Comments of Vanguard Group on S7-36-02

Vanguard Group

December 5, 2002

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 5^th Street, NW
Washington, DC 20549-0609

Re: Proposed Rule Requiring Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies

Dear Mr. Katz:

The Vanguard Group¹ appreciates the opportunity to comment on the proposed rule by the Securities and Exchange Commission to require mutual funds to disclose their proxy voting policies and proxy voting records.² In summary, Vanguard supports requiring funds to disclose their proxy voting guidelines in their registration statements. However, Vanguard strongly opposes requiring funds to disclose their proxy voting records and explain in shareholder reports any proxy voting decisions that are inconsistent with the fund's proxy voting guidelines. Vanguard's opposition centers on these three points:

1) Preserving confidential voting is essential to ensuring the independence and integrity of the proxy voting process. In Vanguard's view, requiring funds to disclose their proxy voting decisions would politicize the proxy voting process. It would expose funds to considerable pressures from corporate management and special interest groups seeking to influence proxy voting decisions, and it would force funds to commit key intellectual capital to respond to highly publicized and controversial issues having nothing to do with maximizing shareholder value. Vanguard believes that forcing funds to deal with those outside pressures and extraneous issues would not be in the best interests of fund shareholders by any standards.

2) Disclosing proxy voting records would provide no benefits to fund shareholders. In Vanguard's view, requiring funds to disclose their proxy voting records would not help fund investors make informed investment decisions and would not increase shareholder value. Rather, it would cause funds to incur considerable costs to provide investors detailed information that they have not asked for and do not need to be informed investors. Vanguard believes that there is far more essential information that investors should focus on when selecting and evaluating funds, and drawing attention to proxy voting records sends the wrong message to investors on the important factors they need to consider with respect to their fund investments. Vanguard also believes that requiring funds to disclose their proxy voting records would not promote greater shareholder activism or better proxy voting decisions on the part of funds. Funds have all the necessary competitive incentives to engage in corporate governance matters when such matters affect the value of their portfolio securities, and requiring funds to disclose their proxy voting records would only serve to distract and disrupt the investment management process to the detriment of fund shareholders.

3) Enhancing board of directors oversight would better achieve the Commission's objectives. In Vanguard's view, enhancing board of directors oversight over proxy voting decision-making would be a far more appropriate and effective means of achieving the Commission's objectives than requiring the disclosure of proxy voting records. Vanguard would recommend that the Commission require that fund boards formally adopt proxy voting guidelines, including structures and procedures for addressing potential conflicts of interest. Vanguard would also recommend that the Commission require that the party responsible for the fund's voting decisions provide the board with a report each year: (1) certifying whether all proxies were voted in a manner consistent with the fund's voting guidelines, and (2) specifically identifying any votes that were inconsistent with the voting guidelines with an explanation of the reasons for the inconsistent vote. The Commission could use its inspection and examination authority to determine whether the fund's proxy voting decisions were made consistent with the fund's voting guidelines and whether any inconsistent votes were due to conflicts of interest. In Vanguard's view, this framework-relying on board of directors oversight, rather than asking fund shareholders to oversee hundreds, if not thousands, of proxy voting decisions-would be far more appropriate and effective in accomplishing the Commission's objectives, and would far better serve the interests of fund shareholders.

Vanguard recognizes that, in today's environment, it would be difficult for the Commission to reconsider proposals that are nominally intended to enhance mutual fund disclosure. Proponents of proxy voting disclosure maintain that shareholders "have the right to know" how their fund's portfolio holdings are voted. Vanguard would maintain that this oversimplifies the issue and frames it too narrowly. The real issue is whether a handful of advocates, pursuing interests separate from those of fund shareholders, have the right to require funds, at considerable costs to their shareholders and to the detriment of the investment management process, to disclose detailed proxy voting information that will be of no interest or benefit to fund shareholders. In Vanguard's view, requiring funds to disclose proxy voting records would not help shareholders make investment decisions and would not add shareholder value. Rather, requiring this disclosure would be a clear disservice to the fund shareholder.

DISCUSSION

A. Vanguard Supports Required Disclosure of Proxy Voting Guidelines.

The Release identifies three reasons for requiring proxy voting disclosure by mutual funds.³ The first reason is to help fund investors make investment decisions. According to the Commission, to the extent investors choose funds based on their proxy voting policies and records, disclosing this information would help investors select funds that suit their particular preferences. The second and third reasons are based on the potential benefits to fund shareholders of making proxy voting "transparent." One benefit is that proxy voting transparency may encourage funds to become more engaged in corporate governance activities, resulting in better proxy voting decisions by funds which could enhance shareholder value. The other benefit is that proxy voting transparency may deter improper voting decisions by funds that are motivated by the business interests of the fund's adviser rather than the best interests of the fund's shareholders.

Vanguard agrees with this general framework for addressing the issue of whether to require proxy voting disclosure by funds. Vanguard believes that proxy voting disclosure should be required only if: (1) it is expected to help fund investors make investment decisions; or (2) it is expected to increase shareholder value by providing benefits to shareholders in excess of the costs.

