Social Investment Forum
1612 K Street NW, Suite 650, Washington, DC 20006
November 11, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street NW
Washington, DC 20549-0609
Dear Secretary Katz:
The Social Investment Forum (the Forum), a membership association representing more than 500 investment advisers, research firms, mutual funds, and other institutional investors involved in socially responsible investing, submits the following comments in response to the Securities and Exchange Commission's proposed rules on September 19th, File Numbers S7-36-02 and S7-38-02, concerning proxy voting policies, procedures, and vote disclosure by mutual funds and investment advisers.
The Forum strongly supports the recommendations set forth by the SEC on these issues, and applauds the agency for this bold initiative on behalf of investor rights and meaningful financial disclosure. These proposed rules are overdue, and will go a long way toward restoring confidence in financial markets. In our response below, the Forum also wishes to address key questions raised by the Commission on the amendments put forward, and recommendations which might help clarify obligations under the proposed rules.
Socially responsible investing constitutes one of the most rapidly growing segments of the investing community, representing over $2.34 trillion - nearly $1 out of every $8 under professional management in the United States.1 For over 18 years, the Forum's members have worked for more responsible corporate behavior on a range of issues, including: diverse and independent boards; excessive executive compensation; conflicts of interest related to audit and non-audit services; labor conditions at home and abroad; improved stakeholder engagement; greater disclosure and transparency in reports and financial filings; and disclosure of social and environmental risks.
Not incidentally, Forum members have been calling for disclosure of proxy votes and voting guidelines for many years, and were the first firms in the nation to voluntarily make such disclosures. In fact, the U.S. fund companies that currently disclose both their guidelines and voting decisions publicly are members of the Forum. Our members do so because they believe mutual funds and investment advisers have a fiduciary duty to vote proxies in a manner consistent with the best interests of their shareholders and clients. If voting proxies is a fiduciary duty - a position the Commission has now embraced - then the policies and practices of mutual funds and investment advisers in voting their clients' securities clearly should be disclosed. We strongly support the Commission's proposal to make such disclosure mandatory, and believe it helps maximize the value of fund investments.
Comments Regarding File No. S7-36-02: Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies
The Social Investment Forum supports Proposed Rule S7-36-02, which would be a major step forward in providing adequate disclosure and transparency to individual investors whose proxy assets are held and voted by mutual fund managers. The proposed rule is also consistent with other recent SEC efforts to enhance mutual fund communications with investors, including the plain English prospectus and more detailed disclosure regarding investment strategies, fees, and risks. With the proposed amendments, the SEC is making an authoritative announcement that proxy voting is a fiduciary duty, and should be exercised in the best interests of mutual fund shareholders.
Historically, most mutual funds have been reluctant to disclose their proxy voting records or the principles that guide their voting of securities. In fact, the nation's largest mutual fund company, Fidelity Investments, "as a matter of policy, does not disclose its vote decision with respect to a particular company, meeting, or agenda item."2 Unlike investment managers of defined benefit plans, most mutual fund firms refuse to tell their investors how they voted on key issues coming to a vote. This is unfortunate, as mutual funds have enormous potential to raise the bar on corporate governance at U.S. companies.
Proxy voting, of course, is the primary forum through which shareowners participate in the governance of a corporation, and through which corporate management seeks affirmation and approval from shareowners. Proxies generally contain management proposals on key issues of corporate governance - including board composition, capital structure, auditing, and executive compensation - as well as shareowner proposals on issues such as workforce diversity, vendor practices, environmental policies, or other emerging corporate liabilities. Yet many of the mutual funds and registered investment advisers who vote proxies on these issues not only decline to disclose their policies, procedures, or votes, but may in fact be voting against the interests of their shareholders and clients. For many years, some fund participants and regulators have questioned the practices of mutual funds that may be automatically voting with management in order to garner profitable 401(k) and other business from companies where proxies are being cast. This potential conflict of interest goes unchecked in a system where fiduciaries are allowed to vote proxies in secret - without disclosing to their shareholders or clients how proxies were exercised. Yet the conflict is real: the largest mutual fund firm, Fidelity, earned more than half of its $9.8 billion in 2001 operating revenues by providing fee-based services to the companies at which it voted proxies on behalf of fund investors.3
John Bogle, former chairman and founder of The Vanguard Group, has also acknowledged this "extraordinary" conflict of interest. "These corporations whose shares we're voting are also the source of our 401(k) and pension business. We don't want to offend the corporations we own."4 The SEC has acknowledged the conflicts as well: "In these situations, a fund's adviser may have an incentive to support management recommendations to further its business interests."5
Disclosure of proxy votes and voting policies would put pressure on fund managers to refrain from unilateral rubberstamping of management's decisions, and would provide investors an additional tool for evaluating and distinguishing among various funds in the marketplace. Transparent voting policies would allow individuals to place their money in funds that promote good corporate governance, and the SEC has noted that such disclosures: "may encourage funds to become more engaged in corporate governance of issuers held in their portfolios, which may benefit all investors, and not just fund shareholders."6
And as the Commission is well aware, the Department of Labor already considers proxy voting to be a fiduciary duty under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA guidelines indicate that voting rights attached to company stock are considered plan assets that must be managed in the best interests of pension plan beneficiaries.
