November 1, 2002
Jonathan G. Katz
Re: Proposed Rule: Proxy Voting by Registered Management Investment Companies
Dear Mr. Katz:
On behalf of Domini Social Investments LLC ("Domini"), a registered investment adviser under the Investment Company Act of 1940, I would like to commend the Securities and Exchange Commission ("the Commission") on its proposed rules issued September 19, 2002, relating to proxy voting disclosure by mutual funds and investment advisers. We are grateful for this opportunity to voice our strong support for the proposed rules, and to offer a few suggestions for how they may be strengthened.
Domini Social Investments manages more than $1.2 billion in assets for mutual fund and institutional investors who seek to create positive change in society by integrating social and environmental criteria into their investment strategies. We manage the Domini Social Equity Fund (Ticker: DSEFX), the nation's oldest and largest socially and environmentally screened index fund.
As you know, Domini filed a Petition for Rulemaking (File No. 4-439) on November 27, 2001, calling on the Commission to adopt a rule mandating that mutual funds disclose their proxy-voting policies and procedures as well as their actual proxy votes.1 We could not be more pleased, therefore, that less than a year later, the Commission has chosen to take this bold step on behalf of mutual fund transparency, shareholder rights and improved corporate governance.
As you may also know, in 1999 Domini became the first mutual fund manager in America to publicly disclose its proxy-voting record. Our votes are published on our firm's website, www.domini.com, and we also publish on an annual basis comprehensive proxy voting guidelines so that our Funds' shareholders know how we are voting their shares on important issues of corporate governance and social and environmental responsibility. We decided to embrace proxy-voting transparency because we agree with the Commission that proxy voting is a fiduciary responsibility of a fund's investment adviser, and that this duty must therefore be discharged "in a manner consistent with the best interests of the fund and its shareholders."2 In its release accompanying the proposed rule, the Commission "applaud[s] these voluntary efforts," but more importantly, states that, "the time has now arrived" for mandatory disclosure of proxy-voting policies, procedures and voting records.3 We could not agree more.
By embracing the principle that proxy voting is a fiduciary duty that must be exercised in the best interests of fund shareholders, the Commission has taken a critical step that necessarily implies - indeed compels - disclosure.4 I can think of no case where the discharge of a fiduciary obligation would not have to be disclosed to the person(s) to whom the duty is owed. Nor can I think of any other instance where the Commission, or the law in general, countenances opacity rather than transparency in the discharge of fiduciary obligations. If proxy voting is a fiduciary duty of a fund's investment adviser - and it clearly is - then it necessarily follows that there must be disclosure of the fund's proxy-voting policies, procedures and voting record.
The Commission has also appropriately noted that proxy voting transparency "would enable fund shareholders to monitor their funds' involvement in the governance activities of portfolio companies, which could have a dramatic effect on shareholder value."5 This underscores important public policy reasons for this reform:
The Commission also should be commended for facing squarely the potential conflict of interest that may arise between a fund's investment adviser and shareholders "when a fund's adviser also manages or seeks to manage the retirement plan assets of a company whose securities are held by the fund." This potential conflict not only means that a fund adviser "may have an incentive to support management recommendations to further its business interests," but is surely part of the reason why so many fund companies routinely vote with company management.7 Needless to say, when shareholders do not know how their fund managers are voting their proxies - or why - then there is simply no way for them to police for such conflicts, or to know whether their best interests are being served or undermined. We believe that the Commission's proposal that funds disclose in their annual and semi-annual reports votes that are inconsistent with the fund's voting guidelines, including an explanation for these inconsistencies, will provide mutual fund shareholders with a valuable tool to gauge the seriousness with which their fund managers take their voting responsibilities. This public semi-annual report should also help fund advisers to police their own efforts to ensure that their votes are consistent with the best interests of their funds' investors.
We believe that disclosure of funds' proxy voting policies, procedures and voting records will benefit investors in a number of ways, including the following:
The importance of this reform cannot be overstated. The Commission has chosen to act at a critical time. Restoring confidence in America's corporate leadership and the integrity of financial markets requires that corporations be made more accountable to their shareowners and other stakeholders. Proxy-voting transparency will protect America's investors while having positive effects not only upon corporate governance, but on the social and environmental performance of corporations whose power and influence - and hence responsibilities - in our own society and globally have never been greater. We applaud the Commission for taking this bold, but reasonable step forward.
