Frank Russell Investment Company
and Russell Insurance Funds
December 5, 2002
U.S. Securities and Exchange Commission
Attention: Jonathan M. Katz, Secretary
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-36-02; Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies
(Release Nos. 33-8131, 34-46518, IC 25739)
Ladies and Gentlemen:
Each of Frank Russell Investment Company ("FRIC") and Russell Insurance Funds ("RIF" and together with FRIC, the "Russell Funds") is an open-end management investment company registered as such under the Investment Company Act of 1940, as amended (the "1940 Act"). The Russell Funds are pleased to have this opportunity to comment upon the proposals (the "Proposed Rule") which are set forth in the above-captioned Release (the "Proposing Release").
Information concerning the Russell Funds. The Russell Funds comprise shareholder investment assets of over $14 billion and approximately 150,000 shareholders of record, not including investors who hold shares through omnibus accounts or variable insurance separate accounts.
The Russell Funds operate in a manner that is distinctly different in several fundamental respects from most other mutual funds, which typically have a single entity serving as investment adviser with respect to all of the assets of the entity. In nearly all of these cases, an advisory fee is paid by the investment company to its adviser, which, in turn, employs and compensates individual portfolio managers who are employees of the adviser hired to make specific securities selections. In contrast, the Russell Funds operate as "manager-of-managers" funds, having pioneered that approach over 20 years ago.
The Russell Funds' manager-of-managers investment methodology is designed to enable investors to achieve multiple levels of diversification within a single investment portfolio. Each series (a "Fund") of a Russell Fund represents a particular "asset class" (e.g., US equity, fixed income, international equity, etc.). Investors in a Russell Fund program are encouraged to apportion their investment assets among multiple Funds using an asset allocation strategy. Each Fund is diversified by dividing the Fund into strategically allocated portions (each such portion, a "Segment"), each of which is earmarked to be invested pursuant to a particular investment style (such as a market-oriented, growth, or value style). The assets of each Segment are assigned to a sub-adviser that specializes in the applicable investment style. Each sub-adviser in the Russell Funds is registered under the Investment Advisers Act of 1940 unless exempt from such registration.
After dividing a Fund into Segments, Frank Russell Investment Management Company, the Russell Funds' principal investment advisor (the "Advisor") selects and monitors for each Fund one or more sub-advisers (each such sub-adviser, a "Money Manager"), each of which exercises investment discretion over a specified Segment based on that Money Manager's expertise in the investment style designated by the Advisor for that Segment. Together, the investment management techniques of the Money Managers for each Fund represent a range of diverse investment styles. For its services, the Advisor receives from the Funds an advisory fee, a portion of which it retains as compensation, and the balance of which it transmits to each Money Manager, as agent of the Funds.
With the prior approval of its Board of Trustees (each, a "Board"), FRIC or RIF enters into an investment sub-advisory agreement (a "Sub-Advisory Agreement") with each selected Money Manager. Each Money Manger manages the Fund Segment assigned to it pursuant to its Sub-Advisory Agreement in accordance with the applicable Fund's objectives, policies, and restrictions. Each Money Manager has complete investment discretion, within these requirements and guidelines, over the management of its Segment and makes all decisions regarding the purchase and sale of securities for the Segment it manages. Although the Money Manager's activities are subject to general oversight by the Board and the Funds' officers, neither the Board, the officers nor the Advisor evaluates the investment merits of the Money Manager's individual security selections. A Money Manager has no authority or control with respect to any Segment or Fund other than the Segment or Fund specified in that Money Manager's Sub-Advisory Agreement.
The Russell Funds believe that proxy voting is an integral part of the investment process. They therefore rely on each Money Manager, which is in the best position to understand the relationship of any matter for which proxies are sought to the Money Manager's own investment strategy, to vote any proxies. To this end, each Sub-Advisory Agreement states that, unless the Advisor gives written instructions to the contrary (which it has never done), the Money Manager will vote all proxies solicited by or in respect of the issuers of portfolio securities held within its Segment and, in doing so, will use its best good faith judgment to vote such proxies in a manner which best serves the interests of the Fund's shareholders.
Currently, FRIC employs a total of 72 independent, unaffiliated, Money Managers to manage the various Segments of its 31 Funds, and RIF employs a total of 26 independent, unaffiliated Money Managers to manage the various Segments of the five RIF Funds. Six FRIC Funds are "funds of funds" that invest in combinations of other FRIC Funds pursuant to allocations directed by the Advisor. No Money Manager to whom management of a Segment is delegated is affiliated with the Advisor.
Comments on the Proposed Rule.
The Russell Funds believe that the Proposed Rule is not in the interests of mutual funds, and particularly of manager-of-managers funds or their shareholders and that the Commission should reconsider the necessity for such rules.
