[Federal Register Volume 70, Number 129 (Thursday, July 7, 2005)]
[Rules and Regulations]
[Pages 39390-39410]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-13314]



[[Page 39389]]

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Part IV





Securities and Exchange Commission





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17 CFR Part 270



Investment Company Governance; Final Rule

  Federal Register / Vol. 70, No. 129 / Thursday, July 7, 2005 / Rules 
and Regulations  

[[Page 39390]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-26985; File No. S7-03-04]
RIN 3235-AJ05


Investment Company Governance

AGENCY: Securities and Exchange Commission.

ACTION: Commission response to remand by court of appeals.

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SUMMARY: The Commission has considered further its adoption of 
amendments to rules under the Investment Company Act of 1940 to require 
investment companies (``funds'') that rely on certain exemptive rules 
to adopt certain governance practices. The reconsideration responds to 
a decision by the United States Court of Appeals for the District of 
Columbia Circuit remanding to us for further consideration two issues 
raised by the rulemaking.

FOR FURTHER INFORMATION CONTACT: Penelope Saltzman, Branch Chief, or C. 
Hunter Jones, Assistant Director, Office of Regulatory Policy, (202) 
551-6792, Division of Investment Management, Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: In Chamber of Commerce of the United States 
of America v. Securities and Exchange Commission, the United States 
Court of Appeals for the District of Columbia Circuit remanded to us, 
in part, for additional consideration certain amendments we adopted 
last year to ten rules under the Investment Company Act of 1940 
(``Investment Company Act'' or ``Act'').\1\ The amendments are 
applicable to funds that rely on any of ten exemptive rules the 
Commission has adopted under the Investment Company Act (``Exemptive 
Rules'').\2\ The amendments were 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. As 
the Court directed, the Commission has carefully considered the issues 
identified by the Court in remanding this matter to us. We have 
determined, in light of that consideration, that the amendments to the 
Exemptive Rules require no modification.
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    \1\ Chamber of Commerce of the United States of America v. SEC, 
No. 04-1300, slip op. (D.C. Cir. June 21, 2005) (``Slip Opinion'').
    \2\ Investment Company Governance, Investment Company Act 
Release No. 26520 (July 27, 2004) [69 FR 46378 (Aug. 2, 2004)] 
(``Adopting Release''). The Exemptive Rules are listed in the 
Adopting Release at footnote 9.
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I. Background

    On July 27, 2004, the Commission adopted amendments to the 
Exemptive Rules under the Investment Company Act to require funds that 
rely on one or more of those rules to adopt certain governance 
practices.\3\ Among other things, the amendments added two conditions 
for relying on the Exemptive Rules. The amendments require that, if a 
fund relies on at least one of the Exemptive Rules to engage in certain 
transactions otherwise prohibited by the Act, the fund must have a 
board of directors with (i) no less than 75 percent independent 
directors,\4\ and (ii) a chairman who is an independent director. We 
adopted the amendments in the wake of a troubling series of enforcement 
actions involving late trading, inappropriate market timing activities, 
and misuse of nonpublic information about fund portfolios.\5\
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    \3\ Adopting Release, supra note 2.
    \4\ In this Release, we are using ``independent director'' to 
refer to a director who is not an ``interested person'' of the fund, 
as defined by the Act. See section 2(a)(19) of the Act [15 U.S.C. 
80a-2(a)(19)].
    \5\ See Adopting Release, supra note 2, at nn.5-6 and 
accompanying text.
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    The two new conditions were challenged by the Chamber of Commerce, 
which submitted a petition for review to the United States Court of 
Appeals for the District of Columbia Circuit. In that case, the Chamber 
of Commerce asserted that the Commission (i) lacked authority to adopt 
the amendments, and (ii) violated the Administrative Procedure Act 
(``APA'').\6\
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    \6\ 5 U.S.C. 551 et seq.
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    On June 21, 2005, the Court of Appeals issued its decision that 
``the Commission did not exceed its statutory authority in adopting the 
two conditions, and the Commission's rationales for the two conditions 
satisfy the APA.'' \7\ The Court noted the broad authority granted to 
the Commission to exempt transactions ``subject only to the public 
interest and the purposes of the [Act].'' \8\ In addition, the Court 
found that our actions were reasonable in light of the significant 
problems we identified with mutual funds that have arisen as a result 
of serious conflicts of interest.
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    \7\ Slip Opinion, supra note 1, at 2.
    \8\ Id. at 7.
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    The Court, however, remanded to the Commission for our 
consideration two deficiencies that it identified in the rulemaking. 
First, the Court held that, in connection with our statutory obligation 
to consider whether the conditions will promote efficiency, competition 
and capital formation, we did not adequately consider costs associated 
with the 75 percent independent board and the independent chairman 
conditions. Second, the Court stated that we did not give adequate 
consideration to an alternative discussed by the two Commissioners who 
dissented from the adoption of the rules (``disclosure alternative''). 
The Court did not vacate the rule amendments, however, and they remain 
in effect.\9\
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    \9\ See id. at 19 (ordering the matter ``remanded'' and citing 
Fox Television Stations, Inc. v. FCC, 280 F.3d 1027, 1048-49 (D.C. 
Cir. 2002) (explaining reasons for remanding a rulemaking without 
vacating) and Allied Signal, Inc. v. U.S. Nuclear Regulatory Comm'n, 
988 F.2d 146, 150-51 (D.C. Cir. 1993) (same)).
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II. Introduction

    In this Release, we further consider and address the two issues 
raised by the Court's remand order. As a threshold matter, we consider 
whether it is necessary to engage in additional fact-gathering to 
implement the Court's remand order, or otherwise engage in further 
notice and comment procedures.\10\ The existing record, which was 
before the Commission at the time the amendments were adopted, was 
developed through full notice and comment procedures. The notice 
initiating those procedures and soliciting public comment proposed two 
conditions for exemption that were substantially identical to the 
conditions that we adopted and that are supported by our additional 
discussion in this Release. Although the Court held that we ultimately 
failed in our Adopting Release adequately to address the issues 
identified by the Court in its opinion, we had specifically sought and 
received comment on the costs associated with the two conditions and 
had considered those costs at the time of the initial rulemaking. We 
further note that the original notice solicited comment on

[[Page 39391]]

whether there were alternatives that would serve the same or similar 
purposes, and elicited comment on the disclosure alternative.\11\ We 
find that the information in the existing record, together with 
publicly available information upon which we may rely, is a sufficient 
base on which to rest the Commission's consideration of the 
deficiencies identified by the Court. Thus, our consideration and 
discussion in this Release of the two issues relies upon that record 
and previously available public information, and we have determined 
that it is not necessary to engage in further notice and comment 
procedures in order to follow the Court's direction on remand.
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    \10\ Where, as here, a court does not specify a required 
procedure, the agency is free on remand to determine whether 
supplemental fact-gathering is necessary. Furthermore, if the 
existing record is a sufficient base on which to address on remand 
the court-identified deficiencies, additional notice and comment 
procedures are not required. See Sierra Club v. EPA, 325 F.3d 374, 
382 (D.C. Cir. 2003) (following the ``usual rule'' by remanding 
``for further explanation, though not necessarily for further 
notice-and-comment rulemaking''); National Grain and Feed Ass'n, 
Inc. v. OSHA, 903 F.2d 308, 310-11 (5th Cir. 1990) (leaving ``the 
agency free on remand to determine whether supplemental fact-
gathering is necessary for correction of the perceived error or 
deficiency.''). See also AT&T Wireless Servs., Inc. v. FCC, 365 F.3d 
1095, 1103 (D.C. Cir. 2004) (upholding after remand additional 
explanation of prior FCC decision where FCC found on remand that 
``the existing record was `a sufficiently adequate base on which to 
rest the Commission's decision * * *'').
    \11\ See Investment Company Governance, Investment Company Act 
Release No. 26323 (Jan. 15, 2004) [69 FR 3472 (Jan. 23, 2004)] 
(``Proposing Release''), at text preceding n.32; see also Comment 
Letter of the Financial Services Roundtable, File No. S7-03-04 (Mar. 
10, 2004) (``[I]nvestors will be able to express their views on this 
[independent chairman] issue, given clear and appropriate 
disclosure. * * * Investors for whom this issue is a priority can 
direct their investments to those funds.''); Comment Letter of 
Greenspring Fund, Incorporated, File No. S7-03-04 (June 17, 2004) 
(``Greater disclosure of relevant information would allow 
shareholders to make better informed decisions. If an independent 
Chairman is desirable in the eyes of some investors, then make that 
information readily accessible.'').
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    Moreover, engaging in further notice and comment procedures is not 
only unnecessary, it risks significant harm to investors without 
significant corresponding benefits, given the adequacy of the 
information currently available upon which we may rely. The amendments 
to the Exemptive Rules are the centerpiece of a broader regulatory 
effort to restore investor confidence in the mutual fund industry in 
the wake of the discovery of serious wrongdoing at many of the nation's 
largest fund complexes and by officials at the highest levels of those 
complexes. Fund managers acted in their own interests rather than in 
the interests of fund investors (which they are required to do), 
resulting in substantial investor losses that were well documented at 
the time we adopted the amendments. Further, subsequent events, 
although they do not form the basis of our action, have shown that the 
level of wrongdoing, and the corresponding investor losses, were in 
fact significantly greater than was known at that time. By acting 
promptly, we hope to bolster investor confidence, resolve any 
uncertainties associated with the remand, and ensure that investors 
receive the protections afforded by the amendments without delay.\12\ 
It is important that we avoid postponement of the compliance date and 
the attendant potential harm to investors and the market that would 
result.\13\
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    \12\ As noted above, the Court, while remanding a portion of the 
rulemaking for our consideration, did not vacate the rule 
amendments. See Slip Opinion, supra note 1, at 19.
    \13\ See Adopting Release, supra note 2, at Section IV (funds 
relying on Exemptive Rules must begin complying with the Exemptive 
Rule amendments after January 15, 2006).
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    Because Chairman Donaldson was scheduled to leave the Commission on 
June 30, 2005, and his replacement, although announced by the 
President, had not been formally nominated by him or confirmed by the 
Senate, we considered it important to act on this important matter no 
later than the time of our open meeting scheduled for June 29, 2005. In 
adopting the amendments to the Exemptive Rules, we carefully considered 
the issues presented by the rulemaking and reviewed the extensive 
record before the Commission. This is the last opportunity to bring the 
collective judgment and learning of all of us, who have spent the last 
year and a half thinking about the issues raised in this rulemaking, to 
bear on the important questions presented to us by the Court. Given our 
unique familiarity with these matters, we think it is both important 
and appropriate for the same five of us to consider the issues raised 
by the Court on remand, especially given the potential harm that may 
result from delay in resolving this matter.
    We take very seriously and act with the utmost respect for the 
Court of Appeals' admonition that we failed adequately to consider the 
costs imposed upon funds by the two challenged conditions, and failed 
to consider the disclosure alternative. Our determination to act 
promptly in no way diminishes our obligation to make a deliberate and 
careful consideration of the issues raised by the Court. We have 
undertaken to address those issues upon remand promptly because we are 
convinced that we can do so with the thoroughness and careful 
consideration required by the Court's direction to us, and without the 
sacrifice to investor protection that delay would risk. Because we have 
previously sought and received comment, the Commission has a 
significant foundation from which to consider the issues remanded by 
the Court. In light of that experience, and because the existing record 
and other publicly available information allow us to undertake the 
additional consideration required, we have determined that we can fully 
discharge our responsibilities within the time necessary to allow 
participation by the same group of Commissioners that adopted the 
amendments to the Exemptive Rules. Our failure to act at this time, 
moreover, risks the creation of significant uncertainties and potential 
harm to investors that would not, in our judgment, be in the public 
interest.\14\
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    \14\ Even prior to our having issued this Release, there have 
been reports that additional legal proceedings may result from our 
action today. Accordingly, we are instructing our Office of the 
General Counsel to take such action as it considers appropriate to 
respond to any proceedings relating to this rulemaking.
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III. Discussion

A. Costs Resulting From Exemptive Rule Amendments

    In the release proposing the amendments to the Exemptive Rules, we 
discussed and solicited comment on the costs and benefits of those rule 
amendments, and whether they would promote efficiency, competition and 
capital formation.\15\ In the Adopting Release, we again discussed the 
costs and benefits of the amendments, and whether they would promote 
efficiency, competition and capital formation.\16\
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    \15\ Proposing Release, supra note 11, at Sections V and VII.
    \16\ Adopting Release, supra note 2, at Sections VI and VIII. As 
the Court noted, section 2(c) of the Investment Company Act [15 
U.S.C. 80a-2(c)] requires the Commission, when engaging in 
rulemaking that requires it to consider or determine whether an 
action is necessary or appropriate in the public interest, to 
consider whether the action will promote efficiency, competition and 
capital formation. Slip Opinion, supra note 1, at 12-13.
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    In this Release, we reexamine the costs of the Exemptive Rule 
amendments in the two areas identified by the Court: (i) The costs to 
funds of complying with the condition that at least 75 percent of a 
fund's directors be independent; and (ii) the costs to funds of 
complying with the condition that the chairman be an independent 
director, particularly the costs of possible additional staff that the 
independent chairman might hire.\17\
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    \17\ In preparing estimates in this Release, we rely where 
appropriate on data that can be obtained or confirmed through 
publicly available filings under the Federal securities laws.
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1. Board Composition
    The amendments will impose additional costs on funds that rely on 
any of the Exemptive Rules by requiring that independent directors 
constitute at least 75 percent of the fund board or, if the fund board 
has only three directors, that all but one director be independent. As 
discussed in the Adopting Release, we have estimated that nearly 60 
percent of all funds currently meet the 75 percent condition.\18\ A 
fund that does not already meet this condition may come into compliance 
with the 75 percent condition by: (i) Decreasing the size of its board 
and allowing some

[[Page 39392]]

interested directors to resign; (ii) appointing new independent 
directors either to replace interested directors (maintaining the 
current size of its board) or to increase the current size of its 
board; \19\ or (iii) electing new independent directors either to 
replace interested directors (maintaining the current size of its 
board) or to increase the current size of its board.\20\ In order to 
provide funds with maximum flexibility, we did not specify which option 
they must select.
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    \18\ See Adopting Release, supra note 2, at n.78.
    \19\ 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)] (board vacancy may be 
filled by any legal manner if immediately after filling the vacancy 
at least two-thirds of directors have been elected by fund 
shareholders).
    \20\ Our description of the three options available to funds 
differs slightly from the description in the Adopting Release. As 
discussed in greater detail below, funds will incur costs to add new 
independent directors regardless of whether those new independent 
directors replace interested directors or increase the size of the 
board. Funds' costs will differ, however, depending on whether the 
board can appoint the new independent directors under section 16(a) 
of the Act or whether the fund's shareholders must approve the new 
independent directors. Unlike funds whose boards can appoint new 
independent directors, funds that must obtain shareholder approval 
for new independent directors will incur proxy solicitation 
expenses.
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    In the Adopting Release, we stated that ``our staff has no reliable 
basis for determining how funds would choose to satisfy this 
requirement and therefore it is difficult to determine the costs 
associated with electing independent directors.'' \21\ The Court of 
Appeals noted, however, that ``[t]hat particular difficulty may mean 
the Commission can determine only the range within which a fund's cost 
of compliance will fall,'' \22\ and directed that the Commission 
determine as best it can the economic implications of the rule. Based 
on the record in this matter, as well as our review of publicly 
available information, we have concluded that we do in fact have a 
reliable basis upon which to consider the range of costs associated 
with each of the different ways in which funds may choose to comply 
with the 75 percent condition, as the Court directed.
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    \21\ See Adopting Release, supra note 2, at text accompanying 
n.80.
    \22\ Slip Opinion, supra note 1, at 15-16 (``That particular 
difficulty [of determining aggregate costs] may mean the Commission 
can determine only the range within which a fund's cost of 
compliance will fall, depending upon how it responds to the 
condition * * .'').
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a. Adding Independent Directors
    Funds that elect to add independent directors in order to meet the 
75 percent condition have two options. They may replace some interested 
directors with independent directors, or they may increase the size of 
the board. Funds that choose simply to replace interested directors 
with independent directors or that add additional independent directors 
and are able to appoint the new independent directors may incur three 
kinds of costs. First, funds may incur initial and periodic costs of 
finding qualified candidates. Second, funds will incur annual 
compensation costs for the new independent directors. Third, funds 
could incur additional annual costs if new independent directors use 
additional services of independent legal counsel.\23\ Because smaller 
fund groups typically provide less compensation (for overseeing fewer 
funds) than larger fund groups (for overseeing more funds), our 
compensation estimates are based on a range of potential costs.
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    \23\ We also considered whether funds might incur additional 
costs as a result of additional premiums for directors' liability 
insurance. Most policies covering mutual fund directors' liability 
are priced based principally on the level of risk estimated by the 
insurer, on the amount of assets under management, and on the 
maximum aggregate limit of liability covered, rather than on the 
number of directors. Given our expectation that implementation of 
the rule amendments, with their effect of strengthening independent 
oversight of conflicts of interest, will reduce the risk of 
misconduct and ensuing investor losses, the cost of insuring against 
such risk should, if anything, be reduced. In any event, we have 
concluded that an increased cost of coverage associated with the two 
conditions, if any, will be minimal and will be adequately covered 
by the allowances for overhead and the cushions we have used in 
considering costs.
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    We understand that a majority of funds have eight or fewer 
directors.\24\ Accordingly, we conclude that most funds could appoint 
one or two independent directors in order to comply with the 75 percent 
condition.\25\ For example, a board with eight directors could comply 
with the condition by replacing one interested director with an 
independent director.\26\ However, we received one comment from a fund 
with five directors that stated it would not want to reduce the number 
of interested directors, and therefore would have to add three new 
independent directors in order to meet the 75 percent condition.\27\ In 
light of this comment, and acting conservatively so as not to 
underestimate costs, we have estimated for purposes of this discussion 
that a fund would appoint three new independent directors.
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    \24\ See Management Practice Inc. Bulletin: Fund Directors' Pay 
Increases 17% in Smaller Complexes, 8% in Larger (June 2003) 
(``Boards are getting smaller with 60% having 8 directors or 
less.'') (available at: http://www.mfgovern.com/); Management 
Practice Inc. Bulletin: More Meetings Means More Pay for Fund 
Directors (Apr. 2004) (``April 2004 MPI Bulletin'') (``Boards are 
staying about the same overall size, with a slight decrease in the 
number of interested directors, which facilitates a new 75% 
independent requirement.'').
    \25\ A fund that currently relies on any of the Exemptive Rules 
would already have a majority of independent directors on the board. 
See Role of Independent Directors of Investment Companies, 
Investment Company Act Release No. 24816 (Jan. 2, 2001) [66 FR 3734 
(Jan. 16, 2001)].
    \26\ An 8 member board of a fund that relies on at least one 
Exemptive Rule currently must have at least 5 independent directors. 
By replacing an interested director with an independent director, 6 
out of 8 (75%) would be independent. By replacing two interested 
directors with two independent directors on a 7 member board (which 
must have at least 4 independent directors), 6 out of 7 (86%) would 
be independent.
    \27\ See Comment Letter of the Disinterested Directors of ICAP 
Funds, Inc., File No. S7-03-04 (Mar. 4, 2004).
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    Based on data from a 2004 survey of mutual fund directors' 
compensation,\28\ we estimate that the median annual salary for 
directors ranges from $111,500 (for boards that oversee a large number 
of funds \29\) down to $12,500 (for boards that oversee from 1 to 6 
funds). Consistent with the approach suggested by the Court with 
respect to the hiring of additional staff in connection with the 
independent chairman condition, we make the estimates based upon the 
potential costs to an individual fund. Thus, we estimate the annual 
compensation cost per fund for appointing one independent director 
could range from $1593 (for boards that oversee a large number of 
funds) to $12,500 (for boards that oversee only one fund).\30\ 
Accordingly, if a fund were to appoint three independent directors, we

