Source: https://www.sec.gov/rules/final/ic-26520.htm
Timestamp: 2019-04-24 06:51:46+00:00

Document:
SUMMARY: The Securities and Exchange Commission ("Commission") is adopting amendments to rules under the Investment Company Act of 1940 to require investment companies ("funds") that rely on certain exemptive rules to adopt certain governance practices. The amendments are designed to enhance the independence and effectiveness of fund boards and to improve their ability to protect the interests of the funds and fund shareholders they serve.
DATES: Effective Date: September 7, 2004.
Compliance Date: January 16, 2006.
FOR FURTHER INFORMATION CONTACT: Catherine E. Marshall, Attorney, Office of Investment Adviser Regulation, (202) 942-0719; C. Hunter Jones, Assistant Director, Office of Regulatory Policy, (202) 942-0690, Division of Investment Management, Securities and Exchange Commission, 450 Fifth St., NW, Washington, DC 20549-0506.
We proposed these rule amendments, along with a number of other initiatives,5 in the wake of a troubling series of enforcement actions involving late trading of mutual fund shares, inappropriate market timing activities, and misuse of nonpublic information about fund portfolios.6 When we proposed these amendments, we expressed concern that the enforcement actions in many cases reflected a serious breakdown in management controls. We observed that, in some cases, the fund was used for the benefit of fund insiders, often the management company or its employees. In addition, we had recently adopted a new rule creating the position of fund chief compliance officer, which reports directly to the board on compliance matters.7 The proposed fund governance standards would complement that rule by placing fund boards in a better position to demand that management adhere to the highest of compliance standards.
The proposal engendered a substantial amount of interest. We received nearly 200 comments from fund investors, management companies, independent directors to mutual funds, as well as members of Congress. We also received several comments from organizations that had a more general interest in corporate governance issues. Most commenters supported our efforts to strengthen fund governance, but many were divided on some of our proposals. Some commenters believed the proposed amendments did not go far enough; others recommended certain modifications.
We recognize that these amendments might not have prevented all of the abuses that were uncovered in the enforcement actions discussed above. Nevertheless, if funds are to engage in the transactions permitted by the Exemptive Rules12 and effectively manage the conflicts of interest inherent in those transactions, greater board independence is needed. We are adopting them substantially as proposed.
Before we discuss the rules we are today adopting, we wish to take this opportunity to make some observations about the role of fund directors and, in particular, independent directors.
Fund independent directors play a central role in policing the conflicts of interest that advisers inevitably have with the funds they advise. Many fine individuals today ably serve investors in this capacity. We do not intend that this rulemaking, or the statements we have made about the need for reform of the mutual fund regulatory framework or mutual fund governance, be construed in any way as a challenge to their integrity or commitment to investors. Our efforts today are designed to strengthen the role that independent directors play and to support their work on behalf of fund shareholders. The amendments are intended largely to preserve the current system of fund governance that on the whole has served mutual fund investors well, while addressing its weaknesses.
To be truly effective, a fund board must be an independent force in fund affairs rather than a passive affiliate of management.13 Its independent directors must bring to the boardroom “a high degree of rigor and skeptical objectivity to the evaluation of management and its plans and proposals,” particularly when evaluating conflicts of interest.14 They must commit their time and energy, and devote themselves to the principles set forth in the Investment Company Act and state corporate and trust law under which the fund is organized.
While the Investment Company Act contains many important requirements with which a fund must comply, the paramount principle that must prevail, and should animate all decisions directors are called upon to make, is that a fund must be managed on behalf of its investors rather than on behalf of the adviser or other affiliated persons of the fund.15 Directors should be highly skeptical of arguments that merely rationalize the resolution of conflicts in favor of the fund adviser, and should seek results that advance the best interest of fund shareholders.
As discussed above, when Congress passed the Investment Company Act, it relied on independent directors to protect the interests of fund investors. A principal purpose of the amendments is to strengthen the independent directors’ control of the fund board and its agenda, so that the interests of investors are paramount. Although the Exemptive Rules currently require a simple majority of the board to be independent and the independent directors to separately approve the transactions covered by those rules, we are concerned that many boards continue to be dominated by their management companies. Accordingly, the amendments provide that each fund relying on any Exemptive Rule must have a board of directors whose independent directors constitute at least 75 percent of the board or, if the fund has only three directors, all but one of the directors must be independent.30 Most commenters supported the 75 percent amendment.31 Some commenters recommended that we adopt an even higher percentage.32 We do not believe that we need to go that far -- there are good arguments for maintaining a management presence on the board. Other commenters questioned whether a slightly lower super-majority requirement (e.g., two-thirds) would suffice.33 We believe the 75 percent requirement adopted by Congress in section 15(f) of the Act will better assure that the independent directors can carry out their fiduciary responsibilities.34 This requirement was designed to help resolve ongoing conflicts of interest, which can result from the sale of an advisory firm.
The board chairman can play an important role in setting the agenda of the board, and in establishing a boardroom culture that can foster the type of meaningful dialogue between fund management and independent directors that is critical for healthy fund governance. The chairman can play an important role in providing a check on the adviser, in negotiating the best deal for shareholders when considering the advisory contract, and in providing leadership to the board that focuses on the long-term interests of investors.47 We believe that a fund chairman is in the best position to fulfill these responsibilities when his loyalty is not divided between the fund and its investment adviser.
Those opposing the amendment, including some independent directors, argued that it would deprive the independent directors of the ability to choose for themselves the most qualified and capable candidate to serve as chairman and thereby undermine the directors’ ability to carry out their responsibilities.48 To be clear, the amendments we are adopting today do not prevent the independent directors from choosing the most qualified and capable candidate. That candidate, however, cannot serve two masters.
Some asserted that independent directors would not have sufficient knowledge or be as well prepared to lead the board through its many tasks, unless the board chairman is affiliated with the adviser and therefore is able to obtain needed information from the advisory firm.49 They similarly argued that the independent chairman might be drawn into the day-to-day management of the fund. As noted above, we believe a board chairman typically plays an important role in setting the agenda of the board and determining what information is provided to the board. An independent chairman will undoubtedly consult with management in carrying out its functions, as well as in leading the board through its various tasks. But the final decisions in setting the agenda will be made by someone independent of management.50 Moreover, the chairman is in a unique position to set the tone of meetings, and to encourage open dialogue and healthy skepticism. We believe an independent chairman is better equipped to serve this role. Finally, representatives of management would still be responsible for the day-to-day operations of the fund, would continue to be able to serve as fund directors and would have access to information from the adviser. We do not believe that this amendment will deprive the board of management’s knowledge and judgment.
If the board is to provide effective oversight of the management company, there may be times when it must be prepared to say “no” to the manager’s chief executive officer.51 We do not mean to suggest that the relationship between the board and the management company need be adversarial. Indeed, we believe that a crucial challenge to every fund board involves establishing an appropriate balance between cooperation with the management company and oversight of the management company. Our primary concern, and the one that has led us to adopt this amendment, is that too often the proper balance has not been achieved, particularly where an executive of the adviser has exerted a dominant influence over the board. While having an independent chairman should not disadvantage a board that is properly balanced, it may significantly benefit one that is not.
We carefully considered alternatives suggested to us by commenters, including designation of a lead independent director and increased reliance on board committees chaired by independent directors. A lead independent director could provide useful leadership to the independent directors when dealing with the board chairman,57 and independent committee chairmen may provide important services to the fund. Neither of these arrangements, however, would create a position that is likely to be filled by a person with sufficient stature within the fund complex to serve as an effective counterweight to a fund chairman who may also be the chief executive officer of the management company.58 Further, as commenters pointed out, “[a]ppointing a lead director does nothing to ensure that independent directors control the agenda, information requests, and terms of board debate.”59 Commenters recommended a variety of other alternatives, including having the audit committee chair set the agenda. We believe that the board’s agenda should be under the control of an independent director.
Our action today should not be construed as diminishing the value that executives of the adviser, including the adviser’s chief executive officer, bring to the fund boardroom. We fully expect that these executives will continue to serve on fund boards, although not in the capacity of chairman, and thus will have every opportunity to engage the board on issues important to the fund investors as well as the management company.60 Similarly, to the extent that some executives of the adviser leave fund boards in order to meet the supermajority requirement, we expect that they will continue to participate, in appropriate circumstances, in board and board committee deliberations.
We are also amending the Exemptive Rules to require fund directors to evaluate, at least once annually, the performance of the fund board and its committees.61 This evaluation must include a consideration of the effectiveness of the committee structure of the fund board62 and the number of funds on whose boards each director serves. Most commenters supported this amendment, and we are adopting it as proposed.
We are also amending the Exemptive Rules to require independent directors to meet at least once quarterly in a separate session at which no directors who are interested persons of the fund are present.64 Commenters supported this provision, which is designed to give independent directors the opportunity for a frank and candid discussion among themselves regarding the management of the fund, including its strengths and weaknesses.65 The rule does not specify the matters that should be discussed by the independent directors at the separate executive sessions, although we expect that the independent directors would use this forum to discuss, among other things, their views on the performance of the fund adviser and other service providers.
Finally, we are amending rule 31a-2, the fund recordkeeping rule, to require that funds retain copies of the written materials that directors consider in approving an advisory contract under section 15 of the Investment Company Act.69 Commenters supported this amendment, and we are adopting it as proposed.70 The amendment requires funds to retain the materials for at least six years, the first two years in an easily accessible place.
The recordkeeping amendment is designed to improve the documentation of a fund board’s basis for approving an advisory contract, which would assist our examination staff in determining whether fund directors are fulfilling their fiduciary duties when approving advisory contracts. The amendment underscores the importance of the information requests that precede the directors’ consideration of the advisory contract. Further, it may encourage independent directors to request more information, and this information may enable them to obtain more favorable terms in advisory contracts.
