December 5, 2002
Via Electronic Filing
Mr. Jonathan G. Katz
Re: Proposed Rule: Proxy Voting By Investment Advisers; Release No. IA-2059; File No. S7-38-02
Dear Mr. Katz:
The Investment Counsel Association of America1 appreciates the opportunity to submit comments on the Securities and Exchange Commission's proposed new rule and rule amendments under the Investment Advisers Act of 1940 related to an investment adviser's fiduciary obligation to clients who have given the adviser authority to vote their proxies.2 The proposal has significant implications for ICAA members that exercise proxy voting authority over client securities. The ICAA supports the proposal with certain important modifications and clarifications.
I. INTRODUCTION AND SUMMARY
The Commission has proposed a new rule under Section 206(4) of the Advisers Act, which would make it a fraudulent, deceptive, or manipulative act, practice or course of business within the meaning of Section 206(4) for an investment adviser to exercise voting authority with respect to client securities, unless the adviser: (1) has adopted and implemented written policies and procedures that are reasonably designed to ensure that the adviser votes proxies in the best interest of its clients; (2) discloses to clients how they may obtain information as to how the adviser voted their proxies; and (3) discloses information regarding its proxy voting procedures to its clients. The proposal also would amend the Advisers Act record-keeping rules to require advisers to retain certain records related to proxy voting.
The basic premise of the Commission's proposal is that advisers have a fiduciary duty to their clients that extends to all services performed on behalf of clients, including proxy voting.3 Advisers are subject to a strict fiduciary duty, articulated by the Supreme Court4 and reiterated by the Commission in various pronouncements over the last several decades.5 As fiduciaries, advisers owe their clients a duty of honesty, loyalty, and fair dealing, and are obligated to act in the best interests of their clients at all times. Over the years, the Commission has indicated more specifically that this fiduciary duty includes the duty to render suitable investment advice, as well as to obtain best execution for client transactions.
With this proposal, the Commission has stated formally for the first time its position that advisers have a fiduciary duty with respect to voting proxies on behalf of their clients.6 We concur that an adviser's duty extends to services it has contractually agreed to perform on behalf of the client. We also agree that the right to vote proxies belongs to the client. When the client clearly delegates this right to its adviser, the adviser is acting on behalf of the client. As the ultimate owner of the security underlying the right to vote a proxy, the client should be able to obtain information regarding how the adviser voted on its behalf. Thus, we believe that the underlying premise of the proposed rule is sound.
However, we are concerned with the more subtly stated goal of the proposal to urge investment advisers to "substantially influence" the corporate governance practices of public companies.7 While such a goal is understandable given the current political environment, we believe the Commission should exercise extreme caution in implying an affirmative obligation of investment advisers to focus on corporate governance issues when voting client proxies. We submit that raising the bar on corporate governance is more suitably the province of the Commission, the exchanges, and the states in which the companies are domiciled. Clients almost always hire advisers to seek the best investment performance for their portfolios consistent with their investment goals and objectives. Clients generally do not hire advisers to serve as activists promoting governance issues for the perceived general good of the markets.8 Thus, investment advisers typically are acting in the best interest of their clients when they focus their attention and resources on selecting issuers in which to invest on behalf of clients based on strategy, style, and a variety of factors that may or may not focus principally on corporate governance issues with respect to a given issuer. In fact, the common adviser strategy of selling securities of issuers when management is not making prudent decisions (i.e. the "Wall Street Rule") may often benefit clients more than maintaining the clients' investment in such a company and seeking change through the proxy process or otherwise. The extremely important tool of money managers to "vote with their feet" is also a significant influence on management.9 Given these realities, we strongly believe that the Commission should ensure that the burdens imposed by the proposal do not outweigh the limited nature of its goal.
Accordingly, we offer the following comments and concerns regarding specific aspects of the proposal.
Each of these issues is addressed in greater detail below.
II. CONFLICTS OF INTEREST
The proposed rule would require that an investment adviser adopt and implement policies and procedures that are reasonably designed to ensure that the adviser votes proxies in the best interest of clients.10 Specifically, the proposed rule would require that the policies and procedures: (1) be written; (2) describe how the adviser addresses material conflicts between its interests and those of its clients with respect to proxy voting; and (3) address how the adviser resolves those conflicts in the best interest of its clients.11
We applaud the Commission's recognition that, because advisers have different types of conflicts and organizational structures, a "one-size-fits-all" approach to proxy voting policies and procedures is inappropriate. We agree with the Commission that the variation in advisory clientele makes it impractical to specify policies and procedures for advisers and we support the proposal's position that each adviser should be free to construct its own version in accordance with the size and nature of its particular advisory business.
