Thursday, December 16, 2010

Mutual Fund Industry Opposes Applying SEC Proxy Access Rule to Funds

The Investment Company Institute has joined the effort to vacate the proxy access rule adopted by the SEC. In an amicus brief filed in the U.S. Court of Appeals for the District of Columbia, the ICI, joined by the Independent Directors Council, focused exclusively on the application of the rule to registered investment companies and urged a panel of the court to vacate the proxy access rule as it applies to funds. (Business Roundtable and US Chamber of Commerce v. SEC, US District Court for the District of Columbia Circuit, No. 10-1305, Dec. 9, 2010)

The proxy access rule would permit shareholders to place their director nominees on a company’s proxy statement. The ICI does not oppose the proxy access rule per se and, in fact, supports in principle the SEC’s efforts to further enfranchise shareholders. The ICI believes, however, that the SEC rule in its present form is unsuited to the unique corporate governance structure of fund companies and boards and could increase costs for investors if implemented.

The brief argues that the SEC failed to consider the very different context presented by funds. As a result, the SEC adopted a one-size-fits-all standard that fails to take into account the extensive regulatory requirements and governance structure that are unique to investment companies. In the ICI’s view, the SEC’s regulatory statement provides no logical explanation for why the Commission deemed the material differences between funds and operating companies to be wholly irrelevant to Rule 14a-11.

The brief noted that the federal regulation of funds sets independence requirements for fund boards; imposes specific responsibilities on independent directors; requires shareholder approval for key fund decisions; and provides an avenue for shareholder lawsuits against an investment adviser for receipt of excessive compensation. There are no comparable provisions with respect to public operating companies

In view of the comprehensive protection of fund shareholders afforded by the Investment Company Act of 1940, the ICI found it ``hard to fathom’’ the SEC’s summary conclusion that the regulatory protections of the 1940 Act do not decrease the importance of shareholders’ state law rights. The question, said the ICI, is not whether in a vacuum state rights are important, but whether the 1940 Act’s robust federal protections reduce the need for the new federal right embodied in Rule 14a-11, or, at a minimum, call for special tailoring. Although urging the SEC to exclude funds from Rule 14a-11, the ICI did not take the position that funds should not be subject to any proxy access rules, but rather that such rules should reflect consideration of, and tailoring to, the unique circumstances of funds.

The ICI contended that the ill-conceived regulation of the $11.5 trillion fund industry was arbitrary and capricious. The ICI urged the court to grant the Chamber of Commerce and Business Roundtable petition for review and vacate the proxy access rule as to the extent that it applies to funds.
The ICI also noted that fund complexes generally have adopted specific board structures, sometimes known as unitary boards, designed to efficiently oversee multiple funds, increase board knowledge of fund operations across the complex, and strengthen oversight of the investment adviser. But the ICI fears that the benefits of a unitary board are threatened by the proxy access rule’s invitation to elect different directors for particular funds within the complex.

The brief also contended that the SEC relied on empirical studies that expressly excluded funds. Given the unique features of funds, as well as the size of the fund industry, argued the ICI, the SEC cannot rationally rely on those studies without considering whether there are meaningful differences between funds and operating companies that require a different analysis. Amici further contended that the SEC failed to consider whether current federal law provides sufficient protections for shareholders so as to outweigh the obvious efficiency costs of the rule, and then compounded its error by failing to consider the extent of existing competition in its analysis.

The brief also argued that the SEC’s state law rationale cannot be squared with the position that the Commission adopted as recently as July 2009 when it approved an exemption for funds from a NYSE rule concerning director elections. Like Rule 14a-11, the NYSE rule was intended to protect shareholder voting rights by preventing brokers from voting shares in their custody, absent express instructions from their customers. In approving the fund exemption from this restriction, the SEC concluded that such protections were less necessary because, among other reasons, the Investment Company Act requires a fund to obtain the approval of a majority of its voting securities before taking key actions, and this different regulatory regime supports the exemption.