1) Consistent with this framework, Vanguard supports the required disclosure of proxy voting guidelines.⁴

Vanguard agrees that disclosure of proxy voting guidelines would be helpful to any investors who care to make fund selections based on that information.Vanguard also agrees that disclosure of proxy voting guidelines could benefit fund shareholders by encouraging any funds that do not do so already to become more active in corporate governance activities when such activities could enhance shareholder value and by discouraging any funds that do not exercise their fiduciary responsibilities properly from voting proxies in a manner inconsistent with shareholders' best interests. For these reasons, Vanguard supports the Commission's proposal to require funds to disclose their proxy voting guidelines in their registration statements.

Importantly, from Vanguard's perspective, there are no serious drawbacks or costs associated with disclosing this information in the manner prescribed by the Commission. Disclosing this information would be relatively inexpensive for funds to implement and-unlike publicizing proxy voting records and proxy voting exceptions-should not hamper funds' ongoing corporate governance activities or unduly distract fund management. Therefore, applying a cost/benefit analysis, Vanguard believes that requiring disclosure of proxy voting guidelines would be warranted, and in fact Vanguard already provides interested investors and shareholders with a summary of the Vanguard funds' proxy voting guidelines on the Vanguard website.⁵

2) The proposals require the appropriate degree of specificity.

Vanguard believes that the Commission's proposals require an appropriate level of detail on funds' proxy voting guidelines. In Vanguard's view, the most important information is an identification of the party responsible for proxy voting decisions by the fund and an explanation of the standards that would be applied by that party to make proxy voting decisions. Vanguard agrees that it is also relevant to explain the fund's position on the categories of proposals most frequently presented at shareholder meetings, which today include election of directors, appointment of auditors, approval of equity-based compensation plans, approval of changes to corporate structure and shareholder rights, and approval of social and corporate responsibility proposals. The summary of the proxy voting guidelines for the Vanguard funds that is on the Vanguard website includes most of the information that would be required by the Commission's proposal and Vanguard has received few, if any, requests by investors or shareholders for more detailed proxy voting information.

3) The SAI is the appropriate disclosure vehicle.

Vanguard strongly agrees with the Commission's proposal that, if disclosure of proxy voting guidelines is to be required, the Statement of Additional Information (SAI) is the appropriate location for the disclosure. As the Commission has previously recognized:

"[T]he primary purpose of the disclosure in a fund's prospectus is to help an investor make a decision about investing in a fund . . . . Funds should limit disclosure in prospectuses to information that is necessary to the average or typical investor to make an investment decision. Detailed or highly technical discussions, as well as information that may be helpful to more sophisticated investors, dilute the effect of necessary prospectus disclosure and should be placed in the SAI." ⁶

Vanguard strongly believes that information on funds' proxy voting guidelines should not be considered information necessary for the average or typical investor to make investment decisions. Vanguard believes that investors should focus on far more important factors with respect to their fund investments, including fund objectives, strategies, risks, costs, and performance. Accordingly, information on proxy voting guidelines should be placed in the SAI, and not the prospectus.

B. Vanguard Strongly Opposes Required Disclosure of Proxy Voting Records.

1) Preserving confidential voting is essential to ensuring the independence and integrity of the proxy voting process.

In Vanguard's view, requiring funds to disclose their proxy voting decisions would politicize the proxy voting process. It would expose funds to considerable pressures from corporate management and special interest groups seeking to influence proxy voting decisions, and it would force funds to commit key intellectual capital to respond to highly publicized and controversial issues that have little impact on shareholder returns.

In Vanguard's experience, companies typically do not know or find out how funds vote their proxies. A significant percentage of companies (approximately 30 percent of S&P 500 companies) explicitly afford shareholders the right to confidential voting, and that percentage is growing. Confidential voting is strongly endorsed by investor groups as an important and effective means to reduce pressure from management to influence proxy voting decisions, and Vanguard is a proponent of confidential voting.⁷ Therefore, from Vanguard's perspective, one significant and particularly undesirable consequence of the Commission's proposals is that, in the case of companies respecting confidential voting, funds would become the only group of investors to be denied confidential voting. Vanguard believes that this result cannot be considered in the best interests of fund shareholders by any standards.

In addition to pressures from corporate management, funds would face pressures from special interest groups on many types of proxy voting proposals. Because of funds' increasing ownership interests in U.S. companies, a multitude of organizations have sought over the years to influence funds' corporate governance decisions to further their own purposes.⁸ This has been especially the case with many of the social policy and so-called "corporate responsibility" proposals in recent years dealing with issues like overseas labor practices, environmental concerns, military contracts, nuclear power plants, infant formula distribution, and so on. On these highly politicized issues, groups have sought to influence funds' proxy voting decisions to advance interests and agendas that have little to do with maximizing shareholder returns.

If funds' proxy voting records were publicized, funds would face increasing pressures from special interest groups that seek to leverage the public disclosure of voting records to influence funds' voting decisions. In some cases, funds may feel incentives to accede to these pressures in order to avoid antagonizing influential and powerful groups and alienating investors who may sympathize with the groups' overall goals.⁹ In a worst case, some special interest groups might encourage members to boycott funds that do not vote proxies in a manner consistent with the group's objectives. It is for these reasons that Vanguard believes that preserving the ability of funds to vote proxies confidentially is the most effective means to ensure the independence and integrity of the voting process.

A related and equally undesirable consequence of publicizing funds' proxy voting records would be the distractions and disruptions caused fund management. Vanguard believes that disclosing funds' voting decisions would require senior fund management to respond publicly to questions and criticisms concerning votes on many controversial issues that have marginal or no consequence to the fund's investment returns. In Vanguard's view, it would be particularly distracting and wasteful for funds to commit key management personnel to address high profile and sensitive matters that do not materially impact the investment management process. As the Commission has recognized, funds must be operated for the benefit of fund shareholders,¹⁰ and Vanguard believes that forcing funds to deal with outside pressures and extraneous issues that have little relevance to fund returns would be a disservice to fund shareholders.