Comments on Opponents' Arguments Against Disclosure
Opponents of proxy-voting disclosure generally advance a handful of arguments that simply do not bear up under close examination:
First, some of the nation's largest mutual fund companies have historically opposed proxy voting transparency, arguing that their investors "have not evidenced any real interest in how [they] discharge [their] voting responsibilities," and hire professional management in part because they "want ... someone to vote their proxy" on their behalf.8 This argument - that proxy voting need not be disclosed because investors are not "demanding" such information - is really beside the point, as this has never been the sole basis or even a primary reason for disclosure. Indeed, in a great many cases where the Commission has required greater mutual fund disclosure and transparency, ordinary investors were simply unaware of what information they were missing, and therefore were not in a position to "demand" it. Certainly, ordinary investors were not demanding disclosure of 12b-1 fees, or comprehensive risk and standardized performance information in a plain English prospectus, but the Commission nevertheless required the same - believing that investor education and mutual fund transparency would lead to better mutual fund governance and stronger financial markets.
When investors buy mutual fund shares they are hiring (and paying for) professional management with respect to both investment services and voting/governance services. The argument advanced by opponents of reform that investors are somehow interested in the former but not the latter is in our view not only disingenuous, but also completely untrue. As the first firm in the country to voluntarily disclose its proxy-voting policies and voting record, we have found that Domini's shareholders are keenly interested in how we vote their proxies on important issues of corporate governance and corporate social responsibility. We understand that other mutual funds that disclose their proxy policies and voting records - including Calvert Group, Pax World Funds, Walden Asset Management, MMA Praxis, Portfolio 21, and Citizens Funds - as well as public pension funds like CalPERS, also find that their investors are very interested in this information (a more complete list of mutual fund managers and other institutional investors that currently disclose their proxy voting guidelines and voting records is available at www.shareholderaction.org/proxy.cfm).
It is also important to note that disclosure is not only necessary to help informed investors make better investment decisions. Disclosure also helps build a larger base of informed investors. Mutual fund investors - representing more than half of the households in America - have been kept in the dark about their own funds' active role in the governance of our corporations. This important rule will introduce many of these investors to the importance of proxy voting for the first time. If it is true that many fund investors have not evidenced an interest in proxy voting policies, we strongly believe that this will change once this rule is put in place.
Opponents of reform also argue that proxy-voting disclosure will be too expensive. Both the Commission's own cost/benefit analysis and the experience of my firm and others that have chosen to disclose their proxy-voting policies, procedures and votes, indicate that the costs are minimal. As you know, Domini responded to the Commission's limited focus inspection of fund proxy voting procedures in August, and provided detailed assessments of the minimal costs we bear to produce our proxy voting guidelines, ensure that our votes are being cast properly, and publicly disclose our votes. We remain ready and willing to provide any further information the Commission requires. We strongly believe that the financial impact of compliance with this rule will be minimal, and that available technology and other resources will render record-keeping and reporting requirements relatively routine. We should also note that the initial cost to draft guidelines and develop procedures are more expensive than the ongoing costs of voting the proxies and maintaining up to date guidelines and voting records. The additional cost to publicly disclose the votes is minimal.
CalPERS, the largest public pension in the world, has disclosed its votes and guidelines since 1999, even though it deals with thousands of companies and proxy votes each year. It does this through web site databases, and hard copy disclosure. We have also found that vote disclosure via a web-based database is not only the most cost-effective way to provide this information to our shareholders, it is also the most useful. This technology allows shareholders to quickly and easily find the specific votes they are looking for, whenever they wish. As we note later in this letter, we strongly recommend that the Commission mandate web disclosure of proxy voting records for those mutual fund complexes that maintain websites.
A third argument sometimes raised by those opposed to proxy-voting disclosure is that they prefer informal discussions with company management behind closed doors, rather than openly confronting management through proxy voting. Some have suggested that public disclosure of votes will impair the efficacy of these dialogues. Although we recognize and often avail ourselves of opportunities to engage management in candid dialogue, we view our fiduciary duty to cast our proxy votes as a separate, although related tool to encourage more responsible corporate citizenship. We have never found the public disclosure of our votes to be an impediment to constructive dialogue with the management teams of companies in our portfolio. Some investment advisers have argued that public disclosure of their voting decisions will affect these discussions. We believe this argument presents a clear case for disclosure. If these confidential discussions may be threatened by public disclosure of votes, it would appear that the risk of conflicts of interest is high.
Mutual fund shareholders have no way of knowing whether fund managers are protecting their interests when dialogues between fund managers and portfolio companies are held behind closed doors. We believe these conversations are often appropriate, but when the manager chooses to act - as managers must do when they vote -- shareholders have the right to know what decisions their management has taken. There may be times when behind-the-scenes dialogue is a useful supplement to public action, but this fact in no way justifies withholding relevant information on concrete actions from shareholders. Under examination, this argument against disclosure also falls apart.
