THE EQUAL DISCLOSURE PROJECT
423 North Avenue West Westfield, New Jersey 07090
Tel: 908-654-8768 Fax: 908-654-8815
November 8, 2002
Mr. Jonathan G. Katz
Secretary, Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
By Electronic Mail and USPS
In Re: File No. S7-36-02 and File No. S7-38-02
Dear Mr. Katz,
I am writing to express our strong support for the substance of both of the referenced Proposed Rules. (We also expect to submit additional comments prior to the end of the comment period.)
We agree that voting rights appurtenant to equity securities are of material value and that investment advisers owe their clients the duty of managing those voting rights with as much care as is required in their managing of the equity securities themselves. We believe that those duties apply equally to all entities that manage assets as fiduciaries for others and we strongly urge that the same disclosure requirements be made of all such entities. We are submitting this letter as comment on both proposed rules with the recommendation that the substance of the final rules apply to all investment advisers.
We note the discussion of voting rights in the 1991 Report of the House Committee on Government Relations1 in the Department of Labor's 1992 Letter to Institutional Shareholder Services, Inc. 2 and in the Department of Labor's 1986/1994 "Avon Letter"3. The DOL's Avon Letter has made it clear for some time that ERISA fiduciaries must treat voting rights as plan assets and must maintain or cause to be maintained "accurate records as to the voting of proxies". If one class of adviser can do this then certainly all can.
We also agree that increased transparency and expanded disclosure are both appropriate and required given the size of the asset base involved, the character of the assets and the fiduciary relationship between investment advisers and their clients or beneficiaries. We believe, however, that in order to accomplish its goals the Commission must expand the current proposals.
In order to provide a full analysis of voting rights held and to reconcile reports of voting actions taken to voting rights held it is necessary that all investment advisers be required:
- to identify all shares that have been loaned to others, and
- to identify all short positions held.
We believe it is also appropriate that all investment advisers, in their statements of proxy voting policies, specifically address the impact of share lending practices.
Advisers currently reporting on Form 13f are specifically instructed not to identify shares that have been loaned to others 4 5and not to include short positions held .
In its letter to C. Hotaling7 the Commission concludes that loaned securities should continue to be reported as holdings on Form 13f on the basis that 1) retention of the right to sell shares amounts to retention of "investment discretion" and 2) non-reporting of loaned securities could "render the data base created by Form 13f filings incomplete and therefore unsuitable for analyses of trading activities of Reporting Managers".
That letter further states that: "Section 13f was enacted by Congress...in response to Congress' directive to study and investigate the purchase, sale and holding of securities by institutional investors of all types..." and that: "The legislative history of Section 13f reveals that its purpose is to: (1) improve and enlarge the available data regarding institutional managers and thus facilitate consideration of the influence and impact of institutional investment managers on the securities markets..."
We believe that it could be argued that the transfer of voting rights that takes place when equity securities are loaned has always been a sufficiently material issue to be reportable under that legislative intent language. However, under the proposed proxy voting rules we believe that it is clear that loaned shares must be identified. Without such identification an advisor will be unable to reconcile the actual voting actions that it takes with the voting rights that it holds. Without the ability to reconcile rights exercised to rights held an adviser will be unable to make a complete and auditable report either to the Commission or to its clients/beneficiaries.
Under current reporting rules shares that are loaned and subsequently sold short cause an additional problem. The share lender continues to be assumed to have voting rights while the new purchaser actually has acquired those voting rights. The total of all voting rights presumed to be held and presumably exercisable, therefore, exceeds the total of all actual voting rights. While it may be unlikely that more than 100% of all shares would be voted in any instance it is still clearly possible that the same shares might be voted twice, which is clearly a violation of the rights of both the issuer and other shareholders.
We believe that the legislative intent of Section 13f is clearly broad enough to have been interpreted as including the reporting of short positions. The language clearly implies the desire for a "complete database" suitable to analyze the "trading activities" of Reporting Managers. Such a database obviously cannot be complete without the inclusion of short sales and short positions.
We note also the substantial discussions that have taken place in the past on the issue of reporting short positions. In prior discussions of the impact of short selling on proxy voting the Commission has taken or acquiesced in the position that the problem is principally a theoretical one on the basis that, in practice, only a small percentage of proxies tend to be returned. While that position has, in the past, provided a convenient rationale for ignoring what we believe is a clear inequity, the new proposals require that it be reconsidered.
Prior proposals to require the reporting of short positions have been drafted to apply only to "large holders": the analog of 13d filers.8 It was argued, correctly, that individual short positions equal to 5% or more of the outstanding shares of a given company are highly unusual and that the potential benefits from such an infrequently-effective requirement did not justify its imposition. It was also argued that short sellers provide valuable services of liquidity and price discovery. We agree. However, those arguments are not convincing in the case of investment advisers.
Investment advisers owe a fiduciary duty to their clients/beneficiaries. Those clients/beneficiaries have a right to material information relating to the management of their assets and the Commission and other regulatory bodies have both the right and the duty to obtain and assess such material information. That seems to have been the clear intent of Section 13f.
The relationship of the parties involved, the character of the investment vehicles and the character of the relevant regulatory environment clearly differentiate the question of short interest reporting by investment advisers from the reporting that has been previously proposed.
We would also note the issue of voting equity that arises when a long holder also maintains a short position. The long position confers voting rights while the short position removes financial risk. Hedging is, of course, a perfectly legitimate and valuable tool. It does, however, reduce the effective financial stake that the holder has in the security and under current reporting rules that reduced interest is not apparent to the adviser's client, to the issuer of the security or to the Commission. The inability of a client to obtain a true picture of an adviser's position with respect to a given security also clearly raises the potential of conflict of interest.
In the current climate of activism on corporate governance and of heightened attention to disclosure and transparency we believe it is both fair and appropriate that clients, beneficiaries, issuers and regulatory bodies be able to ascertain the actual exposure that an adviser has to a given equity security. Without disclosure of both share lending and short positions that is not possible.
Even if it were not clearly within the legislative intent of the Section; even if it were not clearly consistent with the fiduciary responsibility of investment advisers; even if it were not clearly consistent with the prior regulatory characterization of voting rights and advisers' responsibilities with respect to them; we would argue that the effective implementation of the current proposals would require that all investment advisors report both loaned shares and short positions because without such reporting it would be impossible for the advisers, their clients or the Commission to accurately reconcile voting actions taken with voting rights held. And without the ability to reconcile actions to rights the value of the proposed rules will fall short of its potential.
The modifications required to Form 13f to accommodate disclosure of both loaned shares and short positions would be minor and the inclusion in the statement of proxy voting policies of an analysis of the impact of share lending practices would be straightforward.
We applaud the Commission's clear intent to improve transparency and expand disclosure and we urge that the steps outlined above be incorporated in the current proposals.
Charles R. Lightner
The Equal Disclosure Project
|1 ||Report of the House Committee on Governmental Relations 102-414 December 1991 pp31-35
DOL Letter dated 2/20/1992
|3 ||DOL Letter dated 2/23/1994
|4 ||Form 13f FAQ Question #42
|5 ||SEC Staff Letter to C. Hotaling of NY State Teachers Retirement System. November 16, 1990.
|6 ||Form 13f FAQ Question #41
|7 ||See note 5.
8 See SEC 1991 Concept Release