This recommendation would accommodate previously established business arrangements and avoid harmful consequences to shareholders. The provision would prevent a fund that had properly established multiple classes and 12b-1 plans and secured joint fidelity bond coverage under a majority disinterested director requirement from being forced to unwind those arrangements if the fund is unable, through due diligence or other reasons, to elect new disinterested directors to satisfy the majority requirement in the time frames allowed by Rule 10e-1. In this manner, fundamental operations would not be disrupted due to an inability to add independent directors. These rules require this special accommodation because, unlike the other rules which are transactional in nature, they would require substantial changes to the funds' operations without any added benefit to shareholders, particularly since the arrangements under these rules would have been properly adopted at the outset.¹⁴

Although new Rule 10e-1 is designed to address real concerns over what would become the severe consequences of a fund falling below the minimum required percentage of independent directors, and even if the Commission revises it along the lines just suggested, we believe that additional exemptive measures in this area are necessary in order to make the Proposal workable. Our concerns here focus on the current shareholder voting requirements of Section 16(a) of the 1940 Act with respect to fund directors. In general, this section requires that fund directors be elected by shareholders at a regular or special meeting. However, it also provides:

that vacancies occurring between such meetings may be filled in any otherwise legal manner if immediately after filling any such vacancy at least two-thirds of the directors then holding office shall have been elected to such office by the holders of the outstanding voting securities of the company at such an annual or special meeting. In the event that at any time less than a majority of the directors of such company holding office at that time were so elected by the holders of the outstanding voting securities, the board of directors or proper officer of such company shall forthwith cause to be held as promptly as possible and in any event within sixty days a meeting of such holders for the purpose of electing directors to fill any existing vacancies in the board of directors unless the Commission shall by order extend such period.

If the Commission adopts rule amendments that require a fund to have at least a majority of independent directors, the Section 16(a) requirements become significant impediments to orderly fund governance and the source of significant and costly burdens. We have three suggestions to ameliorate these problems.

First, the Commission should adopt a rule that conforms the 60-day meeting requirement of Section 16(a) to the time period for the relief provided in proposed Rule 10e-1. Otherwise, in many cases Rule 10e-1 would fail to provide the relief it is intended to.

Second, the Commission should adopt a rule that would allow a director who has been elected by shareholders to temporarily resign from the board and rejoin it at a later time, without forfeiting shareholder-elected status. The desirability for such a rule is best illustrated by the following example. Assume a fund has five directors, all of whom have been elected by shareholders, three of whom are independent and two of whom are interested. One of the independent directors dies or resigns, and it appears that the fund will be unable to have another independent director elected to the Board within whatever time frame Rule 10e-1 permits. In such a situation, in order to reestablish a majority of independent directors (and thus continue to rely on exemptive rules), the fund's only practical option might be to have one of the interested directors, Director A, resign. Thereafter, a new independent director is added to the Board without shareholder approval, and the Board wishes to have Director A rejoin the Board (as an interested person). Under our proposal, Director A would still be considered to have been elected by shareholders for purposes of Section 16(a). In the absence of such relief, the fund would be forced to go through the expense of a shareholder meeting in order to reinstate Director A. Alternatively, the fund could operate with the three independent and one interested directors, but would be forced to obtain shareholder approval in order to replace another "original" independent director who dies or resigns. It makes little sense to us to accelerate the shareholder voting requirement on a fund under these circumstances, and we do not perceive how adoption of our suggestion would in any way undermine the general shareholder approval principles of Section 16.

Third, in the event the Commission decides to amend its rules to require funds to have at least a majority of independent directors, and to require that independent directors be "self-nominating," we ask that the Commission reconsider the utility and importance of the Section 16 shareholder approval requirements for such funds. In part II.C. of the Release, the Commission proposes an exemption from the statutory requirement for fund shareholders to vote on selection of the fund's independent public accountant. As a basis for this Proposal, the Commission notes that shareholders rarely contest votes over ratification of the Board's selection of an independent public accountant, and that "[m]any believe shareholder ratification has become perfunctory." We agree, and we believe that much the same can be said for shareholder votes on the uncontested election of fund directors. In our experience, it is extremely rare that shareholders will fail to approve a nominee for director in such cases. In addition, we have already referred to the time, expense, and difficulty involved in holding shareholder meetings generally. With these factors in mind, it seems to us that where a fund is currently governed by a majority of independent directors, and these people select and nominate any other independent directors, there may be little to be gained by applying Section 16's shareholder approval requirements when new independent directors are added to the Board. Moreover, we must observe that the Commission's approach to fostering independent director majorities throughout the Proposal is, in essence, coercive: it strikes us as mostly "stick" and very little "carrot." Adoption of an exemptive rule along the lines we suggest would serve as a positive incentive for funds to move to having a majority of independent directors, and would help funds avoid undue expenses.

2. Selection and Nomination of Independent Directors

Federated supports the concept of self-selection and nomination of independent directors, and notes that many funds already follow this process because they have adopted Rule 12b-1 plans. We would recommend that the Commission clarify that management and others may assist the independent directors in fulfilling this responsibility, as they have done in the past, particularly since many funds and boards do not have a separate staff to support independent directors, but rely on management and/or staff of a fund's service provider(s) to provide such help.¹⁵ Also, we recommend that the Commission clarify that it would still be appropriate for interested directors to participate in a full board vote on the election of independent directors.¹⁶ This is necessary to ensure interested directors are not disenfranchised or precluded from fulfilling their statutory or charter obligations and duties. We do not view this as ultimately having any substantive impact on the outcome of the board vote if the board must consist of a majority of independent directors. Thus, no shareholder interests are comprised. However, it does allow interested directors to weigh in for or against nominees with whom they have to share responsibility and legal liability for decision-making.