In a recent letter to the International Organization of Securities Commissions ("IOSCO"), the Investment Company Institute ("ICI") provided comments to a report prepared by IOSCO's technical committee discussing the exercise of voting rights by collective investment schemes.9 The ICI supported the disclosure of proxy voting policies and procedures, arguing that such disclosure "could assist investors in obtaining a general understanding of the fund's policies with respect to the voting of its portfolio securities and permit investors to choose funds with voting policies that best match the investors' preferences. It also could assure investors that funds have appropriate procedures to address any possible conflicts of interest that may exist between the fund and its investment adviser." The ICI opposed the disclosure of the actual votes cast, however, noting that "we believe ... fund investors are not interested in the actual votes cast for a particular portfolio security." Further, the ICI argued that:
"In fact, disclosure of actual votes cast (either before or immediately after a vote) potentially could be detrimental to the interest of the fund and its shareholders. As part of the investment process, investment advisers routinely make assessments of the management of the portfolio company, and disagreements over a management proposal of the portfolio company could signal an intention of the fund to sell its shares in that company if the proposal is adopted. We are concerned that in these circumstances information regarding actual votes could be used to front-run funds to the detriment of fund shareholders."10
Contrary to the ICI, we believe that the disclosure of each fund's actual proxy votes is critically important. Without this disclosure, fund shareholders and regulators will have no way to know how the fund's guidelines are being implemented in the real world. For example, in many cases, voting guidelines will indicate that the fund will evaluate a particular issue on a "case by case" basis. Although such guidelines are often necessary, they provide investors with insufficient information to judge how their managers are making these judgments. Without disclosure of the fund's actual votes, they will have no way to monitor potential conflicts of interest.
In addition, we do not believe that such disclosure presents any real risk of front-running. First, as we understand the proposed rule, funds will only be required to disclose their proxy voting records on a semi-annual basis. This should eliminate any risk of influencing the outcome of the vote, and should also eliminate the risk of front-running. By the time investors receive a fund's votes, several months may have passed. If the fund manager was concerned enough about the outcome of any particular vote to sell its stock, she would already have done so. At Domini, we vote against management on a significant number of issues. We presume that any responsible fiduciary will find numerous opportunities to express dissatisfaction with company management through the proxy voting process. Very few of these disagreements provide sufficient independent grounds to sell. It would be nearly impossible for an outside observer to determine which of these votes present a fund manager with sufficient reason to unload their stock - regardless of whether the votes are disclosed prior to the meeting or at a later date. This argument is especially specious for funds where the portfolio management and proxy voting responsibilities are separated.
Finally, some opponents of reform claim that proxy-voting transparency will "politicize" the process, potentially subjecting funds to pressure from companies whose securities the funds hold, in an effort to influence the way the funds vote their proxies. For better or worse, that is the way our system works. In our system of annual corporate shareholder meetings, both proponents and critics of proxy proposals - be they management or shareholder proponents - have a right to make their case to investors. Large institutional investors are often lobbied heavily by both sides during such contests. (Witness the recent proxy battle over the Hewlett Packard-Compaq merger). In the end, this process is salutary: investors are provided with more information, corporate governance is rendered more transparent, and markets are made more efficient. If fund managers are under such pressure, fund shareholders are far better served by transparency than secrecy.
Sunshine is generally a good thing for corporate governance and financial markets. The Commission's proposed rule embracing proxy-voting disclosure by mutual funds will be one more way to let the sun shine in.
Comments on Specifics of the Proposed Rule
We believe the proposed rule could be strengthened in several respects, and we would respectfully request that the Commission consider the following potential modifications:
1. Methods of Disclosure
In its present form, the proposed rule fails to require disclosure of proxy voting policies, procedures and voting records in a manner that is readily accessible to and useable by mutual fund shareholders.
As proposed by the Commission, the rule would require funds, in their semiannual and annual shareholders reports, to: (1) state that proxy-voting policies, procedures and records are available upon request and on the Internet (the fund's website, if applicable, and the SEC website); and (2) disclose any proxy votes that are inconsistent with their proxy-voting policies and procedures. In their Statement of Additional Information (SAI), funds would include their proxy-voting policies and procedures - including procedures the fund will follow when a vote presents a conflict between a fund's investors and its adviser, principal underwriter or affiliated person of the fund - and state that their voting records are available upon request and on the Internet. Funds would be required to send a copy of their proxy-voting policies and procedures within three business days of receipt of a request for the same. Our understanding is that funds' actual voting records, which would be disclosed on the new form N-CSR, would also be subject to this three-day delivery requirement.
