CEI Files Comments With The Securities And Exchange Commission On Its Proposed Rulemaking On Proxy Vote Disclosures By Managemen




File No. S7-36-02; 67 FR 60,828 (September 26, 2002)




The Competitive Enterprise Institute (CEI) hereby submits these comments on the proposed rule and form amendments under the Investment Advisers Act of 1940, as amended. The proposed rules (hereinafter the “Proposal”) would require management investment companies to disclose to shareholders of their portfolios (a) the policies and procedures they use to determine how to vote proxies and (b) the votes they cast in shareholder meetings of issuers of portfolio securities. The proposed rule applies to all management investment companies that have authority to vote their client’s securities.


The Securities and Exchange Commission’s proposal affects the conduct and speech of management investment companies. CEI opposes the mandated speech component of the Proposal requiring management investment companies to disclose the votes they cast at shareholder meetings of their portfolio companies. As explained below, the proposed rule is not compatible with the First Amendment rights of management investment companies, even given the slightly lesser protection afforded commercial speech. Mandating the release of information regarding the voting of proxies is a form of compelled speech. As the proposed rule stands, it does not directly advance a substantial governmental interest and is more extensive than necessary to serve its objectives.




CEI is a non-profit research and advocacy organization that has been extensively involved in issues dealing with the environment, food safety and technology. CEI is particularly interested in analyzing alternatives to government regulation in the marketplace and promoting private solutions to consumer information issues. CEI has long been active in the area of government regulation of the financial industry. In addition, the Project on Technology & Innovation is extending the Institute’s efforts into new territories, including antitrust in high technology and network industries, privacy, e-commerce, intellectual property, and telecommunications.




Mandating the dissemination of a management investment company’s proxy voting record violates the rights of such companies under the First Amendment to the United States Constitution. The U.S. Constitution places strict limits on government attempts to regulate speech. Inherent in the right to speak is the right not to speak. Limits on the government’s ability to regulate speech apply to compelled speech as they do to prohibited speech.1 Moreover, the Supreme Court has held that the right not to speak applies to corporations as it does to individuals.2


The framework for reviewing regulations concerning commercial speech is expressed in Central Hudson Gas & Electric Corp. v. Public Service Commission of New York, 447 U.S. 557 (1980). First, the commercial speech must concern lawful activity and not be misleading. Second, the asserted governmental interest must be substantial. Third, the regulation must directly advance the governmental interest asserted. Lastly, the regulation must not be more extensive than is necessary to serve the governmental interest asserted.


The Commission asserts an interest in furthering the flow of proxy vote information to fund investors.3 In particular, it supports (a) increasing the transparency of proxy voting that “could have a dramatic impact on shareholder value,”4 (b) enabling shareholders “to make an informed assessment as to whether funds are utilizing proxy voting for the benefit of fund shareholders”5 and (c) assisting fund shareholders “regarding the overall management of their investments”.6 The Proposal also acknowledges the ability of management investment companies to influence the corporate governance of public companies and that recent corporate scandals have created renewed investor interest in issues of corporate governance.7 However, the Commission’s Proposal fails in terms of the realities of consumer behavior. Moreover, the Commission’s Proposal fails the third and fourth prong of the Constitutional test expressed in Central Hudson.


I. Those Consumers Who Want Proxy Vote Information Can Already Receive It From Mutual Funds That Cater To Them


If financial consumers really do care about how their mutual funds vote on proxy issues, they will select a fund that discloses such information. Indeed, the Proposal states that such investment companies already exist to serve the consumer that demands such information.8 As an example, the Calvert Group’s slogan is “investments that make a difference” and it advertises that it has an in-house “Social Research Department” that analyzes each company’s societal impact in such areas as the environment, labor, international human rights, community relations and defense.9 Likewise, Domini Social Investments touts that its Domini Social Equity Fund is “the oldest and largest socially and environmentally screened index fund in the world” and that it has two unique investment vehicles, the Domini Social Bond Fund and the Domini Money Market Fund, that invest in community economic development.10 These funds provide a service to those investors that desire to invest in a certain type of “socially conscious” fund just as many investors choose a fund based on its investments in biotechnology companies.


