October 16, 2002

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549-0609

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:

  • Fundamentally, the Act was motivated by a desire to curb abuses by operating companies, and the legislative history does not cite problems or concerns about the adequacy of mutual fund financial statement disclosures. 3

  • The complexity and diversity of the organizational and financial structures of public operating companies made it difficult to detect the abuses that led to the enactment of the Sarbanes-Oxley Act. Yet the organizational and financial structures of mutual funds are relatively straightforward and largely homogeneous.4 Unlike the financial statements of operating companies, investment company financial statements do not include complex consolidated reports involving special purpose entities and other subsidiary relationships. Investment companies do not have a variety of alternative accounting methods to choose from, nor do they issue debt. Fund accounting processes are tightly controlled on a daily basis because, unlike operating companies, funds must close their books at market value daily.

  • Public operating companies, unlike investment companies, usually have one set of consolidated financial statements that is filed quarterly. Investment company firms, which are typically overseen by one principal executive officer and one principal financial officer, have dozens, perhaps hundreds, of funds with staggered fiscal year-ends. These firms, like Vanguard, file fund financial statements with the Commission throughout the year, usually every month. The proposed rules underestimate the practical impact of the required certifications on the CEOs and CFOs of fund companies. At a minimum, the final rules should not require duplicate reviews of the same financial data.

  • The securities laws govern the activities of public operating companies by requiring disclosure of material information, but they do not substantively regulate a company's operations. Investment companies, on the other hand, are subject to extensive substantive regulation under the Investment Company Act of 1940 in addition to their public disclosure obligations under the Securities Act of 1933. The Investment Company Act includes core provisions, and extensive SEC rules, that closely regulate conflicts of interest, affiliated transactions, and the daily valuation and safekeeping of fund assets, among other things. In addition, mutual funds and their advisers are subject to regular examination by the Commission. This system of regulation has successfully protected mutual fund shareholders from the type of financial disclosure abuses that were targeted for clean-up under the Sarbanes-Oxley Act.

Our recommendations reflect these basic yet significant distinctions.

I. Summary of Comments

  1. We fully support the Commission's proposal to require mutual fund CEOs and CFOs to certify financial information contained in shareholder reports to the extent intended by Congress in Section 302 of the Act. The Commission's proposals, however, go beyond the Congressional intent of Section 302. As such, we believe the certification requirement should extend only to financial data in the shareholder reports filed under the Securities Exchange Act of 1934 and not to other non-financial information that may be subjective in nature or otherwise ill-suited to the type of certifications required under the Act.

  2. We believe that proposed Form N-CSR, and not Form N-SAR, is the appropriate form for accomplishing the Act's certification requirements. Continuing to require certification of Form N-SAR will result in a duplication of effort with no benefit to fund shareholders.

  3. We question why the Commission has proposed extending the certifications to all investment company filings under the Securities Act, the Exchange Act and the Investment Company Act, particularly when the Commission has not proposed a similar requirement for public operating companies. Expanding the scope of the certifications in this manner will likely cause funds to restructure or duplicate existing controls and procedures to support the new certifications, but we do not believe that these changes will yield substantially different or improved results for investors.

In addition, we support the comments submitted by the Investment Company Institute in its letter to the Commission dated October 16, 2002.

II. Discussion

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.

              Sincerely,

              Heidi Stam
              Principal
              Securities Regulation

cc: Paul F. Roye, Director
Division of Investment Management
U.S. Securities and Exchange Commission

John J. Brennan, Chairman and CEO
R. Gregory Barton, Managing Director and General Counsel
Thomas J. Higgins, Principal and Treasurer of the Vanguard Funds
The Vanguard Group, Inc.

50220-1

____________________
1 The Vanguard Group, Inc. ("Vanguard") headquartered in Valley Forge, Pennsylvania, is the nation's second largest mutual fund firm. Vanguard serves 17 million shareholder accounts, and manages more than $550 billion in U.S. mutual fund assets. Vanguard offers 109 funds to U.S. investors and 10 additional funds in foreign markets.
2 Certification of Management Investment Company Shareholder Reports and Designation of Certified Shareholder Reports as Exchange Act Periodic Reporting Forms, Investment Company Act Release No. 25,723 (Aug. 30, 2002); 67 Fed. Reg. 57298 (Sept. 9, 2002) (hereinafter "Release").

3 See, e.g., 148 Cong. Rec. S7350, S7351 (Thurs. July 25, 2002) (statement of Sen. Sarbanes that the Act addresses abuses involving, among other things, special purpose entities, loans to executives, and pro forma earnings statements).

4 See Form N-1A, generally, and Regulation S-X regarding rules for the preparation of investment company financial statements.
5 Financial information subject to certification should only include financial statements prepared pursuant to Regulation S-X (and condensed financial information). See Form N-1A Item 22.
6 See, Disclosure of Mutual Fund Performance and Portfolio Managers, Investment Company Act Release No. 19382 (April 6, 1993) (stating that the MDFP is a discussion of the "factors, strategies and techniques that materially affect fund performance."). See also, Item 5 of Form N-1A.
7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") is an analysis of the financial statements and condition of an operating company required by Rule S-K Item 303.
8 For example, the portfolio manager of Vanguard Wellington Fund wrote in that fund's most recent semi-annual report, "We think that a weaker dollar would be a boon for many of our equity holdings, especially in the basic materials and manufacturing sectors, which suffer from foreign competition when the dollar is strong."
9 Release, 67 Fed. Reg. 57298 at 57299.
10 Rather, Form N-SAR was adopted as a method for filing periodic information with the Commission to aid with its inspection and compliance-monitoring programs. See Semi-Annual Report Form for Registered Investment Companies; Temporary Suspension of Quarterly Reporting Obligations of Certain Registered Investment Companies Pending Receipt of Comments on Proposed Final Action, Investment Company Act Release No. 14299 (Jan. 11, 1985) (adopting Form N-SAR).
11 For example, Form N-SAR does not currently permit registrants to submit complete and accurate information for funds with more than two classes of shares (see Items 72G, 72DD, 73A2, 74A, 74U2, 74V2) or for funds that have more than $99,999,999,999 in assets (see Item74T). Additionally, the form is built in an antiquated technological format that provides little or no mathematical or control functionality, making the entry or adjustment of data in the form and navigation within the form extremely cumbersome. Moreover, the manual workarounds necessary to report accurate information only add time and expense to an already time consuming and costly process.
12 In fact, we believe it would be appropriate to suspend Form N-SAR filings entirely until the Commission has an opportunity to update the form.
13 In most cases, the financial statements and Form N-SAR reports for a fund have to be reviewed separately, thus doubling the time required to meet the certification requirements. Typically, preparation and review of the financial statements occurs first. As a procedural matter, it does not make sense to review the Form N-SAR until after the relevant financial statements are finalized. Applicable data is then entered into Form N-SAR, which then also has to be reviewed under the current rules.
14 We also suggest that disclosure controls and procedures not extend to definitive proxy materials. Section 302 of the Act was passed by Congress to improve financial reporting and to restore investor confidence in the accuracy and completeness of financial reports. Proxy materials do not contain financial reports that would require certification under Section 302. Furthermore, neither Congress nor the Commission have identified abuses in investment company proxy statements that would merit the additional costs associated with a new certification requirement.
15 Release, 67 Fed. Reg. 57298 at 57300 (stating that "it is important that investment companies maintain effective disclosure controls and procedures with respect to the information required in filings under the Securities Act and the Investment Company Act as well as with respect to Exchange Act filings.")
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