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estimate that these annual compensation costs could range, on a per 
fund basis, from $4779 (for boards that oversee a large number of 
funds) to $37,500 (for boards that oversee one fund).\31\
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    \28\ See April 2004 MPI Bulletin, supra note 24. The information 
provided in the Bulletin ``summarizes 2003/4 findings of the Mutual 
Fund Directors'' Compensation and Governance Practices survey with 
data drawn from public documents of 290 complexes, representing 
1,620 directors/trustees and the confidential responses of 
participating complexes.'' Thus, the survey may include compensation 
information concerning both independent and interested directors. 
Because interested directors generally are compensated by the 
adviser, not the fund, we have assumed for purposes of the estimates 
that the compensation reflects annual compensation of independent 
directors. This survey is a widely used industry survey, an earlier 
version of which was cited by the dissenting Commissioners in their 
statement attached to the Adopting Release. See Adopting Release, 
supra note 2, Dissent of Commissioners Cynthia A. Glassman and Paul 
S. Atkins, at n.24.
    \29\ For purposes of these estimates, we define boards that 
oversee a ``large number'' of funds as boards that oversee 70 or 
more funds. The per fund estimates we discuss related to these 
boards are calculated by basing per fund costs on a board that 
oversees 70 funds, which yields greater per fund costs than using a 
higher number would.
    \30\ These annual estimates of the cost of one independent 
director are based on the following calculations: ($111,500 / 70 
funds = $1593); ($12,500 / 1 fund = $12,500). In considering the 
range of costs per fund, we divided the median salary for a director 
overseeing a large number of funds (70 or more) by 70 funds, and the 
median salary for a director overseeing a small number of funds (1 
to 6) by 1 fund. The range of funds was based on data provided in 
the April 2004 MPI Bulletin, supra note 24.
    \31\ These annual estimates of the cost per fund are based on 
the following calculations: ($1593 x 3 directors = $4779); ($12,500 
x 3 directors = $37,500).
    We note that commenters' estimated costs of paying new 
independent directors ranged from $4000 to $20,000, which are 
roughly comparable with and do not exceed our estimated range. See 
Comment Letter of New Alternatives Fund, Inc., File No. S7-03-04 
(Feb. 9, 2004); Comment Letter of Independent Directors of Flaherty 
& Crumrine Preferred Income Opportunity Fund Inc., File No. S7-03-04 
(Feb. 23, 2004).
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    We further estimate that the costs to recruit an independent 
director may equal the independent director's first year salary.\32\ 
This cost may be incurred initially when the independent directors are 
first appointed, and periodically thereafter when, from time to time, 
an independent director is replaced. In our judgment, we conservatively 
estimate that the need to replace a director will, on average, occur no 
more often than once every five years.\33\ Thus, the initial per fund 
cost for recruiting services for three independent directors could 
range from $4779 (for boards that oversee a large number of funds) to 
$37,500 (for boards that oversee one fund).\34\ Based on turnover every 
five years, the annual cost per fund thereafter to replace independent 
directors could range from $956 to $7500.\35\
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    \32\ See, e.g., Andrea Felsted, Headhunters Feel the Heat in 
Quality Quest: Shareholder Reaction to Sainsbury's Choice of a 
Chairman-Designate has Shed a Harsh Light on a Secretive World, 
FINANCIAL TIMES, Feb. 21, 2004, at 5. This one-time cost would be 
shared among the funds that the director oversees.
    \33\ See, e.g., Management Practice Inc. Bulletin: Mutual Fund 
Directors' Compensation Increases 9% in a Turbulent Year (last 
modified Oct. 30, 2001) (available at http://www.mfgovern.com/) 
(noting that, based on a 2000 survey, ``[s]erving trustees have a 
median age of 62 with a median of 10 years of service.'').
    \34\ See supra note 31.
    \35\ These estimates are based on the following calculations: 
($4779 / 5 = $956); ($37,500 / 5 = $7500).
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    We expect that funds will incur additional costs because of 
increased reliance by new independent directors on the services of 
independent legal counsel. Based upon our experience, we estimate that, 
on average, the new independent directors will use an additional 30 
hours annually of independent legal counsel services. We have estimated 
that the average hourly rate for an independent counsel is $300,\36\ 
which yields a total cost of $9000 annually, per board. Thus, the range 
of costs for additional independent counsel services could range from 
$9000 per fund (for a board that oversees one fund) to $129 per fund 
(for a board that oversees a large number of funds).\37\
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    \36\ The $300 per hour estimated billing rate is one we have 
used in recent rulemakings. See, e.g., Disclosure Regarding 
Nominating Committee Functions and Communications Between Security 
Holders and Boards of Directors, Securities Act Release No. 8340 
(Nov. 24, 2003) [68 FR 69204 (Dec. 11, 2003)] at n.149.
    \37\ These estimates are based on the following calculations: 
($9000 / 1 = $9000); ($9000 / 70 = $129).
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    Estimated total costs per fund. Based on this data, we estimate 
that the total costs in the first year, for funds that appoint three 
new independent directors, could range from $9687 per fund (for boards 
that oversee a large number of funds) to $84,000 per fund (for boards 
that oversee one fund).\38\ Annual costs in subsequent years would 
decrease to a range of $5864 per fund (for boards that oversee a large 
number of funds) to $54,000 per fund (for boards that oversee only one 
fund).\39\
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    \38\ These estimates are based on the following calculations: 
($4779 (first year compensation) + $4779 (recruiting costs) + $129 
(independent counsel costs) = $9687); ($37,500 (first year 
compensation) + $37,500 (recruiting costs) + $9000 (independent 
counsel costs) = $84,000).
    \39\ These estimates are based on the following calculations: 
($4779 (annual compensation) + $956 (recruiting costs) + $129 
(independent counsel costs) = $5864); ($37,500 (annual compensation) 
+ $7500 (recruiting costs) + $9000 (independent counsel costs) = 
$54,000).
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    Funds that must obtain shareholder approval for new independent 
directors (whether to replace interested directors or to increase the 
size of the board) will incur additional costs of soliciting proxies 
from shareholders. We estimate the average costs of soliciting proxies 
as $75,000 per fund.\40\ If a fund must obtain shareholder approval for 
three new independent directors, the initial costs to add the directors 
could range from $84,687 per fund (for boards that oversee a large 
number of funds) to $159,000 per fund (for boards that oversee one 
fund).\41\ And as discussed above, costs would decrease in subsequent 
years to a range of $5864 per fund (for boards that oversee a large 
number of funds) to $54,000 per fund (for boards that oversee only one 
fund).\42\
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    \40\ See Investment Company Mergers, Investment Company Act 
Release No. 25666 (July 18, 2002) [67 FR 48512 (July 24, 2002)], at 
Section V. That cost could be substantially diminished if a proxy 
vote were scheduled to be held during the period on other matters.
    \41\ These estimates are based on the following calculations: 
($9687 (first year compensation, recruiting and independent legal 
counsel costs) + $75,000 (proxy costs) = $84,687); ($84,000 (first 
year compensation, recruiting and independent legal counsel costs) + 
$75,000 (proxy costs) = $159,000).
    \42\ See supra note 39.
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    We have also estimated increased costs to funds to reflect the 
increased responsibilities that independent directors may take on as a 
result of the 75 percent condition. To reflect this and other possible 
cost increases (including proxy cost increases), we have estimated that 
costs of complying with the condition may today have increased by as 
much as 20 percent.\43\ Accordingly, we have estimated current first 
year costs of the condition for funds in which the board appoints three 
new independent directors. These costs could range from $11,624 per 
fund (for boards that oversee a large number of funds) to $100,800 per 
fund (for boards that oversee one fund).\44\ We have further estimated 
that the current first year cost for funds that elect three new 
independent directors could range from $101,624 per fund (for boards 
that oversee a large number of funds) to $190,800 per fund (for boards 
that oversee one fund).\45\ Whether the new independent directors are 
appointed or elected, ongoing costs could range from $7037 per fund 
(for boards that oversee a large number of funds) to $64,800 per fund 
(for boards that oversee one fund).\46\
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    \43\ As to director compensation, the conservative nature of 
this estimate is confirmed by publicly available information 
indicating that in 2004, directors' compensation increased by 13 
percent. See Management Practice Inc. Bulletin: More Meetings, More 
Pay: Fund Directors' Compensation Increases 13% as Workload Grows 
(Apr. 2005) (available at http://www.mfgovern.com).
    \44\ These estimates are based on the following calculations: 
($9687 x 1.2 = $11,624); ($84,000 x 1.2 = $100,800).
    \45\ These estimates are based on the following calculations: 
($84,687 x 1.2 = $101,624); ($159,000 x 1.2 = $190,800).
    \46\ These estimates are based on the following calculations: 
($5864 x 1.2 = $7037); ($54,000 x 1.2 = $64,800).
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b. Decreasing Interested Directors
    Finally, funds that simply decrease the size of their boards and 
allow some interested directors to resign are likely to incur, at most, 
only minimal direct costs. The decision to reduce the size of the board 
and eliminate one or more interested directors from the board would 
likely be made at a previously scheduled board meeting.\47\ Because 
this option is the simplest of the three options and imposes the lowest 
direct costs, it is likely that many, if not most, funds will choose to 
comply with the 75 percent condition by using this

[[Page 39394]]

option.\48\ There is the possible non-monetary cost of the loss of 
experience on the board. In other words, having fewer interested 
directors on the board might decrease the expertise of the board. As we 
discussed in the Adopting Release, however, nothing in the Exemptive 
Rule amendments would prohibit interested persons from participating in 
board meetings, if the directors decide to include them in those 
meetings.\49\ Thus we believe that the reduction in the number of 
interested directors will likely result, at most, in only minimal 
direct costs.\50\
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    \47\ In the unusual circumstances in which the interested 
directors are compensated by the fund rather than by the fund's 
adviser, the termination of the interested directors could result in 
a cost savings for the fund. We understand, however, that in most 
cases the fund's adviser compensates the interested directors 
directly.
    \48\ See, e.g., April 2004 MPI Bulletin, supra note 24 (``Boards 
stayed about the same size, but the number of affilaited directors 
declined as the preferred method of achieving the required 75% 
independent.''); Comment Letter of the Directors' Committee of the 
Investment Company Institute, File No. S7-03-04 (Mar. 10, 2004) 
(``While it is our expectation that most funds would reach this 
percentage by asking an interested director to step down from the 
board, there are some boards that will do so by adding an 
independent director.''); Comment Letter of New Alternatives Fund, 
Inc., File No. S7-03-04 (Feb. 9, 2004) (``[I]t is difficult to find 
competent directors. An alternative is for the undersigned founder 
to resign as a director while remaining a manager. We could then 
reach the 75% requirement.'').
    \49\ See Adopting Release, supra note 2, at text following n.50 
and at text preceding and following n.60.
    \50\ It would be impracticable to quantify the indirect costs of 
choosing this option. Of course, if those indirect costs (plus the 
insignificant direct costs) of this option were to exceed the total 
direct and indirect costs associated with either of the other two 
options, then the fund could choose to use one of those other, 
lower-cost options.
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2. Independent Chairman
    The Exemptive Rule amendments also require that a fund relying on 
an Exemptive Rule have an independent director serve as chairman of the 
board. As we noted in the Adopting Release, there may be costs 
associated with the independent chairman condition, such as the costs 
of hiring staff to assist the chairman in carrying out his or her 
responsibilities.\51\ However, we said that we had no reliable basis 
for estimating those costs. The Court of Appeals noted that 
``[a]lthough the Commission may not have been able to estimate the 
aggregate cost to the mutual fund industry of additional staff because 
it did not know what percentage of funds with [an] independent chairman 
would incur that cost, it readily could have estimated the cost to an 
individual fund.'' \52\ Based on the record in this matter, as well as 
a review of publicly available information, we have concluded that we 
do in fact have a reliable basis for estimating the costs to an 
individual fund associated with the independent chairman condition, as 
the Court directed. This estimate also includes possible increased 
compensation to independent chairs to reflect their additional 
responsibilities.
---------------------------------------------------------------------------

    \51\ See Adopting Release, supra note 2, at n.81.
    \52\ Slip Opinion, supra note 1, at 16-17.
---------------------------------------------------------------------------

