[Federal Register Volume 69, Number 15 (Friday, January 23, 2004)]
[Proposed Rules]
[Pages 3472-3482]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-1323]



[[Page 3471]]

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Part III





Securities and Exchange Commission





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17 CFR Part 270



Investment Company Governance; Proposed Rule

  Federal Register / Vol. 69, No. 15 / Friday, January 23, 2004 / 
Proposed Rules  

[[Page 3472]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-26323; File No. S7-03-04]
RIN 3235-AJ05


Investment Company Governance

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing amendments to rules under the Investment Company Act of 1940 
to require registered investment companies (``funds'') to adopt certain 
governance practices. The proposed amendments, which apply to funds 
relying on certain exemptive rules, 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: Comments must be received on or before March 10, 2004.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by one method only. Comments in 
paper format should be submitted in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street NW., 
Washington, DC 20549-0609. Comments in electronic format should be 
submitted to the following E-mail address: [email protected]. All 
comments should refer to File No. S7-03-04; if E-mail is used, this 
file number should be included on the subject line. Comment letters 
will be available for public inspection and copying in the Commission's 
Public Reference Room, 450 Fifth Street NW., Washington, DC 20549. 
Electronically submitted comment letters will be posted on the 
Commission's Internet web site (http://www.sec.gov.) \1\
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    \1\ We do not edit personal, identifying information, such as 
names or E-mail addresses, from electronic submissions. Submit only 
information you wish to make publicly available.

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, 
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450 Fifth St. NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to: 
rules 0-1(a) [17 CFR 270.0-1(a)]; 10f-3(c)(11) [17 CFR 270.10f-
3(c)(11)]; 12b-1(c) [17 CFR 270.12b-1(c)]; 15a-4(b)(2)(vii) [17 CFR 
270.15a-4(b)(2)(vii)]; 17a-7(f) [17 CFR 270.17a-7(f)]; 17a-8(a)(4) [17 
CFR 270.17a-8(a)(4)]; 17d-1(d)(7)(v) [17 CFR 270.17d-1(d)(7)(v)]; 17e-
1(c) [17 CFR 270.17e-1(c)]; 17g-1(j)(3) [17 CFR 270.17g-1(j)(3)]; 18f-
3(e) [17 CFR 270.18f-3(e)]; 23c-3(b)(8) [17 CFR 270.23c-3(b)(8)]; and 
31a-2 [17 CFR 270.31a-2] under the Investment Company Act of 1940 [15 
U.S.C. 80a] (the ``Investment Company Act'' or the ``Act'').\2\
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    \2\ Unless otherwise noted, all references to statutory sections 
are to the Investment Company Act of 1940.
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Table of Contents

I. Background
II.Discussion
    A. Board Composition
    B. Independent Chairman of the Board
    C. Annual Self-Assessment
    D. Separate Sessions
    E. Independent Director Staff
    F. Recordkeeping for Approval of Advisory Contracts
III. General Request for Comments
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Initial Regulatory Flexibility Analysis
VII. Efficiency, Competition and Capital Formation
Statutory Authority
Text of Proposed Rules

I. Background

    Investment companies typically are formed as corporations or 
business trusts under state law and, like other business organizations, 
must be operated for the benefit of their shareholders. Under the 
Investment Company Act, each fund must have a board of directors, which 
is elected by shareholders to represent their interests. Fund boards 
are fully empowered with authority to manage all of the fund's affairs, 
although most delegate management responsibility to the fund adviser 
over whom they retain oversight responsibility.
    In 2001, we recognized the need to improve governance standards and 
adopted rules to improve the effectiveness of the independent directors 
\3\ and their ability to deal with fund managers.\4\ These rules, which 
apply to funds relying on certain of our exemptive rules, require that 
boards have a majority of independent directors, that independent 
directors select and nominate independent directors, and that 
independent directors, when they hire counsel, hire only counsel that 
does not have substantial ties to fund managers.\5\ The rules required 
funds to make modest improvements to their governance practices.
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    \3\ We refer to directors who are not ``interested persons'' of 
the fund as ``independent directors'' or ``disinterested 
directors.'' The term ``interested person'' is defined in section 
2(a)(19) [15 U.S.C. 80a-2(a)(19)] of the Investment Company Act.
    \4\ 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'').
    \5\ See, e.g., rule 12b-1(c) [17 CFR 270.12b-1(c)].
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    Recent events, however, suggest we need to revisit the governance 
of funds. We and state regulators have brought a number of enforcement 
actions involving late trading, inappropriate market timing activities 
and misuse of nonpublic information about fund portfolios.\6\ These 
enforcement actions reflect a serious breakdown in management controls 
in more than just a few mutual fund complexes. In each case, the fund 
was used for the benefit of fund insiders rather than fund 
shareholders. In this respect, the enforcement cases bear a striking 
similarity to the abuses that led to the enactment of the Investment 
Company Act.\7\
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    \6\ See, e.g., In the Matter of Alliance Capital Management, 
L.P., Investment Company Act Release No. 26312 (Dec. 18, 2003) 
(``Alliance Capital Management'') (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, 
Investment Company Act Release No. 26232 (Nov. 13, 2003) (``Putnam 
Investment Management'') (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 Connelly, 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 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).
    \7\ See Sen. Rep. No. 76-1775, at 6 (1940) (``[C]ontrol of 
[investment companies] offers manifold opportunities for 
exploitation by the unscrupulous managements of some companies. 
[Investment company] assets can and have been easily misappropriated 
and diverted by such types of managements, and have been employed to 
foster their personal interests rather than the interests of the 
public security holders.''). See also section 1(b)(2) [15 U.S.C. 
80a-1(b)(2)] (finding that the interests of investors are adversely 
affected when funds are organized, operated and managed in the 
interest of fund insiders).
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    The Investment Company Act relies heavily on fund boards of 
directors to manage conflicts of interest that the

[[Page 3473]]