2) Disclosing proxy voting records would provide no benefits to fund shareholders.

In Vanguard's view, requiring funds to disclose their proxy voting records would be detrimental to the interests of fund shareholders. First, it would not help fund investors make informed investment decisions. Rather, it would overload investors with detailed information that they have not asked for and do not need to be informed investors. Second, it would not promote greater shareholder activism or better proxy voting decisions by funds. Rather, it would distract and disrupt the investment management process to the detriment of fund shareholders. Third, it would not increase shareholder value. Rather, it would cause funds considerable costs and burdens while providing no meaningful benefits in return.

Disclosing proxy voting records would not help fund investors make informed investment decisions.

Based on its experience managing 17 million shareholder accounts, Vanguard is convinced that mutual fund investors have minimal interest in funds' proxy voting records. Vanguard would submit that the only parties seeking proxy voting disclosure have done so not as fund investors (or fund fiduciaries), but rather as promoters of special interests and agendas having nothing to do with maximizing shareholder returns.¹¹

Vanguard believes that fund investors are, in fact, rationally indifferent to funds' proxy voting records in light of the significantly more important information that they should consider when selecting and evaluating funds, and the lack of any evidence showing that proxy voting records have differentiated funds in terms of their ability to add shareholder value. Vanguard would point out that even its largest institutional shareholders representing major corporations, retirement plans, foundations, endowments and similar entities have expressed minimal interest in the Vanguard funds' proxy voting records.¹² Vanguard believes that this behavior also reflects the important element of trust. Just as fund shareholders trust fund management to oversee the day-to-day investment of fund assets, they also trust management to oversee the corporate governance process with shareholders' interests in mind.

Vanguard believes that, when selecting and evaluating funds, investors should focus on the overriding factors that will play a key role in determining investment returns. These include the fund's investment objectives, strategies, risks and expenses, as well as the fund's past performance during different market periods. Vanguard would submit that funds' proxy voting decisions do not approach any similar or comparable role in determining investment returns. Vanguard would also submit that there is no evidence showing that funds' proxy voting records have differentiated funds to any degree in terms of their ability to add shareholder value (indeed, the empirical evidence suggests that proxy voting and shareholder activism in general have not had any material impact on shareholder value¹³).

Vanguard is concerned that the implication that proxy voting information should be an important determinant in fund selection will distract investors from the overriding and differentiating factors they should be focusing on in connection with their fund investments. In Vanguard's view, the Commission has played an instrumental role in recent years in identifying the essential information that investors should evaluate in connection with their fund investments.¹⁴ Vanguard believes that the Commission's proposal to disclose detailed proxy voting records represents a step in the wrong direction and would send the wrong message to investors on the important information they need to consider when investing in funds.

Disclosing proxy voting records would not promote greater investor activism or better proxy voting decisions.

One of the principal reasons identified by the Commission for requiring proxy voting disclosure is to "encourage funds to become more engaged in corporate governance of issuers held in their portfolios, which may benefit all investors and not just fund shareholders."¹⁵

Vanguard believes that funds are actively engaged in corporate governance matters involving issuers held in their portfolios when such matters can impact the value of the fund's portfolio securities.¹⁶ Vanguard also believes that funds need no further encouragement than existing competitive pressures to engage in such matters. The mutual fund industry is one of the most competitive industries in the United States, with over 7,000 funds competing for investor dollars. Mutual funds are ultimately judged by the investment results they return to shareholders, and if corporate governance matters can truly impact the value of portfolio holdings, funds have all the necessary incentives to exert their influence and power as corporate owners.

Vanguard is actively involved in corporate governance matters affecting the portfolio holdings of the Vanguard funds. The boards of trustees of the Vanguard funds have adopted comprehensive guidelines for voting proxies held by the funds and delegated oversight of the voting process to a committee of senior Vanguard officers (the Vanguard Proxy Oversight Group) that is responsible for ensuring that all voting decisions are consistent with the funds' guidelines. Vanguard maintains a full-time governance staff to perform research and analysis on proxy voting issues and subscribes to independent proxy research services as well.

In the past year, the Vanguard funds voted over 11,000 proposals at some 4,500 shareholder meetings for U.S. companies (if these proposals are broken out separately for each of the 50 Vanguard equity funds, and if each director nomination is counted as a separate proposal, then the Vanguard funds voted over 200,000 proxy proposals in the past year). The boards of trustees of the Vanguard funds receive comprehensive reports each year that summarize the proxy voting decisions made on behalf of the Vanguard funds and explain the recent trends and developments in corporate governance that are relevant to formulating the funds' proxy voting guidelines.