Some of the larger mutual fund firms argue that, because they are voting thousands of proxies each year, and may own several thousand stocks, the process of disclosing would be too complicated and costly. Yet smaller fund companies have been doing so for some time, with little cost to investors. It should also be pointed out that many funds already internally track their votes in some manner, and have undisclosed voting guidelines and procedures in place. The proposed disclosures would merely be a matter of reformatting data and streaming it into web-based databases, Form N-CSR, and other vehicles accessible by shareholders. CalPERS, the largest public pension fund in the world, has been posting its votes and guidelines since 1999, and will even send investors a print-out of all votes--hundreds of pages long--when requested.
In the proposed rule, the SEC concludes that the cost of the additional disclosures would be about $2,408 per investment company per year (this includes the costs for vote disclosure announcements, inconsistent votes, and guidelines and procedures disclosure in the SAI, and semi-annual and annual reports). Forum members have also noted that costs were quite low in voluntarily implementing these types of disclosures. These costs, spread over thousands of fund investors, would be minimal to shareholders.
Some mutual funds have also argued against proxy voting disclosure on the grounds that they prefer to informally discuss problems with management behind closed doors, rather than by openly confronting management through the voting of proxies. While socially responsible investors recognize and often avail themselves of opportunities to engage management in candid dialogue, we do not believe that this should be the exclusive approach followed by mutual funds. As a fiduciary, a fund manager must represent the interests of its investors, and this includes voting proxies, as well as possibly voting against management when it is in the best interest of fund shareholders or clients to do so.
Some mutual funds also argue that, if investors show disapproval of or disagreement with management, this could drive down the company's share price. The fact of the matter is that shareholder advocates have been confronting executive mismanagement and looming risks at annual meetings for decades, and there is little or no evidence that such activity adversely impacts share price. CalPERS, with about $136 billion in assets (post-Enron), believes that an active approach to corporate governance -- and the identification of impending risks and liabilities at a company - actually enhances share value in the long term, not the reverse. The Forum agrees with this position, as does a growing body of academic literature.
This rule also empowers investors to evaluate the seriousness of a mutual fund's commitment to good corporate governance and long-term shareholder value. When institutional investors divest shares, instead of engaging corporate managements on issues of concern and asking for reform, it is more likely to disturb the share price.7 Additionally, some shareholder resolutions on the proxy are put forward to protect shareholder rights, and several studies have suggested that "companies that protect shareholder rights perform better in the stock market than companies that do not." Results from another study showed that "firms with weaker shareholder rights earned significantly lower returns, were valued lower, had poorer operating performance, and engaged in greater capital expenditure and takeover activity."8
Finally, the Investment Company Institute, in a media response to the proposed rule, has stated that investors don't care about this information and don't request it either. There are many disclosure items promulgated by the SEC that are not regularly requested by investors (for example, the SAI), yet they still provide sunshine on activities that lead to improved performance and competition in the marketplace. And increasingly, investors are understanding the value of the proxy and the need for clarity on how funds voted on their behalf. Additionally, Forum members that provide such disclosures do so as a service to their investors, who are often quite interested in proxy-voting policies on corporate governance, social, and environmental issues. Funds and advisers that already provide both voting and guidelines disclosure include Pax World Funds, Domini Social Investments, Ethical Funds, Calvert Group, Walden Asset Management, MMA Praxis, Portfolio 21, Christian Brothers Investment Services, and Citizens Funds.
