An actively involved and voting shareholder constituency is the cornerstone to effective corporate governance. The powers vested in the shareholders to select board members by vote helps to ensure that the board members run the corporation for the benefit of the shareholders and those conflicts of interest inherent in management of the corporation by the officers and board members are mitigated to the fullest possible extent.
With the advent of Modern Portfolio Theory and Active Management, the majority of investors retain professional managers and advisers to select and implement investment strategies to help maximize return and minimize risk; nevertheless, investors are not always aware that they retain their proxy voting responsibilities or they assume that their professional managers will vote proxies on their behalf. While investors may provide their managers and advisers the discretion to vote proxies on their behalf, the process in and of itself can create conflicts of interest as the interests of the manager and/or advisor may not always be aligned with the interests of the shareholders.
In an effort to mitigate conflicts of interest regarding the practice of advisers voting client proxies, the SEC established Rule 206(4)-6, which governs how, when and under what circumstances an adviser may vote client proxies. Under rule 206(4)-6, it is a fraudulent, deceptive, or manipulative act, practice or course of business within the meaning of section 206(4) of the Act for an investment adviser to exercise voting authority with respect to client securities, unless the adviser accomplishes the following:
- The adoption and implementation of written policies and procedures that are reasonably designed to ensure that the adviser votes proxies in the best interest of its clients
- A description of the adviser’s proxy voting procedures are disclosed to its clients and copies of those procedures are provided upon request
- A disclosure to clients indicating how they may obtain information on how the adviser voted their proxies
The rule applies to those advisers who have explicit as well as implicit voting authority; further, even if an advisory agreement or contract does not stipulate voting authority, the Rule maintains that the adviser’s voting authority is implied by the overall delegation of discretionary authority. The Rule does not apply to those advisers who merely provide advice to clients about voting proxies but do not maintain authority to vote client proxies.
In addition to the Rule and as of January 1, 2010, brokers no longer have the discretion to vote their clients’ proxies in shareholder election of corporate directors without written instructions from those clients. A client who does not specify written instructions will not have his or her proxies considered for the election.
The SEC has not adopted specific policies and procedures for advisers due to the highly variable nature of each adviser’s business and possible conflicts of interest; however, the Rule provides that an adviser’s policies and procedures must be reasonably designed to ensure that the adviser votes in the best interests of its clients. Additionally, the policies and procedures must describe how the adviser resolves conflicts between its own interests and those of its clients whose proxies it votes.
As part of the recordkeeping requirement for Investment advisers’ proxy voting activities, Rule 204-2, amended, stipulates that advisers must retain:
- Proxy voting policies and procedures
- Proxy statements received regarding client securities
- Records of votes they cast on behalf of clients
- Records of client requests for proxy voting information
- Any documents prepared by the adviser that were material to making a decision how to vote, or that memorialized the basis for the decision.
Under certain circumstances, advisers may rely upon 3rd party services such as EDGAR to satisfy record-keeping requirements.
With the proposal and eventual establishment of new rules giving shareholders more say over executive compensation and the ease of voting proxies electronically, exercising the right to vote proxies is becoming more and more essential for shareholders to ensure that the firm in which they are invested operates for the benefit of the shareholders. Along with the growing importance of shareholders proxy rights is the responsibility that advisers have to ensure that their clients’ best interests are first and foremost in the advisory relationship and that advisers are in compliance with their respective regulatory organizations.
About Red Oak Compliance Solutions
Red Oak Compliance Solutions is the global advertising review software of choice in the financial services industry. It is a comprehensive suite of SEC 17A-4 compliant features that are 100% books and records compliant and provides clients with 35% faster approvals and 70% fewer touches or better. We also offer Smart Review(SM), which solves for the storage and maintenance of disclosures, helping firms reduce risk, decrease review times, and increase the speed of distribution of marketing materials. Smart Registration(SM) automates the licensing and registration management process to help reduce regulatory risk and time spent on manual processes. Overall, Red Oak allows firms to minimize risk, reduce costs, and increase compliance review process effectiveness and efficiencies.