3. Independent Legal Counsel

Federated strongly opposes the Commission's Proposal to hinge reliance on any exemptive rule on the proposed independence standard for counsel to independent directors. We have strong objections to the independence concept proposed by the Commission since we believe it:

However, we do agree with the need for counsel to independent directors to be independent and be able to provide impartial advice and counseling. Accordingly, we recommend that the Commission consider a process-based alternative to achieve its goals in a manner that will be more feasible to implement.

As we noted in our introductory comments, there is an inherent conflict in the supposition that independent directors are to serve as "watchdogs" for shareholders, but can't make their own evaluation and exercise business judgment as to their counsel's independence. There are numerous exemptive rules that defer to the supervision and determination of the directors, including a majority of the independent directors, that transactions between affiliates are fair and reasonable. We are hard pressed to understand the logic behind delegating to independent directors the responsibility of evaluating transactions between the fund and its affiliates for conflicts of interest, yet saying that if you hire counsel to advise you of your responsibilities it must meet these strict requirements of independence, even if it means that you must fire existing counsel because of some remote potential conflict and act without any counsel.

In that regard, we note that the Proposal in its current form puts a greater burden on those independent directors that select counsel than those that do not hire any counsel, and puts funds serviced by such diligent directors at a greater risk of causing the funds to lose the ability to rely on the exemptive rules. This Proposal would tend to discourage, rather than encourage, independent directors to seek expert legal advice from experienced Investment Company Act counsel. In fact, the larger and more experienced the law firm, the more likelihood that it could have provided legal services to fund-related entities and therefore be disqualified. Also, this rule works against larger fund complexes that have advisers with legal needs requiring the use of different law firms for different types of expertise. It also raises potentially insolvable problems for funds that use a multi-manager advisory structure (i.e., hiring various advisers or sub-adviser to manage different portfolios or asset classes) since the use of a different law firm by each adviser would disqualify such law firm from counseling the fund's independent directors. As a result, a potentially larger number of qualified law firms could become ineligible to serve as counsel to the independent directors of a larger fund complex.¹⁷ It could also cause a migration of Investment Company Act counsel away from representing independent directors in favor of a potentially more lucrative revenue source (investment advisers, administrators and principal underwriters), which would adversely affect the ability of independent directors to perform their duties and would conflict with the overall goal of the Commission.

We strongly support giving independent directors the authority and deference to determine whether or not counsel is independent. The Commission's proposed independence standards are too restrictive and inflexible. They do not take into account that independent directors may have engaged a large, prominent, experienced Investment Company Act law firm as its counsel, that counsel may have served them well for many years, yet that counsel would be forced to resign because, for example, a colleague in a different office performed some legal research and advice for a "control person" of the adviser which had no potential to be adverse to the interests of the fund. We are troubled by the lack of any flexibility in the Proposal. For example, it does not even consider any materiality determination, any separation of client matters and attorney contacts within the law firm (such as Chinese walls or other conflict of interest and screening mechanisms that segregate attorneys), or any number of factual scenarios where there would be little if no potential for (and no actual) conflict of interests between the fund and its adviser, administrator or principal underwriter.

If this provision of the Proposal were enacted, Federated and many of the third-party fund complexes it services would be negatively impacted. The Commission does not cite any instance of abuse or problems to support this Proposal. However, we have identified many instances within our organization where this Proposal would force the dissolution of many long-standing, supportive and functional relationships between independent directors and their counsel. This result is neither necessary nor appropriate in the public interest. It is inconsistent with the protection of investors and contrary to the best interests of shareholders, independent directors, fund-related entities, and the Investment Company Act bar.

We also express deep concern that this Proposal could prohibit counsel to independent directors from performing many projects that would not impair their independence. In many instances, these projects may benefit both the fund and the adviser, but would disqualify counsel because the adviser may be the party engaging counsel for the project and/or pay the cost in whole or part to eliminate questions of fairness to the fund or potential overreaching on the part of the adviser or to minimize additional costs to a fund that is small in size or has a high expense ratio.¹⁸ In many instances, counsel to independent directors may be in the best position to perform legal work on behalf of the adviser and the fund efficiently and effectively.¹⁹ As a result, this "dual" representation would disqualify counsel.²⁰

As we noted above, we are recommending an alternative to amending the exemptive rules to require independent directors to have independent counsel: we would propose a process-based approach that is independent of any exemptive rules. We would suggest that, at least annually, the independent directors request from their counsel, and counsel be obligated to provide, information that the independent directors deem necessary to determine whether the work that counsel performs for other fund-related entities would compromise counsel's ability to act impartially, objectively and without bias. Such information and determination could be subject to recordkeeping and retention requirements. In this manner, the independent directors are given the ability to review each case on its own merits and exercise their own business judgment on when counsel's independence may be impaired or compromised. This proposal also avoids putting the fund and its shareholders in jeopardy of violating an exemptive rule. It ensures that the board can focus on its responsibilities of safeguarding shareholders' interests instead of worrying about whether they (or counsel) are continuously performing due diligence on counsel to justify a reasonable belief that counsel has not performed any disqualifying work and thereby mitigate potential exposure to strike suits or enforcement actions.

We do not support any public disclosure regarding the independent directors' analysis of counsel's independence. While we understand the need for the Commission to have access to such analysis, we feel that this an internal governance matter for which public disclosure may inappropriately reveal confidential, financial and client information of law firms.

B. Limits on Coverage of Directors under Joint Insurance Policies

The Commission proposes to amend Rule 17d-1(d)(7) to require joint insurance policies to prohibit exclusion of coverage for bona fide claims by an insured against the independent directors or the fund if it is a co-defendant.