fund adviser inevitably has with the fund. The effectiveness of a fund 
board and the influence of its independent directors depend on both the 
quality of the directors and the governance practices they adopt. Our 
concern is that in many fund groups, including some of the fund 
complexes that have been the subject of our enforcement cases, the fund 
adviser exerts a dominant influence over the board. Because of its 
monopoly over information about the fund and its frequent ability to 
control the board's agenda, the adviser is in a position to attempt to 
impede directors from exercising their oversight role. In some cases, 
boards may have simply abdicated their responsibilities, or failed to 
ask the tough questions of advisers;\8\ in other cases, boards may have 
lacked the information or organizational structure necessary to play 
their proper role.\9\
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    \8\ See, e.g., In the Matter of Hammes, Investment Company Act 
Release No. 26290 (Dec. 11, 2003) (directors of Heartland Funds 
negligently failed to adequately monitor the liquidity of the Funds 
and to take adequate steps to address the Funds' pricing 
deficiencies, and failed to inquire beyond the self-serving answers 
and misrepresentations they received from the advisers regarding the 
board's concerns). One Commissioner believed that the Heartland 
Funds directors' conduct was reckless or knowing. See In the Matter 
of Hammes, Investment Company Act Release No. 26290A (Jan. 7, 2004). 
(Commissioner Roel C. Campos dissenting as to the Commission's 
acceptance of the Heartland Funds directors' settlement offer, on 
the basis that it charged only negligence or non-scienter based 
fraud and because imposition of a cease-and-desist order was 
insufficient to address the conduct).
    \9\ In order to get fund boards the information they need to 
oversee fund compliance, we recently adopted rules requiring 
appointment of a chief compliance officer reporting directly to the 
fund board. New rule 38a-1 will require fund boards (including 
independent directors) to (i) approve the compliance policies and 
procedures of the fund and its service providers; (ii) designate, 
and approve the compensation of, the compliance officer; (iii) 
approve the removal of the chief compliance officer; and (iv) review 
the compliance officer's annual report and meet separately with the 
compliance officer. Compliance Programs of Investment Companies and 
Investment Advisers, Investment Company Act Release No. 26299 (Dec. 
17, 2003) [68 FR 74714 (Dec. 24, 2003)] (``Compliance Adopting 
Release'').
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    Management-dominated boards may be less likely to effectively 
undertake the many important responsibilities assigned to them.\10\ The 
breakdown in fund management and compliance controls evidenced by our 
enforcement cases raises troubling questions about the ability of many 
fund boards, as presently constituted, to effectively oversee the 
management of funds.\11\ The failure of a board to play its proper role 
can result, in addition to serious compliance breakdowns, in excessive 
fees and brokerage commissions, less than forthright disclosure, 
mispricing of securities, and inferior investment performance.
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    \10\ The Investment Company Act places specific responsibilities 
on fund boards and the independent directors, including evaluating 
and approving a fund's advisory contract (sections 15(a) and 15(c) 
[15 U.S.C. 80a-15(a) and 80a-15(c)]), approving the fund's principal 
underwriting contract (sections 15(b) and 15(c) [15 U.S.C. 80a-15(b) 
and 80a-15(c)]), selecting the fund's independent accountant 
(section 32(a)(1) [15 U.S.C. 80a-31(a)(1)]), and valuing certain 
securities held by the fund (section 2(a)(41) [15 U.S.C. 80a-
2(a)(41)]). In addition, state law generally places responsibility 
on directors to oversee all operations of a fund. See Jean Gleason 
Stromberg, Governance of Investment Companies, in The Investment 
Company Regulation Deskbook Sec. Sec.  4.1-2 (Amy L. Goodman ed., 
1997). Many of our exemptive rules rely heavily on independent 
directors to approve transactions and review practices involving 
conflicts of interest that otherwise would be prohibited by the Act.
    \11\ In some cases, fund boards appear to have been deceived, 
misled or not informed as to the existence of serious compliance 
lapses. Our new compliance rule, which requires each fund to 
designate a chief compliance officer who reports directly to the 
board of directors, should get boards the information they need 
about compliance matters. See Compliance Adopting Release, supra 
note 9.
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    We believe that a fund board must be ``an independent force in 
[fund] affairs rather than a passive affiliate of management.'' \12\ 
Its independent directors must bring to the boardroom ``a high degree 
of rigor and skeptical objectivity to the evaluation of [fund] 
management and its plans and proposals,'' particularly when evaluating 
conflicts of interest.\13\ To empower independent directors to better 
serve as an effective check on fund management, we are proposing to 
require funds to adopt better governance practices. Publicly traded 
companies now are required by exchange listing standards to have 
similar practices in place.\14\ Many have been adopted voluntarily by 
some fund complexes.\15\
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    \12\ 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.
    \13\ 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.
    \14\ We recently approved amendments to the corporate governance 
listing standards of the New York Stock Exchange (``NYSE'') and 
NASD. Although many closed-end funds are listed on the NYSE, several 
of the corporate governance listing standards recently adopted are 
not applicable to closed-end funds. See Securities Exchange Act 
Release No. 48745 (Nov. 4, 2003) [68 FR 64154 (Nov. 12, 2003)]. We 
also approved proposed changes to the corporate governance standards 
of the NYSE itself. See Securities Exchange Act Release No. 48764 
(Nov. 7, 2003) [68 FR 64380 (Nov. 13, 2003)].
    \15\ 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) (``ICI Advisory Group 
Report''); Richard M. Phillips, Mutual Fund Independent Directors: A 
Model for Corporate America?, in Investment Company Institute 
Perspective, Aug. 2003, at 1, 3 (stating that a significant portion 
of mutual funds have followed all or most of the recommendations in 
the ICI Advisory Group Report).
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II. Discussion

    The Commission is proposing to amend ten of our exemptive rules to 
require any fund that relies on any of them to adopt certain fund 
governance standards, which we discuss below, in addition to those 
adopted by the Commission in 2001. Each of these rules, which we have 
listed in the margin below,\16\ (i) exempts funds or their affiliated 
persons from a provision of the Act, and (ii) has as a condition the 
approval or oversight of independent directors. For convenience, we 
will refer to these rules as the ``Exemptive Rules.'' The Exemptive 
Rules typically relieve funds from statutory prohibitions that preclude 
certain types of transactions or arrangements that would involve 
serious conflicts of interest. We are also proposing to require that 
funds retain, for our examination, copies of written materials that the 
board considers when approving the fund's advisory contract.
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    \16\ The rules proposed to be amended are:
    Rule 10f-3 (permitting funds to purchase securities in a primary 
offering when an affiliated broker-dealer is a member of the 
underwriting syndicate);
    Rule 12b-1 (permitting use of fund assets to pay distribution 
expenses);
    Rule 15a-4(b)(2) (permitting fund boards to approve interim 
advisory contracts without shareholder approval where the adviser or 
a controlling person receives a benefit in connection with the 
assignment of the prior contract);
    Rule 17a-7 (permitting securities transactions between a fund 
and another client of the fund investment adviser);
    Rule 17a-8 (permitting mergers between certain affiliated 
funds);
    Rule 17d-1(d)(7) (permitting funds and their affiliates to 
purchase joint liability insurance policies);
    Rule 17e-1 (specifying conditions under which funds may pay 
commissions to affiliated brokers in connection with the sale of 
securities on an exchange);
    Rule 17g-1(j) (permitting funds to maintain joint insured 
bonds);
    Rule 18f-3 (permitting funds to issue multiple classes of voting 
stock); and
    Rule 23c-3 (permitting the operation of interval funds by 
enabling closed-end funds to repurchase their shares from 
investors).
    Last October we proposed a new exemptive rule, rule 15a-5, that 
would also 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)]. If we adopt the fund governance 
standards proposed in the current Release, we also intend to adopt 
those standards as a condition of rule 15a-5.
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    In proposing these rules, we recognize that there is a tension 
between the role

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of the board and that of the investment adviser, and that our rules 
need to strike the proper balance between management and oversight. 
Funds meet the investment needs and fulfill the expectations of their 
shareholders because of the efforts and skill of their investment 
advisers. Investors do not generally invest in a fund because of the 
skill or reputation of its board of directors. Nonetheless, the 
ultimate responsibility for the fund lies with its board of directors, 
whose oversight is critical because of the unique set of conflicts the 
investment adviser has with the fund. We ask commenters to address 
whether our proposals strike the proper balance.

