Statement of Paul Schott Stevens President and CEO Investment Company Institute
Proxy Voting Roundtable on Broker Proxy Voting Submitted to the U.S. Securities and Exchange Commission
May 24, 2007
Investment companies (“funds”) have an interest in proxy voting as both investors in securities and as issuers of securities. As investors, funds vote proxies at annual and special meetings of shareholders. As issuers, funds hold meetings of shareholders when required by state law or the Investment Company Act of 1940 and as needed to conduct corporate business. Closed-end funds listed on a securities exchange are required to hold annual shareholder meetings irrespective of the specific matter being presented for a vote.
The Investment Company Institute1believes the current proxy voting system has generally worked well in the interests of both investors and issuers. At the same time, we recognize that given the recent focus on the governance practices of public companies and changes to the methods by which issuers communicate with investors, an examination of the current proxy process may be appropriate.
It is critical that any proposed changes to the current proxy voting system balance the right of shareholders to have a voice in decisions that affect them as owners of an issuer with the responsibilities of management to ensure that it conducts the issuer’s daily business in an efficient manner. In addition, any changes to the proxy voting system must take into account the costs of those changes and must ensure that the benefits of the changes justify their costs.
Our comments will focus on proposed changes to the circumstances in which brokers may vote proxies on behalf of beneficial owners and the impact on funds. As discussed more fully below, the Institute believes that the current system for broker proxy voting should be retained with respect to funds and accordingly that the New York Stock Exchange’s (“NYSE”) proposal to eliminate the ability of brokers to vote proxies on behalf of beneficial owners in uncontested elections of directors should not apply to funds. We also believe that several suggested alternatives to alleviate the effects of the elimination of broker voting in these situations would not sufficiently address funds’ concerns. Finally, we believe that certain actions must be taken prior to the implementation of any reforms to the proxy voting process to address the lack of shareholder education regarding proxy voting and the difficulties in issuers communicating with shareholders.
Table of Contents
Funds and Proxy Voting
When a shareholder vote is required or sought, funds, like other issuers, must obtain both the requisite quorum and the necessary vote for the issue that is the subject of the proxy. Matters in which a shareholder vote is required are characterized as “routine” or “non-routine.” Under NYSE Rule 452, NYSE members (primarily brokers and banks) are allowed to vote shares for which they have not received instructions from the beneficial owner by a date specified in the proxy materials on certain routine proposals. This practice is commonly referred to as “discretionary broker voting.” The vast majority of fund shareholders buy fund shares through intermediaries, including intermediaries that are NYSE member firms subject to Rule 452.
With respect to both closed-end funds and open-end funds, uncontested elections of directors, the ratification of independent accountants and increases in the number of authorized shares of common stock are considered “routine” matters. “Non-routine” matters include many issues that state law or the Investment Company Act require to be presented to shareholders for the vote of a specified number or percentage of outstanding shares. These matters include proposed amendments to advisory agreements and proposed agreements and plans of reorganization.
NYSE Proxy Working Group
In April 2005, the NYSE created a Proxy Working Group to review current NYSE rules regulating the proxy voting process. In June 2006, the Working Group issued a report containing several recommendations with respect to the NYSE’s proxy voting rules and, in general, with respect to the proxy voting process.2
Specifically, the Working Group recommended that the NYSE amend Rule 452 to make the uncontested election of directors a “non-routine” matter. The Working Group asserted that shareholder voting for directors is a critical component of good corporate governance, even where an election of directors is uncontested, and therefore brokers should no longer be permitted to vote the shares of beneficial owners who do not give specific voting instructions.3
There is no indication that the Working Group considered broker voting specifically in the context of funds when formulating its recommendations. To the contrary, it appears from the Proxy Working Group Report that its focus was on the status of broker voting in the context of operating companies. While we believe that shareholder voting for directors is an important component of a strong corporate governance structure, eliminating discretionary broker voting for the uncontested election of directors in the context of funds will not increase or empower fund shareholder voting. In fact, we are not aware of any fund shareholders who have voiced dissatisfaction with the current proxy voting process as it relates to the uncontested election of fund directors. Nor do we believe the current process entails any detrimental effects on funds or fund governance.
