G O D F R E Y & K A H N, S. C.
ATTORNEYS AT LAW
780 NORTH WATER STREET
MILWAUKEE, WI 53202-3590
PHONE: 414-273-3500 FAX: 414-273-5198
January 28, 2000
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
RE: File No. S7-23-99, Role of Independent Directors of Investment Companies
Dear Mr. Katz:
Godfrey & Kahn, S.C. ("Godfrey & Kahn") appreciates the opportunity to comment on Release No. IC-24082 proposed by the Securities and Exchange Commission (the "Commission") regarding the Role of Independent Directors of Investment Companies. While we support the Commission's efforts to enhance the independence and effectiveness of fund boards of directors and better protect the interests of fund shareholders, we are concerned that the proposal to prohibit counsel for a fund's independent directors from also acting as counsel to the fund's adviser, administrator, or principal underwriter, or any of their control persons, may increase legal costs for advisers, fund shareholders, and fund boards of directors and places undue burden on smaller funds. We are also concerned that the proposal may make it difficult for funds, advisers, administrators, principal underwriters and their respective control persons to retain counsel familiar with the Investment Company Act of 1940 (the "Act") and the Investment Advisers Act of 1940 (the "Advisers Act"). Provided below, is a brief summary of our concerns.
Investment Companies and Investment Advisers
In situations where there is separate legal counsel for (1) the investment company and its board of directors and (2) the investment adviser, two law firms review virtually all of the adviser's policies and agreements, including the code of ethics, brokerage and trading policies, soft dollar practices, fund supermarket agreements, and internet access agreements. Two law firms also review the fund's prospectuses and statements of additional information, and participate in special meetings of shareholders and preparation of proxy statements. In these situations, the adviser and fund incur legal expenses that are often duplicative. Such duplicative expenses will ultimately be borne by fund shareholders.
There are many situations where it would be more efficient for counsel for the investment company and its directors also to provide legal services to the adviser. We believe this could be done as long as (1) counsel has made clear that, in the event of a conflict with the investment company, counsel will represent the investment company and its directors; and (2) the adviser waives any objection and understands that disclosures that it makes to counsel are not privileged against disclosure to the directors. For example, often times a Code of Ethics will be drafted to cover not only access persons of the fund, but also access persons of the adviser. From an administrative standpoint it is much easier for the fund and adviser to have one Code of Ethics that governs both parties. Clearly some of the expense of drafting and revising the Code should be borne by the adviser and some by the fund. While counsel in this example would have performed legal services on behalf of the adviser and the fund and billed both parties separately, it is inherently more efficient than having two Codes and should in no way compromise the integrity of the legal services provided to either party.
Certain investment companies rely primarily on the fund administrator for legal-related services. The administrators indicate that smaller investment companies expect that administrative services and fees will include such services. When we are retained by an administrator in such a situation our services to the administrator, the investment company, and its board of directors include preparation of board materials, attendance at board meetings, assistance with prospectuses and statements of additional information, and ongoing advice regarding investment company compliance issues. If, under the proposal, Godfrey & Kahn is unable to represent the administrator, the investment company, and its board of directors, then the investment companies will have to hire separate legal counsel, which is precisely what they were hoping to avoid by contracting with an administrator whose fee includes legal-related services. We respectfully request the Commission to reconsider this aspect of the rule, especially for administrators that do not provide investment advisory services and for smaller funds. Based on the limited nature of the services provided by an administrator, there is limited risk of a potential conflict of interest on anything other than the administrative agreement. Moreover, if there is a potential conflict on a matter, and for review of the administrative agreement, independent counsel could be retained on an ad hoc basis for the board.
An underwriter of a fund may find it difficult to retain counsel familiar with the Act. An underwriter that has a broad business, including underwriting debt and equity offerings, may even find it difficult to retain counsel for traditional securities work if the local firms represent boards of directors of investment companies. We respectfully request the Commission to reconsider this aspect of the rule, especially for underwriters that are not affiliated with the investment adviser. If there is a potential conflict on a matter, and for review of the underwriting agreement, independent counsel could be retained on an ad hoc basis.
The proposal will prohibit counsel for a fund's independent directors from also acting as counsel to the control persons of a fund's investment adviser, administrator, or principal underwriter. This may severely restrict the choice of legal counsel available to the various parties. For example, bank holding companies use legal counsel on a variety of matters, including bank regulatory matters and commercial and real estate transactions. Although the bank holding company's preferred counsel may be the financial institutions, corporate, and real estate teams of a particular firm, they may be unable to retain the firm because the firm represents a mutual fund and its independent directors that has contracted with an administrator owned by the bank holding company. This may force the bank holding company to retain lawyers in a different city and more expensive marketplace. We respectfully request the Commission to reconsider this aspect of the rule. If there is a potential conflict on a matter, independent counsel could be retained on an ad hoc basis. Alternatively, we request the Commission to consider a less restrictive alternative, such as a Chinese Wall arrangement whereby, for example, the securities team of the firm and the other teams do not have access to each others' files and do not communicate with each other on certain matters.
A person would qualify as an "independent legal counsel" under the proposal if the fund reasonably believes the person and his or her law firm, shareholders and associates have not acted as legal counsel for the fund's investment adviser, administrator, principal underwriter, or any of their control persons at any time since the beginning of the fund's last two completed fiscal years. This definition would restrict law firms from hiring laterals with experience with the Act and the Advisers Act. For example, if a firm hires an attorney who represented an adviser owned by a bank holding company, then the firm would be prohibited for a period of at least two years from representing any mutual fund and its independent directors that receive advisory or administrative services from the bank holding company and its subsidiaries. We respectfully request the Commission to consider a less restrictive alternative, such as a Chinese Wall arrangement whereby the lateral hire does not have access to certain files and does not communicate with others on certain matters.
We believe the selection of legal counsel for a fund and its board should be within the discretion of the directors and governed by traditional legal/ethical guidelines, including disclosure of potential conflicts to the board. A uniform prohibition is costly and does not take into account the traditional ethical duties owed by lawyers to their clients.
Should the Commission decide to adopt the proposed amendments with the two-year look back provision, we believe that the definition of independent legal counsel should not be effective for at least two years after the adoption of the rules. This would ensure that all disinterested directors could secure independent legal counsel, if necessary, in a timely fashion. Alternatively, the new rule should be prospective only with a phase-in period to allow various law firms, funds, advisers, administrators and others to re-evaluate existing relationships and make alternate arrangements.
Thank you for your time and consideration. If you have any questions regarding this comment letter, please do not hesitate to contact either Scott A. Moehrke or Carol A. Gehl at (414) 273-3500.
Very truly yours,
GODFREY & KAHN, S.C.
/s/ Godfrey & Kahn, S.C.
Investment Management Practice Group