We support the goal of this Proposal as providing additional protection to independent directors in the performance of their duties. However, we are troubled that the Commission is in effect mandating the scope of coverage as a condition to obtain joint insurance coverage, but not otherwise requiring funds to even obtain insurance. We are particularly troubled by the apparent lack of insured versus insured coverage offered by most commercial carriers.²¹ According to our insurance consultant, coverage to the extent proposed by the Commission may be obtainable only for a hefty premium. We are concerned that the effect of this would be to increase the cost of insurance for funds because they either would have to obtain their own insurance coverage at a higher price than if they were to negotiate joint coverage, or would have to obtain joint insurance coverage at a higher cost than if the funds were able to make their own determination about the scope and propriety of any exclusions.

As a separate comment, we oppose requiring any specified amount of coverage. Since there is no requirement to have errors and omissions insurance, we do not think it is appropriate to require a minimum coverage amount, regardless of whether a policy is separate or joint with affiliates. This should be left to the discretion of the independent directors in consultation with their counsel and any co-insureds.

C. Exemption from Ratification of Independent Public Accountant Requirement for Funds with Independent Audit Committees

The Commission proposes exempting the selection of independent public accountants from the shareholder ratification requirements if the fund establishes an independent audit committee that meets certain criteria. We support this Proposal since it eliminates the need for shareholder action on a matter that has become mostly administrative. We recommend, however, that the Commission clarify the condition requiring the audit committee to have "responsibility for overseeing the fund's accounting and auditing processes." The Release provides no guidance as to what this phrase means. We do not believe it is the Commission's intention to require the audit committee to supervise the daily workings of the fund's portfolio accounting and auditing (i.e., the daily management and operations). Rather, we believe (and seek confirmation) that the Commission intended for the audit committee to exercise traditional, "high-level" oversight of the processes in much the same way as the independent public accountants perform annual oversight of the auditing and accounting functions. Clarification of this language will encourage compliance with this rule amendment by removing uncertainty and reducing the risk of litigation or enforcement action that could develop from the uncertainty. Absent such clarification, there is not much incentive to comply with the rule and its otherwise supportable goal of requiring audit committees to consist entirely of independent directors. This is because the additional burden of having shareholders ratify independent public accountants would outweigh the potential liability issue.²²

We believe the Commission should leave to the internal workings of the fund the appropriate means for establishing the responsibilities and operational methods of the audit committee (i.e., whether it be through resolution, in the fund by-laws, or in a committee charter). We do not support the thought of, nor does the Release provide any justification for, filing a charter with the registration statement or requiring annual committee review of the charter. Like many other exemptive rules, any review or revision of the purposes and functions of the committee should be done on an as-needed basis.

D. Qualification as an Independent Director²³

The Release proposes a new rule that would protect the status of an otherwise independent director who owned shares of an index fund that owned securities of a fund's adviser or principal underwriter or a person controlling these entities. At the outset, we feel it is important to note that Section 12(d)(3) and Rule 12d3-1(c) generally preclude a fund from owning securities of its adviser, its principal underwriter or their affiliates (referred to as "covered securities" for purposes of this letter) absent regulatory relief. Certain index funds have obtained such relief. However, we think that it is a misconstruction of Section 2(a)(19)(B)(iii) to disqualify a director's independence due to ownership of a fund that is allowed to own covered securities. This assumes that you look through to the fund's holdings and attribute any and all of its portfolio holdings to each and every shareholder. There is no basis in the statutory language for such an overreaching construction, and the only precedent cited in the Release (at footnote 138) concerned a markedly different set of circumstances. Thus, we believe the Commission has elevated a proposition of questionable legal origin into an issue of uncertainty which it now proposes to resolve through exemptive relief that attempts to solve a problem where none of substance existed. Therefore, we oppose this rule and suggest a simple clarification in the release stating that a director's ownership of a fund would not implicate a question of independence if that fund owned covered securities. ²⁴

E. Disclosure of Information about Fund Directors

The Commission proposes requiring extensive disclosure about fund directors, including ownership of fund shares; potential conflicts of interest due to positions, interests, transactions, relationships and cross-directorships of the directors and certain family members with various fund-related entities; and the factors the board considers when annually approving advisory contracts.

While we agree with the need for shareholders to have access to basic information about a director, including his or her experience and connections with the adviser, principal underwriter and administrator, we believe that the scope, depth and placement of the proposed disclosure needs to be modified and circumscribed to avoid placing excessive burdens on directors and to make the requirements administratively feasible to implement.²⁵ We also believe the Commission needs to rebalance the Proposal in favor of protecting the privacy interests of the directors against the need to publicly disseminate (or, at a minimum, make available to Commission review) certain financial and personal information about directors and their extended families. We believe that the more accurate assessment of investors' interests and investment priorities is that they select a fund based on its investment objective, its portfolio management, its fees and expenses, and the means by which it is offered, sold and serviced; not based on the identity of fund directors and the degree of their (and their extended families') relationships with the adviser, distributor and administrator.²⁶

Another critical factor that the Commission must address as part of requiring any of this information is the burden imposed on certain fund complexes if they had to gather and update the director information on a fiscal-year basis rather than a calendar-year basis. In its current form, the Proposal would require fund groups that have boards serving multiple funds with staggered fiscal year ends to resolicit directors for changes in information throughout the year. For example, every month marks the fiscal year-end of at least several Federated funds. Requiring this information to coincide with fund fiscal year-ends would result in our having to make extensive inquiries of our directors every month.²⁷ This would be burdensome and costly to the fund and its directors; moreover, monthly updates would distract the directors from their more important function of fund management and oversight. Furthermore, this would be another regulatory burden to discourage director service and, ultimately, be a disservice to fund shareholders. Particularly in the absence of any demonstration by the Commission that these types of disclosures are necessary (or even particularly desired by the vast majority of fund shareholders), we believe that the Commission lacks any justification to impose the kinds of burdens that a fund fiscal year-end requirement would entail.