Furthermore, based on the SEC's review of fund complex materials, it was concluded that "most registered management investment companies currently maintain policies and procedures used to determine how to vote proxies relating to portfolio securities."9 The proposed rule simply seeks clarity and transparency to fund investors of such policies and procedures.
It is of increasing concern to investors that there is no way of knowing how most mutual funds voted on key resolution issues, and therefore, no way to verify that funds are voting in accordance with established guidelines. It is also important to remember that corporate scandals like Enron, Tyco, and WorldCom were not caused by executive greed alone. Institutional investors approved Enron's board of directors, supported CEO compensation packages, and voted against numerous corporate governance measures that may well have prevented some of the abuses we've recently witnessed.
Amy Domini, founder of Domini Social Investments (the first mutual fund in the U.S. to disclose its proxy votes and voting guidelines), makes an important point in this regard: "Proxy voting is the most direct means by which individual investors -- either directly or through financial intermediaries like mutual funds -- can play an active role in influencing corporate behavior." With the spate of corporate scandals witnessed this year, and the current inadequate level of funding for the SEC to monitor corporate activities, additional checks and balances on corporate executives would seem to be a much desired benefit of disclosure.
Rule S7-36-02 would also enable shareholders to monitor mutual funds' involvement in setting higher standards for corporate governance policy at portfolio companies. The proposed amendments would encourage mutual funds to be more actively engaged in the companies they hold, rather than being passive institutional investors.
HOW THE PROPOSED RULE BENEFITS INVESTORS:
- Spotlights conflicts of interests between fund firms that regularly vote with management at corporations where they have 401(k) or other business.
- Provides investors with additional information with which they can evaluate and distinguish among fund companies, including identifying those that have strong corporate governance engagement.
- Forces fund managers to treat the proxy as a client asset.
- Aligns the fiduciary standards governing proxy voting disclosure by mutual funds and investment advisers with those of private pension plans under ERISA guidelines.
- Forces funds to pay attention to critical issues up for a shareowner vote, and mandates that they vote in the best interest of fund participants.
- Alerts fund shareholders when fund managers are voting counter to established voting policies.
- Pressures mutual funds to not neglect their voting duties and responsibilities, and ensures that proxies are voted either for, against, or abstaining.
- Allows mutual funds to more actively engage management on critical issues affecting share value.
- Long-term investors -- particularly indexed mutual funds -- who are not interested in "voting with their feet" by divesting stocks, can instead choose to play a more active role in attempting to influence company policy and long-term performance through proxy voting.
RESPONSE TO INDUSTRY ARGUMENTS AGAINST THIS RULE:
The ICI and some mutual fund families have argued against many of the tenets set forth in the proposed rules. But the Forum has yet to see a robust and clearly articulated argument that supports the industry's reservations.
- Some industry members argue that disclosures are costly or cumbersome to mutual fund companies, but we believe this argument is weak. Small funds with fewer resources and revenues have been doing this for years.
- The largest public pension in the world, CalPERS, also discloses 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.
- Many mutual funds and large institutional investors already engage companies in serious dialogue (ICI's "candid conversations"), yet still vote against management on numerous issues.
- Most fund companies already have web sites, and could easily reach the bulk of their investors through web disclosures, which is low-cost.
- Funds should already be internally keeping track of votes, so it's just a matter of converting existing data to new fields for web interface. In addition, there are a number of service providers that make this process relatively simple.
- Vote disclosure, it is argued, could cause share price to plummet if many investors disagree with management's proposals. Yet corporate governance and other shareholder advocates, including some institutional investors, have been voting against management's recommendations for decades, and have not witnessed any drop in share value as a result of a proxy contest. Furthermore, the SEC is asking for vote disclosures to be made after proxies are cast, not before, so this should not affect share price--particularly if disclosure happens twice a year to most investors.
