October 16, 2002

Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609

    RE: CERTIFICATION OF MANAGEMENT INVESTMENT COMPANY SHAREHOLDER REPORTS FILE NO. S7-33-02

Dear Mr. Katz:

This letter presents the comments of Federated Investors, Inc. ("Federated")1 regarding the proposal (the "Proposal") of the Securities and Exchange Commission ("Commission") to further implement the certification requirements of § 302 of the Sarbanes-Oxley Act of 2002 with respect to management investment companies.2 Among other things, the Proposal would require such companies to file certified shareholder reports with the Commission on proposed new Form N-CSR (while continuing to require certifications to be included in filings of Form N-SAR), and would designate these filings as reports that are required under sections 13(a) and 15(d) of the Securities Exchange Act of 1934 (the "1934 Act"). In addition, the Proposal would require such companies to maintain "disclosure controls and procedures" not only with respect to filings under the 1934 Act, but also with respect to filings under the Investment Company Act of 1940 (the "1940 Act") and the Securities Act of 1933 (the "1933 Act").

According to the Release, the Commission issued the Proposal because:

Although Form N-SAR is currently the form designated for registered investment companies to comply with their reporting requirements under Sections 13(a) and 15(d) of the [1934] Act, we believe that certification of Form N-SAR alone is not sufficient to fully implement the intent of the certification requirement of Section 302 of the Sarbanes-Oxley Act for registered management investment companies. This certification requirement was intended to improve the quality of the disclosure that a company provides about its financial condition in its periodic reports to investors. For registered management investment companies, the required reports to shareholders, rather than Form N-SAR, are the primary vehicle for providing financial statements to investors. We believe that the information in these reports to shareholders should be certified. (Footnotes omitted.)

In Federated's view, the Proposal would impose burdens on open end investment companies ("mutual funds") that so outweigh any possible benefits to fund shareholders as to be oppressive. As explained below, it does so because it fails to take into account both the unique qualities of mutual fund structure and regulation, and the unique burdens the Proposal would impose on the mutual fund principal executive and principal financial officers who would be called upon to make the certifications. After discussing these factors below, and assuming the Commission will feel compelled to impose some form of certification requirement, Federated urges the Commission to adopt a significantly less burdensome alternative to the Proposal.

The Proposal Fails to Consider the Unique Qualities of Mutual Funds.

We do not disagree with the Commission's statement that the "certification requirement was intended to improve the quality of the disclosure that a company provides about its financial condition in its periodic reports to investors." However, we believe that it is also critical for the Commission to acknowledge why this objective was important to the drafters of § 302, along with the implications this should have for regulation of mutual funds under this section.

As some commentators have already pointed out to the Commission, the impetus for the Sarbanes-Oxley Act was the discovery of gross financial irregularities in the operations and financial statements of certain operating companies (Enron, etc.), not mutual funds.3 The material misstatements and omissions in those companies' financial statements violated the securities laws because they misled investors with respect to investment decisions regarding transactions in those companies' shares and made it impossible for the financial markets to accurately value those shares. With respect to operating companies, investment decisions are based largely on the financial information reported by the issuer; the Commission designed the 1934 Act reporting regimen for such companies with this in mind, and § 302 is intended to strengthen that regimen.

These concerns do not exist in the case of mutual funds. This is because Congress and the Commission have made mutual funds unique among issuers of publicly traded4 securities by requiring them to value their own shares every business day, and requiring that all transactions in mutual fund shares be based on those values. And, while it may be true that "the required reports to [registered management investment company] shareholders ... are the primary vehicle for providing financial statements to investors," when it comes to mutual funds, investment decisions are based on the fund's prospectus and the integrity of its mechanisms for internal pricing of its portfolio holdings and daily calculation of its net asset value per share (not on its semi-annual financial statements or its Form N-SAR filings).

