Securities and Exchange Commission
450 5th Street, N.W.
Mail Stop 6-9
Washington, D.C. 20549-0609

E-mail address: rule-comments@sec.gov

Re: Securities Act Release No. 33-7754
Exchange Act Release No. 34-42007
Investment Company Act Release No. IC-24082
File No. S7-23-99

Attn: Jonathan G. Katz, Secretary

Ladies and Gentlemen:

This letter is submitted on behalf of the Committee on Securities Regulation of The Association of the Bar of the City of New York (the "Committee") in response to the Securities and Exchange Commission's (the "Commission's") Release Nos. 33-7754, 34-42007 and IC-24082 and request for comments, dated October 14, 1999 (the "Release"), regarding the role of independent directors of investment companies. The Committee is composed of lawyers with diverse perspectives on securities issues, including members of law firms, counsel to investment advisers, investment companies and their independent directors, academics and members of the judiciary. A list of our Committee members is attached.

The Release, among other things, proposes a variety of amendments to rules under the Investment Company Act of 1940, as amended (the "1940 Act"), dealing with investment company governance and independent directors. This letter will focus on the Commission's proposed requirement that any legal counsel for independent directors of an investment company that relies on certain exemptive rules be "independent legal counsel" (the "Proposal"). For the reasons detailed below, we oppose the Proposal. We believe that the Proposal is unnecessary in light of current regulation of the legal profession with respect to conflicts of interest and in the absence of evidence that any serious abuses have occurred or cannot be adequately addressed by the existing ethics standards and available State disciplinary procedures and civil remedies.¹ Furthermore, the Proposal may be counterproductive. The restrictive nature of the proposed definition of "independent legal counsel" would impose potentially high costs on funds and their shareholders. It also would deprive independent directors of investment companies of the choice of many qualified legal counsel, to the detriment of the independent directors and shareholders, by substituting the Commission's judgment as to the independence of counsel for the judgment of the independent directors.

I. Current Ethical Rules Are Sufficient To Prevent Conflicts of Interest

As the Commission notes in the Release, legal codes of ethics contain provisions aimed at preventing the type of conflict of interest that may arise if a lawyer represents both independent directors and "management organizations" (as defined in the Release in proposed Rule 0-1(a)(6) under the 1940 Act).² In general, these ethical codes provide that in a situation where a conflict may or does exist, a lawyer can represent multiple parties as long as there is a reasonable belief that such multiple representation can be undertaken without harming any of the clients' interests and as long as all parties provide informed consent. For example, Rule 1.7 of the American Bar Association Model Rules of Professional Conduct (which serve as the model for the codes of professional responsibility in a majority of the states³) mandates that:

(a) A lawyer shall not represent a client if the representation of that client will be directly adverse to another client, unless:

(1) the lawyer reasonably believes the representation will not adversely affect the relationship with the other client; and

(2) each client consents after consultation.

(b) A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client or to a third person, or by the lawyer's own interests, unless:

(1) the lawyer reasonably believes the representation will not be adversely affected; and

(2) the client consents after consultation. When representation of multiple clients in a single matter is undertaken, the consultation shall include explanation of the implications of the common representation and the advantages and risks involved.

Paragraph (a) of Model Rule 1.7, although it is most typically implicated in the context of adverse parties in a litigation,⁴ applies when a lawyer represents both an investment adviser and the independent directors during the negotiation and approval of an advisory agreement. In that case, under the rule the lawyer could only represent both parties (and the fund as well) if the lawyer had a reasonable belief that the representation would not harm his relationship with any of the parties and all the parties consented after being informed of the situation.

Paragraph (b) of Model Rule 1.7 deals with the more common situation where a lawyer's representation of a client may be compromised by that lawyer's simultaneous representation of another party or by that lawyer's own interests. As in the case with directly adverse parties, the lawyer could undertake multiple representations only if the lawyer had a reasonable belief that his or her representation of each party would not be adversely affected and all the parties consented after being informed of the situation. Rule 1.7 is clear that in this situation, the lawyer would have to fully explain the nature of the potential conflict and the risks inherent therein.