    In addition to the monetary costs we discuss below, some have 
raised, as a possible non-monetary cost, the loss of experience on the 
board if the interested chairman were to resign from the board. The 
interested chairman, however, typically is one of the most senior 
officers of the fund's investment adviser, which has a direct interest 
in the operations of the fund. Therefore, we anticipate that the 
interested chairman is unlikely to resign from the fund's board, and 
will likely continue to participate actively in board meetings even 
though he no longer functions as the chairman.\53\
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    \53\ Even in the unlikely case that the chairman resigns from 
the board, we believe that the resignation would have minimal costs 
because, as discussed above and in the Adopting Release, nothing in 
the Exemptive Rule amendments would prohibit the former chairman 
from participating in board meetings if the directors decide to 
include him or her in those meetings. See supra note 49 and 
accompanying text.
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A. Additional Staff
    Several commenters suggested that an independent chairman might 
decide to hire staff to help fulfill his or her responsibilities.\54\ 
Although we cannot determine how many independent chairmen would 
require the hiring of additional staff to support them,\55\ we have 
estimated the costs that fund boards may incur as a result of hiring 
additional staff.\56\
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    \54\ See, e.g., Comment Letter of Disinterested Trustees of EQ 
Advisors Trust, File No. S7-03-04 (Mar. 4, 2004) (``[A] fund group 
would need to compensate the [independent] chair commensurate with 
his or her additional responsibility and time commitment and would 
need to hire additional support for that individual.''); Comment 
Letter of New Alternatives Fund, Inc., File No. S7-03-04 (Feb. 9, 
2004) (estimating a $25,000 cost of ``aids to directors''); Comment 
Letter of Sullivan & Cromwell LLP, File No. S7-03-04 (Mar. 9, 2004) 
(``[W]e believe that mandating an independent chairman will 
effectively mandate the retention of an independent staff and/or 
enhanced participation by independent counsel in fund complexes both 
large and small.''). The [chief compliance officer] and independent 
counsel were viewed as the logical persons to interface regularly 
with the Chair and their involvement may alleviate the need for 
permanent staff to the board or Chair. The management company 
typically provides the bulk of the secretarial and clerical support 
for most boards.''). Despite the lack of consensus on whether an 
independent chairman is likely to hire any additional staff, the 
estimate discussed in this section--to avoid any underestimate of 
costs--assumes the hiring of two additional staff members.
    \55\ Adopting Release, supra note 2, at n.81.
    \56\ These costs are for additional staff. An independent chair, 
like a management affiliated chair, will continue to have available 
the services of the existing staff of the fund management company.
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    In our judgment, in most cases, independent chairmen will be 
expected to hire no more than two staff employees, consisting of one 
full-time senior business analyst and one full-time executive 
assistant. We believe that these costs will be borne primarily by 
larger fund complexes, and that independent chairmen at smaller 
complexes will rarely choose to hire additional staff. We have 
estimated the costs of retaining these personnel based on salary 
surveys conducted by the Securities Industry Association (``SIA''), a 
source on which we commonly rely in our rulemakings.\57\ The SIA found 
the average salary (including bonus) of a senior business analyst to be 
$136,671.\58\ Adjusting this salary upwards by 50 percent to reflect 
possible overhead costs and employee benefits, this salary amounts to 
$205,007. The SIA found the average salary of an executive assistant 
(including bonus) to be $73,088.\59\ Adjusting this salary upwards by 
50 percent to reflect possible overhead costs and employee benefits, 
this salary amounts to $109,632. Thus, the hiring of both a full-time 
senior business analyst and a full-time executive assistant for an 
independent chairman would total approximately $314,639 for each board. 
This cost can be expressed on a per fund basis, which we calculate to 
be $42,519.\60\
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    \57\ See, e.g., Disclosure Regarding Approval of Investment 
Advisory Contracts by Directors of Investment Companies, Investment 
Company Act Release No. 26486 (June 23, 2004) [69 FR 39798 (June 30, 
2004)] at n.55.
    \58\ See Securities Industry Association, REPORT ON MANAGEMENT & 
PROFESSIONAL EARNINGS IN THE SECURITIES INDUSTRY (2004). This 
estimate is for a New York salary. The SIA also estimates non-New 
York salaries, which are lower. The estimates in this section use 
the higher figure.
    \59\ See Securities Industry Association, REPORT ON OFFICE 
SALARIES IN THE SECURITIES INDUSTRY (2004).
    \60\ This estimate is based on the following calculation: 
($314,639 / 7.4 funds per board = $42,519 per fund). We estimate 
that there are, on average, 7.4 funds per board. There were 8126 
funds in 2003. See Investment Company Institute, 2004 MUTUAL FUND 
FACT BOOK (May 2004). We estimate that there are approximately two 
boards of directors per fund complex. We also estimate that in 2003 
there were 550 fund complexes, yielding a total of 1100 fund boards. 
Therefore, there are approximately 7.4 funds per board (8126 funds / 
1100 boards).
    This estimate exceeds an estimate provided by a commenter. See 
Comment Letter of New Alternatives Fund, Inc., File No. S7-03-04 
(Feb. 9, 2004) (estimating a $25,000 cost of ``aids to directors'').
---------------------------------------------------------------------------

    Some commenters suggested that another cost of the amendments could 
result from increased reliance by the independent chairman on the 
services of independent legal counsel.\61\ Based

[[Page 39395]]

upon our experience, we estimate that, on average, the independent 
chairman will use independent legal counsel a total of 50 hours a year 
more under the amendments. We have estimated that the average hourly 
rate for an independent counsel is $300,\62\ which yields a total cost 
of $15,000 annually, per board. This amounts to $2027 per fund.\63\
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    \61\ See, e.g., Comment Letter of Sullivan & Cromwell, LLP, File 
No. S7-03-04 (Mar. 9, 2004) (``[W]e believe that mandating an 
independent chairman will effectively mandate the retention of an 
independent staff and/or enhanced participation by independent 
counsel in fund complexes both large and small.'').
    \62\ See supra note 36.
    \63\ This estimate is based on the following calculation: 
($15,000 / 7.4 funds per board = $2027 per fund).
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B. Increased Compensation for an Independent Chairman
    We estimate that compensation for an independent chairman may be 
from 25 to 50 percent higher than the compensation of other 
directors.\64\ In order to calculate maximum likely costs and avoid 
understating those costs, the estimate in this section will use the 
assumption of the higher end of the range, i.e., a 50 percent premium, 
and takes into account the 20 percent increase reflecting possible 
increased compensation costs.\65\ Therefore, based on the estimates 
discussed above regarding compensation for fund independent 
directors,\66\ we estimate that the additional ongoing compensation 
cost, and other cost increases, of appointing an independent director 
as chairman could range from $1147 to $9000 each year, per fund.\67\
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    \64\ See Beagan Wilcox, ``Wanted: Independent Chairmen,'' Board 
IQ, July 6, 2004 (citing estimate of Meyrick Payne, senior partner, 
Management Practice Inc.).
    \65\ See supra text accompanying note 44.
    \66\ See supra Section III.A.1.
    \67\ These estimates are based on the following calculations: 
(($4779 + $956) x 1.2 / 3 x .5 = $1147); (($37,500 + $7500) x 1.2 / 
3 x .5 = $9000). Funds that already have 75% independent directors 
would only incur costs for the additional pay when one of these 
directors is appointed chairman. The costs for funds that must 
appoint or elect new independent directors is discussed in the 
previous section. We expect that almost all funds that do not have 
an independent chairman would select one of the current independent 
directors to be the chairman. If a fund chooses to recruit an 
independent chairman, however, the fund would incur recruiting costs 
in the first year equal to the independent chairman's first year 
salary.
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3. Promotion of Efficiency, Competition and Capital Formation
    As noted by the Court, we must consider the impact of the costs of 
compliance with the two conditions, both quantitative and qualitative, 
on funds' efficiency, competition and capital formation. We find that 
the costs of the 75 percent condition and of the independent chairman 
condition are extremely small relative to the fund assets for which 
fund boards are responsible, and are also small relative to the 
expected benefits of the two conditions. We expect that the minimal 
added expense of compliance with these conditions will have little, if 
any, adverse effect on efficiency, competition and capital formation. 
Indeed, we anticipate that compliance with the two conditions by funds 
that rely upon the Exemptive Rules will help increase investor 
confidence, which may lead to increased efficiency and competitiveness 
of the U.S. capital markets. We also anticipate that this increased 
market efficiency and investor confidence may encourage more efficient 
capital formation.
    With respect to the 75 percent condition, even for funds that elect 
to add independent directors and are required to solicit proxies, the 
costs are minor compared to the amount of assets under management. For 
funds that choose to comply with the 75 percent condition simply by 
decreasing the size of the board, the costs are insignificant. For 
funds that appoint three new independent directors, using the data from 
the 2004 survey and adding a 20 percent cushion as discussed above, the 
ongoing annual costs range from $64,800 per fund, for boards that 
oversee only one fund, down to $7037 per fund, for boards that oversee 
a large number of funds.\68\ Start-up costs in the first year are 
somewhat more per fund: from $100,800 per fund for boards that oversee 
only one fund, to $11,624 per fund for boards that oversee a large 
number of funds.\69\ For funds that cannot appoint the new directors 
and must solicit proxies, the first year costs per fund increase to 
$190,800 for boards that oversee only one fund, and to $101,624 for 
boards that oversee a large number of funds.\70\ Using any of the 
options, the costs per fund will be no more than a very small fraction 
of the fund assets for which the fund boards are responsible.\71\
---------------------------------------------------------------------------

    \68\ See supra note 46.
    \69\ See supra note 44.
    \70\ See supra note 45.
    \71\ We estimate that average fund assets in 2003 were $912 
million based on a total of assets in 2003 of $7.414 trillion and a 
total of 8,126 mutual funds (excluding funds that invest in other 
mutual funds). See Investment Company Institute, 2004 MUTUAL FUND 
FACT BOOK, at 113. Fund expenses are typically measured as a 
percentage of assets under management and are required to be 
disclosed to investors in this manner. See Item 3 of Form N-1A. We 
believe that comparison to net assets is the most helpful for 
investors.
---------------------------------------------------------------------------

    The costs of the independent chairman condition are likewise small. 
Even if the independent chairman hires two full-time staff (at New York 
salaries), and uses 50 hours of additional independent legal counsel, 
the total is only $329,639,\72\ which would be divided among the number 
of funds overseen by the independent chairman. And the additional per 
fund compensation received by the independent chairman could range from 
$9000 for an independent chairman who oversees a single fund, down to 
$1147 for an independent chairman who oversees a large number of funds. 
Even using the highest additional compensation figure, the average fund 
will incur a total cost for staff, legal counsel and additional 
compensation of only $47,220.\73\
---------------------------------------------------------------------------

    \72\ Two full-time staff ($314,639) plus 50 hours of independent 
counsel ($15,000) equals $329,639.
    \73\ Two full-time staff per fund ($42,519, see supra text 
accompanying note 60) plus 50 hours of legal counsel per fund 
($2027, see supra text accompanying note 63) plus $2674 (increased 
compensation and recruiting costs for an independent chairman) 
equals $47,220. The increased compensation and recruiting costs for 
the independent chairman was calculated based on a board that 
oversees 7.4 funds. See supra 60. The estimate of $2674 is based on 
the following calculation: ((($27,480 median compensation for a 
director that oversees 7 to 19 funds / 7.4 funds) + $743 recruiting 
costs) x 1.2 20% cost increase x .5 = $2674). The median salary for 
a board overseeing 7 to 19 funds was based on data provided in the 
April 2004 MPI Bulletin, supra note 24.
---------------------------------------------------------------------------

    Whether the two conditions are viewed separately or together, even 
at the high end of the ranges, the costs of compliance are minimal.\74\ 
We also note that the ranges of costs considered above represent the 
high range of potential cost of compliance for any individual fund. The 
average cost per fund to the industry as a whole will likely be much 
lower.\75\ At the time we adopted the rule amendments, 60 percent of 
funds already complied with the 75 percent condition and will incur no 
additional cost as a result of the implementation of that condition. 
Moreover, we expect few boards to appoint or elect as many as three new 
independent directors. Most are likely to decrease the size of their 
board or add one or two new directors. Our highest cost estimates are 
for boards that oversee only a single fund, which is an atypical 
situation. We think it unlikely that such a board would choose the

[[Page 39396]]

more costly options of adding as many as three new directors and hiring 
two full-time staff to assist the independent chairman.\76\
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    \74\ These costs represent our best estimates of the ranges. We 
recognize that there may be ancillary costs, but we expect them to 
be minor and such costs should be covered by the generous cushion we 
have built into our estimates and by our use of the high end of the 
cost ranges. Moreover, in light of the benefits, we believe that 
even if the costs were several times higher, they would continue to 
be minimal and the rule amendments would still be justified.
    \75\ While the high-end costs may be applicable to a given fund, 
the high-end costs clearly will not be applicable to all funds or 
even most funds. It would be incorrect, and indeed misleading, to 
take the highest possible cost for a single fund and extrapolate for 
the entire industry.
    \76\ Because we find the adoption of the two conditions to be 
appropriate even looking at the high end of the range of costs, we 
would reach the decision not to modify the rule amendments even 
apart from our discussion of the rest of the range of costs. 
However, we consider that range pertinent and helpful in reinforcing 
our determination. Our use of the high end of the range also offsets 
any potential benefit from seeking information as to costs incurred 
by funds that have come into early compliance with the two 
conditions since the date of our original adopting release (which 
funds are likely to constitute an evolving subset that may, in any 
event, not be representative of funds more generally). As we have 
previously noted, engaging in further notice and comment procedures 
to obtain additional information would create a risk of significant 
harm to investors.
---------------------------------------------------------------------------

    Moreover, these costs are slight in relation to the very important 
benefits of the two conditions, as more fully discussed in the Adopting 
Release. The 75 percent condition is intended to promote strong fund 
boards that effectively perform their oversight role. Enhanced 
oversight by a strong, effective and independent fund board will serve 
to protect funds and their shareholders from abuses that can occur when 
funds engage in the conflict-of-interest transactions permitted under 
the Exemptive Rules. This will increase investor confidence in fund 
management and promote investment in funds. While these benefits are 
not easily quantifiable in terms of dollars, we believe they are 
substantial, particularly in comparison to the estimated cost of 
compliance. The independent chairman condition will provide similar 
benefits. The chairman of a fund board can have a substantial influence 
on the fund board agenda and on the fund boardroom's culture. An 
independent chairman will advance meaningful dialogue between the fund 
adviser and independent directors and will support the role of the 
independent directors in overseeing the fund adviser. Moreover, an 
independent board led by an independent chairman is more likely to 
vigorously represent investor interests when negotiating with the fund 
adviser on matters such as fees and expenses. We find that these 
cumulative benefits fully justify the costs associated with the rule 
amendments. Further, it is our judgment that, in the future, each of 
the proposed amendments is likely, when taken together with other 
Commission reforms, to have a significant potential prophylactic 
benefit in preventing harm from conflict-of-interest transactions--
itself a benefit sufficient to justify these costs.
    Consistent with our view expressed in the Adopting Release, we do 
not expect the amendments to the Exemptive Rules to have a significant 
adverse effect on efficiency, competition or capital formation because 
the costs associated with the amendments are minimal and many funds 
have already adopted the required practices.\77\ To the extent that 
these amendments do affect competition or capital formation, we said we 
believed, and we continue to believe, that the effect would be 
positive. Among other things, we believe the 75 percent and independent 
chairman conditions would enhance the quality and accountability of the 
fund governance process. The estimates discussed in this release of the 
costs associated with compliance with the 75 percent condition and the 
independent chairman condition, and our further consideration of the 
effect of those costs on efficiency, competition and capital formation, 
do not alter this conclusion. We believe that a more robust system of 
checks and balances on fund boards should raise investors' expectations 
regarding the governance of these funds.\78\ By promoting investor 
confidence in the fairness and integrity of the individuals that 
monitor investment companies, we promote investor confidence in the 
fairness and integrity of our markets. Investors will likely be more 
willing to effect transactions in those markets, which in turn will 
help to increase liquidity and to foster the capital formation process. 
Increased investor confidence in the integrity of mutual funds also 
will lead to increased efficiency and competitiveness of the U.S. 
capital markets.
---------------------------------------------------------------------------

    \77\ See Adopting Release, supra note 2, at Section VIII. The 
costs for any fund are sufficiently small that we think any adverse 
effect on competition will continue to be minimal and will be 
justified by the benefits of the rule, especially given our judgment 
that small funds will choose options for compliance with the 
conditions at cost levels that do not approach the upper end of the 
range.
    \78\ See, e.g., Comment Letter of Morningstar, Inc., File No. 
S7-03-04 (Mar. 10, 2004) (``Overall, we support the proposal, which 
should be beneficial in restoring the system of checks and balances 
that is essential to ensuring that the interests of fund 
shareholders are represented.''); Comment Letter of Joseph J. 
Kearns, File No. S7-03-04 (June 3, 2004) (``Having an independent 
chairman is in my opinion the most important governance regulation 
needed. * * * The shareholders need to see that boards are truly 
independent including their leadership.'').
---------------------------------------------------------------------------

B. Consideration of the Disclosure Alternative

    The Court of Appeals also stated that the Commission did not give 
adequate consideration to an alternative to the independent chairman 
condition, discussed by the two dissenting Commissioners, that ``each 
fund be required prominently to disclose whether it has an inside or an 
independent chairman and thereby allow investors to make an informed 
choice.''\79\ As discussed below, we do not believe this proposal--to 
provide information to enable an informed investment decision--would 
adequately protect fund investors from the potential abuses inherent in 
the conflict-of-interest transactions permitted under the Exemptive 
Rules. We reach this conclusion in light of the nature of investment 
companies and the purposes of the statutory prohibitions to which the 
Exemptive Rules apply.
---------------------------------------------------------------------------

    \79\ Slip Opinion, supra note 1, at 17. In their dissent to the 
adoption of the rule amendments, Commissioners Glassman and Atkins 
said: ``We were hopeful when these board governance amendments were 
proposed that alternative measures would be considered. Requiring a 
fund to disclose prominently whether or not it had an independent 
chairperson, for example, would allow shareholders to decide whether 
that matters to them or not.'' Adopting Release, supra note 2, 
Dissent of Commissioners Cynthia A. Glassman and Paul S. Atkins, at 
text following n.46.
---------------------------------------------------------------------------

    As we explained in the release proposing the 2001 amendments to the 
Exemptive Rules, funds are unique in that they are organized and 
operated by people whose primary loyalty and pecuniary interest lie 
outside the enterprise.\80\ This ``external management'' structure 
presents inherent conflicts of interest and potential for abuses. The 
investment adviser firms that manage the funds have interests in their 
own profits that may conflict with the interests of the funds they 
manage. And in many cases, as we noted in the Adopting Release, fund 
boards continue to be dominated by their management companies.\81\
---------------------------------------------------------------------------

    \80\ See Role of Independent Directors of Investment Companies, 
Investment Company Act Release No. 24082 (Oct. 14, 1999) [64 FR 
59826 (Nov. 3, 1999)], at n.9 and accompanying text.
    \81\ Adopting Release, supra note 2, at text preceding n.8.
---------------------------------------------------------------------------

