January 28, 2000
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549-0609
Re:Proposed Rule: Role of Independent Directors of Investment Companies
File No. S7-23-99
Dear Mr. Katz:
This letter is submitted in response to a request for comments on proposed rules relating to the Role of Independent Directors of Investment Companies on behalf of OppenheimerFunds, Inc. ("OFI"), the investment adviser to the Oppenheimer Funds, the Panorama Series Fund, Inc., the Oppenheimer Quest Funds and the Oppenheimer Rochester Funds, and on behalf of Centennial Asset Management Corporation, the investment adviser to the Centennial Funds. OFI, including its subsidiaries, manage more than $120 billion in assets. OFI welcomes the opportunity to comment on the Rule proposals. The comments follow the format of the proposing release.
As an introductory note, we would like to point out that while the mutual fund industry has grown tremendously (7,314 funds as of 1998) and assets have increased significantly (over 580% over the last 10 years) the industry has done a fine job of protecting the assets and interests of investors. Credit for such success is attributable in no small part to the diligent oversight provided by the directors/trustees who are not "interested persons" of the fundís investment adviser, principal underwriter, or their respective affiliates ("Independent Directors"). Despite this virtually unblemished record, the effectiveness of existing board compositions, counsel relationships and activities of the Boards (particularly those of the Independent Directors) are now apparently being called into question through the Commissionís proposed rulemaking. Despite the absence of any significant problems, the role of Independent Directors is thought to need enhancement as if it is currently lacking. It has been our experience that the Independent Directors function quite effectively under the present system and diligently serve the interests of fund shareholders.
A. Independent Directors as a Majority of the Board
1. Proposed Board Composition Requirements
The Commission has proposed that, as a condition of reliance on the exemptive rules listed in the release, Independent Directors form a majority of the fundís board. The Commission asserts two justifications for this proposal. First, it states the Commissionís belief that a board that has at least a majority of Independent Directors "is better equipped to perform its responsibilities of monitoring potential conflicts of interest and protecting the fund and its shareholders." Yet the Investment Company Act of 1940 (the "1940 Act") and certain of the exemptive rules the Commission proposes to change already address such "potential conflicts" by requiring approval of a majority of the Independent Directors, not just by the board. Those provisions of the 1940 Act and exemptive rules apparently assume that however few their number and whatever proportion of the entire board they constitute, a majority of the Independent Directors would not be dominated by the adviser. Therefore, approval by a majority of the Independent Directors would certainly seem to be sufficient to address even the most serious potential conflict issues.
The Commissionís second justification for this proposal is to permit, under state law, the Independent Directors to "control the Ďcorporate machinery,í i.e., to elect officers of the fund, call meetings, solicit proxies, and take other actions without the consent of the adviser." We would agree with the Commission that the simple majority requirement would vest sufficient control over decisions requiring Board approval under state law. However, we do not believe that a super majority requirement should be mandated by the Commission. Absent any demonstrated need for a super majority of Independent Directors, a super majority requirement is inappropriate, not called for, and does not add any further protection of investorsí interests. Congress has acted in this area in the past and has never required a super majority of Independent Directors with the exception of Section 15(f) of the 1940 Act. So long as a majority of the Board consists of Independent Directors, it should be assumed that the actions of the Board will not be dominated by the adviser. Accordingly, OFI is not opposed to the Commissionís proposal to require as a pre-condition to relying on the Exemptive Rules that a majority of the Board consist of Independent Directors. In fact, each of our fund boards meets each of these requirements and has done so for some time.
2. Suspension of Board Composition Requirements
The Commission has proposed Rule 10e-1 which would temporarily suspend the board composition requirements of the 1940 Act and rules thereunder for prescribed time periods to allow a vacancy caused by the death, disqualification, or bona fide resignation of an independent director to be filled. While we support the general concept of this rule, we believe that the time periods must be expanded. The time frames proposed by the Commission are in our view inadequate in light of the time needed by Boards to identify and interview qualified candidates. The Boards do not maintain a list of qualified candidates to fill board vacancies if and when they might arise. The process of selecting, nominating and electing qualified candidates may take some time. Because the Independent Directors function as the "independent watchdogs" for investors and "supply an independent check on management," we believe that the process of selecting, nominating and electing those directors should not be hastened by regulatory time frames. However, if the Commission must impose time frames on that process, we would recommend that the period for incumbent directors to name a replacement be 120 days and the period for filling a vacancy by shareholder vote be 240 days.