The amendments to the Exemptive Rules will become effective on September 7, 2004.
After January 15, 2006: (i)�persons may rely upon any of the Exemptive Rules (rules 10f-3, 12b-1, 15a-4(b)(2), 17a-7, 17a-8, 17d-1(d)(7), 17e-1, 17g-1(j), 18f-3, and 23c-3) only if they comply with all of the “fund governance standards” as defined in rule 0-1(a)(7);71 and (ii)�funds must begin to comply with the recordkeeping requirements of amended rule 31a-2.
As discussed in the Proposing Release, the amendment to rule 31a-2 contains a “collection of information” requirement within the meaning of the Paperwork Reduction Act of 199572 because the amendment to rule 31a-2 will require funds to retain copies of the written materials that boards consider in approving advisory contracts under section 15(c) of the Investment Company Act. Funds have to retain these materials for at least six years, the first two years in an easily accessible place for our examiners. This collection of information is necessary for our staff to use in its examination and oversight program. Responses provided in the context of the Commission’s examination and oversight program are generally kept confidential. The collection of information requirement is mandatory and is in the form of an amendment to a currently approved collection of information requirement, the title of which is “Rule 31a-2, ‘Records to be preserved by registered investment companies, certain majority-owned subsidiaries thereof, and other persons having transactions with registered investment companies.’” An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. The approved collection of information associated with rule 31a-2 to be revised by the amendments displays control number 3235-0179. The Commission submitted the collection to the Office of Management and Budget (“OMB”) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. OMB has approved the collection of information under control number 3235-0179 (expiring on July 31, 2007).
The amendment to the collection of information requirement for rule 31a-2 is necessary for our compliance examiners to determine whether fund boards have met the requirements of section 15 of the Investment Company Act when approving investment advisory contracts. Our compliance examiners will review these materials to gauge a fund board’s fulfillment of the requirements of section 15 of the Act.
As discussed above, we are adopting the amendment to rule 31a-2 and this collection of information requirement as proposed. In the Proposing Release, our staff estimated that each fund will spend a total of 0.5 hours annually and a total of $9.46 for clerical time to comply with this amendment.73 In the Proposing Release, we solicited comments on the accuracy of these estimates. None of the comments received specifically addressed our estimates of the costs associated with the collection of information requirement.74 Our staff continues to estimate that each fund will spend a total of 0.5 hours annually and a total of $9.46 for clerical time to comply with this amendment. Because of the increase in the number of registered funds to 5,132 funds, however, our staff estimates that the total hour burden of the collection of information requirement for all funds is 2,566 hours and a total of $48,548.72 annually to comply with this amendment.
We are sensitive to the costs and benefits imposed by our rules. As discussed in section III above, these amendments require that funds relying on any of the Exemptive Rules adopt certain governance practices that are designed to enhance the independence and effectiveness of fund boards. We also are adopting amendments to require that funds maintain materials considered by a fund board when approving an advisory contract. In the Proposing Release, we identified probable costs and benefits of each of these proposed amendments that we are adopting today, and we requested public comment on our analysis of the costs and benefits of each of these amendments.
We expect that funds and fund shareholders are likely to benefit from the amendments because they are designed to strengthen the role of independent directors so that fund boards can more effectively manage conflicts of interest, monitor service providers, and protect the interests of fund shareholders. Boards that satisfy these conditions should be more effective at exerting an independent influence over fund management and other fund service providers because the fund independent directors are more likely to be primarily loyal to the fund shareholders rather than the fund adviser.
The amendment to require an annual self-assessment of the effectiveness of the board and its committees is intended to improve fund performance by strengthening directors’ understanding of their role and fostering better communications and greater cohesiveness. Moreover, the requirement for fund boards to perform an annual self-assessment should help fund boards to identify potential weaknesses and deficiencies. All but one of the comments received expressed support for a requirement that boards perform a self-assessment.
We expect that the requirement that independent directors must meet at least once quarterly in separate sessions, without the presence of directors who are interested persons, likewise will improve fund performance by strengthening the role of independent directors and fostering better communications and greater cohesiveness among the independent directors. Commenters were supportive of this proposal.
We expect that the amendment to require funds to explicitly authorize independent directors to hire employees and to retain advisers and experts will help independent directors address complex matters and provide them with an understanding of the practices of other mutual funds. Fund shareholders should receive substantial benefits because we expect that these requirements will help to ensure that independent directors are better able to fulfill their role of representing shareholder interests. Most commenters expressed support for this amendment. These commenters agreed that fund boards already have the authority to hire employees, but that this is a useful amendment.
Finally, the recordkeeping amendment is designed to improve the documentation of a fund board’s basis for approving an advisory contract, which will assist our examination staff in determining whether fund directors are fulfilling their fiduciary duties when approving advisory contracts. The amendment to rule 31a-2 underscores the importance of the information requests that precede the directors’ consideration of the advisory contract. Further, it may encourage independent directors to request more information, and this information may enable them to obtain more favorable terms in advisory contracts. Comments generally were supportive of this amendment.
The amendments will impose additional costs on funds that rely on an Exemptive Rule by requiring them to satisfy the fund governance standards in rule 0-1(a)(7). The amendments will require that independent directors constitute at least 75 percent of the fund board or, if the fund board has only three directors, will require that all but one director be independent.78 Therefore, a fund that does not already meet this standard may: (i)�decrease the size of its board and allow some interested directors to resign; (ii)�maintain the current size of its board and replace some interested directors with independent directors; or (iii)�increase the size of its board and elect new independent directors. If a fund holds a shareholder election, it will incur costs to prepare proxy statements and hold the shareholder meeting. A fund also will incur costs of finding qualified candidates and compensating those new independent directors.79 As noted in the Proposing Release, our staff has no reliable basis for determining how funds would choose to satisfy this requirement and therefore it is difficult to determine the costs associated with electing independent directors.80 As discussed in section III above, under the proposed amendments, boards that have three directors, unlike fund boards that have four or more directors, would have to be composed of all independent directors in order to meet the 75 percent requirement or, alternatively, would incur costs to increase their board size to four directors. In response to concerns about the effect of the requirement on boards with only three directors, the exception to the 75 percent requirement we are adopting permits boards with three directors to have all but one director be independent.
The amendments also require: (i)�an independent director to be chairman of the board; (ii)�directors to perform an evaluation of the board and its committees, at least once annually; (iii)�independent directors to meet in an executive session at which no director who is an interested person of the fund is present, at least once quarterly; and (iv)�independent directors to be given specific authority to hire employees and retain experts. As discussed in the Proposing Release, our staff is not aware of any out-of-pocket costs that would result from the first three items because these requirements could be satisfied at a regularly scheduled board meeting.81 A few comments expressed concern about costs of requiring separate executive sessions at least once quarterly. However, as discussed in the Proposing Release, we expect that most funds would choose to satisfy this requirement by having directors meet at a breakout session of regularly scheduled board meetings, which would impose no additional transportation and little or no accommodation costs for the directors. Therefore, we expect that the costs of complying with this requirement would be minimal. With regard to the fourth item, our staff is not aware of any costs associated with hiring employees or retaining experts because boards typically have this authority under state law, and the rule would not require them to hire employees or retain experts.
funds relying on any of the Exemptive Rules, are to enhance the independence and effectiveness of fund boards and to improve their ability to protect the interests of the funds and fund shareholders they serve and to effectively oversee management of the fund.
A small business or small organization (collectively, “small entity”) for purposes of the Regulatory Flexibility Act is a fund that, together with other funds in the same group of related investment companies, has net assets of $50 million or less as of the end of its most recent fiscal year.87 Of approximately 5,132 registered investment companies, approximately 233 are small entities.88 As discussed above, the amendments would require funds relying on an Exemptive Rule to comply with rule 0-1(a)(7) and all funds to retain records under rule 31a-2. Whether these amendments to the Exemptive Rules would affect small entities would depend on whether the small entities rely on an Exemptive Rule.89 Under rule 31a-2, all small entities would be required to maintain records of materials considered by a fund board when approving an advisory contract.
The amendments do not introduce any new mandatory reporting requirements. The amendments contain new mandatory recordkeeping requirements. Any fund, regardless of size, is required to maintain records of written materials that directors consider to approve an advisory contract. The amendments also introduce new compliance requirements for any fund that relies on an Exemptive Rule. Any fund that relies on an Exemptive Rule is required to satisfy the fund governance standards in rule�0-1(a)(7), including having: (i)�a board of directors whose independent directors constitute at least 75 percent of the board;90 (ii)�an independent director be chairman of the board; (iii)�directors perform an evaluation of the board and its committees, at least once annually; (iv)�independent directors meet in an executive session at which no director who is an interested person of the fund is present, at least once quarterly; and (v)�independent directors be given specific authority to hire employees and other advisers.
We are concerned about the impact of these amendments on small entities. In response to comments about the impact of the proposed 75 percent independence requirement on small fund boards, we are adopting an alternative for fund boards with only three directors.91 Unlike fund boards composed of four or more directors, fund boards with only three directors would have to be composed of all independent directors in order to meet the 75 percent requirement or, alternatively, would have increase their board size to four directors. We are adopting an alternative to the 75 percent requirement for boards composed of three directors that would permit all but one director to be independent. With respect to the establishment of other special alternatives for small entities, we do not presently think this is feasible or necessary because these amendments are designed to strengthen the role of independent directors so that fund boards can more effectively manage conflicts of interest, monitor service providers, and protect the interests of fund shareholders. The need to strengthen the role of independent directors arises in part from problems uncovered in enforcement actions and settlements. Excepting small entities from the amendments could disadvantage fund shareholders of small entities and compromise the effectiveness of the amendments. Because we believe that small entities are as vulnerable to the problems uncovered in recent enforcement actions and settlements as large entities, shareholders of small entities are equally in need of more independent fund boards. Thus, specific measures must be undertaken by all funds, regardless of size, to increase the independence of boards to provide better oversight of service providers and compliance matters, to better manage conflicts of interest and to better protect fund shareholders.
