No Secrets: How Funds Vote Your Shares

Managers Usually Get Backing in Ballot Box, New SEC Data Indicate

By TOM LAURICELLA and KAJA WHITEHOUSE

October 3, 2006; Page R1

Small investors may rarely think about it, but when they read news of wrongdoing at a big company, there is a good chance they are part-owners through their mutual funds. Ditto for the company paying its top executive millions of dollars, even when its share price is tanking.

With more than 25% of all U.S. stocks under their control, mutual funds could practically run the business world, working with other large investors to throw out overpaid chieftains and force corporate overhauls. But they don’t

For Fidelity’s Thomas Soviero, a winning record is at stake. The bond market is giving investors fits lately, and mutual-fund owners far and wide have a stake in the messages it is sending.

For years, this has been a contentious issue. Critics have contended that fund companies are failing in their obligation to represent shareholders’ best interests, and some also argue that fund companies have an obligation to force companies to act in a socially conscious manner on issues such as the environment or labor practices. Fund companies argue that they do vote in their shareholders’ best interest, but they’re naturally going to support management more often than not because if they didn’t like the way a company was being run, they wouldn’t own it in the first place.

But the debate hadn’t been informed by any data because fund companies didn’t reveal how they voted in the elections that seat board members and help set the broad policies by which companies operate. That is now changing. Thanks to disclosure rules put in place three years ago by the Securities and Exchange Commission — over the objections of the fund industry — mutual funds’ voting habits can be examined under a microscope.

A burgeoning number of researchers are focused on the data, with two general conclusions so far: The biggest mutual-fund companies overwhelmingly do vote with management, more so than at least one leading independent adviser recommends. But they don’t appear to favor companies where they run 401(k) retirement-savings or other investment programs. And on select issues — those seen as directly affecting stock returns, such as votes over anti-takeover provisions — fund companies have proved willing to go to battle.

Mutual funds of the nation’s biggest and best-known money-management companies voted in support of management 92% of the time during the 12 months ended June 30, 2005, according to a study by Corporate Library, a governance-research firm in Portland, Maine. When it came to resolutions sponsored by shareholders, which managements generally oppose, the funds voted in favor less than one-third of the time, or 30%. (These statistics don’t include so-called socially responsible funds, which often vote against managements.)

In contrast, during the same period Glass Lewis & Co. one of several prominent firms that provide so-called proxy-vote recommendations to institutional investors like foundations and pension plans as well as mutual-fund companies, recommended that its clients vote for 80% of management-proposed resolutions and more than half — 53% — of shareholder resolutions.

Mutual-fund companies tend to not want to be on the forefront of shareholder activism, says Robert McCormick, who heads Glass Lewis’s proxy-vote research.

Shareholder activists often complain that fund companies’ 401(k) and other investment-management services create a conflict of interest when the fund firms vote on resolutions at their client companies. But Mr. McCormick, who oversaw proxy-voting research at mutual-fund giant Fidelity Investments’ Fidelity Management & Research Co. prior to joining Glass Lewis, calls that a specious argument. At Fidelity, we never got a call from someone who said, ‘We want this company’s 401(k) business, so vote for management.’

Two studies — one from a pair of University of Michigan professors and another from Baruch College in New York — reviewed mutual funds’ voting histories and found no evidence of fund companies tailoring their votes to specific business relationships. But fund companies may have adopted policies that are friendly to corporate managements to begin with, says Professor Gerald Davis, of Michigan.

Most fund companies see it differently. Given that they decided to buy a company’s shares, they say, it shouldn’t come as a surprise that they would back management. If they didn’t like a company’s direction, they wouldn’t have bought, or they would sell. (That, of course, isn’t true of funds that track stock-market indexes, which have little choice about what they own.)

In general, Dodge & Cox has confidence in the abilities and motives of the board and management, the San Francisco company says in its voting policy.

Many mutual-fund companies find common ground with management in opposing shareholder proposals that limit the discretion of independent directors and company executives. While advocates of corporate-governance change generally maintain that companies are better off with the checks and balances provided when the chief executive isn’t also board chairman, fund companies tend to side with management in believing such issues are better left to managers and board members to decide. Ditto for executive compensation.

A lot of shareholder proposals seek to create a box around what a board can do, says Glenn Booraem, who heads the proxy-voting group at fund company Vanguard Group. Our perspective as shareholders is that we’re not managing the company.

Until 2003, mutual funds didn’t have to reveal information about their votes. Now, revelation is annual. In addition, mutual funds must adopt and make public their voting guidelines, including an explanation of how conflicts of interest are handled. All of this must be approved and reviewed by a mutual fund’s board of directors.

The process of deciding how to vote on tens of thousands of contests every year is handled differently at every fund company. Among common themes, most have taken steps to isolate decision-making from employees who sell 401(k) and other investment programs. There is no place at the table for sales or marketing executives, says Eric Roiter, general counsel at Fidelity Management & Research.

At Vanguard, senior investment-management and legal executives, along with others including Chairman Jack Brennan, formulate voting guidelines and another group casts the vote on behalf of the funds. No one interacting directly with existing or potential Vanguard corporate clients is involved in either step. Of course, skeptics note, fund-company executives such as Mr. Brennan have a vested interest in the sales operation even if it isn’t their primary job. Vanguard’s Mr. Booraem says that doesn’t enter into the equation when setting policy or casting votes.