We are concerned that disclosure of proxy-voting policies and procedures in a fund's SAI, though it may be adequate for reporting purposes, is not adequate for disclosure purposes. In our experience, mutual fund investors seldom if ever request delivery of the SAI. At Domini, we receive less than twenty requests for our funds' SAI per year. Mutual fund shareholders' familiarity with and access to a fund's registration statement is limited to the fund prospectus. This is true for a number of reasons: the prospectus is written in plain English (the SAI is not), the prospectus is required to disclose all primary risks of an investment in the fund (the SAI is a repository for "additional" information), and funds are only required to deliver the SAI to shareholders upon request. The SAI has become a compliance document rather than a shareholder document. Confining proxy-voting policies and procedures to the SAI will undermine the goals of investor education, shareholder engagement and mutual fund transparency that are at the heart of the proposed rule. Information placed in an SAI is not likely to produce a wider base of more informed investors, as very few investors seem to be aware of its existence.
At Domini, our proxy voting guidelines are posted on our website and provided to shareholders, upon request, in the form of a separate booklet. We inform investors that this booklet is available upon request in our funds' prospectus, and through an annual postcard mailing. We believe this has been a cost-effective method to keep our shareholders informed about our funds' voting policies, and we would recommend that these measures, or similar measures designed to increase accessibility and usability of fund voting information, be adopted. We would also note in this context that it is necessary to periodically update proxy voting guidelines and procedures in order to keep pace with emerging corporate governance and social and environmental issues. We would suggest that the Commission require funds to indicate when their guidelines and procedures were last updated, and that they undertake to update them annually. Shareholders should receive an annual notification that new guidelines are available for their review.
As noted above, we would also propose that the Commission mandate that funds maintaining websites provide their proxy-voting records online, and that funds not maintaining web sites be required to include their proxy-voting records in a separate mailing, upon request. Paper copies should always be available for those shareholders that do not have web access. In our experience, we receive very few requests for paper copies of our voting record. We would assume that where a web-based version is available, most shareholders prefer to view their funds' votes electronically.
In addition, we would recommend that the Commission require funds to provide their shareholders with an executive summary of their voting record, including, for example, the percentage of votes cast for and against management, by type of issue. Although we do not believe that such a summary would be adequate to replace the full disclosure of the fund's proxy voting record, it would be useful for the average investor that wishes to gauge her fund manager's attention to various issues.
We believe that these suggestions, if implemented, would provide investors with a more complete picture of a fund's discharge of its fiduciary obligations - both in terms of investment services and proxy-voting services - rather than requiring that investors seek out this information on their own. We believe that they serve the goal of making proxy-voting disclosure easily accessible, understandable and usable by mutual fund shareholders.
2. Categories of Disclosure
In its present form, the proposed rule fails to provide sufficient guidance regarding what matters should be addressed by mutual funds in their proxy-voting policies and procedures.
In its release accompanying the proposed rule, the Commission includes some general and specific proxy-voting policies and procedures "with respect to which disclosure would be appropriate," but offers no further guidance, nor any requirements, regarding what type of policies and procedures funds should adopt or disclose. Among those matters identified by the Commission where "disclosure would be appropriate" include the following:
We agree that the above constitute areas that should be covered by funds' proxy-voting policies and procedures. However, the Commission appears to have offered the above only by way of example. There is no indication that the Commission intends to issue specific guidance or adopt minimum standards or guidelines regarding what matters should be covered in mutual fund proxy-voting policies and procedures. The resulting lack of uniformity among various funds' proxy-voting policies and procedures - in terms of both presentation and content - could undermine the utility and effectiveness of the rule and the accessibility of such information to mutual fund investors. The absence of specific guidelines from the Commission could also create an incentive for funds to adopt as few policies and procedures as possible, thereby minimizing reporting and disclosure obligations. This in turn could undermine or render meaningless the requirement that funds disclose to shareholders information about proxy votes that are inconsistent with their proxy-voting policies and procedures. In fact, without any minimum requirements for these guidelines and procedures, the proposed rule's provision that funds disclose inconsistent votes presents a disincentive for funds to produce comprehensive guidelines.