Section 2(c) of the Investment Company Act requires the Commission, when engaging in rulemaking that requires it to consider or determine whether an action is necessary or appropriate in the public interest, to consider whether the action will promote efficiency, competition, and capital formation. The amendments requiring that funds adopt certain governance practices if they rely on any of the Exemptive Rules are designed to enhance the independence and effectiveness of fund boards. The amendment to require that funds maintain materials considered by a fund board when approving an advisory contract is designed to improve the documentation of a fund board’s basis for approving an advisory contract, which would assist our examinations staff in determining whether fund directors are fulfilling their fiduciary duties when approving advisory contracts. We do not expect these amendments to have a significant effect on efficiency, competition and capital formation with regard to funds because the costs associated with the amendments are minimal and many funds have already adopted the required practices. To the extent that these amendments do affect competition or capital formation, we believe that the effect will be positive because the amendments are likely to reduce the risk of securities law violations such as late trading in mutual funds and market timing violations, and thus increase investor confidence in mutual funds. In the Proposing Release, we solicited comments on our analysis of the impact of these amendments on efficiency, competition and capital formation. We did not receive any comments on our analysis.
We are amending rule 0-1(a) and the Exemptive Rules pursuant to the authority set forth in sections 6(c), 10(f), 12(b), 17(d), 17(g), 23(c), and 38(a) of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-10(f), 80a-12(b), 80a-17(d), 80a-17(g), 80a-23(c), and 80a-37(a)]. We are amending rule 31a-2 under the Investment Company Act pursuant to the authority set forth in sections 12(b) and 31(a) [80a-12(b) and 80a-30(a)].
For the reasons set out in the preamble, the Commission is amending Title 17, Chapter II of the Code of Federal Regulations as follows.
� 270.0-1 Definition of terms used in this part.
(vii) The disinterested directors have been authorized to hire employees and to retain advisers and experts necessary to carry out their duties.
� 270.10f-3 Exemption for the acquisition of securities during the existence of an underwriting or selling syndicate.
(11) Board composition. The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.12b-1 Distribution of shares by registered open-end management investment company.
� 270.15a-4 Temporary exemption for certain investment advisers.
(vii) The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.17a-7 Exemption of certain purchase or sale transactions between an investment company and certain affiliated persons thereof.
(f) The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.17a-8 Mergers of affiliated companies.
(4) Board composition. The board of directors of the Merging Company satisfies the fund governance standards defined in � 270.0-1(a)(7).
(v) The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.17e-1 Brokerage transactions on a securities exchange.
� 270.17g-1 Bonding of officers and employees of registered management investment companies.
(3) The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.18f-3 Multiple class companies.
(e) The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.23c-3 Repurchase offers by closed-end companies.
(8) The board of directors of the investment company satisfies the fund governance standards defined in � 270.0-1(a)(7).
� 270.31a-2 Records to be preserved by registered investment companies, certain majority-owned subsidiaries thereof, and other persons having transactions with registered investment companies.
(6) Preserve for a period not less than six years, the first two years in an easily accessible place, any documents or other written information considered by the directors of the investment company pursuant to section 15(c) of the Act (15 U.S.C. �80a-15(c)) in approving the terms or renewal of a contract or agreement between the company and an investment adviser.
1 Unless otherwise noted, all references to statutory sections are to the Investment Company Act of 1940.
2 Investment Company Governance, Investment Company Act Release No. 26323 (Jan. 15, 2004) [69 FR 3472 (Jan. 23, 2004)] (“Proposing Release”). In 2001, we adopted amendments that require any fund that relies upon certain exemptive rules to have (i)�a board that has a majority of independent directors; (ii)�the independent directors select and nominate independent directors; and (iii)�independent directors, if they hire counsel, hire only counsel that does not have substantial ties to fund managers. Role of Independent Directors of Investment Companies, Investment Company Act Release No.�24816 (Jan. 2, 2001) [66 FR 3734 (Jan. 16, 2001)] (“2001 Adopting Release”).
3 In this Release we are using “independent director” to refer to a director who is not an “interested person” of the fund, as defined by the Act. See infra note 23.
4 As one commenter on the proposal noted, “The current requirement for a bare majority of independent directors does not adequately assure that these directors will dominate the decision-making process.” Letter from Consumer Federation of America, et al., to Jonathan G. Katz, Secretary, SEC (Mar. 10, 2004), File No. S7-03-04 (“Consumer Federation Letter”).
5 See, e.g., Disclosure Regarding Approval of Investment Advisory Contracts by Directors of Investment Companies, Investment Company Act Release No. 26350 (Feb. 11, 2004) [69 FR 7852 (Feb. 19, 2004)] (proposing release) and 26486 (June 23, 2004) [69 FR 39798 (June 30, 2004)] (adopting release); Investment Adviser Codes of Ethics, Investment Company Act Release No. 26337 (Jan. 20, 2004) [69 FR 4040 (Jan. 27, 2004)] (proposing release) and 26492 (July 2, 2004) [69 FR 41696 (July 9, 2004)] (adopting release); Disclosure of Breakpoint Discounts by Mutual Funds, Investment Company Act Release Nos. 26298 (Dec. 17, 2003) [68 FR 74732 (Dec. 24, 2003)] (proposing release) and 26464 (June 7, 2004) [69 FR 33262 (June 14, 2004)] (adopting release) (“Breakpoint Disclosure”); Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings, Investment Company Act Release Nos. 26287 (Dec. 11, 2003) [68 FR 70402 (Dec. 17, 2003)] (proposing release) and 26418 (Apr. 19, 2004) [69 FR 22300 (Apr. 23, 2004)] (adopting release) (“Market Timing Disclosure”); Mandatory Redemption Fees for Redeemable Fund Securities, Investment Company Act Release No. 26375A (Mar. 5, 2004) [69 FR 11762 (Mar. 11, 2004)]; Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26356 (Feb. 24, 2004) [69 FR 9726 (Mar. 1, 2004)]; Amendments to Rules Governing Pricing of Mutual Fund Shares, Investment Company Act Release No. 26288 (Dec. 11, 2003) [68 FR 70388 (Dec. 17. 2003)].
6 See, e.g., In the Matter of Alliance Capital Management, L.P., Investment Company Act Release No. 26312A (Jan. 15, 2004) (finding that an investment adviser violated its fiduciary duty to the fund by failing to disclose agreements, and making special accommodations, to permit select investors to engage in market timing transactions in exchange for the maintenance of “sticky assets,” and finding that the investment adviser divulged material nonpublic information about portfolio holdings); In the Matter of Putnam Investment Management, LLC, Investment Company Act Release No. 26255 (Nov. 13, 2003) (finding that an investment adviser failed to disclose potentially self-dealing transactions in shares of funds managed by several of its employees, failed to have procedures reasonably designed to prevent misuse of material nonpublic information, and failed to reasonably supervise the employees who committed violations); In the Matter of James Patrick Connelly Jr., Investment Company Act Release No. 26209 (Oct. 16, 2003) (finding that a former executive of an investment adviser to a fund complex approved agreements that permitted select investors to engage in market timing transactions in certain funds in the complex, in exchange for the maintenance of sticky assets); In the Matter of Steven B. Markovitz, Investment Company Act Release No. 26201 (Oct. 2, 2003) (finding that a former hedge fund trader violated the federal securities laws and defrauded investors by engaging in late trading of mutual fund shares). See also In the Matter of Pilgrim Baxter & Associates, Ltd., Investment Company Act Release No. 26470 (June 21, 2004) (finding that the investment adviser violated the federal securities laws by failing to disclose to funds' board of directors or shareholder that its principal was engaged in self-dealing transactions through�significant ownership stake in a hedge fund engaged in�market timing of fund managed by him, by permitting market timing despite prospectus disclosure to the contrary, and by disclosing material nonpublic portfolio information to a broker-dealer whose customers engaged in market timing the funds); In the Matter of Strong Capital Management, Inc., Investment Company Act Release No. 26409 (May 20, 2004) (finding that investment adviser violated its fiduciary duties to the funds by (i)�failing to disclose to the funds’ boards or shareholders the conflicts of interest created when the adviser allowed hedge fund to market time certain funds and that the chairman frequently traded certain funds, including a fund for which he served as portfolio manager, (ii)�providing hedge fund manager nonpublic portfolio information for certain funds, and (iii)�filing fund prospectuses that failed to disclose that the adviser would make exceptions to the disclosed policies discouraging market timing in instances where the fund’s chairman or the adviser benefited); In the Matter of Massachusetts Financial Services Company, Investment Company Act Release No. 26409 (Mar. 31, 2004) (sanctioning fund investment adviser for failing to disclose to the fund board that the adviser had entered into arrangements with approximately 100 broker-dealers under which the fund adviser agreed to make certain cash payments or direct fund brokerage to certain broker-dealers in return for preferred treatment in promoting fund sales).
7 Compliance Programs of Investment Companies and Investment Advisers, Investment Company Act Release No. 26299 (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 2003)] (“Compliance Programs”).
8 Directors are generally responsible under state law for the oversight of all of the operations of a mutual fund, and the Investment Company Act assigns many specific responsibilities to fund boards. For example, fund boards must evaluate and approve a fund’s advisory contract and may unilaterally terminate the contract. See section 15 of the Act [15 U.S.C. 80a-15].