A. Board Composition

    We propose to require that any fund relying on any of the Exemptive 
Rules \17\ have a board of directors whose independent directors 
constitute at least seventy-five percent of the board.\18\ The 
Investment Company Act currently requires that at least forty percent 
of the board be independent,\19\ and our 2001 amendments to the 
Exemptive Rules require that a majority of the board be 
independent.\20\ These 2001 amendments largely codified current mutual 
fund practices at the time we adopted them.\21\
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    \17\ As discussed above, our proposal would apply only to funds 
that rely on one or more of the Exemptive Rules. Because almost all 
funds either rely or anticipate someday relying on at least one of 
the Exemptive Rules, we expect they would apply to most funds. For 
convenience, the remainder of this Release assumes that they will 
apply to all funds registered with the Commission.
    \18\ We note that section 15(f)(1) of the Act, which provides a 
safe harbor for the sale of an advisory business, requires that 
directors who are independent of the adviser constitute at least 75 
percent of a fund board for at least three years following the 
assignment of the advisory contract. 15 U.S.C. 80a-15(f)(1). See 
also Alliance Capital Management, supra note 6 (Dec. 18, 2003) 
(including voluntary undertaking to have independent directors 
constitute at least 75 percent of board); Putnam Investment 
Management, supra note 6 (same).
    \19\ See section 10(a) of the Act [15 U.S.C. 80a-10(a)].
    \20\ See, e.g., rule 10f-3(b)(11)(i) [17 CFR 270.10f-
3(b)(11)(i)].
    \21\ 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 n. 39 and 
accompany text (``Today, most, but not all, mutual funds have boards 
with at least a simple majority of independent directors.'').
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    When we proposed the 2001 amendments, we considered requiring that 
independent directors comprise a supermajority of the fund boards, and 
observed that such a requirement ``could change the dynamics of board 
decision making in favor of the interests of investors.''\22\ 
Commenters supporting a supermajority independence requirement asserted 
that a greater proportion of independent directors would help to 
strengthen the hand of independent directors when dealing with fund 
management, and would help assure that independent directors maintain 
control of the board in the event of the illness or absence of other 
independent directors.\23\
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    \22\ See 1999 Proposing Release, supra note 21, at text 
following n. 44. Some economic studies of funds find that boards 
with a higher proportion of independent directors are more 
effective. See, e.g., Peter Tufano and Matthew Sevick, Board 
Structure and Fee-Setting in the U.S. Mutual Fund Industry, 46 J. 
Fin. Econ. 321, 350 (1997) (``Tufano and Sevick'') (``We find that 
funds whose boards have a larger fraction of independent directors 
tend to charge investors lower fees.''); Mutual Funds: Who's Looking 
Out for Investors?: Hearings Before the Committee on Financial 
Services, Subcomm. on Capital Markets, Insurance and Government 
Sponsored Enterprises on the Committee on Financial Services, 108th 
Cong., 1st Sess. (2003) (prepared testimony of Eric W. Zitzewitz, 
Assistant Professor of Economics, Stanford Graduate School of 
Business) (http://financialservices.house.gov/media/pdf/110603ez.pdf) (``My research suggests that boards with more 
independent directors perform better in limiting arbitrage; earlier 
research has shown that these boards negotiate lower expense ratios 
on behalf of their investors.''); Diane Del Guercio, Larry Y. Dann 
and M. Megan Partch, Governance of Boards of Directors in Closed-End 
Investment Companies, 69 J. Fin. Econ. 111, 148 (2003) (``[W]e find 
reasonably strong evidence of an association between [closed-end 
fund] board decisions in shareholders' interests and greater nominal 
independence. Funds with more nominally independent boards have 
lower expense ratios * * *.''). However, we note that the authors of 
these studies concede that fewer independent directors may be a 
symptom rather than the cause of ineffective governance and that 
studies of operating companies have failed to find a correlation 
between the proportion of independent directors and performance. See 
Tufano and Sevick, supra, at 353 (``[W]e must be very cautious about 
attributing causality to empirical results of this type.''); Sanjai 
Bhagat and Bernard Black, The Uncertain Relationship Between Board 
Composition and Firm Performance, 54 Bus. Law. 921, 922 (1999) 
(``studies of overall firm performance have found no convincing 
evidence that firms with majority-independent boards perform better 
than firms without such boards'').
    \23\ See, e.g., Letter from W. Allen Reed, Chair, Financial 
Executives Institute Committee on Investment of Employee Benefit 
Assets (Jan. 24, 2000) (expressing support for two-thirds majority 
requirement by noting that ``the more independent a board is, the 
less likely it will be to have conflicts and, therefore, in a better 
position to serve the needs of the fund's shareholders''); Letter 
from C. Meyrick Payne, Senior Partner, Management Practice Inc. 
(Nov. 3, 1999) (``independent directors are markedly more powerful 
with a 67% majority than they would be with only a 51% majority''); 
Letter from Gerald C. McDonough, Independent Trustee, Fidelity Funds 
(on behalf of the Independent Trustees) (Jan. 28, 2000) (``A two-
thirds super majority of independent directors is necessary to 
maintain an adequate cushion above a bare majority requirement in 
order to assure that independent directors control the corporate 
machinery at all times.''); Letter from Peter W. Gavian, Independent 
Trustee, Calvert Group (Jan. 5, 2000), (welcoming ``a supermajority 
requirement, perhaps even the 100% standard that has apparently 
proven quite successful with bank funds.''). These letters are 
available in the public comment file on that rulemaking, File No. 
S7-23-99. In addition, the ICI Advisory Group Report recommends that 
independent directors constitute at least two-thirds of the fund 
board. The ICI's Board of Governors endorsed these best practices in 
1999. ICI Advisory Group Report, supra note 15.
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    We request comment on the proposed seventy-five percent 
requirement. Is any change from the current requirement necessary? 
Should the requirement be higher? Should it be lower? Should it be 
phrased in terms other than a fraction or percentage, e.g., that all 
directors, or all directors but one, must be independent? We also 
request comment on the appropriate period of time over which, if we 
adopt the new requirement, it should be phased in.\24\ Would eighteen 
months be sufficient? \25\
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    \24\ Proposed rule 0-1(a)(7) would include the requirement that 
currently appears in the Exemptive Rules, that the fund's 
independent directors must select and nominate other independent 
directors. See proposed rule 0-1(a)(7)(i).
    \25\ See 2001 Adopting Release, supra note 4, at Section III.B 
(permitting funds 18 months to comply with fund governance 
amendments to Exemptive Rules).
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B. Independent Chairman of the Board

    We propose to require that the chairman of the fund board be an 
independent director.\26\ The Investment Company Act and state law are 
silent on who will fill this important role on fund boards. Today, a 
director who is also an officer of the fund's investment adviser serves 
as chairman of most, but not all, fund boards. In many cases, he (or 
she) also is the chief executive officer of the adviser. This practice 
may contribute to the adviser's ability to dominate the actions of the 
board of directors.
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    \26\ See proposed rule 0-1(a)(7)(iii).
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    The chairman of a fund board can largely control the board's 
agenda, which may include matters not welcomed by the adviser. The 
board is required to consider some matters annually in connection with 
the renewal of the advisory contract, but other matters the board 
considers at its discretion, such as termination of service providers, 
including the adviser.\27\ Perhaps more important, the chairman of the 
board can have a substantial influence on the fund boardroom's culture. 
The boardroom culture can foster (or suppress) the type of meaningful 
dialogue between fund management and independent directors that is 
critical for healthy fund governance. It can support (or diminish) the 
role of the independent directors in the continuous, active engagement 
of fund management necessary for them to fulfill their duties.
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    \27\ Under section 15(a)(3) of the Act [15 U.S.C. 80a-15(a)(3)], 
the advisory contract must permit the fund board to terminate the 
advisory contract on no more than 60 days' notice.

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[[Page 3475]]

    A boardroom culture conducive to decisions favoring the long-term 
interest of fund shareholders may be more likely to prevail when the 
board chairman does not have the conflicts of interest inherent in his 
role as an executive of the fund adviser.\28\ Moreover, a fund board 
may be more effective when negotiating with the fund adviser over 
matters such as the advisory fee if it were not at the same time led by 
an executive of the adviser with whom it is negotiating.\29\ If such 
negotiation leads to lower advisory and other fees, shareholders would 
stand to benefit substantially.\30\
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    \28\ See Ira M. Millstein and Paul W. MacAvoy, Proposals for 
Reform of Corporate Governance, in The Recurrent Crisis in Corporate 
Governance 95, 119 (2003) (``Millstein and MacAvoy'') (``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. * * *'').
    \29\ We recognize that neither the Investment Company Act nor 
any state law (of which we are aware) requires a fund to appoint a 
chairman of the board. The proposed rule would apply to any person 
designated as chairman of the fund board of directors, or who 
otherwise presides over board meetings and has substantially the 
same responsibilities as a chairman of a board of directors. See 
proposed rule 0-1(a)(7)(iii).
    \30\ In some of our recent settled enforcement cases against 
fund advisers, the funds have undertaken voluntarily to have an 
independent director chair the fund board. See Alliance Capital 
Management, supra note 6; Putnam Investment Management, supra note 
6. We note that the National Association of Corporate Directors 
(``NACD'') recommends an independent director be designated chairman 
of the board. See, e.g., National Association of Corporate 
Directors, Recommendations from the National Association of 
Corporate Directors Concerning Reforms in the Aftermath of the Enron 
Bankruptcy (May 3, 2002) (http://www.nacdonline.org/nacd/enron_recommendations.asp) (``NACD Recommendations'') (recommendations 
include: designation of an independent director as chairman or lead 
director; regular and formal evaluation of the performance of the 
board as a whole; and periodic executive sessions for independent 
directors).
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    We request comment on this proposed amendment. Would it strike the 
correct balance between management of the fund and the proper role of 
independent directors? Could it improve the boardroom culture we 
discussed above? Would it reduce the ability of the fund adviser to 
dominate the board? Or, as some have asserted, would an independent 
board chairman actually weaken fund governance because an independent 
director could not effectively lead the board through a discussion of a 
detailed and, in some respects, complex agenda? \31\ Comment is 
specifically requested on this point from members of those fund boards 
currently chaired by independent directors.
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    \31\ Hearings on H.R. 2420, the Mutual Funds Integrity and Fee 
Transparency Act of 2003, Before the Subcomm. on Capital Markets, 
Insurance and Government Sponsored Enterprises of the Committee on 
Financial Services, 108th Cong., 1st Sess. (``Executive Summary'') 
(2003) (prepared testimony of Paul G. Haaga, Vice President, Capital 
Research and Management Company, and Chairman, Investment Company 
Institute) (http://financialservices.house.gov/media/pdf/061803ph.pdf) (``It is neither necessary nor appropriate to require 
mutual funds to have an independent chairman of the board. In many 
cases, a person needs to be intimately familiar with the operations 
of a company in order to be an effective chairman, and a management 
representative is often in the best position to do this.'').
    Similar criticisms also have been raised of proposals to split 
the roles of the chairman and the chief executive officer of 
operating companies. See, e.g., The Conference Board, The Commission 
on Public Trust and Private Enterprise: Findings and Recommendations 
2003 (``Conference Board Recommendations'') at 1, 35 (dissenting 
opinion of John H. Biggs) (http://www.conference-board.org/knowledge/governCommission.cfm) (``If [organization of the board 
meeting] is done in a perfunctory way, say the day before the 
meeting, it is probably irrelevant. However, to do this competently, 
[the chairman] would have to devote substantial extra time to 
understanding the company's operations, discussing with the CEO and 
others in senior management the issues currently confronting the 
company, and probably ``rehearsing'' the meeting to be sure those 
issues can be discussed adequately.'').
---------------------------------------------------------------------------