B. Selection and Nomination of Independent Directors
The Commission is proposing that, as a pre-condition to relying on the exemptive rules, funds have boards whose Independent Directors select and nominate any other Independent Directors. Because each of the Oppenheimer Funds (except Panorama Series Fund, Inc. and Oppenheimer Money Market Fund, Inc.) have adopted Rule 12b-1 plans, the selection and nomination of Independent Directors is presently committed to the discretion of the Independent Directors as required by Rule 12b-1. Thus, the Funds would be unaffected by this proposal. Yet, the Fund Boards do solicit input from OFI on potential qualified candidates. Often times OFI may know of qualified individuals that have no affiliation with OFI that may be interested in serving on the Board. Therefore, we request the Commission to clearly state in its adopting release that the requirement for the selection and nomination of Independent Directors should not preclude the Board from soliciting the input from the Fundsí investment adviser and its affiliates.
C. Independent Legal Counsel
The Commission is proposing to amend the exemptive rules to require that counsel for a fundís Independent Directors not also act as counsel to the fundís adviser, principal underwriter, or administrator (or their control persons). We would agree with the Commission that "[e]xperienced counsel can help to identify potential conflicts of interest and other compliance issues. They can assist directors in Ďmarsal[ling] arguments to balance those presented by management in matters involving conflicts of interest,í and evaluating legal issues with an independent and critical eye." However, we are not aware of any problems that have arisen in the industry because the Independent Directors were not represented by independent legal counsel that would necessitate such a rule. The Commissionís proposal is somewhat incongruous in that it places a high importance on counsel for the Independent Directors being independent, yet allows those directors to function without counsel if they so choose.
The Commissionís proposal may have the unintended result of discouraging Independent Directors from retaining their own counsel, limiting the pool of eligible and qualified counsel so that some funds may have difficulty obtaining the advice they need, and require Independent Directors to terminate a longstanding relationship with counsel because of a relationship wholly unrelated to the counselís work on behalf of the Independent Directors. For those reasons, we are not in favor of this proposal.
The breadth of the definition of legal counsel would include any legal work performed by any members of a law firm for the adviser or any of its affiliates within the last two years. Thus, a firm representing the Independent Directors may be disqualified solely as a result of a lateral hire from a firm that provided service to the adviser or its affiliates during the last two years. Presumably, that would also be the case if the firm representing the Independent Directors hired an attorney from the adviser or one of its affiliates within the past two years.
Law firms that have 1940 Act practices may also have tax, ERISA, litigation and corporate law practices, to name a few. The proposal would disqualify a firm from counseling the Independent Directors if any individual at the firm represents the adviser or its affiliates in matters not involving the 1940 Act. From a law firmís perspective, representation of the adviser and its affiliates in various types of legal matters may prove to be more lucrative than representing the Independent Directors at four to six meetings per year. Thus, firms that may not be disqualified under the rule may choose for financial reasons not to represent Independent Directors so as not to preclude their acceptance.
The Model Rules of Professional Conduct require counsel to disclose conflicts of interest to its client and obtain their consent. Lawyers who fail to advise a client of conflicts can be held liable for significant liabilities and penalties. The Commissionís rule proposal is unnecessary in light of such requirements.
The Commission proposes a limited exception to the definition of "independent legal counsel." The Independent Directors would be permitted to retain counsel if they determine that counselís representation of the adviser or its affiliates was "so limited that it would not adversely affect the counselís ability to provide impartial, objective, and unbiased legal counsel to the directors." However, the ambiguity of this exception and the commentary of the proposing release would lead one to conclude that it should be interpreted so narrowly as to exclude any relationship between counsel and the fundís adviser or its affiliates. By establishing such a standard in a rule, the Commission may inappropriately expose fund directors to liability if it is ever alleged that counsel failed to satisfy the exception standard.
