Investment Company Institute
December 13, 2002
Mr. Jonathan G. Katz
Re: Insider Trades During Pension Fund Blackout Periods
Dear Mr. Katz:
The Investment Company Institute1 appreciates the opportunity to comment on the Securities and Exchange Commission's proposal to clarify the scope and application of Section 306(a) of the Sarbanes-Oxley Act of 2002 (the "Act").2 Section 306(a) of the Act prohibits certain insiders, including investment company directors, from purchasing or selling any securities issued by their employer that were acquired in connection with their employment during a pension plan blackout period that prevents plan participants from purchasing or selling the employer's securities. The Institute supports the Commission's proposal to the extent that it addresses the policy concern that led to enactment of Section 306(a) - to mitigate the risk of corporate executives putting their personal interests ahead of their responsibilities to their employees.
We believe, however, that the proposal is broader than necessary to achieve its policy objective. Therefore, we recommend that the Commission exclude investment companies from proposed Regulation Blackout Trading Restriction ("BTR") under the Securities Exchange Act of 1934 with respect to deferred compensation plans that limit participation to investment company directors. In addition, we recommend not subjecting investment companies to the proposed Form 8-K filing requirements and instead permitting them to disseminate notice of a blackout period through another method of disclosure that is reasonably designed to provide this notice to their shareholders. We also request the Commission to clarify that any director of an investment company would be permitted to sell investment company shares during a pension plan blackout period if the shares were not acquired in connection with his or her employment.
In addition, we request that the Commission clarify the provisions of the Act in two other respects. As the Commission is aware, many mutual fund firms provide recordkeeping and other plan services to 401(k) and other types of retirement plans. It is from this perspective that we believe the requested clarification is necessary. Specifically, under the requirement that a notice be provided to executive officers and directors regarding the imposition of a blackout period, we request a clarification consistent with the Institute's recommendations regarding the blackout notice requirement under Section 306(b) of the Act, under which all affected pension plan participants and beneficiaries must be notified of a blackout period. 3 Because it is often difficult to identify the precise ending date of a blackout period in the notice - as required by the Proposing Release - the Commission should provide flexibility as to how such a date is described in the notice.
Finally, the Institute seeks clarification under another provision of the Act, Section 402, which prohibits issuers from directly or indirectly extending, maintaining, arranging or renewing a personal loan for directors and executive officers of the issuer. This provision has given rise to concerns over the permissibility of certain loans from 401(k) and other retirement plans. Accordingly, we ask the Commission to clarify the scope of Section 402 with regard to such plan loans.
Each of these comments is discussed in greater detail below.
I. Deferred Compensation Plans for Investment Company Directors
As previously stated, Section 306(a) of the Act prohibits any director or executive officer of an issuer of any equity security from purchasing or selling any equity security of the issuer during any blackout period with respect to such equity security, if the director or executive officer acquired the security in connection with his employment as a director or executive officer. The Proposing Release explains that there have been allegations that at the time that rank-and-file employees were precluded from selling their employer's equity securities in their individual pension plan accounts, corporate executives were exercising their employee stock options and selling other securities acquired through the company's equity compensation plans. The Proposing Release notes that Section 306(a) was intended to address this problem and that the Commission has proposed Regulation BTR to clarify, and seek to prevent evasion of, Section 306(a)'s statutory trading prohibition. The Proposing Release requests comment on whether the Commission should exclude investment companies from proposed Regulation BTR and, if so, what the rationale would be for the exclusion.4
We urge the Commission to take into account the differences between investment companies and operating companies in its consideration of adopting proposed Regulation BTR. Unlike operating companies, investment companies typically do not have employees, and, therefore, typically do not maintain employee pension plans. 5 Moreover, in contrast to operating companies, investment companies are prohibited from issuing securities for services.6 Many investment companies, however, have adopted deferred compensation plans that limit participation to investment company directors in respect of their director fees. 7 In these cases, there are no employees to protect and, as a result, the proposed requirements with respect to these plans are unnecessary under Section 306(a) of the Act, "to address the apparent unfairness of an issuer's directors and executive officers being able to sell their equity securities when the issuer's employees cannot."8 Therefore, we recommend that the Commission exclude investment companies from Regulation BTR, as adopted, with respect to deferred compensation plans that limit participation to directors.9
II. Form 8-K Filing Requirement
The Commission has proposed amending Rules 13a-11(b) and 15d-11(b) under the Exchange Act to subject registered management investment companies to Form 8-K filing requirements to notify the Commission of a pension plan blackout period. The Commission's proposal would apply the same notice filing requirements to investment companies that it is proposing to apply to all other companies. The Proposing Release explains that the purpose of providing notice to the Commission of the blackout period is to ensure that an issuer's shareholders have notice of the blackout period so that they can monitor compliance with the statutory trading prohibition, and that this objective is best achieved by requiring that the notice to the Commission be provided in a publicly-available document.10
