The Securities and Exchange Commission (the "Commission") has adopted new rules and amendments to certain exemptive rules ^[1] (the "Exemptive Rules") under the Investment Company Act of 1940 (the "1940 Act") governing the role of independent directors of investment companies. These new rules and amendments become effective at various dates, beginning February 15, 2001. These new rules and amendments, as discussed in SEC Release No. 33-7932 (the "Release") are outlined below:

1. Independent Directors as a Majority of the Board

The Commission is requiring that funds relying on the Exemptive Rules maintain a majority of independent directors on their boards. The compliance date for this requirement is July 1, 2002, allowing an eighteen-month transition period for selection, nomination and election of new independent directors.

2. Selection and Nomination of Independent Directors

Independent directors of funds relying on the Exemptive Rules must be selected and nominated by the incumbent independent directors. Shareholders may nominate independent directors and advisers may suggest candidates or provide administrative assistance if requested by the independent directors, but the control of the selection and nomination process must remain with the independent directors.

3. Independent Legal Counsel

The new amendments do not require the independent directors to be represented by their own legal counsel, but do require that any legal counsel for the independent directors of any fund that relies on the Exemptive Rules be an "independent legal counsel." A person is considered independent legal counsel if (a) the independent directors determine that any representation of the fund's investment adviser, principal underwriter, administrator or their control persons during the past two fiscal years is or was sufficiently limited, ^[2] and (b) the counsel has undertaken to (i) provide the information necessary for the board to make a determination of independence, and (ii) promptly update the board if the counsel begins, or materially increases the representation of a management organization or control person. The independent directors must make this determination at least annually, and the basis for their determination must be recorded in the meeting minutes.

In the Release, the Commission also lists examples of factors that the independent directors should consider in determining whether a conflicting representation is sufficiently limited. Those factors include:

1. whether the representation is ongoing and substantial;
2. whether it involves the adviser or an affiliate, and the nature and extent of the affiliation;
3. the importance of the representation to counsel and his/her firm;
4. whether it involves work related to mutual funds; and
5. whether the individual who will counsel the independent directors is or was involved in the representation.

4. Limits on Coverage of Directors under Joint Insurance Policies

The Commission also adopted an amendment to rule 17d-1(d), which permits funds to purchase joint "errors and omissions" insurance policies for their officers and directors. This amendment requires any joint insurance policy to include coverage for the independent directors in the case of litigation between the adviser and independent directors.

5. Independent Audit Committees

The Commission adopted a new rule 32a-4 allowing the board of directors to select the independent public accountant without shareholder approval as long as certain conditions are met. Under the new rule, a fund is exempt from the requirement of shareholder approval if (a) the fund establishes an independent audit committee comprised wholly of independent directors, (b) the fund's board of directors adopts an audit committee charter setting forth the committee's structure, duties, powers and methods of operation, or sets out similar provisions in the fund's charters or bylaws, and (c) the fund maintains a copy of the audit committee charter.

6. Qualification as an Independent Director

The Commission adopted a new rule 2a19-3 to conditionally exempt a person from being disqualified as an independent director solely because he or she owns shares of an index fund that invests in the investment adviser or underwriter of the fund, or their controlling persons. The rule provides relief only if the index fund's investment objective is to replicate the performance of one or more "broad-based" indices. ^[3]

The Commission also rescinded rule 2a19-1 which provides relief from the section of the 1940 Act that defines when a fund director with ties to a broker-dealer is considered to be independent in response to the Gramm-Leach-Bliley Act amendments, which established new, almost identical, standards for determining independence under these circumstances.

7. Disclosure of Information about Fund Directors

a. Basic Information

The Commission adopted new disclosure amendments to expand the information that shareholders receive about directors. The basic information must be disclosed in an easy-to-read tabular format, and the table is required to appear in the annual report to shareholders, the SAI and the proxy statement for election of directors beginning no later than January, 2002. The table must include the following information for each director:

• name, address and age
• current positions held with the fund
• term of office and time served
• principal occupations during the past 5 years
• number of portfolios overseen within the fund complex
• other directorships held outside of the fund complex
• for each interested director, a description of the relationship, events or transactions by reason of which the director is an interested person

b. Equity Ownership Information

In addition, the amendments require disclosure of the number of fund shares in a fund complex owned by each director. The disclosure will be presented in dollar ranges (e.g., $50,001--$100,000). Disclosure of beneficial ownership will be based on the definition in rule 16a-1(a)(2) under the Securities Exchange Act of 1934. That definition focuses on whether a director has an economic interest in the securities, rather than his ability to exert voting power or dispose of the securities.

The amendments require a director to disclose (a) ownership in each fund he/she oversees, and (b) aggregate ownership in any funds he/she oversees within a fund family. The ownership information must be included in the SAI and any proxy statement relating to the election of directors.

c. Conflicts of Interest

The SAI and proxy statement also must include information listing the positions, interest, transactions and relationships of directors and their immediate family members ^[4] with the fund and persons related to the fund. The Commission set a threshold of $60,000 for disclosure of interests, transactions and relationships (although smaller transactions could still be viewed as "material") and adopted five-year proxy, two-year SAI time periods for such disclosure. The Commission excluded routine, retail transactions and relationships (e.g. credit cards, brokerage accounts, mortgages) where the director is not accorded special treatment. Such disclosure need only be included for independent directors and their immediate family members.

d. Board's Role in Fund Governance

The Commission also adopted disclosure requirements for the proxy rules and the SAI relating to a fund's board committees, and disclosure in the SAI of the board's basis for approving an existing investment advisory contract. The Release noted that boilerplate disclosure is not appropriate, and that reasonable detail about the particular factors forming the basis of the decision must be disclosed.

e. Separate Disclosure

All disclosure relating to independent directors must be disclosed separately from interested directors in the SAI, proxy statements for the election of directors, and annual reports to shareholders.

8. Recordkeeping Regarding Director Independence

Amendments to rule 31a-2 will require funds to preserve for six years records of:

• the initial determination of independent director qualification
• each subsequent determination of continued qualification
• the determination that any person who is acting as legal counsel to the independent directors is an independent legal counsel.

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1) The Exemptive Rules include, among others:
Rule 10f-3 (permitting funds to purchase securities in a primary offering when an affiliated broker-dealer is a member of the underwriting syndicate);
Rule 12b-1 (permitting use of fund assets to pay distribution expenses);
Rule 17a-7 (permitting securities transactions between a fund and another client of the fund's adviser);
Rule 17a-8 (permitting mergers between certain affiliated funds);
Rule 17e-1 (specifying conditions under which funds may pay commissions to affiliated brokers in connection with the sale of securities on an exchange); and
Rule 18f-3 (permitting funds to issue multiple classes of voting stock).

2) Defined in the Release as "unlikely to adversely affect the professional judgment of the person in providing legal representation."

3) A "broad-based" index is an index that provides investors with a performance indicator of the overall applicable stock or bond markets, as appropriate. According to the Release, an index would not be considered broad-based if it is composed of securities of firms in a particular industry or group of related industries

4) Immediate family members include only a director's spouse, children residing in the director's household, and dependents of the director.

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Prepared by:
Marco E. Adelfio, Co-Chair	(202) 887-1530
Ashley McMurry	(202) 887-8784