Back in January the SEC voted to adopt rule amendments that will finally pull back the curtains on the secretive proxy voting of mutual funds. Despite much protest from the mutual fund industry, around this time next year mutual funds will have to comply and start opening up their votes to scrutiny. Now the next big question is what is really going to happen when they do?
While any answer is conjecture, many in the investment community are willing to share their predictions, fears and hopes regarding the SEC’s landmark decision.
Mainstream funds fear politicization of the voting process, socially responsible funds are all for it, and proxy experts see as it a good way for IR and corporate secretary teams to gain intelligence on what the company’s real owners are actually thinking. Based on the 8,000 comments the SEC received about its proposal, the majority of market participants seem to agree that this is a move toward best practice.
Some mutual funds may see vote disclosure as a hassle, but this is actually another SEC initiative development to protect the interests of investors. According to John Nestor, an SEC spokesman, the aim is to advance investor education, mutual fund governance, transparency in the financial markets and better corporate governance. ‘Mutual funds own property that belong to investors and investors deserve to know how their properties are voted,’ he says. Come August 31, 2004, all will be revealed.
Secret history
Part of the impetus comes from just how much of people’s life savings, as opposed to mere fun money, these funds now handle. The percentage of corporate pension fund assets managed by mutual fund firms jumped from 5 percent in 1990 to 21 percent in 2001. Altogether they manage a total of $2.3 tn in corporate pension assets. The danger is that fund firms both working for and investing in pension clients have a conflict of interest. Thus the revised rules require funds to reveal how they address such conflicts when deciding how to vote. Some mutual funds worry disclosing their proxy votes could ‘invite distraction to the investment management business,’ says John Collins, managing director of information at the Investment Company Institute (ICI). He explains that while the fund industry has no desire to go ahead with the rule, it has no choice but to comply.
But he says, ‘Removing the confidential voting forum for mutual funds is tantamount to inviting political pressure. So we have encouraged the SEC in our comment letter to revisit the matter in the future after some experience is gathered.’
ICI argues that mutual funds have the fiduciary duty to vote in investors’ best economic interest, regardless of what special interest groups may claim. Shining light onto voting records will only increase activist campaigns and the burdensome task of responding to letters from special interest groups. ICI stands by its belief that funds should institute procedures for complete confidential voting of proxies as a means of insulating the proxy voting influence from both sides.
The Vanguard Group, the second-largest US mutual fund company with more than $540 bn in assets under management, has been disclosing its proxy voting policies for four years now and feels the new vote disclosure rules will not affect its voting decisions.
‘What was forgotten in all the froth over this issue that crept into the press over the past year is that, unlike most others who vote the proxies, we have a fiduciary obligation that requires us to act at all times in a manner that solely benefits our fund holders,’ says Brian Mattes from Vanguard’s PR team.
For this mutual fund giant there is likely to be little change when other funds start to disclose their own votes next year. Vanguard will still vote within its policies and the most likely change will be publishing its proxy votes on its web site.
Social resistance
Another big fund not intimidated by social pressures is TIAA-Cref. ‘We are not afraid of the political pressures that some people profess to be afraid of. On this disclosure aspect of it, we are prepared to explain why we voted and defend out vote and I think you will find that our vote is very consistent with our policies,’ asserts Peter Clapman, senior vice president and chief counsel of corporate governance at TIAA-Cref.
Mattes, on the other hand, admits that Vanguard is concerned about being thrust in the middle of social issues that may be advanced by those who have no concern or care for shareholders. But he claims that no matter how great the pressure, it will not influence Vanguard’s voting decisions during next year’s proxy season.
‘At the end of the day we must act in a fiduciary responsible manner that upholds the interests of the shareholders in our funds and if that means voting against a social issue, so be it. But we cannot contradict that requirement,’ Mattes says.
Domini Social Investments was the first mutual fund manager to start disclosing proxy votes back in 1999. It was also the first to petition the SEC to make other funds disclose their votes. ‘Hopefully it will help restore confidence in the markets,’ says Adam Kenzer, Domini’s legal counsel and director of shareholder advocacy. ‘The voting process is already politicized; the only difference now is that funds will feel pressure from both sides – corporations and investors.’
Kenzer predicts companies may see more significant votes for shareholder proposals and hopes this will give ‘corporate management a better indication of what their investors are really thinking and hopefully it will impact policies.’
Timothy Smith, senior vice president at Walden Asset Management and president of the Social Investment Forum, thinks having access to mutual fund voting trends could be a boon to corporate executives. IROs and corporate secretaries will be able to gain more intelligence about their shareowners’ mind set and be able to respond better to issues or concerns they have.
He advises listed companies to ‘carefully study the issues being presented [by shareholders], not as a tax burden on the company but as an opportunity for improvement.’ And he suggests using mutual fund voting records as a tool to build a win-win result where both sides agree on an issue or a proposal.
Mattes also urges companies to make an effort to learn more about shareholders’ thoughts on contentious issues. That way they can get a sense of what they should be putting on their proxy statement, he says.
Guidelines revealed
Last summer Vanguard’s CEO, Jack Brennan, sent a letter to several hundred companies in which the firm owned a substantial amount of stock, to notify them of Vanguard’s revised proxy voting policies.
‘It contained our proxy guidelines, so they knew exactly how we were going to vote, and it made abundantly clear that if the company was intending to put forth a proposal that would result in a very generous improvement in the compensation structure or that would in some manner dilute the holdings of shareholders, we would vote it down. In fact we pointed out that the prior year we had voted down two out of three compensation proposals that came our way because they did not fit our guidelines,’ Mattes recalls.
Institutional Shareholder Services’ Patrick McGurn also advises corporate executives to consider institutional investors’ voting policies in designing management proposals. ‘The frequency of that willingness to vote outside of policies is going to be substantially reduced by the fact that those votes are going to be disclosed and second-guessed by various market participants after the fact,’ McGurn explains.
No last minute changes
Corporate secretaries should not expect to cut deals at the last minute. Eleventh-hour arrangements that result in investors changing their votes – like agreeing to cut a percentage point of your stock option plan – won’t be welcomed by market participants in the future.
‘Communications with big investors – especially on hot button issues like CEO pay or options – must take place much earlier in the process, well before the formal solicitation period starts,’ sums up McGurn. ‘An IRO or corporate secretary who tries to convince a fund manager to vote outside of his firm’s voting policy a week before the annual meeting is going to get placed on the no call list,’ McGurn concludes. ‘Going forward, the board must address shareholder concerns when it drafts proxy proposals. Directors will look to IROs for intelligence on investors’ likely reactions to a proposal.’