In addition to voting proxies, Vanguard interacts on an ongoing basis with management of portfolio holdings to address shareholder interests in advance or irrespective of shareholder meetings. This approach was evidenced in a memorandum that Vanguard sent in August of this year to the chief executive officers of nearly 500 companies in which the Vanguard funds hold more than three percent of the company's outstanding shares. That memorandum, which is attached as Appendix A, explains how Vanguard has been active in corporate governance issues that affect the Vanguard funds' ownership interests and how Vanguard has succeeded in influencing, in appropriate situations and in an appropriate manner, the structure of executive compensation programs, the composition of boards of directors, and other important shareholder issues, to the benefit of Vanguard fund shareholders. The memorandum proceeds to explain Vanguard's position on four critical governance issues facing companies today-board composition, executive compensation programs, audit relationships, and shareholder rights.¹⁷ The expectation of Vanguard is that many of these issues will be addressed jointly with management in advance of any proxy vote and that these efforts will be rewarded from the standpoint of both management and Vanguard fund shareholders.

In Vanguard's view, requiring funds to disclose their proxy voting records would not promote greater shareholder activism or better proxy voting decisions. Rather, this requirement would only serve to distract and disrupt the investment management process to the detriment of fund shareholders. Funds would have to commit valuable investment management resources to explain and justify voting decisions-often on issues of marginal consequence to a fund's investment returns-to outsiders, including the media and other special interest groups. Funds would also have to reveal their voting decisions to all other portfolio companies, who may demand similar treatment notwithstanding differences in their industries or competitive situations, or differences in the fund's relative ownership of their stock. Finally, to the extent any voting decisions in special cases constitute exceptions to the funds' proxy voting guidelines within the meaning of the Commission's proposals,¹⁸ funds would have to explain the positions taken on highly complex and controversial matters in shareholder reports. This disclosure would be costly to funds (as explained below) and of no benefit to shareholders in terms of evaluating their fund's performance.

Disclosing proxy voting records would not increase shareholder value.

Vanguard believes that the total costs and burdens associated with proxy voting disclosure are substantial (and significantly greater than the Commission estimated). As indicated earlier, in the past year the Vanguard funds voted over 200,000 proposals at some 4,500 shareholder meetings for U.S. companies. The costs and burdens associated with disclosing those votes in the format prescribed by the Commission's proposals would be significant.

In addition to the costs of disclosing proxy votes, there would be the costs of explaining in shareholder reports any proxy voting decisions that are considered exceptions to the fund's proxy voting policies within the meaning of the Commission's proposals. As part of the investment management process, Vanguard makes judgment calls and, occasionally, exceptions to the Vanguard funds' general voting guidelines in order to recognize unique industry or competitive situations, or to obtain changes or concessions on corporate governance matters that are beneficial to Vanguard fund shareholders.¹⁹ In many cases, these situations are complex and fact specific, and it would require considerable effort-as well as many pages in shareholder reports-to sufficiently explain these situations and voting decisions to shareholders.²⁰ In Vanguard's view, this type of disclosure would provide no benefits to shareholders in terms of helping them evaluate their fund's performance.

Finally, there are the distractions and disruptions that disclosing proxy voting records would cause fund management. As explained earlier, Vanguard is particularly concerned that publicizing funds' voting decisions would require senior fund management to justify votes on many controversial issues that have little or no consequence to the fund's investment returns. In Vanguard's view, it would be especially wasteful for funds to commit key intellectual capital to address high profile and sensitive matters that do not materially impact the investment management process, and that are primarily of concern to special interest groups, not fund shareholders.

In sum, Vanguard is convinced that the aggregate costs and burdens associated with disclosing proxy voting records would be substantial. At the same time, Vanguard is equally convinced that disclosing proxy voting records would provide no meaningful benefits to shareholders. For these reasons, Vanguard believes that disclosing proxy voting records would decrease shareholder value and should be considered inimical to shareholders' interests.

3) Enhancing board of directors oversight would better achieve the Commission's objectives.

In Vanguard's view, enhancing board of directors oversight of proxy voting decision-making would be a far more appropriate and effective means of achieving the Commission's objectives than publicizing funds' proxy voting records and asking fund shareholders to oversee hundreds, if not thousands, of proxy voting decisions. To address any concerns the Commission may have over conflicts of interest, Vanguard recommends that the Commission require that fund boards receive reports each year certifying whether all fund proxies were voted in a manner consistent with the fund's proxy voting guidelines and identifying any votes that were inconsistent with those guidelines with an explanation of the reasons for each inconsistent vote.

Concerns about conflicts of interest are unwarranted.

One of the principal reasons identified by the Commission for proxy voting disclosure would be to deter voting decisions by funds that are motivated by the business interests of the fund's adviser rather than the best interests of the fund's shareholders. According to the Commission, this type of situation could occur, for example, when the fund's adviser manages the retirement plan assets of a company whose securities are held by the fund.²¹

The Commission presents no evidence of any funds failing to vote proxies in the best interests of fund shareholders due to conflicts of interest and, in Vanguard's view, this lack of any record of funds voting proxies improperly is not surprising. Aside from the overriding ethical and fiduciary considerations involved, it would be irrational for funds to jeopardize their reputation and franchise, and sacrifice potential investment returns, to curry favor with a few institutional clients on proxy voting matters. Funds face far more fundamental conflicts every day in connection with their decisions to buy, hold or sell portfolio holdings in institutional clients. Just as there is no logical basis for assuming that funds would make improper portfolio management decisions involving client holdings in light of the substantial risks and costs involved, there is no logical basis for assuming that funds would make improper proxy voting decisions either.

Any fund firm knows that its value as a going concern is dependent upon its goodwill and reputation for trust and integrity. Firms also know that their ongoing success in the marketplace will be dependent upon their ability to deliver competitive investment returns to shareholders. To assert that fund firms would risk their reputations and franchises, and jeopardize future investment returns, to please certain clients on proxy voting matters would be unwarranted and unfounded.²²

Publicizing proxy voting decisions will increase the conflicts of interest funds have to address.

