Upon the conclusion of a talk about achieving fiduciary excellence that I delivered April 28 at the Mountain States Public Employee Retirement Systems Forum in Denver, and sponsored by the Investment Management Network LLC of New York, an attendee approached me and asked, “What are my obligations as an investment committee member with respect to voting proxies?”
In my remarks, I had made passing reference to proxy voting as an important fiduciary duty, which had apparently triggered her to think: “Our investment managers cast the proxies for us, and we never know how they voted. Is that a problem?”
It’s a problem.
Investment committee members, trustees and other stewards acting in a fiduciary capacity generally are permitted to delegate responsibility for voting proxies to investment managers. However, in doing so, the steward must exercise reasonable care, skill and caution to establish the scope and terms of the delegation, and monitor the procedures employed by the investment manager in voting proxies, to ensure that the best interests of the beneficiaries of the portfolio are being served.
The interests of the end investors must not be subordinated to such other considerations as potential conflicts of interest involving the investment manager.
Establishing the scope and terms of the delegation is straightforward.
The investment manager is given explicit instructions to vote proxies in the best interests of the portfolio’s beneficiaries. For registered investment companies such as mutual funds, this responsibility is acknowledged in the prospectus. When separately managed accounts are used, responsibility for proxy voting typically is assigned to the manager in the engagement letter or account agreement.
Monitoring is generally the hard part of the job, but it isn’t as hard as it used to be. In 2003, the Securities and Exchange Commission adopted rules that require investment companies and advisers to:
• Establish policies and procedures to determine how proxies will be voted.
• Maintain complete and accurate proxy-voting records.
• Make proxy-voting information readily available to shareholders.
Mutual funds are required to file proxy-voting records annually with the SEC. This has made it possible for activist shareholders to do some interesting research on the extent to which fund managers are fulfilling their obligations.
The title of one such study, “Failed Fiduciaries: Mutual Fund Proxy Voting on CEO Compensation,” produced by the American Federation
of State, County and Municipal Employees in Washington, The Corporate Library in Portland, Me., and the Shareowner Education Group, passes clear judgment on that point.
The report analyzed the proxy votes of 29 of the largest mutual fund families on executive-compensation-related proposals from July 1, 2005, to June 30, 2006.
The analysis “found that management proposals on executive compensation were overwhelmingly favorable to management, while shareholder proposals were far more likely to curb such excesses.”
While the report offered a bleak assessment of the diligence of funds in properly voting proxies, it did rightly suggest that proxy voting be the tool of choice to effectuate needed changes in corporate governance. Litigation by shareholders is a poor second choice because it is difficult to prove a breach of fiduciary duty in cases where “business judgment” is involved and because it is so costly to both the plaintiffs and the companies in which they are invested.
The climate is right for shareholder activism.
Companies are recording large write-offs for bad decisions, and even disgraced and departing executives are walking away with paychecks that defy business logic. So it should come as no surprise that we are seeing a surge in shareholder proposals such as claw-backs, which recoup executive bonuses when the awards are based on results that are subsequently found to be erased by financial write-offs and restatements. We’re also seeing an increase in proposals that require shareholder approval of severance packages.
The most hotly debated proposal is whether corporations should be forced to allow shareholders a non-binding vote on CEO compensation. InvestmentNews asked that question in its Online Opinion Poll and reported in the April 28 print edition that 77.7% of 273 respondents voted yes.
Regardless of the proposal, fiduciaries should make sure that proxy votes are cast and counted. Most importantly, their value to beneficiaries must be weighed.
Blaine F. Aikin is president and chief executive of Fiduciary 360 LP in Sewickley, Pa.
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