    It was to address these conflicts of interest that Congress in 1940 
enacted the Investment Company Act, including the statutory 
prohibitions to which the Exemptive Rules apply.\82\ Congress found 
that the disclosure regimes of the Securities Act of 1933 and the 
Securities Exchange Act of 1934 were inadequate

[[Page 39397]]

to cope with the type of conflicts and abuses that pervaded the 
investment company industry.\83\ The Investment Company Act, with its 
prohibitions against transactions involving conflicts of interest and 
its detailed prescriptions for the organization and governance of 
investment companies--particularly the setting of standards for 
independent directors, and their role as ``watchdogs'' for the 
interests of fund shareholders--played a crucial role in restoring 
confidence in investment companies as a regulated medium for investor 
savings.
---------------------------------------------------------------------------

    \82\ See, e.g., S. Rep. No. 1775, 76th Cong., 3d Sess. 7 (1940):
    The representatives of the investment trust industry were of the 
unanimous opinion that ``self-dealing''--that is, transactions 
between officers, directors, and similar persons and the investment 
companies with which they are associated--presented opportunities 
for gross abuse by unscrupulous persons, through unloading of 
securities upon the companies, unfair purchases from the companies, 
the obtaining of unsecured or inadequately secured loans from the 
companies, etc. The industry recognized that, even for the most 
conscientious managements, transactions between these affiliated 
persons and the investment companies present many difficulties.
    \83\ See, e.g., H.R. Rep. No. 2639, 76th Cong., 3d Sess. 10 
(1940):
    The Securities Act of 1933 and the Securities Exchange Act of 
1934 have not acted as deterrents to the continuous occurrence of 
abuses in the organization and operation of investment companies. 
Generally these acts provide only for publicity. The record is clear 
that publicity alone is insufficient to eliminate malpractices in 
investment companies.
---------------------------------------------------------------------------

    In the case of ordinary business corporations, the Federal 
securities laws protect investors by providing disclosure to enable 
them to make an informed investment decision.\84\ Even with respect to 
conflicts of interest on the part of managers of investment companies, 
disclosure in some cases can provide important protections. In the 
context of the subject of this rulemaking, for example, disclosure may 
enable fund investors to decide whether to invest in a fund that does 
not have an independent chair. But the utility of such disclosure is 
limited. Disclosure concerning conflicts of interest on the part of 
fund managers and the potential for self-dealing by them does not 
prevent the managers from putting their interests ahead of investors' 
interests. Disclosure does not prevent them from engaging in self-
dealing. While this is also true in the case of managers of ordinary 
companies, investment companies are different in this regard because of 
the structure and purposes of the Investment Company Act. That Act 
prohibits certain transactions that involve conflicts of interest and 
the resulting potential for self-dealing. Indeed, protection against 
harm from self-dealing is one of the express purposes of the Investment 
Company Act.\85\ We believe the objectives of these conflict-of-
interest prohibitions of the Act will best be served by strengthening--
through enhanced independent oversight--investor confidence that those 
charged with managing their fund will act in the investors' interests. 
Under these circumstances, we do not believe that disclosure alone is 
sufficient to adequately protect a fund investor against the serious 
risk that the managers of his or her investment will engage in self-
dealing.\86\
---------------------------------------------------------------------------

    \84\ Even in the context of ordinary business corporations, the 
federal securities laws do not rely exclusively on disclosure. See, 
e.g., section 13(k) of the Securities Exchange Act of 1934, 15 
U.S.C. 78m(k) (prohibition on personal loans to executives).
    \85\ See Section 1 of the Act, 15 U.S.C. 80a-1.
    \86\ The disclosure alternative would benefit prospective or 
future investors to a greater degree than existing investors in a 
fund. Existing investors, once they receive disclosure of the 
independence of the board's chairman, may not be able to redeem 
without incurring costs, due to deferred sales loads, redemption 
fees, taxes, or other transaction costs. See Payment of Asset-Based 
Sales Loads by Registered Open-End Management Investment Companies, 
Investment Company Act Release No. 16431 (June 13, 1988) [53 FR 
23258 (June 21, 1988)] at text following n.188 (noting the 
restrictions on the ability of existing investors to ``vote with 
their feet'').
---------------------------------------------------------------------------

    Moreover, even if we assume that meaningful disclosure would be an 
adequate alternative to a requirement of an independent chair, there 
are obstacles to making disclosure that would be meaningful. We doubt 
the sufficiency of merely disclosing that a fund does not have such a 
chair.\87\ For prospectus disclosure to be meaningful, investors 
considering a fund would have to be informed of the conflicts of 
interest faced by fund advisers, the complex role of the fund board in 
managing those conflicts, and the potential consequences to investors 
of the failure of fund boards to protect against conflicts. It would be 
difficult to provide meaningful disclosure of these matters.
---------------------------------------------------------------------------

    \87\ Indeed, most funds already disclose in their public filings 
whether the chairman of the board is independent.
---------------------------------------------------------------------------

    In addition, we did not adopt the independent chairman provision in 
isolation. We adopted it as part of a larger package of regulatory 
reforms that should lead to enhanced compliance by funds that have 
independent chairs.\88\ The independent chairman will be in a position 
to receive reports from the fund's compliance personnel. Under rules we 
adopted in December 2003, each fund is required to have a chief 
compliance officer who is responsible for, among other things, keeping 
the fund's board of directors apprised of significant compliance events 
at the fund or its service providers and for advising the board of 
needed changes in the fund's compliance program.\89\
---------------------------------------------------------------------------

    \88\ See Adopting Release, supra note 2, at text accompanying 
nn. 5-6.
    \89\ Compliance Programs of Investment Companies and Investment 
Advisers, Investment Company Act Release No. 26299 (Dec. 17, 2003) 
[68 FR 74714 (Dec. 24, 2003)].
---------------------------------------------------------------------------

    We also observed that the chairman can play an important role ``in 
establishing a boardroom culture that can foster the type of meaningful 
dialogue between fund management and independent directors that is 
critical for healthy fund governance.'' \90\ Meaningful dialogue is 
particularly important where the board is evaluating the types of 
transactions permitted by the Exemptive Rules. A board can most 
effectively manage the conflicts of interest inherent in these 
transactions where the board culture encourages rather than stifles 
open and frank discussion of what is in the best interest of the fund. 
This is especially true in connection with the conflicts of interest 
presented by these transactions because the best interest of the fund 
frequently is different from the best interest of the fund's management 
company. Similarly, we stated that the chairman of a fund board ``is in 
a unique position to set the tone of meetings and to encourage open 
dialogue and healthy skepticism.'' \91\ An independent chairman is 
better equipped to serve in this role. An independent chairman also can 
play an important role in serving as a counterbalance to the fund's 
management company by providing board leadership that focuses on the 
long-term interests of investors.
---------------------------------------------------------------------------

    \90\ See Adopting Release, supra note note 2, at text preceding 
n.47.
    \91\ Id. at text following n. 50.
---------------------------------------------------------------------------

    None of these benefits can be achieved merely by disclosure. We 
continue to find that it is necessary and appropriate in the public 
interest and consistent with the protection of investors to condition a 
fund's reliance upon any of the Exemptive Rules upon its having an 
independent chairman.

IV. Response to Comments of Dissenting Commissioners at Open Meeting

    At the Commission's open meeting in this matter, the dissenting 
Commissioners \92\ raised various objections to our response to the 
Court of Appeals. The dissenters, echoing requests made by others, 
claim (i) that we are acting too quickly, which prevents further notice 
and comment procedures that are either required or desirable, and which 
prevents sufficient consideration by the staff and Commission, (ii) 
that our action is inconsistent with certain aspects of the Court's 
opinion, (iii) that we did not seek comments on the costs associated 
with the independent chair condition at the time of the initial 
rulemaking, and (iv) that acting so quickly is

[[Page 39398]]

unprecedented and unjustified. We disagree.
---------------------------------------------------------------------------

    \92\ Commissioners Cynthia A. Glassman and Paul S. Atkins 
(``dissenters'') voted against this Response to Remand by Court of 
Appeals. Although Commissioner Glassman provided a written copy of 
her oral remarks made at the meeting, the dissenting Commissioners 
did not otherwise provide us with copies of their written dissents 
prior to the completion of this Release.
---------------------------------------------------------------------------

    We have largely addressed these concerns, which are inter-related 
in many respects, previously in this Release. We have discussed the 
reasons that further notice and comment procedures are not required, 
finding that the existing record, together with other information on 
which the Commission may rely, is a sufficient basis for our decision 
on remand.\93\ We also have explained why, although they are not 
required, we should not under the circumstances engage in further 
notice and comment procedures.\94\
---------------------------------------------------------------------------

    \93\ See supra Section II. As noted in our Adopting Release, we 
received nearly 200 comments from fund investors, management 
companies, independent directors to mutual funds, as well as members 
of Congress; and we also received several comments from 
organizations that had a more general interest in corporate 
governance issues. See Adopting Release, supra note 2, at Section I.
    Commissioner Glassman disputed that we sought comments in the 
Proposing Release on the costs associated with the independent 
chairman's hiring of additional staff. In support of this, she cited 
language in the Proposing Release which, she argues, requested 
comments on certain other costs but ``expressly declined'' to 
request comments on the cost of the independent chairman's hiring of 
additional staff. This is incorrect. In fact, the Proposing Release 
expressly sought comments on ``the costs'' of the condition 
requiring ``[a]n independent director to be chairman of the board.'' 
See Proposing Release, supra note 11, at Section V.B. In addition, 
the Proposing Release included a general request for comments on the 
potential costs and benefits of the rule. See id., at Section V.C.
    \94\ See supra Section II & note 76. Commissioner Glassman 
argues that we are using estimates rather than ``actual data'' when 
``actual costs'' are available, now that funds have started to come 
into compliance with the rule amendments. As discussed above, 
however, the estimates are based on actual data previously available 
to us; and, for reasons stated above, we have determined that it is 
unnecessary to supplement that data with information about funds 
that have come into early compliance. See supra note 76.
---------------------------------------------------------------------------

    We have furthermore explained the need to act promptly in this 
matter, noting, among other things, the importance of avoiding a 
postponement of the compliance date and the attendant potential harm to 
investors and the market that would result.\95\ We find that any 
further delay or ambiguity surrounding implementation of the rules 
would disadvantage not only investors but also fund boards and 
management companies, most of which have already begun the process of 
coming into compliance with the rules. By acting swiftly and 
deliberately to respond to the Court's remand order, the Commission 
will reduce uncertainty, facilitate better decision-making by funds, 
and ultimately serve the interests of fund shareholders. We also note 
that the issues remanded to us by the Court are discrete and clearly 
defined; \96\ indeed, the Court observed that part of our task on 
remand could be accomplished ``readily.'' \97\
---------------------------------------------------------------------------

    \95\ See supra Section II.
    \96\ See Slip Opinion, supra note 1, at 2, 15-17.
    \97\ Id. at 16.
---------------------------------------------------------------------------

    With respect to suggestions by the dissenters that our response to 
the disclosure alternative is inconsistent with the Court's opinion, we 
note that our discussion sets out the reasons why the Commission does 
not believe that the disclosure alternative is superior for achieving 
the objectives of the Act, including those of the specific conflict-of-
interest provisions that are addressed by the Exemptive Rules.\98\
---------------------------------------------------------------------------

    \98\ See supra Section III.B. (Consideration of the Disclosure 
Alternative).
---------------------------------------------------------------------------

    Finally, we note that it is in the best tradition of this 
institution, and not at all unusual, for the Commission to act swiftly 
on important initiatives in response to market developments and other 
factors. The Commission has done so on many occasions previously. In 
this matter, the staff and the Commission have a strong foundation of 
experience with the fund governance rules, and that experience has 
enabled us to address the issues raised by the Court within a 
relatively short period of time, with the assistance and extraordinary 
efforts of our staff.

V. Conclusion

    We believe that this release fully addresses the two issues 
remanded to us for our further consideration and explication. The 
Commission commends the efforts of the Commission staff in this matter. 
The staff worked with great diligence, care and tirelessness, as well 
as with its usual even-handedness in the treatment of all 
Commissioners. We further commend the staff for maintaining this high 
degree of professionalism in the face of a sharply divided Commission, 
and against the backdrop of a campaign of unwarranted public attacks on 
the Commission and its processes apparently orchestrated by some 
outside the Commission.
    Upon our further consideration of the costs and of the disclosure 
alternative, we have concluded that the benefits of the 75 percent 
independent director condition and the independent chairman condition 
far outweigh their costs, and that the disclosure alternative does not 
afford adequate protection to fund investors. Accordingly, we have 
determined not to modify the amendments.
* * * * *

    By the Commission.

    Dated: June 30, 2005.
Margaret H. McFarland,
Deputy Secretary.

Concurring Views of Chairman Donaldson at Open Commission Meeting 
Commission Response To Remand by Court of Appeals

    The last item on our agenda is a recommendation from the Division 
of Investment Management relating to rules we adopted last year to 
enhance the governance practices of mutual funds. As a condition to a 
mutual fund engaging in certain transactions involving conflicts of 
interest with the fund's management company, the rules require that the 
fund have a board with at least 75 percent independent directors and an 
independent chairman.
    The Commission voted to approve these fund governance rules in June 
2004, and we are acting today as a result of a recent decision by the 
District of Columbia Circuit Court of Appeals in a case brought by the 
Chamber of Commerce. In that case, the Court agreed with the Commission 
on two central points: first, that the Commission had the statutory 
authority under the Investment Company Act to adopt the fund governance 
rules; and second, that the Commission's underlying policy rationale 
for adopting the rules was reasonable.
    However, the Court remanded two issues for our consideration. The 
Court instructed the Commission to further consider certain potential 
costs of the new rules, and to consider a potential alternative to the 
independent chair rule. Today's recommendation addresses the Court's 
concerns, which we take quite seriously.
    Before turning to the specific issues raised by the Court, I would 
like to briefly put this rulemaking in perspective and highlight some 
of the very important benefits that I believe it will bring to 
investors and to the mutual fund industry.
    When Congress enacted the Investment Company Act in 1940, it 
recognized that conflicts of interest in the mutual fund industry pose 
serious risks to fund shareholders. Funds are organized and operated by 
people whose primary economic interests lie outside the enterprise, 
and, without appropriate checks and balances, this structure can 
readily lead to abuse. To address the conflicts, Congress established 
minimum governance requirements under the Act, based on its 
determination that a fund's board of directors, particularly its 
independent directors, should serve as watchdogs to protect the 
interests of investors.

[[Page 39399]]