With regard to the Form 8-K filing requirement, the Proposing Release requests comment on feasible alternatives that minimize the reporting burdens on investment companies. The Proposing Release also requests comment on the utility to investors of the reports to the Commission in relation to the costs to investment companies and their affiliated persons of providing those reports.11 The Institute strongly urges the Commission not to adopt the Form 8-K filing requirement for investment companies. Investment companies currently are not required to file Form 8-K, and we do not believe it is necessary or appropriate to make them subject to the Form 8-K reporting regime solely for the purpose of notifying investment company shareholders of a blackout period. Rather, we recommend that the Commission require investment companies with employee pension plans to disseminate information regarding a blackout period through another method (or combination of methods) of disclosure that is reasonably designed to provide notice of the blackout period to their shareholders.12 Such methods could include, but would not be limited to, a press release distributed through a widely disseminated news or wire service, or posting of information on an investment company's website.13 This approach would satisfy the Commission's goal of identifying a means for investment companies to provide notice to its shareholders of an employee pension plan blackout period while minimizing reporting burdens on investment companies.
III. Service or Employment Presumption
The scope of Section 306(a)'s proposed trading prohibition, as interpreted by the Commission, is limited to:
Proposed Rule 100(a) under the Exchange Act defines the term, "acquired in connection with service or employment" to include, among other things, equity securities acquired by a director at a time when he was a director of any company, including an investment company, under a compensatory plan or arrangement, including, but not limited to deferred compensation plans. The Proposing Release explains that the proposed definition encompasses any arrangement that results in the acquisition of any equity securities, including investment company securities, in exchange for the performance of services for, or employment with, a company. This approach is designed to ensure that companies do not shift the form of compensation programs to enable directors to evade the application of Section 306(a).15
Proposed Rule 101(b) under the Exchange Act establishes an "irrebuttable presumption" that any equity securities sold during a blackout period were acquired in connection with employment as a director to the extent that the director holds the securities, "without regard to the actual source of the securities sold."16 The Proposing Release acknowledges that Section 306(a), by its terms, does not completely preclude a director from disposing of their company's securities during a blackout period. It then explains that the proposed irrebuttable presumption would simply eliminate the need to trace the source of the equity securities involved in a particular disposition. The Proposing Release requests comment on whether it is appropriate to presume that any equity securities disposed of during a blackout period were acquired in connection with employment as a director. 17
We do not believe that it would be appropriate to subject the disposition of investment company shares during a blackout period to such an irrebuttable presumption. As previously discussed, the Investment Company Act prohibits management investment companies from issuing any of their securities for services.18 The Commission and its staff have granted relief from these restrictions permitting investment companies to establish pension plans subject to certain conditions designed to protect shareholders from dilution of the value of their interests.19 Despite the narrow circumstances under which investment companies may compensate their directors with fund shares, investment company directors are free to purchase shares of the company for which it serves as a director and, in fact, such a practice has been encouraged to help to align a director's interests with those of the investment company's shareholders.20
We believe that the proposed presumption is unnecessary because of the limited circumstances under which investment company directors may acquire fund shares in exchange for their services, and it is inappropriate because it potentially would discourage investment company directors from purchasing, on their own initiative, the shares of the funds they oversee. Moreover, because the redemption price (i.e., disposition price) for any investment company shares would be based on net asset value (in the case of open-end investment companies) and the public offering price (in the case of closed-end investment companies), the value of investment company shares would not be diluted as a result of these redemptions. Therefore, fund shareholders would not be adversely affected by such redemptions. Finally, we believe that the proposed irrebuttable presumption goes beyond what is required by Section 306(a).21 Accordingly, we urge the Commission not to adopt the proposed irrebuttable presumption with respect to the disposition of investment company shares by any directors or executive officers of an investment company during a blackout period.22
IV. Notice Requirement Under Proposed Regulation BTR
The Proposing Release requires that a notice be provided to executive officers and directors regarding the imposition of a blackout period.23 This notice requirement is analogous to the blackout notice rules of Section 306(b) of the Act, under which affected plan participants and beneficiaries must be notified 30 days in advance of any blackout period.24 Among the various items that must be included in the notice is "the actual or expected beginning and ending dates of the blackout period."25 A number of situations exist, however, where the precise date on which a blackout period is expected to end cannot be determined with any reasonable degree of accuracy.