D. Limits on Coverage of Directors Under Joint Insurance Policies
The Commission proposes to amend Rule 17d-1(d)(7) to make it available only for joint liability insurance policies that do not exclude coverage for litigation between Independent Directors and the fundís adviser. While the 1940 Act generally prohibits joint transactions between a fund and its affiliates, Rule 17d-1(d)(7) permits the purchase of joint D&O/E&O policies.
We are not in favor of this proposal. The determination as to the need for specific policy features or the total dollar amount of coverage desired should, we believe, be left to the discretion of the Independent Directors. The Commissionís attempt to dictate the types of policy features a fund should have, while well intentioned, may be counter-productive. This proposal also assumes that policies that do not exclude coverage for litigation between Independent Directors and the fundís adviser are widely available. Since insurance companies are not required to offer such coverage, that coverage may not always be available to certain funds which have experienced litigation with its adviser. Additionally, such coverage may not always be available at a reasonable price, if at all. Thus, funds and the Independent Directors would be required to obtain E&O/D&O policies separate from those of the adviser, which may result in lesser coverage for the Independent Directors and higher premiums to the funds and its shareholders. This may be particularly burdensome for smaller funds.
E. Exemption from Ratification of Independent Public Accountant Requirement for Funds with Independent Audit Committees
The 1940 Act requires that the selection of the fundís independent public accountants be submitted to shareholders for ratification or rejection at their next annual meeting. The Commission is proposing to exempt funds from that requirement if the auditor is subject to the oversight and direction of an audit committee consisting entirely of Independent Directors. We support this proposal because we believe that the Independent Directors are in a better position to evaluate the independence and effectiveness of independent auditors than are fund shareholders. Additionally, we are of the same opinion as that stated in the proposing release that shareholder ratification of the selection of a fundís independent accountant has become perfunctory, to the extent funds even hold shareholder meetings.
We request that the Commission clarify the intended scope of the phrase "oversight of the accounting and auditing process." Because Independent Directors typically have oversight and not direct supervisory responsibility, the Commission should make it clear that this rule proposal does not contemplate directors supervising a fundís day-to-day management and operations, and that the directorís oversight responsibility would cover only the accounting and audit processes of independent auditors.
F.Qualification as an Independent Director
1. Affiliation with a Broker-Dealer
We support this proposal. The Commissionís proposal to decrease the Independent Director restriction on affiliations with broker-dealers will provide the Boards with more flexibility in selecting qualified candidates.
2. Ownership of Index Fund Securities
The Commission proposes a new rule that would conditionally exempt an individual from being disqualified as an Independent Director merely because he owns shares of an index fund that invests in the adviser or underwriter of the fund, or their controlling persons. Because the Commissionís proposal does not extend to managed funds, it introduces the possibility that a director could be "deemed interested" under Section 2(a)(19)(B)(iii) if he or she owns shares of a managed fund that invested in affiliated stock. The Commission states in the release that the "attenuated interest" arising from a directorís ownership of shares of an index fund that in turn owns an interest in the adviser or underwriter "is not the type of interest Congress intended to prohibit independent directors from owning when it adopted section 2(a)(19). Because index fund portfolios typically are spread among a large number of issuers, ownership of their shares is unlikely to have a material effect on the independent judgment of a fund director." That reasoning has more application to managed funds since the composition of the portfolio of a managed fund may change at any time. Therefore, we request that the Commission apply the same conditional exemption to individuals that own shares of managed funds.
G. Disclosure of Information about Fund Directors
1. Basic Information about Directors
a. Location of Information
b. Required Information
The Commission is proposing to require mutual funds to disclose basic information about directors in an easy-to-read tabular format. We have no objection to disclosure of basic information in the Statement of Additional Information, the annual report and in the proxy statement. However, we do not believe it would be appropriate to include such information in the prospectus, because such information "is not essential to a typical investor in making a decision about investing in a fund and would only serve to lengthen the prospectus."
