January 28, 2000
Johnathan G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, DC 20549-0609
Re: File No. S7-23-99
Proposed Rules on Role of Independent Directors of Investment Companies
Release Nos. 33-7754; 34-42007; IC-24082 (the "Releases")
Dear Mr. Katz:
This letter is being submitted on behalf of Allmerica Financial Investment Management Services, Inc., a registered investment adviser ("AFIMS"), and a wholly owned subsidiary of Allmerica Financial Corporation, a New York Stock Exchange listed company ("AFC").
AFC is a holding company whose principal subsidiaries are substantial companies in both the property and casualty insurance field (The Hanover Insurance Company and Citizens Insurance Company of America) and the variable annuity and variable life insurance field (Allmerica Financial Life Insurance and Annuity Company, "AFLIAC" and First Allmerica Financial Life Insurance Company, "FAFLIC"). AFLIAC's sales rank it within the top 20 companies for both variable annuity contracts and variable life policies.
AFIMS and Allmerica Asset Management, Inc. ("AAM"), another wholly owned subsidiary of AFC, which are both registered investment advisers, have more than $13 billion under management. AFIMS serves as investment manager of Allmerica Investment Trust ("AIT"), an open-end management company that is the funding vehicle for many of the insurance companies' separate accounts. AAM is the investment adviser to AFLIAC and FAFLIC, qualified plans and trusts, four portfolios of AIT, Allmerica Securities Trust ("AST"), which is a registered closed-end investment company whose shares are listed on the New York Stock Exchange, and certain other investment accounts. The respective Boards of Trustees which govern AIT and AST include a super majority of disinterested trustees. AIT utilizes a so-called "manager of managers" approach, with AAM and various unaffiliated firms serving as sub-advisers.
It is my understanding that the disinterested trustees of the various Allmerica funds are submitting their own comment letters on the various rule proposals covered by the Releases. This letter represents only the views of AFIMS itself.
A few words on the mutual fund experience of Allmerica's senior management may be of value to enable the Commission to place our comments in context. I have over thirty-five years of mutual fund experience, initially with a firm, then known as Gaston, Snow, Motley & Holt, which acted as outside counsel to the Fidelity Group of Funds, and, since 1968, as a full-time employee of various investment advisory organizations (Fidelity Investments, Quest for Value Advisors, Inc. and Allmerica). In this period of time a substantial part of my activities has involved working with disinterested directors and their counsel. During that time I have also been a member of various NASD committees and have served on the Executive Committee of the Investment Company Institute, serving as Chairman of the Board of Trustees in 1986-1988. John F. O'Brien, the Chairman of AFC, also has over 35 years of mutual fund experience, primarily in various senior executive roles at Fidelity Investments, including responsibility for Fidelity Distributors Corp. About the only role that neither of us has performed in the mutual fund industry is that of disinterested director/trustee.
We think it important to state at the outset that the role of the disinterested trustee and the basic pattern of governance established by the Investment Company Act of 1940 and the rules and regulations that have been promulgated to implement that Act are extremely important and have been a valuable contributing factor to the success of the investment company world and to the benefits that have been provided to the investing public. The proposed rules, building as they do on the so-called "best practices" now being followed in the industry, are, in general, highly appropriate and we are in substantial agreement with them. Notwithstanding this, however, we believe it is important to keep in mind a few underlying principles when considering the various elements of the Releases. The first is that individuals purchase shares of a given mutual fund because of the reputation and investment performance capabilities of the investment adviser or sub-adviser, not because of the identity of the board members. While it is clear that an effective board can be an important contributor in establishing the overall reputation of the adviser, it is my strongly held opinion, based on over thirty-five years of active experience in the sale and management of mutual fund complexes, that the composition of the board, in and of itself, is, at most, a secondary consideration in the purchase decision of investors. The second principle is that care must be taken that in seeking to eliminate any potential conflicts of interest, a regulatory structure not be established which has the perverse effect of discouraging persons of relevant business experience from serving as disinterested trustees. In our judgement, the proposed Rules present just such a risk in certain regards.
1. Composition of Board We believe that it is appropriate to provide for a "super majority" of at least 2/3 disinterested members of a fund's board, provided that the other provisions of the Rules are not so burdensome as to discourage experienced persons from serving. We would be against a 100% disinterested requirement, however. It is important that some members of the board be affiliated with management in order for there to be senior accountability at the board level to insure that all relevant matters appropriate to the ongoing conduct of the business affairs of the enterprise are being addressed. Very few boards are in a position to maintain full-time dedicated staffs to support their activities. Even if that were possible, removing the board members entirely from the day-to-day activities of the fund is not desirable. It runs the risk of relegating the board to a mere formality.
Given that some members of the board are, therefore, likely to be insiders, it is important as a statement of policy and in terms of the dynamics of the operations of the board that at least 2/3 of its members be disinterested. This is important in terms of the balance of power and for practical reasons such as the composition of committees of the board. Having been involved with boards of both large and small investment company complexes, I have not found the 2/3 requirement to be difficult from any practical perspective.
2. Board Vacancies Given the 2/3 requirement, proposed Rule 10 e-1 is highly desirable. It is quite possible that many organizations will just meet the 2/3 requirement - e.g. 6 out of 9 board members being disinterested. Ample time must be given to replace a vacancy in the ranks of the disinterested members of the board. While it would be possible for one of the interested members to resign pending the filling of the vacancy, it is more appropriate to extend the time for filling the vacancy. Given the highly desirable proposal that the process be driven by the disinterested members of the board, we believe that the time periods proposed by the proposed Rule 10e-1 are not broad enough. We believe the standard should be 90 days for board action and 180 days for shareholder action.
