December 6, 2002
Mr. Jonathan G. Katz
Re: IC-25739: Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies (File No. S7-36-02); IA-2059: Proxy Voting by Investment Advisers (File No. S7-38-02)
Dear Mr. Katz:
At the request of the independent directors of the investment companies it advises, Merrill Lynch Investment Managers, L.P. ("MLIM"), an investment adviser registered with the Securities and Exchange Commission (the "SEC" or "Commission") under the Investment Advisers Act of 1940, submits its comments on SEC Release No. IC-25739: Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies (the "RIC Release") and SEC Release No. IA-2059: Proxy Voting by Investment Advisers (the "IA Release"; together with the RIC Release, the "Releases"). MLIM, together with certain affiliates, acts as investment adviser to approximately 200 investment companies that are registered with the SEC (each a "fund" or collectively, the "funds") under the Investment Company Act of 1940 (the "1940 Act").
MLIM has performed in the past, and will continue to perform in the future, all of its fiduciary obligations, including but not limited to, the responsibility to vote proxies and to exercise those votes in the best interests of the funds and other clients. MLIM considers the voting of proxies with respect to portfolio holdings to be an integral part of the investing process. Accordingly, MLIM's practice is to vote all proxies for which it has been delegated proxy voting authority, unless proxy voting is impractical or impossible due to non-US legal requirements or other circumstances beyond MLIM's control. MLIM is pleased to note that it has previously adopted formal proxy guidelines, which are available to its advisory clients upon request.
As discussed fully below, we are seriously concerned by and strongly oppose certain proposals contained in the Releases (the "Proposed Rules"). We believe the Proposed Rules depart from recent policies espoused by the SEC and would significantly increase costs to fund shareholders and non-fund account holders by placing burdensome and costly compliance activities on registered management investment companies ("RICs") and investment advisers with little or no corresponding gain to the ordinary shareholder or advisory client. Moreover, the Commission cites no factual support whatsoever that the benefits of these unduly burdensome proxy voting disclosure proposals outweigh the costs that would ultimately be borne by the investors. In addition, the Commission cites no factual support that current rules have led to any harm to investors or abuses by the investment industry. Further, we believe the Proposed Rules, if adopted, would have severe adverse consequences on certain separate account holders and fund shareholders whose interests the Commission has historically sought to protect, would require costly and extensive development and implementation of recordkeeping and compliance systems for funds and their advisers, would provide no additional investor protection, and will likely have unintended and undesirable results for both RICs and advisory clients.
The SEC has previously considered the issue of proxy voting disclosure. On two separate occasions, the SEC issued and subsequently withdrew proposed rules on this topic. The question remains, however, whether or not the benefits of disclosure of proxy guidelines and/or proxy vote records to fund shareholders outweigh the costs associated with compliance.
The RIC Release
The SEC proposes to amend registration statements (for open-end funds) and new form N-CSR (for closed-end funds) to require the disclosure of fund proxy voting policies and procedures. If the Proposed Rules become effective, RICs that invest in voting securities will be required to disclose in the statement of additional information ("SAI") the policies and procedures used to determine how to vote proxies relating to portfolio securities. This includes procedures that a fund uses when a vote presents a conflict between the fund shareholders and those of the fund's investment adviser, principal underwriter, or any affiliated person of the fund, its investment adviser, or principal underwriter. It also includes any policies and procedures of a fund's investment adviser, or any other third party, that the fund uses, or that are used on the fund's behalf, to determine how to vote proxies relating to portfolio securities.
The Proposed Rules would also require a fund to file its complete proxy voting record as part of its report on proposed Form N-CSR. In addition, the SEC is proposing to require funds to disclose in its SAI and shareholder reports that a description of the fund's proxy voting policies and procedures and proxy voting records are available (i) without charge, upon request, by calling a specified toll-free (or collect) phone number, (ii) on the fund's website, if applicable; and (iii) on the SEC's website. The RIC Release requires funds to disclose in their annual/semi-annual reports to shareholders proxy votes (or failures to vote) that are inconsistent with the fund's proxy voting policies/procedures. Further, the RIC Release requires funds to send a description of the fund's proxy voting policies and procedures and proxy voting records within 3 business days of receipt of the request.
The IA Release
The SEC proposes a new rule under section 206(4) of the Act which would require advisers to adopt and implement procedures for voting proxies, describe those procedures to their clients, and disclose how clients may obtain information about how the adviser has voted proxies. The SEC is also proposing amendments to rule 204-2 under the Act to require advisers to keep certain records regarding their proxy votes on behalf of clients.