Together, these two conflict of interest provisions directly address the situation that the Commission expresses concern with in the Release: that legal counsel representing independent directors and management organizations "...may not suggest courses of action to independent directors that are opposed by their management clients."⁵ If a lawyer, whether intentionally or not, were to find himself or herself in such a situation, then he or she would be in violation of Model Rule 1.7 and similar ethical prohibitions. This is because a lawyer who felt impeded from even suggesting courses of action to independent directors that were opposed by their management clients, by definition, could not reasonably believe that he or she could represent both the independent directors and a management organization without compromising his or her representation of such directors. Of course, such pressures may arise after the dual representation is taken on; in that case, however, Model Rule 1.7 would require the lawyer to cease representing one or both clients.⁶

The Proposal is evidently based on the assumption (for which we believe there is no empirical evidence) that all representations of both management organizations or their affiliated persons and independent directors are tainted by impermissible and non-waivable conflicts of interest. We disagree with this assumption, and the Commission offers no support for assuming a per se non-waivable conflict. As illustrated by Model Rule 1.7, if a conflict exists, ethical rules adopted in all 50 states already provide important standards that must be satisfied by the lawyer before beginning or continuing multiple representation involving potential or actual conflicts of interest. If no conflict exists, or if a particular actual or potential conflict will not affect a lawyer's ability to represent the interests of each client (and, therefore, is a conflict to which independent directors can give their informed consent), the Commission should not prevent otherwise acceptable counsel from serving the independent directors.⁷

The "limited representation" exception contained in the definition of "independent legal counsel" in the Release is, we believe, insufficient to cure the overly broad nature of the Proposal. First, the guidelines discussed in the Release for determining whether the exception is applicable are vague. The Commission notes factors the board should consider, such as the nature of the representation of the management organization, the amount of fees generated thereby and the relationship between an affiliate represented by the lawyer in question and the management organization, but gives no further instruction to directors, pointing them instead to look at "all relevant factors." The Commission further cites the situation where an attorney (or his firm) has represented an affiliate of the fund's adviser in a minor real estate transaction as an example of when the exception may be available.⁸ If this is meant to be an example of the scope of the exception, the exception will rarely be invoked because it is so narrow. We believe that most situations where a potential conflict exists will involve a more material relationship between counsel and a management organization.⁹ Given this fact and the ambiguous "totality of the circumstances" nature of the exception, directors likely will err on the side of disqualifying counsel rather than invoking the exception in order to avoid potential Commission enforcement action.

Furthermore, under existing ethical rules as set forth above, independent directors already would have made essentially the same finding required by the exception (that the lawyer's representation of the management organization is or was so limited that it would not adversely affect the lawyer's ability to provide impartial, objective and unbiased legal counsel to the independent directors) when hiring the lawyer in the first place. The ethical rules would have mandated that counsel disclose possible conflicts to the directors, and, based on such disclosures, the directors (who generally are sophisticated people fully capable of evaluating the business and ethical issues involved) would have made an informed determination that it was appropriate to employ counsel in spite of the potential conflict. In the Committee's experience, the conflicts between a management organization and an investment company and its independent directors rarely involve subtle legal issues. Rather, they almost invariably involve commercial issues that independent directors are fully capable of evaluating through application of their business judgment.

II. The Proposal Would Deprive Independent Directors of Their Choice of Counsel

As stated in the Release, the mutual fund industry has grown rapidly in the past 10 years.¹⁰ This increase in the size of total assets under management has coincided with an increase in the number of financial institutions, large and small, participating in the industry. These institutions and their affiliates often offer many services in addition to asset management, such as banking, securities underwriting and broker-dealer functions. In the course of their activities, these institutions and their affiliates often retain many (and varied types of) lawyers from multiple law firms of all sizes. A single lawyer or firm may provide services to many such institutions. It is highly likely, therefore, that if the Proposal is adopted, counsel to the independent directors of many investment companies, especially counsel who are members of large firms or who provide advice to directors of investment companies whose management organizations are affiliated with large financial institutions, would be subject to disqualification under the Proposal because either the individual lawyer serving as counsel, or (more likely) a member of his or her firm, had provided legal services to a management organization of the investment company or an affiliate of a management organization in the past two years. The Committee notes that long-term trends of consolidation in the financial services industry, use of multiple law firms by industry participants and law firm growth are likely to result in a significant expansion in the number of lawyers that would be disqualified from advising independent directors by the Proposal.¹¹

