Investment Company Institute

June 13, 2003

Mr. Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: Solicitation of Public Views Regarding Possible Changes to the Proxy Rules (File No. S7-10-03)

Dear Mr. Katz:

The Investment Company Institute1 appreciates the opportunity to express its views in response to the Securities and Exchange Commission's solicitation of comments regarding possible changes to the proxy rules under the Securities Exchange Act of 1934. As directed by the Commission, the Division of Corporation Finance is reviewing several topics, including: shareholder proposals; the corporate director nomination process; election of directors; and the disclosure and other requirements imposed on large shareholders and groups of shareholders.2

Rule 14a-8 under the Exchange Act currently provides a framework for formal communications between companies and their shareholders. It balances the right of shareholders to influence the important decisions that affect them as owners of a company with the responsibility of a company's directors and officers to manage the daily business of the company. Investment companies are both shareholders of the companies in which they invest and issuers with respect to their own shareholders, directors and management. Accordingly, the Institute has a keen interest in ensuring that any requirements applicable to the shareholder proposal process strike an appropriate balance between protecting the rights of shareholders and avoiding undue interference with director and management responsibilities (and the attendant costs and burdens).

For the reasons discussed below, the Institute does not believe that it is necessary, at this time, to revise Rule 14a-8. Instead, we recommend that the Commission defer deciding whether to undertake a comprehensive review of Rule 14a-8 until the many proposed improvements to the corporate governance structure of public companies have been implemented and their consequences made clear to regulators, shareholders, issuers and the marketplace.

Our comments focus on the issue of shareholder nomination of directors. Rule 14a-8 currently permits a company to exclude a shareholder proposal that "relates to an election for membership on the company's board of directors."3 The Commission staff is now revisiting this provision in response to concerns that director nominations are under too much control or influence by management.4 Facilitating the ability of shareholders to nominate directors is seen as one way of alleviating this concern.

The Institute agrees that it is critically important that the nomination of directors - particularly independent directors - not be under the control or undue influence of management. This is necessary in order to ensure that independent directors truly have the requisite degree of independence from management.

Shareholder nomination of directors, however, is not the only way to ensure director independence. Investment company boards long have consisted of a majority of independent directors, and their independent directors have controlled the selection and nomination process for other independent directors.5 A senior member of the Commission's staff explained the importance of independent directors choosing and nominating other independent directors, stating that:

I believe that the self-selection and self-nomination of independent directors works to create a greater sense of autonomy from management on the part of independent board members. Directors who are selected and nominated by other directors are unlikely to feel beholden to fund management for their positions and therefore are free to speak their minds, question management and represent investors as their sole concern.6

Subsequently, the Commission essentially codified these common industry practices when it adopted rule amendments that provide that investment companies may not rely on any of ten key exemptive rules under the Investment Company Act of 1940 unless (1) they have a majority of independent directors and (2) independent directors select and nominate other independent directors.7

We believe that these requirements effectively address concerns over director independence in the investment company context. Indeed, independent directors are uniquely qualified to evaluate whether a prospective director is likely to contribute to the continuing independence and effectiveness of the independent directors as a group.

Other corporations likely will be subject to similar requirements soon. The New York Stock Exchange, Nasdaq and the American Stock Exchange all have proposed (or will soon propose) rule changes that will require their listed companies to have a majority of independent directors and to have independent directors select, or recommend that the board select, director nominees.8 The Institute has strongly supported these proposals, which, in effect, would extend requirements presently applicable to investment companies to listed companies. Moreover, all of the Exchange Proposals contain numerous other changes designed to enhance the accountability and oversight of corporate management. 9

In light of these current requirements and pending proposals designed to enhance director independence,10 the Institute does not believe that it is necessary, at this time, to revise Rule 14a-8. Instead, we recommend that the Commission defer deciding whether to undertake a comprehensive review of Rule 14a-8 until the numerous improvements to the corporate governance structure of public companies have been implemented and their consequences made clear to the Commission, shareholders, issuers and the marketplace.

* * * *

We appreciate the Commission's consideration of our comments on this important matter. If you have any questions or need additional information, please contact me at (202) 326-5815 or Dorothy Donohue at (202) 218-3563.

