SEC’s Proxy Voting Guidance: What About Corporate Actions?

The US Securities and Exchange Commission’s recent guidance on proxy voting may have unintentionally raised the issue of whether fund managers are meeting their fiduciary obligations when they vote in one-off voluntary corporate action events.

Compliance managers at several US fund management firms tell FinOps Report that following the publication of the SEC’s publication of series of questions and answers on proxy voting they received numerous calls from fund clients wondering about whether they had any policies for voting on exchange offers, tender offers and other types of corporate reorganizations. They are commonly called voluntary corporate events because investors — such as fund managers — must make decisions. By contrast, dividend and income playments are automatically forwarded.

“We were questioned about how often we vote, how we decide when to vote or not vote and how we decide on which payment option to select,” says one compliance manager at an East Coast fund management firm. “The underlying suggestion was that we had to show that we had voted in their best interest so we were forced to discuss our voting record with our legal counsel.” His comments were echoed by five other compliance managers at other fund management firms.

There are several dozen different types of voluntary corporate actions and depending on the type of corporate action involved the choices on what to accept as payment could vary. Asset managers might accept either cash, additional stock or a combination of cash and stock.

The SEC’s new guidance, released late last month expands on previous 2014 guidance on shareholder vocing on corporate ballots. The regulatory agency didn’t tackle what some institutional investors and issuers describe as an outdated proxy plumbing scenario which can result in lost votes and investors never knowing whether their votes made it all the way to the issuer. Instead the SEC opted to explain the proxy voting responsibilities of investment advisors under the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934.

Much of the SEC’s attention focused on the considerations for selecting a proxy advisory firm, including assessing the firm’s conflicts of interest and potential mistakes in reports. The SEC also reinforced an “anti-fraud” provision for proxy advisors that prohibits ommissions or misstatements in their reports or recommendations.

Proxy advisors have gained more influence in recent year as more investors become involved on politically-significant corporate issues. Proxy advisory firms– such as Institutional Shareholder Services Inc and Glass Lewis & Co.– tell investors how to vote on governance issues in corporate elections and sometimes cast ballots on behalf of asset managers. However, when it comes to voluntary corporate actions decisions, fund management firms typically rely on their internal analysts, portfolio managers or governance committees.

Given the SEC’s silence on corporate actions in its new guidance, why are investment funds raising the issue of voting? Presumably, they are taking advantage of the opportunity to prompt some necessary change. “The SEC’s new guidance does point to the fact that the fund manager must have written policies and procedures implemented for proxy voting to ensure the best results for their clients,” says Sander Eijkenduijn, chief operating officer for London-headquartered voting data analytics firm Scorpeo. “More often than not there is no policy in a voluntary corporate action. The fund manager will either make a case-by-case assessment or decide on a default mechanism with its custodian bank.”

If the custodian bank doesn’t hear from the fund manager by a certain time it will vote according to the default or standing instruction. If the company’s reorganization offers multiple payment options, the default option is generally cash.

Given the dozens of iterations of corporate actions fund managers must vote on each year, evaluating each event on its individual merits makes perfect sense. It is far easier to design a formal policy on recurring voting items, such as the separation of functions of a CEO and president or compensation for board members than a one-off voluntary corporate action where more than one payment option is available. However, too often the fund management shop uses the default mechanism, acknowledge compliance managers. The portfolio management team or analysts either found out about the corporate action too late to study the available options or think it isn’t worth their effort.

Selecting cash as a form of payment isn’t the worst idea, but is the fund manager really fulfilliing its fiduciary obligations to investors? Picking a combination of cash and securities or securities alone could have generated a higher return in some cases, says Scorpeo. Eijkenduijn says that it is impossible to predict what percentage of the time fund managers will ean more for their fund clients if they select a payment option other than cash.

However, there is plenty of historical evidence to show they are missing the boat. The firm’s analysis of scrip dividends since 2011 indicates that over US$9 billion has been left on the table by fund managers who picked cash when they could have picked either cash and securities or securities alone. Scrip dividends represent dividends where the fund manager has the choice of accepting either a cash payment or a payment in the form of additional securities.

Eijkenduijn cites one recent case involving the UK’s National Grid to show how making the right choice can make a big difference to investors. About 55 percent of shareholders selected cash as a form of payment for the firm’s scrip dividend when picking additional securities would have generated 24 extra basis points.

Attorneys specializing in US investment management law are hesitant to say what effect, if any, the SEC’s recent guidance will have on fund managers’ decisions regarding voluntary corporate actions. However, some legal counsel still recommend that fund managers review their voting policies, procedures and guidelines against the recent SEC guidance and make any necessary changes. “Fund managers should discuss with legal counsel whether their voting record meets their fiduciary obligations,” says Gwendolyn Williamson, a partner with the law firm of Perkins Coie in Washington,D.C. “Adviser proxy voting policies and procedures typically cover corporate actions.”

It is unlikely that mutual fund managers will now decide to document the rationale for every single decision they make. It is simply cost-prohibitive. However, compliance managers at fund management firms predict that fund clients could force them to start paying closer attention to how often a fund manager votes and question why it didn’t vote or why it selected a cash payment too often.

Investment funds might ultimately ask to include more specific instructions on corporate action voting in their agreements with investment advisors beyond simply saying a decision will be made on a case-by-case basis or allowing a default mechanism. Case in point; what criteria does the fund manager use in its decision-making in different corporate action events.

Will the SEC care? No one asked by FinOps Report wanted to predict whether the regulatory agency’s examiners for investment advisors would ask for voting records and documentation on voluntary corporate actions. However, some legal counsel caution that it’s better to be safe than sorry. At the very least, the advisor should document how it voted in each corporate event and in the case of events affecting large positions what factors did it take into account. If SEC examiners don’t ask about the methodology, board of directors might when reviewing voting records during annual meetings.

The SEC likely didn’t intend for its guidance on proxy voting to incite behind the scenes discussions on voluntary corporate actions between fund advisors, their clients and legal counsel. However, that it did might eventually result in what the agency always advocates– the best interest of investors.