CORRESP 1 corrletterforbfiling121.txt CORRESP LETTER FOR B FILING [SHIP LOGO} [THE VANGUARD GROUP/ (R)/ LOGO] November 30, 2004 Christian Sandoe, Esq. Division of Investment Management U.S. Securities and Exchange Commission via electronic filing 450 Fifth Street, N.W., Fifth Floor Washington, D.C. 20549 RE: VANGUARD CHESTER FUNDS; COMMENTS ON PEA 29 Dear Mr. Sandoe: The following responds to your comments of November 23, 2004 on the post-effective amendment of the registration statement of Vanguard Chester Funds. You commented on PEA number 29 that was filed on October 12, 2004 pursuant to Rule 485(a). Please note that each prospectus page reference is to the Vanguard PRIMECAP Fund prospectus. COMMENT 1: VANGUARD PRIMECAP FUND (PROSPECTUS PGS. 1 AND 4) ----------------------------------------------------------------- Comment: The More on the Fund section provides that the Fund's board may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. Is the Fund's investment objective a fundamental policy? Item 4(a) requires a fund to designate whether the investment objectives may be changed without shareholder approval, and Item 11(c) requires a fund to disclose a policy that a fund deems fundamental, including the objective. Response: The PRIMECAP Fund has a fundamental investment objective. As such, we will add the following sentence to the "Investment Limitations" section of the SAI: "INVESTMENT OBJECTIVE". The investment objective of each Fund may not be materially changed without a shareholder vote." COMMENT 2: VANGUARD PRIMECAP FUND (PROSPECTUS P. 8) --------------------------------------------------------- Comment: In the Cash Management section, Vanguard CMT Funds are described as funds "established under an SEC exemption." The funds were not established by the exemption, rather the use of the funds by other affiliated funds was permitted by an SEC exemption. Clarify this language. Post Office Box 2600, Valley Forge, Pennsylvania 19482-2600 (610) 669-1000 . www.vanguard.com Christian Sandoe November 30, 2004 Page 2 Response: We propose to revise the first sentence of the Cash Management section as follows: "Vanguard may invest the Fund's daily cash balance in one or more Vanguard CMT Funds, which are very low-cost money market funds. The Fund is permitted to invest in the CMT Funds under the terms of an exemptive order granted by the Securities and Exchange Commission." COMMENT 3: VANGUARD PRIMECAP FUND (PROSPECTUS P. 9) --------------------------------------------------------- Comment: In the prospectus discussion of the Fund's investment advisor, there is the following statement, "Under the terms of an SEC exemption, the Fund's board of trustees may, without prior approval from shareholders, change the terms of an advisory agreement or hire a new investment advisor--either as a replacement for an existing advisor or as an additional advisor." Is this statement consistent with the Fund's multi-manager exemptive order? Response: Yes. The disclosure is consistent with the Fund's exemptive order. See Vanguard Convertible Securities Fund, et al., SEC File No. 812-12380, Investment Company Act Release Nos. 26062 (Notice) (May 29, 2003) and 26089 (Order) (June 25, 2003). COMMENT 4: VANGUARD PRIMECAP FUND (PROSPECTUS P. 19) ---------------------------------------------------------- Comment: On page 19 of the prospectus, there is a disclosure of share class conversions from the Investor Share Class to the Admiral Share Class based on an investor's tenure in the Fund. One of the conditions of a tenure conversion is the investor's registration on Vanguard.com. Why is there a requirement to register with Vanguard.com in order to convert from Investor to Admiral Share Class based on tenure in the Fund? Response: Limiting Admiral Share eligibility in certain circumstances to those shareholders who register with Vanguard.com is designed to encourage more shareholders to register. It costs far less to effect transactions (buys, sells, exchanges), communicate information, and conduct other business over the web than it does through other channels such as phone or mail. Although web-registered shareholders are not required to transact or communicate with Vanguard using the web, we believe that many, if not most, investors who register will soon interact with Vanguard primarily through the web, generating savings that are passed through directly to all Vanguard fund shareholders. The eligibility criteria for Admiral Shares is part of the PRIMECAP Fund's Rule 18f-3 Multiple-Class Plan. The current version of the Plan was filed as an exhibit to the Fund's filing on October 12, 2004. COMMENT 5: VANGUARD PRIMECAP FUND (PROSPECTUS P.26) --------------------------------------------------------- Comment: On page 26 of the prospectus, there is a statement that Vanguard "reserves the right to ... redeem an account, without the owner's permission to do so, in cases of threatening conduct or suspicious or illegal activity." Confirm that this policy Christian Sandoe November 30, 2004 Page 3 is consistent with instances where the SEC has expressly permitted forced redemptions. Also, confirm that the "illegal activity" referred to in the disclosure is related fund activity and not to other illegal activity of the investor. For example, confirm that an investor's drunk driving conviction will not constitute "illegal activity" that could result in a forced redemption. Response: We propose no change to the current disclosure. We recognize that the disclosure provides Vanguard with a great deal of flexibility. However, we need that flexibility because we cannot conceive of, and therefore cannot disclose, every illegal activity [or abusive practice] that might cause us to reject a transaction or force a redemption. Thus, having that flexibility is in the best interests of the fund, its shareholders, and Vanguard employees. Of course, Vanguard will apply that flexibility in a manner consistent with any relevant SEC guidance. COMMENT 6: SAI (P. B-34) ------------------------------ Comment: Add disclosure to the SAI concerning the factors considered by the Fund's board of trustees in reviewing and approving revised terms of the Fund's investment advisory agreement with PRIMECAP Management Company, pursuant to Item 12(b)(10) of Form N-1A. Response: We will include the following disclosure in the SAI concerning the Board's review and approval of the Fund's Amended and Restated Investment Advisory