Fidelity Management & Research CompanyEric D. Roiter
Via Electronic Mail Mr. Jonathan G. Katz
Re: Proposed Rule: Certification of Management Investment Company Shareholder Reports and Designation of Certified Shareholder Reports as Exchange Act Periodic Reporting Forms (Release Nos. 34-46441; IC-25723; File No. S7-33-02) Dear Mr. Katz: On behalf of Fidelity Management & Research Company, I am writing in response to the above-captioned Release, which proposes not only to extend certification requirements to mutual fund shareholder reports but to impose upon CEOs and CFOs of mutual funds personal responsibility for the design, periodic evaluation and certification of "disclosure controls" relating to any fund filing made with the SEC - whether or not such filing is subject to the certification requirements of the Sarbanes-Oxley Act (the "S-O Act"). Fidelity is the investment manager for over 260 registered investment companies in the Fidelity Group of Funds with aggregate assets in excess of $625 billion. The Fidelity Group of Funds currently files over 520 semi-annual and annual reports on Form N-SAR each year and an equal number of semi-annual and annual shareholder reports pursuant to Rule 30e-1 of the Investment Company Act of 1940. Fidelity supports in all essential respects the views expressed by the Investment Company Institute and the Business Law Section of the American Bar Association in their respective letters to the Commission dated October 16, 2002. Fidelity strongly supports the goal of improving the accuracy and accountability of financial reporting by corporate America to investors - including mutual funds. The financial reporting and accounting scandals occurring at Enron and other operating companies inspired passage of the S-O Act. Because mutual funds and other investors are the intended beneficiaries of the reforms introduced by the recent legislation, we strongly urge the Commission to reconsider its rulemaking priorities and to re-assess the policy and legal implications of imposing upon mutual funds - and upon their CEOs and CFOs personally - certification burdens that greatly exceed those to which operating companies are subject. In particular, we urge the Commission to strike a different, and more appropriate, balance in its rulemaking in at least three important respects. First, certification requirements should not be applied to any part of the Form N-SAR - a document that is not distributed to fund shareholders and falls technically within the S-O Act only by happenstance. A realistic balancing of the perceived benefits and burdens of Form N-SAR certifications casts serious doubt on the need, or utility, of such a requirement, particularly in the case of mid- to large-size fund complexes managing scores of different funds. Second, with respect to shareholder reports, the Commission should draw a distinction between a fund's financial statements and other information, notably the Management Discussion of Fund Performance, which is subjective in nature and does not lend itself to a fact-driven certification process. Mandatory certification of the latter will have a chilling effect on disclosure in shareholder reports, to the detriment of investors' interests. Third, extension by the Commission of "disclosure controls" requirements to all filings by mutual funds (whether under the Securities Act of 1933, the Securities Exchange Act of 1934, or the Investment Company Act of 1940) singles out the fund industry for significantly greater compliance burdens than those imposed on operating companies. This proposal raises serious questions regarding the Commission's rulemaking authority beyond Section 302 of the S-O Act, which, by its terms, applies only to quarterly and annual reports under the 1934 Act. I. The Form N-SAR Certification Requirement Should be Eliminated. Form N-SAR filings are ill-suited for certification under the S-O Act, not only because they are not delivered to shareholders, but also because, by design, they contain little, if any, information directly relevant to investment decision-making by those buying or redeeming mutual fund shares. Form N-SAR has served solely as a census-type filing for use by the Commission staff in carrying out their inspection and other oversight functions.1 To the extent that random parts of the form might be useful to investors, these items are drawn from a fund's financial statements, which themselves will be subject to separate certification requirements under the Commission's rule proposals. Form N-SAR has no impact on investment decisions, and plainly falls outside the scope of Congressional intent underlying the S-O Act. It is difficult to conceive how certification of Form N-SAR produces any discernable benefit to investors. Further, the process of certifying N-SAR reports is exceedingly costly and time consuming. The Commission has seriously underestimated the amount of time required to certify Form N-SARs - a more accurate estimate is a minimum of 20 hours per fund certification on an ongoing basis.2 Under the Commission's current and proposed rules, our funds' CEO and CFO will certify more than 520 Form N-SARs and 520 shareholder reports over the course of a year - compared to 4 certified filings by the CEO and CFO of an operating company. Even if the Commission's estimate of 5 hours per fund N-SAR certification were accurate, certification of the Fidelity Funds' N-SARs would require more than 2,700 hours per year. The Form N-SAR slated for filing by Fidelity Select Portfolios trust later next week is illustrative of the burdens the Commission's rules will impose upon the fund industry with little conceivable benefit to investors engaged in investment decision-making. The Form N-SAR of the Fidelity Select Portfolios, which has 42 individual funds, will comprise more than 2,300 pages. Scores of pages will detail - series fund by series fund - an extensive listing of subcustodians within the network of each global custodian for each fund in the trust. Each custodian and subcustodian must be entered on a separate page (N-SAR exhibits are prohibited other than in a few limited circumstances).3 Additionally, much of the financial data and other N-SAR