At T. Rowe Price Investments, a 14-person group develops vote recommendations, aided by proxy-vote adviser Institutional Shareholder Services, of Rockville, Md. Fund managers make the final decisions on how to vote, but any who vote counter to a recommendation must explain why in writing and answer whether anyone tried to influence the vote. Votes against policy are taken very seriously, says Anna Dopkin, a portfolio manager and co-chair of the firm’s proxy committee.

If conflicts of interest exist, many funds default to the recommendation of an outside party such as ISS or Glass Lewis, of San Francisco. But definitions of what constitutes a conflict vary. At Fidelity, the nation’s largest provider of corporate retirement plans, one is considered to exist if a person involved in a proxy vote knows the subject company is a Fidelity client. Lord Abbett & Co. spells out specific circumstances, such as a proxy vote at a securities brokerage that sells lots of its funds. In that case, it would turn to ISS for a vote recommendation.

Many companies’ guidelines state they will support management unless doing so would hurt their investment, but don’t explain how they determine when that might happen. At Dreyfus Corp. a unit of Mellon Financial Corp. the policy it makes public states that the fund family generally votes with management on issues that neither unduly limit the rights and privileges of shareholders nor adversely affect the value of the investment. In 2005, Dreyfus voted with management 98.3% of the time, according to Corporate Library. Dreyfus’s unpublished guidelines are more detailed, says spokeswoman Patrice Kozlowski. Dreyfus votes in the best economic interest of our clients. All proxy issues are considered very carefully, she says.

Fidelity’s guidelines — a lengthy, complex document — are detailed on many issues, but silent on a hot topic: shareholder proposals on executive compensation, which often seek to limit or control pay practices. As a result, shareholder resolutions on pay get pushed to Fidelity’s default position of generally rejecting shareholder proposals unless they are reasonably likely to maximize shareholder value.

As for elections of board members, many companies state that they tend to support the board’s nominees. Others provide some criteria, such as expecting that directors attend a minimum number of board meetings, usually three of every four. On proposals related to social issues, fund companies commonly vote against them or abstain, basing their decision on whether the measures would financially benefit shareholders.

With these guidelines as a starting point, 30 of the 38 mainstream mutual-fund companies studied by the Corporate Library cast votes in support of management at least 90% of the time. Dodge & Cox voted most often on management’s side: 99.7% of the time. BlackRock Inc. was close behind, at 98.7%. Dodge & Cox, like most of the fund companies contacted for this article, declined to comment beyond pointing to their publicly available policy guidelines.

Of the companies that came in under 90%, Vanguard agreed with management about 80% of the time. OppenheimerFunds Inc. a unit of MassMutual Financial Group, and Bridgeway Funds were the boldest — they voted alongside management 70% and 68% of the time, respectively.

Shareholder proposals got the most support, at 62%, from Bridgeway, which has guidelines that support many issues backed by advocates of governance changes. TIAA-CREF, long active in pushing for governance changes, voted for nearly one of ever two shareholder proposals. Goldman Sachs Group Inc.’s family of funds, which generally follows the voting guidelines of ISS, supported shareholder resolutions 46% of the time.

On the other end of the continuum was Fidelity, which backed barely one in 10 such proposals. Vanguard and Barclays Global Investors, a unit of Barclays PLC, supported roughly one in five. The sole factor considered by Barclays in voting is the best economic interests of shareholders, a spokesman said.

Eliminate Poison Pills

Many votes in favor of shareholder proposals came on a particular type: proposals to knock down barriers to hostile takeovers. These included votes to eliminate poison pills that prevent an interested party from gaining control of a company by buying up stock in the open market. These barriers have been shown to hurt investors’ returns, and many companies have moved in recent years to remove them.

Mutual funds cast 84% of their votes in favor of resolutions to eliminate or put to a vote a company’s poison pill, according to Corporate Library. That’s in line with Glass Lewis’s recommendations, which suggested investors approve measures to limit poison pills 83% of the time.

Mutual funds also have been relatively strong backers of shareholders’ so-called majority-vote proposals, which seek to do away with archaic systems for electing corporate directors that can literally allow directors to be elected if they receive only a single vote. Funds supported such proposals 60% of the time, according to Corporate Library. Glass Lewis recommended support for these proposals 100% of the time.

In general, mutual funds have been hesitant to support proposals without proven economic benefits. For instance, shareholder proposals to split the chairman and CEO jobs garnered mutual-fund support 46% of the time, according to Corporate Library. Glass Lewis recommended shareholders vote in favor of all of these plans.

On shareholder measures that sought to overhaul executive-pay practices, sometimes by placing caps on compensation, mutual funds supported just over one in four, while Glass Lewis favored such proposals 39% of the time.

Fund companies argue they should get credit for lobbying behind the scenes to improve governance practices and, in some cases, shaping the proposals that managements put to a vote. Fidelity, for example, said it voted against 54% of all management-sponsored stock-compensation proposals in the 12 months through June 30. The fund company says the figure would have been 67% had it not been successful in negotiating with companies to meet its guidelines.

And although Vanguard opposed majority-vote proposals for directors, the firm followed up with a letter to dozens of companies saying they shouldn’t interpret its no vote as meaning its fund managers were happy with the election rules. Doing nothing in the near term is not an acceptable response, Vanguard wrote.

Write to Tom Lauricella at tom.lauricella@wsj.com and Kaja Whitehouse at kaja.whitehouse@dowjones.com