1. Basic Information about Directors

We support the proposed tabular presentation of basic director information. We believe this is appropriate for inclusion in proxy statements relating to director election. This allows shareholders to make informed decisions. We also believe it is appropriate for inclusion in other shareholder documents, but not both the Statement of Additional Information (SAI) and the annual report. We believe this is duplicative and unnecessary. We would recommend its continued inclusion in the SAI and not require it either in the annual report or the prospectus. We believe the annual report should remain primarily a financial and performance analysis document. Inclusion of this information could easily increase the size and cost of the annual report (particularly for funds with large, active boards) without the supporting justification that shareholders really want to get this information or would find it useful for purposes of making investment decisions.²⁸ As a means of making shareholders aware of the availability of this information, we would suggest that the annual and semi-annual reports reference the availability of information about the directors in the SAI, with information on how to obtain free copies upon request.

2. Ownership of Equity Securities in a Fund Complex

The Commission proposes increased SAI and proxy statement disclosure of fund ownership by directors, based on the assumption that additional disclosure of fund ownership will allow shareholders to determine whether a director's interests are aligned with those of shareholders.²⁹ We believe this premise is flawed for several reasons; thus, we must oppose this requirement. First, directors have a statutory and common law duty of care and loyalty to the fund and its shareholders. Owning shares won't necessarily create or demonstrate a greater alignment of interest since directors already put their reputation and personal financial interests at stake when they serve in such capacities. Second, there are too many variables that cloud the relevancy or could cause a misinterpretation of the import of a director's ownership of fund shares. Third, this type of disclosure represents an intrusion into the financial privacy of directors without a countervailing, compelling argument that outweighs this privacy right.

Here are some reasons why we believe disclosing fund share ownership to the extent proposed is of questionable value. First, each fund board sets its own compensation policy; the compensation policy of the fund complexes that are administered of distributed by Federated vary tremendously due to the different size of the funds each board is responsible for, the asset sizes and types of funds in each fund complex, and the range in complexity of the board's oversight responsibilities. We also note that the directors vary widely in economic and financial backgrounds. Accordingly, it would be unfair to draw the conclusion that Director A, who owns $100,000 or more in shares within a fund complex (or family of investment companies), has a greater alignment of interest with the funds he or she serves than Director B, who owns $10,000, particularly if the latter $10,000 investment is a greater percentage of the aggregate net worth of that Director B.

Second, directors with equal amounts invested in a fund complex could represent ownership interests in different types of asset classes. If one director owns only shares of a treasury money market fund, does that director share the same alignment of interest with the fund complex as a director who allocates the same amount proportionately among all the funds offered by that complex? And what if a director is recently elected, but only invests a relative small amount in the fund complex because the director's assets are invested elsewhere and the director does not want to generate tax consequences by transferring these assets into the fund complex. Is that director's interests less aligned with the fund complex than a director who has been on the board for many years and owns the same amount as the new director?

Nevertheless, if the Commission is not convinced by these arguments, we would urge the Commission to make the modifications recommended by the ICI in its comment letter (i.e., only require disclosure of fund ownership in the aggregate instead of individually by fund, require disclosure on the basis of funds within a "family of investment companies" instead of by "fund complex," and specify amounts within dollar ranges that top out at over $100,000³⁰) for the reasons set forth in that letter.

3. Conflicts of Interests

We oppose adding disclosure to SAIs and proxy statements about potential conflicts of interest due to positions, interests, transactions, relationships and cross-directorships of the directors and their "immediate family members" with funds and various fund-related entities.³¹ We believe this additional information will be of limited value to shareholders, and that the information currently required is adequate for directors to make informed decisions on the election of directors.

In that regard, we believe that none of this additional disclosure should be required of directors who are interested persons since their independence has already been deemed impaired by statutory standards. Requiring compilation of this information to further evaluate the degree of an interested director's lack of independence is a moot exercise that only creates administrative burdens and costs for these directors, their funds, and legal counsel.³² Once a director has the stigmata of interested status, the red flag has been waved, and further inquiry of this nature is unnecessary.

As for the applicability to independent directors, we believe the scope of the information should be scaled back considerably in certain areas, but otherwise would feel it is appropriate to gather as part of an internal annual determination and reevaluation of the independence of a director rather than inclusion in public disclosure documents. We note that many funds already send annually a directors' questionnaire to validate the independence of directors. We believe the questionnaire could be expanded to solicit certain additional information to evaluate the ongoing independence of directors, but not to the extent currently proposed since much of the information is too personal and private for public consumption and dissemination.

We believe public disclosure of this information will have limited value to shareholders given the likely low rank that director information has in a shareholder's investment decision-making process. We also are concerned about the potential liability associated with inadvertent but material omissions or misstatements if this information is required in a fund's registration statement. Given the scope and detail of information required, the risk is too great that something may be overlooked, despite the most conscientious attention to details. If independent directors are faced with this risk, we believe it may discourage them from serving on fund boards.