Sincerely,

Craig S. Tyle
General Counsel

cc: Alan L. Beller, Director
Martin P. Dunn, Deputy Director
Grace K. Lee, Special Counsel
Division of Corporation Finance

Paul F. Roye, Director
Susan Nash, Associate Director
Paul G. Cellupica, Assistant Director
Division of Investment Management
U.S. Securities and Exchange Commission

____________________________
1The Investment Company Institute is the national association of the American investment company industry. Its membership includes 8,688 open-end investment companies ("mutual funds"), 556 closed-end investment companies, 110 exchange-traded funds and 6 sponsors of unit investment trusts. Its mutual fund members have assets of about $6.475 trillion, accounting for approximately 95% of total industry assets, and 90.2 million individual shareholders.
2 SEC Release No. 34-47778 (May 1, 2003) [68 FR 24530 (May 7, 2003)].
3 Rule 14a-8(i)(8).
4 See, e.g., Letter from Sarah A.B. Teslik, Executive Director, Council of Institutional Investors, to Jonathan G. Katz, Secretary, Securities and Exchange Commission, dated May 10, 2003.
5 See Investment Company Institute: Report of the Advisory Group on Best Practices for Fund Directors: Enhancing a Culture of Independence and Effectiveness (June 24, 1999) ("Best Practices Report"). The Best Practices Report recommends fifteen best practices for enhancing the effectiveness and independence of fund boards and was issued by an advisory group of independent and management fund directors organized by the Institute. The Best Practices Report's recommendations include (1) making independent directors responsible for the selection and nomination of other independent directors and (2) having independent directors constitute at least two-thirds, or a super-majority, of the directors of every investment company board (which is a more stringent standard than that required under the Commission's rules, discussed infra). Best Practices Report at 10. The discussion in the Best Practices Report recognizes that independent director control of the selection and nomination process for independent directors was already "commonplace" in the investment company industry at the time the Best Practices Report was issued. Best Practices Report at 15.
6 What Does It Take to be an Effective Independent Director of a Mutual Fund, ICI Workshop for New Fund Directors, Keynote Address by Paul Roye, Director, Division of Investment Management, U.S. Securities and Exchange Commission (April 14, 2000).
7 SEC Release Nos. 33-7932; 34-43786; IC-24816 (January 2, 2001) [66 FR 3734 (January 16, 2001)]. The release adopting these rule amendments noted that many commenters on the proposal agreed that "the self-selection and nomination of independent directors fosters an independent-minded board that focuses primarily on the interests of the fund investors rather than its adviser." 66 FR at 3737. In addition to these requirements, to rely on these rules, any legal counsel for the independent directors must be an independent legal counsel. Most, if not all, investment companies rely on one or more of these exemptive rules.
8 See SEC Release No. 34-47672 (April 11, 2003) [68 FR 19051 (April 17, 2003)] (proposing changes to Section 303A of the NYSE's Listed Company Manual that would require any NYSE listed company to have a majority of independent directors and a nominating committee composed entirely of independent directors that would identify individuals qualified to become board members, and select, or recommend that the board select, director nominees) ("NYSE Release"); SEC Release No. 34-47516 (March 17, 2003) [68 FR 14451 (March 25, 2003)] (proposing changes to NASD Rule 4350 that would require a company to have a majority of independent directors and, under all but "exceptional and limited" circumstances, the nomination of company directors to be determined either by a majority of the independent directors or a nominations committee comprised solely of independent directors); American Stock Exchange Corporate Governance Proposals (May 2003) (describing proposed changes to their listing standards that would require a company to have a majority of independent directors and, under all but "exceptional and limited" circumstances, the nomination of company directors to be determined either by a majority of the independent directors or a nominations committee comprised solely of independent directors) (hereinafter referred to collectively as the "Exchange Proposals"). The Commission is currently reviewing, and has not yet approved for publication, this and other changes to the American Stock Exchange's listing standards related to corporate governance.
9 See, e.g., NYSE proposed requirements relating to: shareholder approval of stock option plans; corporate governance committees; compensation committees; audit committees; corporate governance guidelines; codes of business conduct and ethics; and chief executive officer certifications regarding violations of the NYSE corporate governance listing standards.
10 In addition to enhancing board independence as described above, the Exchange Proposals all would require non-management directors to meet at regularly scheduled executive sessions without management. Such a requirement is intended to empower independent directors to serve as a more effective check on management. See NYSE Release at 19053. For similar reasons, the Institute's Best Practices Report included separate meetings of independent directors as one of its recommended best practices. Best Practices Report at 24.