Moreover, as other commentators have already pointed out to the Commission,5 there are other significant differences between mutual funds and operating companies. These include unique investor protection provisions in the 1940 Act and the Commission's rules thereunder that already prevent mutual funds from engaging in the types of abuses that helped inspire the Sarbanes-Oxley Act. Among other things, funds may not engage in principal and joint transactions with, or making loans to, "affiliated persons" (and affiliated persons of such persons). They may not issue options or warrants to their officers, directors or employees. They are severely constrained with respect to leverage and other aspects of capital structure generally.

Finally, and in Federated's view most importantly, mutual funds continuously offer shares that are registered under the 1933 Act on the basis of an effective registration statement (which must include financial statements and a significant amount of other financial information). As a result, the mutual fund principal executive and principal financial officers (not to mention directors) who sign the registration statements are continuously subject to civil liability under section 11 of the 1933 Act for material misstatements or omissions in the registration statements. Moreover, section 49 of the 1940 Act imposes criminal penalties for violations of the 1940 Act and material misstatements or omissions in any registration statement or report filed under the 1940 Act. Thus, while § 302 and other provisions of the Sarbanes-Oxley Act might serve to impose new or additional penalties on officers of operating companies, mutual fund officers were already subject to severe penalties before passage of that Act.

In sum, prior to the adoption of the Sarbanes-Oxley Act, mutual funds were already required be organized and operated in such a way as to preclude the very abuses that § 302 is intended to address for operating companies, and mutual fund principal executive and principal financial officers are already subject to equal, if not greater, liabilities for false or misleading financial information than the Sarbanes-Oxley Act might impose. Thus, it appears that mutual fund investors would gain little, if any, benefit from adoption of the Proposal (or any imposition of a certification requirement). Indeed, the differences between mutual funds and operating companies are so vast that at least one commentator has already suggested to the Commission that it "would serve no useful purpose to amend rules under the [1940 Act] simply to require certifications under § 302 covering annual and semiannual reports to shareholders," and has urged the Commission to exempt registered investment companies entirely from the certification requirement of § 302.6

The Proposal Would Impose Inordinate Burdens on Mutual Funds

Ironically, while the benefits of certifying mutual fund shareholder reports are minimal, the burdens imposed on mutual fund complexes in completing such certifications are unrivaled by any operating company. Regardless of the number of subsidiaries in the corporate organization, most operating companies file consolidated financial statements. This means that, during the course of a year, the vast majority of operating companies will file at most four financial statements that they must certify in compliance with § 302.

In rare circumstances, a corporate organization may include subsidiaries with publicly traded securities that must file separate financial statements. However, these subsidiaries generally share the same fiscal year as the parent and their financial statements are based on the same information as the consolidated financial statements. Thus, in the rare cases where a principal executive officer and principal financial officer must certify subsidiary financial statements, they may do so at the same time as the consolidated financial statements in reliance on largely the same processes and information. Moreover, the number of separate financial statements can almost always be counted on one hand.

In contrast, Federated (which is by no means the largest mutual fund complex in the U.S.) filed 131 semiannual reports during the twelve months ended August 31, 2002. This does not include annual reports that were combined with the mutual fund's prospectus. However, it does include several shareholder reports that combined the financial statements of several separate investment company portfolios. In one case, the shareholder report included financial statements for 17 different mutual funds.

All in all, during 2002 Federated will have prepared and filed financial statements for over 265 separate mutual funds. Every month, Federated makes numerous filings with the Commission as some of these funds reach the end of a fiscal year or semi-annual period. Although these mutual funds may be part of the same complex (and in the case of combined reports, portfolios of the same registrants) their financial statements are completely independent. Unlike operating companies, mutual funds cannot consolidate their disparate financial results into a single financial statement. Each mutual fund is owned by a different set of shareholders who require specific information as to their mutual fund's performance.