Accordingly, we provide the Commission with the following comments. We note that they follow closely the ICI's recommendations in its comment letter of a recordkeeping requirement that would require compilation of certain information about independent directors only, which would be made available to the Commission. This would then allow the Commission access to information about the independent director to assist the Commission in monitoring the determination of a director's independent status and evaluate whether there is a "material business or professional relationship" of the director that would change his or her status to an "interested person" under Section 2(a)(19).

a. Immediate Family Members

We strongly oppose the application of this information to "immediate family members" in its proposed definitional form. It is unrealistic to believe that a director could request and obtain with any degree of accuracy or certainty the types of detailed personal, financial information from anyone other than his or her dependents³³ or members of the immediate household. Family relationships today are too complex and sometimes too tenuous to expect directors to invade the privacy of their extended family relatives for this information.³⁴ Plus, we believe that the relationships included in the definition are too far-reaching; so much, that the likelihood of conflict of interest decreases proportionately with the increase in degree of familial relationship. Under such analysis, we feel the extra burden and costs and invasion of privacy imposed on funds and their directors to compile and analyze this information outweigh any benefit to be derived from gathering this information beyond a subset of the proposed immediate family members. Ultimately, directors have a duty of loyalty to the fund and its shareholders that prohibits the directors from placing their own interests ahead of the interests of the fund and its shareholders. Accordingly, we recommend a modified definition of immediate family members that would be limited to the director's dependents and household members. We believe this creates an acceptable balance between the privacy rights of individuals, the relevancy of the information from distant family members that the directors may not control, the administrative costs and burden in obtaining this information, and the diminished potential for conflicts of interests when dealing with an extended set of family members.

b. Related Persons

The Commission proposes requiring disclosure about circumstances between directors and the fund or its related parties. We recommend that the information should not cover thirty-party fund administrators. Unless an administrator is affiliated with the fund's adviser or principal underwriter, there is no statutory basis under Section 2(a)(19) for declaring a director an interested person due to relationships or affiliations with a third-party administrator.

c. Control Persons

We recommend that the Commission tailor the scope of the information to those entities that are parents or subsidiaries of the adviser or principal underwriter, and not to the more extensive group of entities that are directly or indirectly controlling, controlled by, or under common control with the fund's adviser or principal underwriter. We believe that an all-inclusive list of commonly controlled entities becomes unmanageable in larger financial institutions with wide-ranging operations and affiliates, particularly if the affiliates are engaged in different lines of business.³⁵ Also, we believe the further away the degree of affiliation, the less likely it will be that there will be a potential conflict of interest due to a position, interest, transaction, or relationship between a director and such affiliate. In summary, we do not feel the public interest is served when you compare the administrative burden and cost against the potential value of this information to determining a director's independence.

d. De Minimis Thresholds

We strongly recommend a dollar threshold in lieu of a "materiality" standard since the latter is too vague to provide adequate guidance to directors and the fund industry. Because of the subjective nature of a materiality standard, we anticipate inconsistencies within the industry, which only serve as a basis for litigation or enforcement against those outside the median range. A bright-line test using a dollar amount greatly aids the industry in meeting its regulatory obligations. We note that an existing benchmark currently exists in the proxy rules and regulations ($60,000 threshold requirement for disclosure of certain director information). We propose using this as a basis for materiality, although we believe this amount is deserving of a meaningful upward adjustment due to inflation and the general improvement in the economic situation of society.

e. Cross-Directorships

The Commission proposes disclosure of cross-directorships, which are situations involving a fund's director or his/her immediate family member serving as an officer of any company for which certain related parties are directors.³⁶ For the same reasons expressed above, we believe the scope of this requirement needs to be scaled back to a more administratively workable list of people in light of the burden that would otherwise be imposed and the limited potential for conflict of interests. Thus, information would be gathered on cross-directorships of only interested directors, using a narrower set of their immediate family members, and only examining such relationships with a fund's adviser, principal underwriter and their parents or subsidiaries. If this requirement is not modified in this manner, it would require surveys of relationships between directors, an extended list of family members, and potentially thousands of other people in the case of financial conglomerates.

f. Time Periods

The Commission proposes covering information for up to five years. We recommend that any information sought should be limited to the past two calendar years instead of fiscal years. We believe the two years should be calendar-based in order to make it administratively feasible for directors of larger fund complexes with staggered fiscal year-ends.

4. Board's Role in Fund Governance

We strenuously disagree with the purported value of requiring SAI disclosure of the material factors and conclusions that formed the basis for the board's annual renewal of existing advisory agreements. We contrast this more routine, annual board approval of advisory contracts with the more unusual proxy statement process that requires such disclosure when shareholders are being asked to approve initial or material changes to advisory contracts. We believe that disclosure of the board's annual considerations will tend towards lengthy boilerplate disclosure without giving any added benefit to shareholders.

5. Separate Disclosure

We do not agree with the Proposal to require physically segregated disclosure of information about independent and interested directors. We believe the current designation of interested directors with an asterisk is adequate to distinguish the two categories of directors. In addition, to the extent that disclosures must be made in tabular form, it has been our experience that having to present separate tables that either give different information about the same set of people, or the same information about different sets of people, can be confusing to the reader and unduly lengthens the document. Thus, we urge the Commission to make clear that funds can combine tabular presentations so long as the disclosure remains clear.

6. Technical and Conforming Amendments

We disagree with the Commission's Proposal to require SAI disclosure about any arrangement or understanding between a director or officer and any other person pursuant to which he or she was selected as a director or officer. We believe this current proxy rule language is vague in its current form and should not be perpetuated elsewhere. Instead, we suggest elimination of this requirement, particularly if the independent directors of all funds must be self-nominated and selected.

7. Compliance Date

Assuming the Proposal is modified as suggested, we recommend that any new requirements be effective at the fund's first new fiscal year starting one year after the adoption of the Proposals to allow for an orderly transition and implementation of the requirements.