3. Selection Process We believe that the nomination and selection rules, as proposed, are entirely appropriate. At the same time we believe it is highly desirable for the adopting Releases to make clear that it is also appropriate for members of management to propose candidates to the Nominating Committee. In addition, the fact that one or more members of management may have had extensive business or social contact with the individual being proposed should be considered a matter for disclosure and evaluation but not a matter for per se disqualification. While this is implicit in light of other aspects of the proposed Rules, specific references to this in the adopting Releases would be helpful.
4. Independent Counsel We believe that this section of the proposed Rules is the most troublesome. In its search for "perfection" the Commission is risking a tipping of the balance against retaining independent counsel. The aim of any Rule proposal should be to encourage the retention of counsel who are experienced in mutual fund regulatory affairs as individuals and who are members of firms which can provide broad support to the individual who acts as regular independent counsel to the board. The recent experiences of our Board in this regard may be instructive. Our Board has been advised by an individual who, although highly qualified and experienced, having retired after over 40 years experience with major law firms which had extensive mutual fund experience, was a sole practitioner with no backup and without access to the extensive resources of a large firm. AFC is a multi-line insurance company with an active financial services business practice. As such, we have extensive dealings with many law firms for both litigation or other business purposes. Our Board felt that it would be desirable to be advised by an experienced, local law firm. Being located within 45 miles of Boston, a city with an extensive mutual fund legal fraternity, this would seem to have been relatively easy. This was not the case, however. Two of the leading firms, Ropes & Gray and Hale & Dorr had significant ongoing ties to AFC. A committee of disinterested directors interviewed representatives of three other firms, two of which had performed legal work for AFC over the years. The one selected, Kirkpatrick & Lockhart, an eminently qualified firm, had, in fact, advised an AFC affiliate on becoming a federally charted trust company and occasionally provided general advice on relevant regulatory developments. The total billings involved were quite minor compared to the firm's overall billings. This was disclosed to and evaluated by the committee and the board and found not to be a disqualifier.
This conclusion would seem to be fully covered by the proposed "exception" provision of the proposed Rule. What is not so clear, however, is what are the standards by which such determination could be attacked and what would be the consequences of an adverse judicial or regulatory ruling on that issue? Given the potentially adverse consequences of such a ruling, we suggest that the proposed Rule make it clear that a board's decision, reached after full disclosure of the relevant facts, be given strong weight and that any adverse decision be given prospective application only, provided the committee and board acted in good faith. In this respect an adverse decision on independent counsel would parallel the provisions for an adverse ruling by the Commission on the disinterested status of an individual board member - Section 2(a) (19) of the Investment Company Act of 1940.
5. Disclosure of Information This section of the proposed Rules proceeds on the assumption that "shareholders have a significant interest in knowing who the independent directors are ...". This is far from obvious in our experience. Conceding for discussion purposes that this is the case, however, we believe the reach of the proposed disclosure is excessive and will serve to discourage many individuals from serving as disinterested board members. We have the following specific comments.
a) Ownership of Equity Securities While in general a logical rule, it has
problems where applied to the trustees of a separate account underlying an insurance contract. Due to prevailing rules under the Internal Revenue Code, the investment vehicles underlying these contracts can not consist of mutual funds available to the general public. Thus, to have a beneficial interest in these shares, a trustee would have to own an insurance contract. It seems undesirable to impose this burden on trustees and, in the case of a variable life insurance policy may not even be possible, due to underwriting considerations. Would the trustees' interest in the financial strength of the insurance company and its ability to meet the contractual guarantees itself present a conflict of interest? Directors of insurance related funds should be excused from this role.
b) Conflict of Interest The requirement for disclosure of factors and/or
"relationships" that may present conflicts of interest for the individual director, let alone of "immediate family members", starts along a continuum which could cause otherwise highly qualified, desirable individuals to decide not to serve. Many individuals are reluctant to disclose information about themselves, let alone engage in extensive inquiry and subsequent disclosures about family members, such as in-laws, with whom the trustee may not have had any contact for years. There is no evidence pointed to in the Releases that lends support to the need for such disclosure. It is interesting to note that while earlier sections of the Releases have extensive citations to supporting statements from the SEC's Roundtable and point to parallel provisions in the Investment Company Institute's "Best Practices" release, there are no such citations for this section of the Releases.
While traditional proxy type disclosure could well be included in the Annual Report, we see no need for expanded disclosure of the type proposed in public documents. Fund records should include any relevant business or other relations between a trustee and management. These records should include members of the immediate family of the trustee but should not extend to in-laws as proposed. (Query: Would the fact that a sibling of a trustee's spouse owned a mutual fund which held the stock of an affiliate of this adviser be a disqualifier?) While these fund records could arguably be made available on demand, we believe the risk of discouraging service as a disinterested trustee outweighs any potential value that could be said to be served by mandatory full public disclosure in order to meet the asserted, but unsubstantiated, active public interest in this information.
c) Toll-free number While it may strike others as perfectly reasonable to
provide a toll-free number or collect telephone service for inquiries about trustees, our experience is that toll-free numbers tend to encourage nuisance calls. Most complexes have general toll-free numbers for existing or prospective investors. Inquiry could be made in this fashion. If it was thought to be appropriate, the direct dial number of the funds' Secretary could be included in the Annual Report. Interested people could use that number. If they really are interested, it would not seem that the cost of the call will discourage their inquiry.
Subject to the above comments, we believe that the Proposed Rules are desirable and urge their adoption.
Richard M. Reilly
President & CEO
Allmerica Financial Life Insurance & Annuity Company