    Are there alternatives that would serve the same or similar 
purposes? For example, should we instead require independent directors 
to appoint a ``lead director,'' who would chair separate meetings of 
the independent directors, act as their spokesperson and interact with 
their independent legal counsel? \32\ Should the chairman of all board 
committees, or certain board committees, also be required to be an 
independent director? Should we require instead that the chairman--
whether or not independent--be elected annually by both a majority of 
the board as a whole and by a majority of the independent directors? Is 
a requirement mandating an independent chairman necessary if the 
Commission adopts a supermajority requirement, as discussed in Section 
II.A, supra, since a majority may empower the independent directors to 
select the appropriate person to serve as chairman, whether or not 
independent? Similarly, is a requirement mandating an independent 
chairman even necessary under current standards that generally mandate 
a majority of independent directors?
---------------------------------------------------------------------------

    \32\ See ICI Advisory Group Report, supra note 15, at 25 
(recommending as a best practice that the independent directors of a 
fund appoint a lead independent director).
---------------------------------------------------------------------------

C. Annual Self-Assessment

    We also propose to require fund directors to perform an evaluation, 
at least once annually, of the effectiveness of the board and its 
committees.\33\ The self-assessment process can improve fund 
performance by strengthening directors' understanding of their role and 
fostering better communications and greater cohesiveness.\34\ It gives 
directors an opportunity to step back and review their own performance, 
so that they can best consider any changes in their governance 
practices.\35\
---------------------------------------------------------------------------

    \33\ See proposed rule 0-1(a)(7)(iv). The ICI, NACD, Business 
Roundtable, and Conference Board all recommend that boards evaluate 
their performance and effectiveness. See ICI Advisory Group Report, 
supra note 15, at 29; NACD Recommendations, supra note 30; The 
Business Roundtable, Principles of Corporate Governance (May 2002), 
at 28-29 (http://www.businessroundtable.org/pdf/704.pdf) 
(``Business Roundtable Principles''); Conference Board 
Recommendations, supra note 31, at 31.
    \34\ See Katherine McG. Sullivan and Holly J. Gregory, Creating 
a Board Self-Evaluation Methodology, The Metropolitan Corporate 
Counsel, Mar. 1996, at 1, 12.
    \35\ See ICI Advisory Group Report, supra note 15, at 29-31 
(recommending periodic self-evaluation by fund board).
---------------------------------------------------------------------------

    The self-evaluation should focus on both substantive and procedural 
aspects of the board's operations. Our proposed rule would leave for 
the directors to decide those aspects of board operations they should 
address in their evaluation, except for two procedural matters. First, 
we propose to require the directors to consider the effectiveness of 
the board's committee structure. Fund boards, like corporate boards, 
often designate board committees to which they delegate certain 
functions and activities.\36\ The proposed 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. The requirement also is designed to facilitate a 
critical assessment of the current board committees.\37\
---------------------------------------------------------------------------

    \36\ See American Bar Assoc., Fund Director's Guidebook, 59 Bus. 
L. 201, 212-17 (2003).
    \37\ We would expect that the minutes of the board of directors 
would reflect the substance of the matters discussed during the 
board's annual self-assessment.
---------------------------------------------------------------------------

    Second, we would have the directors carefully evaluate whether they 
have taken on the responsibility for overseeing too many funds.\38\ 
Directors often serve on a large number of fund boards within a fund 
complex.\39\ This

[[Page 3476]]

practice has over the years generated some criticism that directors are 
unable to pay adequate attention to their obligations to each fund.\40\ 
Others, however, strongly support the practice as a necessary 
recognition that many issues facing a particular fund in a fund group 
are common to all of the funds, and argue that it may actually give 
directors greater leverage when dealing with the common adviser.\41\ It 
would be difficult to determine the optimum number of funds that a 
particular director or group of directors can serve, which should 
depend upon a number of factors.\42\ We are, however, sufficiently 
concerned that we are proposing to ask directors to evaluate each year 
this aspect of their service on fund boards.
---------------------------------------------------------------------------

    \38\ See proposed rule 0-1(a)(7)(iv).
    \39\ See, e.g., Tufano and Sevick, supra note 22, at 333-334 
(for the 50 largest funds sampled, the average number of boards on 
which a director serves is 16, with the highest being 151); Raj 
Varma, An Empirical Examination of Sponsor Influence Over the Board 
of Directors, 38 Fin. Rev. 55 (2003) (for the closed-end funds 
sampled, the average number of board seats held by independent 
directors for a given sponsor is 32.4, with the highest being 99).
    \40\ See, e.g., Mutual Funds: Trading Practices and Abuses That 
Harm Investors: Hearings Before the Subcomm. on Financial 
Management, the Budget, and International Security of the Senate 
Governmental Affairs Committee, 108th Cong., 1st Sess. (2003) 
(statement of Senator Susan M. Collins) (webcast: http://govt-aff.senate.gov/index.cfm?Fuseaction=Hearings.Detail&HearingID=124 HearingID=124) (``There are, in fact, plenty of fund family 
directors who serve on the boards for 80 or even 90 different funds, 
which seems too many to me. The chairman of Bank of America's 
Nations Fund sits on the boards of 85 funds. The chairman at Janus 
sits on 113 fund boards. Now, I realize that many of the funds have 
similar structures and approaches so there may be some economies of 
scale, if you will. But it's hard for me to see how anyone, any one 
director could effectively monitor the activities of so many 
different entities.''); Tufano and Sevick, supra note 22, at 329 
(``The potential for conflicts of interest may be compounded when 
the independent directors serve on multiple boards for a single fund 
sponsor. * * * By seeking to protect the current and future stream 
of compensation from existing and new board membership, an 
independent director's interests could become more closely aligned 
with the fund sponsor than with the shareholders of the fund, 
leading to less vigilant oversight and higher fees.''); Varma, supra 
note 39 (``a more important factor that can weaken director 
independence is multiple board service for the sponsor''); Geoffrey 
Smith, Mutual Funds: Investors Are Still in the Dark, Bus. Wk., Apr. 
29, 2002, at 90 (``the independent directors are often on the boards 
of so many of the funds in the same family that it's hard to 
distinguish them from full-time employees''); Anna Robaton, et al., 
Is There a Cushier Part-Time Job? Board Stiffs: Pay Swell for Fund 
Directors, Investment News, Feb. 22, 1999, at 1 (quoting Barry 
Barbash, ``What troubles me more is the number of fund boards on 
which a director serves.'').
    \41\ See ICI Advisory Group Report, supra note 15, at 28 
(``[S]ervice on multiple boards can provide the independent 
directors of those boards with an opportunity to obtain better 
familiarity with the many aspects of fund operations that are 
complex-wide in nature. It also can give the independent directors 
greater access to the fund's adviser and greater influence with the 
adviser than they would have if there were a separate board for each 
fund in the complex.'').
    \42\ Funds must disclose to shareholders in their statements of 
additional information and proxy statements the number of fund 
boards on which each director serves. Form N-1A (Item 13(a)(1)) [17 
CFR 274.11A] (requiring disclosure of the number of portfolios in 
the fund complex overseen by each director); Schedule 14A, Item 7 
[17 CFR 240.14a-101 (Item 7); 17 CFR 229.401 (Item 401)(a)] 
(requiring disclosure of all positions and offices held by each 
director).
---------------------------------------------------------------------------

    We request comment on our proposed self-evaluation requirement. 
Should we require boards to make written reports of their self-
assessment? We also request comment on whether we should ask directors 
to evaluate their committee structures and the number of boards on 
which they serve. Should we require that boards form committees to 
address certain matters? Should we restrict the number of fund boards 
on which a director serves? If so, what should be the maximum number of 
fund directorships any individual should hold? Alternatively, should 
boards be required to adopt policies on the number of other boards that 
directors may serve? Should service on non-fund boards factor into any 
limitation? Should we require that boards also consider how frequently 
they meet, in light of the number of funds that they oversee?