Cost-Benefit Analysis

In the introductory sentence of Section III. of the Release, the Commission expresses its sensitivity to the costs and benefits imposed by its rules. We appreciate this sensitivity and hope that our concerns forcefully articulate our fears that many aspects of the Proposal will impose substantial costs without substantiated benefits.

In that regard, we strongly disagree with the statement: "The proposed amendments to the Exemptive Rules may impose some costs on funds that choose to rely on those rules. Funds that do not rely on an Exemptive Rule, however, will not be subject to the proposed conditions, or any costs associated with those conditions" (our emphasis added). First, as we indicated initially in this comment letter, we believe a "supermajority" of existing funds currently rely on these rules, and they do so not so much out of choice, but as a business and legal necessity to operate efficiently and competitively. The most prominent example is Rule 18f-3. Variations in distribution channels and sales charges structures are not merely voluntary choices in today's competitive mutual fund industry. Investors and brokers alike demand these options. A fund with one class is essentially at a competitive disadvantage to its peer group in its distribution efforts. It has become critical to the success of many funds to have the flexibility to price and structure a fund with multiple share classes without increasing the associated costs. Since the Commission's Proposal would increase the costs of relying on these ten exemptive rules, we think the financial impact of the Proposal is underestimated.

Second, small funds are at a particular disadvantage if continued reliance on the exemptive rules were to require them to expand their board to increase the percentage of independent directors. Similarly, there are likely to be substantial costs incurred by funds if they are forced to hire new counsel to independent directors because counsel also has represented the adviser. Because a new law firm will not have the historical experience and background to serve the independent directors as efficiently as existing counsel, there will be additional costs associated with new counsel familiarizing itself with the fund, its charter documents, its contracts, the service providers and other types of necessary information to effectively counsel the fund's independent directors (we believe that the time new counsel needs to get up to speed will be proportionately related to the number of years current counsel has served). Moreover, as the already rapid pace of acquisitions and mergers of fund advisers is only likely to accelerate, many fund boards will increasingly have to look to outside counsel as one of the few, if not the only, source of continuity and institutional knowledge.

In Section III.B. of the Release, the Commission discusses the estimated costs funds would incur to comply with the new independent counsel condition of the exemptive rules. However, the Release does not factor in the costs of law firms to initially screen and thereafter continuously monitor legal work they perform to ensure their continued independence. This becomes proportionately more expensive the larger and more sophisticated the law firm and the fund complex are since there is a greater potential for overlap in representation.

In Section III.C. of the Release, the Commission did not anticipate any costs to funds that would result from the enactment of proposed Rule 10e-1. We believe there could be significant additional costs incurred if the Commission does not expand the time frames beyond its current Proposal. As we indicated previously, we suggest an expanded time frame to allow such matters to be dealt with during the course of normally scheduled board meetings and without subjecting funds to an unrealistic time frame in which they would have to hold special board meetings. For larger fund complexes with a common board, such as Federated, the additional time becomes critical when you have to solicit over 100 funds to approve a new independent director.

In later parts of Section III. of the Release, the Commission discusses the estimated costs for compiling information about fund directors for disclosure in the proxy and registration statement, and the costs for maintaining records of director independence. While the Commission estimated the amount of time the funds would incur to disclose the information and maintain records ($4.78 million just for complying with the N-1A requirements), the Commission did not appear to include in its estimate the value of the directors' time to survey their "immediate family members" and compile information to comply with the disclosure requirements about their potential conflicts. Also, to the extent legal counsel would be involved in expanding and reviewing the annual directors' and officers' questionnaire to compile this information (which we feel is a likely industry approach), the Commission has not factored in the legal costs law firms would charge the funds to perform these functions.

Conclusion

In summary, we believe that the Proposal requires substantial revisions in order for it to be implemented without great hardship and administrative costs on funds, their independent directors, their counsel, and their service providers.

We believe that the Commission has not fully justified the scope or the breadth of much of the Proposal, has overestimated the interests of shareholders in the proposed disclosure, and has underestimated the cost of gathering, synthesizing and disclosing the disclosure information.

Therefore, we urge the Commission to defer action on the Proposal to give the mutual fund industry more time to consider and implement the Best Practices Recommendations. Alternatively, we recommend that the Commission modify certain aspects of the Proposal and eliminate other aspects of the Proposal in order to best serve the interests of the mutual funds and their investors.

Federated very much appreciates having the opportunity to comment on this important Proposal. If you would like to discuss these comments or any other aspects of the Proposal with us, please contact the undersigned by phone at (412) 288-1432 or by e-mail at vsiclari@federatedinv.com. You may also contact Jay S. Neuman, Corporate Counsel, at 412-288-7496 or jneuman@federatedinv.com. Thank you very much.

Very truly yours,

Victor R. Siclari
Senior Corporate Counsel

cc: Paul F. Roye, Director
Division of Investment Management

Footnotes

1 Federated is one of the largest asset management and mutual fund firms in the United States. Through its subsidiaries, Federated manages total assets of more than $115 billion, and serves as administrator for over 450 classes of fund shares, including those of over twenty independently managed mutual fund clients.

2 Release No. 33-7754; 34-42007; IC-24082, October 14, 1999; 64 Fed. Reg. 212, November 3, 1999 (the "Release").

3 Investment Company Institute, Report of the Advisory Group on Best Practices for Fund Directors: Enhancing a Culture of Independence and Effectiveness (June 24, 1999).

4 In that regard, we point to the industry's history of broad acceptance and implementation of such recommendations, as evidenced in the revisions of codes of ethics to address problems of personal trading abuse in response to the "Report of the Advisory Group on Personal Investing."