Eliminating discretionary broker voting will create significant difficulties for funds in achieving quorums and getting directors elected. These concerns are not theoretical. As discussed in detail below, our members report significant difficulties in achieving quorums and getting matters approved when brokers are not permitted to vote. To get matters approved, it is frequently necessary for funds to engage soliciting firms and conduct multiple mailings, the costs of which can be significant. Even with these measures, funds often must adjourn meetings due to an inadequate voting response. Changing approval of directors from a “routine” to a “non-routine” matter will greatly exacerbate this problem.4Because the elections that are the subject of the NYSE proposal are uncontested, the same directors, in virtually every case, will be elected whether or not funds and their shareholders bear the additional costs. For these reasons, the Institute strongly recommends that the current system of discretionary broker voting be retained with respect to funds.5
NYSE Proposal to Eliminate Discretionary Broker Voting and Institute Report on Proposal’s Impact on Funds
In October 2006, the NYSE filed a rule proposal with the SEC which would effectuate the Proxy Working Group’s recommendation to eliminate discretionary broker voting for the uncontested election of directors.6For the reasons discussed below, the Institute urges that investment companies be excluded from the NYSE proposal.7
The rule proposal applies to proxies relating to both closed-end funds and open-end funds whose shares are held through NYSE member firms. While the NYSE and the Proxy Working Group both recognized that eliminating discretionary broker voting may increase proxy solicitation costs for issuers in general, we understand that they did not collect or examine any cost data to measure the extent of costs that would be specifically incurred by funds and their shareholders if discretionary broker voting were eliminated. That the NYSE’s proposal could advance so far in the absence of such fundamental analysis is of great concern to the Institute. We strongly recommend that, going forward, the SEC by rule, or Congress by law, require that all self-regulatory organizations perform a formal cost/benefit analysis prior to submitting regulatory proposals to the SEC.
To inform the regulatory process, the Institute surveyed its members to assess the impact of the NYSE rule proposal on funds and their shareholders and prepared a report with its findings in December 2006,8which we shared with the NYSE and the SEC.9Our report concluded that the rule proposal will have a disproportionate impact on funds as compared to operating companies, will create significant difficulties for funds in achieving quorums and electing fund directors, and will cause funds to incur significant and unnecessary costs–costs which ultimately will be borne by fund shareholders.
Eliminating Broker Voting Will Have a Disproportionate Impact on Funds
Investment companies have a far higher proportion of retail shareholders than most operating companies. Because retail shareholders are less likely than institutional investors to vote their proxies (many institutional investors have a fiduciary responsibility to do so), eliminating broker voting will have a disproportionate impact on funds, and funds will incur greater costs from the elimination of discretionary broker voting. Our research indicated that while retail shareholders hold about forty-eight percent of the value of operating company shares, they hold about sixty-four percent of the value of mutual fund shares. This disparity is even greater for closed-end funds, where retail investors own about ninety-eight percent of the value of shares.10
Funds Will Have Difficulties Achieving a Quorum if Broker Voting Is Eliminated
NYSE members hold a substantial portion of fund shares in street name. Our research indicated that half of funds sold through sales forces had at least eighty percent of the fund’s total shares outstanding held in this manner. Our report found that beneficial shareholders tend to return their proxies at a fairly low rate - approximately thirty-two percent of fund shares held in street name were voted. In contrast, when brokers are permitted to vote uninstructed shares, almost all shares (ninety-three percent) held in street name were voted. Eliminating broker voting for fund shares held in street name will create significant difficulties for funds in achieving a quorum, and, in turn, electing fund directors.