The proposal would require that an adviser's policies and procedures describe how the adviser addresses and resolves material conflicts.12 The proposal raises a series of examples of conflicts of interest that the Commission apparently believes may influence how an adviser votes a proxy, including: (1) instances where an adviser has an interest in maintaining or developing business with a particular issuer whose management is soliciting proxies (e.g. asset management, employee benefit plan administration, or brokerage, underwriting, insurance, or banking services); (2) instances where the adviser has a business relationship with a proponent of a proxy proposal (e.g. an employee group for which the adviser manages money); (3) personal and business relationships with participants in proxy contests, corporate directors or director candidates; and (4) instances where an adviser has a personal interest in the outcome of a particular matter before shareholders (e.g. an executive of the adviser has a relative who serves as a director of a company).13
While we recognize that genuine conflicts of interest may arise in the proxy voting process, we are concerned with the Commission's implied presumption that conflicts exist in every relationship that an adviser, its affiliates, and its directors, officers and employees has with an issuer, its pension plans, and its directors, officers, and employees. We are not aware of any evidence presented by the Commission or others that the proxy voting process has in fact been systemically tainted by such relationships. In reality, these relationships rarely present a material conflict of interest or are of such a nature as to improperly influence the proxy voting decision-making process of an adviser.14 Even where one of these relationships exists, if the adviser votes in accordance with the positions generally stated in its proxy voting guidelines, any influence the relationship could have had is eliminated.15
We urge the Commission to narrow its overly broad description of potential conflicts to the types of relationships that truly present a material conflict. Otherwise, large advisers or those with many affiliates will not feasibly be able to track all of the relationships discussed by the Commission on an ongoing basis. Many large advisers follow hundreds or even thousands of issuers, while employing hundreds or thousands of employees. Maintaining accurate lists of which employees or directors or employees or directors of affiliates have "personal or business relationships"16 with issuers, their employees or directors, participants in proxy contests, or proponents of proxy proposals would be extremely onerous, if not impossible. The Commission should clarify that to be material, a personal relationship would have to involve the person or one of the persons who has authority to, and actually does, make the voting decisions. With respect to business relationships, the business or relationship must be of substantial economic value to the adviser and the proxy outcome must have a potentially substantial effect on shareholder value.
On the other side of the coin, many advisers have few employees and manage assets primarily for individuals or private companies. These advisers are highly unlikely to have any business or personal relationships with issuers in which they invest or with proxy proponents or candidates. The Commission should recognize that these advisers may not need to develop formal policies and procedures to address and resolve conflicts of interest and should not require them to expend the resources to do so.
We also seek clarification as to how an adviser may appropriately handle a genuine conflict in the absence of a stated policy or guideline regarding a specific type of proxy proposal. For example, advisers often provide in their guidelines that decisions with respect to mergers and corporate restructurings will be considered on a case-by-case basis. This provides no pre-set guideline for voting in an area where the result may have a significant effect on shareholder value. We seek confirmation that an adviser may reasonably employ one or more of the following techniques: (1) provide the client an opportunity to vote the proxy itself; (2) abstain from voting; (3) vote in accordance with the adviser's policies and procedures where applicable; (4) vote and document the reasons the decision makes economic sense for clients; (5) split the votes equally or proportionately; (6) erect information barriers around the person or persons making voting decisions; (7) designate a person or committee to vote that has no knowledge of any relationship between the adviser and the issuer, its officers or directors, director-candidates, or proxy proponents; (8) designate a third party to vote where material conflicts are detected; (9) designate a third party to vote all proxies on behalf of the firm's clients;17 or (10) any other approach appropriate to managing the conflict.
III. AMENDMENTS TO RULE 204-2: RECORD-KEEPING
The proposal would also amend rule 204-2 to require an adviser subject to proposed rule 206(4)-6 to keep relevant records for a period of five years, including: (1) its proxy voting policies and procedures; (2) records of proxy statements received; (3) records of votes cast; (4) records of all communications received and internal documents created that were material to the voting decision; and (5) a record of each client request for proxy voting records and the adviser's response.18 According to the proposal, these records are necessary for the proposed disclosure requirements and for Commission examiners to ascertain compliance with the rule.19 While we understand the need for record retention of proxy-related materials, we believe aspects of this portion of the proposal are unnecessarily burdensome and may detract from the investment process.20 We offer the following recommendations with respect to the proposed record-keeping requirements.
First, we are concerned that the requirement that an adviser maintain all communications received and internal documents created that were material to the voting decision is unnecessarily burdensome and impractical. Special interest groups frequently contact many of the larger advisory firms, as do the proxy solicitation firms engaged by the issuer. It may be difficult to decide whether such contact is material and it would be burdensome to document every contact of this nature. We believe that this documentation should be required only when the proxy vote relates to an identified material conflict of interest and the adviser has not substantially followed the positions generally stated in its proxy voting guidelines. This approach would significantly ease the administrative burden imposed by the rule, while enabling the Commission to examine records documenting how the adviser handled conflicts of interest in a given proxy contest.