Furthermore, it is important to note, as the Commission does in the Proposal, that it is the mutual fund, rather than its investors, that beneficially owns and has a right to cast the proxy votes.11 Most mutual fund investors understand and are aware of this arrangement and assume that the management investment fund will vote in a way that increases the value of the fund. Nevertheless, the Commission characterizes its objective in terms of catering to consumer interest and assisting a consumer’s “right to know.” However, for those investors that desire proxy vote information about mutual funds, they should do as the Second Circuit Court of Appeals suggested to milk consumers in a mandatory labeling case and “exercise the power of their purses by buying products from manufacturers who voluntarily reveal it.”12


II. The Proposed Rules Do Not Directly Advance the Flow of Proxy Vote Information to the Benefit of Fund Shareholders


Even if we assume that the Proposal asserts a substantial government interest, it does not propose rules that directly advance this interest. This third element of the Central Hudson test has been elaborated further upon by the Supreme Court to require that the government “demonstrate that the harms it recites are real and that its restriction will in fact alleviate them to a material degree.”13 The Commission asserts that by furthering the flow of proxy vote information to fund investors, shareholder value will increase.14 However, the Proposal does not demonstrate the alleged harm to financial consumers of not having access to proxy vote information of their mutual fund investments. Furthermore, the Proposal speaks in terms of aggregate and cumulative alleviating effects too remote and speculative to quantify.


First, the Proposal does not cite any harm to mutual fund consumers other than the nebulous “recent corporate scandals” that “underscore the need for mutual funds…to play a more active role in corporate governance.”15 Far from increasing the corporate governance role of management investment companies, the Proposal creates a disincentive for corporate management to share information with mutual fund advisers and creates incentive for retaliation.16 Corporate management may refuse to respond to legitimate requests for corporate information needed by investment companies for investment analysis if the corporation knows that the investment company had previously opposed management’s recommendations. When fund advisers have less access to information about a portfolio company, fund shareholders ultimately bear the brunt of less informed decisions through diminished returns on their mutual fund investment.


Second, the mandated disclosure proposed by the Commission will not in fact promote the interests of mutual fund investors to a material degree. The consumer demand for proxy vote information only tangentially relates to the investment product itself. Indeed, the overriding rationale for the proposed rules regards the effect that disclosure of proxy votes will have on the corporations in which the funds invests, not the performance of the fund per se. Most consumers select a mutual fund based upon its financial performance and the proposed rules will not directly advance the knowledge of a fund’s financial return.


The Proposal also mentions a possible conflict of interest that might be prevented if a management investment company knew it must disclose its proxy votes. But in most cases the interests of the fund and those of the investor are harmoniously aligned – maximizing shareholder value. As an agent of the investor, an investment company has a fiduciary duty to the investor to avoid a conflict of interest. The Proposal would at best only have an indirect effect in preventing conflicts.


III. The Proposal Imposes Extensive and Significant Costs Despite the Existence of Obvious Less-Burdensome Alternatives


Finally, the proposed rules are more extensive than is necessary to provide proxy vote information to those investors that demand it. According to Central Hudson, the regulation must not be more extensive than necessary to serve the governmental interest asserted. The restriction fails if there are “obvious less burdensome alternatives to the restriction on commercial speech.”17 Here, the Proposal imposes significant compliance burdens on management investment companies; costs the investor to the fund will ultimately bear. The Proposal downplays these costs by making passing reference to technological advances and easy distribution via the internet.18


While the distribution costs or even the record keeping costs may be burdensome, the most pernicious result of mandating disclosure of proxy votes relates to the relationship that the mutual funds have as stakeholders in the in companies in which they invest. The proposal would prevent mutual funds from exercising a right that companies, in accordance with principles of good corporate governance, are increasingly extending to their shareholders. This is the right to cast confidential proxy votes. The costs of not having this right are difficult to quantify. The potential for coercion or retaliatory action from the management of companies in which the fund is invested is increased when votes are cast in opposition to management’s recommendations. In addition, compelling disclosure of proxy votes would create an unnecessary and wasteful arena for special interest groups whose agendas and interests conflict with the interests of fund shareholders.19 The potential for retaliation from management and intermeddling from special interests would distract from the ability of management investment companies to maximize the value of the fund to the fund’s shareholders.


