Douglas G. Ober, Chairman, Adams Express Company and Petroleum & Resources Corporation President, Closed-End Fund Association

In the wake of corporate scandals, investors can observe several legislative and regulatory initiatives that have tightened controls and heightened accountability for financial reporting by public companies. The Sarbanes-Oxley Act sought, among other things, to improve our system of financial reporting by reinforcing the checks and balances that are critical to investor confidence. It requires key executives of public companies to certify their financial results and caused accounting firms to share more information collected from their audits with the Board’s audit committees.

Most would agree that the additional disclosures have been positive in boosting public confidence. However, as additional regulations are established and contemplated, there may be a risk of the pendulum swinging too far, bringing higher costs of compliance and other unintended consequences. As examples, we find one promulgated SEC rule, another new SEC rule still under consideration and, third, a set of proposed new rules for mutual funds from Congress.

The SEC’s April 14, 2003 rule on disclosure of proxy voting policies and records is now in force. Investment companies, including closed-end funds, must now disclose the policies and procedures that they use to determine how to vote proxies relating to portfolio securities they hold. The costs in terms of additional reporting requirements are purportedly balanced by an increased view by fund shareholders into the ways funds respond to the shareholder issues of portfolio companies.

The SEC rationale for proxy disclosure is that mutual funds hold $2 trillion in corporate equities – representing about 18% of the market – and that transparency of proxy voting policies would be a benefit to fund shareholders. No longer, the SEC concluded, would the traditional “Wall Street rule” suffice under which funds either agree with corporate management decisions or simply sell the stock.

As a result of the proxy disclosure rule, however, investment managers now fear interference by outside influences on their management of portfolios. Any well-organized interest group (insert your choice of investing organizations with labor, social, religious, environmental or political agendas here) can try to impose their policies on fund managers through the proxy voting process.

An open question for the SEC is how much power through proxies should be exerted over portfolio company managers by fund shareholders who are organized and vocal, even though they don’t represent a majority of shareholders? It will now presumably be possible for any special interest group with enough clout to swing company proxy votes to their views, especially on vote/no vote issues.

Still under consideration by the SEC is a new, additional set of proxy matters that have been raised by the agency’s Division of Corporate Finance and are headed toward Commission consideration during the August-September period. Chief among the Division’s recommendations are:

• More robust disclosure of the nominating committee process of public companies, including consideration of candidates recommended by shareholders.  
  
  
• Specific disclosure of the process by which shareholders may communicate with the directors of companies in which they invest.  
  
  
• Access by “major, long-term shareholders” to the director nomination process at times that, for instance, proxy results are not acted on by companies or when there is substantial shareholder dissatisfaction with the operation of the proxy process.

It’s not hard to project the possibility that managers responding to these proposed new rules would spend appreciably more time in the political realm and less on paying attention to the operation of their businesses. Some fund complexes have chosen to outsource their proxy voting burden entirely, at further cost to shareholders. 

The third example of the “swinging pendulum” is the proposed Mutual Funds Integrity and Fee Transparency Act (HR 2420) that was sponsored by Louisiana representative Richard H. Baker. In part, the bill proposed to separate the office of chairman from chief executive officer, and to require that corporate chairmen be selected from among independent directors. This aspect of the bill, along with others, has been publicly opposed by people inside and outside Congress as being unnecessarily meddlesome in the fair and ethical operation of mutual fund management companies and was subsequently dropped from the current version of HR 2420 that is making its way through Congress. All of these initiatives demonstrate that further input to regulators and elected officials from those in the closed-end fund community may be necessary to help prevent the pendulum from swinging too far in the interest of addressing the recent spate of corporate malfeasance.

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