March 10, 2004

Jonathan G. Katz, Secretary
U.S. Securities & Exchange Commission           via Electronic Mail
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: Proposed Rule: Investment Company Governance; File No. S7-03-04

Dear Mr. Katz:

We are the independent directors of the Vanguard funds and we are writing to express our shared views on the SEC's proposed mutual fund governance rules. We collectively bring more than 65 years of mutual fund board experience to our role as overseers of the Vanguard mutual funds. Over the years, we have given considerable thought to what we believe are the appropriate governance practices to best serve the interests of the Vanguard funds and their shareholders.

Before addressing the Commission's proposed rules, we thought it appropriate first to explain our approach to the governance of the Vanguard funds and the practices we have followed in our oversight of the funds. Several years ago we codified our longstanding practices in a comprehensive set of corporate governance principles. They include the following:

  • A supermajority of directors on the boards of the Vanguard funds should qualify as independent directors. (Currently all Vanguard fund directors are independent, with the sole exception of our chairman-John J. Brennan-who also serves at our pleasure as chief executive officer of the Vanguard Group, the Vanguard funds' wholly-owned management company.)

  • All members of the board's audit, nominating and compensation committees should be independent directors.

  • The independent directors should elect a lead independent director (currently J. Lawrence Wilson) who coordinates the activities of the independent directors, chairs our meetings, and can call executive sessions at any time to consider matters outside the presence of management. Also, any director can add items to the agenda of any board meeting or raise subjects not on the agenda.

  • The chairman of the Vanguard funds and chief executive officer of the Vanguard Group should be the same person to ensure effective day-to-day leadership and clear accountability.

  • The independent directors can retain independent legal counsel and other experts at any time, with the costs of such retention borne by Vanguard.

  • The board should periodically assess its operating effectiveness in terms of both the substantive and procedural aspects of its operations.

  • The boards of the Vanguard funds should include many if not all of the same directors, to provide greater familiarity with the funds' operations that are complex-wide in nature and assure common issues are addressed on a knowledgeable and consistent basis.

We recognize that this has been a difficult year for the mutual fund industry and we share the Commission's concerns about ensuring the integrity of the industry and maintaining the confidence of mutual fund shareholders. While we understand the Commission's desire to strengthen mutual fund boards in the current environment, we urge the Commission to adopt rules that allow independent boards to determine the appropriate governance practices that will best serve the interests of fund shareholders.

Support for proposals to enhance board independence. We strongly support, as we have in the past, proposals that enhance the independence of fund boards and the power of the independent directors to serve the interests of fund shareholders. Accordingly, we support the Commission's proposal to require a 75 percent majority of independent directors. Although not part of these proposals, we believe that the definition of independence should be clearer and stricter.

We also support, consistent with our own practices, the Commission's proposals to require that: (1) the directors conduct periodic self-evaluations of the board's performance; (2) the independent directors be explicitly authorized-although not required-to hire their own experts and advisors; and (3) the independent directors meet in executive session without management present. We believe these widely recommended "best practices" can enhance the effectiveness of board oversight at minimal cost and disruption, and are easily attained once the independent directors constitute a supermajority.

Concerns with proposals to limit board judgment. In contrast, we seriously question the benefit of those proposals that would constrain the ability of independent boards to exercise their judgment on key governance matters. We strongly believe that once the Commission has assured the independence of fund boards, the Commission should leave to the independent directors those decisions that require the application of experience, expertise and judgment to the situation at hand. In our view, what are the "right" governance practices for any fund will depend on many factors, including the board's experience with the personnel and operations of the fund's management company, the level of meaningful dialogue and exchange of information between the independent directors and the management company, and the composition, backgrounds and dynamics of the board itself.

At Vanguard where the funds and ultimately fund shareholders own the management company, the conflicts of interest facing other funds do not exist and management is fully aligned with the independent directors in solely serving fund shareholders. We mention this because it has been a key factor in determining the governance practices we follow in our oversight of the Vanguard funds. While Vanguard's corporate structure may be unique, our point applies to independent boards in general: the independent directors are in the best position to determine what governance practices work best in particular situations to serve the interests of fund shareholders.