There are obvious, less burdensome ways of achieving transparency of voting that would increase consumer choice and prevent conflicts of interest. The most evident alternative to mandated dissemination of proxy vote information is to allow the market to respond to the preferences of investors regarding the voting of proxies.20 Investors will dictate whether mutual funds must disclose their proxy votes if they want to remain competitive in the financial marketplace.


Furthermore, less burdensome mechanisms already exist to monitor and respond to potential conflicts of interest. Fund investors entrust a fund’s board of directors to monitor potential conflicts of interest. The Proposal makes redundant the role established by the Investment Advisers Act of 1940 and rules promulgated thereunder for a fund’s board of directors to monitor and respond to any potential or actual conflict of interest of the fund’s investment adviser.




For the foregoing reasons, the proposed rules should not be enacted into law. The Proposal ignores the fact that most financial consumers select a mutual fund based upon its financial performance. Those investors that do care about how their mutual funds vote on proxy issues will select a fund that discloses such information. The Proposal also violates the free speech rights of management investment companies. It fails to directly advance a substantial interest because the Commission does not demonstrate that investment consumers have been harmed by the lack of disclosure and that its proposed rule will improve the alleged “harm” to a material degree. Furthermore, the Commission’s information disclosure rules are more extensive than necessary because there are obvious less burdensome alternatives to the mandated speech requirements. These alternatives include market controls such as consumer preferences and internal mechanisms such as board oversight. First Amendment rights must not be cast aside even in the face of the information disclosure goals of federal securities regulation.

Respectfully submitted,

Sam Kazman General Counsel

Braden E. Cox Technology Counsel

Competitive Enterprise Institute 1001 Connecticut Ave. NW Suite 1250 Washington DC 20036 Tel: (202) 331-1010

January 15, 2003

1.       United States et al. v. United Foods, Inc., 533 U.S. 405 (2001). In West Virginia Board of Education v. Barnette, 319 U.S. 624 (1943), Justice Murphy’s concurrence stated that “the right of freedom of thought and of religion as guaranteed by the Constitution against State action includes both the right to speak freely and the right to refrain from speaking at all.” 319 U.S. at 645.


2.       Pacific Gas & Elec. Co. v. Public Utilities Comm’n of California, 475 U.S. 1 (1986).


3.       Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies File No. S7-36-02; 67 FR 60,828.


4.       67 FR 60,829.


5.       67 FR 60,836.


6.       67 FR 60,836.


7.       67 FR 60,829.


8.       See Calvert Group, Ltd. available at http://www.calvertgroup.com; Domini Social Investments LLC available at http://www.domini.com; Fidelity Management & Research Company available at http://www.fidelty.com; PAX World Management Corporation available at http://www.paxfund.com; Teachers Insurance and Annuity Association of America-College Retirement and Equities Fund available at http://www.tiaa-cref.org; The Vanguard Group available at http://www.vanguard.com (all sites visited January 8, 2003).


9.       See Calvert Group, Ltd. (visited January 8, 2003).


10.   See Domini Social Investments LLC (visited January 8, 2003).


11.   67 FR 60,829.


12.   International Dairy Foods Association. v. Amestoy, 92 F.3d 67, 74 (2nd Cir. 1996).


13.   Edenfield v. Fane, 507 U.S. 761, 771 (1993).


14.   See Infra p. 2.


15.   67 FR 60,829.


16.   See Richard Teitelbaum, “For Funds, Disclosure is Hardly in Fashion,” New York Times, Sunday, Jan. 5, 2003, sec. BU, p. 28 (“Once a proxy is voted against a portfolio company’s management…fund companies will be open to retaliation); (Analysts and portfolio managers may be denied access to senior management).


17.   City of Cincinnati v. Discovery Network, Inc., 507 U.S. 410, 417 n.13 (1993).


18.   67 FR 60,830.


19.   See Teitelbaum at p. 28, (the disclosure of proxy votes will politicize the process and be seized upon by outside activists as a tool to interfere with fund management – and ultimately undermine returns).