any of their control persons) at any time since the beginning of the fund's last two completed fiscal years. The proposal contains an exception which would permit independent directors to retain counsel who does not otherwise meet the definition of "independent legal counsel" if they determine that the counsel's prior or current representation of a management organization (or any of their control persons) was (or is) so limited that it would not adversely affect the counsel's ability to provide impartial, objective and unbiased legal counsel to the independent directors. Such determination would require an examination of all relevant factors, including whether the representation presented a direct and ongoing conflict with the fund, the amount of legal fees generated by the representation and the nature and extent of the affiliation between a control person and a fund management organization.
We agree with the SEC that independent directors should, if they so choose, be represented by independent legal counsel. But, we want to make clear that we do not believe that such representation should be required. This determination should be left up to the discretion of the independent directors. To require the independent directors to retain independent legal counsel (the costs of which the fund, and its shareholders, would bear) would be tantamount to usurping the authority of the directors to exercise their business judgement in matters affecting the fund, which we believe is inappropriate.
As for the definition of "independent legal counsel" and, in particular, the exception noted above, we have the following thoughts based on our experience with the Fund. Counsel for the Fund has, on occasion over the last several years, provided limited legal advice to the Fund's investment adviser, Institutional Capital Corporation. This advice has primarily been related to issues affecting the Fund but paid for by the adviser.
Because the Fund is self-distributing and unaffiliated with an NASD member, the adviser is responsible for preparing marketing materials for the Fund (and bearing the costs associated therewith). Counsel for the Fund has been asked to review such advertising and to file it with the SEC on an as-needed basis. However, the expenses associated therewith cannot be borne by the Fund and must be billed to and paid by the adviser. Similarly, the Fund's Code of Ethics also covers the adviser and its access persons. When expenses related to revising the Code have been largely related to changes initiated by the adviser, Fund counsel has billed the expenses directly to, and such expenses have been paid by, the adviser. Conversely, when the changes were necessitated based on, for example, changes to Rule 17j-1 of the 1940 Act, the Fund has been billed for, and has borne, the expenses associated with such changes. In our view, because of the limited nature of the advice provided, we do not believe Fund counsel has been compromised in any way and could, under the definition proposed above, be characterized as "independent legal counsel."
Nevertheless, we believe that not all cases are so clear cut as ours, or that ours will continue to be so clear cut in the future. To provide independent directors with a better yardstick by which to measure counsel's independence in the context of the exception noted above, and to avoid second-guessing by third parties later on, we believe the exception should contain a threshold which relates to the amount and/or percentage of legal fees generated by the representation. In our view, if the amount of legal fees generated from representation of a management organization (or any of their control persons) in any one year is less than $100,000 or constitutes less than 5% of the law firm's revenue, the exception should be available to allow such counsel to serve as "independent legal counsel" to the independent fund directors. This approach is appealing to us because of its ease of administration, and because of its common sense.
Based on the foregoing, while we recognize the usefulness of independent counsel for independent fund directors, we do not think that it is appropriate for the SEC to mandate the retention of such counsel. In addition, we believe that providing independent directors with an objective standard by which to measure counsel's independence will, in the long run, be the most workable solution to this issue.
Finally, the proposed amendments would preclude a person from acting as counsel for independent directors for two years after having acted as legal counsel to a management organization. In light of this proposed two year look back provision, we believe that the definition of independent legal counsel should not be effective for two years after the adoption of the rules. This would ensure that independent directors could secure independent legal counsel, if necessary, in a timely fashion.
3. Disclosure of Information About Fund Directors-Conflicts of Interest
The SEC proposes to require disclosure of three types of circumstances that could affect the allegiance of mutual fund directors to their shareholders: positions, interests, and transactions and relationships of directors. In addition, the SEC proposes to extend the disclosure requirements to the "immediate family members" of directors. For this purpose, "immediate family member" includes any spouse, parent, child, sibling, mother- or father-in-law, son- or daughter-in-law, or sister- or brother-in-law, including step and adoptive relationships.
With respect to the disclosure of director interests, the SEC is proposing to require disclosure of securities currently owned, and material direct and indirect interests held during the past five years, by each director and his immediate family members in (i) an investment adviser, principal underwriter or administrator of the fund or (ii) a person (other than a mutual fund) directly or indirectly controlling, controlled by or under common control with an investment adviser, principal underwriter or administrator. While we believe this information would be valuable to fund shareholders, we think that its value is compromised if immaterial interests as well as material interests are disclosed. As a result, and to provide some level of certainty to funds and their counsel, we believe that the SEC should establish a de minimis threshold for the disclosure of such interests. In other words, if the interest does not exceed this threshold, we do not believe it needs to be disclosed. In our view, the SEC should be guided by the proxy rules and define an interest to be material (and, therefore, required to be disclosed) if it exceeds $60,000 in value.
With respect to disclosure of transactions/relationships, the SEC is proposing to require disclosure of any material interest, direct or indirect, of any director or his immediate family member in any material transaction since the beginning of the last two completed fiscal years (or currently proposed) to which the fund or a "related party" (as defined in the proposal) was or is to be a party. The SEC is also proposing to require disclosure of any material relationship, direct or indirect, of any director or his immediate family member that exists, or has existed at any time since the beginning of the last two completed fiscal years, or is currently proposed, with the fund or a related party. To provide some level of certainty to funds and their counsel, we believe that the SEC should establish a de minimis threshold for the disclosure of such transactions and relationships. In our view, a transaction or relationship would be material if the interest of the director or his immediate family member in the transaction or relationship exceeds $60,000 in value (again, using the proxy rules as guidance).
Finally, we believe the proposed definition of "immediate family member" is far too broad and, as a result, unworkable from a practical perspective. In our view, the definition should only include those family members living in the same household as the director. The information the SEC proposes to require funds to disclose cannot realistically be obtained (without significant effort) from persons who are related to directors by marriage or blood, but otherwise have no connection to the director. Furthermore, to ask directors to obtain this information from such relatives is, in our opinion, intrusive. Accordingly, we believe that the definition of "immediate family member" as proposed is too broad and should be scaled back.
Based on the foregoing, we think a de minimis threshold would be appropriate to determine whether an interest or relationship or transaction should be disclosed and that the proposed definition of "immediate family member" should be revisited to make it more workable.
Thank you for your time and consideration. If you have any questions regarding this letter, please contact the Fund's attorneys, either Carol A. Gehl or Pamela M. Krill at 414-273-3500, and they will be able to reach us.
Very truly yours,
the Independent Directors of ICAP FUNDS, INC.
/s/ Dr. James A. Gentry
Dr. James A. Gentry
/s/ Joseph Andrew Hays
Joseph Andrew Hays
/s/ Harold W. Nations
Harold W. Nations
-- The Fund consists of four separate series with combined assets of approximately $1.2 billion. -- It is possible that the Fund would have to solicit shareholder approval even assuming the resignation of certain interested directors, because not all of the Fund's interested directors have been elected by the shareholders.