AEI - How Do Mutual Funds Vote Their Proxies?

EVENTS

How Do Mutual Funds Vote Their Proxies?

Date:	Thursday, July 10, 2008
Time:	9:00 AM -- 10:45 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

Mutual Funds and Shareholders' Interests

WASHINGTON, JULY 11, 2008--Mutual funds represent approximately 90 million shareholders and control almost thirty percent of the stock of U.S. companies. Consequently, as Paul Stevens of the Investment Company Institute (ICI)--a trade association for the mutual fund industry--explained at AEI on July 10, "how [these funds] vote for their proxies is a matter of no small interest and public commentary." Stevens unveiled the results of a much-anticipated ICI study that investigated recent criticism that funds "care little about their shareholders . . . and rubber-stamp virtually all management proposals"--essentially an accusation that funds are not fulfilling their mandate to use proxy votes to further the interests of their shareholders.

ICI's comprehensive, year-long study analyzed more than 3.5 million proxy votes cast by mutual funds in 160 of the largest fund families. The report found that mutual funds work hard to promote the interests of shareholders by carefully voting for proxies that increase the economic value of the company. Stevens explained that funds devote significant time and effort to making sure that institutional or personal conflicts of interest do not interfere with proxy votes. When applicable, funds must follow predetermined proxy voting policies, which set forth guidelines that ensure that the proxy votes adhere to each fund's stated priorities.

Despite funds' good faith efforts to navigate conflicts of interest, Martin Lybecker of WilmerHale noted that a 2003 ruling by the Securities and Exchange Commission (SEC) has made funds particularly susceptible to litigation. This SEC holding requires firms to "inform the clients of the [conflict of interest] and give them time to revoke the authority" of the fund to cast their proxy votes. Fulfilling this requirement is close to "impossible" in some situations because the client may be an entity, like an irrevocable trust, rather than an actual person. If the client cannot be informed of the conflict of interest, the fund adviser is paralyzed and the client essentially loses his proxy vote. Though the fund's inaction is consistent with the SEC's ruling, it violates the fund's responsibility to vote proxies in shareholders' best interest, Lybecker said. "It's very unfair to tell someone that they have a fiduciary duty and give them no way of satisfying it."

Critics often view proxy votes in favor of management proposals as a blanket endorsement of entrenched management practices. Similarly, fund votes against shareholder proposals are thought by some to be a rejection of legitimate shareholder priorities. However, Stevens notes that these are overly simplistic perspectives: "simple tallies of fund votes--counting whether funds voted ‘for' or ‘against' management or shareholder proposals--mask the complexity of issues that fund advisers weigh when determining which proposals are most likely to lead to value-enhancing changes at a portfolio company."

Any out-of-the-ordinary proxy proposals must be evaluated "on a case-by-case basis," and fund managers often consult with proxy administrators or advisory firms to gain impartial recommendations. Michael Ryan of Proxy Governance, one of the five proxy advisory firms in the United States, explained the importance of looking at each proxy issue individually rather than voting by using a "check-the-box approach." He warned against funds having "policies that are designed to be a sort of a flow-chart that gets them to a result without actually looking at a particular company." Ryan also suggested that the best policy for evaluating proxies--for both in-house fund advisers as well as for advisory firms--is to look at the metrics of the specific company and decide how each proxy proposal relates to that unique corporation.

Given that "a lot of shareholder votes are becoming highly politicized," the ICI study is important because it helps to clarify mutual funds' views of their proxy responsibility to shareholders. AEI's Peter J. Wallison predicted that "shareholder proposals at corporate annual meetings [will] one day become major subjects of media interests." Wallison was unhappy with the prospect that mutual funds will likely encounter increased public pressure to vote on social and environmental matters, because these issues do not have "a clear economic advantage to shareholders." He explained that it is difficult, if not impossible, for a fund manager to vote for one side of a "politically fraught" issue because he may be "picking a [political] position on behalf of people who may not agree with it at all."

Demonstrating the extent of the controversy about the responsibility of mutual funds for social and environmental issues, Heidi Schooner of the Columbus School of Law at Catholic University disagreed with Wallison. She posited that increased social and environmental regulation will cause many of these matters to "end up impacting shareholder value." Schooner suggested that in the future, there will be a "more expansive view of fiduciary obligations. . . . Conventional interpretations of fiduciary duty [will] mutate over time as society recognizes the risks and rewards associated with certain social and environmental issues."

--KAREN DUBAS

For video, audio, and more information about this event, visit www.aei.org/event1754/.

AEI has sponsored extensive research on the mutual fund sector:

Peter J. Wallison and Robert E. Litan authored Competitive Equity: A Better Way to Organize Mutual Funds (AEI Press, 2007)
Wallison has moderated AEI conferences on topics including the survival of the SEC's Rule 12b-1 and a series of events on a better way to regulate mutual funds, whose speakers included Vanguard founder John Bogle.
In the Wall Street Journal, Wallison recently addressed the SEC's planned requirement to require three-quarters of fund board members to be independent of the fund's investment adviser.
Wallison's monthly Financial Services Outlook has addressed mutual funds.

For media inquiries, contact Véronique Rodman at 202.862.4870 or vrodman@aei.org.

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