January 14, 2000
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-23-99
Comments in Response to the Proposed Amendments to Certain Exemptive Rules Under the Investment Company Act of 1940
Dear Mr. Katz:
These comments are submitted in response to the proposed amendments to certain Exemptive Rules under the Investment Company Act of 1940 by McMorgan and Company, a registered investment advisor for a small family of mutual funds. The family of mutual funds currently has less than $750 million in assets. As the investment advisor to these funds, we believe that the governing board of directors, which currently includes independent directors constituting at least 40% of the full board, effectively and independently oversees the operations of the mutual funds.
While we favor enhancing the effectiveness and independence of the funds' boards of directors, McMorgan and Company believes that some of the proposed rule amendments restrict the operations of the governing boards and needlessly complicate oversight. We address the specific proposed rule amendments which we find problematic, below.
1. Independent Directors As A Majority Of The Board:
McMorgan and Company believes that mutual funds which are governed by boards where independent directors constitute a simple majority, act independently in accordance with their legal obligations. In fact, it has been our experience that a small board with 40% independent directors has exercised strong oversight and independent review of the mutual fund's operations. A requirement that independent directors constitute a "super-majority" (2/3) of a board seems excessive and requires smaller funds to incur greater expenses by creating and filling board positions. Our experience has been that our family of mutual funds (McM Funds) has kept advisor fees well under industry average and other areas of possible conflict, such as affiliated brokers, have not been an issue at all. We believe that a "super-majority" requirement should be saved for those funds where a demonstrated conflict of interest exists or where the funds are so big that larger boards of directors can be justified. We support the notion that independent directors select and nominate other independent directors.
2. Independent Legal Counsel:
Legal counsel for a mutual fund must represent the board of directors which acts for and on behalf of the fund shareholders. There are times when a mutual fund acts through the full board of directors and other times when it acts through the independent directors only. For example, the independent directors will nominate additional independent directors and set the advisor's fee. Where the mutual fund functions through the independent directors, it is appropriate for fund counsel to represent those directors. Where a mutual fund acts through its full board of directors, counsel obviously will represent the full board. Where however, a conflict of interest arises between some of the directors and the board and the interests of the shareholders, we agree with the Commission that fund counsel should be precluded from representing the party with the conflicting interest. Accordingly, it would be inappropriate for counsel to represent the advisor if a dispute over the advisory fee arose. By the same token, it would be inappropriate for fund counsel to represent the independent directors if a dispute arose with the remaining inside directors over the independent directors' fees. We trust legal counsel to determine when a conflict precludes his or her role as an advisor to the conflicted party.
McMorgan does not believe the Exemptive Rules should be amended to preclude fund counsel from providing legal services to the fund's advisor, principal underwriter, or administrator provided legal counsel does not provide advice on a matter which is the subject of a conflict between the client and the mutual fund. There are even occasions where legal counsel for the fund is in the best position to give advice to the advisor, principal underwriter, or administrator. For example, the fund advisor may seek advice from fund counsel with regard to the code of ethics which must be adopted by both the advisor and the mutual fund. It is expensive and wasteful for multiple attorneys to be consulted where legal consistency is important.
We believe the proposed amendments should be modified so that legal counsel to the fund may provide legal advice to the fund's independent directors, advisor, principal underwriter or fund administrator provided no material conflict of interest exists between the client and the fund itself. Where a conflict does exist, independent counsel must be retained.
3. Disclosure of Information About Fund Directors:
We agree with the Commission's proposal that mutual funds disclose basic information about directors in an easy-to-read format. We also agree that information about the directors should be included in the annual report. We take issue with the Commission however, over some of the information to be provided. While shareholders are entitled to know whether a director hold shares in a fund complex thereby aligning the director's interest with those of other shareholders, we believe it is inappropriate for directors to disclose the dollar value of the securities held. To avoid trampling upon personal privacy rights of directors and discouraging otherwise well qualified individuals from serving as directors, we believe a disclosure should be made by directors indicating whether they hold a particular threshold of shares or not. For example, each director could indicate on a regular basis whether he owns at least $10,000 or $50,000 of equity securities of funds in a fund complex. This would provide shareholders with sufficient information regarding the "aligned interests" with the directors without requiring the disclosure of confidential financial information.
The privacy issue for directors is of particular significance in circumstances where a small family of mutual funds is utilized by institutional investors (i.e. private pension funds) which have an ongoing relationship with the plan advisor. Under this scenario, we are informed and believe that directors will be discouraged from either investing significantly in the family of funds or from sitting as a fund fiduciary at all. The Commission proposal regarding the disclosure should be modified to accommodate these issues.
4. Disclosure of Potential Conflicts of Interest:
McMorgan supports the proposal by the Commission that the positions, interests and transactions of directors creating a bias or conflict of interest be disclosed to shareholders. We believe however, with regard to the interests held by a director, that it is sufficient for the director to disclose the existence of a security interest currently or previously held by the investment advisor, principal underwriter or administrator of the mutual fund. We do not believe that a specific dollar value of the security interest should be disclosed. Rather, we recommend that a general watermark be set indicating the general extent of the interest. For example, disclosure can indicate security interest less than $100,000 or security interest exceeds $100,000. We are making this suggestion because we are again concerned about the privacy rights of the directors and the discouraging effect the proposal by the Commission will have on existing and prospective mutual fund directors. This is particularly true where a small family of mutual funds is utilized significantly by institutional investors having an ongoing relationship with the fund advisor. We believe that the general categories of disclosure proposed in this comment letter sufficiently reveal a bias by or "interested person" status of a director.
Respectfully submitted by:
McMorgan & Company
By Robert M. Hirsch