All of these factors make certification under § 302 a continuous, time consuming process for mutual funds, as contrasted to even the most complex operating company. This December alone, Federated will certify as many financial reports as sixteen operating companies will certify in an entire year. Our certification process (as it has been developed over the past six weeks) involves certificates from eight service providers,7 which are reviewed by a Disclosure Committee of six members, who assist the principal executive and principal financial officers in their review and certification. Certification by the service providers takes collectively at least two hours; review by the Disclosure Committee of the service provider certificates and financial statements takes collectively at least one hour; and final review by each of the certifying officers may require one-half hour for each mutual fund. Thus, in December alone, Federated and other service providers to our mutual funds will spend at least 264 hours implementing the certification process, nearly the equivalent of two full time positions.

Indeed, if unabated, § 302 will have redefined the job description of treasurer to a mutual fund. Instead of serving as the chairman of our valuation committee, managing portfolio accounting, setting accounting standards and policies and responding to financial and regulatory developments, our funds' treasurer will devote most of his time to certifying mutual fund financial statements. Shareholders will lose the benefit of the treasurer's oversight and management of the preparation of their financial statements so that he may spend his time reviewing and certifying the statements as required by the Proposal. Federated cannot see how this trade-off could possibly improve investor protection.

To Properly Balance the Benefit of Certification, the Commission Should Minimize the Burdens on Mutual Funds

Although Federated agrees that it would be altogether appropriate to exempt mutual funds from the § 302 requirement, we also acknowledge that the Commission may well feel compelled to implement that section with respect to investment companies in some manner. The issue then becomes one of how best to do so, given the unique nature of (and investor protections inherent in) the mutual fund structure discussed above. We believe that there are four dimensions to § 302: (1) the number of reports covered by the certification, (2) the frequency of the certification, (3) the scope of disclosure controls and procedures and (4) the authority of the mutual fund's board of directors to designate certifying officers. Federated believes that by minimizing the first three dimensions, and maximizing the fourth, the Commission can do much to reduce the otherwise arduous burden of certification by mutual funds while satisfying the letter and spirit of § 302.

    1) Number of Reports. The Proposal would require mutual funds to continue to certify Form N-SAR in addition to certifying new Form N-SCR. Federated agrees with other members of the Investment Company Institute ("ICI") that certification of Form N-SAR has not served, and will never serve, any useful purpose. Federated has just completed the evaluation of its controls and procedures for Form N-SAR in order to comply with the current regulations. We did not find any elements of Form N-SAR that would be of significance to mutual fund investors that are not also contained in the prospectus, statement of additional information or financial statements. However, there are many elements of the Form that could not be of any significance to mutual fund investors.8 Therefore, Federated recommends that the Commission no longer treat Form N-SAR as a report filed under §§13 or 15(d) of the 1934 Act, and amend its rules accordingly.9

    Federated also supports the ICI's recommendation that Item 1 of Form N-CSR only require the filing of the mutual fund's financial statements, not the entire shareholder report. As noted in the ICI's letter, the other information is not financial in nature nor is it analogous to operating company reports. Moreover, unlike any operating company, mutual funds file the principal narrative portions of their shareholder reports and any accompanying materials with the NASD for review as sales literature. This subjects the narrative portion of each report to independent review by a self-regulatory organization that applies both its rules and those of the SEC to help assure investor protection and guard against fraud.

    Finally, adoption of the Proposal will force Federated and other mutual funds to discontinue the economical practice of publishing a mutual fund's annual audited financial statements as part of the same document as its prospectus. Incorporation of the financial statements into the prospectus is more convenient for shareholders (who can refer to one rather than two documents), assures that new investors also receive complete financial statements, and reduces both printing and mailing costs (which are expenses borne by the mutual funds). However, Federated will not subject fund officers to potential liabilities and penalties beyond those already imposed by the 1933 Act by filing and certifying an entire prospectus as a report on Form N-CSR. Adoption of the Proposal will therefore force mutual funds to create separate annual reports, which will increase the costs and inconvenience borne by fund shareholders.

