FOOL ON THE HILL
How Does Your Fund Vote?

Institutional investors, a large number of them mutual funds, control 45% of all equities. These funds, as part of their service, vote the shares on behalf of investors. Unfortunately, it's impossible for investors to find out how their shares were voted. Equally unfortunate is the fact that many funds simply don't bother to vote, giving managements carte blanche to do what they want. The SEC is trying to change all that.

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By Bill Mann (TMF Otter)
September 24, 2002

Those who own individual equities know the drill: Every year, we receive an annual report and proxy statement with a series of corporate and shareholder proposals put up for a vote, including approval of accountants, directors, questions about equity, stock options plans, and so on. Many times, outside investors offer their own proposals, which management invariably opposes, so they fail.

I vote every time I get one of these cards, even when I agree with management's proposals. Yes, it takes some time, but I generally get a good view of management's priorities by making a quick run through the proxy statement describing all business up for a vote. Still, even when I vote "No" for every stock option program I come across, I know this is a protest vote -- like voting Libertarian for president. It's not going to do a darn bit of good, because my votes are paltry compared to those of insiders.

But there's another force at play. Institutions control more than 45% of all equity in U.S. companies: Pension funds, endowments, and mutual funds are all big players in the market. And because they're shareholders, well, they also get the same opportunity to vote on corporate direction.

Actually, it's not quite accurate to call funds "shareholders," because they aren't. Their underlying investors are shareholders, but it's hardly practical for them to receive proxies. After all, don't many people hold mutual funds because they don't want to deal with investing? Due to the size of their investments in companies, fund managers could be tremendous advocates for sensible corporate governance, reasonable executive compensation, and other things beneficial to outside shareholders.

Sadly, they tend to play no such role. It's a poorly guarded secret that fund managers rarely bother to vote company proxies, with the exception of the few activist companies, such as TIAA-CREF. And even if the funds do vote shares on behalf of shareholders, they're under no obligation to disclose how they voted to anyone, even investors.

Last week, the Securities and Exchange Commission voted in favor of a proposal that would force mutual fund companies and other investment advisers to make available their proxy voting record to individual investors. Mutual fund managers, not surprisingly, are opposed to this additional requirement, with one trade association stating that its investors were simply "not interested" in things like votes.

This is more than likely true. I saw a statistic not long ago that suggests people who buy individual stocks read annual reports less than 18% of the time, so it seems unlikely that many mutual fund holders get all that excited about how their funds voted. In many cases, they have no idea what companies the funds even hold.

Further, this would come at a considerable cost, in additional reporting and data collection, to mutual fund managers. They're also somewhat concerned that activists will use voting records against them. This may also be true. I think the true resistance to this proposal from funds comes from something far simpler. It's not that they don't want to make votes public; it's that they don't want it made public that they don't vote.

Heck, why would funds vote on boards of directors? The average holding time of a stock by an actively managed mutual fund is 354 days -- less than one year. They don't care what happens to the companies long term -- they'll be long gone. Also, keep in mind many of these funds are owned by companies that are themselves public. It's hard to get up in arms about absurd compensation practices at a company you own when your own company's practices are just as bad, if not worse.

So, we have a situation where companies can count on nearly half of their shares not being voted at all. Worse yet, it's, in many cases, the only block of shares not controlled by management. Individual investors are just too dispersed to mount much of a battle against bad proposals -- it's simply much easier for us to sell if we disapprove.

It is entirely possible, then, that a requirement to make their votes public may actually shame many investment companies into voting. That, in and of itself, would be a victory for individual investors, even those who don't hold a single mutual fund share.

It's no coincidence that mutual fund assets under management rise with corporate malfeasance. Where pension funds have significant mandates to meet, mutual funds generally only provide share performance of one flavor. In an environment where such a large block of investor power is essentially is abdicated, is it any wonder so many companies saw fit to cut dividends, beat accounting principles like a bad puppy, binge on debt, issue massive amounts of stock options, and fill their boards with a bunch of mouth-breathing headnodders? Not for me, it's not.

This industry seems to have forgotten it's dealing with individuals' hopes and dreams. Mutual funds were structured as a convenience to investors who don't wish to brave the harsh waters of buying stocks themselves. Is it far-fetched to assume that at least some mutual fund investors wish to see how mutual funds are voting their shares and money? This information should be available.

Look, we at The Motley Fool aren't fans of actively managed mutual funds. But we recognize that they have a place in many people's lives, and they are a major component of many companies' 401(k) plans. We'd rather more people move their kit over to a good index fund, but we recognize that many aren't going to. At a minimum, we're tired of watching those who could do the most to promote healthy corporate governance do absolutely nothing.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Bill Mann has never, ever breathed through his mouth, nor nodded his head. He is the senior editor for investing at The Motley Fool, which has a living, breathing disclosure policy.