If the Commission believes that conflicts of interest raise concerns with respect to funds' proxy voting decisions, the Commission should recognize that requiring funds to publicize their proxy votes will likely increase the outside pressures and conflicts that funds face, by encouraging influential and powerful outside groups to exert pressure on proxy voting decisions to serve their own purposes.

The one potential conflict situation that the Commission identifies in the Release is where the fund's adviser manages the retirement plan assets of a company whose securities are held by the fund. According to the Commission, in this type of situation the fund's adviser may have an incentive to support management recommendations to further its business interests.²³ However, as explained earlier, most companies do not know or find out how funds vote their proxies, and one undesirable consequence of the Commission's proposals is that funds would become the only group of investors to be denied confidential voting. It would be ironic and unfortunate if the Commission's proposals to address conflicts of interest involving corporate clients would eliminate the most effective means for funds to avoid pressures from corporate clients on proxy voting matters.

As indicated earlier, more significant pressures may come from prominent and powerful outside organizations seeking to influence funds' proxy voting decisions to serve the organization's own purposes. Funds will be exposed to increasing pressures to support the positions of many special interest groups to avoid antagonizing the group and alienating its members. Again, this is why Vanguard believes that preserving the ability of funds to vote proxies confidentially is the most effective means to ensure the ongoing independence and integrity of the voting process.

Existing structures and procedures for addressing conflicts of interest would better serve to address proxy-voting conflicts of interest.

Vanguard believes that existing structures and procedures for addressing funds' conflicts of interest-including board of directors oversight and Commission examinations-would be far more appropriate and cost-effective in addressing any proxy-voting conflicts of interest than the Commission's proposals. The Commission recognizes in the Release that the fund's board of directors has ultimate responsibility for voting proxies for the fund's portfolio securities,²⁴ and the Commission has recognized on numerous occasions that the independent directors serve as the "independent watchdogs" for fund shareholders.²⁵ Indeed, the cornerstone of the Investment Company Act of 1940 is the critical role played by the board and its independent directors in protecting shareholders from all conflicts of interest involving the fund's affiliates. In Vanguard's view, the potential conflicts of interest raised by proxy voting pale in comparison to those raised in other areas where Congress and the Commission already rely on fund directors to protect fund shareholders.²⁶

The boards of trustees of the Vanguard funds exercise oversight over all aspects of the proxy voting process. As stated earlier, the boards of trustees have adopted guidelines for voting proxies for the securities held by the Vanguard funds, which are reviewed and approved by the board each year. In addition, the boards of trustees receive comprehensive reports that summarize all proxy voting decisions made on behalf of the Vanguard funds each year and review all recent trends and developments in corporate governance that are relevant to the ongoing formulation of the Vanguard funds' proxy voting guidelines.

If the Commission has concerns about proxy-voting conflicts of interest, there are steps the Commission might take to enhance board of directors oversight of the proxy voting process. For example, Vanguard would recommend that the Commission require that fund boards formally approve the fund's proxy voting guidelines, including structures and procedures for addressing potential conflicts of interest. In addition, Vanguard would recommend that the party responsible for the fund's voting decisions provide the board with a report each year (1) certifying whether all proxies relating to the fund's portfolio holdings have been voted in a manner consistent with the fund's proxy voting guidelines; and (2) identifying any proxy votes that were inconsistent with fund's proxy voting guidelines with an explanation of the reasons for each inconsistent vote.

In addition to board of directors' oversight, the Commission could use its inspection and examination authority to determine whether a fund's proxy votes were made consistent with the fund's guidelines and procedures, and whether any inconsistent votes were due to conflicts of interest. In Vanguard's view, relying on board of directors oversight and Commission examinations would be a far more appropriate and effective way to address potential conflicts of interest than requiring funds to publicize their proxy voting decisions.

CONCLUSION

As stated at the outset, Vanguard recognizes that it would be difficult for the Commission in today's environment to reconsider proposals that are designed to enhance mutual fund disclosure. While proponents of proxy voting disclosure insist that shareholders "have the right to know" how their fund's portfolio holdings are voted, Vanguard believes that the real issue is whether a small group of advocates, pursuing their own interests, have the right to require funds, at considerable costs to their shareholders and to the detriment of the investment management process, to disclose detailed proxy voting information that will be of no interest or benefit to fund shareholders.

Anyone familiar with Vanguard knows the overriding importance that Vanguard attaches to disclosing all information about the Vanguard funds that can help Vanguard fund shareholders (who are Vanguard's owners) make better investment decisions. In Vanguard's view, requiring funds to disclose proxy voting records would not help investors make investment decisions and would not add value for fund shareholders. Rather, requiring this disclosure would be a disservice to both investors and fund shareholders.

To summarize once again, Vanguard's opposition to the Commission's proposal to require funds to disclose their proxy voting records centers on these three points:

1) preserving confidential voting is essential to ensuring the independence and integrity of the proxy voting process;

2) disclosing proxy voting records will provide no benefits to fund shareholders; and

3) enhancing board of directors oversight would better achieve the Commission's objectives.

We trust that the Commission will give this matter very careful consideration. The Commission should feel free to contact Vanguard if additional information or further discussion of these comments would be helpful.