If the IA Release becomes effective, it would be a fraudulent, deceptive or manipulative act, practice or course of business (within the meaning of section 206(4) of the Investment Advisers Act) for an investment adviser to exercise voting authority with respect to client securities, unless: (i) the adviser has adopted and implements written policies and procedures that are reasonably designed to ensure that the adviser votes proxies in the best interest of its clients, (ii) the adviser discloses in its brochure to clients how they may obtain information on how the adviser voted their proxies, and (iii) the adviser has disclosed its proxy voting procedures to its clients.
Under the proposed rule amendments, each adviser subject to rule 206(4)-6 would be required to keep: (i) proxy voting policies and procedures, (ii) records of proxy statements received, (iii) records of votes cast, (iv) records of all communications received and internal documents created that were material to the voting decision, and (v) a record of each client request for proxy voting records and the adviser's response in an easily accessible place for five years, the first two years in an appropriate office of the investment adviser.
A. Disclosure of Proxy Votes
In reproposing proxy voting disclosure requirements, the Commission indicated that recent corporate scandals underscore the need for mutual funds and other institutional investors to play a more active role in corporate governance.1 The RIC Release suggests that despite the fact that mutual funds hold substantial institutional voting power, limited information is available regarding how funds vote their proxies and that potential conflicts of interest exist with respect to the exercise of a fund's proxy voting power. We agree that ample evidence indicates that investors have increased their holdings in mutual funds over time in return for professional management. We believe, however, that requiring fund complexes and investment advisers to disclose their proxy voting guidelines and actual proxy votes to every investor or potential investor is an extremely expensive undertaking with little or no impact on the ordinary investor's investment decision-making process.2
In the IA Release, it states that "[m]any advisory clients may not be interested in information about votes."3 MLIM has received requests for its proxy voting guidelines from certain institutional advisory clients. To date, MLIM has never received one request from an investor in a RIC for either its proxy voting guidelines or proxy voting record. We believe our experience is similar to that of other large advisers to registered management investment companies. We are not aware of (and the SEC has not cited) any credible evidence that ordinary fund investors seek to utilize funds' proxy voting records to determine which funds are suitable investments - and we are highly skeptical that such investors would use such information as part of their fund selection prowess even if it were made readily available to them. MLIM is, accordingly, surprised and dismayed at the proposed requirement to disclose proxy votes to fund shareholders, especially in light of the cost of the record-keeping and compliance burdens involved.
The few proponents of proxy information disclosure assert that such disclosure is mandatory for institutions to comply with their fiduciary obligations. This assertion wrongly concludes that registered management investment companies and investment advisers which do not disclose their proxy voting guidelines and actual proxy votes are per se deficient in the performance of their fiduciary obligations and must therefore necessarily engage in secret proxy voting manipulation. Such baseless conclusions are devoid of factual support. Does it logically follow that mutual funds that have not previously disclosed asset segregation policies and trading execution policies to investors are deficient in the execution of their fiduciary obligations? Of course not. Following the slippery slope of this assertion, registered investment management companies and investment advisers should disclose everything related to their fiduciary obligations. In the end, mutual funds would impose exorbitant fees based on their required disclosure as fiduciaries and investors would have much lengthier documents which contain increasingly less relevant information to assist them in their investment decision-making process.
B. Inconsistency with SEC's Plain English Policies
"As lawyers and regulators have loaded up the prospectus with more and more information, that document has strayed from its primary purpose of helping people decide whether to invest in a particular company or fund. Today, most prospectuses, by their very length and complexity, tend to obscure the essential information that would help people make investment decisions.
One of the main targets of our Plain English initiative is the SEC itself. We recognize that we share responsibility for the state of the modern prospectus. Our passion for full disclosure has resulted in fact-bloated reports, and prospectuses that are more redundant than revealing. It turns out that more disclosure does not always mean better disclosure and that - especially in an environment that virtually inundates us with data - too much information can be as much a curse as too little."4
Through the "plain english" policies established in 1998, the SEC promoted fund disclosure documents that effectively communicated essential information to investors, i.e. by focusing on information that will help investors decide whether to invest in a particular fund.5 The Commission noted in a footnote that it did not intend to use disclosure requirements as a means of regulating the conduct of funds, because funds are already subject to extensive substantive regulation under the 1940 Act.6 However, without adequate discussion, the RIC Release requires funds to specifically note whether or not their proxy vote was against management's view and whether the vote was inconsistent with the approved policies and procedures. Whether intentionally or not, the result is to regulate a fund's conduct. Based on the SEC's prior use of disclosure requirements, this result is inappropriate and unjustified.
No record exists which purports to demonstrate that investors either request or utilize proxy voting information as part of their investment decision-making process.7 Disclosure relating to fund proxy voting would not improve prospectus disclosure because substantially all fund companies would adopt nearly identical "boilerplate" disclosure of their proxy voting policies. The more detailed the disclosure requirements, the more we believe such requirements are likely to promote the "fact-bloated" prospectuses of earlier years that the Commission has more recently sought to discourage (e.g., the Proposed Rules require more extensive disclosure on proxy voting rather than more fundamental matters, such as a fund's Code of Ethics).