Second, the requirement to maintain records of oral communications is impractical, unworkable, and unprecedented among record-keeping requirements under the Investment Advisers Act. Arguably this requirement could extend to internal and external communications that would be simply impossible to track or control systematically. Requiring portfolio managers or other advisory employees to document calls received throughout the day would seriously detract from the important work of monitoring market events and making investment decisions for clients. Moreover, this requirement could significantly chill the proxy voting decision process or other communications with management of issuers. Accordingly, we urge the Commission to eliminate the proposed requirement to document oral communications.
Third, we believe the proposed requirement that an adviser maintain records of each individual proxy statement received for a five-year period would significantly burden adviser administrators, while offering limited additional protection to advisory clients. The vast majority of proxy statements are required to be filed with the Commission and are publicly available through the EDGAR system. As we have previously submitted, an adviser should not be required to maintain publicly available records of any nature.21 Accordingly the Commission should revise the proposed record-keeping requirements to exclude publicly available materials in all instances. Additionally, an adviser should be able to maintain "records of proxy statements received" that are not publicly available by making an appropriate log entry of the proxy.
Finally, an adviser should not be required to duplicate the proxy voting materials that are maintained or prepared by a third party that votes on behalf of an adviser. We request that the Commission clarify in the final release that an adviser can comply with the proposed record-keeping requirements by ensuring that it can promptly obtain proxy voting records from relevant third parties.
IV. APPLICATION OF PROPOSED RULE
The proposed rule would generally apply to advisers registered with the Commission that have voting authority with respect to client securities. We agree with the proposal that only advisers that have voting authority should be subject to the rule.22 Advisers are not entitled to vote the client's proxies unless they are authorized to do so. Thus, any duties associated with proxy voting authority are generally a function of the contractual relationship between an adviser and its client. The Commission is correct to refrain from altering these contractual relationships. We have the following additional comments with respect to the application of the proposed rule.
A. Proxy Voting Authority Should Not Generally Be Implied.
The proposal states that an "adviser's authority to vote client proxies may be implied in the overall delegation of authority provided in the advisory contract, power of attorney, trust instrument or other document."23 Given the scope and consequences of the proposal and the contractual basis of proxy voting authority, we do not believe that it is appropriate for the Commission to imply proxy voting authority in a contract that is silent on the issue.24 An adviser should not be required to presume it should exercise authority that has not been clearly granted.25 We urge the Commission to confirm this principle in the adopting release. In the alternative, we suggest that the Commission specify in the adopting release that authority to vote client proxies will be implied only under very limited circumstances where the contract includes broad language granting the adviser authority or power of attorney over all aspects of the client's interest in or ownership of securities.26
B. Providing Advice to a Client Should Not Subject an Adviser to the Proposal.
We strongly agree with the Commission that the proposed rule should not apply to an adviser that provides a client with advice as to how the client should vote a proxy.27 Any suggestion to the contrary could chill discussions between an adviser and its client. Accordingly, we ask the Commission to confirm in the final release that an adviser is free to respond to client inquiries with respect to proxy voting without triggering the rule.
C. The Rule Should Not Apply in Cases of Partial Authority.
The Commission has requested comment as to how the proposed rule should apply to an adviser that retains some authority over a proxy vote, e.g., the client retains voting authority with respect to certain issues or the contract provides that the adviser should consult with the client on voting matters.28 We believe that the proposed rule should apply only to proxies with respect to which an adviser has full discretion to vote. The rule should not apply in instances where the client has retained some voting authority. In those cases, it is the client's responsibility to monitor decision making and the client will know how the proxy is voted.
V. PROXY PERSONNEL
The proposal states that proxy voting polices and procedures should: (1) identify personnel responsible for monitoring corporate actions; (2) describe the basis on which decisions are made to vote proxies; (3) identify personnel (or groups) involved in making voting decisions and those responsible for ensuring that proxies are submitted in a timely manner; and (4) specify the extent to which the adviser delegates proxy voting responsibility to committees, or relies on the advice of third parties.29 We request clarification of three issues related to proxy personnel.
First, we suggest that the Commission eliminate the requirement to identify personnel responsible for "monitoring corporate actions."30 Only the largest firms would have administrative personnel specially designated to monitor corporate actions. Most portfolio managers and analysts monitor corporate actions in the course of their investment decision-making functions. This requirement would create an administrative burden and is not necessary because the person or group "responsible for making voting decisions" will have information related to corporate actions.
Second, we ask the Commission to clarify in the final rule that naming a particular individual in the policies and procedures is not necessary, and that a reference to the position or positions responsible for the appropriate functions is sufficient disclosure. While we understand the interest in identifying a specific individual in order to reduce the opportunity for confusion and for accountability reasons, we do not believe that naming a specific individual adds any particular value in terms of investor protection. We are concerned that reference to a specific individual could generate inaccuracies caused by general attrition, promotion, maternity and other leave, and firm reorganizations.
