Investment advisers likely will have to become shareholder activists, based on an interpretation of SEC rules on proxy voting.
"Yes, there may be circumstances when I believe an investment adviser may have to become a shareholder activist," said Robert Plaze, associate director, division of investment management, Securities and Exchange Commission.
Although he stressed that the new rules "are about proxy voting, not shareholder activism," Mr. Plaze added, "Advisers will have to look at the cost/benefit analysis. Looking at that analysis, there are certain times when there will be an obligation for a shareholder to take a shareholder activist role."
At issue is a footnote in SEC's proxy voting rules, stating, "An adviser's fiduciary duties to a client do not necessarily require the adviser to become a `shareholder activist' ... ," according to Mr. Plaze.
People have been asking what "not necessarily" means, he said.
"There is no definition of shareholder activism," he added.
Karen L. Barr, general counsel at the Investment Counsel Association of America, Washington, said, "Part of the premise of the SEC rule (on proxy voting) is that advisers are voting too mechanically with management. The SEC believes advisers should get more involved in good corporate governance."
She believes "it's too soon in this process" to tell whether the proxy voting rules will be interpreted to place a fiduciary obligation of shareholder activism on investment advisers.
Andrew J. Bowden, deputy general counsel at Legg Mason Inc., Baltimore, said, "it's not an issue I had given thought to" until it was raised by a participant in a recent panel discussion on the new proxy voting rules, sponsored by ICAA. "We'll have to see how it plays out ... how the SEC enforces it."
"We don't know if it is a fait accompli," Mr. Bowden added.
Thomas P. Lemke, partner in the securities practice group at Morgan Lewis & Bockius LLP, Washington, raised the issue in the panel, noting in a statement, "Greater transparency, the SEC believes, may encourage funds and advisers to become more involved in corporate governance matters affecting their portfolio companies, which may benefit all investors, including fund shareholders and other adviser clients."
"The commission would never say there is no obligation" to engage in shareholder activism, Mr. Plaze said.
For instance, "if an adviser acquires a controlling share of a company, that adviser may be obligated to become active."
Or "an adviser with distressed securities may be called to take an active role."
He declined to discuss the circumstances under which advisers that own only a single-digit percentage of companies, typical of most portfolio managers, might have to become active.
"I don't want to get into that," Mr. Plaze said,"other than to say how far you go (in activism) may depend on the size of your ownership, the length of time you intend to hold the security, the amount of your share compared with other investors."
Would advisers have to document the cost/benefit analysis to establish reasons precluding them from shareholder activism? "I think that is taking things a little too far," he added.
Mr. Plaze doesn't think the SEC will address anytime soon specifically the shareholder activism role of investment advisers, or issue general guidance about it.
The proxy rules suggest investment advisers could decide not to vote proxies when the cost of voting proxies might outweigh benefits, such as considering the cost of translating corporate documents into English.
"I would never say advisers would never have to take a shareholder activist role," Mr. Plaze said. "Nor would I say an adviser should be out there soliciting proxies because a company has had one bump in the road."
But he added, "The obligation of an adviser is to work on behalf of the clients, which may require at times to take steps beyond passively voting proxies."
For example, he said, "Advisers have an obligation to protect the interest of client assets by joining class actions, by participating in class-action settlements."
"In 1991, when the (Department of Labor) issued rules on pension fund proxy voting," he said, "some people then suggested the rules would require pension funds to become shareholder activists." But sponsors were never forced to that role.
`A matter of contract'
"The scope of the obligation to become a shareholder activist is principally a matter of contract," Mr. Plaze said. "If the client says the matter is outside the scope of the adviser's investment duties, then the issue is settled.
"An adviser typically isn't compensated for these activities," he added, referring to shareholder activism, which may be a factor determining the extent of an adviser's involvement on a cost/benefit basis.
"We acknowledge the cost/benefit issue, but we don't want an adviser to say that voting is a waste of time, that its vote doesn't count" in the scheme of all the other proxy votes cast, Mr. Plaze said.
Advisers "have undertaken a contractual obligation to do it (vote proxies) by investing in securities."
Ms. Barr said it's premature to interpret the activism issue. The focus of investment management is on the investment decision-making process. Shareholder activism "takes time and effort and money. It's a distraction from investing, the core effort of investment management," she said.
"In my view, there is no indication the SEC will force advisers to become shareholder activists," Ms. Barr said. "Presumably, clients can make decisions based on a manager's policies and procedures, if it (shareholder activism) is important to them." n