C. Role of Directors is Diminished
For more than twenty years the SEC has consistently looked to independent directors as arbiters of conflicts of interest. In prior rule-making proposals and speeches, the Commission has repeatedly stated that independent directors are the watchdogs for fund investors and their primary role is to police potential conflicts of interest.8 Accordingly, the Commission has relied upon directors to protect funds and their shareholders from potential conflicts of interest in numerous areas, such as affiliated transactions. Indeed, after the Commission adopted rules and rule amendments to enhance the independence and effectiveness of fund directors in early 2001,9 the staff indicated its intention to rely even more heavily on directors to police possible conflicts of interest.10 MLIM does not believe, nor has the Commission suggested, that proxy voting raises conflict of interest concerns that are greater than those in areas in which the Commission or the 1940 Act already relies primarily on fund directors to police conflicts of interest. Surprisingly, the Proposed Rules are silent as to a role for directors in this regard.
Rather than mandating such expensive disclosure, which provides little utility to investors, it seems entirely consistent for the SEC to propose specific board oversight requirements which would provide a more direct, effective, and less costly means of dealing with potential conflicts than the Proposed Rules. For example, the Commission could mandate that fund directors approve proxy voting policies and procedures. Instead of purchasing individual stocks and directly voting proxies, investors choose to invest in mutual funds for, among other things, diversification and receipt of professional management. Consistent with such professional management, shareholders would gain the benefit of the board of directors' direct oversight of a fund management's exercise of proxy votes consistent with approved guidelines.
D. Disclosure of "Inconsistent" Votes
If the Proposed Rules are adopted, funds would be required to disclose in their shareholder reports any votes that are inconsistent with the fund's policies and procedures. However, this presupposes that fund's policies and procedures are rigid, which is typically not the case. For example, funds may generally vote a certain way on a type of proposal but reserve the right to vote differently in particular cases. Reserving the right to exercise this type of judgment is presumably what one would expect of an investment professional subject to fiduciary standards. It is far from clear, however, whether such an `exception' vote would be considered "inconsistent" and thus subject to the proposed disclosure requirement. In our view, such proposals would effectively promote registered management investment companies and investment advisers to adopt similar general policies. With such general policies, actual votes would arguably never be inconsistent with the overall policies and procedures. This approach would defeat the purpose of requiring funds to disclose their guidelines in the first place. We fail to see how this result in any way serves to protect mutual fund shareholders or separate account holders.
E. Disclosure of Actual Votes Will Politicize Proxy Voting and Increase Conflicts of Interest
As discussed above, MLIM and its affiliates diligently exercise their proxy voting responsibilities in order to ensure that all votes cast are in the best interests of fund shareholders. To the detriment of shareholders, the proxy voting process for RICs, however, will be politicized if funds are forced to disclose publicly their proxy votes. Clearly, certain vocal proponents of proxy voting disclosure are motivated by their own social or political agendas. One does not have to disagree with those special interest agendas in order to recognize that they frequently will be inconsistent with mutual fund objectives which seek to maximize the economic value of its investment.
Requiring MLIM and its affiliates to disclose publicly its proxy votes will subject us to pressure from these outside groups. Inevitably, if recent history is a valid indicator, this will lead to distractions (e.g., responding to picketing and hiring public relations specialists to deal with any corresponding negative publicity generated by such outside groups). Such distractions will not only detract from a RIC's ability to focus on portfolio management but will also subject RICs to new conflicts of interest. For example, some outside groups may threaten to pull their member's investments out of a fund unless it votes in a certain way. If portfolio management determines that such a vote would not be in the overall interests of fund shareholders, the fund will be placed in a conflict situation. Obviously, MLIM and its affiliates will always comply with its fiduciary obligations but that misses the larger point which is that the Proposed Rules will effectively increase, rather than decrease, a fund's exposure to conflicts of interest during the proxy voting process.
F. Imposing Burdens on Mutual Funds to Benefit Others Is Inappropriate
The Commission states in the RIC Release that "requiring greater transparency of proxy voting by funds may . . . benefit all investors and not just fund shareholders."11 MLIM objects to the Commission's desire to use mutual funds as the vehicle to effect changes for the benefit of "all investors." The Investment Company Act requires funds to be managed in the best interests of their shareholders.12 As noted below, the Commission has significantly underestimated the costs associated with compliance with the Proposed Rules. MLIM believes it is unfair to single out fund shareholders and force them to bear the burdens of the Commission's broader objectives.