Sincerely,

/S/ R. Gregory Barton

R. Gregory Barton
Managing Director and General Counsel

cc: The Honorable Harvey L. Pitt
The Honorable Paul S. Atkins
The Honorable Roel C. Campos
The Honorable Cynthia A. Glassman
The Honorable Harvey J. Goldschmid
Paul F. Roye, Director
Division of Investment Management
U.S. Securities and Exchange Commission

M E M O R A N D U M

TO: Companies in which the Vanguard Funds have Substantial Equity Ownership

DATE: August 16, 2002

SUBJECT: Corporate Governance Matters

There has been a great deal of publicity about corporate governance issues in the wake of the Enron, Andersen, Adelphia, WorldCom, etc. debacles. As a holder of approximately $300 billion in equity assets, and the owner of more than 3% of your company's shares, the Vanguard funds, and their Board of Trustees, have a vital interest in this subject. This memorandum is intended to share our views with you and other leaders of companies where the Vanguard funds have a meaningful ownership position.

At Vanguard, we have always been active in corporate governance issues that affect our funds' ownership interests and we take our oversight duties very seriously. We consider voting proxies for our funds' shareholdings to be an important part of our investment management responsibilities on behalf of millions of institutional and individual investors in our funds.

We emphasize at the outset that we have no intention of trying to manage the businesses of the companies in which the Vanguard funds invest, and we do not seek publicity with respect to the way we handle proxy voting and other corporate governance matters. We have always been willing to talk "off the record" to corporate leaders and their management teams about governance issues, and we are happy to explain up front our views on important matters affecting the value of our funds' shareholdings. We feel strongly that the interests of corporate management and Vanguard's interests as a major shareholder should be very tightly aligned, as both parties have an overriding interest in increasing the long-term value of the corporation. Over time, we have been pleased with our ability to influence, in appropriate situations and in an appropriate manner, the structure of compensation programs, the composition of boards of directors, and other important shareholder issues.

Given the recent prominence of corporate governance issues with regulators, legislators and the media, the Board of Trustees of each of the Vanguard funds and our management team felt that it was important to write to companies where we are meaningful shareholders to confirm our views on several of the major governance topics of the day. Our intention is solely to surface these views in advance and give companies ample time to respond in any case where a response may be appropriate. Although every company is unique and there is no one governance structure that fits all companies and all industries, there are certain fundamental checks and balances and certain shareholder protections that we would expect to see in any company where we are a significant owner acting on behalf of our funds' shareholders. Nevertheless, all proposals by management would remain open for objective consideration and discussion from Vanguard's perspective.

Let me address four of the most critical governance issues facing companies today:

Board Composition - The New York Stock Exchange has approved recommended changes to its listing standards to require that all listed companies have a majority of independent directors. We strongly agree that an independent board is vitally important for effective corporate oversight and accountability. In addition, we agree with the NYSE position that all audit, nominating and compensation committees be composed entirely of independent directors who are assigned important oversight responsibilities. Although we recognize that it may take several years to complete the transition, we expect all companies to comply with these standards for independent boards and independent committees, regardless of whether the company is listed on the New York Stock Exchange. Accordingly, going forward, we will only support boards of directors that meet (or commit to meet) the new NYSE standards.

Compensation Programs - As an owner of stock in a corporation, it is obviously contrary to our interests-and the interests of our funds' shareholders-to have our proportionate ownership in the corporation materially diluted by excessively generous equity-based compensation programs. And, yet, in the past, we have been surprised by how often we see poorly designed or overly dilutive stock option plans submitted for shareholder approval. In fact, when reviewing data from the first half of this year, we found that we voted against 64% of the stock-based compensation proposals presented at annual meetings. That result is surprising and disappointing. We fully expect the New York Stock Exchange and other exchanges to require in the future that all stock option plans be approved by shareholders, and we strongly suspect (and hope) that other institutional investors will start paying close attention to whether stock option plans appropriately further the interests of both management and shareholders.
To be clear, we think that equity-based compensation programs can be a very effective way to align the interests of the long-term shareholders and the interests of management, employees, and directors. Thus, we support them in concept. However, when such plans are overly dilutive or include structural features that are inherently objectionable, we will vote against them.
In this regard, with respect to stock option programs, we consider such factors as the size of annual grants (generally less than 2% of outstanding shares is acceptable) and total dilution (more than 15% is generally unacceptable). These are guidelines, not floors or ceilings, and when assessing a plan's impact on our shareholdings we consider other factors, including the nature of the industry, size of the company, employee coverage, and holding periods. In addition, we regard as inherently objectionable certain structural features, including: (a) the ability to re-price underwater options; (b) the ability to issue options with exercise prices below the current fair market value of the company's stock; and (c) the ability to issue re-load options. In our view, stock option plans with these features run counter to our interests as shareholders and fiduciaries, and we have aggressively discouraged companies from adopting these types of plans.
We expect that best practices in equity-based compensation programs will evolve quickly toward requiring long-term stock ownership by senior management. In our view, current best practices include: (a) requiring senior executives to hold at least a minimum amount of stock in the company (frequently expressed as a certain multiple of the executive's salary); (b) requiring a meaningful holding period for shares purchased through option plans; and (c) using stock grants (with holding period requirements) instead of options. Each of these practices further aligns the interests of management and long-term shareholders and we encourage your compensation committee to consider their implementation.
Finally, we support expensing the fair value of option grants because it substantially eliminates their preferential financial statement treatment vis-à-vis stock grants, furthering our case for increased ownership by corporate leaders and employees. While we recognize that there are sound arguments on both sides of this issue and that there are many implementation challenges, we believe that this treatment will ultimately be mandated -- in one form or another -- and early voluntary adoption will make future compliance that much easier.
Audit Relationships - The Sarbanes-Oxley Act recently signed by President Bush has mandated substantial restrictions on the relationship between a company and its auditors. Consistent with the new law, we believe that the relationship between a company and its auditors should be limited primarily to the audit engagement, although it may also include certain closely related activities (such as tax compliance work) and possibly other selective activities that do not, in the aggregate, raise any appearance of impaired independence. We believe that, at a minimum, the fees paid auditors for any consulting or other non-audit work should never exceed their audit fees. We encourage companies in which we invest to take these considerations into account and, if there are significant non-audit services provided by their independent auditors, to disclose in detail the nature of those services in their proxy statements. Such disclosure will allow us to make a fair assessment of whether the relationship with the outside auditors appears sufficiently independent.
Corporate Structure and Shareholder Rights - Although this topic may not be as prominent today as others we have noted, it is always important to us and our funds' shareholders. Vanguard reviews all corporate structure issues (e.g., poison pills, staggered boards, etc.) on a case-by-case basis and we vote proxies in a manner that provides management with the greatest operational latitude, without compromising our ownership rights as shareholders. In general, our view is that barriers erected by corporations to thwart mergers or takeovers may depress the corporation's value in the marketplace. Again, there are some best practices that we can often support in this area (for example, in the case of poison pills, we like to see sunset provisions and so-called "TIDE" provisions requiring three-year independent director evaluation). We believe that companies should be particularly sensitive, when designing these types of plans, to ensuring an appropriate balance between operational freedom and shareholder rights. In cases where Vanguard is a major shareholder, we would be pleased to share our perspectives in advance.