5 Section 2(c) of the 1940 Act requires the Commission to consider or determine whether a rulemaking action is consistent with the public interest and the protection of investors, and whether the action will promote efficiency, competition and capital formation. Section 6(c) of the 1940 Act requires the Commission to consider whether an exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the 1940 Act.

6 This is in accord with certain Commission statements in the Release. See footnote 66 of the Release, in which the Commission acknowledges that funds with Rule 12b-1 plans represent a majority of all funds, and represent more than 7,000 funds in the industry. Also, see footnote 253 of the Release, in which the Commission assumes that approximately 90% of all funds that could rely on one or more of the exemptive rules actually do rely on the rules each year.

7 In the Release, the Commission states that it is "not proposing to require all funds to adopt these measures. Funds that do not rely on any of the Exemptive Rules will not be subject to these requirements." In reality, we believe this understates the likelihood of the number of funds that will be forced as a matter of business practice to comply with these requirements since these exemptive rules have become an integral part of mutual fund operations. Many large and small fund complexes, such as Federated and its mutual fund clients, use a common board for all of the funds in their complex. Therefore, even if some of the funds within the complex would not avail themselves of any of the exemptive rules, they would still be burdened with these additional conditions.

8 Footnote 45 of the Release states that, "[a]s a result of the Glass-Steagall Act, most bank-sponsored funds have boards comprised entirely of independent directors." This statement is simply incorrect, and it is important for the Commission to realize that many bank-sponsored(advised) funds will be affected by the Proposal. We act as a service provider to more than 20 such fund complexes. Most of our bank-advised fund complex clients have interested directors on their boards; only two of those complexes have boards composed entirely of independent directors. We believe many other bank-advised funds also have interested directors on their boards, and with the passage of the financial services reform legislation (Gramm-Leach-Bliley Act), more bank-advised funds will seek to add directors that are affiliated with the bank.

9 We acknowledge that the Commission proposes a "reasonable belief" standard in determining the independence of counsel and an exception for minor conflicts that may arise from such dual representation. However, for the reasons discussed further below, we still oppose this provision as unworkable and contrary to the best interests of the funds, the independent directors and shareholders. Also, we note that the Commission does not address both the potential ramifications on the fund and its independent directors if the conflict cannot be resolved, and the potential for the subjective nature of a "reasonable belief" standard to encourage plaintiffs to engage in second-guessing through litigation.

10 Nor would we support a percentage of independent directors above two-thirds.

11 In making this suggestion, we would also recommend that the Commission consider a potentially conflicting provision in Maryland corporation law. Section 2-501 of Md. Code Ann., Corps. & Assns. establishes the requirements for holding shareholder meetings of Maryland corporations. Many mutual funds are organized as Maryland corporations and opt not to hold annual shareholder meetings. However, paragraph (b)(2) of this section states that any special shareholder meeting (of entities that don't hold annual meetings) to elect directors shall be designated as an annual meeting. Subparagraph (c)(2) then requires such "meeting be held no later than 120 days after the occurrence of the event requiring the meeting." Even if the Commission permits shareholder elections to occur up to 240 days rather than 150 days, one could interpret this section as requiring a meeting to be held within 120 days of the "event requiring the meeting." We were unable to find any legislative guidance on interpreting this phrase, but could conceive several possible "events" as the trigger: the date a director lost independent status, the date the fund became aware it fell below a majority percentage of independent directors, the date the board (or independent directors) meet to nominate a new director and/or approve the agenda and holding of a special meeting. Therefore, we urge the Commission to take appropriate steps to address this uncertainty that mutual funds organized as Maryland corporations will likely face.

12 For example, the funds need time to draft a proxy statement that contains the factors the board has considered at its meeting, file the proxy with the Commission, print and mail the proxies, hold the shareholder meeting, and obtain the requisite quorum and vote.

13 In footnote 53 of the Release, the Commission acknowledges the consequences funds would face if they were no longer able to rely on these exemptive rules as a result of falling below the required percentage of independent directors.

14 We note and support the ICI's recommendations to entirely exclude Rule 15a-4 from the three additional conditions.

15 In footnote 63 of the Release, the Commission quotes a former Commissioner's statement and support for the involvement of the adviser in the independent director selection and nomination process. Yet footnote 58 notes that "[s]election and nomination refers to the process by which board candidates are researched, recruited, considered and formally named." Therefore, it is unclear what role, if any, would be permissible of the adviser and interested directors.

16 See footnote 72 and accompanying text, which contemplates that only the independent directors elect other independent directors when no shareholder approval is required.

17 With the passage of the Gramm-Leach-Bliley Act, we foresee increasing consolidation in the fund industry. Coupled with the consolidation of law firms, it will become harder for these large fund organizations to identify competent Investment Company Act counsel to serve their independent directors without running into situations where counsel has represented the fund organization or its predecessors. It could equally adversely impact small fund groups who try to minimize expenses by using a single law firm to support the legal needs of the adviser, fund and independent directors consistent with the attorney's ethical obligation regarding conflicts of interest (which may dictate hiring separate counsel if interests of multiple clients are adverse).

18 At the end of footnote 87, the Commission states that "we would not view a lawyer as `acting as legal counsel' to a fund's investment adviser merely because the lawyer accepts payment of fees from the adviser for legal services performed on behalf of the fund or its independent directors as permitted by relevant professional ethics rules." This appears to assume that counsel is being paid by the adviser, but not representing the adviser. This statement, however, does not address the situation where the adviser hires counsel to represent the interests of itself as well as the fund, those interests do not conflict, and the counsel is paid by the adviser (in whole or in part). We fail to see how this representation would impair the independence of the directors or their counsel, but the Proposal appears to prejudge this situation and disqualify counsel.