Rule 23c-3 (permitting the operation of an interval fund by enabling a closed-end fund to repurchase shares from investors, if the directors adopt a repurchase policy for the fund and review fund operations and portfolio management in order to assure adequate liquidity of investments to satisfy repurchase payments).
Last October we proposed a new exemptive rule, rule 15a-5, that also would be conditioned on meeting the fund governance standards that are currently included in these ten exemptive rules. See Exemption from Shareholder Approval for Certain Subadvisory Contracts, Investment Company Act Release No. 26230 (Oct. 23, 2003) [68 FR 61720 (Oct. 29, 2003)]. As we stated when we proposed the fund governance amendments we are adopting today, if we adopt rule 15a-5, we intend to condition its use on compliance with the revised fund governance standards. See Proposing Release, supra note 2, at n.16.
10 These rules (i)�exempt funds or their affiliated persons from provisions of the Act that can involve serious conflicts of interest and (ii)�condition the exemptive relief on the approval or oversight of independent directors. See Proposing Release, supra note 2, at text accompanying n.16.
11 For the reasons discussed throughout this Release, we believe that amending the Exemptive Rules to provide for greater board independence and to enhance a board’s ability to perform the responsibilities under those rules is necessary and appropriate in the public interest and is consistent with the protection of investors and the purposes of the Act. See, e.g., section 6(c) (authority of the Commission to conditionally exempt a person or transaction if it 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 this title.”). Each of the Exemptive Rules permits a fund to engage in transactions or conduct that presents significant conflicts of interest and that otherwise would be restricted or prohibited by the Act. As the Commission already determined when it made similar amendments to the Exemptive Rules in 2001, establishing conditions for the Exemptive Rules based on the independence of the fund board is appropriate to address the types of conflicts Congress identified in the Act. The amendments therefore are well within the Commission’s broad authority to “conditionally or unconditionally exempt any person, security, or transaction” from any provision of the Act. See also infra Statutory Authority section.
12 As we stated when we proposed the fund governance amendments that we adopted in 2001, the amended rules do not require all funds to adopt these measures. Although the Commission urges all funds to consider adopting the measures to strengthen the independence of their boards, funds that do not rely on any of the Exemptive Rules will not be subject to these requirements. See Role of Independent Directors of Investment Companies, Investment Company Act Release No. 24082 (Oct. 14, 1999) [64 FR 59826 (Nov. 3, 1999)] (“1999 Proposing Release”) at text preceding n.34.
13 See Division of Corporation Finance, Securities and Exchange Commission, Staff Report on Corporate Accountability (Sept. 4, 1980) (printed for the use of Senate Committee on Banking, Housing, and Urban Affairs, 96th Cong., 2d Sess.) at F2 (noting importance of corporate boards of directors in overseeing performance of corporate management).
14 Donald C. Langevoort, The Human Nature of Corporate Boards: Law, Norms, and the Unintended Consequences of Independence and Accountability, 89 Geo. L.�J. 797, 798 (2001). “[T]here are industries where the case for independence is compelling. The best example here is the mutual fund industry, where conflicts of interests are commonplace and traditional checks on managerial overreaching, such as vigorous shareholder voting and hostile tender offers do not exist.” Id. at 814.
15 Section 1(b)(2) of the Act [15 U.S.C. 80a-1(b)(2)] (“[T]he national public interest and the interest of investors are adversely affected�… (2) when investment companies are organized, operated, managed, or their portfolio securities are selected, in the interest of directors, officers, investment advisers, depositors, or other affiliated persons thereof, in the interest of underwriters, brokers, or dealers, in the interest of special classes of their security holders, or in the interest of other investment companies or persons engaged in other lines of business, rather than in the interest of all classes of such companies’ security holders …”).
16 See S. Rep. No. 91-184, at 4902-03 (1969) (“The directors of a mutual fund, like directors of any other corporation, will continue to have … overall fiduciary duties as directors for the supervision of all of the affairs of the fund.”); Burks v. Lasker, 441 U.S. 471, 478-79 (1979) (“The [Investment Company Act] does not purport to be the source of authority for managerial power; rather, the Act functions primarily to ‘[impose] controls and restrictions on the internal management of investment companies.’ … The ICA and the [Investment Advisers Act] … do not require that federal law displace state laws governing the powers of directors unless the state laws permit action prohibited by the Acts, or unless ‘their application would be inconsistent with the federal policy underlying the cause of action’ ….”) (emphasis in original) (citations omitted). See also Green v. Fund Asset Management, L.P., 245 F.3d 214, 226 (3d Cir. 2001).
17 See Stanley J. Friedman, The Role of Outside Directors in Negotiating Investment Company Advisory Agreements, 24 Rev. Sec. & Commod. Reg. 49, 57 (1991) (“[T]he negotiation of investment advisory agreements and renewals is a [serious] business in which the participation of independent directors who are ‘qualified, fully informed, and … conscientious’ will not only benefit the investment company and its shareholders but will also greatly enhance the position of the investment adviser in litigation.”); American Bar Association, Fund Director’s Guidebook, 59 Bus. Law. 201, 223 (2003) (“The 1940 Act contains important provisions governing the relationship between the adviser and the fund’s board of directors in negotiating an advisory contract.”) (emphasis added); David A. Sturms, Mutual Fund Regulation, Part III: Regulation of the Adviser and the Fund Portfolio, PLIREF-MFR �6:7 (2002) (“[T]he 1940 Act sets forth a specific framework for governing the relationship between the adviser and the fund’s board of directors in negotiating an advisory contract.”) (emphasis added); Review of Current Investigations and Regulatory Actions Regarding the Mutual Fund Industry: Fund Operations And Governance: Hearings before the Senate Committee on Banking, Housing and Urban Affairs, 108th Cong., 2d Sess., 7-8 (Feb. 26, 2004) (statement of David S. Ruder, Professor, Northwestern University School of Law (“[Fund directors] must bargain with the adviser regarding the costs of its services�…”)) (http://banking.senate.gov/files/ruder.pdf). See also Schuyt v. Rowe Price Prime Reserve Fund, Inc., 663 F. Supp. 962, 986 (S.D.N.Y. 1987) (“This is not a case where a contract was rubber-stamped by docile individuals; this is a case where competent, aggressive individuals analyzed the facts and actively bargained to obtain a better deal for the Fund.”) (emphasis added); SEC, Public Policy Implications of Investment Company Growth, reprinted in H.R. Rep. No. 89-2337, at 127 (1966) (“Advisory Fees and the Limitations of Disclosure”).
18 15 U.S.C. 80b-6. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 201 (1963) (noting that an investment adviser may not trade on the market effect of his recommendations without “fully and fairly revealing his personal interests in these recommendations to his clients”); Vernazza v. SEC, 327 F.3d. 851, 860 (9th Cir. 2003) (noting that investment advisers had a duty to disclose any potential conflicts of interest accurately and completely). See also In the Matter of Putnam Investment Management, LLC, supra note 6.
19 Proposing Release, supra note 2, at n.30 and accompanying text.
20 See Statement of the Commission Regarding the Enforcement Action Against Alliance Capital Management, L.P., SEC Press Release 2003-176 (Dec. 18, 2003).
21 See, e.g., Market Timing Disclosure, supra note 5; Breakpoint Disclosure, supra note 5; Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies, Investment Company Act Release No. 26372 (Feb. 27, 2004) [69 FR 11244 (Mar. 9, 2004)]; Confirmation Requirements and Point of Sale Disclosure Requirements for Transactions in Certain Mutual Funds and Other Securities, and Other Confirmation Requirement Amendments, and Amendments to the Registration Form for Mutual Funds, Investment Company Act Release No. 26341 (Jan. 29, 2004) [69 FR 6438 (Feb. 10, 2004)]; Fund of Funds Investments, Investment Company Act Release No. 26198 (Oct. 1, 2003) [68 FR 58226 (Oct. 8, 2003)].
22 As in effect before these amendments, the Exemptive Rules have required that, for any fund relying on any of the rules, the independent directors must select and nominate other independent directors of the fund. See, e.g., rule 10f-3(c)(11)(i) [17 CFR 270.10f-3(c)(11)(i)]. Before we proposed to amend the Exemptive Rules in 1999, we had already included a similar condition in rule 12b-1 and rule 23c-3. See Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)]; Repurchase Offers By Closed-End Management Investment Companies, Investment Company Act Release No. 19399 (Apr. 7, 1993) [58 FR 19330 (Apr. 14, 1993)]. See also 1999 Proposing Release, supra note 11, at n.30.
23 In this Release we are using “independent director” to refer to a director who is not an “interested person” of the fund, as defined by the Act. Section 2(a)(19) of the Act [15 U.S.C. 80a-2(a)(19)] defines “interested person” of a fund to include (i)�any affiliated person of the fund; (ii)�any member of the immediate family of any natural person who is an affiliated person of the fund; (iii)�any interested person of any investment adviser of or principal underwriter for the fund; (iv)�any person, or partner or employee of any person, who acted as legal counsel for the fund during the last two completed fiscal years of the fund; (v) any person who executed portfolio transactions for the fund or loaned money or property to the fund during the past six months, or any affiliated person of such a person; and (vi)�any natural person who the Commission has determined is an interested person because of his or her material business or professional relationship with the fund during the past two years.
24 See Investment Company Institute, Report of the Advisory Group on Best Practices for Fund Directors: Enhancing A Culture of Independence and Effectiveness (June 24, 1999), at 12-13 (“ICI Advisory Group Report”) (recommending that former officers or directors of a fund’s investment adviser, principal underwriter, or certain of their affiliates not serve as independent directors of the fund); Investment Company Institute, Resolution of the Board of Governors of the Investment Company Institute (Oct. 3, 2003) (resolving that ICI members adopt practices to disqualify persons with certain family relationships from serving as independent directors of funds) (http://www.ici.org/issues/dir/03_fund_gov_best_stmt.html).