D. Separate Sessions

    We propose that independent directors be required to meet at least 
once quarterly in a separate session at which no interested persons of 
the fund are present.\43\ Such meetings, which we understand are held 
by many fund boards, would afford independent directors the opportunity 
for a frank and candid discussion among themselves regarding the 
management of the fund, including its strengths and weaknesses. 
Regularly required sessions would prevent any ``negative inferences 
from attaching to the calling of such executive sessions.'' \44\ The 
requirement is also designed to help strengthen the collegiality and 
cohesiveness of the independent directors. We request comment on this 
proposed amendment. Should separate sessions be held more or less 
frequently than quarterly?
---------------------------------------------------------------------------

    \43\ See proposed rule 0-1(a)(7)(v). Under the compliance rule 
that we recently adopted, the fund's chief compliance officer and 
the independent directors must meet separately at least once a year. 
See rule 38a-1(a)(4)(iv), to be codified at 17 CFR 270.38a-
1(a)(4)(iv). NYSE and NASD listing standards require that 
independent directors meet without management, and the ICI, NACD, 
Conference Board, and Business Roundtable also recommend that 
independent directors meet without the presence of management. See 
Securities Exchange Act Release No. 48745 (Nov. 4, 2003) [68 FR 
64154 (Nov. 12, 2003)]; ICI Advisory Group Report, supra note 15, at 
24; NACD Recommendations, supra note 30; Conference Board 
Recommendations, supra note 31, at 41, and Business Roundtable 
Principles, supra note 33, at 26 (``Independent directors should 
have the opportunity to meet outside the presence of the CEO and any 
other management directors.'').
    \44\ Report of the New York Stock Exchange Corporate 
Accountability and Listing Standards Committee (June 6, 2002) at 8 
(recommending that independent directors meet at regularly scheduled 
sessions without management).
---------------------------------------------------------------------------

E. Independent Director Staff

    We are proposing that any fund relying on any Exemptive Rule 
explicitly authorize the independent directors to hire employees and 
others to help the independent directors fulfill their fiduciary 
duties.\45\ Use of staff and experts may be important to help 
independent directors deal with matters that are beyond the level of 
their expertise, or help give them an understanding of better practices 
among mutual funds.\46\
---------------------------------------------------------------------------

    \45\ See proposed rule 0-1(a)(7)(vi).
    \46\ See Millstein and MacAvoy, supra note 28, at 115, 116 
(recommending that ``[b]oards should feel free, without the consent 
of management, to retain such consultants and advisers as they deem 
necessary to carry out their responsibilities * * *. In order to 
monitor management effectively--and sufficiently, in light of 
emerging legal responsibilities--directors must know more, and 
understand more, about how the company functions.''). See also ICI 
Advisory Group Report, supra note 15, at 20.
---------------------------------------------------------------------------

    We request comment on this proposed amendment. If independent 
directors receive this explicit authority, are they likely to hire 
their own staff? Should the rule require independent directors to hire 
their own staff? \47\ If so, should such a requirement be limited to 
funds with a certain minimum amount of assets under management? Should 
the staff be employed by the fund rather than the fund adviser? Should 
we also require that committees of the board be explicitly authorized 
to hire their own staff or experts? \48\
---------------------------------------------------------------------------

    \47\ See Alliance Capital Management, supra note 6 (voluntarily 
undertaking to hire compliance staff and to give notice and 
invitations to independent staff of directors to attend and 
participate in meetings of Internal Compliance Controls Committee); 
Putnam Investment Management, supra note 6 (voluntarily undertaking 
to designate independent administrative staff of the trustees to 
assist the board in monitoring compliance with federal securities 
laws, fiduciary duties and the funds' codes of ethics; to review 
compliance reports; and to attend meetings of the Internal 
Compliance Controls Committee).
    \48\ See, e.g., Exchange Act rule 10A-3(b)(4) and (5) [17 CFR 
240.10A-3(b)(4) and (5)] (rules of securities exchanges and 
associations must provide that a listed company's audit committee 
must have authority to engage independent legal counsel and other 
advisers as it determines are necessary to carry out its duties, and 
that the company must provide for appropriate funding for the audit 
committee as determined by the committee).
---------------------------------------------------------------------------

    We also request comment on whether we ought to require that 
independent directors have an independent legal counsel. In 2001, we 
began to require that independent directors, if they retain counsel, 
retain ``independent legal counsel,'' i.e., counsel who the independent 
directors determine at least annually is free of significant conflicts

[[Page 3477]]

of interest that might affect their legal advice.\49\ At that time, we 
did not require that independent directors retain independent legal 
counsel. We noted, however, that the likely result of our rule 
amendments would be that many fund directors would seek independent 
legal counsel. We also cited with approval an American Bar Association 
Report stating 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.'' \50\ Should we take the next step and require 
independent legal counsel?
---------------------------------------------------------------------------

    \49\ See 2001 Adopting Release, supra note 4, at nn. 34-56 and 
accompanying text.
    \50\ 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 also 2001 Adopting Release, supra note 4, at n. 35.
---------------------------------------------------------------------------

F. Recordkeeping for Approval of Advisory Contracts

    Finally, we propose to amend 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. Section 15 requires that fund directors, 
including a majority of independent directors, approve the fund's 
advisory contract each year.\51\ It also requires that the directors 
first obtain from the adviser the information reasonably necessary to 
evaluate the contract.\52\
---------------------------------------------------------------------------

    \51\ The directors must approve the advisory contract initially, 
and annually thereafter if it continues in effect for more than two 
years. 15 U.S.C. 80a-15(a) and (c). The Act also requires that 
shareholders approve the contract, and prohibits the assignment of 
the contract to other advisers. 15 U.S.C. 80a-15(a) and (b). The 
advisory contract must be very specific about the amount of the 
adviser's fee, and the adviser has a fiduciary duty with respect to 
that fee. 15 U.S.C. 80a-15(a)(1), 80a-35(b).
    \52\ 15 U.S.C. 80a-15(c). This requirement was added to the 
Investment Company Act in 1970, to ensure that directors would have 
adequate information upon which to base their decision about the 
advisory contract generally and the advisory fee in particular. See 
Securities and Exchange Commission, Analysis of S. 1659 (in Staff of 
Senate Comm. on Banking and Currency, 90th Cong., 1st Sess., 
Investment Company Act Amendments of 1969 9 (Comm. Print 1967)). See 
also S. Rep. No. 90-1351, at 6 (1968).
---------------------------------------------------------------------------

    The information request requirement in section 15 provides fund 
directors, including independent directors, a tool for obtaining the 
information they need to represent shareholder interests.\53\ Careful 
consideration of the information enables them to better negotiate the 
amount of the advisory fee.\54\ Conversely, the failure of a board to 
acquire information sufficient to scrutinize the advisory fee and other 
fund expenses can suggest an inability or lack of interest on the part 
of the board in negotiating on behalf of the fund. In this regard, the 
Mutual Fund Directors Forum, an independent organization that advises 
fund directors, is preparing best practices recommendations for 
directors on the types of information that they should request and 
consider when reviewing advisory contracts.\55\
---------------------------------------------------------------------------