Of course, the Proposal does not mandate that the independent directors have independent legal counsel; it only requires that if a fund relies on the exemptive rules, and that fund's independent directors have legal counsel, then such counsel be independent. As a practical matter, the vast majority of investment companies rely on at least one of those exemptive rules, and many have separate legal counsel for the independent directors. Therefore, many funds would be subject to the Proposal. We believe those funds that would be required to would change counsel to comply with the Proposal rather than stop using the exemptive rules. It is also possible that some smaller fund complexes, which may be under great expense pressures, may ask fund counsel to cease advising the independent directors, solving a compliance issue to the detriment of the persons the Proposal was designed to help.

The probable effect of adopting the Proposal, therefore, will be to deprive many independent directors of their chosen legal counsel.¹² As discussed above, ethical considerations already provide an effective mechanism for insuring the independence of a lawyer that advises both a management organization and a fund's board. Under these ethics rules, the independent directors would have been told of any potential conflict and would have made an informed decision that counsel could maintain the dual representation. In addition, many of the lawyers most experienced in the 1940 Act and the Investment Advisers Act of 1940 work at law firms that have relationships with affiliates of management organizations, thereby potentially threatening their "independent" status under the Proposal. By adopting the Proposal, the Commission would be substituting its judgment as to the independence of counsel for the judgment of the independent directors and supplanting existing state regulation of attorneys without substantial evidence either that serious abuses are occurring or that available disciplinary procedures and civil remedies are inadequate to redress any such abuses or any public policy in the 1940 Act relating to regulation of counsel.

We believe that given the role independent directors play in investment company governance and under the 1940 Act, they, not the Commission, are in the best position, provided that they have been adequately informed as to any risks involved in a dual representation, to decide when counsel has a conflict of interest and cannot effectively represent the directors. If the independent directors, after receiving full disclosure of potential conflicts (as the ethical rules require), decide that a given attorney or law firm is best suited to represent their and shareholder interests, the Commission should not interfere.

III. The Proposal Would Impose Significant Costs

Effective representation of any client, including independent directors of an investment company, requires a lawyer to possess a working knowledge of that client's business and history. For that reason, when a client hires a new lawyer, it is common for that lawyer to spend a fair amount of time doing background diligence on the client. It is also true that, as a general matter, a lawyer who has worked with a client for many years can handle matters more efficiently than a lawyer who has only recently been hired.

We believe that the adoption of the Proposal would impose substantial costs on investment companies, especially smaller ones, that would be forced to hire new counsel to the independent directors. First, funds would incur the cost of searching for new counsel. This can be a time-consuming process, especially since, in light of the Proposal, both lawyers and funds will have to do extensive conflict checks. More significantly, these funds would incur the cost of making sure new counsel was "up to speed." Among other things, new counsel would have to review existing service agreements and arrangements as well as educate itself regarding any special issues involving the directors and fund governance. In light of the sufficient protections afforded by State conflict of interest rules and civil remedies, such costs, which would be passed on to shareholders, are unnecessary.

IV. Conclusion

We believe that considering current regulation of the legal profession with respect to conflicts of interest, the fact that the Proposal would deprive many independent directors of legal counsel of their choice and the potentially high costs imposed on funds and their shareholders, the Proposal should not be adopted.

Members of the Committee would be pleased to answer any questions you might have regarding our comments, and to meet with the Staff if that would assist the Commission's efforts.

