Alert February 05, 2008

Mutual Funds Denied No-Action Relief to Exclude Shareholder Proxy Proposal Seeking Adoption of Procedures to Screen Out Investments Based on Ethical Criteria

The staff of the SEC’s Division of Investment Management (the “staff”) denied no-action relief to certain affiliated mutual funds seeking to omit the following shareholder proposal from the proxy materials for their upcoming shareholder meetings: 

“RESOLVED:            In order to ensure that [the investment company] is an ethically managed company that respects the spirit of international law and is a responsible member of society, shareholders request that the [investment company’s] Board institute oversight procedures to screen out investments in companies that, in the judgment of the Board, substantially contribute to genocide, patterns of extraordinary and egregious violations of human rights, or crimes against humanity.” 

The funds sought to exclude the proposal on two grounds pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended.  The funds first sought to exclude the proposal under Rule 14a‑8(i)(7), which permits omission of a proposal if the proposal deals with a matter relating to the investment company’s ordinary business operations.  Specifically, the funds argued that the proposal would interfere with the fund’s ordinary business operations because it touched on the central function of their day‑to‑day management, the selection of securities, as opposed to any broad or fundamental corporate policy.  The funds also asserted that the proposal was not within the exception to the Rule 14a-8(i)(4) exclusion recognized by the staff for proposals that raise significant social policy issues.

The funds also cited Rule 14a-8(i)(3), which allows an issuer to exclude a proposal that violates any of the proxy rules including the general anti-fraud provisions of Rule 14a-9, as additional grounds for excluding the proposal.  The funds argued that the supporting statement for shareholder proposal included statements directly or directly impugning character, integrity or personal reputation or directly or indirectly making charges concerning improper, illegal or immoral conduct or association, without factual foundation – a basis for excluding a proxy proposal under Rule 14a-8(i)(3) recognized by the staff in the past. The funds also argued that the proposal was misleading in violation of Rule 14a-9 because of its vagueness: (a) the proposal used the term “screen out,” which could be interpreted to mean that the screening procedures must address future investments or could be interpreted to also include divestment of existing holdings that fail the screening standards, and (b) the proposal did not provide an appropriate mechanism for each fund’s board to determine the standard against which companies would be judged, therefore making it difficult for shareholders to know what actions would result from their vote on the proposal.

The staff gave no reasons for its denial of no‑action relief.