An uncontested director election by its nature is highly unlikely to elicit strong interest or participation from rank and file fund shareholders, only fifteen percent of whom ascribe significance to information about a mutual fund’s directors when selecting a fund, according to a 2006 Institute survey.11Consider, for example, an uncontested election of directors of money market funds. Beneficial owners of money market funds understandably consider these funds to be a cash management tool akin to a bank account, and they are unlikely to evidence high interest in voting proxies at all, much less voting them in an uncontested election of directors.12
Fund Proxy Costs Will More than Double with the Elimination of Broker Voting
Because a significant number of fund shareholders choose not to vote shares held in street name, funds are forced to incur increased costs taking steps necessary to encourage shareholders to vote their proxies. Our research showed that these costs are significant. Because funds will have to engage in multiple solicitations, typical proxy solicitation costs will more than double from $1.65 to $3.68 for each shareholder account. Fund expense ratios will rise between one to two basis points, on average, with some funds’ expense ratios increasing more than five basis points.13
Alternatives to the Elimination of Broker Proxy Voting
Several alternatives to alleviate the effects of eliminating discretionary broker voting have been suggested, including adopting a proportional voting system, lowering quorum requirements, or adding the shareholder ratification of auditors to fund proxies. For the reasons discussed below, the Institute believes these alternatives would not sufficiently address funds’ concerns with the elimination of discretionary broker voting for the uncontested elections of directors and are not an adequate substitute to excepting funds from the NYSE proposal.
The alternative that has received the most attention and consideration is the adoption of a proportional voting system. Under a proportional voting system, uninstructed shares would be voted in the same proportion as instructed shares, with no minimum amount of instructed shares being required. Proportional voting may have certain practical advantages, such as facilitating reaching a quorum. Nevertheless, before considering whether proportional voting is a viable solution to funds’ concerns and proposing it as an alternative to the elimination of discretionary broker voting, it would seem incumbent upon the NYSE and SEC to address a variety of issues relating to the potential costs and operation of such a system.14
First and foremost, a comprehensive analysis of the costs that would be imposed on funds by proportional voting must be conducted. Adequate time also should be provided to evaluate, and comment on, the particular proportional voting system that would be implemented. For example, it is unclear whether proportional voting would be implemented on an individual broker-by-broker basis, or in a way that aggregates all votes cast across all brokers. If implemented at the individual broker level, the views of active minority shareholders will have a greater effect on the outcome of the vote, particularly if their shares are held at one (or more) broker(s) with a large number of uninstructed shares.15In the case of closed-end funds, dissident shareholders could manipulate voting results if a broker-by-broker proportional voting system is adopted. With respect to an aggregate system, the entity that would aggregate votes would have to be determined, as well as whether that entity will vote the uninstructed shares on behalf of each broker. For both systems, it would have to be determined whether instructed shares should be voted in proportion to all votes cast at the meeting or in proportion to instructed shares held in street name.
It also will be necessary to determine whether proportional voting will be used with respect to all non-routine issues, or only for uncontested elections of directors. If proportional voting is required for all non-routine issues, it will be important to clarify that funds can use proportional voting to obtain approval of non-routine matters that currently require a supermajority vote under the Investment Company Act.16
Lowering Quorum Requirements
Lowering quorum requirements has been raised as a possible solution to funds’ concerns with the elimination of discretionary broker voting. This proposal raises significant problems. For example, funds would have serious difficulties in changing their quorum requirements. State law would need to be amended in some jurisdictions where funds are domiciled. Funds also would need to seek shareholder approval to amend their charters, declarations of trust, and/or by-laws to change quorum requirements. Because such an amendment would itself be a non-routine issue, the same problems created by eliminating discretionary broker voting in achieving a quorum would exist. Moreover, there likely would have to be a large reduction in funds’ quorum requirements to have a measurable impact on costs because of the low rate at which beneficial shareholders return their proxies. Such a scenario seems to diminish, rather than enhance, shareholder rights.
