ICI/IDC Letter to SEC Regarding Proposal to Facilitate Shareholder Director Nominations
[24235]
April 15, 2010
TO: CLOSED-END INVESTMENT COMPANY MEMBERS No. 20-10ETF ADVISORY COMMITTEE No. 12-10
SEC RULES MEMBERS No. 32-10
SMALL FUNDS MEMBERS No. 23-10
INVESTMENT COMPANY DIRECTORS No. 8-10 RE: ICI/IDC LETTER TO SEC REGARDING PROPOSAL TO FACILITATE SHAREHOLDER DIRECTOR NOMINATIONS
The Investment Company Institute and Independent Directors Council have sent a letter to Securities and Exchange Commission Chairman Schapiro and Commissioners Aguilar, Casey, Walter, and Paredes reiterating concerns over the application to investment companies of the SEC’s proposal to facilitate shareholders’ ability to nominate directors. [1] Certain data regarding the assets and board structures of investment companies, information relating to regulatory requirements for investment companies, a legal memorandum prepared by outside counsel regarding investment companies’ use of confidentiality agreements, and the ICI/IDC’s Overview of Fund Governance Practices, 1994-2008 were included with the letter. The letter (with attachments) is available on both the ICI’s and IDC’s websites. [2] The letter is summarized below.
The letter points out that the proposal, disappointingly, does not account for the most prevalent types of investment company boards – unitary or cluster boards—or for other stark differences between operating companies and today’s complexes of investment companies. In addition, it points out that the SEC paid scant attention to investment companies when conducting empirical analysis in connection with the original proposal, and the effect of the proposal on investment companies was not addressed at all by the SEC when it re-opened the comment period in December 2009.
The letter recommends that, given these shortcomings, the SEC exclude investment companies from the proposal. The SEC instead should consider whether a proxy access proposal should apply to investment companies at all, and, if so, how it could craft a new proposal better suited to the unique attributes of investment companies.
Benefits of Unitary and Cluster Board Structures
The letter discusses the most significant difference between investment companies and operating companies – the almost universal use of unitary or cluster boards of directors for investment companies – and the effect that the proposal could have on these structures if a shareholder nominee is elected. The letter points out that there are sound practical and economic benefits associated with the unitary and cluster board structures, none of which were taken into account by the Commission. These benefits include enhanced board efficiency and greater board knowledge of the many aspects of fund operations that are complex-wide in nature. For example, fund directors are required to establish standards for the valuation of portfolio securities and review compliance procedures. The standards that govern directors’ determinations in these areas apply to all funds in the same complex, and consistency among funds greatly enhances both board efficiency and shareholder protection, as there is less likelihood for compliance errors if all funds operate under consistent procedures. For these and other reasons detailed in the letter, director oversight of multiple funds within a complex has served shareholders well and disrupting this effective corporate governance mechanism should not be done without considerable forethought and good reason, neither of which was demonstrated by the Commission in the proxy access proposal.
Effect of Proposal on Unitary and Cluster Boards
The letter points out that, under the Commission’s proposal, if a shareholder in one of a complex’s funds nominates a director who is elected, the complex will no longer be able to maintain its current unitary or cluster board structure. The letter also notes that, despite Commission staff statements to the contrary, requiring shareholder-nominated directors to enter into confidentiality agreements will not suffice to preserve the unitary/cluster structure. [3] The letter also points out that although the use of unitary and cluster arrangements are quite common, within those structures there are other aspects of board organization that vary from complex to complex. The Commission’s analysis does not take into account any of these differences.
Need for Empirical Analysis
The letter states that the Commission has not weighed the proposal’s anticipated benefits against its costs and burdens for investment companies or small funds in particular, despite the requirement that it do so.
Other Concerns that Are Not Relevant in the Investment Company Context
The letter states that while the proposal is designed to address declining governance practices, the trend for investment company boards is to have strong governance practices. In addition, while the proposal states the current federal proxy process may unintentionally frustrate shareholder voting rights, the Commission did not make any mention of the fact that the Investment Company Act preserves the ability of investment company shareholders to participate in key decisions unlike shareholders of operating companies.
Dorothy M. Donohue
Senior Associate Counsel
Annette Capretta
Deputy Managing Director
endnotes
[1] See Letter from Paul Schott Stevens, President and Chief Executive Officer, Investment Company Institute to Elizabeth Murphy, Secretary, United States Securities and Exchange Commission, dated August 17, 2009 and Letter from Michael S. Scofield, Chair, Governing Council, Independent Directors Council to Elizabeth Murphy, Secretary, United States Securities and Exchange Commission, dated January 14, 2010 (letters commenting on the proposal). A copy of the Commission releases regarding the proposal is available at http://www.sec.gov/rules/proposed/2009/33-9046.pdf and http://www.sec.gov/rules/proposed/2009/33-9086.pdf (re-opening the comment period).
[2] They may be accessed at http://www.ici.org/pdf/24235_letter_to_sec.pdf
[3]See Memorandum to Investment Company Institute and Independent Directors Council from Eric F. Fess and Felice R. Foundos, Chapman and Cutler LLP, Regarding the Use of Confidentiality Agreements for “Non-Conforming” Directors (February 24, 2010) (memorandum regarding the effectiveness of confidentiality agreements).