SPECIFIC RECOMMENDATIONS ON RULE DETAILS:
- The Forum would like to see more specific guidance from the SEC on what constitutes a proxy voting policy or set of guidelines. Over 700 resolutions are filed by shareholders each year, on a spectrum of issues, and voting policies should reflect the diversity of concerns coming to a vote.
In its present form, the rule doesn't provide sufficient guidance to funds regarding what issues should be addressed in voting guidelines or policies. While the Commission includes some topics and procedures where "disclosure would be appropriate," there is no set requirement or guidance for what funds should address in their guidelines, or how such policies should be disclosed. The Forum supports the seven areas outlined by the Commission deemed "appropriate," and further suggests that a final rule address minimum standards regarding what should be covered under written voting guidelines and procedures.
The lack of uniformity among various funds' policies and procedures could well undermine the effectiveness and utility of the proposed rule, and the accessibility of such information to fund investors. The absence of specific guidelines could also create an incentive for funds to adopt as few policies and procedures as possible, thereby minimizing reporting and disclosure obligations. This would also render "inconsistent votes" meaningless, as funds could create such vague policies that no vote would be considered inconsistent with the policy established. In the absence of any minimum requirements, the rule also creates an incentive for funds to omit procedures or issues out of their guidelines entirely.
- We suggest lengthening the 3-day mailing rule to give funds more time to meet hard copy requests. If most mutual funds are investing time and infrastructure into maintaining clear voting disclosure on their web sites, meeting a sudden request for numerous hard copy reports seems onerous. Forum members suggest a 7-day window instead--the same window funds have to mail the prospectus.
- The Forum recommends that proxy votes and guidelines be posted to a fund's website, if one exists, to lower disclosure costs and make it less burdensome for investors to gain access to the desired disclosures. Acknowledgment of how to obtain fund votes and guidelines should be clearly explained in the fund company's annual report, SAI, and prospectus. Printed copies should also be made available to those investors that do not have access to the Internet.
- In the voting disclosure requirements, resolution subjects need to be clearly identified. Specifically, the Forum recommends implementing SEC Rule #9B, which governs how corporations must describe the issue up for vote on the proxy statement.
- Investors need greater clarification on whether one company would have different guidelines for different funds. It is not unusual for one investor to own several funds at the same company.
- Extend "Best Practices" guidelines in the Investment Advisers' Rule S7-38-02, to mutual fund guidelines and voting disclosure methods.
- It would be helpful to investors monitoring potential conflicts of interest if a new column on Form N-CSR would indicate when the fund company is doing business [401(k) or other] with the issuing company.
- It would be useful to investors to have an executive summary of a fund's annual voting record. This would include the percentage of votes cast for and against management, sorted by the type of issue. While this does not replace the actual voting record, it gives investors a clearer picture of funds' attention to proxy issues, and may help spotlight how funds are voting in the best interest of clients.
The Forum believes that proxy voting disclosure is critical in maintaining confidence in mutual fund markets. Without such disclosures, fund shareholders and regulators will have no way of knowing how a fund's guidelines and procedures are being implemented. When funds indicate they will evaluate an issue on a "case by case" basis, which may be necessary in some circumstances, it does not allow for investors to know or judge how their managers are making crucial proxy decisions. Without disclosure of a fund's actual votes, investors have no way of monitoring potential conflicts of interest.
There is also mounting evidence that attention to shareholder rights, and social and corporate governance issues, is linked to long-term corporate performance. When all mutual funds reveal how they use proxy votes, enabling shareholders to know what is being done in their name, we can expect long term shareholder value to greatly improve.
Comments Regarding File No. S7-38-02:
Proxy Voting By Investment Advisers
Under this rule, investment advisers are expected to create policy guidelines to disclose to clients how they will vote on given proxy issues. Advisers are also to keep adequate records of their voting in order to provide transparency to clients when requested. It is the Forum's position that transparency around adviser voting is critical to improving investor education, restoring confidence in financial markets, and strengthening corporate governance at U.S. companies.