Agreement with PRIMECAP Management Company: VANGUARD PRIMECAP FUND. The board of trustees of Vanguard(R) PRIMECAP Fund adopted a new advisory fee schedule for the Fund, effective October 15, 2004. The Fund's trustees regularly evaluate its investment advisory agreement, focusing on many factors, including but not limited to, the advisor's investment process, style consistency, performance, and the composition and depth of the firm's management and research teams. In deciding to adopt the new fee schedule, the trustees considered the Fund's performance and a wide range of information relating to PRIMECAP Management Company ("PRIMECAP"), which has managed the Fund since its inception in 1984. The Fund's trustees retained PRIMECAP under the terms of an Amended and Restated Investment Advisory Agreement. The board's decision to revise the current advisory fee schedule was based upon its most recent evaluation of the advisor's investment staff, portfolio management process, and performance results. In considering whether to approve the new agreement, the board engaged in arms-length discussions with PRIMECAP and considered the following factors, among others: * The board considered the benefits to shareholders of retaining PRIMECAP as the advisor to the Fund, particularly in light of the nature, extent, and quality of services provided by the firm. The board considered the quality of investment management provided to the Fund over both the short- and long-term and the firm's organizational depth and stability. The trustees found that the Fund has grown considerably since inception and that the portfolio Christian Sandoe November 30, 2004 Page 4 management team has expanded to handle the increase in Fund assets. The new fee arrangement will help PRIMECAP continue to attract and retain top investment talent, and thereby enhance the organizational depth and stability of the firm. The Board noted that although the Fund has entered into an Amended and Restated Investment Advisory Agreement with PRIMECAP to reflect the new fee schedule, other terms of the existing agreement have not changed. * The board considered the investment performance of the Fund in comparison with the Fund's peer group and benchmarks. The trustees found that the Fund has a superior performance record under PRIMECAP's management relative to both the S&P 500 Index and the Fund's peer group. The Fund's investment performance is reflected in the following table: (Insert Performance Table Here) * The board considered the fair market value of services to be provided, including consideration of competitive fee rates and the fact that, after the adjustment, the Fund's advisory fee remains considerably below that of most of its peers. The board observed that after the adjustment, the estimated advisory fee rate for the Fund would be 0.22%. The estimated rate is considerably less than the average fee rate of the Fund's peer group, which is 0.58%. The board noted that the new fee schedule is expected to raise the Fund's expense ratio to 0.50% from 0.46% for Investor Shares and to 0.35% from 0.31% for Admiral Shares for the current fiscal year. These increases represent an additional $4 in fees on a $10,000 investment. Additional data about the Fund's expense ratio, advisory fee rate, and those of the Fund's competitors are expressed in the following table: (Insert Advisory Fee Table Here) * The board considered the extent to which economies of scale would be realized as the Fund grows, including a consideration of appropriate asset-level breakpoints in the fee schedule. By adjusting the fee through increases in asset breakpoints, rather than increases in fee rates, the Fund's trustees revised the fee schedule in a way that will allow investors to realize economies of scale by holding shares of a large fund. * The board considered whether the Fund should obtain alternative portfolio management services and concluded that, under all the circumstances and based on its informed business judgment, the most appropriate course of action in the best interest of the Fund's shareholders was to enter into the Amended and Restated Investment Advisory Agreement with PRIMECAP. COMMENT 7: SAI (P. B-38) ------------------------ Comment: Explain how the Fund's "Proxy Voting Guidelines" address conflicts of interest. Response: The following disclosure concerning conflicts of interests appears in Section IX of the policy where it states: Christian Sandoe November 30, 2004 Page 5 The Board, including a majority of the independent trustees, appoints the members of the [Proxy Voting] Committee who are principals of Vanguard, and who have the requisite expertise to oversee proxy voting for the Vanguard funds. The Committee does not include anyone whose primary duties include external client relationship management or sales. This clear separation between the proxy voting and client relationship functions is intended to eliminate any potential conflict of interest in the proxy voting process. In the unlikely event that a member of the Committee believes he or she might have a conflict of interest regarding a proxy vote, that member must recuse him or herself from the committee meeting at which the matter is addressed, and not participate in the voting decision. COMMENT 8: TANDY REQUIREMENTS ------------------------------------ Comment: The SEC is now requiring all registrants to provide at the end of response letters to registration statement comments, the following statements: - The Fund is responsible for the adequacy and accuracy of the disclosure in the filing - Staff comments or changes in response to staff comments in the filings reviewed by the staff do not foreclose the Commission from taking any action with respect to the filing. - The Fund may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. Response: As required by the SEC, we will provide the foregoing acknowledgements. * * * * * As required by the SEC, the Fund acknowledges that: - The Fund is responsible for the adequacy and accuracy of the disclosure in the filing. - Staff comments or changes in response to staff comments in the filings reviewed by the staff do not foreclose the Commission from taking any action with respect to the filing. - The Fund may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. Please call me at (610) 503-2320 if you have any questions or further comments. Sincerely, /s/ Christopher A. Wightman Christopher A. Wightman Associate Counsel