Independent chairman and staff proposals. Consistent with these concerns, we strongly believe that there is no need to dictate by regulation an independent chairman for all fund boards when the independent directors control the board by a substantial margin. We believe that the use of a lead independent director has worked exceptionally well for the Vanguard funds, although we can envision different approaches for other mutual funds and fund families, depending upon the particular facts and circumstances of each situation. In our case, we have made the decision that the Vanguard funds are best governed by having the chairman of the Vanguard funds and chief executive officer of the Vanguard Group be the same person and by having a lead independent director. We frankly fail to see how the Commission would be in a better position to decide otherwise.

In the same vein, we believe the independent directors should be allowed to use their judgment to decide when and how to use independent legal counsel and whether to hire outside experts or retain their own staff. Again, the independent directors are in a far better position than the Commission to decide these types of issues for a particular fund.

Service on multiple fund boards. We agree with the Commission's proposal to have the independent directors consider the scope of their board service, including the number of funds they oversee, during their annual assessment of board performance. This is a far better approach than the Commission substituting its judgment for the independent directors regarding the appropriate number of fund boards on which they may serve. We believe that proponents of limiting the number of boards on which directors may serve greatly underestimate the value of a common board and the power it brings to the independent directors in their relationship with the management company.

In our experience, service on multiple fund boards provides greater familiarity with the funds' operations that are complex-wide in nature (e.g., audit, compliance, and controls processes and procedures) and permits the directors to address common issues on a knowledgeable and consistent basis. This arrangement also avoids the substantial additional costs, administrative complexities, and redundancies that would result from having a different slate of directors for each and every fund. Indeed, our experience over many years indicates that many of the important matters that we address on behalf of the Vanguard funds are complex-wide in nature. We are convinced that having tens if not hundreds of boards with different members deciding these common issues separately would not serve the interests of Vanguard fund shareholders.

Accordingly, we urge the Commission not to select an arbitrary limit on the number of fund boards on which independent directors may serve. As with other matters mentioned above, the ability of directors to effectively oversee multiple funds depends on various factors, including the resources, support and access to information and personnel provided by fund management. These types of matters are best left to the experience and judgment of the independent directors.

In conclusion, the Commission should let the independent directors, who, by the Commission's proposed rules must be a supermajority, do the job they are called upon to do - exercise their judgment on behalf of fund shareholders. Once the independence of fund boards has been assured, we urge the Commission to provide flexibility to independent boards to determine what best serves the interests of fund shareholders.

Thank you for the opportunity to express these views. We hope the Commission will not hesitate to call upon us directly if we may provide additional information or assistance in considering governance issues for mutual funds.

/s/ Charles D. Ellis
Charles D. Ellis
Senior Adviser and Former Managing Partner
Greenwich Associates
/s/ Burton G. Malkiel
Burton G. Malkiel
Professor of Economics
Princeton University
/s/ Rajiv L. Gupta
Rajiv L. Gupta
Chairman and Chief Executive Officer
Rohm and Haas Co.
/s/ Alfred M. Rankin, Jr.
Alfred M. Rankin, Jr.
Chairman, President and Chief Executive Officer
NACCO Industries, Inc.
/s/ JoAnn Heffernan Heisen
JoAnn Heffernan Heisen
Vice President, Chief Information Officer and Member of Executive Committee
Johnson & Johnson
/s/ J. Lawrence Wilson
J. Lawrence Wilson
Retired Chairman and Chief Executive Officer
Rohm and Haas Co.

cc: Chairman William H. Donaldson
Commissioner Paul Atkins
Commissioner Cynthia A. Glassman
Commissioner Harvey Goldschmid
Commissioner Roel Campos

Paul F. Roye, Director

Division of Investment Management