Adding Shareholder Ratification of Auditors to the Proxy
Another proposed solution to funds’ concerns with the elimination of discretionary broker voting involves adding shareholder ratification of auditors to the proxy. The NYSE currently views shareholder ratification of auditors as a routine matter. Because brokers would be permitted to vote on this issue, adding it to a proxy containing the uncontested election of directors may help assure a quorum. Asking funds to take this action for the sole purpose of achieving a quorum, however, is an unacceptable way to resolve issues associated with the proposal. Funds have not been required to ratify the selection of fund auditors since 2001, when the SEC adopted Rule 32a-4 under the Investment Company Act of 1940.17It therefore would be illogical and inappropriate for the SEC to put funds in a position of choosing between seeking a shareholder vote on the ratification of auditors or being forced to incur the costs and difficulties associated with resolicitations and adjournments for the uncontested election of directors. There also is no assurance that in the future the NYSE will continue to view the ratification of auditors as a routine matter, potentially putting funds in the exact same position that they are in today.18
Shareholder Education and Communication Between Issuers and Shareholders
The difficulties created if discretionary broker voting is eliminated would be compounded by the fact that shareholders typically do not understand the proxy process, typically choose not to vote, and in most cases, cannot be contacted by the issuers who would urge them to vote. In our July 2006 letter, prior to the NYSE’s filing of its proposal to eliminate discretionary broker voting, we recommended that the NYSE continue to allow brokers to vote uninstructed shares on uncontested director elections until certain steps are taken: (1) shareholders are sufficiently educated about the proxy process and the importance of voting so that they exercise their right to vote; and (2) the SEC revises its rules to permit issuers to contact their shareholders. We believe these efforts must go hand-in-hand with any initiatives to reform the proxy voting process.
As the Proxy Working Group Report notes, there appears to be a general lack of understanding in the investor community with respect to the proxy voting process and few investors realize the significant burdens and costs that are often incurred if they do not send in their proxy votes. We therefore believe that it is critical that any changes to the proxy voting process be accompanied by a significant effort to educate shareholders about the mechanics of proxy voting and its importance to issuers. Only after such an effort is undertaken and it is found that shareholder voting has increased should the elimination of discretionary broker voting be considered.
Communication Between Issuers and Shareholders
As discussed above, a majority of shares, including investment company shares, are held in “street name,” by brokers, banks, or their depositories. Shareholders choose whether issuers may contact them. Shareholders who object to having their names and addresses disclosed to issuers are called “Objecting Beneficial Owners” or “OBOs.” Shareholders who do not object to having their names and addresses given to issuers are called “Non- Objecting Beneficial Owners” or “NOBOs.” SEC rules prohibit banks and brokers from providing issuers with the names of OBOs. More than half of fund shares held in street name are held by OBOs.19
This feature of the proxy process presents a significant obstacle for issuers trying to obtain a quorum and get matters approved. The Institute recommends that the SEC explore ways to alleviate this problem, while continuing to protect investors’ privacy.20 One approach might be to eliminate the NOBO/OBO distinction and permit investors who choose to remain anonymous to appoint a nominee who could be contacted by issuers.
Elimination of Annual Meeting Requirement for Closed-End Funds
NYSE rules require closed-end funds to hold annual shareholder meetings. For many years, the Institute and its closed-end fund members have believed that this requirement is unnecessary because closed-end funds are already subject to voting requirements under the Investment Company Act, which are designed to ensure that shareholders participate in what are considered to be the most significant decisions concerning the fund.21In addition, we believe that in view of the fact that federal and, in many instances, state regulators22have concluded that it is not necessary for closed-end funds to have annual shareholder meetings, the NYSE should exempt closed-end funds from its annual shareholder meeting requirement. As discussed above, there are significant costs associated with holding annual meetings due to difficulties in obtaining a quorum, which then forces adjournments and resolicitations – costs that will be increased if the NYSE proposal is adopted. The Institute therefore recommends that the NYSE exempt closed-end funds from its annual meeting requirement. At the very least, we urge the NYSE to scale back the shareholder meeting requirement for closed-end funds to once every three years.