Consequently, we urge the Commission to clarify that issuers may satisfy the requirement to include an expected ending date in the notice by providing (1) a single expected ending date, where that date is determinable, (2) a range of dates in which the ending date is expected, where the specific ending date cannot be determined with reasonable accuracy, or (3) a description of the circumstances under which the blackout period is expected to end, in those rare situations where even a range of expected ending dates would be essentially meaningless.26 In any situation where a single expected ending date is not included in the blackout period notice, the issuer should be required to provide a subsequent notice to affected individuals identifying the ending date once it has been determined.27
Perhaps the most common example of the difficulty in determining the ending date of a blackout period with any reasonable degree of accuracy occurs when a plan's recordkeeper is being replaced. The "conversion" of a plan to a new recordkeeper is a highly complex process involving the transfer of detailed plan records and extensive coordination among numerous parties, including the plan sponsor, the plan trustee, the former plan recordkeeper, the new recordkeeper and possibly the provider(s) of the plan's investment options. Not surprisingly, this process necessarily requires that participant accounts be frozen in order to preserve the integrity of plan records.28
Factors that may make it difficult to determine the actual length of the blackout period with reasonable accuracy, even after the commencement of the conversion process, include the following.29
We submit that the clarifications requested above would allow notices required by Section 306(a) to accommodate plan conversions and other situations in which the ending date of a blackout period cannot be determined with reasonable accuracy. Moreover, our recommended approach would ensure that all affected individuals receive the most accurate and useful information before and during the blackout period.
V. Treatment of Plan Loans Under Section 402 of the Act
Apart from Section 306(a) and the rules set forth in the Proposing Release, the Institute seeks clarification with regard to the scope of Section 402 of the Act. That provision, which prohibits issuers from extending, maintaining, arranging or renewing a personal loan for any director or executive officer of the issuer, has generated confusion with regard to whether executive officers and directors are prohibited from obtaining loans from their 401(k) and other retirement plan accounts. Plan loans, which are expressly permitted under the Employee Retirement Income Security Act ("ERISA") and the Internal Revenue Code, are a common feature in retirement plans and are frequently offered to encourage rank-and-file employees to participate in their plans.30 Institute members, as service providers to retirement plans, often assist employers in processing such plan loans.
To eliminate the confusion surrounding the permissibility of plan loans, we ask the Commission to clarify whether Section 402 is applicable to them. Given the nature of plan loans and the current rules that govern them, it appears that loans from retirement plans31 fall outside of the scope of Section 402. Several reasons support this view.
First, a participant who obtains a plan loan is borrowing from the plan - an entity separate and distinct from the issuer - and is typically borrowing against the balance in his or her own plan account. Because the issuer is not the party providing the loan, Section 402 should not affect such loan programs.
Second, ERISA and the Internal Revenue Code require that plan loan programs be made widely available to participants and prohibit their use to favor highly compensated employees.32 Given that these programs, by law, cannot discriminate in favor of highly compensated employees, it would seem unnecessary to subject them to a rule that limits its application to insiders.33
Finally, ERISA and the Internal Revenue Code contain rigorous safeguards that address the potential for abuse and limit the degree to which an individual may take advantage of a plan loan program. ERISA's fiduciary and prohibited transaction provisions prohibit self-dealing and other actions involving conflicts of interest by plan fiduciaries.34 Similarly, Section 72(p) of the Internal Revenue Code and the regulations thereunder impose a panoply of requirements on the establishment and administration of plan loan programs. For instance, plan loans to an individual cannot exceed $50,000, and outstanding loan amounts generally must be repaid within 5 years.35
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The Institute appreciates your consideration of our views on these issues. If you have any questions regarding our comments or would like additional information, please contact the undersigned at 202/218-3563 or Thomas Kim at 202-326-5837.
cc: Alan L. Beller, Director
Giovanni P. Prezioso, General Counsel
Paul F. Roye, Director