Third, we ask that the Commission clarify in the final rule that an adviser's policies and procedures are not required to include the details of the mechanics of voting proxies or the personnel responsible for ensuring proxies are received in a timely manner. This is a back office and custodian function that is not material to clients. Instead, advisers should simply include a provision ensuring that reasonable efforts will be made to vote proxies in a timely manner.31
VI. HOW CLIENTS CAN OBTAIN INFORMATION ON VOTES
The proposal would require an adviser to disclose to clients how each client can obtain information from the adviser on how the adviser voted its particular proxies.32 The proposed rule would not prescribe the nature, format, or scope of the information that must be disclosed, and would allow the specific decisions to be made by clients and their advisers.33
We strongly support the proposed position that each adviser be provided the flexibility to construct on an individual basis a format for disclosing how the adviser voted that client's proxy. A prescribed format is not appropriate given the diversity in advisory clientele. Indeed, as with many issues, institutional clients, particularly those with consultants, are likely to have their own views regarding appropriate receipt of this information.
As discussed above, we agree with the Commission that the client as the beneficial owner of the interest represented by the proxy is entitled to information on how that client's proxy is voted.34 We also agree that identifying a specified right to that information is not necessary, because it is presumed and consistent with an adviser's fiduciary duties.35 We recommend, however, that an adviser only be required to respond to client requests for information on how the adviser voted its particular proxies for a reasonable time period (e.g. one or two years).36 This is a reasonable period of time for a client to monitor how the adviser has voted its proxies and would substantially ease the administrative costs to the adviser.37
VII. DISCLOSURE OF POLICIES AND PROCEDURES
The proposal would further require advisers to describe their proxy voting policies and procedures to clients, and to furnish a copy of the policies and procedures to clients upon request.38 The proposal states that this disclosure would "help clients understand how the adviser votes proxies and permit clients to select advisers whose procedures and policies meet their expectations" and also "serve to encourage more effective policies and procedures."39
The proposal specifies that the requirement to describe the adviser's policies and procedures could be satisfied by disclosure in the adviser's brochure.40 Presumably this disclosure would be shorter than the full version of the adviser's policies and procedures given the separate requirement that the adviser provide a full copy of the policies and procedures to the client upon request. We are concerned, however, that the comments in the proposal surrounding this requirement may create an expectation that an adviser will disclose the substance of how it generally votes on particular issues, which may not be satisfied by a brief description in the adviser's brochure. These policies can be extensive and cover numerous topics.41 Inserting voluminous policies and procedures into an adviser's brochure would detract from other important aspects of the brochure, such as brokerage and personal trading policies and procedures. Accordingly, we ask that the Commission clarify that the adviser's description of its proxy voting policies and procedures need only be a general summary of the process or the adviser's philosophy.42 We also recommend that this brief summary be accompanied by disclosure in the adviser's brochure that the adviser's policies and procedures are available upon request.43
This approach would protect against overwhelming clients with detailed information that may detract from other material information in Form ADV, while reminding clients that they are entitled to review the adviser's proxy voting policies and procedures at any time. It would also eliminate the concern that the proposed summary disclosure may become boilerplate language that does not provide meaningful information to advisory clients.
The proposal would make it a fraudulent, deceptive, or manipulative act, practice or course of business within the meaning of Section 206(4) for an investment adviser to exercise voting authority with respect to client securities without complying with the requirements of the proposal. We are concerned that the proposal may have the unintended result of seriously penalizing certain proxy voting actions made in good faith. For example, inadvertent failure to vote a proxy on behalf of a client in accordance with the adviser's policies and procedures that does not involve material conflicts of interest resulting in harm to the client's interest should not be the subject of enforcement action by the Commission.44
We support the Commission's recognition that an adviser would not violate its fiduciary obligation to a client by deciding to refrain from voting a proxy.45 The proposal discusses as an example instances where the cost of voting the proxy exceeds the expected benefit.46 There are many reasons an adviser may abstain from voting a client proxy, including for example: (1) when the effect on shareholder economic interest or the value of the portfolio holding is minimal or indeterminable; (2) in the event language barriers or timing issues related to holdings of non-U.S. securities make voting impractical; or (3) as a result of certain share blocking requirements. We ask the Commission to confirm in the final rule that such properly disclosed policies are consistent with an adviser's fiduciary duties and permissible under the proposal.
* * *
The ICAA supports the proposal and the broader initiative taken by the Commission to improve disclosure requirements and the financial reporting system. We appreciate the opportunity to comment on this important development and would be pleased to provide any additional information.
Karen L. Barr
cc: Harvey L. Pitt, Chairman