    \53\ This provision was intended to ``facilitate well-informed 
directorial consideration of the matters relating to advisory fees'' 
and ensure that ``the attention of the directors will be fixed on 
their responsibilities.'' See Securities and Exchange Commission, 
Analysis of S. 1659 (in Staff of Senate Comm. on Banking and 
Currency, 90th Cong., 1st Sess., Comparative Print Showing Changes 
in Existing Law 9 (Comm. Print 1967)); S. Rep. No. 91-184, at 7 
(1969).
    \54\ See S. Rep. No. 90-1351, at 14 (1968) (``[T]he directors 
would be handicapped in determining the reasonableness of 
compensation for advisory services if they [for example] could not 
determine what portion of the total compensation was paid for that 
service and if they did not have relevant information.''). See also 
Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d. 923, 
930 (2d Cir. 1982) (``[T]he expertise of the independent trustees of 
a fund, whether they are fully informed about all facts bearing on 
the adviser-manager's service and fee, and the extent of care and 
conscientiousness with which they perform their duties are important 
factors to be considered in deciding whether they and the adviser-
manager are guilty of a breach of fiduciary duty in violation of 
Sec.  36(b)'').
    \55\ Chairman Donaldson recently requested that the Mutual Fund 
Directors Forum develop best practices recommendations to guide 
directors in areas where director oversight and decision making is 
critical for investors, including information requested to approve 
the advisory contract. See Letter from William H. Donaldson, 
Chairman, Securities and Exchange Commission, to David S. Ruder, 
Chairman, Mutual Fund Directors Forum (Nov. 17, 2003). The Mutual 
Fund Directors Forum is a non-profit organization for independent 
directors ``dedicated to improving mutual fund governance by 
promoting the development of concerned and well-informed independent 
directors.'' Mutual Fund Directors Forum Web Site, www.mfdf.com.
---------------------------------------------------------------------------

    As part of our examinations of funds, our staff has reviewed the 
materials that directors considered in approving the advisory contract, 
if the materials were available. Our examiners have found that the 
nature and quality of these materials vary widely among funds. Some 
fund boards have failed to request the materials they need to make an 
informed assessment of the advisory contract. In one case, we brought 
an enforcement action against directors who neglected to request and 
evaluate sufficient information under section 15(c).\56\
---------------------------------------------------------------------------

    \56\ See Heart of America Investment Services, Investment 
Company Act Release No. 11975 (Oct. 6, 1981) (settling an 
administrative proceeding that arose in part because of the failure 
of the fund's independent directors to ``request and evaluate'' the 
proper information in connection with their approval of advisory 
contracts).
---------------------------------------------------------------------------

    Our compliance examiners also have reported that often they are 
unable to determine whether the requirements of section 15 of the Act 
were met, in part because the funds did not retain the materials that 
the board considered in approving the advisory contract. We propose to 
address this problem by amending our recordkeeping rules.\57\ Funds 
would retain the materials on which the board relied in approving the 
advisory contract, for at least six years, the first two years in an 
easily accessible place.\58\
---------------------------------------------------------------------------

    \57\ See proposed rule 31a-2(a)(6).
    \58\ Id.
---------------------------------------------------------------------------

    We request comment on the proposed amendment to our fund 
recordkeeping rule. Are there any reasons why a fund would not be able 
to keep some or all of the required documents? Are there additional 
documents that funds should maintain that are relevant to the 
directors' consideration of the advisory contract? Should we require 
that funds maintain the records for a period shorter or longer than six 
years? We also specifically request comment, as required by section 
31(a)(2) of the Investment Company Act [15 U.S.C. 80a-30(a)(2)], that 
commenters address 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 the 
nature of firms' internal compliance policies and procedures.

III. General Request for Comments

    The Commission requests comment on the rule amendments proposed in 
this Release, suggestions for additional provisions or changes to 
existing rules, and comments on other matters that might have an effect 
on the proposals in this Release. We note that comments that are of 
greatest assistance are those that are accompanied by supporting data 
and analysis of the issues addressed in those comments.

IV. Paperwork Reduction Act

    Certain provisions of the proposals contain ``collection of 
information'' requirements within the meaning of the

[[Page 3478]]

Paperwork Reduction Act. We are submitting these proposals to the 
Office of Management and Budget (``OMB'') for review in accordance with 
44 U.S.C. 3507(d) and 5 CFR 1320.11. ``Collection of information'' 
requirements would apply to funds because the proposed amendments would 
require them to maintain records. The proposed amendments to rule 31a-2 
would 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 would have to retain these materials 
for at least six years, the first two years in an easily accessible 
place for our examiners. The information would not be kept 
confidential. The title for the collection of information associated 
with the proposed amendments 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, which would be 
revised by the proposed amendments, displays control number 3235-0179.
    Our staff estimates that each fund would spend a total of 0.5 hours 
annually and a total of $9.46 for clerical time to comply with this 
proposal, and that all funds would spend a total of 2,562 hours 
annually and a total of $48,473.04 annually to comply with this 
proposal.\59\ Pursuant to 44 U.S.C. 3506(c)(2)(B), we solicit comments 
in order to: (i) Evaluate whether the proposed collections of 
information are necessary for the proper performance of the functions 
of the Commission, including whether the information will have 
practical utility; (ii) evaluate the accuracy of the Commission's 
estimate of the burden of the proposed collections of information; 
(iii) determine whether there are ways to enhance the quality, utility, 
and clarity of the information to be collected; and (iv) minimize the 
burden of the collections of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
---------------------------------------------------------------------------

    \59\ We estimate that 5,124 funds would incur costs under this 
proposal. To calculate these costs, our staff used $18.92 per hour 
as the average cost of clerical time.
---------------------------------------------------------------------------

    Persons wishing to submit comments on the collection of information 
requirements of the proposed amendments should direct them to the 
Office of Management and Budget, Attention Desk Officer of the 
Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10102, New Executive Office Building, 
Washington, DC 20503, and should send a copy to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-03-04. OMB is 
required to make a decision concerning the collection of information 
between 30 and 60 days after publication of this Release; therefore a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release. Requests 
for materials submitted to OMB by the Commission with regard to this 
collection of information should be in writing, refer to File No. S7-
03-04, and be submitted to the Securities and Exchange Commission, 
Records Management, Office of Filings and Information Services.

V. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules. As 
discussed in section II above, we are proposing to 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 proposing to require that 
funds maintain materials considered by a fund board when approving an 
advisory contract.

A. Benefits

    We believe that funds and fund shareholders are likely to benefit 
from the proposals, which 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 proposed amendments are designed to 
enhance the independence and effectiveness of independent directors, 
who are charged with overseeing the fund's activities and transactions 
under the Exemptive Rules. Boards that meet these conditions should be 
more effective at exerting an independent influence over fund 
management. Their independent directors should be more likely to have 
their primary loyalty to the fund's shareholders rather than the 
adviser.
    A board of directors whose independent directors constitute at 
least seventy-five percent of the board may help strengthen the hand of 
the independent directors when dealing with fund management, and may 
help assure that independent directors maintain control of the board in 
the event of the illness or absence of other independent directors. 
Requiring fund boards to be chaired by an independent director should 
provide similar benefits. The chairman of a fund board can have a 
substantial influence on the fund boardroom's culture, which can foster 
(or suppress) meaningful dialogue between fund management and 
independent directors and can support (or diminish) the role of the 
independent directors in fund management. We expect that the 
opportunity for frank and candid discussions among independent 
directors will increase their effectiveness.
    Requiring funds to explicitly authorize the independent directors 
to hire employees should help independent directors fulfill their 
fiduciary duties. Use of staff and experts may be particularly 
important to help independent directors address complex matters or 
provide an understanding of the practices of other mutual funds. This 
requirement should provide substantial benefits to shareholders by 
helping to ensure that independent directors are better able to fulfill 
their role of representing shareholder interests.
    Finally, the proposed 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 self-
assessment could help identify potential weaknesses and deficiencies.
    The proposed 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 proposed amendment to rule 31a-2 
would underscore 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. These amendments would benefit both shareholders 
and the Commission by enabling the Commission's staff to monitor the

[[Page 3479]]

independent directors' determination of whether their counsel is 
independent.
    The proposed amendments seek to promote strong fund boards that 
effectively perform their oversight role. By increasing the 
independence of fund boards, the amendments are designed to improve the 
quality of the oversight of the process for the benefit of fund 
investors. Vigilant and informed oversight by a strong, effective and 
independent fund board may help to prevent problems such as late 
trading and market timing. These benefits may increase investor 
confidence in fund management. While these benefits are not easily 
quantifiable in terms of dollars, we believe they are real, and that 
the proposed amendments will strengthen the hand of independent 
directors to the advantage of shareholders.