    Congress also prohibited funds from engaging in certain types of 
affiliate transactions and other transactions that are most susceptible 
to abuse, while at the same time granting the Commission broad 
authority to provide exemptions when in the public interest. Since 
1940, the Commission has adopted a variety of exemptive rules that 
permit otherwise prohibited transactions, but only under certain 
carefully tailored conditions, which include active oversight by 
independent directors.
    Beginning in 2003, a series of scandals were uncovered in the 
mutual fund industry involving truly egregious, illegal and unethical 
behavior on the part of fund advisers. Advisers in a host of different 
fund complexes knowingly endorsed, among other abuses, late trading, 
market timing (including some advisers timing their own funds), 
directed brokerage, and selective disclosure to favored investors. The 
scandals resulted in enormous losses for investors, and revealed 
systemic breakdowns in compliance systems, weaknesses in fund 
governance structures and a significant betrayal of investors' trust.
    The Commission responded to the scandals in a swift and 
comprehensive manner. We have brought numerous enforcement cases and 
obtained over $2.2 billion in disgorgement and penalties, which can be 
used to compensate harmed investors. In addition, in the last year and 
a half, the Commission has adopted a number of rules designed to ensure 
better compliance by funds and advisers with the Federal securities 
laws, promote the accountability of fund officers and directors, and 
enhance disclosure to investors.
    The fund governance rules are a critical component of the 
Commission's reform efforts. By strengthening the role of the 
independent directors, the rules enhance the ability of fund boards to 
provide badly needed oversight of the activities of their advisers and 
monitor conflicts of interest. The independent chair condition allows 
individuals who are truly free from conflict to exercise leadership in 
the boardroom. This point was underscored in a comment letter submitted 
by all seven of the living former Chairmen of the Commission, who 
wrote: ``An independent mutual fund board chairman would provide 
necessary support and direction for independent fund directors in 
fulfilling their duties by setting the board's agenda, controlling the 
conduct of meetings, and enhancing meaningful dialogue with the 
adviser.''
    The Commission recognizes that there are fund chairmen who strive 
to represent the interests of fund investors in the boardroom while 
also serving as executives of the fund's adviser. But they undeniably 
face a central conflict of interest. When the CEO of a mutual fund's 
adviser is simultaneously serving as the chairman of the mutual fund 
itself, this person is in the untenable position of having to serve two 
masters. On the one hand, he or she owes a duty of loyalty and care to 
the mutual fund; on the other hand, the person owes a separate duty to 
the shareholders of the fund's investment adviser. It is easy to see 
that these two duties are often in conflict, particularly when it comes 
to setting the level of fees the fund will pay the adviser.
    The independent chair condition is the capstone of our series of 
mutual fund governance reforms that will help foster a culture in fund 
boardrooms based on transparency, arm's length dealing, and, above all, 
protection of the interests of fund shareholders. The rules will also, 
I believe, help to strengthen the compliance function at mutual funds 
by providing a truly independent body to which the chief compliance 
officer can report.
    Before turning to today's proposals, I would like to underscore an 
important point. The recent opinion of the Court of Appeals upheld the 
validity of the fundamental rationale underlying the Commission's fund 
governance rules. The Court agreed with the Commission that 
strengthening the role of independent fund directors was a reasonable 
response to the risks of further abuse in the mutual fund industry. 
Moreover, as I noted a moment ago, the Court found that the governance 
rules fall within the Commission's statutory authority under the 
Investment Company Act and, specifically, that the emphasis on 
independent directors is consistent with the structure and purpose of 
the Act.
    The Court identified two specific issues that required further 
consideration by the Commission. First, with respect to costs, the 
Court stated that the Commission should give further consideration to 
the potential costs of the 75 percent independent director condition 
and the independent chair condition. Prior to adopting the fund 
governance rules, the Commission sought and received comment on the 
costs associated with these conditions, and we concluded that the costs 
were minimal in relation to the benefits. As instructed by the Court, 
today's proposal provides a detailed estimate of these potential costs, 
based on a variety of different possible approaches of complying with 
the new rules, and the Commission has carefully considered the 
potential impact of these costs. I will leave it to the staff to 
explain the numbers in greater detail, but suffice it to say that our 
analysis strongly confirms the conclusion that the potential costs to 
mutual funds of appointing independent chairmen, and ensuring that 75 
percent of their directors are independent, are minimal when compared 
to the substantial benefits that these governance rules can bring in 
terms of reducing conflicts of interest and protecting investors.
    Second, with respect to alternatives, the Court asked the 
Commission to give further consideration to an alternative to the 
independent chair condition that would require funds simply to disclose 
whether or not they have independent chairmen. This is an issue on 
which we received comment prior to adopting the independent chair rule 
last year, and today's proposal explains our reasons for rejecting the 
disclosure alterative. While many of our other rules are based on 
disclosure requirements, there are important reasons for taking a 
stronger, more substantive approach in the context of mutual fund 
governance. As I noted a few moments ago, the very structure of the 
typical mutual fund gives rise to serious conflicts of interest between 
the adviser and the shareholders, and this is the reason that Congress 
established flat prohibitions on certain types of fund transactions. 
For the Commission to grant exemptions from these prohibitions, we must 
see to it that investors are given assurances that their interests will 
be protected. As adopted, the independent chair condition will go a 
long way toward providing those assurances. Relying solely on 
disclosure, on the other hand, would allow a flawed governance 
structure to continue in many funds to the detriment of fund 
shareholders.
    Concern has been raised about the timing of the Commission's 
actions today. The Commission's actions today are fully consistent with 
the opinion of the Court of Appeals and with the other legal 
requirements applicable to Commission rulemaking. The issues raised by 
the Court are clearly defined, and the existing rulemaking record and 
other publicly available materials have permitted the Commission to 
address them in the manner contemplated by the Court without further 
notice and comment. Indeed, by not vacating the governance rules, but 
instead remanding them to the Commission without ordering any 
particular procedures, the Court contemplated that any deficiencies in 
the initial rulemaking could be cured without unnecessarily reversing 
course or restarting the rulemaking process.

[[Page 39400]]

    Moreover, there are compelling policy reasons for the Commission to 
act expeditiously on these matters. As I have stated, the governance 
rules are a critical component of our reform efforts, and any further 
delay or ambiguity surrounding their implementation would disadvantage 
not only investors but fund boards and management companies, most of 
which have already begun the process of coming into compliance with the 
rules. By acting swiftly and deliberately to respond to the Court's 
concerns, the Commission will facilitate better decision-making and 
ultimately serve the interests of fund shareholders.
    I would also point out that it is in the best tradition of this 
institution, and not at all unusual, for the Commission to act swiftly 
on important initiatives in response to market developments and other 
factors. In this case, the staff and this Commission have a strong 
foundation of experience with the fund governance rules, and that 
experience has enabled us to address the issues raised by the Court 
within a relatively short period of time, albeit with the assistance of 
truly Herculean efforts on the part of our staff.
    There is another important reason for us to act today. Our failure 
to act would, I fear, throw the future of this rulemaking into an 
uncertain limbo until a new Chairman is confirmed and the new Chairman 
is able to familiarize himself with the rulemaking record and the 
policy considerations weighing for and against the decision that we 
made last year. Today, however, we have intact the full complement of 
Commissioners who have spent the last year-and-a-half thinking about 
the issues raised in this rulemaking, and with my imminent departure 
from the Commission, today is the last opportunity to bring the 
collective judgment and learning of we five Commissioners to bear on 
the important questions presented to us by the Court.

Concurring Views of Commissioner Harvey J. Goldschmid at Open 
Commission Meeting Commission Response To Remand by Court of Appeals

    As has just been demonstrated by Commissioner Glassman, emotions 
have run extremely high in this area. There has been too much confusion 
and hyperbole--``hyperbole'' is the most gentle word that I can use. 
Among others, I found her statement about the staff's cost analysis 
being ``back of the envelope'' quite extraordinary. I reviewed the cost 
analysis with great care, and everyone knows how hard the staff has 
worked on it. It is a very serious cost analysis.
    Let me begin a more serious discussion by making clear what the 
D.C. Circuit Court did--and did not do--on June 21st.
    First, the Court expressly upheld our statutory authority to 
require mutual funds to have a board consisting of no less that 75% 
independent directors and an independent chair. In the face of claims 
of ``regulatory overreach,'' the Court held that the ``Commission did 
not exceed its statutory authority'' in adopting the two governance 
conditions.
    Second, there were challenges to the wisdom and effectiveness of 
our mutual fund governance provisions. I have stated often that given 
the fundamental need for directors to deal with the inherent conflicts 
of investment managers, a critical mix of at least 75% of independent 
directors makes compelling policy sense. The Supreme Court has 
described mutual fund independent directors as necessary ``watchdogs'' 
to police mutual fund conflicts of interest. Similarly, an independent 
chair helps to ensure proper information flows, establish sensible 
board priorities and agendas, and encourage candid and thorough 
discussions in the boardroom.
    The D.C. Circuit Court recognized our prudence in ``strengthening 
the role of independent directors in relation to exemptive transactions 
as a prophylactic measure * * * .'' The Court held that our policy 
rationales for the two new governance provisions were justified.
    Third, the Court then remanded in the two deficiency areas that 
have been identified , and asked us to address them.
    An initial issue for us was whether it was necessary to engage in 
additional fact-gathering or further notice and comment procedures. We 
concluded that the information in the existing record (which had 
involved an extensive notice and comment process) provided a more than 
sufficient basis to address the deficiencies. The Circuit Court could, 
of course, have required us to do new fact-gathering, but did not do 
so.
    Given what we believe is the adequacy of the information available 
in the record, there would be large costs to new fact-gathering. By 
acting promptly we avoid the cost of new fact gathering, avoid what 
could be a substantial period of uncertainty for mutual fund 
governance, and ensure that fund shareholders will receive the critical 
protections afforded by the new governance rules without further delay. 
The mutual fund business is based on investor trust, and, after the 
grievous breaches of trust disclosed by the mutual fund scandals, it is 
of great importance to continue to bolster investor confidence in the 
governance of funds.
    This Commission has spent nearly two years considering mutual fund 
disclosure, governance, and other rules. As was true of our action 
today on ``securities offering reform,'' we have labored too hard--and 
the governance provisions are too important--for us not to act in the 
public interest. As Chairman Donaldson put it, ``failure to act would 
have a severe detrimental effect'' on investors. Of course, as we have 
just done with respect to securities offering reform, a future 
Commission would be able to modify or reverse anything we do today that 
the new Commission concludes is counterproductive.
    Let me now address briefly the crocodile tears being shed about the 
need to not move forward out of respect for the Court of Appeals. I 
believe that the release we will approve today fully responds to the 
Court's concerns. I have great respect for our panel of three strong, 
highly intelligent and talented judges. This matter will quickly be 
back before those judges. If we are wrong about being fully responsive, 
the Court will certainly tell us so. But, if we are right about being 
fully responsive, we will have ensured an enormously better day for 
investors in mutual funds. As the Circuit Court recognized, our two 
governance rules are designed to strengthen the independence and 
effectiveness of fund boards, and thereby, protect shareholders from 
serious conflicts of interest.
    Obviously, for me, in an $8 trillion industry, the benefits of the 
two new governance provisions plainly and overwhelmingly outweigh their 
costs.
    A full discussion of the ``disclosure alternative'' to the 
independent chair provision is contained in our release. For now, let 
me just emphasize again that the interrelation between investment 
advisers and mutual funds presents complex and pervasive conflict-of-
interest issues.
    The dynamics of a mutual fund boardroom--including what may be the 
dominance of the chair (who often controls information flows, board 
agendas, etc.)--is extremely difficult to disclose in a meaningful way. 
It is similarly difficult for the 90-plus million shareholders of 
mutual funds to digest and evaluate. But those of us who have spent 
most of our professional lives working on issues of corporate 
governance--and have witnessed the

[[Page 39401]]

failings of mutual fund governance demonstrated by nearly two years of 
enforcement actions--fear that permitting investment managers to 
continue to chair mutual fund boards would significantly increase the 
danger of future abuse.
    I think the same reasoning convinced Congress in 1940, in enacting 
the Investment Company Act, to go well beyond disclosure and provide 
both Exemptive Rules (prohibitions against transactions involving 
conflicts of interest) and detailed prescriptions for the organization 
and governance of mutual funds. As we said in our July 2004 Adopting 
Release: ``[the chair of a fund board] is in a unique position to set 
the tone of meetings and to encourage open dialogue and healthy 
skepticism.'' An independent chair can both help to counterbalance the 
fund's investment adviser and provide leadership that makes paramount 
the interests of fund investors. Put bluntly, the disclosure 
alternative does not afford adequate protection to fund shareholders. 
In this area, it is simply an unrealistic idea.
    Finally, this is Chairman Donaldson's final public meeting. I must 
express my deep sadness--both on a personal level and for all decent 
participants in our financial markets--at his leaving. Bill, you have 
played a major role in restoring investor faith in the integrity and 
fairness of the nation's financial markets. You have also restored the 
public's faith in the SEC. Your leadership, honesty, and courage will 
long be celebrated, and you will be greatly missed.
    The Commission staff has done a splendid job on this release. Mike 
Eisenberg, Bob Plaze, Giovanni Prezioso, Jonathan Sokobin, and all the 
rest of you, thanks for your terrific effort.
    I have no questions.

Concurring Views of Commissioner Roel C. Campos at Open Commission 
Meeting Commission Response To Remand by Court of Appeals

    Thank you Chairman Donaldson. I have a short statement to make 
about this action regarding our Agency's mutual fund governance 
rulemaking and the Response to the Remand by the Court.

I. American Mutual Fund Investors Have Been Under Attack

    Beginning about two years ago the American public and this Agency 
became suddenly aware that American mutual fund investors were under 
attack. In quick order, investigations by this Agency and other State 
Attorney Generals revealed that dozens of well known mutual fund 
families had turned large profits at the expense of mutual fund 
investors. Looking only at the top nine fund families, billions of 
dollars were literally stolen from mutual fund investors by executives 
who placed their personal gain above the interests of their investors 
whom they were sworn to protect. It became clear that many fund 
executives participated in sweetheart schemes in which privileged third 
parties such as hedge funds were allowed to market time mutual funds 
and to engage in late trading, siphoning off billions of dollars of 
fund value at the expense of unknowing and unsuspecting mutual fund 
investors.
    Indeed the scandal and harm was so egregious that Republican 
Congressman Mike Oxley, who of course authored with Senator Paul 
Sarbanes the famed Sarbanes-Oxley Act, decided to study the situation. 
Long a champion of protecting investors, Congressman Oxley did his 
homework and wrote several strong letters of support for the SEC's 
subsequent independent Chairman rulemaking that is the subject of the 
Court's Remand. In his letter to the Commission dated May 20, 2004, 
Congressman Oxley noted that he had been closely following the debate 
regarding the SEC's proposal to require independent fund Board 
Chairman. After reviewing publicly available information, the 
Congressman stated in his letter that ``The statistics I uncovered are 
startling. Eighty-four percent of the mutual fund families implicated 
in the market timing and late trading scandals (sixteen of the nineteen 
mutual funds) have had management-affiliated chairmen [non-independent] 
at some point during the alleged or admitted violations.'' He noted the 
SEC's actions against Invesco Funds, Franklin Templeton Funds, Janus, 
Putnam, Strong Funds, and MFS Funds in particular, which collectively 
settled for a total of over $700 million in disgorgement and penalties. 
Urging the Commission to adopt the proposed rule without amendment, 
Congressman Oxley went on to say, ``I believe the Commission's 
independent chairman proposal would eradicate the self-dealing by 
interested, management-affiliated chairmen and its harmful effect on 
mutual fund shareholders.''
    Unfortunately, threats to mutual fund investors continue to be 
uncovered by our Agency. On May 31, 2005, for example, the Commission 
announced a settlement with Citigroup Global Markets, Inc and Smith 
Barney Fund Management. The Commission's Order noted that the 
investment adviser placed its interest in making a profit ahead of the 
interests of the mutual funds it had a duty to serve. In this case the 
adviser recommended that the mutual funds contract with an affiliate of 
the adviser to serve as transfer agent without fully disclosing to the 
mutual funds' boards that most of the actual work was to be done under 
a subcontract arrangement that had been negotiated with the mutual 
funds' existing third-party transfer agent at steeply discounted rates. 
Rather than passing the substantial fee discount on to the mutual 
funds, the adviser, through the newly created affiliated transfer agent 
took most of the benefit of the discount for themselves, reaping nearly 
$100 million in profit at the funds' expense over a five year period. 
The funds did not have an independent Chairman. Citigroup and Smith 
Barney paid over $200 million in disgorgement and penalties.

II. The Agency's Objective Has Been Investor Protection and To Restore 
Confidence

    In response to this explosion of mutual fund fraud and theft by 
adviser executives, the Agency moved promptly to protect investors. It 
designed a combination of new governance and compliance rules. One of 
these rules mandates that advisers establish chief compliance officers 
who report directly to the mutual fund board. The capstone however of 
the SEC's effort to protect investors and deal with a serious breakdown 
in management controls were the two conditions adopted on July 27, 2004 
that are the subject of this Remand, that fund boards have at least 75% 
independent directors and an independent chairman.
    The Agency's purpose in proposing the conditions was to protect 
investors from serious harm and from a breakdown in funds' existing 
controls and structure. In addition to investor protection, I and the 
other majority Commissioners were also very concerned that the mutual 
fund industry as a whole was under siege by the acts of a greedy few. 
Investor confidence in the integrity of mutual funds was damaged and 
needed to be restored. Our mission also to protect the integrity of the 
financial sector was being challenged. It is worth noting that the 
industry association the Mutual Fund Directors Forum also supports the 
rules because of their concern for the overall health of the industry, 
even though a significant fund family was against the rule.

[[Page 39402]]

III. The Court of Appeals Upheld the SEC's Authority To Enact the Rules 
and Approved of the Rationale

    The two new conditions adopted by the SEC were challenged by the 
Chamber of Commerce, which submitted a petition for review to the U.S. 
court of Appeals of the District of Columbia Circuit. On June 25, 2005, 
the Court of Appeals issued its decision. The decision has been 
regularly been mischaracterized in the press.
    The DC Circuit Court stated on page 2 of its opinion, ``We hold 
that the Commission did not exceed its authority in adopting the two 
conditions, and the Commission's rationales for the two conditions 
satisfy the Administrative Procedures Act.'' The decision is meaningful 
because it clarifies the Commission's authority to regulate the 
corporate governance of mutual funds under section 6(c) of the 
Investment Company Act and dispels the notion that such issues are left 
entirely to state law.
    As the Court holds on page 12 of its opinion, ``The Commission 
reasonably concluded that raising the minimum percentage of independent 
directors from 50% to 75% would strengthen the hand of the independent 
directors when dealing with fund management, and may assure that 
independent directors maintain control of the board and its agenda.'' 
The Court also upheld the Commission's conclusion that an independent 
chairman provides ``a check on the adviser, in negotiating the best 
deal for shareholders * * * and in providing leadership to the board 
that focuses on long-term interests of investors.''
    In considering both the 75% rule and the independent chairman 
requirement, the Court held, on page 12 of the opinion, ``In sum, the 
Chamber points to nothing in the Investment Company Act that suggest 
the Congress restricted the authority of the Commission to make 
`precautionary or prophylactic responses to perceived risks' and the 
Commission's effort to prevent future abuses * * * was NOT arbitrary, 
capricious, or in any way an abuse of its discretion. * * *''

IV. The Commission Has Carefully Followed the Directions of the Remand 
With Respect to the Finding That the Commission Did Not Adequately 
Consider the Costs Imposed Upon the Funds by the Two Challenged 
Conditions

    The Court remanded to the Commission two deficiencies that it 
identified in the rule making. First, the Court held that, in 
connection with the statutory obligation to consider whether the 
conditions will promote efficiency, competition and capital formation, 
the Commission did not adequately consider costs associated with both 
the 75 percent independent board and the independent chairman 
conditions. Secondly, the Court stated that the Commission did not give 
adequate consideration to an alternative called the ``disclosure 
alternative.''
    The Commission in its Response to the Court's Remand has carefully 
considered the adequacy of the existing record and the need for further 
fact finding to properly consider and to follow the Court's direction 
on remand. Given that the Commission labored for over one year in 
studying the matter, it is not surprising that the existing record, 
developed through full notice and comment procedures, is vast and 
ample. Specifically the Commission had also previously sought and 
received comment on the costs of the two conditions and had further 
elicited comment on the disclosure alternative. It is clear under 
Circuit cases that the agency is free on remand to determine whether 
supplemental fact-gathering is necessary and sufficient to address on 
remand the court-identified deficiencies. Accordingly, after careful 
review, the Commission has determined that the existing record and 
information publicly available at the time of the original adoption is 
a sufficient base on which to consider and follow the Court's 
directions on remand.
    The proof of the sufficiency of the existing record is in the 
careful estimates of costs and calculations performed in the 
Commission's Response. The estimates and ranges track exactly the 
directions in the Court's Opinion for formulating the estimates for the 
costs of the two conditions. Conservative estimates have been made and 
cushions to cover all possible costs have been added to calculations.
    The key conclusion is that under the most conservative estimates of 
costs for implementing the conditions, the total costs are minimal 
under any measure. As such, there is no reasonable basis for believing 
that any additional fact finding would alter in any way this 
conclusion. Indeed, as allowed for consideration under Circuit cases, 
the Commission's Response cites recent studies subsequent to the 
original adoption that confirm the original information. (See Response, 
FN 69)
    The Commission also reanalyzes and discusses why the notice 
alternative is deficient. As explained, this alternative was previously 
considered and implicitly rejected. The Court's directions to expressly 
consider the alternative is accomplished in a full and adequate manner 
in the Commission's response.