25 The annual self-assessment performed by the board under the amended rules also may enable independent directors to identify subject areas, such as valuation of portfolio securities, in which the board needs future independent directors to have expertise. See infra Section III.C.
26 See supra note 9.
27 The fund governance conditions of the Exemptive Rules apply to investment companies, including registered investment companies and business development companies, if they rely on these rules.
28 Rule 0-1(a)(7) [17 CFR 270.0-1(a)(7)], which defines the term “fund governance standards,” incorporates the following fund governance requirements with which funds have had to comply since 2001 in order to rely upon any of the Exemptive Rules: (i)�a fund’s board must have a majority of independent directors, (ii)�the fund’s independent directors must select and nominate any other independent directors, and (iii)�any person acting as legal counsel to the independent directors must be an “independent legal counsel.” See 2001 Adopting Release, supra note 2. The majority independence condition also is being revised to a 75 percent independence condition.
29 We are also adopting technical amendments to rule 10f-3 to revise certain cross-references within the rule.
31 We received approximately 98 comments on this proposed amendment. Comments were submitted from investors, directors (both interested and independent), funds, trade associations, and fund service providers.
32 See, e.g., Letter from Tom Walker to Jonathan G. Katz, Secretary, SEC (Mar. 9, 2004), File No. S7-03-04 (recommending that fund boards be completely independent); Letter from John and Judy Hesselberth to Jonathan G. Katz, Secretary, SEC (Feb. 24, 2004), File No. S7-03-04 (recommending that the percentage be 100%).
33 See, e.g., Letter from Association for Investment Management and Research to Jonathan G. Katz, Secretary, SEC (Mar. 19, 2004), File No. S7-03-04.
34 See, e.g., Letter from John E. Murray, Jr., Lead Director, The Federated Funds, to Jonathan G. Katz, Secretary SEC (Mar. 11, 2004), File No. S7-03-04 (“Murray Letter”). A few commenters recommended that the independence requirements established by the Investment Company Act be tightened. Letter from Independent Directors of the Vanguard Funds to Jonathan G. Katz, Secretary, SEC (Mar. 10, 2004), File No. S7-03-04. See section 2(a)(19) (definition of “interested person”).
35 Consumer Federation Letter, supra note 4. See also Letter from David Certner, Federal Affairs, AARP, to Jonathan G. Katz, Secretary, SEC (Mar. 12, 2004), File No. S7-03-04 (“Certner Letter”) (“By requiring that three-quarters of board members -- including the chairman -- be independent, the proposed rule helps to ensure that this oversight function will be controlled by individuals whose sole obligation is to ensure that shareholders' interests are protected”).
36 As we noted when we proposed these amendments, section 15(f) of the Act, which provides a safe harbor for the sale of an advisory business, requires that fund directors who are independent of the adviser constitute at least 75 percent of the fund board for three years following the assignment of the advisory contract, and that no unfair burden be imposed on the fund. 15 U.S.C. 80a-15(f). This increased independence of the board was designed to help protect the fund from receiving unfair treatment in circumstances involving potential conflicts of interest. See S. Rep. No. 75, 94th Cong., 1st Sess. 140 (1975) (“These conditions are designed to prevent any unfair burden from being imposed on the investment company in connection with such a transaction.”). Because the Exemptive Rules permit certain transactions that involve potential harm to the fund as a result of conflicts of interest, see supra notes 10-11 and accompanying text, we anticipate that a 75 percent level of independence will similarly equip fund boards to monitor and guard against such harms in connection with the activities of the fund undertaken in reliance on those Rules.
37 As one commenter noted, a 75 percent level can be more effective than a simple majority in ensuring control of the board by independent directors if one or more independent directors are absent from a board meeting. See Consumer Federation Letter, supra note 4 (“[I]f one or more of the independent directors has a mediocre attendance record, the majority [of independent directors] may in reality function as a minority.”).
38 Control of the board and its agenda by fund management can hinder the ability of the directors to oversee the fund’s operations under the Exemptive Rules. See, e.g., Repurchase Offers by Closed-End Management Investment Companies, Investment Company Act Release No. 19399 (Apr. 7, 1993) [58 FR 19330 (Apr. 14, 1993)] (noting the need for active independent director involvement in the oversight of rule 23c-3 because the determination of the amount of each repurchase offer presents a potential conflict of interest between the investment adviser and shareholders: the investment adviser may be interested in making a small repurchase offer in order to retain maximum assets under management).
41 See, e.g., Certner Letter, supra note 35. See also Letter from James J. McMonagle to William H. Donaldson, Chairman, SEC (Jan. 14, 2004), File No. S7-03-04 (“McMonagle Letter”); Letter from Patricia Rizzolo to Jonathan G. Katz, Secretary, SEC (Feb. 24, 2004), File No. S7-03-04.
42 See supra note 11.
43 See 2001 Adopting Release, supra note 2. See also S. Rep. No. 76-1775, at 6-7 (1940); S. Rep. No. 91-184, at 5-6 (1969); Division of Investment Management, Protecting Investors: A Half Century of Investment Company Regulation 255-263 (1992).
44 See supra note 4.
45 See supra note 9 (describing the responsibilities of fund directors and independent directors to oversee fund activities pursuant to the Exemptive Rules).
46 A number of our Exemptive Rules require the board to address the fund’s activities in circumstances involving these conflicts of interest. See, e.g., rule 12b-1(b)(2) (requiring the fund board to approve the plan for using fund assets to pay for the distribution of fund shares); Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)] (noting the conflicts of interest between the fund and its adviser when fund assets are used for distribution of shares); rule 17a-8 (requiring directors to request and evaluate information reasonably necessary to determine that the merger of the fund with an affiliated fund is in the fund’s best interests, and to determine that the interests of fund shareholders will not be diluted as a result of the merger); Investment Company Mergers, Investment Company Act Release No. 25666 (July 18, 2002) [67 FR 48511 (July 24, 2002)] (discussing some of the factors that directors should consider in approving affiliated fund mergers); rule 15a-4 (permitting temporary contract between fund and investment adviser without shareholder approval); Temporary Exemption for Certain Investment Advisers, Investment Company Act Release No. 23325 (July 22, 1998) [63 FR 40231 (July 28, 1998)] at text accompanying notes 24-25 (noting the responsibility of the board under rule 15a-4 to determine that the scope and quality of services under the temporary contract are at least equivalent to those under the previous contract, and noting that the board is empowered to terminate the temporary contract upon short notice, in order to allow it to act quickly if advisory services decline in quality).
47 See Letter from Anne J. Mills, Trustee, to Jonathan G. Katz, Secretary, SEC (Feb. 2, 2004), File No. S7-03-04 (stating that while appointing a lead independent director has improved involvement of independent trustees, “it is still difficult to influence the Board meeting agenda to assure full discussion of the more important items. Having an independent chair will significantly change the dynamics of the board meetings.”); Letter from Ashok N. Bakhru, Chairman of the Board and Independent Trustee, Goldman Sachs Trust and Goldman Sachs Variable Insurance Trust, to Jonathan G. Katz, Secretary, SEC (Mar. 9, 2004), File No. S7-03-04 (supporting the amendment and adding that “It has been our experience that the chairman can provide an important and meaningful role in the preparation of board agenda and in fostering the dialogue between fund management and the independent directors on fund-related matters.”).
48 See Letter from Investment Company Institute to Jonathan G. Katz, Secretary, SEC (March 10, 2004), File No. S7-03-04; Murray Letter, supra note 34.
49 See Letter from F. Pierce Linaweaver, Chairman of the Committee of Independent Directors, T. Rowe Price Mutual Funds, to Jonathan G. Katz, Secretary, SEC (Feb. 25, 2004), File No. S7-03-04.
50 See Letter from Chairman Michael G. Oxley, House Committee on Financial Services, to William H. Donaldson, Chairman, SEC (May 20, 2004), File No. S7-03-04 (“I believe the Commission's independent chairman proposal would eradicate the self-dealing by interested, management-affiliated chairmen and its harmful effects on mutual fund shareholders.”) (“Chairman Oxley Letter”).
51 We received a particularly insightful comment letter from a fund independent director who stated that his board’s appointment of an independent chairman was instrumental in causing the board to switch fund advisers. See McMonagle Letter, supra note 41 (stating that the mutual fund of which the author was an independent director changed the advisory contract from one adviser to another, and observing that “[i]f the Chairman of the [mutual fund’s board] had not been independent, I am satisfied that we would not have moved the advisory contract.”) (emphasis omitted). See also Letter from David S. Ruder, Chairman, and Allan S. Mostoff, President and Treasurer, Mutual Fund Directors Forum, to Jonathan G. Katz, Secretary, SEC (May 14, 2004), File No. S7-03-04 (stating that the Mutual Fund Directors Forum will recommend as a best practice that fund boards be chaired by an independent director, because that approach would enhance the power and authority of independent directors and eliminate the chairman’s conflicts of interest).