    2) Frequency of Reporting. As illustrated by the Proposal and existing regulations, the 1940 Act gives the Commission full authority to mandate the filing of shareholder reports by mutual funds. These reports have never before been treated as reports filed under the 1934 Act, nor can Federated find any provision of the 1934 Act or the Sarbanes-Oxley Act that compels the Commission to do so. Nevertheless, as noted above, we understand that the Commission may not be willing to exempt mutual funds from filing reports under the 1934 Act (and therefore from the Sarbanes-Oxley Act) entirely. However, the Commission could subject mutual funds to the full effects of the Sarbanes-Oxley Act, while at the same time cutting the time spent certifying reports in half, by requiring mutual funds to file one only shareholder report a year under the 1934 Act.10

    Requiring annual, rather than semiannual, certifications is the most significant step the Commission could take to reduce the inordinate burden imposed on mutual fund complexes by the Sarbanes-Oxley Act. It should not reduce the benefits to mutual fund shareholders one iota. As previously noted, the 1933 Act already subjects the principal executive and principal financial officers of a mutual fund (as well as the directors) to personal liability for misrepresentations in the mutual fund's registration statement (including the financial statements). Large complexes, such as Federated, which file annual reports each month will still need to conduct quarterly evaluations of disclosure controls and procedures to make their certifications. While smaller complexes may perform less frequent evaluations (even the Proposal would require only two a year), once effective disclosure controls and procedures are established, it is hard to image how they could become inadequate over the course of a single year. Finally, with regard to internal controls, investment companies (unlike operating companies) have been filing annual assessments by their independent auditing firms with their Form N-SAR for years, without any problems that more frequent assessments would have addressed. Therefore, Federated does not believe that the Commission can find any benefit that would justify the filing by mutual funds of more than one certificated report per year.

    3) Scope of Disclosure Controls and Procedures. The Proposal would further magnify the burden on mutual funds by requiring that their disclosure controls and procedures cover all filings made with the Commission. Federated again joins with the other members of the ICI in urging the Commission to limit the scope of disclosure controls and procedures to the financial statements included in the Form N-CSR. The 1933 Act already provides adequate incentives for the principal executive and principal financial officers (as well as the principal underwriter and the directors) to exercise due diligence in the preparation of a mutual fund's registration statement. Requiring a formal evaluation of the process for preparing registration statements will increase the number of hours required to comply with the Proposal substantially, without having any affect on the process itself. The Commission is not proposing to impose such a burden on operating companies (even those that maintain shelf-registration statements). In addition, requiring investment companies to treat the procedures used to prepare filings such as those on Forms N-8A, N-8F and 24F-2 with the same gravity as the preparation of shareholder reports can only diminish the perceived significance of this aspect of the Proposal.

    4) Authority of Fund Boards to Designate Certifying Officers. Some practitioners have questioned whether mutual funds in the same complex can have different principal executive and principal financial officers. Their question arises from (a) the fact that all mutual funds in the complex will follow the same disclosure controls and procedures and (b) the requirement that certifying officers must certify that they "are responsible for establishing and maintaining disclosure controls and procedures." At first blush, this would appear to suggest that whoever establishes the disclosure controls and procedures for the complex must be treated as the principal executive and principal financial officers of all of the funds in the complex.

    Federated believes that neither the Sarbanes-Oxley Act nor the Proposal would limit mutual fund complexes to one principal executive officer and one principal financial officer. Under state laws, the power to select officers and delegate responsibility for controls and procedures lies within the business judgment of a firm's board of directors. This should be as true for the board of a mutual fund as it would be for the board of an operating company. Consequently, we believe that mutual fund boards have the authority to appoint any qualified individual as the fund's principal executive or principal financial officer, and charge such individuals with the responsibility for establishing and maintaining disclosure controls and procedures.