V. Dispatch, Focus, and Diligence Does Not Equate to Inattentiveness or 
Failure to Analyze Carefully

    There has been a consistent reporting in the press that advocates 
for the Chamber's position claim that any action in response to the 
Court's remand that does not include a new notice and comment period is 
somehow improper and disrespectful to the Court of Appeals. Quite 
simply, that contention is absurd on its face. Immediate attention and 
diligence and a focusing of staff resources to respond to the Court's 
Remand shows the utmost in respect and in placing the matter at the 
highest level of priority.
    Quite frankly, this Agency prides itself in meeting impossible 
deadlines and turning around prodigious amounts of work in short time 
frames. Examples are innumerable. However, one clear example occurred 
during the last days of former Chairman Pitt's tenure from January 22, 
2003 to January 31, 2003. In a ten day period, the Commission (with the 
same four Commissioners that enacted the rule in question, except for 
Chairman Donaldson), enacted no less than ten rulemakings, several on a 
twice a day schedule, and several being final rules or comments. The 
day after WorldCom filed a surprise restatement, this Agency had filed 
a lengthy complaint to move swiftly to protect assets for victims of 
fraud. This Agency never missed a deadline in fulfilling Congress' 
mandates to implement the requirements of Sarbanes Oxley, resulting in 
more rulemakings in one year alone, during 2003, than in any other 
decade in its history.
    The ultimate refutation of the accusation to a rush to judgment is 
the ostensible high quality of the Commission's Response and the 
analysis therein.

VI. There Is an Absolute Urgency in Moving Forward To Implement the 
Protections Judged Necessary by This Agency

    This Commission has concluded that serious threats exist to mutual 
fund investors. The Commission's judgment is that extra prophylactic 
measures in the two conditions involving the 75% independent board and 
the independent Chair will add significant benefits to investor 
protection to combat the types of fraud that have been uncovered. The 
Court in its Opinion stated that such conclusions were reasonable and 
that

[[Page 39403]]

there exists ``no basis upon which to second guess that judgment.''
    The Commission therefore has a binding obligation to implement as 
expeditiously as possible the subject rule to protect investors and 
also to aid sustaining investor confidence resulting in protecting the 
integrity of the markets. Quite simply, a variation of an old adage 
applies in this context: ``Investor protection delayed is investor 
protection denied.'' To not move quickly would be a violation of the 
duty of the Agency to protect investors and the markets.
    There have been accusations that the Commission is doing something 
for that, for lack of a better term, is ``sneaky'' or devious in 
responding to the Court within the last days of this particularly 
constituted Commission. Again, this accusation is patently absurd. The 
Commission is not doing anything ``under the cover of darkness.'' The 
Commission acknowledges the fact that Chairman Donaldson is at the end 
of his service. This fact only adds to the urgency in that the full 
Commission that has thoroughly studied the issue should be the one to 
deal if possible with proper care with the Court's instructions on 
Remand.
    There is also another clear set of facts that the Commission must 
deal with. If it did not act expeditiously in responding carefully and 
fully to the Court's Remand, a state of limbo will occur as to this 
rulemaking. There can be no prediction when the new Chairman and 
possibly other Commissioners will be nominated by the President and 
confirmed by the Senate. What is certain is that many mutual funds that 
are in the midst of implementing the new rules will be ``left hanging'' 
and may have to incur unnecessary or additional costs as they await 
finality on these rules.
    Ultimately, if the Commission were not to have acted with speed and 
dispatch in responding to the Court's Remand, investor protection and 
integrity of the markets will not be served.
    I for one must support the protection of investors and our markets.
    Therefore, I conclude that the Commission had no choice but to act 
expeditiously and quickly in responding to the Court's Remand. The 
Commission was also in a position to prepare a thoughtful and quality 
response in short order.
    Indeed, anyone who supports another course of action by the 
Commission risks hampering investor protection and places other 
interests above investors and the overall health of the markets.
    I vote in favor of the proposed response to the Court's Remand and 
I support all of the substantive contents in the proposed response.

Dissent of Commissioner Cyntha A. Glassman to the Commission Response 
To Remand by Court of Appeals Investment Company Governance

    I disagree with this rush to respond to the Court's remand of the 
``independent chair'' rulemaking in the strongest possible terms. Last 
fall, the Chamber of Commerce of the United States of America 
challenged two provisions in the Commission's mutual fund governance 
rule, adopted over my and Commissioner Atkins' dissent, in July 2004, 
namely, the requirements that investment companies relying on our 
exemptive rules have an independent chair of the board of directors and 
a board composed of at least 75 percent independent directors. Last 
Tuesday, June 21st, the United States Court of Appeals for the District 
of Columbia Circuit granted the Chamber's petition requesting the Court 
to set these requirements aside and prohibit the Commission from 
implementing and enforcing them. In its unanimous decision, the Court 
held that the Commission violated the Administrative Procedures Act, or 
the APA, by failing adequately to consider the costs mutual funds would 
incur in order to comply with the conditions and failing adequately to 
consider at least one reasonable proposed alternative to the 
independent chair condition. The Court therefore remanded the 
proceeding to the Commission to address the deficiencies identified by 
the Court.
    In my view, a prudent response to the Court's mandate would be for 
the Commission to seek public comment on the issues identified by the 
Court as violating the APA. Instead, if this action is approved, the 
agency, through a chairman who is resigning effective tomorrow, will 
have elevated form over substance once again.
    On the same day that the Court issued its decision, I received an 
e-mail message from the Chairman's chief of staff informing me, without 
prior consultation, that the staff had reviewed the Court's opinion and 
``concluded that the court's concerns can be addressed on the basis of 
the record already before the Commission.'' As such, the Chairman 
determined that this matter would be on today's open meeting agenda--a 
mere week following the Court's remand. While the Commission has an 
excellent and hardworking staff, it is simply not possible to conduct a 
thorough review ``of the record'' in this time frame. The fact that the 
decision to hold today's meeting was made just hours after the issuance 
of the Court's decision further demonstrates the cursory nature of the 
``review.'' It does not require a clairvoyant to discern the real 
reason for the rush to judgment--indeed, much to my surprise, the 
proposed release openly states it--the Chairman has announced his 
resignation effective tomorrow and therefore this meeting must be held 
today. What is not expressly stated in the release, but is equally 
clear, is the majority's fear that in the absence of the Chairman's 
participation, the rule will not be implemented. This concern, whether 
real or imagined, does not justify ignoring the Commission's obligation 
to address properly the APA deficiencies found by the Court.
    Before addressing some of the substantive problems with the 
proposed release, it is important for the public to understand the 
procedural deficiencies surrounding this proceeding. To begin, the 
procedure employed by the Chairman in placing this matter on the agenda 
today was unusual. The Code of Federal Regulations requires that we 
provide a ``sunshine notice'' of an open meeting. An individual 
Commissioner known at the ``duty officer'' typically signs this notice. 
The designation of duty officer rotates weekly among the Commissioners, 
but not the Chairman. Last week, I was the designated ``duty officer.'' 
Nonetheless, I did not learn until the next day that the Chairman had 
instead opted to serve as the duty officer for this matter and ``sign 
off'' on the notice. To the best of my knowledge, the Chairman has 
never previously served as duty officer during his tenure and his 
decision to do so--in this matter only--is without precedent.
    A claimed rationale for proceeding on the matter today is that it 
is ``important and appropriate for the same five of us to address the 
issued raised by the Court on remand'' because of our ``unique 
familiarity with these matters.'' This is ludicrous--I do not believe 
and I challenge the majority to find any support for the notion that 
only those involved in a particular rulemaking have enough knowledge to 
effect any changes to it. Indeed, if this observation were true, the 
agency's regulations would be set in stone and could never be modified 
once there was a change in the Commission's constitution.
    More disturbing is the statement in the action memorandum 
circulated with the proposed release ``request[ing] that any concurring 
or dissenting statements be circulated prior to the meeting'' today. 
This is yet another new procedure unique to this proposal. The stated 
basis for this request is to allow

[[Page 39404]]

any such statement to be published contemporaneously with the release, 
because it is contemplated that the release will be adopted today and 
published before the Chairman's departure. What this really shows is 
that the issues have been ``pre-judged,'' which is a violation of our 
duty as Commissioners and yet another reason to believe that this 
matter will not survive a legal challenge. In any event, as a practical 
matter, no ``advance copy'' of a dissent was possible given the 
compressed time frame for this meeting and the fact that the staff 
continued to revise the proposed release up until and including 
yesterday evening. I request that this statement accompany the release 
and serve as my dissent pending an opportunity to provide a more formal 
dissent after I have had an opportunity to review the release as 
adopted.
    Turning to the proposed release, on Friday evening, June 24, the 
staff circulated a 27-page draft of it. This draft, produced a mere 
three days after the Court's opinion, contains what can only be 
described as a back of the envelope calculation of costs that rest 
largely on the staff's ``estimates'' and ``judgment''--two buzzwords 
used repeatedly in the release. Subsequent drafts were circulated late 
Monday and Tuesday evening. Numerous revisions were made to each draft 
to which I have not been afforded adequate opportunity to review. I 
have no way of determining whether there is any validity for the cost 
analysis and the context for these costs. For example, how do these 
costs relate as a percentage of a fund's total expenses?
    I need not dwell on the failings of the proposed release. It is 
sufficient to state that the release is an assembly of false 
statements, unsupported assumptions, flawed analysis, and 
misinterpretations. However, one often-repeated statement in the 
release--that the Commission can address the Court's concerns on the 
basis of the record already before the Commission--must be corrected. 
To be clear, the Commission cannot address the Court's concerns on the 
basis of the record already before the Commission. It cannot address 
the costs because, contrary to whatever representations the staff makes 
today, the Commission has repeatedly and consistently represented to 
the Court, to Congress and to the public that it has ``no reliable 
basis for estimating'' the costs. This statement, both in connection 
with the costs associated with electing independent directors, and with 
the costs incurred by an independent chair hiring staff, appears 
repeatedly in the proposing and adopting release, in the Commission's 
brief to the Court, and most recently, in the April 2005 staff report 
submitted to the Congress which submission was mandated by the 
Consolidated Appropriations Act of 2005. It strains all credibility to 
believe that the Commission, professing for the past year and a half 
its lack of a reliable basis, has mystically within the past week been 
able conclusively to estimate costs associated with the rule.
    More fundamentally, the Commission cannot address the costs 
associated with the independent chair's hiring of staff and experts 
because it expressly declined to ask for comment on this issue. 
Specifically, in part V.B. of the proposing release, published in 
January 2004, the Commission recited that the proposed release would 
require: (1) An independent director to be chair; (2) directors to 
perform an annual evaluation of the board; (3) independent directors to 
meet in executive session at least quarterly; and (4) independent 
directors be given specific authority to hire employees. Immediately 
thereafter, the release states: ``We request comment on the costs of 
the first three items above, and on whether boards would choose to hire 
employees.'' Although the last version of the proposed release I 
received last night continues to state that we ``specifically sought 
and received comment'' on this cost, it is indisputable that we have 
never solicited comment on the costs associated with the hiring of 
staff--one of the very issues that the Court has now directed the 
Commission to address on remand.
    In an apparent effort to bolster the argument that the Commission 
had, in fact, considered costs based on the record before it, the 
proposed release indicates that information ``publicly available at the 
time we originally adopted the amendments'' is sufficient to base the 
Commission's current discussion of costs. The latest version of the 
release now also includes a passing reference to ``supplementary public 
information'' without elaboration. It is curious indeed that in 
proposing this release the Commission has forgone examining subsequent 
data of real costs that mutual funds have incurred since the adoption 
of this rule last year as these funds prepare for the rule's 
implementation date. It is even more curious that the purported basis 
to exclude actual data rests on the theory that our estimate of costs 
is on the ``high end of the range'' rendering an examination of actual 
data unnecessary. This logic is backwards--it is the actual data which 
makes estimates unnecessary. As an economist, I cannot accept estimates 
and ``best judgments'' to support a cost/benefit analysis when actual 
costs are readily available and can easily be obtained through a 
request for public comment.
    Likewise, the Commission cannot on the basis of the record before 
it address the alternative proposal identified by the Court that each 
fund be required prominently to disclose whether it has an inside or an 
independent chair and thereby allow investors to make an informed 
choice. When the Commission initially sought comment at the proposal 
stage, it did not seek specific comment on whether disclosure was a 
viable alternative. Rather, the Commission only asked generally for 
comment on alternatives, followed by a series of specific alternatives 
that did not include disclosure. Nonetheless, today's proposed release 
attempts to suggest that robust comment on a disclosure alternative was 
solicited, citing two comment letters that briefly mention--and I might 
add support--disclosure as an alternative. It is noteworthy that the 
staff, in compiling for us a summary of the 200 plus comment letters to 
this rulemaking, did not include any reference to disclosure as 
alternative. This is because this issue simply was not addressed in 
more than a handful of these letters.
    As the Commission conceded in its brief to the Court, the truth of 
the matter is that the Commission did not consider ``all'' alternatives 
in adopting the rule because, in the majority's view, the Commission 
was not required to do so. Implicit in the single paragraph in the 
Commission's brief devoted to this significant issue is the 
acknowledgement that no consideration was given to a disclosure 
alternative, even though this alternative provides the Commission with 
a rule-making option that, as the Court observed, is ``neither 
frivolous nor out of bounds.''
    The proposing release rejects disclosure as an inadequate 
alternative on the basis that it would not protect investors from the 
``potential abuses inherent in the conflict-of-interest transactions 
permitted under the exemptive rules.'' In its remand opinion however, 
the Court dismisses this argument as irrelevant, finding instead that 
the fact the Congress in the Investment Company Act required more than 
disclosure with respect to some matters governed by that statute does 
not mean that Congress deemed disclosure insufficient with respect to 
all matters. Without soliciting comment on this issue, we have no basis 
to discern whether the public would or would not find disclosure 
meaningful. Nonetheless, the release concludes that disclosure would 
not be meaningful, citing a recent speech in which I

[[Page 39405]]

questioned the length of fund prospectuses. Not only does this argument 
misinterpret what I said, but it leads to the illogical conclusion that 
once a prospectus reaches a certain length, it is full and therefore no 
additional information can be added.
    The proposed release indicates that a reason for proceeding today 
is because expedited consideration is necessary in order to protect 
investors. For the reasons stated above, this statement is completely 
disingenuous. The case has never been made to my satisfaction that the 
benefits of this rule are more than cosmetic. In this regard, the 
Chairman's reference to market timing scandals at mutual funds with an 
interested chair as warranting the rule is misplaced. The share of 
these scandals at funds with interested chairs versus independent 
chairs was proportionate to their share of funds. In any event, in my 
view, protection of investors compels that we carefully consider the 
costs and alternatives before rushing to judgment. To allow this open 
meeting to proceed as if the Commission can simply fill in the blanks 
for APA deficiencies, without requesting public comment on these 
significant issues, makes a mockery of the process. Today's action is 
nothing more than window-dressing. It violates the spirit, if not the 
letter of the Court's opinion, which in directing the Commission to 
address the deficiencies, clearly contemplated that the Commission 
would do so by applying ``its expertise and its best judgment'' to 
bear. Rather than attempt in good faith to respond appropriately to the 
Court's direction, the Chairman has hastily scheduled this meeting 
designed to give the appearance that the Commission has judiciously 
considered its prior APA deficiencies, but in reality, is simply an 
attempt to obtain the same result without any serious examination of 
the costs associated with the rule and the alternatives available.
    One additional point is worth mentioning. While the Chairman has 
refused to allow a public comment period for this proceeding, the 
public has not been silent in the past week. The Commission has 
received letters and statements from former Commissioners (including at 
least one Chairman), former staff, and trade associations, and there 
has also been much media coverage. Many of these public comments voice 
their opposition to the manner in which this proceeding has been 
conducted. They question the timing of this proceeding, the lack of 
public input into the process, and the likely long-term damage that 
will result to the agency as a result of operating in this fashion. 
While we are responding to these letters in our release, it is my 
understanding that the letters will not be posted to our Web site for 
public review.
    Accordingly, for all the foregoing reasons, I am compelled to vote 
against the proposal. In closing, I would like to take this opportunity 
to apologize. First, to the Court, for the agency's failure to respond 
appropriately to the Court's directive to undertake a meaningful 
review. Second, to those staff members who were uncomfortable having to 
participate in this exercise. And third, to the public, which must 
continue to live with the uncertainty surrounding the legality of a 
rule that was adopted in violation of the APA and, after having already 
been stricken by a Court, will most certainly be challenged again as a 
result of our action today.
    I have one question. The most recent version of the release has 
added a new footnote 15 which states that: ``Even prior to our having 
issued this Release, there have been reports that additional legal 
proceedings may result from our action today. Accordingly, we are 
instructing our Office of the General Counsel to take such action as it 
considers appropriate to respond to any proceedings relating to this 
rulemaking.'' I have never seen this before.
     Have we ever done this before?
     What does it mean?
     What is the effect?