information must be manually entered into the form, given that the Commission's filing software was not designed for easy assimilation of data from the fund industry's data management programs. We strongly urge that the Commission, taking into account the gross imbalance of substantial burdens to be borne by the fund industry and the dubious benefits to be realized by investors, drop the Form N-SAR as a certified document under the S-O Act by converting it to a filing made solely under the 1940 Act. II. In Shareholder Reports, Only Financial Statements Should be Certified. Many mutual funds include in shareholder reports much information not required under the Commission's rules. These reports typically include a letter from the fund's chairman or president and frequently an interview with the portfolio manager. Many funds include a Management Discussion of Fund Performance (MDFP) in both semi-annual and annual reports - even though this information is required only on an annual basis. The MDFP discusses a fund's past performance and describes the factors that affected that performance, including relevant market conditions and the investment strategies and techniques used by the fund's investment adviser, as well as performance information. A substantial portion of the information in the MDFP is subjective in nature - reflecting the portfolio manager's insights about market events and fund performance - and simply does not lend itself to a fact-driven certification process. This is also true for letters from a fund's president. A broad rule requiring certification of all information in shareholder reports raises the likely prospect that much of what is now voluntarily provided in those reports will be dropped. The rule will have a chilling effect on the expression of opinions and insights by fund managers and is likely to lead to boilerplate "discussion" limited strictly to objective data. To avoid this result, the Commission should limit certification requirements to the fund's financial statements - in keeping with the focus of the S-O Act. In so doing, the Commission will strike a more appropriate balance that will redound to the benefit of investors. III. The Commission Should Not Extend Disclosure Controls Requirements to 1933 and 1940 Act Filings. The Commission's proposal to require mutual fund CEOs and CFOs to design and certify disclosure controls underlying 1933 and 1940 Act filings raises serious questions of legal authority and policy. The Commission's proposal would effectively pre-empt a fund's board of directors from exercising its business judgment as to how best to allocate responsibilities within a fund complex among a fund's officers, investment adviser and service providers. It runs counter to recent rulemaking by the Commission that has sought to strengthen the role of independent directors.4 We recognize the importance of strong controls that ensure the accuracy of disclosure documents upon which fund investors rely. This is not at issue. The Commission is not proposing a rule requiring that mutual funds design and maintain such controls - or that the fund's board appoint an agent, whether the fund's advisor or its administrator do so. Rather, the Commission is proposing to impose this duty personally upon the CEO and CFO of a fund. We recognize that by enacting the S-O Act, the Congress has imposed certification duties on CEOs and CFOs of all public companies with respect to 1934 Act filings. But the S-O Act, by its terms, does not extend to filings under other federal securities statutes. None of the statutory sections invoked by the Commission in its proposed rulemaking address the Commission's authority to impose personal obligations upon any particular fund officer in respect of 1933 Act and 1940 Act filings. In its proposal, the Commission has gone beyond not only the terms, but also the legislative intent, underlying the S-O Act. Congress certainly did not intend that mutual funds be subjected to substantially greater burdens than operating companies. Further, Congress evidenced no intent to impose upon CEOs and CFOs any personal duty to design and evaluate controls other than "internal controls" - which are commonly understood to extend only to financial statements. For example, the Report of the Senate Committee on Banking, Housing and Urban Affairs states that:
The Commission itself has acknowledged in its release adopting N-SAR certification requirements that "disclosure controls" are different from internal controls.6 Yet, it is far from clear what the Commission's source of authority is for extending design and certification requirements upon fund CEOs and CFOs for non-financial information (indeed, for any information) in 1933 and 1940 Act filings. It certainly cannot be found in the S-O Act. Indeed, the Commission states in its proposing release that all investment companies should maintain disclosure controls regardless of whether a particular company is subject to the 1934 Act at all.7 It is difficult, however, to reconcile the circumscribed scope of the 1940 Act with the Commission's proposal, which would effectively limit the availability of the business judgment rule under state law that allows a fund's board or adviser to determine how responsibilities regarding the management and operation of a mutual fund may be assigned and delegated to particular individuals within a mutual fund complex. 8 The Commission's intentions to expand upon the S-O Act are clear, but a belief that disclosure controls are in the public interest does not itself supply rulemaking authority.9 For the reasons set out above, we respectfully request that the Commission withdraw its proposal concerning mutual fund disclosure controls, and that the Commission subject mutual funds - who are mere accidental participants in the Sarbanes-Oxley certification process - to a financial statement certification requirement, and a financial statement certification requirement only. * * * We appreciate the opportunity to comment on this important rule proposal. Please contact me at (617) 563-7000 should you have any questions concerning Fidelity's views.
cc: Chairman Harvey L. Pitt
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