- The Commission's significantly underestimates the Proposed Rule's substantial costs for mutual funds and their shareholders.
- The benefits of the Proposed Rule have been greatly overestimated by the Commission and are at best illusory.
- The Proposed Rule is inconsistent with investor protection disclosure goals previously identified by the Commission.
Costs of the Proposed Rule. The Russell Funds recognize that expenses alone should not be a determinative factor of whether a new regulation is appropriate or beneficial. However, an accurate balance of the anticipated costs of new regulation against its perceived benefit should be a fundamental consideration. The Russell Funds believe that the Commission has significantly underestimated the costs of the Proposed Rule and has overestimated its benefits.
In the case of the Russell Funds, as with any mutual funds that use sub-advisers, the Proposed Rule would require disclosure of each Money Manager's proxy voting policies and procedures. Under the Proposed Rule, each Russell Fund would be required to include in its registration statement the proxy voting policies of every Money Manager to that Fund, which even individually can be lengthy and complex. Requiring the proxy voting policies of each of the Money Managers to be included in the statement of additional information ("SAI") for a multi-manager fund such as the FRIC Funds would recast the SAI into a compendium of complex policies and procedures, thus obscuring far more material and meaningful disclosures contained in the SAI. Further complicating matters, a formal registration statement amendment would be required every time any of the dozens of Money Managers of the Russell Funds materially changed their proxy voting policies or procedures.
As noted above, each Fund employs multiple Money Managers with different investment styles and disciplines. Accordingly, each Money Manager employs its own proxy voting policies and procedures for its Segment, which are unlikely to be similar to the policies and procedures used by other Money Managers in that Fund. Quite properly, because of these differing policies and procedures, a Fund's Money Managers who hold the same portfolio security in their Segments may well vote differently from one another on any given matter. For instance, it would be understandable and entirely appropriate for a growth-oriented manager for a particular Segment of a large capitalization equity Fund to vote differently on a merger transaction than a value manager for another Segment of the same Fund.
The resulting voting information for that Fund required by the Proposed Rule could easily show a portion of the Fund's portfolio company shares voted for the proposal and a portion against the proposal. Although that information would be meaningless to shareholders, those shareholders would nonetheless bear a substantial cost under the Proposed Rule's requirement that the information be compiled and available for them.
The Proposing Release estimates that compliance with the requirements of the Proposed Rule would cost each mutual fund approximately $2,500 in external and internal costs. As manager of manager funds, however, the 36 Russell Funds estimate that they would be required to incur costs of from $170,000 to $250,000 to develop systems enhancements and to take other actions necessary to achieve compliance with the Proposed Rule. Thereafter, the Russell Funds estimate annual expenses of from $168,000 to $318,000 to comply with the Proposed Rule, including systems maintenance expenses, the costs of additional employees, additional printing costs and additional mailing costs.
Because these are costs that would not be borne by other, direct shareholders of portfolio companies, the Proposed Rule penalizes investors who invest in portfolio companies through mutual funds rather than investing in them directly.
Moreover, the Proposing Release inappropriately dismisses cost concerns in connection with the Proposed Rule by stating that advances in technology over the last 30 years, specifically over the Internet, allow disclosure of proxy voting records to be readily accessible at low cost. Oddly, the Proposing Release later rejects the Internet as the sole medium for communicating proxy voting policies because the percentage of households with Internet access is substantially lower than the percentage of households with telephones. Even without that incongruity, however, the primary costs of such information is not merely in its transmission, but in its compilation and organization, a cost that markedly increases when the voting records and policies of dozens of independent Money Manager firms must be collected and presented, as with the Russell Funds.
Absence of Benefits to Mutual Fund Investors. The Proposed Rule appears to be a costly solution in search of a problem. The Proposing Release provides no compelling support for the Commission's belief that the Proposed Rule will have an "enormous impact on shareholder value" or that there is a pervasive problem of potential conflicts of interest in mutual fund proxy voting.
The proposed disclosure, particularly in respect of manager-of-managers funds, is neither relevant nor useful to investors. The Russell Funds are not aware of ever having received any request from a shareholder for information on the Russell Funds' proxy voting. Moreover, the Russell Funds have received no information to even suggest, much less demonstrate, that decisions to invest in the Russell Funds are ever based upon proxy voting decisions.
Even shareholder groups that are generally perceived as highly educated and socially aware have demonstrated a lack of interest in bearing the costs of obtaining the information and maintaining the procedures required by the Proposed Rule. A shareholder proposal requiring comparable disclosure of proxy voting decisions recently was submitted to the shareholders of TIAA-CREF Funds and was overwhelmingly rejected by the shareholders of those funds. The Russell Funds believe that this demonstrates the lack of relevance and usefulness assigned to such disclosures by shareholders generally.