Respectfully submitted,

/s/ Stephen J. Schulte
Stephen J. Schulte
Chair, Committee on Securities Regulation

/s/ Sarah E. Cogan
Sarah E. Cogan
Chair, Subcommittee on ‘40 Act Investment Companies

cc: The Honorable Arthur Levitt, Chairman
The Honorable Paul R. Carey, Commissioner
The Honorable Isaac C. Hunt, Commissioner
The Honorable Norman S. Johnson, Commissioner
The Honorable Laura S. Unger, Commissioner
Paul Roye, Director, Division of Investment Management

Stephen J. Schulte, Esq. (Chair)
André Weiss, Esq. (Secretary)
Craig Barrack, Esq.
Mark H. Barth, Esq.*
Anthony J. Bosco, Esq.
Jonathan H. Churchill, Esq.
Peter C. Clapman, Esq.*
Sarah E. Cogan, Esq.*
Richard A. Drucker, Esq.
Elisabeth Duncan, Esq.
Mitchell S. Fishman, Esq.
Alan R. Friedman, Esq.
David B. Harms, Esq.
Sarah Hewitt, Esq.
Irshad Karim, Esq.
Clifford E. Kirsch, Esq.*
Paul L. Lee, Esq.
Peter J. Loughran, Esq.
Thomas M. Madden, Esq
James B. McHugh, Esq.
Abby S. Meiselman, Esq.
Charles M. Nathan, Esq.
Ernest T. Patrikis, Esq.*
Janine L. Pollack, Esq.
David W. Pollak, Esq.
Neila B. Radin, Esq.
Walter G. Ricciardi, Esq.
Richard H. Rowe, Esq.
Faiza J. Saeed, Esq.
Kathryn E. Schneider, Esq.
Roslyn Tom, Esq.
James Q. Walker, Esq.
Lawrence J. Zweifach, Esq.
Gregory P.N. Joseph, Esq.

* Member of Subcommittee on ‘40 Act Investment Companies

FOOTNOTES

-[1]- Our comments below focus on existing State ethical standards for addressing conflicts of interest. In addition to these important standards that each lawyer must meet or risk grievous damage to his or her professional reputation and livelihood, a lawyer who engages in an impermissible conflict of interest to the detriment of his or her client exposes himself or herself to a substantial risk of civil liability for professional malpractice with all associated serious financial risks. We note as well that there is no empirical evidence that the rules proposed to be amended have been inadequate to address the transactions covered thereby or that the Proposal will address any problems experienced in the implementation thereof.

-[2]- Role of Independent Directors of Investment Companies, Securities Act Release No. 33-7754 (October 14, 1999), at 9-10. The Release defines a "management organization" as an investment company's investment adviser, principal underwriter or administrator. The Proposal also covers affiliates of management organizations.

-[3]- States that have not adopted the Model Rules as the basis for their legal codes of ethics nonetheless have similar restrictions. For example, Disciplinary Rule 5-105 of New York's Lawyer's Code of Professional Responsibility prevents a lawyer from representing multiple clients where a conflict of interest may arise unless "...it is obvious that the lawyer can adequately represent the interest of each and if each consents to the representation after full disclosure...." All states have some similar ethical rule dealing with conflicts of interest.

-[4]- See American Bar Association, Center For Professional Responsibility, Model Rules of Professional Conduct, Rule 1.7, Comment 7 (1998).

-[5]- Supra note 2, at 10.

-[6]- Supra note 4, Comment 2.

-[7]- Commentators are clear that determining whether an impermissible conflict of interest exists depends on an analysis of the particular facts rather than on any strict bright-line rule, especially when the client has given informed consent to the dual representation. See, e.g., Charles W. Wolfram, Modern Legal Ethics '7.2 (1986).

-[8]- Supra note 2, at 11.

-[9]- For example, a law firm may serve as counsel to the independent directors and represent a broker-dealer affiliate of the adviser in an underwritten securities offering.

-[10]- Supra note 2, at 3.

-[11]- The Committee doubts if many law firms with financial services practices would deem representation of independent directors to be so lucrative as to justify precluding the possibility of ever working for an affiliate of an adviser that is part of a significant financial services organization. Thus, the Proposal could deprive independent directors of funds that may be the most likely to be exposed to complex legal issues of the possibility of hiring counsel with a broad perspective on financial services industry issues.

-[12]- The Committee is unable to quantify the potential dislocations that could result from adoption of the Proposal. However, informal polling of Committee members indicates that several would be disqualified