We have stated publicly our strong belief that the scandals that have dominated the headlines represent a very small minority of corporations and that the vast majority of corporate leaders and boards fulfill their duties with integrity and professionalism. That said, ensuring that corporations' oversight and compensation structures are shareholder-focused is an ongoing and vital concern for any responsible investment manager. Indeed, large institutional investors like Vanguard must ensure that their proxy voting guidelines address the substantive issues and concerns of the day (and, today, those issues clearly include auditor independence and the changes to the New York Stock Exchange's listing standards). We want to ensure that the leaders of companies in which we invest understand our views and our strong conviction that the interests of management and long-term shareholders should remain very much aligned.

Glenn Booraem (610-669- ), who leads our proxy voting program, would be happy to discuss in greater detail with you or members of your staff any of our proxy voting principles that are outlined briefly here.

JJB/grm

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¹ The Vanguard Group, Inc. ("Vanguard") headquartered in Valley Forge, Pennsylvania, is the nation's second largest mutual fund firm. Vanguard serves 17 million shareholder accounts and manages more than $540 billion in U.S. mutual fund assets. Vanguard offers 112 funds to U.S. investors and 10 additional funds in foreign markets.
² Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies, Investment Company Act Release No. 25739 (Sept. 20, 2002), 67 Fed. Reg. 60828 (Sept. 26, 2002) (the "Release").
³ Id at 60830.
⁴ Vanguard believes that the term proxy voting "guidelines" would be more appropriate than proxy voting "policies." As explained below, Vanguard votes thousands of proxies on behalf of the Vanguard funds each year, and each company's proposals present unique issues. Vanguard considers proxy voting an important part of the investment management process. For this reason, Vanguard believes it is vitally important to reserve management flexibility and discretion in proxy voting guidelines to recognize the unique circumstances and challenges facing each company and to recognize that no one corporate governance structure fits all. Vanguard believes that funds should have general guidelines or principles to guide day-to-day proxy voting decisions-not rigid policies that do not allow for the exercise of responsible judgment or investment discretion.
⁵ See http://www.vanguard.com.
⁶ Registration Form Used by Open-End Management Investment Companies, Investment Company Act Release No. 23064 (Mar. 13, 1998), 63 Fed. Reg. 13916 (Mar. 23, 1998) (emphasis supplied).
⁷ The proxy voting guidelines adopted by the boards of trustees for the Vanguard funds provide that the funds should vote for shareholder proposals to adopt confidential voting, and the Vanguard funds have in fact consistently voted for confidential voting proposals.
⁸ For example, just in recent days it has been widely reported how an interest group picketed the headquarters of Fidelity Investments and distributed pamphlets at Fidelity branch offices because of Fidelity's refusal to disclose its voting position on certain proxy proposals.
⁹ Many investment managers, including Vanguard, believe that ordinary business matters having a direct or indirect effect on corporate profitability are primarily the responsibility of management, subject to oversight by the corporation's board of directors. For this reason, as explained in the Vanguard funds' proxy voting guidelines, Vanguard generally votes against most social policy and corporate responsibility proposals, with exceptions in certain cases where the proposal has substantial economic implications.
¹⁰ Release, supra note 2, at 60829.
¹¹ Vanguard understands that several special interest groups have recently started campaigns to encourage members to email their support for proxy voting disclosure to the Commission. To the extent these efforts succeed in drumming up interest in proxy voting disclosure, Vanguard believes that this activity should be considered membership endorsement of these special interest groups and their goals, as opposed to genuine interest on the part of investors in proxy voting disclosure.
¹² In the case of any investors who are interested in proxy voting information, there are funds available (as the Release recognizes) that have voluntarily elected to publicize their proxy voting records. If more investors express interest in proxy voting information, more funds may elect to disclose their proxy voting records as part of their investment process or marketing strategy.
¹³ As noted in a recent law review article cited by the Commission, the available empirical studies indicate that shareholder activism has produced "negligible effects on share values and earnings" although activist investors would assert otherwise. Alan R. Palmiter, Mutual Fund Voting of Portfolio Shares: Why Not Disclose?, 23 Cardoza L. Rev. 1419, 1424, n. 2 and 1440 (2002).
¹⁴ For example, in 1998 the Commission completed a major overhaul and simplification of the fund prospectus in order to "focus the disclosure in a fund's prospectus on essential information about the fund that will assist investors in deciding whether to invest in the fund." Investment Company Act Release No. 23064, supra note 7. In Vanguard's opinion, this was the most significant and investor-friendly development in mutual fund disclosure in many years. Another noteworthy and investor-friendly development was the release of the Commission's web-based mutual fund cost calculator in April of 1999.