Currently, there are mutual funds available to investors who support greater fund involvement in the governance of portfolio companies and who are willing to pay the costs associated with such involvement. The Proposing Release notes several such mutual fund complexes that voluntarily provide proxy voting information to investors, often on their websites, and, in a very few cases, their actual proxy voting decisions. By investing, those funds' shareholders have demonstrated their willingness to absorb the costs of preparing, maintaining and providing proxy voting information.
The Commission identifies only three funds groups that make their proxy voting information available. Those funds have not attracted the broad investment that would be expected if the Proposed Rule's requirements were attractive to investors generally. Nor have they inspired other fund complexes to follow similar practices with a view toward attracting a sufficient number of investors who are concerned with proxy voting information. Indeed, the absence of investor demand for the information and procedures required by the Proposing Rule can be measured by the relatively few such funds and the small percentage of all mutual fund assets that are invested in those funds.
The particular interests and willingness to absorb those costs of the investors in those three fund groups should not be arbitrarily attributed to the vast majority of mutual fund investors. If mutual fund investors demonstrate an interest in information required by the Proposed Rule, mutual funds will be compelled to provide such information in order to compete in the market place and to attract and retain assets.
The Commission should not be misled by the mere quantity of support letters it receives on the Proposing Release or by the efforts of labor unions and other political action groups with an interest in pressuring portfolio companies via the proxy process to generate and appearance of general support for the Proposed Rule.
Indeed, two of the three fund groups referred to in the Proposing Release that make their proxy voting information available have each established a website which provides investors, presumably a great number of which are the funds' own shareholders, with a form letter which can be filed electronically with the Commission. An examination of the comment letters available on the Commission's website filed by individuals discloses that a very high percentage were filed using these form letters.
Although each of those websites urges visitors to support the proposal neither provides any indication that the costs of compliance with the Proposed Rule would be borne entirely by mutual fund shareholders or what those costs might be, especially for funds with structures more complicated than theirs. The websites purport to describe the objections of other members of the mutual fund industry to the Proposed Rule but do so in ways that often are inaccurate and sometimes inflammatory. The Russell Funds respectfully request that in considering responses to its request for comments on the Proposed Rule and considering its action with respect to the Proposed Rule, the Commission take into account that this limited sub-set of mutual fund investors do not speak for all mutual fund investors.
To the extent that the Proposed Rule is intended to force mutual funds to become more actively engaged in the corporate governance of portfolio companies, the Russell Funds submit that, however laudatory the concept of corporate governance, it is not consistent with the role of a mutual fund or mutual fund investors' expectations. Mutual funds do not hold themselves out to investors as engaged, or even qualified to engage, in the business of managing or operating portfolio companies, and investors do not expect fund resources to be directed to such activities. Indeed, they are specifically prohibited from doing so by section 3(b)(1) of the 1940 Act.
Under the Proposed Rule, shareholders who expect their funds to make proxy voting decisions as one of many aspects of the overall investment process and do not wish to absorb the costs of preparing, maintaining and delivering proxy voting materials for every portfolio holding, no matter how insignificant, would have no choice in the matter. This seems odd, particularly given that the 1940 Act does not include any specific requirements with respect to the voting of proxies in respect of mutual fund portfolio securities.
The Russell Funds, like all other mutual funds, hold themselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. The business of buying and selling portfolio securities is very different from managing or operating the businesses of portfolio companies. The Proposed Rule's objective, as described in the Proposing Release, of causing mutual funds to engage more actively in influencing and directing the businesses of portfolio companies is thus at odds with the 1940 Act itself. It is also strangely at odds with the expectations of investors themselves, who do not expect mutual fund resources to be directed to the monitoring, improvement or rehabilitation of portfolio companies' corporate governance, a role more effectively and appropriately performed by portfolio companies' boards of directors and regulators, such as the Commission. Mutual fund investors purchase their shares with the expectation that their funds will focus their efforts on making investment decisions with a view toward achieving the funds' investment objectives.
Additionally, if the Proposed Rule is intended to regulate the conduct of mutual funds and their portfolio companies, it represents, at best, an extremely inefficient form of regulation. In this regard, the Proposing Release states that, as of December 2001, mutual funds held approximately 19% of all publicly traded U.S. corporate equity. However, based upon information in the Proposing Release, this 19% ownership is spread among approximately 3,700 investment companies.