1The Investment Company Institute is the national association of the U.S. investment company industry. ICI members include 8,826 open-end investment companies (mutual funds), 666 closed-end investment companies, 398 exchange-traded funds, and four sponsors of unit investment trusts. Mutual fund members of ICI have total assets of approximately $10.634 trillion (representing 98 percent of all assets of U.S. mutual funds); these funds serve approximately 93.9 million shareholders in more than 53.8 million households.
2See Report and Recommendations of the Proxy Working Group to the New York Stock Exchange (June 5, 2006) (“Proxy Working Group Report”).
3The Working Group considered recommending the elimination of Rule 452 in its entirety but concluded that Rule 452 continues to have an important role in the proxy process, particularly with respect to allowing issuers to achieve a quorum for regular meetings.
4As investors, funds consider the voting of proxies of companies in which they invest to be part of the investment process. Accordingly, the vast majority of proxies that funds receive are voted. Therefore, whether the election of directors is deemed a routine or a non-routine matter will have little, if any, effect on the voting practices of funds as investors. See Letter from Craig S. Tyle, General Counsel, Investment Company Institute, to Jonathan G. Katz, Secretary, Securities and Exchange Commission, dated December 6, 2002 (Institute letter regarding proxy voting by investment companies and investment advisers). To the extent that the companies in which funds invest are subject to higher costs in connection with solicitation of proxies, funds will share that burden along with other investors in the company.
5The Institute has taken numerous steps to inform the NYSE and the Proxy Working Group of the adverse consequences for funds and their shareholders if discretionary broker voting is eliminated. In June 2005, prior to the issuance of the Proxy Working Group Report, the Institute wrote to the Working Group expressing our concerns regarding the impact of the proposal on funds. Letter from Frances M. Stadler, Deputy Senior Counsel, Investment Company Institute, to Mr. Larry Sonsini, Chairman, NYSE Proxy Working Group, dated June 3, 2005 (“June 2005 Letter”). In July 2006, in response to the recommendation of the Proxy Working Group that discretionary broker voting be eliminated,the Institute wrote to NYSE staff reiterating our concerns. See Letter from Elizabeth R. Krentzman, General Counsel, Investment Company Institute to Catherine R. Kinney, President and Chief Operating Officer, NYSE Group, Inc., dated July 18, 2006 (“July 2006 Letter”).
6See NYSE File No. SR-2006-92.
7The Institute understands that the NYSE intends to amend the rule proposal to exclude investment companies from the scope of the proposal.
8 Costs of Eliminating Discretionary Broker Voting on Uncontested Elections of Investment Company Directors, Investment Company Institute (December 18, 2006) (“ICI Broker Voting Report”). A copy of the report is attached as Exhibit A.
9Letter from Paul Schott Stevens, President, Investment Company Institute to Catherine R. Kinney, President and Chief Operating Officer, NYSE Group, Inc., dated December 18, 2006, letter from Paul Schott Stevens, President, Investment Company Institute to Richard Ketchum, Chief Executive Officer, NYSE Regulation, dated December 18, 2006, and letter from Paul Schott Stevens, President, Investment Company Institute, to the Honorable Christopher Cox, Chairman, U.S. Securities and Exchange Commission, dated December 18, 2006. See also letter from Paul Schott Stevens, President, Investment Company Institute, to the Honorable Christopher Cox, Chairman, U.S. Securities and Exchange Commission, dated February 20, 2007.
10ICI Broker Voting Report at pp.3-4.
11See Understanding Investor Preferences for Mutual Fund Information, Investment Company Institute (2006).