52 We are not aware of any conclusive research that demonstrates that the hiring of an independent chairman will improve fund performance or reduce expenses, or the reverse. Commenters did not refer us to any pre-existing studies that spoke to this issue. One commenter submitted a study that it commissioned in response to the proposal, that sought to ascertain a correlation between independent chairmen and the performance and expenses of funds. With regard to performance, the study found a correlation between funds with management chairmen and higher performance. The study noted, however, that this correlation may be due to “other important differences [than independence of the chairmen] that may have impacted performance results,” such as the prevalence of independent chairmen among bank-sponsored fund groups. With regard to fund expenses, the study found, depending on the method of calculation, lower (but not statistically significant) expenses associated with independent chairmen funds, or higher expenses for those types of funds. The study stated that the expense analysis comparisons were less clear than with the performance results, and “differ considerably depending on what expense measure is used.” See Geoffrey H. Bobroff and Thomas H. Mack, Assessing the Significance of Mutual Fund Board Independent Chairs, A Study for Fidelity Investments (Mar. 10, 2004) (attached to Letter from Eric D. Roiter, Senior Vice President and General Counsel, Fidelity Management & Research Company to Jonathan G. Katz, Secretary, SEC (Mar. 18, 2004), File No. S7-03-04)). On the other hand, some commenters viewed the data differently and concluded that “[i]ndependently-chaired funds did only slightly better in terms of returns, but at lower cost …. Even accepted at face value, Fidelity’s data constitute muddy and unpersuasive evidence for continuing to allow senior management company officials to sit in the fund chairman’s chair.” Remarks by John C. Bogle, Founder and Former CEO, The Vanguard Group, before the Institutional Investor Magazine Mutual Fund Regulation and Compliance Conference (May 5, 2004), File No. S7-03-04. See also Letter from John A. Hill, Chairman, The Putnam Funds, to William H. Donaldson, Chairman, SEC (May 12, 2004), File No. S7-03-04.
53 See Ira M. Millstein and Paul W. MacAvoy, Proposals for Reform of Corporate Governance, in The Recurrent Crisis in Corporate Governance 95, 119 (2003) (“The first important initiative is for the [corporate] board … to develop an identified independent leadership, by separating the roles of chairman of the board and CEO and appointing an independent director as chairman. Independent leadership is critical to positioning the board as an objective body distinct from management. … The board cannot function without leadership separate from the management it is supposed to monitor. On behalf of the shareholders, the board must be enabled to obtain the information necessary to monitor… the performance of management ….”). See also Consumer Federation Letter, supra note 4 (“In light of the fact that the board’s chief responsibility is to police conflicts of interest and ensure that shareholders’ interests are protected, it is also symbolically important that the chairman be independent. Putting a representative of the investment adviser in this position creates the appearance, and inevitably in some cases, the reality, that the fox is guarding the henhouse.”).
54 One commenter, however, provided statistics indicating that a large majority of mutual fund families implicated in recent scandals have had management-affiliated chairmen at some point during the alleged or admitted violations. Chairman Oxley Letter, supra note 50.
55 See Compliance Programs, supra note 7.
56 Section 15 requires that fund directors, including a majority of independent directors, approve the fund’s advisory contract each year. The directors must approve the advisory contract initially, and annually thereafter if it continues in effect for more than two years. Section 15(a) and (c) of the Act [15 U.S.C. 80a-15(a) and (c)]. It also requires that the directors first obtain from the adviser the information reasonably necessary to evaluate the contract so that directors would have adequate information upon which to base their decision about the advisory contract generally and the advisory fee in particular. Section 15(c) of the Act [15 U.S.C. 80a-15(c)].
57 See ICI Advisory Group Report, supra note 24, at 25 (recommending that independent directors designate one or more lead independent directors).
58 See Letter from Fergus Reid III to William H. Donaldson, Chairman, SEC (May 18, 2004), File No. S7-03-04 (“The Lead Director concept is flawed – A lead director is immediately at a disadvantage when dealing with a strong interested chairman. To assert him or herself, the lead director must oppose or go around the wishes of an interested chairman. This creates tension and ill will and is rarely politically expedient”). The by-laws of some funds may state that the board chairman is an officer of the fund. Under the amendments we are adopting today, a fund in those circumstances that relies on an Exemptive Rule would need to amend its by-laws, because an officer of the fund is an interested person of the fund. See section 2(a)(19)(A)(i) of the Act [15 U.S.C. 80a-2(a)(19)(A)(i)] (definition of “interested person”). Funds whose by-laws do not contain such a requirement also may wish to amend their by-laws to require that the chairman be an independent director, as a good corporate practice, to help ensure that a fund relying upon any Exemptive Rule satisfies these fund governance standards. In either case, funds would have to disclose the appointment of any new chairman and the changes to by-laws in their filings with the Commission.
59 See Consumer Federation Letter, supra note 4.
60 Rule 0-1(a)(7)(iv) provides that a fund may rely on an Exemptive Rule only if an independent director serves as chairman of the board of directors of the fund, presides over meetings of the board of directors and has substantially the same responsibilities as would a typical chairman of a board of directors. In response to the amendments we are adopting today, some funds might be tempted to circumscribe the role of the independent chairman to preserve the current role of an interested board chairman. We caution against such action, which may result in the loss of multiple exemptions from provisions of the Act and multiple violations of the Act. For example, a fund could not designate an interested director to preside over meetings or set meeting agendas, or name an interested director as a “co-chairman” of the board. We would not, however, consider temporary performance of a chairman’s duties (e.g., due to a chairman’s illness or inability to attend) by an interested director (e.g., by a vice chairman) as a failure to meet the requirements of rule 0-1(a)(7)(iv).
62 The requirement is designed to focus the board’s attention on the need to create, consolidate or revise the various board committees, such as the audit, nominating or pricing committees, and to facilitate a critical assessment of the effectiveness of current board committees.
63 See Proposing Release, supra note 2, at n.37.
65 We anticipate that the frank and candid discussion among the independent directors also would cover the fund’s activities pursuant to the Exemptive Rules. The independent directors, for example, could discuss the use of fund assets to pay for the distribution of fund shares under rule 12b-1 and the fund’s 12b-1 plan adopted by the board. See supra note 46.
66 See rule 0-1(a)(7)(vii). The amendment does not require independent directors to hire employees or retain advisers or experts.
67 Some of the Exemptive Rules, for example, require that fund directors oversee complex transactions. See, e.g., rule 10f-3 (permitting funds to purchase securities in a primary offering when an affiliated broker-dealer is a member of the underwriting syndicate if the fund’s board, including a majority of its independent directors, (i) approves procedures regulating purchases of these securities and (ii) determines at least quarterly that the purchases complied with the board-approved procedures). The rules also require directors of funds relying on the rules to exercise vigilance in protecting funds and their investors. See, e.g., Exemption for the Acquisition of Securities During the Existence of an Underwriting or Selling Syndicate, Investment Company Act Release No. 22775 (July 31, 1997) [62 FR 42401 (Aug. 7, 1997)], at n.52 and accompanying text (the fund’s board should be “vigilant” not only in reviewing the fund’s compliance with the procedures required by rule 10f-3, but also “in conducting any additional reviews that it determines are needed to protect the interests of investors”). Directors may need to hire staff to help conduct these reviews.
68 One of the most useful advisers independent directors should consider engaging is their own counsel. Although we are not requiring independent directors to have their own counsel, we agree with the American Bar Association’s view that “[t]he complexities of the Investment Company Act, the nature of the separate responsibilities of independent directors and the inherent conflicts of interest between a mutual fund and its managers effectively require that independent directors seek the advice of counsel in understanding and discharging their special responsibilities.” American Bar Association, Report of the Task Force on Independent Director Counsel, Subcommittee of Investment Companies and Investment Advisers, Committee on Federal Regulation of Securities, Section of Business Law: Counsel to the Independent Directors of Registered Investment Companies at 3 (Sept. 8, 2000). See generally James D. Cox, Symposium: Lessons from Enron, How Did Corporate and Securities Law Fail? Managing and Monitoring Conflicts of Interests: Empowering the Outside Directors with Independent Counsel, 48 Vill. L. Rev. 1077 (2003). If independent directors do hire their own counsel, and their fund relies on any of the Exemptive Rules, such counsel must be an “independent counsel.” Rule 0-1(a)(7)(iii).
69 See rule 31a-2(a)(6). See also supra note 56 and accompanying text.
70 We did not receive specific comment on the detailed questions on which we sought comment pursuant to section 31(a)(2) of the Act [15 U.S.C. 80a-30(a)(2)], i.e., whether there are feasible alternatives to the proposed amendment that would minimize the recordkeeping burdens, the necessity of these records in facilitating the examinations carried out by our staff, the costs of maintaining the required records, and any effects that the proposed recordkeeping requirements would have on firms’ internal compliance policies and procedures. We have nevertheless considered those issues in the course of adopting this recordkeeping rule amendment. We do not believe that there are any feasible alternatives to the amendment that would minimize recordkeeping burdens, and, as discussed above, the records are necessary to facilitate the examinations carried out by our staff. Finally, we are not aware of any adverse effects that the recordkeeping requirement will have on the nature of firms’ internal compliance policies and procedures. In fact, we anticipate that the recordkeeping requirement will facilitate fund internal compliance programs because the fund’s compliance staff will be able to monitor the information on which directors rely in approving the fund’s advisory contract.
71 After the effective date but before the compliance date of the amendments, a person that relies on an Exemptive Rule must continue to meet the fund governance requirements of the Exemptive Rules we adopted in 2001 concerning a majority of independent directors, independent director self-selection and self-nomination, and independent legal counsel. See Proposing Release, supra note 2.
72 44 U.S.C. 3501 to 3520.
73 In the Proposing Release, we estimated that 5,124 funds would incur costs under this requirement. To calculate these costs, our staff used $18.92 per hour as the average cost of clerical time. We now estimate that there are 5,132 registered funds that may incur costs under this amendment.
74 See Letter from James H. Bodurtha, Chair, Directors’ Committee, Investment Company Institute, to Jonathan G. Katz, Secretary, SEC (Mar. 10, 2004), File No. S7-03-04 (stating that “We believe that the retention costs should be minimal and should not be a consideration in the implementation of this proposal. Requiring retention, in our opinion, will not change practices in terms of the volume of information requested by directors in connection with their review of the advisory contract.”) (“ICI Letter”).
