60 Heritage Drive
Pleasantville, NY 10570
August 16, 1998
Jonathan G. Katz, Secretary
Mail Stop 6-9
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: File No. S7-22-98
Dear Mr. Katz:
I am writing to comment on the proposed amendments to rule 15a-4 under the Investment Company Act of 1940 ("ICA" or "1940 Act") that permits an investment advisor, in certain circumstances, to serve temporarily under a contract pending a shareholder vote. Since the Commission routinely grants exemptive relief in this regard, it makes good sense to codify its position.
My concern is with the meaningfulness of the eventual shareholder vote to approve the new investment advisory contract after the prior one has been automatically terminated by virtue of its assignment. Section 15(a) of the ICA requires that a majority of the fund's outstanding voting securities approve the new contract at an annual or special meeting of shareholders. A 1940 Act majority is the vote of shareholders owning the lesser of (a) 67 percent or more of the shares present at the meeting, if the holders of more than 50 percent of the fund's outstanding shares are present or represented by proxy; or (b) more than 50 percent of the fund's outstanding shares.
As a general proposition, any matter requiring approval by a 1940 Act majority is important to shareholders. Rule 452 of the New York Stock Exchange ("NYSE" or "the Exchange") generally bars member organizations from voting on such matters without instructions from the beneficial owner. Traditionally, the Exchange's policy had been that member organizations were precluded from voting on new investment advisory contracts without instructions from the client. However, on March 4th 1992 the NYSE submitted a proposed amendment to its interpretation of Rule 452 that would permit member organizations to vote only on the initial approval of investment advisory agreements if the beneficial owner failed to do so. The Exchange argued that the proposed change did not diminish shareholder rights because "the initial investment advisory contract is described in the prospectus the investor receives when making a decision to invest in these securities." As explained in SEC Release No. 34-30697, "The Exchange states that a shareholder who has recently purchased shares and has not taken the trouble to return a proxy card to the member organization is probably unaware that his inaction is the equivalent the voting against the very investment advisory contracts that were described in the prospectus and were presumably a key factor in his investment decision." Based on these representations, on May 13, 1992 the Commission approved the Exchange's proposed rule change.
However, the assumptions put forth by the Exchange in its application are not applicable when shareholders of an investment company -- in particular, a closed-end investment company -- are asked to vote on a new advisory contract after the prior contract has been terminated. The very fact that a different advisor is proposed renders the matter non-routine. Despite this important distinction and a lack of Commission approval, the Exchange's policy is, absent a formal proxy contest, to permit its members "discretion" to vote for an advisory contract after termination of the prior contract if a client fails to give instructions to the contrary. Currently, under those circumstances, member organizations can and usually do vote to approve such contracts.
In my opinion, this practice makes a travesty of the requirement that an advisory agreement needs the approval of a 1940 Act majority. Surely, the purpose of this requirement is to insure that the true owners of the fund, i.e., the investors who pay the advisor's fees, and who benefit or suffer from the advisor's decisions, shall determine whether or not to approve the proposed contract. The true owners are the beneficial shareholders -- not back-office clerks of brokerage firms who have no fiduciary duty to thoughtfully cast a vote on their client's behalf.
It is common knowledge that many closed-end funds trade at a discount to their net asset value. Many shareholders of these funds believe that the investment adviser is an impediment to taking action to narrow the discount because it may lead to lower advisory fees. Furthermore, these investors contend that even those directors who are nominally independent are influenced by the advisor's views. Therefore, when shareholders finally have an opportunity to send a message to management by voting against an advisory contract, it is unfair to allow so-called "discretionary" votes to undermine their "real" votes. Unfortunately, that is precisely what happens today and the Commission should put a stop to it. It should not tolerate a practice that can serve to gut such a critical provision of the 1940 Act as rule 15a-4.
Last year's vote by shareholders of the Scudder Spain and Portugal Fund (the"Fund") on a proposed advisory agreement is illustrative of the problem. As a result of a merger between Scudder, the Fund's former advisor and Zurich-Kemper, the Fund's investment advisory contract with Scudder was terminated. At a special meeting called for October 21, 1997, shareholders were asked to approve a new contract with Scudder-Zurich. Using the exemption allowed by Rule 14a-2(b)(1), I solicited shareholder support to defeat the proposed contract. Although I notified the NYSE of my efforts, the Exchange, over my protests, permitted its members to vote their clients' unreturned proxy cards as management recommended. Of the 6,511,154 shares outstanding as of the record date of the meeting, the results were: 2,689,422 votes "FOR" the contract and 2,669,349 votes "AGAINST." Each and every "AGAINST" vote was consciously cast by a beneficial owner. On the other hand, although the NYSE has refused to tell me the actual number of "discretionary" votes cast by its members, a very conservative estimate is that they accounted for more than half of the "FOR" votes (and none of the "AGAINST" votes). Had those "discretionary" votes not been cast, the proposed contract would have failed by an overwhelming margin. Instead, the Fund adjourned the meeting (since, even with the discretionary votes, a 1940 Act majority had not yet been obtained) and eventually announced that, if they approved the contract, shareholders would be able to realize net asset value for their shares. At the reconvened meeting held two days later, the proposed contract was approved.
In that instance, discretionary votes certainly affected the outcome of an election on a very important matter. This should never happen. NYSE Rule 402.06 states: "Rules 450 through 455 are designed to facilitate solicitation of proxies in respect of shares held in names of brokers or their nominees, while safeguarding the rights of beneficial owners. The rules' purpose is to aid companies in meeting quorum requirements and in obtaining a representative vote of shareholders, thereby enabling them to maintain quorum requirements sufficiently high to insure such representative vote (emphasis mine)." Surely, it is more important that discretionary votes not affect the outcome of a shareholder vote on an important matter than that a fund's proxy solicitation expenses be minimized. (Otherwise, why have a shareholder vote at all?) Consequently, discretionary voting should not be permitted if there is any doubt whatsoever that it will affect the outcome of an important matter at a shareholder meeting.
There is virtually no doubt that, absent discretionary voting, the proposed investment advisory contract with Scudder-Zurich would have been defeated. The NYSE has declined to disclose how many discretionary votes were cast for the proposal. Therefore, I ask that the Commission request the Exchange to provide that information. (There is no reason why the number of discretionary votes cast on any matter should not be made publicly available.) It can then judge for itself the extent to which discretionary votes can affect the outcome of a shareholder vote on an important matter like the approval of an investment advisory agreement.
To conclude, the purpose of the 1940 Act is to protect investors, not investment advisers. To allow "discretionary" votes to ever cause an investment advisory contract to be approved when it would be defeated if only "real" votes were cast is inconsistent this objective. Therefore, I respectfully urge that the Commission rule that nominees may not cast votes on a matter requiring a 1940 Act majority without instructions from the beneficial owner when there is any possibility that such votes may affect the outcome of the shareholder vote.
Very truly yours,