2. Ownership of Equity Securities in Fund Complex
The Commission proposes to require disclosure of the aggregate dollar amount of equity securities of funds in the fund complex owned beneficially and of record by each director. While we do not necessarily disagree with the premise that the interests of a director who holds shares in the fund complex will tend to be aligned with the interests of other shareholders, we do not believe disclosure of a directorís holdings of shares in a fund complex would be useful to shareholders. We do not object to disclosing whether a director owns shares of funds in the fund complex, but we feel that disclosure of the aggregate dollar amount is overly intrusive when combined with the other required information (i.e., name and address), and this outweighs any potential value such disclosure may provide to shareholders. Additionally, a directorís impartiality and commitment to performing his or her functions as an Independent Director should not and cannot be measured by the amount of fund securities owned in the fund complex.
3. Conflicts of Interest
If changes are to be made in this area, we support a de minimus threshold of $100,000 for the public disclosure of securities owned by a director and his/her immediate family members in the adviser, principal underwriter or administrator, as well as the disclosure of a transaction or relationship with a company that engages in a transaction or has a relationship with a fund or related party. Public disclosure of transactions or relationships where the interest of a director or his or her immediate family member arises indirectly through ownership of an interest in a company that is involved in a transaction or relationship with a fund or related party should be limited to instances where the director or his immediate family own 10% or more of the companyís securities.
While we agree that disclosure of conflicts of interest should be extended to include those of immediate family members, we believe that the definition of immediate family members is overly broad and will make compliance with the proposal burdensome, if not impossible. The proposal would require funds to circulate questionnaires to a directorís immediate family members each time a Fundís registration statement requires updating. The fiscal year ends of the various Oppenheimer Funds, Centennial Funds, Panorama Series Fund, Inc., Oppenheimer Quest Funds and Oppenheimer Rochester Funds are spread over six different annual periods. Given the scope of transactions, relationships and interests that would be subject to disclosure, it may be difficult for a fund to obtain the requisite information on a timely basis each and every time. The inability to disclose that information could expose the directors to potential liability for material omissions. In addition, potential candidates for directorships may feel this requirement to be so burdensome and intrusive upon his/her immediate family members as to dissuade them from serving on a fund board. Instead, the Commission should require disclosure of ownership interests and relationships of immediate family members sharing the same household. That standard has been used successfully in connection with the regulation of short-swing profits under Section 16 of the Securities Exchange Act of 1934.
4. Boardís Role in Fund Governance
The Commission proposes that mutual funds discuss in the Statement of Additional Information in reasonable detail the material factors and conclusions that formed the basis for the Boardís approval of the investment advisory contract, including a discussion of any benefits derived by the investment adviser. This information is currently required to be disclosed under the proxy rules when the approval of an investment advisory contract is being solicited to shareholders. The rationale for disclosing this information in proxy statements would not seem to apply to disclosure in SAIs. The disclosure of the material factors and conclusions that formed the basis for the Boardís approval of an advisory contract does not add useful information for an investor to make an informed investment decision. An investorís decision to purchase or sell shares of a particular fund will be driven by a variety of factors that may include investment objective, risk tolerance, past investment performance, name recognition, service, fees and the like. Accordingly, we are not in favor of this proposal.
5. Separate Disclosure
The Commission is proposing to require funds to present all disclosure for independent directors separately from disclosure for interested directors in the SAI, proxy statements for the election of directors, and annual reports to shareholders. The reasoning for this proposal is to provide more prominent disclosure about independent directors. We do not support this proposal. We believe that the current requirement that funds indicate with an asterisk the directors who are interested persons of the Fund sufficiently highlights to investors those directors who are interested.
Any bi-furcated information about the directors would serve no useful purpose and would confuse shareholders.
Should you have any questions or require additional information, please contact the undersigned.
Very truly yours,
/s/ Denis R. Molleur
Denis R. Molleur
Vice President and
cc:Andrew J. Donohue, Esq.
Bridget A. Macaskill