G. Adverse Effect of Recordkeeping Requirements to Separate Account Holders
MLIM and its affiliates advise over 30,000 non-fund accounts, including privately managed accounts for individuals and institutional investors, offshore funds, private funds, and other pooled investment vehicles. Over fifty-five percent of these non-fund accounts would be subject to compliance with the IA Release. MLIM does not oppose disclosure of its proxy voting policies to such clients - indeed, MLIM currently voluntarily makes its proxy voting policies available upon request to any client or prospective advisory client with an interest in obtaining such policies. MLIM adamantly opposes the proposed recordkeeping requirements that would be imposed upon investment advisers by the Proposed Rules, however. MLIM believes that the proposed recordkeeping requirements would (a) impose enormous compliance burdens, and corresponding costs, on investment advisers, and (b) have a chilling effect on investment advisers' investment decision-making. In particular, MLIM believes that the proposed requirement to maintain records of all communications received and internal documents created that were material to a proxy voting decision would be adverse to the best interests of investors. Many proxy voting decisions - especially those with the greatest significance, such as votes relating to mergers, recapitalizations, spinoffs and other material corporate events - are essentially investment decisions regarding how to maximize economic value for shareholders. The requirement to make records of all communications received in connection with such decisions would, we believe, require the presence of legal or compliance personnel at any meeting between an investment adviser's research personnel and a corporate issuer. Similarly, the requirement to maintain any internal document that could be deemed relevant to a proxy voting decision would require legal or compliance personnel to pore through all internal research material. We cannot help but believe that this will discourage communications with issuers and the creation of proprietary research, to the detriment of investors.
H. Recordkeeping and Compliance Burdens on RICs
The Release asserts that the recordkeeping burden for funds is relatively minimal. The Commission cites no clear factual basis for this observation, and our experience leads us to take exception to the Commission's view. We believe that the Commission has significantly underestimated the costs, both in terms of dollars and employee time, of compliance with the proposed amendments. The proposal would require compliance and recordkeeping systems, which have not been designed to address the Releases. MLIM, and we would strongly suspect most other fund complexes, would need to create compliance and recordkeeping systems designed to interface with Institutional Shareholder Services' ("ISS") database, and extensively train personnel charged with enforcement of the Releases' requirements. If the proposed Rules and amendments are adopted, the systems would have to be designed from scratch to ensure compliance with the new requirements, and personnel trained, at significant expense. Imposing these additional costs with little impetus from actual investors and based on what appears to be conclusory observations about potential conflicts, strikes us as unjustified.
I. Cost is Significantly Higher Than the SEC's Estimate
The Commission estimates that compliance with the RIC Release will require 10 additional hours to file Form N-CSR at a cost of $1,379 per investment company. This figure grossly underestimates the actual cost involved. Currently, MLIM utilizes ISS to assist in its proxy voting. In order to comply with the format proposed by the RIC Release, ISS intends to charge $12,000 for the first fund, and $1,000 for each additional fund, plus an initial $3,000 set-up fee. However, the costs to fund shareholders do not end there. MLIM would need to develop an internal operating system to interface with ISS's records in order to ensure a smooth transition to form N-CSR. In addition, the cost to file Form N-CSR would skyrocket. For example, if a fund holds 200 equity securities and each security has 5 proxy voting issues, to comply with the Commission's reporting format, this fund's voting records would be approximately 200 pages. Multiply that by the number of total funds and two filings per year per fund, and the printing/mailing costs increase significantly. In addition, MLIM would need to hire additional compliance personnel to ensure its internal controls and procedures are followed for its CEO/CFO to certify the accuracy of Form N-CSR for each fund. Moreover, there are substantial costs associated with MLIM's proxy committee's and disclosure committee's time spent reviewing the proxy voting policies and accuracy of proxy voting records. Lastly, compliance with such proposals will diminish a portfolio manager's time to focus on fund investment and performance objectives. Surely, these additional financial and opportunity costs are a disservice to shareholders.
Instead of increasing costs to shareholders via the preparation of ever-lengthening disclosure documents, firms could attach an exhibit to the registration statement (and respond promptly to investor requests, if any, for such information) or insert proxy voting guidelines on their website. This alternative would allow investors and the Commission to access and review such proxy information at any time. Indeed, the Commission acknowledges that advances in technology over the past 30 years, specifically the internet, would allow this type of disclosure to be readily accessible at low cost.13
For the reasons set out above, we strongly believe that the proposals to disclose proxy voting policies and procedures, along with actual votes cast by a registered management investment company and an investment adviser is unnecessary, costly, provides no additional investor protection, and will likely have unintended and undesirable results for both funds and separate account holders. Since no abuses have been cited, no factual record has been made thus far and no investors seem to be asking for this type of information, we believe making the policy available on a website and having directors police conflicts of interest are the only appropriate changes to the current system.
We appreciate the opportunity to comment on the proposed rulemaking. Please call the undersigned at 609-282-2021 or Ira P. Shapiro at 609-282-8127 if you have any questions regarding the letter.
cc: The Honorable Harvey L. Pitt