October 16, 2002
Jonathan G. Katz, Secretary
RE: Certification of Management Investment Company Shareholder Reports and Designation of Certified Shareholder Reports as Exchange Act Periodic Reporting Forms: File No. S7-33-02
Dear Mr. Katz:
The Vanguard Group1 appreciates the opportunity to comment on recent proposals by the Securities and Exchange Commission to adopt rules governing the certification of management investment company shareholder reports pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.2 The management and Board of Trustees of the Vanguard funds have always stood behind the accuracy and integrity of the financial information Vanguard provides to shareholders. We support the Commission's proposals to the extent they are designed to implement the intent of the Act and impose a consistent level of care in financial reporting for public companies.
While we strongly support the Commission's effort to obtain CEO and CFO certifications of financial information, we urge the Commission to better tailor these rules to mutual funds for the ultimate benefit of mutual fund investors. In our view, mutual fund companies have important differences from public operating companies that have not been recognized in these proposals. We believe the Commission is in the best position to understand these distinctions and ensure that the regulations arising out of the Sarbanes-Oxley Act are designed to work effectively and efficiently in the interests of mutual fund investors.
We urge the Commission to consider the factors discussed below in refining the proposed rules as they apply to mutual funds:
Our recommendations reflect these basic yet significant distinctions.
I. Summary of Comments
In addition, we support the comments submitted by the Investment Company Institute in its letter to the Commission dated October 16, 2002.
1. The Commission should require certification of financial information consistent with Congressional intent.
We support the Commission's proposal to require certification of financial information contained in shareholder reports to the extent required by the Act. We believe, however, that the Commission's proposal goes beyond the scope of Section 302 of the Act. Section 302, entitled "Corporate Responsibility for Financial Reports," simply requires principal executive officers and principal financial officers to certify financial reports filed pursuant to the Exchange Act. Under the current proposal, investment companies would have to certify the contents of both Form N-SAR and shareholder reports, rather than just financial information in the shareholder reports. We recommend that the certifications only apply to financial information in the semi-annual and annual reports filed with the Commission on proposed Form N-CSR. 5
Non-financial statement information included in shareholder reports should not be certified. For example, "Management's Discussion of Fund Performance" ("MDFP") and other non-financial information contained in shareholder reports are not appropriate subjects for certification. 6 Unlike the "MD&A" that is required in operating company reports, the MDFP is not an analysis of the financial statements.7 The adviser letters that appear in Vanguard fund reports, for instance, are appropriately the responsibility of the fund's portfolio manager because they contain the manager's opinions about the factors that affected the fund's performance and the manager's investment outlook for the future.8 While it is certainly appropriate for the CEO to oversee the management of the fund and for the CFO to oversee the financial reporting for the fund, it is neither appropriate nor feasible for these individuals to certify the opinions reflected in the MDFP.
Other information that is included voluntarily in shareholder reports should not be certified. Funds voluntarily include a variety of information in shareholder reports in an effort to make the reports more useful to investors. Voluntary information often includes a portfolio manager's discussion of market conditions or investment concepts that is extremely useful to investors, but difficult if not impossible to certify. We are concerned that significant additional certification requirements and the compliance infrastructure they would demand would have a chilling effect on this type of educational, investor-friendly information.
2. Form N-CSR, not Form N-SAR, is the appropriate form for certification.
We believe Form N-CSR is the appropriate form for achieving investment company compliance with Section 302 of the Act and we strongly recommend that the Commission adopt Form N-CSR and eliminate the current requirement to certify Form N-SAR.
The Commission has noted that Congress' intent in adopting the Section 302 certification requirement was "to improve the quality of the disclosure that a company provides about its financial condition in its periodic reports to investors."9 Certifying Form N-SAR is not consistent with Congressional intent because the form is not provided to investors, does not contain complete financial statements, and is not used by investors to make investment decisions.10 Form N-SAR certification, therefore, does not improve investor reporting, but instead creates an unnecessary compliance burden with no benefit for investors. Complicating matters, Form N-SAR is outdated and in need of significant modernization.11 Under the circumstances, the certification requirement for Form N-SAR should be eliminated because the time and expense of preparing, reviewing and certifying each Form N-SAR does not result in commensurate benefits for investors.12
Certifying financial statement information in shareholder reports as part of Form N-CSR would be an efficient and accurate way to capture Congress' intent of improving investor confidence in financial reporting. Although the proposed certification requirements will result in additional up-front and ongoing costs, we do not object to those costs that relate to financial statements in shareholder reports. We do, however, object to incurring the costs of Form N-SAR certification, which we view as duplicative and unnecessary. 13 Consistent with that view, we strongly believe that fund officers should not be required to certify both the N-CSR and the N-SAR.
3. Certifications regarding disclosure controls and procedures should not apply to all Securities Act, Exchange Act, and Investment Company Act filings.
We question why the Commission has proposed to require all investment companies to maintain specified "disclosure controls and procedures" with respect to all filings made pursuant to the Securities Act, Exchange Act and Investment Company Act.14 Although we certainly agree that mutual fund companies should have appropriate controls to govern their public disclosure obligations, we believe such controls are already in place. We are concerned that the proposal underestimates the disruption and cost of duplicating existing disclosure controls merely to suit the new certifications and overstates the anticipated benefit to investors.
Although this aspect of the proposal significantly expands the scope of the certification beyond the intent of the Act and the provisions that have been applied to public operating companies, the Commission has not cited any particular problem or abuse regarding mutual fund disclosure or compliance practices. Nor has the Commission identified any shortcomings of the existing regulatory regime that includes both substantive and disclosure regulations governing mutual funds. Rather, the Commission has made a blanket statement in support of this proposal for mutual funds, but not for public companies, without any suggestion that the existing regulatory or compliance structures of funds are in any way inadequate.15
The proposing release does not assess the number and types of filings that would be the subject of "disclosure controls and procedures". Each year, Vanguard prepares approximately 2,600 documents under the federal securities laws. While we have existing internal controls and compliance procedures that support our obligations under the federal securities laws, they were not designed specifically to meet the certifications of Section 302. We believe that proposed rule 30a-3 will result in unnecessary duplication of effort and require a significant restructuring of existing compliance controls and procedures that the Commission already regularly examines. We estimate that applying the certification requirements regarding disclosure controls and procedures for all filings would result in many additional hours of preparation, review and documentation, the cost of which would ultimately be paid for by fund shareholders.
We are unconvinced that devoting significant resources to establishing and maintaining a duplicative control function is justified. This is especially true in light of the fact that CEOs, CFOs and their firms are already subject to significant liability under the federal securities laws for misleading statements and omissions in fund prospectuses, shareholder reports and other communications with investors.
* * *
We emphasize our support for the Commission's effort to enhance the integrity and responsibility of financial statement reporting for public companies and we support the proposals to require CEOs and CFOs of mutual funds to certify fund financial statements. We urge the Commission to modify the proposals to eliminate the duplicative Form N-SAR certification requirement. Further, we encourage the Commission to limit certifications to the objective financial information that is contained in shareholder reports and is suitable for certification within the intent of the Sarbanes-Oxley Act.
We appreciate the opportunity to comment. If you would like to discuss these comments further, or if you have any questions, please feel free to contact me at (610) 503-4016, or Christopher A. Wightman, Associate Counsel, at (610) 503-2320.
cc: Paul F. Roye, Director
John J. Brennan, Chairman and CEO