Addedum June 30, 2005

    These dissenting remarks are based on the draft release circulated 
Tuesday evening, June 28, 2005 for the open meeting held at 10 a.m. on 
June 29, 2005. The final post-meeting release has been changed by the 
majority apparently in reaction to some of the procedural deficiencies 
noted in my dissent. These changes do not cure those deficiencies, 
however they may make some of my references at the meeting to 
statements in the release appear inapposite. As an aside, footnote 15, 
which the general counsel refused to explain in response to my 
questioning at the open meeting, has now been renumbered footnote 14.

Dissent of Commissioner Paul S. Atkins to the Commission Response To 
Remand by Court of Appeals Investment Company Governance

    On June 29, 2005, three of the five commissioners (the 
``majority'') of the U.S. Securities and Exchange Commission (``SEC'' 
or ``Commission'') voted to reaffirm a rulemaking \1\ eight days after 
the United States Court of Appeals for the District of Columbia Circuit 
(the ``Court'') remanded the rulemaking to the Commission.\2\ I 
dissented from the majority's action. Although I have substantive 
objections to the rule amendments that the majority reaffirmed,\3\ my 
concerns about today's actions of the majority run much deeper. The 
majority's action is the product of a gravely flawed process, which is 
far from the informed deliberation that should have preceded any final 
action in response to the Court's remand. My concerns are set forth 
below.
---------------------------------------------------------------------------

    \1\ Investment Company Governance, Investment Company Act 
Release No. 26985 (June 30, 2005) (``Remand Release''). Because at 
the time of this writing (2:30 p.m. on June 30, 2005) I do not yet 
have a final version of the release, this dissent refers to the 
draft release circulated on June 27, 2005.
    \2\ Chamber of Commerce of the United States of America v. 
Securities and Exchange Commission, No. 04-1300, slip op. (D.C. Cir. 
June 21, 2005) (``Slip Opinion'').
    \3\ These concerns are set forth in the dissent that 
Commissioner Glassman and I filed when the rules were adopted. See 
Dissent of Commissioners Cynthia A. Glassman and Paul S. Atkins to 
Investment Company Governance (July 27, 2004) [69 FR 46390 (Aug. 2, 
2004)] (available at: http://www.sec.gov/rules/final/ic-26520.htm#dissent) (``Adoption Dissent'').
---------------------------------------------------------------------------

Background

    Last year, the Commission, in a split vote, adopted amendments to 
ten widely relied-upon exemptive rules in order to mandate a uniform 
corporate governance structure for all investment companies.\4\ The 
three commissioners who voted in favor of the amendments last year are 
now reaffirming the adoption of these amendments. In the interim, the 
Chamber of Commerce of the United States of America (the ``Chamber'') 
petitioned the Court for a review of two of the amendments.\5\ On the 
morning of Tuesday, June 21, 2005 the Court granted, in part, the 
Chamber's petition and remanded the matter to the Commission to address 
two violations of the Administrative Procedure Act (``APA'')\6\ that 
the Court identified in the process by which the Commission had 
approved the rules. Specifically, the court held that the Commission 
had (i) ``violated its obligation under 15 U.S.C. 80a-2(c), and 
therefore the APA, in failing adequately to consider the costs imposed 
upon funds by the two challenged conditions,'' and (ii) violated the 
APA by failing to consider a disclosure based

[[Page 39406]]

alternative to the independent chairman condition.\7\
---------------------------------------------------------------------------

    \4\ Investment Company Governance, Investment Company Act 
Release No. 26520 (July 28, 2004) [69 FR 46378 (Aug. 2, 2004)] 
(``Adopting Release'').
    \5\ The amendments require that, if a fund relies on one of the 
exemptive rules, the fund must have a board of directors with (i) no 
less than 75 percent independent directors, and (ii) a chairman who 
is an independent director.
    \6\ 5 U.S.C. 551 et seq.
    \7\ Slip Opinion, supra note 2, at 17.
---------------------------------------------------------------------------

    A summary of the events that followed the issuance of the Court's 
opinion provides a window into the nature of the deliberation that 
preceded the majority's reaffirmation of the rule amendments.\8\ On 
Tuesday evening, less than twelve hours after the Court had issued its 
opinion, the Chairman of the Commission scheduled the matter for a vote 
on June 29, 2005. The Chairman's chief of staff explained in an e-mail 
that the staff had ``concluded that the court's concerns can be 
addressed on the basis of the record already before the Commission.'' 
That same evening, the Chairman displaced the designated duty officer 
for the week to authorize unilaterally the issuance of a public notice 
of the meeting.\9\ This ``sunshine act notice'' was issued the next 
morning.\10\
---------------------------------------------------------------------------

    \8\ A timeline laying out the events of the past week is 
attached to this dissent. See Exhibit A. Even under normal 
circumstances, the Commission could not conduct a meaningful 
analysis within eight days, as the majority claims it has done. 
During the eight day period at issue, the commissioners and their 
staffs moved to a new headquarters building, which meant that they 
had no access to office space or computers for more than two of the 
eight days. In addition, the Chairman and two commissioners were out 
of the country for much of this period.
    \9\ The Commission's Rules of Practice provide for the 
delegation of certain matters to a ``duty officer.'' See 17 CFR 
200.43. ``To the extent feasible, the designation of a duty officer 
shall rotate, under the administration of the [Commission's] 
Secretary, on a regular weekly basis among the members of the 
Commission other than the Chairman.'' 17 CFR 200.43 (a)(2) (emphasis 
added). I can recall only one other instance from my years as a 
Commissioner and, before that, on the Commission staff, when a 
Commission chairman has taken the place of the designated duty 
officer to authorize Commission action. I am not contending that the 
Chairman's acting as duty officer was illegal, simply that it was 
irregular and evidenced the hurried and prejudged nature of the 
process.
    \10\ Available at: http://www.sec.gov/news/openmeetings/ssacmtg062905.htm.
---------------------------------------------------------------------------

    On Friday evening, less than eighty hours after the Court's 
decision, the staff, recommending against additional fact-gathering, 
provided the Commissioners with a 27-page draft release that purported 
to analyze the issues remanded by the court. The staff typically 
provides their recommendations to the Commission at least two weeks 
(and often thirty days) before the meeting at which they are scheduled 
for consideration. On Monday evening, shortly after asking the Chairman 
to remove the item from the Commission's calendar in order to seek 
additional comment, a substantially revised draft of the release was 
distributed. We were instructed by the Chairman's staff to submit any 
dissenting statements by noon the following day.\11\ On Tuesday, after 
the close of business, we received the draft of the release that would 
be considered at the Commission meeting the next morning.
---------------------------------------------------------------------------

    \11\ Because I had not yet seen the final pre-meeting version of 
the release, I was unable to comply.
---------------------------------------------------------------------------

    Thus, before the ink on the Court's opinion was even dry, the die 
was cast for the predetermined result of the Commission's 
deliberations. There was never a serious attempt made to solicit my 
views or incorporate them into the Commission's release. The procedural 
flaws that characterized this process did not mitigate, but rather 
compounded, the flaws in the adoption process that were identified by 
the Court. This peculiar sequence of events is a very fitting capstone 
on this rulemaking process in which the majority's self-described 
``logic and experience and anecdotal evidence'' \12\ has counted more 
than anything else.
---------------------------------------------------------------------------

    \12\ Open Meeting to Consider Investment Company Governance 
Amendments (Jan. 14, 2004) (Webcast available at: http://www.sec.gov/news/openmeetings.shtml) (statement of Commissioner 
Harvey Goldschmid) (``there are moments where logic and experience 
and anecdotal evidence compels your conclusions and this for me is 
one of those areas . . .'').
---------------------------------------------------------------------------

Analysis of Costs

    After protesting repeatedly over the past year and a half about the 
Commission's inability to conduct an analysis of costs, the majority 
claims to have done just that in about a week. When the majority 
adopted the rule, it described the costs as minimal, explained that our 
staff had no ``reliable basis'' for estimating costs, and complained 
that doing so would be ``difficult.'' \13\ After the rule's adoption, 
Congress directed the Commission to submit a report justifying the 
rule.\14\ The staff report,\15\ which the majority submitted in April 
2005 over Commissioner Glassman's and my objections,\16\ continued to 
insist that costs were ``minimal,'' ``speculative,'' or could not be 
estimated.\17\
---------------------------------------------------------------------------

    \13\ See Adopting Release, supra note 4, at VI.B (``Costs''). In 
addition, the ``Consideration of Promotion of Efficiency, 
Competition and Capital Formation'' section of the adopting release, 
which the Court found to be deficient (Slip Opinion, supra note 2, 
at 17), contained only two sentences of analysis. See Adopting 
Release, supra note 4, at Section VIII. This is peculiar given the 
majority's belief that these amendments will have a profound effect 
on the market. See, e.g., Remand Release, supra note 1, at text 
accompanying note 13 (``It is important that we avoid postponement 
of the compliance date [of the investment company governance 
amendments] and the attendant potential harm to investors and the 
market that would result.'').
    \14\ See Consolidated Appropriations Act, 2005, Pub. L. No. 108-
447, 118 Stat. 2809, 2910 (2004).
    \15\ Staff Report, EXEMPTIVE RULE AMENDMENTS OF 2004: THE 
INDEPENDENT CHAIR CONDITION: A REPORT IN ACCORDANCE WITH THE 
CONSOLIDATED APPROPRIATIONS ACT, 2005 (April 2005) (available at: 
http://www.sec.gov/news/studies/indchair.pdf) (``Staff Report'').
    \16\ See Letter from Commissioners Cynthia A. Glassman and Paul 
S. Atkins to the Honorable Thad Cochran, Chairman, Senate Committee 
on Appropriations (Apr. 29, 2005) (available at: http://www.sec.gov/news/speech/spch050205cagpsa.htm.
    \17\ Staff Report, supra note 15, at 60-61.
---------------------------------------------------------------------------

    The order of an unanimous court should have chastened the 
Commission, but the majority's Remand Release only perpetuates the 
cavalier attitude with which we have approached our obligations in this 
rulemaking.\18\ While the Court, appreciating the difficulty of 
estimating costs in this area, did not demand perfection, it did direct 
us to do the best we can.\19\ I respectfully submit that our eight-day 
reconsideration of the rule does not meet this standard.\20\
---------------------------------------------------------------------------

    \18\ Arguably, the Commission should already have been chastened 
by embarrassing miscalculations of cost in connection with earlier 
rulemakings. In connection with the adoption of regulations to 
implement Section 404 of the Sarbanes-Oxley Act, for example, ``we 
estimated the aggregate annual costs of implementing Section 404(a) 
of the Sarbanes-Oxley Act to be around $1.24 billion (or $91,000 per 
company).'' Management's Reports on Internal Control Over Financial 
Reporting and Certification of Disclosure in Exchange Act Periodic 
Reports, Securities Act Release No. 8238 (June 5, 2003) [68 FR 36636 
(June 18, 2003)] at Section V.A. A subsequent industry report found 
the implementation costs to be ``more than 20 times greater than our 
2003 estimates.'' Alex Davern, et al., SARBANES-OXLEY SECTION 404: 
THE ``SECTION'' OF UNINTENDED CONSEQUENCES AND ITS IMPACT ON SMALL 
BUSINESS (Feb. 2005), at 2 (available at: http://www.aeanet.org/governmentaffairs/AeASOXPaperFinal021005.asp). See also Financial 
Executives International, Press Release: Sarbanes-Oxley Costs Exceed 
Estimates (Mar. 21, 2005), at 1 (available at: http://www.fei.org/files/spacer.cfm?file_id=1498) (based on a survey of 217 public 
companies with average revenues of $5 billion, FEI found that 
``[t]heir total cost of compliance averaged $1.34 million for 
internal costs, $1.72 million for external costs and $1.30 million 
for auditor fees''). Additionally, Congress has reprimanded the 
Commission in the past for its failure to conduct the type of 
analysis that the Court found flawed. See Gramm-Leach-Bliley 
Conference Report (Nov. 1, 1999) (available at: http://banking.senate.gov/conf/somfinal.htm), at Title II.A) (``In 
addition, during the rulemaking process, the SEC must also make a 
number of findings. When considering whether such an action is in 
the public interest, the SEC must also consider whether the action 
will promote efficiency, competition and capital formation * * * The 
Conferees note that the SEC's record in implementing section 3(f) 
has failed to meet Congressional intent. The Conferees expect that 
the SEC will improve in this area.'').
    \19\ The Court stated specifically that the difficulty of the 
task ``does not excuse the Commission from its statutory obligation 
to determine as best it can the economic implications of the rule.'' 
Slip Opinion, supra note 2, at 15.
    \20\ I cannot, without more information and more time, take a 
position on the quality of particular estimates in the majority's 
cost-benefit analysis, but the majority's estimates may not be 
conservative. For example, how would the majority's estimates change 
if it used average instead of median salary information to calculate 
the cost of new independent directors? See Remand Release, supra 
note 1, at text following note 28. Do the salary figures cited 
include additional costs of expenses related to traveling to board 
meetings?

