Speech by SEC Commissioner:
to the Investment Company Institute Procedures Conference
by Paul R. Carey
Commissioner, U.S. Securities & Exchange Commission
December 9, 1999
The views expressed herein are those of Commissioner Carey and do not necessarily represent those of the Commission, other Commissioners or the staff.
Thank you for that kind introduction and for the invitation to speak to you today. As you know, mutual fund governance is an issue of considerable importance to the Commission. I would like to share some of my views with you today on one aspect of fund governance. Specifically, I would like to spend a few minutes discussing how fund investment advisers vote the securities held in their funds' portfolios. Before I begin, I should note that these are my views and not necessarily the views of the Commission.
Mutual funds own approximately 3 trillion dollars in common stocks. With a total market capitalization of 17 trillion dollars, funds or more accurately, their investment advisers control a significant percentage of voting stock in this country.
The mutual fund governance question is obvious: How should investment advisers exercise this voting power?
In theory, and under the law, the answer is clear. Advisers are fiduciaries. As fiduciaries, advisers must act in the best interest of their beneficiaries. Thus, when voting portfolio securities, a fund adviser must act in the best interest of the fund, and not in its own interest.
However, in practice, in deciding how to vote portfolio company shares, how effectively are advisers carrying out their responsibilities as fiduciaries? What are funds and advisers doing to promote responsible proxy voting? Industry participants are focussing more attention on these issues, as well. In fact, in a recent speech, John Bogle, the founder of the Vanguard Group, questioned whether fund advisers were living "up to their responsibility of corporate citizenship."
But, let's step back a minute. Prior to casting a single vote, fund advisers could, and many do, use their influence as large shareholders to highlight certain management practices that may not increase shareholder value. Consistent with their fiduciary duties, fund advisers may discuss with management their views on key issues that affect shareholder value, such as:
- setting executive compensation levels;
- repricing stock options; and
- managing earnings through inappropriate accounting practices.
Opening lines of communication with portfolio company management to discuss these types of issues can often prove very beneficial to fund shareholders.
We have seen some examples of advisers communicating their views on these types of issues with management. When Michael Price was the portfolio manager of the Mutual Series Funds, he often advocated for change in the companies in which his funds held large positions.
This type of active role, however, seems to be the exception rather than the rule. Some fund advisers approach these corporate governance issues simply by voting proxies according to the recommendations of proxy consultants. Many other fund advisers "vote with their feet" by selling if they are dissatisfied with company management, rather than trying to work with company management to increase shareholder value.
Again, an obvious question is called to mind: Should fund advisers do more?
Sometimes, fund advisers may not do more because they have concluded that doing more is not in the best interest of the fund. Clearly, fund advisers must engage in a cost/benefit analysis, and weigh the costs of possible courses of action against the potential benefits to the fund. In some cases, the costs of engaging company management on an issue may outweigh the potential benefits that may accrue to the fund. Fund advisers should not expend resources if they have no reasonable expectation that doing so will provide a net benefit to the fund. For example, if a fund holds only a small position in a company, a decision to not engage management in discussions, or to switch rather than fight, may be appropriate particularly if the issue involved would not significantly affect the value of the fund's holdings.
Unfortunately, sometimes, fund advisers may not do more, because, to do more, might conflict with the interests of the adviser. A fund adviser could have an economic interest to vote the fund's shares to please company management, even if such a vote might not be in the best interests of the fund. This could be because a fund adviser might manage or hope to manage the retirement plan of a company whose stock is owned by the fund. If the fund adviser wants the pension business of XYZ Company, or it wants to continue to manage XYZ's pension business, it might think twice before voting against the recommendation of XYZ's management even if voting against the recommendation could increase the value of the funds' holdings. Clearly, this result is contrary to a fund advisers' fiduciary duty to the fund and its shareholders.
Fund Boards can and should play a role in the voting process. They typically delegate the voting power to the fund adviser, but they continue to oversee how the adviser uses that power. What should fund boards do to ensure that the funds' voting power is being exercised to benefit fund shareholders?
- First, fund boards should communicate with their advisers and find out:
- Whether the adviser actually is voting the shares, and, if not, why not;
- How the adviser is voting the shares; For example, is the adviser relying on the recommendations of a proxy consultant?
- How the adviser is making voting decisions.
- Second, fund boards should consider providing guidance to advisers about how fund shares should be voted. They should consider the following questions:
- How does the board want portfolio shares to be voted? Does the board want the adviser to follow a specific strategy?
- What type of cost/benefit analysis does the Board think, or expect, that the adviser should engage in?
- When does the board think it is appropriate to use voting power to influence company policy in hopes of maximizing shareholder value?
Some funds and institutional investors have established written policies on voting. These policies provide guidance to fund advisers when they vote shares on important issues such as:
- corporate governance;
- executive compensation plans;
- capital structure; and
- anti-takeover defenses.
Most important of all, fund boards need to consider how they want voting power to be exercised in conflict of interest situations. As is always true in conflict situations, an adviser can disclose the conflict to the fund board and obtain consent to vote as the adviser recommends. In other words, a fund board could adopt a policy that, in the event of a conflict, the board will be advised of the conflict, and, if appropriate, approve any proposal to vote fund shares made by the adviser.
Fund boards also may want to consider whether funds should disclose voting policies or practices to fund shareholders. As you know, funds are not required to make this kind of disclosure, and, most do not. Thus, investors who want to monitor how their funds vote portfolio shares generally cannot do so.
The Internet, however, provides an easy and relatively inexpensive medium to provide voting information to shareholders. And, I am aware of at least three entities that have begun to provide voting information to shareholders on their websites.
CalPERS, the California Public Employees Retirement System, has set up a corporate governance website. This site contains information about how CalPERS will vote its portfolio securities, and whether CalPERS has engaged in discussions with company management.
Similarly, the Domini Social Equity Fund discloses its voting on its website. And, TIAA-CREF, the 255 billion dollar pension plan, also publishes its voting policies on its website.
I expect that providing voting information on websites will become more prevalent as funds and their shareholders continue to focus on efforts to maximize value. I also note that the Division of Investment Management is exploring possible recommendations concerning investment advisers' obligations to disclose how they vote proxies.
In closing, fund governance issues continue to be at the forefront of our concern. How investment advisers exercise fund voting power is an important issue that fund boards and advisers should consider. I ask that you think about what you can do to enhance funds' voting power in order to maximize shareholder value, and to fairly recognize and address conflict of interest situations. Consider whether it makes sense to have procedures in place to address these issues. Know what process is taking place now, and decide if that process is in the best interest of the fund. I also ask that you consider whether disclosing fund voting practices or policies would be useful information for your shareholders. I thank you for your time and attention and wish you all a happy and healthy holiday season.