75 For a more complete discussion of the benefits to shareholders and boards in overseeing a fund’s activities under the Exemptive Rules, see supra Section III.
76 The majority of commenters generally agreed that increasing the independence of fund boards was beneficial to fund shareholders. Some commenters recommended that the percentage of independent directors be greater than 75 percent or that the conditions for being an independent director be stricter.
77 Commenters were divided as to the relative benefits of this requirement. See supra text following note 40.
78 As indicated in the Proposing Release, our staff estimated that nearly sixty percent of all funds currently meet this requirement. See Proposing Release, supra note 2.
79 Under some circumstances a vacancy on the board may be filled by the board of directors. See section 16(a) of the Investment Company Act [15 U.S.C. 80a-16(a)].
80 With respect to the requirements related to independent selection and nomination of other independent directors and independent legal counsel, this amendment incorporates the current requirements of the Exemptive Rules, and therefore these amendments do not impose new costs.
81 There may, however, be indirect costs associated with these provisions. An independent chairman, for example, may choose to hire staff for assistance in carrying out his or her responsibilities as chairman. We have no reliable basis for estimating those costs.
82 For purposes of the Paperwork Reduction Act, our staff estimates that each fund would spend approximately 0.5 hours annually maintaining records of documents reviewed by fund boards when approving advisory contracts. See Proposing Release, supra note 2, at Section IV.
83 See ICI Letter, supra note 74.
84 See Proposing Release, supra note 2, at Section VI.
85 These commenters defined small entities as entities with assets ranging from assets under $218 million to assets under $100 million, as opposed to assets under $50 million.
86 These amendments that we proposed and are adopting, however, do not require independent directors to retain independent legal counsel or to hire staff for independent directors, nor do these amendments require funds to increase the size of their boards.
88 Some or all of these entities may contain multiple series or portfolios. If a registered investment company is a small entity, the portfolios or series it contains are also small entities.
89 We now estimate that there are 5,132 registered funds, of which 233 are small entities. As discussed in the Proposing Release, our staff estimates that approximately 90 percent of all registered investment companies, or 4,619 funds, rely on at least one Exemptive Rule. If 90 percent of all small entities rely on at least one Exemptive Rule, then approximately 210 funds that are small entities would rely on at least one Exemptive Rule and would therefore be affected by the amendments to the Exemptive Rules. See Proposing Release, supra note 2.
90 If the board consists of three directors, however, the board need only include two independent directors.
91 We estimate that 30 funds that are small entities have boards with only three directors.
As the release indicates, although the benefits of the amendments are difficult to quantify, a majority of the Commission “believe[s] they are real.”3 The majority postulates that the new independence requirements will “strengthen the hand of the independent directors when dealing with fund management, and may assure that independent directors maintain control of the board and its agenda.”4 However, despite the existence of empirical data that could have been analyzed to evaluate potential benefits, the proponents provided no such analysis. Moreover, the majority speculates sanguinely that the benefits of these amendments will come at “minimal” cost to funds.5 Positing that empirical evidence is unnecessary, the majority dismisses pleas for more deliberate action.6 A particular standard of independence is not, in and of itself, a legitimate regulatory objective. Therefore, before we mandate that all funds meet any particular independence standard, it must be objectively linked (by more than anecdotal evidence and “gut impression”) to real benefits for shareholders.
The existing independence requirements already enable independent directors to set the agenda and determine the outcome of decisions made by the board.13 As the Commission noted three years ago, a majority requirement is sufficient to “permit, under state law, the independent directors to control the fund’s ‘corporate machinery,’ i.e., to elect officers of the fund, call meetings, solicit proxies, and take other actions without the consent of the adviser.”14 “[I]ndependent directors who comprise the majority of a board can have a more meaningful influence on fund management and represent shareholders from a position of strength.”15 A majority of independent directors also can insist, if they determine that it would be beneficial, on an independent chairperson.
The majority’s choice of seventy-five percent is puzzling. The majority points to the only section in the Investment Company Act that dictates this percentage, section 15(f).18 The majority does not explain that section 15(f) is a safe harbor provision that “make[s] clear that an investment adviser can make a profit on the sale of its business subject to two principal safeguards to protect the investment company and its shareholders.”19 Congress did not intend for it to serve as a universally-applicable requirement for fund boards.
A fact largely ignored by this rulemaking is that independent directors are not the only ones charged with protecting the interests of fund shareholders. An investment adviser has a fiduciary duty to act in the best interests of a fund it advises.31 Further, all fund directors have a fiduciary duty to shareholders.32 It is true that fund managers serve two constituencies -- shareholders of the adviser and shareholders of the fund. The interests of these two groups are not, however, entirely at odds. Interested fund directors have an incentive to maximize fund performance because good performance matters to fund investors, who factor it into their investment decisions. Thus, market forces compel fund advisers to offer fund shareholders good performance for a reasonable fee in order to preserve the integrity and hence, marketability, of its brand. This rulemaking overlooks these market forces and seems to suggest that there is no counterweight to the pressure to impose fees on the fund.
Concluding nonetheless that investors would benefit from an independent chairperson, the majority ignores the costs fund investors will bear by the adoption of this requirement.33 The majority did not identify “any out-of-pocket costs” associated with the independent chairperson requirement. Yet an estimated eighty percent of funds will need a new chairperson. If a sitting independent director accepts the position, the fund will need to pay him more to accept the new responsibilities.34 If none of the sitting independent directors wants the job or none is qualified,35 the fund will need to launch an expensive search. It may be difficult for funds to find an individual with the requisite industry experience whom they can afford to hire.
Under the cover of “good atmospherics” and the shroud of “investor protection,” the majority has decided to adopt measures the benefits of which are illusory, but the costs of which are real. We conclude that the majority has not justified this forced restructuring of the corporate governance of the vast majority of funds and fear that it provides investors with a false sense of security.
For the foregoing reasons, we respectfully dissent.
1 The change is effected by making these governance requirements conditions of ten commonly used exemptive rules. Because these rules are used by virtually all funds, these requirements are effectively universally applicable.
2 See, e.g., Securities and Exchange Commission, Invest Wisely: An Introduction to Mutual Funds (available at: http://www.sec.gov/investor/pubs/inwsmf.htm#key) (“Even small differences in fees can translate into large differences in returns over time. For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5%, then you would end up with $60,858 — an 18% difference.”).
3 See Section VI.A of the Adopting Release (“Benefits”).
4 See Adopting Release, text accompanying note 75.
5 See Section VIII of the Adopting Release (Consideration of Promotion of Efficiency, Competition and Capital Formation”).
6 See Securities and Exchange Commission, Open Meeting Webcast, June 23, 2004 (available at: http://www.sec.gov/news/openmeetings.shtml) (dissenting views on the value of empirical data).
7 See section 10(a). 15 U.S.C. 80a-10(a). Congress initially considered, but later rejected a majority independence requirement because of concerns “that if a person is buying management of a particular person and if the majority of the board can repudiate his advice, then in effect, you are depriving the stockholders of that person’s advice.” Investment Trusts and Investment Companies: Hearings on H.R. 10065 Before the House Subcomm. on Interstate and Foreign Commerce, 76th Cong., 3d Sess. 109-110 (1940) (testimony of David Schenker). Since approximately 90 percent of funds utilize these exemptive rules, the majority is effectively mandating these changes for all funds. See Adopting Release at note 88. Given the clearly stated, legislatively prescribed independence mandates, we question whether the Commission is acting outside its authority under the Investment Company Act.
8 15 U.S.C. 80a-10(b)(2). See also section 10(c) (a majority of the board of a registered investment company may not consist of persons who are officers, directors, or employees of any one bank or bank holding company).
9 15 U.S.C. 80a-15(c). See also section 32(a)(1) of the Act (a fund’s auditor must be selected by the vote of a majority of the fund’s independent directors).
10 Rule 17a-7, for example, requires that fund directors, including a majority of the independent directors, determine at least quarterly that all affiliated purchase and sale transactions were made in compliance with procedures adopted by the board, including a majority of the independent directors. 17 CFR 270.17a-7.
11 Role of Independent Directors of Investment Companies, Investment Company Act Release No. 24816 (Jan. 2, 2001) [66 FR 3734 (Jan. 16, 2001)] (“2001 Adopting Release”).
12 See Adopting Release at note 8.
13 Last year, the staff noted the power already possessed by fund independent directors: “[A]lmost all funds have boards with at least a majority of independent directors. Thus, one could question whether there is a need to mandate that a fund’s chairman be independent because independent directors representing a majority of a fund’s board already are in a position to control the board and, if they deemed it appropriate, could already influence the agenda and the flow of information to the board.” Memorandum from Paul F. Roye, Director, Division of Investment Management, to William H. Donaldson, Chairman, SEC, re Correspondence from Chairman Richard H. Baker, House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, at 50 (June 9, 2003) (available at: http://financialservices. house.gov/media/pdf/02-14-70%20memo.pdf) (“Baker Memorandum”).
14 2001 Adopting Release at text accompanying note 22.
15 2001 Adopting Release at text accompanying note 23.
16 See Section II.C of the Adopting Release.
17 “Independent director” is a term commonly used to refer to a director who is not an “interested person” as defined in section 2(a)(19). 15 U.S.C. 80a-2(a)(19). The Commission, of course, would need to petition Congress for such a change. Indeed, last year the staff asked Congress to consider revising section 2(a)(19) of the Act to give the Commission “rulemaking authority to fill gaps in the statute that have permitted persons to serve as independent directors despite relationships that suggest a lack of independence from fund management.” See Baker Memorandum, supra note 13, at 47.