19 In start-up fund situations, the sponsor/adviser may engage counsel to create and register the fund. While this counsel may now be in the most knowledgeable position to advise the independent directors about the fund, its beginnings and its current management and operations, we are concerned that the Proposal could be interpreted as disqualifying counsel from doing so.

20 Some examples of this type of work are performing lobbying work for the adviser on matters of interest that also could benefit the funds; trademarking the fund name for the adviser; preparing proxy statements and other documentation to merge or dissolve funds (such as combining funds to create a larger asset base to better bear fund expenses or improve performance); and preparing exemptive applications to allow the fund and its affiliate to engage in transactions or activities that benefit the fund (such as mergers that can't rely on Rule 17a-8 due to affiliation of 5% or more shareholders, or establishing a line of credit with a custodian affiliated with the adviser). In the case of seeking affiliated exemptions, the Proposal could require the fund and the independent directors to hire separate counsel, resulting in additional and probably duplicate costs.

21 In that regard, the Release notes that joint D&O/E&O policies have historically excluded coverage of such claims. The fact that, as noted in footnote 111 of the Release, ICI Mutual Insurance Company currently offers this policy endorsement to its members does not solve these problems for the many funds, including the Federated Funds, who obtain their coverage elsewhere (because of other equally important factors, such as scope of coverage on other matters and/or price).

22 Shareholder meetings are infrequent enough and the nuisance factor associated with having shareholders ratify the independent public accountants is low enough that funds will not seek to avail themselves of the exemption if it exposes the directors to greater liability.

23 We note that the portion of this Proposal addressing director affiliation with a broker-dealer has been rendered moot by the passage of the Gramm-Leach-Bliley Act.

24 For purposes of a director's status under Section 2(a)(19), we would make a differentiation between the Commission's general supposition (attributing ownership of portfolio holdings to a director who is a shareholder) and the more problematic (and we believe less likely) individual situation involving an independent director who owns 5% or more of the voting shares of a fund that owns 5% or more of the securities of its adviser, principal underwriter or affiliate thereof.

25 In the paragraph of the Release containing footnote 193, the Commission itself expresses concern about the scope of the disclosure and how the burden imposed on mutual funds might outweigh the value of information to investors.

26 While there is plenty of evidence that shareholders buy into a fund or redeem out of a fund based on changes in advisers, individual portfolio managers and performance, we are unaware of any statistical data or surveys showing any correlation between shareholder investment decisions and changes in board composition. Given the absence of any citation, we question the need for this extensive public disclosure and instead recommend compilation of this material in a more focused and circumscribed manner for purposes of independent Commission review, consideration and evaluation of a director's independence status.

27 A common board serves all of the funds managed by Federated and the eight other fund complexes managed by other advisers; the funds have staggered fiscal year-ends. In any one month, there are multiple funds that are annually updating their prospectuses or producing their annual reports. Therefore, using a calendar year instead of a fiscal year would be a more practical and administratively feasible standard for gathering information about directors.

28 We believe that such disclosure would be particularly inappropriate for the prospectus. As the Commission stressed when it adopted dramatic changes to mutual fund prospectus requirements, "A fund's prospectus principally should include essential information about the fundamental characteristics of, and risks of investing in, the fund." Release No. 33-7512, March 13, 1998, text preceding footnote 23.

29 We note that current disclosure rules already require disclosure when a director owns five percent or more of a fund's shares and when directors and officers as a group own one percent or more of a fund.

30 The ICI recommends the following dollar ranges: none; $1 to $10,000; $10,001 to $50,000; $50,001 to $100,000; and over $100,000.

31 The Commission proposes a definition of "immediate family member" to include "any spouse, parent, child, sibling, mother- or father-in-law, son- or daughter-in-law, or sister- or brother-in-law, including step and adoptive relationships. The fund-related entities include the adviser, principal underwriter, administrator, and any person controlling, controlled by or under common control with any of those entities.

32 In Section II.E.3.(b) of the Release, the Commission identifies three purposes that would be fulfilled by the disclosure of directors' potential conflicts of interests: (1) alert shareholders of circumstances that may affect a director's allegiance (this is moot for interested directors); (2) provide the public, including the press and other third-party information providers with access to information about potential conflicts of interest (again, a moot purpose for interested directors; as for independent directors, not only might it discourage the selection of independent directors who have relationships or engage in activities that raise questions about their independence, it might discourage most people from being selected as independent directors because of the invasion of their privacy); and (3) assist the Commission in evaluating whether an independent director has material business or professional relationships that impairs such independence (a justifiable purpose that can be satisfied by non-public compilation and retention of information that is made available to the Commission).

33 As suggested by the ICI in its comment letter, we also propose that a dependent be a person who is claimed on the director's federal income tax return.

34 In the simplest of scenarios, directors are expected to gather information about in-laws. Generally, a director would have no leverage over these family members unless he or she supports them. It gets more complicated with divorces and subsequent remarriages, and the inclusion of siblings, parents, children, in-laws and adoptive relationships of these marital events. We note the existence of one fund director who has twelve siblings and eight children. Not including in-laws, he already has twenty people to survey. Add the in-laws, and he now has to survey about double that number. Consider that he serves on a board that serves a fund complex having fund fiscal year-ends in every calendar month, it is easy to see the burden this would impose, and why it is necessary to modify the Proposal in the manner we suggest. He could easily spend most of his time each month just compiling this information.

35 With the passage of the Gramm-Leach-Bliley Act, we anticipate that future consolidation in the financial services industry will make the scope of this Proposal even more burdensome and unmanageable.

36 The related parties are any officers of the fund's adviser, principal underwriter, administrator, or of their commonly controlled companies.