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Are Ballots Too Secret? Fund Advisers Should Tell How They Vote Proxies

Funds, as big stockholders, wield great power, yet few reveal how they use it.

The

AFL-CIO

, following the lead of other consumer representatives, has petitioned the

Securities and Exchange Commission

to require mutual funds to disclose their portfolio holdings more frequently.

The world's largest union organization joins 13 other groups, including my advocacy group,

Fund Democracy

, in asking the SEC to require that funds invest at least 85% of their assets in the types of securities their names suggest and to disclose their portfolios monthly on the Internet.

The AFL-CIO's petition actually goes further, also demanding that funds disclose their proxy voting policies and voting records as well. Corporate governance activists have long campaigned for greater accountability in corporate boardrooms, and funds that make social criteria part of their investing strategies have recently joined their ranks. The AFL-CIO's support will help push the accountability issue onto fund shareholders' radar screens.

In a nutshell, the issue is this: With ownership of stock comes voting rights in key areas such as seats on the board of directors and merger proposals. Most mutual funds, though they own stock on behalf of their shareholders, neither consult their shareholders on proxy votes nor disclose how they voted, assuming they voted at all.

Built-In Conflict for Funds

If you assume mutual fund advisers will always vote the best interests of their shareholders, think again. Fund advisers sometimes have "an economic interest to vote the fund's shares to please company management, even if such a vote might not be in the best interests of the fund," says SEC Commissioner Paul Carey, who has encouraged the fund industry to consider disclosing fund voting practices.

Fund advisers frequently seek to manage the pension assets of the very companies whose proxies they vote for their funds. "If the fund adviser wants the pension business of XYZ Co., or it wants to continue to manage XYZ's pension business, it might think twice before voting against the recommendation of XYZ's management -- even if voting against the recommendation could increase the value of the funds' holdings," says Carey.

Corporate governance activists echo Carey's concerns. "It is well known that mutual funds are subject to strong conflicts of interest that may affect their voting decisions," says Sarah Teslik of the

Council of Institutional Investors

. "The fact that mutual funds resist disclosure suggests their voting is influenced by factors other than the financial interests of the people whose money they are investing, and they don't want that discovered."

Bill Patterson, director of the AFL-CIO's Office of Investment, argues that the practice of concealing proxy votes also "makes it impossible for a mutual fund investor to select a fund whose philosophy fits with the investor's."

Some Embrace Disclosure

Some funds already are heeding the call for full proxy disclosure.

Domini Social Investments

was the first fund group to provide public access to its proxy voting record in April 1999. Domini, which manages $2 billion, screens investments based on a variety of social and environmental criteria and updates its proxy votes daily on its Web site,

www.domini.com.

"The AFL-CIO proposal is right on target," says Amy Domini, managing principal of Domini. "Mutual funds were created to empower small investors, to give them access to all the benefits of professional management that large investors have. Yet they behave like the old guard and seem to say, 'Now, now my dear, don't you worry your pretty little head about it, we know what is best.' "

Last month,

MMA Praxis Mutual Funds

became the first faith-based fund family to post its proxy votes on its Web site,

www.mmapraxis.com. MMA Praxis, which invests to match

Anabaptist

Christian beliefs, recently led a coalition of 27 institutional investors calling on

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not to offer pornography on its cable TV stations.

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Pax World Balanced fund also discloses its proxy votes online, and

Citizens Funds

and

Walden Funds

plan to do so this winter.

Given the growing popularity of social investing, more funds are likely to voluntarily let shareholders see how they are voting proxies. The

Social Investments Forum

reports that between 1995 and 1999, the number of socially screened mutual funds grew from 55 to 175, and their assets rose to $154 billion from $12 billion.

The

Allied Action Owners

fund goes one step further. The fund invests in smaller companies and tries to boost their value by urging the companies' shareholders to become activists. The fund's managers use their Web site,

eRaider, to rally shareholders (eRaider's self-styled "guerrilla army") to join Allied Action in challenging company management.

How are mutual funds doing as shareholders? "With a few exceptions, mutual funds are the least responsible of shareholders and contribute significantly to the problem of poor corporate governance," says eRaider co-founder Aaron Brown. Brown believes the AFL-CIO's proposal holds out some hope. "Disclosing a voting philosophy will force most mutual funds to develop one," he says.

Forcing Funds to Take a Stand

The disclosure of proxy votes by mutual funds may provide more firepower to corporate governance activists. "I'm not sure that disclosing proxy votes will have much benefit to fund shareholders," says Bruce Babcock, president of proxy voting adviser

Institutional Shareholder Services

, "but it would put more pressure on funds to support corporate governance activists."

Public disclosure of funds' votes will make it "hard for funds not to support activists on governance issues, such as poison pills, declassifying the board, requiring an independent chairman and reviewing strategic options, such as selling the company," speculates Babcock. On social issues, such as the manufacturing of tobacco and weapons and publishing of pornography, however, Babcock expects funds to vote with management.

The mainstream fund industry (i.e., nonsocial investing complexes) is likely to oppose the AFL-CIO initiative, as it generally has fought attempts to improve fund disclosure on the ground that it's too costly. In 1994, it used this argument to defeat an SEC initiative to require quarterly disclosure of money market fund holdings.

But the industry's cost argument may now fall on deaf ears at the SEC, judging from comments made by Paul Roye, director of the SEC's funds division, at a recent conference. "The Internet provides real opportunities," in light of which "the cost issue ... sort of falls away," Roy said.

"If a relatively small shop like ours can do it," confirms Domini, "large mutual fund complexes can too."

Industry Opposes Disclosure

In opposing proposals for more frequent disclosure, the industry has insisted that shareholders don't want this information. The AFL-CIO, which believes that 29% of union households own stock mutual funds, counters that investors can't make informed investment decisions without it. The breadth of support for the petitions filed by groups representing tens of millions of fund shareholders suggests the union has the better argument.

The

Investment Company Institute

, the trade organization for fund management companies, declined to comment on the AFL-CIO's proposal, pending review of the union's petition.

Under pressure, the SEC is expected to adopt a rule this year requiring mutual fund names and investing strategies to coincide. But it has been mum about its plans regarding more frequent online portfolio disclosure and has not yet addressed the AFL-CIO's proxy vote proposal.

Mark Latham, founder of the

Corporate Monitoring Project

, contends the proxy proposal is not worry-free. He is concerned that disclosing voting records would publicly identify funds voting against management proposals and expose the funds' managers to pressure or even retaliation by company management. He believes, however, that this risk probably would be "outweighed by the positive benefits the AFL-CIO is after."

Latham envisions a day when funds will pass proxies of companies in their portfolios directly on to fund shareholders. Until then, the AFL-CIO's more modest proposal holds out the best hope for improving corporate democracy in 2001.

Mercer Bullard, a former assistant chief counsel at the Securities and Exchange Commission, is the founder and CEO of Fund Democracy, a mutual fund shareholder advocacy group in Chevy Chase, Md.