18 15 U.S.C. 80a-15(f). Section 15(f) requires funds to maintain boards comprising at least seventy-five percent independent directors for the three-year period after an adviser has sold its advisory business to another entity. This provision was added by Congress to limit the effects of Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 1971). In that case, the court had held that it was a violation of an adviser’s fiduciary duty to transfer an advisory contract to another adviser for profit.
19 Committee on Banking, Housing and Urban Affairs, Report No. 94-75 to Accompany S. 249 (Apr. 14, 1975).
20 See Investment Company Institute, Report of the Advisory Group on Best Practices for Fund Directors: Enhancing a Culture of Independence and Effectiveness at 10-12 (June 24, 1999) (available at: http://www.ici.org/pdf/rpt_best_practices.pdf).
21 See 2001 Adopting Release at note 25. The majority, conceding that “there are good arguments for maintaining a management presence on the board,” portrays itself as reasonable because it rejected the higher independence percentages recommended by some commenters. See Adopting Release at note  and accompanying text (citing Letter of Tom Walker to Jonathan G. Katz, Secretary, SEC (Mar. 9, 2004), File No. S7-03-04 (“While your changes are moving in the right direction in advocating for a more independant [sic] boards. I believe it still allows for too much room for cornyism [sic] and nepotism to play out on what should be truley [sic] independant [sic] directors.”); Letter of John and Judy Hesselberth to Jonathan G. Katz, Secretary, SEC (Feb. 24, 2004), File No. S7-03-04 (“In addition the requirement that 75% of the directors of a mutual fund must be outside directors is sound. It probably should be 100%, but 75 is a step in the right direction from the current 50%.”).
22 See Letter from Craig S. Tyle, General Counsel, Investment Company Institute, to Jonathan G. Katz, Secretary, SEC (Mar. 10, 2004), File No. S7-03-04 (stating that “a change from the current [common industry] practice of a two-thirds supermajority to a seventy-five percent requirement would mean that at least half of all fund boards would have to change their current composition, according to Institute data.”).
23 Adopting Release at text accompanying note  (footnote omitted).
24 A survey found that in 2002, the median compensation for independent directors at the 50 largest fund groups was $113,000 a year and at the smaller fund groups was $18,000. See Rick Miller, In Off Year, these Cats Get Fatter: Fund Board Directors Collect a Big Pay Raise, Investment News, April 7, 2003, at 1 (reporting results of a survey conducted by Management Practice Inc.). This amount, of course, does not include up-front search costs and annual non-compensation costs associated with a director’s performance of his or her duties.
25 See, e.g., Letter from Congressman Michael G. Oxley to Chairman William H. Donaldson (May 20, 2004).
26 In pointing out this and other potential benefits that an interested chairperson might bring to a fund board, we do not intend to suggest that all boards should select an interested chairperson. To the contrary, we maintain that what works well for one fund board might not work well for every other fund board. Under certain circumstances, a fund board might conclude that an independent chairperson is essential. See, e.g., Tom Lauricella, Strong Steps Down from Fund Board but Stays on as Head of Firm, Wall St. J., Nov. 3, 2003, at C12 (reporting that following Richard Strong’s resignation from his post as chairman of the board of the Strong Mutual Funds, “[t]he independent Strong directors have begun a search to replace Mr. Strong with a chairman who is independent from Strong Capital management”).
27 At the Commission Open Meeting during which the Commission voted to propose the amendments, Commissioner Glassman requested that proponents and/or staff provide empirical data that would support the amendments.
28 The application of “Total Quality Management,” the management philosophy of W. Edwards Deming, and a later variant, “Six Sigma,” would emphasize the importance of discerning whether the fund advisers’ fraudulent activity (the variation from desired results) derives from a common cause or something aberrant in a particular adviser’s management process – that is, a special cause. If common causes are to blame for the fraudulent activity, then the system is flawed and redesign is necessary. Special causes require more targeted solutions. As discussed below, the fact that funds with independent chairpersons seem proportionally implicated in this fraudulent activity indicates that the lack of an independent chairperson is not a common cause for the fraudulent activity by fund advisers. In addition, the empirical data that we have found this far supports this observation. Consequently, a redesign of the fund governance system is not indicated by the data. The majority’s redesign of the system will not, and cannot be expected to, cure the flaws of the system.
29 See Geoffrey H. Bobroff and Thomas H. Mack, Assessing the Significance of Mutual Fund Board Independent Chairs, A Study for Fidelity Investments (Mar. 10, 2004) (attached to letter from Eric D. Roiter, Senior Vice President and General Counsel, Fidelity Management & Research Company to Jonathan G. Katz, SEC (Mar. 10, 2002), File No.�S7-03-04)). In an effort to support its position and rebut challenges that it has not considered any empirical evidence, the majority laments the fact that commenters did not submit any pre-existing studies and dismisses the findings of this study, which was commissioned in response to the Commission’s request for comments on the proposed amendments. See Adopting Release at note 51. The majority’s intimation that the data must be discounted because of the “prevalence of independent chairmen among bank-sponsored fund groups” is troubling if it is intended to suggest that bank-sponsored mutual funds are inherently inferior to their non-bank counterparts. We acknowledge that one study cannot conclusively resolve the debate about independent chairpersons, but its conclusions contribute to the debate. Boards of directors, not the Commission, should weigh the evidence to decide whether an independent chairperson would be beneficial for their fund shareholders.
31 See Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 1971); Brown v. Bullock, 194 F. Supp. 207, 229, 234 (S.D.N.Y.), aff'd, 294 F.2d 415 (2d Cir. 1961). See also Section 36(b) of the Investment Company Act [15 U.S.C. 80a-35(b)] (investment adviser of a fund has a fiduciary duty with respect to the receipt of compensation paid by the fund). More generally, investment advisers owe a fiduciary duty to their clients. SEC v. Capital Gains Research Bureau, 375 U.S. 180, 191 (1963) (interpreting Section 206 of the Investment Advisers Act of 1940).
32 In addition to standard state law duties applicable to all corporate directors, fund directors have fiduciary duties under the Investment Company Act. See Section 36(a) of the Investment Company Act. 15 U.S.C. 80a-35(a).
33 See Section VI.B (“Costs”) of the Adopting Release.
34 According to one estimate, an independent chairperson could command a 25 to 50% premium over other board members. See Beagan Wilcox, Wanted: Independent Chairmen, Board IQ, July 6, 2004 (citing estimate of Meyrick Payne, senior partner, Management Practice).
35 Independent directors have “diverse backgrounds in business, government or academia.” Investment Company Institute, Understanding the Role of Mutual Fund Directors, at 6. Fund independent directors without experience in the fund industry can apply their experiences in other areas to perform their responsibilities as independent directors, but may not be adequately equipped to handle responsibilities of board chairperson.
36 Of necessity, both the independent chairperson and his or her staff are likely to be dependent on fund management and, therefore, may lose independent perspective on matters facing the board. Sir Derek Higgs recognized this in his review of corporate governance in Britain. See Derek Higgs, Review of the Role and Effectiveness of Non-Executive Directors (Jan. 2003) at 24 (explaining that, even if a chairperson is independent prior to appointment, thereafter he or she will work closely with management in carrying out his or her duties, so “[a]pplying a test of independence at this stage is neither appropriate nor necessary.“).
37 See Section VI.B (“Costs”) of the Adopting Release.
38 The majority reassures independent directors that the amendments “do not prevent the independent directors from choosing the most qualified and capable candidate.” See Adopting Release, at text following note 47. We contend that a conscientious board might reasonably determine that the most qualified and capable candidate is someone with the deep familiarity with day-to-day fund operations. The majority apparently believes they know better.
39 See Adopting Release at note 5.
40 Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings, Investment Company Act Release No. 26418 (Apr. 19, 2004) [69 FR 22300 (Apr. 23, 2004)].
41 Disclosure Regarding Approval of Investment Advisory Contracts by Directors of Investment Companies, Investment Company Act Release 26486 (June 23, 2004) [69 FR 39798 (June 30, 2004)].
42 Compliance Programs of Investment Companies and Investment Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 2003)].
43 These initiatives are described in Mandatory Redemption Fees for Redeemable Fund Securities, Investment Company Act Release No. 26375A at Section II.F (Mar. 5, 2004) [69 FR 11762 (Mar. 11, 2004)].
44 See Confirmation Requirements and Point of Sale Disclosure Requirements for Transactions in Certain Mutual Funds and Other Securities, and Other Confirmation Requirement Amendments, and Amendments to the Registration Form for Mutual Funds, Investment Company Act Release No. 26341 (Jan. 29, 2004) [69 FR 6438 (Feb. 10, 2004)] and Request for Comments on Measures to Improve Disclosure of Mutual Fund Transaction Costs, Investment Company Act Release No. 26313 (Dec. 18, 2003).
45 Amendments to Rules Governing Pricing of Mutual Fund Shares, Investment Company Act Release No. 26288 (Dec. 11, 2003) [68 FR 70388 (Dec. 17, 2003)].
46 Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26356 (Feb. 24, 2004) [69 FR 9726 (Mar. 1, 2004)].
47 In 1999, the Investment Company Institute’s Advisory Group on Best Practices for Fund Directors included among its recommendations the designation of one or more persons as a lead director. See Investment Company Institute, Report of the Advisory Group on Best Practices for Fund Directors: Enhancing a Culture of Independence and Effectiveness at 25 (June 24, 1999) (available at: http://www.ici.org/pdf/rpt_best_practices.pdf).
48 The majority acknowledged that these alternatives could be useful, but explained that funds would have difficulty finding persons of “sufficient stature” to act as “an effective counterweight to a fund chairman who may also be the chief executive officer of the management company.” See Adopting Release at text accompanying note 57. We question whether funds will find it easier to fill the position of independent chairperson with a person able both to act as an “effective counterweight” and also to fulfill the routine administrative responsibilities of running a fund board.

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