Wednesday, December 29, 2010

Hedge Fund Industry Asks SEC to Require Fund Managers to Disclose Information on Say on Pay Only When They Instructed the Share Voting

Hedge fund managers and other institutional managers should be required to report information to the SEC on say-on-pay voting only when they have instructed an intermediary to vote their shares, according to the hedge fund industry. In a letter to the SEC on the Commission’s proposal requiring institutional investment manager with voting power over a vote on executive compensation to report voting information on Form N-PX, the Managed Funds Association said that reporting information with respect to such non-votes is not required by the Dodd-Frank Act, would be of minimal use to investors, and would be burdensome for managers. Many hedge fund managers would fall within the definition of “institutional investment manager” as proposed in the Release, and thus would be subject to the new reporting requirements.

As fiduciaries, hedge fund and other institutional managers act in the best interests of their clients. Informed by their fiduciary duty to their clients, hedge fund managers determine whether it is in the best interests of their clients for them to participate in shareholder votes. For a variety of reasons, noted the MFA, hedge fund managers may elect to refrain from exercising their voting power. For example, a manager implementing an investment strategy that is designed to achieve returns through short-term trading may determine that the substantial costs associated with tracking votes and identifying matters to be voted outweigh the benefit of participation in the shareholder vote, particularly if the manager is unlikely to continue to hold the shares at the time of the shareholder meeting and beyond.

Moreover, requiring managers that determine not to exercise their voting power to report information about the shareholder vote would not serve any clear policy objective. In the case of a private fund manager, said the MFA, investors in funds it manages are sophisticated individuals and institutions that are aware of the manager’s proxy voting policies. There would seem to be little benefit to such investors or the public generally in requiring reporting and disclosure of voting information if a manager has declined to vote.

Thus, the MFA urged the SEC to require hedge fund managers to report information only when they have instructed an intermediary to vote their shares. In the industry’s view, such a requirement would elicit more useful information from institutional investment managers and avoid imposing an unnecessary cost on investors when managers do not vote their securities, such as those that use investment strategies that are not related to the voting of proxies. This approach would also be consistent with Section 951 of Dodd-Frank, which does not appear to require reporting when a manager has not voted. The statute says that every institutional investment manager subject to Section 13(f) must report how it voted.

The MFA also asked the SEC to modify the proposal to take into account the complex mechanics of proxy voting for institutional managers. While appreciating the goal of requiring managers to report how they have voted, the MFA noted that current portfolio management and custody practices in many cases do not allow an institutional manager to confirm whether its instructions to its broker were followed. In maintaining securities for institutional managers, prime brokers often have authority to lend the securities on behalf of the manager, and may also have authority to re-hypothecate the securities under the terms of their arrangements with the manager. Both securities lending and re-hypothecation have the effect of transferring voting power from the manager to another firm, and may not include a procedure for notifying the manager. For example, a prime broker may loan securities it holds on behalf of institutional managers without identifying which managers’ securities were loaned. As a result, managers may not know over which securities they have voting power at the applicable record date.

Moreover, managers that submit instructions for shares to be voted often are unable to verify that the shares were actually voted according to the instructions due to the number of intermediaries involved in the proxy voting process. The involvement of such intermediaries in the submission of a manager’s shareholder proxies, including proxy voting service providers, custodians, and others, create significant operational challenges to confirming that votes were submitted and recorded by an issuer. A requirement that an institutional manager report on Form N-PX how the shares were actually voted would attach liability to the manager, which would likely be passed through the chain of intermediaries in some manner, further raising the costs and creating additional complications to any confirmation process.

With this in mind, the MFA suggested the proposed rule require instead that each institutional investment manager report on Form N-PX how it instructed the shares to be voted. Such a requirement would continue to provide important information about a manager’s voting on the Section 14A executive compensation matters, and would avoid mandating that managers undertake a new, costly vote confirmation process.

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