B. Costs

    The proposals would impose additional costs on funds that rely on 
an Exemptive Rule by requiring them to satisfy the fund governance 
standards in proposed rule 0-1(a)(7).\60\ The proposals would require 
that independent directors constitute at least seventy-five percent of 
the fund board. Our staff estimates that nearly sixty percent of all 
funds currently meet this requirement.\61\ Therefore, this proposal 
would impose costs on funds that do not already meet this standard. A 
fund could comply with this requirement in one of three ways: (i) 
Decrease the size of its board and allow some inside directors to 
resign; (ii) maintain the current size of its board and replace some 
inside directors with independent directors; or (iii) increase the size 
of its board and elect new independent directors. If a fund were to 
hold a shareholder election, it would incur costs to prepare proxy 
statements and hold the shareholder meeting. A fund also would incur 
costs of finding qualified candidates and compensating those new 
independent directors.\62\ We have no reliable basis for determining 
the costs associated with electing independent directors, however, 
because we have no reliable basis for determining how funds would 
choose to satisfy this requirement.\63\ We request comment on the 
manner in which funds would likely choose to satisfy a seventy-five 
percent independence requirement.
---------------------------------------------------------------------------

    \60\ Funds that do not rely on any Exemptive Rules, however, 
will not be subject to enhanced fund governance standards in rule 0-
1(a)(7) and would not incur costs associated with the proposed 
amendments. Our staff estimates for purposes of this cost-benefit 
analysis that approximately 4,610 funds (90 percent of all 5,124 
registered investment companies) rely on at least one Exemptive 
Rule.
    \61\ See also Hearing on H.R. 2420, the Mutual Fund Integrity 
and Fee Transparency Act of 2003, Before the Subcomm. on Capital 
Markets, Insurance and Government-Sponsored Enterprises of the 
Committee on Financial Services, 108th Congress (2003) (prepared 
testimony of Paul G. Haaga, Executive Vice President, Capital 
Research and Management Company, and Chairman, Investment Company 
Institute (http://financialservices.house.gov/media/pdf/061803ph.pdf) (``It is the Institute's understanding that most fund 
boards * * * currently have a super-majority of independent 
directors.'').
    \62\ 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)].
    \63\ With respect to the requirements related to independent 
selection and nomination of other independent directors and 
independent legal counsel, this proposal incorporates the current 
requirements of the Exemptive Rules, and therefore funds would not 
bear new costs related to those provisions.
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    The proposals also would 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 interested person 
of the fund is present, at least once quarterly; and (iv) independent 
directors to be given specific authority to hire employees. We are not 
aware of any out-of-pocket costs that would result from the first three 
items because these requirements could be performed at a regularly 
scheduled board meeting. We are not aware of any costs associated with 
the fourth item because boards typically have this authority under 
state law, and the rule would not require them to hire employees. We 
request comment on the costs of the first three items above, and on 
whether boards would choose to hire employees.
    The proposal that funds retain copies of materials considered by 
the board in approving advisory contracts would result in increased 
recordkeeping costs. Our staff anticipates that the cost increases will 
be limited, however, because many if not most funds already maintain 
the documents that the proposed amendment would require them to 
keep.\64\ Even for firms that do not already maintain such records, our 
staff anticipates that the costs of the proposed amendment will be 
limited.\65\ This recordkeeping proposal merely requires the retention 
of documents already prepared. Further, as with other records, funds 
would be able to maintain the required records electronically.\66\ For 
purposes of the Paperwork Reduction Act, our staff estimates that each 
fund would spend a total of 0.5 hours annually and a total of $9.46 for 
clerical time to comply with this proposal, and that all fund would 
spend a total of 2,562 hours annually and a total of $48,473.04 
annually to comply with this proposal.\67\ We request comment on the 
number of funds that already retain these materials, and on the costs 
of retaining such materials. We also request comment on whether 
directors, as a result of the proposed amendment, are likely to request 
more written materials from investment advisers.
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    \64\ Of course, if this proposal causes independent directors to 
request more information from the adviser, the fund's cost of 
recordkeeping may also increase.
    \65\ 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 supra Section IV.
    \66\ See rule 31a-2(f) under the Act [17 CFR 270.31a-2(f)].
    \67\ See infra Section IV of this Release.
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C. Request for Comments

    We request comment on the potential costs and benefits of the 
proposals. We encourage commenters to identify, discuss, analyze, and 
supply relevant data regarding any additional costs and benefits. For 
purposes of the Small Business Regulatory Enforcement Act of 1996,\68\ 
we also request information regarding the potential impact of the 
proposals on the U.S. economy on an annual basis. Commenters are 
requested to provide data to support their views.
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    \68\ Pub. L. No. 104-121, Title III, 110 Stat. 857 (1996).
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VI. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis (``IRFA'') has been 
prepared in accordance with 5 U.S.C. 603. It relates to the proposed 
amendments to the Commission's rules relating to independent directors 
of investment companies.

A. Reasons for the Proposed Action

    As described more fully in Section I of this Release, the reasons 
for the proposed amendments are that the Investment Company Act relies 
heavily on fund boards of directors to manage conflicts of interest 
that the fund adviser inevitably has with the fund, and the breakdown 
in fund management and compliance controls evidenced by our enforcement 
cases raises troubling questions about the ability of many fund boards, 
as presently constituted, to effectively oversee the management of 
funds.

B. Objectives of the Proposed Action

    As described more fully in Section II of this Release, the 
objectives of the proposed amendments, which would apply to funds 
relying on any of the

[[Page 3480]]

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.

C. Legal Basis

    The proposed amendment to rule 0-1 and proposed amendments to the 
Exemptive Rules are proposed 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. The proposed amendment to rule 31a-2 is 
proposed pursuant to the authority set forth in sections 12(b) and 
31(a).\69\
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    \69\ See infra Statutory Authority Section of this Release.
---------------------------------------------------------------------------

D. Small Entities Subject to the Proposed Rule and Amendments

    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.\70\ Of approximately 5,124 registered 
investment companies, approximately 204 are small entities.\71\ As 
discussed above, the proposed amendments would require funds relying on 
an Exemptive Rule to comply with proposed rule 0-1(a)(7) and all funds 
to retain records under proposed rule 31a-2. Whether these proposed 
amendments to the Exemptive Rules would affect small entities would 
depend on whether the small entities rely on an Exemptive Rule.\72\ 
Under proposed rule 31a-2, all small entities would be required to 
maintain records of materials consulted by a fund board when approving 
an advisory contract. We request comment on the effects and costs of 
these proposed amendments on small entities.
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    \70\ 17 CFR 270.0-10.
    \71\ 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.
    \72\ As discussed above, our staff estimates that approximately 
4,610 funds (90 percent of all 5,124 registered investment 
companies) rely on at least one Exemptive Rule. If 90 percent of all 
small entities rely on at least one Exemptive Rule, then 
approximately 184 funds that are small entities would rely on at 
least one Exemptive Rule and would therefore be affected by the 
proposed amendments to the Exemptive Rules.
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E. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposals do not introduce any new mandatory reporting 
requirements. The proposals contain mandatory recordkeeping 
requirements. Any fund, regardless of size, would be required to 
maintain records of written materials that directors consider to 
approve an advisory contract. The proposed amendments also would 
introduce new compliance requirements for any fund that relies on an 
Exemptive Rule. Any fund that relies on an Exemptive Rule would be 
required to satisfy the fund governance standards in proposed rule 0-
1(a)(7), including having: (i) A board of directors whose independent 
directors constitute seventy-five percent of the board; (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 
interested person of the fund is present, at least once quarterly; and 
(v) independent directors be given specific authority to hire employees 
and others for the independent directors.

F. Duplicative, Overlapping, or Conflicting Federal Rules

    We have not identified any federal rules that duplicate, overlap, 
or conflict with the proposed amendments.

G. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish the stated objective, while 
minimizing any significant adverse impact on small entities. 
Alternatives in this category would include: (i) Establishing different 
compliance or reporting standards that take into account the resources 
available to small entities; (ii) clarifying, consolidating, or 
simplifying the compliance requirements under the rule for small 
entities; (iii) using performance rather than design standards; and 
(iv) exempting small entities from coverage of the rule, or any part of 
the rule.
    With respect to the establishment of special compliance 
requirements or timetables under the proposals for small entities, we 
do not presently think this is feasible or necessary. The proposals 
arise from enforcement actions and settlements that underscore the need 
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. Excepting 
small entities from the proposed amendments could disadvantage fund 
shareholders of small entities and compromise the effectiveness of the 
proposed amendments. Nevertheless, we request comment whether it is 
feasible or necessary for small entities to have special requirements 
or timetables for compliance with the proposed amendments. Should any 
of the proposed amendments be altered or reduced in order to ease the 
regulatory burden on small entities, without sacrificing the 
effectiveness of the proposed amendments?
    With respect to (i) further clarifying, consolidating or 
simplifying the compliance requirements of the proposed amendments, 
(ii) using performance rather than design standards, and (iii) 
exempting small entities from coverage of the rule or any part of the 
rule, we believe such changes are impracticable. 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. We believe that 
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. Exempting small 
entities from coverage of the rule or any part of the rule could 
compromise the effectiveness of the proposed amendments.

H. Solicitation of Comments

    We encourage the submission of comments with respect to any aspect 
of this IRFA. Comment is specifically requested on the number of small 
entities that would be affected by the proposed amendments, and the 
likely impact of the proposals on small entities. Commenters are asked 
to describe the nature of any impact and provide empirical data 
supporting the extent of the impact. These comments will be considered 
in connection with the adoption of the proposed rule and amendments, 
and reflected in the Final Regulatory Flexibility Analysis.
    Comments should be submitted in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street NW., 
Washington, DC 20549-0609. Comments also may be submitted 
electronically to the following E-mail address: [email protected]. 
All comment letters should refer to File No. S7-03-04; this file number 
should be included on the subject line if E-mail is used.\73\
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    \73\ Comments on the IRFA will be placed in the same public file 
that contains comments on the proposed amendments themselves.
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VII. Efficiency, Competition and Capital Formation

    Section 2(c) of the Investment Company Act requires the Commission,

[[Page 3481]]

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 proposal to require that funds adopt certain 
governance practices if they rely on any of the Exemptive Rules is 
designed to enhance the independence and effectiveness of fund boards. 
The proposal 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 anticipate that these proposals 
will have a significant effect on efficiency, competition and capital 
formation with regard to funds because the costs associated with the 
proposals are minimal and many funds have already adopted some of the 
proposed practices. To the extent that these proposals do affect 
competition and capital formation, we believe that the effect will be 
positive because the proposals would likely 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.
    We request comments on whether the proposed rule amendments, if 
adopted, would promote efficiency, competition, and capital formation. 
Will the proposed amendments or their resulting costs materially affect 
the efficiency, competition, and capital formation of funds? Comments 
will be considered by the Commission in satisfying its responsibilities 
under section 2(c) of the Investment Company Act. Commenters are 
requested to provide empirical data and other factual support for their 
views to the extent possible.

Statutory Authority

    We are proposing amendments to 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 proposing amendments to 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-31(a)].

Text of Proposed Rules

List of Subjects in 17 CFR 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

    For the reasons set out in the preamble, the Commission proposes to 
amend Title 17, Chapter II of the Code of Federal Regulations as 
follows.

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. The general authority citation for Part 270 is amended by adding 
the following citation to read as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 
unless otherwise noted.
* * * * *
    Section 270.0-1(a)(7) is also issued under 15 U.S.C. 80a-10(e);
* * * * *

    2. Section 270.0-1 is amended by adding paragraph (a)(7) to read as 
follows:


Sec.  270.0-1  Definition of terms used in this part.

    (a) * * *
    (7) Fund governance standards. The board of directors of an 
investment company (``fund'') satisfies the fund governance standards 
if:
    (i) At least seventy-five percent of the directors of the fund are 
not interested persons of the fund (``disinterested directors''), and 
those directors select and nominate any other disinterested director of 
the fund;
    (ii) Any person who acts as legal counsel for the disinterested 
directors of the fund is an independent legal counsel as defined in 
paragraph (a)(6) of this section;
    (iii) A disinterested director serves as chairman of the board of 
directors of the fund, or otherwise presides over meetings of the board 
of directors and has substantially the same responsibilities as would a 
chairman of a board of directors;
    (iv) The board of directors evaluates at least once annually the 
performance of the board of directors and the committees of the board 
of directors, which evaluation must include a consideration of the 
effectiveness of the committee structure of the fund board and the 
number of funds on whose boards each director serves;
    (v) The disinterested directors meet at least once quarterly in a 
session at which no directors who are interested persons of the fund 
are present; and
    (vi) The disinterested directors have been authorized to hire 
employees and to retain advisers and experts necessary to carry out 
their duties.
* * * * *
    3. Section 270.10f-3 is amended by revising paragraph (c)(11) to 
read as follows:


Sec.  270.10f-3  Exemption for the acquisition of securities during the 
existence of an underwriting or selling syndicate.

* * * * *
    (c) * * *
    (11) Board composition. The board of directors of the investment 
company satisfies the fund governance standards defined in Sec.  270.0-
1(a)(7).
* * * * *
    4. Section 270.12b-1 is amended by revising paragraph (c) to read 
as follows:


Sec.  270.12b-1  Distribution of shares by registered open-end 
management investment company.

* * * * *
    (c) A registered open-end management investment company may rely on 
the provisions of paragraph (b) of this section only if its board of 
directors satisfies the fund governance standards as defined in Sec.  
270.0-1(a)(7);
* * * * *
    5. Section 270.15a-4 is amended by revising paragraph (b)(2)(vii) 
to read as follows:


Sec.  270.15a-4  Temporary exemption for certain investment advisers.

* * * * *
    (b) * * *
    (2) * * *
    (vii) The board of directors of the investment company satisfies 
the fund governance standards defined in Sec.  270.0-1(a)(7).
    6. Section 270.17a-7 is amended by revising paragraph (f) to read 
as follows:


Sec.  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 Sec.  270.0-1(a)(7).
* * * * *
    7. Section 270.17a-8 is amended by revising paragraph (a)(4) to 
read as follows:


Sec.  270.17a-8  Mergers of affiliated companies.

* * * * *
    (a) * * *
    (4) Board composition. The board of directors of the Merging 
Company satisfies the fund governance standards defined in Sec.  270.0-
1(a)(7).
* * * * *

[[Page 3482]]

    8. Section 270.17d-1 is amended by revising paragraph (d)(7)(v) to 
read as follows:


Sec.  270.17d-1  Applications regarding joint enterprises or 
arrangements and certain profit-sharing plans.

* * * * *
    (d) * * *
    (7) * * *
    (v) The board of directors of the investment company satisfies the 
fund governance standards defined in Sec.  270.0-1(a)(7).
* * * * *
    9. Section 270.17e-1 is amended by revising paragraph (c) to read 
as follows:


Sec.  270.17e-1  Brokerage transactions on a securities exchange.

* * * * *
    (c) The board of directors of the investment company satisfies the 
fund governance standards defined in Sec.  270.0-1(a)(7); and
* * * * *
    10. Section 270.17g-1 is amended by revising paragraph (j)(3) to 
read as follows:


Sec.  270.17g-1  Bonding of officers and employees of registered 
management investment companies.

* * * * *
    (j) * * *
    (3) The board of directors of the investment company satisfies the 
fund governance standards defined in Sec.  270.0-1(a)(7).
* * * * *
    11. Section 270.18f-3 is amended by revising paragraph (e) to read 
as follows:


Sec.  270.18f-3  Multiple class companies.

* * * * *
    (e) The board of directors of the investment company satisfies the 
fund governance standards defined in Sec.  270.0-1(a)(7).
* * * * *
    12. Section 270.23c-3 is amended by revising paragraph (b)(8) to 
read as follows:


Sec.  270.23c-3  Repurchase offers by closed-end companies.

* * * * *
    (b) * * *
    (8) The board of directors of the investment company satisfies the 
fund governance standards defined in Sec.  270.0-1(a)(7).
* * * * *
    13. Section 270.31a-2 is amended by:
    a. Removing the word ``and'' at the end of paragraph (a)(4);
    b. Removing the period at the end of paragraph (a)(5) and adding 
``; and''; and
    c. Adding paragraph (a)(6) to read as follows:


Sec.  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.

    (a) * * *
    (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. Sec.  80a-15(c)) in 
approving the terms or renewal of a contract or agreement between the 
company and an investment adviser.
* * * * *

    By the Commission.

    Dated: January 15, 2004.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-1323 Filed 1-22-04; 8:45 am]
BILLING CODE 8010-01-P