¹⁵ Release, supra note 2, at 60830. Vanguard would question any inference that funds should engage in corporate governance activities to benefit "all investors." As recognized in the Release, mutual funds must be operated exclusively for the benefit of their shareholders. As a result, the degree to which funds should engage in corporate governance activities must be determined solely by the benefits that can be attained for fund shareholders in light of the costs.
¹⁶ In Vanguard's view, the extent of a fund's engagement in corporate governance matters involving a portfolio company will often be determined by the fund's relative position in the company (as well as the company's relative weight in the fund's overall portfolio). If a fund has a small ownership position in a company, it would not be worthwhile for the fund to become extensively involved in the company's corporate governance since the fund would have little opportunity to exercise influence or initiate change. However, Vanguard believes that funds have every competitive incentive to become actively involved in corporate governance matters when they have significant ownership positions and those matters can impact the value of the fund's portfolio holdings.
¹⁷ For example, the memorandum forewarns that, with respect to executive compensation plans, Vanguard has seen many poorly designed or overly dilutive stock option plans submitted for shareholder approval and, as a result, Vanguard voted against 64 percent of the stock-based compensation plans presented at annual meetings in the first half of 2002. The memorandum explains the factors that Vanguard takes into account in deciding whether to approve stock option plans.
¹⁸ Release, supra note 2, at 60829.
¹⁹ For example, in recent months, Vanguard made the following judgment calls and exceptions to the Vanguard funds proxy voting guidelines:
The Vanguard funds voted against a shareholder proposal to redeem a Fortune 100 company's poison pill plan, notwithstanding the funds' voting guidelines that generally support such proposals. The Vanguard Proxy Oversight Group was receptive to management's explanation of the company's need for such a plan in its industry and management's agreement to add "TIDE" provisions requiring the plan to be reviewed by independent directors at least once every three years.
The Vanguard funds voted to approve a Fortune 200 company's stock option plan, notwithstanding the funds' voting guidelines that generally oppose similarly structured plans. The Vanguard Proxy Oversight Group voted to approve the plan upon management's agreement to amend the plan to prohibit re-pricing of underwater options.
The Vanguard funds voted against a proposal to require shareholder approval of a Fortune 200 company's executive severance agreements, notwithstanding the funds' voting guidelines that generally support these proposals. The Vanguard Proxy Oversight Group agreed with management's assessment that the proposal was too restrictive in light of the unique and challenging conditions facing the company and its industry.

²⁰ Vanguard would suspect that sufficiently explaining just one exception to a poison pill or stock option proposal, for example, could require several pages in a shareholder report. The additional costs borne by Vanguard fund shareholders for the disclosure of one such exception for a widely held security could well exceed $200,000.
²¹ Release, supra note 2, at 60829.
²² Even assuming that funds were willing to vote proxies to ingratiate large institutional clients, the strategy would fail even with respect to the intended beneficiaries. Institutional clients are sophisticated and demanding. They would recognize that if funds will vote their company's proxies to win their business, they would likely do the same for other clients as well, to the detriment of the fund's investment returns. Institutional clients demand performance and complete integrity in the investment management process.
²³ Release, supra note 2, at 60829.
²⁴ Id.
²⁵ See Role of Independent Directors of Investment Companies, Investment Company Act Release No. 24082 (Oct. 14, 1999), 64 Fed. Reg. 59826, 59828 (Nov. 3, 1999).
²⁶ Under the Investment Company Act of 1940, fund boards are charged with overseeing the most important aspects of fund management and protecting fund shareholders from conflicts of interest. The board's oversight responsibilities include:
evaluation of fund performance;
review and approval of investment advisory agreements;
valuation of fund securities holdings;
approval of distribution plans under rule 12b-1;
approval of procedures for funds to purchase securities when an affiliate is part of the selling syndicate under rule 10f-3;
approval of cross transactions between advisory clients under rule 17a-7;
approval of mergers between affiliated funds under rule 17a-8; and
payment of commissions to affiliated brokers under rule 17e-1.
If fund boards are capable of overseeing these fundamental aspects of fund operations and protecting fund shareholders in these areas that are prone to conflicts of interest, then surely fund boards are capable of effectively overseeing the proxy voting process.