The Proposed Rule provides no exception from its requirements for proxies in respect of portfolio positions that are not significant - measured in relation to the number of a portfolio company's securities entitled to vote on a matter or in relation to the fund's portfolio. Costs associated with compliance with the Proposed Rule simply would not be justified in the case of proxies for insignificant numbers of portfolio securities which realistically would not affect the outcome of a vote or provide a means to influence management. The costs are even higher for manager-of-managers funds, such as the Russell Funds, in which the multiple investment managers' varied holdings result in a high number of portfolio securities for the Funds.
Finally, it is unclear how proxy voting information would have any significance to investors in funds that use strictly quantitative means to determine when to buy or sell securities (an approach designed to remove subjective judgments regarding portfolio companies from investment decisions) or to funds which aggressively and frequently trade rather than buy and hold portfolio securities, or to index funds which hold a broad spectrum of portfolio securities. In such cases, the Proposed Rule would not advance the interests of the mutual funds' investors but would merely reduce their returns by the amount of expenses incurred by their funds in complying with its burdensome requirements. These problems are particularly challenge in the context of the manager-of-managers structure utilized by the Russell Funds in which multiple investment styles, disciplines and philosophies are generally employed within the same Fund.
Inconsistency with Commission's Stated Disclosure Goals. The Proposed Rule would require the inclusion of information in mutual fund registration statements and in annual and semi-annual reports to shareholders that is simply not relevant to most investors and is at variance with views previously expressed by the Commission in its efforts to simplify and enhance disclosure documents.
As noted above, the Russell Funds would be required to include in their registration statements the proxy voting policies and procedures for each Money Manager for each Fund. The disclosure contemplated by the Proposed Rule would add tens of pages to each Russell Fund SAI notwithstanding the absence of any demonstrated relevance or usefulness of this additional information to the Fund's shareholders.
Because Money Managers may reach different decisions with respect to the voting of proxies in respect of common portfolio securities for their Segments of a single Fund, additional discussion of voting information would almost certainly be required for shareholders to understand raw voting information. Such discussion would add to the length and density of the SAI. Series investment companies that offer multiple funds in the same registration statement and utilize even a single sub-adviser for the funds - a relatively common approach - would face a similar problem. Fund-of-fund structures also would face particular difficulties in complying with the Proposed Rule without adding significantly to the length of their SAIs.
In its release entitled "Registration Form Used by Open-End Management Companies" (Release Nos. 33-7512; 34-39748; IC-23064; S7-10-97) February 20, 1998 (the "Simplification Release"), the Commission acknowledged that some interpretations relating to Form N-1A disclosure taken by the Staff in the past had contributed to fund prospectuses become dense and less inviting to read by shareholders. The Commission expressed its firm belief that achieving the goals underlying the amendments to Form N-1A adopted in the Simplification Release "necessitates discipline on the part of the Commission and its staff, as well as on the part of the funds and their advisers. In exercising discipline, all parties involved in the disclosure process should look not only to Form N-1A disclosure requirements, as amended, but also to those principles reflected in the Form."
An article by then Chairman Arthur Levitt1, cited in the Simplification Release, states that "we recognize that we share responsibility for the state of the modern prospectus. Our passion for full disclosure has resulted in bloated reports and prospectuses that are more redundant than revealing." In the Simplification Release, the Commission announced that it had generally instructed the staff to avoid as much as possible using disclosure requirements as a means of regulating the conduct of funds, which are subject to extensive regulation under the Investment Company Act. The Proposing Release is in direct opposition to the Simplification Release by making clear that Commission intends not only to regulate the conduct of mutual funds but also to force mutual funds to regulate the conduct of portfolio companies.
In its release entitled "New Disclosure Option for Open-end Management Investment Companies" (Release Nos. 33-7513; IC-23065; File No. S7-18-96) March 13, 1998, the Commission stated:
The Commission's strongly held belief is that the principal goal of fund disclosure, whether it takes the form of a long or short document, should be to provide investors with useful and relevant information.
The Commission states in the Proposing Release that proxy voting decisions are part of the mutual fund investment process. In the Proposing Release the Commission directly implies that proxy voting decisions are reflected in portfolio value. The Russell Funds agree and respectfully submit that the mutual fund performance information currently required by Form N-1A is the most effective measure of whether a fund is performing its proxy voting responsibilities effectively and in a manner that is directly relevant to investors. The information required by the Proposed Rule is not only irrelevant to investors as described above, but is also redundant.
Conclusion. The Russell Funds urge the Commission to carefully reconsider the need for the Proposed Rule. As explained above, the Russell Funds believe that the Proposed Rules would deliver no significant benefits to the vast majority of fund shareholders to justify the costs associated with the Proposed Rule.
Frank Russell Investment Company
Russell Insurance Funds
Karl J. Ege,
General Counsel and Secretary
|1 ||Levitt, Plain English in Prospectuses, N.Y. ST. B. J., Nov. 1997, at 37.