Federal securities laws do not address how advisers should exercise such voting responsibilities, but the Forum believes the proposed rule somewhat ameliorates the current paucity of guidance on this issue. Furthermore, disclosing to clients how advisers are voting may go a long way toward addressing potential conflicts of interest among advisers who are voting in their own, rather than their clients', best interests. Because advisers manage assets and 401(k) and other benefit plans, or provide banking and insurance services, underwriting, or brokerage services to companies where a proxy issue is being debated by shareholders, there is enormous pressure on advisers to vote with management to maintain business relationships or garner new business from these corporate clients. When advisers act in this way, it clearly compromises their fiduciary duty to clients. Yet inadequate disclosure around such activity allows such conduct to go unchecked - which is precisely why transparency is needed.
It is unclear to clients when advisers have undisclosed personal or business relationships with a company's management, directors, or resolution proponents -- which could possibly influence them to vote against clients' best interests. The SEC has recognized for some time that such conflicts exist,10 as has the Department of Labor, which has noted that these conflicts "can adversely affect the management of employee benefit plans."11 As stated above with respect to mutual funds, it is time these conflicts of interest were addressed by the Commission, and its proposed rule constitutes a giant step forward in doing so.
HOW THIS RULE BENEFITS ADVISER CLIENTS:
- Investors can determine whether proxy voting assets are being exercised in their best interests - and not management's or adviser's best interests.
- Transparency and policies around adviser voting of assets brings voting interests in line with client's financial and other goals.
SPECIFIC RECOMMENDATIONS ON RULE DETAILS:
- In its present form, the rule for advisers is inconsistent with the rule for mutual funds on several fronts. There seems to be much greater clarity for mutual funds than advisers in how to meet disclosure obligations and reporting mechanisms for investors.
- The Commission needs to provide more specific guidance to advisers on what should be included in published voting records, as well as what items should be addressed in voting policies and procedures, and private communications to clients on this issue.
- The Forum urges the Commission to adopt a somewhat uniform format for reporting and disclosure of proxy voting information. While mutual funds would most likely use form N-CSR, the SAI, and shareholder reports, and advisers might report such information in an amended Form ADV, we suggest that the same information be disclosed to shareholders in an equally and easily accessible manner. Inconsistent formats and types of information being disclosed will only render proxy voting records less understandable and usable by investors, thereby reducing opportunities for investor education, improved corporate governance, and the detection of conflicts of interest.
These proposed rules also have a broad cross-section of support, including the AFL-CIO, the International Brotherhood of Teamsters, religious institutional investors working through the Interfaith Center on Corporate Responsibility, the Connecticut State Treasurers Office, CalPERS, the Council of Institutional Investors, Institutional Shareholder Services, Fund Democracy, a dozen mutual fund companies, and many individual investors, including corporate governance expert Robert Monks.
The Forum believes that the proposed rules on proxy voting disclosures constitute an historic step forward on the path toward true transparency for individual investors who invest through intermediaries such as mutual funds or investment advisers. Today, many investors have become disenchanted and feel disempowered as a result of corporate scandals that have dominated headlines for the past year or more. They are looking for assurance that an adequate system of checks and balances is in place to prevent future "Enrons." In its proposed rules affecting proxy-voting disclosure by mutual funds and investment advisers, the Commission has taken a significant step forward in providing that assurance. We commend you for this decision, and strongly support the Commission's proposals.
Thank you for the opportunity to comment on the proposed rules.
Timothy H. Smith
President and Chair
Social Investment Forum, Ltd.
cc: Chairman Harvey Pitt; Commissioners Harvey Goldschmid, Roel Campos, Paul Atkins, and Cynthia Glassman.
|1|| Social Investment Forum, 2001 Socially Responsible Investing Trends in the U.S., pages 2, 4.
|2|| 2 AFL-CIO, What is Fidelity Investments Hiding?, page 1.
|3|| AFL-CIO, Five Excuses About Mutual Fund Proxy Voting Disclosure, page 1.
|4|| Investment News, May 13, 2002.
|5|| Securities and Exchange Commission, Rule S7-36-02, Introduction and Background, page 5.
|7|| SRI World Group, Leading Social Investment Indicators Report 2001, page 99--referencing The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic, by James P. Hawley and Andrew T. Williams.
|8|| Corporate Governance and Equity Prices, Paul A. Gompers, Joy L. Ishii, and Andrew Metrick.
|9|| Securities and Exchange Commission, Rule S7-36-02, page 50.
|10|| Securities and Exchange Commission, Rule S7-38-02, Background, page 3.