    The fact that two mutual funds use the same disclosure controls and procedures should not change this conclusion. Large mutual funds complexes are forced to adopt standard controls and procedures in order to cope with the massive number of filings described above. Different mutual funds may have different certifying officers, who nevertheless choose to adopt the same controls and procedures, without diminishing the certifying officers' distinct responsibilities to their respective funds. (In fact, we would contend that a board for multiple mutual funds has the right to require that the certifying officers for those funds adopt common controls and procedures.)

    To prevent any further confusion as to this issue, Federated recommends that the Commission acknowledge in the release promulgating its final rules that mutual funds in the same complex with common boards of directors may have different certifying officers. The practical effect of this will be to confirm that a board for a large complex may spread the review and certification work among several qualified individuals, without requiring these individuals to devote substantially all of their time to this work. Given the large number of filings, this can only enhance the effectiveness of the review process, while allowing large complexes to operate efficiently.

* * * * *

With respect to rulemaking, Congress has generally mandated that the Commission "... shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation."11 Passage of the Sarbanes-Oxley Act did not repeal these provisions. Thus, it is incumbent on the Commission to weigh carefully the expected benefits of its actions against the burdens that registrants will have to bear as a result. In our view, seldom should the Commission take this duty more seriously than in regard to the Proposal. In light of the discussion above, we believe it is indisputable that the burdens that would be imposed on mutual funds and their officers (and, at least to some extent, on mutual fund shareholders) under the terms of the Proposal vastly outweigh any additional benefit or protection that fund shareholders would gain. We believe that the approach we have outlined above will achieve a more appropriate balance than the Proposal.

Federated very much appreciates having the opportunity to comment on this 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) 288-1567 or by e-mail at skeen@federatedinv.com. Thank you very much.

                Very truly yours,

                Stephen A. Keen
                General Counsel

cc: Paul F. Roye, Director
Division of Investment Management
J. Christopher Donahue
John W. McGonigle
Richard J. Thomas

__________________________
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 $175 billion and serves as adviser, subadviser, distributor, and/or administrator for over 280 mutual funds, as of September 30, 2002.
2 The Proposal is set forth in Investment Company Act Release No. 25723 (August 30, 2002), 67 Fed. Reg. 57298 (September 9, 2002) (the "Release").
3 See, e.g., Comments of Dechert on S7-21-02, dated August 19, 2002 (commenting on Release No. 34-46300, dated August 2, 2002) (the "Dechert Letter").
4 Although mutual funds are public companies, their shares are rarely traded at all. In contrast to operating companies, almost all mutual fund transactions consist of the issuance or redemption of shares by the mutual fund, not an exchange of shares among shareholders. This is another reason that the prospectus, rather than shareholder reports, represents the primary basis for investment decisions regarding mutual funds.
5 See, e.g., the Dechert Letter, and the comments of The Association of the Bar of the City of New York - Committee on Investment Management Regulation on S7-21-02, dated August 15, 2002 (commenting on Release No. 34-46300, dated August 2, 2002) (the "ABNY Letter").
6 ABNY Letter.
7 Portfolio accounting, custody, treasury administration, transfer agent, portfolio manager, legal, tax and risk management.
8 For example, whether the mutual fund maintains securities in a central depository, the fund's holdings of securities subject to Rule 12d3-1 of the 1940 Act, the fund's monthly sales and redemptions, and whether particular attachments are filed with the form.
9 In this regard, Federated further recommends that the Commission propose either (a) elimination of Form N-SAR or (b) modification of Form N-SAR to obtain only information of use to the Commission and its staff. We do not believe that the Commission will ever have a better opportunity to receive informed commentary from those responsible for completing Form N-SAR.
10 To be clear, Federated is not recommending that shareholders receive less frequent financial reports. Instead, we are recommending that the SEC not treat all shareholder reports required by the 1940 Act as filings under §§ 13 and 15(d) of the 1934 Act.
11 Section 3(f) of the 1934 Act and section 2(c) of the 1940 Act.