Davis Polk & Wardwell
Mr. Jonathan G. Katz
Dear Mr. Katz:
We are writing in response to the Commission's request for comments on the recently proposed rule 206(4)-6 and amendment to rule 204-2 (the "Proposed Rule") under the Investment Advisers Act of 1940, as amended, addressing an investment adviser's fiduciary obligation to clients who have given the adviser authority to vote their proxies. The Proposed Rule would require advisers to: 1) adopt and implement written proxy voting policies and procedures to ensure that they vote proxies in the best interests of their clients, 2) disclose to clients their proxy voting procedures, 3) advise clients whether they can obtain information regarding how the adviser voted their proxies (and specify the process to obtain this information, if it is available) and 4) maintain proxy voting books and records for five years. We appreciate the opportunity to comment on the Proposed Rule and do so on behalf of a number of our investment adviser clients.
We agree with the Commission that it is imperative that investment advisers uphold their fiduciary duty by voting proxies in a manner consistent with their clients' best interests. However, we do not believe that requiring advisers to implement general voting policies as contemplated under Section 206(4)-6(a) of the Proposed Rule is necessary or appropriate. Our concerns are particularly magnified for advisers of funds that are excepted from the definition of "investment company" by virtue of Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, as amended ( "Private Funds"). Further, although we generally support Section 206(4)-6(b) of the Proposed Rule, requiring advisers to disclose to clients whether (and how) they may obtain information regarding how the adviser voted their proxies, we again do not believe this is an appropriate requirement for advisers with respect to Private Funds. We ask that the Commission consider the following issues prior to final adoption of the Proposed Rule.
I. Proposed Rule Section 206(4)-6(a): Requirement to Adopt Written Policies and Procedures
A. General Application.
Under Section 206(4)-6(a) of the Proposed Rule, advisers would be required to adopt proxy voting policies and procedures that 1) are written, 2) describe how the adviser will address material conflicts between its interests and those of its clients with respect to proxy voting and 3) detail how the adviser will resolve the conflicts in its client's best interests.
We believe that it is unreasonable to expect investment advisers to adopt written voting policies that are general enough to apply to all of their portfolio securities, yet specific enough to anticipate the variety of unique issues that may arise and still be useful to investors. Often an adviser's portfolio companies have widely disparate issues and concerns. We believe that a prudent adviser would represent its client's "best interests" by fully evaluating the circumstances of each issue brought to vote rather than being constrained by a policy statement drafted to apply generally. Further, a blanket policy statement describing the basis of proxy voting decisions, identifying personnel involved in making decisions and ensuring proxies are submitted in a timely manner will be of minimal value to investors and exceptions to the general policy will predominate. Advisers will incur significant costs in preparing the policies themselves and preparing disclosure about the policies. These costs will ultimately be borne by investors and will considerably outweigh any benefit received from a general policy statement.
B. Application to Advisers of Private Funds.
As drafted, the Proposed Rule applies to all registered advisers that have voting authority with respect to client securities. As stated above, we do not think any investment advisers should be subject to Section 206(4)-6(a) of the Proposed Rule. We think there are particularly compelling reasons to not require advisers to have voting policies and procedures with respect to Private Funds, particularly Private Funds that invest in the securities of portfolio companies that are privately held such as buyout funds and venture capital funds. Should the Commission decide to approve the Proposed Rule, we ask that the applicability of Section 206(4)-6(a) be narrowed in this context for the reasons set forth below.
First, interests in a Private Fund are sold to investors in offerings that are exempt from registration under the Securities Act of 1933, as amended (the "Securities Act"). These investors are either "qualified purchasers" under the Investment Company Act or "accredited investors" under the Securities Act, and as such have sufficient knowledge and experience in financial and business matters so as to be capable of evaluating the merits and risks of investing in a Private Fund without the investor protections afforded by the Securities Act and the Investment Company Act. When investing in a Private Fund, these investors negotiate the terms and conditions of their investment to address the issues that they believe are important in order to protect their interests. Thus these investors are in a position to effectively negotiate the terms and conditions they require with respect to the voting of proxies by the investment adviser to the extent they believe that such terms and conditions are necessary or desirable from their perspective. If an investment adviser of a Private Fund is not prepared to agree to detailed voting policies and procedures that investors demand, those investors can choose to invest elsewhere.
We note that, in the context of these Private Funds, investors generally do not seek access to proxy voting information. It seems to us more cost effective for Private Funds and their investors that these investors continue to retain the ability to require the terms and conditions they believe are appropriate (including the terms and conditions relating to the voting of proxies) as opposed to requiring the adoption and implementation of general policies and procedures that these investors would not otherwise have required. Furthermore, an adviser to a Private Fund is typically a limited purpose company, whose sole purpose is to serve as the adviser for a specific Private Fund. These advisers would, in many cases, not have the same economies of scale as advisers to large fund complexes. As a result, the costs of adopting and implementing these kinds policies and procedures would be greater for these advisers (which costs would ultimately be borne by the investors).
Second, these proxy voting proposals are likely to be particularly burdensome for Private Funds, such as buyout funds, venture capital funds and other private equity funds, that invest in portfolio companies that are privately held. The terms of the investments in these kinds of portfolio companies typically require the portfolio company to obtain shareholder approval before taking a wide range of actions − in fact, much more so than in the case of an issuer that is publicly traded. Consequently, these Private Funds, as shareholders, have significant approval rights with respect to their portfolio companies. A general voting policy that attempts to address the voting of securities in these kinds of portfolio companies would not be useful to the investors in the Private Fund or the adviser. A vote on whether to approve a proposed matter (for example whether the portfolio company should be permitted to purchase a new line of business) often requires broad analysis of many factors, such as detailed financial and market analyses and consideration of alternative strategies for the portfolio company. These are not matters for which a formulaic set of policies and procedures would be appropriate. Formal voting requirements for investment advisers may also make portfolio companies less willing to give consent rights to their Private Fund shareholders. Such a result is certainly not in the best interest of the Private Funds, the advisers or the Private Fund investors. Finally, many Private Fund shareholders routinely have one or more representatives serving on the board of directors of their portfolio companies. Consequently, these representatives assist in formulating proposals to be submitted to shareholders. It seems excessive to require that advisers develop a policy outlining how to vote on matters the adviser's board representatives have already supported and may have even proposed. Consequently, if Section 206(4)-6(a) of the Proposed Rule is adopted we request that it not apply to voting policies made by an adviser on behalf of a Private Fund, especially with respect to the voting of proxies relating to a privately held company's securities.
II. Proposed Rule Section 206(4)-6(b): Disclosure of How Clients Can Obtain Information on Votes
Section 206(4)-6(b) of the Proposed Rule requires that advisers subject to the rule disclose to clients (1) whether the client may obtain information on how the adviser voted their proxies and (2) the process by which they may obtain such information (if it is available). We believe that it is generally useful for advisers, as fiduciaries, to provide clients details on how to obtain proxy voting information. However, we believe that this should not apply to clients that are Private Funds. As discussed above, investors in these funds have the bargaining power to contract for such information or invest elsewhere with advisers who choose to provide such information.
We appreciate the opportunity to respond to the Commission's request for comments. If you have any questions please feel free to contact Yukako Kawata at (212) 450-4896, Julie Winarski at (212) 450-4610 or the undersigned at (212) 450-4684.