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[[Page 39407]]

    The Remand Release purports to undertake a consideration of the 
deficiencies identified by the Court on the basis of information in the 
existing record and information that was publicly available at the time 
of adoption.\21\ This approach is problematic on several fronts. First, 
and most importantly, some funds have already begun to comply with the 
fund governance rules. Instead of relying on estimates, the Commission 
could easily conduct a survey asking questions about actual costs to 
comply with the rules. Why would we not seize on this fortuitous 
opportunity to utilize current, relevant data? \22\ In this regard, 
just two days ago, the ICI volunteered to assist the Commission with 
obtaining this information from its widespread and representative 
membership.\23\
---------------------------------------------------------------------------

    \21\ See Remand Release, supra note 1, at text preceding note 
11. The majority purports to look at ``supplementary public 
information available subsequent to our original adoption of the 
amendments'' only to ``confirm[] the information available at the 
time of our original adoption.'' See Remand Release, supra note 1, 
at note 11. In several instances, however, the majority appears to 
rely only on post-adoption sources for cost estimates. See Remand 
Release, supra note 1, at note 32 (for cost of recruiting an 
independent director, citing J. Bel Bruno, ``Recruiter Picked for HP 
Search,'' THE PHILADELPHIA INQUIRER, Feb. 18, 2005, at C03); Remand 
Release, supra note 1, at note 43 (for percentage increase in 
director compensation during 2004, citing MPI Bulletin, ``More 
Meetings, More Pay: Fund Directors'' Compensation Increases 13% as 
Workload Grows'' (Apr. 2005) (available at http://www.mfgovern.com)).
    \22\ The majority cited post-adoption materials when doing so 
served its purposes. See, e.g., Remand Release, supra note 1, at 
note 69 (citing, for proposition that ``[r]ecently industry experts 
have similarly noted that the quantitative effect of the independent 
chairman condition will be modest,'' Kathleen Pender, ``SEC's Fund 
Rule, Revisited,'' San Francisco Chron., June 23, 2005, at C1 
(quoting fund governance analyst Meyrick Payne as estimating ``that 
the industry-wide cost of having independent chairs, `at an absolute 
maximum, is $18 million' a year, which is `a drop in the bucket' for 
an industry with $8 trillion in assets.'').
    \23\ See Letter from Elizabeth R. Krentzman, General Counsel, 
Investment Company Institute, to Jonathan G. Katz, Secretary, SEC 
(June 27, 2005) (``ICI Letter''), at 2.
---------------------------------------------------------------------------

    Second, the Remand Release implicitly acknowledges that the 
rulemaking record contained critical gaps regarding costs. Recognizing 
this flaw, the majority haphazardly searches for additional information 
that happened to be publicly available at the time of the rule's 
adoption to attempt to justify its actions.\24\ The majority takes a 
sort of ``judicial notice'' of the newly-discovered information by 
treating it as irrefutable fact and uses it to ratify its prior 
decision.\25\
---------------------------------------------------------------------------

    \24\ Given that the majority supplements the record, it is not 
clear why they cite cases that stand for the proposition that ``if 
the existing record is a sufficient base on which to address on 
remand the court-identified deficiencies, additional notice and 
comment procedures are not required.'' See Remand Release, supra 
note 1, at note 9 (citing Sierra Club v. EPA, 325 F.3d 374, 382 
(D.C. Cir. 2003); National Grain and Feed Ass'n v. OSHA, 903 F.2d 
308, 310-11 (5th Cir. 1990); AT&T Wireless Servs., Inc. v. FCC, 365 
F.3d 1095, 1103 (D.C. Cir. 2004). Each of these cases is also 
distinguishable on the grounds that there was no dissent within the 
decisionmaker. Both the Environmental Protection Agency and the 
Occupational Safety and Health Administration are led by a single 
administrator and the action at issue in the third case was reached 
by the decision of an unanimous Federal Communications Commission. 
The instant matter is distinguishable; the Commission's action is 
the product of a divided Commission, two members of which have 
continually expressed concerns about the process by which the 
determination on how to proceed was reached.
    \25\ The majority also relies heavily on its own experience for 
specific estimates that are central to its cost-benefit analysis. 
See, e.g., Remand Release, supra note 1, at text preceding note 36 
(``Based upon our experience, we estimate that, on average, the new 
independent directors will use additional independent legal counsel 
services a total of 30 hours a year.''); Remand Release, supra note 
1, at text following note 56 (``In our judgment, independent 
chairmen will hire no more than, on average, two staff employees, 
consisting of one full time senior business analyst and one full 
time executive assistant.''); Remand Release, supra note 1, at text 
following note 61 (``Based upon our experience, we estimate that, on 
average, the independent chairman will use independent legal counsel 
a total of 50 hours a year more under the amendments.''). The use of 
the Commission's judgment and experience is appropriate, but where, 
as here, the Commission's judgment and experience are the source of 
the basic elements of its cost analysis, members of the public 
should have the opportunity to counter with estimates from their own 
judgment and experience and with empirical data.
---------------------------------------------------------------------------

    The majority's primary discovery to supplement the flawed 
rulemaking record was a two-page newsletter, which summarizes the 
results of a nonpublic survey about director compensation conducted by 
a private consulting firm.\26\ Incidentally, the Commission staff did 
not obtain a copy of the underlying nonpublic survey, apparently 
because doing so would contradict the majority's intention to rely only 
on the purportedly adequate public record. In any case, before relying 
so heavily on this summary, the majority should have included this 
summary in the comment file to alert the public of its intention to 
rely upon it. The public then could have reacted to it. The 
Commission's economists should have evaluated the underlying data. The 
information presented in the summary may inform any decision that we 
make,\27\ but it should not do so in isolation. Others who are not 
consultants to independent directors, as the author of this summary is, 
might have supplemented or contradicted the data.\28\ Of course, this 
process could not possibly have occurred within the eight-day period 
the majority allowed itself. Therefore, after having forced the 
Commission to act within an impossibly short timeframe, the majority 
cannot claim to have not done the ``best it can,'' as the Court 
directed the Commission to do.\29\
---------------------------------------------------------------------------

    \26\ Management Practice Inc., ``More Meetings Means More Pay 
for Fund Directors'' (Apr. 2004) (``April 2004 MPI Bulletin''). The 
Remand Release cites to this or one of three other MPI Bulletins 
approximately seven times. The Remand Release also cites two 
newspaper articles that quote from Meyrick Payne, a senior partner 
of MPI. See Remand Release, supra note 1, at note 64 (citing Beagan 
Wilcox, ``Wanted: Independent Chairmen,'' Board IQ, July 6, 2004 
(citing estimate of Meyrick Payne, senior partner, Management 
Practice, Inc.)); Remand Release, supra note 1, at note 69 (citing 
Kathleen Pender, ``SEC's Fund Rule, Revisited,'' San Francisco 
Chron., June 23, 2005, at C1 (quoting fund governance analyst 
Meyrick Payne as estimating ``that the industry-wide cost of having 
independent chairs, `at an absolute maximum, is $18 million' a year, 
which is `a drop in the bucket' for an industry with $8 trillion in 
assets.'')). Before relying so heavily on the data from Management 
Practice Inc., the majority should have analyzed whether the data 
are robust and representative.
    \27\ As the Draft Release notes, Commissioner Glassman and I 
cited an earlier version of the data in our dissent. Remand Release, 
supra note 1, at note 28 and Adoption Dissent, supra note 3, at note 
24.
    \28\ A recent e-mail from C. Meyrick Payne, a senior partner at 
Management Practice Inc. (``MPI''), the author of the summary, 
suggests that MPI might have an interest in perpetuating this 
rulemaking. See E-mail from C. Meyrick Payne to Various Recipients 
(June 26, 2005) (attachment to Letter from Cory J. Skolnick of 
Gibson, Dunn & Crutcher LLP to Jonathan G. Katz, Secretary of the 
SEC (June 28, 2005) (in the email, Mr. Payne stated that, in advance 
of the Commission's open meeting, people might want to express their 
support for the independent chairman provision: ``If you, or your 
board, feel that an independent chair is an appropriate response to 
the recent mutual fund scandals you might like to write to SEC or 
your favorite newspaper on Monday or Tuesday so that your opinion 
can be influential.'').
    \29\ Slip Opinion, supra note 2, at 15.
---------------------------------------------------------------------------

Disclosure Alternative

    In addition to finding fault with the Commission's analysis of 
costs, the Court took issue with our consideration of alternatives. 
Specifically, the Court stated that the Commission should have 
considered the disclosure alternative that Commissioner Glassman and I 
suggested as an alternative to the independent chairman 
requirement.\30\ The Commission's failure to do so violated the APA 
\31\ because, as the Court said, ``the disclosure alternative was 
neither frivolous nor out of bounds.'' \32\ Accordingly, the Court 
directed the Commission to ``bring[] its expertise and its best 
judgment to bear'' to consider the disclosure alternative.\33\ Oddly, 
neither the majority nor the staff solicited our views on the 
disclosure

[[Page 39408]]

alternative before (or after) circulating a draft that concluded that 
the disclosure alternative was without merit. Thus, the majority's 
action cannot be said to embody the expertise and best judgment of the 
Commission.
---------------------------------------------------------------------------

    \30\ Slip Opinion, supra note 2, at 17.
    \31\ Slip Opinion, supra note 2, at 17.
    \32\ Slip Opinion, supra note 2, at 18 (citation omitted).
    \33\ Slip Opinion, supra note 2, at 19.
---------------------------------------------------------------------------

    The Remand Release largely reiterates an argument, already 
dismissed by the Court as unconvincing,\34\ namely that the Investment 
Company Act always favors a prescriptive approach over a disclosure 
approach.\35\ As the court explained, ``that the Congress required more 
than disclosure with respect to some matters governed by the ICA does 
not mean it deemed disclosure insufficient with respect to all such 
matters.'' \36\ The release ignores that we have found disclosure 
rather than presciptive, one-size-fits-all solutions to be sufficient 
in other contexts.\37\
---------------------------------------------------------------------------

    \34\ Slip Opinion, supra note 2, at 18.
    \35\ Remand Release, supra note 1, at text accompanying notes 
76-82.
    \36\ Slip Opinion, supra note 2, at 18.
    \37\ See, e.g., Disclosure Regarding Approval of Investment 
Advisory Contracts by Directors of Investment Companies, Investment 
Company Act Release No. 26486 (June 23, 2004) [69 FR 39798 (June 30, 
2004)] (requiring investment companies to provide disclosure to 
shareholders regarding determinations that formed the basis for the 
board's approval of advisory contracts).
---------------------------------------------------------------------------

    The majority claims that the proposing release elicited comment on 
the disclosure alternative. Although the proposing release did ask 
whether the Commission should consider any alternatives to the 
proposal, disclosure was not specifically mentioned.\38\ As the 
majority notes, a few commenters \39\sua sponte raised the possibility 
of allowing investors to choose among funds based on clear disclosure 
about the independence of their chairman.\40\ These comments were 
ignored and the staff's summary of comments, which was provided to the 
Commission prior to adoption, did not discuss them. Commissioner 
Glassman's and my attempts to find a disclosure-based compromise were 
also ignored. In light of the failure of the majority to consider the 
disclosure alternative prior to adoption, it is hard to understand how 
the pre-adoption rulemaking record can now be relied upon to form the 
basis for a full and fair discussion of this alternative.
---------------------------------------------------------------------------

    \38\ See also Staff Report, supra note 15, at 59-60 (a section 
entitled ``Alternatives Were Considered'' makes no mention of 
disclosure as an alternative).
    \39\ See Comment Letter of the Financial Services Roundtable, 
File No. S7-03-04 (Mar. 10, 2004) (``[I]nvestors will be able to 
express their views on this [independent chairman] issue, given 
clear and appropriate disclosure. * * * Investors for whom this 
issue is a priority can direct their investments to those funds.''); 
Comment Letter of Charles K. Carlson, President, Greenspring Fund 
Incorporated, File No. S7-03-04 (June 17, 2004) (``Greater 
disclosure of relevant information would allow shareholders to make 
better informed decisions. If an independent Chairman is desirable 
in the eyes of some investors, then make that information readily 
accessible.'').
    \40\ Remand Release, supra note 1, at note 10 and accompanying 
text.
---------------------------------------------------------------------------

Plea for a Deliberative Approach

    Commissioner Glassman and I have both called for a more deliberate 
response to the Court. We could, for example, conduct a formal, 
unbiased survey, host a roundtable, or solicit additional public 
comment on the issues raised by the Court. Many others have made 
similar pleas for a more deliberate approach than that pursued by the 
majority.\41\ Because the failures identified by the Court relate to 
issues that were not fully aired during the notice-and-comment process, 
one logical approach would seem to be to do so now. As the Court 
explained, ``uncertainty may limit what the Commission can do, but it 
does not excuse the Commission from its statutory obligation to do what 
it can to apprise itself--and hence the public and the Congress--of the 
economic consequences of a proposed regulation before it decides 
whether to adopt the measure.'' \42\
---------------------------------------------------------------------------

    \41\ See, e.g., ICI Letter, supra note 23, at 1 (``In light of 
the court's decision, we recommend that the Commission invite 
additional public comment and collect additional data to assure a 
thoughtful and deliberative process.''); Letter from Eight Senators 
to Commission (June 22, 2005), at 1 (``[W]e are asking that the 
Commission defer final action on this controversial and complex 
matter until the Commission's new chairman is in office and the full 
Commission can make a deliberate decision.''); Letter from Joseph A. 
Grundfest, W.A. Franke Professor of Law and Business, Stanford Law 
School, to Commission (June 23, 2005), at 3 (``The inescapable 
concern is that this sequence of events supports the inference that 
the matter has been prejudged and that any additional consideration 
of the record is being conducted more as a procedural fig leaf than 
as a professional and good faith inquiry.''); Letter from Bevis 
Longstreth to the Commission (June 24, 2005) (``Input on these 
issues from both the industry and its client base must be obtained, 
and this evidence-gathering cannot be done in a week's time.''); 
Letter from Harvey L. Pitt, Kalorama Partners LLC, to Commission 
(June 23, 2005) (writing, as one of the seven ``living former SEC 
Chairmen'' who supported the rulemaking prior to adoption, to 
recommend a more deliberative approach); Letter from Eugene Scalia, 
Gibson, Dunn & Crutcher LLP, to Giovanni P. Prezioso, General 
Counsel, SEC (June 23, 2005) (writing on behalf of the Chamber of 
Commerce to urge the Commission to ``engage in a thorough, rigorous, 
and deliberate process''); Letter from Walter B. Stahr to Commission 
(June 24, 2005), at 1 (urging the Commission to reconsider its plan 
``to re-issue the same rules, presumably on the basis of a quick 
analysis of the costs and alternatives''); Letter from Richard M. 
Whiting, Executive Director and General Counsel, The Financial 
Services Roundtable, to Jonathan Katz, Secretary, SEC (June 27, 
2005), at 1 (requesting that ``no final action on the Rule be taken 
prior to the conclusion of [a] new public comment and fact-finding 
process'').
    \42\ Slip Opinion, supra note 2, at 17 (emphasis added).
---------------------------------------------------------------------------

    In the Remand Release, the majority boldly states that taking more 
than eight days to reflect on this issue ``risks significant harm to 
investors.'' \43\ The majority does not elaborate on how delaying 
action on the remand for the short time that it would take to do a 
thorough study would endanger investors.\44\ When circumstances have 
required it, the Commission has delayed other actions that it has 
deemed to be of great importance to investors.\45\ The urgency of 
forcing funds to change their governance structures seems to be more 
closely tied to the imminent departures of Chairman William Donaldson 
\46\ and Commissioner Harvey Goldschmid \47\ than to legitimate 
concerns about the well-being of the shareholders in the many fund 
groups that do not have independent chairmen.
---------------------------------------------------------------------------

    \43\ Remand Release, supra note 1, at text following note 11.
    \44\ The majority's claimed interest in certainty for funds 
rings hollow because, by taking this hasty action, they have 
virtually ensured further litigation over this matter. See Remand 
Release, supra note 1, at note 15 (``Even prior to our having issued 
this Release, there have been reports that additional legal 
proceedings may result from our action today. Accordingly, we are 
instructing our Office of the General Counsel to take such action as 
it considers appropriate to respond to any proceedings relating to 
this rulemaking'').
    \45\ See, e.g., Amendment to Rule 4-01(a) of Regulation S-X 
Regarding the Compliance Date for Statement of Financial Accounting 
Standards No. 123 (Revised 2004), Share-Based Payment, Securities 
Act Release No. 8568 (Apr. 15, 2005) [70 FR 20717 (Apr. 21, 2005)] 
(allowing companies to delay implementation of accounting standard 
governing employee stock options); Management's Report on Internal 
Control over Financial Reporting and Certification of Disclosure in 
Exchange Act Periodic Reports of Non-Accelerated Filers and Foreign 
Private Issuers; Extension of Compliance Dates, Securities Act 
Release 8545 (Mar. 11, 2005) [70 FR 13328 (Mar. 18, 2005)] 
(extending a rule implementing Section 404 of the Sarbanes-Oxley 
Act, which was a direct statutory mandate).
    \46\ SEC Chairman William H. Donaldson to Step Down on June 30, 
SEC Press Release 2005-82 (June 1, 2005) (http://www.sec.gov/news/press/2005-82.htm).
    \47\ Robert Schmidt and Otis Bilodeau, SEC's Nazareth is 
Democrats' Choice for Commissioner, BLOOMBERG (May 18, 2005) 
(reporting ``Goldschmid's plan to retire from the SEC by August and 
return to teach at Columbia's law school'').
---------------------------------------------------------------------------

    The Remand Release admits that the timing of this action is 
personnel-driven. It explains that the Commission needs to act 
expeditiously to marshal ``the collective judgment and learning'' of 
the five commissioners that originally considered the rule.\48\ It does 
not note the significant procedural and substantive objections that 
Commissioner Glassman and I raised before the rule was originally 
adopted. It does not note our futile pleas that the Commission obtain 
more empirical

[[Page 39409]]

evidence. More importantly, though, if the Commission adopts a 
meritorious rule under lawful procedures, then the composition of the 
Commission that adopted it is irrelevant. The rule should be able to 
weather the inevitable personnel changes at the Commission and stand on 
its own without the support of the three commissioners that originally 
voted for it.
---------------------------------------------------------------------------

    \48\ Remand Release, supra note 1, at text preceding note 14.
---------------------------------------------------------------------------

    Lastly, I question the majority's conclusion that ``[t]he Court did 
not vacate the rule amendments * * * and they remain in effect.'' \49\ 
The Court specifically identified two statutory violations in the 
process by which the majority adopted these rules. Until these 
statutory violations are remedied, the rule is not in effect, because 
the Commission has not satisfied the statutory predicate for legitimacy 
and enforceability of our rules. The only way for us to cure these 
fatal flaws is to comply with the Administrative Procedure Act and the 
Investment Company Act as the Court has directed us to do and which 
today's action does not do.
---------------------------------------------------------------------------

    \49\ Remand Release, supra note 1, at text preceding Section II 
(``Introduction'').
---------------------------------------------------------------------------

    The Court gave the Commission a chance to redeem itself. It told us 
what we needed to do to fulfill our legal obligation. Unfortunately, 
the majority has squandered this opportunity. For the reasons stated 
above, I dissent.

BILLING CODE 8010-01-P

[[Page 39410]]

[GRAPHIC] [TIFF OMITTED] TR07JY05.031

[FR Doc. 05-13314 Filed 7-6-05; 8:45 am]
BILLING CODE 8010-01-C