We would therefore propose that the Commission go beyond simply identifying matters "where disclosure would be appropriate" and consider issuing guidelines regarding what general categories of disclosure should be included in proxy-voting policies and procedures. In addition, within each category (e.g., election of directors, anti-takeover provisions, executive compensation, corporate social responsibility) the Commission should determine whether there are any specific matters where disclosure would not only be "appropriate" but should be required. It should be noted that the types of issues funds are voting on are reasonably consistent from year to year, and are determined by the corporate proxy statement, not the fund or adviser. Every year, for example, funds vote on a broad range of shareholder resolutions addressing corporate social and environmental performance. We would never suggest that the Commission mandate any particular voting policy, but it does not seem unreasonable to require that each fund have a section in its voting guidelines that addresses these types of resolutions. We highlight this particular area because these resolutions present issues that are of great public concern, and are uniformly opposed by corporate management. There is therefore a high risk that fund advisers face a conflict of interest when casting their votes. In the absence of any minimum requirements, this situation creates an incentive for funds to simply leave them out of their guidelines.
3. Disclosure by Registered Investment Advisers
In its present form, the proposed rule applicable to mutual funds is needlessly inconsistent with a proposed rule applicable to investment advisers issued on the same date.
On the day the Commission issued its proposed rule relative to mutual funds, it also issued an analogous rule applicable to investment advisers, requiring disclosure of proxy-voting policies, procedures and voting records (File No. S7-38-02; Release No. IA-2059).
However, the Commission not only declined to specify the policies or procedures that advisers must adopt, but also expressly declined to specify the content and format of proxy-voting records that must be disclosed. We think this is a mistake.
We would urge the Commission to consider adoption of a uniform format for disclosure of advisers' proxy-voting records and that it be the same format specified in the proposed rule applicable to mutual funds. Inconsistent formats - both among advisers and between advisers and mutual funds - will only render proxy-voting records less accessible, understandable and useable by investors, thereby undermining the rationale for the proposed rules: improved investor education, reduced conflicts of interest, greater transparency within investment organizations and improved corporate governance.
In recommending that reporting requirements for mutual funds and investment advisers be the same, we strongly support the view that requiring investment advisers to disclose their actual proxy votes to clients would not be any more burdensome than requiring mutual funds to disclose theirs to shareholders. In most cases, the best interests of an investment adviser's various clients would not diverge, but would be relatively uniform - as uniform as the best interests of mutual fund investors - so it is doubtful that advisers would be casting proxies differently for different clients except in very rare circumstances. Moreover, many if not most mutual funds are managed by investment advisers who manage separate accounts as well. It makes sense to institute uniform proxy-voting disclosure requirements for all investment advisers, whether they are reporting to separate account clients or mutual fund shareholders.11
The recent corporate scandals revealed that our system of corporate governance and accountability is broken. Too many corporations have been transformed into vehicles whose primary purpose seems to be to make a small group of management insiders enormously rich, at the expense of shareholders and other stakeholders. It is clear that shareowners - including mutual funds and other institutional investors - must begin to play a more active role in the governance of the companies they own. Proxy voting is the most direct means by which investors - either directly or through mutual fund or other financial intermediaries - can play an active role in influencing corporate behavior.
In fact, proxy voting has had a measurable impact on corporate accountability and responsibility - and in the view of many, on corporate and mutual fund performance - over the last decade. This includes pressuring companies doing business in South Africa during Apartheid (including IBM and Mobil Oil) to change their policies; helping to convince Home Depot to stop selling timber harvested from old growth forests; and persuading Coca-Cola and Pepsi to increase recycled content in plastic bottles. Numerous companies have agreed to release EEO data, adopt non-discrimination policies toward gay and lesbian employees and improve environmental reporting as a result of proxy votes. Finally, increased shareholder vigilance on matters such as stock options, CEO pay, auditor and board independence and other corporate governance issues will likely be a critical tool of corporate reform in the years ahead.
There is also mounting evidence that progress on social, environmental and corporate governance issues is linked to long-term corporate performance, and increasing numbers of institutional investors actively vote their proxies as a strategy for influencing corporate behavior and enhancing portfolio performance.12 Significantly, the Commission has recognized that proxy-voting transparency will enable fund shareholders to better monitor their funds' involvement in the governance activities of portfolio companies, which could substantially impact shareholder value.13
We strongly support the Commission's decision to mandate proxy-voting disclosure by mutual funds, and would again commend the Commission for this giant step forward in promoting full disclosure and transparency in financial markets. We believe the end result will be greater mutual fund transparency, improved corporate governance and corporate social responsibility, stronger long-term financial performance and restored confidence in our financial markets. We strongly urge expeditious adoption of the proposed rules, and consideration of the proposed modifications outlined above.
Thank you very much for this opportunity to provide our perspective.