March 10, 2004
Mr. Jonathan G. Katz
Re: Proposed Rule: Investment Company Governance, Rel. No. IC-26323
Dear Mr. Katz:
The Financial Services Roundtable (the "Roundtable") represents 100 of the largest integrated financial services companies providing banking, insurance, and investment products and services to the American consumer. Roundtable member companies provide fuel for America's economic engine accounting directly for $18.3 trillion in managed assets, $678 billion in revenue, and 2.1 million jobs. The Roundtable appreciates the opportunity to comment on the proposal issued by the Securities and Exchange Commission (the "Commission") on investment company governance.
The Commission is proposing amendments to rules under the Investment Company Act of 1940 to require registered investment companies ("funds") to adopt governance practices. The proposed amendments, which apply to funds relying on exemptive rules, are designed to enhance the independence and effectiveness of fund boards and to improve their ability to protect the interests of the funds and fund shareholders they serve.
The Roundtable's member companies agree that mutual funds should strive for vigorous ethics and governance standards. At the same time, it is important to understand that mutual funds differ from operating companies. Mutual funds typically do not have employees. The fund's investment adviser is responsible for its day-to-day operations.
The Roundtable supports the Commission's proposal to require a supermajority of independent directors for funds. However, we oppose requiring a board to have an independent chairman. Instead, we believe that boards consisting of a supermajority of independent directors should be given the opportunity to select their own chairman. This would better serve investors' interests, especially if funds maintain governance safeguards for non-independent directors and if funds institute strong, comprehensive internal compliance programs.
The Roundtable Supports Requiring a Supermajority of Independent Directors
The Commission proposes a requirement that funds have a board of directors whose independent directors constitute at least seventy-five percent of the board.
The Roundtable's member companies support requiring a supermajority of independent fund directors. Independent fund directors play a critical role in the protection of fund shareholders. Directors approve advisory contracts and oversee the adviser's performance. Oversight by fund boards is the most effective method of managing potential conflicts of interest that could harm shareholders.
We believe that the vast majority of mutual fund boards already have a majority of independent directors. Most have a supermajority of independent directors. This rule would codify this practice and ensure that the rights of the investor are protected.
The Roundtable Opposes an Independent Chairman Requirement
The Commission's proposed rule would require all mutual funds relying on exemptive relief to have independent directors serve as chairmen of their boards of directors. The Roundtable strongly opposes this proposal. We believe that it would be inappropriate to impose such a mandate on each and every mutual fund.
We support the requirement that a supermajority of fund directors be independent because it ensures that the independent directors will control the board. Given this fact, we feel that a board with a supermajority of independent directors should select its chairman. The independent directors are best situated to make this decision. They will be able to choose a director they believe is in the shareholders' interests. Rather than impose this requirement on all funds, fund independent directors should retain the discretion to select the fund chairman, whether or not that individual is an independent director.
The Roundtable believes other factors are even more important to the proper functioning of a mutual fund board than having an independent chairman. Directors must be qualified and be independent in action as well as in name. They must have experience that will allow them to exercise oversight of the fund advisor and to identify issues that require their attention. They also must be able to commit the time necessary to carry out their role effectively.
The Roundtable believes that investors will be able to express their views on this issue, given clear and appropriate disclosure. Many fund complexes already have independent directors serving as fund chairmen. Investors for whom this issue is a priority can direct their investments to those funds. Investors who do not prioritize this issue, or who may even prefer an alternative arrangement in specific cases, are free to invest in funds with interested chairmen.
The Commission's proposal expresses concern that an interested chairman may favor the interests of the investment adviser over that of fund shareholders. The Roundtable notes that some of the mutual funds involved in the recent instances of late trading and market timing already had independent chairmen, which suggests that a requirement applicable to all funds would not guarantee fund shareholders protection against abuses.
The Roundtable recommends requiring governance safeguards if a non-independent director is elected as chairman. These include requiring the independent directors to choose a lead director and hire their own counsel; requiring the board nominating committee to be composed entirely of independent directors; and requiring the independent directors to set their own compensation. These additional safeguards ensure that a non-independent chairman cannot control a board and that independent directors will retain the ability to discharge their responsibilities to fund shareholders, even if the chairman is a non-independent director.
The Roundtable Supports Strong Internal Compliance Programs
Requiring mutual funds to have comprehensive internal compliance programs will help protect fund investors from violations of the securities laws. These programs will ensure that fund directors have a centralized, rather than fragmented, assessment of fund compliance and one that is not influenced by the management of a fund's investment adviser. This will help fund directors oversee the management of funds. Designating an individual with the responsibility for enforcing compliance programs for each mutual fund will increase accountability and help establish a "culture of compliance" within funds.
The SEC has taken important steps to ensure that independent directors have the tools they need to discharge their responsibilities to fund shareholders, regardless of the identity of the fund chairman. The recently-adopted rule 38a-11 requires a majority of a fund's independent directors to approve comprehensive compliance policies and procedures for the fund and the fund's investment adviser. Every fund must now have a chief compliance officer to administer its compliance program. That individual must be approved by a majority of the fund's independent directors and can be removed only with the approval of a majority of the independent directors. The chief compliance officer also must meet at least annually with the fund's independent directors and report in writing on the operation of the fund's and the adviser's compliance program. These requirements will help ensure that a fund's independent directors have the information they need to judge whether the fund is being run properly and fund shareholders are being adequately protected.
The Roundtable supports the Commission's efforts to improve mutual fund governance. We support requiring a supermajority of independent fund directors. We believe a board with a supermajority would adequately protect investor's interests. However, we do not support any mandate that requires boards to select an independent chairman. A board with a supermajority should be given the discretion to select its chairman.
Finally, the Roundtable supports comprehensive internal compliance programs in which a fund's chief compliance officer reports directly to the fund's independent directors. These compliance programs, along with additional safeguards, would enhance governance standards in the mutual fund industry.
If you have any further questions or comments on this matter, please do not hesitate to contact me or John Beccia at (202) 289-4322.
Richard M. Whiting