12To illustrate the difficulties in attempting to achieve a quorum for a proxy vote of money market fund shareholders, the largest money market fund alone has 4.8 million shareholder accounts. Source: Strategic Insight Simfund (data as of March 2007).
13To obtain approval of non-routine matters, it is frequently necessary for funds to engage soliciting firms and conduct multiple mailings, the cost of which can be significant. Even with these measures, funds often must adjourn meetings due to an insufficient voting response. Our research indicated that no shareholder meeting in our entire sample with only routine matters on the agenda required a re-solicitation of shareholders or was adjourned for lack of a quorum. This result was due to the high rate at which brokers vote. In contrast, more than half of shareholder meetings in our sample with at least one non-routine matter required at least one re-solicitation.
14The Institute previously recommended proportional voting as a fallback to the elimination of broker discretionary voting after our initial examination of the Proxy Working Group’s recommendations. See June 2005 Letter and July 2006 Letter. Given the significant costs and disproportionate impact on funds of the NYSE’s proposal identified in our subsequent research and the complex issues that regulators must address in connection with proportional voting, we now have reservations about the feasibility and operation of this approach.
15The Working Group stated that it was concerned that with broker-by-broker proportional voting the results can be skewed if one particular broker has a large number of uninstructed shares. Proxy Working Group Report at p.17.
16Under the Investment Company Act, certain matters, such as changes to fundamental investment policies, must be approved by the vote of a majority of the fund’s outstanding voting securities. Section 2(a)(42) of the Investment Company Act defines “the vote of a majority of the outstanding voting securities” in a technical way. Specifically, it is defined as “the vote, at the annual or special meeting of the security holders of a fund duly called (A) of 67 per centum or more of the voting securities present at such meeting, if the holders of more than 50 percent of the outstanding securities of such fund are present or represented by proxy; or (B) of more than 50 percent of the outstanding voting securities of the fund, whichever is less.” In most cases, because fewer than 50 percent of votes are returned, funds must obtain 67 percent (or a supermajority) of all votes returned. Because broker non-votes or abstentions are counted as present for quorum purposes, they are, practically speaking, counted as a vote against the proposal. This means that a greater number of beneficial shareholder votes will be required to obtain the requisite percentage (67 percent) of the votes present needed to pass these types of proposals.
17Rule 32a-4 eliminates the requirement that fund shareholders ratify the selection of auditors for any fund with an audit committee composed wholly of independent directors. Fund audit committees typically consist entirely of independent directors.
18See, e.g., Proxy Working Group Report at p.9 (finding that a number of corporate governance commentators have indicated that auditor ratification should not be a “routine” matter in today’s environment, particularly given the role of the auditor as “gatekeeper”).
19See ICI Broker Voting Report at p.10 (Figure 6).
20It is important to permit investors to keep their identities confidential if they so choose. For example, an institutional investor in the process of increasing its stake in a particular issuer may not want to disclose its current trading activity or ownership position to company management or others. Preserving the confidentiality of trading information is an issue of great concern to the Institute and its members. See, e.g., Letters from Paul Schott Stevens, President, Investment Company Institute, to the Honorable Christopher Cox, Chairman, U.S. Securities and Exchange Commission, dated September 14, 2005 and August 29, 2006.
21For example, Section 13 requires a shareholder vote before an investment company may change certain investment and other policies, Section 15 requires shareholder approval of the investment management agreement between the fund and its investment adviser, Section 16 requires that an investment company’s initial board of directors be elected by shareholders, and Section 32 requires that a fund's independent public accountant be approved by the shareholders under certain circumstances.
22Many closed-end funds are domiciled in jurisdictions that do not require annual meetings. For example, many closed-end funds are Massachusetts business trusts, which are not required to hold annual shareholder meetings. In addition, a number of closed-end funds are incorporated in Maryland, which requires a fund to hold a shareholder meeting only when required by the Investment Company Act.