Association for Investment Management and Research®
CHARLOTTESVILLE HONG KONG LONDON
560 Ray C. Hunt Drive P.O. Box 3668
19 March 2004
Mr. Jonathan G. Katz
Re: Proposed Rule: Investment Company Governance (File No. S7-03-04)
Dear Mr. Katz:
The U.S. Advocacy Committee (USAC) of the Association for Investment Management and Research (AIMR)1 appreciates the opportunity to comment on the SEC's proposed rule amendments requiring registered investment companies to adopt certain governance practices.
The USAC is a standing committee of AIMR charged with responding to new regulatory, legislative, and other developments in the United States affecting the investment profession, the practice of investment analysis and management, and the efficiency of financial markets.
We heartily endorse the SEC's focus in this proposal on fund governance practices to strengthen a system that oversees the interests of shareholders in numerous ways. Accordingly, we strongly support the use of a supermajority independence requirement in determining the composition of a mutual fund board. However, we suggest that requiring two-thirds of the board to be independent would be preferable to a 75% requirement.
If the SEC does adopt a supermajority of independent directors standard for mutual fund boards, we do not believe that it is necessary for the chair to be an independent director and would recommend this not be a mandatory requirement. Instead, we recommend that the final rule incorporate the approach of having an independent "lead director".
Finally, we question the usefulness of implementing a new rule requiring directors to do an annual assessment of their performance. We would hope that responsible parties are already performing this assessment, even if informally. We do, however, support the use of mechanisms to remind directors of their ongoing fiduciary duties to shareholders.
These positions are discussed in more detail below.
We welcome new procedures and requirements in the mutual fund industry that are designed to address conflicts of interest. We believe there is a compelling need to ensure that investors' best interests remain at the forefront of decision-making while taking into account the complexities of the business world. To this end, we strongly support increasing the number of independent directors on mutual fund boards, and implementing other measures that can help mitigate the inappropriate influence of self-interested parties.
We strongly endorse the proposition that a fund's board of directors must be "an independent force in [fund] affairs rather than a passive affiliate of management." Since the board serves as the watchdog for investor interests, it must be structured so as to foster independent decision-making and to mitigate potential conflicts of interest. To this end, we support the proposed amendments to require a supermajority of "independent" directors.
We believe that a supermajority of independent directors would go a long way in establishing the appropriate environment within which the board can address business issues that may affect investor interests and to providing a mechanism for making important decisions without undue influence from the fund manager or other interested parties. However, we believe that the goal of fostering objective decision-making can be met with a lower supermajority requirement than the proposed 75%.
In our consideration of this requirement, we strongly agree that a tilt in the board toward independence is desirable. We believe that it will help address some of the issues at the heart of this matter. However, independence alone might not always be in the best interests of the investor if such persons (albeit independent) are carrying out the duties of director while lacking sufficient knowledge or expertise relative to the mutual fund industry. We believe there must be a critical mass of directors who are very familiar with the mutual fund's business model and management, even if these directors are not necessarily independent. Thus, when viewed in its entirety, we believe it is important that the board should not be asked to compromise its effectiveness so as to insure compliance with a quota mandated by regulation.
In particular, we are concerned that a sufficient pool of qualified candidates may not exist to fully support a 75% supermajority independence requirement. We believe that fund groups and investors alike are best served by board members that bring a wealth of expertise and knowledge to their position. Yet, the diverse, specialized or highly technical nature and investment strategy of some funds may require a particular expertise not readily shared by all those who would otherwise qualify for a board position. A number of these specialized funds may fall under the umbrella of a few of the larger fund groups, who could not share directors with the needed expertise, thereby further reducing the pool of qualified board candidates.
In light of this concern, and in our belief that important objectives will not thus be sacrificed, we urge the SEC to reduce the supermajority independence requirement to two-thirds.
We believe that the supermajority requirement also reduces the need for the board chair to be independent. Instead, we believe that the independent directors would act in the best interests of shareholders to elect the best-qualified chair, whether or not independent.
We appreciate the SEC's concern that there is a heightened possibility of conflicts of interest, when the chair of the fund board is the CEO of the fund adviser. However, when there is a supermajority of independent directors, the chair is unlikely to wield the influence that might occur in a simple majority situation. Moreover, in some situations, we believe that an interested "inside" director may be able to provide experience and insights into complex areas not available from some independent parties. In these situations, having an "interested" person at the helm would ultimately benefit investors' interests.
We therefore endorse the alternative approach discussed in the proposal that would require independent directors to appoint a "lead director" who would be responsible for chairing separate meetings of the independent directors, interacting with their independent legal counsel, and acting as their spokesperson. We believe that such an approach strikes the appropriate balance for ensuring the continued independence of the board deliberation and decision-making process.
Under the proposal, fund directors would be required to perform an annual self-assessment of how well the board and board committees are performing their jobs. In particular, they would be expected to assess the effectiveness of the board's committee structure and whether the directors oversee too many funds.
We believe that these are precisely the types of questions that directors should be asking themselves regularly, not just once a year. In fact, it is arguable that directors who are not engaging in this type of self-assessment should resign their board positions in favor of those who will be more engaged in the type of active debate and critical self-evaluation that comprise a necessary and important part of the director's responsibilities. Thus, we find it tautological that this analysis would have to be mandated by SEC rule.
We strongly support the SEC's efforts, through this rule proposal, to strengthen fund governance structures so that they are more attentive to investor needs. We believe that adopting a supermajority independent requirement alone will go far in appropriately tilting the balance away from conflicted decision-making that may not inure to the ultimate benefit of the shareholder.
If we can provide additional information, please do not hesitate to contact James W. Vitalone at 704.553.0455, firstname.lastname@example.org or Linda Rittenhouse at 434.951.5333, email@example.com.Sincerely,
cc: U.S. Advocacy Committee